Stock Valuation Quotes

Growth requires reinvestment.

Einstein was right about relativity, but even he would have had a difficult time applying relative valuation in today's stock markets.

The intrinsic value of an asset is determined by the cash flows you expect that asset to generate over its life and how uncertain you feel about these cash flows.

A firm can have value only if it ultimately delivers earnings.

Avoid companies that are cavalier about issuing new options to managers

The entrepreneurs of new firms as much as the management of the old (whether modernizing or not) are forced to do whatever is necessary to attract the players in the casino and then worry as much – or more – about the perfor-mance of their stock valuations as about their actual profits. Financial capital reigns arrogant and production capital has no alternative but to adapt to the new rules; some agents with glee, others with horror.

It seems that the uglier the stock, the better the return, even when the valuations are comparable.

Growth firms get more of their value from investments that they expect to make in the future and less from investments already made.

Success in investing comes not from being right but from being wrong less often than everyone else.

It is impossible to say whether an asset class valuation is cheap or expensive in isolation. The valuation of an asset is relative to the valuations of all other assets.

The valuation picture is very much affected by our zero-based interest rate structure. Clearly, stocks are worth far more when government bonds yield 1% than when they yield 5%.

It's not that Twitter isn't successful, it just isn't successful enough to justify all the money investors have pumped into it.

Be greedy when others are fearful and fearful when others are greedy.' Easier said than done for the vast majority of stock traders. ... On every stock trade there is someone who wants to sell and someone who wants to buy, at least at a particular price. ...the person who is selling thinks that she is getting out just in time while the person buying thinks that he is about to make good money. ... The truth is that the market doesn't really reflect some magical perfect valuation of a stock under the efficient market hypothesis. It reflects the mass consensus of how actual individual investors value the stock. It is the sum total of everyone's hopes and fears...

As a result, Keynes warned, the stock market would become “a battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years.

In the intrinsic valuation chapter, we observed that the value of a firm is a function of three variables—its capacity to generate cash flows, its expected growth in these cash flows, and the uncertainty associated with these cash flows.

The problem with fiat is that simply maintaining the wealth you already own requires significant active management and expert decision-making. You need to develop expertise in portfolio allocation, risk management, stock and bond valuation, real estate markets, credit markets, global macro trends, national and international monetary policy, commodity markets, geopolitics, and many other arcane and highly specialized fields in order to make informed investment decisions that allow you to maintain the wealth you already earned. You effectively need to earn your money twice with fiat, once when you work for it, and once when you invest it to beat inflation. The simple gold coin saved you from all of this before fiat.

Alterations in real prices occur slowly as a rule. But this stability of prices has its cause in the stability of the price-determinants, not in the Law of Price-determination itself. Prices change slowly because the subjective valuations of human beings change slowly. Human needs, and human opinions as to the suitability of goods for satisfying those needs, are no more liable to frequent and sudden changes than are the stocks of goods available for consumption, or the manner of their social distribution;

To build wealth it didn’t matter when you bought U.S. stocks, just that you bought them and kept buying them. It didn’t matter if valuations were high or low. It didn’t matter if you were in a bull market or a bear market. All that mattered was that you kept buying.

The funny thing about using the last transaction price as a proxy for the fair value is; that even the two people, buyer, and seller, who caused the transaction do not agree that the transaction price is the fair value of that stock. They have opposite views about the real value.

The truth is that the market doesn’t really reflect some magical perfect valuation of a stock under the efficient market hypothesis. It reflects the mass consensus of how actual individual investors value the stock. It is the sum total of everyone’s hopes and fears about what a company is capable of doing.

Discounted Cash Flow The discounted cash flow method of valuation is the most sophisticated (and the most difficult) method to use in valuing the business. With this method you must estimate all the cash influxes to investors over time (dividends and ultimate stock sales) and then compute a “net present value” using an assumed discount rate (implied interest rate).

If the possessor of a units of money receives h additional units, then it is not at all true to say that he will value the total stock a + h exactly as highly as he had previously valued the stock a alone. Because he now has disposal over a larger stock, he will now value each unit less than he did before; but how much less will depend upon a whole series of individual circumstances, upon subjective valuations that will be different for each individual.

They asked forty-two experienced investors in the firm to estimate the fair value of a stock (the price at which the investors would be indifferent to buying or selling). The investors based their analysis on a one-page description of the business; the data included simplified profit and loss, balance sheet, and cash flow statements for the past three years and projections for the next two. Median noise, measured in the same way as in the insurance company, was 41%. Such large differences among investors in the same firm, using the same valuation methods, cannot be good news.

The case for bitcoin as a cash item on a balance sheet is very compelling for anyone with a time horizon extending beyond four years. Whether or not fiat authorities like it, bitcoin is now in free-market competition with many other assets for the world’s cash balances. It is a competition bitcoin will win or lose in the market, not by the edicts of economists, politicians, or bureaucrats. If it continues to capture a growing share of the world’s cash balances, it continues to succeed. As it stands, bitcoin’s role as cash has a very large total addressable market. The world has around $90 trillion of broad fiat money supply, $90 trillion of sovereign bonds, $40 trillion of corporate bonds, and $10 trillion of gold. Bitcoin could replace all of these assets on balance sheets, which would be a total addressable market cap of $230 trillion. At the time of writing, bitcoin’s market capitalization is around $700 billion, or around 0.3% of its total addressable market. Bitcoin could also take a share of the market capitalization of other semihard assets which people have resorted to using as a form of saving for the future. These include stocks, which are valued at around $90 trillion; global real estate, valued at $280 trillion; and the art market, valued at several trillion dollars. Investors will continue to demand stocks, houses, and works of art, but the current valuations of these assets are likely highly inflated by the need of their holders to use them as stores of value on top of their value as capital or consumer goods. In other words, the flight from inflationary fiat has distorted the U.S. dollar valuations of these assets beyond any sane level. As more and more investors in search of a store of value discover bitcoin’s superior intertemporal salability, it will continue to acquire an increasing share of global cash balances.

