Category Archives: Valuation Techniques

Hedge Fund Quiz: Economies of Scale

Economies of scale.

If costs per unit decline as volume increases, because fixed costs make up a large share of total costs, then even with the same basic technology, an incumbent firm operating at large scale will enjoy lower costs than its competitors.

Edison Schools IPO’d at $18 per share and now it trades near $14.   Your boss runs in and throws the Edison School’s 2001 annual report on your desk and a top-rated analyst’s report on Edison.   “Get back to me in thirty minutes on what should we do: Buy a boat-load of stock, buy some, buy a little, short or stand aside?”  Your Boss says that management owns a lot of stock along with “smart” money.

You glance at the analyst report:

Greg Capelli, MBA, at Credit Suisse First Boston issued a $30 dollar price target in his fifty-page report.   Capelli says that Edison Schools is extremely undervalued because of “first-mover advantage” and “INCREASING OPERATING LEVERAGE THROUGH ECONOMIES OF SCALE.”

As a refresher you whip out Greenwald’s Competition Demystified:

LOCAL CHAMPIONS

In an increasingly global environment, with lower trade barriers, cheaper transportation, faster flow of information, and relentless competition from both established rivals and newly liberalized economies, it might appear that competitive advantages and barriers to entry will diminish. The fate of once powerful American firms in industries like machine tools (Cincinnati), textiles (Burlington Industries, J. P. Stevens), and even automobiles (Chrysler, GM, and Ford) seems to support this position. Either profits have shrunk or companies have disappeared entirely under the onslaught of imports. But this macro view misses  one essential feature of competitive advantages—that competitive advantages are almost always grounded in what are essentially “local” circumstances.

Consider the history of Wal-Mart, one of the greatest economic success stories of the late twentieth century. The retail business, especially discount retailing, is not an industry with many trade secrets or rare skills. The practices for which Wal-Mart is known, like “everyday low prices” and efficient distribution, are hardly proprietary technologies, impossible for other firms to duplicate. Yet Wal-Mart has successfully dominated many, although not all, of the markets in which it competes. The way in which it achieved this position is instructive.

Wal-Mart began as a small and regionally focused discounter in a part of the country where it had little competition. It expanded incrementally outward from this geographic base, adding new stores and distribution centers at the periphery of its existing territory. The market that it dominated and in which it first enjoyed competitive advantages was not discount retailing in the United States, but discount retailing within a clearly circumscribed region. As it pushed the boundaries of this region outward, it consolidated its position in the newly entered territory before continuing its expansion. As we shall see, when it moved too far beyond its base, its results deteriorated.

An Analyst ALWAYS ASKS:

OK, now you dig in quickly to the Edison Schools AR_2001

What do you say to your boss?  Your comments should be no more than a sentence or two of explanation backed up by a few simple calculations.   Besides the financials, what do you point out in the annual report?   Take no more than twenty minutes.   You go immediately to the important data and disregard the rest.

Address Capelli’s “First Mover Advantage” comment.

Next week, I will post analysis.

AFTER you have answered, you can see the future for investors in Edison:  https://youtu.be/QUYKSWQmkrg

UPDATE 4/17/2017

ETF Insanity is destroying price discovery–opportunity will return.

https://vimeo.com/209940152/f2154e4d3d

An Example of the Analyst Course

It is 2006, and you want to know the true sustainable free cash flow of Mohawk because you love sleepy, mundane industries that are slowly growing. Why? Because people love to buy lottery tickets and glamour so you “go where they ain’t.”

So what is the difference between Mohawk’s GAAP earnings per share and your estimate of FREE CASH FLOW per share?    Use cash flow from operations and maintenance capex (which you need to roughly estimate). Be roughly right, not precisely wrong.

Can you explain the difference?   What is going on with Mohawk and the industry?   Note the ten-bagger or 25% CAGR for almost ten years (move over Buffett) from the 2009 lows.  Surprising or not?    MHK-2006 AR FCF Analysis.   Can you use this as a way to find other ten-baggers?

