P/E doesn't tell me anything about the company's value. It just tells me what foolish premium the market paid for a given number of earnings, not what a sensible investor should pay.
Perhaps, but underestimation is usually a good thing. If my estimation of a given security's value is lower than the next guy, and we both acquire the same security, but he listens to the analysts/market and I listen to me (because I am a business analyst not a market analyst)... I'll have acquired it at a discount. If we both then dispose of it at the same price, my net gain exceeds his. But if something catastrophic were to happen, I'll have (in combination with other limiting factors) insured myself against significant risk exposure.
Not only does one have to look at telecom industry churn rates, carrier limitations (Apple isn't on every carrier, nor are they likely to be, given the terms they seek), and market segmentation (apple isn't going after every type of cell phone customer, nor will they... otherwise they risk brand dilution and cannibalization), but one also has to look at the dynamics of Apple's target market (smartphones), the available pool of that target market (they have 25%, so the remaining available pool they're likely to gain against competition is much smaller than the general cell phone market), and their own total share of wallet (how many apple products will a household be able to purchase at any given product cycle? discretionary income is finite).
Given those dynamics, it's a much narrower picture than you or any professional analysts had estimated.
Apple's shares are 70% institutionally-owned. The institutions are using similar models to mine to evaluate the business... When you say it doesnt mean share price will stop growing, do you think these institutions are going to pay 30 times 40 times, 500 times book value? As Apple scales up, the growth in earnings will shrink to single digits because the marginal growth will be a smaller numerator against existing revenue, compounded by the shrinkage in available share of wallet. That's a mathematical certainty.
Brand loyalty is reflected in the consistency of operating cash flows. Anything else would be an overestimation... I do internal analysis on customer retention for my company, and I can tell you that there's a marked difference between general surveys on customer intent to purchase, Net Promoter scores, and actual customer behavior... in precisely that order. Put another way: the proof is in the purchase. A customer can say they're loyal, but the only meaningful proof of that is their actual purchasing behavior. So operating cash flow is a good indicator of that, because it escapes the accounting magic that can manipulate other figures like earnings and net income through activities that have zilch to do with operating income.
So operating cash flow consistency is the only way I care to look at customer behavior. It doesn't matter if I'm wrong because if my calculations lead me to acquisitions at a deeper discount, then that's a win-win for me.
As for the cash (which isn't really cash, it's about $67 billion in long term investments that are basically illiquid, and another $20 billion in short term investments, and about $10 billion in cash. Implicit in my estimation of value are any assets that can be converted to cash in the short term because that's precisely what net working capital is (current assets minus current liabilities). I don't care how big a toilet Tim Cook has, or how many billions of dollars their factories cost them... none of these things have any significant bearing on what the operating cash-generating capacity of a business is.
It's a triangulation of a few things... Net working capital gives me the starting point of tangible operating value, then net operating cash flows ten years forward gives me the growth... two things have to be applied here: Growth (implicitly incorporating future churn) and then discounting future operating cash flows to net present value. Other cash flows are meaningless to me because cash from financing activities can be manipulated by staggering disposition of Level 1-3 assets to offset any shrinkage in operating cash flows. But OCF is the only measure by which you can evaluate how well a company does what is uniquely in the business of doing.
To get some directionality on growth rates, I look a little bit at what analysts who understand supply chain management, market demand, etc. have to say just to get a read on pipeline data I may not directly have access to, but then I undercut them with more conservative estimations of growth even slowing to a terminal rate by year 5 in my DCF (not to be confused with FCF) analysis, figuring that their primary job is to drive up interest among high net worth individuals and institutional buyers to keep the market liquid for the securities they cover, making their fund clients rich, and consequently themselves. My job as a business analyst is to derive, as much as possible, a pragmatic, not optimistic, projection of outcomes because routinely my internal data for my own employers is used to make business decisions to drive resources to where they are needed most.
Therefore, I calculate conservatively, which means I tend to acquire companies at their moments of deepest discount. People often seem to think that I am either making bets on what the price will go to, or that I am never going to be in the market for a company I think is currently overpriced. This is not the case. If I can get Apple (or any other large manufacturing company with US-based operations) at a significant discount to my calculation of their intrinsic value, I will... if I can't, but the company has wide competitive moat, sound long term management and a very steady (not volatile) operating record, then perhaps I'll wait for some market event to underprice them.
These calculations about future growth are never going to be dead on... you work with some assumptions, but that's why it's critical to err on the side of caution. No company really knows what its pipeline looks like more than five quarters from now: Not from a product development perspective but from a sales operations perspective. Apple can know what products they're going to release 3 years from now, but they don't know exactly what the market landscape will be or what the buyer reaction will be. Even brand loyalty doesn't help if you come out with the G4 Cube.
