Value Added: Market Value Added and Economic Value Added

VALUE ADDED

• MARKET VALUE ADDED
• ECONOMIC VALUE ADDED

MARKET VALUE ADDED (MVA)

Market value added (MVA) 

= Current market value or capitalisation (to which debt may be added) – Total shareholders’ equity  

Example:

Capitalisation of a company is $100

Shareholders’ equity in balance sheet is $50

For every $1 of shareholders’ equity, the company has added $1.

ECONOMIC VALUE ADDED (EVA)

Companies should be expected to produce not only an accounting profit but also one that more than covers their cost of capital.

It is argued that EVA is better than earnings per share or price/earnings ratios as these do not take account of the real cost of capital.

Example:

After the charge of $10 ($100 x 10%) representing the estimated cost of capital, the company shows an EVA of $30 for the period.

After tax profit $40

Capital Employed $100

Cost of Capital 10%

After tax profit $40

Cost of Capital $10

ECONOMIC VALUE ADDED $30

A positive EVA indicates that a company is providing investors with added value.

A company with a consistent EVA should have an increasing MVA; it will be generating a rate of return above the cost of capital so the share price should rise.

Examples:

These three companies are all generating a positive return on capital employed.

Company A

After-tax profit $50

Capital employed $200

Cost of capital (10%) $20

ROCE (%)  25

EVA ($)  $30

Company B

After-tax profit $60

Capital employed $400

Cost of capital (10%) $40

ROCE (%)  15

EVA ($)  $20

Company C

After-tax profit $50

Capital employed $600

Cost of capital (10%) $60

ROCE (%)  8

EVA ($)  -10

Although company C produces a positive 8% return on capital employed, it is actually destroying shareholder value with a negative $10 EVA.

In practice, the calculation of EVA requires several adjustments – to allow for the treatment of R&D, goodwill, and brand values, leases and depreciation – to be made to the after-tax profit figure.

It is claimed that EVA, as a single monetary figure, is better at concentrating management attention on the “real” results of running the business than are standard performance ratios such as ROTA.

EVA is often used as a basis for managers’ performance-related incentives.

Growth is often seen as the best measure of corporate success.

Growth is often seen as the best measure of corporate success.

A company growing at a rate of 15% per year is doubling in size every five years.

Rapid-growth companies can be defined as those with annual growth rates of 20% or more.

Super-growth companies show a compound growth rate of around 40% per year.

MARKET SHARE INFORMATION

Market share information can provide valuable support to the analysis and interpretation of changes in a company’s turnover.

The majority of companies provide turnover growth details in their annual report, but few offer any details of market share.

When turnover is known for several firms competing in the same market, it is possible to devise a simple alternative to market share information.

Company	A	A	B	B	C	C	D	D	TOTAL	TOTAL
Year	1	2	1	2	1	2	1	2	1	2
Sales ($bn)	2.5	2.9	16	16.3	5.9	5.5	17.2	18.8	41.6	43.5
Share (%)	6	7	39	37	14	13	41	43	100	100

How their share of the joint total market changes can readily be followed.  If this is done for a number of years, the analysis can form the basis for a performance comparison.

RAPID GROWTH COMPANY IS NOT ALWAYS A SAFE AND SOUND INVESTMENT.  RAPID GROWTH CANNOT ALWAYS BE SUSTAINED. 

A common view is that a rapid-growth company is safe and sound investment.

However evidence suggests that rapid growth cannot always be sustained.  There are of course exceptions.  

BE CAUTIOUS OF GROWTH THROUGH DIVERSIFICATION OR ACQUISITION, THROUGH INCREASING DEBT FINANCING AND THROUGH TURNOVER GROWTH WITHOUT PROFIT.

·         However, it is probably safer to assume that rapid growth, particularly if associated with diversification, often through acquisitions, will not continue.

·         If high compound growth rates are matched by increasing debt financing, extreme caution is called for.

·         For some companies, turnover growth is seen as the prime objective and measure of success, even when it is being achieved at the cost of profitability.  In the late 1990s, e-business provided many extreme examples of this.

ONE-PERSON COMPANY

• GROWTH THROUGH DIVERSIFICATION, COMMONLY THROUGH ACQUISITION.

Being pushed towards diversification to fuel continued growth is often the final challenge for the one-person company.  Having proved itself in one business sector it moves into new areas, commonly through acquisition.  More often than not its old skills prove not to be appropriate in the new business, attention is distracted from the core business, and it is viewed as having lost the golden touch.  Its survival may depend on new management and financial restructuring.

• WHEN A ONE-PERSON COMPANY’S GROWTH SLOWS AND CRITICISM MOUNTS

When a one-person company’s growth slows and criticism mounts, two scenarios may occur. 

• ·         In one, the individual running the company begins to take increasingly risky decisions in the hope to returning to previous levels of profit growth. 
• ·         In the other, recognising that there is little that can be done immediately to improve operating performance, the individual steps outside the law and accepted business practice to sustain his or her personal image and lifestyle.  Often in these companies other executives are reluctant to rock the boat and go along with the deception.

