A very quick and cool way to determine if a stock is reasonably valued or not.  

Price  = (Earning for next year / Required return ) + Present Value of Growth Opportunities

Simply solve for Present value of Growth Opportunities(PVGO)

While I would advice the average investor not to get too technical with the formula, I will give you my method of obtaining the variables.

Price is simply the current market price of the security being valued, the idea is market is somewhat efficient and accurate (feel free to insert your joke here, I do!)

(Earning for next year / Required return ) is the Value of a static no-growth firm; PVGO represents the market price of the hopes and the dreams and the aspirations for the firm to add value additionally to the assets and/or earning power that are already in place.

Earning for next year can be looked up from yahoo finance analyst estimate (again, feel free to insert your joke here!)

Required return is simply derived from the Capital Asset Pricing Model(CAPM)(Just bear with me for a minute).  For the market return, I use the Long term S&P 500 return of 9.6% (Hang on, not just yet), and for  risk free rate, I use 10 year Treasury, and the Beta from Yahoo Finance.  Plug the numbers into the variables of the formula to calculate the required return:  Required return = Risk free rate+ Beta *( Market Return-Risk free rate)

The drawback of this formula is the fact that it’s a rule of thumb.  Like any number crunching, I believe in GIGO, Garbage In Garbage Out.  Here are some of the possible situations of how the inputs can be flawed.

Earning estimate for next year could be skewed.  Inputs for CAPM are flawed, for example, what risk-free rate to choose, what is the market in market return, how many years should I regress the Beta, and should the Beta be levered to reflect the proper debt ratio?  What about cash hoard on balance sheet beyond the necessary reinvestment for growth and working capital and cap ex?

Those are all legitimate questions, but I don’t believe this is the time and place to get bogged down.  The idea is to determine quickly off the top of your head if the price of a stock is reasonably valued, and worth looking into.

For example:  Apple Inc. (股票代號: AAPL)

Next year estimated earning= $48.13 ( from Yahoo Finance)

Beta of AAPL=0.93 (from Yahoo Finance)

Market Return(3 years annualized S&P 500 Total Return)=10.87% (from Standard & Poor’s)

Risk Free Rate=1.91% (from Yahoo Finance, 10 years treasury)

Market Price of Apple Inc.= $527

PVGO of Apple= $527- ($48.13 / {0.0191+[0.93*(0.1087-0.0191)]})=$57.11

The future growth of Apple Inc. is worth about a mere 11% of its current stock price.

Oh Wait!  What about the more than $110 billion worth of cash, which translate to about an additional $117 per share and increasing, on its balance sheet?

The NO-Growth Apple based on this quick calculation is worth $587 per share and increasing by the minute.

People, please do a comparison to your beloved company, try adding an element of rationality into your investment process.

For comparison purpose, Google’s PVGO is $737.97-$358.14=$379.83;  approximately 51.5% of its current price.

The idea is that if a company’s growth does not pan out, the crash and burn will be relatively more substantial than that of Apple’s.

You should play around with high growth company such as Facebook and check for yourself how much did you pay for the hopes and dreams of the projected growth.

This is where you should start your investigation on whether the company’s future growth prospect as reflected by the market price is warranted, according to your own opinion based on facts and sound logic.

Good Investing.

 

 

Previous Post on Berkshire Hathaway BuyBack

A few days ago it was reported that Berkshire Hathaway bought back $1.2 Billion dollars worth of CLASS A Berkshire Hathaway(股票代號: BRK-A).  The purchase was not done on the open market, and it was all purchased from a single long time investor.  For comparison purpose, the company has spent only $126 Million dollars for the net purchase of shares the last four quarters combined.

Berkshire Hathaway has announced raising its maximum target price of Class A shares to 120% of Book Value.  Previously the most Berkshire Hathaway was willing to pay was 110% of Book Value.  Obviously Book Value is a number updated at most quarterly because it is a balance sheet item.

There is a speculative possibility that Warren Buffett sees an improving economy through the lens of his collections of businesses.  Aside from insurance and investment, Berkshire has a number of housing related businesses.  I am not sure about the rest of the country, but in the San Francisco bay area, especially the silicon valley, I notice a dramatic positive attitude shift towards housing, and prices are appreciating rapidly.  This could mean the company is becoming even more undervalued.  The Net Present Value of purchasing its own share could be more favorable than many other investment projects that the company has looked at.  Buying a dollar for fifty cents is the primary motive of any value investor.

