100 To 1 in The Stock Market - Seeking Wisdom

100 to 1 in the stock market | Seeking Wisdom
http://janav.wordpress.com/2014/09/02/100-to-1-in-the-stock-market/
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Jana Vembunarayanan / September 2, 2014
One of the best ways to learn any domain deeply is to look at the actions of the
experts in that domain and clone it. Cloning is not blind copying but instead it is
rediscovering the reasons behind those actions and learning from it. This way we
increase our odds of becoming an expert one day. I have seen this working in (1)
Investments in the form of 13Fs (2) Programming; reading the code written by
engineers better than us (3) Reading books which are read by people better than us.
I follow few experts when it comes to reading books. I purchased the book 100 to 1
in the stock market by Thomas W. Phelps as soon as I saw the recommendation
given below. In this post I will be summarizing some of the key ideas from it.
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Meet Mr. Paul Garrett

Paul Garret was an accomplished man facing retirement in 1956 at the age of 64. He
determined to make his last years his best years rather than sit out the rest of his life
as so many pensioners do. He wanted to increase his wealth in order to increase his
power to help others. He did not have any children so he was not heir-selfish. He
decided to increase his wealth by investing in fast growing companies that met his four
criteria.
Excerpt from: 100 to 1 in the stock market

1. It must be small. Sheer size militates against great growth.
2. It must be relatively unknown. Popular growth stocks may keep on
growing but too often one has to pay for expected growth too many
years in advance. Probably to meet this criterion the stock he wanted
would be traded overthe-counter rather than on any stock exchange.
3. It must have a unique product that would do an essential job better,
cheaper, and/or faster than before, or provide a new service with
prospects of great and long-continued sales increases.
4. It must have a strong, progressive, research-minded management.
He had few friends in the Wall Street and in business. Without asking for any
confidential information he asked for the names of smaller companies which they liked
but were not sure of. He came up with a list of fifty stocks. Then he did his homework
on these companies by studying their financial reports. He shortlisted three of them
and did field trips and met their chief executive officers. Finally he chose one, Haloid,
now Xerox, and invested $133,000 in its stock between 1955 and 1959. On average
each stock costed him $1. In 1971 each stock was selling for around $125. His initial
investment grew from $133,000 to $16,625,000. His wealth compounded at 32.85% in
17 years.
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Sounds easy, but Mr. Garrett first had to find the stock he wanted. Then
he had to buy it in the face of recommendations against it by people who
either knew nothing about, or had pets they liked better, or believed in
diversification no matter what. And finally, he had to hold on, and buy
more, against repeated sell recommendations he began to receive
even before the stock had double in price.
The key takeaway is: To make money in stocks you must have the vision to see
them, the courage to buy them and the patience to hold them. Patience is the
rarest of the three.
Where does one look for 100-to-one stocks?

Making a 100 bagger in the stock market is a black swan event. For that happen
we need to get exposed to them. Phelps suggests the following places to get an
exposure to them.
1. Inventions that enable us to do things we have always wanted to do but could
never do before. Some examples are automobiles, airplane and television.
2. New methods or new equipment for doing things we long have had to do but
doing them easier, faster, or at less cost than before. Some examples are
computers and earth-moving machinery.
3. Processes or equipment to improve or maintain the quality of a service while
reducing or eliminating the labor required to provide it. Some examples are
disposable syringes and frozen foods.
4. New and cheaper sources of energy such as kerosene replacing whale oil, fuel
oil replacing oil, and electricity generated by atomic power replacing them all.
5. New methods of doing essential jobs with less or no ecological damage. An
example is the use of sterilized insects to wipe out a pest rather than employing
chemicals harmful to many desirable forms of life.
6. Improved methods or equipment for recycling the materials used by civilized
man instead of making mountains of waste and oceans of sewage.
7. New methods for delivering the morning newspaper without carriers or waste,
yet having it instantly available for review at later date. Think of Internet.
8. New methods or equipment for transporting people and goods on land without
wheels.
Four categories of stocks producing 100-to-one returns

