My equity bond (Nestle)

Nestle Malaysia

Latest after-tax ttm-EPS is $2.39 per share

Nestle's underlying earnings are so consistent.

And Nestle is growing its earnings at about 8% per year.

A company with a durable competitive advantage, over time, the stock market will price the company's equity bonds or shares at a level that reflects the value of its earnings relative to the yield on long-term risk free interest rate.

Capitalized at the risk free interest rate of 3.5%, Nestle's after-tax earning of $2.39 per share is worth approximately $68.30 per equity bond/share.  ($2.39/3.5% = $68.30).


Here is a difference worth noting. 

Nestle is worth $68.30 per share  and it is trading today at around $68.00.  Therefore, for the Graham-based value investors, who wants to buy only at $40 per share, Nestle is not "undervalued"

But for those who are willing to apply their reasoning or thinking cap, just take a look at this scenario.

1.  You are being offered a relatively risk-free initial after-tax rate of return of 3.5% today when you buy at $68.30 sen per share.

2.  This after-tax rate of return is expected to increase over the next 20 years at an annual rate of approximately 8% per year.

3.  Then ask this question:  Is this an attractive investment given the rate of risk and return on other investments?

4.  What other attractive investment give the rate of risk and return of this nature?




I bought a long time ago at $10.20 per share

Thus, Nestle is my equity bond or share that is currently giving an after-tax yield of 23.4% ($2.39 / $10.20 = 23.4%) that is relatively risk-free and which is expected to increase over the next 20 years at an annual rate of approximately 8%. 

Growth or the lack of it, is integral to a valuation exercise

The value of a business, a share of stock or any other productive asset is the present value of its future cash flows.

However, value is easier to define than to measure (easier said than done).

Valuing a business (or any productive asset) requires estimating its future performance and discounting the results to present value.  The probable future performance includes whatever GROWTH (or SHRINKAGE) is ASSUMED.

SO GROWTH (OR LACK OF IT) IS INTEGRAL TO A VALUATION EXERCISE.

This supports the point that the phrase value investing is redundant.  Investing is the deliberate determination that one pays a price lower than the value being obtained.  Only speculators pay a price hoping that through growth the value  rises above it.

Growth doesn't equate directly with value either.  

Growing earnings can mean growing value.  But growing earnings can also mean growing expenses, and sometimes expenses growing faster than revenues.  Growth adds value only when the payoff from growth is greater than the cost of growth.

A company reinvesting a dollar of earnings to grow by 99 cents is not helping its shareholders and is not a value stock, though it may be a growth stock.

Value investing is conventionally defined as buying companies bearing low ratios of price-to-earnings, price-to-book value, or high dividend yields.  But these metrics do not by themselves make a company a value investment.  It isn't that simple.  Nor does the absence of such metrics prevent an investment from bearing a sufficient margin of safety and qualitative virtues to justify its inclusion in a value investor's portfolio.

Is Growth Always A Good Thing?

Rapid growth in revenue and earnings may be top priorities in corporate boardrooms, but these priorities are not always best for shareholders. We are often tempted to invest large amounts in risky or even mature companies that are beating the drum for fast growth, but investors should check that a company's growth ambitions are realistic and sustainable.

Growth's Attraction
Let's face it, it's hard not to be thrilled by the prospect of growth. We invest in growth stocks because we believe that these companies are able to take shareholder money and reinvest it for a return that is higher than what we can get elsewhere.

Besides, in traditional investing wisdom, growth in sales earnings and stock performance are inexorably linked. In his book "One Up on Wall Street," investment guru Peter Lynch preaches that stock prices follow corporate earnings over time. The idea has stuck because many investors look far and wide for the fastest-growing companies that will produce the greatest share-price appreciation.



Is Growth a Sure Thing?
That said, there is room to debate this rule of thumb. In a 2002 study of more than 2,000 public companies, California State University finance professor Cyrus Ramezani analyzed the relationship between growth and shareholder value. His surprising conclusion was that the companies with the fastest revenue growth (average annual sales growth of 167% over a 10-year period) showed, over the period studied, worse share price performance than slower growing firms (average growth of 26%). In other words, the hotshot companies could not maintain their growth rates, and their stocks suffered.

