The stocks (equity bonds) of this portfolio

 

Company	Gain Multiples	DY (today)	DY (bought)	DPO Ratio
XF	6.95	5.17%	35.94%	42.82%
XB	18.73	1.67%	31.25%	28.77%
XC	14.10	1.59%	22.38%	97.94%
XA	3.33	4.68%	14.00%	57.07%
XH	2.10	4.24%	8.81%	47.85%
XG	0.40	0.56%	7.56%	337.50%
XD	0.39	0%	0.00%	0.00%
XE	2.62	0%	0.00%	0.00%

The sorted table reveals two distinct investment stories based on the yield from the original purchase price (DY (bought)).

• High Yielders & Winners (XF, XB, XC): The top three holdings (XF, XB, XC) provide an exceptional yield-on-cost ranging from 22% to 36%. This is paired with massive capital gains, as shown by their Gain Multiples between 6.95x and 18.73x. These were spectacularly successful investments where you bought early at very low prices. Their current yields (DY today) appear modest because their share prices have grown so much.

• Mixed Performers & Losses (XA, XH, XG, XD, XE): The remaining stocks show the trade-offs of investing.

  • XA and XH are profitable (Gain Multiples > 2) and offer decent yields on cost (8.8% - 14%), though lower than the top group.

  • XG, XD, and XE are problem areas. XG's unsustainable 337.5% payout ratio and 60% capital loss (Gain Multiples: 0.40) are major red flags. XD and XE have no dividends and sit at a 61% loss and a 162% gain, respectively, highlighting pure capital gain speculation that hasn't paid off for XD.

In summary: This portfolio is anchored by a few outstanding "home run" investments (XF, XB, XC) purchased at rock-bottom prices. The overall results are dragged down by several underperformers, particularly XG, which requires immediate review due to its financial unsustainability and large loss.

"Very low-growth firms often have high PEs" seems counterintuitive at first, but it can be true under specific conditions.

The statement that "very low-growth firms often have high PEs" seems counterintuitive at first, but it can be true under specific conditions. Let's break down the mechanics and rationale behind this phenomenon.

The Core Principle: The P/E Ratio is a Function of Multiple Factors

The standard Gordon Growth Model (a simplified dividend discount model) helps explain this:
P = D / (r - g)
Where:

• P = Price

• D = Dividend

• r = Required Rate of Return (discount rate)

• g = Perpetual Growth Rate

Since Earnings (E) and Dividends (D) are linked by the payout ratio (p), we can reframe this for the P/E ratio:
P/E = p / (r - g)

This shows that the P/E ratio is inversely related to the spread between the discount rate (r) and the growth rate (g). A high P/E can result not only from high *g*, but also from a very low (r - g) spread.

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Why Low-Growth Firms Can Command High P/E Multiples

1. The "Stable Cash Flow" or "Bond Proxy" Effect

   • Low Risk (Low 'r'): Very low-growth firms are often mature, defensive businesses in non-cyclical industries (e.g., utilities, consumer staples, certain REITs). They have predictable, non-discretionary demand.

   • Implied Discount Rate: Because their cash flows are stable and less risky, the market assigns them a lower discount rate (r). In the formula P/E = p / (r - g), if r is very low, the denominator (r - g) remains small even if g is low, supporting a higher P/E.

   • Analogy: These stocks are treated like long-duration bonds. When interest rates fall, the value of stable, long-duration cash flows rises. A high P/E in this context reflects a low equity risk premium.

2. High and Sustainable Dividend Yield (The "Income Stock")

   • Payout Ratio (p): These firms typically have limited reinvestment opportunities (low growth). Therefore, they return a large portion of earnings to shareholders as dividends, resulting in a high payout ratio (p). In our formula, a high p directly increases the justified P/E.

   • Yield Support: Investors bid up the price to capture the attractive, reliable dividend yield. This price appreciation pushes the P/E higher. The high P/E is not a bet on future earnings growth but a reflection of current income attractiveness in a low-interest-rate environment. If the dividend yield is 5% and 10-year bonds yield 3%, the stock becomes compelling despite no growth.