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There are four categories of stocks that can produce 100-to-one returns. They
are (1) Advance primarily due to recovery from extremely depressed prices at bottom
of greatest bear market in American history. Special panic or distress situations at
other times belong in this group too. (2) Advance primarily due to change in supplydemand ratio for a basic commodity, reflected in a sharply higher commodity price.
(3) Advance primarily due to great leverage in capital structure in long periods of
expanding business and inflation. (4) Advance primarily due to the arithmetical result of
reinvesting earnings at substantially higher than average rates of return on invested
capital.
My favorite is the fourth category and this is what Buffett and Munger does. This book
was written in 1972 and the author explains about the durable competitive advantages
of a business by using the word gate. Buffett fans should read it as moat. Remember
in 1972 Buffett was still practicing Graham style of cigarbutt investing and this guy has
already figured out the holy grail of investing.
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My fourth category of stocks showing one hundredfold appreciation is
that of companies reporting a far above-average rate of return on
invested capital for many consecutive years. In such issues the
investor has simple arithmetic and Father Times on his side. Even
in this category, however, there is no free lunch, no sure thing. First
there is the danger that the high rate of return on invested capital may
attract too many competitors. No business is so good that it cannot be
spoiled if too many get into it. It is vitally important that the high rate
of return be protected by a gate making entry into the business
difficult of not impossible. Such gates may be patents, incessant
innovation based on superior research and invention, ownership of
uniquely advantageous sources of raw material, exceptionally
well-established brand names you can fill in others as you choose. Just
be sure the gate is strong and high. Most of us want pretty much the
same material things in life good food, good clothes, a home on the
right side of the railroad tracks, good schools for our children. To get
more than the average we must be able to do more than the average, or
do what we do better than the average. If all we can do is take in
washing there will always be someone down the street ready to take it
for two cents a pound less than our price.
Thousands of investors have owned one or another of these 100-to-one
high-gate stocks at sometime or other in the last forty years. Probably
not one in a thousand has held his winner until it increased one
hundredfold in value. All of course wish they had done so. Yet it would
be just as great a mistake to assume that what has been will continue to
be forever and ever. Or to pay now for all the growth that can be
foreseen.
The total number of years and the rate of return required to increase the stock price
to increase by 100 times is given below. Albert Einstein is absolutely right when he
said that compounding is the eighth wonder of the world.
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Figuring the odds

Investing is not a game against nature, but against other investors. Both buyers and
sellers are acting on the same information but doing opposite things. Who is right? The
recent earnings and dividends reported is history and the seller already enjoyed the
benefits. As a buyer you are buying an unknown future. Investing is a game of
probabilities and possibilities but not certainties. A rational investor should
understand this. If not he is a damn fool. Stock market is like the game of poker. A
wise investor bets big only when the odds are stacked heavily in their favor. If not they
dont do anything.

By seeing favorable probabilities that are greater than generally
appreciated, or finding stocks priced at levels which discount rather fully
the unfavorable probabilities apparent to all. In the first instance the
buyer simply recognizes a value that others do not see. In the second
case the buyer says in effect, Since the price of this stock already is
discounting the worst that can be seen for it, there is no downside risk.
And since the soup is rarely eaten as hot as it is cooked, the buyer is
likely to get more than he is paying for.
Buffets purchase of Coke falls into the first category and his purchase of American
Express falls into the second category. But how can we measure what millions of
other investors are expecting? Phelps gives a logical solution for this with three simple
rules (1) The value of any security is the discounted present worth of all future
payments (2) A dollar of income from one fully taxable source is worth as much as
dollar of income from any other fully taxable source (3) Hence it follows that when
investors pay more for a dollar of income from one source more than they need to pay
to get an equivalent dollar of income from another source they are expressing implicitly
the opinion that the income stream from the first source will rise faster or dry up more
slowly than the income stream from the second source. Otherwise what they do
makes no sense.
Stock price has two components to it. One of them is the actual earnings per share
and the other one is the multiple people are willing to pay for $1 of earnings. Multiple
is commonly referred as p/e ratio.
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Price = Earnings per share * Multiple
Imagine you bought a stock for $10 which is earning $1 and has a multiple of $10. The
business is doing really well and the expectations of the market is exuberant and they
bid up the multiple to 40. For this stock to become a 100 bagger your earnings needs
to increase by 25 times. The math is given below.
Old Earnings = $1
Old Multiple = 10
Old Price
= $10 ($1 * 10)
New Earnings = $25

