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How to value a website or business

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Posted 16th March 2015 at 04:04 PM by Jonwebb

The newer approach to security analysis attempts to value a common stock independently of its market price. If the value found is substantially above or below the current price, the analyst concludes that the issue should be bought or disposed of. This independent value has a variety of names, the most familiar of which is “intrinsic value”.

– Ben Graham,

Value investing is figuring out what something is worth and paying a lot less for it.”

- Joel Greenblatt

“The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure… two people looking at the same set of facts… will almost inevitably come up with at least slightly different intrinsic value figures.”

– Warren Buffett

These three quotes, sums up nicely what it is to try to figure out what it means to attempt to figure out the “price you pay”. Intrinsic value isn’t a precise number that you can get to via a model created in a spreadsheet, and while you can try to use those as tools ( as I have many times including on this site) to help you come up with a purchase price. Investing comes down to:

How much you expect to earn

How much you are will to pay for those earnings.
I do some ‘fancy’ math when I write-up a company profile ( like this one Exxonmobil) but that is mostly for this place, in my “real life” I read a lot, and think, not a lot off pen to paper. I try to come up with three scenarios ( good, bad, ugly) trying to create a realistic view on the company’s future normalized earnings. From there I compare the company’s yield to the 10 year US Bond. If the business is yielding +4 to that of the bond and if I think the business will perform closer to the “best” scenario then I’ll pull out my checkbook, and invest. ( I’ll invest if the bad, or ugly as long as the competitive advantages are still intact, and if it is selling at a premium yield)

Lather, Rinse, Repeat.

Investing like this comes back to the same thing I always say ” think of investing as a business. As if you are buying a private business.

Example

What’s a tutorial with out an example?

Lets say you are buying a website that generates $12,000 a year after expenses. you want to “sit” on the website and not invest any more cash into building up this site, so you expect the earnings to stay the same.

From here we want to create a good, bad, and ugly scenario for simplicity’s sake the good scenario, the viewership increases because of a recent change in google’s search algorithm which leads to more eyes on the website. As a result earnings increase to $14,000.

The bad scenario, the inverse happens ( decreased viewership) so earning fall to $10,000.

The Ugly scenario would be because the site, only had one way of generating revenue from the website, when that source was blocked for an extended period of time causing free cash to drop to $7,000.

Now, we know that the current bond yield is 2.08% so if we add 4% to that number we get 6.08% ( easy so far right?)

The owner of the website is trying to sell this website for $100,000. which gives us a yield of 12% if everything stays the same. If things go great for us, the yield will be 14%, if bad 10%, and if ugly 7%.

Looking at the yield for all the possible scenarios it is clear that this is an investment that makes this an offer that we really should look into.

Where should you focus?

On easy to predict the businesses. Every business can not be valued by you or me, it is important to focus on your circle of competence. What do you understand? People often make mistakes in the fact that they try to out think the thinker, by trying to value businesses that you don’t really understand. Instead of focusing on a simple business like Walmart, they try to analyze Wells Fargo.

If you don’t understand the business move on.

I often come across businesses that I find things about that I don’t understand. Theres no shame in moving on.

Be careful what you compare the business to

In our example I worked compared the earning yield to the 10 year US bond. In some cases you can miss out on a really great business, by only looking comparing it to a bond. One business you should compare the business to is the businesses, own historical earning yield. While it may not be yielding %6.08 it is yielding higher than it has in the past 10 years. That may be a buy signal, only more research can see if that is true or not.

Closing

I don’t think Graham ever used a model, and I don’t think Buffett does either. This may not be the best way to value a business, but it is dead simple, and doesn’t require higher math, just some numbers with a focus on competitive advantages.

I hope this discussion is somewhat useful
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