Svolder A: The Big Short

A Case Study of Unintelligent Speculation

Svolder’s A-share (ticker: SVOL A) today closed at SEK 243.50, down from an intra-day high of SEK 275.00. During the last twelve months the A-share reached a low of SEK 112.50 and a high of SEK 275 (Source: Avanza).


Svolder is a Swedish investment company founded in 1993 and listed on the Nasdaq OMX Nordic exchange. Svolder invests in small and mid cap listed entities. Click image below for a brief history in Swedish of Svolder (Source: Svolder).


Net Asset Value per Share as of May 31, 2016

The equites portfolio as of May 31, 2016 is shown below. As of this date, the market value of the equities portfolio amounted to SEK 1,644.1 billion. Adjusting for net debt/net receivable results in a total net worth of SEK 1,859.6 billion, equal to a net asset value (NAV) of SEK 144.60 per share (Source: Svolder).

Svolder’s equities portfolio as reported in the most recent quarterly report per May 31, 2016 was made up of the following equities (Source: Svolder).


Net Asset Value per Share as of August 12, 2016

Per August 12, 2016, Svolder reported a NAV of SEK 162 per share (Source: Svolder). The current share of SEK 243.50 is about 150.3% of NAV. At SEK 275 it’s 169.8%. A reasonable expectation would be that the share price would stay close to NAV.

One may wonder why on earth someone would be willing to pay a lot more than NAV for the A-share for a collection of marketable common stocks that Svolder currently owns? Sure, you get 10 votes for each A-share compared to 1 vote per B-share. But that looks like a very optimistic view in regards to the value of the votes connected to each A-share.


Shares Outstanding

Svolder’s shares outstanding disclosed in the 2015 annual report per December 31, 2015 was 12,800,000, consisting of 622,836 A-shares (10 votes per share) and 12,177,164 B-shares. Below an excerpt from the 2015 annual report (in Swedish).


Final Words

To wrap this up. Right now the Svolder A-share is trading at a price-level that is not supported by underlying value. I’m on the sidelines here, but when I saw this case earlier today I was just fascinated of what I was just looking at. One last question: How long will it take for the A-share to trade in line with underlying NAV? Guess we’ll have to wait and see.

For some final words, here’s an excerpt from The Intelligent Investor.

Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook. More than that, some speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone. There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation than you can afford to lose.

Disclosure: I have no position in the stock mentioned, and no plans to initiate any position within the next 24 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion, and should not be considered investment advice. Always do your own due diligence and contact a financial professional before executing any trades or investments.


The Buffett/Munger Investment Checklist

“When investing, we view ourselves as business analysts—not as market analysts, not as macroeconomic analysts, and not even as security analysts.”

—Warren Buffett, Letter to Shareholders, 1987

The Buffett/Munger Investment Checklist: A Framework for Business Analysis and Valuation

How to go about when performing a business analysis, and what to look for in doing so, is nothing but the holy grail of investing. A business analysis could be carried out in a number of different ways. You just have to make sure that you have a way that works for you, a process for analyzing and evaluating businesses that is continually updated along the way as you learn about new facts and circumstances.

When building your own framework for business analysis, you should always remember to keep things simple, since it most likely will tend to get hard enough anyway in the end. Also, you don’t have to come up with your own stuff, you are perfectly free to use everything there is from great men that’s come before, as Charlie Munger noted when he said: 

I believe in the discipline of mastering the best that other people have figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart.

To set the scene to sort of create an investing map to follow it’s worth considering what Warren Buffett once wrote:

In our view, though, investment students need only two well-taught courses—How to Value a Business, and How to Think About Market Prices.

To be able to value a business, you have to understand the business. And to be able to say that you understand a business you would likely want to know about its products/services and revenue sources, operating leverage, financial leverage, competitive position, industry characteristics, etc. These questions all belong to the first section of the Buffett/Munger Investment Checklist, i.e., understanding the business.

When you understand a business and its management, and have evaluated the long-term prospects as favorable, the next step is to value the business, i.e., come up with an estimate of intrinsic business value that is to be compared to the current market price of the business. If you manage to, and have the luck, to check each of the four main parts of the checklist, you most likely have an investment worth making.

In his 1977 letter to shareholders Warren Buffett explained his and Charlie’s process for analyzing and evaluating businesses.

We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price. We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term.  In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.

So, already back in 1977 Warren Buffett laid out the checklist that he and Charlie go through when evaluating a business. This will serve as a good starting foundation for anyone who wants to build their own investment checklist. Each checklist point could then be expanded to included a number of supporting sub-questions needed for coming up with a conclusion about the “main” checklist question being evaluated.

From the above quote and discussion, keep in mind the foundations of our Buffett/Munger Investment Checklist:

  1. Understand the business
  2. Favorable long-term prospects
  3. Operated by honest and competent management
  4. Very attractive price

To make it easier to remember the top four checklist points, memorize the acronym “UFOV.” That’s easy to remember, right? It’s just “UFO” plus a “V.”

As always, when talking about the subject of checklists, make sure to use them in an appropriate wat and also remember Warren Buffett’s words that “A checklist is no substitute for thinking.”


“Take a simple idea and take it seriously.”

—Charlie Munger

Fortnox: Visma’s Cash Offer Re-Engineered

Fortnox: A High Growth Small-Cap with High Profitability

Fortnox is, according to themselves, the leading provider of Internet-based applications for businesses, associations and accounting and auditing firms (a big part being their offering of accounting software). The business concept is to offer a wide range of Internet-based applications that are easy to learn and use, yet is powerful and feature-rich enough to meet most needs and wishes. Fortnox has been growing at a fast pace back since it was founded in the early 2000s.


Below a page from the 2015 Fortnox annual report with my own notes (I now see that I made a mistake when I wrote 2016 which is incorrect, should be 2015 and nothing else).

Cash Offer from Visma

On March 14, 2016, Visma made a cash offer to acquire Fortnox for a total purchase price of SEK 1,406 billion, or SEK 24 per share. To read the press release, click here.

In its quaterly report for Januari-March 2016 Fortnox disclosed a non-recurring item of approximately MSEK 1 for consultations, a so-called fairness opinion, in connection with the Visma bid mentioned above. The Fortnox Board of Directors have evaluated Visma’s bid by themselves, and from taking in a fairness opinion, decided to favour Visma’s bid.