Free Cash Flow

FREE CASH FLOW

An important factor in Shareholder Value Added analysis is the free cash flow (FCF) generating capability of a company.

This is the cash flow available after allowing for capital maintenance and interest payments.  FCF is calculated as:

Operating profit

Plus depreciation

Less cash tax paid

= Cash profits

Less investment in non-current assets and investment in working capital

= Free Cash Flow

FCF is useful in providing an indication of the level of a company’s cash flow generation.  

It also measures the amount of cash potentially available to cover the financing costs of the business after all necessary investment has been made.  Can the company safely consider raising more finance or making a major capital investment?

Companies often provide figures for their FCF, but there is no standard definition of the term so be cautious in using them.

If all interest payments are deducted, the resultant “levered free cash flow” indicates the amount of cash potentially available for dividends and future growth.

It is useful to compare the growth in free cash flow with that of earnings.  If the trends are significantly different, is it possible to find the reason?

RISK DISCLOSURE

RISK DISCLOSURE

Risk relates to future events that are quantifiable.

Uncertainties are future events that are indeterminate and non-quantifiable.  

In the 1990s, companies began to move from simple risk analysis to more proactive risk management.

Companies should disclose their risk management practices.

IFRS 7 deals with the risks associated with financial instruments.

There should also be discussion of the major risks and uncertainties facing the company and how these are being dealt with.  

The main classes of risk are identified as:

• -          Market risk:  exchange rate, interest rate or other price movements;
• -          Liquidity risk:  possible problems in making cash available.
• -          Credit risk:  customers fail to pay.

If there is an existing or potential liability, this is fully disclosed in the annual report as you need to know about this in order to properly assess the company.

RISK FACTORS

The risk factors are normally listed in order of significance.  

These provide some insight into management’s view of the risks seen to be facing the business.  

These may be related to a country’s economy, or a company’s industry or geographic location.  

Market risk includes interest rates, foreign exchange and commodity price risk.

“New” measure of risk.

An alternative approach to company risk assessment has been offered,  It is suggested that the number of times the word “new” appears in the annual report may provide a measure of risk.

Future Profit overrides Current Liquidity. Success or failure?

Ideally, a company can be expected to focus on 2 principal objectives:

1.  Future Profit:  To provide an acceptable and continuing rate of return to investors.
2.  Current Liquidity:  To maintain an adequate level of financial resources to support current and planned future operations and growth.



Future Profit and Current Liquidity

A company can survive without profit as long as it has access to cash.

A profitable company with no cash faces difficulties.

No company can survive for more than a few days with neither profit nor cash.



Future Profit overrides Current Liquidity

A profitable company is less likely to fail than an unprofitable one.

The overriding factor in deciding whether to allow a company to continue in business is its profit potential, which is more important than its current liquidity.

A company with low liquidity and a high profit potential will almost certainly be helped to overcome what may be regarded as a temporary problem.  

A highly liquid company with declining or no profit potential is unlikely to survive for long.   Why should investors leave their funds to dwindle?   The only decision facing such a company is 

• whether to end operations  immediately or 
• to continue and see liquidity and profitability decline until matters are taken out of management's hands.

7 signs you're building wealth faster than you think

• If you're maxing out a retirement plan and being mindful of your investments, you may be on the fast track to building wealth.
• To be sure, most people don't get rich overnight. But, if you avoid high-interest debt, are focused on increasing your income, and have clear goals and a plan to achieve them, you're doing better than you think.

You have to commit to building wealth — it rarely happens by accident.

But if you're mindful and deliberate about saving, investing, spending, and earning money, you may be building wealth faster than you think.




Below, seven signs you could be rich sooner than you realize.

1. You max out your retirement accounts every year

IRAs and 401(k)s are two of your greatest allies in setting yourself up for a comfortable retirement.

If you can afford to put the full $19,000 into your 401(k) this year — or you're moving closer to that limit — you're accomplishing a few things.

First, you multiply your earning potential in the market. Second, if your company offers to "match" your 401(k) contributions, you score that free money. And lastly, you shelter a sizable chunk of your income from income taxes (you'll pay those taxes later, but for now your money grows tax-free).

You can also contribute up to $6,000, or $7,000 if you're over age 50, to an IRA in 2019. The tax savings are set up differently than a 401(k), but the fundamental strategy is the same: The more money you put in the market now, the more you stand to earn.


2. You're thoughtful, but not obsessive, about your investment choices

If you've made thoughtful choices about where to invest the money you put into your 401(k), you're head and shoulders above the rest.

Too many people make the mistake of treating their 401(k) like a savings account and don't touch the money once it's in there, certified financial planner Eric Roberge previously told Business Insider.

Some 401(k) plans have a fine default investment selection, but you should always double-check to make sure it matches your own time horizon and risk tolerance, Roberge says.

