Let’s say you bought an ownership stake in The Coca-Cola Company ten years ago, and you somehow managed to get your shares at a price equal to book value; you got the shares without paying a premium in other words. That would be far below what the shares traded for, but think of this as a thought experiment. Then let’s say for some reason the stock market was shut down right after you bought your shares, and it still is. How might you think of the outcome of your investment so far?
Since the stock market it closed, and you are not getting any information about what the stock is selling for, you turn to the business figures for an answer.
The last ten years you have collected a dividend well over twice of what you paid. And the dividend has grown by about 6.6% yearly. Your earning power from dividends has made you richer by the year, outpacing inflation. Your current dividend yield on your initial investment has climbed from about 15% to nearly 30%. Over the period your equity per share has decreased somewhat with about 80% remaining. Your equity capital in the business is now lower than what it was when you invested.
In the perspective of earnings on equity, which would be the earnings yield on the amount of capital you have in the business, you’d be glad to know that you have gotten a pretty good average annual return of about 27%.
Would you consider to be invested in a good business? Warren Buffett would certainly say so. For him a wonderful business is a company that manages to earn a yearly return of at least 20% on tangible equity capital. We’ll come back to what that means later.
The point of this post and more posts to come is to address what it means to be invested in a wonderful company versus a fair one. To illustrate the point we might make some thought experiments where we make a few simple assumptions. We might compare businesses in an environment where ownership of companies could be bought and sold at book value only, and there’d be no premium to pay. And to keep things simple we may assume that the stock market is closed.
I hope you will enjoy the ideas and get another perspective to use in your investing journey.