Investing style is a religion

[galumay]

generally speaking a quality "growth" stock (e.g. Blackmores, CSl, etc) will typically trade on a much higher price to earnings ratio then a quality "income" stock.

Until they dont, and then the rerating is often savage.

There is a reason for this and I am not sure why some people here struggle to grasp it.

One of the reasons is that P/E is not a accurate or meaningful measure of value. There is a reason for this and I am not sure why some people here struggle to grasp it. (Hint - "P")

 

[Value Hunter]

Galumay let us get to the point of the discussion. If you own shares in Seek or Credit Corp or Cochlear, etc would you rather management keep retaining a portion of the earnings or would you rather they pay 100% out as a dividend? Would you ascribe them the same intrinsic valuation if they switched to a 100% dividend payout ratio?

 

[Value Hunter]

I will give one more simplified hypothetical example to cement the point. Lets say company A shares always trade on a p.e. ratio of 15 and the return on equity is always 20% (including on reinvested earnings) and the dividend payout ratio is 0%. I am also leaving out tax to simplify the example.

So in year 1 the earnings per share is $1 and the share price is $15. After 10 years of reinvesting earnings, earnings per share are now just over $6.19 and the share price is $92.87. So you turned $15 into $92.87 after 10 years.

The alternative for investment is company B. Shares always trade at 15 times earnings and return on equity is always 20%. The dividend payout ratio is however 100% instead of 0%. So the earnings growth is zero and the dividend yield is 6.6666%. Every year you use the dividends to buy more shares. So after 10 years the share price would still be $15 but for every share you originally owned you now own approximately 1.9 shares. So you turned $15 into $28.65.

I think it should be clear to everybody why dividend payout ratios affect company valuation. Galumay, Cynic are you actually both trying to make the absurd argument that a company's dividend payout ratio does not affect its intrinsic valuation?

 

[luutzu]

generally speaking a quality "growth" stock (e.g. Blackmores, CSl, etc) will typically trade on a much higher price to earnings ratio then a quality "income" stock. There is a reason for this and I am not sure why some people here struggle to grasp it.

Most share market investors in the long-term will be lucky to even get a low double digit (net) return from the sharemarket. Therefore for the vast majority of investors a company that can reinvest a portion of its earnings at high returns (e.g. returns north of 20%) will (generally speaking) be worth more (and will thus be typically valued using a higher price to earnings ratio) than a comparable company that pays out most of its profits as dividend. If A2 milk or Blackmores suddenly decided to stop growing and pay out 100% of their earnings as a dividend their share prices (and price to earnings ratios) would rightly plummet.

You're assuming that a business can only grow from its owner's equity.

While most business might very well "grow" if it keep back its earnings, and/or raise new equity to make investment to grow. That capital from equity is not the only option.

A business can perfectly grow through liabilities/debt.

In fact, the mark of a quality business is one that rarely need to retain its earnings or raise new equity to grow.

It can "owe" its suppliers money in paying it later than the supply being turned to cash once received. It can, say, delay paying its employees or enslave them. Can also grow by borrowing at mates' rates. etc. etc.

 

[cynic]

I will give one more simplified hypothetical example to cement the point. Lets say company A shares always trade on a p.e. ratio of 15 and the return on equity is always 20% (including on reinvested earnings) and the dividend payout ratio is 0%. I am also leaving out tax to simplify the example.

So in year 1 the earnings per share is $1 and the share price is $15. After 10 years of reinvesting earnings, earnings per share are now just over $6.19 and the share price is $92.87. So you turned $15 into $92.87 after 10 years.

The alternative for investment is company B. Shares always trade at 15 times earnings and return on equity is always 20%. The dividend payout ratio is however 100% instead of 0%. So the earnings growth is zero and the dividend yield is 6.6666%. Every year you use the dividends to buy more shares. So after 10 years the share price would still be $15 but for every share you originally owned you now own approximately 1.9 shares. So you turned $15 into $28.65.

