Valuation is generally the first and last thing I look at when researching a new business

  • (Very) early on in the process, I look for valuation to appear somewhatsane (i.e. is this worth my time now?)
  • I’ve heard Christian Ryther (#FF) say he prefers not to see valuation metrics when he begins initial work on a name. I think there’s a lot of validity to this point and may eventually end up in that camp
  • On the back-end of my research, I fine-tune my views on valuation to determine how actionable (if at all) the opportunity is

No single method for looking at value — dependent on company/industry

“Triangulate” around a few of the following methods:

  • DCF — best academic option (IF you can keep yourself honest)
  • FCFE/FCFF Yield — most useful metric (closest to real value driver), but generally relevant for more mature (cash-flowing) businesses
  • EV/EBITDA — use for most (of my) businesses
  • P/E — mostly look at as a sanity check b/c “others” look at it too
  • Take-out Value — sometimes useful to know; avoid underwriting to it

For the above yields/multiples, I look at valuation relative to key peers — but more than anything, I do so to help (a) determine what might be a reasonable (think guideposts) value for the business I’m analyzing, and (b) spot (and then research) potential fundamental differences are between business models.

I will not get into what drives value here — that’s another, much bigger topic that I’ll leave for others to articulate for now.

What I (and apparently everyone else today) really look for is reasonableness

  • Is valuation reasonable (or preferably better) for a high quality business?
  • If high returns, real organic growth, sustainable comp adv, and healthy market structure, easy to be comfortable starting pos. at merely “reasonable” valuation
  • Also look at moderate quality names — but valuation and “catalysts” (loosely defined) become more important: (a) positive cyclical/secular backdrop is a must, (b) stress test both the model and the “multiple”, (c) when valuation becomes the focus, I try to step back and look at the business with an even more skeptical eye: is it really of decent quality or am I deluding myself?
  • Try (hard) to avoid names of lower quality, regardless of “valuation” — not my core competency

I fully acknowledge this focus on “quality at a reasonable price” is in vogue right now — but I have yet to find a better approach.

In establishing a price target, I use my own estimates and look for a path that ends up at a reasonable valuation 1–3 years out

  • Build a full 3-statement model + DCF for all businesses I research — and back-solve for what consensus estimates are assuming
  • Comfortable using my own estimates (different than consensus), but (a) wary when they are lower than consensus (even if value is there), and (b) I mostly defer to consensus for shorter-term (<1 year) estimates
  • Including detailed Bull/Base/Bear scenarios in every model seems like a best practice

Other, miscellaneous/related items:

  • FX: real impact on earnings power (and therefore valuation) and should not be ignored. For me (and I assume most others), the impact should be to the estimates — not the multiple. For example, if a company’s otherwise strong growth is hit hard by FX translation, it should not have the multiple of a low growth business for an extended period of time
  • The 10% FCF yield “rule”: if you can buy a good business at a 10% FCF yield, it’s an easy decision. But this framework is useful for lesser quality names too (e.g. 10% should be the minimum yield required for medium- or lower-quality names)
  • (Lack of) Focus on Valuation: I recently noted that at this year’s VALUEx Vail, I couldn’t recall a single question/pushback on valuation in the 20+ formal stock pitches. I think this is directionally correct and personally spend more of my time trying to understand the qualitative aspects of the business and the (sustainable) direction of fundamentals. Maybe this dynamic will change someday



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