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Research and Analysis


getting more sophisticated – trying to prove something rather than see if we can disprove it by killing the business – we get into trouble. Bruce Berkowitz, 4.28.06

I’d consider our style more as GULP, growth at unreasonably low prices. Why pay a reasonable price for anything? If you’re ever in Pennsylvania and see a license plate that says “10XFCF”, that’s me. That comes from Bill Miller speaking about how things trading at ten times free cash flow, if you understand the business, don’t go down much. Our clients over the years have made a lot of money off that advice. James Clarke, 10.31.06

We value companies based on our estimate of earnings per share, usually two or three years out. I don’t look six months to a year out because too many other people are doing that, and I don’t look four or five years out because there are too many uncertainties in looking out that far. Then it’s a question of putting a multiple on those projected earnings. Over the past forty years the stock market has sold, on average, at about 15x earnings, so I conclude that an average company is worth 15x earnings. Aboveaverage companies, of course, should be worth more than 15x. Ed Wachenheim, 2.29.08

equities over long periods of time has been around 10%. When you clean up the accounting, the real return on equity [ROE] of American business averages in the low teens. So our conclusion is that a stock’s return will approximate the company’s ROE over time, given a constant valuation and absent distributions. So we choose to swim in the pool of companies where the returns are a whole lot better than average, in the 20% range. Charles Akre, 11.30.06

We’re looking for businesses whose shares are trading at a 40% or more discount from our assessment of their private market value. To avoid value traps, we focus on companies that have forward expected movement in that intrinsic value per share from positive growth dynamics. Finally, we’re looking to invest in management teams that treat shareholders as partners. As long as each of those elements remains in place, our preferred holding period is forever. Clyde McGregor, 4.30.08

The metrics we use to determine value are pretty much what you’d expect. We do private-market-value analysis using discounted future cash flows and by looking at breakup values. At the same time we like stocks that are statistically cheap on a traditional price/earnings basis. We focus

Winter 2008

Once we understand the business and where we think it’s going, we’ll estimate the sustainable free cash flow the company can generate – net income, plus depreciation and amortization, minus maintenance capital spending. Depending on the growth potential, defensibility and profitability of the business, we’ll put a 10- 14x multiple on that free cash flow to arrive at a target price. At a minimum, we want to expect to make at least 50% over the next two years. Robert Lietzow, 2.29.08

We define intrinsic value as what a knowledgeable investor or corporate competitor would pay, in cash, for 100% of the company. From the ground up we build that by making all the relevant adjustments to the income statement and balance sheet, then applying a multiple that reflects the quality of the business to the resulting normalized earnings. Charles de Lardemelle, 11.26.08

Essentially, we forecast three years out what we believe a company is going to earn and then, based on its expected return on capital, its capital growth and prevailing interest rate levels, we arrive at the multiple at which we believe the shares should trade. Including any dividends, we want to see a minimum 25% annualized return potential over three years. Randall Abramson, 12.21.07

In probably 90% of the cases we use 15x as our target multiple of normalized free cash flow. That has been the average for American stocks over the past 200 years and it results in a roughly 6.5% freecash-flow yield, which is quite reasonable if risk-free interest rates are 4-5%. Francisco García Paramés, 11.26.08

I look at it this way: The average annual total return from

on companies trading at a 40% or greater discount to our private market value or no more than 13x our estimate of next year’s earnings. We have to have one or the other to buy. John Rogers, 11.30.05

“I do my own thing.”

We don’t have a problem with cyclicality. Wall Street still looks for certainty in areas Value Investor Insight 21

Words of Investing Wisdom  

Greatest Hits” collection of investing insight from Value Investor Insight

Words of Investing Wisdom  

Greatest Hits” collection of investing insight from Value Investor Insight