In his latest presentation to Nedgroup Investments, Steven Romick illustrates, using historical data, why high earnings growth is unsustainable, and why price matters. Here’s an excerpt from the presentation:
Romick: A lot has to go right for these companies in the 10th decile to earn equity-like rates of return. Some may do well of course but the odds overall are stacked against us, as a result we don’t own any of them.
To support the argument as to why the odds are stacked against us look at history going back to 1979 where success isn’t guaranteed just because you have a growing business.
The top 1,000 companies as measured by market cap that have had more than 10% earnings growth in a given year, let’s look and see how they did in subsequent years.
In that first year 353 at the top… of the largest thousand companies had earnings growth of greater than 10 percent, but looking out three years only 74 of those companies had growth of greater than 10 percent, and then looking out over five years only 21 of those companies on average had earnings growth of greater than 10 percent.
So given such a small percentage of these larger companies, it’s very difficult to argue that these largest companies in the top decile with this high level of valuation, as shown in the previous slide, is going to be supported ultimately by the current prices and therefore the expected rate of return will be in our view less than what the market thinks it might be.
You can watch the entire presentation here:
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