Category Archives: Valuation Techniques

Seth Klarman


…When men live by trade–with reason not force, as their final arbiter–it is the best product that wins, the best performance, the man of best judgment and high ability and the degree of a man’s productiveness is the degree of his reward.   (Atlas Shrugged)

Seth Klarman

Below are links to Seth Klarman’s investor letters and appearances.  I would try to study his philosophy, attitude, and approach to investing–see if you can integrate some of his approach to YOUR OWN methods.

New material from a reader (generous!) KLARMAN Response to Lowensteins Rational Investors found here:Graham Dodd Revisted by Lowenstein







Klarman 2013 Letter Excerpts



Yamana Valuation

Upon returning from vacation, I have put off updating my valuation of Yamana. When there are fish, you must fish.   I promise to have it posted by this weekend.   I do recommend anyone who wants to hear a good management team explain their strategy for managing assets to listen to Yamana’s second quarter’s conference call:

Yamana Gold Inc_ Q2 2014 MDA Final (SEDAR)_v001_t1ii3h

Yamana Gold Inc_Q2 2014

PresentationQ2 2014 – Conference Call Final

Asking a girl for her phone number

Whacked on W A C C (Wgt. Avg. Cost of Capital)


Whacked on WACC

A reader asked how Prof. Bruce Greenwald determined WACC.

You can use traditional finance techniques of applying Beta (see links below) but I prefer estimating what other investors would require to risk their equity capital in the particular business because you are forced to think about business, financial and management risks.  Don’t substitute models for your own thinking. 

I will quote Prof. Greenwald’s discussion of WACC in Value Investing, pages 95-98

After we have completed the first step in arriving at an EPV (earnings power value) which is to calculate distributable earnings (Think of after-tax owner earnings using true maintenance capex instead of depreciation) for the company. Now we need to determine the appropriate cost of capital to use in the equation of EPV = Adjusted earnings x 1/R, where R = WACC.

Professional finance calls for a calculation of the weighted average cost of capital, known affectionately as the WACC.

There are three steps:

  1. Establish the appropriate ratio between debt and equity financing for this firm.
  2. Estimate the interest cost that the firm will have to pay on its debt, after taxes, by comparing it with the interest costs paid by similar firms.
  3. Estimate the cost of equity. The approved academic method for this take involves using something called the capital asset pricing model (see link below), in which the crucial variable is the volatility of the share price of the firm in question relative to the volatility of the stock market as a whole, as represented by the S&P 500 . That measure is called beta, and as much as it is beloved by finance professors, it is viewed with skepticism by the value investors. (98) Value Investing (Greenwald).

CSInvesting: Why? Because price movement is not risk! Risk always has an adjective preceding it like business-risk, management-risk, financial risk, regulatory risk, etc.

An alternative approach is to begin with the definition of the cost of equity capital: what the firm must pay per dollar per year to induce equity investors voluntarily to provide funds. This definition makes determining the cost of equity equivalent to determining the cost of any other resource. The wage cost of labor, for example, is what employers must pay to attract that labor voluntarily. There is no need to be esoteric about how to calculate the cost of equity in practice. We could survey other fund raisers to learn what they feel they must pay to attract funds. Venture capitalist in the late 1990s told us that they believed they had to offer at least 18 percent to attract funding. Venture investments are clearly more risky than those in WD-40 (wdfc); it is understandable that potential investors would demand higher returns. Alternatively, we could estimate the total returns—dividend plus projected capital gains—that investors expect to obtain from companies with characteristics similar to WD-40.  This method, the details of which we avoid here, produces a cost of equity of around 10 percent. Because long-term equity yields are about 12 percent per year, and because WD has a much more stable earning history than the average equity investment, 10 percent meets the reasonability test.


I do not like the traditional financial approach that uses Beta or CAPM.  Beta is misleading, See Beta vs Margin of Safety_Mauboussin and Beta and Risk.

I prefer the Greenwald approach because it forces you to think about the business and financial risk of the particular company. Also, the CAPM that uses the lower cost of debt financing would lead you to a lower WACC if you had 99.9999% debt financing and .0001 equity financing. Obviously the financial risk would rise dramatically for equity holders.

