In order to value a business, you need to do your home work. In a recent article in Fortune entitled “Best Advice I ever got”, Jim Rogers talks about how you can get an edge on the vast majority of people on Wall Street if you simply read everything you can on a prospective investment.
"The best advice I ever got was on an airplane. It was in my early days on Wall Street. I was flying to Chicago, and I sat next to an older guy. Anyway, I remember him as being an old guy, which means he may have been 40. He told me to read everything. If you get interested in a company and you read the annual report, he said, you will have done more than 98% of the people on Wall Street. And if you read the footnotes in the annual report you will have done more than 100% of the people on Wall Street. I realized right away that if I just literally read a company's annual report and the notes -- or better yet, two or three years of reports -- that I would know much more than others. Professional investors used to sort of be dazzled. Everyone seemed to think I was smart. I later realized that I had to do more than just that. I learned that I had to read the annual reports of those I am investing in and their competitors' annual reports, the trade journals, and everything that I could get my hands on. But I realized that most people don't bother even doing the basic homework. And if I did even more, I'd be so far ahead that I'd probably be able to find successful investments."
Rogers likes to lay out the data on a company in spreadsheets that go back ten to fifteen years. He believes it is essential to have a long-term historical view of a company. When he sees a period of difficulty or decline, he wants know why, and likewise for periods of prosperity. Copies of Rogers’ spreadsheets can be found in the appendix of John Train’s “The New Money Masters”. I have adopted them for my own work and found them to be highly useful. It is worth noting that they involve no projections.
Staying with the advice giving theme, Buffett recounts a story in a 1991 speech at Notre Dame about when Bob Woodward asked him how to make some money in the stock market. Buffett advised Woodward to go out and research a company like he would a news story. If the company was an obvious bargain, Buffett told him to buy it, if not, take a pass. It is clear from the speech that Buffett uses private market valuations in his business valuation process.
"Bob Woodward one time said to me “tell me how to make some money” back in the ‘70s, before he’d made some money himself on a movie and a book. I said “Bob, it’s very simple. Assign yourself the right story. The problem is you’re letting Bradley assign you all the stories. You go out and interview Jeb Magruder.” I said “Assign yourself a story. The story is: what is the Washington Post Company worth? If Bradley gave you that story to go out and report on, you’d go out and come back in two weeks, and you’d write a story that would make perfectly good sense. You’d find out what a television station sells for, you’d find out what a newspaper sells for, you’d evaluate temperament.” I said “You are perfectly capable of writing that story. It’s much easier than finding out what Bill Casey is thinking about on his deathbed. All you’ve got to do is assign yourself that story.”
“Now, if you come back, and the value you assign the company is $400 million, and the company is selling for $400 million in the market, you still have a story but it doesn’t do you any good financially. But if you come back and say it’s $400 million and it’s selling for $80 million, that screams at you. Either you are saying that the people that are running it are so incompetent that they’re going to blow the $400 million, or you’re saying that they’re crooked and that they’re operating Bob Vesco style. Or, you’ve got a screaming buy when you can buy dollar bills for 20 cents. And, of course, that $400 million, within eight or 10 years, with essentially the same assets, [is now worth] $3 or $4 billion.”
That is not a complicated story. We bought in 1974, from not more than 10 sellers, what was then 9% of the Washington Post Company, based on that valuation. And they were people like Scudder Stevens, and bank trust departments. And if you asked any of the people selling us the stock what the business was worth, they would have come up with an answer of $400 million. And, incidentally, if it had gone down to $60 or $40 million, the beta would have been higher of course, and it would have therefore been [viewed as] a riskier asset. There is no risk in buying the stock at $80 million. If it sells for $400 [million] steadily, there’s much more risk than if it goes from $400 million to $80 million.
But that’s all there is to business. But now you say “I don’t know how to evaluate the Washington Post.” It isn’t that hard to evaluate the Washington Post. You can look and see what newspapers and television stations sell for. If your fix is $400 and it’s selling for $390, so what? You can’t [invest safely with such a small margin of safety]. If your range is $300 to $500 and it’s selling for $80 you don’t need to be more accurate than that. It’s a business where that happens.
Suggested (minimum) checklist for thoroughly researching a company:
1. Annual reports / 10-K’s – five years (including those of competitors). Read the footnotes.
2. 10-Q’s and Proxy Statements – one year, including transcripts of earnings calls (include those of competitors). Seeking Alpha is a good source of transcripts.
3. Build a 10-year spreadsheet on the company, by operating segment if applicable (see Rogers’ spreadsheet for a model). Don’t rely on third party sources for anything more than preliminary research. Going to primary sources will not only ensure the data’s accuracy, but also force you to think about the numbers and what they mean.
4. All available relevant articles in the business trades and press. In addition to the general Internet (Google, Bing, etc.), many libraries offer excellent free online databases, such as Proquest.
5. Build a database of all relevant private market transactions (minimum 5 years).
6. Compare relevant valuation metrics for company to those of competitors (P/S, P/B, P/E, EV/EBIT, EV/EBITA, P/(Owner Earnings). Include an analysis of any industry specific metric, for example, ROA for banks.
