bert111 (86.12)

A Different Way to Value Earnings

March 02, 2010 – Comments (2) | RELATED TICKERS: BOLT

Have you ever watched an interview of a Wall Street legend who touts a stock and its ability to generate exceptional rates of earnings returns only to wonder why your screen missed it?  Well, some of this is beyond me, such as why Buffett bought Kraft, but I've identified a different approach to valuing earnings that may address a portion of this all-too-familiar experience. 

The short description is that I segregate today's stock price into two piles -- the dollar-for-dollar equivalent of the stock price that accounts for shareholder's equity per share and the premium the market is demanding above and beyond equity.  I do this because, year-over-year changes in shareholder's equity tend to be less volitile than the premium.

Thereafter, I calculate the current return for the higest-yielding investment-grade corporate bond and apply it to the shareholder's equity portion of the stock price, and I then subject the premium to the much higher required rate of return for more risky equity investments.  This higher rate starts with the yield on the current 30-year US Government bond and adds an 8.6 percent premium for market volatility -- to which others may add the stock's beta as a measure of volatility for the specific equity under consideration.

Add together the portion of the stock price attributable to the premium and the adjustments for the required return on shareholder's equity and the premium paid and you have the numerator for the yield on Free Cash Flows or Owner's Earnings (Buffett's preferred measure).

Confused?  Well, I've created an entry on my personal blog that provides a more thorough explanation, with charts and graphs using Bolt Technologies as the example case.  I should mention that this blog is, indeed, personal.  There is no registration required and no advertisements.  Just the description of the approach I've found helpful with my investing.  You can find it at: