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Yesterday RealMoney.com published a column I wrote about the Earnings Power PIV-ER test, which I devised last Fall. I can't reproduce the column verbatim here, so I have deleted the actionable ideas. Please do not ask me which companies they are, as this is unfair to paying subscribers. Besides, I think the tool is more valuable in the long run than the companies to buy and sell today.

If you use the PIV-ER test, I believe it will help you stay on top of all the promising stock ideas you read about in a disciplined manner. In addition, PIV-ER can improve your portfolio management performance, a vital but little-discussed topic on the sites I visit!

PIV stands for price-intrinsic value and ER for expected return. PIV is a measure of downside risk, and ER gives a sense of upside potential. The lower a stock's PIV and higher its ER, the better.

You need four pieces of data to build a PIV-ER test. To illustrate, let's use Wal-Mart (WMT). I took these numbers from Yahoo! Finance earlier this week.

· Current stock price: $48
· Earnings per share (trailing 12 months): $2.62
· Book value per share: $14
· Annualized growth, five years: 13.0%

Using these numbers we construct three scenarios--High, Medium, and Low.

The High scenario has Wal-Mart's earnings growing at the consensus estimate, 13%, for the next five years. Because analyst estimates are unreliable (more below), the Medium and Low rates are 75% and 50%, respectively, of the High.

Beginning in year six, I assume annual growth is one-half of the forecasts for years one through five. The reason I assume growth will slow is because of the law of regression to the mean. So High growth slows to 6.5% a year, while Low and Medium are 3.3% and 4.9%, respectively.

Terminal growth, which begins in year 11, equals inflation, which I assume is 3%.

Estimates for intrinsic value to common equity range from $62 to $84 a share. If we assume the chances of the Low, Medium and High scenarios occurring are 40%, 35% and 25%, respectively, then intrinsic value is $71 -- i.e., $25 + $25 + $21.

If Wal-Mart's stock price is $48 and its intrinsic value is $71, then its price-intrinsic value (PIV) is 67%. This means we can buy a dollar's worth of value (part current net worth, part future earnings) for 67 cents. When you buy a company for less than true worth, you give yourself a margin of safety to protect yourself against what Ben Graham famously called "miscalculation or bad luck." The lower the PIV, the bigger your margin of safety -- provided, of course, that your intrinsic value estimate is solid.

Now, upside potential. Wal-Mart's expected return (ER) is 48%, which I calculate by subtracting the stock price from intrinsic value and dividing that result by the stock price -- i.e., ($71-$48)/$48. Expected return tells us how much profit we can expect, in percentage terms, if we buy Wal-Mart at the current price and then the market immediately bids it to fair value. The bigger the expected return, the better.

As mentioned, PIV-ER is conservative. Two of the three scenarios used in the test are based on growth rates below analysts' consensus, growth in all three scenarios is modeled to fall 50% in year six, terminal growth begins just 11 years from now, and 75% of intrinsic value is based on the Low and Medium scenarios.

I built these safeguards into PIV-ER because analysts' earnings forecasts are unreliable. In Contrarian Investment Strategies, legendary contrarian investor David Dreman found that the average error was 44% annually (!!!), based on a study of 500,000 quarterly estimates of more than 1,500 companies from 1973 to 1996. Given this deficient track record, a hopeful but cautious pro forma is the best policy.

Now that you can build a PIV-ER, here's how to use it to improve your productivity: Run every company in your portfolio through this test and then put their PIV and ER results into a spreadsheet. Then calculate your portfolio's PIV and ER. Assess every new investing idea's PIV and ER, and compare them to your portfolio average.

My portfolio's weighted average PIV and ER are 52% and 128%, respectively (fluid numbers, to be sure). This means that on average, my stocks sell for just more than half their intrinsic value, and my potential upside is north of a double. I like this risk-reward mix. Of course, my growth forecasts may be wrong.

Again, as you get new ideas, log the PIV and ER results in a spreadsheet and then compare them to the values for what you already own. You want to methodically nip-and-tuck to get the best risk/return combination. While I recognize Wal-Mart's earnings quality and competitive advantage, the stock has to fall to the low $40s before it will strengthen my portfolio. If a company does not have a lower PIV than 52% and a higher ER than 128%, then it is illogical for me to buy it.

PIV-ER saves time. But as with any quantitative model, PIV-ER is only as good as the numbers that go into it. So use it as a preliminary screen. Then, after using the Earnings Power Chart (www.earningspower.com) to gauge the quality of GAAP profits and assessing a firm's competitive advantage, use PIV-ER a second time. Once you know the company better, you might want to use free cash flow instead of GAAP earnings, or perhaps adjust the growth rate assumptions. It's your choice.

Also inspect book value carefully. Assets may include intangibles that don't add revenue or cut costs, forcing management to write them off at some point. On the liability side, operating leases, unfunded pension plans, employee stock option liabilities and environmental hazards can also overstate corporate net worth. The company may also have hidden assets, which give net worth a boost.

If I update It's Earnings That Count (McGraw-Hill, 2004), I intend to devote a chapter to the Earnings Power PIV-ER test. I look forward to using PIV-ER to optimize my portfolio in 2007, and to also determine which companies belong on my “on-deck circle.”

I am also posting this on the Hidden Gems and Inside Value discussion boards, and will be happy to answer questions.

Hewitt
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Hewitt,

This is the secret of my success. :-) You've nailed my latticework for portfolio management exactly. I intially got the idea from Longleaf years ago. Longleaf updates their Price to Value ratio in every quarterly management letter and that always made sense to me. I think the best way to measure the future success of any portfolio/manager is to asses the degree in which the PIV-ER works in ones favor.

There are a couple other characteristics to think about when managing a portfolio. When one is measuring their PIV-ER ratio it also helps to think about portfolio position sizes. Obviously, having your largest position with the widest PIV and ER is ideal but one has to factor in the durable, sustainable advantages of their companies. If a company has no moat yet very wide discounts to IV you, IMO, need to limit having too large of a portfolio position in a company like this -- regardless of it's PIV-ER. This does two things 1) keeps one discplined and keeps emotions out of it and 2) tends to help ones long term returns.

Thus, if one is a concentrated Buffett type, you need discounts from PIV but you also need sustainable, durable advantages because of the lack of diversification. On the other hand, if one is a Grahamite/Schloss/Magic Formula Person/Etc. then your modus operandi probably shouldn't be loading up in any one position anyway but having roughly equally weighted positions.

I totally agree with you about the places I frequent that don't "get it" when it comes to managing a portoflio...at .least from my perspective.

VP
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Hi VP,


You've nailed my latticework for portfolio management exactly. I intially got the idea from Longleaf years ago. Longleaf updates their Price to Value ratio in every quarterly management letter and that always made sense to me.

Do you find that the IV's change significantly from quarter to quarter?

I can understand a large investment house doing this, but for the lay-investor this seems like a tall order and implies a sense of precision in the IV calculations that simply doesn't exist.

An annual basis, would seem more than adequate for the small timers.

Do you agree?

Rich
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can understand a large investment house doing this, but for the lay-investor this seems like a tall order and implies a sense of precision in the IV calculations that simply doesn't exist.

