Students of Roger Montgomery's (Buffett's) intrinsic valuation method

[Macros]

It is a false assumption that any business or earnings go to infinity.

Research their resources and exploration potential. You might say their mine life is limited, however as I see it, it depends on the quality of management which can increase existing resources via exploration or acquisition. It is dynamic.

Much better to think about their production profile over the next 10 years. Anything beyond that is unknown and I'd argue the same for most businesses. For example, Medusa currently produces 100k oz pa but will be increasing production to 400k oz pa over the next few years. They will not do so unless they know that it is reasonably sustainable.

Many in the undustry recognize that most gold producers are very cheap right now (US based commentary). I use IV to gauge the potential, but they are so cheap it doesn't matter what the exact number is.

Factors to consider include free cash flow, production costs and control, good mine life, management quality, expansion potential and direction of gold price.

Also, IVs can gauge companies like BHP and other single sector producers. No reason to think it does not apply to this sector. If they look cheap, it is because they generally are. The major risk lies in cost control and sufficient mine life.

 

[tinhat]

After having been away on holidays, mainly out of mobile/wifi signal, I've been catching up on things since I've been back (for two weeks now). Just now, I'm listening to Roger on Switzer via a embedded utube video at switzer.com. The date of the entry on the switzer website is 23/09/11 but these videos tend to get posted onto the Switzer website one or two days after television broadcast.

Anyway...

What does Roger open with.... oh, well, we were 90% cash in April. Really, is that what he was saying back then?

I don't follow the guy that much in his day to day gabbing. I bought his book and found it very useful - and not from the point of view of finding the magic formula pages, but more for his insight and examples about analysing fundamentals. Whatever I gave him for the book - $20 or $50 or what ever it was - fair enough, but after than... I'll just listen and watch thank you.

 

[Tysonboss1]

. The major risk lies in cost control and sufficient mine life.

Add to that revenue risk, they like all commodity companies rely on the sale price of the resource their earth moving operation is recovering.

If I were looking to buy a gold producer ( which I am not ), then I would want it to be one of the lowest cost producers with a mine life extendiing past 20 years minimum, almost no debt, and a pipeline of high quality projects, and it must be selling at a price that still has a margin of safty given a historical average price of the commodity.

That is the minimum I need for any single commodity producer.

The only exposure to gold I have is through BHP, which I am much happier with, the portfolio of low cost long life assets, diversified by commodity, Low debt and expansion project pipeline, and managements firm shareholder return focus gives it the edge in my veiw.

 

[Macros]

Add to that revenue risk, they like all commodity companies rely on the sale price of the resource their earth moving operation is recovering.

Generally all companies rely on the sale price of their products. Neither price nor demand is not set in stone. Therefore it is up to the investor to determine these risk factors for any business over their investment timeframe.

The only exposure to gold I have is through BHP, which I am much happier with, the portfolio of low cost long life assets, diversified by commodity, Low debt and expansion project pipeline, and managements firm shareholder return focus gives it the edge in my veiw.

It is a matter of perspective. Whilst I think BHP is a good business, majority of profits come from iron ore. Therefore when investing in BHP you are going (approximately) 50% iron ore and 50% diversified minerals. I'm bearish on iron ore and wouldn't personally invest in the 50% iron ore business therefore don't invest in BHP. If I could invest in the 50% diversified minerals business of BHP, I'd be a lot more interested.

 

[GG999]

There are some things that I'm not sure about
One is that P/E isn't important
Another is that companies with high ROE are automatically given a higher Intrinsic Value if they retain more of their profits.

Although I realize that high ROE and a high Price to Book usually go together, it would seem to me that it's more accurate to say that it is when a company has a high P/B that (at least on paper) it appears better to have earnings reinvested.

Both in Roger's book and in this pdf there is discussion on how a low ROE company that retains profits actually gives a lower IRR (Investors Rate of Return)

In all the examples, ROE is fixed, and so is P/E (only used to determine the change in share price)
But if these are fixed then so is the P/B, and in the case of the low ROE company the P/B = 0.5

The low ROE company has a P/E of 10 and so if all earnings are paid out as dividends, the IRR is 10%. So in this case the P/E must be very important to an investor because it tells him or her what the earnings yield. They might know nothing about ROE or equity - but they would be interested in the fact that for each dollar they spent on shares they get back 10 cents in dividends due to P/E =10

When the low ROE company with P/B = 0.5 keeps 10 cents of earnings and the P/B is fixed then it only increases share price by 5 cents, leading to IRR = 5%. Another way of looking at it is the investor simply gets the same as the companies ROE.


