Geoff Gannon

# Blind Stock Valuation #2: What Would You Pay for This Stock?

May 16, 2012 | About:

Since I wrote my original blind stock valuation over at my old blog, I’ve gotten a lot of requests to do another one. I think it’s a helpful exercise. So I will.

For those who don’t know, a blind stock valuation is when I “blind” you to the name of a stock. But I give you most of the important financial numbers. Based on the numbers, you try to value the stock.

Now, with the original blind stock valuation, I tried – unsuccessfully it turned out – to use a stock literally no one could recognize. I picked a water company on the island of Bermuda. Unfortunately, through the power of Google – someone was able to recognize the stock. But it took a lot of work. And most people were truly analyzing the stock blind.

Today, I think I’ve improved my identification countermeasures. But it’s still a real company. And it’s still possible you can recognize it. I hope you’ll resist the urge to try. And instead analyze this company without any idea what its name is.

It’s good practice.

Like last time, I’ve changed a single identifying detail that would bias you.

(Translation: I'm lying about one thing. And only one thing.)

When you’ve decided what the stock is worth, send your intrinsic value estimate along with an explanation of how you calculated it to:

[email protected]

I’ll post the best intrinsic value estimates. And explain why I liked them.

And now the stock you’ll be valuing blind:

 Sales Gross Profit EBITDA EBIT 2001 \$44,286,012 \$11,460,244 \$3,633,007 \$3,365,477 2002 \$78,014,164 \$19,422,785 \$6,443,458 \$5,983,911 2003 \$124,889,141 \$31,798,906 \$10,302,090 \$9,509,399 2004 \$167,560,892 \$44,222,274 \$13,964,474 \$12,828,608 2005 \$236,209,000 \$59,618,000 \$15,527,000 \$14,008,000 2006 \$340,331,000 \$88,858,000 \$26,666,000 \$24,556,000 2007 \$478,807,000 \$126,138,000 \$36,995,000 \$33,724,000 2008 \$678,456,000 \$174,631,000 \$49,530,000 \$44,459,000 2009 \$900,298,000 \$239,236,000 \$69,295,000 \$59,891,000 2010 \$1,248,176,000 \$328,871,000 \$91,752,000 \$78,726,000 2011 \$1,643,199,000 \$435,397,000 \$123,063,000 \$105,087,000

That’s the income statement information you need.

Here’s the balance sheet:

 Receivables Inventory PP&E Accounts Payable Accrued Expenses 2001 \$212,532 \$10,654,640 \$3,079,607 \$3,760,511 \$874,688 2002 \$434,554 \$18,452,663 \$7,079,703 \$6,807,512 \$1,541,421 2003 \$1,114,203 \$29,427,119 \$13,233,161 \$8,000,282 \$2,378,301 2004 \$1,211,168 \$41,470,471 \$14,656,507 \$13,275,531 \$3,037,111 2005 \$1,407,000 \$50,582,000 \$19,157,000 \$14,090,000 \$4,163,000 2006 \$2,576,000 \$64,371,000 \$23,646,000 \$17,750,000 \$6,560,000 2007 \$2,708,000 \$88,815,000 \$29,169,000 \$28,054,000 \$8,338,000 2008 \$5,449,000 \$135,845,000 \$44,467,000 \$45,427,000 \$13,868,000 2009 \$5,398,000 \$172,640,000 \$62,763,000 \$65,001,000 \$19,411,000 2010 \$7,806,000 \$235,315,000 \$98,760,000 \$100,102,000 \$34,656,000 2011 \$12,666,000 \$280,021,000 \$116,781,000 \$97,445,000 \$46,604,000

The company has 32,324,445 shares outstanding.

Do you need anything else?

I don’t think so.

Assume the company has no debt. It pays normal taxes. It’s a U.S. company. And it’s financed entirely with common stock.

How much would you pay per share?

Email your best guess to: [email protected]

Or post your intrinsic value estimate on my GuruFocus message board.

Or you can Tweet your best guess. But at 140 characters, it’ll have to be a concise analysis.

At the start of June, I’ll write an article collecting everybody’s intrinsic value estimates and discussing the best analysis I got.

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### About the author:

Geoff Gannon

 Currently 3.33/512345 Rating: 3.3/5 (21 votes)

Ryandarcy - 5 years ago    Report SPAM
I'd pay no more than \$16.25 per share.
Mcturra2000 - 5 years ago    Report SPAM
There's clearly been phenomenal growth in the company, so something good appears to be going on.

Just looking at 2011 figures, I get capital of \$265.5m (116.8+12.7+280-97.4-46.6). Net earnings are presumably around \$68.25m (EBIT \$105m less 35% tax), giving it a ROCE of 26% - a very high number.

Given the high ROCE and growth, 8X EBITDA would be a fair price to pay as an enterprise value. That comes to \$984m (8 x 123m). It has no debt, and you didn't state the cash position, so I'll assume \$984m for the common stock. Given 32.3m shares, that works out at value of about \$30 per share.

