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  • Why PepsiCo Is Better Than Coke For Dividend Investors [View article]
    5 years ago Coke was clearly the better value than Pepsi. Pepsi stock is flat because it was probably overvalued in the past. Of course, what matters is now, not 5 years ago. Now, Pepsi appears to be a better value than Coke. If I had done this same analysis 5 years ago I would have come to the opposite conclusion.
    Apr 12, 2012. 05:20 PM | 4 Likes Like |Link to Comment
  • Discounted Cash Flow: What Discount Rate To Use? [View article]
    The risk that I care about is the risk of the future cash flows not occurring or being less than I estimated. This risk has nothing to do with beta or the past stock performance or volatility. A company uses WACC to determine if a project will be profitable, and that's all well and good. But when you make an investment, you have a specific rate of return that you require. This should be your discount rate. Why would you discount at the company's WACC ( or whatever other CAPM-derived rate)? Why do I care about WACC if I require a specific return? If you can find anything wrong with my explanation of discount rate in this article (above the discussion of WACC), let me know.

    If you were offered a private company that generates $1 million per year in cash flow, the amount you would be willing to pay for that company depends on the rate of return that you require. It's no different for a publicly traded company. There is no "correct" discount rate. If I required a 10% rate of return I would pay at most $10 million for this hypothetical company. I would then apply a margin of safety to account for the risk of the cash flows not occurring, and that would give me the highest price I'd be willing to pay to achieve my return.

    You can calculate whatever you want from beta or CAPM or whatever and use that as a discount rate. You could also count the number of fingers that you have and use that as a discount rate. Both are equally valid discount rates. Neither one is "more correct" than the other. The danger is not understanding what a discount rate actually is.
    Mar 28, 2012. 06:26 PM | 2 Likes Like |Link to Comment
  • Buy Corning At A Discount [View article]
    Many people use the WACC as their discount rate, but it makes absolutely no sense to do so. WACC depends on cost of equity which depends on beta which is a measure of past correlation between the stock price and the market as a whole. Basing the value of a company on past performance of the stock doesn't make sense. Many people consider beta as a measure of risk, but it is only the risk of short term volatility in the stock price and has nothing to do with the risk of the company. A cash flow is a cash flow, regardless of the underlying stock performance. I use 15% because that is how much i value a future cash flow; it is my required rate of return. There is no "correct" discount rate, it depends on your expectation for the investment.

    Another problem with WACC: Imagine two identical companies, except one has half of it's capital structure as debt and the other is all equity. The company with more debt would be given a lower discount rate according to WACC, since the cost of debt is typically lower than the cost of equity. I would argue that the higher debt company carries more risk.

    I base the growth rate on the return on invested capital, and reduce it each year to a low long term growth rate since the further you project, the more uncertain you are. I think it is pointless to try to come up with more "exact" numbers based on competition, etc. for a company like Corning. I assume that Corning will continue to generate return on investment generally in line with the past. They've been a company for a very long time and have a long history of doing so. So it seems reasonable to assume that this will continue. Obviously, for a small company with short history this would be more dubious. And this is why Margin of Safety is important. It allows you to be occasionally be wrong and still achieve your desired rate of return.
    Mar 26, 2012. 02:18 PM | 2 Likes Like |Link to Comment
  • Cisco Has Entered The Bargain Bin [View article]
    Last year there was so much pessimism about Cisco when it was around $16. I don't know if it'll ever get that low again, but given the irrational prices that pop up from time to time I wouldn't be surprised.

    @kcajc, I would be buying if I wasn't fully invested. If I sell any of my positions soon Cisco is on the top of my list.
    Aug 16, 2013. 08:56 PM | 1 Like Like |Link to Comment
  • McDonald's The Stock Is Ahead Of McDonald's The Company [View article]
    PBI isn't growing and has a huge amount of debt. Owner earnings have been decreasing, so if i assume no growth going forward I put the value around $10 per share using the same method as in the article, so it's a far worse investment than McDonalds'.
    Apr 6, 2012. 11:48 AM | 1 Like Like |Link to Comment
  • McDonald's The Stock Is Ahead Of McDonald's The Company [View article]
    I don't see capital expenditures as a "bad thing". The definition of owner earnings is the amount of cash that can be pulled out of a business after expenditures needed to maintain the business and long-term growth. It doesn't make sense to not deduct capital expenditures from operating cash flow because that money needs to be spent.

    I am not making the claim that management is not investing their cash flow efficiently. I made a point in the article saying that they are. All I'm saying is the the current market price is high relative to how much I think the company is worth based on how much cash they generate.