By now Soros had melded Karl Popper’s ideas with his own knowledge of finance, arriving at a synthesis that he called “reflexivity.” As Popper’s writings suggested, the details of a listed company were too complex for the human mind to understand, so investors relied on guesses and shortcuts that approximated reality. But Soros was also conscious that those shortcuts had the power to change reality as well, since bullish guesses would drive a stock price up, allowing the company to raise capital cheaply and boosting its performance. Because of this feedback loop, certainty was doubly elusive: To begin with, people are incapable of perceiving reality clearly; but on top of that, reality itself is affected by these unclear perceptions, which themselves shift constantly. Soros had arrived at a conclusion that was at odds with the efficient-market view. Academic finance assumes, as a starting point, that rational investors can arrive at an objective valuation of a stock and that when all information is priced in, the market can be said to have attained an efficient equilibrium. To a disciple of Popper, this premise ignored the most elementary limits to cognition.

And as a long-short fund, he'd also been obligated to take short positions — betting against companies — which was a tactic that, to most experts in finance, was uncontroversial. The thinking went, when companies were performing poorly, or were mismanaged, or were in an industry that was being overrun, or were simply likely to fail, taking a short position wasn't just logical — it protected the marketplace by pointing out overpriced stocks, prevented fraud by acting as a check against dubious management, and poked holes in potential bubbles. Short sellers also added liquidity and volume to a stock — because they were obligated to buy the stock back at some point in the future. Yes, short sellers profited when companies failed, but usually a short seller wasn't banking on a company failing — just that the stock's price would eventually correct toward its true valuation. Sometimes, though, a trader picked up a short position because the company in question really was going to fail. Because, perhaps, it was in an industry that was dying; had management that seemed completely unable or unwilling to pivot; and had deep fundamental issues in its financing that seemed impossible to overcome.

This is a favourite fallacy of today’s economics, which lacks a coherent concept of time—or, at least, it has a mechanical technique for dealing with time which can be applied uncritically. The key principle underlying the treatment of time here is the rate of interest. Economics recognises that if a person needs to borrow money from another person with whom he or she is not in a close reciprocal relationship, then the lender will reasonably expect to get something back for the money he provides (usually interest), in the same way as any other provider of goods and services. That introduces the principle of “discount”—money you won’t have until a future time is worth less than it would be worth if you had it now. The problem arises when the discount principle is applied to other assets. For example, the value in a hundred years’ time of a stock—such as a fishery—discounted at a rate of 3% per year, is just 5% of its present value, and if a valuation of this kind is taken literally, it can be used as a justification for fishing it to destruction now, because it is a depreciating asset. The fact that the interest rate calculation can be made does not necessarily mean that people will be foolish enough to make it, or to apply it uncritically, but, if they do, economics provides an apparent justification.

You can gain great insights about investing from a careful study of Buffett’s Generals. He was constantly appraising the value of as many stocks as he could find, looking for the ones where he felt he had a reasonable ability to understand the business and come up with an estimate for its worth. With a prodigious memory and many years of intense study, he built up an expansive memory bank full of these appraisals and opinions on a huge number of companies. Then, when Mr. Market offered one at a sufficiently attractive discount to its appraised value, he bought it; he often concentrated heavily in a handful of the most attractive ones. Good valuation work and proper temperament have always been the two keys pillars of his success as an investor. Buffett

The 4% withdrawal rate simply isn’t safe when stock market valuations are at historical highs and yields are at historical lows.

Do not be afraid to make mistakes.

THE FOLLOWING DAY, the Apple share price fell 10 percent and the company lost $75 billion in value. The single-day decline was Apple’s biggest in six years and sank its valuation to a level it had not seen since February 2017. It shook the U.S. economy. The company had become one of the most widely held institutional stocks, included in mutual funds, index funds, and 401(k)s. Thanks in part to Warren Buffett and Berkshire Hathaway, everyone from grandmothers in Florida to autoworkers in the Midwest had an interest in Apple’s business. They all suffered.

But being short something where your loss is unlimited is quite different than being long something that you’ve already paid for. And it’s tempting. You see way more stocks that are dramatically overvalued in your career than you will see stocks that are dramatically undervalued. I mean there — it’s the nature of securities markets to occasionally promote various things to the sky, so that securities will frequently sell for 5 or 10 times what they’re worth, and they will very, very seldom sell for 20 percent or 10 percent of what they’re worth. So, therefore, you see these much greater discrepancies between price and value on the overvaluation side. So you might think it’s easier to make money on short selling. And all I can say is, it hasn’t been for me. I don’t think it’s been for Charlie. It is a very, very tough business because of the fact that you face unlimited losses, and because of the fact that people that have overvalued stocks — very overvalued stocks — are frequently on some scale between promoter and crook. And that’s why they get there. And once there — And they also know how to use that very valuation to bootstrap value into the business, because if you have a stock that’s selling at 100 that’s worth 10, obviously it’s to your interest to go out and issue a whole lot of shares. And if you do that, when you get all through, the value can be 50. In fact, there’s a lot of chain letter-type stock promotions that are sort of based on the implicit assumption that the management will keep doing that. And if they do it once and build it to 50 by issuing a lot of shares at 100 when it’s worth 10, now the value is 50 and people say, “Well, these guys are so good at that. Let’s pay 200 for it or 300,” and then they could do it again and so on. It’s not usually that — quite that clear in their minds. But that’s the basic principle underlying a lot of stock promotions. And if you get caught up in one of those that is successful, you know, you can run out of money before the promoter runs out of ideas. In the end, they almost always work. I mean, I would say that, of the things that we have felt like shorting over the years, the batting average is very high in terms of eventual — that they would work out very well eventually if you held them through. But it is very painful and it’s — in my experience, it was a whole lot easier to make money on the long side.

