Australian Example

There are over 30 different functions in Valuesoft. most important activity of an investor is to be able to estimate with confidence the profit rate on buying stock in a company and holding it for your investment time frame. And you want to be able to do this based on numbers that you can see and adjust such as the growth rate of earnings.

You can do this and more in a few minutes with the Valuesoft Investment System.

Valuesoft provides essential tools for investors of all levels, from those just getting started to the most experienced professionals.

The building blocks of Valuesoft are investment functions. You can use these functions on their own. Or you can use them to build templates to suit your own needs. With these functions and templates you will be able to focus on the important aspects of investing and not get hung up on jargon, rumors, and complex calculations.

All the functions are clearly explained in the manual along with examples of different types of templates. The following is an example of how to use three of the Valuesoft functions to analyze a company.

Level 1 Templates

Let's do an analysis on ARB Corporation, the company that manufactures, distributes and sells four wheel drive motor vehicle accessories and light metal engineering works in Australia and worldwide. (ASX code: ARP). After having done some research on the company (its products, competitors, and so on), you are ready to crunch some numbers. This is where the Valuesoft Investment System comes in. We will look at three different templates each using a single function from Valuesoft:

• Stock Return using STRETD
• Stability using STAEGR
• Intrinsic Value using DCF2S

1. Stock Return using STRETD

Suppose you are considering an investment in ARB Corporation, the company that manufactures, distributes and sells four wheel drive motor vehicle accessories and light metal engineering works in Australia and worldwide. (ASX code: ARP).

After having done an analysis of the company (its products, competitors, and so on), you are ready to crunch some numbers. (For an example of a USA company, click here.)

This is where the Valuesoft Investment System comes in.

Suppose you are interested in estimating the percentage return on buying ARB now and holding it for 5 years. You will need some data. You can get what you need free from YahooFinance or from NineMSN Money. You can also obtain data from various online brokers such as Commsec. (You will need to open an account.)

For this example we will use MSN Money. The data we need is on the following pages. (Notice that instead of using the symbol ARP for ARB Corporation, we use AU:ARP since it is a U.S. site. If you use, Yahoo, you will need to use the symbol ARP.AX.)

Enter the symbol AU:ARP and click on Company Report. This gives you the page:
http://moneycentral.msn.com/detail/stock_quote?Symbol=au%3Aarp.

You will also need the page Financial Results (Highlights):
http://moneycentral.msn.com/investor/invsub/results/hilite.asp?Symbol=AU%3aARP

You might find it easiest to print these pages before you start. The following is the list of the required data. (More details of these terms can be found in our glossary Click here. For the financial glossary at Yahoo, click here.)

Current price: this is the last price at which the stock was sold
Earnings per share trailing 12 months (EPSttm): the total earnings of the company for the most recent 12 months (two half-yearly reports) divided by the number of shares outstanding. Think of this as the amount of money that the company is earning on your behalf for each share that you own.
Projected price to earnings ratio (P/E ratio): the current price divided by the earnings per share (Profile page).
Projected growth rate of earnings: this is a forecast of the average growth rate of earnings for the next 5 years. In the Level 2 Templates you will see how to use the historical growth rate with a margin of safety as a forecast. But for now we will just use 12 percent.
Years: the time frame of your investment. Generally this will be 5 years or more.
Payout rate: this is the percentage of earnings that the company pays out in dividends. You can find this on the Highlights page.

For things like the P/E ratio and the projected growth rate, don't worry too much about decimal places. It is likely that you will change them to more conservative figures when you have everything all set up.

The last two requirements are:

Tax rate on dividends: this is your marginal rate of tax.
Tax rate on capital gains: for simplicity I will set these at 0% in the following examples.

Enter this data into an Excel page to get something like shown in the following figure:

I have added some color and borders around the required data. 

In the cell I3 type =STRETD(A4,B4,C4,D4,E4,F4,G4,H4) and press return. (You don't need to use uppercase letters. If you are familiar with Excel, you can get the same result more quickly by using  the function button and going to the function STRETD, which stands for STock RETurn with Dividends reinvested.) Notice that the dividend payout ratio is 125%. This is becvause tghe company paid a sp[ecial deividend. We will lower it to the long-term level in the margin of safety section below.

