Calculating Intrinsic Value

[D.T.]

One for Intrinsic_Value (or anyone else who can help),

After reading some titles by Roger Montgomery, Warren Buffet and Ben Graham and reading/watching some online resources by the same, I've been trying to calculate intrinsic value for myself using RM's method. This is basically a function of what return on equity the business is generating by their payout ratio (ie how much of their returns do they keep and what sorta return do they get on those returns).

I'll show all my workings here, and hopefully I can be told where I'm going wrong. Source of these numbers is Financials from Westpac Trading Platform

Example company in this case is JB HiFi (ASX code JBH):

2013 Equity: $243.3 Million
2012 Equity: $184.5 Million
Therefore Return on Equity (ROE): is 31.87% (I'll use 30% in calcs)

2013 quantity of shares: 98.9 Million.
Therefore Equity per Share (ie 2013 Equity divide 2013 quantity, or EQPS): $2.460


NPAT: $116.4M
Reported Dividends: $71.208M
Therefore payout ratio (POR): 61.2% (And retaining ratio is 38.8%)

Lets say my Required Return (RR) is 10%.

So,
A) EQPS x POR x multiplier from Montgomerys table = A
B) EQPS x Retain ration x multiplier from Montomerys table = B

A = $2.46 x .612 x 3 = $4.52
B = $2.46 x .388 x 7.225 = $6.90

Valuation = A + B = $11.42 , which is about half the value most others are getting.

So does my maths suck or does am I using crap inputs?

 

[Intrinsic_Value]

One for Intrinsic_Value (or anyone else who can help),

After reading some titles by Roger Montgomery, Warren Buffet and Ben Graham and reading/watching some online resources by the same, I've been trying to calculate intrinsic value for myself using RM's method. This is basically a function of what return on equity the business is generating by their payout ratio (ie how much of their returns do they keep and what sorta return do they get on those returns).

I'll show all my workings here, and hopefully I can be told where I'm going wrong. Source of these numbers is Financials from Westpac Trading Platform

Example company in this case is JB HiFi (ASX code JBH):

2013 Equity: $243.3 Million
2012 Equity: $184.5 Million
Therefore Return on Equity (ROE): is 31.87% (I'll use 30% in calcs)

2013 quantity of shares: 98.9 Million.
Therefore Equity per Share (ie 2013 Equity divide 2013 quantity, or EQPS): $2.460


NPAT: $116.4M
Reported Dividends: $71.208M
Therefore payout ratio (POR): 61.2% (And retaining ratio is 38.8%)

Lets say my Required Return (RR) is 10%.

So,
A) EQPS x POR x multiplier from Montgomerys table = A
B) EQPS x Retain ration x multiplier from Montomerys table = B

A = $2.46 x .612 x 3 = $4.52
B = $2.46 x .388 x 7.225 = $6.90

Valuation = A + B = $11.42 , which is about half the value most others are getting.

So does my maths suck or does am I using crap inputs?

Assuming your figures are correct, this sounds about right.
There are multiple methods to calculate intrinsic value, there is no single best method.


This calculation is done using the return on equity method.
Using this calculation i am more lazy in doing this calculation, for myself its just:

BV x ROE/10
Using your figures it would be around $7.56.

However this is a static figure, it just captures a 'point in time' and makes no regards to future profit.

So you could input some broker forecasts a couple of years out and see what the change in 'value is'.

However this also has drawbacks, because how accurate are future broker forecasts.

Also the Equity valuation method has serious drawbacks for cyclical companies and utility like companies.

By the way i was buying JBH when it was below $12. I want to sell my holdings but have held for less than a year so don't want to get wacked for CGT (without the discount). So am just holding, since price is not dropping i will just wait, until i can offload.

One of the other problems with RM 'multiplier' is that assumes that re-invested profits will earn the same ROE in the future, this can be dangerous, its rare that a business will be able to reinvest profits at the same ROE, usually if a company has a high ROE and is NON-cyclical, it will pay out a good portion of the profits, since the retention of profits will actually reduce future ROE

Another variation to this valuation method that i use is cash flow per share rather than profit per share.

