# Paying for Growth? Case Study

What Price for the whole business would YOU pay? Then tell me the per share price.  The company had operations for 25 years prior to going public. The company’s stock price will under perform the market (SPY) about 1/3 of the time over the next forty years.

 BUSINESS XXX? 1974 1973 1972 1971 1970 Cash \$2,238,263 \$2,168,224 Working capital 27,132,580 16,796,897 LT Debt ** 10,578,269 5,065,567 Shareholders’ Equity 30,734,128 \$24,753,623 Outstanding Shares 6,542,250 6,512,950 Net Sales \$167,560,892 \$124,889,141 78,014,164 44,286,012 30,862,659 Income Bef. Taxes 11,883,754 8,917,188 5,569,027 3,170,599 2,198,764 Pro-forma Net Income \$6,158,520 4,591,469 2,907,354 1,651,599 1,187,764 EPS \$0.93 \$0.70 \$0.47 \$0.30 \$0.23 Units in operation 78 64 51 38 32 ROE 38.67% 36.02% ** Co. has a \$12 mil. Credit line renewed yearly of which it has borrowed \$4 mil. Assume Co. needs all cash for operations Assume strong growth for 40 years.You need a required rate of return of 15%

Can you guess the actual name of the company?

To give you some historical perspective of 1974 see:A Study of Market History through Graham Babson Buffett and Others

Winner gets a date with my Ex: http://youtu.be/E55ni_xc4ww  (PLEASE do NOT click on the link unless you win the prize)

### 19 responses to “Paying for Growth? Case Study”

1. tom

I would pay \$18.20 or 10X pre-tax earnings – just like Buffett.

2. John Jernigan

Hey john

I think the company is walmart and I would pay \$100 given the growth rate over the next 40 years

3. John

Value per share = \$5.22. Assumes an ROE resiliency factor of .7 (40 years of strong growth). = 30,734,128 + (6,158,520- 15% * 30,734,128)/(1+15%-.7) / 6,545,250

4. jc

I figured out the company, and 10x pretax is too low.I won’t spoil john’s challenge, except to say interesting choice.

5. John

I accidently posted the company name earlier but I would pay \$100 given the strong growth over the next 40 years.

6. i just f** up big time! OMG, that clip of you ex.. f crazy. it was my fault i never read the footnotes “PLEASE do NOT click unless you win the prize”. expensive lesson learned .

7. blevo

not to spoil the challenge i could give another hint: it is the largest overall employer in the USA

in the current markets, would not be surprised if this traded at 2.5x-3x revenues

ps DO NOT click the link!

8. Rubén

If I were confident that the company is able to maintain those ROE levels I wouldn’t pay more than \$19.4 per share with a preferable range between \$14.5 – \$17.5.

9. Rubén

Although it seems to me that the company is absorbing, not generating, cash. When a company grows at a higher rate than its ROE, chances are that it’s absorbing cash.

10. Rubén

BTW, growth in working capital and in long term debt are awful (perhaps a company that went bankrupt a long time ago?)

• John Chew

Ruben:

You can click on the link for that. 🙂

• Rubén

After all it wouldn’t be my worst date…

11. Rubén

Ups, it’s Wal-Mart! Shame on me!

12. Buz

Probably WMT or smth alike with such huge amount of debt and WC. It was in its expanding phase. Assuming 20% growth for the next 20 yrs on average and a cost of equity of 15% which will decrease. Also assuming ROE will decrease over time with decease amount of debt in 2nd phase of expansion. I would pay 20-25x at least if I thought the business model was stable.

13. Wal-Mart. I urge I be made the winner as Ruben got it after 4 chances!

OK- Jokes apart, I would like to have a post from your side about why you think Wal-Mart clicked. This is because most people think that Wal-Mart’s success could have been explained but it is mostly with hindsight.

Most investors including Warren Buffett have personally tried their hands in retail and burned their hands.

14. MAR

Would pay up to \$24/share given you mention strong growth

I would guess it would be a supermarket/grocery store or a retail operation that doesnt own its brand, given the margin profile and scale profile.

15. I’d pay a max of 23. I assumed 3 growth scenarios, 15%, the 32% average and 40% with probabilities of 40%, 40% and 20% respectively. I only projected 5 years for earnings.

I believe the most important thing to highlight is the degree of confidence with which we can project growth. That is to say if we find franchise value hidden here. So as Buffett recognized pricing power, customer demand, external protection and economies of scale, he went forward and placed his investment.

Another thing I’d say is the ability to recognize the stage at which the company is in a particular time. This can give a clearer idea of how sustainable is a high growth rate assumption.

Great case study!

16. Fabian

actual share price is ~78; share price Dec 31, 1974 was ~10 (adjusted for splits ~0,02). this means if you paid a share price of 160 (!) in 1974, you made a 15% annualized return until now.

17. what was the actual high/low price in 1974?

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