1. it is instrumental to the operations of the business (i.e., the building can’t be sold and operations moved to another location), in which case you wouldn’t calculate that value separately, or
2. it is an “extra” asset, like excess cash, that you would value separately and consider in your purchase price as money you could get back when the building is sold.

Make sense?

I was wondering, if when analyzing a small privately held business, you would consider not using a margin of safety for say a building that you were sure of the market value if sold? Would it be wise just to discount the future projected free cash flows from operations and using a margin of safety on that value and just adding the value of a building that you were sure of the market value to that? I see normally you use a margin of safety on the shareholder equity of a public company also. Why would you need a margin of safety on something if you were sure of the value when sold?

Thank you Joe and have a Merry Christmas!

That is the entire idea – buy companies for less that their actual value. For us, that means buying underpriced stocks. In the merger and acquisition world, that means making $50 acquisitions for $30.

If you get to the point where you’re buying entire companies, your valuation methods and approach will be the same. Find a $1.00 business, buy it for $0.50 to $0.75.

I was looking at FDC -company with great cash flows (median of 14%) – if I use the FCF model, then value is $ 52 per share; FDC is recently being acquired by KKR at $34 -am I missing something? how could there be so much of a variance?

Regards

Sridhar

I started looking into HOG yesterday but got sidetracked. I’ll finish this weekend and get back to you on Monday or Tuesday.

Sridhar,

There are two ways to go about valuing a business: the no-brainer way and the dig-deeper way. If you don’t want to be an analyst and dig deeper into companies like Wal-Mart, you don’t have to. You’ll have less investment choices by eliminating the “Wal-Marts”, but you’ll still uncover great companies. On the other hand, you can choose to turn over more rocks and dig into more companies…and find more opportunities. There are so many companies out there that you don’t have to feel bad about missing some and sticking your money in the clear winners.

As far as standard deviation, I think that would make your focus too narrow. In business, anything can happen in one or two years. Revisit Calculating The Value Of A Business – Part IV and you’ll see Coca-Cola’s consistency vs. Campbell’s inconsistency. At one point, Coca-Cola’s owner earnings dropped 2%, then soared 68% the following year. That would have thrown off a standard deviation and perhaps portrayed Coca-Cola as a “risky” venture.

In the end, however, the narrowest moat companies with the craziest cash flows would definitely require a gigantic MOS. But, do you really need/want to invest in those? (Maybe, just asking) Just because a stock can be valued and bought at a substantial discount doesn’t mean it should.

My two cents – and thanks for coming back every day!

A couple of questions

a) one of the biggest challenges, I see in using free cash flows is the complexity in being able to segregate capital expenditure into core capital expenditure that is used for maintenance and the ‘growth’ capital expenditure ie actually owners’ earnings used to fund growth . Your WalMart example is a classic case-if one went just by the free cash flow as indicated by the finance websites, we would dismiss Walmart as not an attractive buy as the CAGR of free cash flow has over the last 10 years has been flat

b) while using a median across various time frames does address fluctuations, do you think that we should look at the standard deviation of cash flows over the 10 year period and build a margin of safety based on the volatility (also factoring in the economic moat) e.g a narrow moat company with a high volatility in free cash flows (we need to define ‘high’) would require the highest MOS and vice versa

Your blog is becoming a daily read-the content keeps getting better

Cheers

Sridhar

I’ve been using your spreadsheet with a few companies to try and get a feel for how it works. For HOG, for instance, I get a per share value of $91.28. The median growth in FCF, however, was a hefty 16.1%.

While continued growth for the next ten years at that rate is possible, of course, in my judgment (best guesstimate based on my research, really, I’m no pro) it seems likely that the growth of HOG may be slowing.

I’m sure there is no pat answer for my question, but I’m interested to hear your thoughts. I would like to lower my estimation of the growth of FCF for HOG over the next 10 years, to build in a more comfortable margin of safety, but I don’t know what factors to consider to come to an appropriate estimation. I’ve plugged in various percentages to see how that affects the per share value, but I don’t know how to evaluate which one I should use.

Any guidelines here, or do I just go with my gut?

By the way, you are right on with your comments on 401(k) plans. I love the idea of 401(k) plans, but I’m not thrilled with my investment selection. I tried to push for a self-directed option a couple of years ago, but that never went anywhere. In fact, everyone thought I was crazy for even wanting to try and pick my own investments. My 401(k) is flat for the year. It generally underperforms the market, but follows it up and down. My personal investment account with Scottrade shows an IRR of almost 30% YTD (tracked through Quicken). I’m absolutely convinced that I will not do that well for an extended period of time. But I’m also pretty convinced I can do better than my 401(k) mutual fund choices. I’m thinking about changing employment in the next year, though, so I will probably roll the 401(k) into self-directed IRA if possible.

Your site is great for providing information that any intelligent and interested person can apply to their personal investing education. Keep it up!

Justin