Glenn Greenberg of Brave Warrior Capital uses a 15% rate of return.   If he can buy at a price which he feels will return 15% per year compounded, then he will buy.  So let’s say the market reprices upward the business where the stock price infers an 8% return in the future because the stock price rose due to positive expectations, and then he might sell and redeploy his capital–no wonder he has averaged 18% returns. The market reprices his stocks before his estimated time- frame.   The point is not to double discount. If you can buy a business at a price that implies your required return of 15 (in Glenn Greenberg’s case) then you would not try to wait for a 50% discount on top of that.

Joel Greenblatt in his special situation class in discussing American Express described WACC in terms of valuation this way: If I can buy Amex here at $45 I think it will be worth $60 in two years because pension funds will need to buy it to meet their 9% hurdle.  I am paraphrasing and I may be misquoting, but that is one way he approached valuation. I guess that is where the art form comes in. How would he know pension funds would use 9%? Experience?

I always stress fundamentals. Try to sit down with a Value-Line and go back over companies’ 12-year history and see what the implied WACCs were on the businesses over time. After going through 2,000 companies month after month, you will have a good feel for when to use 8% vs. 12%. But wait for the obvious fat pitch. If the investment is too close to call at 9% or 10% then pass.

Read more:Whacked on WACC

Compare to traditional finance:


Weighted Average Cost of Capital Article A short summary

Evaluating Debt and WACC Damoradan  More than you would ever want to know! :)

CAPM Damordaran

Choose what works for you!

Let’s Value Yamana (AUY)

big (1)


First, you have a try: Yamana BoAML Presentation_v001_r6047f


I will back with my valuation by the end of the week.   Why has AUY been lagging the GDX (an index of senior miners like GG, AEM, ABX) after outperforming in terms of stock price?



INFLATION  Note the ZIRP-induced distortion in the production structure.


Fed and Stocks



PKW is a buy-back ETF which only chooses companies that will buy back at least 5% of their shares per year.

Treasure Chest 

Lecture Links  Thanks to a generous contribution! Let me know what you learn.

Four Ways to Value the Stock Market; Shareholder Rape; Mal-investment Lunacy

Chick Magnet


 What is the Real Value of the Stock Market?  This:

Nominal Stocks

or this:

Stocks in gold


Four Ways to Value The Stock Market

Case Study in Management Rape of Shareholders

from: Bob Moriarty Archives   May 7, 2014

In 13 years running this website and visiting dozens of projects yearly I have run into every sort of charlatan, crack addict, drunk and all-round scam artists among the legions of fools who believe they can run a mining company successfully. In most cases, they have been lucky enough to collect absurd salaries long enough before the abused shareholders toss the bastards out.

Write these names down and keep them handy. If you ever see them associated with any company you are considering buying, prepare yourself to be raped. Ian Rozier, President of Newport Exploration, Barbara Dunfield, CFO of Newport and David Cohen, Director of Newport. What they pulled on Newport Exploration wasn’t just your typical screwing shareholders that we all expect on a regular basis, they raped Newport shareholders on a continuing basis.

I would describe Newport Exploration as pretty much a shell company. In November of 2010 they entered into a JV with another pretty much shell company named Reva Resources. This action can be considered one of the first examples of rape since two significant shareholders of Reva are directors of the Company. So in essence, directors of a shell company with enough cash in the bank to pay salaries to people for doing nearly nothing does a JV with another shell company that they just happen to own much of. If you are kind you can think of it as a sweetheart deal.

As a result of the unannounced press releases detailing the royalty payments, Newport shares were trading on the open market for $.04 a share while management knew that they had $.17 in cash at the end of October. In effect, company A paid themselves in company B shares worth four times as much in cash as in the open market because nobody reads quarterly reports from companies not doing anything. So the real issue is, was this a conflict of interest between the interests of management and the interests of shareholders and what exactly is a material disclosure? I think both questions are easy to answer.

Read more:

The Current State of Mania

Junk Bond Mania

Embracing Leverage Again


Mal-Investment Lunacy:

Outsider CEOs (Skilled Management vs. Shareholder Rape)

A Great blog: http://student of







Ecclesiastes tells us: “The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun.” Myrmikan Research applies this principle to the subject of credit bubbles.

The ancient Greeks discovered that debt could magnify wealth. The debtor feels richer from the use of the borrowed property, while the lender feels richer from the compounding interest yielded by his claim. Both indulge in consumption more freely. As long as the accumulating claims remain contingent, the bubble grows. But, eventually, someone asks to be paid, and the expandingclaims on wealth must be reconciled to tangible wealth, much of which has been consumed.

