The Death of Equites: Not Quite
Thursday, March 19th, 2009We are a little bit late with this piece - but we wanted to highlight it anyway. James Berman has a fantastic piece of analysis in The Huffington Post called Reports of the Death of Equities: Greatly Exaggerated. In the article Berman makes a very clear case for the fundamental valuation of equities and the understanding of concepts like intrinsic value. We strongly recommend the article as outlining a framework similar to how we here at Valuecruncher look at valuing companies.
On understanding why intrinsic value matters
“To understand why intrinsic value matters, we need to step away from the panic and the bleak macro picture to understand that stocks are valued on earnings or cash flows. The latter is preferable because it strips out the accounting fictions of depreciation, amortization, goodwill write-downs and other non-cash charges. I teach my NYU students to follow the cash flows, not the earnings, because cash is what a business actually runs on.
Let’s take the example of Automatic Data Processing, or ADP (which is a core holding in both the Torray Fund, which we own for clients in separate accounts, and in the JBGlobal Fund L.P.). ADP is the largest payroll processor, the leader in a tremendously stable and unglamorous business. Due to rising unemployment, its stock has been hit hard, despite the fact that ADP has virtually no debt, an enormous cash position, healthy cash flows (even in this severe recession), and virtually no chance of going bust. I chose ADP but I could have chosen so many of the stocks now trading on the Dow, given how undervalued stocks are on a global basis.
ADP is currently trading at $32 per share, or 9 times its operating cash flows of $3.50 per share. In 1999 it was around four times as expensive, trading at 37 times cash flows. In effect, it is selling at a 76% discount to its 1999 price. People get excited when a pair of shoes, a car or a house sell at a 76% discount — but not stocks. As Benjamin Graham (the father of value investing and Warren Buffett’s mentor) liked to say, you should buy your stocks like you do your groceries, not as you do your jewelry: you should be happy to buy a stock when it’s on sale, even if a bleak environment is responsible for the sales price. As value investors often preach, you pay a dear price for a cheery consensus.”
The Valuecruncher interactive analyst report for ADP agrees that the stock is undervalued.
And on Warren Buffett
“Warren Buffett readily admits that his secret in acquiring enormous wealth was not vastly superior intelligence, prescience, or any trading strategy — but in always looking at stocks for what they really were: claims on the underlying cash flows of a business. Instead of trying to time the market, trade in and out, predict macroeconomic trends or divine the next stimulus package, he simply tried to buy businesses selling at reasonable prices relative to their cash flow and hold them for long periods of time — as they increased in value — often “forever.”
His secret was in understanding that when the price of a valuable business goes down, it’s time to buy, not sell. This understanding allowed him to hold stocks during the paralyzing market of the Seventies. At that time, the world seemed like it was coming to an end with Watergate, war in the Middle East, Vietnam, horrible inflation, recession, price controls, gas shortages, double digit unemployment and riots in the streets. But he held and bought more stocks (as he is now) because he understood the value at such prices.”
Well worth the read.
