Tag Archives: valuation

Sandstorm Gold–So What’s it Worth?

If am able to provide an investing course, then once the fundamentals are covered, we could study cases.  Let me know your thoughts.

The Life of an Analyst

Your boss slaps these documents on your desk.  “Let me know what you think. I want a back-of-the-envelope valuation and a sixty-second summary of this business by this afternoon.”

What’s the essence of this business? Hannibal Lecter will guide you:  https://youtu.be/UhDZPYu8piQ?t=58s

Your analysis should be clear and simple:

How can the portfolio manager expect YOU to answer quickly with this deluge of info? That’s what we will learn here today.

I will post my “answer” by Tuesday of next week.   Email me at aldridge56@aol.com if you wish to share your thoughts or do so at the deep-value group at Google Groups (sign up here: http://csinvesting.org/2015/01/14/deep-value-group-at-google/) rather than post in the comments section, because readers shouldn’t be influenced by others.  No help!   This case illustrates the reality at investment firms.   Your boss dumps a 500-page prospectus and says get back to me in two hours–“What’s it worth?”

Have fun!

Poking Holes in the Market Bubble Hypothesis

Nygren Commentary September 30, 2017

CSInvesting: We can’t increase our IQ but we can try to improve our critical thinking skills by seeking out opposing views to the now current din of pundits screaming that this “over-valued market is set to crash.”  1987 here we come.  What do you think of his arguments?  I certainly agree about how GAAP accounting punishes growth investments.  

At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.

“All the company would have to do is raise prices 50% and the P/E ratio would fall to the low-teens.”   -Analyst recommending a new stock purchase

We are nine years into an economic and stock market recovery and P/E ratios are elevated somewhat beyond historic averages. So when an experienced portfolio manager hears a young analyst make the above comment, he hears alarm bells. But instead of seeing this as a sign that the market has peaked, we purchased the stock for the Oakmark Fund. But, more on that later.

For several years, the financial media has been dominated by pronouncements that the bull market is over. Throughout my career, I can’t remember a more hated bull market. Many state that a recession is “overdue” since past economic booms have almost never lasted as long as this one. But do nine years of sub-normal economic growth even constitute a recovery, much less a boom? If recessions occur to correct excesses in the economy, has this recovery even been strong enough to create any? Maybe recessions are less about duration of the recoveries they follow and more about the magnitude. If so, earnings might not even be above trend levels.

Bears will also point to the very high CAPE ratio—or the cyclically adjusted P/E. That metric averages corporate earnings over the past decade in an attempt to smooth out peaks and valleys. But remember that the past decade includes 2008 and 2009, frequently referred to as the “Great Recession” because of how unusually bad corporate earnings were. I’ll be the first to say that if you think an economic decline of that magnitude is a once-in-a-decade event, you should not own stocks today. But if it is more like a once-in-a-generation event, then that event is weighted much too heavily in the CAPE ratio. If the stock market and corporate profits maintained their current levels for the next two years—an outcome we would find disappointing—simply rolling off the Great Recession would result in a large decline in the CAPE ratio.

Higher P/E ratios are also caused by near-zero short-term interest rates because corporate cash now barely adds to the “E” in the P/E ratio. When I started in this business in the early 1980s, cash earned 8-9% after tax. Consider a simple example of a company whose only asset is $100 of cash and the market price is also $100. In the early 1980s, the $8 or $9 of interest income would generate a P/E ratio of about 12 times. Today, $100 would produce less than $1 of after-tax income, driving the P/E ratio north of 100 times. There is, of course, uncertainty as to whether that cash will eventually be returned to shareholders or invested in plants or acquisitions, but it seems that making a reasoned guess about the value of cash is more appropriate than valuing it at almost nothing.

A less obvious factor that is producing higher P/E ratios today is how accounting practices penalize certain growth investments. When a company builds a new plant, GAAP accounting spreads that cost over its useful life—often 40 years—so the cost gets expensed through 40 years of depreciation as opposed to just flowing through the current income statement.

But when Amazon hires engineers and programmers to help it prepare for sales that could double over the next four years, those costs get immediately charged to the income statement. When Facebook decides to limit the ad load on WhatsApp to allow it to quickly gain market share, the forgone revenue immediately penalizes the income statement. And when Alphabet invests venture capital in autonomous vehicles for rewards that are years and years away, the costs are expensed now and current earnings are reduced.

