There are many ways to measure how leverage a company can be.
For bond holders, they will typically be interested to know the liquidation value of the company since bondholders are senior to equity in their claim for assets on liquidation. The debt ratio will provide such a measure:-
Debt Ratio = Total Liabilities / StockHolder' Equity
To get a measure of the amount of leverage taken on by a company relative to its size, the Debt-to-Equity or Leverage ratio would provide such a measure. It disregard current liabilities as such liabilities are day-to-day related and short-term.
Leverage Ratio = Long Term Debt / StockHolder's Equity
To get a measure of whether a company can service its debt, the interest cover ratio will be useful. Because earnings rise and fall depending on market and economic conditions, it would be preferable if the company’s earnings were much higher than interest expense in most years; otherwise, investing in the company would incur significant risk when the economy falters, as it always does eventually
Interest Cover Ratio = EBIT / Interest Expense of Long Term Debt
Some companies use EBITDA to calculate interest cover ratio, but you should be careful in those circumstances as the usual claim is always Depreciation and Amortization is not actual cash expense and does not affect the ability to pay debt interest.
Monday, September 6, 2010
Sunday, September 5, 2010
Why I invest in SBS Transit
Everybody knows what SBS Transit does. It runs 75% of the buses in Singapore and the NE Line. It also manages the 17+ bus interchanges located throughout Singapore. It is one of those businesses perceived to go on and on but probably will grow very little and maybe shrink down a bit when the MRT coverage is more comprehensive. But it is a very stable business that will not be jolted in a severe recession. This is a stock that no analyst wants to cover because liquidity is low and it is so unexciting.
Before I invest, I made the following assessment:-
I calculated the total Cash from Operating Activities from 2002 to 2009. It is 918.5M.
The total capex from 2002 to 2009 is 573.2M. I noticed that in 2008 and 2009, capex was exceptionally high as SBS upgraded most of it fleet during the recession.It is not possible to do a meaningful assessment on a single period. A multi-year assessment is probably more appropriate.
The average FCF per year work out to be 43.2M.
I did not noticed any long term debt and cash and equivalent is about 14.8M
So the Enterprise value is 554M - 14.8M = 539.2M.
So, FCF / Enterprise Value work out to be 0.08. The company is generating 0.08 ct of cash per dollar of Enterprise Value. Assuming no major changes in operating environment, the company will be able to get back a dollar of cash in 12.5 years for a dollar of Enterprise Value.
But, I think there will be some upsides
1) With all the major capex done in 2008 and 2009, I believe the FCF moving forward will look better
2) There is the possibility that SBS will win another operating MRT line besides the NE Line due to its successful track record with NE Line and the desire to avoid a monopoly by the government
3) The resident population will most likely move up higher to around 6 to 6.5 million.
Hence, I vested at an average price of $1.73 a few months ago and had hence received two dividends totalling 8.8cts
Note: If a use Benjamin Graham's intrinsic value calculation, assuming only a 0.5% growth rate, it will be
intrinsic value (SBS) = 17.75 * (8.5 + 1) = 1.69. Pretty close to my purchase price, though
Before I invest, I made the following assessment:-
I calculated the total Cash from Operating Activities from 2002 to 2009. It is 918.5M.
The total capex from 2002 to 2009 is 573.2M. I noticed that in 2008 and 2009, capex was exceptionally high as SBS upgraded most of it fleet during the recession.It is not possible to do a meaningful assessment on a single period. A multi-year assessment is probably more appropriate.
The average FCF per year work out to be 43.2M.
I did not noticed any long term debt and cash and equivalent is about 14.8M
So the Enterprise value is 554M - 14.8M = 539.2M.
So, FCF / Enterprise Value work out to be 0.08. The company is generating 0.08 ct of cash per dollar of Enterprise Value. Assuming no major changes in operating environment, the company will be able to get back a dollar of cash in 12.5 years for a dollar of Enterprise Value.
But, I think there will be some upsides
1) With all the major capex done in 2008 and 2009, I believe the FCF moving forward will look better
2) There is the possibility that SBS will win another operating MRT line besides the NE Line due to its successful track record with NE Line and the desire to avoid a monopoly by the government
3) The resident population will most likely move up higher to around 6 to 6.5 million.