Visma’s current bid puts a total value of MSEK 1,406 for the shares outstanding, or SEK 24 per share. On the same day as the bid was made public the share price rose from SEK 18.2 to SEK 23.9, an increase of +32%. With the value of equity at MSEK 1,406, almost no debt (only MSEK 0.5) and cash of MSEK 46 at year-end 2015 (compared to MSEK 52 per March 30, 2016) Fortnox has an enterprise value of about MSEK 1,360.

Re-Engineering Visma’s Cash Offer

Reverse engineering a certain valuation makes it possible to back out what growth is implied in it, as noted by James Montier:

So, if one can’t use DCF how should one think about valuation? Well, one solution that I have long favoured is the use of reverse engineered DCFs. Instead of trying to estimate the growth ten years into the future, this method takes the current share price and backs out what is currently implied. The resulting implied growth estimate can then be assessed either by an analyst or by comparing the estimate with an empirical distribution of the growth rates that have been achieved over time, such as the one shown below. This allows one to assess how likely or otherwise the implied growth rate actually is.

Let’s see what implied growth assumptions we get if we reverse engineer Visma’s cash offer per share of SEK 24, equal to a total purchase price of MSEK 1,406.

I have put together three different scenarios, all starting with earnings per share (EPS) of SEK 0.43 (calculated by assuming 25% growth in revenues in FY2016 and an operating margin of 20% with a 22% corporate tax rate). A discount rate of 10% is used in all the scenarios.

  • Scenario 1. Forecast period of 5 years with a compounded annual growth rate (CAGR) of 25%.
  • Scenario 2. Forecast period of 10 years with a compounded annual growth rate (CAGR) of 15%.
  • Scenario 3. Forecast period of 3 years with a compounded annual growth rate (CAGR) of 35%.

Scenario nr. 1 requires, except for the assumed 25% CAGR during 2016-2020, a terminal growth rate beyond 2020 of 6.76% to end up with an intrinsic value per share of SEK 24, equal to the cash offer from Visma. The numbers and the calculation of the reverse engineered scenario nr. 1 valuation is shown in the table below.


Scenario nr. 2 requires, except for the assumed 15% CAGR during 2016-2025, a terminal growth rate beyond 2025 of 6.76% to end up with an intrinsic value per share of SEK 24, equal to the cash offer from Visma. The numbers and the calculation of the reverse engineered scenario nr. 2 valuation is shown in the table below.


Scenario nr. 3 requires, except for the assumed 35% CAGR during 2016-2018, a terminal growth rate beyond 2018 of 7.20% to end up with an intrinsic value per share of SEK 24, equal to the cash offer from Visma. The numbers and the calculation of the reverse engineered scenario nr. 2 valuation is shown in the table below.Fortnox_V_s3

Discount Rates and Terminal Growth Rates

By altering the discount rate used we can solve for what terminal growth rate needed to get an intrinsic value per share of SEK 24.

See table to the right where different growth rates are shown for each of the three scenarios depending on what discount rate is applied, ranging from 8.0% to 15.0%. Depending on the discount rate used the growth rate range between 4.1% to 13.1%. What should be considered a reasonable discount rate as well as growth rate is up to each individual investor to decide.


The Trade-Off and Where to Go From Here…

I have not, and I do not, own any shares in Fortnox. Clearly, I was too late to the party and didn’t find this gem before Visma made its bid public. Without doing a lot more digging into this case it looks like Visma’s cash offer per share is reasonable. Of course Fortnox could go on and grow even faster. As always, the future is uncertain, but selling and taking the cash received to look elsewhere for new investment cases may be the thing to do. By reverse engineering the SEK 24 per share cash offer from Visma we are at least able to see what kind assumptions give this value.

Before making any further decisions about what to do, one would have to take a look at what levels of revenues that each EPS is derived from and analyze them to come up with an answer to whether they could be deemed reasonable or not. A quick look at revenues from the three different scenarios is shown in the table below. Scenario nr. 2 gives MSEK 395.8 in revenues in 2020, CAGR of 25%. This growth looks to be in line with the underlying growth in the industry (see link to analysis, in Swedish though, that I found that is referring to Statistics Sweden).

Before making any decisions one would likely want to have a closer look at revenues, both for Fortnox but also for the whole industry, to decide what levels could be deemed reasonable.


See tables below for some historical Fortnox key ratios.



Disclosure: I have no position in the stock mentioned, and no plans to initiate any position within the next 24 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion, and should not be considered investment advice. Always do your own due diligence and contact a financial professional before executing any trades or investments.

Longleaf Partners: Valuation Principles

“You do eliminate a lot of interference by being in Memphis as opposed to Manhattan.” —Mason Hawkins

This post contains a discussion of the valuation principles followed by Longleaf Partners. In it Mason Hawkins and his colleague Stanley Cates discuss the valuation approach underlying Longleaf Partners daily work in valuing businesses.

Letter To Our Shareholders

The first quarter of 2015 saw a continuation of the themes from the second half of 2014. Almost all of our individual businesses delivered solid operating performance, and our management partners pursued productive ways to build long-term per share values. This activity produced strong excess returns in Longleaf Partners Small-Cap Fund,“which helped the Longleaf fund earn the No. 1 ranking among small-cap U.S. equities funds.” (1) By contrast, the Partners, International, and Global Funds’ relative performance remained challenged as solid company results could not overcome three ongoing broad headwinds: the fall in energy prices, the U.S. dollar strength, and the Chinese government’s pressure on Macau gaming. While these challenges affected only a handful of our holdings, they were large enough to offset the good results at the vast majority of our companies.

The steady upward climb of the S&P 500 has intensified the debate over active versus passive investment approaches, and given this, we want to detail the reasons we are confident that our portfolios can outperform relevant benchmark indices and deliver on our absolute goal of inflation plus 10% over the long term. Our current underperformance is the exception. The three Longleaf Funds with a greater than 5-year track record have since inception returns well above their benchmarks.

Our history aside, future performance is all that matters to our shareholders and to us as the largest collective shareholder in the Longleaf Funds. Normally, we discuss future performance in terms of our price-to-value ratio (P/V), an indicator of our absolute return opportunity. Today, the P/V is above our long-term average, which is not surprising given the bull market run. A more objective and simple comparison to address the current focus on relative returns versus the indices is price-to-free cash flow (P/ FCF), which measures the multiple being paid for the cash earnings coupon that businesses will generate over the next twelve months. The free cash flow coupon is a better reflection of cash profits than are stated earnings. That P/FCF multiple translates into FCF yield (the inversion of P/FCF), which is the FCF return that an investor will earn over the next year if the stock prices remain the same, assuming the 12-month FCF estimates are accurate. That yield can be enhanced if the FCF coupons grow. We can distill our investments’ and the indices’ future return prospects down to the following objective formula:

Going-in free cash flow yield


Organic growth our companies can generate without spending that cash yield


Any excess returns our managements generate from reinvesting those cash coupons.