Of course, the above question is not hard for you since you have already read this 412 page book several times: Wiley Creative Cash Flow Reporting.  You do not have needed to read that book to answer the question. Use common sense and a small bit of accounting knowledge like (amortization of goodwill-hint!)

This an example of how the analyst course would teach. You have to do many case studies to practice learning concepts like free cash flow.  Like flying and sex, you have to practice.

Update: April 11, 2017: The price you pay

If you pay too much even for a great business, then you will have poor returns.

Take the three Value-Lines of Coke (KO).   VL KO and note the $80 + plus price, then track its free cash flow (as calculated by Value-Line which is After-tax earnings plus depreciation + amortization then minus capital expenditures), then earnings.   Track the price and those metrics: KO_VL_Jan 2013 and Ko_VL 2017.   You will see that on average cash flows and earnings and dividends rise from 1998 until 2017, yet returns have been just OK.   Paying too high a price hurts your total returns even with a strong, stable business like Coke. Investors were extremely optimistic over Coke’s growth prospects.  If you held Coke for a long time, your return would equal the company’s long-term return on equity.

Also, Buffett’s non-controlled public investments have generally lagged the S&P 500 Berkshire Hathaway AR 2016.

Good luck.    Those who do not provide the correct answer will have to spend time with my ex-wife:

Fundamentals vs. Technicals, Templeton, Ackman, Analysis of Valeant

Fundamental vs. Technical Analysis

https://monetary-metals.com/technical-vs-fundamental-report-19-mar-2017/

Technical analysis, in all of its forms, uses the past price movements to predict the future price movements. In some cases (e.g. momentum analysis) it calculates an intermediate signal from the price signal (momentum is the first derivative of price). But no matter the style, one analyzes price history to guess the next price move.

This is necessarily probabilistic. There is no way to know that a particular price move will follow the chart pattern you see on the screen. There is no certainty. And when it does work, it is often because of self-fulfilling expectations. Since all traders have access to the same charts, and the same chart-reading theories, they can buy or sell en masse when the chart signals them to do so.

Fundamentals or Arbitrage:

Arbitrage works just like a spring. If the price in the futures market is greater than the price in the spot market, then there is a profit to carry gold—to buy metal in the spot market and sell a futures contract. If the price of spot is higher, then the profit is to be made by decarrying—to sell metal and buy a future.

There are two keys to understanding this. One, when leveraged speculators push up the price of gold futures contracts, then that increases the basis spread. A greater basis is a greater incentive to the arbitrageur to take the trade. Two, when the arbitrageur buys spot and sells a future, the very act of putting on this trade compresses the spread.

If someone were to come along and sell enough futures contracts to push down the price of gold by $50 or $150 or whatever amount is alleged, then this selling would be on futures only. It would push the price of futures below the price of spot, a condition called backwardation.

Backwardation just has not happened at the times when the stories of the big “smash downs” have claimed. Monetary Metals has published intraday basis charts during these events many times.

The above does not describe technical analysis. It describes physics—how the market functions at a mechanical level.

There are other ways to check this. If there was a large naked short position in a contract that was headed into expiry, how would the basis behave? The arbitrage theory predicts the opposite basis move. We will leave the answer out as an exercise for the interested reader, as thinking this through is really good work to understand the dynamics of the gold and silver markets (and you can Google our past articles, where we discuss it).

This check can be observed every month, as either gold or silver has a contract expiring (right now it’s gold, as the April contract is close to First Notice Day).

Templeton

Ackman and Valeant

Ackman and his disasterous investment in Valeant The are many psychological lessons in this article.  What can you learn?

Ironically, one of the best research on Valeant was done by Allergan: Allergan analysis of Valeant 2014.   Did Ackman’s analysts even read it?   At least you have an example of solid research.

Compare to Ira-Sohn-2015-Presentation on Valeant and Other Platform Companies   Studying the two different presentations provides a FREE course on valuation and presenting a research idea.  But not 1 person in 10,000 would be willing to sweat the details like studying the two documents linked above.