The first recorded credit bubble popped in 594 B.C. Athens. Threatened with a civil war of creditor versus debtor, the Athenian ruler Solon pulled down the mortgage stones to free the debtors and devalued the drachma by 27% to relieve the bankers. Every credit collapse since – from the Panic of A.D. 33 to John Law’s Mississippi Bubble to the Great Depression and many others besides – has followed Solon’s template of debt default and currency devaluation.

“The natural remedies, if the credit-sickness be far advanced, will always include a redistribution of wealth: the further it is postponed, the more violent it will be. Every collapse of a credit expansion is a bankruptcy, and the magnitude of the bankruptcy will be proportionate to the magnitude of the debt debauch. In bankruptcies, creditors must suffer.” – Freeman Tilden, 1936

And against what is currency and debt devalued? Carl Menger, founder of the Austrian School of economics, was the first to explain that money is liquidity and that gold is the most liquid asset. Thus, gold has served as the reference point of value since the origins of money and is that against which currency must be devalued to relieve debts. Paper promises depreciate.

“The faith is lost. All with one impulse people rush to seize the gold itself as the only reality left—not only people as individuals; banks, also, and the great banking systems and governments do it, in competition with people. This is the financial crisis.”
– Garet Garrett, 1932

Myrmikan Research chronicles the collapse of the current, global credit bubble – the largest and broadest in history – analyzing current events from the perspective of Austrian economics and placing them in historical context.  Many links to books:

A Value Investor/Analyst,  Click on Samples link on the left and read examples of company research. If you want to be a professional analyst, his research sets a high standard.  Note the format: Thesis stated right up front. He eats his own cooking too.


Gavin Andresen, Chief Scientist of the Bitcoin Foundation, talks with EconTalk host Russ Roberts about where Bitcoin has been and where it might be headed in the future. Topics discussed include competing cryptocurrencies such as Dogecoin, the role of the Bitcoin Foundation, the challenges Bitcoin faces going forward, and the mystery of Satoshi Nakamoto.



Question on ROE vs. ROCE; Comprehensive Look at EBITDA

EBITDA and an interesting look at margins here:

Respecting the Reality of Change

The following chart shows CPATAX divided by GDP from 1947 to present.  The black line represents the average from 1947 to 2002, and the green line represents the average from 2003 to 2013.


As you can see in the chart, CPATAX/GDP is wildly elevated at present.  It currently sits 63.3% above its average from 1947 to 2013, and a whopping 75.0% above its average from 1947 to 2002.

As readers of this blog have probably inferred by now, I’m not very patient when it comes to waiting for “mean-reversion” to occur.  In my view, when a variable deviates for long periods of time from a reversion pattern that it has exhibited in the past, the right response is to expect something important to have changed–possibly for the long haul, such that a predictable reversion to prior averages will no longer be readily in the cards.  The task would then be to find out what that something is, and try to understand it. Go here:   (Interesting blog)

Reader Question:

Can you help me understand one aspect of ROE? In Indian companies, some of the companies have ROE < ROCE.

Isn’t that a violation of the observation that ROE ~ ROCE times Leverage.

I define ROCE as Return on Capital Employed.

ROCE = EBITDA (1-Tax Rate)/Total Capital Employed (=Debt+Equity)

I use ROCE as a measure of the attractiveness of the industry and the company. High ROCE is good, implying a moat, low ROCE is not.

Some of the reasons I could think of are:

  1.  Exceptional losses, which lead to Net Income << EBIT(1-Tax) *Leverage
  2.  Extremely high interest charges. ( higher than return on the        debt portion) which leads Net Income << EBIT(1-Tax)* Leverage
  3.  There is a slump sale of a division, and thus suddenly huge            amount of profit has come in increasing inordinately the            average shareholder equity. So suddenly the effective leverage        has dropped.

Update May 1: 

I made a mistake in describing ROCE.  In my defense, I dont exactly calculate ROCE and merely use the numbers from screens.
ROCE = EBIT(1-Tax Rate)/ Total Assets and not EBITDA as mentioned before.

