Mark:
You had a disagreement with Allen, to wit:
Allen: Even more important, there is a missing term that should contain an approximation, estimate or whatever, for the future value beyond year 2011.
Mark: Again, I was being very generous. You projection called for a 6% growth rate at that point and a discount rate of 10%, so the situation keeps getting worse, the further out you project earnings into the future. The future value is negative when the future growth rate is less than the discount rate!
That is very wrong. The value of the earnings stream for even a non-growing instrument (like a bond) is positive, not negative. There is even a common equation you can use, based on the Gordon Dividend model. In using this Allen, like W. Buffett, essentially applies the Miller-Modigliani (sp?) Dividend Irrelevancy Theorem in determining each year's return to the shareholder.
Now where we run into troubles, and this would have been a legitimate criticism of Allen's numerical methods, is in the calculation of what W. Buffett calls "residual value" or what Allen has more commonly referred to as "selling price at some future date." If one is to be consistent, then one must use the Gordon equation once again - if we say that the value of a stock is equal to the discounted value of the future stream of dividends/earnings returned to the shareholder, then we must apply that condition to determining residual (sales) value. If we do this, we get numbers that should raise eyebrows. For example, if we discount at 8.3% (the average long bond yield in the USA since 1970) then a 5% grower is worth 30x the next years earnings! Using this method, an awful lot of stocks can be shown to be "undervalued."
Alternatively one could estimate what the "market" will pay for a stock at some point in the future. This can serve as a check (even though it is NOT consistent with the application of the projected stream of earnings method!) but caution is advised. It is downright silly to assume that the market will pay a premium in the future for any stock, no matter how great it might seem now. Investors are prone to long periods of irrational valuations (up and down) even on well capitalized stocks.
Pirah |
