Tuesday 1 May 2012

You should seek companies that can create the equivalent market value for each $1 of retained earnings, for the shareholders

Guinness Anchor

Year    DPS   EPS

2001    27.4    19.4
2002    27.4    24.0
2003    28.1    25.8
2004    30.4    32.6
2005    30.1    35.7
2006    30.2    42.4
2007     32.9   37.3
2008     36.4   41.7
2009     41.0   47.0
2010     45.0   50.5
Total    328.9  356.4

From the year 2001 to 2010
Total dividend paid out  328.9 sen
Total earnings 356.4 sen
Total retained earnings  27.5 sen



Price Range of each Guinness Share
2001  Low $ 2.75 -  High $ 3.58
2010  Low $ 6.60 -  High $ 10.16

Subtracting the highest price of 2001 from the lowest price of 2010, the gain in the share price of Guinness from 2001 to 2010 was $3.02  ($6.60 - $3.58 = $3.02 )

The change market price of Guinness from 2001 to 2010 was a minimum of $3.02.

Therefore, for every $1.00 of retained earnings, Guinness has created at least $3.02/ $0.275 = $10.98 in market value, that is, for every 10 sen retained earnings, Guinness has created a market value of a minimum of $1.098.



How does the company use the retained earnings?  Do the retained earnings reflect in the stock price?


When the management of a company invests earnings back into the business, that investment should yield a higher return because of those retained earnings.  When the management does a great job using retained earnings, it will increase the earnings of that company, and , in turn, earnings per share will increase.

Market price does not always reflect the true value of the company during the short term.  But, if you are looking at 10 years or more, market price reflects the true value of the company.

In the above example, using Guinness, the last 10 years of EPS were added and compared with the market price of the stock in those years.

Warren Buffett teaches that you should seek out those companies that can grow at least the equivalent $1.00 of market value for each $1.00 of retained earnings.  To not do so, the company is destroying value.

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