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Buffettology: Sustainable Growth Strategy

Written by Sakshi Jain
Tue Mar 16 2021
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Buffettelogy: Sustainable Growth Strategy

Introduction

The Buffettology method is a comprehensive investing strategy used by the world-renowned Investor, Warren Buffet, as mentioned by one of her daughters-in-law Mary Buffet along with David Clark in their book, The New Buffettology. This strategy brings together Buffett’s focus on value and business quality. It helps to work out whether the stock is reasonably valued. The strategy tries to forecast the companies that possibly have a durable competitive advantage. This strategy gained popularity due to its unique identification style, which Mary Buffet explains as “Consistency is everything. Warren is not after a company that occasionally has high returns on shareholders’ equity, but one that consistently earns high returns’’, in her book.

Learn to Invest – Warren Buffet style

The Buffettology claims and analyses whether every stock is reasonably valued, the strategy forecasts sustainable earnings growth; the higher that growth rate is, the more likely it is that the company has a durable competitive advantage. The strategy also looks for low debt and a growing earnings yield, return on equity and return on capital employed. Buffett is famous for looking beyond financial measures when examining the quality of a business franchise. Buffett targets successful businesses with excellent economics, competent management, and expanding intrinsic values. He seeks to buy at a price that makes economic sense, defined as earning a long-term annual rate of return of at least 15%. 

Buffett uses the average rate of return on equity and average retention ratio (1 – average payout ratio) to calculate the sustainable growth rate [ROE * (1 – payout ratio)]. The sustainable growth rate is used to calculate the book value per share in year 10 [BVPS ((1 + sustainable growth rate) ^10)]. Earnings per share can be estimated in year ten by multiplying the average return on equity by the projected book value per share [ROE * BVPS]. To assess the future price, you multiply the earnings by the average price-earnings ratio [EPS * P/E]. If dividends are paid, they can be added to the projected cost to compute the total gain.

Working explained using the MarketXLS template
Follow the below mentioned steps to fill out the template and seek information:

  • Step 1: The investor needs to enter the stock ticker in the Index sheet.

  • Step 2: The investor needs to enter the year in the Index sheet.

  •  The template will display the result as per Buffettology’s sustainable growth screen.

 

Enter Stock Ticker  TSLA
Stock Name Tesla Inc.
Sector Consumer Cyclical
Industry Auto Manufacturers
Current Year 2021

 

Year 2020 2019 2018 2017 2016 2015
EPS 0.64 -0.16 -0.2 -11.83 -4.68 -6.93
EPS Growth -500.00% -20.00% 2.00% 152.78% -32.47%
Return On Equity 3.90% -11.70% -21.60% -52.90% -16.30% -82.00%
Return On Capital Employed 4.30% -2.00% -2.90% -11.50% -5.80% -20.90%
Free Cash Flow Per Share 2.81 1.07 -0.26 -24.54 -9.68 -16.43
Long Term Debt  9607 11634 9404 9418.389 7301.577 2269.767
NP Before Extraordinary Items 690 -870 -976 -1962 -674.914 -888.663
NAV 16.91 6.67 5.22 27.91 7.62 7.62
Price 215.962 44.568 68.9 72.322 42.456 53.652
Earnings Yield 0.30% -0.36% -0.29% -16.36% -11.02% -12.92%

 

Criteria (Quantitative)             ———
EPS Growth Streak >4 0
ROE % 5y Avg > 15% 0
ROCE % 5y Avg > 12% 0
FCF >0 1
Price 5y CAGR > 0% 1
NAV 5y CAGR > 0% 1
Debt < Net Profit before Extraords 0
Earning Yield % > 3 0
Total Score 3

 

 

Criteria (Qualitative)
Qualifies in top 200 stocks sorted by Exp Return 1 Enter 1 if Yes & 0 if No.
Total Score 1

 

Does the stock pass the Sustainable Growth Screen? NO

Expected Parameters

The requirements from a company’s stocks to flourish on the sustainability growth screen strategy pertaining to Buffettology can be evaluated as per below mentioned points:

  • The five year average of return on equity should be greater than 15%. 
  • The five year average of return on capital employed should be greater than 12%. 
  • The free cash flow (TTM) should be greater than 0 million. 
  • The Long Term Debt Latest should be less than  5 x Net Profit Before Extraordinary TTM
  • The 5 Year Compound Annual Growth Rate should be greater than 0%.
  • The 5 Year Book Value Per Share Compound Annual Growth Rate should be greater than 0%
  • The earnings yield of last year should be greater than 3%.
  •  The Expected Return (Sustainable Growth) estimate should be greater than 15%
  • The stock should qualify in the top 200 stocks sorted by Expected Return Descending.

 

Conclusion 

Warren Buffett’s approach identifies “excellent” businesses based on the industry’s prospects and management’s ability to exploit opportunities for shareholders’ ultimate benefit. The approach makes use of “folly and discipline”: the discipline of the investor to identify excellent businesses and wait for the folly of the market to buy these businesses at attractive prices. For individual investors who want to duplicate the process, it requires a considerable amount of time, effort, and judgment in perusing a firm’s financial statements, annual reports, and other information sources to thoroughly analyze the business and quality of management. 

Disclaimer

None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein. The article is written for helping users collect the required information from various sources deemed to be an authority in their content. The trademarks if any are the property of their owners and no representations are made.

References

https://www.stockopedia.com/

https://web.csulb.edu/

 

 

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