Many financial analysts will find Emerson and Emery more interesting and appealing stocks than the other two—primarily, perhaps, because of their better “market action,” and secondarily because of their faster recent growth in earnings. Under our principles of conservative investment the first is not a valid reason for selection—that is something for the speculators to play around with. The second has validity, but within limits. Can the past growth and the presumably good prospects of Emery Air Freight justify a price more than 60 times its recent earnings?1 Our answer would be: Maybe for someone who has made an in-depth study of the possibilities of this company and come up with exceptionally firm and optimistic conclusions. But not for the careful investor who wants to be reasonably sure in advance that he is not committing the typical Wall Street error of overenthusiasm for good performance in earnings and in the stock market.* The same cautionary statements seem called for in the case of Emerson Electric, with a special reference to the market’s current valuation of over a billion dollars for the intangible, or earning-power, factor here. We should add that the “electronics industry,” once a fair-haired child of the stock market, has in general fallen on disastrous days. Emerson is an outstanding exception, but it will have to continue to be such an exception for a great many years in the future before the 1970 closing price will have been fully justified by its subsequent performance. By contrast, both ELTRA at 27 and Emhart at 33 have the earmarks of companies with sufficient value behind their price to constitute reasonably protected investments. Here the investor can, if he wishes, consider himself basically a part owner of these businesses, at a cost corresponding to what the

It is clearly evident that unethical and corrupt practices were the bedrock of Prannoy Roy journalism. After getting the Doordarshan contract through patronage and a quid pro quo, he shrewdly cashed out over Rs.23 crores (to his personal account in 1994-95) in a short span of few years (see Table 1 below) by selling shares at astronomical valuations to a foreign investor. Simply put, through political patronage he built a business and cashed out for personal profit.  Table 1. Source: NDTV public issue prospectus filed with SEBI in 2004. Date of transfer No. of Equity Shares (Face value of Rs.10) Cost per Shares (Rs.) Price (Rs.) Nature of payment No. of Equity Shares (of Face Value of Rs.4) post splitting 21 Oct 1994 48,140 10 675 Cash 120,350 16 May 1995 99,070 10 675 Cash 247,675 Jul 21 1995 121,625 10 675 Cash 304,063 Aug 22 1995 81,481 10 675 Cash 203,702 After inking favorable deals with Doordarshan, many people in Central Government in 1997 helped NDTV to clinch a magical figure deal with Rupert Murdoch’s Star TV[3] during the liberalization period. The Lutyens Delhi’s cozy club arm twisted Murdoch into an agreement with Prannoy Roy’s NDTV to launch the Star News channel.

The criteria that I found most valuable when making my decisions were the following: What is the size of the investor community invested in other offerings on the platform to-date? Does the platform accept investments via credit card? For example, about 40% of my crowdfunding investors invested with a credit card. Does the platform allow for campaign extensions (if you fall short of your goal within your campaign period, can you extend the campaign until you reach your goal)? I’ve extended my campaigns multiple times. Does the platform allow for multiple disbursements? I prefer to disburse money from my campaign once a month. However, many platforms don’t allow you to disburse the funds until after the campaign is over What are the fees? Platforms can charge between 5-20% of your raise as fees, with some platforms having complicated fee structures that involve taking some of your Securities as part of the offering. Some platforms require you to pay them cash upfront before launching an offering. Does the platform allow you to set your own terms? For example, some platforms don’t allow you to sell convertible notes. Some others don’t allow you to sell non-voting common stock. Some platforms insist that they set the valuation for your startup in order to launch—the logic being that they know their investors, and they want to provide them with a “good deal.” For many reasons, you want to sell the Security that’s right for your startup. Does the platform allow you to have design freedom on the campaign page? You want to make sure that your brand is well represented. The aesthetics and optimization of the page are highly correlated with conversion (how many people invest after visiting your page). Does the platform support analytics? You need advanced analytics to market your offering. Some platforms, for example, allow you to enter a Facebook Pixel and Google Analytics code into the campaign page, while others do not. Does the platform have a good reputation? You will be driving a lot of potential investors and media folks to this platform, and you want to be sure that your platform of choice hasn’t been involved in anything shady in the past. Does the platform allow you to update your investors and prospective investors with campaign notifications? Some platforms have a built-in functionality where you can post updates right on the campaign, download email, and mailing contact lists of your investors (allowing you to contact them by email and allowing you to build Facebook “lookalike audiences”). Whereas, other platforms don’t even share the email addresses of the folks who have already invested in your startup. Does the platform support or plan to support secondary trading for the Securities that it sells on its platform? Will your investors be able to sell the Securities that they buy from you? The ability to sell Securities in a marketplace brings a lot of liquidity and increases its value significantly. In order to allow for secondary trading, the platform needs to obtain an Alternative Trading System (ATS) approval from FINRA.

Taking all these things together–the emphasis on pricing, the focus on cost reduction and balance sheet efficiency–an improvement in both margins and return on capital was to be expected. As for valuation, the average free cash flow yields of 6–7 per cent imply growth rates of around GDP or a little less, which suggests that the stock market is underestimating the potential long-run benefit to be derived from market consolidation and improved discipline. In the light of an improving capital cycle among brewers, we find ourselves able, to paraphrase Sir Winston, to overcome our prejudice and begin increasing our exposure to beer. 6

A guy from Blackstone, the world’s biggest private investment firm, called Sam to say that he thought a valuation of $20 billion was too high—and that Blackstone would invest at a valuation of $15 billion. “Sam said, ‘If you think it is too high, I’ll let you short a billion of our stock at a valuation of twenty billion,’” recalled Ramnik. “The guy said, ‘We don’t short stock.’ And Sam said that if you worked at Jane Street you’d be fired the first week.

Greif had a quirk in its share structure that presented a valuation challenge. The company had two shares of stock, Class A and Class B, but only the A shares were publicly traded. The B shares were closely held and not exchange-traded. Like most companies with dual-class share structures, they had differing voting rights. Unlike most companies with dual-class share structures, the classes were entitled to differing dividend distributions and liquidation proceeds. The A shares—the class Buffett bought—had first rights to liquidation proceeds and dividends. Plus, the A shares were entitled to cumulative dividends while the B shares were not. The A shares would only gain voting rights if the company failed to pay the A’s entitled dividend for four quarters. However, the Class B shares received a higher split of additional dividends once the distribution exceeded a certain rate. This made calculating market capitalization figures difficult since there was no price readily available for the Class B shares.

So not only were the liabilities from Allied’s bankruptcy becoming defined, but the core business was not showing any signs of stress from the scandal. That left valuation. At his $40 per share purchase price, and in contrast to most of the stocks discussed in this book, American Express did not sell for an obvious bargain price. With a $178.4 million market capitalization and $124.1 million enterprise value, the stock sold for 15.8x 1963 earnings, 7.8x EV/1963 EBIT, and 2.3x P/TB. It didn’t look that cheap, and this valuation didn’t include an adjustment for the cost of the salad oil settlement.270

The valuation analysis was simple—anyone could see the stock was incredibly cheap. But it had been traded below net cash for several years before the company distributed cash to shareholders. Returning the cash was the critical factor in driving excellent returns. Assuming Buffett bought the stock in 1954 at $35 and sold in 1957 (having received the $50 per share distribution and a few dollars extra in dividends) when it traded between $20 and $28, he would have more than doubled his money and earned around a 30% IRR.135 The stock didn’t work because it was cheap—it worked because management returned capital to shareholders. The other securities discussed in this book were also incredible bargains—but it took action to drive wonderful returns for shareholders.