While imprecise, the PVER concept seems to me still important and the exercise useful. Even with a 50% deviation as a confidence interval, the exercise forces the individual investor to choose their best investment idea now, allocating capital within the portfolio. The exercise becomes a tall order only when the portfolio lacks concentration. One carries out the exercise as often as one wishes to allocate capital - the better the exercise, the more concentrated the portfolio; the more sure the investor, the more concentrated the portfolio, the "shorter" the order. Like most new ideas, the first time ranks as the greatest challenge. Journey of a thousand miles and all that.

Rog
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Hi Rog,

Just to clarify, I wasn't questioning the importance of doing the excercise. Simply, how worthwhile it was to do it on a quarterly basis for a lay investor.

Most of the stocks I own fall into the large cap category and they simply don't move that fast. :)

Rich
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Exercise frequency depends on how often one allocates capital. Frequent new capital demands frequent assessment. Less frequent capital allocation means less frequent analysis. Organic re-allocation frequency depends on the nature of the portfolio and the investor. Investments in large capitalization companies can approach intrinsic value over the course of a quarter in certain circumstances (check out MCD's chart over the past year for example). Since the equations involved in the exercise involve numbers that change on a quarterly basis (analyst earning projections - with all their inaccuracies) portfolio assessment on a quarterly basis seems reasonable as a starting point.

Rog
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Rich,

Your questions aren't as simple as they first might appear. As a professional money manager, I do have my opinions to your anwers. But let me boil down your questions to one simple answer:

You have to know yourself as an investor.

This is especially true if you are a DIY (Do it Yourselfer) because you are essentially your own portfolio manager. Therefore, you need to know yourself which entails knowing how much time you want to allocate to your portfolio, what kind of investor you are, what your performance goals are, etc.

I would suggest, if you haven't read it already, to read The Intelligent Investor by Benjamin Graham which has the anwers you need. If you're looking for superior returns you need to be an enterprising investor....and if this is true you need to 1) put significant time into your enterprise and 2) you need to know what you're really doing which entails business analysis, opportunity costs, etc.

Going on the information you've given, it appears to me you may be a defensive investor, whom is happy with satisfactory returns but not seeking superior returns (for ie: killing the indices). In this case, holding large companies even if they're selling at times a bit above IV may work for you. Your returns will suffer but you get tax deferral benefits and you need to spend far less time monitoring the changes in prices to IV. But I'm only going by your very small post and have no idea who you are as an investor.

But here's my direct answers to your questions:

Do you find that the IV's change significantly from quarter to quarter?

I find that it's far more common that market prices change significantly from quarter to quarter than the IV of a company. I've had stocks literally double in 3/6 months --and in 06 I had a company increase by 200+% -- which typically means the company's quoted market price has changed significantly to the company's business value.

This converegence of Intrinsic Value needs to be assesed for someone seeking superior returns because of the potential and real opportunity costs this may present. IV does and can change over short periods of time (due to competitive pressures, etc.) but not near the extent that market prices are changing all over the map in short order. As Buffett/Graham has said the market is there to either take advantage of or ignore (to serve and not instruct). But if you're a passive investor than large/multinational stocks held for the very long term may be right for you.

I can understand a large investment house doing this, but for the lay-investor this seems like a tall order and implies a sense of precision in the IV calculations that simply doesn't exist.

Acutally, it really works better for the small investor. Money is a drag on returns (nearly every major brokerage houses model portfolios have sucked in returns). As a small investor, you have far more flexibility to take advantage of Mr. Market's mood swings and to do so based on value -- you need to constanstly assess the market and businesses that you know well. Again, though, I believe this is true if 1) you know how to value businesses and 2) have the time to do it and 3) would like more than just satisfactory returns.

An annual basis, would seem more than adequate for the small timers.

Do you agree?


I agree if you don't care about achieving truly great returns (while some might argue this point I think history shows the best investors are really on top of their investments). Buffett's greatest returns came when he bought below IV, sold at IV, and repeated the cycle. Every great investor I know of has done it this way (though I know there are some other successful approaches this approach tends to be far more prevelant and has far more of a history of many successes). But I'd be really happy to hear the argument on other really successful approaches.

In a nutshell, I believe if you want great returns you need to spend a great amount of time on your processs. If you don't have the time hire someone that does or be happy with passive/satifactory results.

VP






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Hewitt

A quick thanks thats one of the best explanations of a valuation method that I have seen to date. I really do appreciate you sharing and enjoy the fact that your valuation method makes so much sense.

Will
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Thank you VP,

I appreciate your response.

FWIW, my investment approach has been most influenced by WEB and Philip Fisher. I've read Intelligent Investor at least a half dozen times and believe it to be a very valuable reference. So is Security Analysis. I would classify myself as an enterprising investor. But, one who still has much to learn.

I devote nearly every waking hour other than my day-job and my family time to learning about investing and different companies. That would total at least 20 to 30 hours per week spent on investing. For a DIY, I'd think that is pretty enterprising.

My investment approach is just as WEB's is:

"Our equity-investing strategy remains little changed from what it was fifteen years ago, when we said in the 1977 annual report: "We select our marketable equity securities in much the way we would evaluate a business for acquisition in its entirety. We want the business to be one (a) that we can understand; (b) with favorable long-term prospects; (c) operated by honest and competent people; and (d) available at a very attractive price." We have seen cause to make only one change in this creed: Because of both market conditions and our size, we now substitute "an attractive price" for "a very attractive price." (Source: 1992 Berkshire Annual Report)

Do to my small size, I've not relaxed the "very attractive price" requirement, though. :)

Ideally, I'm looking for a few excellent companies that meet WEB's three hurdles above and Fisher's 15 Points, as well. (I hope your familiar with Fisher's book "Common Stocks and Uncommon Profits", too) Companies that can do that and which happen to sell at a discount to IV at the time of purchase make very attractive long-term holdings (5, 10, 15 years, or a life time). These are companies whose minor quarterly fluctuations in both share price and performance metrics mean very little.

Granted, many of my large cap holdings do not satisfy these hurdles.

So far in my search I've found one that may be a serious candidate and its market cap is only $200 million currently. It is my largest holding and has performed extremely well even by your standards in the short time that I've held it. But even for it, I simply can't see recalculating the IV on a quarterly basis. Checking to make sure it is performing up to expectations is one thing, re-doing a valuation based on one quarter's results simply seems like a waste of time.

If we are throwing out numbers. I've had companies double in a year too. 200% in two years. 80% in six months. Still, I'm not getting it. Maybe I'm too dense.

Hey, if you got something growing at a gazillion percent per year and a stock price rocketing to the moon, maybe its justified. But if that is the case, I might suggest that even you can't guess at the companies value that closely anyway. Plus or minus one or two hundred percent might be all that's doable.

Personnally, I don't believe that great returns can be achieved by trading in and out of stocks on a monthly, quarterly or even yearly basis. It is thinking like that that got me out of mutual funds and picking my own stocks in the first place.

I mean no disrespect and I really appreciate your taking the time to chat with me about this topic, thank you. I'm sure you are good at what you do. In the end, I'm sure we'll have to agree to disagree on this point.