New Multiple = 40
New Price
= $1000 ($25 * 40)
On the other hand if you bought the stock for $100 which is earning $1 and has
a multiple of 100. If the multiple stays constant (which is very rare) then the earnings
should grow by 100 times for you to make a 100 bagger. The math is given below.
Old Earnings = $1
Old Multiple = 100
Old Price
= $100 ($1 * 100)
New Earnings = $100

New Multiple = 100
New Price
= $10000 ($100 * 100)
The moral of the story is simple. If you pay too much for the stock then for the price to
go up all the heavy lifting should be done by growing the earnings. Multiple reflects
market psychology and it oscillates between extreme fear and greed. One has to be
extremely careful to not pay too much for the stock. But this simple fact is often
forgotten. Peter Lynch explained this concept beautifully which I have given below.
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Excerpt from: One up on wall street

If you remember nothing else about p/e ratios, remember to avoid
stocks with excessively high ones. Youll save yourself a lot of grief and
a lot of money if you do. With few exceptions, an extremely high p/e
ratio is a handicap to a stock, in the same way that extra weight in the
saddle is a handicap to a racehorse.
A company with a high p/e must have incredible earnings growth to
justify the high price thats been put on the stock. In 1972, McDonalds
was the same great company it had always been, but the stock was bid
up to $75 a share, which gave it a p/e of 50. There was no way that
McDonalds could live up to those expectations, and the stock price fell
from $75 to $25, sending the p/e back to a more realistic 13. There
wasnt anything wrong with McDonalds. It was simply overpriced at $75
in 1972.
And if McDonalds was overpriced, look at what happened to Ross
Perots company, Electronic Data Systems (EDS), a hot stock in the late
1960s. I couldnt believe it when I saw a brokerage report on the
company. This company had a p/e of 500! It would take five centuries to
make back your investment in EDS if the earnings stayed constant. Not
only that, but the analyst who wrote the report was suggesting that the
p/e was conservative, because EDS ought to have a p/e of 1,000.
If you had invested in a company with a p/e of 1,000 when King
Arthur roamed England, and the earnings stayed constant, youd
just be breaking even today.
Quality Of Earnings and Management