In his 1961 letter to partners, Buffett laid out three broad categories of investments: generals, workouts, and controls. Generals were undervalued securities where Buffett had no say in corporate policies, nor a timetable for when the stock might reflect its intrinsic value. Buffett pointed out that the generals would behave like the Dow in the short term but outperform the index over the long term. Buffett expected to have five or six positions in this category that were 5% to 10% of total assets each, with smaller positions in another ten to fifteen. Later on, in his 1964 letter, Buffett would break generals into two categories: private owner basis and relatively undervalued. Private owner generals were generally cheap stocks with no immediate catalyst, while relatively undervalued securities were cheap compared to those of a similar quality. Relatively undervalued securities were generally larger companies where Buffett did not think a private owner valuation was relevant.173 Workouts were securities whose performance depended on corporate actions, such as mergers, liquidations, reorganizations, and spin-offs. Buffett expected to have ten to fifteen of these in the portfolio and thought this category would be a reasonably stable source of earnings for the fund, outperforming the Dow when the market had a bad year and underperforming in a strong year. He anticipated these investments would earn him 10% to 20%, excluding any leverage. Buffett would take on debt, up to 25% of the partnership’s net worth, to fund this category. While he didn’t disclose his allocation every year, he put around 15% of the partnership in workouts in 1966 but increased that to a quarter of the portfolio in 1967 and 1968, when he was having trouble finding bargains.174 The final category was controls, where the partnership took a significant position to change corporate policy. Buffett said these investments might take several years to play out and would, like workouts, have minimal correlation to the Dow’s gyrations. Buffett pointed out that generals could become controls if the stock price remained depressed.

Valuation premiums of quality companies often reflect some degree of expected operational outperformance, but actual performance tends to exceed expectations over time. Stock prices thus tend to undervalue quality companies.

To fit into the Golden Straitjacket a country must either adopt, or be seen as moving toward, the following golden rules: making the private sector the primary engine of its economic growth, maintaining a low rate of inflation and price stability, shrinking the size of its state bureaucracy, maintaining as close to a balanced budget as possible, if not a surplus, eliminating and lowering tariffs on imported goods, removing restrictions on foreign investment, getting rid of quotas and domestic monopolies, increasing exports, privatizing state-owned industries and utilities, deregulating capital markets, making its currency convertible, opening its industries, stock and bond markets to direct foreign ownership and investment, deregulating its economy to promote as much domestic competition as possible, eliminating government corruption, subsidies and kickbacks as much as possible, opening its banking and telecommunications systems to private ownership and competition and allowing its citizens to choose from an array of competing pension options and foreign-run pension and mutual funds. When you stitch all of these pieces together you have the Golden Straitjacket. . . . As your country puts on the Golden Straitjacket, two things tend to happen: your economy grows and your politics shrinks. That is, on the economic front the Golden Straitjacket usually fosters more growth and higher average incomes—through more trade, foreign investment, privatization and more efficient use of resources under the pressure of global competition. But on the political front, the Golden Straitjacket narrows the political and economic policy choices of those in power to relatively tight parameters. . . . Governments—be they led by Democrats or Republicans, Conservatives or Labourites, Gaullists or Socialists, Christian Democrats or Social Democrats—that deviate too far from the core rules will see their investors stampede away, interest rates rise and stock market valuations fall.36

The right price: Great growth companies can be bad investments at the wrong price. While multiples such as PEG ratios have their limitations, use them (low PEG ratios) to screen for companies that are cheap.

When a company is paying out more in dividends, it is retaining less in earnings; the book value of equity increases by the retained earnings.

If this provision is in place, lead managers would naturally propose right valuation (price) for the issue, driven by the fear that they have to buy them back if price falls below the proposed level. Then,

An unknown software company with fifty plus workers (do I need to call them software engineers or analysts?) would price its issue at a valuation higher than that of Infosys. Even that would be received by the market with both the hands open and chest wide. People

Nike, Microsoft Amazon and similar companies went public relatively early in their growth cycles. As a result, public investors had the opportunity to participate in 95 to 99% of their overall price appreciation. Founders, early employees and VCs took all the risk. Most of the reward was left for grabbing – anyone could’ve bought those stocks on the secondary markets.   As the Federal Reserve prints more money and interest rates remain low, an increasing percentage of capital is flowing into risky asset classes like venture capital and “angel investing.” This capital has chased up valuations in the pipeline preceding IPOs, making the IPOs feel more like the end of the journey, not the beginning. Thus,

Nevertheless, some analysts on the sell-side have justified Tesla’s valuation. We recently observed a televised analyst say “when Tesla is earning $25 a share. …” That estimate, presumably at some point in the future, is used as an anchor for a target price as the stock shifts into a “concept holding.” The

Driving the move is a focus by Beijing on the Internet and innovation-driven sectors to boost slowing growth by easing listing rules. Another factor is a stock rally that has seen the Shanghai Composite Index climb 43% this year, although it fell 6.5% on Thursday. Meanwhile, Chinese investors are pouring money into funds that target startups. In 2014, 39 angel investment funds were set up in China, raising $1.07 billion, a 143% increase from the previous high in 2012, according to investment database pedata.cn, which is run by Zero2IPO Research in Beijing. Angel investors typically provide personal funds to finance small startups. High valuations and the loosening of listing rules will draw more Chinese companies to their home market, said Jianbin Gao of PricewaterhouseCoopers in China. “We anticipate significant growth in technology listings on domestic exchanges,” he said.

It is interesting that an investor who has some knowledge of the principles of equity valuations often performs worse than someone with no knowledge who decides to index his portfolio.