3. The "Maturity" and "Fade" Assumption

   • For a high-growth firm, a high P/E embeds expectations of sustained high growth. Any stumble in growth (a "growth scare") leads to a severe P/E contraction (derating).

   • For a 0-2% growth utility, there is no growth to disappoint. The market already assumes perpetual low growth. The risk of a negative growth surprise is minimal, so the multiple is less volatile and can sustain at a higher level than the simplistic "growth vs. P/E" heuristic would suggest.

4. Accounting and Cyclicality Factors

   • Low Point in the Cycle: Sometimes, a firm's trailing earnings (the 'E' in P/E) are temporarily depressed due to a cyclical trough or a one-time charge. If the market prices the company based on normalized future earnings, the trailing P/E will appear artificially high, even though the business is stable. This is a "P/E illusion."

   • Asset-Intensive Businesses: Some low-growth firms (e.g., industrial, telecom) have large depreciation charges that reduce accounting earnings (E) but do not impact cash flow. The Price-to-Cash-Flow multiple might be more normal, while the P/E looks high.

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Important Caveats and Nuances

• This is not a universal rule. Many low-growth firms trade at low P/Es (e.g., legacy automotive, some banks). The high P/E scenario applies to a specific subset: low-growth plus low-risk plus high payout.

• Interest Rate Sensitivity: This phenomenon is most pronounced in low-interest-rate environments. When risk-free rates (like the 10-year Treasury yield) are low, the relative appeal of these "bond proxies" is high, inflating their P/Es. When interest rates rise sharply, these stocks are often the hardest hit because their low (r - g) spread widens, causing their justified P/E to contract dramatically. 2022 was a perfect example of this.

• The Growth Trap: A firm with a 5% growth rate but high volatility and risk might trade at a lower P/E than a firm with 2% growth but extreme stability. Risk (r) is just as important as growth (g).

Real-World Examples (Hypothetical & Historical)

1. Utility Company (XLU): Grows at ~2-3% per year. Often trades at a P/E of 18-22x, higher than the market average, because its earnings are government-regulated, demand is inelastic, and it pays a ~4% dividend. It's a classic "widows-and-orphans" stock.

2. Consumer Staples (KO, PG): Historically traded at premium P/Es (25x+) despite low growth, due to global brand stability, pricing power, and reliable dividends.

3. Tobacco (PM, MO): A stark example. Facing long-term volume decline (negative growth), these companies often traded at high P/Es because they generated enormous, predictable cash flows and paid very high dividends, making them attractive income vehicles.

Conclusion

Your statement is astute. A high P/E on a low-growth firm is not a paradox but a signal that the market is valuing the firm primarily for the quality and safety of its cash flows and its income distribution, not for growth. It reflects a low discount rate (r) and a high payout ratio (p), rather than a high growth rate (g).

Key takeaway: The P/E ratio alone is meaningless. It must be interpreted through the lens of growth expectations, risk profile, dividend policy, and the prevailing interest rate environment. A high P/E on a low-growth stock is often a sign of a low-risk "bond-like" equity, not an overvaluation error by the market.

Valuing Nestle Malaysia like an equity bond of Warren Buffett

Very low-growth firms (<5%) often have high PEs due to stable cash flows or dividend yields.

Let's look at Nestle.  It has very stable cash flows and also dividend yields.  We can value it like an equity bond of Buffett.

Its PBT profit in FY 2024 was RM 2.36 per share
Today, its share price is RM 114.10 per share
Its business is projected to grow at a slow pace of 2.4% per year.

The share price is the bond, the PBT is the bond interest payment. 

Thus, at RM 114.10 per share, the equity bond of Nestle is paying a bond yield of  = RM 2.36/ RM 114.10 = 2.07%.

FD fixed interest rate (risk free) today is 3.5% to 4%.

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The price of Nestle went down to its lowest in March 2025 at RM 64.

At RM 64, this equity bond (Nestle) was paying a Bond Yield of RM 2.36/RM64 = 3.93%.

