Forum Archive Index - October 2000

["Brian Brakenridge" <brianbrak@xtra.co.nz>]

Another consideration which I'll throw into the pot for a stir is that Buffett, Fisher, Templeton etc all advocate a very concentrated portfolio. Now this goes against everything they would have taught you in "Personal Finance 101" and will make all the generic and conformist financial advisors out there hyperventilate and purse their lips and say "tut tut" but, I think we want to limit our list to 3 and maybe 4 companies. The more you select the more average you are going to be, ask the vast majority of fund managers out there, most of whom struggle to be even average, (we'll save that topic for another day).

 

Another Buffett quote goes roughly "when every kid gets out of school they should be given a ticket with 20 clips on it and every time they make an investment decision you use up one clip." This ensures that you research your companies thoroughly and limits the number of times you make an investment decision based on a hot tip the taxi driver gave you.  

 

Phil: I'm at the same stage as you and while I understand the logic behind what is being explained, putting it into practice is a little more difficult. As any investment banker will tell you there are many different ways to value a company. I would also be very interested in hearing from anyone who uses this method, i.e. calculates the earnings of a company 5 years out then discounts it back to present value using a discount rate, in Buffetts case 15%. In other words the figure he ends up with tells him what he will have to pay for a company to get a 15% compounding return on investment 5 and preferably 10 years down the track. And, this is where the discipline comes in, once he has identified a company he really likes and calculated what price he has to pay, will sit and wait until the market, for whatever reason decides to discount that stock.

 

I'll put my.....on the table so to speak and have a go at calculating BCH using this method. I'm pretty sure it's wrong but I'll never learn if I don't ask. Here goes. Incidentally I've got a financial calculator which I'd be lost without because I think I missed that particular lesson at school when the told us about algebra.

 

BCH had (weighted) EPS this year of close enough to 21c. Over the past 5 years this figure has been climbing at a rate of 23% annually. So lets say we are happy with the qualitative aspects of the company and are confident that the company will continue to perform at 23% for the next 5 years. The EPS will grow to close to 60c. Now, and this is the bit I am slightly hazy on Phil, if I discount this figure using 15% as my target, I end up with a present value of EPS at 30c. Now, do I multiply that by todays PE which I think is 55. This will give me a price of about $16.50. But I think that the PE is way to high. So if I use a more realistic figure of 40 I get a price of $12 or at 30 I get $9. Or the average NZSE PE is about 16 which will give a price of $4.80.

 

Now folks at this point I'll sit back and ask for my work to be assessed. If there is deathly silence at the other end I'll know it's time to move on but I am sure that there will be someone out there who can help and I agree with Phil, that if we are going to continue on with this train of thought we need to get our hands dirty.

 

Cheers, Brian