METHODS

VALUE INVESTING


Element 1 : The Value of the Assets

First, we can speak about the present condition of the company. We are going to start with an asset value for the firm. We begin with the balance sheet and examine the value of the company's assets at the end of the most recent operating period, as determined by the company's accountants. We know that these accounting values are to be more accurate for some assets than for others. Thus as we work up the balance sheet, we accept or adjust the stated numbers as experience and analysis dictate. We do the same for the liabilities side of the balance sheet. At the end, we subtract liabilities from assets to obtain the current net asset value. There is no need for us to forecast the future. The assets and liabilities exist today. Many of them are tangible (or quasi-tangible, like money in the bank account as confirmed by the bank). and these can be valued directly with great precision.


Element 2 : Earnings Power Value

The second most reliable measure of a firm's intrinsic value is the value of its current earnings, properly adjusted. This value can be estimated with more certainty than future earnings or cash flows, and it is more relevant to today's values than are earning in the past. To transform current earnings into an intrinsic value for the firm requires us to make assumptions both about the relationship between present and future earnings and about the cost of capital. Because we need to rely on these assumptions, intrinsic value estimates based on earnings are inherently less reliable than estimates based on assets.


Element 3 : The Value of Growth

When does growth contribute to intrinsic value ? We have isolated the growth issue for two reasons. This third and last element of value is the most difficult to estimate, especially if we are trying to project it for a long period into the future. Uncertainty regarding future growth is usually the main reason why value estimations based on present value calculations are so prone to error. By isolating this element, we can keep it from infecting the more reliable information incorporated into the asset and earnings power valuations.