Hence, I vested at an average price of $1.73 a few months ago and had hence received two dividends totalling 8.8cts
Note: If a use Benjamin Graham's intrinsic value calculation, assuming only a 0.5% growth rate, it will be
intrinsic value (SBS) = 17.75 * (8.5 + 1) = 1.69. Pretty close to my purchase price, though
Cash Flow
I like to make a note here on Cash Flow because it is such an important item to be looked at when someone is evaluating a company, but more often than not, it is typically not highlighted in the press releases when reporting quarterly or annual results.
The cash flow of a business is the total amount of cash actually received in a given period minus the total amount of cash actually paid out in that same period. Positive cash flow is the receipt of more cash than was paid out; negative cash flow results from paying out more cash than receiving.
Cash Flow = Cash Received - Cash Paid
In accrual accounting, which most companies use, income is listed when it is earned, even before it is actually received, and expenses are recorded before the money is actually paid out. Depreciation or amortization, for instance, is an expense that doesn't require the immediate payout of cash. Thus, net income alone, which is the income after all expenses are subtracted from all income in a given time period is not an accurate representation of how much cash a company has, or even how much it is generating.
Cash Flow = Net Income + Depreciation + Other Noncash Expenses
For companies in matured or regulated industries, the main evaluation should really be the stability of their cash flow generation since at the end of the day, when you invest in these companies, what you really are investing is in the cash generating power of these businesses.
Watch out for the company Cash Flow from Operating Activities figure every quarter if you have significant investment in these companies. If you see major deviation in the trend, you should really find out why.
Additional concept you may encounter is Free Cash Flow (FCF)
Free Cash Flow (FCF) = Cash Flow from Operating Activities - Capex
FCF is a measure of how much value can be extracted from the company without altering the cash generating power of the company. You need not be alarmed if you see in certain quarter where the company may be running into negative FCF because it may need to make major capital expenditure during those times to upgrade the business. But consistent negative FCF over many quarters should be investigated thoroughly. If you consistently track these numbers with those companies you own, you will start to understand their businesses.
The cash flow of a business is the total amount of cash actually received in a given period minus the total amount of cash actually paid out in that same period. Positive cash flow is the receipt of more cash than was paid out; negative cash flow results from paying out more cash than receiving.
Cash Flow = Cash Received - Cash Paid
In accrual accounting, which most companies use, income is listed when it is earned, even before it is actually received, and expenses are recorded before the money is actually paid out. Depreciation or amortization, for instance, is an expense that doesn't require the immediate payout of cash. Thus, net income alone, which is the income after all expenses are subtracted from all income in a given time period is not an accurate representation of how much cash a company has, or even how much it is generating.
Cash Flow = Net Income + Depreciation + Other Noncash Expenses
For companies in matured or regulated industries, the main evaluation should really be the stability of their cash flow generation since at the end of the day, when you invest in these companies, what you really are investing is in the cash generating power of these businesses.
Watch out for the company Cash Flow from Operating Activities figure every quarter if you have significant investment in these companies. If you see major deviation in the trend, you should really find out why.
Additional concept you may encounter is Free Cash Flow (FCF)
Free Cash Flow (FCF) = Cash Flow from Operating Activities - Capex
FCF is a measure of how much value can be extracted from the company without altering the cash generating power of the company. You need not be alarmed if you see in certain quarter where the company may be running into negative FCF because it may need to make major capital expenditure during those times to upgrade the business. But consistent negative FCF over many quarters should be investigated thoroughly. If you consistently track these numbers with those companies you own, you will start to understand their businesses.
Saturday, September 4, 2010
Why I am giving Oceanus a miss right now
If you look at my portfolio, you may conclude that I am very conservative and will not and is not looking at investing into small high growth stock which pay little or no dividend. This is not exactly true though I am not terribly optimistic that I will find such opportunities frequently in the local market. They are by far too few and if they happen to be there, I may not be able to spot it early on and get invested.
But that does not stop me not continuously scouting and looking around for such potential. If I think I find one, I will be mostly willing to put some money in it.
Today, I will talk about one such potential that I have been looking at for a while but I must conclude that I am not convinced by it as yet. - Oceanus. This is an interesting case as all the standard valuation techniques cannot be used.
There is not FCF and actual sales is not exciting. Why Oceanus?
Yes, Oceanus - a land-based abalone farming company operating in Southern China whose Chairman is a Singaporean. It offer an enticing notion - more than a billion consumers in a rapidly affluence country where abalone is considered a "luxury" food item.