Expected cash return for shareholders

We believe comparing the FCF yield and prospective coupon growth in the Longleaf portfolios to those in the relevant indices indicates how well our current holdings are positioned and why we are confident in our ability to deliver long-term outperformance with low risk of permanent capital loss.

Going-in free cash flow yield:

FCF yield is the primary source of expected cash return. Today we are paying, on average, 11X forward free cash flow (P/FCF) for the Funds’ common stocks. If none of our companies grew, and they simply earned cost-of-capital-type returns on what they reinvested, we would expect a 9% return from the FCF earnings yield (the reciprocal of 11X). Admittedly, this number is based on our next 12-month cash earnings estimates, which may be no better than Wall Street’s estimates for any given company. In aggregate, however, our estimates for the whole portfolio generally even out any single- company misses and prove to be conservative.

Organic growth our companies can generate without spending that cash yield:

In addition to our estimated 9% FCF yield, the quality of our businesses and operating skill of our management partners will largely determine organic earnings growth. Beyond FCF coupons, returns will be powered by owning high quality businesses that can grow revenues and margins without substantial spending. We mostly own companies we believe are competitively superior like Aon, adidas, and Vail Resorts, where pricing power and other advantages enable organic growth that requires virtually no capital. Additionally, margin improvements can further boost organic earnings growth. We own companies like FedEx and Philips, where margins are nowhere near peak, and where the predominant sell-side descriptor is “self-help” – meaning they can raise margins even without an economic or revenue tailwind. Oil and gas companies, which are hurting performance right now, are the noted exception to our FCF profiles, but in the face of depressed energy prices, our partners are finding other ways to build value.

Any excess returns our managements generate from reinvesting those cash coupons:

Wise capital allocation by our management partners can create additional return beyond the sum of our FCF yield and earnings growth from organic revenue and margin gains. We own companies like Level 3 and Lafarge that are using capital to grow revenues with huge IRR (internal rate of return) expectations on the amount they invest above depreciation and amortization. Melco opening a new Macau casino, Chesapeake picking among millions of acres and thousands of possible well sites in an effort to drill the most profitable projects, and Scripps buying stock back far below private market value are representative of the high IRR projects our management partners are undertaking to grow value per share and thereby increase our ultimate returns.

If the three listed FCF return components perform as we expect, we should achieve our absolute return goal of inflation plus 10%. The yield is based on a constant stock price, but ultimately Longleaf’s performance should also benefit from the gap between stock prices and intrinsic values closing. Contrasting our companies’ metrics with those of the indices highlights the strength of our relative position. Our P/Vs range between 70-80%, while we believe the indices trade close to or above full value. The S&P 500, MSCI EAFE, and MSCI World indices sell for 21-22X next year’s estimated FCF, and the Russell 2000 is at 30X. This translates to a 4.7% yield (the reciprocal of 21-22X) for the first three and a 3.3% yield for the Russell 2000.(2) Earnings growth is limited with margins of the S&P and MSCI World indices near peak levels. Even if margins can stay at these highs, earnings growth is confined to organic revenue growth in a universe where most economies expect low single-digit growth. Conversely, if margins regress to the mean, the outlook for earnings growth is poor. Nor is capital allocation likely to generate growth, because the collective group of CEOs at index companies is not earning excess reinvestment returns. The most telling example is the recent manic stock repurchasing within the S&P 500. Ironically, we are huge supporters of share buybacks when a stock trades at a big discount to intrinsic worth; it de-risks capital allocation while boosting our value per share. But most companies tend to do just the opposite. When stocks had a fire sale in 2009, S&P companies repurchased $138 billion, but as the index was approaching historic highs in 2014 with many stocks trading above intrinsic values, these companies bought back $553 billion, close to their entire FCF coupon after dividend payments.

This behavior is boosting stock prices for now (and indirectly feeding the index’s outperformance of active managers), but will likely end badly, as all overpriced share repurchases ultimately do.

After the dramatic declines in the global financial crisis (GFC), the Funds’ absolute returns over most periods at the end of 2008 fell below our inflation plus 10% goal. We told our partners that because our P/Vs were below 50% and our P/FCF multiple was 7X, yielding 14%, we anticipated stronger compounding than normal. Over the six years since then, the Partners and Small-Cap Funds have made substantial money for shareholders as our absolute returns have far exceeded inflation plus 10% and we have outperformed the relevant benchmarks. Today, we face a similar end point challenge in the Partners, International, and Global Funds, but it is our relative returns that have underperformed. While we are committed to our absolute goal, given FCF yields, P/V levels and a slim on-deck list, we anticipate lower absolute returns than we did at the end of 2008. We feel as strongly now about our ability to outperform the indices over the next five years as we felt about our absolute opportunity after the GFC. Our portfolios sell on average for 11X FCF, slightly higher than our normal 9-10X, but very attractive against broader markets at 21-22X versus their historic 17-18X (and an even higher multiple in the Russell 2000). Said differently, we own portfolios with 9% FCF yields where we believe the cash coupons will grow versus the markets’ 4.7% FCF yields where the coupons will likely decline in the next few years.

While the payoff pattern may be unpredictable, the transaction activity that helped produce our substantial Small-Cap Fund returns in the past few years is occurring in companies across all of our portfolios. Exceptionally positive corporate activity is generating value growth in U.S. holdings such as Chesapeake, CONSOL Energy, and Murphy Oil. Likewise, our non-U.S. partners at Philips, Vivendi, Exor, CK Hutchison, and Lafarge are involved in transactions that have gone partially unrecognized in their stock prices thus far. In addition to owning quality businesses with relatively high FCF yields, we have partners making superior capital allocation decisions that we believe will further drive excess returns.

