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 (NYSE: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. Click here for an in-depth, narrated presentation of our process.
This involves performing significant valuation analysis, both on a DCF and relative value basis, as well as assessing 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 SOHU's (NASDAQ:SOHU) case, we think the shares look undervalued at today's prices. Our fair value estimate for SOHU is $79 per share, over 40% higher than where it is currently trading. In the spirit of transparency, we make available our fully-populated DCF valuation models to all of our financial advisor and institutional customers here (we also make available our DCF valuation model template for interested individual investors).
We assume annual average top-line growth will average in the high teens over the next five years. We also assume that SOHU 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 13%) by Year 20 in our model.
Our estimated fair value ranges between $53 per share and $105 per share. Though this is a relatively large range, it considers the risks inherent to SOHU's business as well as the future potential variability in the company's free cash flow stream. SOHU is on the watch list for consideration in the portfolio of our Best Ideas portfolio.