However, when I Iook into it a bit more, I am not comfortable with it. There is a possibility that it will take off but there is also a high chance that this will blow-up or just shrivel down and die away quietly. Or even sold off to some bigger acquaculture company at an unexciting price eventually.
First, the actual sales it not really there, RMB 106M in Q12010, RMB103M in Q22010. It made a net margin in both quarters by having a fair value gain in it biological asset (BA) of RM 177M in Q12010 and also RM 177M in Q22010. What is fair value gain in BA? It basically means that the abalones in the farm have gotten bigger and worth more in the market and new young abalone additions that did not exist last quarter. Now, this is counted as revenue which in reality the sales did not actually happen and the risk is still with Oceanus. Also, there is no guarantee that the market price will remain the same or go higher.
The bulk of Oceanus assets is in the BA, currently at RM 987M. Although, the company have taken some preventive steps to prevent large scale infection (by separating them into tanks) and insuring part of the BA assets, this is no guarantee that nothing bad will happen.
Most of Oceanus land-based farms are near the coast, a torrent of heavy floods or typhoons could possibly wreck havoc with the crop. There is also the possibility of poaching when the abalones have grown bigger and hence more valuable. I have not seen any comments by the management how they can prevent this from happening.
I also, read that abalone need 5-7 years to reach length and weight maturity. Small abalones are worth very much less than bigger ones. This means that Oceanus is currently "burning" cash very fast to feed the young abalones. Real profits are still a few years away.
Evidence from this is from the cash holding which drop from RM 561M in Q42009 to RM 185M in Q22010. Oceanus has recently completed two rounds of TDR in Taiwan to raise cash, I believe. They took a loan of $74M in 2009 at a interest rate of 9%. In exchange, they issue 490M warrants to the lenders which can be exercised at any time before 2012 at a price of 0.15ct/shr. There is definitely heavy dilution going on but I think this may not be suffice. I think they will need additional cash later on but I doubt they can get them on good terms. As at June 2010,one-third of the warrants have been converted. I guess they have been converted in exchange of TDR which is currently trading at a premium to the SGX shares. This may allow the investors a window to take risk off the table and profit.
I read from some sources that the ratio you can keep young abalones (< 1 year) to mature ones (> 5 years) in tank is about 12:1. Now, I think most of the abalones in Oceanus farms are young, if they grow bigger, they might have an issue with tank sufficiency. I read that there are going to put the bigger ones into into sea for conditioning and fattening, but I think the issues behind could be tanks sufficiency. Trying to acquire more tanks means acquiring more farms but the cost may be prohibitive. The group intend to implement sea-farming once the trial is successful to enhance weight and selling price, but we know sea farming is riskier than land-farming due to difficult to migitate natural disasters.
I also note that they tried unsuccessfully to established a cafe-style restaurant chain serving abalone-meals in China due to poor net margins. I wonder if demand for live abalone at the right price is so good in China, why the management need to bother about setting up a restaurant channel to consume the produce from the farms at this stage in the company growth cycle. Lately, they are turning to processing farm produce into canned abalones instead. With this, I am getting the impression that may not have sufficient confidence and market know-how in selling the live produce in the china market as yet when volume ramp-up.
Yes, despite all my analysis, I might turn out to be wrong and this will turn out to be an excellent opportunity. But as value investor, I look at it and decided that it is not worth taking the risk at 0.315cts/shr as I inclined to believe that there may be more dilution to go on to raise capital assuming no serious aquacultural disasters.
I hope to revisit Oceanus at some future date for a reassessment.
But that does not stop me not continuously scouting and looking around for such potential. If I think I find one, I will be mostly willing to put some money in it.
Today, I will talk about one such potential that I have been looking at for a while but I must conclude that I am not convinced by it as yet. - Oceanus. This is an interesting case as all the standard valuation techniques cannot be used.
There is not FCF and actual sales is not exciting. Why Oceanus?
Yes, Oceanus - a land-based abalone farming company operating in Southern China whose Chairman is a Singaporean. It offer an enticing notion - more than a billion consumers in a rapidly affluence country where abalone is considered a "luxury" food item.
However, when I Iook into it a bit more, I am not comfortable with it. There is a possibility that it will take off but there is also a high chance that this will blow-up or just shrivel down and die away quietly. Or even sold off to some bigger acquaculture company at an unexciting price eventually.
