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Investment Analysis Clubs / The BMW Method


Subject:  Re: Valuation tool Date:  3/6/2007  9:00 PM
Author:  TMFRichDad Number:  21785 of 42343

Hi Everyone,

One of the inputs is "Equity Risk Premium" (in the second column on the right, part way down). The default appears to be 3%, which is low, IMHO. I would suggest changing it to 5% in all cases.

If you want a stock that it finds as overvalued, try DAVE. It trades at a little over $18. Valuepro, with the default settings, says its worth $8.30. FWIW, my analysis has the value pegged at over $30, but I used an approach based on my knowledge of the company, not historical financials. (Oh whatismyoption, I'll be in Melbourne next week, keep my beer cold, thanks). <grin>

The calculator is simply taking trailing tweleve months (ttm) results and using analysts projected long term growth rates. So, to the extent ttm results is indicative of the future (probably 25% of time, i'd say) the results you get will be in the ballpark.

If you plan to use this tool, I'd recommend clicking on the name of each of the input parameters. A definition box pops up, describing what exactly the input is and what the default settings are. The links on the right of the page lead to a summary discussion of the methodology employed - something the user should understand.

For, MMM it gives a value of $103 and for JNJ a value of $96 based on default settings. If I adjust the risk premium to 5%, then I get $82 for MMM and $78 for JNJ. Those numbers are in the ballpark.

Be carefull about the growth rate being used. The growth rate needs to be the expected growth rate over the "high growth period" which defaults to 10 years. Ten years is a long time and high growth rates over 20% for that long are very rare. If analysts projected growth rates are unavailable, then it uses past results. So small companies without analysts coverage and stellar historical results will get wopping big values that are likely incorrect. I'm sure this was GOOG's problem (try GOOG with 5% risk premium and 15% growth rate).

It does not account for share dilution. So, companies that "reward" C-level management excessively with stock options will probably be overvalued, everything else being equal.

Also, it is using the Capital Asset Pricing model (CAPM) and beta to determine the company's WACC. Beta sucks. Watch what it is using. Except for the blueest of Blue Chips, I would not use a beta less than 1.

I do believe the calculations behind the scenes are reasonably accurate. So, if the inputs are good, the resulting value it calculates will be reasonable.


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