Monthly Archives: November 2010

Buffett on Certainty

Here is an email exchange between Jeff Raikes of Microsoft and Warren Buffett. Raikes is explaining to Buffett why Microsoft is (was) a great investment. The primary lesson of the exchange is how Buffett thinks about certainty when making an investment and the importance he places on it.

Email Exchange With Microsoft’s Jeff Raikes (August 1998) (courtesy of http://warrenbuffettresource.wordpress.com/)

My Watchlist – November 29, 2010

I have reviewed issue 1 of Value Line looking for companies that have exceptional returns on equity, strong book value growth or strong “guru investor” sponsorship.

The idea here is to have a dashboard of substantially all the larger-cap high quality businesses in the U.S. in one place that you can review at least weekly to see what Mr. Market is making available to you.

Because of a limit on the number of functions that Google allows in a single spreadsheet, I had to split the spreadsheet into two parts.

This week’s update is in part 1.

Watchlist – Part 1

Watchlist – Part 2

Stocks from issue 1 (see Watchlist – Part 1)

Amazon.com, Inc.

eBay Inc.

Dionex Corporation

Mettler-Toledo International Inc.

Waters Corporation

Alcon, Inc.

Baxter International Inc.

Becton, Dickinson and Co.

C.R. Bard, Inc.

Cardinal Health, Inc.

IDEXX Laboratories, Inc.

Johnson & Johnson

Medtronic, Inc.

Meridian Bioscience, Inc.

Stryker Corporation

Varian Medical Systems, Inc.

A few thoughts…

Nothing in this group appears to be a screaming buy with many of the stocks near a 52-week high.

Johnson & Johnson appears to fit Buffett’s saying that, “I would sooner buy a great business at a fair price than a fair business at a great price.”

According to data at Dataroma, the stock has been widely purchased by several prominent value investors over the past year.

Here is a quick DCF on JNJ that assumes that free cash flow grows at 8% and a discount factor of 10%. I assume a terminal multiple of 15x on the free cash flow in year 9. Based on Value Line, I estimate free cash flow in 2011 to be $5.30 a share. You should plug in your own assumptions and look at multiple scenarios.

The author of this blog is NOT an investment, trading, legal, or tax advisor, and none of the information available through this blog is intended to provide tax, legal, investment or trading advice. Nothing provided through these posts constitutes a solicitation of the purchase or sale of securities/futures. The data and information presented in this blog entry is believed to be accurate but should not be relied upon by the user for any purpose. Any and all liability for the content or any omissions, including any inaccuracies, errors or misstatements in such data is expressly disclaimed.

Acquisition Values

Acquisition values can be a useful part of an investor’s valuation toolkit. As Michael Price points out, these are particularly meaningful because they are not theoretical: they represent what an informed, sophisticated buyer is actually willing to pay for a business.

I like to pay close attention to when there is an acquisition to see what price was paid for the business, and I have begun to build a database of past deals within my circle of competence that I can refer to when evaluating a possible investment. Bear in mind that, just like the market in general, acquisitions are subject to irrational exuberance. Also, focus on deals that were done in the last couple years, keeping in mind the macro economic conditions that prevailed when the deal was done.

This morning it was announced that two private equity firms are close to a deal to purchase the clothing retailer J. Crew for $43.50 a share. J. Crew closed yesterday at $37.65 a share so the offer represents a premium of approximately 15%. One common metric used to value these types of deals is ratio of the enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA).

Caution: I think this metric has utility as a comparative metric because it normalizes differences in capital structure and tax rates and is widely used by investment banks and investment firms, but, following Buffett, I think it is deficient in helping to determine the intrinsic value of a business because it does not include the cost of capital expenditures which are essential to maintaining and growing a business.

At the offer price ($43.50), J. Crew has an EV/EBITDA of 7.3.

Based on yesterday’s closing prices, here is the EV/EBITDA ratio for several of J. Crew’s competitors:

Abercrombie & Fitch Co. – 8.1

American Eagle Outfitters Inc. – 6.8

Gap Inc. – 4.2

Urban Outfitters – 11.1

Aerospotale – 4.5

Based on this metric, Gap and Aeropostale look undervalued.

My Watchlist – November 22, 2010

I have reviewed issue 13 of Value Line looking for companies that have exceptional returns on equity, strong book value growth or strong “guru investor” sponsorship.

The idea here is to have a dashboard of substantially all the larger-cap high quality businesses in the U.S. in one place that you can review at least weekly to see what Mr. Market is making available to you.

Because of a limit on the number of functions that Google allows in a single spreadsheet, I had to split the spreadsheet into two parts.

This week’s update is in part 2.

Watchlist – Part 1

Watchlist – Part 2

Stocks from issue 13 (see Watchlist – Part 2)

Fiserv, Inc.

Total System Services, Inc.

Wright Express Corporation

Automatic Data Processing

Accenture Plc

H&R Block, Inc.

Paychex, Inc.

American Express Company

Brown & Brown, Inc.

Citigroup Inc.

Federated Investors, Inc.

MasterCard Incorporated

SEI Investments Company

T. Rowe Price Group, Inc.

Visa Inc.

Wells Fargo & Company

Cognizant Technology Solutions Corp.

Infosys Technologies Limited (ADR)

Microsoft Corporation

Oracle Corporation

SAP AG (ADR)

Google Inc.

Exelon Corporation

Stock Focus: Fiserv

Background:

Fiserv – Wikipedia, the free encyclopedia

Fiserv’s Ambitious Credit-Crunch Plans – Forbes.com

Fiserv’s Got Your Back (Office) – Barron’s

Why Is Buffett Buying Shares of Iron Mountain, Fiserv? — Seeking Alpha

Fiserv, Jack Henry Upbeat About Core Client Spending – American Banker Article

Notable owners:

Warren Buffett: 3,910,800 shares

Glenn Greenberg: 2,088,579 shares

Future Prospects

Growth prospects per Jan. 28, 2010 writeup on Value Investors Club.

