Payback Time

The day after I told Manny (Kiplingers) to get in, the market shot up 500 points. Nice call on the market if I do say so myself.  And pure luck.  I was thinking it would continue down for a while.  But businesses are cheap, and that’s what we really care about.  And now it's time to figure out what to buy.   You guys asked me about Apple, (AAPL), Altria (MO),  Verizon (VZ), AT&T (T), Microsoft (MSFT) & ConocoPhillips (COP).  I’ll dig in on these, but only after you tell me what they are worth and why.

As always, I want you to do the homework.  You sent me two opinions of value for AAPL – Charpe197 thinks $286 is retail.  Lynn suggests the right retail value is $151.  Since I didn’t see their work, I can’t say for sure why the difference in value, but I thought I’d add another layer of information for those of you who are looking to buy some businesses right now.

I assume both of these investors are using Phil Town's 4Ms to determine the growth rate and PE and from there doing the calculations to find the value.  That’s good, but it takes some experience to determine those things and get a solid value.

The best way to go at it is to be sure you’re working on businesses that are easy to understand, so you can get a long-term view of their prospects for earnings way down the road.  If you can’t do that, you’re taking a lot of risk without really being aware of it.

You’re sort of like these guys who created formulas for determining risk in a mortgage derivative:  It looked good on paper, but it wasn’t even a close guess in the real world because their math formulas ignored the obvious – real estate might not continue to go up forever, and when it came down, it would create the mother of all bubble-popping melt-downs.

What they discovered is that you can’t determine value just by looking at the numbers.  That lesson applies to us, too.  We have to understand what we’re buying.

Let’s take Apple as an example.  Apple is a technology-driven company.  They come up with cool new stuff, and we all run out and buy it.  They created the Macintosh computer and all that cool software, fired Steve Jobs, and then found out they got rid of the one guy in the company who could accurately determine what was going to be cool and what was total bs.  And Apple almost went down the tubes.

Then Steve came back, looked through all the new products in development, got rid of most of them, kept the iPod and the iPhone, and the rest is history.

The point is, can you tell me where Apple will be for sure in ten years?  I love their stuff, but I have no idea.  For example, Google just announced a new phone service that will do a lot of what the iPhone does – and a lot more.

Technology is enormously difficult to predict.  When you buy a tech company for a long-term investment, you better have a good grip on the industry – better than mine.  Better than Buffett’s, too.

But let’s say you’re going to go for it with Apple.  Long term.  Let me show you a way to look at value that is a bit different than what I’ve shown you before.

When I look at buying a private business, I can’t be sure when I can sell it like I can a public stock, so I take a hard look at how long it's going to take me to get my money back just from earnings.  I call this valuation concept “PAYBACK TIME”.

The advantage in buying a company like Apple is that I might not be able to see down the road where Apple is going to be in 20 years, but if I can buy Apple and get my money back in five years, I might just do that deal.  Five years from now I have no money in the deal (at least theoretically) and I’m playing with house money.  That would be a much less risky investment than hoping Apple will continue to crank out genius devices for twenty years.

I’m going to write about Payback Time here for a few posts.  I want to give you guys an idea about how to use (and why to use) Payback Time as a way to determine the value of a public business.

More to come about Phil Town Payback Time, and then we’ll look at some companies like the ones you asked about.

Now go play.

Phil Town