John Burr Williams on what a company is worth

From How to Pick Stocks Like Warren Buffett by Timothy Vick

In 1938, John Burr Williams postulated that a company is worth no less and no more than what owners can take out of it in earnings.  You can determine what a company is worth by calculating what it can earn over its eternal lifetime and adjusting earnings for inflation and the time value of money.  If you estimate that Intel will earn $175 billion over its expected life, after adjusting for inflation and your risk tolerance, then you should be willing to pay up to $175 billion to acquire the whole company.

If Intel had 1.75 billion shares outstanding, each share must reflect the appraised value of the whole and should sell for no more than $100.

To Williams, four concepts are vital to appraising a company:

1.      You must see yourself as an owner of the business and appraise a public company as you would a private enterprise.

2.      You must estimate the company’s future earnings potential.

3.      You must determine whether future earnings will be erratic or a steady “annuity.”

4.      You must adjust the value of future earnings by the time value of your money.

Benjamin Graham NCAV or Net-Net Working Capital and Intrinsic Value Formula

Benjamin Graham

NCAV or Net-Net Working Capital

NNWC = (Cash & Investments * 100%) + (Accounts Receivable * 75%) + (Inventory * 50%) – Total Liabilities

Intrinsic Value Formula

                                    The formula as described by Graham is as follows:

Value = Current (Normal) Earnings x (8.5 + (2 x Expected Annual Growth Rate)

Where the Expected Annual Growth Rate "should be that expected over the next seven to ten years."

The value of 8.5 appears to be the P/E ratio of a stock that has zero

growth. It is not clear from the text how Graham arrived at this figure, but it is likely it represents the y-intercept of a normal distribution of a series of various P/E values plotted against corresponding growth figures.

Graham's formula takes no account of prevailing interest rates; at the time he last updated the chapter, around 1971, the yield on AAA Corporate Bonds was around 4.4%. We can adjust the formula by normalizing it for current bond yields by multiplying by a factor of 4.40/{AAA Corporate Bond Yield}. Bond yields

can be found on Yahoo!

Let’s take a real-life example, using IBM. According to Yahoo!, the expected growth rate for IBM over the next 5 years is 10% per annum (note data is only available for 5 years ahead rather than the 7-10 years Graham states, but this should not make a significant difference). EPS for IBM over the last 12 months is $4.95. Taking these values and plugging in the 20 year AA Corporate bond yield of 5.76% (AA Bond yields are higher than AAA so will give a more conservative estimate of IV) in our adjustment gives:

Intrinsic Value = 4.95 x (8.5 + (2 x 10) x (4.40/5.76) = $107.77

IBM is currently trading at around $91, so it is currently slightly undervalued.

Building The Core With Vanguard: Domestic Bonds http://t.co/xmmU3xlKLn $AGG $BSV $SCHZ $VTI $BND

— ETF Investing (@SAlphaETF) June 11, 2015

Warren Buffett on CNBC – The Billionaire Next Door

December 27, 2006

Warren Buffett on CNBC – The Billionaire Next Door

Interviewed by Liz Claman

Family had grocery store he worked at.  The store was in his family for 100 years.  From 1869 until 1969 when his uncle retired.

Started out selling Wrigley’s chewing gum and Coca-Cola he bought from his grandfather.

He bought his first stock at age 11.  City Service Preferred stock.  He said he doesn’t know why he wasted so much time before then.

Bought a farm at the age of 14 using money he had saved from paper routes.

What he’s looking for in a business?

1. Something he can understand.  Something in his “circle of competence”.

                                                               i.      He doesn’t understand what car company, software or chemical company will win 10 years from now.  But he does understand that Snicker’s Bar will be the number one candy bar in the U.S. just as it has been for the last 40 years.

2. Durable Competitive Advantage

                                                               i.      A business that will dominate for what appears to be forever.

3. An Honest and Able management.

4. A price that he wants to pay.

Berkshire Hathaway has acquired 68 subsidiaries since Buffett took control in 1964.

            1964 - National Indemnity Insurance

            1972 - See’s Candies

            1983 -  Nebraska Furniture Mart

            1989 – Borsheim’s Fine Jewelry

            1998 – Dairy Queen, Geico, NetJets, General Re

            2002 – Fruit of the Loom

            2006 – Iscar Metalworking Companies (1^st foreign holding)

The average person today lives better than John D. Rockefeller.

The ultimate luxury is getting to do what you love to do everyday.  Particularly if you can do it with terrific people around you.

Liz Claman mentions that Warren has stayed honest by doing what he loves.  Warren laughed and said that know one will really know if he was honest in a sense.  Because he never had two kids at home sick and not enough money to feed them.  You will never know whether he would have held up a liquor store because he never had to.

Buffett Playbook

1. Rule #1, Don’t Lose Money.

2. Rule #2, Don’t forget rule #1.

3. Look for unique companies that are hard to replicate.  They have a moat around the business.

4. Circle of Competence.  Do what you know.

Pat Dorsey’s The Five Rules for Successful Stock Investing

Do your homework.

Find economic moats.

Have a margin of safety.

Hold for the long haul.

Know when to sell.

 

National Association of Investors Corporation (NAIC) Guiding Principles

1.   Invest regularly.

2.   Reinvest earnings.

3.   Choose quality growth stocks and mutual funds at a reasonable price.

4.   Diversify.    

www.better-investing.org

Lou Simpson’s Five Investment Principles

1.   Think Independently.

2.   Invest in high-return businesses that are run for the shareholders.

3.   Pay only a reasonable price, even for excellent businesses.

4.   Invest for the long-term.

5.   Do not diversify excessively.