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1 year ago

The “Masters of the Universe” Portfolio

2kPeeW7

corporate bonds in 1962

corporate bonds in 1962 when Graham created the model, and Y is the current yield of the 20 year AAA corporate bond. I used data from Nasdaq, Google Finance, and Yahoo! Finance to determine the EPS, five year growth estimate, and current yield of 20 year corporate AAA bonds. Data on 15 June 2016 shows the 20 year corporate AAA at 3.09% Example: International Business Machines (IBM) EPS = $13.28, g = 3.44, Y = 3.09 Step 1: $13.28 x (8.5 + 2*3.44) x 4.4 / 3.09 Step 2: $13.28 x (8.5 + 6.88) x 4.4 / 3.09 Step 3. $13.28 x (15.38) x 4.4 / 3.09 Step 4: $13.28 x 15.38 x 4.4 / 3.09 Step 5: $898.68 / 3.09 Intrinsic value of IBM: $290.83 (Current Price 6/15 $151.66) Example: Coca Cola (KO) EPS = $1.65, g = 5.79, Y = 3.09 Step 1: $1.65 x (8.5 + 2*5.79) x 4.4 / 3.09 Step 2: $1.65 x (8.5 + 11.58) x 4.4 / 3.09 Step 3. $1.65 x (20.08) x 4.4 / 3.09 Step 4: $1.65 x 20.08 x 4.4 / 3.09 Step 5: $149.09 / 3.09 Intrinsic value of KO: $49.68 (Current Price 6/15 $45.15)

In my final look at valuation I use the Private Equity / Leveraged Buyout technique I learned from Jeffrey Hooke, author of M&A: A Practical Guide to Doing the Deal (Wiley Finance). Jeffrey walks you through the process in the New York Institute of Finance Coursera course; M&A Professional Certificate Part 1 - Concepts and Theories: An Introduction: Lesson 4: Comparable Acquisitions and Leverage Buyout Valuations. According to Jeffrey, in a leveraged buyout or private equity deal, debt is usually 70 or 80 percent of the capital structure with investors putting up 20 to 30 percent of equity. In his example he uses a simple ratio for interest coverage of 1.4 on a deal financed with 75 percent debt. If the company has $100M Earnings Before Interest and Taxes (EBIT), they could borrow $952M. $100M / 1.4 = $71.4M available for yearly interest payments. Assuming a lenders interest rate of 7.5 percent, the company would carry $952M in debt ($71.4M / .075 = $952M) The 25 percent equity portion of the capital structures requires investors provide $317M for an Enterprise Value (EV) of $1.26B ($952 / .75 = $1269 EV) $1269 - $952 Debt leaves $317 in required equity. Example: International Business Machines (IBM) I’ll stick with the interest coverage ratio of 1.4. IBM had $16.4B EBIT. I’m using the Corporate AAA bond rate of 2.19 percent and a risk premium of 5 percent for a buyout loan interest rate of 7.19 percent. The capital structure will be 75 percent debt, 25 percent equity. $16.4 EBIT / 1.4 interest coverage = $7.4B yearly interest payments. $7.4B Interest / 7.19 loan interest rate = $102B debt. $102B debt / .75 = EV of $136B EV = $102B Debt + $34B Equity

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