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

To: Chuzzlewit who wrote (741)	12/23/1998 8:24:00 PM
From: cfimx	Read Replies (1) \| Respond to of 4691

>>First forget P/E because it is like driving a car with your view provided by the rear view mirror. The P/E concept was devised by Ben Graham as shortcut for valuation. It works well enough for stocks that aren't growing, but it is pretty dismal for growth companies.<<< you just spent half your post bashing the p/e ratio. Now a paragraph later you USE IT to justify Dell's valuation? >>Now back to the valuation issue. DELL may earn around $1.60 next year, giving it a forward P/E of around 44. Conservatively speaking, Dell has a five year growth rate estimated at around 40%. The S&P has a forward P/E of around 24 with a long-term growth rate of around 11% (looking past the current year). What I do is calculate the YPEG for the S&P and divide that number into the YPEG of the target stock to give me a normalized PEG (so-called CNPEG). If you do this you get a CNPEG for DELL of around 0.50. The interpretation of that metric is that you can buy growth through DELL at roughly 50% of what it costs in buying the S&P. How's that for value?<<

To: Chuzzlewit who wrote (741)	12/23/1998 10:29:00 PM
From: cfimx	Read Replies (1) \| Respond to of 4691

Chuzz, you said this in another post: >>Assume each number represents disposable free cash flow. What is the value of the stream of future cash flows? The point that I have made is that using a static P/E (either forward or backward) is simply insufficient to capture the value inherent in the stream.<< And In this post, you started off with: >>First forget P/E because it is like driving a car with your view provided by the rear view mirror. The P/E concept was devised by Ben Graham as shortcut for valuation. It works well enough for stocks that aren't growing, but it is pretty dismal for growth companies. Obivously, you HATE the P/E ratio. Or as George Bush would say...P/E ratio, baaad...DCF...good!. You don't value stocks that way, you told us. But, strangely, you then went on to USE that useless P/E ratio to help you VALUE Dell, as the following abstract demonstrates. >>Now back to the valuation issue. DELL may earn around $1.60 next year, giving it a forward P/E of around 44. Conservatively speaking, Dell has a five year growth rate estimated at around 40%. The S&P has a forward P/E of around 24 with a long-term growth rate of around 11% (looking past the current year). What I do is calculate the YPEG for the S&P and divide that number into the YPEG of the target stock to give me a normalized PEG (so-called CNPEG). If you do this you get a CNPEG for DELL of around 0.50. The interpretation of that metric is that you can buy growth through DELL at roughly 50% of what it costs in buying the S&P. How's that for value?<< Question Chuzz. When you valued Dell at the end of your post, why didn't you utilize the discounted free cash flow method that you claimed to work with? Curiously, you used a P/E approach that you derided earlier in your note. Since you presumably use the DCF, you must have at the ready, your estimates for Dell's future cash flows. Furthermore, since you are obviously still quite bullish, you would have already, it seems to me, MADE this calculation, so you could safely JUSTIFY your bullishness with hard evidence. It strikes me as really weird then that you would choose to value DELL with a P/E ratio method you claim is utterly useless, instead of DCF, which you champion. I would love to hear your answer. You could also try this: 1) Give us your cash flow assumptions on Dell. 2) Tell us how you would discount those cash flows (rate, etc.) and 3) then tell us the result of this valuation exercise, the value of Dell. It should be WAY ABOVE $77, given your assumption that the S&P 500 at 26 times earnings is fair value, right Chuzz? Chuzz?

To: Chuzzlewit who wrote (741)	12/24/1998 12:07:00 AM
From: James Clarke	Read Replies (2) \| Respond to of 4691

I will agree that Dell is an excellent company. And I will also agree that its business model has more barriers to entry than I would have thought. I came to that conclusion after arguing about Dell from a position of ignorance until I read the Harvard Business Review article that has been linked here in the previous posts a few months ago. Even if you have no interest in Dell, it is worth your time to read this article. But your logic on P/E is pretty convoluted. If anybody here is saying that a 10 P/E stock is a better buy than a 30 P/E stock for that simple statistic, I would laugh at them too. Of course you have to look at the growth prospects. But telling me that something is going to grow at 40% for the next five years is a pretty daring statement. (And don't tell me that's what the Wall Street analysts say or you'll just prove my point). The computer business is growing at whatever double digit percent, but is probably slowing. But Dell is gaining market share. OK, could they do it. Yeah, they probably could. But would I put my own money on a bet like that at 50 times earnings? Probably not. And no, we're not as stupid as you think we are, we value investors - we recognize that you want to discount future growth. But a) I would never bet on a number higher than 18-20% in my valuation - especially going out five years, and b) 50 or 60x earnings already discounts a hell of a lot of it. The way I explain the risks of a high P/E to people is this. You've got a stock earning $1 a share, trading at 50. A 50 P/E. But you KNOW its going to grow at 10% for the next two years. OK, so next year's earnings are going to be $1.30 and the year after is $1.75 or so. Lets say you're absolutely right on your two year forecast. Congratulations for your first miracle. But have you made any money? What if in two years, the growth outlook begins to slow? The company is still a growth company, but a mature one, growing at say 18% with a 25 multiple. Still a growth multiple, not cheap. 25 times 1.75 is what, $42. So you were absolutely right on your two year forecast and you still lost 16% on your investment. Imagine what happens if you're wrong. That is what the word risk means. Do any of you REALLY believe you can forecast Dell long term the same way you can forecast a Coke or a Disney or a Fannie Mae? (yes, I did remember I am on the Buffetology thread) You're telling me you think you can if you buy Dell at these prices. I don't mean this as a specific statement on Dell, and lets not get drawn into that again. Dell may very well be a Buffett stock - when a) they prove it with a few more years of a track record; and b) when the valuation is reasonable. I mean this as a warning to those who think Buffett investing is about buying great businesses whatever the price. I'm not saying that about anybody on this thread, and certainly not about the individuals who invested so astutely in these high multiple stocks years ago when they were steals. (And its not just hindsight - Dell was trading at 12 times earnings when I looked at it in 1995, and I whiffed, because I did not understand the implications of direct selling). Likewise, I have two relatives who work for AT&T, and when Lucent was spun off it was a steal. I should have bought it because both of them sold their AT&T and held onto their Lucent shares (even though one of them was still with AT&T). But did I buy Lucent? No. So don't trash these guys too bad - we might miss an opportunity to learn something. Although we should try to nudge things back toward Warren Buffett. Jim Jim