Groupon is a study of the hazards of pursuing scale and valuation at all costs. In 2010, Forbes called it the “fastest growing company ever” after its founders raised $135 million in funding, giving Groupon a valuation of more than $1 billion after just 17 months.5 The company turned down a $6 billion acquisition offer from Google and went public in 2011 with one of the biggest IPOs since Google’s in 2004.6 It was one of the original unicorns. However, the business model had serious problems. Groupon sometimes sold so many Daily Deals that participating businesses were overwhelmed . . . even crippled. Other businesses accused Groupon of strong-arming them to sign up for Daily Deals. Customers started to view the group discount (the company’s bread and butter) as a sign that a participating business was desperate. Businesses stopped signing up. Journalists suggested that Groupon was prioritizing customer acquisition over retention — growth over value — and that it had gone public before it had a solid, proven business model.7 Groupon is still a player, with just over $3 billion in annual revenue in 2015. But its stock has fallen from $26 a share to about $4 today, and it has withdrawn from many international markets. Also revealing is that the company is suing IBM for patent infringement, something that will not create customer value.8 Many promising startups have paid the price for rushing to scale. We can see clues to potential future failures in the recent “down rounds” (stock purchases priced at a lower valuation than those of previous investors) hitting companies like Foursquare, Gilt Group, Jet, Jawbone, and Technorati. In their rush to build scale, executives and founders search for shortcuts to sustainable, long-term revenue growth.

valuation of any company.

global events may affect the stock prices of high-quality companies but not their business strength; the fact that investors were dumping stocks was not a problem but an opportunity; businesses’ market valuations may take a hit but not their intrinsic value; the opportunity cost of not investing in troubled times far exceeds any near-term pain owing to notional losses.

When expectations, theory, and reality diverge, that’s when the vibes get really weird. Economic theory is the perfect example of this. There is a gap between what textbooks say is going to happen and what companies actually end up doing. Economics is known as the dismal science, but it really should be known as the dismal art. Most stock valuation models are an educated guess about the future; most economic theory is measurable, but on the basis of loose facts. As the English author Hilary Mantel wrote in a 2017 Guardian piece on facts, history, and truth, “Evidence is always partial. Facts are not truth, though they are part of it—information is not knowledge. And history is not the past—it is the method we have evolved of organising our ignorance of the past. It’s the record of what’s left on the record.

Table 3.7 Estimating Sustainable Growth Growth in earnings How much are you reinvesting? How well are you reinvesting? Operating income = Reinvestment rate × Return on capital (ROIC) Net income = Retention ratio × Return on equity (ROE)

In relative valuation, you price an asset based on how similar assets are priced in the market. A prospective house buyer decides how much to pay for a house by looking at the prices paid for similar houses in the neighborhood. In the same vein, a potential investor in Twitter's IPO (initial public offering) in 2013 could have estimated its value by looking at the market pricing of other social media companies. The three essential steps in relative valuation are: Find comparable assets that are priced by the market; Scale the market prices to a common variable to generate standardized prices that are comparable across assets; and Adjust for differences across assets when comparing their standardized values. A newer house with more updated amenities should be priced higher than a similar-sized older house that needs renovation, and a higher growth company should trade at a higher price than a lower growth company in the same sector. Pricing can be done with less information and much more quickly than intrinsic valuations, and it is more likely to reflect the market mood of the moment. Not surprisingly, most of what passes for valuation in investment banking and portfolio management is really pricing.

The differences in value between discounted cash flow valuation and relative valuation come from different views of market efficiency or inefficiency. In discounted cash flow valuation, we assume that markets make mistakes, that they correct these mistakes over time, and that these mistakes can often occur across entire sectors or even the entire market. In relative valuation, we assume that while markets make mistakes on individual stocks, they are correct on average. In other words, when we value a new software company relative to other small software companies, we are assuming that the market has priced these companies correctly, on average, even though it might have made mistakes in the pricing of each of them individually. Thus, a stock may be overvalued on a discounted cash flow basis but undervalued on a relative basis if the firms used for comparison in the relative valuation are all overpriced by the market. The reverse would occur if an entire sector or market were underpriced.

A good valuation is a bridge between stories and numbers, connecting a story about a business to inputs into a valuation, and by extension, to value.

As you craft a business story for your company, it is worth reminding yourself that you are not a creative novelist and that you are creating a foundation for a valuation. Consequently, you should aim to do the following: Keep it simple: When telling business stories for companies, it is easy to get distracted by strands of these stories that may be interesting but that have little relevance for value. The most powerful business stories in valuation tend to be compact, boiling the company down to its core. In our valuations of Amazon from 1997 to 2012, our core story for Amazon was that it was a Field of Dreams company, built around the belief that if you build it (revenues), they (profits) will come, and in our valuations after 2013, the story shifted to that of a Disruption Machine, a company that would go after any business that it felt had soft spots that could be exploited by a more efficient and patient player. Keep it focused: No matter what business you are valuing, the end game, for it to be valuable, is that it must make money. In short, a business story, even if it is not money making now, must include pathways to make money in the future.

Once you have constructed a business story for your company, you must stop and check to see whether your story passes what we call the 3P test, i.e. Is it possible? Is it plausible? Is it probable? We capture the differences between the three tests in Figure 5.2. As you go from possible to plausible to probable, you are making the tests more stringent, requiring more compelling explanations or more data from the storyteller. The “possibility” test is the weakest of the three, requiring only that you show that there is some pathway that exists for your story to hold and that it is not a fairy-tale. The “plausibility” test is stronger and requires evidence that you have succeeded, at least on a smaller scale (a market test, a geography), with your business. The “probability” test is the most difficult one since you must show that your business story can scale up and that your barriers to entry work.

For a story to become part of a valuation, you must convert its parts into valuation inputs. If you have a valuation model with dozens of inputs and complex output, this will become difficult, if not impossible, to do. One reason that we believe valuations should be parsimonious, with as few inputs as possible and limited output, is because they lend themselves much more easily to story connections. In Chapter 3, we introduced the basics of valuation and argued that you can tie the value of a company to a handful of inputs, and we summarize those in Figure 5.3.

Thus, to connect a business story into value, you must consider which of these inputs to change to reflect that story. Thus, if the key selling point of your business story is that it has a large potential market, it is revenue growth that will best reflect that belief, whereas if it is that your company has significant advantages (technological, brand name, patent protection) over its competition, it will show up as higher market share.

Let us assume that you have a story for your company and you have made sure that the story passes the 3P test, converted the story into value inputs, and valued the company. As you celebrate, it is worth reminding yourself that this is not the value for the company but your value, reflecting your story and inputs, and that you will be wrong. That is why it so critical to keep the valuation process open for feedback, especially from those who disagree most strongly with you. As you read or listen to their critiques, rather than react defensively, you should consider using their arguments to strengthen and solidify your story.

