Recent IV10/price ratios

Investment Analysis Clubs Manlobbi's Descent
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There were some posts about Apple on the Berkshire board, so I’ll add the comparison between Apple, Berkshire, Google, Alibaba and Broofield Asset Management here.

Firstly about Apple. I posted a thesis about Apple in 2012 which underlined engagement of developments as important (similar to what caused DOS to remain dominant for ludicrously long despite the technology literally a decades behind competitors) and these developers having a large learning curve and career-destroying switching costs. Unknown to many, this is still the main reason Apple is doing so well today. They have a pretty good phone product on top, but the size of the developer community is ludicrously large - and very dependent upon the software sales linked to their experience with iOS programming. The product could falter far longer than people imagine (look at DOS vs the other extremely more advanced OS environments around at the time), and they will still retain the developer partnerships and be completely dominant in software for a long, time. Don’t compare this to Nokia as their development community was a joke. Google would be a threat, except that if they heavily marketed their own phone, hardware competitors would jump ship (it would be like Microsoft bringing out their own PC, which would kill DOS, and they were smart enough to not do that).
https://discussion.fool.com/intrinsic-value-29846517.aspx

I wrote a 6 part thesis in 2012 for which this is just one part and I strongly encouraged purchasing Apple in 2012. I predicted that earnings in 20 years (that is 2022, so now) would move towards services, and even from here I think it will be important for Apple when looking out to 2032.

Even though I deem Apple to be Steadfast, some investors might be overconfident about how much higher Apple’s earnings will be ten years away. They’ll be higher, but there is only so much $$$ you can extract per customer once you have near market saturation.

A good argument for Apple’s having no problems with the per-customer spend ceiling is that most people consider what they get out of using their phone to be far higher than the dollars they are spending each year on the phone. That isn’t always important, but is important when combined with the next paragraph.

This relates to the phone, but is also related to what we spend for our mobile access to the internet generally, for which the product will vary over time but we will still want to have the best version available, and won’t want second best. There will be a market for “nearly as good, but cheap”, but there will also be a market for “only the best”, and you can think of the markets as distinct, the latter never going away or being replaced with the former.

The last time I investigated Apple closely (a few years ago), I put its earnings growth into these components:

  • 11% total annual growth, comprised of…
  • 1.5% dividend and buybacks
  • 3% from real increase in services
  • 2.5% from very lumpy but the real normalised increase from new product categories
  • 2% increase in new users
  • 2% inflation

I think Google is a much better investment than Apple, though, mostly because of Apple’s relatively high multiple right now (32x). Apple will unlikely grow earnings as fast as Google over ten years, so should have a lower multiple than Google’s (28x), not higher. Fortunately all of those nuances get summarised by just one ratio, the IV10/price.


*Apple*
Normalized earnings per share	5.6
Average earnings per share	9.74
Earnings multiple at year 10	20
IV10   				277.56
Price today			179
IV10/Price			1.6
		
*Google*
Earnings per Share normalized 	95
Average earnings growth rate	13.00%
Earnings per Share at year 10	322.48
Earnings multiple at year 10	25
IV10   				8062.1
Price today			2900
IV10/Price			2.8

IV10 is defined (in 2022) as near-worst-case estimate of intrinsic value of a company in 2032, no inflation adjustment or earnings discounting. For most firms this is close to $0 as our worst case is a wipeout, so this only works for firms that are Steadfast. Everything posted here is Steadfast (crudely defined as the firm definitely around in 20 years, and earnings above some minimum predictable baseline after 10 years).


*Berkshire Hathaway*
Book Value per Share, Sept 2021		211
10 year increase in BVPS 		8.00%
Book Value per Share 2032		455.53
Intrinsic Value = BV per Share * 1.5	683.3
Price today				308
IV10/Price				2.2

*Brookfield Asset Management*
Shares outstanding			1587
Book value per share today		19.98
Fee business (25 Fee related earnings)	28.36
IV0. 1.0 x book, plus fee business 	48.33
Accumulated value generation incl. divs	13.00%
IV10   					164.06
Price today				60.52
IV10/price				2.7

And don’t forget Mr. “Popular”:


*Alibaba*
Earnings per Share 2022			8
Earnings per Share 2026			12.17
Earnings per Share 2032			26.9
Earnings multiple at year 10		24
IV10   					645.54
Price today				112
IV10/Price				5.8

If you think the 24 earnings multiple is too high for Alibaba above, come up with your own multiple, but at least have something that is consistent through both good and bad new story cycles.

