Growth stocks are defined as companies with high rates of change of earnings growth of 15% to 20% or better. Growth stocks offer the potential for share prices to rise in lockstep with their profit growth in the long run. Therefore, the PEG ratio formula (price equals growth rate) tends to be the most appropriate formula used to value growth stocks. However, due to the exponential nature of compounding large numbers, PEG ratio forecasts are capped at 40%.
Because of the higher valuation typically awarded to fast growth, growth stocks offer the potential for greater capital appreciation. On the other hand, they also offer higher risk. First of all, they tend to command much higher than average PE ratios, and second, achieving very high levels of growth is very difficult to sustain. Consequently, forecasting future earnings growth is more important with high growth stocks than any other class of stock. Also, the average growth stock typically plows all of its profits back into the company to fund its future growth, instead of paying dividends.
Green Mountain Coffee Roasters (GMCR): Large-cap Growth at a Reasonable Price
About Green Mountain Coffee Roasters, Inc. (from their Website):
Green Mountain Coffee Roasters, Inc. is recognized as a leader in the specialty coffee industry for its award-winning coffees, innovative brewing technology and socially responsible business practices. GMCR maintains two business units: the Specialty Coffee Business Unit, which includes the Green Mountain Coffee® and Tully's Coffee® brands, and the Keurig Business Unit. The Company employs a combined total of over 1,400 employees.
Earnings Determine Market Price: The following earnings and price correlated graph clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.
Green Mountain Coffee Roasters: Historical Earnings, Price, Dividends and Normal PE Since 2002 - click to enlarge images
Performance Table Green Mountain Coffee Roasters: The Two Keys to Long-Term Performance
Years of research and experience have taught us that there are two critically important keys to achieving above-average, long-term shareholder returns at reasonably controlled levels of risk. The first key is earnings growth, or what we like to call the rate of change of earnings growth. The faster a company can grow its business (i.e. earnings), the larger the income stream it can produce with which to reward shareholders. This is because of the power of compounding, which Albert Einstein was alleged to have called "the most powerful force on earth." Ultimately, both capital appreciation and dividend income will be a function of a company's ability to grow its profits.
The second key is valuation. When a company can be purchased at its intrinsic value based on earnings and cash flow generation, the shareholders' rate of return or long-term capital appreciation will inevitably correlate to and/or equal its earnings growth rate. Overvaluation will lower that rate of return and conversely, undervaluation will increase it. Consequently, paying strict attention to the valuation you pay to buy a stock is a critical component of both greater return and taking lower risk to achieve it. Because, ironically, when you overpay for even the best business, you simultaneously lower your return potential while increasing your risk of achieving the lower return.
The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two keys to long-term performance. Notice the impact that valuation (black line above or below orange earnings justified valuation line) had on the following performance results.
The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 2002.
A further indication of valuation can be seen by examining a company's current price to sales ratio relative to its historical price to sales ratio. The current price to sale ratio for Green Mountain Coffee Roasters is 3.17 which is historically normal.
Looking to the Future
Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:
1. The rate of change (growth rate) of the company's earnings
2. The price or valuation you pay to buy those earnings
Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.
Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. Green Mountain Coffee Roasters is clearly an industry-leading superior business, which based on the consensus estimates from leading analysts, appears to be capable of growing earnings at an above-average rate for the foreseeable future. At its current price, which is attractively aligned with its True Worth™ valuation, Green Mountain Coffee Roasters represents an opportunity for growth at a reasonable price. The important factor is that Green Mountain Coffee Roasters, with its strong balance sheet and potential for future earnings growth, has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for outsized returns.
The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.
The consensus of 7 leading analysts reporting to Capital IQ forecast Green Mountain Coffee Roasters' long-term earnings growth at 32.3%, Green Mountain Coffee Roasters has low long-term debt at 23% of capital. Green Mountain Coffee Roasters is currently trading at a P/E of 34.4, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 38.7. If the earnings materialize as forecast, Green Mountain Coffee Roasters' True Worth™ valuation would be $334.21 at the end of 2017, which would be a 33.1% annual rate of return from the current price.
EARNINGS YIELD ESTIMATES
Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because earnings determine market price in the long run, we expect the future earnings of a company to justify the price we pay. Since all investments potentially compete with all other investments, it is useful to compare investing in any perspective company to that of a comparable investment in low risk treasury bonds. Comparing an investment in Green Mountain Coffee Roasters to an equal investment in 10 year treasury bonds, illustrates that Green Mountain Coffee Roasters' expected earnings would be 9.2 times that of the 10 Year T-Bond Interest. (See EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.
Summary & Conclusions
This report presented essential "fundamentals at a glance" illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although, with just a quick glance you can know a lot about the company, it's imperative that the reader conducts their own due diligence in order to validate whether the consensus estimates seem reasonable or not.
Green Mountain Coffee Roasters has been a very volatile stock since early 2011. After first becoming significantly overvalued, the company's stock price fell from approximately $116 to a low of $32.73 before recovering back to its current price on February 3, 2012 of in excess of $66. Nevertheless, even after this strong recovery, Green Mountain Coffee Roasters appears reasonably valued based on its high expected future earnings growth.
Disclosure: F.A.S.T. Graphs™ is a research tool, and therefore has no position in any companies.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.