The Business of Value Investing.pdf

110 The Business of Value Investing

growth rates given, a multiple of 12 times 2013 free cash fl ow would

be appropriate. The company has the ability to grow free cash fl ow

by 10 to 20 percent because of its relatively small size and the future

increased need for oil drilling in more remote (and thus more prof-

itable) areas. This would create a terminal value of $ 5.2 billion dis-

counted back to the present. The terminal value of $ 5.2 billion plus

the $ 2 billion of cash fl ow yields to a total value of $ 7.2 billion. In

2008, Ensco had 142 million shares outstanding.

Dividing the $ 7.2 billion by the 142 million shares outstanding

produces a stock price of approximately $ 51 a share. So, according

to the analysis, Ensco ’ s intrinsic value is $ 51 a share. If the company

performs better than the given assumptions, intrinsic value will be

higher, and vice versa. In June of 2009, shares were trading at $ 35,

having rallied sharply as oil prices rebounded from their precipi-

tous decline in 2008. Having rallied over 50 percent since March

2009, Ensco shares aren ’ t the undervalued bargain they were, based

on the above analysis.

However, the initial analysis is a big step in the right direction

and shows that Ensco could still be a great investment if the com-

pany delivers results stronger than those used in the above analysis.

Nonetheless, investors will probably do well over time buying busi-

nesses at a 50 percent discount to intrinsic value.

Even more so, you need to know the business inside and out

in order to estimate cash fl ow growth with a high degree of con-

fi dence. The ability to assess the quality and competence of man-

agement thus becomes critical. Knowing how management spends

company dollars tells you a lot about how much cash the company

will produce years down the road. In short, do your due diligence...

and when you are done, do it again.

Calculating intrinsic value is simple and straightforward. It ’ s

having accurate data that ’ s the diffi cult part. That ’ s why Benjamin

Graham remarked: “ You are neither right nor wrong because the

crowd disagrees with you. You are right because your data and

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