So, after three years, your average annual return is 26%. The stock price and the company at resting comfortably at $148.17. Now you must decide — do you sell and look for another opportunity, or do you hang on for the long-term? Being three years later, you expect your company to grow at 14%, and that growth should contine to sell.

Invested in the company, you could reasonably expect a 9% average annual return over the next fifteen years. Combined with the 26% return from the first three years, you would earn more than 10% over 18 years.

Selling allows you to seek out more opportunities for 26% returns.

Remember: Just because you are discounting at 15% — your desired return — doesn’t mean you’ll get it going forward. As growth slows, the company becomes less and less valuable in the future. If you discount at 15% today, expecting 15% growth (slowing at 5%), a company generating $100 today would be worth $1,458.57. As growth slows, that same company next year would be worth $1,602.53 — just ten percent more. Why the discrepancy? As time goes on, the growth will slow and those future cash flows will not be worth as much.

If that doesn’t make sense, email me and I’ll try to clarify further.

I understand the message is to sell generals is when price rises and meets intrinsic value. My question is, does this mean to sell when the Margin of Safety (either 25 or 50%) has been eliminated? Or do you hold until the price rises further and eliminates most of your “discount rate”. Because if you are using a conservative (say 15%) discount rate, then you will still have that 15% return going forward.

Hope I phrased my question so you could understand. Thanks so much for your wonderful website.

Gustavo Sapienza: MCO has been assuming quite a bit of debt, and that has caused Shareholder Equity to drop. The question is: What effect will that have on the cash flow of the business? Is this good debt that the company will use to increase owner earnings? Or, is this a bad move by management – one that will utlimately put a strain on cash flow?

Congrats once again for the blog and post.

Can you please comment your view about MCO.

Moody´s was once a favorite for our Master Teacher Warren Buffett.

In the meantime MCO´s results were deteriorating, and there is also an interesting case of negative shareholder equity.

Thank you, and best regards

Morningstar lets you screen for companies with positive cash flow for the last 10 years, but you must pay for it.

David

thanks

But something about this post really has me scratching my head. The example above of your purchase and sale of the Graham (GHM) corporation just doesn’t seem to fit with your method of discounted cash flow analysis. How could you have predicted any future level of free cash, given it’s very erratic past? Determining Intrinsic Value for this one just seems impossible.

Was this “cigar butt” investing? I didn’t think that was your style. Please explain!

Any insight into why WEB will hold GCI potentially forever? My only guess is that it has treated him well for a long time and unless it becomes overvalued he has no intention to sell. Well, I guess the bottom line is that it is not overvalued and it’s probably not going out of business any time soon.

As a holder of GCI myself, I have no intention to add more even though it is attractively priced. One thing is for sure. It’s far from grossly overvalued.

And I hope I got what WEB said about GCI correct. I’m saying this from memory and have no link to point you to.