Tracking the daily changes in your stock portfolio has never been easier, thanks to online brokers such as Ameritrade (NASDAQ:AMTD) and portfolio trackers on websites such as Fool.com or Yahoo! (NASDAQ:YHOO). Unfortunately, now that we can effortlessly watch stocks move up and down, many of us forget the true purpose of equity investing.
Investing in a stock is ultimately about buying a claim to a future stream of earnings and cash flows, received either directly as dividends or indirectly through capital gains. Therefore, a portfolio is simply a collection of claims to multiple companies' earnings. Few companies distribute all their earnings to shareholders, and in the short run, market prices rarely reflect the full value of a company's earnings. How can investors determine the total earnings attributable to their portfolio holdings?
Here's where the concept of look-through earnings, made famous by Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) Warren Buffett, becomes a useful tool. Look-through earnings is a relatively simple concept, rarely used by investors, in which you sum each company's earnings attributable to your shares, calculated by multiplying the EPS times the number of shares you own.
Instead of seeing just a smattering of gyrating stocks, look-through earnings allow us to view our portfolios as holding companies, with a number of partially owned operating subsidiaries. As a simple example, I've come up with the following hypothetical portfolio:
| Price | Shares | Investment | EPS | P/E | LT Earnings | |
|---|---|---|---|---|---|---|
|
ExxonMobil (NYSE:XOM) | 46.89 | 100 | $4,689 | $3.01 | 15.6 | $301 |
|
Microsoft (NASDAQ:MSFT) | 28.07 | 100 | 2,807 | 0.75 | 37.4 | 75 |
|
Wal-Mart (NYSE:WMT) | 52.87 | 100 | 5,287 | 2.12 | 24.9 | 212 |
|
IBM (NYSE:IBM) | 85.71 | 100 | 8,571 | 4.66 | 18.4 | 466 |
| Total | $21,354 | 20.2 | $1,054 |
From a look-through perspective, we've paid 20.2 times earnings for this portfolio, which has an earnings yield (the inverse of the P/E) of only 4.9%. Whether this portfolio is acceptable, I'll leave up to you, but notice how your portfolio can be seen as a single entity and valued in much the same way as individual stocks.
Look-through earnings put a different perspective on an investment portfolio than maybe you're used to seeing. Yet it's sensible to view a portfolio as a single business, knowing that over time, the intrinsic value of each company's earnings stream will be reflected in the individual stock prices, and therefore the value of your business.
Fool contributor Chris Mallon also likes look-through free cash flows. He owns shares of Microsoft through his private investment partnership.
