Value Investing Forum

Post edited 2:17 am – September 23, 2011 by valueinvestortoday

 "118% per year?? ;-) ..hmm so $1 should have grown to $49 ;-) ..congratulations ;-)"

Well, you finally got an answer right :)

 "ROIC = $5,46/$12 = ~45% ;-)"

And you can chalk that one up to another calculation that you don't know how to do :) You don't add one time events when calculating the return on capital of a business – nor do you just pick one year but that is another equation that WILL get you into trouble in the future because you don't know how to calculate it properly and iits another computation I won't be teaching you. ;-)

Post edited 8:10 am – September 22, 2011 by valueinvestortoday

"Sorry, but we really differ at this point."

Nell, I'm done with the conversation for one simple reason: I don't make a habit of throwing good money after bad. When you average 118% per year over the last 5 years during a down market, you can come teach me. I'm not interested in what some website suggests EV is. I went to school for this. I didn't get my diploma online. Good luck.

P.S. The scope of the conversation is meritless to begin with anytime you account for the market price of any business because that is not value investing. Two points:

1. By correctly creating an EBIT Multiple, you have to take market price into account.

2. By picking an EBIT Multiple out of thin are because (10%) annual return is what you require from your investment is not value investing; it's guessing – especially when the company doesn't even produce a 10% return on investment. A 3.5% return on investment with a 7% cost of capital doesn't produce a positive hurdle rate in order for one to assume he'll recieve 10% on his investment.

Enterprise value (EV), attempts to measure the value of a company's

cost to buy this business free of its debt and other liabilities?"

That is a terrible explanation of EV because it doesn't answer that question. The question it answers is: What would it cost me to purchase this business, pay off its debt, and continue to operate it if I were to buy the business today for the asking price the market is currently demanding. In no way is EV a "valuation" tool – unless you believe in the EM Theory which in that case you couldn't be a value investor either. The only thing in common EV has with valuation is that it is in the name of the model much to the same degree that an Earnings Power Value has ultimately nothing to do with earnings the way the general population percieves as earnings to be (Net Income).

Post edited 4:04 am – September 22, 2011 by valueinvestortoday

"net interest-bearing debt: shortterm debt (=0) + longterm debt (=0) – excess cash (= total cash = $223,091)"

You still don't understand the definition of "Net Interest-Bearing Debt". I believe your mistake is transpiring for a couple of reasons. 1) you are interpreting "Net Interest-Bearing Debt" incorrectly as "Net OF Interest-Bearing Debt" & 2) you are only recognizing what the balance sheet terms as "debt" rather than what actually "is" debt. Again, the definition of NIBD is (and this doesn't come from Yahoo but rather a University): "The market value of interest-bearing liabilities (financial liabilities and other non-current liabilities) less the market value of cash at bank and in hand and other easily convertible interest-bearing current assets."

Let's break that down. First, interest-bearing liabilities are most often, not always, a "current" obligation and are often listed under current liabilities. Financial liabilities and non-current liabilities is "everything" else that is owed regardless if it bears interest or not. It makes no sense to assume you wouldn't owe a debt just because it doesn't bear interest. Simply think about it. Debt is debt and regardless if it bears interest – you're going to have to pay it. Continuing. The definition of Excess Cash is the cash left over after all current obligations are paid for. Therefore, if you're argument is that the majority of this company's debt is "current", the excess cash calculation wipes that notion out because you subtract current debt from current assets to arrive at excess cash. If your argument is the company's debt is non-current, re-read the definition of NIBD. There is no other debt that "interest-bearing liabilities", "financial liabilities", and "other non-current liabilities". Therefore, the end result adds up to "Total Liabilites".

"As reference: http://finance.yahoo.com/q/ks?"

Accountants don't use Yahoo as reference material. I'm not interested in the link. If subject matters, such as this one which is advanced, were so easy that it could be explained by Yahoo, there would be no need for MBA's and some of the finest education institutes in the country.

P.S. your Excess Cash calculation is incorrect.

Excess Cash = Total Cash – MAX[(0,Current Liabilities-Current Assets(net of cash otherwise you'd obviously be double counting)]

Current Assets (net of cash): $65,097

Total Cash: $223,091

Current Liabilities: $75,304

Therefore, after Current Assets Current Liabilities, you still need to come up with $10,207 extra because CA doesn't cover CL. Therefore, that amount is deducted from total cash to come to Excess Cash producing the answer: $212,884 (in thousands). But since the definition of NIBD covers the entire spectrum of ALL debt, the correct formula of our Excess Cash formula is:

Total Cash – MAX(0,Total Liabilites-Current Assets) which produces the result: $198,307 (in thousands).

"I have just one little request and ofcourse i will never again argue with you about financial terms, but could you please prove your above statement with the balance sheet some posts below? ;-)"

Unless I'm not understanding your question, I thought I already have done so in great detail. Is there something specific you'd like me to do? Debate is good, especially in the world of finance. It allows you to 1. "think" and 2. rationalize your convictions.

"ps: sorry for my flapsy "you must be kidding" statement ;-) i prefer a factual discussion. thanks"

Since the process of value investing is scientific and science consists of facts, a factual discussion is all I'm interested in.

