Question for the fundamentalists out there

[scalf]

[img]/forums/images/icons/tongue.gif[/img] i would argue that buffet knows how to truly value assets; and very important..and, knows how to buy assets cheaply, and combine them in a way that creates cash flow...but saying that is the same thing as book value misses the point....entirely...jmho..gl..i think if ya buy a share of buffet for 65k or so..it will be 550k in 10 years..more than he postulates..gl [img]/forums/images/icons/cool.gif[/img] [img]/forums/images/icons/diamond.gif[/img]

[Ray Zee]

any company's value is really only its breakup value. the value if its sold out. same as with a person. sell off all their assets and thats the value. but stocks also are given a current value which is the price they trade at. that value is solely based upon what the company looks like it is going to earn in the near future. basically its the P/E ratio more or less but close.
you can also throw in blue sky and good will and other such things. but they only apply when sold to a willing buyer who expects to keep the company going.
my premise is that a stock trades at its earning value so when you make the decision to buy or sell thats what you use to decide. you job is to guess correctly which way its going. thats why i always say buy or sell stocks where you see a change happening, and bet in the direction of what the change will be.
then you must weigh the earning potential with the current forcast for the cost of money. thats your cost to hold that stock. especially with ones that do not pay dividentds.

as to dividends. would you buy a stock if told they would never pay a dividend to investors. that means you never recover your investment. a public company is nothing more than a private business that sold shares. would you invest in a friends company if he told you you would never get a return, and your only salvation would be to find another buyer for the shares.( the greater fool theory)

[GrapeJuice]

Ray, your thinking is off. A company's value is not it's current break-up value. A company's value is it's break-up value in the future, discounted to a present value.

Of course, the amount that the company earns between now and the time it's liquidated plays a *huge* factor. Normally, you expect that the amount that the company earns between now and the end would stay with the company or be doled out in dividends. And hopefully, those earnings will far outweigh present "book value" or present liquidation value. That's why we buy these companies for the long-run (for those of us who believe in the long-run).

You wrote: "as to dividends. would you buy a stock if told they would never pay a dividend to investors."

Yes, I would! If the company can use the money well to create more money then the company should hold on to the excess profits! In the distant future, should the company liquidate, if holding onto the excess profits creates a larger liquidation value then that should affect market price of the company. The effect on market price should hold true not just in the distant future, but also in the present because of the expected future value of the company!

[GrapeJuice]

Here's why you want book value to be on the low side:

When a company claims, for instance, a piece of real estate, it's value is part of the 'book value'. But the value of that real estate that's actually booked is the purchase price of the real estate. So if a company holds a piece of land that it bought in 1906 for $20,000 and it's worth $1,000,000 now, it's carried on the books at $20,000. On the other hand, if the property goes down in market value, that's booked immediately. Since the appreciation in value is never booked until the property is sold, you want book value to be way on the conservative side. See, if someone doesn't look carefully enough at the company, they won't notice that (in the example above) the company is worth at least $980,000 more than it at first appears.

[Wildbill]

Ray also misses the easy to overlook, but hard to ignore factor that many of these companies give off their cash in an indirect way by buying back shares. Most partnerships work this way and so it is in the stock market. You and 3 buddies start up a business today. In a few years its obvious one buddy just isn't into it, so someone or all of you buy him off and pay him based more on the valuation at the day you make the deal, not the value he bought in at when you started. Same with companies, while you think they might not issue dividends, if they are willing to buy 10% of the shares that is essentially saying we will go out and buy out the 10% of the shareholders that have the least faith in our future business and we will even give you what the market thinks is a fair price today. While of course its not that simplistic, it still works and gives you a reason to buy something that may never pay standard dividends, but gives you an assurance that you can get your value out of an investment before breakup.