You're in good shape so long as you choose investments that diversify your portfolio — i.e. a mix of stocks and bonds — and don't levy too many fees. Roberge recommends choosing either an all-in-one target date fund, which automatically rebalances itself, or building a portfolio of individual funds that provide appropriate diversification.

Checking on your asset allocation periodically to ensure it matches your overall risk tolerance is smart, but obsessing over the details could easily lead to emotion-fueled mistakes.


3. You're focused on the 'big wins'

Spending less than you make may be the golden money rule — but it's not the only rule.

Yes, it's important to cut your spending "mercilessly" on the things that don't add value to your life, says financial expert and bestselling author Ramit Sethi. But people who are good with money know that $2 here and $10 there won't make you rich, he says.

"There are a few Big Wins in life where — if you simply get them right — you almost never have to worry about the small things. If you can focus on the 5-10 Big Wins, rather than 50 little things, you can have an insurmountable edge in life," Sethi says.

For example, paying down debt, saving automatically, negotiating a higher salary, and investing early will have a much greater impact — and in a shorter time frame — than forgoing your morning coffee or weekly brunches.

4. You don't keep too much cash

If you understand the power of compound interest, chances are you never keep more than you need in cash or sitting in a checking account.

The best way to multiply your money is to invest it in the market, but that's not always an option. You can still grow the money you need in the short-term by storing it in a high-yield savings account or certificate of deposit (CD).

Any savings account or CD with an interest rate above 2% is worth considering. At the very least, your money won't lose value to inflation. At best? You'll boost your savings by a few hundred dollars, with zero effort required.


5. Your income is higher than last year, but your spending hasn't changed

If you're bringing home more money than you did at this time last year, congrats! That's a huge sign of progress, particularly if you haven't increased your spending along with it.

Whether you scored a raise, landed a better-paying job, or created a second or third income stream, increasing your earnings is a form of leverage that can never be exhausted.

"If you can take the cap off of that and increase your income — it's not always easy to do that, which is probably why people don't pay attention to it — but if you can do that, it gives you a lot more room to both spend and save," Roberge said on an episode of his podcast, Beyond Finances.

6. You have no high-interest debt

Consumer debt is a proverbial wealth killer.

The stock market returns an average of 7% to 8% each year, adjusted for inflation. Meanwhile, the average credit card charges an APR of 17%. Carrying a balance at that rate would mean you have to invest twice as much money just to break even.

The bottom line: It's not worth it. When you avoid high-interest debt, you can optimize each and every dollar you have coming in.

As Robert Kiyosaki writes in the personal finance classic, " Rich Dad Poor Dad," "Most people fail to realize that in life, it's not how much money you make. It's how much money you keep."


7. You have financial goals and a plan to achieve them

There's no problem with aiming high.

But if you have a road map to getting there — and you actually put it into action — your chances of achieving your goals increase greatly.



You don't have to seek professional help for managing your money or coming up with a plan, but it could be worth it if you're feeling stuck. According to a Northwestern Mutual report, people who work with a financial adviser are more likely to know how to balance spending now and saving for later; set specific goals and feel confident that they will achieve those goals; and have a plan in place to weather economic ups and downs.


Tanza Loudenback Aug. 17, 2019

https://www.businessinsider.com/signs-building-wealth-faster-than-you-think-2019-8?IR=T&fbclid=IwAR3gsdUEuB3um8AFsHXwzugprcrOEWgjcqnvb1KwSvKAHKiTHCTzW7al1c4

The Biggest Lie In Investing That You Believe In | TEDx Talk

"Be greedy when others are fearful."  Warren Buffett

"The way to MAKE MONEY is to buy when blood is running in the streets."  John D. Rockefeller.



So, how to PROFIT from a or the next crisis?

If a hurricane storm (OR FINANCIAL STORM) was heading your way, what would you do?

It is about BEING PREPARED!



The BIGGEST LIE.

There are 2 types of information:
1.  Information for the MASSES, and
2.  Information for the CLASSES.

Here is the lie:  "The economy is doing better, so the stock market should do better, too."

IT IS ACTUALLY THE OPPOSITE.

There is NO CORRELATION between the economy and the Stock Market!


Warren Buffett does NOT waste time thinking about the economy when investing:

• GDP
• Unemployment,
• interest rates,
• housing numbers,
• bankruptcies.

Peter Lynch says:  "If you spend 13 minutes thinking about economic forecasts, you have wasted 10 minutes."



Stock Market vs. Economy

In year 2009, there were a lot of negative news around and everybody hated stocks and dumping them.  There was blood in the street.  But at that time, the insiders (the classes) were buying.  At the peak of unemployment in 2009, the stock prices gone up 60%.



What is REALLY going on?

There are about 20 funds that do 80% of World's trading.
They have between $50 - $100 billion under management.
They employ smartest individuals to figure out what the economic trends will be (e.g. unemployment).
Example:  if these Funds believe that in 3 month, job figures will improve, they will decide to buy (& vice versa).