I think it should be clear to everybody why dividend payout ratios affect company valuation. Galumay, Cynic are you actually both trying to make the absurd argument that a company's dividend payout ratio does not affect its intrinsic valuation?

No!
I am merely pointing out that either undisclosed presumptions exist, or the reasoning offered in support of the evaluation is seriously amiss.

Now, do I need to point out the various logical and mathematical errors you have presented here to "cement" your point"?

Or would you prefer to first spend some time revisiting the logic and mathematical calculations, before I attempt to explain why what you have posted here is seriously amiss?

 

[galumay]

Ditto.

 

[luutzu]

I will give one more simplified hypothetical example to cement the point. Lets say company A shares always trade on a p.e. ratio of 15 and the return on equity is always 20% (including on reinvested earnings) and the dividend payout ratio is 0%. I am also leaving out tax to simplify the example.

So in year 1 the earnings per share is $1 and the share price is $15. After 10 years of reinvesting earnings, earnings per share are now just over $6.19 and the share price is $92.87. So you turned $15 into $92.87 after 10 years.

The alternative for investment is company B. Shares always trade at 15 times earnings and return on equity is always 20%. The dividend payout ratio is however 100% instead of 0%. So the earnings growth is zero and the dividend yield is 6.6666%. Every year you use the dividends to buy more shares. So after 10 years the share price would still be $15 but for every share you originally owned you now own approximately 1.9 shares. So you turned $15 into $28.65.

I think it should be clear to everybody why dividend payout ratios affect company valuation. Galumay, Cynic are you actually both trying to make the absurd argument that a company's dividend payout ratio does not affect its intrinsic valuation?

You're not taking in the perspective of the investor as the buyer today vs the investor who had bought then became the new owner and eventual seller.

To rephrase what Monty and your example above, Monty is saying this:

If you buy a company that earns money, take all that earning out, spend it however you like, you will pay less for it.

If you buy the same company with the same earning, but instead of taking that earning out to enjoy, you put it back to reinvest, you will have to pay more for it (because it will become more valuable, with your retained earnings saved and compounded).

You don't need any maths to work out why that line of reasoning is just wrong.

I mean, buy for cheap and getting to enjoy the cash each year?

Buy for more because you defer enjoying the cash today?

 

[Value Hunter]

My main point was that a company's dividend payout ratio does affect its valuation. Cynic its good to see that we agree that the dividend payout ratio does affect a company's intrinsic valuation. I think given we agree on this main point we can end this rather pointless discussion rather then get bogged down quibbling on the details.

 

[Value Collector]

Dude, like I said before, I understand that a business with higher ROE is worth more. If it retain its earnings and reinvested it, it will be worth more [all else being equal].

But unless those retained and reinvested earnings are already made [past tense there]... then I should not be paying for those future value and benefits my retained earning made possible. Because those future I've bought and paid for.


.

Mate you are simply not getting it, and your examples you are using demonstrate you don't get.

Another example...

Say I bought an ATM. It dispenses $1000 a day, everyday.

Why is the ATM worth any more or less to me as its new owner if I were to spend that $1000 daily earning or put it back into the ATM?

Against my better judgement, let me attempt one last time to explain the concept to you that you are missing, and what you aren't understanding about how ROE matters when we are dealing with retained earnings.

Lets say me and you both have some lazy money to invest, and we are looking to get into the pizza industry, we find 2 pizza shops, management is in place and ownership is completely passive.

Shop 1, Has $300,000 of equity (Pizza ovens, fridges, counters, signage etc etc) and Net profit after tax of $75,000 of after tax profit, thats a 25% return on equity. The business isn't really suited to expand, so management will pay $75,000 dividend each year.

It's on the market for $750,000 which would give the future owner a 10% earnings yield.


