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

[drlog]

With JBH dividends for the prior financial year are paid in Sept the following financial year. Cashflow statements reflects the dividend paid date so you will find that the total dividend paid out in cash terms for FY10 was (29c + 33c) x 108m shares = ~$67m.

For valuation purpose however the payout ratio is (33c + 33c) x 108m shares / earnings.

Thanks for the insight. Now here is another question: Why not use DPS / EPS? It is easy to show that it is mathematically equivalent to (DPS) x shares / NPAT by dividing by shares.

 

[skc]

Thanks for the insight. Now here is another question: Why not use DPS / EPS? It is easy to show that it is mathematically equivalent to (DPS) x shares / NPAT by dividing by shares.

You've said it. It's the same.

 

[Billyb]

For those of you interested in finding out the full formula behind Montgomery's Valuable and Richard Simmon's explained and fully detailed, see the link in my signature of this post.

Quite interesting explanation that goes on to take the formula apart and explain the logic behind it.

You can then see the pro's and con's to that specific formula as a method of filtering.

DeCal

Thank you for that post DeCal. Like you, I think it's important to understand the formula if we are going to use it to do our research, otherwise we might as well let our brokers choose all our stocks.

There's a few insights I've learned. By thinking of this a little bit differently, I now understand it better for myself. I thought I'd post my thought process, all this is my personal opinion of course, and may be wrong, so feel free to correct me. ALso, I've ordered value.able but yet to read it.

IMO, Roger's formula is nothing more than a prediction of where the share price will go. How can it be a true valuation of a company? The value of anything is how much you have to pay for it if you wanted it now or at a certain point in time, i.e the price that someone in the market will sell it to you for. It depends on a lot of factors -supply and demand, mood, business performance etc. But ultimately, it is determined by what people are willing to buy the thing for. The value of ORL is exactly the price it is right now, not Roger's intrinsic value calculation now or for 2 years time away, since these are not values, they are predictions of value. However, his prediction is based on the premise and assumption that the market will be [/reasonable and predictable/] and will eventually pay a price for ORL that is in proportion to it's business performance, particular equity factors, in the long term. I haven't been doing shares for long, but my understanding is that usually, this is what will happen, which is why Roger is usually right.

Roger talks a lot about all the other factors besides ROE and earnings that are important in a successful company, but none of these factors are in his formula, because it's impossible to quantify everything. Hence I think it is easy to miss the rest of his message, the 'wood for the trees', which is that other factors (management, debt, competitive advantage, cashflow etc) are as important or more important than the calculation itself.

The other thing is that Roger's experience allows him to to perform these calculations in a more accurate way than most. He know what RR is most suitable, he knows how to read a business better than most, he has access to paid forecasts and raw data from various brokers, and possibly the most important thing he has is time. So his calculations are less likely to be misinterpreted by himself, and he is more likely to come up with better predictions that the average folk. We have seen how his formula can come up with some very variable figures, just ye changing the numbers slightly. Experience is the key to knowing what numbers to use.

My 2 cents.

 

[Intrinsic Value]

Thank you for that post DeCal. Like you, I think it's important to understand the formula if we are going to use it to do our research, otherwise we might as well let our brokers choose all our stocks.

There's a few insights I've learned. By thinking of this a little bit differently, I now understand it better for myself. I thought I'd post my thought process, all this is my personal opinion of course, and may be wrong, so feel free to correct me. ALso, I've ordered value.able but yet to read it.

IMO, Roger's formula is nothing more than a prediction of where the share price will go. How can it be a true valuation of a company? The value of anything is how much you have to pay for it if you wanted it now or at a certain point in time, i.e the price that someone in the market will sell it to you for. It depends on a lot of factors -supply and demand, mood, business performance etc. But ultimately, it is determined by what people are willing to buy the thing for. The value of ORL is exactly the price it is right now, not Roger's intrinsic value calculation now or for 2 years time away, since these are not values, they are predictions of value. However, his prediction is based on the premise and assumption that the market will be [/reasonable and predictable/] and will eventually pay a price for ORL that is in proportion to it's business performance, particular equity factors, in the long term. I haven't been doing shares for long, but my understanding is that usually, this is what will happen, which is why Roger is usually right.

