Table of contents:
- Foreword
- What are growth stocks anyway?
- "CAGR" ( Compound Annual Growth Rate) - calculate the annual growth rate
- PEG ratio ( price-earnings-growth ratio)
- KUV ( price/sales ratio)
- Rule-of-40 score
- Conclusion
I. Foreword:
After my last post "Stock guide chapter 1: Dividend stocks" surprisingly
well
was surprisingly well received AND I was also named ccf winner in the second week of August (thank you very much for that <3), the second chapter follows today, which focuses on some key figures specifically for the valuation of growth stocks. Of course, I will again try to explain the individual key figures as simply and clearly as possible. I very much hope you enjoy reading chapter 2. That's enough talk...
Let's get started...
II. What are growth stocks anyway?
On the stock market, a rough distinction can be made between two strategies. Value investors, for whom a regular cash flow and stable companies are important, and growth investors, for whom it is important that the money generated flows back into the company and is used for expansion into other countries, new innovations, new strategies, in short, for the expansion of their own market position. The average growth rates for fast-growing companies are around 20-25% per year.
Growth stocks are often popular with younger people who have a longer investment horizon and do not need the money invested in the next few years. They can therefore afford higher risks and losses than older people who prefer regular cash flows, for example to supplement their pension,
prefer regular cash flows.
III CAGR (compound annual growth rate)
In order to calculate the growth of a company over a certain period of time, we need a formula. The best-known method is the CAGR, which indicates the rate at which, for example, sales or profits increase each year. This is expressed as a percentage. The formula looks like this:
CAGR = (( EV/BV)^(1/n) - 1) - 100
where:
EV = Ending Value ( last value )
BV = Beginning Value (first value)
n = Number of years ( number of years )
It looks complicated at first, but it's not.
Let's take a look at the example of Apple:
Apple's revenue in 2021 amounted to approx. $365.817 bn.
( that would be our EV) and in 2017 approx. $229,234 bn ( that would be our BV). The number of years, i.e. our nis 5 ( since: 2017,2018,2019,2020,2021 = 5 years)
Let's now insert our values for EV, BV and n into the formula:
So we take Apple's revenue from 2021, divide that by the revenue from 2017 and then take that to the power of one fifth. Then we simply calculate minus one and times 100 to get the result as a percentage.
CAGR = (365,817/229,234)^(1/5) -1 - 100
≈ 9,8%
Apple's turnover has therefore increased in the last 5 years
by approx. 9.8% per year.
The CAGR is a very useful tool for calculating the growth rates of a company over a certain period of time. Nevertheless, even this formula is not perfect and error-free. "What about the sales in the years in between?" some people will probably be asking themselves. This is precisely the small error in this formula. That's why I only use the CAGR for companies whose sales grow constantly and are not so dependent on the economy (i.e. cyclical companies such as Rio Tinto or Volkswagen) These companies usually have a sharp increase in sales in one year (because, for example, many people want to buy a car) and in the other year things look bleak again. So if the calculation falls into one of these scenarios, it can lead to our calculation being distorted.
So remember:
Never use just one key figure for valuation, but always include other factors as well. This applies not only to growth stocks, but in general.
IV. PEG ratio (price-earnings-growth ratio)
The PEG ratio ( Price/Earnings to Growth Ratio) sets the P/E ratio ( Price/Earnings Ratio) in relation to the expected earnings growth ( EPS growth, Earning per Share). The ratio is an extension of the price/earnings ratio and makes sense because P/E ratios tend to be higher for growth stocks, making them appear overvalued, although the valuations can still be fair if growth is taken into account.
If we want to calculate the PEG ratio, we first need the P/E ratio, which is calculated as follows:
P/E ratio = share price/ earnings per share
Once we have calculated the P/E ratio, we next need the EPS growth of the last five years (the last five years are a sufficient period). Once we have also calculated this, we must finally relate the P/E ratio to EPS growth:
PEG ratio = P/E ratio/EPS growth over the last 5Y.
Depending on the result, a company may be undervalued, fairly valued or overvalued. A value of...:
<1 auf eine Unterbewertung
=1 auf eine faire Bewertung
>1 indicates an overvaluation
indicates an overvaluation.
Let's take a look at the whole thing using the example
of Salesforce:
The P/E ratio: Salesforce had earnings/share of €4.48 in 2021 and is currently trading at €154.66 P/E RATIO = 154.66/4.38 ≈ 34.5
2. EPS growth: Salesforce's earnings per share amounted to €4.48 in 2021 and €0.26 in 2017.
0,26€. In section III. we learned about the CAGR, which we can apply directly here.
