Navigating from Future EPS to Sticker Price: A Practical Guide
The next step in mastering Rule #1 investing – understanding the journey from Future EPS to Sticker Price. This pivotal phase involves connecting the dots between future earnings, market price, and ultimately, the price you're willing to pay for a business. Let's dive into the process that empowers you to make savvy investment decisions.
From Future EPS to Future Market Price
Once you've projected the EPS of a business in 10 years, the logical next step is estimating its price per share – the Future Market Price. This calculation involves a crucial factor: the PE (Price/Earnings) ratio. Multiply the Future EPS by a chosen PE to determine the Future Market Price. If, for instance, you anticipate a PE of 40 based on historical trends, a Future EPS of $8 would yield a Future Market Price of around $320 ($8 * 40).
Decoding the Sticker Price Calculation
From the Future Market Price, you can work backward to discover the Sticker Price using a clever application of the Rule of 72. With a minimum acceptable rate of return set at 15 percent, you can anticipate doubling your investment roughly every five years. Therefore, you'll double your money twice in 10 years. Dividing the Future Market Price by four provides the Sticker Price, ensuring a 15 percent return. If your projected Future Market Price is $320, your Sticker Price today would be $80. This reveals a consistent pattern – the Sticker Price is typically about a quarter of the Market Price a decade from now.
Transitioning from Sticker Price to Margin of Safety (MOS)
Remember, the goal is never to pay the Sticker Price; a Margin of Safety (MOS) is essential. Achieving a substantial MOS means buying a dollar's worth of value for fifty cents. This cushion safeguards your investment. If your calculated Sticker Price is $80, a wise target for the MOS Price would be $40 – offering a comfortable buffer for your desired 15 percent return. By securing this wonderful business at $40 per share, you create a safety net for selling at $320 after a decade.
The Rule of 72 "Cheat Sheet"
As you navigate this process, remember the Rule of 72 – a simple tool for estimating how long it takes for your investment to double at a given growth rate. Here's a quick reference guide:
2 Years: 36% Growth Rate
3 Years: 24% Growth Rate
4 Years: 18% Growth Rate
5 Years: 15% Growth Rate
6 Years: 12% Growth Rate
7 Years: 10% Growth Rate
8 Years: 9% Growth Rate
9 Years: 8% Growth Rate
10 Years: 7% Growth Rate
Conclusion
Congratulations, you've unlocked another layer of Rule #1 investing wisdom. By mastering the transition from Future EPS to Sticker Price, you've gained a powerful tool to assess investments with confidence. Remember, your journey toward financial success is built on understanding these critical principles and applying them effectively. Armed with this knowledge, you're well-equipped to uncover opportunities, make informed choices, and build a robust investment portfolio.