When you have done this you will get:

In this case I have formatted the cell I3 as a percentage.

The number 15.48% is an estimate of the after-tax annual return by purchasing ARP at its current price and holding it for 5 years. This is the average percentage return each year for 5 years.

Of course, the above only works when you have purchased and loaded Valuesoft. Without Valuesoft, you will get the result #NAME?

Margin of Safety
Remember,  none of the inputs can be totally accurate. It is up to you to adjust them to allow for a margin of safety and other outcomes of your investigations. (In the Level 2 Templates we show how Valuesoft has built-in fictions for calculating a level of safety as a staring point for your own margin of safety.)

In the 1999 annual report of Berkshire Hathaway, Warren Buffett said that he employs "a range of values, rather than some pseudo-precise figure." With Valuesoft this is a snap since each time you enter a new number and press return, the answer is automatically recalculated.

For this simple case, we will just make an estimate of a reasonable margin of safety for the P/E ratio, the projected growth rate, and the payout ratio. The data and results are shown in the next figure.

This time the estimated after-tax return in Cell I1 is much lower. What this means is that under a margin of safety you will make at least this rate per year over the next 5 years. At the same time it leaves the upside open so that the final return could be much higher.

With more experience, you can do the above analysis in a few minutes. Once you have set it up for a company, it is a simple matter to update that data as new information becomes available. We are looking for companies that give us a reasonable rate of return with a high level of confidence. Then, in practice, the actual return is frequently much higher.

STRETD is only one of the 30functions in Valuesoft. Another of my favorite functions is TARGD. This calculates the price that you would need to pay to achieve your desired return. When you do this, you set yourself up to wait until there is a dip in the price. At that moment you can buy the stock you want at your price to get your return.

2. Stability using STAEGR

The importance of focusing on companies with high stability in the growth of earnings and sales is described in Chapter 13 of The Conscious Investor. This is done via a proprietary function called STAEGR. (It is pronounced stay-ger and comes from the expression "stability of earnings growth.")

Staegr measures the stability or consistency of the growth of historical earnings per share from year to year, expressed as a percentage in the range 0 to 100 percent. When applied to data over any number of years, high STAEGR corresponds to high stability and low STAEGR corresponds to low stability. STAEGR of 100 percent signifies complete stability, meaning that the data is changing by exactly the same percentage each year.12 The function has the feature of adjusting for data that could overly distort the result, such as one-off extreme data points, negative data, and data near zero. It also puts more emphasis on recent data.

The image on the right shows how it can be used. The entry in cell C13 is calculated as "=STAEGR(C8:C12)" and calculates the stability of earnings per share over the 5 years.

Similarly the entry in cell C14 is calculated as "=STAEGR(C8:C12)" and calculates the stability of earnings per share over the 10 years.

3. Intrinsic Value using DCF2S

Calculating intrinsic value is a basic method used by many analysts. Usually it is based on the assumption that free cash flow will grow at a constant rate over a specified period (called the initial growth period) followed by a second constant rate over the remaining life of the business (called the terminal growth rate). These cash flows are then discounted back to present time. The sum of these discounted values is called intrinsic value and the method is called the discounted cash flow (or DCF) method. This method is discussed in detail in Chapter 7 of The Conscious Investor along with its strengths and weaknesses. The most serious weaknesses are based on the fact that the method requires forecasts to be made over infinite periods.

In Valuesoft the function DCF2S is a function that calculates intrinsic value using a two-stage approach. The following table is a simple example. The data is placed in cells A21 to E2. Cell F2 contains the entry "=DCF2S" and calculates the intrinsic value. Instead of free cash flow in cell A2, dividends, or any other financial measure can be used.

According to these calculations, the company is slightly overvalued. However, as explained in The Conscious Investor, the results from discounted cash flow calculations are highly unstable. This means that just small changes in the inputs can give exceptionally large changes in the final value.

Note: Earlier versions of Valuesoft contained the function PRESVAL which combined a two-stage discount formula and a version of a three-stage discount formula. This has now been replaced by DCF2S for two-stage discounted cash flow calculations and DCF3S for three-stage discounted cash flow calculations.

Level 2 Templates Click here