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How to determine HEPS growth

Apr 19 2017 07:42
Simon Brown

Simon Brown, founder and director of JustOneLap.com.

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In a recent article titled When is the share price right? (30 March edition), I wrote about how I determine the price I should pay for a stock I like. A large part of that process is future earnings, or headline earnings per share (HEPS) growth. Being able to work this out is a critical part of any investor’s toolbox. Sure, we expect growth from a company we invest in, but in some cases we need more refined details as to what that growth is likely to be. So how do we determine this?

Working with analysts’ consensus views

In the case of many large stocks (about the top 100 in terms of market capitalisation) we can get consensus data if our stockbroker provides it. Consensus data is just what the name suggests – the consensus view of the several research analysts covering the stock.

Various financial data providers will canvas the analysts on a weekly basis and ask their view on future HEPS, dividends and whether they rate the stock a buy, sell or hold. That data is then averaged and published.

This is great if your stock is covered and if your broker provides this data. But is it any good? Well, the first thing you need to do is to determine how many analysts are being canvassed. If it is one, then the predictions are not of much use, but if we have five or more, we’re starting to get a real consensus. But then, of course, they could still be wrong. Or something unexpected could happen.

So while it’s great to have these consensus views, they are far from perfect and I always do my own digging as well.

Determining your own view of HEPS growth

If it is available, I will start with the consensus view and then determine my own view and see how they fit together. If no consensus is available, I’ll come up with and use my own.

I start with the last seven years’ HEPS growth and look for the trend. Is it moving higher, by how much per year and has that growth per year slowed? Was there anything in any of the previous seven years that may have hindered or helped the growth? For example, the recent drought has hit food producers, so one would smooth out that HEPS decrease as drought is not an annual event.

What I am looking for is the trend in increasing HEPS and trying to smooth it into the future. What is also important is to understand that a fast-growing company will see growth slow, as we’ve seen with Capitec* over the past seven years.

I will also look to other stocks in the same sector and see how they’re doing. This is especially useful if the other stocks maybe report results a few months ahead of the stock I am analysing. However, you need to be careful – the different reporting periods may skew things, such as the booming holiday season making an impact on one set of results but not the other. But this does give a great indication of how the overall sector is doing.

We’ll also get a trading update when the results announcement is near, but this is close to results. So we would have been using our number for a while and the update is more about checking if we are in line with expectations. At the end of the day, this is a very dynamic number and while I may only look to adjust it every quarter, it certainly is changing.

Lastly, you must make note of two vital points: First, if you’re using consensus data, you must accept that it may be wrong and you must take that responsibility. You can complain and rant against the analysts, but you used it and so must accept the consequences. Second, accept that you may also be wrong. Looking into the future is fraught with risk and with errors; be prepared to make mistakes.

*The writer owns shares in Capitec.

This article originally appeared in the 13 April edition of finweek. Buy and download the magazine here.
investment  |  trading  |  portfolio

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