Mark is a policeman in Kansas City who found Garmin for us about a year ago. He did the 4M analysis and determined that the business had Meaning, Moat, and Management and that the Sticker Price was $80 with an MOS of $40. It was priced very near the MOS at the time and Mark jumped in there. Here is his result to date:
"Looking at my account, it's reporting a net gain of 62.65%. Much better than the .1% that same money was getting in a savings account!"
He's continued to stay on top of GRMN developments and thinks the products and moat are better than ever. And here is his question:
"So here's my dilemma, rerunning the same numbers I sent to you in May (P/E = 25, Growth rate of 20%) and updating the EPS to its current $2.85, I get a sticker of $109... so do I sell at my first sticker of $80 or hold out for something closer to $109?"
Wonderful businesses have this thing in common -- they are more successful than most at consistently growing their sales, earnings, equity and cash flow. If GRMN is growing all four of these steadily at that same 20% rate, if the ROIC remains solid (not dropping), and if they are not loading up with debt, then it's time to reevalutate the Sticker Price.
First thing to do is to get on GRMN's website and listen to the management discuss their future expectations. They put a transcript of their latest chats with analysts in Investor Relations under Events Calendar. I would also read the latest SEC filing called the 10Q (filed quarterly) or the 10K (filed annually). They file that on their website in Investor Relations under Financial & SEC.
Mark, in this case, I would especially dig in on the Moat. You are rapidly becoming an expert in the field of GPS devices. As an expert, do you think that Garmin can compete without lowering its prices, or will Garmin have to compete with TomTom on price?
Is Garmin's moat huge like Coke or is it narrow like Ford? In other words, how big a Moat does Garmin have that can protect it against competition? The reason I ask is that the analysts who follow this industry seem to think that Garmin can't keep getting 23% earnings growth. They think it's going to get cut down by more competition and that Garmin will be forced to compete on price.
Do you think so, too? It might be fun to ask the gang at Garmin what they think. Why don't you get on the next conference call with the Garmin execs and the analysts and jump in there and ask that question (unless it's already been asked and answered). Let us know what happens.
So assuming you like what you hear, it's time to re-do the Sticker.
And we go through the same process we did a year ago:
1. Compare your
estimate of growth rate to the analysts.
You'll notice they are predicting 15%. And when you look at Zack's numbers the range is fairly narrow for the 5 analysts who are willing to call the growth rate. They range from 13% to 18%.
But when we look at GRMN's historical numbers both long and short term, the equity growth rate is above 20%, the EPS is above 23%, and sales and cash are growing even faster. ROIC is off the chart. Really Mark, the numbers here are just beautiful.
The rule is to go with the lower of our best estimate or the analysts -- simply because I fear they might know something I should know but don't. But this is very tempting to give it at least a 20% growth rate again. Thus I am urging you to answer the Moat question.
2. I also would give a quick look at historical PE.
The range of the multiple that Garmin sells for over its earnings goes from 12 to 35 -- big range. I'd be comfortable putting the PE at 30 historically instead of the 26 you are using. A 26 reflects more like a 13% expected growth rate, and GRMN is better than that. Sure, the price will drop with normal market fluctuations, which will take the actual PE down to 12 sometimes -- but those same normal fluctuations will also put it at 36 from time to time.
3. Then I look at my growth rate, double it and see if that number is lower or higher than 30.
A 20% growth rate gives
me a 40 PE. Higher. And a 15% growth rate gives me a 30 PE. Same.
4. So let's run both sets of numbers and see what we get:
We start with the average analysts growth rate of 15%, a 30 PE and the trailing twelve months eps of $2.85.
If you are doing this with the Rule of 72, you double the $2.85 twice -- since 15 (growth rate) goes into 72 five times, which means 5 years to double once... and we're doing a ten year projection -- therefore two doubles.
So $2.85 doubles once to $5.70 and again to $11.40.
Now we apply the multiple of 30 to get the price -- $340 or so.
And now we divide by 4 to get Sticker Price. [Since our
minimum acceptable return is 15% a year, which we already know doubles
twice in ten years -- therefore 1 becomes 2 and 2 becomes 4... meaning all we have to do is divide by 4 to get to Sticker. A little confusing for those of you who don't love math, but trust me, it works.]
$340
divided by 4 is $85. If you do this with an excel spread sheet or on
Investools valuation tool you get $88 for the Sticker.
The current price is $75, not even 20% below the Sticker -- so we've mostly lost our MOS if the $88 is right. If we stay with this one, we're sticking in there to make a 15% return this year if everything goes well.
If you use a higher growth rate -- say 20% as you suggest -- that will double us up every 3.5 years (72 divided by 20) and that is about 3 doubles in ten years, right?
So instead of $11.40 in ten, we get one more double to $23. Now apply the 30 PE and we get $690 for the future price. Divide that by 4 (since our minimum acceptable rate of return is always 15%) and we get a Sticker of $170.
Wow. Big difference that extra double made. It doubled the Sticker Price.
So now what? The stock price is $75 and with analyst estimates we get a Sticker of $88... and with the historical growth rate we get $170.
This is a great example of how important it is to know your business. Mark, the best thing to do here is to act as if you had 8 billion dollars and were thinking of buying the entire business, and once you made that investment, Garmin was going to become your only source of income for the rest of your life. Obviously you would want to make sure you were buying a wonderful business at an attractive price. You don't have to steal the company. But you do have to get a fair price. And that means you need to know what it's worth today as a business.
Without knowing if they are going to have to compete on price, it's very hard to know what this business is worth. Clearly the range of reasonable prices is giagantic -- almost double depending on how you view the future battles looming in the GPS field.
If I'm doing this and love the business and feel good about the moat, I'm going to split the difference and put the Sticker Price about where you suggested, at $109 to $120 someplace. And it turns out that if you use the upper range of analyst projections and a 30 PE you get a Sticker of $120.
All of this work is to get us comfortable that the Sticker price today has increased 20% or so above what it was a year ago -- so we can continue to stay with this investment and expect at least 15% a year on the return. In this case, I'd be good with that.
And now that I've said all that, I'll add one more thing -- if you learn to use some technical tools, you can be more confident about using the higher valuation simply because the signals will tell you that the big guys are selling and you can sell, too. You won't make as much money if you are right about the continued 20% plus growth because you'll be getting in and out and you will inevitably miss some nice gaps up. But you will also not ride the stock down from some high point.
So that would be my suggestion. Go with your valuation and start learning how to read the tech signals on MSN Money.
Now go play!