Oh well, opportunity for those who work.

A Reader’s Question on DCF


 

 

 

QUESTION:  So the intrinsic value of a company is the present value of all future cash flows?

Now everyone has a different required rate of return or discount rate, so does that mean one person’s intrinsic value of a business will be different from another person (not because of different estimates of future cash flows but because of discount rate)?

CSInvesting: Yes, a pension fund may be fine with a discount rate of 8.5% but you require 15%.

I just want to confirm what it means when in articles, famous investors talk about their investments and they would say for example that they found a business which they think is worth $50 but was trading at $15. Is their estimate of $50 the value they came up with after using their own discount rate, or is it more a comparable analysis of using a discount rate of the industry norm and that’s the value that they come up with.

I don’t know what discount rate they are using, but when you see a company trading at $15 and you think it is worth, then probably your valuation is off.   Markets are not ALWAYS inefficient, but they are usually not GROSSLY inefficient.  Say, you value a miner based on today’s gold price of $1,200 and it trades at triple the price in two years but the gold price trades at $1,600 (US) then a speculative element changed your valuation.

 

I ask because some say they will buy only if there is a 50% discount to their intrinsic value and would sell around 90-100% of their intrinsic value.  But say for example that you used a discount rate of 20% to get your intrinsic value and it so happens to be selling at 50% discount and you bought it.  Even if price reached 100% of such intrinsic value, basically what that means is going forward for that price, you will be getting 20% returns for holding that investment, which to me is an excellent investment and would hold on and not sell (assuming that the cashflow is certain for the example).

 

I think you are double counting.   You use 20% discount rate when usually the cost of equity capital is 7% to 11% AND it trades at a 50% discount, then your valuation is probably in fantasy land.

Some go to Prof. Damodaran’s Industry Cost of Capital Spreadsheet

 

http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/wacc.htm  But I wouldn’t use it other than to see what most analysts use.
REMEMBER the iron law of CSInvesting.  If you know or do something that everyone else does in the market, then it is probably useless.

DANGER with USING DCFs

STANDARD THINKING

Better:

Chapter 8 Cost-of-Equity-Capital Credit Model by Hackel 

The analysis of risk represents the single most underexplored factor in security research and the primary reason for investor disappointment in their investment returns.

The cost of equity capital, while known as a measure of investors’ attitudes toward risk, more aptly should represent the uncertainty to the cash flows investors can expect to receive from their investment in the security being considered.  Only through n accurate and reliable cost of equity capital can fair value be established as well as the determination of whether management is creating value for shareholders, as measured by the return on invested capital (ROIC) in comparison with its cost.

Because security analysts are not confronted with the daily barrage of problems and hazards that managers and executives working directly for the entity face a wide swath of hidden risks that tends to be ignored or not calibrated properly. Investors need to think and behave like corporate insiders to truly appreciate this multitude of exposures so as to accurately place a cost of capital that takes into account these uncertainties, of which any one could damper cash flows or even threaten the entity’s survival.  On the other hand, if investors were to overweigh such risks, the entity’s valuation multiple would depress, causing misevaluation.

Say the standard tech company has a cost of capital of 9%.  Well, Apple’s might have a lower, 7.6% cost of equity capital, because of the lower operational risk of its business as noted by the cost of its credit.

Use a credit model for the cost of equity capital –See ch. 8: Security Valuation and Risk Analysis by Kenneth Hackel. (in Value Vault)

At least you are garnering a different perspective.    Good questions.

Case Studies on Buffett’s Investing: NYU Course This April

 The Fundamentals of Buffett-Style Investing

Learn the investment techniques of Warren Buffett, the world’s most legendary investor. Examine case studies of Buffett’s acquisitions in order to review the real-world principles that the “Oracle of Omaha” uses to pick companies. Topics include both quantitative methods, such as valuation metrics and cash flow analysis, as well as qualitative principles, such as competitive advantage and economic moats. As a final project, partner with a classmate to present a publicly traded company you believe Buffett would buy. At the conclusion, understand what Buffett means by a “great business at a good price.” This course is appropriate for beginners in the industry and for individuals with a broad array of backgrounds. The final session is taught synchronously from the Berkshire Hathaway annual meeting in Omaha.

