In the long term, stock prices always follow the evolution of the intrinsic value. That’s why earnings growth is so important for investors. I’ll teach you everything you need to know in today’s article.
CQ, greetings from London. Thank you SO much for all of your work and generosity in sharing this excellent knowledge. It is an outstanding resource and the first port I go to when I see something new. Would love one day to have a Compounding Quality get together in person. Flying over to attend the Berkshire AGM in Omaha in May 2024, given that Warren will be 93 and Charlie will be 100. Might not have too many more chances to see them both in action.
Thank you once again for delivering yet another superb gem of an article. Your consistent ability to provide insightful analysis and deliver it with eloquence positions this latest piece as a prime candidate for inclusion in economics curricula, be it at the school or university level.
The incorporation of a quote from Mr. Terry Smith, a figure I deeply admire, truly stood out to me. As you are aware, my admiration for Maestro Terry Smith runs deep, and I am proud to be an investor in his fund. Moreover, I want to acknowledge your skill in seamlessly integrating valuable commentary alongside your articles. This often-overlooked aspect serves as a valuable extension of the already illuminating content you provide.
Without fail, every Tuesday and Thursday, I find myself filled with gratitude for the way you elucidate the intricacies of the investing craft. Your commitment to education reverberates clearly through your work, benefiting readers like me who are constantly striving to enhance our understanding of the field. Once again, your work proves to be an invaluable resource.
I wish you a week filled with productivity and positivity.
Well... You take a PE that is reasonable/fair according to you.
If you think it's 10x, you should take 10x.
Personally, I think Evolution Gaming is a beautiful business and as a result I would be more than happy to buy/own the company at 20x earnings, which is why I choose 20x.
I also find it difficult to find a fair PE or a fair earnings growth for the future because I always think, well I'm biased anyway. So do you have any tips? Should I rely on Analysts estimated values?
Superb. I am booking a table at Gorat's Steak House, Buffett's favourite. Spoiler alert, there just might be a famous Fundsmith person joining and a gent who used to run that Seilern fund.
Big fan of yours. A few questions, as by chance I was working on the same topic today:
1) shouldn't shareholder yield include also reduction / increase in net debt? (E.g. how they do in private equity).
2) does it make sense to form an expectation of where ronic will be in 10 years based on moat and where growth will be in 10 years based on TAM and then compute implied reinvestment ratio and derive justified PE multiple in 10x based on that?
3) can we compute our earnings growth expectation as ronic x reinvestment ratio, coherently with the numbers above?
1) I personally don't include reduction / increase in net debt. It might be a good idea for companies to pay down debt of they have a lot of debt on their balance sheet, but I solely invest in quality companies and in > 65% of the cases they already have a net cash position
2) Absolutely! As Charlie Munger once said:
"Over the long term, it's hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you're not going to make much different than a six percent return - even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result."
The above only makes sense when a company has plenty of reinvestment opportunities
3. You can certainly do this. I should also defintely write an article about ROIIC because it fits this topic.
Regarding the debt part, you are right of course. I just was trying to use the shareholder yield formula on Philip Morris, and felt something was missing. The company recently completed a sizeable acquisition and is now a bit levered, so that it will prioritize debt repayments to buybacks in the coming years. Then it occured to me that net debt repayment is also a form of yield (i.e. cash not invested for growth, but benefitting shareholders). Albeit - unlike divs and buybacks - net debt repayment is not available in perpetuity.
Thx very much for your answer. Looking forward to next posts, especially those regarding ROIIC and deployment!
So for the Stable Inc. and Growth Inc. example: The valuation (P/E) only matters if you buy a stock or if the P/E goes ridiculously up like it's at Nvidia right now.
First of all, it's important to underline that the formula is just a rule of thumb to calculate your expected return. The formula is very easy in theory, but very hard in practice.
If management guides a LT growth rate, it's easy and you can use that one.
Usually I take a combination of the historical growth and the outlook of management and analysts.
Evolution Gaming grew astonishingly over the past decade which is why I assume that 13% per year is reasonable. But as you already see by know, it's no rocket science at all.
CQ, greetings from London. Thank you SO much for all of your work and generosity in sharing this excellent knowledge. It is an outstanding resource and the first port I go to when I see something new. Would love one day to have a Compounding Quality get together in person. Flying over to attend the Berkshire AGM in Omaha in May 2024, given that Warren will be 93 and Charlie will be 100. Might not have too many more chances to see them both in action.
Hi Sebastian,
It's an honor.
I am also going to Omaha so we can definitely meet there next year!
Dear friend CQ,
Thank you once again for delivering yet another superb gem of an article. Your consistent ability to provide insightful analysis and deliver it with eloquence positions this latest piece as a prime candidate for inclusion in economics curricula, be it at the school or university level.
The incorporation of a quote from Mr. Terry Smith, a figure I deeply admire, truly stood out to me. As you are aware, my admiration for Maestro Terry Smith runs deep, and I am proud to be an investor in his fund. Moreover, I want to acknowledge your skill in seamlessly integrating valuable commentary alongside your articles. This often-overlooked aspect serves as a valuable extension of the already illuminating content you provide.