The media is obsessed with supposedly bubble-like valuations of the FANG stocks—Facebook, Amazon, Netflix and Google (Alphabet). The FANG companies account for over 7% of the S&P 500 and sell at a weighted average P/E of 39 times consensus 2017 earnings. In our opinion, the P/E ratio is a very poor indicator of the value of these companies. Alphabet is one of our largest holdings, and our valuation estimate is certainly not based on its search division being worth 40 times earnings. If one removed the FANG stocks from the S&P multiple calculation—not because their multiples are high, but because they misrepresent value—the market P/E would fall by nearly a full point. And, clearly, more companies than these four are affected by income statement growth spending.

In addition, no discussion of stock valuations would be complete without some consideration of opportunities available in fixed income. Many experts argue that investors should sell their stocks because the current S&P 500 P/E of 19 times is higher than the 17 times average of the past 30 years. By comparison, if we think of a long U.S. Treasury bond—say, 30 years—in P/E terms, the current yield of 2.9% results in a P/E of 34 times. The average yield on long Treasuries over the past 30 years has been 5.5%, which translates to a P/E of 18 times. Relative to the past 30 years, the long bond P/E is now 90% higher than average. We don’t think the bond market at current yields is any less risky than equities.

The point of this is not to advance a bullish case for stocks, but rather to poke holes in the argument that stocks are clearly overvalued.

We think our investors would also fare best by limiting their in-and-out trading. We suggest establishing a personal asset allocation target based on your financial position and risk tolerance. Then limit your trading to occasionally rebalancing your portfolio to your target. If the strong market has pushed your current equity weighting above your target, by all means take advantage of this strength to reduce your exposure to stocks.

Now, back to the P/E ratio distortions caused by investing for growth. This highlights a costly decision we made six years ago. In 2011, when Netflix traded at less than $10 per share, one of our analysts recommended purchase because the price-per-subscriber for Netflix was a fraction of the price-per-subscriber for HBO. Given the similarity of the product offerings and Netflix’s rapid growth, it seemed wrong to value the company’s subscribers at less than HBO’s. But, at the time, streaming was a relatively new technology, HBO subscribers had access to a much higher programming spend than Netflix subscribers and Netflix was primarily an online Blockbuster store, providing access to a library of very old movies. Netflix had only one original show that subscribers cared about, House of Cards, and churn was huge as they would cancel the service after a month of binging on the show. Despite the attractive price-per-sub, we concluded that the future of Netflix was too uncertain to make an investment.

Today, Netflix trades at $180 per share and has more global subscribers than the entire U.S. pay-TV industry. Netflix provides its subscribers access to more than two times the content spending that HBO offers, making it very hard for HBO to ever match the Netflix value proposition. Finally, Netflix is no longer just a reseller of old movies. The company has doubled its Emmy awards for original programming in each of the past two years and now ranks as the second most awarded “network.” On valuation, Netflix is still priced similarly to the price-per-subscriber implied by AT&T’s acquisition of HBO’s parent company Time Warner, despite Netflix subscribers more than quadrupling over the past four years while HBO subscribers have grown by less than one third.

Last quarter, when our analyst began his presentation recommending Netflix, selling at more than 100 times estimated 2017 earnings, I was more skeptical than usual. His opening comment was that Netflix charges about $10 per month while HBO Now, Spotify and Sirius XM each charge about $15. “All the company would have to do is raise prices 50% and the P/E ratio would fall to the low teens,” he argued. Anecdotally, those who subscribe to several of these services tend to value their Netflix subscription much higher despite its lower cost. Quantitatively, revenue-per-hour-watched suggests Netflix is about half the cost (subscription fees plus ad revenue) of other forms of video. Netflix probably could raise its price to at least $15 without losing many of its subscribers. For those reasons, Netflix is now in the Oakmark portfolio.

So, is Netflix hurting its shareholders by underpricing its product? We don’t think so. Like many network-effect businesses, scale is a large competitive advantage for content providers. Scale creates a nearly impenetrable moat for new entrants to cross. With more subscribers than any other video service, Netflix can pay more for programming and still achieve the lowest cost-per-subscriber. As shareholders of the company, we are perfectly amenable to Netflix’s decision to forfeit current income to rapidly increase scale.

Because we are value investors, when companies like Alphabet or Netflix show up in our portfolio, it raises eyebrows. Investors and advisors alike are full of questions when investors like us buy rapidly growing companies, or when growth investors buy companies with low P/Es. Portfolio managers generally don’t like to be questioned about their investment style purity, so they often avoid owning those stocks. We believe our portfolios benefit from owning stocks in the overlapping area between growth and value. Therefore, we welcome your questions about our purchases and are happy to discuss the shortcomings of using P/E ratio alone to define value.

