George had asked this question about CHS recently:
the 9 year equity (BVPS) rate from 1997-2006, goes 48%, 53%, 53%, 53%, 52%, 50%, 47%, 44%, 42%.
the last years you can see the growth rate descending, but the rate is so very high above the the 10% minimum for which we are looking, i just have to ask:
does this high rate every year override the principle that the growth need to be climbing each year?
This is a good question. You see a business that has Meaning to you in the Rule #1 sense of the word and you want to determine the future growth rate. You do the Big Five Numbers and see that the growth rate is consistent across all numbers and it's very high. But it's also declining a bit every year.
First, is this a bad sign, and second, how do we estimate the future growth rate if the historical rates are sliding every year?
A really high rate of growth usually only happens when a business is
relatively new and has something unique. You see it a lot in high tech
companies and in some kinds of retail.
If the rate of growth is coming
down, it isn't necessarily a sign of a problem with the Moat. It's just
a mathematical issue. The bigger a business gets, the harder it is to
sustain any given growth rate because every year the bar got raised that
you not only have to beat, but exceed by the same percentage you
exceeded it the year before.
Obviously at some point that gets to be
impossible if your original growth rate was very high — if only because
the power of compounding high sustained growth results in a business
being too big for its entire market.
This was the problem with
forecasting continued high growth for Yahoo in 1999. For Yahoo to
sustain the growth rate necessary to justify its $135 price tag it
would have to quickly become the largest business in the world. Which
seemed unlikely for a website portal business.
So the law of
projections is that if a trend can't be sustained, it will stop.
stopped and Yahoo is now selling for $28. (Of course it didn't help
Yahoo that Google came out of nowhere and is kicking its butt — but
that's the nature of technology and the reason that it is risky to
project into the ten year future for a high tech business, and the
reason Google stays in the Risky Biz portfolio.)
Point being that
extremely high growth rates are great but not sustainable. Therefore
we have to use a lower rate for a ten year projection. But WHAT rate?
One way to decide is to look at what growth rate really successful
businesses in that or similar industries have been able to sustain for
long periods of time and use that rate.
For example, some retail
businesses have been able to sustain growth rates of 15% for over
twenty years. Walgreens, for example, grew its stock price from $0.05
to $44 over 30 years. Over 9 doubles. Call it 3 years to double
once. That's about 24% for 30 years for price growth.
were way undervalued in 1975 but they fueled that incredible price
growth with a sustained 15% growth rate in sales, earnings, book value
and cash with amazingly high consistency. (Today, by the way, WAG is
worth about $56 and selling for $40. Gotta love that, sports fans. If
you've been keeping up on WAG and been a buyer, you are looking at
buying back in at anything under $44.)
Urban Outfitters, a trendy
clothing store chain, has been on a nice run for many years well in
excess of 20% across the board with incredible consistency.
The key to look for once you've checked out the potential for long term
growth is to see consistency across all the growth numbers and a rock
solid ROIC number.
Forget EPS all by itself. You don't want to use a
number that is vastly higher than what cash, sales and the
all-important book value are growing at. In fact, I point out in Rule
#1 that if I had to use just one number to determine the future growth
rate, I'd use the Book Value Per Share growth rate. It is, after all,
the number that grows because of surplus cash, and that is the best
indicator of a healthy Moat.
But the MOST critical thing to see is
that the numbers are consistent across all the key numbers. That's
what lets us be so arrogant as to assume we can actually figure out
what this business is worth.
I'd say most businesses are pretty much
impossible to put a really good long term value on. You can always
find the liquidation value, but that's hardly the real value of a
business, is it? We want to know what this thing is worth as a going
concern that produces surplus cash. But most businesses either have no
moat and are, therefore, subject to possible sudden destruction, or are too
inconsistent to really know what they are going to grow like in the
We're stuck with finding those few that we think we really can
put a value on and sticking to those.
So let's look at Chico's through
that Rule #1 lens.
Chico's numbers are incredible, but the concern is that the EPS numbers
are sliding down from 60% average over the last ten years to a TTM year
over year of 22% — and there may be more slowing in the near term.
analysts' expectations for the next five years range from 15% to 30% and
average 22%. So that's one number.