Southeastern has followed the same proven investment disciplines under the same leadership for four decades. While our concentrated, valuation- based approach has not outperformed the indices all the time, it has delivered strong relative results most of our history. Ultimately, our partners have been rewarded for owning strong businesses run by good management teams when the discounts between prices and values have closed. The payoffs tend to occur in periodic bursts that do not necessarily correspond with the broader markets. As the largest owners of the Longleaf Funds, we believe our portfolios are positioned to experience a burst of outperformance because they reflect a:

• Time-tested investment discipline rooted in the principles of investors such as Keynes, Graham, Templeton, and Buffett and implemented by a singularly focused, aligned manager,

• Set of criteria that has produced a track record of high rates of outperformance over multiple periods throughout our 40 year history,

• Strong position against benchmarks near historic high levels after a long-winded bull run in what arguably has become a “passive bubble,” and

• Carefully selected set of competitively advantaged businesses that are generating solid operating results with capable, motivated managements driving above average value growth and in many cases, creating catalysts for value recognition. We are grateful for our supportive, long-term partners who share our conviction. If you missed our shareholder webcast on Wednesday, May 6, a replay is available on our website.


/s/ O. Mason Hawkins

O. Mason Hawkins, CFA Chairman & Chief Executive Officer Southeastern Asset Management, Inc.

/s/ G. Staley Cates

G. Staley Cates, CFA President & Chief Investment Officer Southeastern Asset Management, Inc.

May 14, 2015

(1) Bloomberg Markets April 2015, “Staying Active.” Returns through 12/31/14

(2) Factset

(Source: Letter to Our Shareholders, Q1, 2015 – see link below)

The Cautionary Statement in the quarterly report contains a few definitions that can be useful to know.


EBITDA is a company’s earnings before interest, taxes, depreciation and amortization.

EV/EBITDA is a ratio comparing a company’s enterprise value and its earnings before interest, taxes, depreciation and amortization.

Free Cash Flow (FCF) is a measure of a company’s ability to generate the cash flow necessary to maintain operations. Generally, it is calculated as operating cash flow minus capital expenditures.

Free Cash Flow Yield (FCF Yield) equals a company’s free cash flow per share divided by the current market price per share.

The Global Financial Crisis (GFC) is a reference to the financial crisis of 2007-2008.

Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows from an investment equal zero.

A master limited partnership (MLP) is, generally, a limited partnership that is publicly traded on a securities exchange.

Organic growth is the growth rate a company can achieve by increasing output and enhancing sales, as opposed to growth via mergers and acquisitions.

P/V (“price to value”) is a calculation that compares the prices of the stocks in a portfolio to Southeastern’s appraisal of their intrinsic values. The ratio represents a single data point about a Fund and should not be construed as something more. P/V does not guarantee future results, and we caution investors not to give this calculation undue weight.

Further Reading

Southeastern Asset Management, Inc. 

Letters to Shareholders – All Years Consolidated(1997Q4 to Present)

Longleaf Partners Funds Quarterly Report, Q1 2015

Berkshire Hathaway Value Update, Year-End 2014

“As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock). In our 2010 annual report, however, we laid out the three elements – one of them qualitative – that we believe are the keys to a sensible estimate of Berkshire’s intrinsic value. That discussion is reproduced in full on pages 123-124.

Here is an update of the two quantitative factors: In 2014 our per-share investments increased 8.4% to $140,123, and our earnings from businesses other than insurance and investments increased 19% to $10,847 per share.”

—Berkshire Hathaway, Annual Report 2014, p. 7

Intrinsic Business Value Update

Last weekend I read the 2014 annual report from Berkshire Hathaway. As usual I enjoyed it, and even more so this year due to the extra writings from both Warren and Charlie.

Buffett himself summed up Berkshire’s 2014 in a good way in the beginning of the shareholder letter, when he said that “It was a good year for Berkshire on all major fronts, except one.” The exception was attributable to BNSF that according to Buffett “…disappointed many of its customers. These shippers depend on us, and service failures can badly hurt their businesses.”

The table below shows some key financial data for the prior ten-year period, including an estimate of intrinsic business value (by using the so-called “two-bucket approach”).

By using this two-bucket approach and applying a pre-tax earnings per share multiple of 10 times, results in a intrinsic business value per A share of $248,593 (or $166 per B share) at the end of 2014, and increase of 12.8% year-over-year. Book value per share increased 8.3%, from $134,973 to $146,186. The biggest change was in the price per share, increasing 27.0% year-over-year, from $177,900 to $226,000.


The 10-year average intrinsic business value (IBV) to book value (BV) was 1.65. Price to book value and price to intrinsic business value averaged 1.38 and 0.84 respectively.


At the moment (March 6, 2015) the A share is trading at $218,986 (or $146 per B share), giving a margin of safety of 12%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

Annual Report: Handelsbanken, 2014

Handelsbanken is a full-service bank for both private and corporate customers. The Bank has a nationwide branch network in Sweden, the UK, Denmark, Finland, Norway and the Netherlands. The Bank regards these countries as its home markets. Handelsbanken was founded in 1871 and has operations in 24 countries.

Annual Review: Handelsbanken in 2014

In this post I take a quick look at Handelsbanken’s performance during 2014 from a few key metrics and also update my intrinsic business value range. A more in-depth analysis will be done in another post.

Key Metrics

  • Total income increased 5.5% (3.6) to SEK 38.3 billion (36.3)
  • Total expenses increased 1.6% (2.2) to SEK 17.3 billion (17.1)
  • Profit before loan losses increased 8.9% to SEK 21.0 billion (19.3)
  • Net loan losses of SEK -1.8 billion (-1.2)
  • Profit for the year from continuing operations increased 6.8% (1.1) to SEK 15.1 billion (14.2)
  • Diluted earnings per share from continuing operations SEK 23.45 (22.07)
  • Book value per share increased 12.9% (7.6) to SEK 194.2 (172.0)
  • Return on average equity (cont. op. after dilution): 12.8% (13.3)
  • Return on average equity (total op. after dilution): 12.9% (13.4)
  • Ordinary dividend increased 8.7% (7.0) SEK 12.50 (11.50)
  • Extra dividend of SEK 5.00 (5.00)
  • Loan loss ratio of 0.10% (0.07)
  • Impaired loans reserve ratio of 47.2% (56.2)
  • Proportion of impaired loans of 0.25% (0.18)
  • Operating profit increased to SEK 19.2 billion (18.1)
  • Common equity tier 1 ratio, CRD IV: 20.4% (18.9%)
  • Total capital ratio, CRD IV: 25.6% (21.6%)
  • C/I ratio: 45.2% (47.0)
  • C/I ratio, incl. loan losses: 49.9% (50.3)
  • Number of branches: 832 (810)
  • Average number of employees: 11,692 (11,503)

Ten-year Overview: EPS, BVPS and ROE

Earnings per share and book value per share increased steadily during the last ten years, at a CAGR of 5% and 7% respectively. Return on equity has declined from a somewhat higher average level of 15.8% in 2005 to 2008, compared to 13.4% during 2010 to 2014.