Given below is the income statement of John and Peter. Both are of same age and
their income and earnings are also the same. If I ask you to assign an earnings
multiple for them how much would you assign?
You cannot assign the same multiple to both of them. Why? I have not given you the
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complete information. Now take a look at the complete information. It should be very
clear that Johns earnings should receive higher multiple than Peter. Why? John
spends a lot of money in educating himself. Also he pays higher rent which suggests
that he is living in a better community and he is spending more on eating healthy
foods. But Peter spends half his income on gambling and drinks and none on
education. Given these facts it should be obvious that John is likely to earn more in
future and it will result in his earnings growing at a faster rate.
What is the takeaway lesson? Companies are like people and their earnings vary so
much in quality. Hence comparing them blindly is like comparing cows and horses on
the basis of how fast they can run. Phelps talks about two kinds of earnings
accounting and conceptual. Buffett fans should immediately recognize this as
nothing but owners earnings.
Here are few things every investor should consider when looking at earnings (1) Does
the company manipulate earnings by cutting down its spending on R & D (2) Does the
company sells a lot of items using credit which increases accounts receivable and
earnings (3) Do they build up inventory by running its plants more than its allowed
capacity which results in reducing unit of cost of production and increases earnings (4)
Do they squeeze their employees to increase earnings (5) Do they pollute their
environment by cutting corners. If you answer yes to any of these questions then the
quality of earnings is strained. The reason is because all these items might boost
earnings in the short term but they are awful in the long term. Remember we are in the
long term game for 40 years.
Never do business with a man you do not trust. If the management is not trustworthy
then avoid it like a plague. Phelps explains why using an analogy from biology.
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Suppose you meet today an old friend whom you have not seen for
fifteen years. Biologists tell us that there is probably not a single cell in
either of you that was there when you last met. Yet you have no trouble
recognizing each other and recalling matters which interested you both
when you last met. This is possible only because each dying cell is so
faithfully replaced by a like cell. So it is with corporations. No matter how
broad-minded we are, how dedicated to equal opportunity, we tend to
hire and promote our kind of people.
When morally derelict men get to the top of great corporations and stay
there for a period of years, the evil they do does indeed live after them.
Inevitably they bring into the organization and promote to higher levels
men like themselves. The moral cancer thus introduced cannot be
extirpated simply by removing the evil genius at the top. It may take a
generation under a good management to purge the organization of the
unprincipled sharp-shooters brought in by a bad management. Hence it
is unwise to look for a quick turnaround in any organization whose
management has demonstrated a lack of moral principle.
Earning Power
Stocks go up and down for many reasons. Even their earnings may go up or down for
many reasons. As an investor what we should think about is earning power. What is
the difference between earnings and earning power? One of the best explanation
given by Phelps.
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Earnings are simply reported profits no matter how obtained. As we
have already seem, earnings may rise because of a sudden,
non-recurring surge in demand, because of a price advance, because of
a change in accounting practices, because of improvement in business
generally which permits utilization of what previously was excess
productive capacity. None of those reasons reflects earning power any
more than the movement of a cork downstream attests its motive power.
Earning power is competitive strength. It is reflected in above
averages rates of return on invested capital, above average profit
margins of sales, above average rates of sales growth. It shows to best
advantage in new or expanding markets.
Failure to distinguish between ephemeral earnings fluctuations and basic
changes in earning power accounts for much over trading, many lost
opportunities to make 100 for one in the stock market.
To check if the firm has earning power every investor should see 10 year trends for (1)
Sales growth (2) Profit margins (3) Return on equity (4) Return on invested capital (5)
Ratio of sales to invested capital (6) Buildup of book value. We should make sure that
they are not showing signs of weakness. Read the paragraph given below several
times. To me this is the secret of hundredfold returns.
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Real growth is as simple and certain as arithmetic if the book value of a
stock is increased by retained earnings while the rate of return on
invested capital remains constant. To illustrate, let us assume our
company has a book value of $10 a share, with no senior securities, and
is earning 15 percent on its invested capital. In this example, book value
and invested capital per share are the same. Let us assume further that
our company pays no dividends.
At the end of the first year per share book value will be $10 plus 15
percent of $10, or $ 11.50. At the end of the fifth year book value will be
$20, and at the end of the tenth year $40. If our company can continue
to earn at the same rate on this invested capital, its earnings in ten years
will be four times the starting figure.
If our company pays out a third of its earnings in dividends, the amount
plowed back each year will be 10 percent per share book value. At that
rate it will take nearly fifteen years, instead of ten, for book value and
earnings to quadruple.
Earning at 15 percent and paying no dividends, our stock would grow
one hundredfold in thirty-three years. Earning 15 percent and paying a
third of earnings in dividends, out stock would take more than forty-eight
years to multiply its assets and earnings by 100.
Chipotle Mexican Grill is a chain of restaurants, specializing in burritos and tacos. I

