Rule #1 Finance Blog

With Investor Phil Town

MORE ON THE RULE OF 72

Here’s another  exchange I had with someone about Growth Rate & The Rule of 72. I’m also playing around with a new post format for letters. Let me know if you like it.

On 8/29/05, Bret wrote:

Phil,

I’ve been addicted to your blog site. My wife is starting to call me a "stock geek."  You see once I get interested in something, it becomes somewhat of an obsession.  At least early on.

Anyway, I’ve been trying to use the formulas from your site in an excel spread sheet.  The one piece of information I’m have the most trouble locating on MSN Money is the Growth Rate for a stock. Could you please tell me where that percentage is located and is it called anything else?

I worked out the spreadsheet for the Eli Lilley drug stock from the blog entry on the 26th and it seemed to work out in my spread sheet.  This stock sounds extremely bloated at this time and if I’m correct, I think the fellow should sell it at the first chance he gets.  It’s like dump it and run, FAST!! before anyone realizes.  Am I right?

The Google I, II, III blogs were enlightening.  Thank you for getting me interested in something that just may help me in the future.  I never even thought about the stock market much until I saw you and your system.  I’ll keep practicing.  Oh, by the way.  I just bought a copy of The Automatic Millionaire on ebay.  I look forward to reading it in the coming weeks.  Thanks for listening.

Bret
Washington, PA

Date: Sep 2, 2005

Hi Bret,
 
Thanks for the email.  I’m glad you’re working on this.  It’s a fun obsession with a nice payoff down the road. 
 
The growth rate for a business is something we have to decide on
for ourselves, although what the analysts think it’s going to be is
posted on MSN Money.  After you put in a stock symbol, look at the left
menu for ‘Earnings Estimates’


Click on that and you’ll see four tabs
across the top of the page.  The fourth tab is called Earnings Growth
Rates
Click that and you’ll see what the analysts think, on average,
the business will grow its earnings at for the next 5 years.  If you
are looking at LLY you will see an estimate of 10.30%.
 
But I would never invest without looking at the ROIC and the four
growth rates
Sales, EPS, Equity and Cash.  Those you have to figure
out on your own
(although Morningstar and Investools – two sites that
charge for data – both do it for us.)
 
If you are cool with Excel, use the RATE formula.  If you just
want to get a quick idea of the growth rate, use the Rule of 72.  It’s easy to use: just
figure out how many doubles it takes to get from the oldest number for,
say, book value per share, to the most recent.  For example the 1995 BVPS for LLY is $4.93.  The 2004
BVPS is $9.65.  That’s about one double
in 9 years.  Now divide 9 into 72.  Answer: 8.  So, by the Rule of 72
the growth rate for LLY’s equity is 8%.  Simple.
 
Notice the experts think 10%, but historically the equity growth is
8%.  I probably wouldn’t be comfortable expecting more than 8% growth,
no matter what the EPS is.  But a quick look at EPS growth shows 1995
at 1.13 and 2004 at $1.66
.  That’s less than half a double in 9 years.
Call it a double in 20.  20 into 72 is 3-4% EPS growth.  And it’s
been negative growth rate for the last 5 years. 
 
The Rule of 72 is quick and easy.  Gets us off the bad ones and onto the good ones without a single excel spreadsheet.