Graham - Appraisal method

[goponcho]

So reading the intelligent investor. Chapter 8 is security analysis for the lay person.
Graham talks about common stock analysis and coming up with a valuation:

Valuation = estimated future earnings x capitalisation factor

And the capitalisation factor is meant to account for a whole range of things pertaining to the quality of the company eg long term prospects, management, capital structure, dividends. Uses a cap factor ~8-20

This seems soo inaccurate to pick a cap factor? Does anyone use this method to value a company?

 

[dreamxite]

So reading the intelligent investor. Chapter 8 is security analysis for the lay person.
Graham talks about common stock analysis and coming up with a valuation:

Valuation = estimated future earnings x capitalisation factor

And the capitalisation factor is meant to account for a whole range of things pertaining to the quality of the company eg long term prospects, management, capital structure, dividends. Uses a cap factor ~8-20

This seems soo inaccurate to pick a cap factor? Does anyone use this method to value a company?

The cap factor is just a very general 'multiple', something like PE. But from my understanding not many ppl use that. Most people use PE (which is inaccurate), FCF multiples, EV/EBIT or DCF

 

[Value Collector]

This seems soo inaccurate to pick a cap factor? Does anyone use this method to value a company?

There is not a one size fits all cap factor or Pe you can use to value all businesses.

This is where your business skills come in, this is where guys like Buffett excel, because he understands businesses, not just accounting.

if you were buying into a local news paper, with a dwindling advertising base, you may not want to pay much more than the net assets or a Pe of 2 or 3. However if you are buying into a media company like Disney, with growing revenues, and a diverse asset base, and long life content, and high returns on equity, you would be willing to pay more than the net assets and probably accept a much higher Pe.

 

[luutzu]

So reading the intelligent investor. Chapter 8 is security analysis for the lay person.
Graham talks about common stock analysis and coming up with a valuation:

Valuation = estimated future earnings x capitalisation factor

And the capitalisation factor is meant to account for a whole range of things pertaining to the quality of the company eg long term prospects, management, capital structure, dividends. Uses a cap factor ~8-20

This seems soo inaccurate to pick a cap factor? Does anyone use this method to value a company?

Discussed elsewhere on AFS.

Use V = E x (8.5+2g).
Where E = current earnings, g = expected growth rate over next 7 to 10 years.

So if g is est. to be 2; V = E x (8.5+4)

You could use the E as simply the reported earning and use this for a quick estimate. But I'd take a closer look to see the earning power for E, and to also estimate the g potential.

It's simplistic and too easy and what not... but not really.
Very difficult to get the E estimate, got to do a lot of work to get a good est of the g over next decade.

Difficult in that you will need to really understand the business, the industry; know the company's financial performance and position/solvency etc. know its plans and competitors... But once you're familiar with the company and the business... it can be quite simple and quick.


The most useful thing out of it is, as Graham have said... you can play around with these two variables and can gauge the implication of your own estimate as well as that of the market through the current quoted price.

That is much more valuable than doing DCF where you just look really smart doing it, but won't have a clue as to what went right or what went wrong to repeat the right and avoid the wrongs.

And btw, I have an app for it

 

[tech/a]

Doing some work on F/A and T/A methods.

Are there any papers anyone knows of which
explores and tests this or any other F/A or
T/A method which has a quantified conclusion.

I have some from Dr Bruce Vanstone and a few others.
Adding to the collection.

Graham seems to be well followed in the F/A field.
Would love to get my hands on anything offered up
in his book the Intelligent Investor which has been
tested.

Thanks.

 

[ROE]

Doing some work on F/A and T/A methods.

Are there any papers anyone knows of which
explores and tests this or any other F/A or
T/A method which has a quantified conclusion.

I have some from Dr Bruce Vanstone and a few others.
Adding to the collection.

Graham seems to be well followed in the F/A field.
Would love to get my hands on anything offered up
in his book the Intelligent Investor which has been
tested.

Thanks.

Plenty of super investors use Graham principles but they all has their way of picking stock and adapt it to their style
but Graham principles is the foundation.

https://en.wikipedia.org/wiki/The_Superinvestors_of_Graham-and-Doddsville
most of these are old.

Seth A. Klarman current fairly young living legend using the same principle
https://en.wikipedia.org/wiki/Seth_Klarman

Aussie Kerr Neilson

I am sure there heaps more around

 

[craft]

The most useful thing out of it is, as Graham have said... you can play around with these two variables and can gauge the implication of your own estimate as well as that of the market through the current quoted price.

