Valuation cheat sheet

By Invest In Assets

This cheat sheet will provide:

An easy valuation method

Make you equipped to estimate:

Growth rates

Intrinsic value

Future PE multiples

Give concrete examples of valuing 3 different businesses

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Valuation cheat sheet 1
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 Keeping valuations simple
Creating advanced and complicated financial models will only lead to being precisely
wrong, instead of directionally right. None of the greatest investors in the world are
using complicated models, so why should you? Here is a simple valuation method that
is used Francois Rochon to determine if a company is a buy or not.

Francois Rochon's simple valuation method

The formula:

EPS = Earnings per share

G = growth rate in decimal
PE5Y = Expected PE multiple in 5 years

Let me explain.

Earnings per share (EPS)

Think about the current EPS for a business you want to value. I’ll use Evolution Gaming
as an example.

Evolution EPS in 2022 was $3.89. EPS can be calculated as follows:

Valuation cheat sheet 2

 Growth rate

Next thing you must do, is to estimate the growth of the EPS for the next 5 years.
Evolution Gaming is a fast grower. It has grown its profits by 75% pa. over the last 5
years, and 43% over the last 3 years. When choosing a growth rate we should assume
a conservative number.
The number we choose for Evolution is 20%.

EVO EPS of $3.89*1.2^5= $9.68

EVO will have a EPS of $9.68 in 2027 if they can keep a 20% growth rate.

Multiple (PE)

The next step is to choose a suitable PE in 2027 for EVO. Looking at the company’s
historical PE, we can see a wide range, between 20 and 70. As we expect growth to
decelerate in the next 5 years, we can also expect the premium (multiple/PE) to be
lower.

Let’s say that the PE in 2027 will be 25.

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 Source: https://companiesmarketcap.com/evolution-gaming/pe-ratio/

Putting it together
Now, we take the EPS of $9.68 and multiply it by 25:

$9.68x25=$242 per share

This is our rough estimate of what the stock will be worth in 2027. To compare it, today's
price of stock ticker $EVVTY is $133.15.

Now, our next move is to divide the 2027 stock price of $242 by 2.
242/2= $121 per share

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 The reason we divide the future stock price by 2 is that it is roughly the same as
dividing it by 1.15^5, which is 2.011. 1.15^5 is how you would discount the EPS in a
discounted cash flow (DCF) analysis. To simplify this process, we just divide by 2. The
price we end up with from this formula, is the price we would ideally pay today, to
achieve a 15% annual return on the business we want to buy.

Even my grandmother would be able to use this valuation method.

If we are right about our assumptions, EVO will be worth $242 per share in 2027.

Now, let’s compare the two prices in our example:

Current price: $133.15

Expected 2027 Price: $242

If we want a 15% annual return on EVO we would purchase the stock at ~$121
The current price needs to pull back ~9% to meet this requirement.

Keep in mind, we have to be right about our assumptions. If there is a higher probability
that the stock will do better than our assumptions, this is a fantastic result. If our
assumptions are too optimistic, there will be more risk in the estimate as it is less likely
to play out in the real world.

An important nuance to the method

When estimating for future PE multiple, one should also think about the growth rates. If
a business is growing at 20% annually, it might be unlikely that the business can keep
this growth sustainable for 5-10 years. Businesses will run into the law of big numbers,
competition, possible regulatory issues and so on. At the end of the 5 year period, we
might see a substantially lower PE multiple than the historical one as the company
matures.

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 The PE estimate should be based on the growth rates expected after this 5 year period,
because that is what the business will be valued based on. In our example, we choose
a PE of 25, as we expect a 20% growth rate for the next 5 years. But if growth drops to
12% pa. after that 5 year period, we might see a PE of 15.

Example: Francois Rochon CarMax

CarMax is a business Rochon bought back in 2007. CarMax is a market leader in the
used car market and uses scale economics to achieve a competitive advantage, its
well-managed, has a great reputation and a long runway for growth. Rochon added to
his position in 2011 and 2016 when Mr. Market gave him opportunities to buy at a
discount to intrinsic value.