7. Study who owns the stock (and who doesn't). (You may be able to find information on the company in reports and letters of quality institutional investors that own the stock.) Are insiders buying or selling? Do they have "skin in the game"? What about the directors?
"The best advice I ever got was on an airplane. It was in my early days on Wall Street. I was flying to Chicago, and I sat next to an older guy. Anyway, I remember him as being an old guy, which means he may have been 40. He told me to read everything. If you get interested in a company and you read the annual report, he said, you will have done more than 98% of the people on Wall Street. And if you read the footnotes in the annual report you will have done more than 100% of the people on Wall Street. I realized right away that if I just literally read a company's annual report and the notes -- or better yet, two or three years of reports -- that I would know much more than others. Professional investors used to sort of be dazzled. Everyone seemed to think I was smart. I later realized that I had to do more than just that. I learned that I had to read the annual reports of those I am investing in and their competitors' annual reports, the trade journals, and everything that I could get my hands on. But I realized that most people don't bother even doing the basic homework. And if I did even more, I'd be so far ahead that I'd probably be able to find successful investments."
Rogers likes to lay out the data on a company in spreadsheets that go back ten to fifteen years. He believes it is essential to have a long-term historical view of a company. When he sees a period of difficulty or decline, he wants know why, and likewise for periods of prosperity. Copies of Rogers’ spreadsheets can be found in the appendix of John Train’s “The New Money Masters”. I have adopted them for my own work and found them to be highly useful. It is worth noting that they involve no projections.
Staying with the advice giving theme, Buffett recounts a story in a 1991 speech at Notre Dame about when Bob Woodward asked him how to make some money in the stock market. Buffett advised Woodward to go out and research a company like he would a news story. If the company was an obvious bargain, Buffett told him to buy it, if not, take a pass. It is clear from the speech that Buffett uses private market valuations in his business valuation process.
"Bob Woodward one time said to me “tell me how to make some money” back in the ‘70s, before he’d made some money himself on a movie and a book. I said “Bob, it’s very simple. Assign yourself the right story. The problem is you’re letting Bradley assign you all the stories. You go out and interview Jeb Magruder.” I said “Assign yourself a story. The story is: what is the Washington Post Company worth? If Bradley gave you that story to go out and report on, you’d go out and come back in two weeks, and you’d write a story that would make perfectly good sense. You’d find out what a television station sells for, you’d find out what a newspaper sells for, you’d evaluate temperament.” I said “You are perfectly capable of writing that story. It’s much easier than finding out what Bill Casey is thinking about on his deathbed. All you’ve got to do is assign yourself that story.”
“Now, if you come back, and the value you assign the company is $400 million, and the company is selling for $400 million in the market, you still have a story but it doesn’t do you any good financially. But if you come back and say it’s $400 million and it’s selling for $80 million, that screams at you. Either you are saying that the people that are running it are so incompetent that they’re going to blow the $400 million, or you’re saying that they’re crooked and that they’re operating Bob Vesco style. Or, you’ve got a screaming buy when you can buy dollar bills for 20 cents. And, of course, that $400 million, within eight or 10 years, with essentially the same assets, [is now worth] $3 or $4 billion.”
That is not a complicated story. We bought in 1974, from not more than 10 sellers, what was then 9% of the Washington Post Company, based on that valuation. And they were people like Scudder Stevens, and bank trust departments. And if you asked any of the people selling us the stock what the business was worth, they would have come up with an answer of $400 million. And, incidentally, if it had gone down to $60 or $40 million, the beta would have been higher of course, and it would have therefore been [viewed as] a riskier asset. There is no risk in buying the stock at $80 million. If it sells for $400 [million] steadily, there’s much more risk than if it goes from $400 million to $80 million.
But that’s all there is to business. But now you say “I don’t know how to evaluate the Washington Post.” It isn’t that hard to evaluate the Washington Post. You can look and see what newspapers and television stations sell for. If your fix is $400 and it’s selling for $390, so what? You can’t [invest safely with such a small margin of safety]. If your range is $300 to $500 and it’s selling for $80 you don’t need to be more accurate than that. It’s a business where that happens.
Suggested (minimum) checklist for thoroughly researching a company:
1. Annual reports / 10-K’s – five years (including those of competitors). Read the footnotes.
2. 10-Q’s and Proxy Statements – one year, including transcripts of earnings calls (include those of competitors). Seeking Alpha is a good source of transcripts.
3. Build a 10-year spreadsheet on the company, by operating segment if applicable (see Rogers’ spreadsheet for a model). Don’t rely on third party sources for anything more than preliminary research. Going to primary sources will not only ensure the data’s accuracy, but also force you to think about the numbers and what they mean.
4. All available relevant articles in the business trades and press. In addition to the general Internet (Google, Bing, etc.), many libraries offer excellent free online databases, such as Proquest.
5. Build a database of all relevant private market transactions (minimum 5 years).
6. Compare relevant valuation metrics for company to those of competitors (P/S, P/B, P/E, EV/EBIT, EV/EBITA, P/(Owner Earnings). Include an analysis of any industry specific metric, for example, ROA for banks.
7. Study who owns the stock (and who doesn't). (You may be able to find information on the company in reports and letters of quality institutional investors that own the stock.) Are insiders buying or selling? Do they have "skin in the game"? What about the directors?
