On June 30th 1914 the New York Times ran the headline:
Trading Very Dull, with Prices a Little Lower
The article had this to say about Europe:
The assassination of the heir to the Austrian throne was an event whose consequences were closely considered by the markets abroad, but the calmness which they showed indicated clearly that political complications were not feared as a result of this incident. Indeed, the view that it would tend to lessen rather than to increase political strife in Southeastern Europe found wide acceptance.
“Intrinsic value is a guess. Buying is the belief. You don’t need to
use a lot of math to prove exactly what something is worth. You just
need to present a convincing case for buying it.”
Interesting observation. I’ve seen a few YouTube vids with Bill Ackman
in them. The interviewers have sometimes pressed him for what he
thinks a stock is worth. He never gives a numerical answer. I get the
distinct impression that he never has a definite intrinsic value X
when he buys a stock; only that a stock is “clearly undervalued” at a
current price. As Ben Graham would say: you don’t have to know a man’s
weight to know that he is fat.
All the best,
Mark
I think there are really 4 questions you answer before buying any stock:
Is it safe?
Is it a great business?
Am I getting a great price?
Can I hold this stock for as long as it takes?
The ideal stock would get 4 “yes” answers.
The 5 Japanese net-nets I own do not get 4 “yes” answers. But I made sure they passed questions #1, #3, and #4.
A lot of differences in style come down to how you answer these 4 questions. Someone emailed me saying he thought Mohnish Pabrai was more of a Ben Graham investor than a Warren Buffett investor.
Not really. Graham was obsessed with question #1. He wanted to know a stock was safe. Pabrai cares less about #1 and more about #3. Pabrai’s overwhelming focus is on getting a great price.
Graham wanted a great price. But safety always came first.
There are stocks Pabrai has owned that Graham wouldn’t. Nothing wrong with that. Different people invest differently.
We all rank these 4 questions a little differently. We obsess about one. And our standards are a little too loose on one of the others.
But I think most stock decisions come down to these four questions.
If you can answer those questions – you don’t need an exact estimate of intrinsic value.
And Andrew August at The Frog’s Kiss writes about Dreamworks (DWA). It’s a 14 page report. After reading his analysis, I emailed Andrew saying it was “the best analyst report I’ve ever read.”
You’ll notice Andrew never puts an exact value on the stock. Which tells you something about good analysis.
A lot of value investing blogs and articles calculate intrinsic value for you. If you read Ben Graham and Warren Buffett – you’ll see they almost never do this.
Intrinsic value is a guess. Buying is the belief.
You don’t need to use a lot of math to prove exactly what something is worth. You just need to present a convincing case for buying it.
All else being equal, which measure is preferred for financial firms such as banks: ROIC or ROE? I am using ROIC for non-financial firms but I didn’t know if it gave a useful reading for financial firms or not.
Thanks,
Chad
ROIC is not useful.
For non-financial companies:
I know you like ROIC. But I think it’s too clever by half.
I use the pre-tax return on tangible invested assets.
In other words, I look at what a company earns and divide those earnings by the assets on its balance sheet excluding cash and intangibles.
For financial companies:
Normally you use return on assets. Then you multiply ROA by an appropriate leverage ratio.
Say Wells Fargo (WFC) has a long-term average ROA of 1.3%. If in the future you expect banks to be levered 10 to 1, you would multiply 1.3% times 10 to get a 13% ROE. If you expect normal leverage to be 12 to 1 – you’d multiply 1.3% times 12 to get a normal ROE of 15.6%.
These are long positions only. Weschler shorts stocks and uses leverage. For details, see Carol Loomis’s story.
Weschler is an investor after my own heart. His top 5 positions make up 90% of his portfolio. And he spent time at two of the companies he owns: W.R. Grace and WSFS Financial.
The W.R. Grace connection is well documented.
Weschler became a director of WSFS in 1992. He’s 50 now, so he must have become a director of WSFS at 31 or 32. By age 34, Weschler is shown as a director of 6 different companies. And described as “the general partner for several investment partnerships.”
Weschler worked for Quad-C which controlled Thrift Investors LP which in turn owned 24.81% of WSFS Financial back in 1996 (the earliest date when WSFS filed with EDGAR). So, in reality, Weschler was WSFS’s biggest shareholder as far back as the 1990s.
This supports the general impression that Weschler – like Buffett – buys what he knows. He holds few stocks. And he has relationships with some of these companies going back many, many years.
I see you tweeted about CAW again. What about that company attracts you? I don’t see that it is particularly undervalued and I am trying to understand what I am missing.
Sardar Biglari bought into the company. He will now have 2 board seats.
10-year average EBIT is about $5.75 million. So, the long-term average earnings would be about 50 cents a share after tax. Cash and securities is about $1.67. The stock trades around $6. That’s maybe a little less than 10 times earnings (after breaking out the cash).
Here’s the types of business they are in.
Dietary Supplement: 33%
Skin Care: 30%
Oral Care: 20%
Nail Care: 10%
Free cash flow tends to be equal to or greater than reported earnings. Cap-ex is virtually zero.