I always tend to overestimate the value of these things, BTW.
Batbeer2 - 5 years ago
22-25% gross margin, 3-6% EBIT margin, a decade of consistent high growth, asset light.....

Here goes: There's no debt so EBT and EBIT should be roughly equal. Also, there's consistent high growth so GAAP EBT understates true owner earnings due to discretionary growth expense.

They can't be spending a lot on capex (not much PP&E) so they are probably spending on some form of advertising or possibly R&D. A lot of R&D would make it like Cisco or Apple. A high-tech company or for that matter services company (like DNB) typically has a much higher gross margin though.

For now, I assume 20% of Gross Profit is being spent on growth (as opposed to just maintenance) thereby depressing EBIT by roughly \$ 87m in 2011. Growth expenditure is discretionary so you need to add it back to EBT to estimate sustainable, steady-state owner earnings. I add back \$ 87m of discretionary expense to \$ 105m of EBT (=EBIT).

In short, my estimate of run-rate owner earnings is roughly \$ 190m.

To me, given my personal hurdle of 15% yield on owner earnings, it's worth 7x \$ 190m => \$ 1.3B => \$ 40 per share.

I wouldn't bid on this without some annual reports to check the expenses (I'd screen for advertising expense first !). I would also have to know who it competes with to see if there's room to grow. Unless this stock were trading under \$ 60, I wouldn't bother though.

>> Unfortunately, through the power of Google – someone was able to recognize the stock.

BTW, thanks for this and other articles.
Wrowsey - 5 years ago    Report SPAM
I would put intrinsic value somewhere near \$90/share. I would start thinking about buying it at a healthy discount from that number, somewhere in the \$40 - \$50 range. In the end, I think I would probably wait for a price in the mid-30s before I actually pulled the trigger as I am not personally comfortable with paying higher than 16-17x earnings for a stock - and that's only if it is an exceptional stock. All told, my preferred price would be something like \$32/share, but I might consider something higher if I could get more info on the business and industry.

To arrive at these numbers I did a quick NPV analysis. Slapped on a 35% tax rate to EBIT. Assumed 18% average annual earnings growth for the next 10 years (a little less than half its historical 10yr average growth rate). 2.5% horizon growth rate. Used a fairly conservative 10% discount rate. I think this makes sense for a few reasons. This is obviously an incredible business, consistently earning nearly 40% on net tangible equity, pre-tax. Growth has been very consistent and very strong. While earnings growth has averaged 44% per year over the past 10 years, the trend has been downward. 2002 growth was around 100%; 2011 growth around 33%. I think it is safe to assume a healthy discount to historical growth, both based on the underlying business reality that 44% just cannot be sustained, and also in the interest of being conservative. I do note that growth really started slowing down with the economy (in 2007). It is conceivable that the earnings power and “growth power” will come through in a big way if the world economy were to improve.

The assumptions I used are less conservative than I would normally be comfortable with. But this is obviously a high moat business. The moat comes through in the numbers. I am willing to assume a little more for such consistent strength. I also think the fairly conservative horizon growth rate keeps the valuation reasonable.

One more note. I think using estimated after-tax earnings for this valuation is conservative. True owners’ earnings (what I would normally use) for a high growth company like this will probably be considerably higher than reported net income. This is because the money required for pure maintenance of the business is most likely much lower than what they are currently spending in cap-ex and R&D to fuel growth. And in this case, this investment in growth clearly makes good business sense.

Put another way, estimated after-tax EPS for this company is around \$2.1. I would like it in the 15x-17x P/E range, or about \$31 - \$35 range, given the company's consistent growth and high returns on capital. I think paying 20x earnings for a business like this is justifiable, if you can get more comfort with management, the industry, and the business as a whole.

Blainehodder - 5 years ago    Report SPAM
Looks good. Fair Price around 15 times earnings.
Ankitgu - 5 years ago    Report SPAM
Here is how I analyzed what's going on: http://i.imgur.com/jlUv9.png

Quantitative Intrinsic value for the business to average market participant:

No growth: \$190M-\$250M

7% growth: \$325M-\$426M

Overall: \$190M-\$425M

Notes: Average market participant implies a 12% cost of equity. A per share value is not given because there is a lack of information regarding past stock issuances. If no past stock issuances, this results in an intrinsic value range of \$5.87-\$13.15. (This is just for entertainment value, because I would typically assign a liquidation value unless I understand what they're actually doing)

Areas for further investigation:

1. The implied life of PP&E (assuming minimal amortization...) has changed from 12 years to 17 years and is now down to 6.5 years. Accounting tricks would have likely been caught already, so I'm assuming that they must have gone into businesses with very different financial characteristics throughout their time.