What to buy?

We only want QUALITY STOCKS.

Would you rather buy a BENTLEY at a 75% discount to a KIA at the same discount?



What are QUALITY BUSINESSES?

= Quality Stocks

1.  Solid earnings growth
2   Undervalued
3.  Cash rich
4.  Low Debt
5.  Growing sales.

Examples: Apple, Microsoft, Intel, Coca Cola, Walmart, Rolls Royce, Caterpillar



So WHEN do we buy them?

We want to buy our stocks when NOBODY wants them.

When are stocks hated, feared and unpopular ...?

Recall what John D. Rockefeller said, "The way to MAKE MONEY is to buy when blood is running in the streets."



WARNING!  STOP.

To invest successfully, you must do the psychologically impossible ...

And this is the hardest part.

BUY .. when everyone is afraid.

SELL .. when others are excited with greed.

The Biggest Lie In Investing That You Believe In

https://m.youtube.com/watch?v=B5-IpSYbeiQ&feature=youtu.be

Property counters: How are shareholders rewarded? How exciting are property counters in terms of investment returns?

Property counters

1. Land held for development.

2. Land being developed and properties for sale.

3. Investment properties held for rental income.



How are shareholders rewarded?

After successful development and realisation of profits from the projects, the property counter may choose to reward the shareholders by paying half their earnings as dividends.

The investment income from properties held as investment can also be partially disbursed as dividends.

[How exciting are property counters in terms of investment returns?]

Compound interest is the most powerful force in the universe.

Intelligent investment is rewarding over the long run.

Intelligent investor should recognise the force of the axiom:  compound interest is the most powerful force in the universe.


1.  The reinvestment of returns over a long period has dramatic consequences.

Over 10 years, $100 invested at 1% rate of compound interest over a decade, would become $110.  At compounding interest of 8% per year , $100 becomes $216 in a decade.

Over 40 years, the difference between a 1% return and one of 8% is the difference between $149 and $2,172,


2.  Reinvested dividends play a large role in long-term capital accumulation.

While many amateur investor tend to be attracted by capital gains and attach little weight to dividends, reinvested dividends play a large role in long-term capital accumulation.

If your target 8% return were made up of 3% dividends and 5% capital gain, your $100 would accumulate to $2,172 within reinvested dividends and $704 without them over 40 years..

Why do retail mutual fund investors do so badly?

Why do retail mutual fund investors do so badly?

1.  Charges are part of the explanation.

Mutual fund investors pay not only management fees but also the trading costs within the funds they hold.

They also pay further trading costs when they themselves buy and sell, which they do too often.


2.  But the principal explanation is bad timing.

Retail investors buy high, and sell low.  They are late into fashionable sectors, and late out of unfashionable ones. 

There is probably no worse investment strategy than following the conventional wisdom with a time lag, and that is precisely what many small investors do - often with the encouragement of their advisers.

Understanding Economic Cycles and Market Valuation.

Understanding the economic cycles and market valuation will not help anyone predict the direction of the market in the short term or even in midterms like a year or two.  However,

• it keeps investors from looking in the rear-view mirror, and 
• they will have a clearer view of the future and be able to stay rational when the market gets euphoric or sinks into fear again.

For analyzing individual companies, having a good knowledge of business cycles and the likely future market returns can be useful in evaluating

• management's capital allocation decisions, 
• their aggressiveness in accounting and 
• the quality of earnings related to pension-fund return assumptions.

Buffett is a bottom-up value investor and rarely talks about the general market.  But he has a tremendous understanding of 

• business cycles, 
• the role of interest rates, 
• market valuations and 
• the likely future returns and risks.

Over the long term, investors should always be optimistic.  They should focus their investments on the quality companies that not only can pass the test of bad times, but also can come out stronger.

Now, more than any other time, it is vital to invest only in good companies.

Look for three things in a person - Intelligence, Energy and Integrity.

“You’re looking for three things, generally, in a person – Intelligence, Energy, and Integrity. And if they don’t have the last one, don’t even bother with the first two.”

Buffett

Sourced from Farnam Street

Quality first, then Value.

Over the long term, investment return is more a function of business performance than valuation, unless the valuation goes extreme.

More effort should be put into identifying good businesses and buying them at reasonable valuations.

Investors should not be obsessed with the valuation calculations. All calculations involve assumptions. They are valid only if the underlying businesses perform as expected.

All eyes on Genting Malaysia’s 1Q results

All eyes on Genting Malaysia’s 1Q results
Joyce Goh
/
The Edge Malaysia

April 30, 2019 15:00 pm +08


This article first appeared in The Edge Malaysia Weekly, on April 22, 2019 - April 28, 2019.

The 400,000 sq ft Skytropolis Funland indoor theme park was opened a few months ago.
Photo By Annual Report

Source: Genting Malaysia Bhd Annual Report


Source: Bursa Malaysia


INVESTORS will be keeping a watchful eye on Genting Malaysia Bhd’s results for the first quarter ended March 31 (1QFY2019), which are due next month. They will be interested to see how well the casino operator is handling the hike in gaming taxes that came into effect in January.

