Example: Coca Cola (KO) I’ll still use interest coverage at 1.4. KO had $10B EBIT. I’ll use the Corporate AAA bond rate of 2.19 percent and a risk premium of 4.5 percent for a buyout loan interest rate of 6.69 percent. The capital structure is 75 percent debt, 25 percent equity. $10B EBIT / 1.4 interest coverage = $7.1B yearly interest payments. $7.1B Interest / 6.69 loan interest rate = $106B debt. $106B debt / .75 = EV of $141B EV = $106B Debt + $35B Equity When using the PE/LBO valuation technique, you’ll need to do research on interest rates and the capital structure of comparative deals closed within the last twelve months. Three of my valuation metrics would indicate IBM is a buy. IBM is overvalued using the Private Equity/Leverage Buyout method. In addition, IBM is owned by “Master of the Universe” investor Warren Buffett. This is considered Buffett’s first foray into ‘tech’. Arguably, it’s not working out so well. Forbes reports Buffett began acquiring IBM in the second quarter of 2011 and notes he paid approximately $172.00 on average for his stake of more than 81 million shares. You and I can pick it up for around $150.00 today, which is about a 14% discount from where Mr. Buffett bought it. True, this investment has been limping along for nearly five years now. But remember, just under five years isn’t enough time to reach a verdict on one of Buffett’s investments. Using the B ratio, FCF Yield, and Private Equity/LBO, KO is overvalued. However, Benjamin Graham’s revised formula shows KO is slightly undervalued. None of the four valuation methods are perfect. Attempted valuation along with using a checklist should be thought of as a screen to prevent you from making serious mistakes. As Buffett said, quoting Carveth Read, “It is better to be vaguely right than exactly wrong.”
Portfolio Allocation: For my own portfolio I use a combination of the valuation techniques to allocate my percentage of new purchases in companies I already own. For example, if my research shows company A is 30% below my estimate of intrinsic value and company B is 10% below my estimate of intrinsic value, I divide the lower number by the higher number and split the new investment that way: New Investment $1000.00 10% / 30% = .33 $1000 x .33 = $333. $1000 - $333 = $667 Company A new investment $667 and Company B new investment = $333 In essence, I’m allocating a larger portion of my new investment to shares that are more ‘deeply valued’.