The Risks
Fast growth looks good, but companies can get into trouble when they grow too fast. Are they able to keep pace with their expansion, fill orders, hire and train enough qualified employees? The rush to boost sales can leave growing companies with a deepening difficulty to obtain their cash needs from operations. Risky, fast-growing startups can burn money for years before generating a positive cash flow. The higher the rate of spending money for growth, the greater the company's odds of later being forced to seek more capital. When extra capital is not available, big trouble is brewing for these companies and their investors.

Companies often try increasingly big - and risky - deals to push up growth rates. Consider the serial acquirer WorldCom. In the 1990s, the company racked up growth rates of more than 20% by buying up little-known telecom companies. It later required larger and larger acquisitions to show impressive revenue percentages and earnings growth. In hopes of sustaining growth momentum, WorldCom CEO Bernie Ebbers agreed to pay a whopping $115 billion for Sprint Corp. However, federal regulators blocked the deal on antitrust grounds. WorldCom's prospects for growth collapsed, along with the company's value. The lesson here is that investors need to consider carefully the sustainability of deal-driven growth strategies.

Being Realistic About Growth
Eventually every fast-growth industry becomes a slow-growth industry. Some companies, however, still pursue expansion long after growth opportunities have dried up. When managers ignore the option of offering investors dividends and stubbornly continue to pour earnings into expansions that generate returns lower than those of the market, bad news is on the horizon for investors.

For example, take McDonald's - as it experienced its first-ever losses in 2003, and its share price neared a 10-year low, the company finally began to admit that it was no longer a growth stock. But for several years beforehand, McDonald's had shrugged off shrinking profits and analysts' arguments that the world's biggest fast-food chain had saturated its market. Unwilling to give up on growth, McDonald's accelerated its rate of restaurant openings and advertising spending. Expansion not only eroded profits but ate up a huge chunk of the company's cash flow, which could have gone to investors as large dividends.

CEOs and managers have a duty to put the brakes on growth when it is unsustainable or incapable of creating value. That can be tough since CEOs normally want to build empires rather than maintain them. At the same time, management compensation at many companies is tied to growth in revenue and earnings.

However, CEO pride doesn't explain everything: the investing system favors growth. Market analysts rate a stock according to its ability to expand; accelerating growth receives the highest rating. Furthermore, tax rules privilege growth since capital gains are taxed in a lower tax bracket while dividends face higher income-tax rates.

The Bottom Line
Justifications for fast growth can quickly pile up, even when it isn't the most prudent of priorities. Companies that pursue growth at the cost of sustaining themselves may do more harm than good. When evaluating companies with aggressive growth policies, investors need to determine carefully whether these policies have higher drawbacks than benefits.


Read more: http://www.investopedia.com/articles/fundamental/03/082003.asp#ixzz2KA5lFtVB

What is good business and what is good managers?

Good business is this: It generates more cash than it consumes.


Good managers is this: They keep finding ways of putting that cash to productive use.

In the long run, companies that meet this definition are virtually certain to grow in value, no matter what the stock market does.

http://hongwei85.blogspot.com/2011/03/what-is-good-business-and-what-is-good.html

Which type of Company would you rather own?

Would you prefer to own:

A.  One that consistently posts better earnings and whose stocks plows steadily higher?

or

B.  One that made the same amount of money for six years but was (a) profitable and (b) disciplined in paying hefty dividends back to investors?  (Note:  These companies are harder to find, but in such situations, a no- or low-growth company may actually be OK.)

or

C.  One that has made the same amount of money for six straight years, has little sense of enterprise, and has a stock that is trading at the same price it was ten years ago?


Related:

Be a stock picker: Buy GREAT companies and hold for the long term until their fundamentals change

Examples of companies in:

A - PetDag, PBB, LPI, PPB

B - Nestle, Guinness, DLady

C - Too many in this group in the KLSE.

