Value, Special Situations, author, Valuation
Contributor Since 2007
I am an author of books related to the decision framing and optimizing processes of Buffett and Munger. These books are available at www.frips.com and: http://www.amazon.com/Bud-Labitan/e/B002D1ERT4 With integrity and patience, we can also earn superior profits by carefully evaluating facts and continuously exercising discipline. I have been a steelworker, student, medical doctor, county board of health member, medical director, and a software developer. In 2003, I earned my MBA, and started a career in intrinsic value investing. You can contact me via email: firstname.lastname@example.org
A Rough Valuation of JPM with a penalty perspective.
Does JPM make for an intelligent investment or intelligent speculation today? Keeping in mind that valuations are estimations of the productivity of an ongoing business, how do we adjust in a penalty for the recent mark-to-market loss of about $2 billion in the first six weeks of the second quarter? For this risk taking debacle, and for simplicity sake, I adjust its forward growth rate downward. Think of it as an impairment to goodwill that places friction on potential forward growth rate.
Let us do a simplistic valuation of the stock's intrinsic value per share. Starting with a base estimate of annual net income flow at a value of approximately $17,500,000,000 and the number of shares outstanding at 3,810,000,000 shares; we use an assumed FCF annual growth of 5 percent for the first 10 years and assume zero growth from years 11 to 15. Review the Free Cash Flow record here: http://financials.morningstar.com/income-statement/is.html?t=JPM
The resulting estimated intrinsic value per share (discounted back to the present) is approximately $60.13.
Market Price = $33.5
Intrinsic Value = $60.13 (estimated)
Price To Value (P/V) ratio = .56 and the estimated bargain = 44. percent.
Before we make a purchase, we must decide ( filter #1 ) if JPM is a high quality business with good economics. Does JPM have ( filter #2 ) enduring competitive advantages, and does JPM have ( filter #3 ) honest and able management.
Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But, high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.
Growth benefits investors only when the business in point can invest at incremental returns that are enticing; only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor. The wonderful companies sustain a competitive advantage, produce free cash flow, and use debt wisely.
Does JPM make for an intelligent investment or speculation today? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today? If JPM can get its house in order, there may be a decent bargain here for the longer term investor.
Bud Labitan, MD, MBA
is the author of "The Four Filters Invention of Warren Buffett & Charlie Munger" and "Price To Value" and "Moats: The Competitive Advantages of Buffett & Munger Businesses"
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.