The price you pay determines the base earning yield

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One advantage of investing in stocks has over investing property is that you can start small with only 1,000 dollars and all without the need to carry the heavy burden of debt.

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But, is starting with such a small amount of money worth it?

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Especially if you are not using debt as leverage?

Yes, absolutely.

The Little Bluey Portfolio.

This is the primary purpose of the Little Bluey $1,000 Portfolio.

Along with showing the Share Investors Blueprint members, and prospective members, the seven investment steps in practice.

These seven steps are the same lessons you will find on the page Have You Given Up?

And, I’m going to explain how I have grown little Bluey from 1,000 dollars from January this year to $4,500 today.

Start with the End in Mind.

The goal is to grow Little Bluey into $2 million within 20 years.

Let’s look at what is required to achieve this goal.

I will need to contribute 2,000 dollars each year and earn a compounded annualised return of 20%.

According to Noel Whittaker’s compound interest calculator, it would take approximately 16 years to grow the value into $2 million. This gives me a four-year buffer, which will help cover the down years and taxes payable.

Timeline of Investments to date.

My first stock purchase was Vita Group (VTG.ASX), purchasing 826 shares on the 12th of January at $1.20 per share.

On the 13th of March, I purchased an additional 588 shares of Vita Group, Which lowered my Purchase per share cost down to $1.117 per share.

The second stock purchase was Adairs (ADH.ASX), purchasing 847 shares on the 19th of March at 71 cents per share.

Six days later purchasing more shares at 69 cents per share, this slightly reduced my total average purchase price per share.

By purchasing, both Adairs and Vita Group, when the share price fell at a lower share price, I was dollar-cost averaging down. An effective strategy to lower your purchase price per share, which reduces the profit breakeven point.

For example, Vita Group has a profit breakeven point of $1.117 per share, but if I didn’t buy more shares, the profit breakeven point would have been $1.20

March was the month the market fell due to the Covid-19 pandemic. And, it was the month I contributed 1,819 dollars, so I could take advantage of the fall in share prices of Adairs and Vita Group.

On the 27th of May, a few days ago, I brought my third stock – People Infrastructure (PPE.ASX). I was buying 478 shares at $2.09 per share.

The People Infrastructure share purchase was paid for out of the profits made selling half of the shares I owned in Adairs, which was 585 at $1.574 on the 8th of May.

The table below is the current state of the Little Bluey Portfolio.

Little Bluey Portfolio

In the Share Investors Blueprint I had wrote the following:

‘In Step 1, we were aiming for a 9% compounded annual return to grow our wealth, which is our required rate of return (RRR)…. And, we can see that [Woolworths] share price is double our EPV, and by dividing our Owner Earnings figure by the share price, it tells us that buying at the current share price we would be earning a 4.30% yield (1.6/37.34).’

The earning yield is crucial as it relates to the goal of earning a 20% compounded annualised rate of return over 20 years.

And you can see that the Bluey portfolio is earning a 14.50% average earning yield.

Slightly, below our target of 20%.

And there are three essential points to make:

  • Growth in net earnings increases the earnings yield.
  • The price you pay for shares determines the base earnings yield.
  • The average earnings yield on the total portfolio is used to assist in answering question two.

The earnings yield measures the net earnings return on investment.

Warren Buffett’s purchase of See’s Candy provides a great example.

“[We] brought See’s [Candy] early in 1972 for $25 million, at the time See’s had about $8 million of net tangible assets. This level of tangible assets was adequate to conduct the business without the use of debt, except for short periods seasonally. See’s was earning about $2 million after tax at the time, and such earnings seemed conservatively representative of future earning power in constant 1972 dollars. In 1972 (and now) relatively few businesses could be expected to earn 25% after tax on net tangible assets that were earned by See’s.”

By 1983, Buffett and Charlie Munger’s purchase of See’s was earning about $13 million after tax on $20 million of net tangible assets. The earning yield grew to 52%.

And, by 1990, See’s was earning about $24 million after tax, close to a yield of 100%.

I’m expecting People Infrastructure to grow net earnings over the next five years at close to a 10% compounded growth rate. If they manage to achieve this growth rate, their net earnings per share will grow from 0.147 cents per share to 0.499 cents per share.

At $0.499 net earnings per share, my original earnings yield grows from 7.30% to 28.90%.

The price you pay determines the base earning yield.

If I had paid $2.22 per share for People Infrastructure, the earnings yield would have been 6.80%, but if I had paid 99 cents per share back in late March, then earnings yield would have been 15.30%.

https://i0.wp.com/www.searchingforvalue.org/wp-content/uploads/2020/05/ASX-PPE-SP-1.png?w=470&ssl=1

ASX.PPE Share Price

As you can see, on the Little Bluey portfolio screenshot, the average portfolio earnings yield is 14.50%.

I use this yield as one benchmark for buying new stocks.

For instance, if had brought People Infrastructure at 99 cents per share, then the portfolio’s average earnings yield would have grown from 14.50% to 17.70%.

Whereas, before I brought People Infrastructure, the portfolio had an average earnings yield of 18.10%.

But, the because I brought People Infrastructure shares at $2.09, the 7.30% earnings yield ended up lowering the portfolio’s average earnings yield.

In regards to People Infrastructure, there is a real risk that the net earnings increases but the earning yield slightly decreases.

Why this is okay and how it occurs is because People Infrastructure’s management has issued several shares to raise capital so they can fund the acquisition of new businesses.

The acquisition of new businesses should increase revenues and thus, net profits. I would have preferred that they used debt instead of issuing new shares, as the interest payable on debt is lower than the market’s equity risk premium.

The market’s equity risk premium is the share markets fancy way of saying our Required Rate of Return (RRR).

Which is what investors expect the rate of return on shares should be in addition to the risk free rate of return on bonds.

What about the 100%+ share price rise in Adairs?

So, far I haven’t mentioned the gains made from the share price appreciation.

That’s because if you focus on identifying high quality businesses and buying them at reasonable prices, the share price gains take care of themselves.

If a stock I own sees it shares rise in price within 12 months, I put it down to luck most of the time. You do put the odds in your favour when you buy a lot of value at a low price that is the aim of the game.

As uncle Buffett says…

‘[Share] prices will be determined by future earnings. In investing, just as baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard.’

I had no idea that Adair’s share price would rise 100%+ above the average price I paid for their shares, only two months later.

Or, that People Infrastructure would immediately rise 4% the next day after buying their shares.

Vita Group has only now moved above the average price I paid for their shares back in January and March.

You are invited to join us at the Share Investors Blueprint – Click Here.

Oh, and join before the 1st of July, as the price of the membership – $399, will increase to $418.95.

Yours in investing

Adam C. Parris