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The models on finbox. I didn't see anything unusual in Apple's earnings so I used the numbers as reported. Here is a look at the buildup: By default, finbox. At the mid-point, the model use the median over last five years. I left these assumptions unchanged since they seemed reasonable. Apple has historically spent an average of 9. Step 3: Estimate a Normalized Tax Rate "In this world, nothing can be said to be certain except death and taxes. To estimate the portion of income the company will need to forfeit in taxes, historical effective tax rates can be useful for guidance: Over the last five years, Apple has paid This felt a little low compared to the Step 4: Estimate Maintenance Capital Expenditures As a company operates, it's machines, office space, and property start to wear down.
To account for this normal wear and tear, we need to estimate how much the company will need to spend on capital expenditures CapEx to maintain it's current level of earnings going forward. Incidentally, that shortcoming doesn't bother us.
What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes. Second, and equally important, we insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we're not interested in buying.
Risk is "the possibility of loss or injury. This is an antidiversification device, and it has a manifold influence on their entire investment process. First, they need to have two types of confidence in the selection: confidence in their ability to understand the company, its industry, and its business prospects; and confidence in the company, that it will continue to perform well and increase the wealth of its shareholders. Chieftain portfolio has far fewer than the 20 names that a strict 5 percent rule might imply.
The partners normally hold 8 to 10 stocks in their accounts, and they are willing to invest heavily in a situation that they are thoroughly convinced will work out for them. To improve their odds, all four professionals in the firm study the same stocks, and they have to agree before they buy a share. If diversification is a substitute for knowledge, then information and understanding should work in reverse. If it normally holds shares in 10 or even fewer companies, then on average it needs to put hundreds of millions into any one name.
Because great situations are so difficult to find, they are prepared to buy 20 percent or more of any one company. While there are around 1, or more companies large enough for them to own, their "good business" requirement probably shrinks that list by 80 percent, leaving them with no more than possible Chieftain is not attracted to turnaround companies or cyclicals, where a successful investment depends on timing.
He does not believe in speculating that an underperforming company will be taken over, because most managements resist selling out. Before the arrival of the personal computer and the electronic spreadsheet, he and his partner would analyze a company by isolating its business segments and projecting revenue and expenses no more than two or three years into the future. By assuming that it would grow steadily from then on, they could calculate its current value by discounting that cash flow back to the present, using only a hand calculator.
Now, with spreadsheets, they can make their projections more detailed and carry them forward further in time. Discounted cash flow analysis, a method about which we expressed some reservations in the first part of this book, is Greenberg's valuation technique of choice for all the investments he makes. He is only interested in companies with stable earnings and relatively predictable cash flows. And he is careful to make sure that all of the assumptions that are built into a present value analysis are reasonable and conservative: sales growth rates; profit margins; the market prices of assets such as oil, gas, and other fuels; capital expenditure requirements; and discount rates.
Common sense serves as the touchstone against which all spreadsheet projections are assessed. He uses the model; he doesn't let it control him. The real value of doing all the work required for a full discounted cash flow analysis is that it forces the investor to think long and hard about all the factors that will affect the future of the business, including the risks it may face that are currently unexpected and unforeseen.
With few stocks in their clients' portfolios, each of them purchased as a long-term investment, the partners of Chieftain do not need to find many new companies to add to their list. In some years, they buy no additional names, in other years three or four. This slow turnover leaves them time to keep thoroughly informed about the firms they do own, a necessity given the large stakes they maintain in each of their companies. All the partners go to the companies' meetings; all of them scrutinize the quarterly filings; and all of them keep current about the industry.
They talk with management regularly, and they read the trade journals and other relevant material. In addition to the superior returns we described, their work has earned them the respect of the executives with whom they speak.
They have been told by management that they understand the company better than all sellside analysts covering it. Greenberg readily acknowledges, they make plenty of mistakes and are often quite inexact in their estimates of a company's revenues and earnings. They tend to err on the high side, which puts them in the camp of most analysts.
How then have they done so well? For one thing, as value investors, they have not based their investment decisions on expectations of perfection. They do not buy high multiple stocks for whom an earnings disappointment can mean a punishing drop The companies in their portfolio are sound enough to recover from short-term problems. As a consequence, the mistakes they have made have not buried them. Their poor investments, Greenberg says, have resulted more in dead money than fatal declines.
By establishing the ranges with precision, this approach provides a check on the emotions that can distort investment judgment, both the exuberance engendered by a rising market and the despair occasioned by a falling one. To estimate the intrinsic value of a firm, Price asks one question: How much is a knowledgeable buyer willing to pay for the whole company? He finds his answer by studying the mergers and acquisitions transactions in which companies are bought and sold. It is important to wait for the market to offer a price with a discount large enough to allow for a margin of safety.
It is much easier to understand a security than an economy, and the way to profit is by using that understanding. Their office-Castle Schloss has one room-is spare; they don't visit companies; they rarely speak to management; they don't speak to analysts; and they don't use the Internet. The Schlosses would rather trust their own analysis and their long-standing commitment to buying cheap stocks.
This approach leads them to focus almost exclusively on the published financial statements that public firms must produce each quarter. They start by looking at the balance sheet. Identifying "cheap" means comparing price with value. What generally brings a stock to the Schlosses' attention is that the price has fallen. They scrutinize the new lows list to find stocks that have come down in price.
When they find a cheap stock, they may start to buy even before they have completed their research. Schlosses believe that the only way really to know a security is to own it, so they sometimes stake out their initial position and then send for the financial statements. The market today moves so fast that they are almost forced to act quickly. This book is very good for anyone interested in the basic precepts of value investing basically, looking for good companies that are currently out of favor with the stock market.
