McDonald's, Coke and Campbell's Relative Valuation

Relative Valuation Comparing Three Consumer Monopoly Companies

	McDonald's	Industry Average - Hotels & Restaurants	Coke	Industry Average - Hotels & Restaurants	Campbell's	Industry Average - Food Products
P/E (Trailing Twelve Months)	18.8%	27.4%	18.4%	16.8%	13.14%	10.36
P/E (5-Year Average)	19.5%	28.4%	17.8%	21.1%	16.18%	28.5
PEG Ratio	1.9%	1.7%	2.9%	58.0%	2.78%	2.21%
Price/Cash Flow (Most Recent Quarter)	18.5%	14.1%	17.6%	19.4%	7.68%	14.72%
Price/Cash Flow (TTM)	15.6%	15.4%	14.7%	15.8%	9.59%	16.36%
Price/Sales (Most Recent Quarter P/E)	3.7%	2.6%	3.5%	3.7%	1.17%	10.22%
Price/Sales (TTM)	3.8%	2.8%	3.3%	2.9%	1.31%	1.34%
Price/Book	7.2%	6.5%	4.7%	4.0%	9.65%	0.70%

Definitions:

Trailing Twelve Months – the last 12 months of data. Think of this as a “rolling” metric. Trailing twelve months for October 2015 would be October 2014 to September 2015.

P/E – the price to earnings ratio or a company found by dividing the company’s current share price to its per-share earnings. Can be used for relative valuation purposes. A firm trading at a P/E of 5 appears cheap compared to a firm trading at a P/E of 20. Lower is better.

PEG Ratio – the price to earnings growth ratio, a forward-looking metric, found by dividing the stock price of a company by its earnings growth. Peter Lynch asserts that a company that is fairly priced will equal its growth rate and thus, a fairly valued company will have a PEG equal to 1.

Price / Cash Flow – similar to the price to earnings ratio except price to cash flow removes the effects of depreciation and other non-cash factors. This truly whittles the relative valuation down to the cash and is found by dividing the Share Price by the Cash Flow Per Share.

Price / Sales – a fairly useless metric that doesn’t take into account expenses or debt. It is useful when comparing similar companies. Found by dividing a firm’s current stock price by its revenue per share.

Price / Book – Also known as the price to equity ratio, it is found by dividing the current closing price of the stock by the latest quarter’s book value per share with book value being Total Assets – Intangible Assets and Liabilities. “A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company.” [i]

So, just looking across this, the only guy that shows some potential value at this point is Campbell's with a Price to Cash Flow ratio that is fairly below the industry average. Of course the company is also exhibiting a high Price to Book value so all in all, these companies appear fairly valued using relative valuation, no value meals here!

_____________________________________________________________________

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

OneMillionJobsNow.com

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

One Million Jobs.

Like us on Facebook to find out how you can support this mission!

---

[i] Investopedia - http://www.investopedia.com/terms/p/price-to-bookratio.asp#axzz1mOel1Kzo

Warren Buffett and the Magic of Retained Earnings

The following is an excerpt from Building a Small Business That Warren Buffett Would Love, available March 12th at Amazon.com and BarnesandNoble.com.

_____________________________________________________

If I had a magical process for investing capital at a high rate of return, let’s say at 20 percent, and you invest $5 with me, at the end of the year I will have made you $1.

You will now be faced with three options:

1. You can take the $1, in which case you can spend it or invest it elsewhere, perhaps in a llama farm.

2. You can leave the $1 with me and allow me to reinvest it for you.

3. Or together, we can use the $1 to buy out existing shareholders.

The first question that should come to mind, if you leave the money with me to reinvest, is “are our children learning,” and next, “Will I have the ability to continue generating the 20 percent rate of return?” Then, if you take the $1, what rate of return can you expect to achieve … in the llama farm? The answer to the first question is found in two components:

1. The track record of ROE in my business.

2. The historic retained earnings off of my business’s balance sheet.

If historically, my business has retained earnings and the ROE has remained strong, averaging 20 percent, then by all appearances the business has the ability to put the $1 to good use, reinvesting it at the high rates of return on equity. If, on the other hand, my business has historically retained earnings (plowed them back into the business for expansion, new business projects, and so on), yet the return on equity has steadily dropped over the years, then it appears that I have poorly allocated retained earnings into low returning investments, and I do not have the capability to effectively expand the business or, at the very least, the core, original business has begun to suck wind. Either way, you will see this as a drop in ROE and perhaps a paltry, anemic ROE track record.

To read the full chapter, pre-order your copy of Building a Small Business That Warren Buffett Would Love at Amazon.com orBarnesandNoble.com.