Shop 2, Has $300,000 of equity (Pizza ovens, fridges, counters, signage etc etc) and Net profit after tax of $75,000 of after tax profit, thats a 25% return on equity, this businesses is well suited to expand, and management, have a credible plan to open identical pizza shops all over Australia each new store will take $300,000 of equity to open, and deliver the same 25% return on that equity.
Management will retain all earnings so will not pay a dividend (for 10 years), but will use the retained earnings to expand store numbers.

Its on the market for $850,000 which would give the owner a 8.8% earnings yield.

--------

Now you seem to be saying that shop 2 is not worth anymore than shop 1, because they both have $75,000 of earnings each year, so if you paid $850,000 for shop2, you are getting a worse deal than shop 1.

What Roger and I would say is that the fact that Shop 2 has a credible way to retain earnings and put them to work at 25%, makes it more attractive to us today, So we would do a calculation as he described to work out what its future vale is going to grow to, and then decide whether todays price represents good value or not.

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Shop 1, pays out all earnings as dividends and won't grow, so it is never going to be worth more than $750,000 if you need a 10% return.

however,

Shop 2, retains earnings and reinvests them at 25%, so its earnings are going to grow rapidly, So todays price of $850,000 is very cheap when we require a 10% return, because given its likely growth rate, we could actually pay $1,500,000 for it and still get a 10% return if its growth plans go well.

after 10 years,

Shop 1, still only has 1 stores and still only earns $75,000

however

shop 2, now has 6 stores and earns $450,000 per year. (and thats without using debt), at a 10% earnings yield shop 2 is now worth $4,500,000.

Rogers valuation would have said you could have paid up to $1,500,000 for shop 2 and still got the same 10% earnings rate as shop 1, So his calculation would have helped us see that shop2 at $850,000 market price was the better investment, even though you would have missed it, as you think shop 1 and shop 2 are equal.

I mean, buy for cheap and getting to enjoy the cash each year?

You should be able to see how that attitude would lead you to miss huge investment gain if it makes you avoid companies that can retain earnings at high ROE.

 

[luutzu]

Mate you are simply not getting it, and your examples you are using demonstrate you don't get.



Against my better judgement, let me attempt one last time to explain the concept to you that you are missing, and what you aren't understanding about how ROE matters when we are dealing with retained earnings.

Lets say me and you both have some lazy money to invest, and we are looking to get into the pizza industry, we find 2 pizza shops, management is in place and ownership is completely passive.

Shop 1, Has $300,000 of equity (Pizza ovens, fridges, counters, signage etc etc) and Net profit after tax of $75,000 of after tax profit, thats a 25% return on equity. The business isn't really suited to expand, so management will pay $75,000 dividend each year.

It's on the market for $750,000 which would give the future owner a 10% earnings yield.


Shop 2, Has $300,000 of equity (Pizza ovens, fridges, counters, signage etc etc) and Net profit after tax of $75,000 of after tax profit, thats a 25% return on equity, this businesses is well suited to expand, and management, have a credible plan to open identical pizza shops all over Australia each new store will take $300,000 of equity to open, and deliver the same 25% return on that equity.
Management will retain all earnings so will not pay a dividend (for 10 years), but will use the retained earnings to expand store numbers.

Its on the market for $850,000 which would give the owner a 8.8% earnings yield.

--------

Now you seem to be saying that shop 2 is not worth anymore than shop 1, because they both have $75,000 of earnings each year, so if you paid $850,000 for shop2, you are getting a worse deal than shop 1.

What Roger and I would say is that the fact that Shop 2 has a credible way to retain earnings and put them to work at 25%, makes it more attractive to us today, So we would do a calculation as he described to work out what its future vale is going to grow to, and then decide whether todays price represents good value or not.

--------------

Shop 1, pays out all earnings as dividends and won't grow, so it is never going to be worth more than $750,000 if you need a 10% return.

however,

Shop 2, retains earnings and reinvests them at 25%, so its earnings are going to grow rapidly, So todays price of $850,000 is very cheap when we require a 10% return, because given its likely growth rate, we could actually pay $1,500,000 for it and still get a 10% return if its growth plans go well.

after 10 years,

Shop 1, still only has 1 stores and still only earns $75,000

however

shop 2, now has 6 stores and earns $450,000 per year. (and thats without using debt), at a 10% earnings yield shop 2 is now worth $4,500,000.