Rich
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Rich,

It's no problem. There are many roads to Damascus and your beliefs are what they are. I'm very familiar with Fisher too. His books do have a place in my library.

Interestingly, as recently as a few months ago Buffett says he's "85% Graham and 15% Fisher." The investment approach that Buffett mentions in his 1977 letter was post his partnership years and also the start of Mungers influence on him (pay up for quality). Buffett's truly phenomenal returns came during his partnership years where he often invested in companies that were merely statistically cheap.

Buffett's need for continuity and Mungers influence gave way to a transition in his investment framework. Buffett has said without the leverage he's had with the insurance float he probably would have had much more moderate returns in Berkshire. Even then, his truly stellar returns came in the 50's per Buffett himself.

Companies that can do that and which happen to sell at a discount to IV at the time of purchase make very attractive long-term holdings (5, 10, 15 years, or a life time).

True enough. But held over the very very long term and your return will roughly equal the companies return on equity. One of the very best with this approach I believe is Ruane/Sequoai Funds, and if you subracted their holding in Berkshire, the long term return of the Sequoui fund would have been around 13%. So one of the very very best at this particular long term buy and hold route averaged about 13%. I also think it takes far more of a crystal ball to envision what companies will be great 15 plus years from now than it is to handicap your odds with a 2-5 year mathematical outlook.

If we are throwing out numbers. I've had companies double in a year too. 200% in two years. 80% in six months. Still, I'm not getting it. Maybe I'm too dense.

Hey, if you got something growing at a gazillion percent per year and a stock price rocketing to the moon, maybe its justified. But if that is the case, I might suggest that even you can't guess at the companies value that closely anyway. Plus or minus one or two hundred percent might be all that's doable.


I'd say I've been very very good at estimating IV of companies I can figure out (circle of competence) well within the parameters you're putting forth. However, the majority of publicly traded companies I have no idea what their IV's are and my answer is to not own them. I think once you really get a sense of a companies rough IV you'd realize that you might be costing yourself some very real upside in your portfolio by suggesting that a company that increases in value a great deal over a short period of time shouldn't be fully re-analyzed. Buffett regrets a great deal that he didn't sell Coke in 2000.

Personnally, I don't believe that great returns can be achieved by trading in and out of stocks on a monthly, quarterly or even yearly basis. It is thinking like that that got me out of mutual funds and picking my own stocks in the first place.

I think there is a large difference between "trading" based on mere price quotations and making allocation decisions based on receiving more value than one is paying for. Peter Lynch's turnover was 300% -- he averaged 29% FWIW. Graham was not a buy and holder, Buffett in his partnership years had a good amount of turnover, etc. But I wouldn't charaterize any of their behavior as "trading" nor do I of my own portfolio management style. As Buffett has said of the Graham and Doddsivillers, they simply exploit discrepencies between price and value -- "that is the one common theme." To exploit it, you must act on it.

There are many roads to Damacus and I'm not suggesting any of them are the absolte right answer - but I do beleive the best returns that come from the Greenblatt's, the Greens, the Buffett Partnership years, have a tendency to move money around far more than you may be comfortable with.

VP



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VP,

Thanks again. You've given me somethings to think about. And, I will think about it a great deal.

I did happen to read Buffet's letters to partners a few months back. It did occur to me that he bought and sold over a time frame of less than a few years. One investment, early on, was about a years hold for a double IIRC.

That road to Damascus you mentiond - when we both get their I'll buy you a beer (or other if you prefer).

Rich
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Hi Hewitt
Thanks for sharing and the continued education. I may be missing something, but I am unsure why you appear to have taken one metric and turned it in to two. As the PIV is really just the reciprocal of the ER, what is the benefit of showing it both ways?

You say The lower a stock's PIV and higher its ER, the better. This really made me think I was missing something, as reciprocals the lower the PIV the higher the ER must be. To me this appears to be discount to intrinsic value, one of the original concepts in security analysis. There is nothing wrong with that, and it is certainly a point worth reinforcing; my question really comes out of self doubt that I am missing something.

Your idea of including this as a column in a portfolio is a wonderful idea; I plan on implementing it this week. I think it will greatly aid me in quickly being able to assess my current holding compared to prospects.

Kind Regards
Dean
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Hi Hewitt or anyone
I was very motivated by your ideas and have started adding some appropriate columns to my portfolio tracking spreadsheet. When doing that I realised I was missing an element I consider essential, the fourth dimension, time. Perhaps my thinking in too tainted by my options trading or my predilection for CAGR, but after determining the intrinsic value or equivalent I realised I really need to apply a time value to derive my CAGR.

As an example WMT may have an IV of $71 and ER of 48%. If this move takes 2 years I like the CAGR of 22%, but if it takes three years I'm not so happy with 14% CAGR (yes call me greedy if you will), but my point is I think a timeframe is essential and wonder what your or anyone's thoughts is on that.

Kind Regards
Dean
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Hi Hewitt and All,

Current stock price: $48
· Earnings per share (trailing 12 months): $2.62
· Book value per share: $14
· Annualized growth, five years: 13.0%


I believe this data is easily found on sites such as Yahoo Finance but....

Estimates for intrinsic value to common equity range from $62 to $84 a share.

Could somebody tell me where Hewitt gets those estimates? Is it something he does himself? How?

Sorry for my ignorance.

mpfd
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MFPD -

My Real Money column has a chart, which I did not provide above because I do not know how to copy/paste graphics on these discussion boards.

If it helps, a reader on another discussion asked about AAP. Here are my comments. See if you can recreate the math. I assume readers know how to "grow" EPS at a specified growth rate, calculate operating values in the post-forecast period, and how to do present value calculations. If not, check out the spreadsheets in Aswarth Damodaran's website, which a Google search will point you to. He has lots of spreadsheets, and you should find what you need there.


Hewitt



EPS is $2.18, and the High growth rate is 15% for the next 5 years. So the Medium growth rate is 75% of the High, or 11.3%. Low growth is 50% of the high, or 7.5%. So EPS five years from now for the Low, Medium, and High is $3.13, $3.71, and $4.38, respectively.

Now, years 6-10. To be conservative, we assume growth here is 50% of years 1-5. So our Low, Medium, and High growth rates are 3.8%, 5.6%, and 7.5% a year. Imputed EPS 10 years from now is $3.76, $4.88, and $6.29 for Low, Medium, and High.

Terminal value beginning in year 11 is 3% a year.

Now we estimate intrinsic value. We start with book value, which is $9.41 per share. Then we add the present value of EPS from years 1-10 (forecast period), and also the present value of EPS beginning in year 11 (post-forecast period). I use a 10% discount rate. You may think 10% is too low, that, say, 11-12% (or higher) is more appropriate. I do not object. But I use 10% for all companies because I want to compare them as economic equals. Once I get to know the business better, I may go back and adjust the discount rate.

Per-share intrinsic values are $49, $59, and $70, based on the above assumptions. The weighted average intrinsic value is $58, based upon 40% for the Low, 35% for the Medium, and 25% for the High forecast.

