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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: Daniel Chisholm who wrote (176)	4/17/1998 2:22:00 PM
From: Daniel Chisholm	Read Replies (1) \| Respond to of 1722

Correction re: EVA & porcupine --''''> It seems that I confused porcupine's real name (Reynolds Russell) with Reginald Middleton. The only excuse that I can offer are that both their first names begin with the letter "R", and porcupine mentioned EVA. My apologies, and perhaps I can attempt to un-muddy the waters a bit. My comments concerning how I think EVA ought to be improved would probably make more sense to someone who followed RCM's thread (now inactive) at: exchange2000.com I believe he referred to an EVA analysis he did, which concluded that MSFT was not overpriced, even though traditional valuations techniques might suggest that it was. And that conversely, even though NOVL had a great deal of cash (and might therefore seem to be a sound value play), they had a history of not delivering value (destroying wealth - or at least not creating a good enough return). My thumbnail sketch of his EVA model is that he considered all the different sources of a company's capital (debt, common, etc), and assigned a "cost of capital" to each class. Obviously for the debt part this is easy, it's just the interest rate that you have to pay. For the equity part he assigned a number like 12%. Then he did what was (as far as I could tell) a discounted free cash flow analysis, and determined from this whether or not the company earned enough to pay for its cost of capital. Any excess generated was classified as "EVA", indicating that management was generating above-par returns, and was therefore competent. The thing that bothered me was the a priori choice of a cost of equity capital of 12%. I believe the rationale for this is that this is an historic return required for equity capital. Though this is at least a rational rationale, I had (and have) some doubts about using an historical cost of equity (derived from all equity investments). My concern was that this would set excessively high or low hurdles for management, since it did not take into account the riskiness of their industries, etc. Perhaps this makes my previous post clearer? Regards, - Daniel