Also, the graph below shows Handelsbanken’s pretty stable growth at a CAGR of 15%, from Q3 2007 onwards.


Loan losses were SEK -1.2 billion (-1.2). Loan losses as a proportion of lending were 0.10 per cent (0.07). According to Handelsbanken “The corresponding figure for other major Nordic banks was 0.12 per cent (0.15).”


Intrinsic Business Value Range

  • Book value per share: 194.20
  • Earning power: 23.40
  • Earnings multiplier: 12-15x
  • Earnings value: 281-351 SEK

Value range: 194-351 SEK

Price per share, March 5, 2015: 417.20 SEK

Margin of safety: None.

Price-to-book multiple

As of today Handelsbanken is trading at a price to book value of 2.15.

In the table below I have calculated different price-to-book multiples depending on differences in assumed growth rates and cost of equity, with return on equity unchanged at 13.0% (slightly below average five-year return on equity for Handelsbanken).

So, for example, a growth rate of 3.5% going forward and a cost of capital of 8% results in a price-to-book multiple of 2.11. A 9.5% cost of capital and a growth rate of 6.5% results in a multiple of 2.17.


Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

The Acquirer’s Multiple & the Quest for Value

The Acquirer’s Multiple On the Rise Again: Are We Back In the Danger Zone?

In the great book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias E. Carlisle, the enterprise multiple or the Acquirer’s Multiple, is discussed.

The acquirer’s multiple is defined in the book as:

Enterprise Multiple = EBITDA ÷ EV

EBITDA = Earnings Before Interest, Taxes and Depreciation & Amortization

EV = Enterprise Value = Market Capitalization + Debt – Cash

Carlisle asks the question “Why is the enterprise multiple so good at identifying undervalued stocks?” By analyzing returns from different valuation multiples, he says:

We found that both variations of the enterprise multiple had the most success identifying undervalued stocks, with the value portfolios of the EBIT form generating a compound annual growth rate of 14.6 percent and the EBITDA form earning 13.7 percent over the full period (for context, the S&P500 Total Return Index earned 9.5 percent). Wall Street’s favorite metric—the price-to-forward earnings estimate ratio—was by far the worst performing of the price-to-value ratios, earning a compound annual growth rate of just 8.6 percent and underperforming even the market.

Let’s put this great book aside for a few seconds, and see to an article from the Economist discussing the current valuation levels.

The Economist: The new rules of attraction

A recently published article in the Economist, Mergers and acquisitions: The new rules of attraction, discusses the current valuation levels compared to earlier periods.

Whether dealmaking is sensible is once more an important question, because M&A are back with a vengeance, after a lull following the financial crisis. Worldwide, $3.6 trillion of deals have been announced this year, reckons Bloomberg, an information provider, approaching the peak reached in 2007. In pharmaceuticals (see article) and among media firms the activity is frantic. Deals worth more than $10 billion are again common. America and Britain, with their open markets for corporate control, account for a disproportionate share of the action. So do cross-border deals, which have risen from a sixth of activity in the mid-1990s to 43% today.


The first part of the article discusses whether or not there are any value-added to be expected from mergers and acquisitions. A relevant question by any means. Here is what the article has to say:

On paper, M&A make sense. When two firms combine they can cut duplicated overheads, raising their margins. By adding together their market shares they can gain pricing power over customers and suppliers. By cross-selling each other’s product ranges in each other’s geographic markets, merging firms can make their combined sales a lot bigger than the sum of their individual ones.

M&A folklore, however, dwells on giant catastrophes, such as the combinations of Time Warner and AOL in 2000 just as the dotcom bubble burst, or Royal Bank of Scotland (RBS) and ABN AMRO in 2007, as the subprime crisis struck. Yet some of the world’s most successful firms are the result of giant deals. Exxon became the energy industry’s top dog thanks to its purchase in 1999 of Mobil, which had an under-appreciated collection of global assets. AB Inbev has done $100 billion of deals over two decades to become the world’s biggest brewer, with thirst-quenching profits.


The second part of the article discusses the cycles of history and looks at the current valuation level in deals that have closed. Having a firm grasp of how history played out, can sometimes serve as a guide going forward. Even if history doesn’t repeat, maybe it does rhyme? Anyways, about the cycles of history, the article says:

Cycles of history
The first test is whether a bandwagon is rolling, with corporate bosses jumping aboard unthinkingly. In America between the 1890s and the early 1900s there was a craze for creating monopolies, in steel, tobacco and other industries, prompting trustbusting laws to break them up. In the 1960s conglomerates were in fashion; by the 1980s these lumbering giants were also being dismantled, with the aid of the newly created junk-bond market. In 1999-2000, during the dotcom bubble, technology and telecoms firms accounted for 40% of activity, only to be among the biggest to pop subsequently. In the last surge of deals, in 2003-07, several bandwagons were rolling, including a rush into emerging markets and commodities, and a gallop into private-equity buy-outs. (These accounted for a quarter of deals in 2007, but are down to 19% so far this year.)

So far this time there is no widespread mania. There are pockets of silliness: the pharmaceutical industry is in a frenzy of “inversion” deals, in which American firms buy foreign ones in order to switch their domiciles and avoid American tax rules. But inversions account for only 9% of M&A activity so far this year.

Meanwhile, there are lots of relatively unadventurous deals, says Roger Altman, the boss of Evercore, an investment bank. These seek to build firms’ shares of existing markets, strengthen their product portfolios and cut costs rather than to enter completely new industries or distant countries.

Among the biggest of these, Comcast’s $68 billion bid for Time Warner Cable will, if regulators approve it, give the bidder control of 17 of the top 25 cable markets in America. GSK and Novartis, two drugs firms, are swapping assets to bolster their respective strengths in vaccines and oncology. Verizon’s $130 billion purchase of Vodafone’s share in their American mobile venture was the largest deal in 2013-14 but hardly a leap into the unknown: Verizon already manages the business.

