Tag Archives: technology

What Can We Learn from IBM?

PS: I may not post the See’s Candies case study until tomorrow….backed up with work. Until then, tackle this:

Why did Buffett buy IBM?

IBM_VL    Don’t cheat! Look at the Value-Line and write what Buffett sees in IBM. (Disclosure: I own IBM along with BDX, BCR, CSCO, LXK, NVS, TESCO, ORI, etc. and I will not announce if and when I sell. I may be incorrect in the assessment of those businesses either in price paid or assessment of value.)

What do you think of IBM’s growth? Is this a good business? What might be driving returns for shareholders? How would you classify this company?  A rapid compounder? Value trap?

How can a company as well-known as IBM become mis-priced?

Hint: For those who wish to start your own fund….research the studies on horse track betting where favorites are SYSTEMATICALLY under-bet (under priced) while long shots are SYSTEMATICALLY over bet or over priced.


Betting on Favorites

See research:Favorite_Longshot_Bias


One of the common criticisms I (Investor lecture at Columbia GBS) hear about this type of investing is that it is akin to betting on favorites at the race track. Once you have identified a company that is so obviously superior, how likely is it to be undervalued since the whole world will have perceived that it is an extraordinary company? The stock won’t have a margin of safety and may be persistently over-valued. The stock may be over-loved and overvalued.

Let me back up a second. As part of my misspent youth, I spent a lot of time in horse racing and handicapping. In fact, bettors in aggregate in pari-mutual betting are, in fact, very good at picking winners at the racetrack. Favorites do win races. But betting on favorites does not make you money; it loses you the least amount of money. Because there is a tremendous track take. So the horse racing/handicapping is a minus 20 percent on typical betting. If you just put money down on favorites as a mechanical system, the record shows that you will lose over time only 2%, 3% or 4%. If you bet on long shots, you will lose 20+% of your money.

Now in the case of the stock market over a long period of time, it has been a plus 9, plus 10, plus 11% game so it is very much more favorable business than horse betting. But betting on favorites, betting on quality as opposed to junk is a winning bet, as long as the valuation discipline is appropriate.

Prize awarded: Boom, Gloom, and Doom Report for the BEST reply.

Ok, now take a look at these articles: http://tech.fortune.cnn.com/2011/11/14/warren-buffett-ibm/

and  http://seekingalpha.com/article/510371-what-does-warren-buffett-see-in-ibm

Lessons learned?

If I can stress anything–and it took me TEN years to learn and I fall off the wagon occasionally–keep things simple!

The Innovator’s Dilemma and Porter’s Five Forces

Buying a cyclical (company) after several years of record earnings and when the P/E ratio has hit a low point is a proven method for losing half of your money in a short period of time. –Peter Lynch, Beating the Street

Link right below for the book


Now in the books folder within the VALUE VAULT. Thanks to a gracious  contributor.

Readers discussed the importance of this work: http://wp.me/p1PgpH-13O.

A reader’s review: http://valueprax.wordpress.com/2012/05/07/review-the-innovators-dilemma-innovation/

For those who wish a supplement to Porter’s Five Forces: Five forces industry analysis

Will a careful reading help save me from another Nokia? Let’s pray.

Valuation from a Strategic Perspective, Part 1: Shortcomings of the NPV Approach to Valuation


For beginners and a review of Present Value—see these 10 minute videos: http://www.khanacademy.org/finance-economics/core-finance/v/introduction-to-present-value and  http://www.khanacademy.org/finance-economics/core-finance/v/present-value-2 and http://www.khanacademy.org/finance-economics/core-finance/v/present-value-3

and Discounted Present Value: http://www.khanacademy.org/finance-economics/core-finance/v/present-value-4–and-discounted-cash-flow

Prof. Damodaran’s Handout on NPV:DCF Basics by Damodaran

Prof. Greenwald Lecture Notes (See pages 10-13 on NPV Valuation):OVERVIEW Value_Investing_Slides

And The Dangers of Using DCF (Montier and Mauboussin)

CommonDCFErrors (Montier) and dangers-of-dcf (Mauboussin)

Part I: What are the three major shortcomings of using the Net Present Value Approach (“NPV”) to valuing companies?

The NPV approach has three fundamental shortcomings. First, it does not segregate reliable information from unreliable information when assessing the value of a project. A typical NPV model estimates net cash flows for several years into the future from the date at which the project is undertaken, incorporating the initial investment expenditures as negative cash flows. Five to ten years of cash flows are usually estimated explicitly. Cash flows beyond the last date are usually lumped together into something called a “terminal value.” A common method for calculating the terminal value is to derive the accounting earnings from the cash flows in the last explicitly estimated year and then to multiply those earning by a factor that represents an appropriate ratio of value to earnings (i.e., a P/E ratio). If the accounting earnings are estimated to be $12 million and the appropriate factor is a P/E ratio of 15 to 1, then the terminal value is $180 million.