2. How did receivables drop from 2008 to 2009 despite 29% revenue growth?

3. No debt is employed? They must be on an M&A spree and using their super currency as payment material, because the revenue has grown like clockwork.

4. Margins have been *really steady* between 25% and 27%. Is this typical in their industry?

5. A/P in 2010 just seems pretty high... I'm curious how this is possible.

6. What industry are they in and what do they do?

Edit: For what it's worth, I never thought about Owner's Earnings as a method of valuation. I used to run a small business and could say that for every \$1 in sales, my theoretical earnings if I only cared about extracting cash would be something like 20 cents. In all reality, there were still plenty of growth opportunities and so I would reinvest those 20 cents. On the income statement, it would show me operating at break-even or even a loss, because most of it was all expensed because I had very little in the way of assets. I viewed this reinvestment as a "continued bet" because if the business model ever fell apart, those reinvestments would disappear because any cash return relied upon at least being able to maintain a level of business. Unless we are able to say that a business is going to be around in 10-20+ years, or however long it takes for excess cash after all economically profitable growth is feasible, it's an increased level of risk, because we're paying for even more future earnings.

Why were my growth expenditures all expensed? It was mostly in the way of advertising/marketing spend. I knew that my business' retention was higher than the industry average, because of the level of customer service provided, and so I could show that when advertising/marketing was all brought to a complete halt, the organic growth from referral business would approximately replace lost customers, maintaining a certain level.
Sriraja - 5 years ago    Report SPAM

Wow...what great consistent margins. I would bribe my way to get them :)

Given that the growth story is consistent here and they are under a couple of billion dollars in revenues, I am sure they can grow even more.

A key note here is the consistent gross and operating margin, that shows that this business cannot squeeze anymore and that they are selling something that their customers are buying purely for the price. Their consistent growth means they are just opening up their business in new places and strive to maintain the same margins.

Since Gross is in the 25s, the cost of inventory is high. SGA remains constant at 19%. So significant part of the SGA has to be newspaper ads or something that stays the same.

Inventory seems to be the higher number here even compared to PPE. So this is a business that does uses inventory a lot to generate their revenues.

There seems to be a meticulous focus on SGA spending to get the margins on a consistent basis and it happens only with companies that do not do any R&D and try to extract the best value for their customer.

PPE is lower compared to the growth story and depreciation is even slower, so PPE assets are either lot of land or ships that depreciate over a long period of time or management is not doing it for some purpose. But over 10 years, this company is paying a lot of taxes given that there is not much LT Debt.

Valuation - here is the tough part because I already read the story book.

But with due fairness, given the growth story I can safely pay 6-10x EBIT and hope the growth continues for at least 5 years.

That brings my price to \$19.51 and the maximum I would go is \$32.51, because on such a high growth business, there is always a chance of the growth slowing due to some random recession or some world issue.

If the price is out of that range, that means I need to do more research as to why it is so low or why it is so high.

>> Unfortunately, through the power of Google – someone was able to recognize the stock.

@Batbeer2, you will have a long way to go if you follow Buffett's advice

DocMoney - 5 years ago    Report SPAM
I am not an accountant, but accrued expenses seem to represent a progressively larger portion of EBITDA... Also, is the share count static? Increasing? Decreasing? Right now I'm thinking not much more than 20 bucks.
Sobko - 5 years ago    Report SPAM
With such strong growth, low capex and no debt, this seems like this must be some kind of software company, or a company that owns patents on something and licenses rights. With about \$2.11/share in 2011 net income, i'd say they are "worth" around 15x earnings or around \$32.00. Being a value guy, i'd find this company interesting in the \$15-\$20 range. But I would not be surprised to find out that this company currently trades somewhere between \$30-\$40 per share.

Zerol05 - 5 years ago    Report SPAM
Discretionary cash flow = profit + D&A - maintenance capex = 4.47% of revenue (currently \$2.37 per share) with very little variation. Growth capex is earning 25% returns.

Gross margin showing almost no variation, evidencing both a defensible competitive position and immunity to the business cycle.

Overhead growing as a share of GP, suggesting the increasing costs of complexity as the business grows. On would expect EBIT/GP to grow as revenue grows but it isn't.

Perhaps, then, the growth pattern is like a cell replicating itself. This, in turn, suggests a retail, hotel or restaurant franchise expanding its footprint.

Except that the fixed assets line is too small for any of those.

If it is one of these and the operating leases have been left out of the example, then we're at the early stages of the growth story and I'd be happy to accept a 7% yield on the current coupon, knowing that it will compound from there. That is, I'd buy in for (\$2.37/7%) = \$33.85.

DiscountValue - 5 years ago    Report SPAM
38.86 is my best estimate of I.V, based on 22% growth, 15% Discount, 1.39 EPS.

With a 50% M.O.S., I'd buy it under 19.43 sight unseen if I had to.

Sriraja - 5 years ago    Report SPAM
Now that Geoff had said the name, did anybody guess the company correctly?