At $38, AAP's PIV is 66%. Its expected return is 52%.

For an exceptional company (Earnings Power Staircase, durable competitive advantage), you might decide to buy at a maximum PIV of 75%, or $43. You might also decide to sell if the PIV is over 125%, or $72.

For a run-of-the-mill company (upper-right box of the Earnings Power Chart in 4 of the last 5 years but no staircase, no competitive advantage) you may decide to pay no more than 60% of intrinsic value, and then sell at 100%.

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whatismyoption-

ER is not exactly the reciprocal, it's the reciprocal - 1. The 1 is less influential as P/IV gets really small, and the reciprocal gets really big. We don't really see this happen in the stock market though.

piv=P/IV
ER=(IV-P)/P

then,
ER=IV/P-P/P =1/piv-1

so ER always equals (1/piv)-1. Try it on the WMT example. For a piv of 52%, Hewitt's ER should be 92% though.

Colin
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Thanks Colin, I did realise that. It just wasn't relevant to my question to include that detail.

My thinking why Hewitt may double up this way is the same as some people like to see P/E converted to a yield, e.g. p/e of 20 is 5%. Seeing one number conveys the same info to me, but I know others prefer to see both. I was just wondering whether I had missed another point.

cheers
Dean
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Yea, I see your point. They both depend only on the value of P/IV. Maybe I am missing something here too?

Colin
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The way I look at it is that the PIV gives an idea of the margin of safety, while the ER gives an idea of the return one could expect if the price suddenly reverted to its intrinsic value. In a way, they're two sides of the same coin, but giving different perspectives. To be sure, one will always go up as the other goes down. But while they're inversely related, it's not a simple proportional relationship where they move in opposite but equal directions (at least to my mathematically untrained eye). Here's a hypothetical scenario:

Current
Price IV PIV ER
----- --- ----- -----
150 100 150.0% -33.3%
140 100 140.0% -28.6%
130 100 130.0% -23.1%
120 100 120.0% -16.7%
110 100 110.0% -9.1%
100 100 100.0% 0.0%
90 100 90.0% 11.1%
80 100 80.0% 25.0%
70 100 70.0% 42.9%
60 100 60.0% 66.7%
50 100 50.0% 100.0%

I think both serve a useful purpose.

Paul
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Hi Hewitt,

Paul helped me nail down the exercise and I was able to replicate his BWLD example.
http://tinyurl.com/3a6jaw
http://tinyurl.com/2w6mhy

Anyways....I notice you can get your book value yourself from the latest SEC filing balance sheet:

Total Stockholder's Equity divided by shares issued (from Paul's BWLD ex.)

96848/8616 = $11.24


Why are we using the "issued" shares in the balance sheets "issued and outstanding respectively" line (which was 8776 instead of the 8616)? It doesn't have to be the BWLD example...just any in general. Which is the correct share amount to use to derive the book value?


Lastly....:

If BWLD or another business we apply this to had "preferred stock" (BWLD does not)...would you subtract the preferred stock dollar amount from
the total stockholder's equity before dividing by the shares?

Anyone can help and I would appreciate it!

mpfd
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Dean -

I agree we need to factor time into our valuation. In one sense, PIV-ER takes the time value of money into account because we use a discount rate. With a discount rate, the further out we go in years, the smaller the present value of our forecastead earnings. The lower the present value of forecasted earnings, the smaller a firm's intrinsic value, the higher its PIV (bad), and the lower its ER (again, bad).

But if you are thinking along the lines of a minimum CAGR, I have another valuation spreadsheet for that.

Have you estimated your portfolio's weighted average PIV-ER (or have any other readers?)


Hewitt
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Have you estimated your portfolio's weighted average PIV-ER (or have any other readers?)

Hewitt,

I've evaluated my portfolio and my overall PIV is 67%, my ER is 62% using a 10% discount rate. If I use 12%, those numbers become 84% and 29% respectively. Not quite as much safety or upside as your portfolio.

It's a very intriguing tool. What I've noticed is that homebuilders and energy companies seem to rank near the top of the list as far as discount to value (in my portfolio and watchlist, at least). I haven't dug in to see if that's due to book value or earnings potential. But I found it interesting.

Thanks,

Paul
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mfpd33 -

8,616 is BWLD's shares outstanding on 12/31/05, and 8,776 is shares outstanding on 9/24/06.

As for preferred stock, it is a hybrid form of capital, containing elements of both debt and equity. A few important things to know about preferred stock/preferred stockholders include:

- Receive their dividends ahead of common shareholders;
- No voting rights;
- Is a separate class of stock from common stock and has its own stock symbol;
- In the event of a liquidation, claims are subordinate to creditors and bondholders but have a senior preference to common stockholders.

Because preferred dividends are not tax deductible (as is interest to bondholders), it is more expensive than straight debt. So, you'd prefer the companies you own not to issue this type of capital.

All this is a long-winded way of saying that I exclude preferred stock from book value. To me, "book value" is what remains after you liquidate the business and pay off all the claims ahead of the common stockholders.


Hewitt

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Paul -

Thanks for sharing. Your goal this year should be to lower your PIV and increase your ER. This is what I try to do every day.

By the way, just as a general comment, you may decide that a 50% decline in earnings in year 6 and then a flat 3% growth rate in year 11 is too pessimistic. That's fine...feel free to manually override the default growth assumptions. As long as you have an intrinsic value estimate you can use PIV-ER.

Also, as for the discount rate, some may say 10% is too low. Here again, this is your call. I tend to use 10% but then I also have a rule not to buy companies unless their PIV is 50%-65%. So my margin of safety, or at least one of my margins of safety, is the low PIV requirement.

When you play around with various growth rates (assuming 50% decline in year 6 and 3% growth beginning in year 11), you find the best PIV-ER companies are the El Cheapos. You can make a lot of money buying single-digit growers selling at single-digit P/E ratios. But the theory works in real life, as the myriad studies in Tweedy Browne's What Has Worked in Investing prove. You can the booklet here: http://www.tweedy.com/content.asp?pageref=reports.


Hewitt

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Great post HH, and great tread.

But hey, is it customary to add book value to calculate IV??

I thought Damodoran wrote "the value of any asset is the PV of expected future cashflows discounted at a rate appropriate to the riskiness of the cash flow".

Thus I've run many dozens DCF models and never added book value or anything to the PV of expected cashflows.

Am I a fool? Is it the rule or the exception to add BV to DCF to calculate IV??

Thanks

Phil

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Also, as for the discount rate, some may say 10% is too low. Here again, this is your call. I tend to use 10% but then I also have a rule not to buy companies unless their PIV is 50%-65%. So my margin of safety, or at least one of my margins of safety, is the low PIV requirement

Hewitt,

One of the comments I made about PIV-ER on another board (BWLD, I believe) was that the somewhat low discount rate is offset by several other checks againts being overly optimistic, namely the conservative growth in outlying years, the use of growth rates that are 75% and 50% of forecasted growth, and the overweighting of those less aggressive forecasts. I think there's plenty of safety built in.