In a further reflection of the restrained mood, some serial acquirers have gone into reverse, divesting or spinning off assets, notes John Studzinski of Blackstone, a financial firm. Dismemberments tend to be investor-friendly. Altria, a conglomerate that included Philip Morris and Kraft Foods, was created in a flurry of deals in the 1980s and 1990s. Since 2007 it has split itself into four main parts, that are today worth $333 billion, almost double what the combined group had been worth.

In October Hewlett-Packard said it would spin off its personal-computer business, reversing its acquisition of Compaq in 2001 (while also offloading its printers business). BHP Billiton, an Australian miner, has been one of the most acquisitive companies in history. But it now wants to spin off its metals and coal businesses, largely reversing a merger that created the firm in 2001 (though it shelved the sale of part of the metals business this week, after failing to get a good price for it).

The trend for spin-offs may have further to go. Plenty of multinationals plunged into emerging markets just before these countries’ economic growth rates slowed: now some of them will be getting cold feet. And many of Asia’s biggest firms, such as Tata Sons in India, Hutchison Whampoa in Hong Kong and Samsung in South Korea, are sprawling conglomerates that may in time be broken up.

The present M&A boom passes the first test: there is little sign of senseless bandwagon-jumping. The second sanity test is the extent of speculative financing and stretched valuations. Here the news is less good. Admittedly, the average premium paid by an acquirer as a percentage of the target’s share price, at 23%, is in line with the 20-year average. But this measure tends to be a poor guide to peaks and troughs. Two other measures are less reassuring.

First, lots of deals are being terminated or withdrawn—15% of total activity this year. For example, Rupert Murdoch’s 21st Century Fox withdrew a $94 billion offer for Time Warner, after Fox’s share price fell. A high failure rate is a sign of a toppy M&A market, with speculative bids made by nervous buyers. The failure ratio was last as high in 1999 and 2006-08.

Second, absolute valuations are creeping up to queasy levels. On average, companies have been bought this year at an enterprise value (roughly speaking, stockmarket value plus net debt) equivalent to 12 times gross operating profit, higher than at the peak of the last two booms (see chart 2). Successful deals are a union of two things: the business combination has to work, but so does the price.

At the peak of the boom in 2000, Wasserstein highlighted seven newly-combined firms he said exemplified an era of globalisation and technology. Since then one has been bailed out (Citigroup), one has gone bust (WorldCom) and two have been dismembered (DaimlerChrysler and Viacom-CBS). However sensible today’s M&A boom feels, as valuations creep into the danger zone, humility is in order.


Deep Value: The Acquirer’s Multiple

DV1In Tobias Carlisle’s latest book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, the fourth chapter entitled The Acquirer’s Multiple discusses “Why … the enterprise multiple [is] so good at identifying undervalued stocks?” as follows:

Why is the enterprise multiple so good at identifying undervalued stocks? First, the denominator in the enterprise multiple—the enterprise value—provides a more full picture of the price paid than does the market capitalization. The enterprise value is closer to a stock’s true cost because, in addition to market capitalization, it includes other information about the contents of the company’s balance sheet, including its debt, cash, and preferred stock (and in some variations minority interests and net payables-to-receivables). Such things are significant to acquirers of the business in its entirety, which, after all, is the way that value investors think about each stock. The enterprise value can be viewed as a theoretical takeover price of a company. After a takeover, the acquirer assumes the company’s liabilities, including its debt, but gains use of the company’s cash and cash equivalents. Including debt is important here. Market capitalization alone can be misleading. Loughran and Wellman, citing Damodaran, give the example of General Motors, which in 2005 had a market cap of $17 billion, but debt of $287 billion. Market capitalization greatly understated the true cost of General Motors, but the enterprise value captured General Motors’ huge debt load, and so gave a more full accounting of its impact on General Motors’ returns. (The risk of a large debt burden moved from the theoretical to the real when General Motors filed for bankruptcy protection in June 2009.) Often a stock that appears superficially undervalued on a book value basis is recognized as being fully valued, or overvalued once its debt load is factored into the calculation. Other researchers confirm that enterprise value is superior to market capitalization, and especially so when companies carry dissimilar debt loads. It is the ease with which enterprise value makes a comparison of companies with differing capital structures that makes it so effective.

The measure of earnings employed in the enterprise multiple—operating earnings, whether defined as EBIT or EBITDA—also contains more information than net income, and so should give a more full view of the firm’s income. Neither EBIT nor EBITDA are impacted by non-operating gains or losses, where net income is impacted by non-operating losses. Nonoperating losses are important over a full operating cycle, but muddy the picture in any given year. Loughran and Wellman view operating earnings—EBIT or EBITDA—as a more transparent and less easily manipulated, shortterm measure of profitability, making a comparison of companies within and across industries possible. Critics point out that EBIT and EBITDA are measures of accounting profit and not a substitute for cash flow, which is where the rubber really hits the road. It would therefore make sense for any valuation proceeding from an enterprise multiple analysis to include some consideration of a company’s operating cash flow, and the extent to which accounting profits translate into cash generation.

Like a careful value investor, the enterprise multiple prefers companies holding cash and abhors companies with high levels of unserviceable debt. In practice, that tendency can be a double-edged sword. Enterprise multiple screens will contain many small “cash boxes”—companies with large net cash holdings relative to their market capitalization—often because the main business has been sold, or the business is a legacy in run-off that lingers like our vestigial appendix. Such stocks tend to have limited upside. On the flip side, they also have happily virtually no downside. In this way they are vastly superior to the highly leveraged companies favored by the price-to-book value ratio, which tends to serve up heavily leveraged slivers of somewhat discounted equity. The enterprise multiple is a more complete measure of relative value than the academic favorite price-to-book value, or any of the other common price-to-value ratios. The enterprise multiple includes debt as well as equity, contains a clearer measure of operating profit, and captures changes in cash from period to period. The empirical returns to portfolios created using the enterprise multiple bear out this rationale. Why does the simple enterprise multiple outperform the Magic Formula, the enterprise multiple and the return on invested capital combined? How can we reconcile the theory behind the deep value strategy—which amounts to fair companies at wonderful prices—with the theory behind Warren Buffett’s wonderful companies at fair prices strategy?

EBITDA Yield: A Historical Perspective 

Patrick O’Shaughnessy published some great graphs—see below—on his blog (see here and here) that shows historical EBITDA yields.

