Different people have different methods of valuing equities, so I can only give you the way I think about things.
When valuing a company I ask 2 questions: (1) how much cash will I receive? (2) when will I receive it? If I told you company X needed to be liquidated today for cash, you would care only about its net current assets (this would in fact be an upper bound on said timetable). If I gave you a week to do it, maybe you could realize a bit more cash. A year, perhaps even more. 5 years, more still. But the whole idea of valuation in my mind is that at some point in the future, this company will be liquidated and that liquidation value, appropriately discounted, is what I should pay for the business now.
This fairly radical point of view forces me to take a very harsh view toward companies that are not building tangible book value for their shareholders. Most people are perfectly happy with a company buying intangible assets, making acquisitions, or repurchasing their stock to increase their earning power. They ignore whether the business actually has retaining power. As Buffett discusses extensively in his letters, poor retaining power is often a function of poor capital-allocation decisions by management. GILD is a good example.
If I see a company that has produced progressively more negative tangible shareholder equity (excluding fixed assets) for 10 years, I view the promises management made 10 years ago as "yet to be realized." Similarly, I assume their promises today will prove "yet to be realized" 10 years hence. It may be wonderful to own a business that - at some unspecified point in the future - will magically start to retain its earnings and accumulate cash to generate a substantial liquidating value, but I prefer businesses that have substantial liquidating value right now and have demonstrated the ability to consistently retain earnings for at least 10 years. Always remember - the value of an intangible asset rests exclusively in the projections for its future earning power. Contemporary managers seem to forget that and view intangibles as trading assets, and their companies as private-equity firms. |
