Comments on: Calculating The Value Of A Business – Part IV http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/ Value Investing Blog Mon, 16 May 2011 10:55:06 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Ian C. http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3135 Ian C. Mon, 04 Jan 2010 06:38:46 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3135 Thanks for the explanation: I had partially misunderstood the meaning of future cash flows, now I understand the concept correctly. Thanks for the explanation: I had partially misunderstood the meaning of future cash flows, now I understand the concept correctly.

]]> By: Adam Davis http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3124 Adam Davis Wed, 23 Dec 2009 14:40:24 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3124 I agree with Collin; margin of safety is everything. If you have to split hairs, then move on or wait for the business to be priced where it makes sense. Do what Charlie Munger says: make things as simple as you can make them, but no simpler. The psychology of this is so important. A long time ago, value investor Mark Sellers gave a presentation to my college investing group. He proposed a simple thought experiment for us bunch of wanna-be Bud Fox's: "how would you feel if Warren Buffett was on the other side of your trade?" Pretty simple but profound. If you were buying and Buffett was the seller, would you still go through with the purchase? This stuff gets a whole lot easier when you think in terms of buying businesses. Envision buying the whole company and not being able to sell it - ever. If you're still happy, then pull the trigger and sleep like a baby. In fact, with public equities, you should be downright upset that you can't purchase the whole business! I agree with Collin; margin of safety is everything. If you have to split hairs, then move on or wait for the business to be priced where it makes sense. Do what Charlie Munger says: make things as simple as you can make them, but no simpler. The psychology of this is so important.

A long time ago, value investor Mark Sellers gave a presentation to my college investing group. He proposed a simple thought experiment for us bunch of wanna-be Bud Fox’s:

“how would you feel if Warren Buffett was on the other side of your trade?”

Pretty simple but profound. If you were buying and Buffett was the seller, would you still go through with the purchase?

This stuff gets a whole lot easier when you think in terms of buying businesses. Envision buying the whole company and not being able to sell it – ever. If you’re still happy, then pull the trigger and sleep like a baby. In fact, with public equities, you should be downright upset that you can’t purchase the whole business!

]]> By: Joe Ponzio http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3120 Joe Ponzio Sat, 19 Dec 2009 06:32:05 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3120 Shares issued and outstanding. Your company has the ability to issue 20 billion shares, but only 713 million are "issued." If you were to purchase the entire company, you'd have to purchase the 713 million shares. Shares issued and outstanding. Your company has the ability to issue 20 billion shares, but only 713 million are “issued.” If you were to purchase the entire company, you’d have to purchase the 713 million shares.

]]> By: Joe Ponzio http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3119 Joe Ponzio Sat, 19 Dec 2009 06:30:13 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3119 Intrinsic value is a range, which has a floor at the break-up value and a ceiling equal to the value of the future cash flows if they were to go on forever. Intrinsic value increases over time as the company generates cash, uses that cash to purchases assets (raising the floor) which then generate more cash in the future (raising the ceiling). The reinvestment return rate is critical, hence CROIC. For example, GM couldn't reinvest back into its own business at good rates of return; so, the intrinsic value of the company grew very little over fifty years. In fact, investors would have been better off owning government bonds because the fifty year CROIC of GM was about 4%, and that's about how quickly (er, slowly) the company grew its intrinsic value over time. During that time, government bonds earned about 6%. GM's management would have served investors better had they taken the excess cash and simply invested it in government bonds. The margin of safety serves the exact purpose you state: It helps protect us from wrong estimates of intrinsic value, to hopefully provide us with the "heads I win, tails I don't lose much" situation. Intrinsic value is a range, which has a floor at the break-up value and a ceiling equal to the value of the future cash flows if they were to go on forever. Intrinsic value increases over time as the company generates cash, uses that cash to purchases assets (raising the floor) which then generate more cash in the future (raising the ceiling).

