Posts Tagged ‘valuation’

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Discounted Cash Flow & Stock Valuation

December 14th, 2008 by Jae Jun

Jae Jun

The purpose of the Discounted Cash Flow (DCF) valuation is to find the sum of the future cash flow of the business and discount it back to a present value. I use the F Wall Street method of valuing a business along with some tweaks here and there to suit my tastes in the free and best valuation spreadsheets you can find on this site.

The advantage of this method is that it requires the investor to think about the stock as a business and analyze its cash flow rather than earnings.

The first and foremost reason a business exists is to make money where money = cash, not earnings. Since cash is what a business needs in order to maintain and grow its operations, it’s only right to consider the possibility of its future cash growth rather than earnings growth.

The disadvantage is that DCF is not suitable for start ups, growth companies or capital intensive companies where the cash flow cannot be accurately determined. The error of prediction and assumptions must also be dealt with in the DCF, which we cover with margin of safety.

I’ll go through the many assumptions to consider with a DCF. (If you are considering using the spreadsheets found on this site, please don’t just follow it blindly.)

Free Cash Flow

FCF = Cash from Operations – Capital Expenditure

The number we want to use is the cash generated from ongoing business operations. This is the cash that is recurring and will allow the business to grow. Cash from one time sales of property or a subsidiary should therefore be taken out as it is of low importance compared to the recurring cash.

With the DCF spreadsheet, a reader pointed out that the current FCF formula includes other non cash items and deferred taxes. Since we are looking at cash over different timeframes to normalize the data, I don’t believe it to be a cause of concern. However, as I kept thinking about this, excluding these items would provide a better indication of how the cash has been growing before these additional additions. This would not produce a more conservative number but a better indication of the actual FCF growth.

If we use FactSet Research Systems (FDS) as an example, the median FCF growth over 10 years is 29.8% with the above formula whereas the FCF value minus taxes and other produces a median FCF growth of 34.1%.

A discussion on capital expenditure is a post in itself so I’ll just state that to truly get a better accuracy in your DCF, the amount of maintenence capex and capex used for growth has to be distinguished.

Expected Growth

This is where we get to the artsy side of the DCF and where we have to come up with a number for the indefinite future.

I’ve previously written a qualitative post on growth rates but the growth number I generally use is the median FCF growth over 10 or 5 years depending on the company. I also compare it to the PE since that is what the market expects from the company. The exception is when the FCF growth rate or PE is ridiculously high, which is going to be unsustainable. My cap for the highest growth is limited to 15% to be conservative.

The goal of choosing a growth rate is to find a number which is conservative yet not low balling, and close to reality in order to capture potential future gains without eliminating too many investment candidates.

Discount Rate

Click for the full post on discount rates. As I mentioned in the linked post, I lean very strongly towards present dollars rather than future dollars. In other words, I use a high discount rate because I prefer the certainty of the present cash rather than the uncertainty of the future.

People in the finance world pour out their hearts to obtain the most accurate discount rate by analysing risk free rates, beta, risk premium and WACC. I say rubbish to all this. What’s the point in learning every method of hammering a nail when all you have to do is hit it on the head. Personally, I just believe that people over complicate this aspect.

The beauty of old school Graham and Buffett is that their investments are based on common sense, not volatility and other mumbo jumbo.

Terminal Value

Since it isn’t practical to forecast cash flows for an infinite number of years, it’s usual to end the DCF with a terminal value. On the spreadsheet, the terminal value is 3% (although the text says 5%).

The terminal value can also be found with the stable growth model(pdf), but once again, I personally don’t see the necessity of having to choose between my fixed 3% and 3.4859474% the formula may give.

Discounted Cash Flow

DCF receives a bad rep with the crowd and growth players because they call it driving with the rearview mirror. But in the private business world where estimates and PE’s are absolutely irrelvant, cash is what is used to judge the value of a business.

However, as investors, we all need to have plenty of tools and know which one to apply at the right time. I hope to write about the different valuation methods in the future.

For an idea of the accuracy of a DCF analysis, check out my intrinsic values vs Morningstar’s.

Tags: DCF, valuation
Posted in Featured, Valuation Methods | 26 Comments »

Ben Graham Net Net Deep Value Stocks

November 24th, 2008 by Jae Jun

(This article first appeared on The DIV-Net)

In 1932 at the bottom of the Great Crash, Ben Graham’s fund had dropped 70%, but it was precisely this time when he wrote an article on Forbes about the cheapness of the market and how the market was selling the United States for free. I feel we are close to the same situation.

