valuation

This article on Ross Stores Inc (ROST) was instigated at the request of a reader.  The Earnings and Price Correlated graph on Ross Stores Inc tells the story of a company with a strong and consistent record of historical earnings growth. We believe this is important information for prospective investors to know.

About Ross Stores Inc:  Directly from their website

“Ross Stores, Inc. is an S&P 500, Fortune 500 and Nasdaq 100 (ROST) company headquartered in Pleasanton, California, with fiscal 2011 revenues of $8.6 billion. The Company operates Ross Dress for Less® (“Ross”), the largest off-price apparel and home fashion chain in the United States with 1,072 locations in 33 states, the District of Columbia and Guam. Ross offers first-quality, in-season, name brand and designer apparel, accessories, footwear and home fashions for the entire family at everyday savings of 20% to 60% off department and specialty store regular prices. The Company also operates 102 dd’s DISCOUNTS® in eight states that feature a more moderately-priced assortment of first-quality, in-season, name brand apparel, accessories, footwear and home fashions for the entire family at everyday savings of 20% to 70% off moderate department and discount store regular prices.”

Earnings Determine Market Price:  The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings.  The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line.  On graph after graph the lines will move in tandem.  If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.  

Earnings & Price Correlated Fundamentals-at-a-Glance

A quick glance at the historical earnings and price correlated FAST Graphs™ on Ross Stores Inc shows a picture of overvaluation based upon the historical earnings growth rate of 19.6% (orange circle) and a current PE of 21.3 (red circle).  Another interesting note is that Ross’ price follows its Historical PE of 15 rather than following its Operating Earnings Growth Rate of 19.6%.  In other words, the market has historically applied a discounted valuation to Ross Store’s relative to its earnings growth.

At the bottom of the graph you can see that earnings have grown from $0.36 per share in 1998, to an estimate of $3.46 per share for 2012 (see green highlighted earnings at the bottom of the graph), with a slight hiccup in 2004 and 2005 (yellow highlighting). As an aside, you can note from the graph that this is the highest valuation or price that you were asked to pay to buy a $1 dollar’s worth of Ross Stores’ earnings since 1998. In other words, Ross Stores’ stock appears expensive today based on historical earnings growth.

Ross Stores Inc:  Historical Earnings, Price, Dividends and Normal PE Since 1998

Performance Table Ross Stores Inc

The associated performance results with the earnings and price correlated graph, validates the principles regarding the two components of total return; capital appreciation and dividend income.  Dividends are included in the total return calculation and are assumed paid, but not reinvested.

When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident.  In addition to the 20.4% capital appreciation (green circle), long-term shareholders of Ross Stores Inc, assuming an initial investment of $1,000, would have received an additional $410.17 in dividends (blue highlighting) that increased their total return from 20.4% to 20.6% (orange highlighting) per annum versus 3.7% (red circle) in the S&P 500.

The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest.  Notice that the current price earnings ratio on this quality company is as normal as it has been since 1998.

A further indication of valuation can be seen by examining a company’s current price to sales ratio relative to its historical price to sales ratio.  The current price to sales ratio for Ross Stores Inc is 1.68 which is historically normal.

Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:

1.            The rate of change (growth rate) of the company’s earnings

2.            The price or valuation you pay to buy those earnings

Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

Analysts are forecasting the earnings growth to continue at about 8.1%, and when you look at the forecasting graph below, the stock appears overvalued, (it’s outside of the value corridor of the five orange lines – based on future growth).

The consensus of 23 leading analysts reporting to Capital IQ forecast Ross Stores Inc’s long-term earnings growth at 14.7% (orange circle).  Ross Stores Inc has low long-term debt at 9% of capital (red circle).  Ross Stores Inc is currently trading at a P/E of 21.3, which is above the value corridor (defined by the five orange lines) of a maximum P/E of 18 but a fair value of a P/E 15 (see orange lines). If the earnings materialize as forecast, Ross Stores Inc’s True Worth™ valuation would be $99.78 at the end of 2017 (brown circle on EYE Chart), which would be a 8.1% annual rate of return from the current price (yellow highlighting).

Earnings Yield Estimates

Discounted Future Cash Flows:  All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because Earnings Determine Market Price in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in Ross Stores Inc to an equal investment in 10 year Treasury bonds, illustrates that Ross Stores Inc’s expected earnings would be 5.9 (purple circle) times that of the 10 Year T-Bond Interest. (See EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.

Summary & Conclusions

This report presented essential “fundamentals at a glance” illustrating the past and present valuation based on earnings achievements as reported.  Future forecasts for earnings growth are based on the consensus of leading analysts.  Although, with just a quick glance you can know a lot about the company, it’s imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.

Disclosure:  Long ROST at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation. A comprehensive due diligence effort is recommended.