About the fact that the market as a whole is getting more expensive O’Shaughnessy says:

Using this measure to look at all investable stocks in the U.S., it’s clear that the market as a whole has gotten more expensive since 2009. The EBITDA yield at the end of February, 2009 was roughly 14% for the entire U.S. market—today it is 9%.  But the market’s overall valuation only tells part of the story. The market in 2009 offered a wide variety of valuations, whereas today, in 2014, the opportunities are much more clustered. Stocks today are more expensive, but valuations are also much more homogeneous.


O’Shaughnessy wraps up the post by saying:

This doesn’t suggest that you should abandon valuation as a key component in stock selection (quite the contrary), but it does suggest there is less of an edge today in cheap stocks than there was five years ago: there are far fewer U.S. stocks that are very cheap.

What Is A Cheap EV/EBITDA Multiple?

Regarding at what levels could be considered very cheap EV/EBITDA multiples O’Shaughnessy in another post says:

I asked Tobias what he considers a very cheap multiple EV/EBITDA multiple, and we agreed that somewhere below 5x indicates a cheap stock, while a multiple of less than 3x indicates very deep value. So here is the problem: today, we face what is perhaps the most difficult environment for deep value investing in history.  Just 3.2% of non-financial, U.S. companies with a market cap of at least $200MM trade at an EV/EBITDA multiple below 5x.  That is just off June’s all-time low of 2.9%.


Some Further Weekend Reading: Geoff Gannon on EV/EBITDA

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Ben Graham’s Net Nets: Seventy-Five Years Old and Outperforming

Ben Graham’s Net Nets: Seventy-Five Years Old and Outperforming


NN1The strategy of buying and holding “net nets” has been advocated by deep value investors for decades, but systematic studies of the returns to such a strategy are few. We detail the returns generated from a net nets strategy implemented from 1984 – 2008, and then attempt to explain the excess returns (alpha) generated by the net nets strategy. We find that monthly returns amount to 2.55%, and excess returns using a simple market model amount to 1.66%. Monthly returns to the NYSE-AMEX and a small-firm index amount to 0.85% and 1.24% during the same time period. We conclude by examining potential factors to explain the excess returns on the net nets strategy. We examine the market risk premium, small firm premium, value premium, momentum, long-term reversal, liquidity factors, and the January effect. Of the various pricing factors, we find only the market risk premium, small firm premium, and liquidity factor are significant. We also note about half of the returns are earned in January. However, inclusion of these factors still does not explain the excess return available from the net nets strategy. Thus, we are left with a puzzle.


See here for full PDF.

See here for Tobias Carlisle’s blog Greenbackd.

Disclosure: I wrote this article myself. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

TBR: Kopparberg Brewery

Kopparberg Brewery: Company Information

Kopparberg Brewery is a family run business, owned and managed by the Bronsman brothers, Peter and Dan-Anders. The brewery still stands on the original site where it was built over 130 years ago. Generations of local families have worked for Kopparberg over the years and to this day it remains the main source of employment for the town’s 4,000 people. The town itself is located in central Sweden, just over a two-hour drive from Stockholm.

Kopparberg Brewery was re-established in 1994, when Peter Bronsman and his brother Dan-Anders Bronsman bought the old brewery in the town of Kopparberg, Sweden. 36 regional brewers originally founded it in 1882. Kopparberg is now sold in more than 30 countries and is the world’s best-selling pear cider. Kopparberg is listed in Sweden on the NGM Nordic MTF. (Source: Kopparberg Company Presentation 2014)

K2_1Revenues, Products and Markets

Kopparberg has shown a rapid growth during the last 20 years. Revenues grew from 46 MSEK in 1994/95 to 2 403 MSEK in 2013, a compounded annual growth (CAGR) rate of 21.9%. Click image below to enlarge. The CAGR in revenues between 2004-2013 was 10.2%.


Revenue Breakdown 2013 (SEK, million)
Sweden 549.8 34.2%
EU 991.1 61.6%
Rest of the World 68.5 4.3%
1,609.4 100.0%

The annual report for 2013 (see here for annual report in Swedish, there is no English version) does not provide a breakdown of revenues per product line.

Kopparberg’s products at the moment are (Source: Kopparberg Company Presentation 2014):

  • Kopparberg Premium Cider
  • Sofiero (beer)
  • Zeunert’s Premium Beer
  • Fagerhult Export (beer)
  • Dufvemåla (bottled water)
  • Gammaldags Svagdricka
  • Frank’s Vodka
  • Richard’s Dry Gin

K1According the Kopparberg itself:

  • Kopparberg Cider is the best selling Pear Cider in the world.
  • Sofiero Original is the best selling beer for the 11th year running at Systembolaget (the Swedish monopolist).

One third of the revenues (549.8 MSEK) comes from Sweden, sales in EU make up about 62% and about 4% comes from sales in the rest of the world.

Return on Capital: Magic Formula

Amounts in SEK millions.
Fiscal year 2013.
Return on Capital 33.5%
EBIT 129.
Net Fixed Assets 404.0
Net Working Capital -19.0
Current Assets 758.0
Current Liabilities 776.0
Excess Cash (>5%) 0.0
Drivers of Return on Capital
EBIT-margin, % 8.0%
× Invested Capital, turns 4.2
= Return on Capital 33.5%
Earnings Yield 7.6%
EBIT 129.0
Enterprise Value 1,696.0
   Market Capitalization 1,432.0
   Debt 263.0
   Excess Cash 0.0

See graph below for a comparison of return on capital and return on equity.

KD2Profitability, Book Value and Dividend

Profit margins have improved during the last ten years, see graph below.

KD3Book value per share has shown a CAGR of 10.4%, amounting to 5.04 SEK in 2004 compared to 12.60 SEK in 2013.

Dividend per share was 1.90 SEK in 2013 compared to 0.15 SEK in 2004, a CAGR of 32.6%. The payout ratio in 2013 was 54.9%, compared to a ten-year average of 53.8%.

KD4Earnings & Cash Flow

Net income grew from 5.7 MSEK 2004 to 71.3 MSEK in 2013, a compounded annual growth (CAGR) rate of 32.5%. Earnings per share (no dilution) in 2013 was 3.46 SEK, compared to 0.27 SEK in 2004, a CAGR of 32.5%.

Free cash flow grew from 18.0 MSEK 2004 to 61.9 MSEK in 2013, a compounded annual growth (CAGR) rate of 14.7%. Free cash flow per share (no dilution) in 2013 was 3.00 SEK, compared to 0.87 SEK in 2004, a CAGR of 14.7%. During the last ten years Kopparberg has invested a lot in capital expenditures to support the revenue growth.

