Business Valuation and Keeping Up With the Joneses

Three Ways to Put a Price Tag on A Business

1. Comparable Market Analysis
2. Asset Approach
3. Earnings Approach

The comparable market analysis is similar to how a Realtor places a price tag on a residential home. Using recent sales data on similar homes, they adjust the price up o

r down depending on superior or inferior qualities - e.g. your house has 2 full baths, a house that sold recently had 3, thus the price your house will be listed at compared to the other will be adjusted down.

The same goes for a business being sold. Market data can be obtained through business appraisal associations and prices can be adjusted up or down.

The asset approach is simply taking the market value of the assets within the business and saying this is the price tag. For example, let's say you have a business with a building and one oven for simplicity's sake. Let's say the market value of the building is $150,000 and the oven is worth $2,000. The asking price is therefore $152,000.

In the earnings approach, the past earnings are averaged and then divided by a capitilization rate, typically thought of as the rate of return one wishes to achieve. For example, let's say a business had earnings of $100, $75 and $125 over the past three years. This averages out to an average earnings of $100. Divided by a capitalization rate of 20% means the business is worth $500. Typically the earnings will be adjusted, adding back in discretionary expenses (meals, travel, home office) and excess owner's salary over and above what a normal manager should be paid.

Keeping Up With the Joneses

One key attribute of a Warren Buffett business is that it has the ability to incr

ease prices to inflation. A business that can increase its prices will increase its earnings per share - the number of shares remain static but the earnings go up due to an increase in prices.

A McDonald's hamburger cost $.15 in 1955 and $.95 in 2011. A ticket to Disney cost $3.50 in 1971 and cost $80 in 2010. Both of these are examples of businesses with the ability to increase with inflation.

Why Warren Buffett Loves Retained Earnings

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The Instruction Manual for Financial Independence

Dear Mr. Buffett ... Please Buy My Business!

Now at Amazon.com!

The core of a strong business is not a mystery nor is it a complicated mess. It is found in the wisdom of Warren Buffett.

This is what he would say if he was buying your small business:

• I want a consumer monopoly …
• with a strong track record of earnings, …
• and a healthy return on equity, …
• with the ability to reinvest those earnings at a high rate of return, …
• with little debt on the balance sheet, …
• the ability to increase prices to inflation, …
• and healthy margins relative to other industries.

These are the same principles he used to turn an initial $105,000 investment into a $40 billion fortune and in a nutshell folks, these are the fundamentals that can be wired into a small business in order to produce superior results. It is not necessary to build the next global, multi-billion dollar, sugar water conglomerate in order to be successful, but the more you “Coke-ify” your business, the better the results.

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Building a Small Business That Warren Buffett Would Love,available atAmazon.comorBarnesandNoble.com.

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The over-arching vision of Building a Small Business That Warren Buffett Would Loveis to create

One Million Jobs.

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Okay Folks ...

Not that anybody cares ... but here is a new list of new goals:

1) Spend more time with the Fam Damily.

2) Generate $100,000 a year from covered call options and LEAPS. (yes, this is possible)

3) Continue to save for the new house ... should have this in the next couple of months.

4) Ratchet up the covered calls/LEAPS to $15,000 a month.

5) Knock off the four-plex debt by my birfday.

6) Complete the freaking sample chapters for the next book and send off to more agents.

7) Get published, ideally with a healthy advance.

8) If all else fails, land a decent job.

Remember, the fam is number one ... I will spend more time with 'em and create a healthy, happy, abundant, stable environment.

Not that anybody cares but this is the blogosphere. So blog-on, Blog-tron.

Earnings and the Consumer Monopoly

Take a look at Coke’s earnings per share for the past 10 years.

.	KO EPS
1999	$1.30
2000	$1.48
2001	$1.60
2002	$1.23
2003	$1.77
2004	$2.00
2005	$2.04
2006	$2.16
2007	$2.57
2008	$2.49
2009	$2.93

Although some dips do exist, in 2002 for instance, overall the earnings per share for Coke have been growing at 13.7% for the past 10 years. The small business owner will find earnings in the income statement although they will not be on an earnings per share basis.

The earnings for our hamburger stand may look something like this:

For existing owners, review your financial statements. If the income statement is not producing steady, growing earnings, why not? Can it be fixed?

For the start-up:

Consider this: even with good marketing research, the owner of a business start has no earthly idea what the business will actually do. At best marketing research is a good guess.

An entrepreneur who goes this route should give serious consideration to paying for quality marketing research.

The five methods:

1. Determining the market demand for your product or services and dividing it by the number of competitors in your market.
2. Taking a friendly non-competitor out to lunch and asking about revenue levels.
3. Reverse engineering the financials and determining the break-even.
4. Conducting primary research by asking the target market how much and how often.
5. Launching a small trial run.

This is the million dollar question: how much revenues will I generate? If you can answer it then you will have a million dollars. Remember, Warren does not invest in businesses without, at minimum, a 10 year track record. The entrepreneur with a pure business start is investing with a zero track record of earnings.

Application

Review the income statement on a regular basis.

Understand that as sales dip, expenses must be monitored and cut in order to maintain a steady level of earnings year after year. Some expenses such as the light bill and rent will remain static.

Maintain efficiencies and expand in good investments that reap large rates of return.

Warren Buffett as Your Small Business Consultant

He doesn’t gamble in the stock market; he doesn’t take short term, technical positions betting on immediate spikes or dips. He is not a buy and hold mutual fund investor. Warren Buffett is a long haul business investor who takes partial if not whole positions in companies with favorable, underlying economics, good management and consumer monopolies.

To draw a quick distinction between a Buffett investment and a Buffett non-investment, ask yourself this question: “if I had to place money on whether consumers will still be drinking Coke or using the iPhone in 20 years, which one would I choose?” This is not a question to make you choose teams. It is meant to be a straight-forward logical question and is really the cornerstone in understanding how Warren Buffett invests. Pretend that one million dollars is on the line. If you answer the question correctly you gain one million dollars. If you answer incorrectly, you lose one million dollars. I would wager that now, even die-hard Apple fans are capitulating.

This analysis is not a comment on the viability of Apple or a statement on the quality of their product. It is simply an examination of the predictability of the nature of the company. Despite the input of raving Apple fans and the over 40 million iPhone users across the globe, why is Coke a surer bet than Apple? Why is Coke a more predictable company?

A short list:

First, some prima facie answers:

1) The company has been around since 1886.

2) Every time I go to the movies I have to go through at least one Coke commercial.

3) Whether by restaurant, convenience store or vending machine a Coke seems to always be within a 100 yard reach.

4) I have a Coke ornament on my Christmas tree.

And some financial answers:

1. Outside of a few blips on the radar, the company has had increasing, steady earnings over the past 10 years.

2. The earnings per share have grown at an approximate rate of 13.65% over the same period.

3. The return on equity has averaged 32% over the past 10 years.

4. The company can pay off its long term debt in about one year strictly from earnings.

5. The company can adjust its prices to inflation: In 1950 a bottle of Coke cost a nickel. Today, depending on location, a Coke will cost you anywhere from one to two dollars.

If you can start thinking in this mode and identify companies that in 20 years will most likely still be churning out underwear (Fruit of the Loom), satisfying the world’s chocolate fix (Hershey’s), filling out your 1040 (H and R Block), fixing a cold with chicken noodle (Campbell’s), then you are well on your way to thinking like Warren Buffett and building a business that he would want to buy, maybe.