In the case of the high ROE company the IRR is again 10% because whatever the ROE, the investor earns the earnings yield only.
But retained, the investor earns the same as the ROE which is much higher. But again I think the critical factor is the P/B which is 2.5 in this case. For every 10 cents retained the price would go up 25 cents.

If P/B = 1 then it wouldn't matter what the ROE is, one wouldn't be able to show (again, at least on paper) that it is better to retain than have dividends.

I'm not used to talking about these sorts of things and so I suspect this might not make much sense to most people but those people that understand these things better might like to point out what I'm not understanding!

 

[robusta]

The new valuation tool Skaffold is released. As handy as it may be I think I might save my money for two reasons.

1) I enjoy researching stocks myself.

2) Not so sure about the future valuations based on analyst forecasts.

I would be interested to hear any other opinions.

 

[Tysonboss1]

1) I enjoy researching stocks myself.

2) Not so sure about the future valuations based on analyst forecasts.

.

Wise move, I try and avoid things that promise to give me fish, and I spend time learning to fish.

 

[odds-on]

The new valuation tool Skaffold is released. As handy as it may be I think I might save my money for two reasons.

1) I enjoy researching stocks myself.

2) Not so sure about the future valuations based on analyst forecasts.

I would be interested to hear any other opinions.

I will not be buying Skaffold. However, i reckon a private investor could earn an annual ROI of between 12 to 20% by buying a dozen or so shares in businesses that have a consistently high MQR. I am sure this is achieveable as long as the private investor is disciplined about purchasing with a safety margin of at least 15%. This will be a purely mechanical investing approach similar to magic formula or graham criteria and i bet it works in the long term.

How long do you think Skaffold will be around for? I reckon a max of 3 years. RM will move onto something else.

Cheers

Oddson

 

[Vargulf]

Hey all,
I finished reading Value.able for the 2nd time a week or two ago. I'm geared up with all the valuation tools to start a 'buffet valuation' of my watchlist to hopefully take advantage of this new share market slump. My problem is I use Commsec and its valuation is useless. I can't find forecast ROE and many other current ratios aren't available. I suspect many of the figures aren't right either. Can anyone recommend a free analysis tool that will give me accurate numbers for valuation?
2nded on Skaffold though. It's to much for the current amount I have invested in stocks. Plus I look forward to doing my own sums. If it was 4 or 5 hundred I would consider it.

In response to GG99,
I think your missing the point. For sure non value investors use P/B and P/E, let them and let them lose money. But both are price related which doesn't equate to what value investors look at for value. We shouldn't give a hoot what a low ROE businesses price related equations tell because we wouldn't be looking at those businesses. For high ROE businesses, sure I 'glance at P/B where Roger doesn't but it true what he says that it is a fairly obsolete ratio. If they had to sell their assets they would be in liquidation and the asset values in their books wouldn't be anywhere close to the sell off prices. And a high ROE business is going to be returning rates far in advance of the book values. The P/B doesn't tell value investors anything they want to know as I see it.

 

[Julia]

However, i reckon a private investor could earn an annual ROI of between 12 to 20% by buying a dozen or so shares in businesses that have a consistently high MQR. I am sure this is achieveable as long as the private investor is disciplined about purchasing with a safety margin of at least 15%.

Have you actually achieved the above with real money?

 

[Ves]

That sounds too good to be true to be honest. Even if you out-perform the market by 3% you're still relying on some heavy "bull" years to out-way the down years.

The best value investors (ie Buffet and friends) achieve a long-term 20% average per year. Why would a program achieve around 15%?

 

[odds-on]

Have you actually achieved the above with real money?

No for the obvious reason that RM has only just released the Skaffold service. I understand that Skaffold allows you to look back at MQR ratings over many years. You would need to research for the companies wih consistently high MQR over many years then apply a disciplined mechanical investing strategy.

Cheers

Oddson

 

[odds-on]

That sounds too good to be true to be honest. Even if you out-perform the market by 3% you're still relying on some heavy "bull" years to out-way the down years.

The best value investors (ie Buffet and friends) achieve a long-term 20% average per year. Why would a program achieve around 15%?