With more mature companies, there is less room for stories to diverge, and you will find more consensus on their valuations. Since the payoff in investing comes from being less wrong than others looking at the same company, it adds credence to the argument that the payoff to doing valuation is greater at young companies, where there is more disagreement about value, than in more mature companies.

It is to cover this default risk that lenders add a default spread to the riskless rate when they lend money to firms; the greater the perceived risk of default, the greater the default spread and the cost of debt. To estimate this default spread, you can use a bond rating for the company, if one exists, from an established ratings agency such as S&P or Moody's. If there is no published bond rating, you can estimate a synthetic rating for the firm, based on its ratio of operating income to interest expenses (interest coverage ratio); higher interest coverage ratios will yield higher ratings and lower interest coverage ratios. Once you have a bond rating, you can estimate a default spread by looking at publicly traded bonds with that rating. In July 2023, S&P gave KHC a BBB rating, and the default spread for BBB-rated bonds at the time was 1.89%, which when added to the risk-free rate of 3.80% yields a pretax cost of debt of 5.69%. Incidentally, if KHC had not had a rating, we could have computed an interest coverage ratio for the firm: With this coverage ratio, we would have obtained a synthetic rating of A–, translating into a default spread of 1.54% and a pretax cost of debt of 5.34%, in July 2023.

If historical growth and analyst estimates are of little value, what is the solution? Ultimately, for a firm to grow, it has to either manage its existing investments better (efficiency growth) or make new investments (new investment growth). In the special case where a company's margins are stable and there is no efficiency-driven growth, you should look at how much of its earnings a firm is reinvesting back in the business and the return on these investments. While reinvestment and return on investment are generic terms, the way in which we define them will depend on whether we are looking at equity earnings or operating income. With equity earnings, we measure reinvestment as the portion of net income not paid out as dividends (retention ratio) and use the return on equity to measure the quality of investment. With operating income, we measure reinvestment as the reinvestment rate and use the return on capital to measure investment quality.

Multiple Companion variable Mismatch indicator for undervalued company PE ratio Expected growth Low PE ratio with high expected growth rate in earnings per share P/BV ratio ROE Low P/BV ratio with high ROE P/S ratio Net margin Low P/S ratio with high net profit margin EV/EBITDA Reinvestment rate Low EV/EBITDA ratio with low reinvestment needs EV/Capital Return on capital Low EV/Capital ratio with high return on capital EV/Sales After-tax operating margin Low EV/Sales ratio with high after-tax operating margin

There are four basic inputs that we need for a value estimate: cash flows from existing assets (net of reinvestment needs and taxes), expected growth in these cash flows for a forecast period, the cost of financing the assets, and an estimate of what the firm will be worth at the end of the forecast period. Each of these inputs can be defined either from the perspective of the firm or just from the perspective of the equity investors.

Market value of equity: The price per share or market capitalization. Market value of firm: The sum of the market values of both debt and equity. Market value of operating assets or enterprise value: The sums of the market values of debt and equity but with cash netted out of the value. When measuring earnings and book value, you can again measure them from the perspective only of equity investors or of both debt and equity (firm). Thus, earnings per share and net income are earnings to equity, whereas operating income measures earnings to the firm. The shareholders' equity on a balance sheet is book value of equity; the book value of the entire business includes debt; and the book value of invested capital is that book value, net of cash. To provide a few illustrations: you can divide the market value of equity by the net income in order to estimate the PE ratio (measuring how much equity investors are paying per dollar of earnings) or divide enterprise value by EBITDA (earnings before interest, taxes, depreciation, and amortization) to get a sense of the market value of operating assets relative to operating cash flow. The central reason for standardizing, though, does not change. We want to compare these numbers across companies.

All Valuations Are Biased You almost never start valuing a company or stock with a blank slate. All too often, your views on a company or stock are formed before you start inputting the numbers into the models and metrics that you use and, not surprisingly, your conclusions tend to reflect your biases.

Your best estimates for the future will not match up to the actual numbers for several reasons. First, even if your information sources are impeccable, you must convert raw information into forecasts, and any mistakes that you make at this stage will cause estimation error. Next, the path that you envision for a firm can prove to be hopelessly off. The firm may do much better or much worse than you expected it to perform, and the resulting earnings and cash flows will be different from your estimates; consider this firm-specific uncertainty. When valuing Cisco in 2001, for instance, we seriously underestimated how difficult it would be for the company to maintain its acquisition-driven growth in the future, and we overvalued the company as a consequence. Finally, even if a firm evolves exactly the way you expected it to, the macroeconomic environment can change in unpredictable ways. Interest rates can go up or down, and the economy can do much better or worse than expected. Our valuation of Marriott from November 2019 looks hopelessly optimistic, in hindsight, because we did not foresee the global pandemic in 2020 and the economic consequences for the hospitality business.

The return on capital varies widely across firms in different businesses, tending to be lower in competitive businesses. The return on equity (ROE) examines profitability from the perspective of the equity investors by relating profits to the equity investor (net profit after taxes and interest expenses) to the book value of the equity investment and can be computed as:

The cash flow to the firm is the cash left over after taxes and after all reinvestment needs have been met but before interest and principal payments on debt. To get to cash flow to the firm, you start with operating earnings, instead of net income, and subtract out the taxes you would have paid if the entire operating income were taxable and then subtract reinvestment, with the latter defined exactly the same way it was to get to FCFF: Using our earlier definition of reinvestment, we can also write the FCFF as follows: The reinvestment rate can exceed 100 percent if the firm is reinvesting more than it is earning, or it can also be less than zero for firms that are divesting assets and shrinking capital. Both FCFE and FCFF are after taxes and reinvestment, and both can be negative, either because a firm has negative earnings or because it has reinvestment needs that exceed income.