Available at Amazon.com and BarnesandNoble.com!

McDonald's and a Golden Crispy Return on Equity

Painting the Picture of Return on Equity

Simply put, return on equity is a measure of how hard the equity in a business is working.

ROE = Net Income/Shareholder’s Equity

Net income can be found on the income statement and equity can be found on the

balance sheet. In a small business with one owner, all of the equity technically belongs to the single owner or the single shareholder, although technically, shares may not exist depending on the entity type. All things equal, a business investment with a 20 percent return on equity is superior to a business investment with a 10 percent return on equity.

Why So Important?

As you can see from our ROE formula, a business with a strong return on equity is delivering a healthy amount of income using the least amount of equity possible. (The numerator is big, the denominator is small, you put the lime in the coconut.)

Back to our comparison mantra, we don’t necessarily want to throw $100,000 worth of equity into a business generating a 10 percent return on equity, or $10,000 a year, when we can invest it in another available option that is firing at 20 percent a year and will deliver $20,000 a year in income. More is better, right, when it comes to income and business.

For an existing business, a low return on equity is an indicator of a problem. If after obtaining your handy dandy industry comparison report you find that your business should be chopping away at a 15 percent return on equity and it is only delivering 7 percent, I would argue that the competition in town is probably eating your lunch (McNuggets included), and sooner or later they will be eating your dessert as well (Snozzberries!). The competition is utilizing their equity more efficiently, leaving them more income at the end of the year to potentially reinvest and grab more market share. Better start tweaking your return on equity or grabbing those McDonald’s references.

And Now Some Examples

Table 4.1 displays three 10-year track records of three consumer monopoly companies that Warren Buffett was at one time or currently in love with: McDonald’s, Coke, and Wal-Mart. Above all else, this picture should give you a crystal clear expectation of what to look for in order to build a business that Warren Buffett would love. Remember, return on equity is found by dividing the net income, from the income statement, by the equity found on the balance sheet.

Table 4.1 Ten-Year Return on Equity for Three Consumer Monopolies

Source: ProfitCents, reproduced with permission.

McDonald’s: The name alone brings to mind those golden, crispy fries, inexpensive hamburgers, Grimace, Officer Big Mac, Mayor McCheese, the useless McNugget mascots.

Look at that golden, crispy return on equity over the years. Despite a very anemic 2002 at 9 percent, we see a steady, strong march through the mid to upper teens and into the lower 30 percent range in the late 2000s, resulting in a hearty, 10-year average return on equity of 21 percent. Beat that Colonel Sanders! (Author’s note: The squinty eyed, bolo-tie wearing, senior commissioned officer connoisseur of fried poultry has in fact annihilated this number … over the past five years, as part of the Yum brands portfolio, according to Morningstar.com, KFC and its Yum counterparts have averaged a 131 percent return on equity. That’s a lot of chicken!) McDonald’s exemplifies a business with steady, strong, and growing return on equity, one that so far, Warren Buffett would love.

___________________________________________________

To read the full chapter, pre-order your copy of Building a Small Business That Warren Buffett Would Love at Amazon.com or BarnesandNoble.com.

Available at Amazon.com and BarnesandNoble.com!

The Consumer Monopoly

What makes a brand distinctive? Better yet, let's name some distinctive brands:

-McDonald's
-Coke
-Hershey's
-Campbell's

If I say soup, what is the first brand name that comes to mind? For me, this is easy. It is Campbell's. (sorry all of you Progresso folks)

So, for argument's sake, a consumer monopoly is emblazoned in the minds and hearts of consumers. It took Coke years, literally hundreds of years of brand building, positioning itself in tin-type pictures gripped in the mitt of Santa Clause, shoving the red color in your face, and endlessly presenting a curved bottle shaped like a hoop skirt in order to establish its endearing presence.

The reason, that Coke is a consumer monopoly is because, even with unlimited resources, it would be very difficult for you and I to start a soft drink business and competitively take out Coke.

The same goes for Campbell's. Even with a billion dollars, I doubt you or I could start a soup company that could rival Cambpell's within a few years. Again, when I hear "soup", I think of Campbell's and a red and white can.

So qualitatively, a consumer monopoly is a well-established brand, founded on years of brand-building that could not easily disappear from the hearts and minds of consumers and could not easily be competitively replicated.

This as opposed to a commodity type business ... a business that has no brand distinction. The classic example that I like to use is a gas station. Even if I am loyal to Joe's gas station and like the sandwiches that Joe fixes at lunch, if Bob's across the street starts offering gas for 25 cents cheaper, I will immediately abandon Joe's. In the consumer monopoly scenario, even if Pepsi started offering cans for 25 cents cheaper, I doubt I would abandon my Coke. The same goes for Campbell's soup. Even if Progresso offered a more price conscious soup, I would find it hard to abandon Cambpell's Chicken Noodle.