The last time we had a candidate with an IV10/price ratio above 5.0 was with BPY last year. Think back to one’s emotions in April 2020 when all properties were temporarily shut down. I was ploughing through the contracts on what happened to be the night of the market’s very lowest quote, making sure the short-term lack of cash flow was fine against their debt, and I couldn’t find any problems. Posts on this board were viciously scathing of its prospects. It was privately bought out at well over twice the quote and public quotes of similar firms are now more than three times higher. For many it felt awful to be an owner in April 2021 though, and many sold out at the lows, and few allocated more capital to BPY whilst the IV10/pice was near 5.0. The Manlobbi Method doesn’t care about news stories and Bloomberg neoliberalist passions - it cares about whether the firm is Steadfast, and what the IV10/price is.

  • Manlobbi
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<<Alibaba
Earnings per Share 2022 8
Earnings per Share 2026 12.17
Earnings per Share 2032 26.9
Earnings multiple at year 10 24
IV10 645.54
Price today 112
IV10/Price 5.8

Except Taobao and TMall, all other divisions are not making money, including cloud service, logistics Cainiao. If you remove the negative impact of those divisions, current earning per share is more than $8. It’s also hard to predict how much those divisions will contribute to earning in 10 years, the potential could be huge, especially the cloud service.

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Except Taobao and TMall, all other divisions are not making money, including cloud service, logistics Cainiao. If you remove the negative impact of those divisions, current earning per share is more than $8. It’s also hard to predict how much those divisions will contribute to earning in 10 years, the potential could be huge, especially the cloud service.

Right, but this is accounted for in the earnings growth. IV10/price ratio of 5.8 is based on the earnings in 2033 ($27 per share) rather than the 25 multiple applied just to today’s $8 earnings.

If we say that there is much growth coming up, and also say present $8 earnings are under-representing future earnings so today’s $8 should be normalised upwards and growth applied from that higher level, then we would be double counting. I am not suggesting you are expressing exactly but just underlining the distinction.

As you correctly point out, much of Alibaba’s earnings growth will come from these middle stage businesses rather than the present most profitable businesses, much as YouTube originally contributed nothing for Google but ultimately added a whole 11% to their growth.

Some of the businesses such as logistics are not there to make money, though, so much as making their core business more competitive. The logistics purchase is smart, but can even be thought as a necessary capital expenditure, just to retain their customers, if framing the information particularly pessimistically.

The cloud business is constantly overestimated as something wonderful. The cloud earnings grow because they are spending money on capacity, not because of organic growth. You could buy boring real estate instead using $1b over a series of years, then another $1b the next year, $2n the year after, doubling the assets owned each year, and brag how your real estate sector is increase revenue 100% a year, thus that part of the business is worth much more even if each property did not grow revenue at all.

  • Manlobbi
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<<As you correctly point out, much of Alibaba’s earnings growth will come from these middle stage businesses rather than the present most profitable businesses, much as YouTube originally contributed nothing for Google but ultimately added a whole 11% to their growth.

Thanks for the clarification. The difficulty is in estimating the potential earning power of these businesses as they have not been making money, the cloud service turned EBITA positive just two quarters ago. On the other hand, the core commercial business (service revenue collected from Taobao and TMall with EBITA about $38b USD) has been growing around 20% until the last two quarters when the growth rate dropped to single digit, which I think reflects more on the overall economic slow down. There are good reasons to believe the core commercial will return to double digit growth in years to come and this alone could take the earning per share up to $27 in 2033 excluding negative drag from other businesses. The reasons being: 1. the online share of the total retail is still low, around 25%, and will keep growing faster than the total retail. 2. China’s total retail has been growing double digits and the trend will continue, as the population become richer, the notorious high saving rate will drop and consumer spending will grow faster than the GDP.

<>

China’s cloud market is much smaller than the US’s but is growing at a much faster rate. Amazon’s cloud service AWS contributes $13.5B operating income for 2020, more than 50% of Amazon’s total operating income. If only this pattern will hold true for Alibaba, the potential earning power could be huge.

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The last time we had a candidate with an IV10/price ratio above 5.0 was with BPY last year. Think back to one’s emotions in April 2020 when all properties were temporarily shut down. I was ploughing through the contracts on what happened to be the night of the market’s very lowest quote, making sure the short-term lack of cash flow was fine against their debt, and I couldn’t find any problems. Posts on this board were viciously scathing of its prospects.

Applying the Manlobbi method to any stock beaten down as dramatically as BPY then and BABA now, the first question, it seems to me, is whether the requirement of steadfastness still applies in the face of whatever has caused the quote to collapse. In your book (an unusually pleasurable read in the field of finance, by the way), you introduce the concept this way:

Steadfastness will be defined, for the purpose of investing, as having no tolerance for the asset carrying economic risk. To be more clear, it refers to any asset . . . [here you list several examples of asset types] having no chance of the normalized earnings produced from the asset declining below the expected level. The question of steadfastness is without a formulae and must be decided with independent reasoning for each situation." (p. 34)

About the only thing that BPY 22 months ago and BABA today have in common is the precipitous fall in the quote. That is not to suggest both are not steadfast, simply to say that by the independent reasoning you prescribe, they require two distinct paths.

