Investing style is a religion

[luutzu]

You are building a straw man.

Roger Wasn't saying "work out what it will be worth in the future and pay that price today", He was saying "work out what it will be worth in the future to see whether todays price represents good value and a margin of safety"

So if I can prove that I didn't made it up, Monty is wrong?

 

[Value Collector]

So if I can prove that I didn't made it up, Monty is wrong?

Make what up? The story about Roger buying car?

All I am trying to show you is that bond 3 in my example is worth a lot more than bond 2, and it’s worth today, no one is saying pay the full future value today, you are just making that up.

Rogers calculation is just showing that you could pay up to $385 for bond 3 and it would still deliver you a 10% return, so paying $285 wouldn’t be over paying, it would be securing a good deal, that will deliver a lot more than 10% return.

 

[luutzu]

Make what up? The story about Roger buying car?

If I can prove to you that his valuation method is what I said it is: that he count his earnings in the business as though it's not his earnings, hence the value of the business is worth more so he'd have to pay more.

So yea, like my car example.

 

[Value Collector]

If I can prove to you that his valuation method is what I said it is: that he count his earnings in the business as though it's not his earnings, hence the value of the business is worth more so he'd have to pay more.

So yea, like my car example.

I honestly don’t think you are understanding it.

Can you see in my simple example that bond 3 is worth more today than bond 2?

 

[luutzu]

Holy cow, I was wrong.

It's worst than I thought. Monty didn't use earnings, he uses Equity. So the more equity that's kept back, the more valuable the business is. Dudeeee.... that ain't right.

I mean, it's right that if I put more equity back its equity will be more. But why am I paying for it twice?


Monty says...

Woolworths is what "an extraordinary business looks like".
- Its NPAT was $295.5 in 2000, grew to $1835.7 in 2009.
- "BUT", he say, forget about that growth. It's not important.

Wait, say what? Why?

- There's something else that grew as well.

What is it Roger?

Equity.

Like QANTAS, Woolies owners have put in a heck of a lot more equity into the business over the past 10 years.

And that is good, how, Roger.

Because WOW had managed to improve its return rate on that equity. So that's good.

Fair enough. That's true if it is in fact true that ROE had improved and not decrease like that idiot Luu is saying [see chart below].

Roger: So in 2000, its ROE was 18.1% vs 26.9%. Phenomenal.

Luu: But dude, equity was $1627.6 then some $5Billion more equity was added. Sooo... but alright, higher is better than lower. Go on. Just mate, those $5B better not be mainly from new equity raised from me. 'cause that would be a different story altogether. But go on... Why is WOW a quality business.



Roger: Well, shareholders have also put in a lot more new equity from share issues. But... OK, its debt in 2000 was $432M and a decade later it's over $3 Billion. That's a big increase (shiet, I should really rehearse this video and picked another company. Wonder if I can dub over and retitled it as a so-so operation ).

But don't worry about it. There's plenty of cashflow, it's generating crazy amount of return on equity. So let's move on. It's a quality business, alright!

Luu: Alright Roger, alright mate. What's a billion or three between lenders and borrowers anyway. What does Munger knows when he and Buffett says "little or no debt". Go on.... It's an "extraordinary business" you were saying.

Roger: Now that you take my word for it. You're wondering "how do I, roger, decide when a stock is cheap."

Luu: "cheap". You're saying you're going to show us when, at what price, you're going to pay for it. Right?

Roger: Right. Stop interrupting Lutz. It's going to get a bit complicated here. There's some maths involved so pay attention.

Luu: Woo... It's not imaginary numbers level of math is it?

Roger: Mate, if you focus, by the time I'm done explaining it. It's going to be very easy.

Ready?

We're going to value its EQUITY.

Equity?

Yea, EQUITY.

Get Woolies Equity divided by its shares outstanding... Just simple fraction. You still with me?




So Equity is $5.98 per share.

Payout Ratio is 70cps.

ROE is NPAT/E = 27.5%.

Your required rate of return is 10%.

Now. Here's the tricky part, it's going to blow your mind my friend.




Luu: What's step 1 and what's the higher $36.94 there?

Roger: Step 1 is the value of WOW if all dividends are paid out to you, its owner.
Step 2 is the value if all the dividend is kept back.

Luu: So why the $20 difference there Roger?

