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Strategies & Market Trends : Gorilla and King Portfolio Candidates

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To: chaz who wrote (45910)	8/27/2001 3:42:22 PM
From: Seeker of Truth	Read Replies (5) of 54805

We need a relatively rigorous system for determining the maximum price at which we can still hold a stock and the maximum price at which we can still consider it a good buy. In principle we have to calculate the discounted cash flow far into the future. Next year's dollar of earnings is now worth $1/1.10 if we expect to make ten percent per year on any investment. A dollar's earnings in the year after next is worth today $1/1.21 etc. So in principle we have an infinite series. I think that is a shade too difficult to estimate. We are supposed to have estimates of the earnings in 2001,2002,2003,2004 etc. etc. I suggest a simpler, rather equivalent method. If you've read my valuation spiel before you can click and go on to some more interesting. post Let's assume that after ten years of growth the company's stock will be growing at the same rate as our cash equivalents. That is what most stocks do. I see that Yardeni, an economist that works for some broker, has a similar assumption. He thinks that the market is overvalued when the earnings yield of stocks is less than that of cash in the bank, let's say. He says bonds, but I think bonds are too risky so I prefer to choose relatively short term savings deposits. I assume such deposits will pay about 5% in 2011 unless the U.S. government rededicates itself to paying down the federal public debt. (In such a case we might even find deposits only paying 3% and P/E's would be correspondingly high.) So let's take SEBL and some renewed assumptions. These are that the earnings in 2002 will be 0.60 per share. We also assume that earnings are the same as cash flow because I don't have the annual report to calculate the real cash flow. We further assume that the growth rate of cash flow over the ensuing 9 years will be 23%. The maximum to be assumed for any company is 25% per year over the next decade. That's because the number of companies which have exceeded this is miniscule. With all these assumptions we get earnings in 2011 of $3.87 per share. Assuming an earnings yield of 5% means a P/E of 20. Hence the price at that time will be 77.33. At $19.33 it would be a good buy now because we would expect to quadruple our money in the decade. Under the present conditions a price of 29.86 would be a message that we should sell it. This would multiply our money by 2.59 over the decade which is only 10% a year. Of course both the buying and selling could be divided into different lots separated a bit in price. Somebody will say that 30% per year is a more likely growth rate over a decade. With such an assumption you will get vastly different numbers. My 23% is not pulled out of the air, well not exactly pulled out of the air. Originally I assumed that this company, which I admire, would do 25% a year. But Siebel's recent wail of anguish suggested to me that the Goldman Sachs analyst who predicted 56 cents per share this year and 60 cents per share next year is probably right. And I also slightly reduced my 25% guess for the long term growth rate. Don't worry, I will wait a year before I post this scheme again. I'm sure there are people out there who have a better system and it is their input which most of us are awaiting. Anyway there is no gorilla game without an evaluation system.

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