Phil Town

What it Means When PEs and EPS Don't Add Up

Dave recently wrote to Phil Town and asked a good set of questions about PE ratios: 

"Why do some companies have a very high PE and low EPS or a low PE and high EPS? This raises a red flag to me when I see a company like US Steel (X $27.37) with a EPS of $18 and a PE of 1.5?"

Here's what it means:

A PE ratio is the stock price per share divided by the earnings per share.

Businesses are valuable to their owners because of the money they make (the earnings).  When an owner decides to set a price to sell the business, they take into consideration the money they are likely to make in the future if they kept the business. 

If it's a wonderful business (a.k.a. a "Rule #1 company"), the owner is quite certain to make money from the business for many years into the future.  For that reason, no owner of a wonderful business will sell it for just the earnings they were going to make in the next year. 

Owners insist on a price that reflects the certainty of the future earnings -- some multiple of today's earnings. 

TOO MUCH GROWTH?

A question for Phil Town

from Mark in Falls Church, VA:

I just had a quick question about upper boundries. In Phil Town's book you often repeat the necessity of moat numbers remaining at or above 10% but do you believe there to be any moat numbers that are too high? I've heard that in general 25% earnings growth is about the highest one should allow before things get scary.

Can there be too much growth?

Oh yes oh yes there can be too much growth.  The laws of compounding prove it.

HOW TO READ "INSTITUTIONAL OWNERSHIP" ON MSN

This question comes from Nitin in Elk Grove, CA:

I recently read your book and am researching potential Rule #1 companies. My question is regarding the importance of institutional ownership. I seem to recall that somewhere you recommend looking only at stocks that have 60% or more institutional ownership. Does that mean that I should exclude the others from analysis? Some stocks like INFY that otherwise look pretty good have low institutional ownership (I think only 11% for INFY).

My response:

First, let's get everybody on the same page.  On MSN Money put in INFY and on the left menu click on 'ownership'.  Notice where it reads "Ownership Information" it says shares outstanding are 554 million.  And right below that it says "Institutional Ownership" 11.40. 

But notice that below that it also says "Mutual Fund Ownership" 33.01.  I consider all these guys "institutional".  They, as a group, are the 'Big Guys' I write and speak about.  So the Big Guys own 44% of INFY.  (For MSN 'Institutions' are non-mutual fund Big Guys.)

DOUBLE CHECK YOUR NUMBERS

Ray from New York makes an interesting observation about data when he noticed that different sites had different numbers for YHOO EPS.   See below:

Hi Phil Town,

I have a question regarding EPS. For "yhoo" the EPS on finance.yahoo.com says 1.24, but finance.google.com says 0.54. On the other hand businessweek.com says 1.25 and nyse.com says 0.54.

So which number do I go by?

Thx,
Ray

The answer:

BusinessWeek and Yahoo Finance are correct.  The TTM EPS is 1.24 per share.  Investools has it right, too.  I checked into it and could find no obvious explanation for why the others are wrong.  Just a bad number.

And the lesson is that before we use real money, check the real SEC docs on the biz.  Always read the 10k and 10Q of any biz you are going to buy just as you would if it were the only business you were going to own for your family's financial future.

Now go play!

Phil Town

YHOO & INTANGIBLES FOLLOWUP

A few days ago, Monk brought up some interesting observations about YHOO and Intangibles in the Comments.

Our exchange is useful enough that I decided to reprint it here.

Monk's comment:

As a new student of all this, I agree that Intangibles do make this process all the more scary. I agree that GOOG has a low percentage of Intangibles, and that may have been a bad example. By my read, YHOO on the other hand seems to have a lot more Intangibles percentage than you came up with. From Morningstar's site, under the balance sheet for 2005, YHOO had a Total Equity of 8566.4 and Intangibles of 3430.2. Am I reading it wrong?

PREDICTING A COMPANY'S LONGEVITY

From the Comments under the YHOO post:

Question Phil. (And thanks for answering the email I sent to you.)  QUOTE:  "Still, as you pointed out, it would be very difficult to predict that YHOO is going to be around for sure in 20 years."

How did we know this early in GE or IBM's lief [sic] that they were going to be around 20 years? How do we know Whole Foods is going to be around. I think with any company there is a bit of speculation don't you think?

Do we have to wait for a comapny [sic] to be around 20 years to know that it is a good company to invest in?

Here's what I told him:

Excellent question:  How can we know that a business will be around in twenty years?

It's all about the first three Ms.  And in this case it's most particularly about the Moat. 

YOUR HOMEWORK: EBAY & YAHOO

Here's one from Ric. Read on:

Phil:

I must say that after reading your book twice I was very impressed and immediately began the process. I realize that Rule #1 works so well, because not many companies fit the specifications. A company must really do well to fit the model. 

I have begun the process and narrowed to three companies. One is almost ready for paper trading and the other two are (via my calculations) ready to go. I started trading on EBAY and YAHOO a few days ago and it looks like I'm losing money in both. Not a lot, but about a percentage point in both. What am I doing incorrectly?