New Value based stock valuation tool in Australia

[selcon]

Hi Pedro,

I've been reading the materials on Clime Asset Management's website and have been trying for a long time to figure out the valuation method that they use. Your excel sheet was an excellent excellent help!

There is still one major point that I don't understand. The formula you put in the spreadsheet to calculate the eventual fair value, I saw that in a CAM article titled "When Share Price Falls Make Headlines and How to Avoid Them". Would you be able to explain how that formula works?

I understand that the numerator represents the "terminal value" that is n years away (e.g. n = 5). Then there is this complicated adjustment of the discount rate R in the denominator to adjust for dividends. Would really appreciate it if you could explain how that adjustment works.

Thanks much.

[Pedro-Egoli]

Selcon,
First off welcome to the forum.

The spreadsheet produced was just to show how it was constructed, and is based on information by Stockval's creator Brian McNiven, in his book "A wonderful company at a Fair Price".

There are various components that make up individual items (eg. C23 "Attributable Retained Earnings" ) ,relates to BROE (Benefical Retained Earnings - which is BE (Benefical Earnings "Grossed up dividends Plus retained profit and amortisation of intangibles,plus or minus changes in reserves, which also need to be adjusted for abnormals and changes in reserves that cannot be attributed to the core operating activity")
this figure is then divided by the average equity employed during the financial year.
Having said that you will see that the formula and principles involved need to be absorbed on a bit by bit basis and that is what the book sets out to do .
Formula involves the Equity Per share , BROE , IRR , required rate of Return on investment and the term.
Some of the terms are those chosen by author and , as I said above, need to be absorbed to see where he is coming from.
To do this it is probably best you read the book, which is well written and worth buying (mine cost $29.65 from Angus & Robertson a few years ago) and should give you the answers to what you are seeking.

[benthonic]

Ah, so that's the connection. I went to a Roger Montgomery presentation, and was given a copy of Brian McNiven's "Market Wise" pub. 2006 (which is heavy going but full of sensible stuff)

At the presentation, Roger M said something that I have been mulling over. It is in relation to ROE and whether it is best to reinvest earnings or pay them out as dividends. His comment was along the lines that in the future, with Superannuation being a powerful and increasingly dominant way to hold assets, it won't matter whether a company pays a dividend or not, because in a zero or low tax environment, the asset holder can just sell a portion of the holding. No capital gains tax.

But to me this misses out accounting for the transaction costs, and ignores benefits of franking.

The context was that for high ROE companies, discounted cash flow calculations show that over the years, it is better, all things being equal and the company maintaining a similar performance, to reinvest any earnings than 'waste' the money paying it out. Performance of the company and net benefit to shareholder can increase at a faster rate this way. For low ROE companies a high dividend is the best way to spread the love around.

B.

[Pedro-Egoli]

Benthonic,
A quick and easy way to see whether retained earnings have been used profitably by company is to check out the increase in profit is above the increase in equity.

Put simply if the ROE has increased from year to year this is happening.

Another thread which discuss the profitability issue is
http://www.sharesguru.com/forum/viewtopic.php?f=4&t=4065

And this one on Brian McNiven Beneficial earnings

http://www.sharesguru.com/forum/viewtopic.php?f=1&t=1923&p=12876&hilit=brian+Mcniven&sid=b9cfa894a15e454c2021811d72d9f193#p12876

In the Stockval formula it takes into consideration the dividend and franking credit ,

[benthonic]

Thanks Pedro, I knew they were somewhere. It isn't laziness on my behalf but hours in the day; but the SG institutional memory is something eh?

[selcon]

Hi Pedro,

Yes I understand Brian McNiven's terms (beneficial earnings, etc.) and his valuation framework, having read through chapters from two of his books: i) Stock Valuation using StockVal: How to Select Under-Priced Stocks, and ii) Market Wise. Though I agree with much of his reasoning, I think there's some logical flaws in the way he has implemented it. But putting that aside for a moment, I'm interested to understand his valuation formulas.

So far, I've seen 3.

In the "Stock Valuation using StockVal" book (1997), the formula was Intrinsic Value = EQPS * IRR / RR * (1 + EP%)^7, where EP% is the Excess Premium, defined as Min(IRR - RR, RB), where RB is the retained beneficial earnings (i.e. RB + D = IRR)

In Roger Montgomery's piece "Avoiding Share Price Collapses" (2002), which I assume follows Brian McNiven's stuff exactly, the formula was Intrinsic Value = ROE * (EQPS * (1 + RE / EQPS)^n) / RR / (1 + (R - EQPS / (EQPS*ROE/RR) * (DPS/EQPS)))^n. I think the StockVal program use n=5.

In Market Wise (2006/2007), the formula was Intrinsic Value = (APC / RR * RI + D) / RR * EQPS, where APC = Adopted Performance Criteria (which can be IRR or ROE), and RI + D = APC.

I've not read "A Wonderful Company at a Fair Price", so I don't know if there's a 4th formula. Basically, In both "Stock Valuation using StockVal" and "Market Wise", Brian did not go into the mathematical details of how the the formulas were derived, and that is what I'm interested in. For example, in the 1997 formula, how did he end up with this formula which has the EP% defined as min(IRR - RR, RB). In the 2002 formula, how did he end up with that complicated adjustment to the discount rate. In his 2006/2007 formula, he highlighted that some simplifications were applied, what were the simplifications?

If you're able to help with understanding the mathematical derivation of the formulas, that would be great.

[Pedro-Egoli]

Selcon,
Sorry for delay in replying , been away .

Also sorry I cannot give you any help with what is behind formulae.

However, I did receive from John Price a copy of updated version of Valuesoft and in it he has a formula for Dividend Discount methods which he calls "DDM"

Using the updated figures for TRS I input these into the spreadsheet previously posted and it changed the figures from estimates in 2007.
This had the effect of changing cell E21 from $8.90 to $5.74.
Using the Valuesoft DDM formula the price came in at $5.69.

In his email advice he mentioned

A few months ago I introduced new margin of safety functions into Valuesoft. Now I have introduced two more functions: DDM and SV.

DDM is a function for calculating the intrinsic value of a stock using the Dividend Discount approach. Its main inputs are return on equity and the payout ratio, the proportion of earnings that are paid out as dividends. It is a two-stege model meaning that you can assume different values of the inputs over, say, the first 10 years and for the remainder of the time.

SV is a restricted case of DDM using the based on calculations StockVal®. SV is included in Valuesoft so that you can compare calculations.

I have also added a new material on valuations using Discount Cash Flow methods and an entire new chapter on Dividend Discount Methods with a discussion of the strengths and weaknesses of these methods..

Valuesoft now contains 16 functions for calculating and estimating the value of stock 6 functions

Of course you will need to purchase the product from John Price, but if you contact him and tell him you are a forum member, and was told about the new DDM by Pedro .
He did post on here early in the piece and can be contacted at
johnp@sherlockinvesting.com

Contact details are

[drewd]

Hi Pedro-Egoli,

I have been looking around for various valuation tools. Have you found the Valuesoft tools to be of benifit?

Kind Regards

DiggerD