Sunday 26 February 2012

Earnings Growth: Good Growth and Bad Growth


GROWTH FIGURES FOR ANHEUSER-BUSCH

Take Anheuser-Busch. Ten-year figures to 2002, using the Value Line summaries, show the following:
YearEarnings per shareReturn on equity %Return on capital %
1993.8923.014.9
1994.9723.415.2
1995.9522.214.3
19961.1127.917
19971.1829.215.6
19981.2729.316.5
19991.4735.817.7
20001.6937.618.2
20011.8942.018.8
20022.2063.421.9

GROWTH IN EPS

For Mary Buffett and David Clark, earnings per share growth, and its ability to keep well ahead of inflation, is a key factor in the investment strategies of Warren Buffett. Earnings that are consistently increased are an indication of a quality company, soundly managed, with little or no reliance on commodity type products. This leads to predictability of future earnings and cash flows.

On the other hand, with a company whose earnings fluctuate, future cash flows are less predictable. The reasons may be poor management, poor quality or an over reliance on products that are susceptible to price reductions.

Take an imaginary company with the following earnings per share:
YearEPS
12.00
22.25
32.98
41.47
51.88
6-.65
72.75
82.20
91.98
103.01

The only conclusion that follows from these figures is that this company has good years and bad years. Year 11 might be great, it might be dreadful, or it might be average. The only certainty here is the unpredictability.

Of course, a fall in margins for one or two years may be as a result of once only factors and this can provide buying opportunities.

The difficulty is making the judgment as to 
  • whether there is something permanently wrong, or 
  • whether the problem has been isolated and resolved.


WARREN BUFFETT AGAIN ON GROWTH

For Warren Buffett the important thing is not that a company grows (he points to the growth in airline business that has not resulted in any real benefits to stockholders) but that returns grow. In 1992, he said this:

‘Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long term market value.
In the case of a low-return business requiring incremental funds, growth hurts the investor.’


http://www.buffettsecrets.com/company-growth.htm

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