More details

You’ll Walk Away with

  • An understanding of the investment techniques of Warren Buffett, the world’s most legendary investor
  • The opportunity to present a publicly traded company you believe Warren Buffett would buy

Ideal for

  • Students with little to no knowledge of investing
  • Professionals across the experience spectrum in regard to investing

READ:

CSInvesting Editor: Let me know if you attend.  Several readers took the class last year and enjoyed it.

I received this email:

Dear Mr. Chew,

You were very kind last year to post a notice about our Buffett investing class on your website.  We had several students from your site, all of whom were excellent and dedicated. According to end-of-semester student surveys, the students enjoyed the class quite a bit. You clearly attract a high caliber of investor to your online community. We would be very grateful if you would consider posting a notice of this year’s class, which starts April 1st.
See below:
New York University’s School of Professional Studies is offering an online class focused on the time-honored techniques of value investing, as practiced by the world’s most legendary investor, Warren Buffett.
By examining case studies of Buffett’s acquisitions, students will explore the real-world principles that Buffett uses to pick companies. The class starts online April 1st and is open to the public for registration.
CONTACT INFO:

The instructor, James Berman, is available to answer questions. He can be reached at 212.388.9873 or jgb4@nyu.edu.

The INSTRUCTOR

If it’s about value investing, I’m interested. I run a global equities fund that invests in the United States, Europe and Asia. As the president and founder of JBGlobal.com LLC, a registered investment advisory firm, I manage separate accounts for high-net-worth individuals and trusts. As a faculty member in the Finance Department of the NYU School of Professional Studies, I teach Corporate Finance and the Fundamentals of Buffett-Style Investing. My book, Lessons from the Lemonade Stand: a Common Sense Primer on Investing, winner of the 2013 Next Generation Indie Award for Best Non-Fiction eBook, is a guide for the first-time investor of any age. I received a B.A. from Harvard University and a J.D. from Harvard Law School. My wife, daughter and I live in Greenwich Village where I find the lessons of value investing as useful with life as with money.

An article from the Instructor on Buffett

The One Word Missing from Buffett’s Annual Letter

 These days, can anyone tweet, converse or goose-step–let alone write 28 pages–without using the five letter word: Trump?

Warren Buffett just did.

As a value investing aficionado and Berkshire shareholder, I anticipate the annual missive from the Oracle of Omaha with bated breath. When it popped online today, I knew enough not to expect much commentary on the economic or the political. A secret to Buffett’s success has been an agnostic view on the too-many moving pieces of the macro scene. By avoiding the human obsession with the short-term and fortune telling, Buffett has always concentrated on the only thing that matters: buying wonderful businesses at fair prices. As Peter Lynch says: “If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.” I myself have found no other investing mantra more important.

But really? No mention of the greatest threat to the democratic process and the rule of law since Nixon–or beyond?

Geico is mentioned 22 times, Charlie Munger 17 times, hedge funds 12 times, table tennis once. Trump zero.

In April of 2016, Buffett went on record saying that Berkshire would do fine even with a Trump presidency. But that was at last year’s meeting–well before the election, and well before anyone thought it was a serious concern. And Buffett made some further post-election comments in December about still buying stocks, but this letter was his first major written opportunity to hold forth.

He even mentions the worthwhile contributions of immigrants but somehow never calls out Trump by name. Perhaps the silence is deafening. Buffett was an ardent supporter of Hillary Clinton in the election and his failure to mention Trump may be the most damning maneuver of all.

Or not.

Because if there’s one thing I wanted as a Buffett follower, it was a reasoned and sober commentary–refracted through the prism of his extraordinary, eminently sensible brain–on what this erratic, errant president means for our country, our markets and our lives.