Deep Value Companies

Stock Market Prognosticator previously shared a list of Net Current Asset Value plays, and I previously wrote about how there were literally hundreds of companies that are being quoted for less than their cash in the piggy bank. One such company that I have analyzed lately is ValueVision Media Inc. These companies are being quoted in the market for much less than their liquidating value, as if they were all destined to be doomed. But does it make sense to be quoted for less than the cash in your hand?

A long time ago a president of the New York Stock Exchanges testified

“In times like these, frightened people give the United States of ours away.”

Liquidating Value

Graham defined liquidating value very conservatively.

Working capital (current assets less current liabilities) then subtract any debt not included in current liabilities.

But we can be just as conservative yet at the same time find logic in a slight variant of the above formula.

The Net Net Working Capital.

Net Net Working Capital = Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) – total liabilities

The formula states that;

  • cash and short term investments are worth 100% of its value
  • accounts receivables should be taken at 75% of its stated value because some might not be collectible
  • take 50% off inventories, due to discounting if close outs occur

The Table of Steals

Until recently, it was quite difficult to find a Net Net stock that had real prospects, but the market is washing them up ashore more and more frequently. The tide has finally gone out and here’s a few that came up. Some a gems covered in mud while most a rocks covered in mud.

Price % to NNWC
VVTV 15.03%
ASFI 16.18%
NUHC 18.14%
SPF 24.57%
PLI 26.28%
TAIT 26.42%
CRV 29.96%
BZH 34.79%
TBAC 35.14%
TWMC 35.92%
MSN 36.64%
TUES 41.20%
NENG 42.12%
HDNG 44.40%

To run the screen yourself, go here. The top 7 are already trading at a huge 66% margin of safety.

However, these types of asset plays are not suited to everybody. There is a lot of volatility involved and there is a risk the value may never being realized by the market.

As always, due diligence is required and ever more in these situations.

Disclosure: I own VVTV at the time of this writing

[tags]ben graham, net net, VVTV,ASFI,NUHC,SPF,PLI,TAIT,CRV,BZH,TBAC,TWMC,MSN,TUES,NENG,HDNG[/tags]

Tags: ben graham, Stock Analysis, valuation, vvtv
Posted in Featured, Valuation Methods | 44 Comments »

Morningstar Vs Old School Fair Value Estimation

November 19th, 2008 by Jae Jun

Until Nov 21, you have access to all the premium content on Morningstar. Quickly sign up (no credit card required) or log in now! Go go go.

Thanks to Contrarian Value Investing for the notice.

Just out of curiosity, I was checking out the Morningstar fair values for my companies and surprisingly, they were all very close, minus AEO. So just for fun, here is a comparison of the intrinsic values between the companies I have written about on this blog. Small caps are not covered by Morningstar, so I have left them out.

(Morningstar fair value estimates as of Nov 19, 2008)

Morningstar vs Old School Value

ETN (published Nov 17, 2008)

Morningstar: $81 | OSV: $77

DPS (published Oct 28, 2008)

Morningstar: $28 | OSV:$25-$32

KSWS (published April 16, 2008)

Morningstar: $19 | OSV: $19.86

AEO (published March 11,2008)

Morningstar $22 | OSV: $37.37

So in the spirit of having some fun with intrinsic value, it doesn’t seem like I need to bother with a premium Morningstar membership. I get pretty much the same quantitative assumptions and you can too starting from only $6.95.

[tags]morningstar, intrinsic value, valuation, spreadsheet, ksws, aeo, dps, etn,  [/tags]

Tags: aeo, dps, etn, intrinsic value, ksws, morningstar, spreadsheet, valuation
Posted in Featured, Valuation Methods | 29 Comments »

GeoEye (GEOY) Analysis

July 30th, 2008 by Jae Jun

I’ve been looking into a company by the name of GeoEye after reading up on a very detailed and well written analysis by Chris Fernandez of Peak Stocks. If you are interested in small caps and don’t believe stock price volatility is a correlated indicator of business performance, then you should consider reading more of his work by going here.

Before you read on, keep in mind that I am in the initial phases of poking around and nothing should be taken as granted. However, I plan to complete my research by August 22. Continue on to find out why.

Business Summary

GeoEye is a provider of high resolution and low resolution global space-based and aerial imagery and geospatial information through their processing and distribution network to customers around the world.

For many people, that sentence is probably a headache but it can be summed up with the following image below.

You may have seen this type of image somewhere… like Google Maps. Google is one of the latest customers making use of GeoEye’s high resolution imagery.