What we're really looking for is
whether we're going to come up with a lower number than that for CHS.
If we get a higher number on our own, we're going to use the analysts'
number simply because its more conservative. Yes, sports fans, when
you get better at this, you, too, can use your number if it's higher
than the analysts', but don't do that until you are investing for at
least five years successfully.
Until then, be patient, be conservative
and don't violate Rule #1.
CHS's BVPS growth rate is consistently at or above 30% right up to
Sales are sliding some from 37% to 32% and Free Cash is ranging
down from 29% to 23%.
So based on historical numbers, we're not likely
to be lower than the analysts' 22%. The only thing that would bring us
to a lower number to use for future growth is if we think something is
off that isn't showing up in the numbers.
That something might be the
CEO telling us that the business is going to grow at about 15% a year.
CEOs do that from time to time. Meg Whitman at Ebay did it a couple
of years ago. Michael Dell at DELL did it last year. John Mackey at
Whole Foods did it a couple of weeks ago.
Some analysts simply dismiss
what the CEO says, but I'm going to listen for the simple reason that I
wouldn't be investing with this CEO if I didn't think he or she was the
kind of CEO who tells investors the truth. I don't expect my CEO to
sandbag me or hype the future. I expect them to give me the
information that I need to determine the value of this business. If
they give it to me and I don't believe it, then why am I investing in
this business in the first place? (Hopefully you start to see how
integrated the 4M analysis really is.)
There is one more key number to discuss: ROIC.
Return on Invested
Capital tells us that the CEO is managing the business well. As long
as that number isn't dropping from where it was long term, things are
going pretty darn good in terms of how the capital is being invested.
The CEO is putting money in places that are producing solid historical
CHS's ROIC is hanging right at the same high level that it
was ten years ago: 23%. Awesome.
Short of the CEO telling me something that puts the growth rate lower
than the average analyst, in this case, I'm going to go with 22%. It's
below all the long term growth rates of the business. And best of all,
its a doable number if the business keeps on being really great.
CHS's case, that is the question. They've got issues. They lost a key
person. The red flags are up. So dig in there and see if you KNOW
that this is a great business for the future.
Are you sure that CHS
will be a player in women's fashion stores twenty years from now… the
way I'm sure that Harley Davidson will be a force in motorcycles in
twenty years? You better be. It's your money. But if you love it that
much, then I'd value it with 22%.
With a PE that ranges from 13 to 60, we've got good reason to believe
that using a 44 (2 x the 22% growth rate) isn't out of the question, and that happens to be both
the Rule #1 PE and the historical PE.
(Which is a
nice not-so-coincidental result. If you are getting growth rates that
consistently result in a much higher PE than the historical PE,
something might be amiss in your view of the predictablility of the
business.) In this case, we gotta be kind of happy with the result.
And the $86 Sticker Price gives us an MOS of $43.
And the price when I wrote this
is… ta da… $23.
Should be interesting for you women's clothing
folks. Think the Big Guys got scared for all the right reasons that
can make us a pile of money? Makes me want to learn the business,
seeing a price that far below a reasonable Sticker. I just might have
to get into it. See if I can figure out if Chico's will be around in
Or is Coldwater Creek a better business to own? Or do I want
to be trendy and own Urban or another business in this industry?
And that's how it goes for us Rule #1 types. You see something this
cheap and you want to dig in and find out if it really is a great long
term business, and off you go learning something. Darn, I hate it when
that happens. Totally interferes with my snowboarding.
Now go play.
P.S. As an addendum:
I built this chart of CHS in Excel by pasting the growth rates from
Investools into Excel and hitting the chart button. Simple, but it
shows us the trend doesn't it?
You can see that 22% growth rate is
right where we want to be if we believe that this thing is going to
level off at a sustainable rate. But what happens if it continues on
down to the bottom of the analyst range of estimates — 15%?
growth rate lowers out PE to 30 and the Sticker to $34. Puts the MOS
at $17. With the price at $23, even with some pretty conservative
projections, the biz is still buyable for all you expert CHS owners out
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.