James Berman teaches The Fundamentals of Buffett-Style Investing, an online class starting April 1 offered by NYU’s School of Professional Studies.

Buffett Warning

Where is he now? http://ericcinnamond.com/buffett-1999-vs-buffett-2017/

Buffett 1999 vs. Buffett 2017

This may sound awful coming from a value investor, but I don’t read Berkshire Hathaway’s annual reports cover to cover. I did earlier in my career. In fact, I’d eagerly await its release, just as many investors do today. However, over the years I’ve gravitated more to what makes sense to me and have relied less on the guidance from investment oracles such as Warren Buffett (see post What’s Important to You?).

While I know significantly less about Warren Buffett than most dedicated value investors, it seems to me that he has changed over the years. I suppose this shouldn’t be surprising as we all have our seasons. And maybe I’m the one who has changed, I really don’t know. But I remember a different tone from Buffett almost twenty years ago when stocks were also breaking record highs. It was during the tech bubble when he went out of his way to warn investors of market risk and overvaluation.

I found an old article from BBC News with several Buffett quotes during that period (link). The article discusses Warren Buffett’s response to a Paine Webber-Gallup survey conducted in December 1999. The survey showed that investors expected stocks to rise 19% annually over the next decade. Clearly investors were extrapolating recent returns far into the future. Fortunately, Warren Buffett was there to save the day and help euphoric investors return to their senses.

The article states, “Mr Buffett warned that the outsized returns experienced by technology investors during 1998 and 1999 had dulled them into complacency.”

“After a heady experience of that kind,” he said, “normally sensible people drift into behaviour akin to that of Cinderella at the ball.

“They know that overstaying the festivities…will eventually bring on pumpkins and mice.”

I really like and can relate to the Warren Buffett of nearly twenty years ago. If I could go back in time and show the 1999 Buffett today’s market, I wonder what he would say. I’d ask him if investor psychology and the current market cycle appears much different than the late 90s.

Similar to 1999, have investors experienced outsized returns this cycle? From its lows in 2009, the S&P 500 has increased 270%, or 17.9% annually. This is very close to the annual returns investors were expecting in the 1999 survey, when Buffett was warning investors.

Have investors been dulled into complacency? Volatility remains near record lows, with every small decline being saved by central banks and dip buyers. Investors show little fear of losing money.

Are today’s investors not Cinderella at the ball overstaying the festivities? It’s the second longest and one of the most expensive bull markets in history!

There are of course differences between 1999 and today’s cycle. While valuation measures are elevated, today’s asset inflation is much broader than in 1999. The tech bubble was extremely overvalued, but narrow. A disciplined investor could not only avoid losses in the 1999 bubble, but due to value in other areas of the market, could make money when it burst. Given the broadness of overvaluation in 2017, I don’t believe that will be possible this cycle. In my opinion, it will be much more challenging to navigate through the current cycle’s ultimate conclusion than the 1999 cycle.

The broadness in overvaluation this cycle makes Buffett’s recommendation to buy a broadly diversified index fund even more difficult for me to understand. Furthermore, given the nosebleed valuations of many high quality businesses, I’m not as confident as Buffett in buying and holding quality stocks at current prices. It again reminds me of the late 90s. At that time, there were many high quality companies that were so overvalued it took years and years for their Es catch up to their Ps. But these are important (and long) topics for another day.

Let’s get back to Buffett 1999. I find it interesting to compare him to Buffett 2017. Surprisingly, Buffett 2017 doesn’t seem nearly as concerned about valuations this cycle. Buffett writes, “American business — and consequently a basket of stocks — is virtually certain to be worth far more in the years ahead [emphasis mine]. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.”

