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Strategies & Market Trends : Buffettology -- Ignore unavailable to you. Want to Upgrade?

To: Richard Nehrboss who wrote (593)	11/23/1998 2:10:00 PM
From: Bob Martin	Respond to of 4691

<<<Bob, I'm using your quick example... 15% for 10 and 5% for 5 with 9% risk free. I use $1 for current earnings.. since we want to get to a PE ratio. This gives an NPV of $21.24 ... Wouldn't this suggest a PE of 21? Thanks for the help Richard >>> ------ Richard, Correct. If you assume 15% growth for 10 years, then 5% growth for 5 years, then no earnings at all after that, with a 9% discount rate, I get a PE of 21.23. In the Hagstrom book "The Warren Buffett Way" there is a formula for calculating the residual discounted earnings, in other words, the "5% growth for all the years after the 10th year". This simplifies the calculation, so you just have to figure out the yearly contribu- tion for the first 10 years, and then do one calculation for the remaining years. Your example also shows another interesting point. Using the formula in the book, 15% for 10 years and then 5% thereafter shows a PE of 40. Your example shows a PE of about 21. This means that almost half of the present "fair" value is from years 16 and out. The lower your discount rate, the more of the current value is represented by the further out years. That is why (according to Hagstrom) Buffet won't use a discount rate lower than 8 or 9% (I can't remember which). Obviously, if inflation becomes a problem, then higher discount rates would need to be used. Bob