Roger: Obvious isn't it. Too bloody obvious.

Think about it.

IF WOW hand you over its earnings, you're going to either blow it at the casino or take the kids to Disneyland.

Luu: Or I could invest it.

Roger: No, you're going to either waste it or put it in a low interest bearing account. A waste! You'll waste it!

Luu: Yea, you're right. What was I thinking. Go on.... Why is WOW worth $36.94 if earnings that belong to me are kept back inside Woolies for the management to play with. Why.

Roger: Obvious. For one, the more equity that's kept back the higher the equity will be. Then two, the magical effect of compounding... If more of your equity that's kept back are compounded, there will be more of it, so it's worth more.

Luu: Bloody genius. So that mean that if I save my earnings, put it back into the business it will grow the business. Then when I come to sell it later down the track it'll be worth more. Why can't I see that.

Roger: You're not me that's why. Takes brain power my friend.

Luu: So Monty. What price do I pay for WOW now?

Roger: Huh? You pay $36.94 for it. That's the value of WOW if all your woolies earnings are kept back.

Luu: Wait. You're telling me that if I buy woolies, decides to take all its annual earnings out as dividend and enjoy life. I get to pay

Roger: That's what it looks like doesn't it. But... but Woolies doesn't pay out all its earnings, only 70% so you'll....

Luu: Say no more my friend, say no more.

Btw, I have a $100M account. What say you take it off me for $130M even?

 

[Value Collector]

Holy cow, I was wrong.

It's worst than I thought. Monty didn't use earnings, he uses Equity. So the more equity that's kept back, the more valuable the business is. Dudeeee.... that ain't right.

I mean, it's right that if I put more equity back its equity will be more. But why am I paying for it twice?


Monty says...

Woolworths is what "an extraordinary business looks like".
- Its NPAT was $295.5 in 2000, grew to $1835.7 in 2009.
- "BUT", he say, forget about that growth. It's not important.

Wait, say what? Why?

- There's something else that grew as well.

What is it Roger?

Equity.

Like QANTAS, Woolies owners have put in a heck of a lot more equity into the business over the past 10 years.

And that is good, how, Roger.

Because WOW had managed to improve its return rate on that equity. So that's good.

Fair enough. That's true if it is in fact true that ROE had improved and not decrease like that idiot Luu is saying [see chart below].

Roger: So in 2000, its ROE was 18.1% vs 26.9%. Phenomenal.

Luu: But dude, equity was $1627.6 then some $5Billion more equity was added. Sooo... but alright, higher is better than lower. Go on. Just mate, those $5B better not be mainly from new equity raised from me. 'cause that would be a different story altogether. But go on... Why is WOW a quality business.

View attachment 87943

Roger: Well, shareholders have also put in a lot more new equity from share issues. But... OK, its debt in 2000 was $432M and a decade later it's over $3 Billion. That's a big increase (shiet, I should really rehearse this video and picked another company. Wonder if I can dub over and retitled it as a so-so operation ).

But don't worry about it. There's plenty of cashflow, it's generating crazy amount of return on equity. So let's move on. It's a quality business, alright!

Luu: Alright Roger, alright mate. What's a billion or three between lenders and borrowers anyway. What does Munger knows when he and Buffett says "little or no debt". Go on.... It's an "extraordinary business" you were saying.

Roger: Now that you take my word for it. You're wondering "how do I, roger, decide when a stock is cheap."

Luu: "cheap". You're saying you're going to show us when, at what price, you're going to pay for it. Right?

Roger: Right. Stop interrupting Lutz. It's going to get a bit complicated here. There's some maths involved so pay attention.

Luu: Woo... It's not imaginary numbers level of math is it?

Roger: Mate, if you focus, by the time I'm done explaining it. It's going to be very easy.

Ready?

We're going to value its EQUITY.

Equity?

Yea, EQUITY.

Get Woolies Equity divided by its shares outstanding... Just simple fraction. You still with me?

View attachment 87944


So Equity is $5.98 per share.

Payout Ratio is 70cps.

ROE is NPAT/E = 27.5%.

Your required rate of return is 10%.

Now. Here's the tricky part, it's going to blow your mind my friend.


View attachment 87945

Luu: What's step 1 and what's the higher $36.94 there?