Thanks again,

Paul

P.S. By the way, I just realized your book is sitting on my desk right now - I was looking at the section on evaluating management just the other day as part of another discussion. Another helpful contribution to my investing journey.
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Is it the rule or the exception to add BV to DCF to calculate IV??

Phil,

Obviously I'm not Hewitt, but that's a really good question. I've seen debates rage all over about how to properly do a DCF calculation. For example, should growth capex be added back in to FCF (I believe it should only be added in during the terminal growth stage - it's probably not being spent, hence the no growth). Adding back book value is another item to ponder - if we're running DCF projections out as though the business will last forever, would we ever realize the gain from a liquidation that would make book value relevant? Therefore, should it be counted as part of the value?

It's all gets very theoretical. But I find it fascinating.

Paul
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Hi Hewitt,

8,616 is BWLD's shares outstanding on 12/31/05, and 8,776 is shares outstanding on 9/24/06.

Thanks...uh..now I feel really stupid. Must have over thought that and read it funny.

As far as preferred stock...thanks for the answer.

I am right as rain!

Paul and Hewitt....Thanks again,

mpfd
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Have you estimated your portfolio's weighted average PIV-ER (or have any other readers?)

Hi Hewitt,

Love this idea - it's so easy (almost too easy but I know it's not a substitute for real DD). I wanted something like this for a long time but I've never been able to come up with something as neatly packaged as you've presented to us.

I see myself using this to help with two recurring problems I run across:
1. If I run across a "trembling with greed" opportunity and I have no cash on hand, which of my holdings are candidates to trim.
2. Of a number of potential investments, which are the best ones.

My weighted average PIV is 57.5% and expected return is 77.3%.

Cheers,

Rich

p.s. already started using it today to improve my portfolio PIV-ER by purchasing CHK
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Hi Hewitt
Thanks for the great thread and taking the time to respond.

Yes I have taken a first pass at calculating by PIV and ER. To assist in this I have cobbled together a spreadsheet based on Jim Gillies DCF Calculator. The spreadsheet makes the task a lot easier. If anyone wants a copy please feel free to grab it from http://tinyurl.com/29aa6b

This has been an interesting task and a good first pass to prompt me to continue evaluating my companies. It is now clear to me that I need to get a lower PIV. As that has been by aim via focusing on CAGR for the last four months it was good to see my recent purchases all scored very well with low PIV and high ER.

About time:
I was referring to CAGR. I still prefer to view returns based on exchange value than intrinsic value, i.e. I am more interesting in what I expect someone is willing to pay me for something than in what that thing may be worth. The interesting thing is most of the intrinsic values were close to my one to two year estimates; perhaps as both are primarily based on future eps, ttm eps and current price that is not surprising. The greatest variances were in insurance companies, where I think adding in the book value caused issues.

Kind Regards
Dean
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Hi Paul,

Why do you exclude "growth capex" from your FCF calculation? It and any increase in working capital is the fuel for growth and once spent can not be distributed to shareholders. Imo not counting growth capex in FCF falls in the same category as not counting stock options as an expense - it's pure fiction.

Let's say we have two companies in the same industry with a $100m in revenues and produce $10m in FCF. Both require $10m in "maintenance" capex to maintain sales and profitability. Company A is happy to stay at this level but company B wants to grow aggressively and starts ramping up capex to $20m per year. Using your maintenance capex only both companies would only count $10m in FCF. Naturally analysts now project growth for company B, let's say 20% for the next five years vs. little more than inflation, say 5% for company A.

In this example company B gets its growth for free - no inputs needed because growth capex is not included. I see from your profile that you list "business owning" & I'm sure that your own experience of investing "growth cash" would point to its inclusion in capex for the calculation of free cash flow to you the owner

It's easy enough to model zero or negative cash flows for the first few years for high growth companies using a DCF spreadsheet so I'm not sure why its important to exclude growth capex.

I think it's important to understand what maintenance capex is and I've sometimes played around with the DCF for a higher growth company by using maintenance capex only and assuming very modest growth rates - a sort of "what would cash flows look like if the company stopped its rapid expansion" idea.

imo you simply can't have the higher assumed growth rates and at the same time exclude the capital necessary to achieve them

Best Regards
Philip
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Hewitt,

Thanks for the detailed discussion on your approach. I actually read it originally on Real Money and was confused a bit by your calculation of PV Operating Value (Years 1-10) and PV Terminal Value.

In your table, you show PV Y1-10 as $49 for the high estimate. However, that figure appears to be closer to the FV of compounded earnings 2.62*(1.13)^5*(1.065)^5 rather than the PV of earnings.

When I calculate PV Y1-10, I discount the growing annuity for years 1-5 and add that to the discounted growing annuity for years 6-10 which has also been discounted back to the present. This calculation results in a PV Y1-10 closer to $25 than $49.

I also can't recreate your PV Terminal Value of $21. For the PV Y11+ I discount the perpetual annuity and then also discount back to the present which results in a value closer to $36.

What am I missing? Thanks in advance for your Finance 101 guidance!
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Why do you exclude "growth capex" from your FCF calculation?...

imo you simply can't have the higher assumed growth rates and at the same time exclude the capital necessary to achieve them


Philip,

I think we are on the same page, but my wording may have indicated otherwise. I agree with you wholeheartedly reagarding growth capex - that you can't have your cake and eat it too. We've been having this argument on the HG BWLD board, where a DCF valuation was posted using the following formula:

Earnings + Depreciation & Amort - Total Capex + Growth Capex - Working Capital = SFCF. The SFCF is then discounted back to present.

I argued against adding growth capex back in because that money is spent and cannot be returned to shareholders. I do, however, feel that total capex should be adjusted during the terminal growth years to reflect reduced growth capex spending (in those years only). That's the point I was trying to make, but perhaps not as clearly as I should have.

My thought is that the reason we have such a low terminal growth rate is that the company has stopped reinvesting in growth (or reduced it significantly). I believe an adjustment reflecting that is justifiable. If we expect the tepid terminal growth despite continued high growth capex, we are assuming a poor use of capital in the distant future.

So I propose the following:

During growth phase:
Earnings + (Depreciation & Amort) - Total Capex - Working Capital = SFCF.

During terminal phase:
Earnings + Depreciation & Amort - Reduced Total Capex - Working Capital = SFCF, where capex is reduced to reflect lower growth capex spending.

I've seen this discussion often and I think it arises from TomG's Thumbnail valuation, where he adjusts for growth capex. But that's a future multiple valuation, not a DCF valuation. I think the concept has been hijacked, somewhat incorrectly.

As for my business-owning experience, you are painfully correct - and it underscores the point I was trying to make on the BWLD board. My personal cash flow (what ended up in my pocket) was virtually nil during our growth phase. My wife was getting impatient, wanting to know when we'd see a pay off. So I showed her what was being spent on growth and what would happen when we stopped reinvesting. It was a way to see the light at the end of the tunnel. The investment would pay off, but we couldn't buy groceries with it today. And if I'd told someone they could have all the cash I generated in the next twenty years for an up front payment today, I doubt anyone would have paid me for that future lump sum PLUS the money I invested to earn it. Their only interest would be in the cash they would receive. That's how I look at this whole issue.