_________________________________________________________________

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

OneMillionJobsNow.com

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

One Million Jobs.

Like us on Facebook to find out how you can support this mission!

Sub-Prime Mortgage Lenders - The Big Short

According to Michael Lewis, in his book The Big Short, not only were mortgage lenders lending to folks who couldn't afford the loans, they were providing second mortgages so that borrowers could tap equity in their homes (not to buy houses) allowing financiers to expand their business into the largest asset base in America, housing.

Lenders claimed that these products allowed the sub-prime borrowers to finance purchases at lower interest rates instead of using high interest credit cards. Although this is partly true, it allowed borrowers to take out second mortgages on trailers which much like cars, begin to lose their value the second you drive it off the lot.

In the 80s, mortgage bonds were divided into tranches in order to bucket off the risk of "prempayment." (Note: repayment and not default was viewed as the chief risk. The individual in the first tranch was synonymous to a person on the first floor of a house during a flood. They would get hit first if the loan was paid off early thus eliminating their cash flow, leaving them holding the bag when typically, interest rates were at a low. The next person would be on the second floor and get hit second but would realize a lower interest rate payment. So on and so forth.

As the subprime market began lending out second mortgages to the owner's of trailers (again folks, anything on wheels generally depreciates over time) the tranches were established to account for default risk. The person on the first floor receives a higher interest payment but gets hit first. The person on the second floor is next, followed by the third, so on and so forth ... just like a giant set of dominoes.

Building a Small Business That Warren Buffett Would Love

Excerpt from Building a Small Business That Warren Buffett Would ... available now at Amazon.com

Apples to Apples

A duplex cash flowing at $5,000 a year on top of a $50,000 investment is providing a 10% rate of return (by the way, rate of return and return on investment are the same damn thing), a superior investment compared to a duplex cash flowing at $7,000 a year on top of a $100,000 investment for a 7% return.

A stock consistently delivering an average 20% return on equity, in Warren Buffet’s opinion, is in essence delivering a 20% rate of return. He claims this return as his. (more on this later.) A dividend stock paying an annual yield of $.70 with an average price of $10 a share is delivering a 7% rate of return. A business with $20,000 in earnings for the year and an initial investment of $100,000 is yielding 20%.

In the world of small business and investing, rate of return (return on investment, same thing) reigns supreme.

Investing From the Business Perspective

To further illustrate rate of return and how it applies across investments including small business, let us step into the shoes of a rental property investor. A true rental property investor evaluates property based on cash flow and the rate of return. The following table details a cash flow analysis of three sample rental properties, a triplex, fourplex and duplex respectively. The combination of a down payment, closing costs and repairs equal the total down payment needed to invest in each of the three properties. These are culled from real deals folks, so don’t accuse me of making up some hokey numbers.

	1625 Flanigan	1717 O'Shea	1714 O’Brian
Number of Units	3	4	2
Purchase Price	$ 100,000	$ 128,304	$ 97,200
Cash Put In Property
Down Payment	$ 20,000	$ 25,661	$ 19,440
Closing Costs	$ 200	$ 500	$ 500
Repairs	$ 550	$ 500	$ 200
Total Cash Put Into Property	$ 20,750	$ 26,661	$ 20,140
Monthly CF Analysis
Monthly Gross Rental Income	$ 1,275	$ 1,980	$ 1,350
Minus Vacancy Loss of 8%	$ 102	$ 158	$ 108
Total Income	$ 1,173	$ 1,822	$ 1,242
Mo Expenses
Property Mgt Fee of 10%	$ 117	$ 182	$ 124
Accounting	$ 10	$ 15	$ 5
Insurance (hazard)	$ 50	$ 54	$ 50
Yard work	$ 15	$ 20	$ 15
Repairs and Maintenance	$ 90	$ 120	$ 90
Misc.	$ 10	$ 15	$ 10
Reserves	$ 20	$ 20	$ 15
Taxes (Property)	$ 100	$ 139	$ 95
Total Expenses	$ 412	$ 565	$ 404
NOI	$ 761	$ 1,257	$ 838
Loan Pmt	$ 675	$ 866	$ 656
Cash Flow	$ 86	$ 391	$ 182
Rate of Return	5%	18%	11%

Table 1-1

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

OneMillionJobsNow.com

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

One Million Jobs.

Like us on Facebook to find out how you can support this mission!