I've had it...

[Guest JackRiver]

Mandeep

 

I wouldn't pay too much attention to the other comments, but let me ask you this, what is USB worth?  That is, what is your calculated value for USB and what gives you confidence that you have the ability to evaluate USB?

 

Yours

 

Jack River

 

Mandeep

 

I posted the above earlier.  You care to take a stab at these?

 

Yours

 

Jack River

 

 

 

[Mungerville]

Arbitragr,

 

We have spoken about bonds earlier.  I know more than a few board members went into preferreds (between bonds and equity), individual  bonds, etc.  Furthermore, I believe that when you buy ORH, you are essentially buying a bond portfolio at over 100% of NAV and 50% of NAV in stocks.  So you have a lot of bond leverage there - but its high quality municipals and corporates.

 

In terms of junk and higher risk corporates I think that makes sense but I personally don't want an index.  I would rather own individual names I know well there.  OSTK being my first choice.

[Mandeep]

Thanks for the good wishes Parsad. so excited!

 

Hey, JackRiver. I'm making the mistake of not understanding the worth of it and buying anyway.

I still have to read those books that people recommend.

 

In my mind, I think I would be okay if I follow buffett's picks.

Thing about USB is that its an old-fashioned bank. They are very conservative and shouldn't have fallen with WFC and the rest.

Plus the management is great.

 

That's what I've been looking at. Just buy great businesses at great prices, look for modest managers, etc.

 

I'm curious Jack, how would you value USB?

I can't really break it up into numbers. :(

 

 

 

 

[Mandeep]

Jack River got me running to this site:

 

http://www.fwallstreet.com/blog/4.htm

 

But these are just the basics, I guess.

 

I like this site a lot. Thanks for making me think critically, Jack.

 

 

[Guest JackRiver]

Mandeep

 

I know even less about banks than I know about how to win friends and influence people.  As for the rest, I think you get the point I was trying to make.

 

My favorite investment book of all time:

 

How to lose friends and alienate people (the movie version sucked).

 

Yours

 

Jack River

[Mandeep]

Don't know if you agree with the JNJ discounted cash flow analysis or not, but why is he using a 20 year timeline?

Can you use less of a timeline? I used the same growth rate (~15%) for 5 years and I get JNJ's value to be $35 bucks a share.

WTH-

 

What if I only have a 5 year timeline? (I don't want to hold for 20 years) Do I have use a 20 year scenario?

 

Please advise.

 

Feeling confused,

 

-M

[Guest JackRiver]

Don't know if you agree with the JNJ discounted cash flow analysis or not, but why is he using a 20 year timeline?

Can you use less of a timeline? I used the same growth rate (~15%) for 5 years and I get JNJ's value to be $35 bucks a share.

WTH-

 

What if I only have a 5 year timeline? Do I have use a 20 year scenario?

 

Please advise.

 

Feeling confused,

 

-M

 

The only thing I would say to that analysis is that by using a 15% discount rate the analyst is already building in a huge margin of safety.  About 50%.  That is, if long term government bond rates average 7% and if you are confident in your analysis of JNJ's ability to produce that cash flow (that they are as risk free as treasury bonds), then why are you demanding 15% from a sure thing.  That is to say, why would a stable business offer the returns of a risky business.  Investors will recognize JNJ as more stable and predictable and will bid the price up to offer less return in the future.  A smaller premium to long dated gov't bonds.

 

I don't know about the assumptions for growth in free cash flow going forward, but I would build in a modest number based on the underlying business and add to that the inflation rate.  This assumes that expenses grow inline with inflation and that revenues grow in line with inflation (part of my definition of a good business).  That is to say, they can price for inflation without losing unit volume.

