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Hello everyone!

I'm reading through the McKinsey "Valuation" (5th Edition) textbook (https://www.amazon.com/Valuation-Measuring-Managing-Value-Companies/dp/0470424656) and I've had some issues that I was hoping to get answered.

Specifically, in the second chapter, the authors discuss the so called value driver formula: Value =( NOPLAT_i * (1 - g/ROIC) )/WACC-g. Where:

g = constant growth rate of earnings.

ROIC = rate of return on incremental capital invested

NOPLAT_i is the operating profit after tax (before reinvestment) in period 1.

However, then they go on to show this diagram: https://imgur.com/R7umPno, which is a matrix depicting the value of companies for different ROIC, growth rate combination. I understand the *point* of this: when ROIC < WACC, growth destroys value, and vice versa. However, I'm having trouble replicating the specifics of the numbers they get:

In this situation, WACC = 9%, and the initial NOPLAT is $100. They model it for 15 years and then use 3% perpetuity growth formula for the terminal value. I have 2 questions.

1. I don't understand how they can say that the value of the company is $1100 when ROIC and growth are both 9%. The value driver formula would clearly give a value of 0 (I know it's only applicable in constant growth settings, but this assumption is met) because g/ROIC would = 1 when g = ROIC, and thus the numerator goes --> 0. This would also make sense because of the other formula they mention: Investment Rate = growth rate / ROIC. If growth rate = ROIC, then IR = 1 and you reinvest everything in order to get the growth you want.
   
2. Secondly, I've tried to model these scenarios out on my own in Excel not using any plug in formulas but just literally modeling the scenario out for 15 years with a perpetuity terminal value and I don't get anywhere close to the $1100 present value for the time when ROIC = WACC = 9%. The value ($1111.11) is only close for ROIC - 9%, Growth - 3% Anyone want to take a crack at it to help a guy out? Happy to share my spreadsheet
   
   Either way, I feel like I'm missing something really obvious. Help is appreciated :)

I have a pretty comprehensive list of value investing books, articles, blogs, and podcasts on my blog. Haven't updated the book list in a while, but probably enough to get you going.

I'd also strongly recommend Stephen Penman's Financial Statement Analysis and Security Valuation. I think it's FAR superior to the Damodaran stuff, but to each his own.

I also find VIC, Berkshire & Fairfax, and fund shareholder letters to be great resources as well for learning how professionals approach valuing a company. Here's a bunch that I've saved over the year.

I would use the same concepts to value intangible assets as I would tangible assets. In short, I would use Discounted Cash Flow (DCF), Comps, and Replacement Cost. Use multiple methods to pin down a valuation range. The problem I believe you and most others run into while doing so is lack of detailed knowledge of the intangible assets or industry.

It makes sense to use DCFs for intangible assets that are monetized (Think Pharma Patents, Licensed Trademarks, etc). This method exhibits all the downsides to using DCFs (Uncertain Forecasted Cash Flows, Appropriateness of Discount Rates, etc). In other situations it would be much harder. For instance, what value would you attribute to the Coca-Cola brand? In my mind, it would be hard to separate the value of the brand from the company's massive distribution network.

You could use comps to value intangibles that aren't being monetized. The problem is that intangible assets are usually tough to compare and there may not be enough recent transactions in that area to even pin down a starting point. A prominent recent transaction can radically change the value assigned to a portfolio of patents. Look what happened to the value of IDCC after Nortel's wireless patents were auctioned. It would help to have specific knowledge of the individual intangible assets so you can adjust comp values based on scope, useful remaining life, likelihood of lawsuits, history, etc.

Replacement cost is a useful concept to compare those other two values to. Bruce Greenwald uses this method in Value Investing: From Graham to Buffett and Beyond. Replacement cost should be on the lower end of the valuation range of intangible assets. These assets are somewhat unique or are at least without an available functional equivalent so a buyer would pay much more than replacement cost for certain intangibles. Think in terms of how much did a company spend to generate this asset. How many years of SG&A were spent developing a list of clients? How many years of R&D were spent generating a portfolio of patents? How many years of marketing expense would it cost to build that brand? How much would it cost to build a functional equivalent?

• The Intelligent Investor - Benjamin Graham
  
  
• Security Analysis - Benjamin Graham
  
  
• The Interpretation of Financial Statements - Benjamin Graham
  
  
• Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports - Howard Schilit
  
  
• Applied Value Investing - Joseph Calandro
  
  
• Analysis for Financial Management - Robert Higgins
  
  
• Margin of Safety - Seth Klarman
  
  
• Common Stocks and Uncommon Profits and Other Writings - Philip Fisher
  
  
• One Up On Wall Street - Peter Lynch
  
  
• Beating The Street - Peter Lynch
  
  
• The Essays of Warren Buffett - Warren Buffett
  
  
• Snowball: Warren Buffett and The Business of Life - Alice Schroeder
  
  
• Buffett Beyond Value - Prem Jain
  
  
• Value Investing: From Graham to Buffett and Beyond - Bruce Greenwald
  
  
• You Can Be A Stock Market Genius - Joel Greenblatt
  
  
• The Little Book That Beats The Market - Joel Greenblatt
  
  
• The Big Secret for the Small Investor: A New Route to Long-Term Investment Success - Joel Greenblatt
  
