Case Study: Peak Earnings, Value Traps, Cyclical Industries, and Chevron

peak earnings value traps cyclical industries 3As I was running and making zero forward progress on the treadmill last night (as part of the marathon training we are going through at the moment), I had the Nightly Business Report playing on PBS as I usually do when I run on the treadmill and a light bulb in my brain suddenly clicked – a file cabinet in my brain sprung open, information coalesced, and the problem I had been thinking about on and off for several months made crystal clear sense. I had been chewing over the problem of cyclical industries and the dangers of peak earnings and investing value traps. What was puzzling me was that, although it made perfect theoretical sense to me at an instinctual level when I read about it, I just couldn’t fully master it, if that makes any sense. I was missing a vivid example that resonated with me, an example that would make it all come together in a clear, coherent picture. Running, pondering about our energy holdings, and the Nightly Business Report segment on oil last night made it all come together.

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A Quick and Dirty, Back-of-the-Envelope Method for Valuing Berkshire Hathaway

the intrinsic value of berkshire hathawayBerkshire Hathaway is a bit of an anomaly when it comes to conducting a valuation of the business. On the one hand, it is an incredibly complex, and often times secretive, operation where getting exact details of quantitative data can be incredibly difficult. For example, if you peruse the annual reports or 10Ks, the income statement will be presented in a very general sense but not provide details on each individual business unit. However, on the other hand, Warren Buffett has dropped a ton of hints along the way in his annual letters on what he believes is the intrinsic value of the business. Seeing as the most recent annual report has recently come out, Berkshire is on my mind. So let me give you an introduction on how to do a quick and dirty calculation to figure out the intrinsic value of Berkshire Hathaway.

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A Simple Way to Look at Discount Cash Flow

TSMLFor me, value investing is the only logical approach to investing. I recently wrote about how the price you pay for an asset will determine its rate of return, using a condo as a simple example. It really is as simple as that: you need to determine the rate of return you are seeking and then calculate the appropriate price to pay for the cash the asset will generate into the future. Value Investors will talk a lot about discount cash flow analysis. I’ll show you a simple way to look at discount cash flow and how it connects to the price of an asset and the rate of return you are seeking. If you’re still feeling slightly confused, don’t worry, let me show you what I mean by using the ad revenues of this website to determine what price you would need to pay to purchase this asset’s cash stream.

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