Intrinsic Value

Intrinsic value is a balance sheet focused method of determing the true net value of an investment security. There are tens of different definitions used; but, the reality is that it is a mathematical formula modified to the respective industry in order to determine the worst case scenario of monetary compensation back to the investor.

Value Investment Fund – End of May 2022 Report

Value Investment Fund

During May, the Fund expanded the portfolio to include two new positions from among the existing 48 potential investments. The first included three separate tranche purchases of The Walt Disney Company and the second was an opportunity presented when Essex Property Trust, Inc. dropped below its intrinsic value. In addition, the Fund sold two separate option contracts in both positions. The Walt Disney Company position was exercised within a few days of that sale and the current option contract for Essex Property Trust, Inc. remains active. The sale of PUT options (three separate companies) generated $3,019 of realized income after associated transaction fees. Finally, Wells Fargo did issue a dividend worth $271 for the Fund. This dividend sits as a receivable on the books of record as Wells Fargo will pay the dividend during the first week of June.

Essex Property Trust – Value Investment Fund Buy

Value Investment Fund

Recently, the Fund reevaluated Essex Property Trust Inc. and increased the company’s intrinsic value to $291 per share. In an article written in January of 2021, the Facilitator determined intrinsic value at $256 per share. In the course of one year, many market forces have elevated this intrinsic value higher. With real estate investment trusts (REITs), intrinsic value is strongly tied to fair market value of properties. At the end of 2020, the overall fair market value of the entire portfolio of apartments for Essex was estimated at net assets value (adjusted for closing costs, costs to sell, pay-off of associated debt and costs to eliminate book balance of financing outlays) of $19.14 Billion. This made each share worth approximately $283. During the last 16 months, the market value of real estate has jumped over 16%. Using a mere 12% adjustment to this portfolio, the modified net assets value now exceeds $21.8 Billion. This alone adds $36 per share in value. Utilizing net assets value by itself warrants an intrinsic value of $319 per share. And this assumes only a 12% increase in value over 16 months.

The Walt Disney Company – Position Update

The Walt Disney Company

Disney is a DOW Jones Industrial Average member, which means it is one of the top 30 publicly traded companies. Anytime an investor can buy this company at a low price, it will reward patience. This site’s Value Investment Fund took advantage of the recent market decline along with the entertainment industry’s setbacks and now owns three separate tranches of The Walt Disney Company.

Sold PUTs on JPMorgan Chase & Co.

JPMorgan Chase & Co.

Yesterday, May 3rd, 2022, the Value Investment Fund sold 246.9135 PUTs on JPMorgan Chase & Co. with a strike price of $80 per share. These PUTs expire on June 16, 2023 (13 months). The Fund sold the PUTs for $2.76 each and netted $1.76 each after fees. Total realized income was $434.57 (246.9135 * $1.76/ea).

Bank of New York Mellon – Monitor Closely

Bank of New York Mellon

Overall, Bank of New York Mellon is in good financial condition and even with the adjustment for a reduction in revenue tied to Russian transactions, the bank will regain market value once the entire market shifts towards a positive position in comparison to the various index values on 12/31/21. However, the current market price is still too high to warrant a ‘Buy’. Intrinsic value is set at $42 per share and given the additional risk associated with securities valuation and the impact reduced fees will have in the short-term related to earned amounts from Russian activity, a 9% discount is warranted. Thus, a ‘Buy’ price is now set at $38 per share. 

Domino’s Pizza Inc. – Intrinsic Value

Domino's Pizza

Domino’s Pizza is the third largest publicly traded fast-food chain in the world. With over 18,800 locations worldwide, the business model is three pronged with franchising as the primary profit center. However, it has one glaring flaw, the company is highly leveraged to the tune of more than $5 Billion. There is ZERO equity in this company. It’s average annual earnings over the last five years are around $380 Million. The interest expense alone has almost doubled from $99 Million in 2016 to $192 Million in five years. 

Even with an average annual earnings of $525 Million per year, it will take 10 years to get the debt under control. Domino’s Pizza Inc. keeps recapitalizing its debt every couple of years. This recapitalization process increases the aggregated interest paid and given the current Federal Reserve’s attitude towards interest rates, this is going to be a detrimental problem for Domino’s in a few years. The weighted average borrowing rate is currently 3.8% and will remain stable for several years due to timing issues. However, there is a $1.2 Billion refinancing requirement in 2025 which will most likely result in an increase the average borrowing rate. Thus, the ability of Domino’s to continue profitability at more than $600 Million per year after 2025 is questionable.