Rogers valuation would have said you could have paid up to $1,500,000 for shop 2 and still got the same 10% earnings rate as shop 1, So his calculation would have helped us see that shop2 at $850,000 market price was the better investment, even though you would have missed it, as you think shop 1 and shop 2 are equal.



You should be able to see how that attitude would lead you to miss huge investment gain if it makes you avoid companies that can retain earnings at high ROE.

Timing, ownership deed... those are important dude.

When someone else make the savings and investment in their business, it is their business. They use their own savings, put it into their own shop, it grew in value. So it is more valuable to them. True?

So why is Monty, and yourself, asking that owner to pay more for a business that became more valuable only later, after all his own sacrifices. And why would you and Monty do it if you're that future owner.

You're bidding against yourself.


Again, a business that have high ROE, good margin, outstanding this and all that... generates $x earning power.

Those are the qualities and attributes that make it worth, say $10X.

Monty is saying... but since that company is going to reinvest all that $x, or some of it... it's going to be more valuable. So instead of $10x, he's going to now pay $10x + value from retained earnings he will make, call it $10x + y.

Yea, when he come to sell it later, after he bought and made the investment, it will, hopefully, be worth $10x+y. That's LATER. Sold to someone else.


I mean, when Monty first jumped into ownership of that business, the business retain earnings they should have handed over to him, but kept back into the business. Yes, the business becomes more valuable. BUT, but Monty had become the owner and had put aside his earnings [from that business] to grow it further.

So why is the Monty that's on the platform wanting to pay the future Monty more cash to jump in at time-zero.

--------------

Dude, you and Monty can't just assume that the $75K in dividend that's paid out will be wasted. It's real cash, paid out and can be use or invested as I want.

Sure that mean the Pizza shop will have to carry on with its own steam. It will most likely not expand and take over the world.

But the owner, with that additional $75K dividend they're free to allocate it however... might very well invest it a BerkshireHathaway etc. etc.

Or they can waste it... either way, it does not affect the value of the business that generate the same income at Time-Zero.


You have got to freeze the business the moment you value it.

Like that new car example.

A buyer can't tell the dealer that a new car is old and used because in the future he's going to use it.

Likewise, a buyer will not pay a higher price than the asking price simply because he will do it up and treat it well after he bought it.

 

[Value Collector]

Sure that mean the Pizza shop will have to carry on with its own steam. It will most likely not expand and take over the world.

But the owner, with that additional $75K dividend they're free to allocate it however... might very well invest it a BerkshireHathaway etc. etc.

Berkshire is a perfect example of my point, retained earnings deployed at high rate.

Pizza shop 2 will grow at the same rate as Berkshire Hathaway did, because it is deploying its retained earnings at the same rate Berkshire did.

what you are saying is that it is stupid to pay a little extra to invest in a company like Berkshire that can deploy retained earnings at high rates.

When someone else make the savings and investment in their business, it is their business. They use their own savings, put it into their own shop, it grew in value. So it is more valuable to them. True?

So why is Monty, and yourself, asking that owner to pay more for a business that became more valuable only later, after all his own sacrifices. And why would you and Monty do it if you're that future owner.

Because not all businesses can retain and earnings and invest them at 25%, so it makes total business sense to pay a little extra for a business that is going to grow your retained earnings at 25% for you, rather than one that can't do that.
You're bidding against yourself.

Monty is saying... but since that company is going to reinvest all that $x, or some of it... it's going to be more valuable. So instead of $10x, he's going to now pay $10x + value from retained earnings he will make, call it $10x + y.

No, he is saying he is willing to pay a higher multiple for the existing equity in the business, because the business he is buying has the ability to deploy earnings at high rates of return.

