Sunday, May 21, 2006

Why Warren is big on intangibles and low on tangible assets!

See's was bought for 25 million with an earings of 2 million. At that time, it had roughly 8 million of tangible assets and hence the payment for see's created a 17 million goodwil intangible account.

If a hypothetical business did have an intangible asset base of 18 million and had 2 million in earnings, it would have earned 11% on tangible assets. We also assume that this business has no economic goodwill.

Now imagine if a doubling of price level or inflation did take place, both businesses would have to double their earnings to 4 million to keep pace with inflation. Hence, both businesses would have to sell the same number of units at double the earlier prices and assuming that profit margins were unchanged, profits must also double.

To bring about a doubling of profits and to be even with inflation, both companies would have to double their investment in net tangible assets. For See's candies, an investment of 8 million would have to be made while the other would have to make an investment of 18 million.

While both companies are attaining the same amount of profits , See's only had to spend an additional 8 million while the other business had to spend an additional 18 million. This just goes to show that companies with more intangibles (moat) and less tangible assets are better than asset heavy companies when it comes to fighting inflation.

Margin of safety

In 1972, Ben Graham gave a lecture and summarised the concept of margin of safety. It is the difference between the percentage rate of the earnings on the stock on the price you pay for it and the rate of interest in bonds and that margin of safety is the difference which would absorb unsatisfactory developments. If a company was selling at a PE of 11, the earnings yield would be 1/11 which is 9% while a bond yield of 10 year maturity is 4 %. Here in this case, the margin of safety is (9-4)/4 x 100 = 5/4 x 100 = 125%

Also if the intrinsic value of a company is estimated to be between a $100 and $120.(The variation in intrinsic value is due to pessimistic and optimistic growth rates and variations in discount rates. Note: Intrinsic value is an approximation and not an accurate figure) And if the market value is $60 , we say that the stock has a margin of safety of (100-40)/100 x 100 = 40%. For purposes of conservatism, we should take a lower value of $100 of the intrinsic value to calculate the margin of safety.

Test of retained earnings

Capital allocation is an extremely important process. To put it bluntly, poor capital allocation would lead to decreased intrinsic value and superior capital allocation under above average business conditions would lead to increased intrinsic value. According to Warren buffet he expects every dollar retained to result in an increase in a dollare of market value in a 5 year rolling basis. More recently, other test of retained earnings have been developed to check if increases in retained earnings has led to increases in net income or owner earnings. For example, if the change in retained earnings in the last 10 years was $100 and the increase in net income over the last 10 years was $20, then it can be argued that the company's earnings increased $20 from the increase of a $100 in retained earnings , 20% that is. However in my opinion this is still and inadequate test. What i would like to find out is how capital expenditures would lead to an increase in earnings per share in franchise businesses with competitive advantages? Does anyone have any comments over this or suggestions? Do feel free to contact me and share your views!!1

Saturday, May 20, 2006

Washington post, a classic buy and a 100 bagger

As reported in the letters to shareholders, Warren invested 10 million in Washington post in 1973. It has to be one of his most successful investments of all time. Due to lack of data on washington post in the 1970s i can only make intelligent guesses while getting to why Warren bought Washington Post. In his letters to shareholders, he claimed that he bought Washington Post at and average price of $5.63. Using Thomson Financial, i could only get the net income of Washington Post back to 1980. Assuming that net income was similar to 1973's net income of Washington Post back to 1980 and there was no growth in per share net income since 1973, the quick and dirty method for calculating the intrinsic value without efforts for discounting would be:

14 million shares oustanding

Dirty intrinsic value= (30 million x 10 years)/14 million shares outstanding = $21.42 per share

Average price paid by Warren= $5.63

If you asked me, he was essentially buying $21.42 worth of earnings with $5.63 and that is assuming no growth. However, Washinton Post did grow its per shares earnings and hence $21.41 seems to be a conservative valuation. Even at that time, Warren also did feel that the Washington Post was worth approximately 4 to 5 times its average share price in 1973.

Subsequently, Warren managed to influence management through Katherine Graham to perform share buybacks thereby increasing per share intrinsic value. Today, Warren's 10 million investment in WashingtonPost has blossomed to a market value in excess of 1 billion. Thats a 100 bagger for the record!

Friday, May 12, 2006


Dear visitor, Welcome to Value investor Haven!

As its name suggest, this website is primarily meant for bringing like minded individuals from all across the globe to a common place to share and learn more about value investing. My name is Lucas and i am a hard core fan of Warren Buffet, Benjamin Graham, Philip Fisher and many of today's new age value investors.

While i read much literature on value investing, i also hone my skills in the Singapore and US markets. Value investing has always been a topic that lifts my heart and excite my spirits. I hope that through this blog, i can share my experiences and exchange views with like minded individuals to enable me to grow as an investor, but more importantly, as an individual. So please feel free to look around and post your comments and views.