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Greenwald Earnings Power Value EPV Lecture Slides
Greenwald Earnings Power Value EPV Lecture Slides
and Valuation
VALUATION
Assets
Earnings Power
Franchise
REVIEW
Key Issues
Collateral Evidence
Personal Biases
RISK MANAGEMENT
Margin of Safety
Some Diversification
Patience Default
Strategy
3
Systematic Biases
1. Institutional
z
Blockbusters
2. Individual
z
Loss Aversion
Hindsight Bias
Lotteries
VALUATION
Assets
Earnings Power
Franchise
REVIEW
Key Issues
Collateral Evidence
Personal Biases
RISK MANAGEMENT
Margin of Safety
Some Diversification
Patience Default
Strategy
6
Earnings
Multiple
Depends on:
Economic position
EBIT
(Maint. Inv. = Depr + A; Tax =0)
Leverage
EBIT - A
(Maint. Inv. = Depr only)
EBIT-DA
(Maint. Inv. = 0)
Cyclical situation
Mgmt. Quality
Cost of Capital (Risk)
Growth
Valuation Approaches
Net Present Value of Cash Flow
Value =
CF (1 +1 R )
t=0
= CF0 *
1
R-g
In Practice:
Revenues
Parameters:
z
Market Size
Market Share
Market Growth
Price/Cost
Forces:
z
Consumer
Behavior
Competitor
Behavior
Cost Pressures
Technology
Tech
Management
Performance
Margins
Required
Investments
Tech
Management
Performance
Cash Flows
Cost of Capital
1
1+R
Good
Information
(Precise)
+ +CF20
+ ...
1+R
Bad Information
(Imprecise)
= Bad/Imprecise Information
Profit
Margin
Cost of
Capital
Required
Investment
Growth
9
Valuation Assumptions
Traditional:
Strategic:
Profit rate 6%
Industry is economically
viable
10
Value Investing
Basic Approach to Valuation
Least Reliable
Growing Competitive
Advantage
11
Strategic Dimension
Free Entry
No Competitive
Advantage
Asset Value
Reliability
Dimension
Tangible
Balance Sheet
Based
No
Extrapolation
Earnings Power
Value
Current
Earnings
Extrapolation
No Forecast
Total Value
Includes
Growth
Extrapolation
Forecast
12
Industry
Market Value
Entry
Chemicals
(Allied)
$2B
$1.5B
$1.0B
$1B
$1B
$1B
Yes (P MV )
Yes
Stop
Automobiles
(Ford)
$40B
$30B
$25B
$25B
$25B
$25B
Internet
$10B
$0.010B
13
Asset Value
Assets
Cash
Book
Reproduction
Value
Book
Book + Allowance
Inventories
Book + LIFO
Book
PPE
Product Portfolio
0
0
Customer Relationships0
Organization
Licenses, Franchises
Subsidiaries
Liabilities
A/P, AT, AL
Book
Book
Debt
Book
Fair Market
Book
DCF
Bottom Line
14
1
- Earnings Power Value = Earnings * Cost of capital
z
15
16
17
Case A:
Asset Value
EP Value
Free Entry
Industry
Balance
Case B:
Asset Value
EP Value
Consequence of
Comp. Advantage
and/or Superior
Management
Case C:
Asset Value
EP Value
19
CF0
R-G
vs. CF0
Growth Rate
WACC
Growth Requires Investment which
reduces current (distributable) Cash
Flow
CF0 = Earnings y Investment Needed to Support Growth
No Growth CF0
Value of Growth
Quantitative Effects
Investment:
$100 million
Cost of Funds:
5%
10%
20%
$5M
$10M
$20M
Cost of Investment
$10M
$10M
$10M
($5M)
$10M
($50M)
$100M
Qualitative Impact:
Situation:
Value
Destroyed
No Value
Value
Created
Competitive
Disadvantage
Level
Playing
Field
Competitive
Advantage
21
Case A:
Asset Value
EP Value
Free Entry
Industry
Balance
Case B:
Asset Value
EP Value
Consequence of
Comp. Advantage
and/or Superior
Management
Case C:
Asset Value
EP Value
Growth at a competitive
disadvantage destroys value
(AT&T in info processing)
Growth on a level playing field
neither creates nor destroys
value
(Wal-Mart in NE)
Only franchise growth (at
industry rate) creates value
23
VALUATION
Assets
Earnings Power
Franchise
REVIEW
Key Issues
Collateral Evidence
Personal Biases
RISK MANAGEMENT
