Business for sale?

As you know, I’m a member of Networth IQ – and quite an active member, at that! I love reading and answering questions … 

[AJC: you’ve probably already seen that from the detailed responses that I try and give commenters on my posts on this blog … try me, if you have a question … I just won’t give direct personal advice, because I am not a qualified professional, but I will give general advice if I think it will benefit all of our readers]

… and this unique site provides a great platform (as does Tickerhound, which provides a great Q&A forum on everything from stocks to real-estate).

For those of you who aren’t members of Networth IQ, here is an exerpt of a great question:

I found a business for sale that has generated the following free cash flows since 1998.

1998 – $3,426.0 Mil
1999 – $3,949.0 Mil
2000 – $4,917.0 Mil
2001 – $7,133.0 Mil
2002 – $6,077.0 Mil
2003 – $8,333.0 Mil
2004 – $8,956.0 Mil
2005 – $9,245.0 Mil
2006 – $11,582.0 Mil
2007 – $12,307.0 Mil

The current owners are asking $183.49 Bil, …. I don’t have $183.49 Bil, but they said that they would sell me a smaller portion of the business if I wanted … Should I buy?

I like this question on two levels:

1. It’s a neat reminder that when we buy stocks, we’re not just buying ‘bits of paper’ … we’re buying a small piece of a real, live business!


2. It gives me an opportunity to show you the sorts of questions that I would ask – and the types of information that I would be looking at before buying into this – or any – business.

According to Warren Buffet (or sources who purport to know how he works) the intrinsic value of a business is in its discounted cashflow.

That is, a business is – or should be – a cash machine … what’s the reason for owning it, if not to get some cash out?

So, in the above example, we should be able to decide if the business is worth $183.49 Billion (not knowing the company in the above excerpt, I am assuming that this number represents the entire current market capitalization of the business) by discounting the cash-flows shown above …

… a quick look at the most recent cash-flow figure shows that it is currently producing $12 Bill. cash per year (probably growing, if history is any guide); that would mean about 15 years to get our money back … yuk.

Now you know why the stock market is generally a fool’s game … I would by far prefer to invest in my own business, or buy a private one at ‘only’ 3 to 5 years free cash-flow (better yet, Net Income), and grow it … then float it myself!

Or, at least sell it to a public company who can immediately ‘claim’ 15 times my Net Profit (hence, give me 7 to 12 times my Net Profit).

But, if we are going to play ‘the stock market’ game, what would we need to know before we can make an informed decision about ‘investing’ in this stock?

Hmmm …
As I pointed out, the free cash-flows on their own say nothing …
For example, I recently sold two similar businesses: one had been going for many years and generated ‘free cash flows’ [now that’s an oxymoron!] of $1 mill. and the other was less than 2 years old and had yet to make a dime.
Yet, I sold them both (separately) for about the same price! So, there must be more to the valuation of a business than Free Cash-flows, right? Absolutely!Let’s start with Return on Invested Capital:
I’d like to know what it has been for this company (and, the industry) over the past 5 years? I’d like to see an improving trend in excess of 15%, please.
Then, is the company growing?
Cash Flow is just one measure (but, what about operating cash-flow … have they made any strategic purchases / major capital expenditures /etc.), so what about the 10 years trends in: Earnings? Book Value? And, what about plain, old Sales?
I’d like to see a history of growth (min. 10%) in all of these …Now, how is there debt situation?
How long will it take them to cover their long-term liabilities from ‘Free Cash Flow’?
I’d like to see no more than 2 to 3 years.
Do the people who run the company own stock? Are they buying or selling?
Tell me about the company: do they have a ‘sustainable competitive advantage’ (what Warren Buffet calls a ‘Moat’ … but, that’s too much water for me!).

Do I believe this company will be around for the next 100 years … do I really want to buy THIS business in THIS industry?

Lastly, if I like the answers to all of the above (unlikely … so far I’ve only liked the answers to similar questions for 7 companies out of the 5,000+ that I can currently buy a ‘piece’ of) …

…. then how CHEAP can I get this thing!?
PS I made the ‘other’ category … waaaayyyyyy down at the bottom of the 150th Carnival of Personal Finance … whoo hoo!
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0 thoughts on “Business for sale?

  1. Hey Q, I can understand why you’d like [Networth] IQ 🙂 and, it IS a great site! Thanks for posting the link to your own profile, too.

  2. @ Moom – Thanks [how’s Aus?] … could be BRK (that’s Warren Buffett’s company). Does that make it an automatic ‘buy’? Some people want their investment ‘returned’ in 15 months, not years 🙂

  3. I don’t think that it can be Berkshire, they are not this steady due to losses they had in insurance. Berkshire is not even as good as this company, they are worth almost 200 billion and only spin off 6 billion in cash. Even Warren Buffet said not too long ago that a fair price for his company was probably 60-80 billion.

    But this really does make people think about stock in the correct way. You are really buying small parts of a business. This is exactly how Warren, thinks about stock if you plan to hold it long.

    I usually find it easier to make money shorting stocks, it is much easier to spot a failure than a winner much of the time. If you look at most large cap companies, their profits are usually less than 3-5% of their market cap.

    The funny thing is that I can’t find any company like the one talked about.

  4. @ Jason – I don’t know who the company is … but, an interesting exercise in ‘valuation’. I wouldn’t buy no matter how good the cashflows if I didn’t love and understand the company & its management team … as though I was buying and NEVER planning to sell!

  5. This really makes me wonder how many companies are worth buying. Most good real estate will pay for it self in 10 years or less. This would be a P/E ratio of 10. And almost every stock I see has a P/E ratio over 10. I think I will only buy stocks in the future from companies with a P/E of under 10 and from one that I like the business and the management.

    I don’t think it is real, just made up numbers.

    Jason Dragon

  6. @ Jason – The ‘Gold Standard’ in investing is Warren Buffett, from what I understand, he made a lot of his intial money by buying companies at a P/E of 8 … if they return well AND climb to a P/E 15+ … double-whammy!

    Real-estate has a HUGE additional advantage: you can leverage MUCH more than stocks. Thanks for your comments.

  7. Help! I am the assistant manager of a party store in a small town. We are filling a niche here, but with the economy, we are drowning in debt. The owners have asked me to find a buyer… How do I go about this?

  8. @ Carrie – if the absence of debt will make the store more profitable, then ideally you need to find somebody with cash e.g. somebody recently ‘retired’ from the corporate world with a payout that they now need to invest, so run ad ad with headline something like: “Retail Investment Opportunity!”

    Run this – or other ads – in the classifieds in the local papers, as the purchaser will probably be somebody from your area … how about the store manager (is that you?) …. would/would you buy it, and perhaps pay the owners out over time?

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