Without fail, every Tuesday and Thursday, I find myself filled with gratitude for the way you elucidate the intricacies of the investing craft. Your commitment to education reverberates clearly through your work, benefiting readers like me who are constantly striving to enhance our understanding of the field. Once again, your work proves to be an invaluable resource.
I wish you a week filled with productivity and positivity.
Best Regards,
If I got a $ every time you made me smile, I would be financially independent by now. Thank you, Pavel! :)
Always open to your ideas and suggestions so if you want to see a certain topic covered in the near future, just let me know!
As we all know, information like this should be taught in school, I’m talking grade school. But it never will be.
Go over this with your kids!!!
As always great job QC!!
Thank you, Vinny!
Let your kids read all these articles and they'll become very wealthy. :)
Another excellent article! Thank you for continuing to turbo-boost and compound my investing knowledge.
It's an honor. Stay tuned for the 31st of August as I have a big announcement to make!
This is really great information that investors should look at for
At your service, Noname!
"so we state that the stock will trade at 20x earnings in 10 years from now"
But how to predict it? I mean, that PE will be 20x, not 10x, for example?
Well... You take a PE that is reasonable/fair according to you.
If you think it's 10x, you should take 10x.
Personally, I think Evolution Gaming is a beautiful business and as a result I would be more than happy to buy/own the company at 20x earnings, which is why I choose 20x.
I hope this helps!
Kind regards,
QC
I also find it difficult to find a fair PE or a fair earnings growth for the future because I always think, well I'm biased anyway. So do you have any tips? Should I rely on Analysts estimated values?
Hi,
I usually look at 3 things to determine the future growth rate:
- historical growth rates
- outlook of management
- consensus of analysts
It's always very important to use a margin of safety on these numbers as analysts are often way too optimistic for example.
Superb. I am booking a table at Gorat's Steak House, Buffett's favourite. Spoiler alert, there just might be a famous Fundsmith person joining and a gent who used to run that Seilern fund.
You are making me jealous! Always happy to join and stay in touch. :)
compoundingquality@gmail.com
Big fan of yours. A few questions, as by chance I was working on the same topic today:
1) shouldn't shareholder yield include also reduction / increase in net debt? (E.g. how they do in private equity).
2) does it make sense to form an expectation of where ronic will be in 10 years based on moat and where growth will be in 10 years based on TAM and then compute implied reinvestment ratio and derive justified PE multiple in 10x based on that?
3) can we compute our earnings growth expectation as ronic x reinvestment ratio, coherently with the numbers above?
Many thx and keep on the good work
Hi Nicolò,
1) I personally don't include reduction / increase in net debt. It might be a good idea for companies to pay down debt of they have a lot of debt on their balance sheet, but I solely invest in quality companies and in > 65% of the cases they already have a net cash position
2) Absolutely! As Charlie Munger once said:
"Over the long term, it's hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you're not going to make much different than a six percent return - even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result."
The above only makes sense when a company has plenty of reinvestment opportunities
3. You can certainly do this. I should also defintely write an article about ROIIC because it fits this topic.
Regarding the debt part, you are right of course. I just was trying to use the shareholder yield formula on Philip Morris, and felt something was missing. The company recently completed a sizeable acquisition and is now a bit levered, so that it will prioritize debt repayments to buybacks in the coming years. Then it occured to me that net debt repayment is also a form of yield (i.e. cash not invested for growth, but benefitting shareholders). Albeit - unlike divs and buybacks - net debt repayment is not available in perpetuity.
Thx very much for your answer. Looking forward to next posts, especially those regarding ROIIC and deployment!
It's an honor, sir!
Feel free to leave suggestions about topics you want me to write about!
So for the Stable Inc. and Growth Inc. example: The valuation (P/E) only matters if you buy a stock or if the P/E goes ridiculously up like it's at Nvidia right now.
The valuation level matters. But the longer you hold a stock, the less important valuation becomes and the more important earnings growth.
That's why you should try to buy wonderful business at a fair price.
"Expected return = Earnings growth + shareholder yield +/- multiple expansion (contraction)"
Earnings growth - is it future EPS expected growth?
It is indeed your expected EPS growth for the next few years
Predicted (by analytics) expected EPS growth YoY? In fact, average EPS growth YoY?
Let's say:
Year 1: EPS growth YoY is 10%
Year 2: 9%
Year 3: 8%
In this case, I shall take 9 as average value?
Hi Bohdan,
First of all, it's important to underline that the formula is just a rule of thumb to calculate your expected return. The formula is very easy in theory, but very hard in practice.
If management guides a LT growth rate, it's easy and you can use that one.
Usually I take a combination of the historical growth and the outlook of management and analysts.
Evolution Gaming grew astonishingly over the past decade which is why I assume that 13% per year is reasonable. But as you already see by know, it's no rocket science at all.
Thx for clarifying!