Wal-Mart 1990 Case Study Part 2/2
Last time I tried valuation w/ method from Value Investing: From Graham to Buffett and Beyond by Greenwald, the EPV method.
A few realizations I’ve had since doing the EPV valuation. I’ve been struggling with how to account for the high rate of growth that Wal-Mart had in something like an EPV valuation model. I’ve realized, however, that since the only growth accounted for in the model is growth within the competitive advantage, the growth is more reliable than growth anywhere else. So when I approximated 8% eternal growth for Wal-Mart, that may have been seriously understating real growth.
Second, growth in the next 10 years is worth more than growth after that because earnings are discounted more heavily the farther they are into the future. So while I had a 20% margin of safety on Wal-Mart at those prices, I was also getting a free option on growth rates above 8%(remember 25% growth was occurring at the time and Wal-Mart was ramping up store growth) where that growth would have a very serious effect on the value of the company.
I’m sure I could do the terminal value math and figure out the weight of the first 10 years on total valuation compared to the terminal years after but I have a feeling the first 10 years would make up at least 30% to 40% of the total valuation…so growth in early years above 8% would have a fairly significant impact on the valuation, and it’s actually hard to see early year growth below 16% with the kind of growth Wal-Mart has been achieving so far.
Lesson Learned? After finishing any valuation, it’s key to look at all the assumptions that the valuation is making and look at how sensible those assumptions are. After an initial checkup in EPV suggested an average 20% Margin of Safety, checking my assumptions could have easily lead me to a 40% or higher margin of safety on a fantastic business like Wal-Mart.
Valuation: Measuring and Managing the Value of Companies
This is a long process, and I’m still unfamiliar with it. As I read through the practical valuation chapters of the book, I realized that the book is essentially teaching how best to complete a traditional DCF or Economic Profit valuation of a company in the context of value drivers, so after completing the valuation it is clearer how the company looks from a strategic perspective(strengths, weaknesses, etc). However, the specificity of the valuation method is very high and I think I’ll require some more practice in the modern world, where I can analyze industries more accurately with a broader base of information and understand competitive dynamics before I can put it into practice in an older case study like Wal-Mart’s.
So, sorry to disappoint. I’ll make sure to post a case study of my attempt at a McKinsey style valuation ASAP.