Take a look at the table and graph given below. Company A earns $10 every year and has a payout ratio of 100%. Company B earns $10 and has a payout of 50%. It reinvests the remaining 50% to engender its growth. Company A doesn’t grow at all and B grows at a constant rate of 5%…
The earnings that you can take out of the business every year without affecting its competitive position is called as Owner Earnings. I wrote about it in detail here. This term was coined by Warren Buffet and the formula for calculating it is given below. The capital expenditure (capex) he refers to is maintenance capex and…
In 1991 letter to shareholders, Buffett explained his thought process in valuing a business. Given below is the excerpt from the letter. A few years ago the conventional wisdom held that a newspaper, television or magazine property would forever increase its earnings at 6% or so annually and would do so without the employment of additional…
I wrote three posts discussing about (1) p/e ratio (2) discounted cash flows (3) owners earnings (4) residual earnings (5) leverage effects on residual earnings. You can find all of them here. If you haven’t read them, I strongly recommend that you read them before reading this post. In this post I will be discussing about the limitations…
In the first post we learnt about the pitfalls of P/E ratios and the limitations of using discounted cash flows. Buffett owners earnings fixed most of the shortcomings. In the second post we learnt about valuing a company using residual earnings method. But residual earnings has few limitations. One of them is that return on equity…
Seeking Wisdom 