End of 1st Quarter 2022 Report – Value Investment Fund

Value Investment Fund

During the first quarter of 2022, all major indices experienced dramatic retrenchment with the market value of their respective index. At some point during the quarter, most indices had double digit value reduction; the last half of March 2022 saw all of the various types of funds recover from the low points earlier in the quarter. However, this site’s Value Investment Fund experienced continued growth. This is the result of exercising highly selective buys that reduce risk dramatically. In turn, this risk reduction principle minimizes any type of potential loss associated with an economic wide downturn.

McDonald’s Intrinsic Value

McDonald's

President, Chief Executive Officer and Director of McDonald’s Inc. said it best in the earnings call in late January 2022, we are “… witnessing the beginning of the next great chapter at McDonald’s, …”. He continued with “2021 was a record-setting year for McDonald’s on many dimensions, …” Simply put, McDonald’s had the best financial performance ever in its history during 2021. It just didn’t marginally exceed records, McDonald’s dramatically surpassed all financial records in its entire history. McDonald’s was already the standard bearer in the informal-eating-out industry; it took this standard to a whole new level. When a company has net profits of more than 20%, it is labeled a ‘darling’; over 25%, it is just unheard of financial results; in 2021, McDonald’s net profit was greater than 32%. This sets such a high standard for fast-food restaurants; it is unlikely to be matched by others – EVER.

When a company performs to this level, intrinsic value soars. Intrinsic value is built on a company’s inherent worth. The more stable and reliable a company, the greater the intrinsic value for that company. The reason is simple, the discount rate used with evaluating earnings improves because management demonstrates that it can indeed perform and in this case, perform at exceptional levels.

What is even more fascinating is this: 

If you look at McDonald’s balance sheet, total assets on 12/31/21 are $53.8 Billion; total liabilities are $58.4 Billion. McDonald’s has a NEGATIVE EQUITY POSITION OF $4.6 BILLION. You read that correctly. In simple layman’s terminology, this is called ‘Bankrupt’. Every business textbook used in college defines bankruptcy as liabilities exceeding assets. This makes McDonald’s performance just that more impressive. They are so solid, even creditors ignore this situation and will still loan money to McDonald’s. During 2021, McDonald’s was able to acquire long-term loans totaling $1.154 Billion.  To further validate the incredible worthiness of McDonald’s, from page 57 of their filed SEC Form 10-K (annual report), “There are no provisions in the Company’s debt obligations that would accelerate repayment of debt as a result of a change in credit ratings or a material adverse change in the Company’s business.” You can only count on one hand the number of companies that have this level of credit. 

McDonald’s is financially rock solid.

Value or Growth Investing – Which is the Superior Investment Strategy?

Value Investing

There are about a dozen popular investment strategies. Two of them stand out in the crowd as the best due to similar standards of research required; they are value and growth investing. From these two top tier investment methods, which investment strategy is superior, value or growth investing?

Many that are unfamiliar with investing consider value and growth investing as synonymous. The truth is, both are starkly different. First, both have a completely different approach towards risk. Secondly, one places greater emphasis on holding the investment for extended periods of time. A third difference relates to the reliability of the supporting information when researching the potential investments. Finally, one of the methods has a superior dividends payout ratio over the other. 

This article will delve into these four distinct differences and how they play into results. When done, the reader should be able to quantify the value each provides depending on the mindset of the investor. Before getting into the four core differences, readers should understand the emphasis each form of investing has in order to discriminate the four core differences.

Intrinsic Value – Balance Sheet Fundamentals

Intrinsic Value - Balance Sheet Fundamentals

Novice and unsophisticated investors place greater reliance on net profits over the balance sheet to determine intrinsic value. However, most so-called experts forget what intrinsic value means; intrinsic value refers to the universally accepted core value of a company. In many cases, this can be easily derived from the balance sheet. If not derived from the balance sheet, the balance sheet can act as additional assurance that certain intrinsic value formulas are superior and best suited given the balance sheet information.

Understanding how a balance sheet is laid out, works and reports this information greatly assists value investors with determining intrinsic value. Gaining knowledge about balance sheet fundamentals takes a value investor to the next level of comprehension of value investing.

This is the second part in a series about intrinsic value. It is the first in a four-part series about the balance sheet and different intrinsic value formulas that are tied to the balance sheet. The next lesson in this balance sheet series delves deep into analysis of asset matrixes and proper interpretation of that information. It also includes how to tie the asset matrix to the liability layout. Understanding this relationship allows the value investor to apply certain intrinsic value formulas which are explained and illustrated.

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