Every new year, there are articles that discuss the next year and what the best ideas are. As I have thought about the new year from an investment perspective, I keep coming back to the same 3 stocks. By coincidence, these three stocks also happen to be holdings of Warren Buffett's Berkshire Hathaway. This article will focus on these 3 holdings and a discussion of their value. A Discounted Cash Flow(DCF) model will be used to value the companies.
DCF calculations use free cash flows as their underpinning. Free cash flow is interesting because this is the money that can be used to reinvest in the business or given out to shareholders as dividends. Because of this, free cash flow yield can be thought of in the same way as the yield on a CD.
PG
The first holding to discuss is The Procter & Gamble Company (ticker: PG). P&G is an older holding of Warren Buffett's. However it is his 4th largest stock holding. Warren Buffet clearly thinks greatly of P&G. In terms of shareholder friendliness, consider the following excerpt from the most recent quarterly report:
“Free cash flow is defined as operating cash flow less capital spending. We view free cash flow as an important measure because it is one factor in determining the amount of cash available for dividends and discretionary investment. Free cash flow is also one of the measures used to evaluate senior management and is a factor in determining their at-risk compensation.”
This ideology is repeated many times in the quarterly report. It is policy at P&G to look at free cash flow to evaluate the performance of management. This is P&G telling the investor directly that they are interested in serving the shareholder.
Regarding the value of P&G, begin with Free Cash Flow of $13 billion for the first year. Then project free cash flows as growing at 8% for 10 years and at 4% for the 10 years after that. By discounting these future free cash flows to today's dollars by using a discount rate of 9% and assuming shareholder equity of $63 billion, an intrinsic value of $260 billion or $90 per share is calculated. Given the current quote of $60, this represents a discount of about 33%.
P&G currently has a dividend yield of about 3%.
JNJ
The next holding to discus is Johnson & Johnson (ticker: JNJ). Johnson and Johnson has a wonderful management team that is dedicated to the shareholder. The DCF calculation will assumes $15 billion of free cash flow in the first year. This $15 billion represents an 8.5% yield given today's market capitalization of $170 billion.
FCF of $15 billion is then assumed to grow at 8% for 10 years and at 4% from years 11-20. These free cash flows are then discounted by 9% annually in order to determine value in today's dollars. These discounted future free cash flows are worth about $230 billion. We then add shareholder equity of $43B to the estimate to come up with a value of about $273 billion or $99 per share. Given the current quotation of $64, this represents a discount of about 35% to intrinsic value.
Johnson & Johnson also carries a dividend yield of about 3% and a PE of 14.
USG
USG Corporation (ticker: USG) is cyclical in nature. USG is dependent upon a turn around in the housing industry at some point. This is fine. The cyclical nature of stocks can provide opportunity to the value investor. All that is required is patience and the realization that timing the markets is not possible. It is important to think long term and realize the simple truth. A turn around will eventually happen. It has been some time since USG Corporation (sometimes refer to as US Gypsum) has been free cash flow positive. It has essentially been bleeding cash for many quarters. The good news is that as of the most recent quarter, USG is free cash flow positive for the current fiscal year.
Looking over the numbers for USG requires that free cash flow be normalized. Under normal circumstances, USG generates about $200 million in free cash flow. To determine value,FCF of $0 was assumed in the first year and $100 million in year two. For year 3, $200 million was used and FCF is assumed to grow at a rate of 6% for years 4-10. Growth of 4% was assumed for years 11-20. A discount rate of 9% and shareholder equity of $1.5 billion was used. Using these assumptions, USG is worth about $3.7 billion. There is a caveat to per share value though. The 99 million shares outstanding needs to be adjusted to 132 million shares due to the possible conversion of some debt into stock. Assuming 132 million shares, the value of USG stock is about $28 per share. Current quotation is approximately $14 which represents a discount of 50% to intrinsic value.
BRK-A BRK-B
Since we are on the topic of investment ideas related to Berkshire Hathaway (BRK-A, BRK-B), there is a fourth stock to keep an eye on. Berkshire is currently trading at a market cap of $150 billion or $99,000 for one share of A stock or $3300 for a share of B stock. Buying Berkshire for at or under book value presents a reasonable entry point for a wonderful business. Book value of Berkshire is about $126 billion or $81,250 for a share of A stock. This translates to $2700 for one B share. Berkshire would require an 18% drop in share price to get to that level. This may or may not happen, but it is not a bad idea to keep an eye on Berkshire as we enter the new year.
