2

Let's say I have $10,000 to invest and I want to invest all of that money in Apple Inc. (AAPL).

Just for the sake of argument, looking at Apple's ROE for as far as 2008, I realize it almost never went below 30%, and let's say I want to commit to this investment for at least 20 years (meaning I will buy Apple shares worth $10,000 today, and never ever touch'em for at least 20 years!).

So, doing a quick compound interest calculation (using this, for instance); my shares, bought at $10,000 today, can be worth $3,747,379.65 in 20 years (if not more).

I know I am oversimplifying this, but is there an elephant in the room, or am I missing something REALLY BIG?

  • 1
    ROE is not your return as an investor - that is what you are missing. – Victor Oct 22 '18 at 22:31
  • Hey Victor, thanks for your comment. Could you please specify also then what would be the right number/percentage/ratio to look into as an investor instead? – Ali Oct 25 '18 at 6:04
  • 1
    For capital growth the percentage increase or decrease in share price from year to year, and for income the dividend amount each year divided by the price you bought the stock at. And the two together and that will be your total annual return. – Victor Oct 25 '18 at 9:18
  • Also, Victor, if you were to put your comments as an answer, I would gladly accept it as the answer. – Ali Oct 28 '18 at 10:31
0

ROE is not your return as an investor - that is what you are missing.

To work out your return as an investor you need to add your capital growth to your income from the stocks.

To work out your capital growth you work out the percentage increase or decrease in share price from year to year. To work out your income you divide the dividend amount each year by the price you bought the stock at. You then add the two together and that will be your total annual return as an investor.

5

The "equity" in return on equity (ROE) is based on book value -- an accounting construct that does not represent the economic or market value of the company. You do not have the opportunity to invest or reinvest in Apple at book value. Based on the current price-to-book ratio, you have to pay 9.3 times book value. This means the market has already recognized that Apple's profitability justifies a market cap far above its book value. So your investment returns will be far less than the ROE.

  • nanoman, this was a great answer! Thank you. So the percentage I should be looking at would be ROE divided by Price/Book (mrq)? – Ali Oct 24 '18 at 16:00
  • @Ali Yes, and that would be the earnings yield (inverse of P/E), aside from details of definitions. While more factors that this affect investment returns, P/E is a more realistic starting point than ROE. – nanoman Oct 24 '18 at 16:37
5

1.3^20 = 190. Apple's current market cap is $1T today. $190T is a bit more than Total US wealth, just passing $100T.

Even adjusting for inflation won't work.

edit, to respond to OP’s comment. Instead of looking at Apple’s share price, I observe that the market cap, the total value of all shares, is over $1T, a trillion dollars. You ask, I believe, if the 30% growth can continue, long term. Simple math of 30%/yr, multiplying by 1.3 20 times, turns $1T in value to $190T. My answer is no, as the current total US wealth is just $100T. Not looking to debate projected US wealth, but even if we assume $400T, it would be difficult to imagine one company having such value, in comparison.

There is a concept called the law of large numbers, and it suggests that growth has to level out at some point. Consider, cell phones were introduced and had a remarkable growth curve. Could phone sales grow faster than world population forever? Even if every human had a phone and bought a new one every year, the ceiling is 7B units/yr.

  • Try adjusting for hyperinflation instead. – Hart CO Oct 22 '18 at 23:07
  • JoeTaxpayer, thanks for taking time to answer; unfortunately I don't understand none of what you just said (it's me, not you). My understanding is only at a very basic level at this point, and I am learning as I go. Do you think would you be able to explain your answer in simpler terms? – Ali Oct 24 '18 at 16:02
  • 1
    @Ali 1.3^20 = 30% growth for 20 years, market cap is the number of shares outstanding multiplied by the current price per share, it's unreasonable for Apple's value to exceed current total US wealth, it's just another figure pointing out how 30% growth is not sustainable. – Hart CO Oct 24 '18 at 17:38
  • Okay, still confusing, but overall, the idea behind "30% grow at that size, each year, for 20 years, is not sustainable" makes total sense, for sure! Thank you. – Ali Oct 25 '18 at 6:02
3

ROE is NOT a measure of stock price increase. It is simple a measure of net income as a percentage of total equity (meaning assets - liabilities on the balance sheet, not market cap). What the company does with that income has an influence on stock price (does it use the money to grow, or just pay dividends), but there is not necessarily a direct correlation.

The stock price today MIGHT assume that the same ROE will continue in perpetuity, or may decline slightly as time goes by, but just because a company has an ROE of x% does not mean that the stock will also grow by x% per year.