Yea, when he come to sell it later, after he bought and made the investment, it will, hopefully, be worth $10x+y. That's LATER. Sold to someone else.

Can you not see in my pizza shop example that it would be well worth paying an extra $100 for the company thats going to grow to be worth $4.5 Million?

and can you not see that even if you did pay $1.5 Million for it you are not paying for "all" future growth.

I mean, when Monty first jumped into ownership of that business, the business retain earnings they should have handed over to him, but kept back into the business. Yes, the business becomes more valuable. BUT, but Monty had become the owner and had put aside his earnings [from that business] to grow it further.

So do you not see the difference between a company that can retain earnings and deploy them at 25% vs one that can't?

Do you think a company retaining earnings and deploying them at 10% is equal to a company deploying them at 25%?

Dude, you and Monty can't just assume that the $75K in dividend that's paid out will be wasted. It's real cash, paid out and can be use or invested as I want.

No one is saying it's wasted, thats your straw man you are building.

 

[Value Collector]

Listen to this from the 2 minute mark, buffett explains the concept I have been trying to explain (at the 3.15 mark he specifically talks about preferring companies to retain earnings)



at the 4.40 mark of this second video he explains the concept of thinking of stocks as equity bonds.



Rogers method is simply used to estimate the future growth rate of a company, and then discount that back to what your required return is to figure out if the current market price is good value when you apply your margin of safety etc.

applying rogers method to pizza shop 2, shows us that even though on face value it looks more expensive than shop1 one, its actually a solid bargain

 

[luutzu]

....

what you are saying is that it is stupid to pay a little extra to invest in a company like Berkshire that can deploy retained earnings at high rates.

No I didn't.

I'm saying that the price I'm willing to pay for Berkshire already take into account all that is good and valuable. I've already gone infinity, came back with a value for Berkshire.

What Monty is doing is to go there, came back, then go again to come back with a new value if he were to reinvest his own cash [from its earnings].


From Monty's video:
Price to pay if all earnings paid out: ~$16 per share.

Price to pay if all earnings retained: ~$36 per share.

Soo.... again, if single owner were to tell the current WOW vendor that he intends to take all the future dividends out of the business, he will only need to pay $16

If he intend to sacrifice and reinvest, he'll pay $36 to the guy. Right now.

Doesn't make sense.


I do know that yes, if dividends are reinvested, WOW will be "worth" $36 [let say] in the future. But that's the additional value the new owners made after his purchase, plus all the reinvestments.

So if we follow Monty's formula, we ought to buy WOW at $16. Not at $36.

The $36 is, if everything goes well with the retained earning being invested... will be worth $36 later.

Can you not see in my pizza shop example that it would be well worth paying an extra $100 for the company thats going to grow to be worth $4.5 Million?

and can you not see that even if you did pay $1.5 Million for it you are not paying for "all" future growth.

So do you not see the difference between a company that can retain earnings and deploy them at 25% vs one that can't?

Do you think a company retaining earnings and deploying them at 10% is equal to a company deploying them at 25%?

If someone else were to own the pizza place, use joint's earnings to reinvest, raise their own additional equity to expand etc. Then yes, I'd pay more for it.

But if I were to buy it today, then it's my cash that's going to go back into the business. It'll be more valuable but those value were from my savings etc. etc. Why should I have to pay that future value now, to someone else, for the privilege of me growing the business after I bought it?

No one is saying it's wasted, thats your straw man you are building.

No I didn't.

Monty said that $1 earnings that's paid out is not the same $1 earning that's kept back.

Why not?

Because if it's kept back it'll grow and expand the business.

Of course it will. Heck, it better grow because I could find better use for it at the pub otherwise.


i.e. if the business grew with somebody else's money, then sure it's fair that you and Monty pay for that extra value.

But if it were to grow with your and Monty's earnings being retained. You and Monty shouldn't have to pay for that "growth". You can enjoy the fruit later, for sure. But not pay someone else who already cashed out, then your cash reinvested made possible.