The reinvestment return rate is critical, hence CROIC. For example, GM couldn’t reinvest back into its own business at good rates of return; so, the intrinsic value of the company grew very little over fifty years. In fact, investors would have been better off owning government bonds because the fifty year CROIC of GM was about 4%, and that’s about how quickly (er, slowly) the company grew its intrinsic value over time. During that time, government bonds earned about 6%. GM’s management would have served investors better had they taken the excess cash and simply invested it in government bonds.

The margin of safety serves the exact purpose you state: It helps protect us from wrong estimates of intrinsic value, to hopefully provide us with the “heads I win, tails I don’t lose much” situation.

]]> By: Collin http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3087 Collin Tue, 24 Nov 2009 23:44:21 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3087 Remember that investing is more of an art than science. You don't have to calculate till the fine details. Reason: margin of safety. Take for example you calculated a company to be worth 1B, it's selling for 500M. A margin of safety of 50%, so you bought it. Now Warren Buffett come and tell you that the company is value 700M. So what if your calculation is wrong off 30%? You would have 'earn' 200M. That's the reason for margin of safety. With a margin of safety, you can be way off calculation but still win. So for Keith, if you feel unsure, give your calculation a bigger margin of safety when determinating the purchase price. Remember that investing is more of an art than science. You don’t have to calculate till the fine details. Reason: margin of safety. Take for example you calculated a company to be worth 1B, it’s selling for 500M. A margin of safety of 50%, so you bought it. Now Warren Buffett come and tell you that the company is value 700M. So what if your calculation is wrong off 30%? You would have ‘earn’ 200M. That’s the reason for margin of safety. With a margin of safety, you can be way off calculation but still win.

So for Keith, if you feel unsure, give your calculation a bigger margin of safety when determinating the purchase price.

]]> By: Jack http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3085 Jack Wed, 18 Nov 2009 12:53:48 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3085 WOW! He explained Buffett's genius. Few could do that, even Buffett. I thought I had read everything having to do with how to value/pick a stock. This is a 5 star WOW for its clarity and concise explanation of how to value a business and its stock. I will not say that s serious investor should nto read other sources or seek other knowledge, but I do think you could take this 4 part series and be quite successful using it alone and make your fortune in the stock market, with some patience, and after accounting for the fact we do at times enter periods of abnormality where all the normal rules do not apply, and we have to think outside the box -- including this box -- which clearly happened this past fall to present. But, for the long term, this has to be one of the most risk free, high return formulas out there for stock picking. WOW!

He explained Buffett’s genius. Few could do that, even Buffett.

I thought I had read everything having to do with how to value/pick a stock. This is a 5 star WOW for its clarity and concise explanation of how to value a business and its stock. I will not say that s serious investor should nto read other sources or seek other knowledge, but I do think you could take this 4 part series and be quite successful using it alone and make your fortune in the stock market, with some patience, and after accounting for the fact we do at times enter periods of abnormality where all the normal rules do not apply, and we have to think outside the box — including this box — which clearly happened this past fall to present. But, for the long term, this has to be one of the most risk free, high return formulas out there for stock picking.

]]> By: Keith http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3084 Keith Wed, 18 Nov 2009 10:35:30 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3084 Hello Joe, Forgive me my manners. When valuing a business as if I were going to purchase the whole company. Do you look to the remaining shares and divide 20 yrs cashflow and equity from that number. Or do you look to the shares issued and outstanding. I am trying to determine that for the company Accenture, (ACN) it has 20 Billion shares authorized and 713M issured and outstanding for its voting shares. I am having a difficult time trying to determine which method is the correct one as using remaining shares will greatly affect the ending number that I can purchase at. Hello Joe,

Forgive me my manners.

When valuing a business as if I were going to purchase the whole company. Do you look to the remaining shares and divide 20 yrs cashflow and equity from that number. Or do you look to the shares issued and outstanding.

I am trying to determine that for the company Accenture, (ACN) it has 20 Billion shares authorized and 713M issured and outstanding for its voting shares. I am having a difficult time trying to determine which method is the correct one as using remaining shares will greatly affect the ending number that I can purchase at.