Further Ray might dismiss goodwill, but the concept is very true. You might make a damn good hamburger, but if you stand is Ray's burgers and your across the street competitor is named McDonalds, who do you think will get more business and why? That is the concept of goodwill. If Ray makes such good hamburgers and builds a bunch of his restaurants, he has created goodwill. That goodwill is worth a lot more than the restaurants or equipment he has. The brand name generates more business and higher future profits per store than just a one-store burger business. Breakup value really has almost nothing to do with valuation and earnings isn't as important as its cracked up to be. Indeed discounted cash flows is the best way to value a business, but since companies sell stock like its a fashion statement, so many people miss this point. It reminds me of back when people were paying huge mulitples on Microsoft stock when it already was insanely profitable and big. Someone did the math showing that the only way to justify buying it is if you thought it would be something like 20% of the US economy in 10 years, or something like that. It was utterly ridiculous, but then again that was the world we lived in not so long ago. Things definitely get out of whack, but if you focus only on breakup value you will miss out on the point of owning a company.

[adios]

"The effect on market price should hold true not just in the distant future, but also in the present because of the expected future value of the company!"

Come on it doesn't always work that way. You can be totally right and be wiped out. I disagree that the market prices that effeciently. IMO if you are correct then yes the market does prices very effeciently. I don't think the evidence supports that level of efficiency. This ties into wildbill's post below. The hardest thing for me to finally grasp about the stock market was that prices can literally go anywhere and everywhere and be justified in doing so. Put another way, any kind of discounted cash flow model which could and should take into account other factors such as franchise value can imply some huge trading ranges by changing a few parameters slightly.

As far as being totally wiped out. A few years ago somebody posted about whether or not MO was a good buy. It was trading at $20 a share. I chimed in and said no sell it. Of course it took off from their and went over $50 a share. I noticed that today it went out at about $32. It wouldn't surprise me at all to see that stock end up below $20 a share. Let's say that in a year from now MO trades at $10 a share. If it did was I wrong 2 years ago or was I right? Here's another example. I hardly ever watch Rukheyser. However, there was a controversy about 4 years ago where one of his "elfs" was perpetually bearish saying the NASDAQ at 2000 and the Dow at 8800 or whatever were overpriced. She kept on saying it as the market went higher. Rukheyser fired her for being wrong. Was she though? Finally as I've stated before about dividends. Here is the gist of something Mike Milken said way back when.

"I prefer high yielding bonds to stocks. When I find a high yielding bond that is undervalued I start collecting money right away and if the market never agrees with me I've still collected all the coupon payments and redeemed the bond and still make money. I never have to have the market agree with me that the bond is undervalued to realize it's value. When I find an undervalued stock I have to have someone else agree with me that the stock is undervalued. If I never find someone to agree with me I will never realize it's value and if I do I may have to wait for a very long time. I have to have the market agree with me that it's unvervalued but with the high yield bond I don't."

[Wildbill]

Market worries about weird things is about all I can say. At certain times some worries are more in vogue than others. Right now people are just so enamored with free cash flow and strong balance sheets its silly. Those might have been useful last couple years, but they aren't worthy of adding some premium on top of a stock yet many are doing just that. "Certainty of results/cash flow" they say. What it reflects is that people are afraid of the opposite and just refuse to buy it at any price. Then with the money they have they overinvest in things that exhibit these characteristics they want. Supply and demand takes over and these stocks get overpriced relative to what are perceived as risky stocks. Risky stocks sometimes go bad, but not always and to avoid them completely means you are probably overpaying for what stocks you do hold. If this strategy reflects enough portfolios then you will get pricing imbalances and that is where I see them right now.

People have just gotten so risk averse today that you have to wonder. My thinking is that they got so burned by the burst of the bubble that they have taken a turn in the completely wrong way. When it comes down to it there is always risk in being in the market. That has to be accepted. The key is to pick a relative risk level and keep your investments at that level of risk, regardless of market sentiment or situation for the duration of your investment horizon. You can change your risk tolerance slowly over time as you get closer to retirement age, but that should also be carefully planned out. You shouldn't be getting more risky for awhile, get burned and then turn tail and go full bore conservative. Yet this is the inclination of the market and is why pricing can get messed up very easily. Those that just avoid risk today are quite obviously going to be consistent market losers, the guys or gals that can't figure out why they can't beat inflation with their returns.