Warren Buffett retained earnings = market value

[WBG Redcliffe]

Hi all,

Currently reading The Warren Buffett Way. I have read on a number of occasions that a good indication of a worthy company is if a company is able to show that for every dollar of retained earnings it equates to at least one dollar of market value.

“Buffett’s goal is to select companies in which each dollar of retained earnings is translated into at least one dollar of market value.” Page 117

I believe that the EPS expected price per share x outstanding shares is the retained earnings (not 100% sure) but I’m not sure how to work out the market value?

Can anyone help.

 

[GreatPig]

EPS expected price per share

EPS normally means Earnings Per Share.

By my understanding, retained earnings are the profits kept in the company after tax that can later be paid as dividends.

Market value, I would assume, is just the market cap of the company (ie. share price x number of shares on issue).

If every dollar of retained earnings adds a dollar to the market value, it means the company value is going up in line with the profits it is retaining, which makes sense. Every dollar of profit it retains means the company has an extra dollar of asset value. It is also common that dividends (the paying out of retained earnings) cause the share price to drop by the same or similar amount for the opposite reason.

If a company's value doesn't increase by the amount of retained profits, then other negative factors must be influencing the share price, which I guess Buffet is saying is not a good thing.

GP

 

[WBG Redcliffe]

Thanks for the reply. I’m still confused. Buffett looks for this in a potential company as part of his due diligence. I don't understand how an extra dollar wouldn't translate into an extra dollar of retained earnings.

I thought if I opened Comsec and found the retained earnings of a company and compared this to the dollar value of the company they should equal. If RE were low then company would not fit Buffett’s criteria.

 

[BayView]

I don't understand how an extra dollar wouldn't translate into an extra dollar of retained earnings.

Easily done;

become the CEO, pay yourself a gabillion dollars every year out of earnings, spend lots of other earnings on depreciating "business expenses" like yachts and Maseratis and a few ski lodges.

 

[WBG Redcliffe]

So does that mean that retained earnings are the same as gross earnings and then the expenses like wages bonuses come out?

 

[GreatPig]

According to this definition, retained earnings are the profits (which I take to mean profits after tax) not paid out as dividends but rather reinvested in the company by way of either purchasing assets or paying off debt - or possibly just keeping as cash.

So I would say no, retained earnings does not mean gross earnings, and thus would not include things like salaries.

With regard to debt though, I would assume this means paying off borrowed principal, as presumably interest would come under expenses and already be accounted for (ie. would not form part of profits in the first place, since profit is income minus expenses).

GP

 

[WBG Redcliffe]

GP

Thank you very much that definition makes it so much clearer. Starting to understand what Buffett is looking at.

Thanks again

 

[Sunfish]

Buffett has never written a book. He was a student of Benjamin Graham who wrote The intelligent Investor.

The Buffett Way is something of a con. There is no way he could have compounded his starting stake into billions in the time it took him to do it, using the stated techniques.

A student of share trading should also read Confessions of a Stock Operator, a fictional account of the life of the fabled trader, Jesse Livermore by Lefevre. Unlike Buffett he watched the tape like a hawk.

You and I can never aspire to match their skills so should not attempt to. But a little understanding always helps.

ps. Retained earnings is simply nett profit less dividends paid and stock options granted. The logic is that a good company can use those funds more productively than the individual. Maybe true, maybe not!

 

[WinstonWolfe]

don't know about the resource you are reading, but Buffett's use of earnings from my understanding is something similar to free cash flow, which cannot be easily fudged with dirty accounting tricks.

i.e.
Buffett: owner earnings = net income + depreciation - changes in working capital - capital expenditures

Whether you are a property investor or large enterprise, it is free cash flows that determine ability to add value to an enterprise....especially during a credit squeeze that flattens asset price growth.

 

[chilliaa]

Hi all,

Currently reading The Warren Buffett Way. I have read on a number of occasions that a good indication of a worthy company is if a company is able to show that for every dollar of retained earnings it equates to at least one dollar of market value.

“Buffett’s goal is to select companies in which each dollar of retained earnings is translated into at least one dollar of market value.” Page 117

I believe that the EPS expected price per share x outstanding shares is the retained earnings (not 100% sure) but I’m not sure how to work out the market value?

Can anyone help.

Sunfish is correct in that buffett has never written a book himself. All the books written about him are authors trying to 'explain' how buffett values stocks.

My interpriation of this statement is that over the long term each dollar of retained earnings should be reflected in an appropriate increase in the intrinsic value of the company which should be reflected in the long term by the companies share price. Note the wording long term, Buffect clearly acknowledges that in the short to medium term, a companies share price may be higher or lower than its instrinsic value.

 

[im sparticus]

its "reminiscences of a stock operator"

you must be thinking of "confessions of a heiress" by paris hilton

 

[Sunfish]

its "reminiscences of a stock operator"

you must be thinking of "confessions of a heiress" by paris hilton

How could I possibly have got them confused: One spends millions, the other makes 'em.

But that's still confusing. Celebrities make millions, with the only qualification being that one must be a celebrity.

 

[im sparticus]

How could I possibly have got them confused: One spends millions, the other makes 'em.

But that's still confusing. Celebrities make millions, with the only qualification being that one must be a celebrity.

now you have me confused which one spent them and which one makes them?