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Strategies & Market Trends : Free Cash Flow as Value Criterion -- Ignore unavailable to you. Want to Upgrade?

To: Andrew who wrote (36)	10/28/1997 10:48:00 PM
From: jbe	Respond to of 253

Andrew and Pirah and anyone else who cares to join the fray -- Sorry, Andrew, I did not mean to sound peevish! It's been a bad week for me, and it's no consolation to know that others have suffered too: I'm not into schadenfreude. In any event, we are all looking for the same thing, but we are having trouble getting our numbers to match. It wouldn't be so bad if some of our picks overlapped, but they're not doing that. What that means is that at least one of us is barking up the wrong tree! And if it is me (or I-- that sounds awful), I want to find the right tree. Part of the reason for our differences over Pirah's Picks, if I may call them that, is that I was using as-of-this-minute price/FCF ratios while Pirah was using 1998 projected price/FCF ratios. Just as present price/earnings ratios and projected price/earnings ratios diverge, one should expect the same thing to happen with present and projected price/FCF ratios. Clearly, I am going to have to get to the library and look at all those Value Line materials, to familiarize myself with their data and to understand how they make their projections. Unless I do that, I won't be up to discussing these matters with you folks. Two comments (or reservations), however. One: debt. I don't think you can really get a handle on the future free cash flow stream unless you know how much debt a company has. After all, it is going to have to use cold hard cash to pay that debt off, sooner or later. And the bigger the debt, the bigger the cash layout. Second: I wonder whether projections tend to be too optimistic. What makes me wonder is the wide divergence between present p/e's and projected p/e's. The latter are generally WAY lower than the former. You no doubt have heard all that caterwauling out there to the effect that the market is overvalued, that p/e's are at a historic high, etc., etc. The caterwaulers are talking about as-of-this-minute p/e's. Now, if they would only look at the projected p/e's, they could all relax, because then they would see that the market is terribly UNDERvalued. I exaggerate, for effect (of course), but still.... Joan

To: Andrew who wrote (36)	10/29/1997 12:28:00 AM
From: Pirah Naman	Respond to of 253

Andrew: You wrote: ************ I ask again, what if we go into a prolonged bear market, and the growth companies with great FCF sell at an FCF multiple of 8 for years because everyone is so pessimistic (like they were in the 70's). Since you paid a 14x, you stock is way down. For potentially years. What will you have to calm your frustration? How will you be able to say "I paid a fair price for a great company, and when times get better, the market will recognize this"? What if 14x isn't a fair price? Maybe it is, but whenthe rules change for a while, how will you know? That's why I see value in MCD, and you guys don't. My method allows for changes. ************ I would argue that if anything, your method leaves you more prone to such frustration. There are two reasons for this. First, as we discussed already, with long operating periods even a total slug of a company will appear undervalued. Given this, what does such a test tell you? Not much. It can be used to weed out something incredibly overpriced and that's it. Second, your method allows for changes in both directions. I have doubts about VL's ability to forecast for the next four years, but I have even stronger doubts about any of us making good forecasts for much longer periods of time. If you see value in MCD, I think you have to credit it to being your subjective judgement. I don't mean that in a bad way; as I've stated a couple of times, I think Buffett's success is far more due to his subjective judgement than to his valuationn technique. BTW I think you did a much better job explaining the PM-FCF connection than I did. Also I am aware of VL's practices, but they shouldn't distort EVERY stock to the extent that jbe and I diverged. Pirah