Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

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

To: Axel Gunderson who wrote (614)	8/11/1998 8:05:00 PM
From: Freedom Fighter	Read Replies (1) \| Respond to of 1722

Axel, --- Exact Values Wayne said: >>I am not so sure that it is really possible to give an exact fair >>value. Axel said: >>It is impossible - nobody knows the future. That doesn't change my perspective - if somebody states that stocks are over or under valued, then either they have some estimate of fair value (which they should give and maybe even explain) or they are just spouting off. I think more of a "wrong" answer supported or explained by faulty reasoning than a "correct" answer given with no reasoning.<< My point about an exact fair value was not to say that someone could possibly know the future exactly and place a value on it. It was more or less to say that an investor might say to himself that company "XXX" is worth between 50-65 per share in a private transaction. Or according to personal models it is worth between such and such a range. That is where margin of safety comes in. You just don't buy unless it's below that range (trading at 35-40 or less.) As an example, I recently bought Sbarros. Quite frankly, I am not sure what it is worth privately. I am also not sure what kind of number to put on it based on any of the models I use. And I really don't care. I am just almost certain that with $6-$7 per share of cash, little debt, high return on equity and a low PE it is great deal at present. If you subtract out the cash, the earnings yield on operations + cash is super attractive relative to the market price. If you discount the free cash using the standard free cash models with very unambitious assumptions going forward, you get a very big number. No matter how I slice and dice it, it is cheap. I have no real number in mind (though if you put a gun to my head I would come up with high 30's to low 40's) I just have a range. If it increases in value over time by reinvesting earnings at its normal high ROE and generates a growth rate equal to nominal GDP, and then reaches the new fair value (give or take) within 5-10 years, I am looking at a very satisfactory total return. Cash will just keep piling up in a major way. One would think the market would recognize all this and expand the PE appropriately. Even if that growth rate is not possible the cash generation will still be huge relative to the price. This is also not the type of business that usually deserves a very high risk premium as say a technology or cyclical company might. The models I use for let's say the S&P500 and the Dow place such a wide range on fair value depending on which model I use and which assumptions I make, that if I presented them they would be of little use to anyone except me. The assumptions required to get to 1060 are so rosy and unlikely I would never make the bet. Hence my overvaluation view. Here's one downside possibility: If one assumes there is a close inter-relationship between cost of capital and its return over the long haul, then a return to historical margins or even less is possible given low interest rates. Much lower margins means lower normalized earnings than exist at present. This would also justify much lower PE ratios to boot (according to all models pretty much). What I am suggesting is basically a return to the mean all around within a few years. (5-10 years) Assumptions like that make fair value on the S&P500 around 400. But there is everything between "return to the mean" and above that are possible scenarios. There is also worse than average scenarios if the international monetary system keeps melting down as it is at present. To me fair value is sort of a bet with odds. When it is undervalued it leaps off the pages at you. It does the same when it is overvalued. I believe it is just necessary to have a good grip on how companies are valued privately, have a sense of history and historical valuations in various industries, recognize changes that might effect the valuations relative to the past, understand your company and its specific valuation criteria and risks, lots and lots of models etc.. etc... etc... For me, I am always studying new models and new ways to think about things that might be unrecognized and under-appreciated. If you read Buffettology, If it is correct about Warren, he thinks similarly. He doesn't have a fair value number. I suspect you might find this answer unsatisfactory. If so, I would be happy to send you several of my spread sheets and models. When you see how small changes in assumptions can make large differences in the values you might find my vague answer a little more satisfactory. As far as Abby is concerned, she has said that she is using the standard free cash flow model. Her inputs are the very high levels of free cash we have at present (super high margins of questionable sustainability), super low inflation (lower than any decade average since the 20's and 30's depression - basically since we have active central banking), and a risk premium that is substantially lower than the historical average. She is accepting a much lower risk premium than is usual on the continuation of perfection. To me this point of view is ridiculous. If this point of view is correct (and there is some very small possibility it is) there is almost no reward. If it is not, it is a disaster. That in itself suggests to me that her valuation methodology is very faulty! Why would you make that bet and how can it represent fair value? If you accept perfection as permanent in your inputs you should at least want a high risk premium not a lower than average one. Wayne Value Investor Workshop members.aol.com