Buffett said that he likes to thumb though Moody’s Manuals and Value-Lines without looking at the price of the company.
You are sitting today in the library worried about central banks running their printing presses while flipping through your Value-Line when you see this
A company with $5.50 in after-tax free cash-flow. Sales and cash flows have grown about 9% over the past 10 years and are estimated to continue growing 6% over the next few years. Debt is 15% of total capital. Ret. On total capital has averaged 14.5% over the past ten years; return on equity has been 15% on average. R&D is 16.5% of sales (above average for its industry). Dividend yield is 4.4% and 42% of net profits. This company is considered one of the strongest in its industry and one of the top companies in the world–well-diversified internationally by geography and product type.
What would you pay per share ball park for this business? Take no more than 33 seconds.
What would I pay or what is the company worth?
Company is probably worth in the $90-$100 range
I would buy at 15-20% discount to that price.
Well……you will be happy to see where the actual company is trading!
Here’s my SWAG…
(1) If after tax cash-flow is $5.50 per share, EBITDA-MCX might be about $5.50 / .6 = $9.17
(2) Ideally I’d like to pay an EV no greater than 6x EBITDA-MCX, so target EV purchase price is 6 x $9.17 = $55 per share
(3) But debt is 15% of EV (assuming no minority interest, preferred shares, excess cash, etc.) so target price for equity is 0.85 x $55 = $46.75.
My best, for 33 seconds…
You are a tough, cheapskate. But, who knows? You may get your price if and when Europe dissolves into the sea.
I showed your response to my wife and she confirmed that in her experience I am, indeed, a cheapskate.
For what it’s worth, if you grab the TTM (instead of 2010) FCF from Morningstar and the latest common shares outstanding from the mystery company’s investor relations site, FCF/share has changed from $5.50 to about $5.00.
So if the Berkowitz 10x FCF target price is indeed an attractive entry point, it’s moved from $55 to $50.
The problem with using a multiple (“slapping” a multiple on it) is if you do not adjust for the quality of the business which impacts your discount rate, of course. A 10xs multiple on $5.50 in FCF from NVS is different in risk (a change or decline) than from US Steel (X).
I went Dutch on my honeymoon and it cost me tremendously.
Good advice. My modus operandi is to low-ball because while I know I’d pay 4x for a pure commodity business and 14x for a Coke-style franchise, most companies are somewhere in between so I have no idea of knowing exactly what I should pay.
My math side wants something quantitative to base my multiple on, but I know it’s not beta. I’m also not convinced that franchise-ness can be reliably gauged by examining high ROA / ROE / ROC / profit margin. It’s all looking in the rearview mirror anyway.
I suspect you’ll tell me to read Competition Demystified again. It’s on my Christmas wish list…
John, you are such a tease! I took a little longer, because I wanted to cross-check a few things.
If I were Bruce Berkowitz, I’d want to pay only 10X free cash flow. So that’s $55. I’m not going to adjust for all the other stuff like debt load, other than to say that the company looks pretty good.
I believe 15X FCF would be more reasonable – I think 10X would be stretching it. This would give a price of $82.50.
The reason I took a laittle longer, is that I checked out what was being paid for Diageo, Reckitt Benckiser, and Unilever. These companies were on 20X FCF, and it wouldn’t surprise me to find that the company you have in mind is on that valution. So, about $110.
Ooo, now the eager anticipation to see how close we all are.
Just so that I don’t give myself any wriggle room, I’ll say that my “final answer” is $82.50. But I think the share price is likely to be higher.
I think that is a fair price, but the market disagrees with you. See next post.
I was too late to reply. I was going to say min 10x P/FCF i.e $55. I would want to make sure that on an enterprise value basis, the multiple does not exceed 12x i.e EV/FCF.
For 15% RoE i wouldnt pay more than 12 times FCF
How do you get to $5.50/shr. in FCF from the Value Line data?
Why do you (many people) treat 10x FCF as their minimum hurdle rate? (yes Berkowitz uses this number but I want to see some thought behind it)
When using a FCF multiple, why do some people back out the debt, while others choose to ignore it?
Take the “cash-Flow” from 2011 ($6.50) then subtract all capex ($0.95 or keep it simple $1.00) so $5.50 thereabouts.
Go here for a detailed analysis on reading a Value-Line: http://www3.valueline.com/pdf/The_In-Depth_Guide_to_Reading_a_Value_Line_Research_Report.pdf
I think you should NOT slap a multiple on cash flows. Use YOUR discount rate instead. A multiple is just a discount rate in drag.
Always include net debt in your analysis so you think about what it would cost to buy the entire business–use total enterprise value (TEV). If you buy a house for 20% down, you still owe the debt of 80%.
Hope that helps.
Thanks John – I would still like to hear from others use FCF multiples in practice.
What price would you pay, John and how did you derive that number? Thanks!
I have owned NVS on and off over the past 3 years. I currently own NVS around $53 or so. I have sold some shares scale up above $65 since I buy scale down and up due to my weak psychology. I would pay more since with about 10% Free cash flow yield with 40% of that being paid out to me I get any growth for free (added to may total return). So if NVS grows at 4% to 6% my return could be 14% to 15% per year over the next few years. I have a higher degree of confidence given the company’s returns on capital and reinvestment that growth will be profitable and continue (good drug pipeline).
Now that said, if I spent 24 hours a day every day for the next five years, I don’t think I would have an edge in understanding NVS and its products. I am going by its historical record and belief in its economies of scale in R&D and distribution that it can maintain its returns. I allow for being wrong by not having more than 5% or so in this position.
If you go back to the series of lectures from a GREAT INVESTOR on this blog, you will have an idea of the philosophy behind this type of investing.
Oh, and one more thing….purchases can be effected by what is sold, taxes, and current & future opportunities. That is why I think investing has to be done by YOU and what you feel comfortable doing. I have learned to deal with my ignorance and what I can’t hope to know.
Hi, currently the firm has an ROE of 15% and a reinvestment rate of around 60%. This translates into the current sustainable growth rate of 9% over the last decade as indicated
Now as stated the sustainable growth rate will be 6%. This means either the return on equity will reduce to 10%, or the reinvestment rate will fall to 40%.
Either way this is like a bond with a coupon rate of 6%.
Therefore the only way this can make 20% plus returns is to sell at 0.88 or below if the total return is 1.06
Please let me know if this response is of any value?
P.S. took nearly 3 mins 33 secs
Could not fit the other data points into model
Thanks. LEt me take a look and get back to you………..I am loading Santa’s sleigh for the Big Day on Sunday.