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Lesson: 

When you buy a great company with a great margin of safety, the lower the price you pay, the higher the potential returns. 

Always invert. Always invest. Be greedy when others are fearful. Be fearful when others are greedy. Shut out the noise. Focus on the business, the numbers and think independently.

Concept of Equity Bond of Warren Buffett

Concept of “Equity Bond” of Warren Buffett.

Elaboration of Section 7

This section introduces a powerful mental model used by Warren Buffett that fundamentally changes how one should view a stock investment. It reframes a share of stock not as a speculative ticker symbol, but as a kind of "bond" with unique and superior characteristics.

The core of the concept is broken down into three parts:

1. The Theory: Stock as an "Equity Bond"
Buffett observes that companies with strong, predictable earnings—especially those with a Durable Competitive Advantage (DCA)—can be analyzed similarly to bonds, but with a crucial twist.

• The Analogy:

  • Equity Bond = The Share Price (This is the principal you invest).

  • Bond Coupon = The Company's Pre-Tax Earnings Per Share (This is the annual "interest" the business earns on your behalf).

• The Critical Difference: A normal bond's coupon (interest rate) is fixed. However, for a great company, the "coupon" (its earnings per share) increases year after year because the business is growing. This means the "Equity Bond" becomes more valuable over time.

2. Determining the Share Price (Valuation)
The section explains how the stock market typically values these "Equity Bonds." The price is influenced by the level of long-term interest rates.

• The Formula: The theoretical value of the Equity Bond is calculated by comparing its "coupon" to the prevailing interest rate on Long-Term Corporate Bonds (LTCBR).

  • Equity Bond Value = Coupon Rate / L.T. Corporate Bond Rate

  • Or, more simply: Share Price = Pre-Tax Earnings Per Share / L.T. Corporate Bond Rate

• Examples from the text:

  • The Washington Post (2007): Pre-tax EPS of $54 / 6.5% Bond Rate = $830 per share theoretical value. Its actual price traded around this range ($726-$885).

  • Coca-Cola (2007): Pre-tax EPS of $3.96 / 6.5% Bond Rate = $61 per share theoretical value.

• The Interest Rate Relationship: This model explains why stock prices are sensitive to interest rates.

  • When Interest Rates FALL, the same earnings are worth more (because you are dividing by a smaller number), so share prices tend to rise.

  • When Interest Rates RISE, the same earnings are worth less, so share prices tend to fall.

3. The Investment Decision: When to Buy and Sell
This mental model directly informs Buffett's buying and selling criteria.

• When to Buy:

  • The lower the price you pay, the higher your initial "coupon" (yield) and the greater your long-term return. The example shows that buying Coca-Cola at $6.50 gave Buffett a massive future yield, whereas buying at $21 would have yielded far less.

  • The best time to buy is during bear markets, when wonderful businesses are often sold at a discount to their theoretical value. This is the practical application of being "greedy when others are fearful."

• When to Sell (or Not Buy):

  1. To free up cash for a better opportunity (a company with a higher potential yield).

  2. When the company is losing its Durable Competitive Advantage (the "moat" is disappearing).

  3. During bull markets, when stock prices are driven "through the ceiling" far beyond their long-term economic value. This is when to be "fearful when others are greedy."

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Summary of Section 7

Section 7 explains Warren Buffett's "Equity Bond" concept, a mental model that treats a share of a wonderful company as a bond whose interest payment (the company's earnings) grows every year.

• Core Concept: A stock is an "Equity Bond" where the share price is the bond's face value and the company's pre-tax earnings per share is the bond's interest payment.

• Key Advantage: Unlike a normal bond with a fixed coupon, the "coupon" of an Equity Bond from a great company increases over time, dramatically increasing the value of the original investment.

• Valuation Insight: The fair price of this Equity Bond is influenced by long-term interest rates. Lower rates justify higher stock prices, and vice-versa.

• Practical Application: This model dictates a clear strategy:

  • BUY when you can purchase this high-quality Equity Bond at a low price, giving you a high initial and growing yield.