In the case of BPY, the main argument against steadfastness was that commercial real estate, even high-quality commercial real estate like BPY’s, would be permanently impaired by a combination of the pandemic and the interweb (e-commerce). People had different views on that. You found no reason in BPY’s financials to doubt its ability to weather these storms and the returns from investments made in spring 2020 were handsome. It did not achieve your IV10 multiple because it was taken private more than eight years short of the mark, but the final quote was a triple from those lows, meaning a mere double over the following 8+ years, implying a single-digit annual growth rate, would have hit your multiple.

In the case of BABA, the main argument against steadfastness is that the Chinese government has taken a series of decisions related to private enterprise, and private enterprises in the interweb space in particular, that make it impossible to apply the level of certainty to BABA’s future prospects that steadfastness requires. The terms you use – “no tolerance” for economic risk, “no chance” of normalized earnings disappointing – leave little room for interpretation.

Are fears of yet untold decisions by the Chinese government materially affecting BABA’s future earnings so implausible as to meet these very high hurdles?

Let’s set aside for the moment the topic of embedded Western bias against China and its leadership that you have addressed quite ably. The very nature of embedded bias makes the notion of setting it aside oxymoronic, but let me state the question as neutrally as I can:

Let’s make no value judgments about the recent government decisions that have affected the market quotes of BABA and other Chinese companies. In fact, for the purposes of this discussion, let’s stipulate that they were appropriate. Let’s say only that the drop in BABA’s quote of more than 50% in the past year is mostly a consequence of these decisions and Mr. Market’s fear that there might be more to come. When you compare BABA’s valuation to those of companies in similar businesses outside China, this appears to be a safe assumption regarding Mr. Market’s perception, regardless of whether his fears are justified.

Certainly it is possible to believe that China’s government will not further impair BABA in a material way. Mr. Munger and many other smart people appear to hold this conviction. But as it relates to steadfastness, the question is not what one’s view might be of likely Chinese government steps going forward. The question is only whether further steps that might impair BABA’s future earnings are one plausible outcome.

I believed, like you, that a permanent, severe impairment of BPY’s commercial real estate portfolio due to the pandemic and e-commerce was a highly unlikely scenario driven more by the emotion of the moment than rational analysis. It was a possible scenario, but the history of pandemics, quality of BPY’s assets, and ongoing integration of physical and electronic commerce were strong arguments against its plausibility.

Similarly, there is much in Western analysis of the Chinese government these days based on emotion rather than rational analysis. Dissimilarly, we have relatively little historical record upon which to make predictions about future decisions to be taken by Mr. Xi’s government. How would you make the case today that BABA is steadfast? In other words, what facts make it prudent to dismiss the plausibility of future Chinese government decisions that impair BABA’s future earnings?

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<<In the case of BABA, the main argument against steadfastness is that the Chinese government has taken a series of decisions related to private enterprise, and private enterprises in the interweb space in particular, that make it impossible to apply the level of certainty to BABA’s future prospects that steadfastness requires. The terms you use – “no tolerance” for economic risk, “no chance” of normalized earnings disappointing – leave little room for interpretation.

Could you name a Chinese government’s decision or new rule that would be harmful to private enterprises as a whole?

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Could you name a Chinese government’s decision or new rule that would be harmful to private enterprises as a whole?

Higher taxes, perhaps disguised as voluntary social contributions.

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<<Higher taxes, perhaps disguised as voluntary social contributions.>>

China’s corporate tax rate is 25%, with some industries such as software business enjoying 10-15% tax rate.

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Steadfastness will be defined, for the purpose of investing, as having no tolerance for the asset carrying economic risk. To be more clear, it refers to any asset . . . [here you list several examples of asset types] having no chance of the normalized earnings produced from the asset declining below the expected level.

By that definition no business is steadfast. IMO the only reasonable way to assess steadfastness is via a probability distribution. The probability of a real bad outcome for some businesses like e.g. BRK or KO is very low but not zero. These are the businesses I consider as steadfast.

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Could you name a Chinese government’s decision or new rule that would be harmful to private enterprises as a whole?

One example would be new restrictions on raising capital. Early tech startups like Alibaba and Baidu raised significant sums through IPOs in New York. Forcing Alipay to withdraw its IPO and persuading Didi to delist just weeks after listing suggest that government approval will be required for future IPOs. Add the government’s determination that audit information required by U.S. regulators represents proprietary national information not to be disclosed to foreigners, and the effect may be to close off some sources of Western capital. If listing is henceforth confined to Chinese exchanges, the government may be able effectively to control who is allowed to raise capital, and how much.

