My reaction: such (false) precision was silly and ultimately counter-productive.
To demonstrate I will give you a set of accounts for a consumer staples company.
Annual Standardised in Millions of U.S. Dollars
|Cost of Revenue, Total||3,633||3,454||3,860|
|Cost of Revenue||3,633||3,454||3,860|
|Selling/General/Admin. Expenses, Total||2,665||2,446||2,368|
|Labor & Related Expense||--||--||--|
|Interest/Investment Income - Operating||--||--||--|
|Investment Income - Operating||--||--||--|
|Interest Exp.(Inc.),Net-Operating, Total||--||--||--|
|Unusual Expense (Income)||36||(195)||0|
|Impairment-Assets Held for Use||--||--||--|
|Loss(Gain) on Sale of Assets - Operating||0||(375)||0|
|Other Unusual Expense (Income)||--||--||--|
|Other Operating Expenses, Total||--||--||--|
|Other Operating Expense||--||--||--|
|Total Operating Expense||6,334||5,705||6,228|
|Interest Expense, Net Non-Operating||(297)||(208)||(168)|
|Interest Expense - Non-Operating||(297)||(208)||(168)|
|Interest Capitalized - Non-Operating||--||--||--|
|Interest/Invest Income - Non-Operating||336||306||151|
|Interest Income - Non-Operating||232||154||151|
|Investment Income - Non-Operating||104||152||0|
|Interest Inc.(Exp.),Net-Non-Op., Total||39||98||(17)|
|Gain (Loss) on Sale of Assets||--||--||--|
|Other Non-Operating Income (Expense)||1||35||97|
|Net Income Before Taxes||1,364||1,405||1,064|
|Provision for Income Taxes||496||471||386|
|Net Income After Taxes||868||934||678|
As you can see - it has net income after taxes of just under $900 million.
I am not even going to bother inserting a balance sheet. The company has some debt (as seen by the interest expense) but there is little doubt the debt can be paid - and you can give me a valuation before debt if you want.
There are some substantial (foreign) cash balances as well as well as some investments. The debt and the cash balances and investments are roughly a wash - so you can safely ignore them.
The company has a long record of slow but steady growth - but it has grown a bit faster than that for the past few years. The CEO has been a vast improvement on other CEOs and has done some optimisation.
There is no doubt about the validity of the business. I guarantee you that you have consumed the product.
Also it is a highly stable product and hence should be very amenable to valuation. Volume growth is unlikely to exceed 5% in any year. A volume decline of 5% would be an unlikely disaster. However the last year did have volume growth above 5%.
Before you read any further I want you to write down a range of valuations. Just a lower bound (where on this information you would be falling over yourself to buy it) and an upper bound (where you would be falling over yourself to sell it).
Go on - write it down.
The trick is 40 lines further down - so write down your numbers before you scroll further...
Yes further down.
Further down still.
A little further down.
Okay - I have changed the dates. The real dates for this are 1987, 1986, and 1985 respectively.
And the company in question is Coca Cola.
These are the accounts Warren Buffett bought his stake on.
The market cap is now $178 billion.
I do not think any of you would have come up with a number anywhere near that high. Even if you had bought the stock at the high range for plausible values (say 30 times earnings) the return from then to now was (highly) acceptable. The stock was trading at about 12 times earnings then.
Net income is now over $7 billion and the multiple has expanded a lot.
I do not need to say it - but a valuation was not important in the buy case and would have detracted from the buy case a great deal.
The valuation as such was pretty trivial. Was it realistic to assume that the company over a reasonable time frame could return $12-15 billion to shareholders. The answer to that was a resounding yes.
Was there a margin of safety around that?
Again a resounding yes.
So the stock was easily able to be owned.
The questions that mattered (and still matter) is "can the product be taken to the world", and will the next generation think of it in the positive light the last generation thought of it.
The answers are less obvious now than they were then. Young people it seems drink Red Bull rather than Coke in surprising numbers. They are your future.
This is a general quality of investment analysis. Proper valuations are far more art than science. DCF valuations - especially of something growing near or above the discount rate are famously sensitive to assumptions. The right comparison is to the Hubble Telescope: move direction a fraction of a degree and you wind up in another galaxy.
By contrast there are some things for which a proper valuation should be done and can be done.
If you own a regulated utility what you really own is a regulated series of cash flows with regulatory risk around them.
An accurate valuation is part-and-parcel of the analysis - because it delineates what you own.
The battle here is to work out what the salient details are. Sometimes they are whether young people will continue drinking Red Bull. Sometimes they are working out a technological change.
In rare cases they are working out valuation.
Mostly valuation is simply about bounding a margin of safety. And most of that involves understanding the business anyway.
PS. If you work for a shop that requires a valuation for everything quit now. The pretence will either kill you or your performance.
PPS. I do not think there is a margin of safety around Coca Cola any more. Not enough to make me interested anyway.
This is in the comments so frequently that if you look at Coke's appreciation (and compare to the S&P) Buffett has not done that well. Some even say "if you ignore dividends". But that misses the point.
Here is an extract from Berkshire's last annual report:
Berkshire has a round 400 million Coke shares at a cost base of $1299 million. The dividend is $1.40 per share - or $560 million per year.
That is a 43 percent yield in dividends on his cost base.
If you wish to ignore the dividends (as my commentators do) may you please give them to me.