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INTRODUCTION
VALUE MATTERS
This book will help you make the most of the increase in better and more transparent financial reporting. The final step in this framework is to describe the appropriate tools used to determine an individual investor's level of security for a stock. At the end of the day, you need to be comfortable with the tools you know how to use best.
THE MIND OF THE VALUE INVESTOR
Real risk is a negative and permanent change in the intrinsic value of the company. The value investor's focus should always be on driving the company's intrinsic value. The first is that the stock price fluctuates around the intrinsic value of the company.
BUSINESS AND INDUSTRY ASSESSMENT
Using this statement, an investor can get a sense of a particular company's earnings power—the strength and quality of income the company is expected to earn. The most important thing is the cash flow from operations, since it is the sale of goods and services - the company's ability to survive. Direct labor is labor that actually "touches" the product during its creation, as in the case of workers on an assembly line.
PRICE AND VALUE ASSESSMENTS
Understanding price is the effort to understand how prudent investors value a company, and why. The metric used by this investor base to value a particular company, and those companies in its industry, is not difficult to obtain. There is an asset-based valuation, which focuses on the intrinsic value of the business. The objective is to get a relative sense of the value of the business based on the current value of the company's peers.
The book value of equity on the company's balance sheet is the company's total assets minus its liabilities. While these are good tools to use in valuing a company, value investors also try to measure a company's intrinsic value by examining the entire company—the company's enterprise value. First, if the equity holding is a minority interest, EBITDA does not reflect the income from the holding; however, the numerator—the enterprise value—will include the value of the shareholding in marketable securities.
Below are the critical errors in using EBITDA according to Moody's. The findings presented in this chapter are used with permission from Moody's. Using forward-looking P/E in the numerator already takes into account the company's growth prospects. There are three variables to consider when using DCF valuation – cash flow, discount rate and time.
Three years is too short because the DCF valuation then becomes more like a cash flow multiple, and years beyond ten is too long given the dynamic nature of American business—the business is more likely to be different in a decade.
CATALYST IDENTIFICATION AND EFFECTIVENESS
Stock catalysts boost a company's stock price without improving firm value. However, overspending in these areas is usually at the expense of the company's cash flows. A firm's cost of capital is a combination of the company's cost of debt and equity financing.
If the company is too aggressive in the reduction. working capital, it can actually cause lost sales and ultimately the reduction of the company's value. The net capital investments made by companies—the difference between the company's capital expenditures and depreciation—is cash coming out of the company that reduces the cash flow to the firm. Second, the company can invest the cash in other areas of the company, which can produce a higher return for the company.
Activists typically propose very specific recommendations to the company's management team, such as corporate and financial management strategies to increase the value of the firm. Economies of scale effectively reduce a company's cost of doing business over time, thereby increasing profit margins, and ultimately the value of the firm. The company had a leading position in almost all the markets in which they competed.
The management teams in the various divisions were strong, and each division of the company had seasoned operators.
THE “MARGIN OF SAFETY”
PRINCIPLE
The focus of most value investors has always been on the intrinsic value of the company in question. The reason is simple – the margin of safety is always based on the price of the shares and their value. The margin of safety is determined by the difference between the price paid and the value of the company.
Some adjustments to the Margin of Safety definition include more of the company's intangible assets. Inflation can also negatively affect the true value of an asset. This is then adjusted again based on the degree to which this intangible asset contributes to the value of the business.
The comparison of asset value and the value of the company, as a continuous resource converter, can provide useful insights into the company. One calculation of the value of a company is based on the discounted cash flow generated from its assets. I liked what I read from my initial observation of the company - specifically the company's strategy to create shareholder value.
July 25, 2000: Circuit City, one of the company's major distributors, announces it will exit the appliance business.
ASSESSING THE INVESTMENT
In the area of network security, the majority of the company's revenue had historically come from the McAfee antivirus product line. In the area of network management, most of the company's revenue came from its Sniffer product line. The analysis I had done at Sybron International revealed that the sum of the company's parts was worth more than the whole.
Based on the sum of all the parts, Sybron International was worth at least $37 to $43 per share, creating a 60% upside potential to the company's current price. I started recommending buying the company below $15 per share based on the valuations I placed on the company's many business assets. The following is an excerpt from the company's last quarterly report at that time.
In the United States, the company also held the leading market share position in disposable tableware. The company generated strong free cash flow and had one of the best management teams in the industry. By sum of parts, I have differently evaluated food packaging, protective packaging and company shares in PCA.
Given the quality of the company and its management team, Pactiv's share price was significantly lower temporarily.
BUYING RIGHT AND BEING AN OWNER
The management team is very strong and has the proper financial incentives in place. Nothing had changed
Cost cutting and asset sale opportunities are significant and real
As common shareholders, the more shares you own, the more influence you can have on the company. These types of shares are often controlled by a small number of entities that control the company. This legal document contains information on which shareholders must vote for approval of the management team's upcoming plans.
For people who are not full-time investors, the buy-and-hold strategy may be appealing. Once the shares are purchased, investors do not need to look at the stock's daily price fluctuations to decide whether to sell or not. More time can be spent gaining a better understanding of the business they own.
A negative feature of the buy-and-hold strategy is that your investment may be too early to benefit from any catalytic results. In general, I think the buy-and-hold strategy is good. it's the duration that matters. Therefore, one can conclude that 5 to 10 years may be too long in the modern era and that 3 to 5 years may be a more appropriate time frame to own a stock.
My ongoing research reveals deterioration of the business foundation or permanent impairment of the company's assets.
GENERATING VALUE
IDEAS AND BUILDING AN INDEPENDENT PORTFOLIO
Some publications err more on the side of "reporting" the day's events, while others focus on analyzing the news and predicting future outcomes. Value investors can then turn to the Business Index column if they have a particular company of interest and wish to read any updates that may be included in the current issue. Finally, with the information provided in the paper, the investor can get a perspective on the economy.
Finally, Barron's has a list of companies in the publication's index that a value investor might find worth exploring. Other areas in the paper, such as "The Big Picture" and "Industry Groups," can help value investors understand sectors that the general market may not consider. Many in the investment community refer to concentrated portfolios as "concentrated investing." The goal is to focus on a few well-researched companies that have the greatest potential to generate superior returns.
The genesis of focused investing lies in the value investor's belief that good opportunities are hard to find. The answer lies not in general market sentiment, but in the economics of each individual business. In fact, this is exactly how value investors perceive stock ownership - as buying companies in the form of securities.
Buffett said it best: “The art of successfully investing in public companies is a little different from the art of successfully buying subsidiaries [of companies].
BUSINESS ASSESSMENT TOOLS
