Key points
- Warren Buffett uses compounding earnings growth and P/E ratios to find the best stocks
- Central Asia Metals has solid earnings growth
- With a lower trailing P/E ratio than a major competitor, the shares may be cheap
Warren Buffett is considered by many as the most successful investor of all time. Armed with a long-term view on the market, he has often said that time is the biggest barrier to amassing a fortune. Indeed, it is a fact that Buffett acquired 99% of his $114bn after the age of 50. I’m now looking at two techniques used by Buffett: price-to-earnings (P/E) ratios and compounding earnings growth. This will help me to better understand Central Asia Metals (LSE: CAML), a copper mining firm operating in Kazakhstan. Let’s take a closer look.
What does Warren Buffett look for?
I have previously covered the process of how to calculate compounding annual growth of earnings-per-share (EPS). As a brief reminder, it indicates the constant rate of return over a given period. Indeed, many of Warren Buffett’s biggest holdings display strong compounding earnings growth. McDonald’s, for instance, has a compounding annual EPS growth rate of nearly 3% for the calendar years 2016 to 2020.
Buffett is also interested in the proportion of these earnings that is kept within the firm, instead of being paid as a dividend. If these ‘retained earnings’ are being put to good use, he sees it as an indication that the management is competent in growing the business.
In 2008, Warren Buffet wrote “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down”. Indeed, we may use the important P/E ratio metric for gauging the cheapness of a company. It involves dividing the share price by its previous or forecast earnings. This gives us the trailing or forward P/E ratio, respectively.
Why Central Asia Metals fits the bill
Based on its earnings data, Central Asia Metals has a compounding annual EPS growth rate of just over 1%. While this is far from heart-stopping, it is consistent. I view this as a strength, as the company is delivering growth for its shareholders year in, year out. It is also possible, however, that I could find other stocks with better earnings growth, like Polymetal International.
Furthermore, the business has an earnings retention rate of 41%. In the 2020 calendar year, this equated to $278m and the firm is on the lookout for more mining opportunities. CEO Nigel Robinson has stated that a transaction may take place “within the next year or two”. This is an indication that the management is actively seeking growth opportunities. This is something Warren Buffett would be pleased to see, I think.
Finally, the business may be cheap at current levels. Indeed, it has a trailing P/E ratio of 9.87. This is lower than rival copper miner Antofagasta, which registers 14.6.
By following Warren Buffett’s central principles, I think I’ve found an exciting growth stock that I’ll buy and hold for the long term. It has solid earnings growth and might be a bargain. I will be purchasing shares in the company without delay.
Andrew Woods has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
