A Fistful Of Valuations - Introduction
Five years ago, when I was organizing the ideas of this book together, I knew little about storytelling. Most of my writing is factual and concrete. Much of it still is. However, like a bright sunshine rising in the east, imagine my happiness in reporting these positive results.
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This book offers 5 sample “intrinsic value per share” business valuations in the style that Warren Buffett and Charlie Munger may use. These valuations are based on FCF, the free cash flows that each business produces. Also, keep in mind the flexibility that these discounted cash flow models can be adjusted according to the quality and durability of each business. In other words, some of you will want to build estimation models that have shorter tails for weak businesses and longer tails, think duration, for great businesses.
In each case presented, I simulated an approach that Buffett and Munger would take to valuing a business, based on what they have written and talked about. However, all of the growth assumptions used are my own. No consultation or endorsement was sought with Mr. Buffett or Mr. Munger.
In this third edition, these businesses market prices were updated in 2012, and they are updated again in October, 2015. New comments, observations, and insights are added into this latest edition. This is placed after the main body of discussion from the original first and second editions. In this way, you the reader can appreciate the original valuation and progress on to my newest observations about each business.
How is this portfolio of five businesses doing after almost five years? If the reader had invested an equal amount of money in all five businesses in 2010, the average annual return so far would be 42%.
Both the business factors and the market factors for this nice result is discussed in greater detail, as you read further into this third edition of this book: A Fistful Of Valuations In The Style Of Warren Buffett & Charlie Munger by Bud Labitan. Third Edition, 2015. Now, since this book will also be released into audiobook form at Audible.com, allow me to promote the other two books currently available at Audible.com, Amazon.com, and iTunes. Those two are “The Four Filters Invention of Warren Buffett and Charlie Munger: Second Edition” and “MOATS: The Competitive Advantages of 70 Buffett & Munger Businesses” by me, Bud Labitan.
As I said in 2010, the examples given here are chosen for educational and illustrative purposes only. The valuation cases are estimations written in a style that emphasizes a focus on free cash flow and the number of shares outstanding. Focus was also given to American businesses that were producing real free cash flow in 2010 and had relatively lower debt levels at that time.
Now, in 2015, I have noticed that many corporations have taken on higher debt levels. Some of this is due to the persistently low interest rates. Some of this is due to new capital spending for anticipated growth.
Recall that growth is just one component in the calculation of value. My readers are always encouraged to think about each business’ competitive position. In reality, these businesses may outperform or they may underperform any of my projections. This book is about five of the thirty business cases from my Valuations book that looked like the most attractive bargains in 2010. I intentionally put a dull brown cover on the paperback’s first edition, to see if people would buy it. See the humor in that? At my expense, that book did not sell very well. However, in my gut and in my mind, I anticipated nice returns for these businesses that were selling at bargain prices.
I said in 2010 that folks could look at these five companies in 2015, and see how my predictions worked out. With eagerness and a desire to change the dull cover, in 2012, I updated to the second edition and also placed it on the Amazon Kindle platform. I called your attention to a small flaw in the original valuation calculations done in 2010. Those valuations did not account for the 10 “end of year” compounding periods. This was corrected in 2012, and the resulting “estimated intrinsic value estimations” were slightly lower, but not significantly different from those reported in 2010.
In the Second Edition, I corrected the “estimated intrinsic value estimation” calculations. However, I did not change the text describing the business in 2010. This way the reader can see what I saw and said in 2010. And, you can make your own judgments about the QB or “Quality and Bargain” present within each business at that time.
Now, we look at these five companies again here in 2015, and see how my predictions have worked out. In my view, the best valuations come from a mix of solid qualitative evaluations plus sensible quantitative valuations. I tried to approach each value estimation without emotional bias. Any errors, assumptions, or omissions are my own. In reality, these businesses may outperform or they may underperform any of my projections.
How have my predictions or estimations done in these years? The results are seen in the table below. As of April 27, 2012 UNH, United Healthcare gained the most in market value. UNH went from $29.49 to $57.91 in 2012. As of October 15, 2015, UNH, United Healthcare has gained the most in market value. It has risen from $29.49 to $119.97. I suspect that macroeconomic forces coming from the Affordable Care Act, also known as Obamacare, has had a significant impact on United Healthcare’s business model.
The 2012 and 2015 results are given in the tables below. These results will also be described in words for you audiobook listeners.
Interestingly, two of the medical industry businesses have gained the most in market value. Only one of the three businesses, Jacobs Engineering, still seems to be in bargain territory relative to the 2010 valuation estimates.
This brings up a good question: “How often should we re-do our “intrinsic value” estimation calculations”? My answer is this: If the economics of the business remain sound, a yearly reassessment of value is probably right. The bottom line is this; inferior businesses must be reassessed more frequently. The old Peter Lynch and Warren Buffett joke goes: “We want to own a business that is so good that any idiot can run it.”
Designed as a useful business book, “Valuations” came about because I wanted to show cases on how to sensibly value a business. These cases are full of warnings. For example, take a look at this statement: “Before we make a purchase decision, we must decide ( filter #1 ) if XYZ business is a high quality business with good economics. Does XYZ business have ( filter #2 ) enduring competitive advantages, and does XYZ business have ( filter #3 ), honest and able management.”
My first book, "The Four Filters Invention of Warren Buffett and Charlie Munger" talked about these thinking steps that they perform in "framing and making" an investment decision. I came to the conclusion that the genius of Warren Buffett and Charlie Munger's filtering process was to "capture all the important stakeholders" in a "multi-variable" process. Their rational approach captures Products, Enduring Customers, Managers, and Margin-of-Safety... all in one mixed "qualitative + quantitative" process. In my view, their “decision framing process” was a remarkable advancement in Behavioral Finance.
In the valuations book, I added some material about competitive advantages and competitive disadvantages, as well as the business’ competitors. However, as far as the ability and trustworthiness of each businesses managers, I must leave much of this component of evaluation to you the reader. There are hints about their abilities and trustworthiness hidden in their past performance records and in their compensation numbers.
The basic discounted cash flow model I use is discussed in each chapter. Keep in mind that it is just an estimation model. And, it can be adjusted by growth rate and by length of growth and holding periods according to the quality of an individual business. In this third edition, I add comments and insights that are new to me. And, perhaps these ideas can help you in your future business and stock investments. I hope you enjoy this shorter case book, and that you benefit from the attempts made to advance our knowledge.