]]> By: dddkth http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3083 dddkth Tue, 17 Nov 2009 10:58:03 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3083 When valuing a business as if I were going to purchase the whole company. Do you look to the remaining shares and divide 20 yrs cashflow and equity from that number. Or do you look to the shares issued and outstanding. I am trying to determine that for the company Accenture, (ACN) it has 20 Billion shares authorized and 713M issured and outstanding for its voting shares. I am having a difficult time trying to determine which method is the correct one as using remaining shares will greatly affect the ending number that I can purchase at. When valuing a business as if I were going to purchase the whole company. Do you look to the remaining shares and divide 20 yrs cashflow and equity from that number. Or do you look to the shares issued and outstanding.

I am trying to determine that for the company Accenture, (ACN) it has 20 Billion shares authorized and 713M issured and outstanding for its voting shares. I am having a difficult time trying to determine which method is the correct one as using remaining shares will greatly affect the ending number that I can purchase at.

]]> By: Ian C. http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3081 Ian C. Sun, 15 Nov 2009 11:18:03 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3081 Hello Joe, and thanks for sharing your knowledge with us. I have a question about the evolution of the intrinsic value of a business, defined as equity discounted future cash flows. Specifically, I'm trying to understand which condition(s) must hold true to cause the intrinsic value to increase (or, at least, not to decrease), in for example, ten years from now. In ten years, I expect equity to have increased, assuming of course the company did good; however, it seems to me that discounted future cash flows, as counted starting from that point in time onwards, should be less than those computed starting from now, because cash flows for the elapsed ten years will not be available anymore, and because the day the company ends its activity is fixed (although we don't know when this will happen). If my reasoning is correct, then I cannot grasp what is the exact relationship between the increase in equity and the decrease in expected cash flows. Do they always cancel each other out so that intrinsic value does not change at all ? Does it depend on the percentage of owner earnings retained and reinvested (as any dividends distributed in these ten years will not be available to a future buyer) ? Does the return rate of this reinvestments matter ? The reason I'm trying to understand this is that, if the intrinsic value can decrease over time even if the company is well-run, then it seems to me that the margin of safety should incorporate protection from this possibility above and beyond protection for a wrong estimate of the intrinsic value. Hello Joe,

and thanks for sharing your knowledge with us.

I have a question about the evolution of the intrinsic value of a business, defined as equity discounted future cash flows. Specifically, I’m trying to understand which condition(s) must hold true to cause the intrinsic value to increase (or, at least, not to decrease), in for example, ten years from now.

In ten years, I expect equity to have increased, assuming of course the company did good; however, it seems to me that discounted future cash flows, as counted starting from that point in time onwards, should be less than those computed starting from now, because cash flows for the elapsed ten years will not be available anymore, and because the day the company ends its activity is fixed (although we don’t know when this will happen).

If my reasoning is correct, then I cannot grasp what is the exact relationship between the increase in equity and the decrease in expected cash flows. Do they always cancel each other out so that intrinsic value does not change at all ? Does it depend on the percentage of owner earnings retained and reinvested (as any dividends distributed in these ten years will not be available to a future buyer) ? Does the return rate of this reinvestments matter ?

The reason I’m trying to understand this is that, if the intrinsic value can decrease over time even if the company is well-run, then it seems to me that the margin of safety should incorporate protection from this possibility above and beyond protection for a wrong estimate of the intrinsic value.

]]> By: Joe Ponzio http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv/#comment-3017 Joe Ponzio Thu, 03 Sep 2009 15:54:09 +0000 http://www.fwallstreet.com/article/29-calculating-the-value-of-a-business-part-iv#comment-3017 Oliver, I use excel to help me organize the information, but fingers and toes work too! In all seriousness, there is no holy grail of spreadsheets or calculators out there. Oliver,

I use excel to help me organize the information, but fingers and toes work too!

In all seriousness, there is no holy grail of spreadsheets or calculators out there.

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