Like a puppy chasing its tail, some new investors often chase 'the next big thing', even if that means buying 'story stocks' without revenue, let alone profit. But as Peter Lynch said in One Up On Wall Street, 'Long shots almost never pay off.'
In the age of tech-stock blue-sky investing, my choice may seem old fashioned; I still prefer profitable companies like Netwealth Group (ASX:NWL). While that doesn't make the shares worth buying at any price, you can't deny that successful capitalism requires profit, eventually. Loss-making companies are always racing against time to reach financial sustainability, but time is often a friend of the profitable company, especially if it is growing.
Netwealth Group's Earnings Per Share Are Growing.
If you believe that markets are even vaguely efficient, then over the long term you'd expect a company's share price to follow its earnings per share (EPS). That means EPS growth is considered a real positive by most successful long-term investors. Impressively, Netwealth Group has grown EPS by 31% per year, compound, in the last three years. So it's not surprising to see the company trades on a very high multiple of (past) earnings.
Careful consideration of revenue growth and earnings before interest and taxation (EBIT) margins can help inform a view on the sustainability of the recent profit growth. Netwealth Group shareholders can take confidence from the fact that EBIT margins are up from 35% to 52%, and revenue is growing. Ticking those two boxes is a good sign of growth, in my book.
You can take a look at the company's revenue and earnings growth trend, in the chart below. To see the actual numbers, click on the chart.
In investing, as in life, the future matters more than the past. So why not check out this free interactive visualization of Netwealth Group's forecast profits?
Are Netwealth Group Insiders Aligned With All Shareholders?
Personally, I like to see high insider ownership of a company, since it suggests that it will be managed in the interests of shareholders. So we're pleased to report that Netwealth Group insiders own a meaningful share of the business. In fact, they own 62% of the company, so they will share in the same delights and challenges experienced by the ordinary shareholders. To me this is a good sign because it suggests they will be incentivised to build value for shareholders over the long term. At the current share price, that insider holding is worth a whopping AU$1.2b. Now that's what I call some serious skin in the game!
It means a lot to see insiders invested in the business, but I find myself wondering if remuneration policies are shareholder friendly. A brief analysis of the CEO compensation suggests they are. For companies with market capitalizations between AU$1.5b and AU$4.7b, like Netwealth Group, the median CEO pay is around AU$2.0m.
The CEO of Netwealth Group only received AU$234k in total compensation for the year ending June 2019. That's clearly well below average, so at a glance, that arrangement seems generous to shareholders, and points to a modest remuneration culture. CEO compensation is hardly the most important aspect of a company to consider, but when its reasonable that does give me a little more confidence that leadership are looking out for shareholder interests. It can also be a sign of good governance, more generally.
Is Netwealth Group Worth Keeping An Eye On?
Given my belief that share price follows earnings per share you can easily imagine how I feel about Netwealth Group's strong EPS growth. If you need more convincing beyond that EPS growth rate, don't forget about the reasonable remuneration and the high insider ownership. Each to their own, but I think all this makes Netwealth Group look rather interesting indeed. One of Buffett's considerations when discussing businesses is if they are capital light or capital intensive. Generally, a company with a high return on equity is capital light, and can thus fund growth more easily. So you might want to check this graph comparing Netwealth Group's ROE with industry peers (and the market at large).
Of course, you can do well (sometimes) buying stocks that are not growing earnings and do not have insiders buying shares. But as a growth investor I always like to check out companies that do have those features. You can access a free list of them here.
Please note the insider transactions discussed in this article refer to reportable transactions in the relevant jurisdiction
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