Does someone want to have a crack at this? I see issues whenever you use EBITDA without understanding maintenance capex. Please read this: Placing EBITDA into Perspective

More on WMT: A reader posted this in the comment section:    Does that article even touch upon the ture nature of WMT’s competitive advantage?  No wonder the obvious is overlooked.

Wal-Mart Case Study Part 3


Part 3:Valuation of WMT,

Part 2: and

Part 1:

Stock Splits

Wal-Mart Stores, Inc. was incorporated on Oct. 31, 1969. On Oct. 1, 1970, Walmart offered 300,000 shares of its common stock to the public at a price of $16.50 per share. Since that time, we have had 11 two-for-one (2:1) stock splits. On a purchase of 100 shares at $16.50 per share on our first offering, the number of shares has grown as follows:

2:1 Stock Splits Shares Cost per Share Market Price on Split Date Record Date Distributed
On the Offering 100 $16.50
May 1971 200 $8.25 $47.00 5/19/71 6/11/71
March 1972 400 $4.125 $47.50 3/22/72 4/5/72
August 1975 800 $2.0625 $23.00 8/19/75 8/22/75
Nov. 1980 1,600 $1.03125 $50.00 11/25/80 12/16/80
June 1982 3,200 $0.515625 $49.875 6/21/82 7/9/82
June 1983 6,400 $0.257813 $81.625 6/20/83 7/8/83
Sept. 1985 12,800 $0.128906 $49.75 9/3/85 10/4/85
June 1987 25,600 $0.064453 $66.625 6/19/87 7/10/87
June 1990 51,200 $0.032227 $62.50 6/15/90 7/6/90
Feb. 1993 102,400 $0.016113 $63.625 2/2/93 2/25/93
March 1999 204,800 $0.008057 $89.75 3/19/99 4/19/99

So the price on August 1974 when a 2 for 1 stock split occurred was $23.

What price would I have paid? I would see 38% ROE with little debt ($10.5 mil.) with 40%+ growth. If I paid 4 times the book value of approx. $31 mil. Plus the debt of $10.5 million ( I would not subtract the cash since I assume it is all needed as working capital) or $124 mil. plus $10.5 mil. or $135 million. Divide by $6.542 mil. shares or $20.63 per share or $21 to round up. $23 to $25 was near the highs for 1975 in the fourth quarter but the price was below $20 in the first quarter of 1975. Could I have bought right after the largest decline in stock market history after the Great Depression and with inflation raging? If I knew the value and rarity of an emerging franchise perhaps. But I doubt it.

I would have paid 4 times book value (better is replacement value but this is back of envelope investing) to garner a 9% return but the long term growth of 5% to 6% would give me my required 15% return. Obviously, if I had paid double, that would have been fine.

The key is in recognizing the source of WMT’s competitive advantage and how large the market opportunity to exploit that advantage. The secret is on page 10 of the 1974 WMT annual report 1974-annual-report-for-walmart-stores-inc and on page 11 here: WAL-MART CASE STUDY on Discount Operations 1986 (email if that link is taken down) and ask for the case study.

Note that you would have had to hold on through thick and thin without selling on numerous “market” scares, crashes and fears.  You have the key to becoming rich in investing but now you know why investing is SIMPLE BUT NOT EASY!

If you have questions post them on this blog do NOT email them to me. Thanks.

Hannibal Lecter Analyzes Wal-Mart (Part 2)

Social Networking

The prior post asked you to guess the name and price that you would pay for this case study: (Part 1)

It is WALMART  Annual:1974-annual-report-for-walmart-stores-inc. If you had paid the HIGHEST possible market price in 1974 or the first quarter of 1975 (after reading this annual report),  you would have about 1, 300 times your money over 40 years not including annual dividends which today stand at about 31 times what you paid in the market (WMT 2014) through and despite wars, high inflation, double-digit interest rates, civil unrest, political changes and a mundane, extremely competitive industry, AND WMT’s stock price “UNDER-performing” the general stock market one-third of the time. See Wal-Mart 50 Year Chart_SRC.

Eat your heart out Buffett, Munger, Peter Lynch, and all other investing pantheons. The point is you would have made a lifetime fortune sitting on your hands for more than a third of a century. WMT is the pinnacle of an investment–a relentless compounding machine.  Buffett said the goal of an investor is to put together a portfolio of compounding machines.