Roger: Step 1 is the value of WOW if all dividends are paid out to you, its owner.
Step 2 is the value if all the dividend is kept back.

Luu: So why the $20 difference there Roger?

Roger: Obvious isn't it. Too bloody obvious.

Think about it.

IF WOW hand you over its earnings, you're going to either blow it at the casino or take the kids to Disneyland.

Luu: Or I could invest it.

Roger: No, you're going to either waste it or put it in a low interest bearing account. A waste! You'll waste it!

Luu: Yea, you're right. What was I thinking. Go on.... Why is WOW worth $36.94 if earnings that belong to me are kept back inside Woolies for the management to play with. Why.

Roger: Obvious. For one, the more equity that's kept back the higher the equity will be. Then two, the magical effect of compounding... If more of your equity that's kept back are compounded, there will be more of it, so it's worth more.

Luu: Bloody genius. So that mean that if I save my earnings, put it back into the business it will grow the business. Then when I come to sell it later down the track it'll be worth more. Why can't I see that.

Roger: You're not me that's why. Takes brain power my friend.

Luu: So Monty. What price do I pay for WOW now?

Roger: Huh? You pay $36.94 for it. That's the value of WOW if all your woolies earnings are kept back.

Luu: Wait. You're telling me that if I buy woolies, decides to take all its annual earnings out as dividend and enjoy life. I get to pay

Roger: That's what it looks like doesn't it. But... but Woolies doesn't pay out all its earnings, only 70% so you'll....

Luu: Say no more my friend, say no more.

Btw, I have a $100M account. What say you take it off me for $130M even?

I can’t believe how bad you are misreading the situation, maybe on purpose I don’t know.

Dude, when you buy a share what are you buying?

You are buying the equity of a business, another name for shares is literally “equities”.

Do you understand the whole concept of return on equity?

I am not sure why you aren’t understanding that a company that can generate high returns on equity is worth more than one that earns low returns on equity.

And I don’t understand why you can’t see that a company that has the ability to retain earnings at high rates of return is worth more than one that can’t.

You aren’t paying for equity twice, I have no idea why you are saying that,

You are valuing the company at a higher value because it has the ability to retain earnings and deploy them at 25%.

 

[So_Cynical]

Buy whats cheap and sell it for more than you paid for it - call it whatever you want.

Simples.

 

[luutzu]

I can’t believe how bad you are misreading the situation, maybe on purpose I don’t know.

Dude, when you buy a share what are you buying?

You are buying the equity of a business, another name for shares is literally “equities”.

Do you understand the whole concept of return on equity?

I am not sure why you aren’t understanding that a company that can generate high returns on equity is worth more than one that earns low returns on equity.

And I don’t understand why you can’t see that a company that has the ability to retain earnings at high rates of return is worth more than one that can’t.

You aren’t paying for equity twice, I have no idea why you are saying that,

You are valuing the company at a higher value because it has the ability to retain earnings and deploy them at 25%.

When you buy a company, you also buy its debt, liabilities as well as its equities.

Unless, of course, your deal is that the offer price excludes the debt and obligations. But that condition is not possible when you're buying shares or stocks or a fraction of the business.

that is, when you make a stock purchase you're buying a fraction of the entire enterprise.


Dude, like I said before, I understand that a business with higher ROE is worth more. If it retain its earnings and reinvested it, it will be worth more [all else being equal].

But unless those retained and reinvested earnings are already made [past tense there]... then I should not be paying for those future value and benefits my retained earning made possible. Because those future I've bought and paid for.


Another example...

Say I bought an ATM. It dispenses $1000 a day, everyday.

Why is the ATM worth any more or less to me as its new owner if I were to spend that $1000 daily earning or put it back into the ATM?

I mean, I know the ATM will have more money [worth more] if I put back the $1000. And that's the way it should be. But that $1000 retain is not the previous owner's cash to give. I mean, the only reason there's more cash in that ATM for me now is because I saved up, make sacrifices by putting the cash back into it.

So yes, if I were to later resell it, it will be worth more. But that's for me to gain from, not for me to pay for now.

i.e the reason I buy and paid the price I paid for that ATM is because it gives me $1000 a day. [similar to high ROE, low debt, quality business etc.].