 

[chindonly]

I ran it through my spreadsheet and it calculated $11.43, so your numbers based on Montgomery's formula are correct.

Whenever I am looking, I download all of the ASX and run it through a workbook I set up based on his theories.

I also add a few other criteria and narrow it down - level of debt, market cap, dividend yield, EPS 5 yr growth.

 

[D.T.]

IV: If the maths looks ok, then the inputs must be crap because RM got about $22 or $23 but didnt show his workings. In a podcast, he said that only 4 of the top 100 Australian companies are currently priced below their IV and JBH was one of them.

Chin: Wow that sounds awesome. Whats the odds of me getting a copy of that?

What do you guys generally use as your source of data?

 

[chindonly]

I will PM you. Its a bit messy (and I am too tired to clean it up!), but works well.

Your numbers are a little different to what e-trade has on JBH, particularly ROE.

Maybe that is where some of the differences comes in.

As above, I use e-trade, but also look a bit deeper at the company once it flags as having a high MOS.

Some of the numbers can often be skewed by some unusual events.

 

[Intrinsic_Value]

IV: If the maths looks ok, then the inputs must be crap because RM got about $22 or $23 but didnt show his workings. In a podcast, he said that only 4 of the top 100 Australian companies are currently priced below their IV and JBH was one of them.

Chin: Wow that sounds awesome. Whats the odds of me getting a copy of that?

What do you guys generally use as your source of data?

Two possible solutions:
Re-input using
(a) a lower than 10% required rate of return, with interest rates dropping then the 'risk free rate' is dropping, therefore the risk free rate + equity premium is dropping. So maybe he is using a lower figure say 7 or 8%

(b) Analysts expect a profit of around 133million in 2015. If you plug this number in on the current equity base how does it stack up, on rough figures the ROE goes up to around 55%, on such a high ROE your multiple table should have a pretty high multiple.

For myself, sorry i dont care whether RM thinks JBH is undervalued or not, to myself it is significantly over-valued, so am not prepared to do work on it.

As Buffett said if you have to over annalyse a situation to make an investment opportunity stack up, then its probably not worth it.

 

[D.T.]

Two possible solutions:
Re-input using
(a) a lower than 10% required rate of return, with interest rates dropping then the 'risk free rate' is dropping, therefore the risk free rate + equity premium is dropping. So maybe he is using a lower figure say 7 or 8%

(b) Analysts expect a profit of around 133million in 2015. If you plug this number in on the current equity base how does it stack up, on rough figures the ROE goes up to around 55%, on such a high ROE your multiple table should have a pretty high multiple.

For myself, sorry i dont care whether RM thinks JBH is undervalued or not, to myself it is significantly over-valued, so am not prepared to do work on it.

As Buffett said if you have to over annalyse a situation to make an investment opportunity stack up, then its probably not worth it.

It's not really about caring what RM arrived at but moreso ensuring I'm getting something relevant from my analysis. If I'm +/- on a few vals, I'm ok with that, but I'm off by a magnitude of 50% then I can only assume somethings wrong.

As long as it's consistent each time then it shouldnt matter too much, I guess.

 

[Intrinsic_Value]

The top 10 holdings in the Roger Montgomery Fund:
McMillan Shakespeare A3 18.1 63.7 17.6
CSL Ltd A1 37.3 30.5 23.1
Seek Ltd A2 32.0 22.5 26.5
Resmed Inc B2 19.6 -35.7 19.8
Woolworths Ltd B2 26.2 38.7 17.5
Challenger Ltd B3 22.5 n/a 9.8
Amcom Telecommunications Ltd B2 17.9 9.8 19.6
Kathmandu Holdings Ltd A3 15.6 13.8 16.1
Credit Corp Group Ltd A2 24.4 3.5 13.4
Ainsworth Game Technology A2 29.3 -19.2 22.1

So JBH if held is not currently in the top10 holdings even based on your podcasts statement that JBH is only 1 of 4 top 100 companies trading under IV.