  
• Reminiscences of a Stock Operator - Edwin Leferve
  
  
• Fooled By Randomness - Nassim Taleb
  
  
• The Black Swan - Nassim Taleb
  
  
• Poor Charlie's Almanack - Charlie Munger
  
  
• Rediscovered Benjamin Graham - Janet Lowe
  
  
• The Theory of Investment Value - John Burr Williams
  
  
• Seeking Wisdom: From Darwin to Munger - Peter Bevelin
  
  
• Security Analysis and Business Valuation on Wall Street - Jeffrey Hooke
  
  
• Value Investing: Tools and Techniques for Intelligent Investment - James Montier
  
  
• Investment Valuation: Tools and Techniques for Determining the Value of Any Asset - Aswath Damodaran
  
  
• The Dark Side of Valuation - Aswath Damodaran
  
  
• Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports - Thomas Ittelson
  
  
• Buyout - Rick Rickertsen
  
  
• Influence: The Psychology of Persuasion - Robert Cialdini
  
  
• Why Smart People Make Big Money Mistakes: Lessons from the New Science of Behavioral Economics - Gary Belsky
  
  
• The Warren Buffett Way - Robert Hagstrom
  
  
• The Most Important Thing - Howard Marks
  
  
• Competition Demystified - Bruce Greenwald
  
  
• Accounting For Value - Stephen Penman
  
  
• Distressed Debt Analysis - Stephen Moyer
  
  
• Bankruptcy Investing - Ben Branch
  
  
• The Vulture Investors - Hilary Rosenberg
  
  
• Creating Value Through Corporate Restructuring - Stuart Gilson
  
  
• Distress Investing - Martin J Whitman
  
  
• The Aggressive Conservative Investor - Martin J Whitman

Great idea for a thread. On this topic, I would highly recommend Greenwald's Competition Demystified(http://www.amazon.com/Competition-Demystified-Radically-Simplified-Approach/dp/1591841801/ref=sr_1_1?s=books&ie=UTF8&qid=1348343953&sr=1-1&keywords=competition+demystified) which discusses how to analyse the various sources of competitive moat with examples from different industries

Here's my example:

• Home alarm monitoring (ADT, Securitas Direct & Broadview - both now private):
  High switching costs for customers because the equipment is owned by the provider & must be ripped out if they want to switch. Not worth it to save a few dollars a month on monitoring fees.
  
  As Greenwald notes, switching costs for customers coupled with regional economies of scale often equals durable competitive advantage.
  
  Sales & installation related expenses constitute almost 80% of steady-state costs for an alarm monitoring business. Therefore sales & installation crew efficiency is of critical importance to the success of an alarm monitoring business. Locally dominant firms enjoy an advantage in this respect because their sales crews can make more sales and installation calls per day than competitors whose crews must spend more time driving between installations due to their relatively dispersed customer base.
  
  The result is stable / growing market share and reasonably high steady-state returns on tangible capital for the larger players.

not sure whether you will something applicable right away but I really liked The Art of Short Selling from Kathryn Stalley

also, the good thing with (famous?) short sellers, is that they publish their research. I do not read all of them but I enjoy muddy waters.

oh I have read Creative Cash Flow Reporting and What's Behind The Numbers and it helped me a lot in my regular analysis by the way.

Great paper. However, instead of using EV/Book value of equity, according to Penman, the Enterprise Value version of P/B would be EV/Net operating assets, since EV includes debt in the numerator, and NOA in the denominator is funded by debt as well. Rather than use a justified book value of equity with EV, couldn't you have used a justified NOA value (Geo. average RNOA / WACC)?

The intelligent investor is a big wordy, dated and inaccessible. I'd recommend reading this one to get a good, practical introduction on what to do. The intelligent investor is more about why to do it, than what to do and there are far fewer net net projects to identify in today's markets.

https://www.amazon.ca/Value-Investing-Graham-Buffett-Beyond/dp/0471463396

This has been my bible

Great pick on Penman's text!

If you find yourself wanting a more concise run through, Penman's Accounting for Value is excellent as well and much shorter.

This is the best all around book I've read about value investing.

It explains the concepts well and also branches out beyond where normal VI books go.

Good list, but quite daunting for the new investor.

I haven't read all of these titles myself, but the ones I recommend as starters include One Up on Wall Street, The Black Swan, Fail-Safe Investing, and How an Economy Grows and Why It Crashes. The latter two aren't on value investing per se, but I think they make good complements.