Be a stock picker: Buy GREAT companies and hold for the long term until their fundamentals change

All the above are GREAT companies.

NEVER buy these GREAT companies at HIGH prices.

You can often buy them at FAIR prices.

On certain occasions, you have the chance to buy them at slightly BARGAIN prices.

Rarely, for example during the recent 2008 Crash, you had the chance to buy them at GREAT prices.

It is better to buy a GREAT company at a FAIR price than to buy a FAIR company at a GREAT price.

It is safe to hold these stocks for the long term since these companies have competitive advantages, selling only when their fundamentals change.

The present prices of these stocks are near or above their previous high prices.

Those who bought regularly into these stocks would have capital gains, through dollar-cost averaging.

Further comments:

1. Warren, on the other hand, after starting his career with Graham, discovered the tremendous wealth-creating economics of a company that possessed a long-term competitive advantage over its competitors.  
2. Warren realized that the longer you held one of these fantastic businesses, the richer it made you.  
3. While Graham would have argued that these super businesses  were all overpriced, Warren realized that he didn't have to wait for the stock market to serve up a bargain price, that even if he paid a fair price, he could still get superrich off of those businesses.  
4. In the process of discovering the advantages of owning a business with a long-term competitive advantage, Warren developed a unique set of analytical tools to help identify these special kinds of businesses.  
5. Though rooted in the old school Grahamian language, his new way of looking at things enabled him to determine whether the company could survive its current problems.  
6. Warren's way also told him whether or not the company in question possessed a long-term competitive advantage that would make him superrich over the long run.  
7. By learning or copying Warren, you can make the quantum leap that Warren made by enabling you to go beyond the old school Grahamian valuation models and discover, as Warren did, the phenomenal long-term wealth-creating power of a company that possesses a durable competitive advantage over its competitors.
8. In the process you'll free yourself from the costly manipulations of Wall Street and gain the opportunity to join the growing ranks of intelligent investors the world over who are becoming tremendously wealthy following in the footsteps of this legendary and masterful investor.

Related:

The Evolution of Warren Buffett

Learning and Understanding the Evolution of Warren Buffett
Li Lu sharing his Value Investing Strategies (Video)
The Three Gs of Buffett: Great, Good and Gruesome

The GREAT company has long-term competitive advantage in a stable industry.  This company:

• takes a one time investment capital and 
• pays you a very attractive return (dividend + capital appreciation), 
• which will continue to increase as years pass by;

Here are the golden words of Buffett on the GREAT businesses to own:

1.  On 'Great' businesses, Buffett says, "Long-term competitive advantage in a stable industry is what we seek in a business.

• If that comes with rapid organic growth, great. 
• But even without organic growth, such a business is rewarding. 
• We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. 
• There's no rule that you have to invest money where you've earned it. 
• Indeed, it's often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can't for any extended period reinvest a large portion of their earnings internally at high rates of return."

Growth Stocks: Searching for the Sprinters

Growth Stocks: Searching for the Sprinters

by Douglas Gerlach

Investors who focus on growth try to predict which companies will grow faster in the future -- faster than the rest of the stocks in the market, or faster than other stocks in the same industry. If you're successful in buying a company that does grow faster than other companies, then it's likely that the price of that company's stock will increase as well, and you can make a profit.
(My comment: Provided you did not pay too high a price to buy it.)

The stock of a company that grows its earnings and revenues faster than average is known as a growth stock. These companies usually pay few or no dividends, since they prefer to reinvest their profits in their business.

Peter Lynch primarily used a growth stock approach in managing the Magellan mutual fund. Individuals who invest in growth stocks often prefer it because their portfolio will be made up of established, well-managed companies that can be held onto for many years. Companies like Coca-Cola, IBM, and Microsoft have demonstrated great growth over the years, and are the cornerstones of many portfolios. Most investment clubs stick to growth stocks as well.