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The results of this poll are astounding to me.
It suggests approx. 86% of my followers that responded have a different view than me on intrinsic value.
THREAD on my potential blind spots. https://twitter.com/treyhenninger/status/1286687929532854273
It suggests approx. 86% of my followers that responded have a different view than me on intrinsic value.
THREAD on my potential blind spots. https://twitter.com/treyhenninger/status/1286687929532854273
I use Shareholder Distributions + Growth to estimate long term investment returns. (Here dividends + growth.)
14% of respondents agreed.
The reason for this answer is that retained earnings are typically necessary to receive future earnings growth.
14% of respondents agreed.
The reason for this answer is that retained earnings are typically necessary to receive future earnings growth.
If you use Earnings Yield + Growth, you fall into a problem of “double counting.”
Earnings Yield = Distributions + Retained Earnings
Yet, Growth = Retained Earnings * ROIIC. (Usually shorted for be retained earnings * return on invested capital.)
Earnings Yield = Distributions + Retained Earnings
Yet, Growth = Retained Earnings * ROIIC. (Usually shorted for be retained earnings * return on invested capital.)
Notice how Retained Earnings is being counted on both the Earnings Yield component and the Growth component?
This is where the investment mental model “cost of growth” comes into play.
Growth is not “free” for most companies. It costs you something.
This is where the investment mental model “cost of growth” comes into play.
Growth is not “free” for most companies. It costs you something.
If a company pays dividends it cannot use that capital to grow.
Likewise, if a company retains earnings to grow, it cannot use that capital to pay dividends.
Failure to account for this “cost of growth” will lead to overvaluing growth companies.
Likewise, if a company retains earnings to grow, it cannot use that capital to pay dividends.
Failure to account for this “cost of growth” will lead to overvaluing growth companies.
A few rare companies don’t require incremental capital to grow. Or ROIC is so high as to be meaningless (>100% or infinite)
Examples: $OMC, $OTCM, $MCO
Yet, these companies are rare. Even then, my formula works best because their distributions will = or > Earnjngs Yield.
Examples: $OMC, $OTCM, $MCO
Yet, these companies are rare. Even then, my formula works best because their distributions will = or > Earnjngs Yield.
Investors have a problem if they assume all companies can grow for free. They will end up double counting retained earnings.
This leads me to the Asset / Earnings equivalence mental model.
The best counter argument I’ve seen is that retained earnings don’t disappear. They go to the balance sheet. They buy land, equipment, assets, etc... Those assets have value and can later be sold.
The best counter argument I’ve seen is that retained earnings don’t disappear. They go to the balance sheet. They buy land, equipment, assets, etc... Those assets have value and can later be sold.
The problem? Assets are only as valuable as the earnings they create.
If you sell the assets the earnings will disappear.
You only ever get earnings or assets. Never both.
Again we have an instance where double counting can lead to overvaluation.
If you sell the assets the earnings will disappear.
You only ever get earnings or assets. Never both.
Again we have an instance where double counting can lead to overvaluation.
Asset sales are useful when they are underutilized and not contributing enough to earnings. That’s when they count.
Yet retained earnings used for growth are already achieving optimal usage.
Yet retained earnings used for growth are already achieving optimal usage.
Be careful about overvaluing your companies.
This thread has inspired me to record a podcast episode on the topic.
Will send it out once complete. Follow me to be sure you don’t miss it.
This thread has inspired me to record a podcast episode on the topic.
Will send it out once complete. Follow me to be sure you don’t miss it.
