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Why does Buffett care so much about earnings of his stock picks?

Discussion in 'Investing' started by farmerjohn1324, Apr 17, 2018.

  1. farmerjohn1324

    farmerjohn1324 New Member

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    This seems like a silly question, but hear me out. Obviously, earnings are more important than anything else, but if a person owns common stock, he doesn't necessarily see those earnings.

    For example, Coca-Cola (KO) has 4,264,499,000 shares outstanding. They give out $1.48 in dividends per year per share. This totals $6,311,458,520 in annual dividend payments. Coca Cola's earnings for trailing twelve months are $22.15 billion. This means that only 28.5% of the earnings are distributed to the shareholders.



    As oppose to a company like GEICO that he owns all of, where he would get 100% of the earnings.
     
  2. Andrew Mazza

    Andrew Mazza New Member

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    Earnings dictates performance. As often is the case, when a stock reports better then expected earnings it will raise in price. On august 15th, WMT reported much better then expected earnings. Not only did its stock increase, but it also caused companies like target to surge in the weeks following due to increased market outlook. Earnings is what dictates the success and future of a company. the better the earnings, the brighter the future
     
  3. TomB16

    TomB16 Active Member

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    I've studied Buffett interviews like the Zapruder film. That doesn't make me an expert but it does cause me to be interested in your question. Here's what I understand his view to be:

    Investing is about allocating capital. The capital should be put where it can do the most good.

    In the case of a corporation, the board needs to allocate capital from net income. They should do this as an investor would (although many companies do not).

    - re-invest in the business to create new opportunities
    - expand the operation through M&A
    - buy back the stock (Mr. Buffett has said he feels stock repurchase programs only make sense when the stock is low)
    - distribute what is left to the shareholders

    One of the things I look for is absorption of income at the executive level. It's always camouflaged. If the board and executives want to get rich off the company, they should buy a bunch of stock and manage the company well to make themselves wealthy, instead of syphoning it off the top.

    In the case of Warren Buffett himself, his salary is $100K per year with no additional bonuses or benefits. He has managed to earn a decent living, despite this handicap.
     
  4. TomB16

    TomB16 Active Member

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    Speaking of distributions...

    In the case of a distributing company, a DRIP can be used to reinvest dividends. Berkshire has done a lot of this as evidenced by their reporting of fractional share holdings. It can have a profound affect on a holding, over time. Mr. Buffett has purchased stock to a certain level and let it buy it's way to the level he wants. This has caused problems with owning over 10% of financial institutions through DRIP and/or re-purchase programs. When a non-financial institution owns more than 10% of a financial institution, this triggers several regulations.

    In either case, the gain in ownership ratio is caused by re-investment of earnings.

    In our own case, we have held a couple of REITs for many years. Using DRIPs, these holdings have been steamrollers at the core of our portfolio and are starting to become uncomfortably large.

    Consider what 5% trailing yield means. It's the sum of the dividends for the past year, divided by the current stock price. Forward yield is just the most recent dividend multiplied by 12, divided by the current stock price. These numbers are dumbed down to look like simple interest. So, a 2% GIC is generally compared to a stock yielding 2% but this would only be valid if the stock distributed annually.

    For stocks that distribute quarterly, they also compound quarterly. The same for monthly.

    Consider a REIT yielding 8~10% and distributing monthly (lots of examples, over the years). Each month, you are buying 0.666 ~ 0.833% more stock which will distribute the following month. There is also likely to be a DRIP discount of 3~5% so you get a smidge more stock than face value. Adding it all up, some of these high distributing REITs end up creating an additional .5 to .75% total return between the combination of the discount and monthly compounding.

    Also, there is the upward pressure on valuation from the relentless monthly purchasing of stock. For some unexciting, stogy, stocks, this is significant. There are a couple of REITs in our portfolio which started as value stocks but have gained more than their value. I feel Killam is one such REIT. Killam is an excellent, well run, company, and I don't consider it to be particularly over valued, but it's no longer a value stock so I have lost interest in expanding this holding.

    Earnings matter a lot and can have a huge impact on holdings over time.
     

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