have been eating burritos there since 2006 and the restaurant is always crowded. I
never bothered to read their annual report once and now I am sucking my thumb after
looking at its earning power which is given below. Its return on invested capital is very
solid and improved over the years. Book, Revenue, and Earnings all trending up. Look
at the P/E in 2006. It was 45 and an uncritical mind would have rejected the stock
stating that it is expensive. A critical investor would have asked (1) How many new
stores can they open before saturating in the US (2) Are they expanding internationally
(3) Are the stores crowded (4) Do they have a moat. By doing that he would have
seen the enormous growth potential in the stock.
From 2006 to 2013 earnings increased by 30.06% and P/E stayed almost flat thus
earnings growth contributing to stock price increase from $57 to $530.75. This
represents a compounded growth of 32.17%.
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Closing Thoughts
Buying right will do little good unless you hold on. But holding on will do you little good
and may do you great harm unless you have bought right. 100 to 1 in the stock
market is one of the best investing books I have read. The book ends with the
following statement.
In Alice in Wonderland one had to run fast in order to stand still. In the
stock market, the evidence suggests, one who buys right must stand still
in order to run fast.
September 2, 2014 in Business. Tags: Business, Finance
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33 thoughts on 100 to 1 in the stock market
dileeptom Abraham
September 2, 2014 at 2:32 am
In every post I am learning something new. I really appreciate your

effort. Do you have a pdf copy of 100 to 1 in stock market? In India
both Flipkart and Amazon do not sell this
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Reply
Jana Vembunarayanan
Thanks Dileep. Unfortunately I do not have a pdf.

Regards,
Jana
Reply
Stinkyfeet
December 13, 2014 at 9:46 pm
You can buy it from Amazon dot com. A used copy in

Good condition will cost you at least 4.7k. I paid an
additional 2.4k for express delivery. Standard
delivery/shipping cost would be only 0.65k but may take up
to 45 days for delivery. After reading the excerpts presented
here, I felt, I should read the book, asap.
Reply
Jazz
Seriously, was the book written in 1972!!!

Just Amaziing..
Reply
Jana Vembunarayanan
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28-Dec-14 14:07
Jazz,
One of the best books I have ever read. If I was not a
Buffett fan then I would rate this on par with his
shareholders letters.
Regards,
Jana
Reply
zenmuthu
Hi Jana, Thanks for the very nice write-up and great flow of sharing
details on investing using 100 to 1 book (hidden gem). This excellent
summary has really helped to learn and look for the investments, buy
and sit tight. Will still plan to invest 6K INR money for this great book
as a great investment
Keep sharing. All the best.
Reply
Jana Vembunarayanan
Zen,
Price is what you pay and value is what you get. This book
is worth the price and it is a value buy with a big margin of
safety.
Regards,
Jana
Reply
15 of 29
28-Dec-14 14:07
zenmuthu
Hi Jana,
Thanks for the response. Will it be possible to try
a formula with the following conditions?
To check if the firm has earning power every
investor should see 10 year trends for (1) Sales
growth (2) Profit margins (3) Return on equity (4)
Return on invested capital (5) Ratio of sales to
invested capital (6) Buildup of book value.
Saying ROE for 10 years > 20 AND Sales Growth
> 10 AND ROIC for 10 years > 20 and I hope
we need to have the another aspect that company
is having huge growth potentials from current
levels (Do we need to add a market cap filtering
as well).
This may help to get 100 companies from indian
equity and study in depth to reach 3 convincing
ideas if possible.
Jana Vembunarayanan
Zen,
Your current filter seems to be a good starting
point. Also add the debt/equity ratio is very low.
Regards,
Jana
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rahul
Any stock you found out can turn out to be 10-20x over the years
Reply
Vinay
Learnt a lot from this post. Thank you so much Jana.

