Anyway, I’ve pointed out 10x pretax profits or 10% pretax produce as Buffett’s valuation measure numerous times here and more than once I’ve gotten a reply saying that this hurdle is perfect for private deals rather than for pricing outlined companies. It is true that when Buffett talks of comes back in the stock market, he uses GDP growth and dividend produces; earnings can’t grow more than GDP and stock returns will reflect earnings growth over time plus whatever dividends you get.
Translating that into specific stocks, you’ll get cash flow dividend plus growth produce equals expected return on the stock. The only problem with this is that it generally does not tell you what the business is worth. Could you pay 50x p/e for it? The above computation only works if valuation remains the same.
Anyway, my normal response to the is that many value traders (including Buffett) loves to analyze businesses based on what a logical businessperson would purchase the business in an exclusive purchase. So, if Buffett is ready to pay 10x pretax income for Wells Fargo in an exclusive transaction to choose the whole thing, that is clearly a valuation benchmark for me.
I know that is not actually possible. There are size and regulatory issues that will make this unlikely. However in conditions of valuing businesses, I think it is a useful standard still. Is this how Buffett thinks about it? If he pays 10x pretax earnings for WFC stock, he will not necessarily earn a 10% pretax produce. I have no idea the answer to that question. Maybe that’s a good annual meeting question.
- Charitable Business
- Purpose of Memos
- Good Re-Organization, Bad Re-Organization
- ► March (7) My Business Makes Your Silly Product APPEAR TO BE A
- Consider how effective your business currently is at using its knowledge
- Measure your progress
- First-aid kit
- What clubs will you take part in
But as long as I know that Buffett would be totally happy to pay 10x pretax for your business, that’s good enough for me regardless of whether that will in actuality happen. Yes, you can argue these “private business purchase” valuations are just valid when there is some chance of a private offer occurring.
Is 10x Pretax Reasonable? But 10x pretax cash flow, for listed companies even, is not unreasonable at all. You can translate that 10x pretax into a 15x after taxes p/e ratio, and that wouldn’t be far off from the 100 year or so long-term average of U.S. Since Buffett buys quality, above average businesses, paying 10x pretax is similar to paying an average price for an above average business.