The Business of Value Investing.pdf

28 The Business of Value Investing

think offi ce buildings, houses, schools, and hospitals are disap-

pearing, the need for Mohawk ’ s products is soundly assured. And

its duopolistic position in the industry gives the company a strong

competitive advantage.

So what is the intrinsic value of Mohawk based on the present

value of the future cash fl ows? Let ’ s make some quick yet conserva-

tive assumptions. For the 2008 year free cash fl ow came in at $ 253

million, $ 450 million less than 2007. (The year 2008 was a disaster

for housing related businesses.)

It looks like 2009 won ’ t be much better for the housing/con-

struction industry, so let ’ s assume there is no free cash fl ow growth

from 2008. Given Mohawk ’ s dominance and anticipated industry

recovery in 2010 or 2011, it ’ s not unreasonable for the company to

earn $ 500 million in free cash fl ow in 2010. For the next two years

as the industry recovers from all - time lows, I ’ ll assume a 15 percent

increase in free cash fl ow.

Because money received in the future is worth a lot less than

money in hand today, future cash fl ows need to be discounted back

to the present at an appropriate rate. A very common rule of thumb

is to take the current yield on a U.S 10 - year Treasury note and add a

premium to compensate added risk of the business. Let ’ s assume

a discount rate of 10 percent. For a business as strong as Mohawk,

10 percent might be a notch too high, but the goal is to get a very

conservative valuation. The numbers are:

Year Free Cash Flow Present Value of FCF @10% discount rate

2009 $ 253 million $ 230 million

2010 $ 500 million $ 413 million

2011 $ 575 million $ 432 million

2012 $ 661 million $ 451 million

Total $ 1.53 billion

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