First, the actual sales it not really there, RMB 106M in Q12010, RMB103M in Q22010. It made a net margin in both quarters by having a fair value gain in it biological asset (BA) of RM 177M in Q12010 and also RM 177M in Q22010. What is fair value gain in BA? It basically means that the abalones in the farm have gotten bigger and worth more in the market and new young abalone additions that did not exist last quarter. Now, this is counted as revenue which in reality the sales did not actually happen and the risk is still with Oceanus. Also, there is no guarantee that the market price will remain the same or go higher.
The bulk of Oceanus assets is in the BA, currently at RM 987M. Although, the company have taken some preventive steps to prevent large scale infection (by separating them into tanks) and insuring part of the BA assets, this is no guarantee that nothing bad will happen.
Most of Oceanus land-based farms are near the coast, a torrent of heavy floods or typhoons could possibly wreck havoc with the crop. There is also the possibility of poaching when the abalones have grown bigger and hence more valuable. I have not seen any comments by the management how they can prevent this from happening.
I also, read that abalone need 5-7 years to reach length and weight maturity. Small abalones are worth very much less than bigger ones. This means that Oceanus is currently "burning" cash very fast to feed the young abalones. Real profits are still a few years away.
Evidence from this is from the cash holding which drop from RM 561M in Q42009 to RM 185M in Q22010. Oceanus has recently completed two rounds of TDR in Taiwan to raise cash, I believe. They took a loan of $74M in 2009 at a interest rate of 9%. In exchange, they issue 490M warrants to the lenders which can be exercised at any time before 2012 at a price of 0.15ct/shr. There is definitely heavy dilution going on but I think this may not be suffice. I think they will need additional cash later on but I doubt they can get them on good terms. As at June 2010,one-third of the warrants have been converted. I guess they have been converted in exchange of TDR which is currently trading at a premium to the SGX shares. This may allow the investors a window to take risk off the table and profit.
I read from some sources that the ratio you can keep young abalones (< 1 year) to mature ones (> 5 years) in tank is about 12:1. Now, I think most of the abalones in Oceanus farms are young, if they grow bigger, they might have an issue with tank sufficiency. I read that there are going to put the bigger ones into into sea for conditioning and fattening, but I think the issues behind could be tanks sufficiency. Trying to acquire more tanks means acquiring more farms but the cost may be prohibitive. The group intend to implement sea-farming once the trial is successful to enhance weight and selling price, but we know sea farming is riskier than land-farming due to difficult to migitate natural disasters.
I also note that they tried unsuccessfully to established a cafe-style restaurant chain serving abalone-meals in China due to poor net margins. I wonder if demand for live abalone at the right price is so good in China, why the management need to bother about setting up a restaurant channel to consume the produce from the farms at this stage in the company growth cycle. Lately, they are turning to processing farm produce into canned abalones instead. With this, I am getting the impression that may not have sufficient confidence and market know-how in selling the live produce in the china market as yet when volume ramp-up.
Yes, despite all my analysis, I might turn out to be wrong and this will turn out to be an excellent opportunity. But as value investor, I look at it and decided that it is not worth taking the risk at 0.315cts/shr as I inclined to believe that there may be more dilution to go on to raise capital assuming no serious aquacultural disasters.
I hope to revisit Oceanus at some future date for a reassessment.
Friday, September 3, 2010
MiiF
I bought into MiiF a few months ago. My average purchase price of MiiF is 0.509. I am due to receive my first dividend this month.
The reason I purchased this stock is very simple - I do not want to lose money but is also very conscious of the volatility recently. Remember, money in the bank doesn't earn anything. I remember Warren Buffet who says the first rule of investing is "Do not lose money". The second rule is "Remember the first rule".
For 1H10, MIIF announced a distribution of 1.5 cents per share which will be paid on Sept 9. The fund has no borrowings at the corporate level, cash of 36 cents per share, and NAV is 80 cents. Dividends for 2H10 are expected to be maintained.
They have a 38% stake in Changshu Xinghua Port (Jiangsu), an 81% interest in Hua Nan Expressway in Guangdong, 20% stake in Taiwan Broadband Communications (TBC) and a 100% stake in Miaoli Wind, a wind farm in Taiwan. They have divested all the non-Asian assets.This means I am only paying 14.09 cents for the three major Asian assets (Miaoli Wind is assigned a zero asset value in the B/S - I think a mistake they made in the past with this acquisition). The book value for the three Asian assets is 44cents/shr.
