Different valuation methods for different company and market characteristics

Today a client asked a question that sparked much interest. The individual was a seasoned investor who queried whether different valuation processes were required to estimate the fair value of different companies in different sectors. We strongly believe so. One has to appreciate where assets and liabilities may lie in different businesses by appreciating their different competitive landscapes, business models and accounting practices. Indeed, we try and categorise companies in a flexible way to try and determine how these factors may affect valuation and hence the price we would be willing to pay for the equity of a publically listed company.

Below I include one way we could perceive the intrinsic value of the highest quality companies (this method is not as relevant for other company categories). This category includes companies such as Coca Cola, hence we will use it as our example.

Coca cola is a company that has been doing the same business for over one hundred years. We think their is a credible possibility that it will continue to do so in the next one hundred years. If this is the case, what would be the present value of all the companies future owner earnings during that period should we discount them by 10%. How would the results vary as we altered our assumption for the compounded annual growth rate of the owner earnings during that period. The results are interesting.












We can see that at the current Coca Cola stock price of 54 USD (which is a market cap of approx. 126 billion USD), one is inherently assuming an owner earnings growth rate of 5% in the next 100 years. That may seem low, but I certainly wouldn´t feel comfortable betting that over a 100 year period.

However, assuming a 2% per annum CAGR is a bet I would be willing to play because this is the inflation target for most central banks around the world (in a world of fiat currencies we feel this stated inflation target should be met with ease). A company is not really growing if earnings increase by 2%, this would be purely an inflationary effect. Indeed, more astute investors may suggest that as historic interest rates average approx. 4.5% over the last 100 years, one should feel comfortable betting that region of CAGR for a high quality company over the next 100 years. They may be right - but the real assumption lies in what is a high quality company. As a result, should todays high quality company not be so good in 100 years, we would like to take a lower bet - 2% is fine for us.

At this minuscule rate of growth, you will be suprised to see the market cap of Coca Cola would still be estimated at 80 billion USD by discounting the owner earnings over the next 100 years. This is very close to the lowest price Coca Cola shares traded at in March 2009, approx 38 USD/share. By using this method as a reference, we were keen buyers of this companies stock as it traded between 40 - 42 USD/share.

We remain poised to purchase the common stock of other high quality companies as they approach values we feel comfortable in achieving a satisfactory return on our investment.

Sincerely,

Alessandro Sajwani