Does that make sense? Please correct me if you think I'm wrong, or if you feel I don't understand your thoughts on the subject.

Thanks,

Paul

(For anyone interested, the BWLD discussions begin here http://boards.fool.com/Message.asp?mid=25104167 and here http://boards.fool.com/Message.asp?mid=25114236 – HG subscription/access required)
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Hi Paul,

Okay I must have misinterpreted your post. I agree with what you have just posted. I tend to set capex at around 110% to 120% of D&A for the terminal phase - it should be at least = to D&A. However you still count all capex although it indeed may be reduced or at least growth is reduced. It's tough to say well in advance that a company can actually reduce capex in the terminal phase as competition may require increased maintenance capex. In the case of young growth companies the higher growth period can be a lot longer than 5 or 10 years even up to 20 years. I would rather extend the high growth phase than tinker with the terminal phase.

The reason that we use such low terminal rates is because we expect the competitive advantage to be competed away and 3% approximates long term inflation. Arguably companies like Coke should have a higher terminal growth rate.

Best Regards
Philip
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Hi All
Thanks to Paul, TMFSlydo, here is an updated version of the spreadsheet.
http://tinyurl.com/29aa6b

1) The data now automatically refreshes, so long as you click Enable automatic refresh when the spreadsheet loads. If you choose Disable there is a Refresh button on the front tab.

2) There is now a Calculate button on the Input Sheet, this runs all three DCFs, so need to go to those tabs now.

3) I've also added an Earnings Tab, which downloads data from earnings.com and lets you play with it a bit.

Cheers
Dean
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RetireFoolishly,

Your welcome and good catch.

No change to Wal-Mart's High intrinsic value estimate of $84 or its weighted average intrinsic value of $71. But the forecast period and terminal period values do change, as you correctly point out.

PV operating value (Years 1-10) should be $30, not $49. The corrected PV terminal value (years 11-eternity) now stands at $40, not $21. Book remains the same, at $14. So add it all up and High intrinsic value remains at $84, as mentioned above. Crucially, there are no changes to the “drive-by” weighted average intrinsic value estimates for Wal-Mart or any other company I have mentioned on this or other discussion boards.

The snafu which you caught is because my spreadsheet forecast period covers 20 years, with terminal beginning in year 21. This longer period explains why operating value in my Real Money column is higher than yours (and also why my terminal value is lower than your estimate.) Not every company is going to grow at 3% beginning in year 11, and I want my SS flexible enough so it can value companies that can grow at an above rate for longer than a decade. But these pearls are few and far between. Just flip through a Value Line report and see how few grow staircase-like for more than a few years. Not many! Indeed, most companies experience what British economist I.M. D. Little calls “higgledy-piggledy growth.”

In an earlier post I mentioned the importance of checking all derivative numbers against the 10-K and 10-Q. The Wal-Mart example shows why. Yahoo says EPS is $2.62 a share. But when you divide TTM earnings of $11.68 billion by 4.17 billion shares, you get $2.80 a share. This is a big difference.

For this model I use TTM earnings and then divide by diluted shares outstanding, both of which I get from the latest SEC filing. Also, something I didn't mention before in the interests of keeping things simple: if a company has a history of diluting share count, then make the appropriate adjustment in your valuation work. The more shares a company issues, the lower its intrinsic value per-share estimate.

Thanks for checking my work. My father-in-law, who was a professor of mechanical engineering at M.I.T., says he learned more from his students than they learned from him. While I do not consider any of you students—I am sure your investment results are better than mine—I do learn from you.

Speaking of investment results, I have calculated my performance for the last two years using the Matt Richards/Jim Gillies TWIRR approach, which Jim exhaustively covered on HG in December and early-January. I will provide a link to these results in a few days. Then you can decide if the Earnings Power approach (authentic earnings power, durable competitive advantage, discount to intrinsic value) helps or hurts you.


Hewitt
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Hewitt:
Thanks for the post. I think it's a useful approach.
I was curious though: Mathematically, you can derive the equation ER = (1-PIV)/PIV. IE: for Walmart PIV=48/71=0.676. ER=(1-0.676)/.676=0.479
So what? Well if your portfolio has a PIV of 0.52, it's ER must = (1-0.52)/0.52 = 0.923 or 92.3% not 128%.
Did I miss something here?
All the best,
Zee
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Zee,

The discrepancy arises from the fact that it's an average of numbers and the averages don't fit the same calculation as each individual component. For example, say your portfolio had stocks with the following prices, intrinsic values and PIV-ER's:

Price IV PIV ER
----- --- ------- ------
100 100 100.00% 0.00%
90 100 90.00% 11.10%
80 100 80.00% 25.00%
70 100 70.00% 42.90%
60 100 60.00% 66.70%
50 100 50.00% 100.00%
------ -------
Average (Mean) 75.00% 40.95% (add each column and divide by number of stocks)

But if you use the formula (1-PIV)/PIV, then (1-.75)/.75 = 33%

I'm sure there's some technical mathematical explanation, but this is how it works. Of course, we should also probably look at the weighted average of our portfolio (larger holdings count for more).

Paul (who wondered the same thing when I looked at my own portfolio)
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Sorry, I had a son asking me how to sell Pokemon cards on eBay while I was posting that. Here's a better format (and now he's asking if I can hang a real basketball hoop in his room. Sheesh).

Zee,

The discrepancy arises from the fact that it's an average of numbers and the averages don't fit the same calculation as each individual component. For example, say your portfolio had stocks with the following prices, intrinsic values and PIV-ER's:

Price IV PIV ER
----- --- ------- ------
100 100 100.00% 0.00%
90 100 90.00% 11.10%
80 100 80.00% 25.00%
70 100 70.00% 42.90%
60 100 60.00% 66.70%
50 100 50.00% 100.00%
------ -------
Average (Mean) 75.00% 40.95% (add each column and divide by number of stocks)

But if you use the formula (1-PIV)/PIV, then (1-.75)/.75 = 33%

I'm sure there's some technical mathematical explanation, but this is how it works. Of course, we should also probably look at the weighted average of our portfolio (larger holdings count for more).

Paul (who wondered the same thing when I looked at my own portfolio)
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Paul: OK, I see where he probably got his numbers, however he really should be using the weighted averages and this would result in more useful numbers (and they would agree with the formula). My point is that you really only need to specify the one threshold for screening.
Thanks for the help.
Zee
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Zee -

however he really should be using the weighted averages and this would result in more useful numbers

Just so I am clear, are you referring to WMT's PIV-ER or my portfolio's PIV-ER?

Glad to hear this idea is useful.

