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JohnCLeven (82.24)

Tell me if you think this screen makes any sense

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January 17, 2013 – Comments (9)

Hello Fools!

Tell me if you think this screen idea is a waste of time or not. Or if it even makes sense.

I’m still pretty new to business analysis/investing, and sometimes I just get weird screen ideas. Here’s one I wanted to share.

So first, I’m previously accustomed to “backing out” the cash or debt when considering the prices of stocks, to get a better understanding of what I’d be getting if I bought the whole company.

That habit made me think to myself, “If you can back out the net cash or debt, maybe it would make sense to back out the book value?” This may seem similar to what Bruce Greenwald does when he calculates Earnings Power Value (EPV).

***Now, I understand that book value on a balance sheet is not 100% realistic; inventory usually cannot be resold at carrying cost, plants and equipment may not be worth full carried amount either. Likewise, liabilities come is all sizes and shapes, and are often not, in actuality, worth what the balance sheet says they are.

That said, I think this screen might be a useful for the occasional leads for further in depth research. The value in this crude screen/excel exercise is its speed.

Because, in theory, if you could come up with the real world liquidation value of the book value, you could deduct that from the share price (like you might net cash) to get a better idea of what your actually paying for earnings, right? (I think that's correct)

If two lemonade stands are both selling for the same P/E, wouldn’t you prefer the one with lots of assets and few liabilities, compared to the one with the opposite?

So, I ran a screen for companies with a mktcap over 1B, positive book value per share, positive EPS, and a 5 yr avg return on capital over 12% (To keep quality above average.)

I pasted it all in excel.

Then I subtracted book value per share from the current share price, and divided the resulting amount by EPS. This equals the “bookless PE ratio”. Again the formula is: (Share price - book value per share)/EPS.

Please give me some feedback and opinions.  

Thanks for helping me learn!

-john

 I’m not going to paste all 350 companies  here, but here are some of the notables, and where they turned up sorted by “bookless P/E" 

Really cheap

EZPW 1.56x

DV 1.78x

RDS.A 1.8x

VALE 1.9x

TOT 2x

DECK 3.94x

CVX 4.4x

GD 4.9x

DELL 5.2x

DLB 5.4x

INTC 7x

WU 5.9x

XOM 6x

AZN 6.3x

HAL 7x

CSCO 7.2x

Other notables

AAPL 8.5x

WMT 9.9x

MSFT 10.5x

IBM 12.7x

MCD 14.6x

JNJ 17x

PM 17x

HSY 26x

SBUX 26x

MA 27x

Exorbitantly expensive

UA 39x

LULU 39x

NFLX 107x

AMZN 3628x

9 Comments – Post Your Own

#1) On January 17, 2013 at 2:05 PM, JohnCLeven (82.24) wrote:

Also, if you deducted goodwill from bookvalue before doing this calc, (or maybe even tried to calculate real world liquidation value), and used free cash flow instead of earnings, you might have a pretty good idea of the value of the potential purchase.

That makes sense to me. Does that seem logical to you guys?

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#2) On January 17, 2013 at 4:03 PM, Mega (99.95) wrote:

"If two lemonade stands are both selling for the same P/E, wouldn’t you prefer the one with lots of assets and few liabilities, compared to the one with the opposite?"

Yes, all else being equal.

But, all else is never equal. If one business REQUIRES more assets than another one to earn the same amount of profit, it's a worse business which will have more difficulty growing. This was my biggest takeaway from reading Buffett's annual letters.

The key is understanding which assets are required and which are excess. I'd suggest only excess assets should be subtracted to get "adjusted PE".

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#3) On January 17, 2013 at 4:34 PM, JohnCLeven (82.24) wrote:

MegaShort,

I appreciate your feedback.

What method(s) would you typically use to determine required assets vs excess assets.

Also, this sounds very similar to the idea of separating growth capex from maintenece capex. Would you agree?

Thanks!

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#4) On January 17, 2013 at 6:02 PM, Mega (99.95) wrote:

My rough estimate for excess assets would be net current assets (current assets - current liabilities). In other words, assume that most profitable businesses can be run with a current ratio of 1.

Often you will want to add long-term investments. If they are contributing to earnings, subtract that amount out.

Yes, I agree it's a similar idea to "owner earnings" or adjusted FCF.

The last few years I've moved a little more towards Buffett quality/growth than strict Graham value. Your blog reminds me of one of the few asset-heavy stocks I own - Corning (GLW). There are very few companies with so much excess assets and a record of 15%+ ROIC.

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#5) On January 17, 2013 at 6:08 PM, Mega (99.95) wrote:

I've seen other people's calculations of excess assets as well, more involved based on applying discounts to the various balance sheet items.

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#6) On January 17, 2013 at 7:12 PM, JohnCLeven (82.24) wrote:

Great stuff, thanks again!

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#7) On January 18, 2013 at 4:33 AM, somrh (85.96) wrote:

@MegaShort wrote:

"If one business REQUIRES more assets than another one to earn the same amount of profit, it's a worse business which will have more difficulty growing."

 ^^^ This ^^^

But I think this will also apply here:

"My rough estimate for excess assets would be net current assets (current assets - current liabilities)."

A business that requires its inventories for its operations may have a lot of inventory (relative to current liabilities) but I wouldn't include those in excess assets.

Personally I like the way Jae Jun calculates excess cash (you could easily add in other nonoperating assets like marketable securities and other property that's not used in operations):

Excess Cash = Total Cash - MAX(0,Current Liabilities-Current Assets)

We could modify it to this:

Excess Assets = Cash + Marketable Securities + Other nonoperating Assets - Max(0, Current Liabilities - Current Assets)

. . .

The whole subtracting net cash bit has to do with firm value and enterprise value. The value of the firm is given by two equations: The firm is equal to the value of the equity + value of the debt (+ other stakeholders such as preferred shareholders as well.. we'll pretend they don't exist for simplicity)

V = E + D

The firm value is also equal to the value of the operating assets (enterprise value) + the value of non operating assets (what MegaShort is calling "excess assets"):

V = EV + Excess Assets.

Setting those two equal gets:

EV + Excess Assets = E + D

Now solve for enterprise value:

EV = E + D - Excess Assets

That's what you're doing when you're subtracting out net excess cash.

This number is what you want to compare to firm profits (EBIT, FCFF, etc) since it represents the value of all the profits of the firm (available to all stakeholders: debt, equity, preferred, etc).

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#8) On January 18, 2013 at 12:24 PM, Mega (99.95) wrote:

somrh, I agree that's a much more accurate calculation. Net current assets is just a quick 5 second shortcut (only useful for profitable companies without much debt).

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#9) On January 28, 2013 at 3:12 PM, AnsgarJohn (99.08) wrote:

You're screen makes sense. Here's an example I have been thinking about. 2 retailers :

A Own's stores real estate

B Rent's stores real estate

A Own's stores has a book value of $60 per share ($10 inventory plus $50 real estate)

B Rent's stores has a book value of $10 per share ($10 inventory plus $0 real estate)

A has profits of $5 per share

B has profits of $5 per share

Which is more valuable? 

Bruce Berkowitz would say A, see his pitch for Sears here:

 http://www.fairholmefunds.com/presentations

Graham Number valuation would say A as well: see my work on Dutch stocks here www.vlnvst.com 

Others might say B, because B might be able to grow faster, has a higher return on capital, etc.  

 

 

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