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Strategies & Market Trends : Buffettology -- Ignore unavailable to you. Want to Upgrade?

To: Robert Douglas who wrote (571)	11/20/1998 1:56:00 PM
From: Bob Martin	Read Replies (1) \| Respond to of 4691

Re: valuation/ p/e ratio. Is a company with a 24PE that grows earnings at 7% a year (IBM) a better deal than a company that has a PE of 65, but grows at 50-65%? (i.e., Dell) ? You tell me how long these past growth rates will continue into the future and I will tell you which is the better buy. Will Dell keep 50% growth up for one more quarter, one more year, five more years? As you know, a 50% compounded rate of growth is not going to stay for long. Wall Street analysts love to take a recent trend and extrapolate it into the future. Most earnings predictions could be made by a second-grader with a straight-edge and a piece of semi-log graph paper. Your question is the wrong one because it is backward looking and not forward looking. The temptation to forecast the future by looking at the recent past is folly, practiced by those wishing to sell you something. -- Well in an attempt to give a slightly more objective, numerically-based answer, here's what I see: The following assumes a 9% discount rate, used to discount future earnings. If we assume Dell will grow earnings by 40% for the next 5 years, followed by 5% thereafter, a fair PE right now would be about 100. Since the current PE is about 70, it's selling at about a 30% discount to "fair" value. If we assume IBM will grow earnings by about 10% for the next 5 years, followed by 5% thereafter, a fair PE right now would be about 32. Since the current PE is about 24, it's selling at about a 25% discount to fair value. Now, Dell seems better, BUT, IBM pays a dividend, has a lower current PE, so bad news will affect it less, and can more easily surprise us, since we're only assuming 10% rev growth. In Dell's favor is that it's currently a much smaller company, so it easier to grow sales and earnings more quickly than a big company, and they've had a phenominal record of turning in great performance in the last several years. I guess the main answer to your question of which is better is, which do you have more confidence in growing their earnings according to the assumptions? NOTE: The assumed PEs are based on Cash Earnings (Net earnings (not including one time gains and losses) + Depreciation and amortization - capital expeditures). Since I don't really follow Dell or IBM, I have no idea what their current cash earnings are. I was just using their published PEs in the examples above. Hope this helps, Bob