GeoEye achieves these images through its two satellites, the IKONOS high resolution and Orbview-2 low resolution satellite. They then sell and also have distributors that resell these images to local and worldwide customers for various applications which are listed below.

Growth Strategy

On August 22, 2008 GeoEye will be launching their latest satellite, GeoEye-1. GeoEye-1 is their new polar-orbiting, sub half-meter Earth-imaging satellite. In simple terms, GeoEye-1’s orbiting path is perpendicular to the equator and will travel at a velocity of around 7.5km/sec or 16,800mi/hr 700-800km above the earth and is capable of taking images of objects smaller than a 1m/3.3ft. The satellite is capable of revisiting any point on the earth roughly every 3 days.

With the launch of GeoEye-1, the images collected will have a ground resolution of 0.41m/16in in black and white while color images will be collected at 1.65m/65in resolution. But due to US Government requirements, the images have to be re-sampled to a minimum of 0.5m/20in for all customers.

GeoEye-1 will offer better resolution, accuracy (to within 3m/9ft), agility and capacity (on board memory is 1TB) compared to IKONOS. Already there is quite a large order backlog in anticipation of the GeoEye launch with international customers making up a large sum of the revenue for GeoEye.

Applications in which the images from the satellites can be used are as follows:

  • Defense
  • National and Homeland Security
  • Air and Marine Transportation
  • Oil and Gas
  • Energy
  • Mining
  • Mapping and Location-based Services
  • State and Local Government
  • Insurance and Risk Management
  • Agriculture
  • Natural Resources and Environmental Monitoring

Just look at the vast and diverse range of applications which GeoEye could service.

Competitive Position

GeoEye’s only US competitor is DigitalGlobe for satellite remote sensing. This is where customers can directly access the satellite for real time downloading when the satellite is within their range. You can think of it like a web host. You don’t own the servers but yearly fees provide you with access to it. But why only one competitor?

Consider the following;

  • Niche market
  • These satellites take about 4 years of research, funding, tests and approvals before being launched
  • Requires a synced network of ground operations and processing facilities
  • Highly regulated business which requires licenses from the Department of Commerce (“DoC”) and from the Federal Communications Commission (“FCC”)
  • Remote sensing technology is subject to U.S. export control licensing and regulation
  • To operate internationally, “remote imaging satellites may require International Telecommunications Union (“ITU”) coordination and registration and licenses from the governments of foreign countries in which imagery will be directly down linked.”

This all spells Big moat.

However, in the aerial imaging side of business, there are many smaller and private companies that offer aerial photography due to the low barriers of entry. But these companies are limited in their coverage and operate locally. Due to the high levels of competition in this area, margins are low.

Getting back to DigitalGlobe. DigitalGlobe is believed to offer the current highest level of resolution with its WorldView-1 satellite launched in September 2007. Unlike GeoEye-1, DigitalGlobe can not take color images.

Their next satellite, WorldView-2 is anticipated to launch in late 2008 as well as the company planning to go public.

Risks

For those that had the interest to make it thus far, this is a very high risk/reward company.

Here are some risk factors that I came up with pretty quickly.

  • GeoEye-1’s planned launch was the first quarter of 2007 but due to program delays the launch was rescheduled for April 16, 2008. However, competition and higher priorities for the use of the launch pad during April was too great and GeoEye-1 was again scheduled for August 22, 2008. There is a possibility that the launch may be delayed again or even fail.
  • The launch may be successful but GeoEye-1 could be inoperable once in orbit.
  • The Government which accounts for 55% of GeoEye’s revenue may decide to build their own systems which would reduce GeoEye’s business.

Currently as it stands, the biggest risk would be a launch failure of GeoEye-1. Should this happen, there is no doubt the stock price will plummet vertically. Yet it also has such a high reward factor because the delayed launches have punished the stock from 35 to the low 20’s.

Financials and Valuation

Let’s start with something from Peak Stocks which is dead on. Even an investor on the last conference call was lashing out (very amusing) at management because the company was selling for less than book value.

“In order to build and launch GeoEye’s next generation satellite, GeoEye-1, GeoEye spent about $250 million and was reimbursed for another $250 million from the National Geospatial-Intelligence Agency’s (NGA) NextView program.

All told, it took about 4 years to build and design the satellite, with an expected launch date of August 22nd, 2008.

When you include the costs to build the satellite, test it, launch it and get insurance on it, the total runs at around $500 million.

At today’s market cap, GeoEye is trading for LESS than the actual value of this satellite alone!