I am not suggesting that the progam will achieve around 15%, all i am suggesting is that if a private investor uses the program as a research tool and only buys shares in businesses that have had a consistently high MQR for many years with a reasonable safety margin (15%) they will do nicely and get returns between 12 and 20%. The private investor would need to disciplined with the mechanical investing strategy.

Have you read the Little Book that Beats the Market?
Or googled some of the graham criteria back tests?
Or read about the piotroski screen?

Skaffold can be used to find high quality businesses that you buy at a little bit of a discount. Buying a dozen should cover off all business failure/industry downturn/currency etc risk.

Cheers

Oddson

 

[RandR]

Skaffold can be used to find high quality businesses that you buy at a little bit of a discount. Buying a dozen should cover off all business failure/industry downturn/currency etc risk.

Cheers

Oddson

Thats great ... but I can do the same thing just using comsec's advanced search function ... for free.

I am not suggesting that the progam will achieve around 15%, all i am suggesting is that if a private investor uses the program as a research tool and only buys shares in businesses that have had a consistently high MQR for many years with a reasonable safety margin (15%) they will do nicely and get returns between 12 and 20%. The private investor would need to disciplined with the mechanical investing strategy.

You really should substantiate any claims about returns before blindly decreeing it with some cold hard evidence ...

On Roger Montgomery's blog they have an MQR A1 portfolio, What returns has it achieved this year ?

Roger Montgomery talks in his book so much about the importance of an investor understanding the process of value investing, selling a black box valuation program is sort of an anti-thesis to what a fair bit of his book was about imo.

I might ask, how does it differ from Clime's valuation program ? (roger's previous valuation program) Does anybody know ?

 

[odds-on]

Thats great ... but I can do the same thing just using comsec's advanced search function ... for free.



You really should substantiate any claims about returns before blindly decreeing it with some cold hard evidence ...

On Roger Montgomery's blog they have an MQR A1 portfolio, What returns has it achieved this year ?

Roger Montgomery talks in his book so much about the importance of an investor understanding the process of value investing, selling a black box valuation program is sort of an anti-thesis to what a fair bit of his book was about imo.

I might ask, how does it differ from Clime's valuation program ? (roger's previous valuation program) Does anybody know ?

There are a range of free products that can be used to search for shares. It all depends on how much work you want to put in, the accuracy of the data and your ability to analyse the data. I know my limitations.

There is no hard evidence. RM has just released Skaffold. I am not going to buy it. Maybe somebody who does buy it can do some back tests. Sure it will not make 30% ROI every year but i bet if you use Skaffold to create a 'magic formula' portfolio you will get at 12% ROI per annum over the 5 years. It is only an idea. DYOR.

Cheers

Oddson

 

[robusta]

Hey all,
I finished reading Value.able for the 2nd time a week or two ago. I'm geared up with all the valuation tools to start a 'buffet valuation' of my watchlist to hopefully take advantage of this new share market slump. My problem is I use Commsec and its valuation is useless. I can't find forecast ROE and many other current ratios aren't available.

I am a big fan of Value.able as well but I do have issues with the future valuation sections. From my understanding Buffet does not use analyst forecasts at all, he simply comes up with a current IV and then sits back and thinks about the future prospects of the business.
Part of the selling point of Skaffold is the 'professional' analyst forecast used for every asx listed company, is it Morningstar?

I suspect many of the figures aren't right either. Can anyone recommend a free analysis tool that will give me accurate numbers for valuation?

Annual reports.

2nded on Skaffold though. It's to much for the current amount I have invested in stocks. Plus I look forward to doing my own sums. If it was 4 or 5 hundred I would consider it.

Probably good for creating a watchlist IMO, but still a lot of research before I would invest.

 

[Vargulf]

Yeh ok after a whole day on it I can use Commsecs data to find present IV. But future IV is not nearly as easy to find as suggested in Rogies book. (After a day searching I feel like bitch slapping him, if he hadn't been so helpful already;-)

So can someone please suggest a analyst you can subscribe to that will cover the forecast Equity Per Share, Next years ROE and perhaps the forecaste EPS and DPS (I'm not sure about Commsecs)? As long as it doesn't cost to much because currently I have around 20 stocks on watch and I want to narrow them down.

Beginning equity I gather I can get from the companies Annual Statements once I have narrowed down the list abit.