Post edited 2:27 am – September 22, 2011 by valueinvestortoday

"You must be kidding.."

No, I really am not kidding. You stated that the debt to be factored in consists of "the value of its debt financing (bonds and bank loans, not items such as trade creditors)". I stated that Joel Greenblatt doesn't do it that way and am correct as you rightfully confirmed by stating his definition of debt is "net interest bearing debt" which the definition of that is: "The market value of interest-bearing liabilities (financial liabilities and other non-current liabilities) less the market value of cash at bank and in hand and other easily convertible interest-bearing current assets." The formula can be re-writtten, and he has often re-written as Market Value of Equity + Total Liabilities – Excess Cash which means the EXACT same thing as saying Market Value of Equity + Net Interest-Bearing Debt. Again, we have a disconnect in the use of proper and precise finance terminology.

"I guess you dont understand why i used a specific NOPAT (=EBIT * (1-Taxes)) multiple (= 10).

This is a shortcut valuation of a constant cash flow stream discounted at my personal equity

return target of 10%."

At this point, if I were you, I'd engage Jae in a conversation and ask him to what degree my "understanding" of valuation is since I've written a few advanced valuation articles for his site and he considers me as one of the guru's of the subject matter because the "you must be kidding" argument is starting to get redundantly annoying. I don't see where your last statement (above) served a purpose because it didn't address anything regarding what I was saying about the Market Price of the firm which is the calculation that is performed to arrive at what is known as the "EBIT Multiple". Conversely, it proves my point that even though EBIT didn't change due to its constant value, the overal valuation did change because the EBIT Multiple did change due to the fact that the correct calculation performed  in order to arrive at an EBIT Multiple takes into account the Current Market Price of the firm.

Furthermore, you have now changed, again, your definition of your use of the 10 multiplier which confirms what I initially said (I don't think I stated out loud however), that you are trying to conform your valuation technique to your predetermined outlook of the firms value rather than conforming yourself to the actual value of the firm. It is a terrible habit, and a very misinformed one, that suggests that fundamental investing is as simple as picking a number out of thin air; such as you've done with the 10 multiple by stating it (10%) is what you require from your investment. The fact is, in order to recieve a 10% return on your investment, you need to have a hurdle rate of at least 10% over and above the Cost of Capital in addition to the Risk Free Rate which is very difficult to do when the proper EBIT multiple you arrive at (26.13) is suggesting that the firm's return on its investment is only yielding 3.83% which is less than what the current Risk Free Rate of U.S. Treasury Bonds is even offering currently. As Buffett has said many times, "You can’t compensate for risk by using a high discount rate."

P.S. You stated – "I just took an average EV/EBIT multiple of 10. Whats your formula? ;-)". You also stated – "IV = Sales * Operating Margin * EBIT Multiple * (1 – Tax Rate) / Shares Outstanding + Excess Cash – Financial Debt" (several times was stated). Therefore, you've either changed your formula by stating your '10' multiplier is a 10% expectation of yours or you never did have an understanding of what "EBIT Multiple" meant to begin with. In addition, you stated earlier that you arrived at your multiple by taking "an average EV/EBIT multiple" yet last night in your response to me you contradicted this by stating "Therefore im not interested in a current EV/EBIT multiple". I think you have thoroughly confused yourself of this subject matter.

Post edited 1:13 am – September 22, 2011 by valueinvestortoday

Joel Greenblatt doesn't do it that way. Matter of fact, the only place I've ever seen that does it that way is the site you referenced and I don't know who operates that site and what their credentials are. Enterprise Value is simply trying to find out what it would cost you during a buyout because during the buyout, the purchaser will have to pay for ALL of the debt of the firm but will not have to pay for the excess cash. The formula is inherently flawed from the beginning because it assumes the market price of the firm is correct. Therefore, everytime you would use a formula such as EV, you can throw out the foundational premise to value investing which states that markets are irrational and that price does not equate to value. Quick Example:

Let's assume the market price for this company is trading today for $10 per share.

(18.203,000 * 10) + 89,881,000 – 198,307,000 / 5,540,000 = 13.29

Now assume the company spikes 10 minutes later during today's trading session and trades for $20 per share.

(18.203,000 * 20) + 89,881,000 – 198,307,000 / 5,540,000 = 46.14

In our above hypothetical, if we are relying on our EV – the overal valuation of the firm changed from $4.04 per share to $14.04 per share in one day! The balance sheet didn't change. The cash flows didn't change. The income statement didn't change. Yet, the valuation changed 247.52% Solely because the market participants "felt" the value of the firm was different during that brief 10 minute time period. A 5% fluctuation in market price ($10 ps – $10.5 ps) changes the entire valuation of the firm by more than 12% (12.47). Think about that. How many stocks do you know that fluctuate in any given day, especially in this market, by 5%? Answer: Just about all of them. So you're telling me there's a 12.47% difference in value depending on if the stock is trading at $10 per share or whether it's trading for $10.50? :)

Lastly and in addition to the latter argument, the value of the firm INCREASED in our hypothetical when the market price of the stock went UP. Therefore, EV is saying that when the price goes up, value goes up. That sounds more like momentum investing than value investing to me. EV is a completely useless tool and has no merit in value investing.

