Mason Hawkins at The Ben Graham Centre for Value Investing (Part 2)

1. The second part of the investment process is being able to value a business.

2. Hawkins values a business three ways.

3. The first way is to go down the balance sheet, add up all the assets, subtract all the liabilities, and divide what’s left by the number of shares. Adjustments need to be made: for example, sometimes there are intangibles which overstate the value of a company and sometimes just the opposite is true. Hawkins mentions General Foods which had Jello on the books for very little when it is the dominant brand in its category. You need to be fair and ask what you would pay for the assets.

4. On the liability side, you need to read the footnotes and get into the details.

5. If you can buy a business for 50% of its assets, you have a riskless investment.

6. The second approach is to calculate the discounted cash flow of the business. They look at gross cash flow from operations and then subtract maintenance capex – what is needed to run the business. This is what you could put in your pocket if you owned the business. They are very conservative with the terminal value and they use a conservative 9% discount rate. They limit this valuation process to businesses they can understand.

7. The third approach is to look at private-market arms-length values. They keep an extensive database of all transactions in the industries they follow and compare prospective purchases to the sales price of comparable businesses. They adjust these sales prices to the prevailing interest rates. They have a thirty-year database.

8. Discipline and patience are key. They don’t swing unless there is a significant discount to appraised value. They wait until opportunities occur.

9. They require all their employees to have their equity in the Longleaf Funds which they manage. This focuses people’s attention and prevents conflicts of interest.

10. The vigorously debate all purchases because their own money is on the line.

11. When you look at a company you must look at the entire capital structure. Sometimes the debt is more profitable than the equity. He cites their investment in the debt of Level 3.

12. They evaluate litigation risk with common sense and experience. It is important to remember that you never need to invest. If there’s doubt they will forgo the opportunity.

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