Even if someone came today, and decided to buy out GeoEye and offer them $500 million (a premium of about 66% at today’s closing price), they would essentially be getting the rest of GeoEye’s assets for FREE!

That includes: Their offices and employees, ground stations, current contracts and backlog totaling over $250 million, 2 operating satellites (OrbView-2 and IKONOS), and all other current assets such as their MJ Harden acquisition, joint ventures, etc.” – peakstocks.com

It’s clear that the company is cheap but there are some things to watch for. Although the GeoEye-1 project is fully funded, long term debt is on the high side, by my standards, and cash flows are very erratic and inconsistent. So in addition to the risks stated above, I can’t say for sure how this company will continue to perform many years down the track. But once GeoEye-1 is up, it will certainly give a better indication of the revenue stream to be expected.

Another point to consider about revenues is that GeoEye does not sell “images” like photographs or paintings. Instead, they have contracts for a number of years whereby allowing customers to have access to the satellite. This means that they are paid for the service whether the customer uses it or not.

This is a good business model and is evident in their ever increasing margins. Fiscal 2007 shows gross margins of 58.3% compared to 45.2% in 2006. SG&A margins have decreased from 30% in 2005 to 16% in 2006 and 2007. Operating and net income margins for 2007 were 42% and 23% respectively while it was 28.6% and 15.5% respectively the prior year.

If you look at the type of business GeoEye is in, the way income is generated and take it in context, GeoEye-1 will have a BIG impact on both the top and bottom line.

Taking a quick look with the DCF and Graham formula spreadsheet where my growth input for FCF and earnings is extremely pessimistic and close to no growth, I still get a value showing that GeoEye is trading for a price where you are getting the GeoEye-1 for free.

One thing is clear. The company is cheap. Not due to failing business fundamentals or economic factors, but due to uncertainty which Wall Street hates.

Management

Some quick notes on management.

  • They don’t offer guidance and make it clear that they don’t intend to. This is good because it shows that they are concentrating on the business and not on keeping Wall Street and the single analyst following the company happy.
  • They put their money where their mouth is. Unlike my disappointment with AeroGrow.
  • Interests aligned with shareholders.

Read and listen to a conversation between Chris Fernandez and with GeoEye’s CEO and CFO on his post.

Opinion

Here is a compelling risk/reward company where the risk lies mostly on uncertainties which are not related to business practices and fundamentals.

For those with a long term horizon and can weather small cap volatility, this could be an interesting addition to your portfolio. Just remember, expect your investment to be cut in half if the launch fails. Having said that, I am beginning to see that the upside outweighs the downside.

In the meantime there are still many things I have to go through before August 22.

Disclosure

No position in GEOY.

[tags]geoy, Stock Analysis, valuation[/tags]

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Tags: geoy, Stock Analysis, valuation
Posted in Stock Analysis | 14 Comments »

AeroGrow: Can’t Finish The Race

July 18th, 2008 by Jae Jun

Fiscal year 2008 came to a close for AeroGrow on March 31, 2008. The conference call was held on June 26 and I think it is a good time to provide an update.

Previously I had written about AeroGrow and pointed out good and bad points, but mostly good. With the stock price lower by approximately 35% from my time of purchase. In this post, I won’t gloss over the increase in revenue or store presence and other obvious matters. This post, I’ll be going over the problems.

Here are some recent points to consider.

Positive Points
  • Revenue increased from $13 million to $38 million compared to prior fiscal year March 31 2007
  • Expanded from a presence of 750 stores in December 2006 to 4300 in December 2007 and 5100 in March 31, 2008
  • Direct business grew from $4.2 to $13.7 million (35.7% of revenue)
  • Sold first million dollars of products Internationally (1.9% of revenue)
  • Gross margins increased from 36% to 40% for the fiscal year
Negative Points
  • Bottom line is isnt improving
  • Management on financial handling
  • Net loss of $3.8 million for the quarter as opposed to an expected loss of $1 million
  • Net loss for the year was $9.8 million. Only slight improvement from $10.4 million the year ago
  • Very small insider buying
Viewing Perspective

The numbers look very impressive, and they are, but that depends on how you look at it.

In a 1km race, if a runner sprinted the first 800m only to realize that he didn’t have any energy left for the last 200m and barely finished, how would you rate that performance? I doubt people would pat the runner on the back for doing a great job.

AeroGrow does so well with income only to disappoint at the finish line. This has become the performance and risk of AeroGrow. The problem lies in AeroGrow, not the AeroGarden.

