How to Value Stock | QRTEA Quick Value
Business valuation is not rocket science, if you’re not understanding it I hope this article helps.
Here is my method of valuation.
1) Balance Sheet Value
The balance sheet contains all of the business’s assets and liabilities. The goal here is to estimate the value of the balance sheet (snapshot of the business at the specified date). We value the balance sheet by adding up all of the assets and then subtracting the liabilities.
*Cash is the most appealing asset on the balance sheet.
Pro tip - Assets minus liabilities = shareholders equity (found at the bottom of the balance sheet).
Shareholders equity = Book Value
When evaluating the balance sheet always take note of:
Current assets minus current liabilities.
Cash to current liabilities
Current assets can generally be turned into cash in 12 months.
Current liabilities generally are bills that need to be paid within 12 months.
Net working capital refers to the difference in current assets and current liabilities and is a measure of the companies short-term liquidity.
If a company can’t pay its bills it can attempt to sell long turn assets in exchange for cash, but this can come at a cost. Assets may have to be discounted or the assets being sold may hinder the companies operations.
Let’s look at QRTEA as an example.
Assets:
Current Assets:
Cash: $739m
Total Current Assets: $4,135m
Total Current Liabilities: $4,220
Net Working Capital: = -$85m
Because the current assets are less than the current liabilities that should signal to us to do two things:
Check total assets compared to total liabilities
Check if the company has free cash flow or cash burn.
If the company has excess free cash flow than we estimate if that cash will take care of this minor deficit in net working capital (current assets minus current liabilities).
Total Assets: $16,571m
Total Liabilities: $12,807m
Shareholders Equity: $3,636m
Shares Outstanding: 409m
Book Value Per Share: $8.88 per share.
Shareholders equity can be thought of as the number of dollars in the business that is owed to shareholders.
This is a soft check. If the opportunity is worthwhile we will come back and evaluate the details of the current assets to ensure we aren’t going to find any unexpected surprise. Similar to how traded players in sports have to pass a physical examination before the teams execute the trade. In investing we should run a more in-depth analysis before booking a trade. Saying that, do not waste your time going through in-depth analysis on opportunities that do not offer adequate opportunity. Your time will always be better spent elsewhere, pick up a book, exercise, spend time with your family and friends, search for other trades.
2) The Income Statement
Remember it’s all about cash.
Pro tip: Always be aware of the market cap or as I like to call it “price tag” of the business to better help you have the perspective of the type of opportunity you are looking at. You want to find situations where you are paying a little in comparison to what you are getting.
Sales: is the total dollars given to a business by the customer (topline).
Cost of Good Sold: is the total cost to produce a product.
Gross profit: Sales minus COGS
Gross margin: gross profit/sales. For my investing, I generally like to see this number over 30%. Higher gross margins generally offer businesses more flexibility as more cash can be allocated to different aspects of the business to scale or to be returned to owners.
Now let's look at QRTEA Q1 2021 (a business analysis):
Market Cap for perspective is $4,700m or $4.7b
Sales: $3,337m
COGS: $2,195m
Gross Profit: $3,337m - $2,195m = $1,142m
Gross Margin: 34.2% (Gross Profit / Sales)
Operating Expenses (costs)
Sales, General, Adminstative, and other expenses: $641m (19.2%)
Depreciation and amortization: $128m
Total Operating Expenses: $769m (23%)
Operating Income: $373m
Operating Margin: 11.1%
Interest Expense: $117 (3.5%)
*some small line items I exclude for simplicity sake
Income Before Tax: $278m
Provision For Tax: $54m
Net Income: $224m
Net Margin: 6.7%
Note this is only one-quarter of earnings for QRTEA and business can fluctuate in performance quarter to quarter. Saying that this is a pretty good income statement.
Last Twelve Months
Next, I like to look at the numbers from the last twelve months.
Sales: $14,595m
COGS: $9,553m
Gross Profit: $5,041
Gross Margin: 34.54% (Gross Profit / Sales)
Operating Expenses (costs)
Sales, General, Administrative, and other expenses: $1,899m (13%)
Total Operating Expenses: $3,327m (22.8%)
Operating Income: $1,714m
Operating Margin: 11.74%
Interest Expense: $428 (2.9%)
*some small line items I exclude for simplicity sake
Net Income: $1,430m
Net Margin: 9.80%
This business has roughly 409m shares.
Net Income: $1,430m
Shares Outstanding: 409m
EPS: ~$3.50
My Valuation Method
I like to keep my valuation method consistent and I don’t care about exit multiples. If I get a great multiple when selling awesome, but I aim to buy assets that will put cash in my pocket at an adequate rate without trying too hard to guess at what I don’t know. Knowing what premium people are going to want to pay is unknowable and constantly changes depending on the market environment, don’t overweight exit multiples they’re better used for a very rough gauge as to how large the ballpark is.
The value on the balance sheet is very real. I like to use it as a starting point and a measure of risk, I call this a balance sheet margin of safety. Similar to Ben Graham’s liquidation value strategy.
QRTEA has a book value of $8.88
QRTEA had EPS of $3.50 (ttm).
So I start with $8.88 (generally we will discount this based on the quality of assets).
Next, I make a simple DCF to value the business’s future earnings. I like to estimate a range of scenarios, to do this I highly recommend learning about the business. This is where the journal comes to play.
Let’s keep things simple. If QRTEA makes $3.50 for the next 5 years how much is that worth?
To calculate this it is very easy. We use this formula:
Here is a quick model of QRTEA assuming EPS of $3.50 is stable, a discount rate of 15%, and a longevity of 5 years.
This shows that QRTEA’s earnings value is worth ~$11.73 per share. Now I add back the book value $8.88 to get a business valuation of $20.61 per share. As of right now, QRTEA trades for $11.50.
Bet Value
Business Value: $20.61
Price: $11.50
Reward: $9.11
Price: $11.50
Book Value: $8.88
Risk: $2.62
Reward to Risk: $9.11 / $2.62 reduces to a 3.47 / 1 opportunity.
For simplicity's sake, let’s assume there is a 50% chance QRTEA is only worth book value. Let’s also assume there’s a 50% chance QTREA is worth $20.61.
Let’s quickly value our bet.
Expected Value = ($ Reward x Probability of winning) - ($ Risk x Probabiltiy of losing)
QRTEA Expected Value
($9.11 x 50%) - ($2.62 x 50%) =
($4.555) - ($1.31) = $3.245 of expected value.
Edge is another word for expected value and represents the value of the opportunity.
Conclusion
Business valuation is all about cash. You’re simply trying to take a dynamic and living business and visualize it in cash. Business value is the total amount of profit that will be produced for shareholders over the lifespan of the business. If you pay $150 million for a business that only produces $30m in profit over the course of its lifetime that was a poor pick.
Do not fall into the trap of overpaying for stocks because you overestimate growth.
Do not overestimate how likely the upside is.
Business is a highly competitive game and many people overestimate businesses that are growing. The larger you get the more difficult the game becomes. The MLB is not easier than high school baseball, just because a business has success in high school does not mean that success will come as it progress through the next levels. Focus on identifying what is key for long term success.
In investing, growth is often overestimate and longevity is often underestimated.