The overarching threat is the supremacy of the state across all sectors. The sectors that have been subject to new regulatory imperatives so far represent some of the largest parts of the digital economy, including e-commerce, gaming, education and finance. In China, many sectors of what we might call the old, industrial economy – banking, energy, mining, etc. – are dominated by state-owned enterprises. While these are big companies, they are not private enterprises as we would define the term in the West.

Much of the explosion of private enterprise in China over the past generation has come in the digital space, and it is difficult to identify a sector in that space that is not subject to new regulations about how companies should work and how they should treat the data they collect from customers. When Meituan, for example, is ordered to provide better support to its army of drivers, many of us might cheer the policy choice, but there are obvious implications for the firm’s future profitability and for any future earnings estimates Western investors might have modeled. This affects not only earnings but what investors are willing to pay for those earnings. For example, the brokerage Bernstein sees Tencent’s market multiple falling from 32x in 2020 to 24x in 2022.

Again I emphasize this is purely about the predictability of earnings and earnings growth, not the advisability of China’s policy choices. There are many who view the U.S. as a corporatist economy that places too much emphasis on corporate profitability and too little on other social values. The Chinese government may be in the process of balancing social values in a way that the West has so far been unable to do. But the advisability of China’s recent aggressive regulatory steps is not our subject. Our subject is only whether Alibaba’s future earnings are so safe and predictable that it might be identified as steadfast by a Western investor.

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<<One example would be new restrictions on raising capital. Early tech startups like Alibaba and Baidu raised significant sums through IPOs in New York. Forcing Alipay to withdraw its IPO and persuading Didi to delist just weeks after listing suggest that government approval will be required for future IPOs. Add the government’s determination that audit information required by U.S. regulators represents proprietary national information not to be disclosed to foreigners, and the effect may be to close off some sources of Western capital. If listing is henceforth confined to Chinese exchanges, the government may be able effectively to control who is allowed to raise capital, and how much.

Only business controlling data of more than one million users would need government approval before oversea listing. Forcing Alipay to withdraw IPO because Alipay disguised itself as a technology company while its business of making loans clearly is financial and needs financial regulation. According to report, the government had been investigating DiDi’s data security issues before its IPO and warned it not to list in the US market before the issues are resolved.

<<Much of the explosion of private enterprise in China over the past generation has come in the digital space, and it is difficult to identify a sector in that space that is not subject to new regulations about how companies should work and how they should treat the data they collect from customers. When Meituan, for example, is ordered to provide better support to its army of drivers, many of us might cheer the policy choice, but there are obvious implications for the firm’s future profitability and for any future earnings estimates Western investors might have modeled. This affects not only earnings but what investors are willing to pay for those earnings. For example, the brokerage Bernstein sees Tencent’s market multiple falling from 32x in 2020 to 24x in 2022.>>

The Chinese government had been one of the most hands-off governments regarding data security and privacy regulation until the Trump administration started sanctioning various Chinese companies regarding security issue. Probably it has learnt it from the US government since then that it has to take data security and user privacy seriously. Isn’t that a good thing?

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Manlobbi, IV/Price Ratios as of 4.Jan 2022:
(https://discussion.fool.com/recent-iv10price-ratios-35015320.asp…)

Apple: 1.6
Berkshire Hathaway: 2.2
Brookfield: 2.7
Google: 2.8
Alibaba: 5.8

I updated this with today’s stock prices:

Apple: 2.0
Berkshire Hathaway: 2.5
Brookfield: 2.9
Google: 3.6
Alibaba: 6.1

I have no idea about how IV10 (The worst-case expected IV in 2032) might have changed for those companies (apart from Berkshire: Not at all “of course” :slight_smile:

So this simply provides a picture of how much or not the share prices in the last 1/2 year did change relative to each other, resulting in Apple and Google both being much cheaper than 1/2 year ago (1/4 better ratios now) — supposed their IV10 did not change drastically.

Contrary to those two for the other ones price wise practically nothing changed relative to 4.Jan (which for me personally especially regarding Berkshire is disappointing as from this perspective it doesn’t seem to be the great bargain I saw in it from a historical Price/BV ratio).

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so will make 3.6X your $ from here in 10 years on BRKB?

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my bad. I meant 2.5x?

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That is the theory. Completely dependant on endpoints, but the method just speaks to relative attractiveness of the stocks in question. My best advice is to read the board for Manlobbi’s posts. They are excellent,and explain in detail the theory behind the method.
It is very much worth your time to understand.

Jk

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I find his posts unreadable even though content is excellent. Need plain English.

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