Chapter 87: How to Evaluate a Company

Source: https://www.facebook.com/100063294665283/posts/744115627708253/

[James Origin and Today] Chapter 87 - [How to evaluate a company] (12/05/2023)

[Student question, estimation and calculation of a company’s value]

question :

Teacher JAMES Hello~.

I would like to ask if JAMES has taught me how to calculate the value of stocks before.

is EPS* 1.EPS GROWTH. *PE

Assume that the current EPS is 3.57, the growth rate is 30%, and the PE is 55

3.571.3055=255.25 This is the expected price one year from now. Teacher JAMES, is this reasonable?

My understanding is that the safety margin is 20% off

So, does the teacher’s opinion on PE affect decision-making?

I met my teacher in 20 years and I haven’t sold any shares yet.

I still hold the main position QQQ. At that time, the more it fell, the more I bought.

The overall current situation is from the lowest -50% to the current -18%

keep insisting

Including adding positions at low points. I am very grateful to have the teacher’s company

James answered:

It is actually very difficult to estimate the value of a company because there are too many variables, and even a small change in the variables can make the estimated value significantly different. This is why Buffett is conservative when estimating the value of a company and tries to discount the value as much as possible.

Another way to estimate the value of a company is the business model of the business it is engaged in, its prospects and future. This requires the perspective of investors and is not a value that can be calculated by calculation. If investors have the vision to see the prospects, business and models of companies such as Amazon and Tesla at a very early stage, and see the value of the company before the company makes money or even suffers a large loss, this cannot be explained clearly with calculations or a few words, because "vision" is priceless!

PE is a changing value. In addition to being related to the company's fundamentals and growth rate, most of it is determined by market sentiment. Usually the market is overly optimistic and the market will give the company a relatively high PE. When the market is relatively pessimistic, the company's PE will be relatively low. Therefore, a company's reasonable PE is actually determined by market sentiment and is not a rational number.

Therefore, when determining a company's reasonable PE, it is best not to exceed its profit growth rate. Especially for growth companies, the PE should be set at 20% of the growth rate (this of course varies from person to person).

Company as asked, now $3.57 30% growth

The current reasonable price is simply calculated as 3.57 For investors who plan to hold it for a long time, the reasonable price may be different. Here is a partial explanation!

Next year’s value, estimated EPS =3.57 x 1.3 = $4.641

If the estimated growth is still 30%, the reasonable price next year = $4.641 x 30 = 139.23

Based on this calculation, the reasonable price after five years should be ($3.57) x (1.3)^5 x 30 =$3.57 x 3.71293 x 30 = $397.654803

This is an estimate. In the end, it depends on investors’ estimated growth rate to determine the reasonable price.

Now everyone gives 55 PE because they expect the future growth rate to reach 55, or investors are willing to wait longer. For example, after five years, at least the stock price can reach $397. However, excessive growth estimates may cause relatively high risks to investors.

If you're talking about Tesla, it's $185 today

In five years, if the stock price reaches $397 at a reasonable price

The annualized return is ($397 / 185). Taking the root of 5 years, we get the annualized return of 17.1%.

If you buy it for $107, you can achieve an annualized return of 30%

Think about it in Buffett's role, if Buffett's expected return is 20%. While in five years the reasonable value will be $397, he would now wait to buy it at around $155 or below.

（$397）/ （1.2）^5=$155

If you think about investing for ten years or more, and also believe that the company can grow at 30% for ten years, and the expected required return rate is at least 20%, then the value after ten years ($3.57) x (1.3)^10 x 30 = $1476

Expected return of 20%, current reasonable price ($1476) / [(1.2)^10] = $238

If another 20% off is used as a moat, the current safe price is $190

All the variables calculated above are determined by the following parameters.

1. Estimated growth rate

2. How long do you want to hold it?

3. Expected rate of return

4. Moat % off

If you are willing to pay a high price to buy, you need to plan to hold the investment for a longer period of time, or expect a higher growth rate, or lower the expected rate of return, or there is not much moat price space (you will suffer a larger loss in the short term).

Based on the above calculations:

Short-term investors who want to sell within a year are best to buy below $107. Relatively safe.

It can be held for five years and can be purchased at $155, which is relatively in line with the expected return.

If you want to be a long-term holder, if you have used it for ten years, you can buy it under $240. Can provide stable returns! It is best to buy at $190 which will be relatively safe.