The additional taxes are estimated to total at least RM650 million this year, based on the gross gaming revenue for the group’s Malaysian business last year.

Industry observers and gaming analysts say the group has only a few cards to play this year when it comes to boosting its earnings, but what it can do is to manage cost efficiently to help ease the blow.

“There is expectation that Genting Malaysia’s FY2019 earnings will fall 41% year on year due to the 10-percentage-point casino duty rate hike this year. The group has been hit on multiple fronts of late ... from the delayed outdoor theme park project to the additional gaming taxes. Given the circumstances, Genting Malaysia will have to look at what it can control in terms of financials, and that is clearly cost. It would need to be very mindful of cost,” says an analyst with a local bank.

“A cost-cutting exercise makes sense,” another analyst tells The Edge.

Genting Malaysia chairman and CEO Tan Sri Lim Kok Thay had acknowledged in his chairman’s statement for the group’s 2018 annual report that the revision of casino duties and casino licence fee will impact the group’s earnings from FY2019 onwards.

He noted that in view of the severity of the increases in casino duties, the group will continue reviewing and managing its cost structure, and this includes reducing or delaying capital expenditure as well as implementing various cost rationalisation initiatives such as “manpower optimisation”.

While he did not elaborate on what manpower optimisation means, analysts point out that the possibility of job cuts could be possible for certain high cost segments.

“It had to recruit people for the outdoor theme park and this included some high-cost hires. Now that the project is on hold due to litigation, perhaps Genting Malaysia will need to relook its cost structure for that,” says the analyst with a local bank.

Asked to comment, Genting Malaysia tells The Edge that talk about potential job cuts at the group is “speculative”.

However, a spokesperson says the group has been mindful of its headcount since 2013, when the outdoor theme park closed for the construction of the new theme park, and adopted a strategy not to replace headcount when staff leave certain positions.

Another potential manpower rationalisation strategy would be to instal more machine-enabled games and look at managing its margins when it comes to commission rates and junkets, says the analyst.

“Understandably, it can look at cutting commission rates for junkets and the rebates it gives VIPs, but this can be a double-edged sword because it could also deter VIPs and high rollers from visiting. It is important to maintain the business volume. The regional trend now is for casinos to increase their commission rates and rebates,” he says.

The analyst says another cost-cutting measure would be to increase the number of gaming tables a pit manager looks after. For example, instead of one pit manager managing three or four tables, he or she would have to manage five or six. “At the end of the day, the group will have to ensure any cost-cutting exercise it embarks on is sufficient and enough to help ease the blow from the higher gaming taxes.”

Casino duties were raised to 35% from 25% on gross gaming income — said to be the first hike in casino duties in 20 years — and gaming machine duties rose to 30% from 20% on gross collection. The last hike in casino duty, from 22% to 25%, was in 1998, when the government needed the extra revenue boost for pump-priming measures during the 1997/98 Asian financial crisis.

Duties on gross collection refer to taxes taken straight from the top line prior to deducting expenses.

Taking the FY2018 figures as a guide, a back-of-the-envelope calculation shows that gross gaming revenue is estimated at RM6.5 billion, and an additional 10% hike in casino duties on that would result in RM650 million in additional taxes.

In addition to higher duties, the Ministry of Finance increased the annual casino licence fees by RM30 million to RM150 million, and machine dealer’s licence fees to RM50,000 a year from RM10,000 a year.

Over the years, Genting Malaysia’s stra­tegy has been to diversify into hospitality to transform itself into more than a gaming group. The outdoor theme park is one of the strategies for this diversification, but its timing is unclear given the lawsuits against Fox Entertainment Group LLC and The Walt Disney Co.

Genting Malaysia is suing the two companies for alleged breach of contract related to the Fox World theme park in Genting Highlands, which was set to open this year. Disney’s acquisition of 21st Century Fox apparently raised issues because the Genting resort includes a casino, which conflicts with Disney’s stance against gambling. Fox units have filed a counterclaim against Genting Malaysia.

Nevertheless, the 400,000 sq ft Skytropolis Funland indoor theme park was recently opened as well as Imaginatrix, an attraction that combines physical rides with state-of-the-art virtual reality gaming technology.

It also recently acquired Equanimity, the super yacht formerly owned by fugitive businessman Low Taek Jho, for US$126 million, but it has yet to reveal what it intends to do with the luxury vessel.

Genting Malaysia’s share price was battered in November last year following the announcement of the increase in gaming taxes and closed at a 7½-year low of RM2.72 on Dec 14. It has since recovered 19% to close at RM3.24 last Friday. At RM3.24, the stock is still trading at a 44% discount to its 7½-year closing high of RM5.77 in August 2017.

According to Bloomberg data, 35% of ana­lysts covering the stock have a “buy” recommendation, with 45% calling a “hold” and 20%, a “sell”. The 12-month consensus target price stood at RM3.46.