  • SELL if the business's moat collapses, the price becomes irrationally high, or a far better Equity Bond becomes available.

In essence, this concept forces the investor to think like a business owner, focusing on the underlying earnings power of the company and the price paid for it, rather than on short-term stock price fluctuations. It is a cornerstone of value investing that links business fundamentals directly to investment returns.

How can I value this stock using the equity bond concept of Warren Buffett?

 I have a stock A. It pays steady growing dividends for decades. It is in a great business and has grown its revenues and earnings consistently for decades. How should I value this stock? Warren Buffett advises to treat this company like a equity bond. How can I value this stock using the equity bond concept.

Excellent question. This "equity bond" concept is a powerful mental model directly from Warren Buffett's playbook, and it's perfectly suited for the type of stock you're describing.

Let's break down how to value your stock using this framework.

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The Core "Equity Bond" Concept

Buffett's insight is simple yet profound: treat a wonderful, predictable business not as a volatile stock, but as a bond-like instrument where the "coupon" (earnings) grows over time instead of being fixed.

• A Traditional Bond: Has a fixed coupon and a maturity date. Its value is the present value of those fixed, certain payments.

• An "Equity Bond": Has an initial "coupon" (current earnings per share) that is expected to grow predictably over time. Its value is the present value of these growing, owner-earnings.

This shifts your focus from short-term price fluctuations to the long-term, predictable economics of the business itself.

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Step-by-Step Valuation Using the Equity Bond Method

Here is a practical guide to applying this concept to Stock A.

Step 1: Identify the "Coupon" (Owner Earnings)

For a bond, the coupon is clear. For an equity bond, we need to find the equivalent. While dividends are a good starting point, Buffett focuses on the earnings power that is ultimately available to the owner.

• Primary Metric: Earnings Per Share (EPS). Use the company's normalized, or owner earnings. This means adjusting reported EPS for one-time charges/gains to get a true picture of recurring profitability.

• Example: If Stock A has reported EPS of $5.00, but this includes a one-time gain of $0.50, its normalized EPS might be $4.50. This $4.50 is your starting coupon.

Step 2: Estimate the Perpetual Growth Rate ("The Coupon Growth")

This is your estimate of how much the company can grow its "coupon" (EPS) per year, forever. Be conservative.

• The Anchor: The growth rate cannot exceed the long-term nominal GDP growth (say, 3-5%). A wonderful company might sustainably grow slightly faster than GDP for a long time.

• Base it on History and ROIC: Look at the company's long-term track record. A company that has grown EPS at 8% annually for decades might be reasonably expected to grow at 5-6% in perpetuity, assuming it can reinvest its earnings at a high rate of return (a high ROIC).

• Example: Let's assume a conservative and sustainable perpetual growth rate for Stock A of g = 5.0%.

Step 3: Determine Your "Equity Bond" Yield (The Discount Rate)

This is the most critical step. Instead of using the complex CAPM, Buffett simply uses the long-term government bond yield as his benchmark and then asks, "What yield do I require for this superior but still somewhat risky asset?"

• Start with the Risk-Free Rate: Get the current yield on the 30-Year Treasury Bond. This is your opportunity cost. Let's say it's 4.5%.

• Add a Minimal Risk Premium: Because Stock A is a wonderful, predictable business, it is less risky than the average stock. However, it's not completely risk-free. You deserve a small premium over the risk-free rate to compensate for business risk and uncertainty.

• Your "Equity Bond" Yield: For a stellar company, this might only be 1-3% above the long-term bond yield.

  • Example: 30-Year Treasury (4.5%) + 2% Equity Risk Premium = 6.5%.

This 6.5% is your discount rate (r). It is your required return for this specific "equity bond."

Step 4: Calculate the Value Using the Growing Perpetuity Formula

This is mathematically identical to the Gordon Growth Model, but the inputs are framed differently.

