My journey to understand business and evaluation of business - Part 2

 

 

 

It is important to predict business outcomes for long term of at-least 10 years with good safety margin irrespective of market quotation for success in long term investment strategy. 

For this business should have good earning potential in next 10 years.

I prefer to follow this strategy as I am not a full time trader.

List you circle of competence and go to step 1 only if its inside my circle of competence.

Step 1

Predictable earnings - 10 yrs EPS to be found

See if it has upward trajectory if there is any anomaly in any years - find the reason behind the anomaly.

Step 2

Higher the price you pay lower the rate of return

Find the initial rate of return:

Price of the stock in current year(x) :

Expected earning per share for current year(y) :

                                                    Price of stock in current

Initial rate of return(z) :            ----------------------------------------

                                        Expected earning per share for current year 

Step 3

Determine per share earnings growth : 

Retained earnings must be used by company in a manner that it increases the per share earnings of the company there by increasing value of the shareholders.

Increase in per share earnings will in time increase the valuation of the company.

 Compounded growth rate formulae 

 

CAGR formulae for annualized return

10 year Compounded growth rate per year :

5 year Compounded growth rate per year :

Inspect if the per share earning are growing at same rate, If not answer the following questions 

Why the change ?

What effect will past economics will have on our ability to predict the future earnings ?

What where the business economics that caused this change ?

Are they buying there own stock ?

Are they finding new business ventures to be profitably involved together ?

 

These are the 3 Tests to pass.