Geoff Gannon of http://www.gannononinvesting.com/ posted this great stock valuation exercise. Everyone should talke it. Even though there are many many details missing it is still a great way to think about how you analyze stocks. As he mentions in the article you only have ten minutes to analyze.
Here is the link to the test from Geoff’s website (How Much Would You Pay for This Stock? – Blind Stock Valuation #1) which I also is posted below, I also posted my answer to the question.
In an earlier post, about how to value a business, I said:
Here’s my advice for how to really learn to value a stock. Start with a stock that’s pretty easy to value and completely unknown to you. Don’t look at the stock price! Just try to value the whole company.
Ideally, you should be able to black out the company name, business description, and stock price on a Value Line page and still be able to come up with an approximate appraised value for the business within 10 minutes.
So here’s a blind trial I’ve prepared…
How much would you pay for this stock?
Answer by emailing me your per share appraisal. In other words, tell me how much the stock is worth. I’ll pick the best email answer I get and give the winner a copy of my favorite version of Benjamin Graham’s The Intelligent Investor.
You have until the end of January to send me your email.
Talk to Geoff About Blind Stock Valuation
Here is my response below:
Hi Geoff,
Not sure if you remember me but we have been in touch briefly in the past I
write for GF a lot. I loved your idea of a test, not doing this for the book,
I have read it numerous times, but as an exercise to make me think.
I am trying to take your test obviously there is very limited data so I am
working off that. I do not like the fact that NI and OCF did not increase
over the entire period but since it was a very volatile time period (as
demonstrated by the financials and by not living in a cave) I am using
averages for everything.
I see subtracting Assets from equity there is almost no debt (definitely needs to
be valued as a going concern) and GM% average is ~23 I want to say this is a
tech company. Although, I have no idea why but costs went up in 08 very very
strange due to deflation during the period. I am surprised revenue went up during that period although that confirms my suspicion this might be a tech company (definitely not bank industrial, materials or anything cyclical). Maybe they were using aggressive accounting
methods in prior years to reduce expenses (no idea).
Average Revenue ~97, avg earnings ~22.7, OCF ~32, Avg capex ~16.3, dividend
~4.2 ~FCF 11.5. Sometimes I do not include dividends
avg EPS 2.15*12=25.82, avg FCF per share 1.1*9.5=10.45. The two diverege
dramatically. I like EPS and FCF but FCF seems to indicate a diff picture I will give it a 60% weighting to be conservative to it, and earnings 40% I come up with $16.61 per share
( I added this in afterwards, Note: I am using a buy price and would apply a higher multiple to
Regards,
Jacob
Geoff responded to me almost immediately and had positive praise for my analysis. I do not want to reveal any further information that might give hints to others. I will post Geoff’s reponse once the contest ends (assuming he agrees. I am sure he will) and will be following up with his answer when he releases it.
I am curious what numbers Value Walk readers came up with so besides emailing Geoff please feel free to leave comments below on how you calculated intrinsic value.
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Jacob,
You mentioned a GM% of 23%. Is this supposed to be net margin? (net income / sales)?
Sorry I meant that. Typo there did the write up quickly. Thanks for pointing it out. I took revenue and NI.
Ah, got it. Given that you didn’t have information as to what type of company it was (industry), assume you just used average PE and FCF multiples across industries?
I don’t look at PE averages or FCF for valuation purposes. I just used what I thought would be attractive earning or FCF yields plus it hasa nice divident. But I did state I thought it might be a tech company.
I’m not sure I understand this part:
“avg EPS 2.15*12=25.82, avg FCF per share 1.1*9.5=10.45″
Can you explain why you’re multiplying the EPS by 12 and the FCF by 9.5?
I am giving the company a valuation of 12x earnings and 9.5x FCF
I would expect thing to be trading in the vicinity of $23.75 – i.e. 12x owner earnings. A buy price would be south of $18 and a sell price just north of $22 so as to make a reasonable return oneself while still leaving something for the other guy.
The dividend is a plus and the higher the payout ratio, the better. A profile such as this without a dividend (or buybacks) would turn me off: I can’t imagine what else mgmt could do with the cash earned that wouldn’t risk value destruction.
Jacob,
Can you share why you subtracted dividends from the FCF calculation? I know you said you sometimes you don’t include it, do you have any guidelines or is it to err on the conservative side.
Thanks,
Adam
There are many different ways to calculate FCF. Most analysts I know use OCF-Capex, that is what I tend to do. My generally guidelines really shouldn’t apply here. The payout ratio is low I just did not have time to think about it with the ten minute rule. Normally I would only take out dividends if the company was paying out a significant amount of earnings. For example Altria ticker MO (which I own), which earned $3.2b in 2009 paid out $2.6b in dividends (CapEx was only $273m). In that case I believe it is appropriate to subtract dividends. Here the company earned on average ~$22 and paid out approximately ~$4.20 I do not think it is appropriate to subtract dividends. So in short the buy price of the stock would be higher than what I came up with.