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Author: FDWBaltimore Two stars, 250 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 18386  
Subject: Re: DCF Analysis Date: 5/18/2000 8:20 PM
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I don't understand why you guys want to drive your portfolio with totally backward-looking things like the flow ratio or the Rule Maker spreadsheet and eschew forward-looking attempts at quantifying the value of a company. "Garbage in, garbage out," you say. If all the subjective stuff you guys write about in assessing the greatness of Cisco, Microsoft, or JDS Uniphase is to be taken as the truth, then how does that suddenly become "garbage" when you try to quantify or forecast it?

I remember when the Rule Maker's ideal company was Coca-Cola because of its margins and world dominance. That was 1996 or so, after a particularly spectacular five year streak for the company. Then the ideal became Microsoft, Cisco, and JDS Uniphase, the latter after a particularly spectacular run, albeit in a compressed timeframe. It seems to me that the less you attempt to pay attention to the value of what you are buying and the more you chase things that have worked spectacularly well in the foregoing five years, the more Coca-Colas you're going to have.

If you feel so confident in your assessments of Cisco and Microsoft and JDS Uniphase being world-class investments for the long run, why do you immediately dismiss any attempt at quantifying that excellence as "garbage." I don't want to predict that you won't do well, because you probably will do fine, but your arguments against trying to value things are internally inconsistent. Phil Fisher is great, but Ben Graham and Warren Buffett are great, as well. They counsel "margin of safety," which has worked pretty well.

Buffett and Munger have also said that you can buy something at an expensive valuation, because in the long run your return will approach the company's return on capital. However, you don't make any attempt to ascertain return on capital. You look at margin and working capital efficiency. That doesn't get you there, since you don't consider how much capital something like a Cisco has actually had to shell out to create today's cash flows and how much it will have to shell out to create tomorrow's cash flows. When Cisco pays $7 billion to acquire a company and the goodwill from that acquisition never shows up on the balance sheet, it's not like that capital doesn't exist. Cisco just ignores it and so do you guys. If you're going to quote Buffett in supporting your approach to investment, you should at least quote him correctly. Buffett would count the goodwill, recorded or not, in assessing the company's return on capital.

Well, I've covered enough territory here. I'm not trying to tear you guys down, I'm just trying to say I strongly disagree with your vehement rejection of trying to value a company. I'm also not a fan of selectively quoting Buffett and Munger to support your approach when you're not even considering the assumptions implied in those statements.

In summary, if you guys believe you can so confidently predict that the future is so rosy for JDS Uniphase, Cisco, and the like, then you should at least have some kind of confidence in your ability to quantify those cash flows. Instead, Rob says any estimate that such an exercise doesn't work due to the "garbage in, garbage out" principle. These two belief sets are not internally consistent and certainly not consistent with the teachings of Buffett and Munger. I think it's time you guys put some numbers to your predictions for these companies or to stop making predictions if you don't want to come up with the numbers. Either of those two approaches would be internally consistent, but the current mix-and-match, "we strongly believe these companies will dominate the world, the internet is in its infancy and thus these companies have tons of room to grow, these are great franchises but we refuse to quantify it because that's futile" is really disappointing and is leading people down the primrose path, in my opinion.
Dale
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