When I bought Tandem’s shares (LSE:TND) at £1.59 in April 2019 I figured the average historical owner earnings to be £1.282m over seven years, which gave an estimated intrinsic value of £16.0m or 320p per share (see newsletter posted 10th April 2019). Now that the shares are over £3.70 I thought I’d update the numbers.
We look at historical owner earnings to get a feel for likely future earnings power and therefore future owner earnings. All future owner earnings after discounting at the required rate of return for equity risk capital (I use 8%) are totalled to estimate intrinsic value.
With owner earnings we are trying to obtain the earnings that, in future, would be left for shareholders after the managers’ use of cash generated to pay for items of expenditure to maintain the strength of the economic franchise (e.g. additional capital items, additional working capital, marketing spend, R&D and staff training) and to maintain unit volume and to invest in all value-generating projects available.
Depending on circumstances, the owner earnings figure may be the same for every future year or on a steadily rising (or falling) trend.
Naturally, owner earnings are impossible to obtain with any degree of precision because many of the input numbers are merely educated guesses about the future. Despite this imprecision it remains an important method for thinking through valuations.
Owner earnings analysis is about future cash available for shareholders to take out of the business. But the only evidence we have available is past data. We start with that, and then use qualitative analysis to judge whether to simply project forward the past pattern or modify the previous trend for future orientated thinking.
In the following we use what the company actually invested in new working capital items and in new fixed capital items, and what they spent on marketing, R&D and staff training etc. already deducted from the P&L.
What the analysis really requires is the amount necessary to maintain the quality of the economic franchise, unit volume and invest in value generating projects. To start with we make the bold assumption that what was spent by the managers was also the necessary amount.
When we move to forward-looking analysis to value the firm we need to make another bold assumption on the real amount needed to invest in new WC, fixed capital items, etc., in the future. The historical analysis helps us make that judgment.
£000s YEAR 2012 2013 2014 2015
Profit after interest and tax deduction 611 1,053 1,317 1,086
Add back non-cash items such as depreciation, goodwill and other amortisation 85 211 200 209
Totals to: Amount available for distribution to shareholders before considering the need to spend on fixed capital items and working capital items to maintain the company’s economic franchise, unit volume and invest in value generating projects. 696 1,264………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
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