High management pay relative to the company’s size hides how profitable the business is.
For example, David Edell and Ira Berman made $2.88 million in 2009. This is against – like we said – an average EBIT of about $5.75 million. So, we’re talking more like $8 million+ in EBIT before these two get paid. Other executives are paid more what you’d expect the top folks at this kind of public company would normally make: $300,000 to $500,000.
I checked out the company’s products at a local drugstore. Though there will always be lawsuits, I thought it was a decent space to compete in. In the past, I’d researched a couple companies with similar business models. They had better brands. But CCA Industries was much cheaper.
Given the circumstances, I felt Biglari’s activism would lead to good things.
in your article “Should you Buy Microsoft?” on GuruFocus, you said, that it makes sense for some investors to use LEAPS instead of the stock.
After thinking long about that, I came to the conclusion, that LEAPS can be viewed as a form of leveraged investment with an insurance against a falling stock price included…So LEAPS would make sense, if you want to leverage your portfolio with relatively low risk.
I’m not endorsing LEAPS.
I think they make sense only in situations where there is a level of catastrophic risk in the underlying stock that is not priced into the option. In general, this means low volatility stocks that nonetheless can fail catastrophically if infrequently.
Like banks.
I would use LEAPS to buy a bank because there is always the risk that a bank will go to zero. In that sense, LEAPS leverage your investment and provide protection – basically an involuntary surrender – where you cut down a huge loss while still betting on a favorable outcome.
The problem with LEAPS is that they aren’t long enough dated. 5-year LEAPS would be good. 10-Year LEAPS would be virtually indistinguishable from a stock in terms of a correct analysis resulting in profit. But 2 years is not long enough for a value investor. If Warren Buffett had bought Washington Post 2-year LEAPS instead of Washington Post stock in the 1970s he would have lost his entire investment. By buying the underlying stock, he had a return of 30% a year compounded over the first 10 years.
I’ve had stocks that didn’t work out for 2 years. But, boy, did they work out over 5 years. I would’ve lost money on the LEAPS.
Any bet that depends on the market recognizing something within 3 years is a bet where a value investor can be completely right in terms of analysis and yet lose everything simply because the clock runs out.
Value investing is largely based on being able to hold a position until the market changes its mind. I’d say it’s very unreliable to assume mean reversion in the market mood on a stock within 3 years.
The exception to this is when you’re diversifying both across a group of separate bets and across a period of time. For example, if you buy one stock a month every month and turn over the portfolio every year (by swapping out one stock each month), you may average an acceptable result because you’re actually making a dozen different bets on a dozen different stocks that depend on prices at a dozen different future moments in time.
That’s not what you’re talking about. You’re talking about making one bet on one stock that will succeed or fail based on whether or not the stock reaches a certain price fast enough.
Personally, I’m not interested in LEAPS.
And I really don’t think it makes sense to buy LEAPS on a …
When it comes to valuing a business, do you believe more in asset valuations or earning? Earnings aren’t guaranteed to be there in the future (depending on the industry, of course), but assets are only worth what you can sell them to somebody else for. Do you think a pizza shop should be analyzed based on how much pizza they sell or the value of its real estate & bank account? Should they all be assessed when determining a value for the business? This is the question i’ve been thinking about in trying to understand valuation…
I think earnings and asset valuation are kind of the same, because operating (earning) assets generate earnings. So the value of those earning assets are the present value of future expected earnings (owners’ earnings) generated by those assets…Then I think we need to add things like real estate, cash, marketable securities which i think are non-earning or non-operating (core) assets, then subtract liabilities to arrive at value of the firm as a whole.
Assets and earnings are equivalent.
You can always restate an asset in terms of earnings. And you can always restate earnings in terms of an asset.
You can always ask: what would this asset have to earn to be worth what the balance sheet says it’s worth? And you can always ask what someone would pay for a certain amount of earnings. If they’d pay that amount that means they’d trade you cash today for those earnings. And that means earnings can be thought of as being worth their (cash) sale value. So earnings can always be thought of as if they were an asset.
In physics, mass is a measure of the energy content of a body.
In investing, value is a measure of the earning content of a specific instance of capital.
When I say a business will provide earnings of 40 cents a share pre-tax and a business is worth $4.00 a share – I’m really saying the same thing under special conditions (certain interest rates).
Intrinsic value is always relative.
You can’t value anything without a reference point.
There are two ways you can value an asset. You can value it in static terms by comparing it to other assets and valuing the asset against them. This uses other assets as your reference point. Or you can value an asset by restating it as a flow of earnings and comparing that flow to the price-to-free cash flow multiples of other businesses. This uses other cash flows as your reference point.
Really, you’re just valuing the same thing – capital – in two different states.
This is very obvious if you look at businesses over time. Or if you look at special situations. Or deals of any kind.
Basically, capital starts its life in a business with no earnings and a lot of potential. Then it gets put into all sorts of specific forms (real estate, inventory, receivables, …
