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Having decided that a business meets our standards, our investment team must then decide how much they are willing to pay for its shares.
A great deal of academic research has been conducted over the years to support and refine the methods used to appraise the value of assets and future earnings (cash flow). Nevertheless, the stock market's susceptibility to emotional extremes, investors' differing interpretations of data and their inclination to anticipate cyclical moves cause the shares of public companies to move freely even in the absence of new information becoming available.
Fortunately, because their prospects are less problematic, the small universe of leading companies that W. P. Stewart focuses on usually trade within a more predictable valuation range.
- We have found that. over a long period of time our businesses tend to trade at prices that generate a return between 50 and 100% of the 30-year U.S. Treasury bond yield over the next 12 months, if they paid out all of their earnings as dividends This return is more commonly referred to as a company's earnings yield.
- We have observed that a price providing an earnings yield equal to about two-thirds of the long-term bond yield is a fairly likely outcome at some point in most normal market cycles
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- We develop and maintain detailed five-year profit forecasts for each actual and prospective investment that we monitor. Based on these forecasts, we establish a long-term future fair value for each business, assuming a normalized economic and interest rate environment. We then calculate the current fair value by discounting back the future fair value at an interest rate that includes a significant risk premium appropriate to each investment. The result or 'present value' represents our idea of a fair price for each company' s shares. These estimates are routinely updated reflecting the ongoing research and analysis conducted by our investment team.
- To provide a further margin of safety, we seek to buy, and hold shares selling well below our appraisal of their fair present value. Similarly, we seek to sell shares when they are near or above their fair value.
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