Roger talks a lot about all the other factors besides ROE and earnings that are important in a successful company, but none of these factors are in his formula, because it's impossible to quantify everything. Hence I think it is easy to miss the rest of his message, the 'wood for the trees', which is that other factors (management, debt, competitive advantage, cashflow etc) are as important or more important than the calculation itself.

The other thing is that Roger's experience allows him to to perform these calculations in a more accurate way than most. He know what RR is most suitable, he knows how to read a business better than most, he has access to paid forecasts and raw data from various brokers, and possibly the most important thing he has is time. So his calculations are less likely to be misinterpreted by himself, and he is more likely to come up with better predictions that the average folk. We have seen how his formula can come up with some very variable figures, just ye changing the numbers slightly. Experience is the key to knowing what numbers to use.

My 2 cents.

You are right in a lot of what you say.

The RR is the big wildcard.

Depending on what RR you use the IV varies significantly.

And of course a lot of the formula is based on forecasts.

But even having said all of that RMs track record is a lot better than most pundits and if you look at a share game that was done over 6 months he thrashed the other experts.

 

[ubtheboss]

Billyb-

Once you have actually read RM's book you might understand his methodology better. He postulates (correctly imo) that 'price' is what people are willing to pay which is different to what something is actually worth. Using his formula you can get a rough idea as to what a company is worth on a per share basis. Few people will get the same valuation because the inputs can vary but his track record speaks for itself (as noted by IV above). I would argue that my track record since using his methods and doing my own research on things like management and competitive advantage also speaks volumes.

I could go on and on but better for you to read the book first and then come back for more discussion.

One last point- he certainly does not think of the market as reasonable or predictable in the short term. He just thinks price will chase value in the long term.

Cheers

 

[Intrinsic Value]

Billyb-

Once you have actually read RM's book you might understand his methodology better. He postulates (correctly imo) that 'price' is what people are willing to pay which is different to what something is actually worth. Using his formula you can get a rough idea as to what a company is worth on a per share basis. Few people will get the same valuation because the inputs can vary but his track record speaks for itself (as noted by IV above). I would argue that my track record since using his methods and doing my own research on things like management and competitive advantage also speaks volumes.

I could go on and on but better for you to read the book first and then come back for more discussion.

One last point- he certainly does not think of the market as reasonable or predictable in the short term. He just thinks price will chase value in the long term.

Cheers

I am a convert to RM.

Results are what counts and since I started using the IV method outlined in his book I am tracking up over 70 percent for the current year.

I don't expect that I will be able to maintain those sort of returns (hoping) but I feel much more confident that at least now I have some idea about investing and some control over my financial destiny.

As will all valuation techniques IVs will vary but at least you will be on the right track to identifying good businesses and filtering out all the rubbish.

 

[Billyb]

Billyb-

Once you have actually read RM's book you might understand his methodology better. He postulates (correctly imo) that 'price' is what people are willing to pay which is different to what something is actually worth. Using his formula you can get a rough idea as to what a company is worth on a per share basis. Few people will get the same valuation because the inputs can vary but his track record speaks for itself (as noted by IV above). I would argue that my track record since using his methods and doing my own research on things like management and competitive advantage also speaks volumes.

I could go on and on but better for you to read the book first and then come back for more discussion.

One last point- he certainly does not think of the market as reasonable or predictable in the short term. He just thinks price will chase value in the long term.

Cheers

Yes I will read the book and look forward to more discussion. However, I reckon I understand what RM's talking about and I also understand how/why the formula works.