The top-line growth is coming from several drivers, including:

  1. Increased outsourcing – there are still banks that operate on legacy, in-house developed and inefficient systems. These are slowly being converted.
  2. Online banking is expanding and Fiserv is the largest provider. An increasing number of banks are transforming to digital branches, providing more online services to their customers. Also, online bill payments continue to replace the typical paper payment methods. Fiserv has only 3,900 online customers, a small percentage of the total. There are only 7.8 million E-bill consumers – penetration within the Fiserv’s client base is very low – below 10%. The number of e-bills per subscriber is only 2.5 per month. An average individual pays several times that number in bills a month. Continued adoption should lead to steady growth.
  3. New technology leads to additional billed services.
  4. Growth in number of deposit accounts – industry CAGR for the last 5 years was 7%.
  5. Increased number of debit and prepaid card transactions. These two are projected to grow at 7% and 15%, respectively over the next three years.
  6. Additional add-on products like fraud and loyalty services and cross-selling existing products (increasing penetration)

Long-term guidance provided by Fiserv management at 2010 Investor Conference, October 5, 2010.

Internal revenue growth rate: 4-8%

EPS growth rate: 11-18%

FCF growth rate: 8-14%

Operating margin: 50-100 bps

Valuation

Market cap: 8.38 billion

EV: 11.34 billion

2010 EPS Estimate: 4.05

PE on 2010 estimate: 13.86

TTM FCF: 683 million

FCF Yield: 8.15%

EBITDA: 1290 million

EBIT: 953 million

EV/EBITDA: 8.81

EV/EBIT: 11.9

EBIT/Tangible Capital Employed: 107%

Acquisition comp: Per an article in Barron’s, in 2010, Blackstone Group offered $35 a share to purchase Fiserv competitor Fidelity National Information Services. This works out to about 10 times estimated 2010 EBITDA.

The author of this blog is NOT an investment, trading, legal, or tax advisor, and none of the information available through this blog is intended to provide tax, legal, investment or trading advice. Nothing provided through these posts constitutes a solicitation of the purchase or sale of securities/futures. The data and information presented in this blog entry is believed to be accurate but should not be relied upon by the user for any purpose. Any and all liability for the content or any omissions, including any inaccuracies, errors or misstatements in such data is expressly disclaimed.

Links of Interest – November 19, 2010

Longleaf Partners Quarterly Report – September 30, 2010

Taking Stock – Is Wall Street in for a long funk? By Roger Lowenstein

On the Offensive – Interview with Mason Hawkins and Staley Cates – Value Investor Insights

Ex-Hedge Fund Manager William von Mueffling Changes His Stripes – WSJ.com

Stock ownership of William Von Mueffling – Cantillon Capital Management – DATAROMA – Value investing

Searching for Value in the Stock Market – Part 1 – Interview with Whitney Tilson, Co-founder and Chairman of Value Investing Congress | Benzinga.com

Seth’s Blog: Unreasonable

Pomodoro Technique – a video by Staffan Noteberg – www.pomodoro-book.com

Pretty Good for Government Work – NYTimes.com

Buffett On Why He Prefers Stocks Over Bonds; Top Purchases: WFC, JNJ, BK

Search Tools Tab Added

I have replaced the Investing Ideas section of the blog with “Search Tools” (see the tabs above). This page contains my watchlists of high-quality companies along with additional watchlists and screens.

I plan to add to these over time. Regularly following these watchlists and screens should increase your chances of finding good investment ideas. As always, I welcome your feedback and suggestions.

Valuation is the Essential Skill

Valuation is an art and, as such, it requires practice. Buffett has said that if he were teaching a class on investing he would spend all his time doing case studies where he valued companies.

It is amazing to me how many articles you find on the internet that recommend stocks that contain little or no analysis of the company’s valuation. A case in point is all the talk about GM’s IPO. I have yet to hear or read an analysis of the intrinsic value of GM so an investor can understand what he’s getting if he buys at the offering price. It’s as if this question doesn’t even matter to those buying the stock. (Hint: be very wary when someone is working overtime to sell you something.)

So how do you become better at valuation? First, you must master the basic tools of valuation by studying the great investing books and the letters, articles and speeches of great investors. That’s part of the reason that this blog exists and there are many others out there that are excellent.

Second, start building a file of case studies you come across that include good valuation work.

What’s a good valuation? It should be simple and obvious. The value should be compelling. You should feel a little twinge of greed that you missed that opportunity and have the thought that you’d buy the stock in a second if the opportunity repeated itself.

As you build this file and study it, it becomes, in the language of Munger, your own latticework of mental models that you can draw upon when you come across a possible investment.

For example, yesterday I posted Denali Investors analysis of Cardinal Health’s spinoff of CareFusion. If you study Denali’s thought process and how they valued the two companies, you can draw on that the next time you are analyzing a spinoff. Another rich source of valuations is the Value Investors Club. The ideas are rated, and if you focus on those that are highly rated, you will find some excellent work to emulate. With the benefit of hindsight, you can also see how those ideas worked out.

Of course you need to practice your own valuation work. Ideally, you can share your work with other experienced investors who can give you feedback. Make sure you have a clear, succinct valuation for every stock in your portfolio. You won’t always be right, but if an investment does not work out you want to be in position to learn from it by being able to go back and see where you went wrong.

Valuation is the essential skill to master if you want to be great investor. Without it, value investing makes no sense.