UNDERSTANDING GROWTH OF A COMPANY

The following writeup was done by shiokot bahi at dsetrader more than couple of years ago. In my opinion a very useful writeup for the fundamentalists:

UNDERSTANDING GROWTH OF A COMPANY

Company A
Say this company's earnings history is like this-

Year EPS Net profit Number of stock Dividend
1 10 1000 100 10%B
2 10 1100 110 10%B
3 10 1210 121 10%B


Company B
Say this company's earnings history is like this-

Year EPS Net profit Number of stock Dividend
1 10 1000 100 10
2 10.5 1050 100 10.5
3 11 1100 100 11

Company C
Say this company's earnings history is like this-

Year EPS Net profit Number of stock Dividend Right Issue
1 10 1000 100 10%B --
2 10 1100 110 -- 10%
3 11 1210 121 10% --

For example stock price is same in all cases. Say 100tk each.

Now can you say which company is growing more? and How?

May be most of you should say that company B is growing well. As its EPS is 10% higher in 3rd year compared to the first year. But Company A and C looks same. As their EPS is same in all the years.

Now let us dig in the deep of the three cases.

Say you are holding 100 stocks of each of the company. You bought all of them at 100tk each at the first year. So your investment is 10,000tk in each of the company.

Now from company A you have 133.1 stocks at the end of year three and your stock value is 13310tk. As you have got 10% stock dividend in all the three years. So your growth is 33.10% (3310/10000 = .3310 = 33.10%)

From company B you earn 1000+1050+1100= 3150tk and your stock value is 10,000tk (as you have that 100stock from the very beginning). Now your total value form this stock is 10,000+3150 = 13,150tk. So your growth is 31.15% (3150/10000 = .3115 = 31.15%)

And at last from company C you earn 1000tk as dividend at the 3rd year. And your total stock is 110. Hence your total value is 1331+12100 = 13,431tk. But to acquire 10 stocks as right issue at the year 2 you have paid 1000tk. So your total cost of woning this stock was 10,000 at the beginning and 1000 at year 2. So total cost is 11000tk and your present value is 13,431tk So your return is 2,431tk. Then your growth is 24.31% (2431/11000 = .24.31 = 24.31%)

I think the message is delivered. Though company A looks no growth in terms of EPS they have the highest growth in terms of earnings and return. Though I've put a biased and higher EPS for B and C they can't over take company A in terms of growth.

So you shouldn't count the EPS only in calculating growth rather you should look at the resource the company is using to produce the present level of EPS. Company C used the highest level of resources (by issuing right stock and taking more money from the market) but earned only the same EPS so they performed worst. That is how in consideration to value company A did the best.