That is much more valuable than doing DCF where you just look really smart doing it, but won't have a clue as to what went right or what went wrong to repeat the right and avoid the wrongs.

The formula presented here doesn't allow you to explore the two most important aspects of determining what a business is worth. The cost of growth and the profitability of growth.

Acknowledging the limitations of DCF is smart - throwing it out because of the limitation is dumb - DCF more than any other approach forces you to think about the valuation drivers. Your assumptions on these drivers is the grounding for ongoing monitoring of how reality unfolds against your assumptions (against your story).

If you haven't got a 'full' story you haven't got a robust basis for trade management and if you haven't got trade management your down to relying on luck or prescient prediction. Luck and prediction are not my strong suits (actually I think they are a stupid basis for risking money) but I manage to scrap through with trade management.

 

[luutzu]

The formula presented here doesn't allow you to explore the two most important aspects of determining what a business is worth. The cost of growth and the profitability of growth.

Acknowledging the limitations of DCF is smart - throwing it out because of the limitation is dumb - DCF more than any other approach forces you to think about the valuation drivers. Your assumptions on these drivers is the grounding for ongoing monitoring of how reality unfolds against your assumptions (against your story).

If you haven't got a 'full' story you haven't got a robust basis for trade management and if you haven't got trade management your down to relying on luck or prescient prediction. Luck and prediction are not my strong suits (actually I think they are a stupid basis for risking money) but I manage to scrap through with trade management.

Luck and prediction is not your strong suits and you recommend DCF? Where people have to know interest rates, earnings, and market forces over the next 5 to 10 years?

 

[craft]

Luck and prediction is not your strong suits and you recommend DCF? Where people have to know interest rates, earnings, and market forces over the next 5 to 10 years?

You just don't get it do you! I guess some of the most important thing's can't be explained or at least I can't explain them.

 

[luutzu]

You just don't get it do you! I guess some of the most important thing's can't be explained or at least I can't explain them.

You do realise that a business is an organic entity right? One that live within constantly changing micro and macro environment. So the effect of one having on another, and another... you seriously think that can be predicted or estimated or know with the kind of certainty that a mathematical model require?

Take Australian retail - Lidl could come in and set up shop; Costco is already here and could expand; Walmart could take a bite; maybe eBay and some Chinese firm like Alibaba... What effect would that have on WOW if any of those scenario were to happen? Can they be predicted?

Since they can't reliably be predicted, to make assumptions and then plug it into a model doesn't make it any more accurate or reliable.

 

[craft]

you seriously think that can be predicted or estimated or know with the kind of certainty that a mathematical model require?

I think you don't get it because you don't listen. What you have imputed to me is the exact opposite of what I said - or at least what I think I said.

 

[luutzu]

I think you don't get it because you don't listen. What you have imputed to me is the exact opposite of what I said - or at least what I think I said.

Maybe I know what you really are saying without you actually having to say it

You think that there's some limitation with DCF yea? But it's not too bad that it should be ignored and discarded - just be aware of the issues and tweek or not believe it too much, or something like that.

Fair assumption of what you're saying?

I heard similar words from Damoran from NYU. He with a bunch of DCF models.

He said he can't value Apple because he love their product too much, that it'll be biased and if he add a bit higher or lower here and there, the model will be stuffed. Further, that whatever value the stock is, the model can make it happen. So be aware of that biases and try not to be bias.


eeermm... Did I just repeat that out loud? People actually think that that's wisdom?

Anyway, let's just put it down to me not knowing high finance.

 

[craft]

Maybe I know what you really are saying without you actually having to say it

Maybe you can't learn anything because you already know it all.

 

[galumay]

Maybe you can't learn anything because you already know it all.

That is awfully polite of you craft! My wife had to ask what on earth i was laughing like that for!

 

[luutzu]

Ah well, every village has its idiot.

 

[Joe Blow]

Just a reminder to keep this thread on topic and avoid conflict with others. There's some great discussion in this thread so far, so please keep it coming. Thanks!

 

[luutzu]

I thought the text below are pretty straight forward.

How do you read that, and keep reading a couple more examples he used to illustrate... How do you not understand how powerful it is.

I would understand you'd have a hard time if you're paid to look smart and need to look busy every day with interest rate forecasting and projections and street gossips... But otherwise... it's good to know who we're up against sometimes

 

[craft]

I thought the text below are pretty straight forward.