In July 2023, the risk-free rate was set to the 10-year Treasury bond rate of 3.80 percent, the equity risk premium (ERP) was 5.67 percent, reflecting KHC’s revenue weighted geographic exposure, and the beta for KHC was estimated by looking at the business it operated in, which is food processing, as shown in Table 3.6. Table 3.6 Estimating a Beta for KHC Business Estimated value Proportion of firm Sector beta Food processing $30,146 100.00% 0.69 KHC as a firm $30,146 100.00% 0.69

The accounting income statement measures accrual income, based on the revenues and expenses associated with transactions during a period, but it does not include capital expenses during the period. As a consequence, a company's cash flows can be different from its earnings, and the statement of cash flows represents the accounting attempt to measure cash flows to and from a business. That statement has three parts to it, with the operating cash flow segment estimating how much equity investors derived as cash flows from operations, adding back non-cash expenses and subtracting out changes in non-cash working capital items, the investing cash flow segment looking at capital expenditures and cash acquisitions and the financing segment focusing on cash flows to and from debt financing (debt issued and repaid) and to and from equity investors (new stock issuances and buybacks). Figure 2.3 breaks down the statement of cash flows into its constituent parts:

Note that if KHC had been a multi-business company, we would have estimated a weighted average of the betas of the businesses it operated in, with the weights based on the values of these businesses. Adjusting this beta for the debt in KHC, since financial leverage magnifies business risk, results in a beta of 0.92 for the equity in KHC: The resulting cost of equity is 9.00 percent: While equity investors receive residual cash flows and bear the risk in those cash flows, lenders to the firm face the risk that they will not receive their promised payments—

Ultimately, there are dozens of valuation models but only two valuation approaches: intrinsic and relative. In intrinsic valuation, we begin with a simple proposition: the intrinsic value of an asset is determined by the cash flows you expect that asset to generate over its life and how uncertain you feel about these cash flows. Assets with high and stable cash flows should be worth more than assets with low and volatile cash flows. You should pay more for a property that has long-term renters paying a high rent than for a more speculative property with not only lower rental income but more variable vacancy rates from period to period. While the focus in principle should be on intrinsic valuation, most assets are valued on a relative basis. In relative valuation, assets are valued by looking at how the market prices similar assets. Thus, when determining what to pay for a house, you would look at what similar houses in the neighbourhood sold for. With a stock, that means comparing its pricing to similar stocks, usually in its “peer group.

The principles of present value enable us to calculate exactly how much a dollar sometime in the future is worth in today's terms and to compare cash flows across time.

To measure how well a firm is investing its capital, we can look at the after-tax operating income relative to the capital invested in the firm, where capital is defined as the sum of the book values (BV) of debt and equity, net of cash, and marketable securities. This is the return on capital (ROC) or return on invested capital (ROIC) and it is computed as follows:

Once you have estimated the costs of debt and equity, you estimate the weights for each, based on market values (rather than book value). For publicly traded firms, multiplying the share price by the number of shares outstanding will yield market value of equity. Estimating the market value of debt is usually a more difficult exercise since most firms have some debt that is not traded, and so many practitioners fall back on using book value of debt. Using KHC again as our illustrative example, the market values of equity ($44,756 million) and debt ($19,476 million), and our earlier estimates of cost of equity (9.00 percent) and after-tax cost of debt (4.27 percent), result in a cost of capital for the firm of 7.56 percent.

Intrinsic valuation provides a fuller picture of what drives the value of a business or stock, but there are times when pricing will yield a more realistic estimate of what you can get for that business or stock in the market today. While nothing stops you from using both approaches to put a number on the same investment, it is imperative that you understand whether your mission is to value an asset or to price it, since the tool kit that you will need is different.

When the stock-based compensation takes the form of options, analysts often use shortcuts (such as adjusting the number of shares for dilution) to deal with these options. The right approach is to value the options (using option pricing models) and reduce the value of equity by the option value.

What if the intrinsic value that you derive, from your estimates of cash flows and risk, is very different from the market price? There are three possible explanations. One is that you have made erroneous or unrealistic assumptions about a company's future growth potential or riskiness. A second and related explanation is that you have made incorrect assessments of risk premiums for the entire market. A third is that the market price is wrong and that you are right in your value assessment. Even in the last scenario, there is no guarantee that you can make money from your valuations. For that to occur, markets have to correct their mistakes, and that may not happen in the near future. In fact, you can buy stocks that you believe are undervalued and find them become more undervalued over time. That is why a long time horizon is almost a prerequisite for using intrinsic valuation models. Giving the market more time (say three to five years) to fix its mistakes provides better odds than hoping that it will happen in the next quarter or the next six months.

OSCAR WILDE DEFINED A CYNIC AS ONE WHO “knows the price of everything and the value of nothing.” The same can be said of many investors who regard investing as a game and define winning as staying ahead of the pack.

Always be honest about your biases: Why did you pick this company to value? Do you like or dislike the company's management? Do you already own stock in the company? Put these biases down on paper, if possible, before you start. In addition, confine your background research on the company to information sources rather than opinion sources; in other words, spend more time looking at a company's financial statements than reading equity research reports about the company. If you are looking at someone else's valuation of a company, always consider the reasons for the valuation and the potential biases that may affect the analyst's judgments. Generally, the more bias there is in the process, the less weight you should attach to the valuation judgment.

There are three reasons why a cash flow in the future is worth less than a similar cash flow today. People prefer consuming today to consuming in the future. Inflation decreases the purchasing power of cash over time. A dollar in the future will buy less than a dollar would today. A promised cash flow in the future may not be delivered. There is risk in waiting. The process by which future cash flows are adjusted to reflect these factors is called discounting, and the magnitude of these factors is reflected in the discount rate. The discount rate can be viewed as a composite of the expected real return (reflecting consumption preferences), expected inflation (to capture the purchasing power of the cash flow), and a premium for uncertainty associated with the cash flow. The process of discounting converts future cash flows into cash flows in today's terms. There are five types of cash flows—simple cash flows, annuities, growing annuities, perpetuities, and growing perpetuities. A simple cash flow is a single cash flow in a specified future period. Discounting a cash flow converts it into today's dollars (or present value) and enables the user to compare cash flows at different points in time. The present value of a cash flow is calculated thus:

There are three basic accounting statements. The first is the balance sheet, which summarizes the assets owned by a firm, the value of these assets, and the mix of debt and equity used to fund them, at a point in time. The income statement provides information on the operations of the firm and its profitability over time. The statement of cash flows specifies how much cash the firm generated or spent from its operating, financing, and investing activities.