In any event, you do the calculation anyway you like. I was only trying to help you correctly use investment terminologies and perform calculations correctly in the fashion that some of us have been trained through higher education to do. Have a good day.

P.S. There are certain debts you wouldn't include such as capital lease obligations, obviously because a lease is not an ownership, but that discussion is beyond the scope of our discussion.

"2. You dont understand that i want to value this company Therefore im not interested in a current EV/EBIT multiple, but i want to use the guidance from CFO of RELL to calculate what it should be worth in terms of his estimate FY2012."

I "understand" perfectly. You already included his "guidance" in your intitial computation of EBIT when you accounted for the 5% margin. I didn't change any of that with the exception that I finished the EBIT calculation, which you didn't do, of accounting for Cap Ex., depreciation, and non cash charges. I didn't write it out long hand for you because I thought it was too obvious to waste time doing so since I explained it. Therefore, his "guidance" is also in my production. However, and again, "guidance" doesn't belong in value investing unless, and only unless, the guidance has a long history of being fairly accurate. That's something you'll rarely find and I'm guessing this isn't one of those situations because their name isn't Coca-Cola or Johnson & Johnson. Furthermore, what is termed the EBIT multiple, is essentially an EV/EBIT calculation. That's how you arrive at an EBIT multiple. Again, we are having a disconnect due to the use of precise and correct terminologies.

Post edited 12:08 am – September 22, 2011 by valueinvestortoday

(Shares Outstanding * Market Price) + Total Liabilities – Surplus Funds / EBIT = EBIT Multiple

EBIT = Operating Income before interest (unlevered) and before taxes + depreciation/depletion/amortization + non-cash & one time charges – cyclically adjusted capital expenditures.

In the case of your company:

(18.203,000 * 13.91) + 89,881,000 – 198,307,000 / 5,540,000 = 26.13

The above example does not account for non cash and one time charges because I didn't look up that information. Since the multiple already accounts for cash, you wouldn't add cash back after EBIT. One of the main reasons why is because all EBIT is – is assigning a multiple to Enterprise Value. It is basically EV in a multiple form. This is the main reason I don't like the use of the EBIT multiple – because I don't believe in Enterprise Value. I believe in Balance Sheet and Cash Flow valuation because the fact is: most firms aren't unlevered and to make them as such is unrealistic.

Anyway, the end result of the process is to take EBIT /  shares outstandings * EBIT Multiple. No additions. The result yields $7.95 per share. This means that a company could enter the market and compete against this business and it would only cost them $6 per share to do so. That's all it means. Doesn't mean that's the value of this business. EBIT Multiples are useless in my opinion. Nothing supplements cash flow and balance sheet analysis.

Greenwald's asset reproduction model would be more precise in this situation. In essence, that's what EBIT is trying to do but without being thorough.

Nell,

It changes your valuation to a very significant degree because the calculation for finding an EBIT multiple already factors in excess cash. Your valuation is completely and totally flawed because you are double counting. Furthermore, the EBIT multiple isn't 10 for this company. You can't just pick a multiple out of thin error. There's a formula for arriving at the multiple.

Post edited 8:42 pm – September 16, 2011 by valueinvestortoday

Nell,

It's not called 'excess cash' either. There's already a formula assigned to the terminology 'excess cash'.

Excess Cash = Total Cash – MAX(0,Current Liabilities-Current Assets)

The definition of Excess Cash is: The amount of Cash that is left over after Current Assets can fully cover Current Liabilities. Since "EXCESS" Cash by definition means "in abundance of", the lowest possible quantity the result could have is Zero because the objective is to find EXCESS not NEGATIVE. Accounting terminologies are titled the way they are for a reason; because they make sense. Don't re-invent the wheel. It's already been invented and if you try, you'll be the only one that knows what you're saying; similar to some people who try to speak ebonics. Ultimately, it won't produce good fruit. It's important to learn what has already been established.

According to the balance sheet you provided, Cash & Equiv. = $170,975. Short Term Investments = $52,116.

$170,975 + $52,116 = $223,091

Post edited 5:06 pm – September 14, 2011 by valueinvestortoday

"Cash and cash equivalents + Investments—current = $223,093"

That is not the equation for "net cash". I'm a stickler for using terminology correctly so that one can coversate correctly and understand what the other is saying. Here is the definition of net cash as I've already pointed out:

http://www.investopedia.com/te…..z1Xvy4yAVj

There is no terminology for CCE + STI that I'm aware of but in theory it could definately be called 'Cash & Equivelants'. The reason being is because the definition of Equivelants is an investment that can be turned into cash quickly and are defined as Bonds, Security Deposits, and other marketable securities. Stocks are a marketable security and most often make up to total balance of what companies list on the balance sheet as Short Term Investments. There's no time constraints with Short Term Investments and they can be converted at any time therefore they pass the test of what the definition for equivelants is. In any event, it's definately incorrect to call it 'Net Cash'. Also, the equation, according to the balance sheet you provided produces the answer of $223,091.