In chapter 10 of “Modern Value Investing: 25 Tools to Invest With a Margin of Safety in Today's Financial Environment,” Sven Carlin pulled those tools together in a case study of Daimler (XTER:DAI, Financial), the multinational car manufacturer. Its best-known brands are Chrysler and Mercedes-Benz.
He had two objectives in undertaking his analysis. First, to understand the company, its industry and how it fits with economic cycles and other macro factors. Second, to generate hard numbers that could be used to analyze the fundamentals. It was quite appropriate, then, for him to quote Peter Lynch at the beginning of the chapter: “Know what you own, and know why you own it”
In addition, he wrote that he wanted investors to have a methodology for analyzing companies, one that would allow them to make comparisons and choose the best. Carlin also pointed out that much of the analysis would involve guesses or estimates—discount rates, liquidation values, etc.—and so it was important to always guess using the same criteria.
To do the analysis, data was taken from the 2016 annual return and financial statements, and at the time of analysis the stock was selling for 77.50 euros ($89).
Tools for establishing intrinsic values
The first group of rules revolve around intrinsic value. The tools he used (as described in previous chapter digests) were:
- Use a range of values rather than precise values.
- Establish net present value, which will involve estimating earnings growth and discount rate.
- Liquidation value.
- Stock market price; the following chart shows the volatile path that prices followed between mid-2013 and the end of 2017:
- Private-owner valuation.
- Measure intrinsic value with past value, earnings value and return on invested capital.
A Carlin chart shows his estimate of intrinsic value, which was well below the then-current price of 77.50 euros:
Tools for establishing a margin of safety
- Cash per share.
- Dividend sustainability (also listed as Tool 22, in a different context).
- Business moat, or competitive advantage.
- Research the company using a search engine.
- Quality of management; Carlin assessed this by looking through an investor presentation from 2013 (five years before the date of publication). In the presentation, a key management target was to hit a 10% return on sales. However, by the end of 2017, it had reached only 6.5%, well below the target. Thus, the quality of management would be rated as relatively low.
- Interest among activist investors.
- The price you pay.
The information in this section was summed up in another of Carlin’s charts. Assuming the Daimler stock price repeats its previous path, investors will have chance to buy the stock with a 20% margin of safety in 2024, a 35% margin in 2031 and a 25% margin in 2033:
Sector analysis
This type of analysis is particularly important for Daimler because it is part of the highly cyclical auto industry.
- Tools 17 and 18 are designed to do that. Carlin wrote, “In the case of Daimler, there is always the potential for the stock to drop at least 50% in a market crash, something to keep in mind.”
Is Daimler a value trap?
- Look for catalysts. One that was on the horizon, and on the minds of Daimler investors in early 2018, was the prospect of corporate tax cut, which the company estimated would be worth 1.8 billion euros to them. While the company would have received some relief for fiscal 2018, it would also have faced extra costs from tariffs on steel and aluminum, worth perhaps 500 million to 1 billion euros (General Motors (GM, Financial) has already announced tariffs would cost it $1 billion).
- Avoid declining sectors.
- Check for significant insider activity.
- Sustainability of the dividend.
- Assess market sentiment.
- Quality of assets on the balance sheet.
Carlin winds up by using fundamental data to develop a case that shows at what prices Daimler would be a bargain purchase:
As the table suggests, Carlin recommended waiting for a recession that pulls the price of Daimler stock down by at least 20%. And for a conservative investor looking for a 10% return, he said a fair value would be about 50 euros. A 20% margin of safety would mean waiting for a price of 40 euros.
Of course, a recession will pull down all the car companies and most of the rest of the market, so 40 euros per share should not automatically trigger a buy signal. Carlon wrote, “If and when that happens, the stock has to again be compared to other market opportunities. The opportunities with the lowest risk, biggest discount and most probable catalysts have to be picked for profitable long term value investing.”
(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
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