Looking at the table, would it make more sense to multiply the $124m by 1.26 (1+ ROIC) and then discount that at a 10% rate rather than subtracting the 10% from the ROIC?
Your write: "And yet a paradox exists here because we’re trying to estimate IV and yet need the figure to make an adjustment. The way I’ve tackled this is to fiddle with the enterprise value figure until it gives me a 10% return. With FAST that came out to about $13bn. That means the $33bn current enterprise value is about 2.5 times too high. "
Tackling a circular argument by making an absurd assumption does not solve anything. If you need IV to solve for IV then you are doing something wrongly. Rather than compound the error by adding an assumption, you should stop and examine your process.
The end result is you have the market paying 2.5x too much. This sort of "I can be correct in calculating IV and completely ignore the market's valuation" because I think I am rational and the market is irrational is precisely what gets people into trouble. The assumption and the conclusion are both silly. Why would you need a 10% earnings yield to own a company with a 30% return on equity, with little debt compounding at 8% per annum? I agree you might like it - but would you demand it?
How about this instead: if Fastenal can compound sales at 8% per annum, maintaining a 20% EBIT margin, paying a 25% tax rate and re-investing about 25% of profits then it should earn about USD 1.5 billion profits in 5 years time. That's about a 5% yield on today's EV. Throw in dividends of 2.5% per annum. Instead of asking if this is right, ask if it seems very wrong. Does it? Not to me.
Nov 28, 2023·edited Nov 28, 2023Liked by Adam Mead
Adam, could you please explain how you arrived at the $13 billion figure using the EV calculation you mentioned in the article? I've been trying to understand it for an hour but haven't had much success.
For the cash return would you not divide the distribution by the market cap as opposed to the EV since the aim is to derive a total return to the equity holder and not all owners of the business?
Hi, regarding the organic growth, I wonder whether to use the nominal GDP growth or the real one (nominal - inflation)? which one (nominal or real one) should i use to calculate organic growth return?
I have one more question. If I wanted to estimate future organic growth based on data from previous years. Let's say the average revenue growth rate of the company is 12% over the last five years. Average net income growth is 13% over the last 5 yeras. Should I subtract the average inflation over the last five years from these numbers and then and then add it to the Greenwald's formula?
If I don't subtract inflation from GDP or historical data (revenue, net income), it seems to me that the returns from organic growth are too high.
Looking at the table, would it make more sense to multiply the $124m by 1.26 (1+ ROIC) and then discount that at a 10% rate rather than subtracting the 10% from the ROIC?
Your write: "And yet a paradox exists here because we’re trying to estimate IV and yet need the figure to make an adjustment. The way I’ve tackled this is to fiddle with the enterprise value figure until it gives me a 10% return. With FAST that came out to about $13bn. That means the $33bn current enterprise value is about 2.5 times too high. "
Tackling a circular argument by making an absurd assumption does not solve anything. If you need IV to solve for IV then you are doing something wrongly. Rather than compound the error by adding an assumption, you should stop and examine your process.
The end result is you have the market paying 2.5x too much. This sort of "I can be correct in calculating IV and completely ignore the market's valuation" because I think I am rational and the market is irrational is precisely what gets people into trouble. The assumption and the conclusion are both silly. Why would you need a 10% earnings yield to own a company with a 30% return on equity, with little debt compounding at 8% per annum? I agree you might like it - but would you demand it?
How about this instead: if Fastenal can compound sales at 8% per annum, maintaining a 20% EBIT margin, paying a 25% tax rate and re-investing about 25% of profits then it should earn about USD 1.5 billion profits in 5 years time. That's about a 5% yield on today's EV. Throw in dividends of 2.5% per annum. Instead of asking if this is right, ask if it seems very wrong. Does it? Not to me.
Adam, could you please explain how you arrived at the $13 billion figure using the EV calculation you mentioned in the article? I've been trying to understand it for an hour but haven't had much success.
Thanks in advance.
For the cash return would you not divide the distribution by the market cap as opposed to the EV since the aim is to derive a total return to the equity holder and not all owners of the business?
Hi, regarding the organic growth, I wonder whether to use the nominal GDP growth or the real one (nominal - inflation)? which one (nominal or real one) should i use to calculate organic growth return?
I have one more question. If I wanted to estimate future organic growth based on data from previous years. Let's say the average revenue growth rate of the company is 12% over the last five years. Average net income growth is 13% over the last 5 yeras. Should I subtract the average inflation over the last five years from these numbers and then and then add it to the Greenwald's formula?
If I don't subtract inflation from GDP or historical data (revenue, net income), it seems to me that the returns from organic growth are too high.