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Stocks in DepthTwo Arrows

ROI
Part I
by WealthEffect Staff

  
 

Return on Investment (ROI) is your expected annual return from an investment		  
  ROI is based on the expected growth rate and the P/E  
  If you are happy with the ROI, buy the stock, if not, wait  
 
1.
Return on Investment (ROI) is the annual return you expect to receive on an investment. This annual return is the average of the returns you will receive over many years — in some years, your return will be higher than the average; in others, your return will be lower. For example, a stock might have an expected ROI of 12% — in some years, your returns might exceed 20%; in other years, you might actually lose money; over twenty years, however, you would expect to earn 12% annually, on average.

ROI is composed of two parts: the income and the capital gains. In the case of a stock, the annual income is the dividend, which is usually paid each quarter. Your income return, known as the dividend yield, is simply the amount of the dividends for the year divided by the stock price. Your return from capital gains is the percentage gain in the stock price each year — these capital gains have historically accounted for most of the ROI. In the last half century, stocks have provided an ROI of 13% — dividend yields have averaged about 3% and capital gains have averaged about 10%.

  
 
2.
To determine the ROI of a stock, project a future growth rate for the company's profits (as described in Projections) and estimate the company's profits twenty years out. Then, determine where you expect the stock to be selling at that time based on a realistic p/e multiple and what the annual capital gain will be given the current stock price. Add in the dividend yield, and you have your estimated ROI.		  
 
3.
If the ROI is attractive to you, then buy the stock. If not, wait until the ROI improves, either by a decline in the stock price or by an increase in earnings over time. Keep in mind, however, that you might never get the ROI you really want. Your money might sit in cash, giving you a low return while you wait for an opportunity that never arrives. Meanwhile, you will have passed up a pretty good return from a pretty great company.		  
 
ROI
Part II: The Coca-Cola Company vs. the S&P 500 Index		  
   
The Coca-Cola Company

Coca-Cola: ROI 12%

Projected Growth Rate: 13% for 20 years
This estimate is less than the 15% growth of the last ten years, and is comparable to the 13% growth of the last twenty years and the 13% growth of the last thirty years.

Projected EPS: $17 in 2019
This estimate is based on $1.50 in earnings per share in the next twelve months with growth of 13% per year for 20 years.

P/E Multiple: 30x
This estimate assumes that the average stock, as represented by the S&P500 Index, will sell at 18x earnings. Therefore, at 30x, Coca-Cola is projected to sell at a 2/3 premium to the S&P500 P/E multiple — if anything, this is a conservative assumption since Coca-Cola is not just a better than average company, it is a much better company.

Projected Price: 510 in 2019
$17 in earnings per share times a P/E multiple of 30

Current Price: 64

Projected Capital Gain: 11% annually over twenty years

Dividend Yield: 1%
Current dividend of $.65 divided into the current stock price

Projected ROI: 12% over twenty years

The S&P500 Index

S&P500 Index: ROI 8%

Projected Growth Rate: 8% for 20 years
This estimate is based on an assumption of 3% economic growth plus 2% productivity growth plus 3% inflation; 8% has been the historical growth rate, as well.

Projected EPS: $240 in 2019
This estimate is based on $52 in earnings per share in the next year with growth of 8% per year for 20 years.

P/E Multiple: 18x
This estimate — that the average stock, as represented by the S&P500 Index, will sell at 18x earnings — is based on past history and current interest rates.

Projected Price: 4320 in 2019
$240 in earnings per share times a P/E multiple of 18

Current Price: 1400

Projected Capital Gain: 6% annually over twenty years

Dividend Yield: 2%
Current dividend yield of the S&P500

Projected ROI: 8%

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