Sharek’s Rule of 72
In finance, the traditional Rule of 72 states 72 is divided by the stock growth rate to obtain the years it takes for the investment to double. For example a stock that grows at 12% per year should double in price every six years (72/12 = 6).
David Sharek’s taken the thesis a step further. In the long run, a stock will grow at the same rate profits do, providing the P/E ratio stays the same. So, a company that grows profits 12% a year could also see its stock grow 12% a year.
Sharek’s Rule of 72:
The number of years for a stock to double can be estimated by dividing 72 by the rate profits are expected to grow.
For example, Kellogg (K) grew profits 6% per year during the ’90s and its stock also grew 6% per year. 72/6= 12 years for the stock to double. Conversely a company that grows profits 24% per year could have its stock double every three years, so a $1000 investment could be $2000 after three years, $4000 after six years, $8000 after nine years and $16,000 after twelve years.
In this table above, many stocks grew faster than their profit growth rate because P/E ratios expanded during the decade. But an excellent example of faster profit growth leading to more rapid stock growth is Target (TGT) from 1996-2005. During that span TGT grew profits 24% a year the stock compounded at 24% per year.