2

Past performance is no guarantee of future results.

  • Thanks for taking time and answering to my question Bob. That's a good point, however let's assume (for the sake of argument) Apple continues delivering above 30% ROE for the next 20 years (based on my example); does my math checks out? – Ali Oct 22 '18 at 21:33
  • 2
    The OP asked if $10,000 invested today in AAPL shares can be PROJECTED to be worth $3,747,379.65 in 20 years. My answer is still, past performance is no guarantee of future results. If I felt that this answer was a comment, I would have made a comment. Since you feel otherwise, do what you need to do. – Bob Baerker Oct 23 '18 at 1:57
1

ROE doesn't affect stock price directly, the growth of business (revenue and profit) does.

The growth of earning per share (EPS) is more meaningful in this case. However, excellent historical data can't guarantee Apple would grow its EPS in the future.

1

If the annual gain is 30% (it's not as mentioned by others since ROE is not the same as stock price gain) then after 20 years $10k would grow to $1.9M not $3.7M. You were looking at monthly compounding. Monthly compounding is what you'd use for most loans or earnings on deposit accounts, but if you've derived an annual rate of return for a stock and apply it to future growth you'd want to use annual compounding. You'd use annual compounding because the growth rate you derived was an annual growth rate. You derived 30% growth per year, which means after 1 year you'd have $3,000 in growth on $10,000 with annual compounding. The formula is:

Amount = Principal(1+rate/compounding periods per year)^compounding periods per year*years

So annual compounding for 1 year:

A = 10,000(1+0.30/1)^1*1
A = 10,000(1.3)^1
A = 13,000  ($3,000 growth)

Monthly compounding for 1 year would be:

A = 10,000(1+0.30/12)^12*1
A = 10,000(1.025)^12
A = 13,448 ($3,448 growth)

You know the latter isn't correct, because $3,448/$10,000 = 34.48% growth and you derived an annual return of 30%. As you can see over 20 years that is a very significant difference. When evaluating financial products with a set interest rate, compounding period could vary and you'll need to assess, but when looking at an 'annual return' and applying it to future growth you have to also use annual compounding else you won't actually be using the annual return rate that you intended to.

Also mentioned by others is the fact that this rate of return is unsustainable, but ignoring that, the compounding period was also a flaw in your assessment.

  • Kindly explain the downvote. – Hart CO Oct 23 '18 at 14:22
  • 1
    J Chris got a DV as well. Typically, you know, DVs don't come with a comment. When I see new DVs on my top 10 answers i still wonder. – JoeTaxpayer Oct 23 '18 at 14:51
  • Thank you Hart CO! Could you please explain further why do you think I should be applying annual compounding rather than monthly please? – Ali Oct 24 '18 at 16:05
  • @Ali Hopefully the update is helpful. – Hart CO Oct 24 '18 at 17:12
0

Risk

In the 80's people said, "You'll never lose your job betting on IBM"

In the 90's people said, "You'll never lose your job betting on Microsoft"

Things change, hard as that can be to imagine.

You'll note that both of the companies I picked still exist, and would have been good investments if held for 20 years... I'm just pointing out that they didn't continue to turn in numbers like people would have expected back then.

You said in a comment:
let's assume (for the sake of argument) Apple continues delivering above 30% ROE for the next 20 years

That is your elephant.
At age 33 you have a long time to correct if you happen to be wrong. If you believe it enough, invest the whole 10k in Apple.

  • Food for thought... if it was really that easy, why would people buy stocks which are not Apple? – J. Chris Compton Oct 22 '18 at 21:53
  • I am reading Intelligent Investors by Graham, who mentioned IBM many times in the book. – Xingang Huang Oct 23 '18 at 18:24
  • Thanks J. Chris Compton. What you just stated makes all sense to me. My example (aside being very basic/elementary) was only to get an idea of what I was missing with my current knowledge, so far. I understand, even in long-term investing, some course correction can (or has to) be done. Is this what you're saying please? – Ali Oct 24 '18 at 16:08
  • @ali Yes it is true that course correction is a good thing. However, what I was trying to say is that "putting all your eggs in one basket" might not be the best plan. Individual stocks are risky - because it is one thing. If you only have 10k to invest I would advise you to put at least half in a mutual fund - but that's just me. If you have other investments, like a 401k with mutual funds, and this 10k is on top of that - buy your one stock - use a DRIP (dividend reinvestment plan) if Apple offers one. – J. Chris Compton Oct 24 '18 at 17:27

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.