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

To: porcupine --''''> who wrote (471)	7/6/1998 6:57:00 PM
From: Freedom Fighter	Respond to of 1722

>My problem (and Graham's) with this kind of analysis is that it >projects both earnings growth rates and average interest rates 30 years into the future. Because of exponential compounding, a slight variation in these assumptions will produce a very wide divergence in result. For example, a discount rate of 5.5% annually may turn out to be low, if the monetary spigot is turned off. And, 8% annual earnings growth might be safely predictable for chewing gum or soda pop (although I am skeptical even of this). But, it certainly seems like a brave assumption to project that the demand for a big-ticket item like a car or truck will grow at a rate much faster than global GDP is likely to grow. Your analysis is always welcome. Reader letter follows:] My research doesn't support Russell's comments. Chrysler Ford GM Daimler Toyota Price $43.38 $63.50 $70.50 $95.19 $51.63 Price/Earnings 10.74 11.3 8.94 25.73 24.01 Book Value/Shr $17.52 $25.04 $37.00 $31.00 $24.30 Earnings/Share $4.04 $5.62 $7.89 $3.70 $2.15 ROE 24.7% 23.1% 27.9% 12.0% 0.0% Price/Bk Value 2.48 2.54 1.91 3.07 2.12 Debt/Equity 2.1 7 8.3 1.8 0 Frcst Earnings $5.00 $5.29 $8.06 $5.01 $1.64 Forecast Growth 8.3 8% 8% 17% 7% Current sales vs. Avg. -15.0% -24.5% -20.7% -24.4% -23.9% Current productivity vs. Avg. 6.1% -124.0% -20.9% 740.5% 462.3% Cash flow per share $10.50 $12.18 $33.60 $11.25 $4.20 Cash flow NPV@5.5%, 30 Yr. $120.45 $142.12 $553.48 $258.33 >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> I tend to agree with almost all your points. 1. Projecting out very long periods is a very dangerous idea. 2. Small differences in the discount rate used can cause dramatic differences in the valuation. Hence large room for error. 3. GM is unlikey to grow much faster than the nominal GDP over the next 30 years. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Here a just a few insights: Without getting specific about GM (which I am not familiar with), the assumptions for your model are not the ones that most analysts would use. It is standard to add some risk premium to the treasury bond rate to get the appropriate discount rate to value equities. That risk premium varies with the type of business and the certainty of the projections. We really don't know the future of any company so we should insist on being compensated for the uncertainty. It is almost unheard of to project growth greater than nominal GDP for more than 10 years. Most companies are valued using 5 years of high growth (if appropriate) and then nominal GDP growth. In some cases for younger companies a 2 stage growth model is used. For most it is just nominal GDP. For some it is less. It is Free Cash Flow that is discounted not Cash Flow. Lastly, if inflation turns out to be higher, so will the nominal GDP growth rate. The discount rate used will be too low but so will the assumptions about the growth rate in free cash flow. (Assuming the company has some pricing power) This cushions the miscalculation a little. An investor should try to make normalized future projections and not snapshot the present into the future. In my own investing, I only use these long term dividend discount/cash flow models for those rare companies that I am sure have qualities that ensure their long term viability and growth. For the others, my approach is more like Graham's and I am looking at earnings yields vs bond yields and earnings yields vs. inflation. One last point, It is the errors that are possible in any valuation calculation that require investors (specifically Graham investors) to insist on a margin of safety!