 

Another way to look at it, if we assume that current earnings approximate a normal base of operations and that those earnings are reflective of free cash flow, that they are more or less the same over time, then we are presently looking at an earnings yield of 13 billion matched against (divided by) a market cap of 150 billion equalling an earnings yield of 8.6%.  So buying today produces a one year return of 8.6% (assuming earnings hold up) and whatever growth projections assumed and produced in the future will add to that rate of return on our original cost basis.  That is, a growth in earnings of 10% will produce 10% higher earnings yield (on original cost).  Approx 9.53%.  This is Buffett's equity/bond concept for lack of a better author.  A good example of this at work is Sees candy.

 

Per your time line questions, I would use a longer time frame than 20 years, but this assumes that you've done the requisite analysis that gives you confidence to predict something so far into the future.  To be a little sloppy (superficial) about it I'd wager a guess that JNJ is around 30, 40, or 50 years from now and in good form and that it is a company that you can try this type of analysis on (the discounted cash flows stuff). 

 

I'd be a net buyer of JNJ at todays prices or lower. 

 

The analyst is confusing balance sheet and Income statements a bit.  I wouldn't pay much attention to his comments there.  His thinking makes a few flaws in transitions between them, but Graham covers that well in his books if you are interested.  I think the 3rd or 4th edition of Security analysis.

 

15% is too high a growth rate

 

Sure you can use 20 years, but if the company last longer you are not accounting for that.  In most discouted cash flows years 11 to infinity acount for 60% of present value

 

If you personally only have a 5 year time line, I would assume that that shouldn't alter your analysis though I wouldn't count on this working out as smooth as a shorter term oriented person might wish.  Meaning you should still think and make calculations based on what the company will do over the long term 30 years plus.  The main point of this is not to get the calculations exact, but to first establish for yourself that you are dealing with an excellent business that has better odds than most at being around and in good competitive standing.  The first thing to think about in this regard is the nature of the industry and the nature of the product.  Think airlines and auto companies versus the insurance industry and utilities.  Then I would jump into the competitive aspects among the different companies in the industry.  All the Buffett and Munger stuff they preach to us.  All of it.  Unless you can go through that thought process in an educated way, DCF (discounted cash flows) is meaningless and you are probably speculating and not investing.

 

Sorry this is a bit mumbo jumbo.  I'm not a good writer.  Or explainer of things.

 

Yours

 

Jack River 

 

 

 

 

 

[Mandeep]

Thank you Jack for your intelligent reply.

 

D-o-double d's security analysis should be awesome. I need to find the time and get that book.

 

Thanks again, buddy.

[Guest JackRiver]

Thank you Jack for your intelligent reply.

 

D-o-double d's security analysis should be awesome. I need to find the time and get that book.

 

Thanks again, buddy.

 

Thanks Mandeep that's the nicest thing someone has said to me on these boards. 

 

I don't know where you are in the span of things, but if you are starting out I suspect a solid understanding of accounting would be better use of your time than reading Graham so soon.  Remember, an analyst studies accounting to gain insight into the amounts and timing of future cash flows.

 

Yours

 

Jack River

[Rabbitisrich]

Just to add to JackRiver, even if you have a 5 year time span, by the end of year 5 the stock price will reflect expectations of years 6+. In other words, you shouldn't truncate your discounting period. A better strategy for you would be to focus on event-driven activities and on situations with catalysts.

 

 

 

After reading the thread more carefully, if you are new to investing, I recommend that you turn away from the stock market and just read every finance and accounting book you can find. If you know anyone who took the CFA level 1, try to read the level 1 accounting text. I began my education only a few years ago, and that text really saved me a lot of time. There's so much junk or redundant information in publication; the CFA material can help to organize your reading schedule.

[Guest JackRiver]

Mandeep

 

I should elaborate on my post to you.  My saying that a use of 15% discount rate was already building in about a 50% margin of safety is not entirely accurate.  First you should note that your discount rate is your return given a purchase price at the resultant present value assuming your estimates pan out in amounts and timing (I think the article addresses this), and second, translating a discount rate, earnings yield, or what have you, into a margin of safety only mathematically works if we are assuming no growth or lower growth.  I assumed that for JNJ.  If this is confusing to you, let me give a hint at understanding: 

 

If I buy a stock with a P/E of 7, that's 7 dollars of price for every 1 dollar of earnings.