At RM3.24 per share, Genting Malaysia is trading at one times book value and has an estimated forward price-earnings ratio of 15.12 times.


https://www.theedgemarkets.com/article/all-eyes-genting-malaysias-1q-results

The nine most important words ever written about investing - "Investing is most intelligent when it is most businesslike."

A person who holds stocks has the choice to become

• the owner of a business or 
• the bearer of tradable securities.

Bearer of tradable securities

Owners of common stocks who perceive that they merely own a piece of paper are far removed from the company's financial statements.

• These owners behave as if the market's ever-changing price is a more accurate reflection of their stock's value than the businesses' balance sheet and income statement.  
• They draw or discard stocks like playing cards.

Owner of a business

For Buffett, the activities of a common-stock holder and a businessperson are intimately connected.  Both should look at ownership of a business in the same way.

"I am a better investor because I am a businessman, and a better businessman because I am an investor.  (Warren Buffett)

Buffett's investment philosophy is the clear understanding that, by owning shares of stock, he owns businesses, not pieces of paper.  

The idea of buying stock without understanding the company's operating functions is unconscionable, says Buffett.  These include:

• a company's products and services, 
• labour relations, 
• raw material expenses, 
• plant and equipment, 
• capital reinvestment requirements, 
• inventories,
•  receivables, and 
• working capital needs.

This mentality is reflected in the attitude of a business owner as opposed to a stock owner.




Types of companies to purchase in the future

Buffett is often asked what types of companies he will purchase in the future.

First, he says, he will avoid commodity businesses and managers in which he has little confidence.

What he will purchase is the type of company that

• he understands, 
• one that possesses good economics and 
• is run by trustworthy managers.

"A good business is not always a good purchase," Buffett says, "although it is a good place to look for one."

Coca Cola's intrinsic value when Buffett first purchased it in 1988.

Buffett first purchased Coca-Cola in 1988.  In 1988:

• Owner earnings (net cash flow) of Coca-Cola = $828 million.
• Risk free rate of 30 year US Treasury Bond = 9% yield.

Discounted value of Coca-Cola's current owner earnings.

If Coca-Cola's 1988 owner earnings were discounted by 9% (Buffett does not add an equity risk premium to the discount rate):

• the value of Coca-Cola would have been $828m/9% = $9.2 billion.

$9.2 billion represents the discounted value of Coca-Cola's current owner earnings.




Was Buffett paying too much for Coca-Cola?


When Buffett purchased Coca-Cola, the market value of the company was $14.8 billion, indicating that Buffett might have overpaid for the company.

Because the market was willing to pay a price for Coca-Cola that was 60% higher than $9.2 billion, it indicated that buyers perceived part of the value of Coca Cola to be its future growth opportunities.

People asked, "Where is the value in Coke?"

The company's price was
- 15x earnings (30% premium to the market average), and,
- 12x cash flow (50% premium to the market average).




Where is the value in Coke? Its net cash flows discounted at an appropriate interest rate.


Buffett first purchased Coca-Cola in 1988.

Buffett paid 5x book value for a company with a 6.6% earning yield.

The company was earning a 31% ROE while employing relatively little in capital investment.

The value of Coca-Cola, like any other company, is determined by the net cash flows expected to occur over the life of the business, discounted at an appropriate interest rate.

When a company is able to grow owner earnings without the need for additional capital, it is appropriate to discount owner earnings by the difference between the risk-free rate of return (k) and the expected growth (g) of owner earnings, that is (k-g).




Using a two-stage discount model

Analyzing Coca-Cola, we find that owner earnings from 1981 through 1988 grew at 17.8% annual rate - faster than the risk-free rate of return.

When this occurs, analysts use a two-stage discount model.  

• This model is a way of calculating future earnings when a company has extraordinary growth for a limited number of years, and 
• then a period of constant growth at a slower rate.

We use this two-stage process to calculate the 1988 present value of the company's future cash flows.

In 1988, Coca-Cola's owner earnings were $828 million.

If we assume that Coca-Cola would be able to grow owner earnings at 15% per year for the next 10 years (a reasonable assumption, since that rate is lower than the company's previous seven-year average), by year 10, owner earnings will equal $3.349 billion.

Let us further assume that starting in year 11, growth rate will slow to 5% a year.  Using a discount rate of 9% (the long term bond rate at the time), we can calculate that the intrinsic value of Coca-Cola in 1988 was $48.3777 billion. 

(see Appendix A below for the detailed calculations.)




Using different growth-rate assumptions

We can repeat this exercise using different growth-rate assumptions.

• If we assume that Coca-Cola can grow owner earnings at 12% for 10 years followed by 5% growth, the present value of the company discounted at 9% would be $38.163 billion.
• At 10% growth for 10 years and 5 % thereafter, the value of Coca-Cola would be $32.497 billion.
• And if we assume only 5% throughout, the company would still be worth at least $20.7 billion [$828 million divided by (9% - 5%)].

