AMEX: To Buy or Not to Buy (Part 3: DCF)

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Using Discounted Cash Flow (DCF) with no growth in determining AMEX’s intrinsic value.

I only used Capital Asset Pricing Model‘s (CAPM) cost of equity as the discount rate and not the Weighted average cost of capital (WACC) in this case.

Cost of equity discount rate is solved by this formula: cost of equity = risk-free + beta * (equity risk premium)

These are my variables:

Time period: 5 years

Risk Free (10-year): 2.26

Beta: 0.87

Equity Risk Premium: 4.65

Free Cash Flow: 9,795 USD million (2014’s owner’s earnings)

Growth rate: 0%

Cost of Equity: 6.28%

Deducting 2014’s total debt from the market value I had already computed gave me a net present value of $87,684 million USD.

Dividing that number with remaining shares outstanding in 2014 gave me an intrinsic value of $83.43. A 17% premium from today’s $72.41 market price (11/21/2015).

Although I use 52-different models (before 41) now to determine a company’s intrinsic value, I guess just adding a couple of easy calculations in determining the intrinsic value of a company would not hurt:

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PE IV determination and Graham’s Number. Author’s calculation

Now, let’s get the average: (93+64+83) divided by 3 = $80/share. That is a 10% premium to today’s AMEX price.

Also consider that AMEX, has dividends and buybacks attached to it, which can further stimulate shareholder return.

But, with my previous discussions, it appears that I still think management should think about budgeting those especially after the Costco-breakup that’ll take effect in 2016.

Some of the things that kept me from buying AMEX shares as of this time:

  1. Payout ratio as of 2014 (including buybacks) is almost at 100%
  2. Recent Costco breakup that may result into lower profits
  3. Recent San Francisco court decision that may cost ‘billions’
  4. High D/E ratio among its top peers (Visa and Mastercard)
  5. Recent share buybacks (2012-2013) in high valuations

If someone were to ask me, what will be my buy price for this great company. I’d say 30% will be my required Margin of Safety.

Benjamin Graham, father of value investing, usually bought stocks with 50% margin of safety from its intrinsic value. As I’ve read in most books, margin of safety is the cornerstone of value investing, therefore I should apply it every time I can.

Therefore, my buying price will be at $56/share, and I would basically be holding onto those AMEX shares (whenever it reached that point) and probably sell it only if it would be selling at new HIGHS and if not, just hold it for long term.

To read more on Capital Asset Pricing Model (CAPM) visit this Investopedia link: http://www.investopedia.com/terms/c/capm.asp

I believe they have had explained very well the concept.

Disclosure: I do not have shares in any of the companies mentioned in this article and don’t plan to initiate purchase within the next 24 hours. I would not receive any compensation for doing this article. I am not a professional financial analyst. This is just a hobby. Lastly, my work is not error-free, but I strive for it to be. Do not consider as a buy or sell advice. Invest at your own risk.

If you are interested in this similar approach to investing and would seek updates or share ideas, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Happy investing.

Mark Y.

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