Hi Lars,
I finally found that MCD article in the Oct 94 Fortune (on Microfilm
no less! What a pain...). It was very impressive, like you said. It
basically shows that McDonald's can grow it's profits just by opening
new stores...it's a foregone conclusion that they will make money!
Now I desperately want to take a large position.
BUT...I still don't see much margin of safety. Like you said, it's
very instructive to compare this to Buffett's purchase of Coke in 88.
MCD does seem to now be very much in the position that KO was in then.
However, the market is now at a much higher valuation in general. For
example, (according to Hagstrom) KO was trading at a 30% premium to
the market's P/E, so everyone felt that it was overvalued. But it's
P/E was only 15 then! I don't advocate using P/E's for valuation,
so let's use discounted free cash flows (using the 9% rate that
Hagstrom used). He found that KO was at a 27% discount even if you
assumed only 5% growth. At the more reasonable level of 15% growth
(for 10 years), the margin of safety was a whopping 70%.
That for me is a perfect example of why Buffett is always slugging
them out of the park. GEICO and the Post were like that too - he
"triple-dipped" - after he bought, the companies grew a lot, the
discount narrowed, AND the companies bought back shares.
With MCD at 48, I see a margin of safety of about 30% if they can grow
at 15%. Sure, that's great. But that's certainly not on par with
the margin of safety on KO in 1988. It certainly seems like an
excellent investment, but it just seems a little out of character for
Buffett. Perhaps he feels so sure about their future that he's
willing to pay a fair price rather than a bargain price. But he
got where he is today by paying bargain prices.
Maybe this correction will turn into a bear market and a more
attractive price will come around.
One caveat - I used a 9% discount rate even though the long bond is
currently closer to seven. I feel like that's more conservative.
Maybe I should go back to the KO example, and use 11% there, to see
if the valuation looks different. That way I would be applying
equal doses of conservativeness to each situation.
As usual, I welcome comments on this...
-Andrew |