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.

 

 

 

BEING WRONG (VALE)

Brazil EM

Friday, September 25, 2015

No Mas, No Mas! The Vale Chronicles (Continued)!

Some of my Brazilian readers seem to be upset that I used “No Mas”, Spanish words, rather than Portuguese ones, in the title. To be honest I was not thinking about language, but instead about a boxing match from decades ago, where Roberto Duran used these words to give up in his bout with Sugar Ray Leonard.

I have used Vale as an illustrative example in my applied corporate finance book, and as a global mining company, with Brazilian roots, it allows me to talk about how financial decisions (on where to invest, how much to borrow and how dividend payout) are affected by the ups and downs of the commodity business and the government’s presence as the governance table. In November 2014, I used it as one of two companies (Lukoil was the other one) that were trapped in a risk trifecta, with commodity, currency and country risk all spiraling out of control. In that post, I made a judgment that Vale looked significantly under valued and followed through on that judgment by buying its shares at $8.53/share. I revisited the company in April 2015, with the stock down to $6.15, revalued it, and concluded that while the value had dropped, it looked under valued at its prevailing price. The months since that post have not been good ones for the investment, either, and with the stock down to about $5.05, I think it is time to reassess the company again.

vale

John Chew: At least the author has a process to reassess his investment.  I believe the critical flaw in his analysis (easy to say in hindsight) was not noting the massive mal-investment due to distorted credit markets caused by central bank policies. To normalize iron ore prices you would need pre-distortion prices going back twenty-five years.

Read more: No Mas!

Pop QUIZ

curve

An ode to the end of a con

How long can deception go on?

When prices are set by banks printing debt

All trust in the “markets” is gone!

QUIZ

Two businesses, each earns $10.

Company A: Has $50 in net assets and produces $10 in earnings.

Company B: Has $1,000 in net assets and produces $10 in earnings.

  1. Which is the better business?
  2. Which is the better value?
  3. What is the difference in value between the two companies?

Anyone who doesn’t pass this quiz meets my Ex (Hoping won’t help; prayin’ won’t do you no good!

Hallador Energy, Inc. (HNRG) Valuation Attempt

carlisle_o0c0971

A Reader Writes:
John, Here’s my quick and dirty for Hallador:
Currently not screaming cheap.
Hallador has traded to .6 book before. Current 1.2x. Highest is 4.4 or 30.36 ($4.14-$30 2015 TBV)
ev/ebitda 3mth op. inc + depr = 22341000/.25 to annualize = 6.9

industry multiple (still using the same from CLD) is 8.91

for approx 58.65 – 61.8  TBV is 6.8. Current price is 8.42.

It is making money (not a pure coal company; has oil/gas assets). From VL, it has cash flow after capex, 10% cap of 6.5 for no growth value.
It’s not a bad coal company after buying sunrise coal. The negative thing is its coal is high sulphur whereas CLD has all <1% SO2 coal (some <.5%). China recently announced a ban on high sulphur content coal. Existing shipments from Australia and South Africa in China cannot be used.
It does not break down its international shipments, but gauging CLD exports, its not much. around 4.7mt total shipments.
The thing I need to look into is how the coal companies booked their profits. Using newcastle 2014 price? Currently it is 59.6.
Hallador has good average per ton cost.
2 main areas of coal in the US. East and West.
East is higher while West is lower (CLD is lower because of transportation cost). Hallador has a 11.9 margin per ton with avg cost/ton at 31.43 and price/ton 43.3 as its mine are in the Eastern zone.
As a comparison, ANR’s 2014 Eastern cost/ton is 61.66. And Western 11.5. CLD still lowest but they have only mines in the West.
There was a report earlier in the week about POSCO in talks with Peabody about asset sales or product sales. They may be talking to others. One of the miners in Mongolia announced sales contract to Seoul today. Mongolia coal has a low sulphur too; however, after the Oyu Tolgoi deal recently, top 20 stocks there had a momentum run, and are not cheap. Another market I will look at is Indonesia. The government there has announced plans to remove mining export ban that they blamed on excessive nationalism. Indonesian coal has poor BTU but low sulphur. Also, these things will take a long time to sort out. Maybe next year. Just some things to keep an eye on. There is a special situation SGX catalist stock I’m waiting to see. It has become the parent company of a mongolian miner (2.6x book so not cheap anymore after the run up) and intend to hold other Mongolian coal assets. Will write when I know more.
Looking forward to seeing your write up.
Thank you,
HAVE A GREAT WEEKEND