That I've done the maths, kick the tyres and are confident that the ATM will dispense $1000 a day... hence I wrote the cheque etc. etc.

to then say that... Luu, if you were to not spend that daily cash but instead reinvested it, then you of course need to pay a higher for it now because it'll be worth more.

come on man, that's pretty straight forward and I went back over Monty's video I'm pretty definite I understand what he's saying.


Anyway, his analysis is wrong and his valuation of WOW isn't "cheap" either.

 

[luutzu]

Here's why WOW is not "a great business".

It's so-so. Have its moment. Not losing money.

But not WOW, incredible.





Compare that to WalMart



Earnings paid out as dividend and also retained.

Some equity raising but that pale in comparison to the growth in profit, operating cash. Just look at the amount of dividend in 2014 vs the total equity owners contributed.

Not saying you can find a WalMart quality operation everyday. Or if you find it you can get it for a reasonable price.

Just saying that WOW is so-so. Not one you'd want to pick as exmplary of awesomeness.

 

[cynic]

I suspect that there has been some mathematical sleight of hand in the assessment of the bonds from the 3 bond hypothetical.

If one were to buy bond 2, in multiples of 8, then half the 25% return (i.e. $100) could be reinvested in that same bond specification, thereby rendering it the higher perfoming of the 3 investment choices!!!

 

[gaius]

Where do I sign?


Put another way....

Monty goes to the car dealership. He like this Mustang that's selling for $100K.

So he try to figure out what a $100K car is worth after he bought it.

He said... it's $100K now, but wait til I reskin it with fibreglass; then gold plate that fibre. Change the rim, put in a double turbo. Some extra dark tint.

Oh boy, it's going to be worth at least $150K, easy.

Then he goes ahead and pay $130K for it after a tough negotiation.


That would be pretty silly of Monty right?


It's the same in his valuation.

So he figured that WOW earns $X. From that earning stream, it should be worth $10X, for example.

But then he figured that if he, as its new owner, were to keep back future earning streams (from himself), it is worth a lot more.

Of course it'll be worth a lot more, but that's the worth/value he own... not the owned by the current owner that's selling it to him.

Of course you could argue that Monty is silly for offering $130K instead of $100K, but without the $150K calculation of including future value, Monty wouldn't know of such opportunity at all.

You could keep hitting on 'why not offer $100K', but that doesn't prove the logic behind the $150K valuation methodology is wrong.

 

[gaius]

But unless those retained and reinvested earnings are already made [past tense there]... then I should not be paying for those future value and benefits my retained earning made possible. Because those future I've bought and paid for.

Let me get this straight. Are you suggesting that you want to buy shares from yourself?? and wondering why you should pay more for your own shares because you have already bought and paid for your shares??

Well, I rest my case. Yes, it doesn't make sense. Although the value of your shares increased, you don't have to pay more for your own shares.

 

[Value Hunter]

Luutzu the concept of a valuation changing based on the dividend payout ratio is very simple. How many investors can compound their capital at 20% plus per annum? The answer is not many.

Therefore if you are an investor who is able to generate for example 15% per annum compound returns (sill a pretty good investor) over the long term and you invest in a company that is able to generate a 23% return on incremental equity (i.e on retained earnings). If you can only generate 15% return by investing the dividends the company pays you, whereas by keeping the money the company can generate a 23% return, isn't the company more valuable to you if it retains all of its earnings?

To put it into example if company A generates a 23% return and reinvests all of its earnings. Let's assume you buy the company at book value. Your return will be 23% per annum compounded. Now lets assume company B also earns a 23% return and you pay the same price of book value for company. If company B pays 100% of its earnings to you as a dividend and then you go and invest the dividends somewhere else and get 15% per annum, your compounded return is no longer 23% per annum. Your compounded annual return is now somewhere in between the two figures of 15% and 23%. Therefore in this scenario company A is worth more to you than company B and thus deserves a higher valuation.

 

[cynic]

Luutzu the concept of a valuation changing based on the dividend payout ratio is very simple. How many investors can compound their capital at 20% plus per annum? The answer is not many.

Therefore if you are an investor who is able to generate for example 15% per annum compound returns (sill a pretty good investor) over the long term and you invest in a company that is able to generate a 23% return on incremental equity (i.e on retained earnings). If you can only generate 15% return by investing the dividends the company pays you, whereas by keeping the money the company can generate a 23% return, isn't the company more valuable to you if it retains all of its earnings?