Hewitt
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Paul:
You made me think about this and the answer id that you must use the weighted average ER. IE: You must weight the ER's for P and so you get weightings and a WAER as follows:

ER WEIGHT FACTOR Weighted
0% 0.222 0.0000
11.11% 0.200 0.0222
25.00% 0.178
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Paul:
Ignore that last posting. I was trying to put in a chart showing how the weighting goes, but anyway, you must weight the ER's according to Price and the result will be a weighted ER of 33%!
The universe is unfolding as it should.
The formula holds.
Zee
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Hi Hewitt,
I was referring to your portfolio numbers which must agree with the formula ER = (1-PIV)/PIV.
To get the best numbers, you need to use weighted numbers.
I guess the other point is that you don't need two screening limits as they are not independent. IE: You need to set a limit of PIV of NO MORE THAN or ER of NOT LESS THAN but not both.
Anyway I hope I haven't confused things.
Zee
PS: See TMF Slydo's posts where he has a sample portfolio and the PIV of the portfolio is 75%. He shows the mean ER is 40.9% but the real number to use is the ER weighted to Price and this gives you 33%. So if he was happy with that portfolio, his criteria for new investments is PIV LESS THAN 75% PERIOD. He doesn't need to say ER GREATER THAN 33%.
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Zee,

To estimate your portfolio's weighted-average PIV-ER, add the market value for all your stocks to get your portfolio's market value. Then divide each stock's market value by portfolio market value to get each company's market value weighting to the total.

Let's say you have a $25,000 portfolio. Also, one of your companies is General Electric. If GE's market value in your portfolio is $5,000, then its weighting is 20% of the total.

Next, multiply each company's weighting by its respective PIV. Repeat for every company, then add all the weighted-average PIV's and you have your portfolio's weighted average PIV.

If you think General Electric has a PIV of 90%, then multiply its 20% weighting by its 90% PIV and you get its weighted-average PIV of 18%.

For simplicity, let's assume you have just one other company in your portfolio, Caterpillar. Its market value in your portfolio is $20,000, so its weighting is 80%. If CAT's PIV is 51%, then its weighted-average PIV is 41% (80% x 51%).

Add GE's weighted-average PIV of 18% to CAT's weighted-average PIV of 41% and you get your portfolio's weighted average PIV: 59%. The lower the PIV, the better.

When you base your portfolio PIV on market values, it matters a great deal whether 20% of your portfolio is in GE stock and the other 80% in CAT, or vice versa. With 20% of your portfolio in GE and the other 80% in CAT, your portfolio's weighted-average PIV is 59%, as we just learned. But if 80% of your portfolio is in GE and 20% is in CAT, then your portfolio's weighted-average PIV jumps to 82%.* Not good. So like I said, use a portfolio weighted-average PIV to account for companies that may dominate your portfolio.

(*To get 82% do this: (GE: 80% x 90% = 72%) + (CAT: 20% x 51% = 10%); 72% + 10% = 82%)

Repeat the steps above for ER.

I agree PIV-ER are not independent. But I also believe we need to think in terms of risk (what is my margin of safety if I am wrong?) as well as reward (what is my upside potential if I am right?). When you use PIV-ER, you help accomplish this goal. Of course, getting IV right is the whole ball of wax.

Thanks to TMF Slydo for his help.


Hewitt
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I think this is a wonderful board. And I just read Hewitt's book with the same name. I'm almost up for my first year of investing and plan to do a full review of all my positions and trades. This PIV-ER is definitely an aspect I'm going to look at more closely.

One thing though, a lazy bastard like me always finds it so annoying having to extract these bits of information from various web-pages. I think I'll look into programming a screen with all the portfolio data that I regular use in it and update it automatically with information from the web. Any trading platform I've seen so far is so inadequate in this respect.

I know I'll probably spend more time programming it than it ever saves me in time of looking things up myself, but at least I'll have fun doing it instead of getting constantly annoyed.

Mark
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I know I'll probably spend more time programming it than it ever saves me in time of looking things up myself, but at least I'll have fun doing it instead of getting constantly annoyed.

Hi Mark,

How many times have I said that to myself? I've spent days automating a task that takes maybe five or ten minutes, but I love the challenge.

Btw, I've been working on something similar. Dean (whatismyoption) has a very good spreadsheet available to analyze a single stock, but I'm trying to get something that will do the whole portfolio automatically. My problem is the delay in getting web query data into the spreadsheet fast enough to update each stock before the program moves on to the next stock symbol. If you have a solution for that (I'm using Excel), I'd love to hear it.

Thanks,

Paul

P.S. I, too, am a lazy SOB and automated everything I could with my business. At times I thought it was a bigger waste of time than just manually entering things. But all those minutes saved - and the ability to train a anyone to run them - allowed me to run a very lean operation, which paid off big time when it came time to sell. So much so, that I wrote a book with the working title The Lazy Millionaire. Unfortunately, some dude on the West Coast trademarked that name. So it's back to the drawing board.
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Hi Paul, Mark and all,

I spent some time over the last year or so developing a spreadsheet or two to assist in my stock analysis/valuation.

Then, almost all the sites that I queried decided to change their formating or something and now the queries don't work. I used MSN, Reuters, Yahoo! and M*.

So, watch out. And, is there an easy fix to this problem?

Rich
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So, watch out. And, is there an easy fix to this problem?

Thanks for the warning. I haven't yet really put much thinking in it of course. But when designed properly it should be modularized such that parts like a query can be easily replaced by another one. I was already thinking of designing it such that it could both do a look-up in a local database next to a web-retrieval. A CD with the SI Pro database should be on its way to Brazil by now, I plan to store all of it in an easy accesible way in a database.

Mark
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One thing though, a lazy bastard like me...

LOL Mark - sounds so much like English english!!

I don't see that vernacular used much this side of the Atlantic - My English response when asked "How are you?"

B#&*dy marvellous, it's the other ba#%^#ds!

Best Regards
Philip
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LOL Mark - sounds so much like English english!!

I don't see that vernacular used much this side of the Atlantic - My English response when asked "How are you?"

B#&*dy marvellous, it's the other ba#%^#ds!


Ha, now you had me chuckle. Well, I grew up in a country right next to them, so I suppose the English english rubbed off a bit :) Or it went down together with the pints of beers I had with a great many of them.

Mark
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Hi Hewitt:
Of course I agree on the market value weighting. In Slydo's example, it was assumed that there were equal numbers of shares of eack stock so I just weighted for P.
If you choose to use a different number for ER for other reasons, that's fair.
All the best,
Zee
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First, thanks to Hewitt for the great methodology.  
I ordered the book from Amazon so hopefully the royalty check will arrive soon. :)

Secondly, thanks to Dean and everyone who contributed to the spreadsheet - it's a very nice piece of work.  
Wonder if we could add the Earnings Power calculations to the next release? :)

I ran a number of companies that I have seen recommended by various sources in the past few months through the spreadsheet.
It yielded an interesting list of companies that seem to approach Hewitt's goal of 50% saftey margin with a chance to double.  
However, the list seems to be heavy on financial services companies (which may have inflated BVs) and would appreicate any thoughts on that sector.
Hope you find it helpful to your DD efforts.

