For the calculation of all relevant data, we analyze the 5 most important performance indicators. Phil Town, a modern representative of the Value Investing, for instance, calls them the “Big 5 Numbers” of a company. They enable us to look into the “heart” of a business and clearly indicate the current status of the operation.
On the basis of these indicators we calculate a company’s growth rates over different time periods.
The minimum growth rate that we want to see to call a company “healthy” is 10%. It is the prerequisite for purchasing shares in this enterprise. We expect this minimum growth to last for the return periods of the past 10, 5, 3, and one year(s) in each of the five key performance indicators.
In detail, the 5 relevant indicators are:
1. Return on Invested Capital (ROIC) is the return on capital or return on investment. It describes a model for measuring the return on invested capital.
2. Equity Growth Rate is the growth in equity or the growth in Book Value Of Equity per Share (BVPS). The financial measure book value per share represents a per share assessment of the value of a company’s equity. The equity is the asset that remains after deducting all liabilities. This means that if you divide the firm’s equity by all outstanding stocks, you get the BVPS.
3. Earnings per Share (EPS) growth rate. Growth rate of the earnings per share is a means to assess the profitability of a stock corporation. To determine this ratio, the annual profit of the company (in the examined period) is divided by the weighted average number of the outstanding shares.
4. Sales Growth Rate. The growth rate of the revenue or the revenues in the financial world refers to the equivalent in the form of cash or receivables from the sale of goods and services or from renting or leasing. It is generated by the value-based collection of operating and non-operating (neutral) activity of a company.
5. Cash Growth Rate. Growth rate of the cash flow is an economic measure that represents the incoming or outgoing cash (movement of cash) assembled from sales activities and other ongoing activities during a specified, finite period of time. The measure allows an assessment of the financial health of a company – its ability to generate independently the necessary means for maintaining the substance of its financial assets as shown in the balance and to generate the means to expand. We use free cash flow which is the Cash Flow deducted by Capital Expenditures.
If a business meets these minimal growth requirements in all the key figures just mentioned, we take a closer view at it.
Relevant to us is then the current EPS (earnings per share), the historical EPS growth rate and, upon analysts estimates and estimates of the company itself, the future EPS growth rate.
In addition, we look at the current, historical and probable future Price-Earnings-Ratio (P/E Ratio) of the company. The P/E ratio is an indicator for the assessment of stocks. It shows the current share price relative to the current or expected earnings by the firm per share during a similar period of time.
We then calculate the future earnings per share through the expected growth of the next 5 or 10 years.
By looking at the future EPS and the future P/E ratio, we can now determine the future market price of the stock.
By determining the present value, we can now calculate the sticker price (value price). The sticker price therefore is the calculated, proposed purchase price, the price that a stock is worth according to our calculation.
We calculate the just described again for the perspective of the next 5 or 10 years implying a minimum yield of 10 – 15% p.a. We always want this minimum return to be met. This also means that if we paid the calculated price for the stock on the market, we could still reach a yield of 10 – 15% per year.
At this point, we would like to come back to Warren Buffet’s quote:
” The question as to how to become wealthy is easy to answer. Buy a dollar, but do not pay more than 50 cent for it.“
Warren Buffett (*1930), American Investor
For that reason, we divide the price that we have just calculated by two to create a margin of safety of 50%.
We therefore buy, for example, $ 1 for 50 cents.
That way, we obtain the MOS (Margin of Safety) Price.
We then calculate the above described for 3 scenarios, the optimistic, moderate and pessimistic performance of the company in its market environment.
If the current market price of the stock traded lies below the MOS price, we consider the company worth investing in.
Finally, we look at the long term debt of the company, which should be melted down via the cash flow within the coming 3 years.