I wouldn't call 19.8% compounded annual growth in per share book value since 1965 "low".... In fact, that's one of the most consistent high growth rates of any business anywhere in the world. Berkshire's P/E is low because of a very simple artificial reason: Since there have deliberately been no stock splits of their Class A Common shares since Buffett's partnership acquired the company, Berkshire's price creates a barrier to entry for speculators who would drive the stock price far above its per share book value.
Incorrect. Can I ask how consistently you have read Buffett's annual letter to shareholders? You might want to pore through this year's, particularly Page 8.
Berkshire's float from their core business of property/casualty insurance and reinsurance has grown from $39 million in 1970 to $70.57 billion in 2011. This is a total growth of 180,851%... or, working backward, 20% compounded annually for 41 years. Especially given their risk exposure in their reinsurance arm, run by Ajit Jain, in which claims are rising due to increased frequency of catastrophic loss from natural disasters, 20% annually compounded for 41 years is nothing short of stellar.
Nope. Not really. I've pretty much stuck to the same principles he learned as Ben Graham's star pupil. What Buffett does better than most people, however, is he understands certain fundamental qualities of people. The wildcard in the equation is arriving at some conclusion about the soundness of management. But this is where a margin of safety comes in. Being less of an expert than Buffett on knowing the mechanics of mindset, and the hindrances thereof, I would probably arrive at a similar calculation but then set a larger margin of safety... i.e. if my calculation is X, then my buying signal is .9x, .8x, .7x.... depending on how confident I am in my estimation of the more fuzzy variables.
But what I would say here is that the buy signal is slightly more complicated than the do not buy signal. If a company doesn't meet my basic criteria, I simply don't touch them. That's it. No other analysis required. If a company does meet my basic criteria, then I start diving into more particulars about their underlying business, their financial statements, the backgrounds and track records of their managers (not so much the numbers as what their decision making patterns tell me about where their heads are at), assessing the market to see how wide the moat is... and so on. None of this takes me more than 20 minutes, though like I said I evaluate huge sets of performance metrics on very tight deadlines... It might take a history professor somewhat longer...
There are some more concrete calculations that have their problems... such as the use of beta, another meaningless ratio, in arriving at CAPM, but that's why I prefer WACC as the leading factor in determining the discount rate for cash flows to net present value. The only problem WACC has is that as a company scales operations, cost of capital is not constant.
Apple was 90 days from bankruptcy when Steve came back... so it's equally possible it could have been one of the worst investment catastrophes of the last generation. But most of my investments over the past year have either equalled or beaten Apple's return in share price over the same year. So there you are.
Value investing is constantly poo pooed by people in the financial industry who make more money the more turnover/transactions they do, without necessarily returning value to their clients. I have one portfolio of 12 or so stocks outperforming the 200 or so stocks that my brother's three money managers are canvassing at a cost of 2% of gross proceeds to him.
My reasoning and methodology comes both from a solid career in business analysis and a learning experience when I was young about the foolishness of emotional purchases and/or so-called "technical analysis" ... I adhere to two basic principles:
"Be greedy when others are fearful, and fearful when others are greedy." - Warren Buffett
"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." - Benjamin Graham
It may seem unlikely, but take my word that I have the above statements memorized and burned into my memory and I do not stray from them. Granted, what I can't teach you overnight is how to spot accounting irregularities and red flags, or do more nuanced analysis of financial statements... things that I've had around 20 years of experience with in total... but, It's not rocket science. It's simple... if you keep buying a dollar worth of assets for 60 cents, good things will happen more often than not... and the bad things that do happen won't risk depletion of principal.
Preservation of principal, rather than slam dunk investments, is perhaps the single greatest contributor to the wealth of a value investor... both because existing principal continues to reap compounded returns, and because it provides available capital in times of market distress to sweep in and buy up many underpriced securities of companies whose operating records are otherwise spotless. You might remember Buffett doing this in 1987... People who expose their principal to significant risk, or engage in even abysmally risky schemes such as margin trading, do not accumulate the capital to make swaths of purchases in times of market distress. But those of us who play it steady are very, very happy when the market goes to hell.
Have you ever met a billionaire day trader? I haven't. But what do Warren Buffett, Charlie Munger, Stan Perlmeter, Jean-Marie Eviellard and Irving Kahn all have in common other than being value investors? They're all disciples of Graham's teachings.
I'm sure you've read "The Intelligent Investor" and "The Superinvestors of Graham and Doddsville", though... it wouldn't be a bad idea to pore over them again. I find their insights immeasurably valuable.
Last edited:
