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Author: wayjo One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 6186  
Subject: Re: financial statements - help Date: 4/3/2001 11:34 PM
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This didn't mean to be such a long response but I think it will be worth it so hang in there to the end.

You will have a problem trying to use GP Margins with Autralian companies. CSR is about the only one I know that publishes it. I would also question whether GP margin is an appropriate measure - EBIT margins are usually better (and easier) to work with.

However if you wish to continue with the formula you are working with you will need to exclude Interest payments as they are a financial cost. Using the numbers from the cashflow statement for suppliers etc will be okay as long as Accounts Payable and Accounts Receivable balances have not shifted significantly between the periods, otherwise you will have timing differences to adjust for.

In terms of valuing a company I use a relatively simple formula which is:
Enterprise Value/EBIT

Enterprise Value = Mkt Capn of company + Borrowings - Cash at Bank - Minority Interests (if any)

EBIT = Earnings Before Interest & Tax (most companies publish this number)

Most companies with any sort of "franchise" value sell for about 10x EV/EBIT (ie 10% return)

Companies in industries with low barriers to entry would probably sell closer to 5x EV/EBIT (20% return). This is true in the private market for milk bars and newsagencies as well as the sharemarket for public companies.

The implied 20% return is a good rule of thumb measurement for value investors but bear in mind the business will usually have poorer economic fundamentals. This is where Warren Buffett and Charlie Munger think it's better to pay a fair price for a good company rather than a cheap price for a poor company. That is, you're better to pay 10x for a TV station rather than 5x for say a clothing retailer.

Also keep in mind this formula doesn't work for every industry - banks and insurance companies being the main exceptions.

I rarely use PE Ratios as they can be distorted through using weighted average number of shares and companies loading up on debt late in the financial year or including abnormal items in profit. I don't ignore them but they can be manipulated over the short term - the CBA PE ratio at the moment is a prime example.

To see an Australian investor use this formula ring Hunter Hall International (HHL) or visit their web site www.hunterhall.com.au and ask for a copy of the Annual Report for his Value Growth Trust where Peter Hall explains all his investments utilising this formula. The performance of his trust can be seen in the financial press for equity funds under Australian and International share trusts - and it is impressive.

Peter Hall will probably become the Warren Buffett or Ron Brierley of Australia over the next 20 years and his Annual Reports are required reading for Australian investors.

Hope this helps!!

Wayne
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