However, I think, once again, this recent vote of confidence on its own share is just a cover up.  This could be part of the succession transition plan.  By reducing the float in circulation, this move probably serves to further solidify future management and board control of the company through Class A share, which is worth 1500 times a Class B share but 10,000 times the voting rights of a share of Class B.  This large purchase of not-from-the-open market signals the company’s concern of “CONCENTRATION OF POWER” outside the company insiders.  In stead of Buying Back on the open market from a variety of retail investors whose individual proxy impact is negligible(Why? Because each share Class A costs $130,000.00 yeah! More than the average “ANNUAL” salary!), Buy Back from one large shareholder, who has the potential ability to influence proxies against management’s wish, in essence eliminates future troubles such as proxy fight.

This is not an attempt to undermine Berkshire Hathaway as an iconic company.  On the contrary, Berkshire Hathaway will remain an economic powerhouse for years to come.  As long as the management and board serve with the best interest of all the shareholders in mind, shareholders will benefit from the insights and expertise of the managers.  A corporation is rarely a place for democratic rule.

Most traders and investors are short sighted.  We are wrapped up as a whole in the daily price movement of a stock.  It is true that the SHORT TERM RETURN of a stock can come from capturing share price fluctuation.  However, LONG TERM RETURN can only come from the long term actual profit the underlying business generates.

Berkshire takes it one step further whenever it can,  it buys whole business and skip the waiting for the profit reflection on a stock price.  This way Buffett and company have direct access to the profit generated and apply that capital to make more investments that churn out more cash.  The current Free Cash Flow after paying for debt service is about $17 Billion a year.  The company has about $46 Billion on its balance sheet.  That is a lot of ammunition, and the company is yearning for the next big investment.

With Berkshire’s business model and Buffett and company’s sharp investment acumen and unwavering mentality, this is how INTEREST COMPOUNDING can truly work to make people wealthy.

I am long term bullish.  A price floor may have been temporarily established at 120% of current book value due to buyback.  However, always proceed cautiously and buy with a margin of safety.

We welcome comments and thank you for your supports.  Have a Safe and Happy Holidays!

 

 
CAT product demand is driven by global economic growth, construction activity, commodity prices, government spending on infrastructure, and end users’ access to capital.
It’s lagging currently, partly because of its relatively weak exposure to agriculture (drought depresses crops yield and heighten food price) compare to peer like Deere.  On the other hand, mining and energy exploration has been held back by lower commodity price.
I like CAT the business and company in general, it is definitely one of the best among its peer group.  But my enthusiasm for CAT is temporarily dampened due to Macro headwind.  (Short term skeptic, long term bull)

The revenue streams are strategically diversified, less than 30% is from North America, (the good recovering economy), revenue stream may continue to weaken, unless 1) spending on infrastructure, 2)urbanization, 3)mining, 4)construction, 5)Capital Ex Investment, pick up, which are entirely possible.  The reasons could include government stimulus spending, economy picking up around the world.
Revenue and Net Income have been increasing dramatically at least over the past 3 years, but Operating Cash flow has stayed relatively range bound.
This company operates on rather high leverage historically, and as a result the Return on Equity for last year has been spectacular.  The current ratio is 1.4 with about 40 billion of Total Debt, the company has raised more debt capital since last year, and the Total share outstanding has increased from 628 to 666 million shares.  The average nine years ROE has been about 33.89%, but that could be skewed because we went through the construction boom from housing and infrastructure both domestically and abroad, urbanization of emerging markets, and commodity boom for the past decade.  The company has nevertheless, demonstrated uncanny ability to meet obligations, as well as expectation of revenue and income growth.
Buffett once said, he would rather buy a great company at a fair price, then a fair company at a great price.  If we simply take the Net Income reported at face value, couple with the current consensus 5 year earning growth rate analysts predict, the fair value could be somewhere around $101.2/share.  Please proceed with caution and an appropriate margin of safety as always.
 