By the way Robusta,
I've been reading other Buffet books and the man plays his cards close to his chest. Realistically I don't think many know if he has a future val formula. There's no question present IV is more important. The future IV can just help get you into the right ball park once you have chosen a strong competitive adv company with stable and high cashflow and ROE. Nowhere does R.M suggest Buffet uses the same forecast of IV he is selling. Nor do I think he would, Buffets a genius he wouldn't trust analysts unless they were his, he prob does it himself. I'm no Buffet tho lol. I'm happy to outsource.

 

[GG999]

In response to GG99,
I think your missing the point. For sure non value investors use P/B and P/E, let them and let them lose money. But both are price related which doesn't equate to what value investors look at for value. We shouldn't give a hoot what a low ROE businesses price related equations tell because we wouldn't be looking at those businesses. For high ROE businesses, sure I 'glance at P/B where Roger doesn't but it true what he says that it is a fairly obsolete ratio. If they had to sell their assets they would be in liquidation and the asset values in their books wouldn't be anywhere close to the sell off prices. And a high ROE business is going to be returning rates far in advance of the book values. The P/B doesn't tell value investors anything they want to know as I see it.

Thanks Vargulf
To ask in a different way - since you've read the book and understood the case that was made that a company with a high ROE should retain earnings whereas a company with low ROE should pay it all out as dividends -

could this be shown if both companies had P/B =1 ?

 

[Tysonboss1]

Even with a price to book of 1,

It basically comes back to how much the company can earn on retained profits.

Eg, if a company can only earn 5% on the money it retains then it is not worth them retaining it they should return those profits to the owners,

However if the company has options to invest $$$ and earn 20%, then the company should retain earnings and invest them rather than pay dividends

 

[craft]

In response to GG99,
I think your missing the point. For sure non value investors use P/B and P/E, let them and let them lose money. But both are price related which doesn't equate to what value investors look at for value. We shouldn't give a hoot what a low ROE businesses price related equations tell because we wouldn't be looking at those businesses. For high ROE businesses, sure I 'glance at P/B where Roger doesn't but it true what he says that it is a fairly obsolete ratio. If they had to sell their assets they would be in liquidation and the asset values in their books wouldn't be anywhere close to the sell off prices. And a high ROE business is going to be returning rates far in advance of the book values. The P/B doesn't tell value investors anything they want to know as I see it.

A Business can have a high ROE because:
1. The business has had good luck;
2. The business has been more operationally efficient than its competitors;
3. The business has a temporary competitive advantage;
4. The business’s earnings are high because the industry or the economy is at a cyclical peak;
5. The business is in a new industry and competitors have only started to enter the industry.
6. The business has a sustainable competitive advantage

The problem is that most of these reasons are likely to be unsustainable. This is because:
1. The business’s good luck can easily run out;
2. Competitors can become more operationally efficient, or the business becomes less efficient;
3. The business’s temporary competitive advantage disappears;
4. The business’s earnings falls because the industry, or economic, cycle turns; or,
5. Competitors enter the new industry.

Only a business with a sustainable competitive advantage can sustain a high ROE long term.

To value all occurrences of high ROE the same is illogical because the high ROE’s will persevere for different time periods depending on what underlies the current high rate.


Changes to ROE is more important to a valuation then just about any other variable. Mistaking a high ROE as sustainable when it is not can put your valuation out by many multiples. This is the risk of buying high multiple P/B stocks.

If you are going to pay any more than the replacement cost of a business assets you had better be pretty sure it has a sustainable competitive advantage.

Once an understanding of the business competitive advantage is made The Price/Book ratio is probably the most useful of the superficial ratios IMO, though it is often distorted by Goodwill so Price/NTA is better.

Thanks Vargulf
To ask in a different way - since you've read the book and understood the case that was made that a company with a high ROE should retain earnings whereas a company with low ROE should pay it all out as dividends -

could this be shown if both companies had P/B =1 ?

GG999

As you obviously understand - there can be no difference. Some however will continue to tell you black is white.

Your observation is the logic behind Buffet stating that that each dollar of retained earnings must be translated into at least one dollar of market value. This only happens where the P/B is 1 or greater. Only when a business invests new funds at a rate higher than the discount rate applied by the market will a P/B premium be awarded for those new investments.

To make the assumption that the market will automatically apply the historical P/B ratio to future incremental capital deployments is very dangerous. All new investments have to be considered on their own merits.