Webby,
Actually I did respond to you in some detail, and the post has disappeared completely. That's why my response was a bit flippant, I thought you had read it and ignored it! SI was down for a while yesterday afternoon, and my suspicion is that they lost posts from right before the outage. Anyway, I'll try to reconstruct it here.
I took your 25% growth for 10 years, and then reduced it to 15% for 10 and 10% thereafter. The world is only ready for so many donuts, so while I can believe 25% for 10 years, at some point it has to slow down.
As for the discount rate, I would use 20%. I wouldn't go much lower than that for any stock, when you can get 6% or 7% on risk-free investments. Maybe a few exceptions, like utilities, where I'd go lower, but certainly not a highly competitive industry like fast food. Most companies I know assume at least 20% as their cost of equity, and in the high tech or venture capital world, much higher.
KK doesn't have enough of a history to try to calculate a valid long-term beta, but I never had a lot of faith in beta-derived cost of equity assumptions anyway, they fail to capture risks of future changes in markets, companies, performance etc. that were not reflected in the past. All they really capture is market risk, and when you play stocks short and long, you can avoid most of that anyway.
When I ran the present value calculations under your scenario with a 20% discount rate, it came out to around $37 a share.
Personally I'm more comfortable with a slightly lower earnings trajectory after the first few years, and I think a fair price based on that is somewhere in the low 30s. You could argue that they can continue to grow the business by expanding geographically and/or into new product lines, and I would agree, but then I would argue that (a) margins will suffer and/or (b) risk would increase because they would be moving away from the one place where they have a defensible competitive advantage. Either way, I don't think it would have a material impact on the PV calculation until such time as success became clear (and hence risk reduced).
Fund |
