Ranking And Valuation Of Shares By Warren Buffet’s Methodology

Information Technology

In the order of desirability the ten investments are ranked in association with risk per unit of return factor. The formula used to determine the rank of the company is Beta/ cost of Equity. It can be observed from the above calculations that Iress Limited is ranked as number 1 because of risk per unit of return is 0.12 which is lowest as compared to other companies and sectors. However it will also depend upon the choice of the investor. Therefore, they have been ranked according to the beta value (Owens, 2018).

At times when the investor is ready to take certain risks in life the approach gets changed automatically. If higher returns are a major concern that the investor can opt for either Altium Limited or Genworth Mortgage. Buying these two classes of shares will definitely ensure more returns along with risk. Therefore, the procedure of the selection will depend upon the type of the firm.

In the information technology sector there are three companies namely Altium Limited, Iress Limited and Xero Limited. Warren buffet is an American Business investor who is currently positioned as CEO of Berkshire Hathaway. In one of the recent interviews Warren Buffet recapitulated his choice and termed his favourite period as forever.  In his opinion the price of Altium Limited can shoot up over the next upcoming years. The design of the circuit board of Altium Limited is significantly popular and currently captures a market share worth 16%. The forecast made by the management involves a shift of US$100 million from the current year to the financial year 2020 (Owens, 2018).

The next company is IRESS Limited and from the latest analyst’s view it can be observed that its earnings are expected to increase considerably by 67.48% in the coming three years. Currently the EPS of the company is $0.3 and it is expected to shoot up till $0.57. The good growth prospects are predicted by Warren Buffet. The revenue also took a jump form $407 million to $536 million. However, profit is predicted to grow from up to $94million in upcoming years, IRE’s earning growth was hardly 0.72%. IRESS limited distributed a $0.28 worth dividend which forms about 124.29% of its earnings as dividend. While forming portfolio IRESS can be a complicated choice. This kind of stock can be selected if the investor is not investing just for the purpose of dividend (Owens, 2018).

Energy

Similarly in energy sectors there are shares namely Woodside petroleum limited, Washington and soul Pattinson company, Santos limited and Oil search limited. The business of Woodside Petroleum Limited is too forecasted to escalate till 21.8% in the upcoming year. Also the return on equity of Woodside’s Petroleum of 7.26% leaves a lot for the investors. There is a room for improvement as there is a rise of 8.5 %. But according to the analysis Woodside Petroleum faces a challenging outlook (ASX, 2018).  

Taking into consideration the financial sector shares, the shares of ANZ banking Group Limited are expected to showcase a growth of 19.4% increase. The investors are expecting a 27.2% overall increase in earnings in a period of upcoming three years. This would deliver an increase in the earning per share to an average of $2.51 in relevance to previous years. In opinion of Warren Buffet this share is expected to slightly improve its return on investment by 12.4%. Over the past ten years the Bendigo and Adelaide Bank Limited has accumulated a return of 6.00% from the pay-outs through the dividends. The current rate of the dividend to shareholders accounts for 6.45% making it relatively the attractively dividend stock (Akansu, 2017).

According to Warren Buffet, the Washington H. Soul Pattinson currently trades more than its book value which is at 1.27 times its book value. This means that the trades are made at discount to the intrinsic value of share by this company. The revenue is predicted to grow from $4.08 billion to $4.60 billion in 2019. The Oil search limited stock is considered as a high growth stock, yet the investors are puzzled over its last closure price of A$7.18 which do possess some kind of potentials (Akansu, 2017). In opinion of Warren Buffet, going through the current earnings the share seems over valued as compared to other prevailing companies in the industry. Santos’ five year beta of 1.93 means that company value will escalate more than the existing market. This kind of volatility showcases greater risks for the investors who are investing in the stock market passively. In opinion of Warren Buffet Santos limited can help in magnifying the portfolio (Ahmadi, 2017).

According to Warren Buffet approach the share valuation can be done as follows. In Buffet’s opinion, he is not considered about the intricacies of the demand and supply factors prevailing in the market. In fact the stocks are chosen by him on the basis of the overall potential as a company. The following factors are considered before taking the overall decision. The questions are as follows;

Financials

Has the company consistently performed well in terms of return on equity?

It is calculated on the basis of a formula Net Income/ Shareholder’s Equity. According to Warren Buffet the investor shall g through the historical performance of past 4 to 10 years in terms of ROE.

Has the company avoided the excessive debt?

The ratio of Debt/Equity is one of the factors taken into consideration by Buffet. A small amount of debt is preferred by Warren Buffet so that the revenue can be generated from shareholder’s equity in contrast to the borrowed money. The following formula is used to calculate the ratio. Total Liabilities/ Shareholder’s Equity.  A lower level of Equity eventually is clubbed with volatile earnings and huge amount of expenses.

Are profit margins high? Whether they are increasing?

A good profit margin is not sufficient rather than an increasing margin is required. This margin is calculated as Net Income/Net Sales. A sound profit margin will indicate the performance of the company and how efficiently they are working on controlling expenses.

How long the company has been public?

Buffet typically considers only those shares of the company which are into existence since past 10 years. Only those business shall be executed in which there is a proper description and understanding. Therefore, it can be analysed from the above research that Buffet adopts the valuation exercises and attempts to determine the return on investment, growth rate of book value, earnings per share, Price earnings ratio, revenue, net income, future stock price. All these intricacies will eventually help in determining which share to purchase and when (Akansu, 2017). 

Warren Buffet’s Two-column Valuation Methodology deals with the Market price and intrinsic value. The one more element that can be added to this valuation methodology is the efficacy of retaining the earnings for future purposes. The methods that are used for valuation of shares are Relative valuation model, Dividend Discount Model, Discounted Cash flow model.

• Relative Valuation Model:

This model is utilised when there is a need to compare the companies working in the similar industry. Under this method the main component is calculation of P/E Ratio. For example if the P/E ratio of the company is lower that company is considered as undervalued. This method is easy to calculate and understand; therefore this method is adopted by most of the investors for calculation of share valuation.

• Dividend Discount Model

This model helps in deriving the true picture and worth of the firm on the basis of the dividends that are paid to the shareholders of the company. Under this model, the first there exists two phases. The first phase deals with the calculation of the dividend. The second phase deals with the determination of the fact whether the dividend is stable and predictable.

• Discounted Cash Flow Model

This model is associated with situations where there is a possibility of irregular dividends or no dividends. The greatest advantage of this model is utilised by the firms who do not pay out the dividends.

Therefore, the approach that can be preferred will depend upon the type of the industry and the prevailing company. Also it depends upon the investors, what kind of valuation option they are choosing.  Often investors like to involve in number of calculations and options to create a wide range of possibilities and alternatives. At times it happens a single valuation is not sufficient to decide which share should be bought therefore; one single approach cannot be a solid criterion to decide the valuation (Owens, 2018).

References

Ahmadi, A. (2017). The Stock Price Valuation of Earnings per Share and Book Value: Evidence from Tunisian Firms. The Journal of Internet Banking and Commerce, 22(1), 1-11.

Akansu, A. N. (2017). The flash crash: a review. Journal of Capital Markets Studies, 1(1), 89-100.

ASX. (2018, may 09). ASX. Retrieved from ASX LIMITED: https://www.asx.com.au/prices/company-information.htm

Owens, D. (2018). Simply Wall ST. Retrieved from https://simplywall.st/stocks/au/banks/asx-ben/bendigo-and-adelaide-bank-shares/news/what-makes-bendigo-and-adelaide-bank-limited-asxben-a-great-dividend-stock/

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