I have to say that I'm not familiar with your valuation model.
it is precisely the discounting method Buffett describes in that quote i put up. i also account for share dilution, assuming a mere 3% dilution.
But if it calculates expected return to be only 11% given those world-beating growth figures, I can't help but be a little skeptical
it all depends on the price one pays, doesn't it?
the way some people figure QCOM's future value is basically to:
1. figure some number of CDMA phones in the future, with QCOM making $X per phone
2. assume QCOM has operating margins more than twice the current level
3. apply a PE to the assumed operating earnings
this is all a bit different than the approach presented by Buffett (and used by me), which is calculating the implied growth rate for a given expected rate of return, which serves as the discount factor.
the idea is very simple: if you want an 11% return in perpetuity, then the company needs to give you 11% on your money this year and every year hereafter, or else needs to give you more than 11% annually in the future (increasing at 11% per annum). in the case of an options-issuing company like QCOM, one must also consider that total company earnings in the future could be diluted on a per share basis, due to a steadily increasing share count. therefore, i assume a discount factor for dilution as well.
when i put it all together, i get a given NPV based on a given expected return.
you shouldn't be surprised if your method and my method yield different expected prices, because we're measuring different things. to take the example of 40% CAGR over the next four years...
let's assume they do indeed achieve this, and $1 in 2002 becomes $5.38 in 2007 (let's call it $5 even to simplify and account for a little of the share dilution).
now your approach is to simply apply a PE of 25 to that amount, so you see the stock as worth 125 in 2007. but let's assume QCOM stopped growing in 2007, and always made $5 per share thereafter. what is the stock worth? according to your method, which is just to apply a PE of 25 to whatever the earnings are in 2007, the stock is still worth 125.
but according to my method, and still assuming 13% expected return, the NPV is calculated at just about $22.50. this amount is less than the $35 i calculated in the previous scenario (where i assumed 40% CAGR for 4 yrs, 20% CAGR for 6 yrs, and then 6% (or average market) CAGR for the next 20 yrs).
the reason it is less is obvious: if you held the stock for 30 years, the $22.50 scenario would provide less earnings accumulation than the $35 scenario. this is why i made a point of making an assumption for CAGR for yrs 1-10, when QCOM CAGR is assumed to be better than average. it is important to capture all those earnings in the NPV.
the thing is, at any given moment in time, stocks may be priced according to this or that PE. but over very long periods of time, the return one can expect from date of purchase will tend to reflect the gains over time. PEs vary significantly over the years, so one cannot be sure that today's seemingly "low" 25 PE (or 40 forward PE suggested by slacker) will be the norm five or ten years from now.
however, money in the bank is money in the bank, so if QCOM grows true retained earnings at a given rate, and delivers these earnings as dividends or retains them as cash, then that value over time contributes to the NPV. the difference in this approach vs. the "slap a PE on it" approach is that my approach is more like if you owned the business yourself (buying it at price X), what will your return be over time. you have probably heard Buffett say he buys businesses, not stocks. the returns he looks for in these "businesses" are based not on a future PE, but on the expected return calculated from future earnings assumptions.
it may be the case that the "slap a PE on it" approach will work out well, as long as one picks the right time frame. QCOM could earn $5 and then get a 125 price. but then if earnings go nowhere for a few years, the stock price may go nowhere or down. so while you might get to 125 by 2007 for a 27% or whatever return, if the stock then flatlines for a few years, your 27% average return will become a lower average return. and if you hold for 30 years, i would guess the return will average less as well. so a lot of the "expected return" thing may depend on what one's holding time horizon is. |