If if you and Monty wanted to, I still have that $100M bank account you were welcome to pay $130M for it today.

 

[Value Collector]

Soo.... again, if single owner were to tell the current WOW vendor that he intends to take all the future dividends out of the business, he will only need to pay $16

You just don't get it, that sentence proves it, so I will leave you to your ignorance now, I have heard its bliss.

 

[luutzu]

Listen to this from the 2 minute mark, buffett explains the concept I have been trying to explain (at the 3.15 mark he specifically talks about preferring companies to retain earnings)



at the 4.40 mark of this second video he explains the concept of thinking of stocks as equity bonds.



Rogers method is simply used to estimate the future growth rate of a company, and then discount that back to what your required return is to figure out if the current market price is good value when you apply your margin of safety etc.

applying rogers method to pizza shop 2, shows us that even though on face value it looks more expensive than shop1 one, its actually a solid bargain

Of course you'll want a high ROE business to retain the earning and compound the heck out of it.

Save you from tax, and save you the trouble of having to find another company to compound that earning.

So by all mean, keep the capital if management can do it well.


That does not, in no way, detract from the fact that if the earning is paid out in dividend its enterprise price today is any more or less. It's the same business.

So if it were to retain and compound well.... that's tomorrow's business, tomorrow's value.

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Yes, I understand perpetuity. I actually agree with it.

So, where in Monty's valuation formula did he apply that earning/coupon?

He literally only value equity in the business.

That's all fine and fair if it's other people's equity he's valuing when he works out how much to buy it for.

It's ridiculous to price it at both before and after he bought the business. Then go about paying for both the past and the future equity he himself already paid for.

-----------------------

Perpetual Annuity:

Present Value = Earning / r

Where r is the owner's required rate of return.
So if the company can keep compounding the E at my required r, then keep my E and do your work.

If the company cannot meet that r requirement, pay it out and I'll try to find some place.

But at the time of purchase, a company is not supposed to cost more or less simply because I, as its new owner, decide what and where to put what will be my earning.

Further, in that formula, where does it says the present value depends on how the Earning is split?
Remember that Earnings mean the company's NPAT.

If anything, if you want to split the earning so that you can buy it for cheap... which was that Monty said was his aim... you'd want to define "Earning" as only the dividend that's paid out to you the new owner, see what those are worth because it's dividends paid out that goes into your pocket.

 

[luutzu]

You just don't get it, that sentence proves it, so I will leave you to your ignorance now, I have heard its bliss.

Not ignorance dude. Stupidity. No need to be polite

Ignorance is if I never heard of the subject. To have heard and debate it mean I am norance of it , just too thick to understand it.

 

[Value Collector]

Of course you'll want a high ROE business to retain the earning and compound the heck out of it.

Save you from tax, and save you the trouble of having to find another company to compound that earning.

So by all mean, keep the capital if management can do it well.


That does not, in no way, detract from the fact that if the earning is paid out in dividend its enterprise price today is any more or less. It's the same business.

.

I get it, you don't think a business that can retain earnings and invest them at 25% is worth more today than a company that doesn't have that ability and can only deploy retained earnings at 10%.

All I can say is that you are wrong, companies that have the ability to deploy earnings generating 25%+ on an ongoing basis are rare, and are worth more than their face value of equity, and worth more than stranded earnings multiples, if you can't see that, then thats your loss.

All rogers calculation is about is estimating how much that future growth might be, and working out a rational price to pay for that today. the reason he split the valuation between paid out and retained, is because its only the retained earnings that will stick out and compound, so he applies a smaller multiple to the part of the equity that pays out its earnings, and a higher multiple to the part of the equity that retains and compounds its earnings.

So, where in Monty's valuation formula did he apply that earning/coupon?

He literally only value equity in the business.

the coupon is the ROE.

As I tried to explain earlier.

