Investing is an art. But it’s also a craft and a science at the same time. In this article, I’ll teach you everything you need to know about an Earnings Growth Model. This models tells you which return to expect from your investments.
@Pieter, do you always use the 0.1 in the EEG model for all the stocks in the Watchlist? I am trying to work backwards on all the data to understand and sanity check the different expected return numbers :D
Follow up question. In the Watchlist sheet. Sometimes you use the 10 Year Average Forward PE as the Fair Exit PE. Other times you adjust. For example Adobe:
Fair Exit Multiple 25
10 Year Average Forward PE 32.
A -21% downward adjustment.
For some you just round it it seems, and others you use the exact 10 year average.
It's a nice article, no doubt. But as far as I can find, it does not explain *why*.
Translating that into a simple question: *why* does it make sense to *sum* the dividend per stock price with the change rate (!) of the earnings per share?
In this model, I assume the Forward PE goes back to ‘normal’ (reversion to the mean) within 10 years. 1/10 = 0.1 —> That’s why a factor of 0.1x is used.
It’s a smart idea to also do the calculations under the assumption that the valuation goes back to normal in 5 years. In that case, you need to use 0.2x as a multiplier (1/5). You’ll see that some high-growth companies will be less attractively valued when you do this.
A mathematical question: how do you get to the -1.7% contraction? I know it’s (new-old/old), but i don’t understand the 0.1.
Thanks you!
It's because we estimate that the valuation will normalize in 10 years. That's where the 0.1 comes from :)
With the Earnings Growth model, are you usually conservative with the multiples?
Absolutely.
Better to surprise on the upside :)
That was very easy to read and follow, Pieter! Well done! 🙂
I need to re-read this and run through the exercise in my journal to have the lesson glue itself to my brain. 🖋️
Always feeling blessed to see you here, Boris!
thanks for sharing this simple and valuable model
It's a true honor!
Thank you for continuing to write these in a simple, straightforward way.
It's a true honor, Gary!
Thanks for detailing the model. Always helpful to see how others value companies.
I appreciate you, Joel!
I would replace Dividend Yield with Total Shareholder Yield, which includes share buybacks and debt payments.
Buyback is included in the EPS Growth. That's why we just use the dividend yield.
Otherwise you would include the buyback yield twice. :)
How did you get that the fair P/E was 16x ?
Yeah I couldn’t figure how the P/E ratio in example was 16x either.
Think it’s just an assumption he was making as an illustration
What The Curious LP mentions is correct.
To determine a fair Exit PE, the Microsoft example provides more guidance
@Pieter, do you always use the 0.1 in the EEG model for all the stocks in the Watchlist? I am trying to work backwards on all the data to understand and sanity check the different expected return numbers :D
@Peter Nielsen when you assume that the forward PE will go back to normal after 10 years, multiplying it by 10 is indeed what I do.
When you want to do the calculations with a rerating within 5 years, your multiplier should be 0.2x
Follow up question. In the Watchlist sheet. Sometimes you use the 10 Year Average Forward PE as the Fair Exit PE. Other times you adjust. For example Adobe:
Fair Exit Multiple 25
10 Year Average Forward PE 32.
A -21% downward adjustment.
For some you just round it it seems, and others you use the exact 10 year average.
What causes you to adjust? Caution?
Correct. The better I know the company, the better I can make calculations myself.
When I’m not sure yet, I use the 10-year average. :)
It's a nice article, no doubt. But as far as I can find, it does not explain *why*.
Translating that into a simple question: *why* does it make sense to *sum* the dividend per stock price with the change rate (!) of the earnings per share?
Hoping to get an answer but for some reason my question dropped almost to the bottom.
It's a serious question, I do hope to understand the logic of the model.
Or, if the model is just to get a quick but valuable insight and it's not about strict logic, please tell me 😅
I replied to it but for some reason it disappeared. Didn’t you get a notification of my reply? In that case I’ll write it again. :)
Nope :( Got an email about this response, but nothing previous.
Meanwhile I have an intuitive understanding, but I'd still appreciate to understand the actual logic :)
So here’s a visual explaining the earnings growth model: https://www.google.com/url?sa=i&url=https%3A%2F%2Fwww.compoundingquality.net%2Fp%2Fearnings-growth-model&psig=AOvVaw0hfJRUHcsSHBA3uAJAGgfl&ust=1748006232666000&source=images&cd=vfe&opi=89978449&ved=0CBQQjRxqFwoTCIDxgeaUt40DFQAAAAAdAAAAABAE
In this model, I assume the Forward PE goes back to ‘normal’ (reversion to the mean) within 10 years. 1/10 = 0.1 —> That’s why a factor of 0.1x is used.
It’s a smart idea to also do the calculations under the assumption that the valuation goes back to normal in 5 years. In that case, you need to use 0.2x as a multiplier (1/5). You’ll see that some high-growth companies will be less attractively valued when you do this.
Does this make sense?
Ok i see it now! Sorry! You are dividing the multiple compression over the 10 years to smooth it out. Thank you for explaining.
Exactly!
So then if it’s 9 years it’s 0.09? Sorry for the questions?!
Than it would be 100/9 :)
When it would be 5 years, you multiply it by 0.2x