Depends on what you want to invest in a guess. I read part VI on balance sheets first, then part V on income statement and last part VII. I am interested in equity investing. I would add a modern touch to the reading list; Applied Value Investing and Margin Of Safety by Seth Klarman if you can find it.

https://www.amazon.com/Applied-Value-Investing-Application-Acquisitions/dp/0071628185

Nice, here are some more.

https://rbnenergy.com/

http://www.amazon.com/Oil-101-Morgan-Downey/dp/0982039204

http://belfercenter.ksg.harvard.edu/publication/24870/falling_short.html

http://www.theoildrum.com/node/2470

http://www.igu.org/sites/default/files/node-page-field_file/IGU%20-%20World%20LNG%20Report%20-%202014%20Edition.pdf

There is the occasional subreddit food-for-thought, like this

Just got this for xmas, but haven't read it yet... supposed to be good

I'm reading this book https://www.amazon.com/Financial-Shenanigans-Accounting-Gimmicks-Reports/dp/0071703071

Still early in the book. One thing that stood out was too good to believe revenue growth as compared to similar companies during a set time period. e.g Enron

Financial Statement Analysis and Security Valuation is the go to accounting book for valuation.

In consideration of your 3 points, however, I would encourage you to skip the financial narratives (as they are time sinks) and go straight to the investing concepts. Read The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success as a start; then if you feel that's the kind of thing you're looking for, feel free to ask for more recommendations.

As for the intuition behind the methods, you really just have to think a lot about WHY things are the way they are, and not just HOW. Just read widely and keep at it, it's not going to happen overnight but knowledge compounds and you'll eventually get there. The fact that you're even asking this question would make me consider you for an interview if I was in a hiring position.

The answer to the headline question is no, a thousand times no.

Even Citi's vice chairman Robert Rubin was blind to e.g. 'liquidity puts' on massive off-balance sheet liabilities, which drastically changed Citi's economics to put in mildly. If Citi doesn't understand their own balance sheet, what chance have you got?

Even Warren Buffett sometimes gets blindsided. For instance, Amazon's cloud is eating IBM's lunch of running corporate IT departments and data centers, commoditizing what used to be a high-ticket, high-margin service business.

Even Warren Buffett puts a lot of stuff (most stuff?) in the too hard pile. Especially Warren Buffett.

You don't have to understand how to drill an oil well (although it helps, see e.g. http://amzn.to/24hNwlw , http://amzn.to/1sIYV22 ). What you have to understand is whether we're going to keep drilling oil wells, whether the guys who own and drill wells are going to keep needing Halliburton, and whether Halliburton can keep earning, growing and making a good return on capital re-invested.

I have http://www.amazon.com/The-Intelligent-Investor-Definitive-Investing/dp/0060555661 and have no complaints about it. It is based off of Graham's 1973 edition, and every chapter has a followup chapter written by Zweig in 2003. The followup chapters are really nice and help show which sections are outdated and which are really important

Here's some for the value investor:


Security Analysis - Graham and Dodd

Value Investing: From Graham to Buffet and Beyond - Bruce Greenwald, et al.

Value Investing: Tools and Techniques - James Montier

The Little Book of Behavioral Investing: How not to be your own worst enemy - James Montier

Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor - Seth Klarman

Security Analysis and Business Valuation on Wall Street - Jeffry Hooke

Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism by Jeff Gramm as well.

Here are the amzn links:
https://www.amazon.com/Cable-Cowboy-Malone-Modern-Business/dp/047123639X/ref=mt_hardcover?_encoding=UTF8&me=

https://www.amazon.com/Dear-Chairman-Boardroom-Shareholder-Activism/dp/0062369830/ref=pd_sbs_14_4?_encoding=UTF8&pd_rd_i=0062369830&pd_rd_r=2645B4B5CFJGN5GK9VER&pd_rd_w=nVwLn&pd_rd_wg=qiGtq&psc=1&refRID=2645B4B5CFJGN5GK9VER

I haven't read it yet but Oil 101 was recommended to learn about the Oil industry.

Reading Competition Demystified right now - the list is definitely missing a business strategy book!

Security Analysis.

This? https://www.amazon.com/Valuation-Measuring-Managing-Value-Companies/dp/0470424656

Are you able to find Common Stocks and Uncommon Profits?

The Interpretation of Financial Statements

Here is the mobile version of your link

Not exactly accounting per sé, but check out Financial Shenanigans.

Thanks so much, truly.

Dear Chairman

https://www.amazon.com/Dear-Chairman-Boardroom-Shareholder-Activism/dp/0062369830

Fatal Risk, by Roddy Boyd

https://www.amazon.com/s/ref=nb_sb_noss_2?url=search-alias%3Dstripbooks&field-keywords=fatal+risk

All the devils are here, McLean & Nocera

https://www.amazon.com/s/ref=nb_sb_ss_i_1_10?url=search-alias%3Dstripbooks&field-keywords=all+the+devils+are+here&sprefix=all+the+de%2Cstripbooks%2C239&crid=258QBL9E51HTO&rh=n%3A283155%2Ck%3Aall+the+devils+are+here

And "Business Adventures", by John Brooks- said to be Buffett and Gates' favorite business book.

https://www.amazon.com/s/ref=nb_sb_ss_i_1_13?url=search-alias%3Dstripbooks&field-keywords=business+adventures&sprefix=business+adve%2Cstripbooks%2C233&crid=BOABWVISSX0I&rh=n%3A283155%2Ck%3Abusiness+adventures