MiiF track record before I made my purchase was spotty partly due to timing (2008/2009 crisis) and partly management lack focus and strategy. But, I am buying at an average price of 0.509 when the IPO price is $1. There are no rights or dilution in between my purchase and IPO. However, I could sense from recent statements that management have realise their mistakes into making too many minority stake purchases all over the globe with a small Fund.
I also check the composition of the board. I think I have quite a bit of buffer on this one.
I must admit that I did not check on the debt status of the underlying assets though. Sometimes, it is possible for the Fund to be debt free but the underlying assets may be overloaded with debt.
The reason I purchased this stock is very simple - I do not want to lose money but is also very conscious of the volatility recently. Remember, money in the bank doesn't earn anything. I remember Warren Buffet who says the first rule of investing is "Do not lose money". The second rule is "Remember the first rule".
For 1H10, MIIF announced a distribution of 1.5 cents per share which will be paid on Sept 9. The fund has no borrowings at the corporate level, cash of 36 cents per share, and NAV is 80 cents. Dividends for 2H10 are expected to be maintained.
They have a 38% stake in Changshu Xinghua Port (Jiangsu), an 81% interest in Hua Nan Expressway in Guangdong, 20% stake in Taiwan Broadband Communications (TBC) and a 100% stake in Miaoli Wind, a wind farm in Taiwan. They have divested all the non-Asian assets.This means I am only paying 14.09 cents for the three major Asian assets (Miaoli Wind is assigned a zero asset value in the B/S - I think a mistake they made in the past with this acquisition). The book value for the three Asian assets is 44cents/shr.
MiiF track record before I made my purchase was spotty partly due to timing (2008/2009 crisis) and partly management lack focus and strategy. But, I am buying at an average price of 0.509 when the IPO price is $1. There are no rights or dilution in between my purchase and IPO. However, I could sense from recent statements that management have realise their mistakes into making too many minority stake purchases all over the globe with a small Fund.
I also check the composition of the board. I think I have quite a bit of buffer on this one.
I must admit that I did not check on the debt status of the underlying assets though. Sometimes, it is possible for the Fund to be debt free but the underlying assets may be overloaded with debt.
Thursday, September 2, 2010
Understanding ROA/ROE/ROIC
When you go through company annual or quarterly reports, you will encounter things like ROA/ROE and ROIC. It is important to have an inkling what they are especially when you have thousands of dollars vested in them.
Return of Assets (ROA). It is basically a measure of a company efficieny in translating assets into profits.
ROA = Net Margin * Asset Turnover where
Net Margin = Net Income / Sales and
Asset Turnover = Sales / Assets
Net Margin tells you how much each dollar of sales a company keeps as earnings after paying all the cost of doing business
Asset Turnover tells us roughly how efficient a company is at generating sales from each dollar of asset.
With ROA, there are two routes to operation profitability either by charging higher prices (high net margin) or turning over assets quickly. But ROA if fine if companies are just a pile of assets but in reality, many companies are partially finance by debt, which gives their return a leverage component which need to be taken into account.
Return on Equity (ROE)
Return on Equity is a measure of a company's profitability based on its efficiency with which the company is using shareholder's equity.
ROE = ROA * Financial Leverage where
Financial Leverage = Assets / Shareholder's Equity
Financial Leverage is a measure of how much debt a company carries relative to shareholder's equity.
Hence, ROE = Net Margin * Asset Turnover * Financial Leverage
There are three levers that can boost ROE - Net Margin, Asset Turnover an Financial Leverage. Utilities, is a good example of companies using Financial Leverage to boost ROE (CitySpring, SP Ausnet in my portfolio are all classic examples)
Return on Invested Capital (ROIC)
ROIC improves on ROA and ROE because it put the debt and equity financing on an equal footage. It removes the debt-related distortion that can make highly leveraged company looks very profitable when using ROE.
ROIC = Net Operating Profit After Taxes (NOPAT) / Invested Capital
Invested Capital = Total Assets - Non-interest bearing current liabilities (ie A/P) - Excess Cash (not needed in day-to-day ops) - Goodwill
Return of Assets (ROA). It is basically a measure of a company efficieny in translating assets into profits.
ROA = Net Margin * Asset Turnover where
Net Margin = Net Income / Sales and
Asset Turnover = Sales / Assets
Net Margin tells you how much each dollar of sales a company keeps as earnings after paying all the cost of doing business
Asset Turnover tells us roughly how efficient a company is at generating sales from each dollar of asset.
