Hi, I’m Ian.
Recently, I was in touch with a new subscriber of mine at Bursaking.com.my, a platform where I educate and share my knowledge and journey on making consistent profits from savvy stock investing. Here was how our conversation went that day:
Subscriber: ‘Ian, I want to invest for capital gains.’
Ian: ‘Great. How much capital gains do you intend to achieve? Is there a time frame to it?’
Subscriber: ‘I don’t know.’
Today, if you are reading this and, like my subscriber, you have absolutely no idea on what capital gains to expect from your stock investments, let me first tell you that: ‘It is normal. Many people buy stocks without knowing what to expect anyway.’ This is why many people resort to gambling and speculation in the stock market … which true investors like Warren Buffett don’t.
In this article, I’ll share 5 steps that I’ve learnt from reading ‘Buffettology’ to quickly estimate the potential capital gains of a stock before you invest in it.
Step #1: Grow Profits Consistently
First, the method described in ‘Buffettology’ is meant for stocks that fulfilled two criterias. They must possess predictable business models which could be expandable over the long-term and possess a track record of growing profits consistently over the last 10 years.
This means, you can’t use this method for stocks that are involved in cyclical or sunset industries, have unpredictable business models, or have a mediocre or unpredictable set of financial results over the long-term. In fact, this is also a strategy to minimize risks of making bad investment decisions. Look: There are plenty of stocks which have excellent financial results. I think, there is no need for you to take unnecessary risks on mediocre stocks.
Here, I’ll use LPI Capital Bhd (LPI) as my case study. This is because LPI has a predictable business model which is expandable and has a decent record of growing profits consistently. The stocks that you choose must have a pattern of profits as shown below:
Source: Annual Reports of LPI
Step #2: Calculate Past Earnings Growth Rate
Next, we would calculate the earnings growth rate of LPI from 2008 to 2017, which is a duration of 9 years. The figures needed are as followed:
Earnings 2008 (RM ‘000) = 87,770
Earnings 2017 (RM ‘000) = 313,794
No. of Years = 9
You may click onto the link below to use a free CAGR calculator:
If you input the figures above as followed:
Beginning Value = 87,770
Ending Value = 313,794
Number of Periods = 9
You should get a CAGR of 15.21%. This means, LPI has grown its earnings at a rate of 15.21% per year over the last 9 years. This is useful for us to estimate LPI’s future earnings as described in Step #3.
Step #3: Project Earnings per Share (EPS) 10 Years Forward
Here, this method assumes that LPI will continue to grow its earnings by as fast as 15.21% a year. The actual growth rate may differ from your projection. Please take note of that.
In 2017, LPI made RM 313.794 million in shareholders’ earnings. If earnings continue to grow at 15.21% a year, how much would LPI be making in 2027 (10 Years Forward from 2017)?
The figures needed:
Interest Rate = 15.21%
Number of Periods = 10
Present Value = 313,794 (the latest figure reported is in 2017)
You may click onto the link below to use a free Future Value calculator:
From which, you should get 1,292.845 in Future Value. It means, the amount of earnings projected that LPI could make in 2027 is RM 1,292.845 million.
Next, we would need to divide it with the number of ordinary shares LPI has to have LPI’s earnings per share (EPS) in 2027. From its latest quarter report, LPI has 331.986 million ordinary shares. Thus, LPI’s EPS 2027 is projected to be RM 3.894 a share.
= Earnings / Ordinary Share
= RM 1,292.845 million / 331.986 million shares
= RM 3.894 a share
Step #4: Estimate the Potential Stock Value of LPI in 2027
In this step, we would first need the calculation of LPI’s P/E Ratio from 2008 to 2017. From which, I’ve discovered:
Lowest P/E Ratio: 12.44
Highest P/E Ratio: 19.29
10-Year Average P/E Ratio: 16.80
In general, an investor would view that P/E Ratio of 12.44 to be undervalued, P/E Ratio of 16.80 to be fairly valued and P/E Ratio of 19.29 to be overvalued.
To be conservative, an investor would take the lowest P/E Ratio to find what could be the potential stock value of LPI in 2027. The formula is as followed:
Lowest Potential Stock Value (2027)
= Lowest P/E Ratio x EPS 2027
= 12.44 x RM 3.894 a share
= RM 48.44 a share.
Step #5: Estimate Capital Gain Returns
As I write, LPI is trading at RM 16.38 a share.
So, let me describe the investment in LPI in brief. Today, you buy LPI at RM 16.38 a share. 10 years later, by 2027, LPI has potential to increase in value to RM 48.44 a share. If it happens as described, what is my capital gain returns from investing in LPI?
You may use the CAGR calculator:
If you input the figures above as followed:
Beginning Value = 16.38
Ending Value = 48.44
Number of Periods = 10
You should get a CAGR of 11.45%. It means, you should expect your capital to grow at a rate of 11.45% a year over the next 10 years to 2027.
Question: ‘Really, is it possible for LPI to grow from RM 16.38 to RM 48.44 in 10 years?’
First, nobody can guarantee that it would happen. This calculation involves assumptions which may or may not happen in the future. Thus, capital gain investing is one that involves estimates and guessworks.
Second, let us look at LPI’s past stock price performances:
Stock Price = RM 9.45 a share
No. of Ordinary Shares = 137.67 million shares
Market Capitalization = RM 1.30 billion
Stock Price = RM 18.16 a share
No. of Ordinary Shares = 331.986 million shares
Market Capitalization = RM 6.03 billion
Thus, LPI has grown its market capitalization by 357% from 2018 to 2017. So, if LPI is to continue its profit growth on a consistent basis, then, it is likely (Warning: No Guarantees) to expect LPI’s stock price to reflect this growth over the long-term.
The strategies outlined in this article / report / written material is intended for education & illustration purposes. It is strictly not intended to be an investment advice & must not be relied upon as personal financial advice. If you need specific investment advices, please consult the relevant professional investment advices.
No warranty is made with respect to the accuracy, adequacy, reliability, suitability, applicability, or completeness of the information contained.
The author disclaims any reward or responsibility for any gains or losses arising from direct and indirect use & application of any contents of the article / report / written material.
Stock 101 Quiz