The equity is like the face value of the bond, eg a company with $5 of equity per share is like a bond with a face value of $5, if that company has a ROE of 25%, each share is basically a $5 bond paying a 25% interest rate coupon,

So that $5 equity bond earning 25% is worth more than one only earning 5%,

and a $5 Equity bond earning 25% ROE that allows you to reinvest the earnings back at 25%, is worth more than one that doesn't.

 

[luutzu]

I get it, you don't think a business that can retain earnings and invest them at 25% is worth more today than a company that doesn't have that ability and can only deploy retained earnings at 10%.

All I can say is that you are wrong, companies that have the ability to deploy earnings generating 25%+ on an ongoing basis are rare, and are worth more than their face value of equity, and worth more than stranded earnings multiples, if you can't see that, then thats your loss.

All rogers calculation is about is estimating how much that future growth might be, and working out a rational price to pay for that today. the reason he split the valuation between paid out and retained, is because its only the retained earnings that will stick out and compound, so he applies a smaller multiple to the part of the equity that pays out its earnings, and a higher multiple to the part of the equity that retains and compounds its earnings.



the coupon is the ROE.

As I tried to explain earlier.

The equity is like the face value of the bond, eg a company with $5 of equity per share is like a bond with a face value of $5, if that company has a ROE of 25%, each share is basically a $5 bond paying a 25% interest rate coupon,

So that $5 equity bond earning 25% is worth more than one only earning 5%,

and a $5 Equity bond earning 25% ROE that allows you to reinvest the earnings back at 25%, is worth more than one that doesn't.

Of course it's going to worth more.

Any idiot would know that.

Question is, whose equity is it that made it worth more.

If it's the previous owner's equity... well that had already been paid for.

if it's the new owner's equity.... why should he pay more for what is already his?

 

[luutzu]

.....

All rogers calculation is about is estimating how much that future growth might be, and working out a rational price to pay for that today. the reason he split the valuation between paid out and retained, is because its only the retained earnings that will stick out and compound, so he applies a smaller multiple to the part of the equity that pays out its earnings, and a higher multiple to the part of the equity that retains and compounds its earnings.

That's the problem with Monty's approach there.

He mixes the future worth/value his reinvestment will be worth later. Mix that with the price that's being asked of him today, before those reinvestment are made and compound.

i.e. he's bidding against his future self.

Clear as mud McFly?

 

[Value Collector]

Of course it's going to worth more.

Any idiot would know that.

Well its been a hell of a long road to get you to admit that, Rogers calculation is used to estimate that future growth rate, and provide you with a maximum price you could pay to make she you aren't over paying for the growth and putting your required return at risk.

Question is, whose equity is it that made it worth more.

It is the underlying economics of the business that make it worth more.

What makes it worth more today, is that this particular company has something about it that makes it possible for the company to be able to continue retaining earnings and deploying them at high rates eg 25%+

If it's the previous owner's equity... well that had already been paid for.

if it's the new owner's equity.... why should he pay more for what is already his?

Again, this comment makes me think you still are not really understanding the process of valuation.

When valuing a company, we are looking at the existing equity in the company, and trying and figure out how much that equity is worth to us.

Knowing that there is $5 of equity per share doesn't tell you anything by itself, you have to look at other factors,

If that $5 of equity is only producing a 5% return the share is worth much less than $5 to me its worth $2.5 at best, even less if they are retaining the earnings and deploying it at 5%

if the $5 of equity is earning a 25% return, the share is worth much more than $5 to me, at least $12.50, and more if they are deploying earnings at 25%

If the company is mature, and can't deploy fresh capital at 25% ROE, and instead is just paying out large dividends and buying back shares, I can't pay more than 2.5 times the $5 of equity ($12.50), other wise I won't get my 10% return.

However, if the company is one of those rare companies, that can continually retain earnings and deploy them at 25%, the compounded equity growth happening inside the company will make earnings grow at a high rate, So it is worth buying even if you have to pay more for it today.

The premium you may pay today is being paid because you are recognising the companies solid economics.