Regards,
Vinay
Reply
Jana Vembunarayanan
Thanks Vinay.
Regards,
Jana
Reply
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28-Dec-14 14:07
ragranov@comcast.net
September 2, 2014 at 6:23 pm
Doesnt that Chipotle example right away contradict what you tried to
say before, Chipotle investor is lucky in its PE staying high because if
it contracted to typical restaurant stock it would have crushed the
investor. Poor choice of an example IMHO.
Reply
Jana Vembunarayanan
Thanks a lot for your comments. The point I was trying to

make is that the earning power behind Chipotle business is
really strong and what drove the stock price was its
tremendous growth.
Also let us assume that the PE got cut into half which comes
to 22.5 (45 / 2). But with 2013 EPS of 10.47 the stock price
will trade at $235.57. This gives a compounded return of
around 23% in 8 years.
Regards,
Jana
Reply
18 of 29
28-Dec-14 14:07
Rocky 2.0
Great Buffet like thoughts. Most of us retail investors dont have the
time to do the proper research. Maybe when we become pensioners
we can follow these fantastic rules of investing. It still is remarkable
how professional managers including genius hedge fund guys usually
have problems beating the averages.
Reply
Dilip Mehta
Excellent blog! My own experience bears out the ideas and concepts
of the book. A query: Colgate Palmolive meets all the basic
requirements earning power, management quality, consistently high
ROE/ROCE, etc. Do you think these would trump 2 apparent
negatives: High PE and low retained earnings due to very high
dividend distribution ? Does the latter show Co. s inability to deploy
fresh capital profitably ?
Reply
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28-Dec-14 14:07
Jana Vembunarayanan
Dilip,
Thanks. I have not looked Colgates annual reports. The
latter is because its current business does not need any
additional capital. Also the management does does not want
to diversify into new businesses.
Regards,
Jana
Reply
diliprmehtadilip mehta
Thanks for the prompt reply. Re Zemmuthus

filters, apart from debt/equity, he has also left out
the most imp. earning power variable, namely
cash flow. Jana, as there are problems with
computing free cash flow because of maintenance
capex vs. discretionary capex distinction, should
one stick to easily available fig. of operating cash
flow? By the way, Zenmurthy has also left out the
key filter of the margin of safety like P/E ratio etc..
Jana Vembunarayanan
Dilip,
You are right about free cash flow which
eliminates capital expenditure. For a growth
company like Amazon it will be zero or negative.
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28-Dec-14 14:07
But every $1 retrained and invested back in the

business adds value. This is not accounted for in
free cash flow.
As Buffett does we can only subtract maintenance
capital expenditure and get the owners earnings.
But most companies do not reveal them. This
leads to assume it is equal to depreciation. But
that might be incorrect too as the company can
accelerate it.
Penman handles explains all these concepts
beautifully and adjusts accounting to measure the
value (residual earnings) added by the business. I
would highly recommend this book.
Accounting for Value (Columbia Business School Publishing)
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28-Dec-14 14:07
Regards,
Jana
AJITH
Superbly written article. Wonderful insights.

Reply
Dilip Mehta
Thanks Jana for the detailed response. Will check out the
book suggested by you.
Is there a web based source for getting the ranking of, say,
top 500, listed Indian companies, as per the Joel Greenblatt
magic formula? Do you have this info.?
Reply
Jana Vembunarayanan
Dilip,
Check this out:
http://www.screener.in/screens/59/Magic-Formula/
Regards,
Jana
22 of 29
28-Dec-14 14:07
Rahul
Wonderful Article. Lots of learning! A regular follower of your blog,

Jana.
Observed you read a lot, can you please suggest your top 10 must
read books. And top 10 for being Better Investor..
thanks.
Reply
Jana Vembunarayanan
Rahul,
Thanks.
Check out this post for books to read across multiple
disciplines.
http://janav.wordpress.com/2014/03/12/books-i-wish-i-hadread-before-20/
On investing I would recommend the following
1. Buffett letters to shareholders
2. 100-to-1 in the stock market Thomas Phelps
3. The little book that builds wealth Pat Dorsey
4. Accounting for value Stephen Penman
5. The most important thing Howard Marks
Regards,
Jana
Reply
23 of 29
28-Dec-14 14:07
Fractal
Jana, Thank you for generously sharing your learning from the book.
Reply
Ganesh
Hi jana,
Great article, i reuest you to post some article abt complex financial
derivatives products.
Regards,
Ganesh.
Reply
Fasil
Great Article Jana,

