Notes: 100 to 1 in the Stock Market
Pattern of 100 baggers
- Recovery from extremely depressed prices at the bottom of bear market.
- Very rare to occur (happened in 1932/33)
- Change in supply-demand ratio
- E.g: Discovery of oil field can make a stock soar. Again it is kind of luck to find it.
- Great leverage of capital structure in long periods of expanding business
- Dual purpose fund.
- Reinvesting earnings at higher than avg rate of return on invested capital
- Maybe one can find it with enough knowledge.
Quality of Earnings
Inputs
Three identical companies A,B,C
Capital: 100 million each
Earnings: 20% before tax on the invested capital
Tax rate: 50%
All the three companies wish to expand to 200 million.
A: Issues additional shares of 100MB: Sells 8% long term bonds for 100MC: Acquires 100M of additional facilities by lease financing with 10% interest
| Company | Earnings On Capital (%) after Tax | Earnings On Equity (%) after Tax | Explanation |
|---|---|---|---|
A | 10 | 10 | 20% is the earnings, 50% tax on it. |
B | 10 | 16 | 20% of 200M = 40M; 40M - 8M interest = 32M; 50% tax on 32M = 16M = 16% of equity 100M |
C | 15 | 15 | Lease financing details do not end up in the balance sheet. 20% of 200M = 40M; 40M - 10M interest = 30M; 50% tax on 30M = 15M = 15% of equity/capital 100M |
On the negative side
If the business turns bad that the companies can now earn only 5% on the invested capital, naturally the company which barrowed money for interest hight than 5% would be in trouble.
Now the earnings will look like this:
| Company | Earnings On Capital (%) after Tax | Earnings On Equity (%) after Tax | Explanation |
|---|---|---|---|
A | 2.5 | 2.5 | 5% is the earnings, 50% tax on it. |
B | 2.5 | 1 | 5% of 200M = 10M; 10M - 8M interest = 2M; 50% tax on 2M = 1M = 1% of equity 100M |
C | 5 | 0 | 5% of 200M = 10M; 10M - 10M interest = 0M; It earns 10M on the invested capital before tax. |
PE Ratio
- Very important thing to look before invest.
- High PE AND someone is still buying means that the earnings should grow faster than the current phase, which is usually hard.
Quotes
Don’t marry a man to reform him.
Those who buy [the stock] on the price alone are that man’s lawful prey.
It is a bad mistake NOT to barrow when it is profitable.
Nothing is worth anything unless someone wants it.
A problem well defined is half solved.
Every sell decision is a confession of a mistake.