Phil Town on Investing: WAG Valuation

For starters, let’s set a growth rate for WAG.

It should pretty much jump out at us once we know what are we looking for.

Let’s start with the historical equity growth rate. Strangely, the first place I go is the Cash Flow Statement to see if the business has been paying a lot of uneven dividends. By that I mean to check whether they paid out a big lump sum of equity to investors. If so, that needs to be added back in.

WAG pays dividends, but very evenly -- so there is no need to mess with that.

I also check to see if they’ve been buying back stock, another thing that affects the equity line if you aren’t doing this per share.

WAG has been buying stock, but they now have basically the same number of shares they had ten years ago -- so no big deal.

So now we can go to the Balance Sheet and go to work. Actually, now we know we can use the pre-calculated equity growth rates on MSN or Investools or Yahoo which tell me that WAG equity has been growing consistently at roughly 15% for years slightly down from 17%.

That number now becomes my defacto Rule #1 growth rate. Now I’m going to see if the other growth rates will make me want to lower or raise that number.

EPS growth is sliding slightly from 16% long term and is probably about 14-15%.

Sales growth is sliding slightly down from 15% and is now 13-14%.

These numbers make me want to nudge the growth rate down to 14% as Doug and Frank did.

Free Cash is usually a mess for retailers and therefore not much help, so I go to Operating Cash to get a better picture. The long term Cash growth is 16% for 10, 28% for 5 and 18% for 3.

This number makes me want to nudge the growth rate up to 16%.

If ROIC is staying strong (and it is at about 11%) then I feel pretty good about management keeping their eye on the business.

These, taken together, make me feel pretty good about a number that is 15%-ish. So now let’s see what the pros think.

I’m now looking at projections on Investools. It's on MSN, too. 12 pro analysts estimate the growth for WAG to range from 14% at the low end to 17% at the high end, averaging 15.5%.

First thing this tells me is that this company is quite predictable. That is a very small range for that many analysts. That’s good news.

The second thing is that my comfort level with 15% is in good company. I’m right in the middle of the bell curve.

And the third thing is that if I was sitting on the fence to move the projection up a bit, I wouldn’t be out of line to do so.

And lastly, that using 14% is a very conservative number. Maybe too much so.

All that said, I’m pretty happy with my 15%, so I’m going to stick with that. And now that I have my growth rate, I also automatically have my Rule #1 PE Ratio: 30. We just double the growth rate.

And now I want to see what the historical PE ratio range is. On MSN I look at financials, key ratios, price ratios.

On Investools I click on Phase 2 Financials.

Investools tells me that WAG has a PE in the mid 30’s every year as a high and the low is mid 20’s. I could fairly put the average PE near 35 and not be wrong. I could also be really conservative and put it in the mid 20’s. Doug and Frank did that, too. Nothing wrong with that, but it is very conservative. Investools is telling me that the average PE is 28-29. But with the PE consistently higher than that sometime during all the years, I’m totally good with it at 30, so that’s my PE.

Remember, we’re trying to put a real value on this business, not lowball the thing. We want to know what a reasonable buyer would pay without all the ulterior motives that private equity has or public companies have to pay too much -- and we want to be fair to the business. We’re not trying to steal it. Yet. We'll get to that part soon enough.

Now grab the current trailing twelve months EPS. It's $2.04, as everyone pointed out.

And here it makes sense to look briefly at the quarter by quarter EPS over the last couple of years to make sure we’re not trying to price this business just as it had a monster out of the ordinary quarter one way or the other.

Just make sure the last twelve months are representative of what you should expect long term. A quick check on Investools’ Quarterly Earnings (under Fundamental Analysis) and we can see a graph that tells us visually that this last twelve months is much like the previous twelve.

And then we do the math. Using the Rule of 72, $2.04 growing at 15% doubles twice in ten years to $8.16 ($8.25 using Excel). Multiply by 30 and we get $244 or so. Divide by 4 and we get $61.

Let’s call my valuation of WAG today $61 a share.

Since I’m experienced at this one, now I know I can buy WAG when it is priced below 80% of $61. So my MOS for WAG is anything below $49.

If you are new at this or not too sure you’ve got a solid valuation, go for a bigger MOS of 50%. In this case that means you are hoping to buy WAG for about $31.

Obviously the problem with trying to buy something this predictable with that big of a discount is that you might be waiting for a big scary meltdown of the whole market before you can pick it up. Well, that’s not so bad. That’s what Buffett does. And is doing. He’s sitting on about $45 billion in cash right now waiting for exactly that, so if you sit with him, you are in good company.

On the other hand, we are so much more nimble than Buffett, as he readily admits. So if WAG starts to melt down, I’m going to get out. That fact makes me feel pretty solid about investing in it when it's below $49.

And what’s the price right now? $44.

So if I buy it at $44 and just hold it (forget what I just said about getting out), I should be able to sell it in 2017 sometime for about $245. And if I can do that, I will have compounded my money at 19% per year. And if I get out at the high end of the PE range my return might be as much as 21% compounded for ten years.

Now go play.