Awhile back, Stifel Nicolaus analyst Meyer Shields put that highly publicized ‘sell’ recommendation
on Berkshire; a few weeks ago he renewed it. Shields is an industry-experienced insurance actuary -- no small accomplishment of course, but a different perspective from CFA. While Shields might deserve our attention for insurance-related insights – such as those behind his recent ‘sell’ reiteration - we also might look back to some of his specific concerns (http://blogs.wsj.com/marketbeat/2010/07/08/marketbeat-qa-the...), included the comment: ”with widespread professional ownership, the “cult-stock” aspect (some investors use valuation methods for Berkshire that don’t work for any other name) will weaken, making the shares more “normal.”. We might suppose that Shields was referring to the Intrinsivaluator, our ‘two-column’ talk, maybe ‘look-through earnings’ and such.
Actually, the two-column method has long been widely used by the folks who get paid to assign dollar values to difficult-to-value securities – it just hasn’t been called that explicitly. Taking a page from these folks, where we see ‘EV’ (enterprise value) in an analysis, we’re likely looking at an acknowledgment of some two-column thinking.
Joel Greenblatt helped popularize EV as valuation ratio component in his The Little Book That Beats the Market and its ‘Magic Formula Investing’ technique. Greenblatt left out a key component of ‘two-column’ (the entire cash+investments column) in his assessment and ranking of company results - also, we can quibble with the relative ranking part of his formula - but an important Magic ingredient was the EBIT return on EV. Nonetheless, his formula does help us identify two-column high-potential candidates for a closer look. As a refresher, 'EV' is calculated as Market Capitalization + Debt – (Cash + Securities). This gets us to the implied value of the unleveraged operating business. Rather than compare earnings to ‘price’ (market cap) we can look at the return on just the value assigned to the businesses, 'EV' (before taking on debt).
Just out of curiosity I ran the Greenblatt Magic Formula screening (comprised of the Formula's two ratios: EBIT/EV and Earnings/assets invested in the company, calculated as Working Capital + Fixed Assets + Goodwill) -- for all small-capitalization publicly traded US companies, and ranked out the results. Guess what popped up in the top tier? (EBIT at 35% of EV) Munger’s Daily Journal Corp.
With a PE of 13 or so, popular P/E screening sources would hardly have given the Daily Journal Corp. a second glance. Earnings are about $7 million per year and in slow decline, against a $99 mill market cap. But the Daily Journal’s balance sheet is showing about $63million of cash and securities. Set that cash, etc aside (or distribute it out) and the business represented by that remaining $36 market cap (EV) is earning that $7 million, after tax. We have to make an assessment of DJCO’s future earnings potential of course, but perhaps it's worth a closer look? For anyone following their specific DJCO’s of the world, this is elementary stuff – but we often overlook these two-column candidates in cursory scans or reviews.
We hear a lot about companies holding high levels of excess cash (and securities) these days. The question for investors is whether they’ll ever see dollar-for-dollar value. While the Magic Formula won’t answer the subjective questions of whether management is capable of doing the right thing with the money, at least it shows us where to look (after running the EBIT/EV and Earnings/Invested-Assets Magic Formula scans for candidates, we can subtract the EV’s from market capitalizations, and look for big numbers for that cash-equivalent 'second column').
Shifting to the other extreme, I ran a Magic Formula-type scan of the largest (non-financial) companies world-wide – those with over $50B market caps. $25B-plus excess cash+investments levels popped up at the usual US tech suspects – Microsoft, Cisco, Apple, Google. While there may be some excess cash accumulations in the lower-capitalization tiers, in the $50B+ size range there weren’t widespread excesses (after also considering debt). Depending on our assessment of a company’s ability to utilize cash, we might give them some ‘two-column’ credit. Two-column aside, looking at that full $50B-plus market cap population and ranking out those companies on the two Magic Formula performance ratios, Microsoft was at the top of the US value+performance heap (followed by Cisco), while Toyota, BMW, Caterpillar, and Volkswagen were in the international value+performance cellar.