So i wouldnt worry too much about it, as a mental excercise maybe you want to run these top 10 holdings through your IV models and see how they stack up.

 

[Intrinsic_Value]

It's not really about caring what RM arrived at but moreso ensuring I'm getting something relevant from my analysis. If I'm +/- on a few vals, I'm ok with that, but I'm off by a magnitude of 50% then I can only assume somethings wrong.

As long as it's consistent each time then it shouldnt matter too much, I guess.

no you are not, your valuations came up about right based on your inputs.

But what inputs to use?????

Maybe montgomary is using different inputs, and without knowing those inputs you cant back test it.

For example as i said previously try a 7% required rate of return instead of 10, try future estimated profit.

The multiplier table you are using is based on a required rate of return of 10%, maybe he is now using a lower required rate of return, so you have to re-calibrate that multiplier table to the lower rate of return, this will increase the multiplier

 

[Intrinsic_Value]

By the way for myself, i am an absolute investor, not a relative investor.

So i always use the 10% required rate of return as the discount factor.

If the numbers dont stack then they dont stack, i am not interested in valuations relative to the risk free return.

So as i said JBH doesnt cut it for me.

Some people also like increasing the discount factor for 'increased risk'. Myself i think this is very risky, increasing the discount factor doesnt remove that risk. I prefer sticking with 10%, but for more risky investments, i will then go through the financials in more detail.

 

[D.T.]

The top 10 holdings in the Roger Montgomery Fund:
McMillan Shakespeare A3 18.1 63.7 17.6 Price $12.62 IV $20.87
CSL Ltd A1 37.3 30.5 23.1 Price $67.75 IV $26.54
Seek Ltd A2 32.0 22.5 26.5 Price $12.80 IV $18.46
Resmed Inc B2 19.6 -35.7 19.8 Dont have data
Woolworths Ltd B2 26.2 38.7 17.5 Price $34.76 IV $26.42
Challenger Ltd B3 22.5 n/a 9.8 Price $6.10 IV $4.38
Amcom Telecommunications Ltd B2 17.9 9.8 19.6 Price $1.98 IV $0.81
Kathmandu Holdings Ltd A3 15.6 13.8 16.1 Price $3.30 IV $1.40
Credit Corp Group Ltd A2 24.4 3.5 13.4 Price $9.32 IV $8.20
Ainsworth Game Technology A2 29.3 -19.2 22.1 Price $4.20 IV $4.11

So JBH if held is not currently in the top10 holdings even based on your podcasts statement that JBH is only 1 of 4 top 100 companies trading under IV.

So i wouldnt worry too much about it, as a mental excercise maybe you want to run these top 10 holdings through your IV models and see how they stack up.

I've tweaked my method of valuing, to use 5 yr avg for ROE (as I feel this is fairer for those that are cyclical or perhaps had a great/poor year), this made JBH value at $24.71 which is 11% discount at current price. My answers using this new method are in red above. Only 2 of those stacks up according to my method. I use 10% RRR in all of them.

I'm curious what you dont like about JBH IV? 5 year avg ROE is 50%, long term debt is 14%.

 

[Intrinsic_Value]

I've tweaked my method of valuing, to use 5 yr avg for ROE (as I feel this is fairer for those that are cyclical or perhaps had a great/poor year), this made JBH value at $24.71 which is 11% discount at current price. My answers using this new method are in red above. Only 2 of those stacks up according to my method. I use 10% RRR in all of them.

I'm curious what you dont like about JBH IV? 5 year avg ROE is 50%, long term debt is 14%.

main reason, how long can JBH maintain its long term growth rate.
To me its mainly because I think JBH is reaching market maturity, therefore can any re-invested profits continue to generate 50% ROE.

If they cant then my simple calculate shows a simpler 'non-growth' IV which is less than half of the current share price.

I could be wrong, but I don't loose money by being wrong on something I haven't invested in, I just loose an opportunity

 

[D.T.]

Thanks for your input.

What company's debt level do you consider the limit of to buy into? Is Long Term Debt / Assets the best metric to use or do you refer to interest cover?