You can include me as a naysayer of current prices and valuations of most risk assets I analyze. Based on the valuations of my opportunity set, I’ll take the advice from another naysayer – the Warren Buffett of 1999. As he recommended, I plan to avoid extrapolating outsized returns and will not ignore signs of investor complacency. I plan to remain committed to my process and discipline. By doing so, when the current market cycle concludes, I hope to achieve two of my favorite Warren Buffett rules of successful investing – avoid losing money and profit from folly.

The World of Inefficient Stock Markets

“Let us not, in the pride of our superior knowledge, turn with contempt from the follies of our predecessors. The study of errors into which great minds have fallen in the pursuit of truth can never be uninstructive… Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one… Truth, when discovered, comes upon most of us like an intruder, and meets the intruder’s welcome… Nations, like individuals, cannot become desperate gamblers with impunity. Punishment is sure to overtake them sooner or later.”

Charles MacKay, Extraordinary Popular Delusions and The Madness of Crowds, 1841

My prior post on Charts and Technical Analysis is here: http://csinvesting.org/2017/01/04/chartists-and-technical-analysis/

The point is to realize that charts are a tool but using them to predict is a fools’ game.   You can try to find disconfirming evidence,but make sure the sample size is a large one.   More on market inefficiency from Bob Haugen.

Readers’ Questions

control-what-you-can
When you have questions–first try to solve the problem for yourself–build a good investing/accounting/finance library. Then join and reach out to the Deep-Value Group at http://csinvesting.org/2015/01/14/deep-value-group-at-google/
There you will find many serious investors who are nice enough to answer an intelligent question.  Many are far more knowledgeable than this wretched scribe.
Ok, your questions………..
Estimated Reproduction Cost is Above your EPV
My question pertains to circumstances in which your estimated reproduction cost of assets is above your EPV. If this circumstance arises not because of managerial incompetence or malfeasance, but rather because the industry as a whole has significantly overinvested and faces excess capacity, does this change what you use as your estimate of intrinsic value?
No.  You have to normalize your earnings power value, EPV, (See Graham’s discussion in Securities Analysis, 2nd Ed.) using a long-enough period like ten years to average mid-cycle (if highly cyclical company) earnings and eliminate the highest and lowest values.  Reproduction value will have to decline to EPV or, mostly likely, EPV has to rise to reproduction value as capital leaves the industry. 
Do a search on CSinvesting (use search box at top right corner of this blog) and look up Maritime Economics.   Then Capital Returns.  Right now Shipping companies are not able to cover their voyage costs, but new builds trade above scrap.  The market estimates that eventually rates have to normalize and ship owners cover their costs.  
QUESTION
 
Am I wrong to think that although this industry is viable, you should use your calculated EPV as the more conservative estimate of intrinsic value rather than current reproduction cost of assets because presumably some of the capacity that will subsequently come offline will be that of the firm you are valuing? Accordingly, the firms in this industry will return to earning the cost of their invested capital but this will be achieved through some combination of increased prices as capacity comes offline and a reduction in individual capital bases.
The only circumstance I can think of in which this situation warrants using the current reproduction cost of assets would be if all the capacity that exited the market was the capacity that belonged to firms other than the one you are valuing.
Greenwald from Value Investing, pages 93-94:
In Chapter 3, we defined  the EPV of a firm as earnings after certain adjustments time 1/R where R is your current cost of capital. The adjustments mentioned:
  1. Undoing accounting misrepresentations, such as frequent one-time charges that are supposedly unconnected to normal operations. The adjustment consists of finding the average ratio that these charges bear to reported earnings before adjustments, annually, and reducing the current year’s reported earnings before adjustment proportionally.
  2. Resolving discrepancies between depreciation and amortiztion, as reported by the accountants, and the actual amount of reinvesatment the company needs to make in order to restore a firm’s assets at the end of the year to their level at the start of the year. The adjustment adds or subtracts this difference.
  3. Taking into account the business cycle and other transient effects. The adjustment reduces earnings reported at the peak of the cycle and raises them if the firm is currently in a cyclical trough (know your company and industry to do this effectively!)
  4. Applying other modicifations as are resonable, depending on the specific situation.