Well, Wal-Mart was the king of compounders; a company that could generate high returns on capital AND reinvest those high returns into similar high returns.  As many of you know, it is easy to spot a company with high ROIC or ROE but how do you know if the company can grow and reinvest those high returns at the same high rates? If not, then that company should return the excess capital which it can’t reinvest to you through dividends or appropriate (below intrinsic value) stock buy-backs.

You could have paid any price in 1974, 1975, 1976, 1977, 1978, 1979 and generated over-15% annual returns.  How would you know that WMT would keep growing with such high returns? What could you have KNOWN? What can we use for tomorrow’s investments?

AT Hindsight Capital (my firm) we always pick the Wal-Marts.

Joking aside, what is the point of this case study and what are the lessons we can use?  Let’s be realistic, we may never find another “Wal-Mart” but at least we can study “perfection” or the best to grasp what principles to look for in a company and an investment. You could do worse than spend weeks or months studying the history of Wal-Mart. Start here and go to here: WalMart_AR. And read: Sam-Walton-Made-America.

What’s the point of viewing one of THE best?

Hockey Player

NY Giants Lawrence Taylor on the loose:

Playing the Piano:

You gotta at least see and hear excellence to know it.

Let’s get back to Wal-Mart. What is the essence–the key–to its ability to grow profitably for so long? What can you spot in the 1974 annual report that would have alerted you to its competitive advantage? In other words, follow Hannibal Lecter’s tutelage when analzing any investment: What is its nature?

Here are two hints:

Sam Walton‘s passions included flying his own plane over the American countryside, hunting with his dogs, and sharing his good fortune with his family. But Walton will always be best remembered for his lifelong passion for providing low prices and good service to customers at Wal-Mart, his chain of discount stores that revolutionized the retail industry.

Walton did not invent the discount store when he opened his first store in 1962. But he did do something new. Wal-Mart introduced the concept of selling a large number of items at cheap prices to residents of rural towns—customers other discount retailers ignored. From that base, Walton expanded Wal-Mart across the United States and eventually reached into foreign markets, using the latest technology to keep costs low.

“I think I overcame every single one of my shortcomings by the sheer passion I brought to my work.… If you love your work, you’ll be out there every day trying to do it the best you possibly can.” Read more: Walton

The second hint is that you will not see the financial results of WMT’s competitive advantage in its GROSS margins but in its NET margins. WHY?

The answer to my questions can be found in Competition Demystified (Chapter 5) but don’t cheat yourself. Think it through. In fact, if YOU wanted to get a job at hedge fund, investment firm or even work for a major service firm, you could do a comprehensive study of Wal-Mart’s rise and semi-fall of its competitive advantage and then find a new company or industry (Auto-parts?) where the same factors are at work.  Show what you can do while providing a study of value.  You will stand out from all the Harvard and Columbia MBAs.

I will post in Part 3: Analysis on WMT next week. Meanwhile focus on what is important.

How Markets Work (Trading Places)


Paying for Growth? Case Study


What Price for the whole business would YOU pay? Then tell me the per share price.  The company had operations for 25 years prior to going public. The company’s stock price will under perform the market (SPY) about 1/3 of the time over the next forty years.


BUSINESS XXX? 1974 1973 1972 1971 1970
Cash $2,238,263 $2,168,224
Working capital 27,132,580 16,796,897
LT Debt ** 10,578,269 5,065,567
Shareholders’ Equity 30,734,128 $24,753,623
Outstanding Shares 6,542,250 6,512,950
Net Sales $167,560,892 $124,889,141 78,014,164 44,286,012 30,862,659
Income Bef. Taxes 11,883,754 8,917,188 5,569,027 3,170,599 2,198,764
Pro-forma Net Income $6,158,520 4,591,469 2,907,354 1,651,599 1,187,764
EPS $0.93 $0.70 $0.47 $0.30 $0.23
Units in operation 78 64 51 38 32
ROE 38.67% 36.02%
** Co. has a $12 mil. Credit line renewed yearly of which it has borrowed $4 mil.
Assume Co. needs all cash for operations
Assume strong growth for 40 years.You need a required rate of return of 15%

XXX Company Worksheet (Excel Spreadsheet)

Can you guess the actual name of the company?

To give you some historical perspective of 1974 see:A Study of Market History through Graham Babson Buffett and Others

Winner gets a date with my Ex:  (PLEASE do NOT click on the link unless you win the prize)