The appropriate multiple for high quality compounders

[BG2008]

The winners from the last few years are high quality compounder that grew EPS over time.  FANGs are a different animal as the growth rate is in excess of 15-20%.  What is the appropriate multiple for a high quality business like a Sherwin Williams, Ferrari, Heico, etc? It seems that these growth compounders do really well if they continue to grow their cash EPS and buy back shares.  For the first time in a long time, investors have to take a hard look at the denominator and use math that involves declining EPS (even if temporary).  So what is the appropriate multiple for a high quality company then? 

 

For those people looking for potential short candidates, Ferrari is still trading at 32x 2020 P/FCF.  They just announced factory stoppage for 2 weeks.  I thought that Boeing was a very good short candidate before the implosion as they were dealing with the Max issues and the virus was a game changer in terms of reducing flight demand.

[chrispy]

A company which sells physical goods is nearing the too hard pile, temporarily. I don't know how Copart car auction services will be impacted and there will be very few accidents. Does heico get more or drastically less business and for how long?

 

It seems to me paying a slightly greater premium for companies primarily delivering digital services is the way to go. If Copart is hit very hard for half a year then one would be able to cycle back in. If they aren't affected then MSFT and V will not be

[coc]

I would be careful assuming there is an “appropriate multiple” for a certain type of company simply based on a classification you give it (ie “compounder”). The question as always is (A) How long will it grow and at what rate? (B) How much capital will it use to finance its growth? © What kind of business will it be when its growth slows? (D) How much stock does it issue to employees? And so on.

 

In the case of the last one, for example, I know of companies (“high quality compounders” in your lingo) which issue so much stock that their real earnings may be 70% or less than what’s reported. So the multiple should be a lot lower. And in some cases, almost all growth is acquired - again, that lowers the multiple a great deal.

 

The temporary problems of now affect all of this a bit, but assuming the company will

make it through, all kinds of different companies should end up with all kinds of different multiples. I would go case by case.

[scorpioncapital]

I would also not throw out physical business in favour of the virtual. Some mix of the two seems best. Defensive quality real world stocks can be very good.

[nspo]

It's too hard to come up with an appropriate multiple for growth stocks as the vast majority of their value comes from the terminal value assigned. The way successful investors in the past have gone about it is to use the IRR method, instead.

 

One of the best resources I've seen for valuing growth is to read the Constellation Software presents letter. The valuation model takes into consideration more sustainable ROIC+organic growth and contrasts against the yield and growth in FCF. It's imprecise but that's what makes the game interesting, I guess.  :)

 

Check out this attachment for additional insight.

Fair_PE_ratio_for_growth.pdf

Fair_PE_ratio_for_growth.pdf