Market price has nothing to do with value

The stock market's value of Coca-Cola in 1988 and 1989, during Buffett's purchase period, averaged $15.1 billion.

But by Buffett's estimation, the intrinsic value of Coca-Cola was anywhere from

• $20.7 billion (assuming 5% growth in owner earnings), 
• $32.4 billion (assuming 10% growth), 
• $38.1 billion (assuming 12% growth), 
• $48.3 billion (assuming 15% growth).

So Buffett's margin of safety - the discount to intrinsic value - could be as low as a conservative 27% or as high as 70%.




"Value" investors using P/E, P/B and P/CF considered Coca-Cola overvalued and missed purchasing it.

"Value" investors observed the same Coca-Cola that Buffett purchased and because its price to earnings, price to book, and price to cash flow were all so high, considered Coca-Cola overvalued.





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Appendix A: 

The Coca-Cola Company Discounted Owner Earnings Using a Two-Stage "Dividend" Discount Model (first stage is 10 years)

First stage:
Owner Earnings in 1988  $828 m
Growth rate 15% for next 10 years
Discount factor 9%

Sum of present value of owner earnings   = $11,248 
(Year 1 to 10)


Second stage:
Residual Value or Terminal Value

Owner earnings in year 10  $3,349
Growth rate (g)  5%
Owner earnings in year 11   $3,516
Capitalization rate (k-g)  4%
Value at end of year 10   $87,900
Discount factor at end of year 10  0.4224

Present Value of Residual                           =  $37,129


Intrinsic Value
Intrinsic Value of Company                        =  $48,377


Notes: 
Assumed first-stage growth rate = 15%
Assumed second-stage growth rate = 5%
k = discount rate = 9%
Dollar amounts are in millions.



Descriptive step-by-step approach to the above DCF:

The first stage applies 15% annual growth for 10 years. 

In year one, 1989, owner earnings would equal $952 million; by year ten, they will be $3,349 billion.

Starting with year eleven, growth will slow to 5% per year, the second stage.

In year eleven, owner earnings will equal $3,516 billion ($3,349 billion x 5% + $3,349 billion).

Now we can subtract this 5% growth rate from the risk-free rate of return (9%) and reach a capitalization rate of 4%.

The discounted value of a company with $3,516 billion in owner earnings capitalized at 4% is $87.9 billion.

Since this value, $87.9 billion, is the discounted value of Coca-Cola-s owner earnings in year eleven, we next have to discount this future value by the discount factor at the end of year ten  1/(1 + 0.09)^10 = 0.4224. 

The present value of the residual value of Coca-Cola in year ten is $37.129 billion. 

The value of Coca-Cola then equals its residual value ($37.129 billion) plus the sum of the present value of cash flows during this period ($11.248 billion), for a total of $48.377 billion.

What dictates dividend policy?

Management determines if it is going to 

• distribute earnings in the form of a dividend or 
• reinvest all earnings to further the business plan of the company. 

The ratio of dividends paid out to investors versus the amount of earnings retained is called the payout ratio.  

The Dividend Decision

Changes in tax law and investor preference can influence decisions in the corporate boardroom regarding how much profit to retain or to pay out to investors in the form of dividends.  

However, dividend increases often lag behind an increase in earnings because management will want to be certain that a new higher dividend payment will be sustainable going forward.

Change in Dividend Yield has a lot to do with change in Share Price

Looking back over market history, we can see that dividend policy and payouts have remained relatively steady and that any change in dividend yield has had a lot more to do with the change in stock prices than with changes to dividend policy made by corporate directors.  (Note:  You can 'price' your stocks by looking at historical dividend yields.)




A cut in dividends is often perceived negatively

Management is usually very reluctant to reduce dividends because a cut is often perceived as a sign of financial weakness.  

Even during the Great Depression, companies were loath to cut dividends.  

• From 1929 to 1932, dividend yields soared because most companies maintained their dividends as stock prices collapsed in the crash.  
• But, as stock prices rose from 1933 to 1936, dividend yields fell - even though companies were actually increasing the dividends they paid.

This inverse relationship between dividend yield and price was really evident during the huge bull market run from 1982 to 1999.  

• Companies increased dividends steadily over the period, actually increasing dividends paid by almost 400 percent.  
• Yet the dividend yield collapsed to historic lows because stock prices increased by 1,500 per cent.

Some companies do run into trouble and cut or omit their dividend payments, but this is the exception rather than the rule. 



The typical dividend-paying company

The typical dividend-paying company not only maintains the dividend payout it establishes, but follows a policy of steadily increasing its dividend as earnings increase. 

Some companies increase their dividend payments 

• (1) every quarter, 
• (2) some once per year, and 
• (3) others only as profits allow.

Some companies will even pay extra or special dividends if earnings have been quite good for a number of years.


Dividend policy

Many established public companies pay cash dividends and have a dividend policy that is well known to their investors.  