Invert, Always Invert

I’ve been reminded the importance of bottom up thinking when researching companies. Unfortunately, a question that I did not ask myself and fully investigate was “what is wrong with the company?” or “why is it the way it is?”. Had I told myself that the answer was “I’m not sure”, it would be safe to say that I would have kept waiting and monitoring the company on the sideline.

So, what is wrong with the picture? Simply, I see it as the lack of discipline in capital expenditure and experience within the management team. This was the risk I outlined in my previous posts and one which played out.

“For the quarter and year-ended March 31, 2008, the story is a consistent one. We easily beat our expectations on the top line but missed them on the bottom line.”

This above statement shows that management wasn’t expecting much from their bottom line to begin with. In fact, it doesn’t sound promising at all if management themselves call it a “consistent” story.

Future Steps to Improve The Business?

During the conference call, the CEO briefly went over 3 issues from the previous quarter conference call.

  1. “The first step we took was the establishment of our P&L centers, with changes in accountability and expectations for the organization, including building the cost accounting systems I talked about earlier.”
  2. “Number two is our new distribution center…We’ll open the center in Indianapolis and expect to save about $1 million in shipping costs and gain 1.5 points of gross margin this year as a result of this change.”
  3. “Number three is that we’ve taken significant steps to right-size our organization. We cut our head count by 28% since the first of the year…he changes we’ve made will make us a far more efficient company..”

Unfortunately, this wasn’t the information I was hoping for. There were no explanations, elaborations or deadlines on how the above was going to be acheived. I was a little surprised that deeper probing questions weren’t raised during the Q&A section. I wanted to know things like how saving $1 million in shipping would prevent or benefit the company when they are still losing around $10 million or as it is stated in the 2008 annual report in the risk section;

“As of March 31, 2008, our losses from operations have resulted in an accumulated deficit of $39,628,084. There is no assurance that we will ever attain profitability.”

Insider Buying

During the conference call, the CEO mentioned that insider buying would begin on July 2. Since then I’ve been monitoring every SEC filing (I have the RSS set up for AeroGrow). What I see isn’t a whole lot of activity. The max number of shares purchased by each individual is 5000. I’m not sure whether there is a rule or  limit, but 5000 shares at around $2 doesn’t show a whole lot of conviction in the company. Besides Walker Jack Jonas who has purchased 20,000 shares during this time, the new CEO has only committed to 5,000 shares.

If a CEO of the company, who I assume is getting paid in the 6 figure range, commits around $10,000, his $10,000 is equivalent to my $1,000. i.e. a small portion of his portfolio.

Opinion

I could be coming across as stubborn, but considering it’s a small portion of my portfolio and I have been aware of the risk to some extent, I’ll be holding onto my shares.

I don’t agree with the “dump AeroGrow” call but if the company does not break even or is profitable by 2009, I will definitely reconsider my position.

Disclaimer

I am long AeroGrow.

Tags: aero, aerogarden, aerogrow, Stock Analysis, valuation
Posted in Stock Analysis | 4 Comments »

Business Valuation: Basic and Premium Spreadsheets

July 15th, 2008 by Jae Jun

With increasing prices in food, commodities and inflation, I have decided to distribute the spreadsheets via an alternative method.

The spreadsheets have now been split into a basic and premium version.

The basic spreadsheets are the free versions which now only contain the financial statements and a valuation page. After using it, I hope that users will want to upgrade to the premium version.

The different premium spreadsheets available are:

  1. 10 year Graham Valuation Spreadsheet
  2. 10 year Discounted Cash Flow Spreadsheet
  3. 10 year Graham + DCF spreadsheet
  4. 5 year Graham Valuation Spreadsheet
  5. 5 year DCF spreadsheet
  6. 5 year Graham + DCF spreadsheet
  7. Full package: 10 year Graham + DCF spreadsheet AND 5 year Graham + DCF spreadsheet

The premium spreadsheets include the following:

  • Financial Statements
  • Valuation (Either DCF or Graham Formula)
  • Historical Stock Price Chart
  • Competitor Information (new version integrated)
  • Company Stat Charts (new version integrated)

Improvements to Free Version

  • Updated user interface
  • Easier to read with less inputs
  • Formulas revised and edited
  • Ranges and cells revised and edited
  • All spreadsheets combined

A lot of thought and effort has gone into this spreadsheet over the months in editing and updating and I believe the price is very small compared to that. I also believe it will greatly benefit and help you investigate a company.

For more pricing information, please click here.

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Tags: intrinsic value spreadsheet, Stock Analysis, valuation
Posted in Investment Tools, Notices | 8 Comments »

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