How does one arrive at the appropriate factor, the proper price to earnings ratio? That depends on the characteristics of the business, whether a project or a company, a terminal date. It is usually selected by finding publicly traded companies whose current operating characteristics resemble those forecast for the enterprise in its terminal year, and then looking at how the securities markets value their earnings, meaning the P/E at which they trade. The important characteristics for selecting a similar company are growth rates, profitability, capital intensity, and riskiness.

This wide range of plausible value has unfortunate implications for the use of NPV calculations in making investment decisions. Experience indicates that, except for the simplest projects focused on cost reduction, it is the terminal values that typically account for by far the greatest portion of any project’s net present value. With these terminal value calculations so imprecise, the reliability of the overall NPV calculation is seriously compromised, as are the investment decisions based on these estimates.

The problem is not the method of calculating terminal values. No better methods exist. The problem is intrinsic to the NPV approach. A NPV calculation takes reliable information, usually near-term cash flow estimates, and combines that with unreliable information, which is the estimated cash flows from a distant future that make up the terminal value. Then after applying discount rates, it simply adds all these cash flows together. It is an axiom of engineering that combining good information with bad information does not produce information of average quality. The result is bad information, because the errors from the bad information dominate the whole calculation. A fundamental problem with the NPV approach is that it does not effectively segregate good from bad information about value of the project.

A second practical shortcoming of the NPV approach to valuation is one to which we have already alluded. A valuation procedure is a method from moving from assumptions about the future to a calculated value of a project which unfolds over the course of that future. Ideally, it should be based on assumptions about the future that can reliable and sensibly be made today. Otherwise, the value calculation will be of little use.

For example, a sensible opinion can be formed about whether the automobile industry will still be economically viable twenty years from today. We can also form reasonable views of whether Fort or any company in the industry is likely. Twenty years in the future, to enjoy significant competitive advantages over the other automobile manufacturers (not likely). For a company such as Microsoft, which does enjoy significant competitive advantages today, we can think reasonable about the chances that these advantages will survive the next twenty years, whether they will increase, decrease, or continue as is.

But it is hard to forecast exactly how fast Ford’s sales will grow over the next two decades, what its profit margins will be, or how much will be requires to invest per dollars of revenue. Likewise, for a company like MSFT, projecting sales growth and profit margins is difficult for its current products and even more difficult for the new products that it will introduce over that time. Yet these are the assumptions that have to be made to arrive at a value based on NPV analysis. (See page 10 of Greenwald notes-link on blog post).

It is possible to make strategic assumptions about competitive advantages with more confidence, but these are not readily incorporated into an NPV calculation. Taken together, the NPV approach ‘s reliance on assumptions that are difficult to make and its omission of assumptions that can be made with more certainty are a second major shortcoming.

A third difficulty with the NPV approach is that it discards much information that is relevant to the calculation of the economic value of a company. There are two parts to value creation. The first is three sources that are devoted to the value creation process, the assets that the company employs. The second part is the distributable cash flows that are created by these invested resources. The NPV approach focused exclusively on the cash flows. In a competitive environment, the two will be closely related. The assets will earn ordinary –the cost of capital—returns. Therefore, knowing the resource levels will tell a good deal about likely future cash flows.

But if the resources are not effectively, then the value of the cash flows they generate will fall short of the dollars invested. There will always be other firms that can do better with similar resources, and competition from these firms will inevitably produce losses for the inefficient user. Even firms efficient in their use of resource may not create excess value in their cash flows,  so long as competition from equally environment, resource requirements carry important implications about likely future cash flows, and the NPV approach takes no advantage of this information.

All these criticisms of NPV would be immaterial if there were no alternative approach to valuation that met these objections. But in fact there is such an alternative. It does segregate reliable from unreliable information; it does incorporate strategic judgments about the current and future state competition in the industry; it does pay attention to a company’s resources. Because this approach had been developed and applied by investors in marketable securities, starting with Ben Graham and continuing through Warren Buffett and a host of others, we will describe this alternative methodology in the context of valuing a company as a whole in Part II.


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Postscript: Moody’s downgrades of 15 global banks is a non-event. The change may raise borrowing costs for banks, but in the current fractional reserve banking system, all banks are inherently bankrupt and survive only because of their ties to central banks.

How Do I Get A Job on Wall Street?

Job Search Strategy

Some may find the links below helpful.

How do I get a job on Wall Street? http://www.economicpolicyjournal.com/2012/06/how-do-i-get-job-on-wall-street.html

Beware of the typical advice, “Conditions are bad now so go get an MBA and then come back in two years when things will be better.”   First, “things” may be worse and how does an MBA equate to investing success?

Go where the money is: http://www.economicpolicyjournal.com/2012/06/hottest-area-in-finance.html

Yes, Wall Street is grim since it is over-bankered/brokered after decades of easy money and over leverage. But areas like manufacturing and energy will grow. You don’t have to be on Wall Street to use your skills. Be creative.