KD1Trailing twelve months (TTM) earnings per share was 3.89 SEK.

Valuation: Quick & Dirty

If we assume an earning power between 3 to 4 SEK per share together with an earnings multiplier range of 15 to 25 times, we get a range of intrinsic business value per share of 45-100 SEK.

Intrinsic Business Value per Share Range
Earning Power 15x 20x 25x
3 SEK/share 45 60 75
4 SEK/share 60 80 100
Price per share 70
Low end High End
Margin of safety -35,7% 14,3%

For the time being, until further research has been done, let’s say a reasonable earning power equals the TTM EPS of 3.89 SEK, and an earnings multiplier of 20 times to be a fair one. This gives an intrinsic value of 77.8 SEK.

Kopparberg will be added to the watch list.

To be researched (TBR)

Some things, among others, to be further researched are:

  • Revenues per product line
  • Competitors and industry characteristics
  • Business risks
  • Capital expenditures
  • Cost structure
  • Financial leverage

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.

TBR: The Electronic Rails of MA, V & AXP

Electronic Rails & Great Business Models

CA2I recently came across two articles, one from 2011 and the other from 2012, where Chuck Akre from Akre Capital Management gives his view on MasterCard and Visa.

In these articles Akre talks about how MasterCard and Visa both “principally own the ‘rails’ over which electronic payments travel worldwide.” Akre thinks both MasterCard and Visa are examples of great businesses.

Emphasis in quotes and excerpts below are my own.

“Another example of a great business model, which is new to our portfolio in the past year, is MasterCard [MA]. It and Visa principally own the ‘rails’ over which electronic payments travel worldwide. Those rails are exceedingly difficult to replicate, there’s a wonderful tollbooth aspect to revenues, and the business has a giant global wind at its back in the growth of electronic exchange of value away from cash and paper.” (Value Investor Insight)

Below is an excerpt from the interview in the AP article (see link below).

“Q: Shares of Visa and MasterCard have risen sharply. Why do you continue to like these stocks for the long-term?

A: These are extraordinary businesses. They have ‘toll booth’ models and operate in much the same way that Microsoft did when it became the dominant operating system for personal computers. As the PC market grew, Microsoft owned the operating system, and you were going to pay for it. Visa and MasterCard are the dominant players in what we might call the ‘rails’ over which electronic transactions take place worldwide, among the millions of merchants where their cards are accepted.

Their customers on both ends are banks — those that issue cards to customers and banks for the merchants on the other end. It doesn’t make any difference whether it’s a card swipe or a payment made using a mobile device. Many of those transactions are going over the rails of MasterCard and Visa. There’s a lot of growth potential, because 85 percent of the world’s transactions involving an exchange of value are still done by cash or check. The 15 percent done electronically can only go up. It’s a phenomenon that will continue to grow worldwide.

Q: Even with such potential, a company must execute well to generate strong profits. What do you think about MasterCard and Visa?

A: It’s not unusual for them to post after-tax profit margins of greater than 30 percent for a given year. Compare that with the single-digit margins that are typical for American businesses. They are doing something unique that causes them to have such high returns on their capital.

Q: Visa and MasterCard last month reached a transaction fee settlement that requires them along with some major banks to pay at least $6 billion to retailers. Some major retailers will be allowed to charge customers more if they pay using a credit card. Is that a risk for Visa and MasterCard? They could make less from transaction fees if some customers switch back to paying with cash or checks.

A: If it works out the way the settlement has been agreed upon, MasterCard and Visa are both fully reserved for it, and it’s been accounted for in their earnings. (Note: For example, Visa increased its litigation provision by $4.1 billion for its recently ended fiscal third quarter, which led the company to post a loss of $1.8 billion.) But that won’t alter their broad outlooks.

Q: Your fund doesn’t own any shares of American Express and Discover Financial Services. Why?

A: Not as many merchants accept American Express, and I like the ubiquity of the Visa and MasterCard acceptance worldwide. As for Discover, it’s an also-ran. That doesn’t mean it always will be, but that’s where it stands now. Also, American Express and Discover are both lenders, in that they issue cards. Visa and MasterCard are more of a pure play in payment processing. They are the rails.”

Links to both of the articles mentioned above are provided below.

Akre also talks about MasterCard and Visa in the third episode of the Value Investing Podcast, which can be found here.

Earnings Record

From reading the articles referred to above, MasterCard and Visa clearly looks like great businesses that I want to research to improve my understanding of the pros and cons of these owners of, at least for the moment highly profitable, electronic rails.

I also included American Express below, since that business also looks like a great one.

VMA2In the table below I have compiled earnings per share data for the ten-year period 2004-2013 (Source: Also included are the trailing twelve month (TTM) earnings per share.

At the moment, I have not looked in to any single year to see if there was any non-recurring income or expense affecting the reported earnings per share (see above and the MasterCard and Visa settlement). This will be done later on.

Price per share data also taken from per September 22, 2014. Bond yield data taken from FRED at the same date.

EPS1Both MasterCard and Visa have shown great growth in earnings per share over the last couple of years. American Express has also posted good earnings per share numbers, doubling earnings per share in the last ten-year period.

Without further digging into the earnings numbers for the moment, I have made a rough estimate of the earning power for each of the three businesses, see table below.

Different values based on a few earnings multipliers are provided in the table below. A reasonable earnings multiplier for each of the three businesses is likely in the range of 15 to 25 times.

At the moment Master Card is trading at 27.5, Visa at 24.5, and American Express at 16.9 times TTM earnings per share, giving an earnings yield (TTM) of 3.6%, 4.1% and 5.9% respectively, compared to the AAA Bond yield that currently stands at 4.1%.

If MasterCard and Visa are able to post high growth in the coming 5-7 years, the current market price looks justified.

What about growth for American Express going forward? If we assume that future growth for American Express won’t be as high as for MasterCard and Visa, a reasonable value likely lies somewhere in the $80 to $110 range, probably in the mid to high end. A mid value in this range gives $95 per share.

But, this is just a brief overview of all three companies. More research will be done to get a better grasp of the business fundamentals, the industry, competitors, profitability and what any significant risks might look like. Before this has been done, all of them will just stay on the watch list (see link below). To watch out for, and learn more about.

EPS2MasterCard, Visa and American Express will be added to the watch watch list.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.