 

The earnings yield on this investment is: 14.29% (earnings / Price or 1/7)

 

If I run the math on that 1 dollar of earnings growing at zero or low constant growth and imply from my earnings yield a discount rate of 15%,  then I will end up with a price multiple that is always about 50% of my discount rate.  Discount rate of 15% approx. equals a price of 7.  People make a mistake related to this of eschewing DCF use and understanding all the time, and Buffett's biographer made the same mistake recently when she all but said that Buffett looks for immediate 15% earnings yield and doesn't do any DCF.  Well, that's all well and good until you realize that it is just another way of saying "a low P/E, or a P/E of 7."  Wouldn't we all like to buy good companies, I assume Buffett is looking at good companies, at P/Es of 7.  And yes, it's obvious you don't need to do discounted cash flow analysis to buy a good business at 7 times earnings and if you focus solely on good businesses then you never have to waste time on discounted cash flow analysis, but you do need to understand how it works.  BTW, you'll do well if you buy good businesses at P/E's of 12 or even 20. 

 

However, if there is massive growth involved, let's go big for emphasis, say 100% per year for 5 years up front, then the mathematics of the assumptions above break down.  I suppose one might argue that that kind of growth is indicative of something faddish or non lasting or unpredictable.

 

If you don't understand the above, then you can intuitively understand this:  That is to say, would you only being willing to pay a P/E of 7 for something that you were confident was growing at 100% per year for at least five years and that would grow moderately thereafter.

 

Yours

 

Jack River

 

 

 

 

 

[scorpioncapital]

From what I read of Buffet's philosphy, he much rather prefers a say 7% initial yield with some reasonable growth than a 15% yield (P/E=7) with little future growth. The reason is that value is hidden in the "back-end". You will still get a 15% return with the 7% initial yield given some growth assumptions you are relatively certain about.

[arbitragr]

I don't think WEB does DCF. Well not alot anyways. I don't think you need to. Just yield (or BV) comparison to alternatives on the market.

[scorpioncapital]

DCF is as easy as the rule of 72. Your money doubles appx every 7.2 years at 10% (3.4 years at 20% return, etc..). Likewise it gets cut in half (discounted) by half every 7.2 years if you want to calculate value of future income streams or inflation. That's all you need to do DCF, forget fancy spreadsheets and models.

 

[Guest JackRiver]

DCF is as easy as the rule of 72. Your money doubles appx every 7.2 years at 10% (3.4 years at 20% return, etc..). Likewise it gets cut in half (discounted) by half every 7.2 years if you want to calculate value of future income streams or inflation. That's all you need to do DCF, forget fancy spreadsheets and models.

 

 

Scorpioncapital and arbitragr

 

What you guys say is right, but for those newer to this, it always makes sense to understand the calculations that get us to our shortcuts which in turn help us better understand any shortcomings or flaws in our shortcuts.  Nobody said anything about fancy spreadsheets and models, but remember, we are always implicitly making calculations that are consistent with what you eschew.

 

Scorpioncapital, as to your 7% initial yield.  If you go back in this thread, you will see I post something that addresses this point to mandeep with regards to initial earnings yield for JNJ.  The thing I hope gets taken away from this discussion is that, both fancy spreadsheets/models and/or rules of thumb and shortcuts are all flawed if applied to something that any and all analysts have no probabilistic insight in applying them.  Think dot coms.  Outside of that the math logic is the same, whether you want to do detailed calculations or whether you want to infer the mathematic logic more intuitively on the back of an envelope.  More specifically the individual analyst has to take this further and question what he/she has the ability to analyze.  One this board and others, there's a lot of slop.

 

Yours

 

Jack River