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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: Pirah Naman who wrote (39496)	2/19/2001 7:02:32 PM
From: Pirah Naman	Read Replies (3) \| Respond to of 54805

Free Cash Flow Part V An Example This will make a lot more sense if you have read the previous parts of this series. I have tried to make this something which everybody else could replicate. So what I did was to get my fat butt to the library and get some numbers from Value Line and Standard and Poor's, as I believe most of you could do the same. I then built up a spreadsheet from scratch - not fancy, but so I could walk somebody through it. What I will do now is show you the numbers I took from Value Line for INTC, and go through the calculation step by step. You can walk through this on paper with your calculator, or plug these numbers into your spreadsheet. I will give you the commands for input into your spreadsheet so that you can make it up if you want - no experience necessary. Note that some have an equal sign at the beginning, and some don't. Those without are pure input by you. The equal sign tells the program that it must perform a calculation. CF2001 = 1.75 CE2001 = 0.65 CF 2004 = 3.20 CE2004 = 1.00 CF stands for cash flow, and CE stands for capital expenditures. Value Line has forecasts for 2001 and for "03-05" which I turned into "04." In this post FCF stands for free cash flow. Those of you making up a spreadsheet - put all of the numbers in row 3. Use row 1 for headers, so that you know what is in each column. Start out by filling in cells based upon what we know already; I will denote cells by A3, B3, and so on, where the letter refers to the column and the number refers to the row. In each cell, type in exactly what I give you inside [ ] and you should get the answers as we go along. At the end you will have a spreadsheet you can modify to meet your needs. A3 [INTC]; B3 [1.75]; C3 [0.65]; D3 [3.02]; E3 [1.00] FCF for 2001 = 1.75 - 0.65 = 1.10 F3 [=b3-c3] FCF for 2004 = 3.20 - 1.00 = 2.20 G3 [=d3-e3] The implied growth rate for the FCF is found by dividing the 2004 figure by the 2001 figure, and raising that number to the power of (1/3). We use (1/3) in this case because we are looking at growth over 3 years. Had we used a five year span, we would use (1/5) instead. Anyway, the implied growth rate, which I will call Gi, is calculated by Gi = (2.20/1.10)^(1/3) = 1.26 H3 [=(f3/g3)^(1/3)] In other words, Value Line's projections imply a 26% compounded growth rate of FCF going forward. Is this reasonable? Using S&P's historical numbers, and performing the same kind of calculation, INTC has grown its FCF by 40% pa over the past 5 years. So 26% is good enough for us to use for now. Now we need a discount rate. The current long bond is at 5.09%, and I decided to use a 4% equity premium. This was somewhat arbitrary on my part, but it seems fair for a Gorilla, and it really doesn't matter here; this example is just for illustration. Anyway that gives me a discount rate of a little over 9%. I3 {1.09] So the value of a dollar to me next year is equal to $1.00/1.09 = $0.91 now. Now I am ready to start calculating the intrinsic value of INTC. What follows are discounted figures. FCF 2001 = 1.10/1.09 = 1.01 J3 {=f3/i3] Now we have already assumed that INTC will grow its FCF at 26%, so we can multiply subsequent years by 1.26, and divide by 1.09 to discount for another year. FCF 2002 = 1.01 x 1.26 / 1.09 = 1.16 K3 [=j3h3/i3] FCF 2003 = 1.16 x 1.26 / 1.09 = 1.34 L3 {=k3h3/i3] FCF 2004 = 1.34 x 1.26 / 1.09 = 1.55 M3 [=l3h3/i3] FCF 2005 = 1.55 x 1.26 / 1.09 = 1.79 N3 [=m3h3/i3] We are going to be conservative (pessimistic) and assume that after 5 years of this 26% growth, INTC slows up and grows its FCF no faster than the overall market. So we will now sum up the FCF for its five years of fast growth: Sum = FCF 2001 + FCF 2002 + FCF 2003 + FCF 2004 + FCF 2005 = 6.86 for the spreadsheet, here you go: O3 [=j3+k3+l3+m3+n3] In 2006, and for as far as we can imagine thereafter, we will assume that INTC grows its FCF at 6% per year. P3 [1.06] We want to calculate its residual value by the equation: RV = FCF 2006/(k-g) FCF 2006 = 1.79 x 1.06 / 1.09 = 1.74 Q3 [=n3*1.06/1.09] We can now calculate the residual value: RV = 1.74 / (1.09-1.06) = 56.35 R3 [=q3/(i3-p3)] The intrinsic value of INTC is the sum of FCFs during its fast growth (6.86) and the sum of its FCFs during its slow growth, or residual value (56.35). Intrinsic Value = 6.86 + 56.35 = 63.22 S3 [=o3+r3] All that remains is to compare it to the current price. At Friday's close it was 34.40 (rounded to nearest dime). T3 {34.40] The price divided by the intrinsic value gives you a relative value. If the relative value is much less than 1, the company is priced at much less than its intrinsic value; if the relative value is much more than 1, the company is priced in excess of its intrinsic value. Relative Value = 34.40 / 63.22 = 0.54 U3 [=t3/s3] There is plenty to nitpick here, but before you start in, please read Part VI, coming up next.