Earnings per Share

90 companies on the UK stock market have what I’d call a decent track record of EPS, turnover and dividend growth.

It’s a fairly subjective list, 24 are in the FTSE100, while the smallest 24 are less than £360m Market Cap. The smallest on the list is valued at less than £14M, the largest at £80B. Some have a magnificent track record, others squeeze onto the list despite suffering a few ups and downs, bad debt situations etc. Some are centuries old, some have been around for less than a decade. Quite diverse!

Anyway, the average P/E is 15. The overall return on the basket since January 2012 is 15%, the median result is also 15%.

The average return on the quality stocks with over a P/E of 15 for 2012 was 12%, while the average return on the basket below 15 P/E was 18% (the two baskets were split almost exactly down the middle, 44-46). The return on stocks with P/Es between 10-20 (to avoid the extremes) was again right down the middle at 15% for 2012.

In 2011, the basket was flat by both median and average measures, around 0.5% gained vs 6% lost on FTSE.

Between 2009 and 2011, the basket gained 92% vs 33% on the FTSE.

In the global financial crisis, in 2008, the basket lost 26%, vs 31% on the FTSE. In 2007, the basket gained 8% against the FTSE’s 3.8%.

Excluding dividends, holding FTSE from 2007 would give you a loss today of 10%, while the basket would’ve returned 63%. It’s an inexact science, but the basket would also have gained considerable dividends to reinvest during that period, or hold as income. Median ROE on the basket is 19%, average is 26%.

While the dividends would compound to provide over 15% for the period, we can write that off for the spread, commission, and the odd lunch at Shampers 😉

Note: Sadly the 90 companies were identified by going through all the listed UK stocks on ShareScope and judging the EPS, Profit, Dividend and Turnover charts over time, along with things like ROE, ROCE and operating margins.

I’m certain you could generate similar results with a decent filter though (mine was only SS Gold at the time). Generally stable, rising EPS over time is the most important criteria to make it onto the list, with the odd forgivable deficit. Companies in cyclical industries (like chemicals) can be excused for a bumpy ride in EPS, so long as there is an obvious track record of growth.
One of the problems with backtesting it is the number of companies taken over, who would previously have been on the list (one was taken over this week). There’s a chance in some cases that the SS data is wrong, and you have to exclude companies that wouldn’t have been on the list in 2007 for example

62 of the 90 would’ve been on the same list in 2005, while BARC, RBS and a few builders would’ve been on it (who now have temporarily at least, fallen off). Using purely that list of 62, the average return since 2005 would be 137%. Even padding it out by adding a few fictitious 100% decliners still keeps the result above 120%.

Update January 2013:

Many quality companies are at fair value for their growth rate, some are far above fair value, but very few good ones are doing well in the market where the price is below fair value for growth.  Finding it hard to find new trades. Most prices seem about right, verging on high but at the same time don’t really want to short. Hmmm. Anybody else feeling the same?

It’s perfectly possible that prices on a whole could be lower in one year.  Or worse, that prices could be lower, and P/Es could be higher, if earnings in your chosen European company decline. The stock market is liable to do just about anything in a period of one year.  Consider this though – if a company can earn £Xmillion when unemployment is over 11%, and consumer spending is depressed, what would its earnings be in a normal year if that % returned to a normal rate of unemployment, as it inevitably will?

Europe as a continent isn’t going away. There are important global companies originating from Germany, Italy, Spain that will probably be around 50 years from now or longer. At current prices, you only need to bank on them being around for the next 8-9 years, even if they don’t grow their earnings at all.  P/Es of around 7-10 are no growth scenarios in the market’s eyes, depending on the rate of interest. In those cases, you’re paying for zero earnings growth, earnings which will be on average the same as they are today… indefinitely.

Earnings do tend to increase though, especially in big solid companies. Say your business consistently returns around 10% on equity, which isn’t very optimistic. Out of the earnings it retains in year two, three, four etc, it’s earning 10% on the increased equity within the business from those previous retained earnings – thanks to simple compound interest, your earnings grow higher over time.

And this translates into market value – though you need to be patient. While you’re waiting of course, on a P/E of 10 for example, you can always sit back and enjoy owning a business making 10% per year on your investment while you wait. The investment pays for itself after around 10 years (opposed to 34 years in a 3% fixed rate bond) – or if earnings grow from their depressed base by even 5% per year on average, the investment could for itself in 7.5 years, all depending on dividend policy. If that scenario played out and was translated into market value, 13% per year is somewhat better than you could expect from the bank!

If a basket of these companies was seriously in terminal decline though… god help the really dreadful companies out there. In that sort of scenario, you can probably forget about gold and bonds too, the best possible investment is probably a cave, a shotgun and 30 years worth of tinned food 😉