So What is it worth? Carbo Ceramics (CRR)

paul-singer

 The consensus (bull case): The power of psychology is overwhelming, and investor sentiment indicates that asset prices are being driven higher by QE and Zirp, that the Fed can be trusted, and that we should not worry too much about the unintended consequences, because the Fed will be able to follow a path to normalization and a soft landing. In any event, America is now a safe haven and always will be a safe haven. Moreover, goes the case, we may be at the sweet spot of the economic cycle. It has taken a long time to get here, but finally we are getting sustainable growth, and we can expect more of the same, Interest rates are completely under control, in fact, long-term rates are in a secular decline, which is not nearly at its bottom. Inflation is virtually impossible, and we really ought to be worrying about deflation instead. If we focus on getting inflation higher, then growth will follow. The currency is also under control, goes this line of thinking, In fact, what could the dollar fall against? The competition is in much worse shape. Banks are in far better financial condition than in 2008 and will gradually bleed off any remaining toxic assets that they own. If anything starts to go wrong, the government will step in to fix it. Pushing investors out on the risk curve in search of yield is a good idea and a clever way to encourage them to do what they should be doing on their own (i.e., taking risks to help the ecobnomy grow).  We should not worry, because things will be okay. We can even trust the representative branches of government, because elected officials will not have to do much that is unplatable or challending–the central bankers have it all covered. Above all, trust the Fed.  –Paul Singer

Do the Lessons of History Apply?

So what’s it worth?

Carbo VL

Carbo 2013

Carbo Presentation Sept 2014

Please do a “down and dirty” valuation giving your assumptions within twenty minutes.  I will post mine tomorrow!

ATCE-2014-post2

 

PRIZE: A Date with my EX! for best valuation!

Seth Klarman

Seth+Klarman+Allen+Company+Annual+Meeting+7bct-wIFGiHl

…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

Seth-Klarmanm-Interview-Financial-Analyst-Journal

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klarman-yield_pig

Klarman_on_running_a_fund_interview

Seth_Klarman-Why_Most_Investment_Managers_Have_It_Backwards

SethKlarman-TIFF_2009

Klarman 2013 Letter Excerpts

A BLOG DEVOTED TO Klarman  http://www.rbcpa.com/klarman.html

1408066-month_gold

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:

http://www.gowebcasting.com/events/yamana-gold-inc/2014/07/31/second-quarter-financial-results/play

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

Buffett Tutorial on Accounting and Valuation: See’s Candies Case Study

I have always maintained that excepting fools, men did not differ much in intellect, only in zeal and hard work.  –Charles Darwin

Value investing works, because it does NOT work ALL the time. –Joel Greenblatt

Today’s post focuses on accounting (GAAP) and valuation through the words of Warren Buffett. The case study on See’s Candies and the other readings will help improve your skills. The burden is on you to understand and apply the lessons. If you do not understand FIFO or deferred taxes, then look up those terms in a basic accounting book, then do problem sets to grasp the concepts. Don’t take Buffett’s words on faith; try to apply the concepts of economic Goodwill to a commodity based company like, for example, US Steel (X) versus a franchise company like Coca-Cola (KO). Do you agree with Buffett’s analysis?

Prof. Joel Greenblatt’s book, The Little Book that Beats the Market, is (simply) an application of Buffett’s thoughts on economic Goodwill.

Helpful hint: Take a subject like share repurchases or divdend policy and try to find many different sources on the subject. Learn the subject to death. Master how, when or if a company should act in returning capital to shareholders.

See’s Candies Case Study:Sees Candies 2012

SUPPLEMENTARY READINGS

A Parable on Valuation: The Old Man and the Tree or a Parable of Valuation

Inflation:Inflation Swindles the Equity Investor and Buffett inflation file

EBITDA: Placing EBITDA into Perspective and TEV to EBITDA Research

Joel Greenblatt: Little Book That Still Beats the Market, The – Joel Greenblatt

Secrets of (view): http://youtu.be/3PShSES5nBc   25 minutes

Corporate Finance

Share Repurchases: Corporate Structure and Stock Repurchases and Assessing Buybacks from all Angles_Mauboussin

Dividends: Dividend Policy, Strategy and Analysis

You will beat Wall Street easily if you apply the above lessons. The hard work is in mastering the material.   Stay the course.