Forum Archive Index - May 2004

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Dean,

>>
>>The basic presumption is that 'the market' has a 'beta' of 1, and
>>that any share with  a 'beta' of less than one is less 'risky' than
>>the market, whereas any share with a 'beta' of more than one is 
more
>>'risky' than the market.  The more volatile a share is the higher
>>'beta' it has.
>>
>>The problem I see with this is that the 'risk' of  investing in a
>>share as measured by beta is not affected by the prevailing share
>>price, or business fundamentals.   Put in the context of WRI, what
>>'beta' is telling you is that the risk of investing in WRI at $1.40
>>is exactly the same as the risk of investing in WRI at $1.00.  
>>Clearly those investors who buy into WRI today at $1.40 are taking 
a
>>far greater risk than those that bought in at $1 in 2003.    So any
>>'risk measure' based on volatility I believe has next to no value to
>>investors.
>>
>>Sure making an adjustment to the market premium required on
>>individual share investments relative to the market is a good idea.
>>But 'beta' doesn't do that as I see it.
>>
>>For WRI I would argue that a suitable coefficient to replace
>>'beta' , which I shall call 'better', should be based on
>>
>>1/ normalised earnings yield
>>2/ the ability to pay back long term debt and
>>3/ consistancy of profitability
>>
>>Such a coefficient would be much more useful indicator of risk.
>>Without going into a formal calculation I would rate WRI as being
>>excellent on points 1 and 2 and fair on point 3 leading to an
>>overall 'better' coefficient of 0.3
>>
>>Rerunning the share valuation DDM model using a 'better' of 0.3
>> gives
>>
>>WRI Equity WAC = 5.87%+ (0.3)(8.35% - 5.87%)= 6.61%.
>>
>>If I take this years core dividend of 2.5c + 6c= 8.5c as my starting
>>point, then using the DDM model I get one WRI share to be worth:
>>
>> = 8.5c/( 0.0661-0.0218 ) = $1.92
>>
>> Any comments on that?
> 
>Hi Snoopy
> 
>Rating a share on its ability 'to generate cash on a consistent basis'
>(if I have interpreted it correctly?) does appear to have merit.
>

Yes I have great sympathy with the 'cash is king' philosophy.     What I 
am saying here is if a company generates imputation credits, whether 
those credits are paid out as dividends immediately or not, those are 
real profits it is making - no argument.

Not revaluation of properties, not revaluation of brands, not tax losses 
carried forward from historic bum deals.    And not pie in the sky 
promises for next year.   All of those can be fudged by accountants or 
doctors of spin.   But there is no fudging of imputation credits.    
Imputation credits represent real tax paid on real profits as declared to 
the tax department.    It is the ability to generate imputation credits 
consistantly into the future that is ideal quality we want in a company.


>
>Can you direct me to where I can get info on this 'co-efficient'? 
> 

Sure can.   It's full name is the 'Dean-Snoopy coefficient' and it is being 
developed right here on sharechat by you and I, and any other 
sharechatters who want to join in of course :-)

>
>The
>only comment I would have and it would only be speculation as I have
>no info on your model, is the rating you have given WRI for debt
>repayment.  Taking past performance into account WRI debt 
increased
>steadily between 1994-97 to the point where they basically had to sell
>off their finance assets to repay it.  Does the input ignore this?
> 

It is open to question how far back you should go.   1994 to 1997 was 
the era of the previous managing director ( an didn't he get a barreling 
in that Grant Samuel report! ).

I would like to come up a simple formula to work out the 'dsc' 
(coefficient) so that we can plug it into the formula below and work out 
'the average cost of equity' by considering.

1/ the company's ability to earn imputation credits
2/ the company's ability to pay back long term debt *and*
3/ Company's consistency of profitability.

You need *all three* to make up a really low risk company.   Somehow 
you have to consider them all together and with the state our coefficent 
is in at the moment it becomes a judgement call.

On top of this, on further thought, there is a fourth factor we need to 
consider.   That is, where is the share price trading in relation to the 
'fair valuation' band.    In the case of WRI, Grant Samuel has give us 
this band.   It is $1.33 to $1.54 (the fair valuation, less the premium for 
control).  

The share was trading at $1.40 today, so that means the 'expected 
downside risk' is only 7c (a loss of 5%).     Throw in an 'expected 
upside risk' of 10% (should the share go to $1.54)  to go with it.  
Couple up with the fact that there is no chance that WRI will default on 
their long term debt (because they haven't got any) and 'to me' that 
means shares in WRI at $1.40 have a 'safety value' very close to cash.
Cash has a 'dsc' of 0, but how did I get the 'dsc' value of 0.3 for WRI 
shares?   I pulled it out of my judgement hat!

Average cost of equity formula

're'='rf'+ ('dsc')( E(rm)-'rf' )

SNOOPY


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