Warren Buffett is perhaps the world’s most famous investor. With a net worth of $98bn, he acquired 99% of this fortune after the age of 50. He once wrote “someone’s sitting in the shade today because someone planted a tree a long time ago”. This is a testament to his long-term outlook. Let’s see how his methods lead me to a top growth stock.
Buffett’s methods: compounding and value
Much of Warren Buffett’s investment philosophy is based on compounding. Specifically, he looks closely at compound annual earnings growth. It essentially tells me the constant rate of return over a given period.
Taking a look at some of Buffett’s biggest holdings, it’s easy to see how central compounding is to his investment analysis. McDonald’s, for instance, had a compound annual earnings per share (EPS) growth rate of 9.5% between 2017 and 2021. It’s a way to gauge profitability and also a good strategy for understanding the speed at which growth is taking place.
Buffett also likes getting a bargain and for this he looks at price-to-earnings (P/E) ratios. To calculate these, all that’s required is to divide the share price by earnings. This would provide the trailing P/E ratio. For forward P/E ratios, I divide the share price by forecast earnings.
A top quality growth stock
These methods lead me to AIM 100 constituent Central Asia Metals. The company – a base metals miner in Kazakhstan and North Macedonia – recently hiked its dividend in 2021 to 20p per share, from 14p in 2020.
Between 2017 and 2021, EPS rose from ¢29.08 to ¢47.69. Using the principle of compound earnings growth, I calculate that the firm has a compound annual EPS growth rate of 10.39% over a five-year period. This is strong, consistent, and a rate I’d be happy with.
Despite this, I’m always aware that this earnings record isn’t guaranteed in the future.
Over this same period, the business more than doubled pre-tax profits from €50m to €109m.
Furthermore, base metal production increased over the first three months of 2022, but there’s the potential for supply chain issues to impact the steady production flow.
The company also has a trailing P/E ratio of 5.72. When compared with an industry rival, Jubilee Metals, it’s possible that Central Asia Metals may be cheap at its current price of 221.5p, because Jubilee has a trailing P/E ratio of 11.92. Using Buffett’s method, I may therefore also be getting a bargain.
Overall, the techniques of Warren Buffett can be extremely effective when trying to find the most rapidly expanding growth stocks. Central Asia Metals has a track record of strong earnings and may be cheap at the moment, so I’ll be adding it to my portfolio soon.