Some of them have been paying cash dividends for a very long time.

The Investment shown by the DCF calculation to be the cheapest is the one that the investor should purchase.

How does Buffett value his companies?

For Buffett, determining a company's value is easy as long as you plug in the right variables: 

• the stream of cash and 
• the proper discount rate.

If he is unable to project with confidence what the future cash flows of a business will be, he will not attempt to value the company  This is the distinction of his approach.



Critics of Buffett's DCF valuation method.

Despite Buffett's claims, critics argue that estimating future cash flow is tricky, and selecting the proper discount rate can leave room for substantial errors in valuation.

Instead these critics have employed various shorthand methods to identify value:

• low price-to-earnings ratios, 
• price-to-book values and 
• high dividend yields.  

Practitioners have vigorously back tested these ratios and concluded that success can be had by isolating and purchasing companies that possess exactly these financial ratios.




Value investors versus Growth investors

People who consistently purchase companies that exhibit low price-to-earnings, low price-to-book, and high dividend yields are customarily called "value investors."

People who claim to have identified value by selecting companies with above-average growth in earnings are called "growth investors."  Typically, growth companies possess high price-to-earnings ratios and low dividend yields.  These financial traits are the exact opposite of what value investors look for in a company.



Growth and Value investing are joined at the hip.

Investors who seek to purchase value often must choose between the value and growth approach to selecting stocks.

Buffett admits that years ago, he participated in this intellectual tug-of-war.  Today he thinks the debate between these two schools of thought is nonsense.  

Growth and value investing are joined at the hip, says Buffett.

Value is the discounted present value of an investment's future cash flow; growth is simply a calculation used to determine value.




Growth can be add to and also can destroy value.

Growth in sales, earnings, and assets can either add or detract from an investment's value.

Growth can add to the value when the return on invested capital is above average, thereby assuring that when a dollar is being invested in the company, at least a dollar of market value is being created.
However, growth for a business earning low returns on capital can be detrimental to shareholders.

For example, the airline business has been a story of incredible growth, but its inability to earn decent returns on capital have left most owners off theses companies in a  poor position.



Which valuation method(s) to use?  Which stock to buy?

All the shorthand methods - high or low price-earnings ratios, price-to-book ratios, and dividend yields, in any number of combinations - fall short, Buffett says, in determining whether "an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value for his investments.............Irrespective of whether a business:

• grows or doesn't,
• displays volatility or smoothness in earnings , 
• or carries a high price or low in relation to its current earnings and book value, 

the investment shown by the discounted -flows-of-cash calculation to be the cheapest is the one that the investor should purchase.

Burned by Dubai, Mobius joins chorus of doom after property bust

Thursday, 4 Apr 2019


Mark Mobius is worried about the frenzy of construction that’s adding to the existing glut in Dubai real estate.

DUBAI: Three years ago, Mark Mobius saw his luxury apartments in Dubai go up in flames. While the suites have by now been restored to their old splendor, the investor has something else to worry about: the frenzy of construction that’s adding to the existing glut in real estate.

The downturn “will get much worse from here,” said Mobius, a pioneer in emerging-market investing, adding he’d hold off on buying more property.

“I would probably want to wait until there’s a real slump when all this new building comes in and people are really hurting to sell.”

Prices and rents have already dropped by as much as a third in the past five years during what S&P Global Ratings has called the property market’s “long decline.”

The slump will run for another 12 to 18 months because government measures to stimulate the economy -- including granting long-term visas which benefit the affluent and people with specialized expertise -- won’t be enough to revive demand, said Lahlou Meksaoui, a Dubai-based analyst at Moody’s Investors Service.

Mobius recalls how he watched on television from Singapore as revelers in Dubai rang in 2016 with fireworks shooting off the iconic Burj Khalifa.

Just steps away from the world’s tallest building, flames were engulfing Address Downtown and the two luxury apartments he owns in the 63-story tower.

Dubai, one of seven of the United Arab Emirates, lives and dies by real estate. When a property bubble burst a decade ago, it needed a $20 billion rescue from neighboring Abu Dhabi to pull back from the brink of default.

Since prices peaked in 2014, the $108 billion economy had a softer landing as it transitioned from boom to bust.

Early signs of a bottoming out in the property sector even prompted Morgan Stanley to “double-upgrade” U.A.E. stocks in February. An index tracking the city’s real-estate and construction stocks climbed 5.8 percent in the first three months of the year, snapping five quarters of losses.

But Mobius said shares of Dubai’s developers aren’t cheap enough. While the World Expo 2020 fair will reinforce the city’s position on the world map, it won’t be enough to revive the emirate’s property sector unless the government relaxes its immigration policies, he said.

“That’s where you’re going to have real problems,” he said.- Bloomberg

Read more at https://www.thestar.com.my/business/business-news/2019/04/04/burned-by-dubai-mobius-joins-chorus-of-doom-after-property-bust/#IxMsdcbKXA628xpI.99