Lars,
It's great to hear other people are trying this! This is a very unconventional method for valuing stocks, judging by everyone's obsession with P/E ratios. P/E is such a superficial measurement,
it's obscene! The problem is, with so many people using it, it
makes a big difference in the short term. But in the long term,
P/E provides very little information. It's so easy to manipulate
or distort using creative accounting techniques.
Owner Earnings (OE= Net Earnings + Depreciation/Amortization -
Capital Expenditures) tells you what you would recieve as the
owner of a business. Net Earnings certainly do not. Long-term investors should concentrate on being part-owners of a business,
not renters of stocks. Because in the long-term, stocks tend to
track growth in OE.
Owner earnings tell you how much excess cash a company generates
to grow the business, buy back stock, pay dividends, make
aquisitions, etc. Net Earnings, a freak of GAAP, do not.
Valuing a company by calculating the present value of future
owner earnings is far from an exact science. But I believe that
by recognizing that, you can use this technique profitably. To
paraphrase Buffett: "I would rather be approximately right than
precisely wrong". If you have to fiddle with the calculation to
justify a purchase, you're missing the point. This method is best
used to identify grossly undervalued companies. Companies priced
such that if someone could buy them out at this price, they would
acheive a phenomenal rate of return even if the company failed to
EVER increase earnings! And I've found several examples.
A lot of variability can be seen by changing the parameters: the
discount rate used, the initial above-average growth rate, the
number of years of above average growth, and the "eternal" low
growth rate after. I introduce a generous dose of conservatism
for each, to compensate for my lack of certainty. I demand a large
margin of safety, because of my lack of faith in my ability to
predict growth rates with any degree of accuracy.
If you believe Hagstrom, Buffett isn't nearly as conservative,
because he IS sure! THAT, AND ONLY THAT, is the reason why he
won't buy tech. He can't be SURE that any particular tech company
has favorable long-term prospects. And that is why he always wins.
When he bought Coke, he KNEW the business was going to grow.
After that, it was just a matter of buying at the right price.
That's where this technique comes in. For us non-Buffetts, it seems
to me that the best we can hope for is to try to say "Hey, this
is a really solid company, and seems well run. Everything seems
to point to it's industry being a good place to be. It's shown
ability to earn good return on equity, and has good or improving
profit margins. Making only these assumptions, how much should I
be willing to pay for it?"
Buffett doesn't add an equity risk premium to the discount factor;
if the company made it this far into his analysis, he doesn't see
any need to. I don't have that kind of confidence in my judgement,
(especially in tech), so I always add a few points to the long bond.
If the analysts predict 30% growth, I won't consider buying it
unless it's a bargin at, say, 10% (Or even 0% !!).
I generally look at 10 years of this kind of growth, but if I'm
really interested in a company, I'll play around with that number,
to see what happens if this company's only exceptional for say 5 yrs.
Right now, I use Hagstrom's number of 5% for "ever after". Due to
the infinite nature of this assumption, it has a huge effect on
valuation. It should be borne in mind anyway.
Those are the assumptions I use Lars...and I've found some really
cheap stocks even in this market. I think IBM is staggeringly
cheap (at $145) even if it's earnings stay flat! I also think that
3COM is a great bargain (at $35), if you think it has any growth at all in it's future. If you've looked at either of those, I'd be interested in hearing if you reached a similar conclusion.
Sorry for the length of this post. I got a little excited. It's
just that I've never had a chance to TALK to anybody about this
stuff before. Anyone who thinks I'm full of it, I'd like to hear
about that too...
Regards,
Andrew |
