All publicly listed companies are totally lacking in one important respect

They all lack a focus on shareholder value.

Not a single company tells their shareholders and the general public what they are worth. And yet, many of them routinely buy back their own shares without even the slightest hint of the expected return on investment.

In my view it should be criminal to buy back shares without communicating clearly what the stocks are worth and showing simply and intuitively why that is. A company’s management is severely lacking in their fiduciary duty to their shareholders, when they buy back shares with no opinion or comment on their worth.

The average company is worth 1x Sales

Whenever a buyback program is suggested and decided upon, there should be a mandatory explanation of why the stocks are worth more to shareholders than investing in expanding the business, buying businesses, buying shares in other companies, or distributing a dividend. A share buyback program should among other things also state what the company’s stock is worth and at what price there is sufficient margin of safety to that value to warrant buying those shares.

A simple model for calculating the value of a company’s shares could be based on a few years of cash flows plus an end value, based on commonly accepted cash flow multiples for similar companies.

The price typically fluctuates between 0.5x Sales and 3x Sales

For example, given the company’s plans for sales, costs, margins, net working capital requirements and investments the coming few years, it’s easy to calculate the level of distributable free cash flow as well as the end point for the period in terms of sales, profits, assets and annual cash flow. At a certain achieved and expected growth rate for those business fundamentals, there are generally accepted valuation multiples (as can in practice be measured on average over previous cycles for similar businesses, or for the entire market if growth rates, profitability and cash conversion levels are similar to the average company). At the very least every publicly listed company that claims to focus on shareholder value should publish updated assessments of what that value is. In particular if the company plans to buy back its own shares.

A share buyback only adds value if the shares are bought below what they are actually worth. That means that the company needs to have a very clear view of what that value is. Further it should be communicated to its shareholders to help guide them to make better decisions on when to sell or buy shares in the company. In particular, the discussion and calculation of that value should follow clear and intuitive value based principles that have stood the test of time over many full economic cycles.

A company should calculate and publish

their best estimate of shareholder value

Over more than a hundred years of modern stock market history, the average company has on average been valued at around 15 times next year’s actual net earnings, or 16-17 times the most recently published actual earnings after tax. Another way to express that historical valuation norm is through the Price/Sales multiple which has been a very convenient 1.0. Averages are averages, however, and very few companies can singlehandedly represent the 500 constituents of the S&P 500 index. But in as much as a company exhibits characteristics similar to the index average, it can be expected on average over a cycle to be valued at 1x Sales and 15x earnings.

Whenever an investor has bought the index at approximately an 15x/1x valuation (“15x”) they have achieved a total compound average annual return (“CAGR”) of 10% – a fair compensation for giving up one’s liquidity, forsaking other investments and consumption, as well as taking the risk that valuations are cyclically lower than average when the money is needed. The average valuation of “15” is an average, sometimes 10x normalized net earnings, sometimes 20x.

It’s not a question of crystal ball forecasts of a likely share price trajectory

but of a best estimate based on time tested fundamental value principles

Due to the cyclicality of profit margins and accounting trends, it’s easier to use the much more stable and reliable P/S multiple. On average an investor has always received 10% CAGR over the coming 25 years (usually over the coming 10 years) when buying the index at the historical valuation average of 1x sales. Buying at distressed low points of 0.5x have yielded 20% CAGR over 10-15-20 years, while buying at very optimistic 2-3x sales have yielded zero total return over the coming decade.

It’s easy: your stock is worth 15x the next 4 quarters of normalized net earnings,

adjusted for business divergencies from the index average

Using these benchmarks makes it easy, albeit not infallible, for a company to establish a likely pretty narrow warranted valuation range for its business and its shares. This value should be stated very clearly on every company publication. If they deem it too difficult to calculate, they should not be allowed to buy back shares, or talk about targeting shareholder value. They can’t target what they have no idea what it is.

The shares 5 years from now will be worth 15x the earnings 6 years from now

(i.e. 15x next year’s earnings)

[normalized , as always; use P/S instead if normalizing earnings is too hard]

The value today is the sum of surplus cash flow over five years plus the end value

(all properly discounted to today, of course)

[and adjusted for differences vs the index average]

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Thanks for bringing this to English.


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