Here’s a homework back-and-forth between me and Adam, who saw me speak at the Get Motivated seminar in Philly. Follow along and drop a note in comments if you have anything to add about Toll Brothers (TOL).
I’ll put this in the FAQ too because it answers a couple common questions: 1) How to buy $1 for $0.50 and 2) Where to find the Sticker Price / Target Price on Investools Valuation section.
On 7/11/05, adam wrote:
Hi Phil,
My name is Adam L. I saw your seminar in April just outside of Philly. I just purchased investools over the phone last week. I am so excited and ready to do this!!!! I wanted to know if I could regularly email you with questions? Would that be ok? I read David Bach’s book “Automatic Millionaire” last year and I have been using some of his strategies to save up and I invested some of that savings into investools….which, I know, will make me a millionaire someday. (hopefully sooner than later). I am looking forward to gaining all the knowledge that I can. I cant wait to read your book next year when it comes out. I guess my first question is…where do I go in the toolbox to find where you displayed the undervalued stock? For example a stock is going for 50 cents but worth 1 dollar. Please help me out I am just getting started and trying to absorb everything I can.
Talk to you soon,
Adam
on 7/12 phil town wrote:
Hi Adam,
Sure, you can send me questions anytime. I’ll do my best to respond quickly.
As for getting $1 for $0.50, here’s how it works:
Sticker Price is my term for what Investools call “Target Price” on their valuation tool. You can find it on the left side of the page on any stock under the heading “Fundamentals”. If it isn’t there yet, it will be by the time you go to class. They are just adding it.
As for using it:
Start by reading the post on my site called ‘YUMMMMY‘. [Now, “YUMMMMY = 4M“.] Then read the Google Posts. That’s how you do it the hard way. With Investools it’s easier.
1. Do a “global search” on Investools and input the phase II numbers you want to search for. You learned that in class, right?
2. From that list, click on the first stock symbol, then click on Valuation (under the Fundamentals menu on the left side of the window).
3. On the Valuation screen find the projected growth rate box. It has the Zack’s est. growth number in it. Find the Discount Rate box. If it doesn’t already have 15 in it, put it in it. Find the Projected PE box. It uses historical PE if there is one. Reduce that number to the smaller of historical PE or two times the projected growth rate. Don’t exceed 50 in any case.
4. Click on Calculate. They call the resulting number “target price”. That’s retail to my Rule #1 way of thinking. That’s the $1.
Divide that in half. That’s what I call the MOS Price (margin of safety). Half of a dollar. That’s what I want to pay… or less.
5. Look at the top line by the name. Today’s selling price is listed. Is it below the MOS Price? If it is, put this one into your Watch List portfolio for further study.
6. Now that you know its cheap, do you want to own this thing? Do the YUMMMMY [4M] thing on the stock and do it well.
7. If you decide you do want to own it because to you it satisfies the 4M’s, then write me and I’ll take a look at it, too. I might even write about it on the blog!
Now go play!
Phil
On 7/17/05, adam wrote:
Hi Phil,
Thanks for the help. I crunched some numbers let me know if these are correct:
I computed the MOS for TOL: the current price is 55.970
The projected growth rate = 17.11%, so 17.11% X 2 =34.22
Projected P/E= 34.22
Target Price is 281.92/2= 140.965….for MOS…. isn’t this a bit much?
Did I calculate this right? Please let me know.
Thanks, talk to you soon.
Adam
phil town wrote:
Hi Adam,
To get the right Sticker and MOS price we have to have three things:
1. The current EPS
2. Our estimated growth rate – which is either our estimate based on history or the analysts estimate whichever is lower.
3. Our estimated future PE – which is either our estimate based on history or 2 times the growth rate that we used.
For TOL
1. the current EPS is 3.44
2. estimated growth rate based on history: Gotta look at its Big Five: ROIC, and these 4 growth rates – equity, EPS, sales, cash and get a number I like. With TOL here’s the big Five
1. ROIC – 12%
2. Equity Growth Rate – 24%
3. EPS 24%
4. Sales 22%
5. Cash – a mess but probably the nature of building with leverage
From this I’d estimate growth to continue at 24% – I always like the equity number if I’m not sure as the best proxy for sustainable growth that will translate into higher value.
But what do the analysts say? 17%. So we use that for our EPS growth rate number.
PE is historically 9. Which is a lot lower than the 34 we get by doubling the eps growth rate, so we use 9.
Okay ready.
=fv(17%,10,,-3.44) and we get $16.44 for future eps.
Now we have to figure out future value so we multiply by the PE = $16.44 x 9 which gives us $149 a share in ten years.
We know we won’t accept anything less than 15% a year so using that we get the Sticker price with this formula: =pv(15%,10,,-149) and we get a Sticker of $37.
In other words, if the analysts are right and TOL grows from today at 17% a year, if we pay $37 we’ll get a 15% compounded return for ten years. But we have no Margin of Safety so
we get one by dividing the Sticker in half. Half of $37 is $18. If we can buy TOL for $18 we are getting a dollar of value for fifty cents and we know we are going to make money.
Unfortunately TOL is selling for $57. Mr. Market has gone a bit nuts (or the analysts are way off). Just for fun, let’s say that our estimate of growth is more accurate and TOL grows at 24% for ten years more. Is $57 a good deal? Not for us. We’d have to buy it at $65 to
make 15% with no MOS. So even at a 24% growth rate, we need to buy it for $33, about half what it’s selling for.
In other words, TOL either fully priced or massively overvalued and in no case a Rule #1 buy. Even though it may be a wonderful business, it certainly is not at an attractive price.
Could it go up? Did Yahoo go up in the Tech boom? Sure. So why wouldn’t TOL go up in the real estate boom? Same thing… a bubble. So if you want to speculate in stocks, you may catch a nice ride on this real estate play, but be honest – you ain’t investing, you’re
gambling. And Rule #1 investors don’t gamble – at least not with your retirement.
Phil
P.S. Can I post our exchange on the blog if I take out your last name & your email address?
Hi Phil,
Thanks for all your help and great insight. I am looking for some more YUMMMMY companies. I’ll let you know if/when I find some. Feel free to post our conversation on your blog.
Talk to you soon.
Adam L.
Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.