Going back to Shield's BRK ‘sell’ call– maybe the question isn’t whether the investment community PE-centric participants will assign value to Berkshire, but whether the investing public will become increasingly sophisticated in identifying and appropriately valuing two-column candidates.
on Berkshire; a few weeks ago he renewed it. Shields is an industry-experienced insurance actuary -- no small accomplishment of course, but a different perspective from CFA. While Shields might deserve our attention for insurance-related insights – such as those behind his recent ‘sell’ reiteration - we also might look back to some of his specific concerns (http://blogs.wsj.com/marketbeat/2010/07/08/marketbeat-qa-the...), included the comment: ”with widespread professional ownership, the “cult-stock” aspect (some investors use valuation methods for Berkshire that don’t work for any other name) will weaken, making the shares more “normal.”. We might suppose that Shields was referring to the Intrinsivaluator, our ‘two-column’ talk, maybe ‘look-through earnings’ and such.
Actually, the two-column method has long been widely used by the folks who get paid to assign dollar values to difficult-to-value securities – it just hasn’t been called that explicitly. Taking a page from these folks, where we see ‘EV’ (enterprise value) in an analysis, we’re likely looking at an acknowledgment of some two-column thinking.
Joel Greenblatt helped popularize EV as valuation ratio component in his The Little Book That Beats the Market and its ‘Magic Formula Investing’ technique. Greenblatt left out a key component of ‘two-column’ (the entire cash+investments column) in his assessment and ranking of company results - also, we can quibble with the relative ranking part of his formula - but an important Magic ingredient was the EBIT return on EV. Nonetheless, his formula does help us identify two-column high-potential candidates for a closer look. As a refresher, 'EV' is calculated as Market Capitalization + Debt – (Cash + Securities). This gets us to the implied value of the unleveraged operating business. Rather than compare earnings to ‘price’ (market cap) we can look at the return on just the value assigned to the businesses, 'EV' (before taking on debt).
Just out of curiosity I ran the Greenblatt Magic Formula screening (comprised of the Formula's two ratios: EBIT/EV and Earnings/assets invested in the company, calculated as Working Capital + Fixed Assets + Goodwill) -- for all small-capitalization publicly traded US companies, and ranked out the results. Guess what popped up in the top tier? (EBIT at 35% of EV) Munger’s Daily Journal Corp.
With a PE of 13 or so, popular P/E screening sources would hardly have given the Daily Journal Corp. a second glance. Earnings are about $7 million per year and in slow decline, against a $99 mill market cap. But the Daily Journal’s balance sheet is showing about $63million of cash and securities. Set that cash, etc aside (or distribute it out) and the business represented by that remaining $36 market cap (EV) is earning that $7 million, after tax. We have to make an assessment of DJCO’s future earnings potential of course, but perhaps it's worth a closer look? For anyone following their specific DJCO’s of the world, this is elementary stuff – but we often overlook these two-column candidates in cursory scans or reviews.
We hear a lot about companies holding high levels of excess cash (and securities) these days. The question for investors is whether they’ll ever see dollar-for-dollar value. While the Magic Formula won’t answer the subjective questions of whether management is capable of doing the right thing with the money, at least it shows us where to look (after running the EBIT/EV and Earnings/Invested-Assets Magic Formula scans for candidates, we can subtract the EV’s from market capitalizations, and look for big numbers for that cash-equivalent 'second column').
Shifting to the other extreme, I ran a Magic Formula-type scan of the largest (non-financial) companies world-wide – those with over $50B market caps. $25B-plus excess cash+investments levels popped up at the usual US tech suspects – Microsoft, Cisco, Apple, Google. While there may be some excess cash accumulations in the lower-capitalization tiers, in the $50B+ size range there weren’t widespread excesses (after also considering debt). Depending on our assessment of a company’s ability to utilize cash, we might give them some ‘two-column’ credit. Two-column aside, looking at that full $50B-plus market cap population and ranking out those companies on the two Magic Formula performance ratios, Microsoft was at the top of the US value+performance heap (followed by Cisco), while Toyota, BMW, Caterpillar, and Volkswagen were in the international value+performance cellar.
Going back to Shield's BRK ‘sell’ call– maybe the question isn’t whether the investment community PE-centric participants will assign value to Berkshire, but whether the investing public will become increasingly sophisticated in identifying and appropriately valuing two-column candidates.
