Posted by: JavaBeans December 29, 2012
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This looks interesting plano80.
Some thoughts before I jump into the calculations:
1) Use of EBIT multiples - this is widely used for valuations but I tend to avoid it. Simple reasons are that (by using EBIT) we omit other operating expenses such as working capital, non operating expenses (which of course is real) such as interest (obligation to creditors) and taxes (govt. want their share), and finally capital expenditure as it is an inevitable component of (any) growth.
2) Growth - assuming the 5% growth refers to operating income (ignore if you meant revenue as operating income return can differ, of course) and using your required rate of return of 10% - there will be a deterioration in value in the long term. As an example, let's say if you paid $7.5m outright for ELSE you would expect to receive ~$750K each year - this is approximately 10% return. Then suppose you decided to reinvest all of it ($750k) to grow the firm. If that incremental investment earns you only $37.5 in operating income (which is 5%) then the value of your original investment has deteriorated - as the return on your incremental capital is less than your required return. In order to increase value we'd like to see return on capital being equal to or greater than the required rate of return.
Quick back-of-the-envelope calculation for ELSE
Years used: 2008 - 2012 (note: last quarter of 2012 is an estimate - exception is the B/S which uses last recent quarter Sep 2012)
Total value: ~$14.1m
Value per share: ~$4.15
Current market price: $3.90
Debt size and cash return looks good - however a few concerns:
Revenue is stable to decreasing (about negative CAGR of 2% per annum)
Discount from value to the current price is about 6% - I would like to see about 20%.
Above is just an initial filter to engage an interest for further research. Before recommending we would want to do a full fledge analysis, i.e. ELSE's business dynamics (industry landscape and corporate strategy), management leadership and so on.
Usual disclaimer: above is not a recommendation to buy or sell - written for educational purposes only.
-JB
Some thoughts before I jump into the calculations:
1) Use of EBIT multiples - this is widely used for valuations but I tend to avoid it. Simple reasons are that (by using EBIT) we omit other operating expenses such as working capital, non operating expenses (which of course is real) such as interest (obligation to creditors) and taxes (govt. want their share), and finally capital expenditure as it is an inevitable component of (any) growth.
2) Growth - assuming the 5% growth refers to operating income (ignore if you meant revenue as operating income return can differ, of course) and using your required rate of return of 10% - there will be a deterioration in value in the long term. As an example, let's say if you paid $7.5m outright for ELSE you would expect to receive ~$750K each year - this is approximately 10% return. Then suppose you decided to reinvest all of it ($750k) to grow the firm. If that incremental investment earns you only $37.5 in operating income (which is 5%) then the value of your original investment has deteriorated - as the return on your incremental capital is less than your required return. In order to increase value we'd like to see return on capital being equal to or greater than the required rate of return.
Quick back-of-the-envelope calculation for ELSE
Years used: 2008 - 2012 (note: last quarter of 2012 is an estimate - exception is the B/S which uses last recent quarter Sep 2012)
Total value: ~$14.1m
Value per share: ~$4.15
Current market price: $3.90
Debt size and cash return looks good - however a few concerns:
Revenue is stable to decreasing (about negative CAGR of 2% per annum)
Discount from value to the current price is about 6% - I would like to see about 20%.
Above is just an initial filter to engage an interest for further research. Before recommending we would want to do a full fledge analysis, i.e. ELSE's business dynamics (industry landscape and corporate strategy), management leadership and so on.
Usual disclaimer: above is not a recommendation to buy or sell - written for educational purposes only.
-JB