Bruce gives a good summary of the traditional value approach as devised by Benjamin Graham and David Dodd, and also profiles a handful of more contemporary value investors Warren Buffett, Mario Gabell I read this book because I'm currently enrolled in Greenwald's Value Investing course and wanted to dig a bit deeper. Bruce gives a good summary of the traditional value approach as devised by Benjamin Graham and David Dodd, and also profiles a handful of more contemporary value investors Warren Buffett, Mario Gabelli, etc.
It was interesting to read about the various practical approaches to value investing to get beyond just theory. I may have preferred more if I was newer to the material. There are some really good case studies, and he clearly articulates concepts like Warren Buffett's "franchise businesses" and Mario Gabelli's idea of a "Private Market Value" using businesses like WD you have a can in your home and you may not even know it.
This book is good for anyone who wants a methodical framework for assessing the value of equity securities. A word of caution, however, the behavioral tantrums of "Mr. Market" make value investing much harder in practice! Tools like DCF suffer from a major problem - the need to predict future earnings which is difficult to predict even for the company stakeholders. Greenwald's method looks at what it takes to value a company if it wants to sustain without any growth.
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Again, we will find all these items listed on the income statements from the annual reports or k. Once we have both of those figures easily add them up and then divide them by the revenue from above, once we have that percentage of revenue, we can find the average of those numbers. Once we have both of those line items added up, we are going to add them back to the EBIT because the EBIT contains all expenses removed; we need to add them back.
Once we the operating expenses margin, we are going to find the low, medium, and high values of those percentages. And then, we will estimate growth adjustments that we will apply to the operating expenses percentage which will give us a boost to the EBIT. No one! But they are a necessary evil, and we need to account for them in our normalized earnings.
The next step is to normalize the tax rate by dividing the income tax expense by the income before taxes. Again we will find all of this information on the income statement. Once we have our effective tax rates for the five years, we take an average of those years and arrive at the rate of Not bad, but a little low for me, and with the upcoming election and the likelihood of a Democratic lead government, tax rates are going to climb. Step Four: Estimating Maintenance CapEx As company ages, its equipment such as computers, office space, and other properties start to wear down, and they need to be replaced.
Accouting for this normal wear and tear, we must estimate how much we think the company will spend on capex capital expenditures to continue with its current level of earnings. We can find these numbers from both the income statement and the cash flow statement. Once we have our numbers, we can then compare the capex to the revenue for our percentage of revenue. Next, we will find the low, medium, and high values of the percentages and then multiply those values by the sustainable revenues.
All of which will give us our maintenance capex numbers. Step Five: Calculate Adjusted Earnings Next to the last step, it is time to calculate our adjusted earnings for Intel. As mentioned above, we will use the TTM as the sustainable revenues for the formula. All the numbers will pull from the steps we followed above, for reference.
A few notes, once we input the sustainable revenues and multiply that by the normalized earnings percentage, we will arrive at our normalized EBIT. After all that gobbly goop is done, we arrive at our adjusted earnings for Intel. Have we got that? If you are confused, just follow the chart down and it should make much more sense. Step Six: Calculate Intrinsic Value Now that we have arrived at our adjusted earnings, we can calculate the intrinsic value based on our range of earnings.
The next value we need is the WACC to find our intrinsic value, for the formula I am going to use a range of numbers for the low, medium and high values to find a range of intrinsic values. To do this, we divide the adjusted earnings by the cost of capital or WACC; once that is done, it gives us the enterprise value of the company.
Remember that enterprise value contains items such as debt and cash, which we need to account for in the calculations. To do that, we add the cash and equivalents to the enterprise value, and then subtract the debt from the enterprise value to arrive at our equity value.
After all that is calculated, we have our equity value for Intel; we can then divide that equity by the shares outstanding from the TTM or last annual report to arrive at our intrinsic value. As a comparison to the current price of Nvidia, who is one of the tech world competitors of Intel. The cost of capital is an important figure in the formula, and for the above calculations, I did put a pretty conservative number; I have seen some calculations using a higher cost of capital, which drives down the value.
I like to use the more conservative numbers because it is closer to the lower beta, lower risk-free rates that are prevalent in the markets today. For those of you familiar with owner earnings, the structure is similar, and in fact, you can easily substitute that for the adjusted earnings, if that is more your cup of tea. The earnings power value formula is another way to determine the intrinsic value of a company.
The main difference from a discounted cash flow is the elimination of estimating growth rates, cost of capital, growth margins, and required investments. Use of this formula with a DCF and any other intrinsic valuation method you choose is another tool to use to help you find a margin of safety in every investment you make. Limitations of the Model Like any formula or model we use to find the intrinsic value of any company, the EPV has limitations.
Depreciation Adjustment We now add back the after-tax depreciation of the most recent year as it may not reflect the true economic cost of depreciation. Subtract Maintenance Capital Expenditure The next step is to deduct the maintenance capex which reflects the economic depreciation. We can calculate this by deducting growth capex from the capex in the cash flow statement. We divide this by cost of capital to arrive at the earnings power value of the firm. After deriving the EPV, we can compare it with the reproduction value.
We can also compare EPV per share with the market price. If market price is below EPV per share, then the stock may be undervalued. For a fair comparison, we must first subtract any corporate debt from the EPV, and add back any cash in excess of operating requirements. This number is then divided by the number of shares to arrive at EPV per share.
Note that there are no hard rules for arriving at the EPV or reproduction value. What Greenwald provides is a method along with his recommendations of how to evaluate each item. Each analyst will come up with a different valuation based on their understanding of the financial statements and the business.
It starts from the operating earnings and then make all the adjustments to calculate the EPV per share of the company. Users need to input some data in cells marked in Yellow. We have marked these cells in Green.
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