“Price is what you pay, value is what you receive.” – Warren Buffett
Q2 hedge fund letters, conference, scoops etc
One of the most important decisions you will make is deciding at what price to buy a share.
Because the price you pay determines your rate of return.
How?
Let’s look at Woolworth’s.
One valuation scenario we calculated in the Share Investors Blueprint, is that Woolworth’s will grow their earnings to point in 2029, where the market will value them in excess of $100 billion. As shown in this Chart.
Before we go on, I want to stress that I’m not implying that you should buy Woolworth’s.
Here we are evaluating the possible compounded rates of return, if we had brought at varies prices throughout year.
Furthermore, I won’t be going into how I calculated the $100 billion dollar market valuation, I might cover it later, but at the moment only Blueprint members can assess this information.
Back to our example. If Woolworth’s meets our expectations, growing owner earnings at satisfactory compounded rates of return over the next ten years, then we can expect a ballpark market valuation of $101 billion, which is equivalent to $78 dollars per share.
Currently, their market capitalisation is $46 Billion, and $37 dollar per share.
Source: ASX
Over the last 9 months, the share price has hit a low of $28.21 dollars per share, and a high of $38.06
Source: Yahoo Finance
If you brought at the price of $38.06 per share, the earnings yield, based upon reported net earnings per share, is 5.4% (2.05/38.06 = 0.0538).
And, the earnings yield at the low price of $28.21 per share is 7.3% (2.05/28.21 = 0.0726).
You could be earning a 7% yield on your investment if you brought at the low point, which is much higher than any term deposit rate. Even the 5% yield is still better then what’s on offer.
Without adding in future [possible] earnings, we can see straightway that the price you pay also determines your earnings yield.
What about capital gains?
To compound your money into a meaningful sum, we need to identify that the company can protect earnings, particularly growth in earnings, from the competition which is why we go through the process of identifying competitive advantages.
We estimated that Woolworth’s can protect earnings to a certain degree, and grow earnings at a nice compounded rate resulting in a valuation of $101 billion, or $78 dollars per share.
If we buy at the high price of $38.06 per share, this produces a compound rate of return is 7.5%
However, if we buy at $28.21 dollars per share, this produces a compound rate of return of 10.5%
At 7% compounded, you will double your money every 9.5 years, and at a 10.5% compounded rate of return you double your money every 6.8 years (Rule of 72).
So far, I haven’t included the amount of dividends you will have received, which will bump up our compounded rate of return, a cherry to top it off.
A 7% compounded rate of return over ten years is a great result, hell it would beat the majority of professional investors!
I hope this example illustrates how important it is to know the difference between price and value, by understanding how the price you pay determines the rate of return you earn on each investment.
I do stress there are a number of other factors to take into consideration before buying, which I touched on lightly.
Helping you make rational investments that grow your wealth over the long term is a core purpose of the Share Investors Blueprint.
Yours in investing
Adam Parris
Article by Searching for Value