The goal is find distributable cash flow (owner’s earnings) Buffett used EBITDA minus maintenance capex for pre-tax owner’s earnings where maintenance capex kept the business competitive at the current level of operations.  If a competitor in your motel business puts in HD TV, then you might lose customers to your competitor unless you join the “arms race.”

Reproduction value is a signpost.  If the reproduction of a mine today is above the required capital returns, then you know that capital will have to be leaving the industry.   Who will build and/or operate a new mine.   Know your industry.   Mines can take over a year to shut-down or restart.   Finding an economical deposit and building a mine may take over 25 years.  You have to have industry knowledge to make a reasonable assessment.   Make sure you give youerself a big margin of safety.   

Take bulk shipping companies, you can see that new orders are slim and scrapping is taking place, so supply will be lessening. The question is how long before supply/demand equals. The pendulum swings. 
Follow up Questions
I have an additional question. This one is regarding Greenwald’s discussion of expected growth rate. He says that your expected return on a growth stock is the (current earnings yield*payout ratio)+(current earnings yield * retention ratio *ROE/r) + organic growth. I really appreciate how intuitive it is and how it forces you to focus on the core issues that generate returns on growth stocks. Moreover, I understand that the formula is not intended to spit out an exact figure of prospective returns, but rather to guide the investor towards a yes no decision about whether or not the stock can be reasonably classified as a bargain.
But one issue I have remains–it seems to me that to a certain extent the organic growth and reinvestment growth are comingled, at least to the extent that Greenwald suggests estimating organic growth by looking at the growth of the market that the business is in. I suppose I’m just worried about any embedded circularity/double counting in disaggregating the growth figure into two figures that may have some overlap with one another. Thank you.
Answer: I don’t know if I fully understand your question. You need to separate maintenance capex from growth capex. So the change in sales over the change in fixed assets shows you total capex, so then you need to subtract maintenance capex to see the remainder, growth capex.  You either find maint. capex in the 10-K or call the CFO/Inv. Relations.
Another Reader
Can you help help me to make the estimates on current earnings, I know Bruce said to do five years average, but he also said add back one time charge, and any cyclicality. Conversely, Joel Greenblatt mention he add back pension liabilities, is he talking about adding back maintenance cap ex  ? This is the only issue I have been having for the last year.. I would appreciate your help.
If you are figuring Enterprise value, then you need to add back liabilities to the market cap, including operating leases, unfunded pension funds, long-term debt, etc. Then deduct non-operating cash –depending upon the business, usually 2% to 3% of sales.
You want to figure out what distributable earnings the company can give you, the owner.    Depreciation and Amortization is an accounting principle while maintanance capex is a TRUE cost to stay in business. 
You drive a cab so your fares minus expenses, including maintenance of running your cab and REPLACING it.
IF you can’t figure out a company, then pass on it.
Good luck,

Back to Basics: Valuing a Cow; Investing Principles

how-to-buy-a-mining-stock-flow-chart

VALUATION

Buffett say there are ONLY two things you need to know as an investor

  1. How to think about prices (Read Chapter 8 in The Intelligent Investor by Ben Graham).
  2. How to do valuation: See below

valuing-a-cow_vk

Then place those two skills in an investing philosophy/framework. See below.

manifesto_on-value-investing

Improve the YOU: http://reasonio.teachable.com/courses/enrolled  a free course on Epictetus and Stoic Philosophy–needed for what is coming!

world-stock-markets

http://millionaire-investor.com/program.html   A value investing training program in Singapore.

Damodaran Valuation Lecture at Google

http://people.stern.nyu.edu/adamodar/New_Home_Page/webcasteqfall16.htm

Valuation Readings:  http://people.stern.nyu.edu/adamodar/New_Home_Page/eqread.htm

Class: http://aswathdamodaran.blogspot.com/2016/09/the-school-bell-rings-its-time-for-class.html

Or take Buffett’s Course  http://www.buffettsbooks.com/howtoinvestinstocks/course3/when-to-sell-shares.html

I don’t understand why business schools don’t teach the Warren Buffett model of investing. Or the Ben Graham model. Or the Peter Lynch model. Or the Martin Whitman model. (I could go on.)

