Essence of Value Investing is Soundness Not Rate of Return

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Furthermore, by examining the blue shaded area representing dividends, relative to the green shaded area representing earnings, it should be clear that Consolidated Edison pays the majority of its profits (approximately 70%) to shareholders, in the form of dividends.  Consequently, it should also be clear that Consolidated Edison’s attractiveness is based more on the consistency and level of its dividend than on capital appreciation.  Also, we can see that dividends provide a significant portion of shareholder’s total return.

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Southern Company (SO) 3.2% Earnings Growth

Our second example, The Southern Company (NYSE:SO), is also a utility stock.  The primary difference in this example is that we are moving up the growth rate chain.  Southern Company has averaged 3.2% earnings growth versus Consolidated Edison’s 1.5% earnings growth.  Nevertheless, it should be clear that our fair value PE ratio of 15 continues to represent a clear proxy for fair valuation.  Although the price line does on occasion move above and below our fair value PE of 15, it continuously moves back into alignment.

Once again we see that a PE ratio of 15 represents an undeniable proxy of fair value for The Southern Company (NYSE:SO).  It is easy to analyze the graph on Southern Company and conclude that we would never want to pay much more than 15 times earnings to invest in it.  Moreover, notice how the price had risen above the fair value PE of 15 (the orange line) for much of 2012, but has since come back into alignment as the price is once again touching the orange line.

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Bemis Company Inc (BMS) 5.6% Earnings Growth

Our third example, Bemis Company, Inc. (NYSE:BMS), a paper packaging company, moves up the growth chain with a historical average earnings growth rate of 5.6%.  Nevertheless we once again see that the price tracks the orange line representing the fair value PE of 15.  Therefore, at this point we see the relevance of the 15 PE over earnings growth rates ranging from 1.5% for Consolidated Edison to 5.6% for Bemis.  But most importantly, we are seeing that the fair value PE continues to apply.

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Cracker Barrel (CBRL) 7% Earnings Growth

Our fourth example, the restaurant chain, Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL), has averaged 7% historical earnings growth which moves us approximately half way through our 0% to 15% range previously discussed.  Once again, we see that our fair value PE represents a strong proxy for fair valuation, even at this higher earnings growth rate.

Remember, that this represents that a 15 PE is a sound investment, but that the total return will be a function of the company’s future earnings growth rate.  Therefore, even though our PE of 15 still represents fair value, Cracker Barrel’s higher historical growth rate will generate more capital appreciation than we saw with our slow growth utility stocks.

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United Technologies (UTX) 10.9% Earnings Growth

With United Technologies Corporation (NYSE:UTX) our historical earnings growth rate now exceeds 10%, yet we continue to see that our fair value PE of 15 continues to represent a clear proxy for fair value.  In other words, by simply reviewing the graph, it is clear that a 15 PE ratio is a sound valuation to pay to buy United Technologies.  Moreover, we also see that any time the price falls below our normal PE of 15, a bargain manifests.  Conversely, we can also state that purchasing United Technologies at a PE ratio above 15 is not optimum.

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AmerisourceBergen Corp. (ABC) 15.6% Earnings Growth

AmerisourceBergen Corp. (NYSE:ABC), our sixth example, is presented because it crosses over our upper threshold of an earnings growth rate of 15%.  Once earnings growth exceeds 15%, the FAST Graphs™ research tool automatically applies the formula PE ratio = growth

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