http://aswathdamodaran.blogspot.com/2012/09/the-dividend-tax-cliff-approaches.html

–Previous related Posts

27 stocks with Giant Dividend and Huge BuyBacks Part 1

27 stocks with Giant Dividend and Huge BuyBacks Part 2

Proceed with Cautions.  S&P 500 has once again bounced back above 1400.  Most people won’t recommend buying stocks for dividend yield right now.  One study by a NYU Professor suggested that if the Post-cliff dividend tax rates advanced to as high as 40%(Clinton Era dividend rate), that would result in a price effect of about -15% for the S&P 500 (with a current yield of 2.02%), -18% for high dividend paying stocks( 4% yield), and about -7% for non dividend paying stocks.

My point being provided the company is healthy with great foreseeable business economic, if the price of such dividend paying stock got ridiculously hammered to beyond recognition, there is a chance you may be able to profit from other’s misfortune.  Remember, retired seniors do need income to live off of, whether it came from savings, selling stocks, annuities, fixed income, rental incomes, pensions, social securities or dividends, and that is going to be the one great legacy and wisdom they bestowed upon us in my humble opinion.

BlackRock(股票代號: BLK)

Price Target
$210
Dividend Yield
3.3%
EPS Accretion From Buybacks
6.4%
Accretion + Yield
8.5%
Description: BlackRock is a fund manager. It is well positioned to take advantage of new federal hedge fund advertising rules.

Marathon(股票代號: MPC)

Price Target
$66
Dividend Yield
2.2%
EPS Accretion From Buybacks
6.4%
Accretion + Yield
8.6%
Description: Marathon is an oil company. It just purchased a refinery from BP.

Norfolks Southern(股票代號: NSC)

Price Target
$78
Dividend Yield
3%
EPS Accretion From Buybacks
6.7%
Accretion + Yield
9.6%
Description: Norfolk makes rail cars. It remains poised to benefit from natural gas drilling.

Coca-Cola(股票代號: CCE)

Price Target
$35
Dividend Yield
3%
EPS Accretion From Buybacks
6.7%
Accretion + Yield
9.6%
Description: Coca-Cola makes drinks. It reached a near two-year high last month.

Lowe’s(股票代號: LOW)

Price Target
$33
Dividend Yield
2.2%
EPS Accretion From Buybacks
9.7%
Accretion + Yield
11.8%
Description: Lowe’s is a retail home improvement company. S&P recently reaffirmed its A- rating and removed them from their CreditWatch warning list.

Ameriprise(股票代號: AMP)

Price Target
$64
Dividend Yield
2.5%
EPS Accretion From Buybacks
9.4%
Accretion + Yield
11.9%
Description: Ameriprise is a financial planning company. It’s rumored to be on the verge of purchasing ING.

Time Warner(股票代號: TWX)

Price Target
$44
Dividend Yield
2.3%
EPS Accretion From Buybacks
11%
Accretion + Yield
13.2%
Description: TimeWarner is a cable and Internet provider. It’s up more than 50 percent in 2012, and is about to add NFL Network.

Travelers Inc.(股票代號: TRV)

Price Target
$75
Dividend Yield
2.6%
EPS Accretion From Buybacks
14.9%
Accretion + Yield
17.5%
Description: Traverlers is an insurance company. It hit an all-time high last month on rising insurance rates.

Assurant Inc.(股票代號: AIZ)

Price Target
$45
Dividend Yield
2.1%
EPS Accretion From Buybacks
19.0%
Accretion + Yield
21.1%
Description: Assurant is an insurance company. Fitch recently affirmed two of the company’s operating units as “stable” based on improved financial performance.

Source: Goldman Sachs

 

Here’s the “high” probability trade to bet that this particular merger goes through:

Long Jef@16.25 and write Jef 16 strike April 2013 Call@1.35

This is a stock for stock deal, comprises of exchanging 0.81 share Luk, the acquirer, for every share of Jef, the acquiree. As of right now, Luk trades at 21.16, so Jef in theory is worth 17.139 per share as of the time I am writing this.
Deal expects to close in first quarter of 2013

Profit of this trade if things proceed as expected is about 6.7% in about 5 months

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