I just read this piece on BusinessWeek which had an interview with Larry Coats of Oak Value Fund. You can find the article here.
I always love it when fund managers reveal their valuation methodology. Here’s Larry Coats’:
What kind of discount do you look for when buying a stock?
“We’re attempting to buy a stock at 65¢ or 70¢ on the dollar, so a 30% to 35% discount. We use a discounted cash-flow model, using an 8% discount rate. The magic in that sauce is not around the discount rate, it’s around the terminal multiple that you put in the valuation equation. Because at the end of year five, you have to assign something as the present value of the future cash flow.
We end up with a portfolio that has, on average, operating margins in excess of 20%, return on equity above 20%, and debt-to-total enterprise value less than 20%. So I’ve got highly profitable businesses generating returns on equity and doing it without significant leverage on the balance sheet.
From a growth perspective, we believe revenue over the next five years for this collection will rise just short of 10%, on average; and earnings growth will be in the mid-teens, or 13% to 15%. We have stocks with higher quality, better growth, less risk in terms of balance sheet, and trade at a market multiple.”