Have a happy new year! May your investments be fruitful. Please free free to add your best ideas for 2010 using the Gurufocus comment system below. Please include rational in your comments.
Disclaimer: The author of this article currently holds USG, JNJ and PG. As always, do your own due diligence.
DCF calculations use free cash flows as their underpinning. Free cash flow is interesting because this is the money that can be used to reinvest in the business or given out to shareholders as dividends. Because of this, free cash flow yield can be thought of in the same way as the yield on a CD.
PG
The first holding to discuss is The Procter & Gamble Company (ticker: PG). P&G is an older holding of Warren Buffett's. However it is his 4th largest stock holding. Warren Buffet clearly thinks greatly of P&G. In terms of shareholder friendliness, consider the following excerpt from the most recent quarterly report:
“Free cash flow is defined as operating cash flow less capital spending. We view free cash flow as an important measure because it is one factor in determining the amount of cash available for dividends and discretionary investment. Free cash flow is also one of the measures used to evaluate senior management and is a factor in determining their at-risk compensation.”
This ideology is repeated many times in the quarterly report. It is policy at P&G to look at free cash flow to evaluate the performance of management. This is P&G telling the investor directly that they are interested in serving the shareholder.
Regarding the value of P&G, begin with Free Cash Flow of $13 billion for the first year. Then project free cash flows as growing at 8% for 10 years and at 4% for the 10 years after that. By discounting these future free cash flows to today's dollars by using a discount rate of 9% and assuming shareholder equity of $63 billion, an intrinsic value of $260 billion or $90 per share is calculated. Given the current quote of $60, this represents a discount of about 33%.
P&G currently has a dividend yield of about 3%.
JNJ
The next holding to discus is Johnson & Johnson (ticker: JNJ). Johnson and Johnson has a wonderful management team that is dedicated to the shareholder. The DCF calculation will assumes $15 billion of free cash flow in the first year. This $15 billion represents an 8.5% yield given today's market capitalization of $170 billion.
FCF of $15 billion is then assumed to grow at 8% for 10 years and at 4% from years 11-20. These free cash flows are then discounted by 9% annually in order to determine value in today's dollars. These discounted future free cash flows are worth about $230 billion. We then add shareholder equity of $43B to the estimate to come up with a value of about $273 billion or $99 per share. Given the current quotation of $64, this represents a discount of about 35% to intrinsic value.
Johnson & Johnson also carries a dividend yield of about 3% and a PE of 14.
USG
USG Corporation (ticker: USG) is cyclical in nature. USG is dependent upon a turn around in the housing industry at some point. This is fine. The cyclical nature of stocks can provide opportunity to the value investor. All that is required is patience and the realization that timing the markets is not possible. It is important to think long term and realize the simple truth. A turn around will eventually happen. It has been some time since USG Corporation (sometimes refer to as US Gypsum) has been free cash flow positive. It has essentially been bleeding cash for many quarters. The good news is that as of the most recent quarter, USG is free cash flow positive for the current fiscal year.
Looking over the numbers for USG requires that free cash flow be normalized. Under normal circumstances, USG generates about $200 million in free cash flow. To determine value,FCF of $0 was assumed in the first year and $100 million in year two. For year 3, $200 million was used and FCF is assumed to grow at a rate of 6% for years 4-10. Growth of 4% was assumed for years 11-20. A discount rate of 9% and shareholder equity of $1.5 billion was used. Using these assumptions, USG is worth about $3.7 billion. There is a caveat to per share value though. The 99 million shares outstanding needs to be adjusted to 132 million shares due to the possible conversion of some debt into stock. Assuming 132 million shares, the value of USG stock is about $28 per share. Current quotation is approximately $14 which represents a discount of 50% to intrinsic value.
BRK-A BRK-B
Since we are on the topic of investment ideas related to Berkshire Hathaway (BRK-A, BRK-B), there is a fourth stock to keep an eye on. Berkshire is currently trading at a market cap of $150 billion or $99,000 for one share of A stock or $3300 for a share of B stock. Buying Berkshire for at or under book value presents a reasonable entry point for a wonderful business. Book value of Berkshire is about $126 billion or $81,250 for a share of A stock. This translates to $2700 for one B share. Berkshire would require an 18% drop in share price to get to that level. This may or may not happen, but it is not a bad idea to keep an eye on Berkshire as we enter the new year.
Have a happy new year! May your investments be fruitful. Please free free to add your best ideas for 2010 using the Gurufocus comment system below. Please include rational in your comments.
Disclaimer: The author of this article currently holds USG, JNJ and PG. As always, do your own due diligence.
