Bobel Investments generally pursues a number of valuation methods to identify quality stocks. Investing strategy is adjusted based on market conditions and economic cycle using derivatives as hedges or to establish stand alone positions.
Discounted Free Cash Flow Value
When conducting Discounted Free Cash Flow to Firm Valuations, we look for companies that are at good prices relative to their cash flow, market position, industry characteristics, and balance sheet. The key assumptions in this type of valuation are the future growth of free cash flow and the discount rate. When determining the appropriate future growth rate, consider past growth in operating cash flow, capital expenditures, and management's future projections. The discount rate is a fairly subjective number; by hovering around 20% a good amount of safety can build into a valuation, but it may also be prudent to adjust downwards for low risk of obsolescence, market dominance, and low macro sensitivity.
This method involves purchasing companies that are trading significantly below what they would be worth if they were broken apart and sold in pieces. It’s like buying a house for $1 million, and selling the land, appliances, tiling, copper piping, and countertops for $1.5 million. Liquidation Value deals don’t arise often, but when they do it is a beautiful time to be an investor. Most recently, the global financial crisis in Q2 2009 created many such opportunities. There are also many risks with this style of investing, but to mitigate them, look for a consistently growing asset base, positive earnings, and liquid inventory to name a few.
Use of Derivatives
Using derivatives is a great way to provide protection for our portfolio, or to generate significant returns. Position are occasionally opened via In The Money Call options and when warranted puts, are purchased either on individual stocks or on the broad market index to offer portfolio protection.
Advance derivative trading strategies are also utilized. A commonly used situation is illustrated by the following example. An attractive stock is trading slightly above a price at which we would be comfortable purchasing the particular equity according to our valuation models and we are expecting significant upside in the stock in the near term. At this point we would purchase an out of the money call option and simultaneously sell an out of the money put option to recover the premium spent on the call option. This effectively allows us to purchase the stock at a price we are comfortable with, in the event the stock's decline and it allows us to take advantage of any near term upside if the stock does not decline to a price which we are comfortable with. Finally, selling puts combined with an equity purchase to open an initial position will at time be also utilized in order to lower the overall entry price for the position.