But how, you will ask, does one decide what [stocks are] "attractive"? Most analysts feel they must choose between two approaches customarily thought to be in opposition: "Value" and "growth" ... We view that as fuzzy thinking ... Growth is always a component of value [and] the very term "value investing" is redundant. -- Warren Buffett, Berkshire Hathaway (BRK.B) annual report, 1993
We take Buffett's thoughts one step further. We think the best opportunities arise from a complete understanding of all investing disciplines in order to identify the most attractive stocks at any given time. We therefore analyze each stock across a wide spectrum of philosophies, from deep value through momentum investing.
This involves performing significant valuation analysis, both on a DCF and relative value basis, as well as a strong consideration of the firm's fundamentals (cash flow, risk, etc.), technicals and momentum indicators. The best stocks, we believe, will be attractive from a number of investment perspectives -- from value through momentum (hence our name, Valuentum). On the other hand, the worst stocks will be shunned by most investment disciplines and display expensive valuations and poor technicals and momentum indicators.
As part of our process, we employ a discounted cash-flow model to arrive at a fair value estimate for every company within our equity coverage universe. In Abbott's (ABT) case case, we think the shares look undervaled at today’s prices. Our fair value estimate for Abbott is $63 per share, over 25% higher than where it is currently trading. In the spirit of transparency, our DCF model valuation template can be found here. We make this template available to investors, and it can be re-used to value any other operating firm in your portfolio.
We assume annual average top-line growth will average in the mid-single-digits over the next five years. We also assume that Abbott will grow earnings at a mid-teens pace during our discrete five-year horizon. We expect the firm’s excess returns on invested capital will fade to our estimate of its cost of capital (about 9%) by Year 20 in our model.
Our estimated fair value range between $50 per share and $76 per share considers the risks inherent to Abbott’s business, as well as the future potential variability in the company’s free cash flow stream. We'd consider adding Abbott to our Best Ideas portfolio, if it became relatively more attractive than our existing long ideas.