Let’s break down Rochon’s investment case in 2011:

2011 EPS: $1.79

2011 PE: 14x

Assumptions:

Growth: 13% for the next 5 years

PE in 5 years: 15

Calculation:

1,79*1,13^5=$3,3 of EPS estimated for 2016

$3.3*15=$49,5 expected stock price in 2016

49,5 divided by 2 (or 1,15^5)= $24,75 the price in 2011 to justify a 15% annual
return in CarMax

The reality of what happened to CarMax stock between 2011-2016:

2016 EPS: $3.26

2016 PE: 16

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 EPS growth rate in the period 2011-2016: 12.74%

2016 stock price: $52,16

PE in 2016: 52.16 / 3.26 = 16

The return for Francois Rochon during the 2011-2016 period:

CarMax returned 16,08% annually.

Example: Francois Rochon - Copart, a mistake of omission

Francois Rochon studied Copart in 2011. He loved everything about the business,
except the valuation and that it was modestly indebted. EPS in 2011 was $0.63 and the
stock was trading at ~$11, a PE of ~18. Rochon proceeded to wait for a better price to
buy the company. The opportunity did not come.

Today Copart has an EPS of $2.27 (2,27/0,63)^(1/11)-1 = 12,35%

Copart’s stock price has compounded by 19.62% annually since 2011

(79/11)^(1-11)-1
Even without the PE expansion, Copart would have done very well. This example
shows the potential downside of being too rigid in your valuation methods. The
best businesses might never offer a discounted price that meets your requirement of
15% compounded annual growth rate.
Hindsight is always 20/20, but in some cases, it's worth breaking your own rules to take
a position in what Francois Rochon would refer to as a masterpiece.

Valuation cheat sheet 7

 Example: Valuing LMVH, a High-Quality Company (High PE)
The problem with high-quality businesses is that they often trade at a premium to the
market. A few examples and their PEs: Zoetis 38, IDEXX Labs. 60, LVMH 31. These
businesses always seem to be expensive from the traditional viewpoint.
Valuing high-quality companies can be a challenge because it can be hard to determine
if the multiple will be at such a high level for a 5-year period. One example is LVMH. The
PE of LVMH has ranged between 8.5 in 2008, to almost 50 in 2020. It is as of this
writing at 31. Historically, this is a high PE for the business. The risk is if the PE
contracts to a historic level of 18-20.
When we create a simple financial model for valuing LVMH, should we assume a future
PE of 30? This breaks the principle of being conservative. If the model only works if you
put a historically high PE in it, then it doesn’t really work.

LVMH valuation example

EPS 2022: £27,44

PE: 31.7
Assumptions:

EPS growth: 13%

Future PE: 25

EPS in 2027: 27,44*1,13^5= £50,56

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 Price per share in 2028: £50,56*25=£1263,9

2027 share price divided by 2 (or 1,15^5): £1263,9 / 2 = £631,95

Today’s share price is £871, suggesting a 27% detraction in price is necessary to meet
the 15% requirement.

Now, let's change the growth estimate and PE estimate:

EPS growth: 16%
Future PE: 30

2027 EPS: £57,63

2027 price per share: 57,63x30=1729 divided by 2 = £864

A share price of £864 is roughly in line with today’s price. This means that if LVMH can
execute a 16% annual growth rate for its EPS, and is valued at 30 PE in 2027, the stock
will return ~15% annually for investors.

Final words
Whether your assumptions play out like expected will be determined by multiple factors
such as the competitive advantage of the business, the financial strength, earnings
stability, and the management team running the business into the future.
A high or low PE in and of itself is not a determinant of value. If a business trading at 25
times earnings can keep up its growth and premium status in the market with stable and
expanding margins and earnings, chances are the premium will expand as the
competitive position is strengthened over the years.
Estimating what the PE will be is hard, and I would not basing your valuation on PE
expansion. It is better to focus on earnings growth. If the company expands its PE, this
should be seen as a positive, but not something savvy investors should focus on. There
are exceptions to this, like if a high quality business runs into temporary trouble. The PE
might contract from 30 to 15, or even 10. As long as we can with a decent amount of
certainty say that this is temporary, we can estimate a future PE that is higher than the
current.

Valuation cheat sheet 9