How do you read that, and keep reading a couple more examples he used to illustrate... How do you not understand how powerful it is.

I would understand you'd have a hard time if you're paid to look smart and need to look busy every day with interest rate forecasting and projections and street gossips... But otherwise... it's good to know who we're up against sometimes


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You of course would know that Graham latter adjusted his formula to include a constant of 4.4/risk free rate. From that you can determine that the constant of 8.5 infers an equity risk premium of 7.36%.

Do you think 7.36% is the right equity risk premium for the risk associated with holding shares? Do you think every company no matter what its size, operational leverage, earnings risk, financial structure etc etc. deserves the same equity risk premium?

According to the formula the P/E goes from 8.5 for a no growth company to a P/E of (2xgrowth rate + 8.5) to account for growth. Do you think all growth is of equal value? Do you think a company investing $4.90 to get $5 growth is equivalent to a company who only has to invest 50cents to get $5 growth? Because the formula implies there is no difference.

And as you use the original formula do you think the relative value of the risk free rate has no impact on equity prices?

 

[luutzu]

You of course would know that Graham latter adjusted his formula to include a constant of 4.4/risk free rate. From that you can determine that the constant of 8.5 infers an equity risk premium of 7.36%.

Do you think 7.36% is the right equity risk premium for the risk associated with holding shares? Do you think every company no matter what its size, operational leverage, earnings risk, financial structure etc etc. deserves the same equity risk premium?

According to the formula the P/E goes from 8.5 for a no growth company to a P/E of (2xgrowth rate + 8.5) to account for growth. Do you think all growth is of equal value? Do you think a company investing $4.90 to get $5 growth is equivalent to a company who only has to invest 50cents to get $5 growth? Because the formula implies there is no difference.

And as you use the original formula do you think the relative value of the risk free rate has no impact on equity prices?

I'm sure stuff like risk-premium, risk free and a bunch of Greek alphabet is really impressive to a lot of people. And quantifying risk/return to the nearest decimal will just blow their mind too... but I'm just too simple to think in foreign languages and too poor to pay for fluff like that.

Funny though... I've been reading "Distant Force" - the history of Teledyne. Henry Singleton and his executives bought over 100 companies and so far I haven't read them using DCF or risk-free rate or things you're talking about in buying companies. Don't know why or how they buy businesses without these stuff. Just simple PE ratio will do, apparently.


Yea... the value of a business will change if I predict future interest rates is X instead of Y. And remain at X for n year instead of at X for m year.

Then it will change again when next month I come back with forecast that it will be X+0.112.

Then change again because it's X+x2 and unemployment rate is blah instead of dah.

Do you buy business for real or do you just buy them on paper?

And do you pay for businesses at their precise price or do you only pay at a much lower price than the indicated estimate of approximate range of values?

What happen if you predict it costs X to X + $1million and then the CEO thought to spend $10,000 on a coffee machine?

---

Let's take a wild guess of how a good business with outstanding competitive position and able management works...

Say I'm precisely, perfectly spot on that it earns E. And I am able to know that the management is not asleep at the wheel, that they know how far they can go with prices and margin...

Then let say interest rate now goes up and costs of business is much much more than it was and E would be E-1 now.

What do you think management who's awake and know their business position would do? They'll probably raise the price or hedge or do whatever it is to bring an otherwise E-1 back to E. Why? Because any sane business person would when they could. And if the company's position mean they can't, then maybe you wouldn't invest in it in the first place.


What you and I, as minor investor and analyst... as people who have no clue and no influence on the business and its policies... You can think that E will be E-1 if i moves by 1% if you like; it just doesn't mean management policies will agree with that.


Anyway... keep doing what you're doing if it works for you.
I'm perfectly clueless about what I don't know so what harm could it do to anyone?

 

[craft]

Anyway... keep doing what you're doing if it works for you.

Ok Thanks.

I'm perfectly clueless about what I don't know so what harm could it do to anyone?

You know I have seen this so often, people dangerously half armed with a little knowledge, not least around the Roger Montgomery valuation formula saga, that it’s quite heart breaking but seemingly inevitable. Reality will mug you at some stage – I hope learning the hard way doesn’t cost you too much. (Actually I don’t care if it costs you heaps – It’s more a hope that people starting out don’t come under the misconception that you have a clue and get harmed by it)

Why is Fundamental Analysis always hijacked by Fundamentalists?

I'm considering this exercise in futility finished.