Wednesday October 03, 2012
by John Reese, editor Validea
Our 'patient Investor' screen is based on the investing strategy of Warren Buffett and one stock that scores a 100% rating on this model is World Acceptance (WRLD).
World Acceptance operates a small-loan consumer finance business in 12 states and Mexico. The company serves individuals with limited access to consumer credit from banks, credit unions, other consumer finance businesses and credit card lenders.
A bedrock principle for Buffett is that his type of company has a "durable competitive advantage" as compared to being a "price competitive" or "commodity" type of business.
There are certain figures that one can look at that can qualify the company as having a durable competitive advantage. And this stock passes all of the screens featured below.
Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings.
WRLD's earnings have increased each of the past 10 years year. WRLD's long term historical EPS growth rate is 20.8%, based on the 10 year average EPS growth rate.
CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY
Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage.
The average ROE for WRLD over the last ten years, is 19.2%, which is high enough to pass. In addition, the average ROE over the last 3 years is 20.3%.
Buffett likes companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive.
WRLD's free cash flow per share of $13.84 is positive, indicating that the company is generating more cash that it is consuming. This is a favorable sign, and so the company passes this criterion.
USE OF RETAINED EARNINGS
Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. WRLD's management has proven it can earn shareholders a 16.7% return on the earnings they kept. Essentially, management is doing a great job putting the retained earnings to work.
BUYING BACK SHARES
Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value.
WRLD's shares outstanding have fallen over the past five years from 16,280,001 to 14,000,000, thus passing this criterion.
If and when he gets positive responses to all the above criteria, Buffett would proceed with a price analysis.
WRLD currently has a book value of $29.29. It is safe to say that if WRLD can preserve its average rate of return on equity, it will have a book value of $169.85 in ten years. If it can still earn 19.2% on equity in ten years, then expected EPS will be $32.64.
Now take the expected future EPS of $32.64 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (which is 9.2) and you get WRLD's projected future stock price of $300.29.
A second approach to price analysis -- based on the 10-year average EPS growth rate of 20.8% -- would project earnings per share in ten years to be $46. Again, multiply this by the lower of the 5 year average P/E ratio or the current PE, and this projects a future stock price of $423.18.
Based on the two different methods, you could expect an 10-year annual compounding rate of return somewhere between 14.7% and 18.7%.
To pinpoint the average return a little better, we have taken an average of the two different methods, suggesting a return of 16.7% on WRLD stock for the next ten years, based on the current fundamentals.
Learn more about this financial newsletter at John Reese's Validea.