"Sorry we couldn't do business" is a phrase you'll hear
from brokers at the Gold & Silver Pawn Shop in Las Vegas
when a deal just doesn't make sense.
And no, I didn't find this out by trying to hock my
grandfather's watch. This pawn shop is featured in a new
History Channel show called
Pawn Stars. As a history buff --
and an investor-- I've quickly become addicted to
the show.
It's amazing what some people bring in either for sale or
to pawn, like an 1849 Colt revolver and Salvador Dali proofs.
Everyone has a great story to tell -- they're trying to get
top dollar, after all. But for the pawnbrokers, a good story
isn't enough. The price also has to be right.
See, if the pawnbroker gets all googly eyed about a great
story and overpays for it, he'll be unable to make a profit
when he tries to sell the item in question. A string of
mistakes like this will quickly put him out of business.
That's why, if the price isn't right, a successful pawnbroker
will simply walk away -- no regrets.
As investors, we could take a page from the pawnbrokers'
approach. If the market isn't offering the right price on a
stock, just walk away.
These boots are made for walkin'
To decide whether you should walk away from a
potential stock purchase, you first need to determine what
the stock should be worth based on the intrinsic value of the
company, which can be measured in most cases using
discounted cash flowanalysis. Put simply, a DCF model
estimates future cash flows generated by the business and
determines what those future cash flows are worth today.
To be sure, estimating a stock's intrinsic value is both
art and science, but establishing even a range of potential
fair values is better than flying by the seat of your pants.
Overpay too often for your stocks and you could be out of
business as quickly as an unskillful pawnbroker.
When the market's rallying off generational lows, it might
seem that
bargain stocks are everywhere, but investors need to take
account of each stock separately and avoid the plethora of
huge value trapsthat have popped up in recent months.
It doesn't take a market genius, for instance, to regard
the rallies in stocks like
Rite Aid (NYSE: RAD) and
OfficeMax (NYSE: OMX) (500%-plus since early
March!) with some definite skepticism.
Is it cheap or not?
With the assistance of the
Motley Fool Inside Value
discounted cash flow calculator, we can begin to develop
an idea of a stock's fair value. In each valuation, I
discounted free cash flow estimates by 12% and assigned 3%
terminal growth.
Here are five results:
Company
Current Price
Median Analyst 5-Year
EPS Estimate
DCF Result
Margin of Safety (risk)
Percentage
eBay
(Nasdaq: EBAY)
$23.58
11%
$29.56
20.2%
Wal-Mart
(NYSE: WMT)
$48.95
12%
$48.37
(1.2%)
Caterpillar
(NYSE: CAT)
$51.04
6%
$50.72
(0.6%)
Home Depot
(NYSE: HD)
$26.38 Continued... |