    Apr 5, 2012. 10:06 PM | 1 Like Like |Link to Comment
  • McDonald's The Stock Is Ahead Of McDonald's The Company [View article]
    Ultimately what matters is how much cash a company generates. Earnings is an accounting number and can be easily manipulated while cash flow is much more indicative of profitability.

    All I've done is calculate the future value of cash flows discounted back to today. The growth rates I used are clearly stated. I don't see what's confusing about it.
    Apr 5, 2012. 08:29 PM | 1 Like Like |Link to Comment
  • Discounted Cash Flow: What Discount Rate To Use? [View article]
    The biggest danger with using DCF is adjusting parameters until you get what you want. I always use the same discount rate and always demand a significant margin of safety. Consistency is the most important thing.
    Mar 28, 2012. 11:06 AM | 1 Like Like |Link to Comment
  • Cisco: The Danger Of Price Targets [View article]
    I don't believe beta has anything to do with the riskiness of the company. According to Yahoo finance, Cisco has a beta of 1.38 and Green Mountain Coffee Roasters has a beta of 0.68. I would argue that Cisco is much less risky an investment that GMCR. The riskiness is a property of the business itself, and fluctuations in stock price are irrelevant.

    If I only require a market rate of return, why not just invest in an index fund? Why bother with individual stocks? My goal is to find stocks that are almost certainly significantly undervalued. I don't need to find 100 stocks that meet my requirements. Sometimes there will be none. But by buying only at a large discount you eliminate much of the risk. Cisco is much less risky an investment at $18 than at $25. I don't expect the market P/E multiple to increase. What I expect is that in the long term stocks fluctuate around their fair value. What that fair value actually is is debatable. But I try to be consistent with my valuation method. Basing the value of future cash flows on past performance of the stock and capital structure, as many people do, makes no sense. If I told you "I'll give you $1000 a year for 10 years", how much would you pay for that cash flow? It depends on what you require as a rate of return. You then apply a margin of safety to account for the risk of me not paying you.

    Mar 23, 2012. 10:57 AM | 1 Like Like |Link to Comment
  • Get Paid 16% To Buy Cisco At A Great Price [View article]
    Cisco's free cash flow is about 2.5 times higher today than it was 10 years ago. If I had estimated its fair value 10 years ago using the same analysis I would have concluded that it was dramatically overvalued and I wouldn't have touched the stock with a ten foot pole. This is a case where the company was playing catch-up with the stock, and for Cisco it took about a decade.
    Jun 26, 2012. 09:53 PM | Likes Like |Link to Comment
  • Get Paid 16% To Buy Cisco At A Great Price [View article]
    The goal of this strategy is to ultimately buy shares of Cisco as a long term holding at a price that you're comfortable with. One bad earnings report doesn't change what I think the company is worth, so if it does tank after earnings I certainly wouldn't sell my shares. I'd probably buy more, as my original thesis that the stock is undervalued is still intact.
    Jun 26, 2012. 09:45 PM | Likes Like |Link to Comment
  • McDonald's Is A Dividend Investor's Dream [View article]
    I don't have enough money to invest in every stock that I write about. McDonald's is certainly on my list of stocks I'd like to own, but it's not possible for me to buy shares in the immediate future.
    Jun 15, 2012. 06:46 PM | Likes Like |Link to Comment
  • Chevron Is A Great Dividend Stock [View article]
    I chose 9% because it's in line with the growth for the last few years. It may even be a little conservative. Typically any discount valuation method like this has an initial growth period and a long term slow-growth period. This is because trying to predict the dividend increase 10 years from now is full of uncertainty, so after 10 years I set the growth rate to roughly the growth rate of the GDP. The calculation is basically a conservative estimate of fair value, and even under these conservative assumptions Chevron offers a good value, so faster dividend growth would make it an even better deal.
    May 3, 2012. 08:43 PM | Likes Like |Link to Comment
  • McDonald's The Stock Is Ahead Of McDonald's The Company [View article]
    The big difference is probably the discount rate used. Discount rate is the rate of return you require on your investment, and i'm guessing Morningstar uses the weighted-average-cost-... as their discount rate, which I don't agree with.
    Apr 9, 2012. 03:22 AM | Likes Like |Link to Comment
  • Dell Is A Steal At These Prices [View article]
    I think you're right about changes in working capital. Some people insist that it should be included, and others insist that it shouldn't be, but what you've said makes sense. I'll have to modify my valuation technique; thanks for the input. In the case of Dell it appears that this doesn't affect the end conclusion that Dell is undervalued.

    I also agree that there may be a better way to incorporate the stock-based compensation. I'll have to think about the best way to do this.
    Apr 9, 2012. 03:18 AM | Likes Like |Link to Comment
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