I like RM, but I am not buying the book to learn about the formula because I don't believe in it for myself (unless the book changes my mind, which I doubt). I don't have the knowledge/ability/time/skill to find good reliable analyst forecasts that I'm confident in. I would argue that most of the margin in safety is actually in the growth of IV rather than the current IV itself, if you have calculated a growing IV >10%/annum then you have a good margin of safety - however the problem with this is that it relies on analysts, and I don't trust analysts too much...they have been proven wrong many times, just look at ABS as well as various other examples. No, the reason I'm buying his book is to learn about the other aspects of what to look for in a business.

IVs are useless unless you understand how to read the business. For example, you can get a high IV, but if you didn't notice the dodgy accounting that is giving you the high IV in the first place, then I don't think there's much point. These are the areas I'm more interested in developing my 'investment eye' for.

Lastly, I feel he may be a self fulfilling prophecy, looking at MCE/FGE; and remember; RM himself says his valuation only finds undervalue on a handful of stocks each year. This leaves a lot of potential misses.

I am still learning so my viewpoint could change, but this is what I think at the moment

 

[prawn_86]

Ok i am only just starting out reunning some numbers based on the earlier spreadsheet in this thread.

Would someone else also be so kind as to check MAQ? I am currently getting IV of $15.64 in 2010 and $17.62 for 2011 with ROE of 24% but i think i am out somewhere.

Help appreciated

 

[titus]

Roger says to use the "Dividends paid" value but my question is: why the discrepancy? And why does that discrepancy change from year to year?

I've just finished Value.able and have been scouring Roger's blog pages. There is one poster who gets his raw information from the Annual Reports rather than analysts figures from Commsec, etrade etc. In particular, the dividend figure is variable and you need to make sure you have the correct figure for valuation purposes. Perhaps this is where your discrepancy stems from.

The link is: http://blog.rogermontgomery.com/how-do-your-value-able-valuations-compare/#comment-6865

Cheers

 

[Bunter221]

Ok i am only just starting out reunning some numbers based on the earlier spreadsheet in this thread.

Would someone else also be so kind as to check MAQ? I am currently getting IV of $15.64 in 2010 and $17.62 for 2011 with ROE of 24% but i think i am out somewhere.

Help appreciated

I have just received the book and look at Suncorp's Value Model as I can't do RM analysis just yet - they show it at $34.36, I appreciate they are using a different group of numbers but a similar principle is applied, ie show perceived value.

Showing a number like you have identified may well be correct but hopefully an expert in the process will come on and explain.

The main issue I noted was the number of shares on issue 20m - not sure if it will be hard to get in and out.

 

[kermit345]

Ok i am only just starting out reunning some numbers based on the earlier spreadsheet in this thread.

Would someone else also be so kind as to check MAQ? I am currently getting IV of $15.64 in 2010 and $17.62 for 2011 with ROE of 24% but i think i am out somewhere.

Help appreciated

I've created a spreadsheet, which I have access to at home (but i'm at work at the moment). So i've quickly grabbed some figures from Etrade and have the following current IV's based on slightly different return requirements:

10.5% Required Return - $14.69 Current IV
11.0% Required Return - $13.22 Current IV

So you can see required returns has a reasonable effect on the basic version of my valuation technique. MAQ has been a company i've only just recently started looking at as it popped up in my initial screen.

 

[prawn_86]

The main issue I noted was the number of shares on issue 20m - not sure if it will be hard to get in and out.

Yes it is a very illiquid share as the Tudehopes (founders) own 60%, plus the other top 20 holders, hence why it has seen such a sustained uptrend.

I've created a spreadsheet, which I have access to at home (but i'm at work at the moment). So i've quickly grabbed some figures from Etrade and have the following current IV's based on slightly different return requirements:

10.5% Required Return - $14.69 Current IV
11.0% Required Return - $13.22 Current IV

So you can see required returns has a reasonable effect on the basic version of my valuation technique. MAQ has been a company i've only just recently started looking at as it popped up in my initial screen.