Margin of Safety
Some Diversification
Patience Default
Strategy
24
Economic Profit
AC
Price
Q
Firm Position
(Efficient Producers)
$/Q
ROE = 12%
AC
No Entry
No Profit
Price
Q
Firm Position
25
Product Differentiation
Branding
(Profitability & Stability)
Coca Cola
Colgate Toothpaste
Tide
Marlboros
Cadillac
Mercedes-Benz
Sony (RCA)
Maytag(Hoover)
Budweiser
Harley-Davidson
Intel
Motorola
Target, Walmart
Verizon, Cingular
WellsFargo, NCNB
Insurance
Gannett, Buffalo Evening News
Dell, HP
Gap, Liz Claiborne
ATT, Sprint
JP Morgan, Chase,
Citibank
Cosmetics
NY Times, WSJ
26
Economic Profit
AC
ROE = 12%
$/Q
No Entry
No Profit
AC
Demand
Curve
Q
Firm Position
27
Barriers to Entry
Incumbent Cost Advantage
$/Q
ACEntrant
ACIncumbent
Demand (Entrant, Incumbent)
Firm Position
Entrant
No Economic
Profit
Incumbent
Economic Profit
ROE = 20%
Sources
Proprietary Tech
(Patent, Process)
ROE = 12%
Learning Curve
No Entry
Special Resources
Not Access to Capital
Not Just Smarter
28
Barriers to Entry
Incumbent Demand Advantage
$/Q
AC (Entrant, Incumbent)
DemandIncumbent
DemandEntrant
Firm Position
Entrant
Incumbent
No Economic Profit
ROE = 12%
ROE = 20%
No Entry
Sources
Habit (Coca-Cola)
High Frequency
Purchase
Search Cost (MDs)
High Complex
Quality
Switching Cost (Banks,
Computer Systems)
Broad Embedded
Applications
29
Barriers to Entry
Economies of Scale
Demand
$/Q
AC
Entrant Incumbent
Firm Position Q
No advantage
AC
Firm Position
No advantage
30
Barriers to Entry
Economies of Scale
$/Q
D-Incumbent
Profit
Loss
Price (Both)
AC
D-Entrant
Sales
Entrant
Sales
Incumbent
31
Key to Sustainability
32
33
No Position
(Hard to Create
from Nothing).
-Enhancement
Product Line Extension
Increase Purchase Frequency
Increase Complexity
Accelerate Progress
Emphasize Fixed vs. Variable
Cost Technology.
34
Procedure in Practice
(1) Verify existence of franchise
i.
ii.
(Dividend + Repurchase)
(4) Identify organic (low investment) growth
(GDP)
(5) Identify reinvestment return
35
Prospective Returns
US & India Markets
U.S. Market
(1)6% (1/PE) + 2% (inflation) = 8%
(2)2.5% (D/P) + 4.7% (growth) = 7.2%
Expected Return = 7.5%
India Market
(1)4% (1/PE) + 5% (inflation) = 9%
(2)2% (D/P) + 7% (growth) = 9%
Expected Return = 9%
36
Source: Company website showing AC Nielsen Quarter Ended Sept 2007 value shares
3737
2002
2003
2004
2005
2006
Revenues
crores
10951,61
11096,02
10888,38
11975,53
13035,06
Net profit
margin
16%
16%
11%
11%
12%
Return on
capital
46.8%
48.7%
37.3%
58.1%
55.4%
Return on
Assets
23%
23%
16%
20%
20%
45,059
31,587
43,419
25
26
31
Share
Price
204.70
143.50
197.25
Stock information
181.75
47,788
26
216.55
3838
Infosys: Performance
Return on Total Capital Declined.
2000
2001
2002
2003
2004 2005
30.2%
2006
2007
31.3% 32%*
.31
.37
.51
.76
1.00
1.5
2.00
* Source: Value Line Data, and Italics show VL Estimate for 2007.
3939
Company
Business
Adjusted ROE
Wal-Mart
Discount Retail
22.5%
American
Express
45.50%
Gannett
15.6%
Dell
Direct PC Supply to
Large organizations
100.0% +
40
Simple Examples
Franchise Verification
Sources of Competitive Advantage
Customer Captivity?
Economies-of-Scale?
Wal-Mart
Local Economies-ofScale
American
Express
Customer Captivity
Some Economies-ofScale
Gannett
Customer Captivity
Local Economies-ofScale
Dell
Economies-of-Scale
41
Wal-Mart
= 1.5%
RE
GROWTH
+ 4.5% +
3.5%
7.5%
= 15.5% + Option
American
Express
9.5% + Option
(x1 Capital
Allocation)
4%
+ 4%
(2% x 2)
Gannett
TOTAL
= 10%
1%
2.0%
7.0% + Option
+ 5%
5.0% + Growth
Dell
0%
+Option
(?)
42
Appendix
43