Equity Bond Value = Current "Coupon" (EPS) / (Your Required Yield - Growth Rate)

Value = EPS / (r - g)

Using our example:

• EPS (Coupon) = $4.50

• r (Your Required Yield) = 6.5% or 0.065

• g (Perpetual Growth) = 5.0% or 0.05

Value = $4.50 / (0.065 - 0.05)
Value = $4.50 / 0.015
Value = $300 per share

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Interpretation and Comparison

• Your Calculated Value: $300 per share. This is the intrinsic value of your "equity bond."

• Current Market Price: Let's say it's $250.

Conclusion: The stock is trading at a 17% discount to your calculated intrinsic value ($250 vs. $300). According to Buffett's principle, this is a buy. You are acquiring a "bond" with a starting yield of $4.50/$250 = 1.8%, but one whose coupon is expected to grow at 5% per year, giving you a very attractive effective yield that will compound over time.

Critical Caveats and refinements

1. The "G" is Everything: The model is extremely sensitive to the growth assumption (g). If you change g to 4.5%, the value plummets to $4.50 / (0.02) = $225. Always be conservative with g.

2. The "No-Growth" Floor: A useful sanity check is to calculate the value of Stock A as if it were a true bond with no growth.

   • Value (No-Growth) = EPS / r = $4.50 / 0.065 = ~$69

   • The difference between $300 and $69 ($231) is the present value of the growth opportunities. This tells you how much you are paying for future growth.

3. Is the Growth Rate Sustainable? The model assumes the 5% growth can continue forever. You must be confident that the company's moat, market size, and return on invested capital (ROIC) support this.

4. Compare to Dividend Model: If the company pays out most of its earnings as dividends, the Dividend Discount Model from our previous conversation will give a similar result. The Equity Bond method is more powerful because it values all the earnings, not just the portion paid out.

In summary, by treating Stock A as an "equity bond," you shift your mindset from a speculator to an owner. You are not buying a ticker symbol; you are buying a claim on a stream of growing future earnings, and your job is to determine what that stream is worth to you today.

I was going to ask, why not use dividend in the equity bond concept to calculate the value of the stock. Why use earnings per share? When would using earnings per share preferred to using dividends, and vice versa?

This is an absolutely brilliant question that gets to the very heart of intelligent investing. The choice between earnings and dividends in the "equity bond" model is crucial, and the rationale reveals a lot about a company's quality and how you should think about returns.

Let me explain the core principle, and then provide a clear framework for when to use each.

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The Core Principle: Ownership vs. Income

When you buy a stock, you are buying ownership of the entire company and its future earnings, not just a claim to its dividends. The "equity bond" concept values your share of the business's total profit-generating capability.

• Using Earnings (EPS): Values the entire profit stream of the business. It answers: "What is the value of my share of all the money this company earns?"

• Using Dividends: Values only the portion of profit that is paid out to you. It answers: "What is the value of the cash payments I receive from this company?"

Why Buffett Prefers Earnings (EPS) for an "Equity Bond"

For the "equity bond" concept, earnings are almost always preferred, and here’s the critical reason why:

Dividends are a decision of management. Earnings are the fundamental capability of the business.

Think of it this way: The "coupon" on a bond is the total interest it generates. You, as the owner, care about that total interest-generating power, regardless of whether you clip the coupon and spend it or let it compound.

Similarly, with an "equity bond":

• The Earnings (EPS) is the total "coupon" the business generates.

• The Dividend is the part of the coupon that management mails to you in cash.

• The Retained Earnings (EPS - Dividends) is the part of the coupon that management reinvests back into the business on your behalf.

For a "great business" as you described, the primary source of your returns is not the dividend yield, but the growth of the underlying earnings, which drives the long-term price appreciation. Using dividends alone would ignore the powerful engine of growth that retained earnings fuel.

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When to Use Earnings (EPS) vs. Dividends: A Decision Framework

Here’s a clear guide on which metric to use and why.

✅ Use EARNINGS (EPS) when...

1. The Company is a "Compounding Machine" (The Classic Buffett Stock)

• Scenario: The company consistently earns a high Return on Invested Capital (ROIC). It can reinvest its retained earnings back into the business to generate high rates of return.

