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?
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.
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
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.
writer owns shares in Capitec.This
article originally appeared in the 13 April edition of finweek. Buy and download the