On 16/03/2011 10:24:18,
Let me start with your second paragraph"Economic moats" and food retailing. I accept that Walmart has dominated the USA in food and other commodity retail, however, the operating margin is 7.5% showing huge competition and not able to 'sustain high margins'.
In your next paragraph you refer to the Graham mechanical method, but I would point out that in his book Intelligent Investor (first edition) he describes a valuation process that could be the lost transitional phase for Buffett's consumer monopoly methods. I have pasted here my personal note about this:
Capitalisation Multiplier Method of stock valuation
Ben Graham has proposed a method of determining an intrinsic value starting with an average projected earnings figure that is grossed up by a multiplier.
B Key Aspects
1. Historic Earnings. The 1949 classic text of ‘Intelligent Investor’ focuses upon the impact of the 1939 – 45 war upon earnings and the expected reversion to norm.
2. General Long Term Prospects. The classic text of ‘Intelligent Investor’ proposed certain sectors were seen as having an endemic 'quality'.
3. Management. Ben Graham has no tools with which to assess the quality of management other than the accounting data.
4. Financial Strength and Capital Structure. While Graham in 'Intelligent Investor' accepts a modest amount of bonds and preferred stock in a company's finance structure he does not provide any guidance to an acceptable quantum.
5. Dividend Record. The classic text of ‘Intelligent Investor' proposes that a track record of uninterrupted dividends to 1949 including the period 1931 – 33 would merit a favourable treatment in the valuation process.
6. Current Dividend Rate. Graham has said that in 1949 the ‘standard dividend policy' was to was to pay out two thirds of average earnings.
7. Asset Value in Valuation Method. Graham points out that in 1949 the value of a company is determined by analysis of expected earnings, general prospects and the tenure and rate of dividends, and that no influence of book value was required.
C Capitalisation Rate
Graham refers to a capitalisation rate or multiplier that should be adopted to convert the earnings per share to an intrinsic value. He refers to 10 for companies with certain levels of debt and /or preferred stock. A multiplier of 20 is inferred as appropriate for top quality stocks.
D Margin of Safety
On p161 the author also recommends the purchase of the stock only if the capitalisation (intrinsic value) exceeds the market price by at least a third.
E Summary and Conclusion
The 1949 text of ‘Intelligent Investor’ provides a framework for the analysis of a stock by historical earnings information, sector and dividend and proposes a variable multiplier method for estimating the intrinsic value. I suspect that this was the corollary to the earlier book ‘Security Analysis’ in which the methods for analysis were discussed. This seems to deny the exclusive ‘Graham cigar butt’ investment process.
In your para 6 'Jean-Marie Eveillard' you refer to the 'qualitative side to the Buffett approach' and I agree that this is the main area with which I struggle. This includes the appraisal of the company management performance and attitude. I have so far only identified limited indicators such as the adoption of ROE as a KPI and the ratio of the remuneration of the top paid directors to the total salary bill. The book 'The Strategy Paradox' by Michael Raynor also helped me to understand strategy from an investor's perspective.
In your para 9 'Other value stocks' you refer to software able to screen for value stocks using the current accounting year (I call this the vertical slice) but I use REFS to source accounting data to populate a spreadsheet for a ten year window (I call this the horizontal slice). For many elements a cumulative average over the period allows comparison between stocks. I admit this is a slow, mechanical method and would only be used on the remaining contenders on a very shortlist. I recently read the book 'Rule No 1' by Phil Town and there are many similarities in my philosophy with his, apart from the sell indicator systems.
Finally in your para 10 'For me,' you refer to Buffett's complex investment approach. I think that Buffett has moved from the valuation by multiple of Graham that I described above to consumer monopolies with considerable competitive advantage and then to cash-rich stocks (reducing the risk from gearing). He also is further up the ladder of qualitative analysis and management appraisal.