How do accountants measure the value of assets? For most fixed and long-term assets, such as land, buildings, and equipment, they begin with what you originally paid for the asset (historical cost) and reduce that value for the aging of the asset (depreciation or amortization). For short-term assets (current assets), including inventory (raw materials, works in progress, and finished goods), receivables (summarizing moneys owed to the firm), and cash, accountants are more amenable to the use of an updated or market value. If a company invests in the securities or assets of another company, the investment is valued at an updated market value if the investment is held for trading and historical cost when it is not. In the special case where the holding comprises more than 50 percent of the value of another company (subsidiary), the firm must record all of the subsidiary's assets and liabilities on its balance sheet (this is called consolidation), with a minority interest item capturing the percentage of the subsidiary that does not belong to it. Finally, you have what are loosely categorized as intangible assets. While you would normally consider items such as brand names, customer loyalty, and a well-trained work force as intangible assets, the most encountered intangible asset in accounting is goodwill. When a firm acquires another firm, the price it pays is first allocated to the existing assets of the acquired firm. Any excess paid becomes goodwill and is recorded as an asset.

If I, today, imagine how I’d respond to stocks falling 30 percent, I picture a world where everything is like it is today except stock valuations, which are 30 percent cheaper. But that’s not how the world works. Downturns don’t happen in isolation. The reason stocks might fall 30 percent is because big groups of people, companies, and politicians screwed something up, and their screwups might sap my confidence in our ability to recover.

Even the simplest multiples are defined and computed differently by different analysts. A PE ratio for a company can be computed using earnings from the last fiscal year (current PE), the last four quarters (trailing PE), or the next four quarters (forward), yielding very different estimates. It can also vary depending on whether you use diluted or primary earnings. The first test to run on a multiple is to examine whether the numerator and denominator are defined consistently. If the numerator is an equity value, then the denominator should be an equity value as well. If the numerator is a firm value, then the denominator should be a firm value as well. To illustrate, the PE ratio is a consistently defined multiple since the numerator is the price per share (which is an equity value) and the denominator is earnings per share (which is also an equity value). So is the enterprise value to EBITDA multiple since the numerator and denominator are both measures of operating assets; the enterprise value measures the market value of the operating assets of a company, and the EBITDA is the cash flow generated by the operating assets. In contrast, the price-to-sales ratio and price to EBITDA are not consistently defined since they divide the market value of equity by an operating measure. Using these multiples will lead you to finding any firm with a significant debt burden to be cheap.

you cannot judge a valuation by its precision, since you will face more uncertainty when you value a young growth company than when you value a mature company. Another is that avoiding dealing with uncertainty will not make it go away. Refusing to value a business because you are too uncertain about its future prospects makes no sense, since everyone else looking at the business faces the same uncertainty. Finally, collecting more information and doing more analysis will not necessarily translate into less uncertainty, since the uncertainty does not just come from estimation mistakes but also reflects real uncertainty about the future.

Success in investing comes not from being right but from being less wrong than everyone else.

Netting operating expenses and depreciation from revenues yields operating income, whereas the income after interest and taxes is termed net income.

Two principles underlie the measurement of accounting earnings and profitability. The first is accrual accounting, where the revenue from selling a good or service is recognized in the period in which the good is sold or the service is performed (in whole or substantially), and a corresponding effort is made to match expenses incurred to generate revenues. The second is the categorization of expenses into operating, financing, or capital expenses.

Cash flows that are riskier should be assessed a lower value than more stable cash flows. In conventional discounted cash flow valuation models, we use higher discount rates on riskier cash flows and lower discount rates on safer cash flows. The definition of risk will depend on whether you are valuing the business or just the equity. When valuing the business, you look at the risk in a firm's operations. When valuing equity, you look at the risk in the equity investment in this business, which is partly determined by the risk of the business the firm is in and partly by its choice on how much debt to use to fund that business. The equity in a safe business can become risky if the firm uses enough debt to fund that business.

As active managers see allocators moving capital to passive investing, they have little choice but to try and stem the flow by trying to demonstrate outperformance immediately. Short-term thinking and decision-making inevitably lead to poor performance. In the market environment of 2019, short-term decision-making translates into buying high-growth stocks, because they have momentum. Popular growth stocks are bought regardless of valuation and the core tenets of cash flow analysis and contrarianism are cast aside. Ultimately this will cause negative performance for those active managers unable to abstain from following the herd and chasing a momentum-driven market to try and keep their investor base.

SoftBank, however, had invested more than $10 billion into WeWork and gotten nothing in return. The Vision Fund was down nearly $2 billion in the most recent quarter, during which Uber’s stock had slipped. SoftBank shares were down 10 percent since Wingspan’s release. Both WeWork and SoftBank executives were coming to grips with the realization that its IPO might be priced at a level far below its $47 billion valuation. While SoftBank’s preferred shares gave it some protection—it could get its money out before the company’s employees—a valuation below what SoftBank paid for its shares would mean that the firm’s investment was underwater, much as

The British Empires conversion of the vast indigenous economy of North America into aristocratic property provides an illuminating paralell, in fact, for a company like Amazon, whose trillion dollar market capitalization is derived from the usurpation of a thriving pre existing system of shops, markets, libraries and the like. With their bundles of patents and global monopolies, twenty-first-centruy tech conglomerates have swelled to the scale of eighteenth century trading companies and with a speed quite foreign to the plodding first economy. But they are more than just businesses. Silicon Valley firms have a profound impact on world organization, and key players such as Peter Thiel creates of PayPal, early investor in Facebook, and cofounder of the surveillance company Palantir Technologies possess political power greater than most heads of state. The old caveats apply once more. First, the second economy serves elites almost exclusively. Again fit is chiefly financialized, and building financial instruments remains the preserve of the rich. 84 percent of corporate stock is owned by the wealthiest 10 percent. But even this decile is largely denied access to the heart of the second economy. Some 80 percent of Facebook stock. worth over half a trillion dollars is owned by 25 individuals and institutions, though Mark Zuckerberg retains only 28 percent of the company, this includes a vital 60 percent of the Class B voting shares. Since Facebook is an entity comparable in scale to a nation state, and serves some of the same functions, this determination not to share political power is instructive. Valuations of such companies are inflated by their monopolistic nature and by the financial institutions that control them to the point of total departure form the first economy. This fall, during the most serious economic recession since the 1930s, the values of Tesla, Amazon and Facebook all hit record stock-market highs

is GROWTH in all its dimensions—sales, margin and valuation.