As you pointed out at the starting of the post, Cloning is the best way
to get the right direction to what we want to pursue (Of course with
salt and pepper changed as per our taste
I wonder & admire about your reading habit, how you are able to read
the books in quick time and able to grasp all the key aspects that are
conveyed in the book ( Its the skill that I want to pursue now
Keep up the work Jana!! Every post of yours is a sincere way to

educate all readers..
Reply
24 of 29
28-Dec-14 14:07
Jana Vembunarayanan
Fasil,
I am a slow reader and I spend a week to finish a book.
While reading, I take notes on the book and reread it before
blogging so that all the key arguments from the book is
captured. If the book is very good then I purchase its audio
version and also listen to it also. This way the concepts gets
engraved in my brain. This process is time consuming but
really worth it.
Regards,
Jana
Reply
Fasil
Thanks for sharing your thoughts Jana, Finishing a

book in a week is impeccable speed
hsahi
October 18, 2014 at 3:48 am
hiii jana,
I am investing in equity market from previous few months through my
friends DMAT a/c. Now i want to do it with my own DMAT. Can you
tell me which brokerage firm gives the best service charging low cost
and for all the people who want to have ebook 100 to 1 in stock
market, you can loan it through http://www.openlibrary.org for 14
days for free.
25 of 29
28-Dec-14 14:07
Thanks
Reply
Giriraj
November 16, 2014 at 6:11 pm
Dear Jana
Excellent post and blog .I have visited your blog first time and feeling
that its too late i discover your blog.worth reading and come again
and again .Thank you very much .
Reply
Ravi
November 19, 2014 at 11:45 am
Jana,
I like the way you combine ideas and concepts from different books
to put forth a consolidated idea. Something like the syntopical reading
suggested in How to read. It is always engaging to read your blog.
Based on your Chipotle example, I have one small question. While it
enforced the point that the book was trying to make it also highlights
the dilemma an investor faces which is what I am interested about. To
remove the hindsight bias let us assume we are in 2006 and looking
at chipotles data. We know that the ROIC is 10.62. When we ask
questions, we would be asking questions like how big is the market
and can they expand to every location and what would the
competition look like etc and we may get some answers to that. But,
it will not give us answers on how quickly would they get there. The
only reasonable quantitative analysis based growth that one could
project is to see the reinvestment rate. Let us for a moment assume
that the ROE of Chipotle was same as ROIC (debt to equity is not
known) and they reinvest the entire earning. In this case, the best
case growth one could think of is a earnings growing at 10.62%. How
could the investor ever forecast that the ROIC would increase from
10.62 in 2006 to 23.52 in 2013 ? Unless they could have forecasted
it, they could have only expected to earn around 10.62% if the PE
remained constant. This is where i am not sure how much of it is skill
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28-Dec-14 14:07
and how much luck (I am sure you would have read the article of
Michael Mauboussin regards to skill and luck). Is there anyway one
can extrapolate how ROIC or ROE of a business would increase?
Dupont analysis would suggest that either the Asset turnover should
increase or the margins should increase. Can we extrapolate that?
Understanding moat is about sustainability of margins and ROEs but
the big multibaggers are generally made when you bought a company
at cheap price and then the business ROE just expands while growing
which gives the double bang for the buck. I would rate it more in the
luck territory. What are your thoughts?
Reply
Jana Vembunarayanan
November 19, 2014 at 12:52 pm
Ravi,
Thanks for the comments. Also your question is fantastic. If
I summarize your question into two words then it will be
Emerging Moats. So far I have identified moats only in
hindsight and I have never identified an emerging moat. I am
not qualified to answer your question. See if you can find an
answer from Anil (contrarianvalueedge.com) who is
passionate in the concept of emerging moats.
Regards,
Jana
Reply
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Jana Vembunarayanan / September 2, 2014