Last Updated on July 7, 2024 at 8:21 pm
We recently added an Earnings Power Box Stock Analyzer to the freefincal investor circle. Readers may also know that we publish monthly reviews of my stock portfolio. These are the earnings power valuation results for the stocks in my portfolio.
What is Hewitt Heiserman Jr.’s Earnings Power Box?
This plots the Defensive EPS (earnings per share) vs Enterprising EPS. The idea is to spot where a company falls in. This is based on the Earnings Power Valuation Model.
Srivatsan has defined enterprising and defensive EPS as follows: Enterprising EPS = (Enterprising Income)/(Shares Outstanding) and Defensive EPS = (Defensive Income)/(Shares Outstanding). Therefore:
Enterprising Income = Net Income – (15% x total capital). Here 15% is the weighted average cost of capital (WACC) and is an expected return (users can change this). Also, 15% x total capital = enterprising interest.
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Defensive Income = Free Cash Flow – change in working capital since last FY. Now, over to Srivatsan.
The idea is to spot where a company falls in.
How to use the Earnings Power Box?
I) This tool is NOT for identifying the next multi-bagger. This is a great tool for identifying what Srivatsan calls the MULTI-BEGGARS.
He explains the pros and cons of using the tool below.
- I am an ignoramus regarding direct stock investing (among several other things). I am worried about making too many blunders. Given my biases and risk tolerances, this is a great tool for knowing WHERE NOT TO PUMP my hard-earned money.
- Anything in Quadrant #3 is a straight reject
- To merit a second thought, the company has to be the bare minimum in Quadrant #2. Quadrant #4 is a judgment call. I will not touch it, though
II) The concept and framework are amazingly simple yet brilliantly profound.
- Any business that generates free cash flow (FCF) and Returns above the cost of capital (ROIC) year after year is great. That’s it. This is true for a roadside petty shop or a Fortune 500 company.
- Forget about the durability of moats, sustainable competitive advantage, intelligent fanatics, and a latticework of metals and their models. Proof of the pudding is in the eating. All these should result in FCF and superior ROIC; If not, it is a great dog and pony show.
- View these two metrics as two eyes of any business. I prefer two eyes, although you can comfortably manage with one eye. I do not want to go blind.
III) Complete Disconnect from market behaviour/psychology – a boon or bane?
- Use this tool IF and ONLY IF
- You are a brutally rational and unemotional investor
- You like to take few concentrated bets with huge payoffs
- You really would like to follow Buffettisms (of owning a few great businesses) and not parrot them mindlessly
- Great stocks can and will be found in ALL 4 quadrants. Can you stick to your guns and invest only in businesses in Quadrant #1?
- You should be like Boman Irani’s hand in Munna Bhai MBBS. Now, can you do it? Even Boman Irani says his hand will shake while operating on his daughter.
- Over the last two years, I have seen stocks in Quadrant 3 zoom 2x, 3x, 5x or even more, and there are no words in English to describe that burning feeling. Can you sit quietly during this period, knowing that the business is a trap while everyone at your office brags during coffee breaks?
IV) Makes entry/exit decisions a lot easier.
- When to buy – When the company first enters Quadrant #1. This makes sense because it means that for the first time, the business has started to be self-sufficient and grow and hence can be expected to start compounding returns
- When to sell – When the company is no longer in Quadrant #1 and drifts to other quadrants. Again, this makes sense because, for whatever reason, business is facing headwinds and is no longer able to sustain the cash flows or returns (or both)
V) Makes Annual stock portfolio review a lot easier
You can use this tool to:
- Assess where the stocks in your portfolio currently stand in the earnings power box.
- How their business performance is trending year after year
- Buy more or liquidate positions accordingly
CAVEATS on the Concept and the Automated Analyzer (Morningstar and Screener versions)
- Heiserman’s Earnings is just one way to evaluate a business from millions of approaches/models/frameworks. It is NOT a silver bullet.
- This tool will be useful for a subset of investors (with limited knowledge level, time, energy, interest, and low-risk tolerances) but not everyone.
- The tool assumes the availability of ten years of reliable and authentic financial statements.
- If you notice carefully, one needs Capex, Working Capital, Other income, and Balance sheet values to use Heiserman’s calculation. Whatever is not directly available must be derived, which comes with limitations.
- Please note that the following are ignored in the automated tool calculations. The error of omission is assumed to be less significant than detrimental to the conclusions.
- R&D expenses (no data)
- Deferred tax assets and liabilities (confusing calculations and inconsistent reporting)
- It is unsuitable for Banking stocks since they have a lot of leverage.
My Stock Portfolio
As of May 10th 2024, all results are computed using our Google Sheets-based stock and MF portfolio trackers.
- The debt-to-equity ratio of the portfolio is 55.63% (vs. 81.2% of the board market, according to Simplywall).st – we assume this is similar to Nifty or Sensex)
- Dividend yield: 1.4% vs 1.2% broad market
- Dividend growth rate: 9.6% vs 12.4% broad market
- Dividend payout ratio: 53% of net income.
Stock picking strategy
- Choose stocks with little or no evaluation or analysis.
- Choose low volatile stocks with sound financial health (low debt min requirement)
- Choose stocks that trade close to their all-time highs (approx momentum indicator). See, for example, A list of stocks that have traded close to their “all-time high:
- Do not be afraid to pick expensive stocks at absolute price and valuation. Note: Value investing may sound intelligent and enticing, but it is riskier. I neither have the age to take on such a risk nor the qualitative insights to pick stocks that the market has shunned but will be discovered sooner rather than later. To appreciate the risk associated with value investing and why it is more qualitative than quantitative, see this analysis: Is it time to exit ICICI Value Discovery & Quantum Long Term Equity?
- When in doubt, ask your wife when she is about to fall asleep in the afternoon.
- Do not fear dividends (or dividend taxation).
- What matters primarily is company health. Whether it is a dividend payer or not is incidental. It makes no sense to say no to a company because it pays huge dividends! It makes no sense to sell a stock because it has increased dividend payout.
- All stock investors over ten years will receive dividends, regardless of whether they like it. There is no choice, unlike mutual funds.
- Dividends are not “extra” regarding returns/performance but represent real profit. It can serve as a source of income for an older investor, Building the ideal retirement portfolio. Younger investors will never understand this, and that is fine.
- Peaceful sleep is the best form of realised gains, hence the importance of low volatility and reasonable momentum to business health (not all stocks in my portfolio will check all these boxes).
- This is the archive of previous portfolio updates.
Related videos: How to buy your first stock without breaking your head
Earnings power valuation of my portfolio stocks
These images were derived using the newly released Earnings Power Box Stock Analyzer.
All the stocks in my portfolio are reasonably healthy. This only means there are no red flags, which is different from a green flag! But as Srivatsan would say, I would rather ensure that there are no “multi-beggers” in my portfolio than worry if I have any multi-baggers!
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
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