• Example: Apple (AAPL) or Amazon (AMZN) in their growth phases. For decades, Apple retained most of its massive earnings to fund R&D, new products, and share buybacks, creating far more value for shareholders than if it had paid all earnings out as a dividend.

• Valuation Logic: Using EPS captures the value of this reinvestment and future growth. Using dividends would dramatically undervalue the company.

2. The Payout Ratio is Low or Fluctuating

• Scenario: The company pays out a small percentage of its earnings (e.g., a 20% payout ratio).

• Logic: If you used the dividend, you'd be ignoring 80% of the profit-generating power of your asset. The "equity bond" coupon should reflect the full $4.50 of earning power, not just the $0.90 that gets paid out.

3. Share Buybacks are a Primary Method of Capital Return

• Scenario: The company aggressively buys back its own shares instead of, or in addition to, paying dividends.

• Logic: Buybacks increase your ownership percentage of the future earnings stream without you spending a dime. Using EPS captures this, as your share of earnings grows over time. A dividend-based model misses this entirely.

✅ Use DIVIDENDS when...

1. The Company is a "Mature Cash Cow"

• Scenario: The business is stable but has limited high-return growth opportunities (e.g., a utility, a REIT, or a tobacco company). Its primary value proposition to the investor is the direct cash distribution.

• Example: AT&T (T) or Southern Company (SO). Their main appeal is the dividend yield.

• Valuation Logic: The dividend is the return. Since management has few good ways to reinvest earnings, they pay most of them out. The "equity bond" coupon is effectively the dividend.

2. The Payout Ratio is High and Stable

• Scenario: The company pays out most of its earnings as dividends (e.g., an 80-90% payout ratio).

• Logic: In this case, the dividend is a very accurate proxy for earnings power. The business model is such that earnings and dividends track each other closely.

3. You are Modeling an Income Portfolio

• Scenario: Your investment goal is to live off the income generated by your portfolio.

• Logic: You care directly about the safety and growth of the cash payments hitting your brokerage account. Valuing based on the dividend stream aligns perfectly with your personal financial goals.

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Practical Example: Stock A Revisited

Let's apply this to your "Stock A."

• If Stock A has a high ROIC and reinvests 60% of its earnings to fund 7% growth, it's a compounding machine. You must value it using EPS. This gives you the full picture.

• If Stock A is a regulated utility with a 5% growth ceiling and pays out 75% of earnings, it's a mature cash cow. You could reasonably value it using Dividends Per Share (DPS).

The Hybrid / "Look-Through" Approach

The most sophisticated way to think about it is a hybrid:

Total Owner Return = (Dividend Yield) + (Growth in EPS from Reinvested Earnings)

The "equity bond" model using EPS inherently values both components. Using DPS only values the first one.

Summary

Metric	Best For...	Why?	Think of it as...
Earnings (EPS)	Growth Compounders, businesses with high ROIC, low payout ratios.	Captures the value of reinvested earnings and the company's full profit-generating power.	The entire pie the business bakes each year.
Dividends (DPS)	Mature Income Stocks, utilities, REITs, companies with high, stable payout ratios.	Accurately reflects the cash return to shareholders when growth opportunities are limited.	Your slice of the pie that management serves to you.

For your "Stock A" that is in a "great business" and has grown for decades, the odds are extremely high that it is the first type—a compounding machine. Therefore, you should value it as an "equity bond" using its Earnings Per Share (EPS). This is the method that truly honors Buffett's wisdom.

Summary:

| Metric | Best For... | Why? | Think of it as... |

| :--- | :--- | :--- | :--- |

| **Earnings (EPS)** | **Growth Compounders**, businesses with high ROIC, low payout ratios. | Captures the value of *reinvested earnings* and the company's full profit-generating power. | **The entire pie** the business bakes each year. |

| **Dividends (DPS)** | **Mature Income Stocks**, utilities, REITs, companies with high, stable payout ratios. | Accurately reflects the cash return to shareholders when growth opportunities are limited. | **Your slice of the pie** that management serves to you. |