To put it into example if company A generates a 23% return and reinvests all of its earnings. Let's assume you buy the company at book value. Your return will be 23% per annum compounded. Now lets assume company B also earns a 23% return and you pay the same price of book value for company. If company B pays 100% of its earnings to you as a dividend and then you go and invest the dividends somewhere else and get 15% per annum, your compounded return is no longer 23% per annum. Your compounded annual return is now somewhere in between the two figures of 15% and 23%. Therefore in this scenario company A is worth more to you than company B and thus deserves a higher valuation.

Momentarily setting aside the subjectivity of tax considerations, why not just purchase company B and then use the issued dividends to purchase more of company B?

 

[Value Hunter]

Cynic in the real world share prices do not stay the same. So by the time you get paid your dividend the share price may have gone up (lets say it got re-rated) and you may for example be 2 times book value instead of the original 1 times book value so you are no longer getting the same return by buying at the higher price.

 

[cynic]

Cynic in the real world share prices do not stay the same. So by the time you get paid your dividend the share price may have gone up (lets say it got re-rated) and you may for example be 2 times book value instead of the original 1 times book value so you are no longer getting the same return by buying at the higher price.

Share prices do typically fluctuate in both directions in the real world!

So it now seems that the justification for higher valuation, is premised upon a presumption that these 23% yields , at the same, or lesser, book value, have little likelihood of future availability!

This would seem to suggest that present pricing has somehow become a fortuitous, never to be repeated anomaly!

 

[Value Hunter]

I'm just telling you how it works in the real world. Few stocks stay substantially undervalued for an extended period (typically oscillating between undervaluation and overvaluation). To assume that an attractive price to buy more shares will fortuitously be available every single time you are paid a dividend over a period of many years is quite a stretch. Sure at certain times the price will be attractive but its not going to happen consistently.

There is a reason why companies that have a high return on equity coupled with being able to reinvest a decent portion of their earnings have been the stocks with the highest total returns. Aside from the occasional speccy junior mining or biotech stock the real big long term winners have been your companies like CSl, Cochlear, Seek, Resmed, Flight Centre, Credit Corp, McMillan Shakespeare, etc. Notice how none of these companies have even close to a 100% payout ratio. Can you name a concrete example of anybody in actual practice buying a Telstra type of pure income (bond like) stock and getting rich from reinvesting the dividends into more shares of the same company? Its just not the way the real world works.

I don't even know why there is a discussion around a concept so basic.

 

[luutzu]

Let me get this straight. Are you suggesting that you want to buy shares from yourself?? and wondering why you should pay more for your own shares because you have already bought and paid for your shares??

Well, I rest my case. Yes, it doesn't make sense. Although the value of your shares increased, you don't have to pay more for your own shares.

The way Monty is valuing WOW, yes, he is essentially buying it from himself today when he have yet to own it.

 

[cynic]

I'm just telling you how it works in the real world. Few stocks stay substantially undervalued for an extended period (typically oscillating between undervaluation and overvaluation). To assume that an attractive price to buy more shares will fortuitously be available every single time you are paid a dividend over a period of many years is quite a stretch. Sure at certain times the price will be attractive but its not going to happen consistently.
....

That assumption is no more unreasonable than the presumption that the healthy yields, currently available, wiĺl subsequently become unavailable.

I don't even know why there is a discussion around a concept so basic.

Because, consequent to unspecified presumptions, it is being misunderstood, at a very basic level!

 

[Value Hunter]

generally speaking a quality "growth" stock (e.g. Blackmores, CSl, etc) will typically trade on a much higher price to earnings ratio then a quality "income" stock. There is a reason for this and I am not sure why some people here struggle to grasp it.

Most share market investors in the long-term will be lucky to even get a low double digit (net) return from the sharemarket. Therefore for the vast majority of investors a company that can reinvest a portion of its earnings at high returns (e.g. returns north of 20%) will (generally speaking) be worth more (and will thus be typically valued using a higher price to earnings ratio) than a comparable company that pays out most of its profits as dividend. If A2 milk or Blackmores suddenly decided to stop growing and pay out 100% of their earnings as a dividend their share prices (and price to earnings ratios) would rightly plummet.