CAGR = ( 4.48/0.26)^(1/5) - 1 - 100 ≈ 76.71%
3. PEG ratio: We therefore have a P/E ratio of 34.5 and EPS growth of 76.71% per year.
PEG = 34.5/76.71 ≈ 0.44
Salesforce therefore appears to be undervalued, if everything has been entered correctly (no guarantee of this), as 0.44 < 1, despite a P/E ratio of 34.5.
</insert><insert attributes="{"bold": true}" >V. P/S ratio (price/sales ratio):</insert><insert attributes="" >
The price/sales ratio puts the market capitalization of a company in relation to its sales. As many growth stocks usually generate little or no profit, it makes sense to value the company using its turnover, i.e. the P/S ratio.
The KUV is calculated as follows:
</insert><insert attributes="{"italic": true}" >KUV = market capitalization/sales</insert><insert attributes="" >
As with the PEG ratio, an overvaluation, undervaluation or fair valuation can also be determined here. A value of...:
>1 indicates an overvaluation
=1 indicates a fair valuation
<1 indicates an undervaluation
indicates an undervaluation. A value >1.5 can already be considered expensive.
As with the PEG ratio, let's take another look at the KUV using Salesforce as an example.
Salesforce currently has a market capitalization of around $153.53 billion
and generated revenue of around $21.25 billion in 2021.
KUV = 153.53/21.25 ≈ 7.22
Salesforce therefore appears to be very expensive based on the P/E ratio.
We therefore have an undervaluation in terms of the PEG and an overvaluation in terms of the P/E ratio. This shows very clearly that you cannot rely on a single valuation indicator and that you should always take several indicators into account.
</insert><insert attributes="{"bold": true}" >VI. rule-of-40:</insert><insert attributes="" >
The sum of sales growth and free cash flow margin is referred to as</insert><insert attributes="{"bold": true}" > Rule-of-40</insert><insert attributes="" >. If the sum is greater than or equal to 40 percent, the rule is fulfilled. This ratio is used to evaluate the efficiency of growth of companies that may not yet be profitable ( negative FCF margin), but still have high sales growth. The formula is as follows:
</insert><insert attributes="{"italic": true}" >Rule of 40 = sales growth + free cash flow margin</insert><insert attributes="" >
The higher the value, the more attractive the business model. If a company can maintain the Rule of 40 consistently over several years or even exceed it, the
the more certain it can be said that the company has particularly healthy growth. However, if growth slows down, a profitable
FCF margin should be achieved, as otherwise it will be difficult for companies to comply with the rule. Let's take a look at the example of Airbnb:
To calculate Airbnb's revenue growth, we can again apply the CAGR
Revenue growth: Airbnb had revenue of $3.652 billion in 2018 and $5.992 billion in 2021 </insert><insert attributes="{"list": "bullet"}" translate="no">
</insert><insert attributes="" > CAGR = (5.992/3.652)^(1/4) - 1 - 100
≈ 13,12%
- FCF margin: Airbnb's revenue in 2021 was $5.992bn and free cash flow was $2.189bn
FCF margin = (2,189/5,992) - 100 ≈ 36.53%
- Rule-of-40 = 13.12 + 36.53 = 49.65%
Airbnb has fulfilled the Rule-of-40 and thus demonstrates healthy growth.
VII Conclusion:
Like dividend stocks, growth stocks are also very attractive. You can watch them grow and they can multiply our capital in a relatively short time ( 1000% and more are possible ) In contrast to dividend shares, the profit does not come back to us through payments, but through price gains. However, high price gains are almost always associated with high risk, which is why you should be able to withstand -50% and more. It is therefore essential that young and unprofitable companies are also examined intensively for quality. In the good times of the zero interest rate policy, as we have had in recent years, every dump was able to dust off an enormous amount of money from investors (see hype from the beginning of 2021), which are now struggling to survive (e.g. HelloFresh, Peloton) and leaving investors with high losses.
Everyone has their own strategy, but you should always have a healthy mix of value and growth in your portfolio. According to Peter Lynch, growth stocks should not account for more than 20% of the total portfolio (keyword diversification).
Of course, I very much hope that you enjoyed chapter 2. As with the first chapter, the effort has already been worthwhile for me if I have already been able to familiarize one person with the topic. If there is still interest in this little series, I will of course introduce other types of shares and key figures, such as asset players or cyclical companies.
To be continued...
Sources:
https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-cagr/
https://www.tagesschau.de/wirtschaft/boersenkurse/
https://www.moneyland.ch/de/kurs-umsatz-verhaeltnis-kuv
https://www.deltavalue.de/peg-ratio-kurs-gewinn-wachstums-verhaeltnis/
https://aktien.guide/blog/rule-of-40-einfach-erklaert
https://www.valuejump.de/peter-lynch/
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