Interesting to see it only popping up in your scan now. If your willing to share i would live to see your spreadsheet when you get home

 

[kermit345]

Yes it is a very illiquid share as the Tudehopes (founders) own 60%, plus the other top 20 holders, hence why it has seen such a sustained uptrend.



Interesting to see it only popping up in your scan now. If your willing to share i would live to see your spreadsheet when you get home

I should clarify what I meant by popping up in my scan now. Its been coming up in my scan for quite sometime however its only recently that I incorporated the financials into my spreadsheet. My spreadsheet assigns ratings to companies based on how certain elements (ROE, D/E, buffer to IV etc) compare to each other on the ones that have passed through my screen.

I recently added the financials for MAQ and it compares favourably to the other 50 stocks i've included within my spreadsheet.

Don't have any plans to pass on my spreadsheet as its taken a lot of work on my part to get it where it is and don't want to give it away. However I can tell you to help me initially find value investments I conduct the following screen:

ROE > 15%
D/E < 30%
Market Cap > 100,000,000

Spits out about 70 or so companies, from there i rank them and then add their financial etc.

 

[Bunter221]

Thanks for the insight. Now here is another question: Why not use DPS / EPS? It is easy to show that it is mathematically equivalent to (DPS) x shares / NPAT by dividing by shares.

Some companies aren't paying a dividend, so as a process in the book using your suggestion may not always work. Thats probably why!

 

[drlog]

Some companies aren't paying a dividend, so as a process in the book using your suggestion may not always work. Thats probably why!

I'm confused. If they aren't paying dividends then that is the easiest case to deal with because the payout ratio is zero no matter which way you look at it.

 

[Bunter221]

I'm confused. If they aren't paying dividends then that is the easiest case to deal with because the payout ratio is zero no matter which way you look at it.

I don't know how RM deals with this - he believes that the company re-investing the dividend is best for an investor as you get the ROE on your money rather than putting it in a bank account getting very low interest rates.
In my preliminary fiddle with the concept I have used a fictious number. Of course your choice will skew the results.
Does anyone have ideas?

 

[drlog]

I don't know how RM deals with this - he believes that the company re-investing the dividend is best for an investor as you get the ROE on your money rather than putting it in a bank account getting very low interest rates.
In my preliminary fiddle with the concept I have used a fictious number. Of course your choice will skew the results.
Does anyone have ideas?

That's right - if the payout ratio is zero, then table 11.2 is used. I dont think you really need a fictitious number for this case. Under the assumption that the payout ratio is zero and the company can keep the ROE the same with increased equity, value goes up a lot if ROE is high.

However, a very high ROE is generally not sustainable and therefore the company will start to pay dividends (payout ratio goes from zero to something above zero).

 

[Bunter221]

That's right - if the payout ratio is zero, then table 11.2 is used. I dont think you really need a fictitious number for this case. Under the assumption that the payout ratio is zero and the company can keep the ROE the same with increased equity, value goes up a lot if ROE is high.

However, a very high ROE is generally not sustainable and therefore the company will start to pay dividends (payout ratio goes from zero to something above zero).

Love the site and the support thanks - I have the book will try to get through it today or so then I will understand fully what is required. Then create a spreadsheet to easily enter company details to generate IV.

 

[robredo]

I think both ACR and CCP are worthy of further investigation.

Has anyone looked into the SFH? big ROE, little debt. Apart from the general retail slow down, is this good value investment material?

I'm looking purely at the financials for SFH on Comsec now, and i can see that the profits for this business in 2010 are the same as they were in 2003. The ROE seems high because the total equity of the company is lower than it was back in 2003 due to a big loss in 2005 and a smaller loss in 2006.

 

[Bunter221]

I note that RM hasn't been a fan of IPL but with low debt 12% ROE and Suncorp Value Model at $5.85 and the need for fertilizer increasing as farmers replant all over Australia, maybe its not that bad.