In English, you study great writers; in physics and biology, you study great scientists; in philosophy and math, you study great thinkers; but in most business school investment classes, you study modern finance theory, which is grounded in one basic premise–that markets are efficient because investors are always rational. It’s just one point of view. A good English professor couldn’t get away with teaching Melville as the backbone of English literature. How is it that business schools get away with teaching modern finance theory as the backbone of investing? Especially given that it’s only a theory that, as far as I know, hasn’t made many investors particularly rich.

Meanwhile, Berkshire Hathaway, under the stewardship of Buffett and vice chairman Charlie Munger, has made thousands of people rich over the past 30-odd years. And it has done so with integrity and a system of principles that is every bit as rigorous, if not more so, as anything modern finance theory can dish up.

On Monday, 11,000 Berkshire shareholders showed up at Aksarben Stadium in Omaha to hear Buffett and Munger talk about this set of principles. Together these principles form a model for investing to which any well-informed business-school student should be exposed–if not for the sake of the principles themselves, then at least to generate the kind of healthy debate that’s common in other academic fields.

Whereas modern finance theory is built around the price behavior of stocks, the Buffett model is centered around buying businesses as if one were going to operate them. It’s like the process of buying a house. You wouldn’t buy a house on a tip from a friend or sight unseen from a description in a newspaper. And you surely wouldn’t consider the volatility of the house’s price in your consideration of risk. Indeed, regularly updated price quotes aren’t available in the real estate market, because property doesn’t trade the way common stocks do. Instead, you’d study the fundamentals–the neighborhood, comparable home sales, the condition of the house, and how much you think you could rent it for–to get an idea of its intrinsic value.

The same basic idea applies to buying a business that you’d operate yourself or to being a passive investor in the common stock of a company. Who cares about the price history of the stock? What bearing does it have on how the company conducts business? What’s important is whether you can purchase at a reasonable price a business that generates good returns on capital (Buffett likes returns on equity in the neighborhood of 15% or better) without a lot of debt (which makes returns on capital less dependable). In the best of all worlds, the company will have a competitive advantage that allows it to sustain its above-average ROE for years, so you can hang on to it for a long time–just as you would live in your house–and reap the power of compounding.

Buffett further advocates investing in businesses that are easy to understand–Munger calls it “clearing one-foot hurdles”–so you can come up with more reliable estimates of their long-term economics. Coca-Cola‘s basic business is pretty staid, for example. Unit case sales and ROE determine the company’s future earnings. Companies like Microsoftand Intel–good as they are–require clearing much higher hurdles of understanding because their business models are so dependent on the rapidly evolving world of high tech. Today it’s a matter of selling the most word-processing programs; tomorrow it’s the Internet presence; after that, who knows. For Coke, the challenge is always to sell more cases of beverage.

Buying a business or a stock just because it’s cheap is a surefire way to lose money, according to the Buffett model. You get what you pay for. But if you’re evaluating investments as businesses to begin with, you probably wouldn’t make this mistake, because you’d recognize that a good business is worth buying at a fair price.

Finally, if you follow the Buffett model, you don’t trade your investments just because our liquid stock markets invite you to do so. Activity for the sake of activity begets high transaction costs, high tax bills, and poor investment decisions (“if I make a mistake I can sell it in a minute”). Less is more.

I’m not trying to pick a fight with modern finance theory enthusiasts. I just find it unsettling that basic business-school curricula don’t even consider models other than modern finance theory, even though those models are in the marketplace proving themselves every day.

 

 

 

The Base Rate Book

nq161005

the-base-rate-view-by-mauboussin  I wonder if readers will find this useful.  We last discussed base rates here: http://csinvesting.org/2016/09/29/hedge-fundfamily-office-consulting-job/