Company	Sector	        Industry	        PIV	ER	CAPS	Recommended By:
TTMI	Tech    	Printed Circuit Boards	33	208	3	TMF - David Gardner
CRYP	Tech    	Software and Services	41	142	4	TMF - Bill Mann
LRW	Services	Staffing Services	45	120	5	TMF - Philip Durell
TWX	Services	Entertainment	        45	123	3	TMF - David Gardner
MDC	Industrial	Resident Construction	42	138	3	TMF - Bill Mann
DW	Industrial	Gen Building Materials	52	92	5	TMF - Tom Gardner
FAF	Financial	Title Insurance	        50	101	4	TMF - Philip Durell
MRH	Financial	P&C Insurance	        49	106	5	TMF - David Gardner
SAFT	Financial	P&C Insurance	        26	292	5	TMF - David Gardner
ENH	Financial	P&C Insurance	        21	361	5	TMF - Philip Durell
STA	Financial	P&C Insurance	        45	121	4	Smart Money 2007
HIG	Financial	P&C Insurance	        46	117	5	Smart Money 2007
FDC	Financial	Money Center Banks	49	105	4	TMF - Philip Durell
JPM	Financial	Money Center Banks	52	92	4	Fortune 2007
WM	Financial	Money Center Banks	48	110	2	S&P, 100 Largest, Highest Yield
WB	Financial	Money Center Banks	48	107	3	S&P, 100 Largest, Highest Yield
BAC	Financial	Money Center Banks	49	105	4	S&P, 100 Largest, Highest Yield
GS	Financial	Investment Brokerage	41	142	4	Smart Money 2007
LEH	Financial	Investment Brokerage	49	106	3	Smart Money 2007
FMD	Financial	Credit Services	        39	154	5	TMF - Bill Mann
SDA	Consumer Goods	Meat Products	        35	187	5	TMF - Bill Mann
DO	Basic Materials	Oil and Gas	        40	152	5	Fortune 2007
COP	Basic Materials	Oil and Gas	        30	238	4	Fortune 2007
CHK	Basic Materials	Oil and Gas	        22	346	5	TMF - Philip Durell
XEC	Basic Materials	Oil and Gas	        33	202	5	TMF - Philip Durell
DOW	Basic Materials	Chemicals       	52	92	4	Smart Money 2007
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Hi Zee,

I posted the following on the "How To Value A Stock" board in reply to TMFSlydo. It's basically saying the same thing as Hewitt, but calculated differently.

Ed

Hi Paul,

I agree with your numbers, but the problem is that you almost always run into problems when you take an average of averages.

To get an average PIV and ER of the portfolio you describe, you have to add the prices of the various stocks, add their IV's, and then do the calculations.

Price IV PIV ER

450 600 75.00% 33.33%

This only gives you an average PIV & ER of the individual stocks in your portfolio. To get a weighted average, you'd have to multiply the price of each stock by the number of shares you hold, and calculate the total IV and ER of each. For example, using the stocks you cited:

Shares Price Value PIV IV ER % ER
------ ----- ----- --- -- ---- --
100 100 10,000 100.00% 10,000 0.00% 0
200 90 18,000 90.00% 20,000 11.11% 2,000
300 80 24,000 80.00% 30,000 25.00% 6,000
400 70 28,000 70.00% 40,000 42.86% 12,000
500 60 30,000 60.00% 50,000 66.67% 20,000
600 50 30,000 50.00% 60,000 100.00% 30,000

2,100 $140,000 66.67% $210,000 50.00% $70,000

The weighted average PIV of the portfolio is then 66.67% (140,000 / 210,000) and the ER % is 50.00% (70,000 / 140,000).

Notice, though, that the ER % is still (1 - PIV) / PIV, or (1 - .6667) / .6667, or 50%.

You could have any number of portfolios comprised of the same stocks, but with different PIV's and ER's depending on the relative holdings of each stock.

Ed
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Yesterday RealMoney.com published a column I wrote about the Earnings Power PIV-ER test, which I devised last Fall. I can't reproduce the column verbatim here, so I have deleted the actionable ideas. Please do not ask me which companies they are, as this is unfair to paying subscribers.

The column seems to be freely accessible now:

http://www.thestreet.com/p/_rms/rmoney/investing/10334511.html

Zz
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Hi RetireFoolishly
I just saw your post as there were some new posts to the board. Sand105 seems to be working on version 2 of the spreadsheet. If you thought my spreadsheet was nice wait to you see what Sand produces, I'm sure it will be way better.
[No pressure there Sand ;-)]

As to your list of companies. Financial service companies have very high book values which throws a spanner in the works. I am not sure how Hewitt or others deal with this, but what I do is increase the Discount rate to discount the high book value and if it is an insurance company then I greatly discount the book value as well. I do this all manually and it reeks of tampering to get a valuation I'm happy with. If anyone else has other ideas please chip in.

Best
Dean

PS I just had a look at TTMI's chart http://stockcharts.com/charts/gallery.html?ttmi and that is just further evidence I still need to get better at watchlisting. I was interested in buying TTMI earlier this year and can't believe it went under $9 and could have easily been bought under $10.

PPS KOMG Komag is currently has the highest ER on my wathclist. It might not have a great future, but might be worth a look considering its low valuations. I have no position, just watching for now.
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Hi Dean,

I use your spreadsheet all the time. I don't know how it can be improved, but I can't wait to see the bigger and better mousetrap!

(if Sand105 is gracious enough to share it with us all)

Regards,
Marjory
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I use your spreadsheet all the time. I don't know how it can be improved, but I can't wait to see the bigger and better mousetrap!

(if Sand105 is gracious enough to share it with us all)


But of course. Still got a bit to go, though. I have replicated Hewitt's PIV-ER calculations and that will go in there as well (it is already in my BMW spreadsheet).

The original file I am using had a bunch of nice work in it - no need to mess up an already good thing (It is a creation of Foulweather - I would love to see yours Dean if you have an IETC sheet). Most of the output content is unchanged.

What is does do is pull in a lot of the numbers automatically. It certainly doesn't obviate the need for going through annual reports, but fact checking is a whole lot less painful than typing all those numbers in.

I will also be able to add the ability to save, increment by year and quarter - so functionality should be pretty nice.
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Mine doesn't have an IETC sheet. A link to download it is here in this post http://boards.fool.com/Message.asp?mid=25127099
My Excel work is a more basic than yours. I have been planning on spending some time looking at BMW spreadsheet to figure out how to do some things.

I do have another IETC spreadsheet called IETC3_1-template.xls I think it was from Foulweather. On the Overview tab it says "Credit to JADooley, whose spreadsheet format I shamelessly ripped and to Hewitt Heiserman, Jr. for both the book It's Earnings That Count and for the QoP and EPC chart code" If you don't have this one let me know and I can email or upload it.

I also have "Earnings Power Scorecard_Motley Fool_112706.xls" which Hewitt emailed out upon request. This spreadsheet is a list for you to score companies against.

Dean

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I do have another IETC spreadsheet called IETC3_1-template.xls I think it was from Foulweather. On the Overview tab it says "Credit to JADooley, whose spreadsheet format I shamelessly ripped and to Hewitt Heiserman, Jr. for both the book It's Earnings That Count and for the QoP and EPC chart code" If you don't have this one let me know and I can email or upload it.

This is the one I am modifying.


I also have "Earnings Power Scorecard_Motley Fool_112706.xls" which Hewitt emailed out upon request. This spreadsheet is a list for you to score companies against.


Don't have this one. Would love to see it.
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