With ROA, there are two routes to operation profitability either by charging higher prices (high net margin) or turning over assets quickly. But ROA if fine if companies are just a pile of assets but in reality, many companies are partially finance by debt, which gives their return a leverage component which need to be taken into account.
Return on Equity (ROE)
Return on Equity is a measure of a company's profitability based on its efficiency with which the company is using shareholder's equity.
ROE = ROA * Financial Leverage where
Financial Leverage = Assets / Shareholder's Equity
Financial Leverage is a measure of how much debt a company carries relative to shareholder's equity.
Hence, ROE = Net Margin * Asset Turnover * Financial Leverage
There are three levers that can boost ROE - Net Margin, Asset Turnover an Financial Leverage. Utilities, is a good example of companies using Financial Leverage to boost ROE (CitySpring, SP Ausnet in my portfolio are all classic examples)
Return on Invested Capital (ROIC)
ROIC improves on ROA and ROE because it put the debt and equity financing on an equal footage. It removes the debt-related distortion that can make highly leveraged company looks very profitable when using ROE.
ROIC = Net Operating Profit After Taxes (NOPAT) / Invested Capital
Invested Capital = Total Assets - Non-interest bearing current liabilities (ie A/P) - Excess Cash (not needed in day-to-day ops) - Goodwill
Wednesday, September 1, 2010
Investment Return & Speculative Return
The stock market has risen quite a bit in the last to days. I thought it may be apt to talk about the above.
Typically, investment return is the appreciation of a stock because of its dividend yield and subsequent earnings growth, whereas speculative return comes from the impact of changes in the P/E ratio.
Let's take a stock that trades for $30 per share, earns $1.50 per share and pays $1.00 in annual dividend. Assuming that earnings and dividends grow at 6% percent per year, and initial P/E ratio of 20 does not change.
After 5 years, earnings will be $2.01. So the stock should trade at $2.01 * 20 =
$40.20. Also, received in total $5.64 dividends. This work out to an annualized return of 8.8%, which is the investment return. Speculative return is zero because P/E did not change.
However, if earnings and dividends grow at the same rate, but P/E ratio decreases from $20 to $15. Then we will still have $2.01 in earnings after 5 years. The stock should trade at $2.01 * 15 = $30.15. Add in the $5.64 dividends which remain unchanged, the annualized return shrink to 3.6%. Conversely, a rise in P/E from 20 to 25 whould yield a fat annualized return of 13.3%
Conclusion, if you buy an excellent company which spits out consistently earnings and dividends like a clockwork but at a high price ie high P/E ratio, you will still suffer with a speculative decline when P/E ratio shrinks due to revaulation process. The dotcom bubble is a classic example when P/E steered into stratospheric regions without regard for fundamental valuation.
You should always pay for an asset less than your estimate of its value and not based on the hope that there will be someone willing to pay a higher price for it some time in the future.
Typically, investment return is the appreciation of a stock because of its dividend yield and subsequent earnings growth, whereas speculative return comes from the impact of changes in the P/E ratio.
Let's take a stock that trades for $30 per share, earns $1.50 per share and pays $1.00 in annual dividend. Assuming that earnings and dividends grow at 6% percent per year, and initial P/E ratio of 20 does not change.
After 5 years, earnings will be $2.01. So the stock should trade at $2.01 * 20 =
$40.20. Also, received in total $5.64 dividends. This work out to an annualized return of 8.8%, which is the investment return. Speculative return is zero because P/E did not change.
However, if earnings and dividends grow at the same rate, but P/E ratio decreases from $20 to $15. Then we will still have $2.01 in earnings after 5 years. The stock should trade at $2.01 * 15 = $30.15. Add in the $5.64 dividends which remain unchanged, the annualized return shrink to 3.6%. Conversely, a rise in P/E from 20 to 25 whould yield a fat annualized return of 13.3%
Conclusion, if you buy an excellent company which spits out consistently earnings and dividends like a clockwork but at a high price ie high P/E ratio, you will still suffer with a speculative decline when P/E ratio shrinks due to revaulation process. The dotcom bubble is a classic example when P/E steered into stratospheric regions without regard for fundamental valuation.
You should always pay for an asset less than your estimate of its value and not based on the hope that there will be someone willing to pay a higher price for it some time in the future.
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