TONY KYNASTON | from QAV Podcast

My guest in this episode is the always welcome Tony Kynaston from QAV. Today, we dove into intrinsic value and company valuations.

Tony explained valuation as a heat map. No single number pins down a company’s worth. He uses multiple methods to gauge value. Companies get valued by assets or earnings. Think of your house—it’s valued by comparing recent sales in your area. A coffee shop works the same way. Its assets, like the premises or equipment, have comparable values. Earnings matter too. Tony uses a discounted cash flow to estimate how long it takes to recover the asking price.

Risk plays a big role. Government bonds set the risk-free rate, currently around 5%. Stocks carry more risk, so you want a lower price-to-earnings ratio. A coffee shop faces more uncertainty than a blue-chip like Procter & Gamble. Startups? Even riskier. Tony avoids them until they prove cash flow. He shared a story from the dot-com boom. Analysts hyped websites with billions of eyeballs. Predictions failed, and companies crashed.

Intrinsic value is one piece of Tony’s heat map. He calculates it two ways. IV-1 uses current earnings per share divided by a 19.5% hurdle rate. IV-2 uses forecast earnings with a lower hurdle rate—risk-free rate plus 6%. Both methods simplify discounted cash flows. Tony learned this from The Warren Buffett Workbook. Analysts might project 10 years out, but Tony stays short-term. Long-term forecasts often miss the mark.

Governance can impact value too. A CEO in jail tanks a stock price. Tony calls these red flags. Poor governance, like surprise bad earnings, keeps him away. He also mentioned sovereign risk. A gold mine in West Africa trades cheaper than one in Australia. Discounts reflect perceived risk, but they can be overdone. Tony buys when the market overreacts.

For beginners, Tony suggests starting with price-to-earnings ratios. Compare them to the market average. Dig deeper to avoid value traps—stocks that look cheap but hide problems. QAV’s checklist helps. It factors in sentiment and cash flow. Tony reassesses valuations during reporting season. In the U.S., quarterly earnings speed things up. Australia’s continuous disclosure keeps data fresh.

Listeners can explore QAV at qavpodcast.com.au or qavamerica.com. The free podcast offers insights into Tony’s process. Use code SFB for a 20% discount on QAV Club or SFBLITE for a free month of QAV Lite. QAV Club gives full access to tools and a community. QAV Lite shares Tony’s trades for guidance.

Tony’s framework keeps emotions in check. Markets swing, but his rules stay steady.

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TRANSCRIPT FOLLOWS AFTER THIS BRIEF MESSAGE

Disclosure: The links provided are affiliate links. I will be paid a commission if you use this link to make a purchase. You will receive a discount by using these links/coupon codes. I only recommend products and services that I use and trust myself or where I have interviewed and/or met the founders and have assured myself that they’re offering something of value.

EPISODE TRANSCRIPT

Tony: Intrinsic value number one is the current earnings per share for the company over a high hurdle rate which is currently 19.5%. So I'm looking for stocks that ah, are deeply discounted based on their current earnings. And that's one element of the heat map. And an IT IV number two is more like, um, how a traditional stock market analyst would look at it. It's the forecast earnings per share. So what's this company going to do next year? And I put it over a lower hurdle rate, which is the risk free cash rate plus 6%, which is called the risk premium.

Phil: G'day.

This is the first in a five part series explaining key company valuation metrics

And welcome back to Shares for Beginners. I'm Phil Muscatello. How much is a company really worth and how can you measure its value? What's the difference between market value and intrinsic value? Today I'm welcoming back to the podcast, old friend of the podcast, Tony Kynaston. Hello, Tony.

Tony: Hi, Phil, how are you doing?

Phil: Good, thank you. Great to have you back on. Tony is the mind behind the Quality at Value system, or qav. Tony's discipline, checklist driven approach to value investing has delivered an impressive average annual return over double the Australian market index. Intrinsic value is only one measure of value. Overall, there's a whole concept of valuing companies. Give us an overview of value, Tony.

Tony: Yeah, thanks Phil. Uh, it's a really interesting topic and in my experience no one can nail a value down to the exact dollar or the exact cent for a company. And so in my mind I see valuation as almost like a heat map. So here are all the ways I can value something and I put them all together and I can get a green reading to say it looks like it's a good value investment, or I can get a red reading saying it's a bit expensive. So that's, I think, the first thing to note. And if I break it down, there are two broad ways of valuing a company, either by its assets or by its earnings. And people will be familiar with that if they haven't had any sort of experience in valuing companies at all just from, for example, valuing their house, which tends to be, uh, an asset valuation metric. And all valuations also tend to be based on relative comparisons. So for a house, if you're thinking of buying a house or if you're thinking of selling a house, you'll be trying to work out what the right price is for that house. And the only way you can really do that is to look at comparable house sales in the area in recent times and then say, well, I'm selling uh, a two bedroom apartment or I'm selling a four bedroom house and here are three or four other ones that have sold the like it in a like suburb and they've gone for a per square metre valuation of X. And therefore if I work out my per square meters, I can think my property is worth about X times the square meter each. That's a good example of how to value something. If I apply that to a company, the company is going to have assets as well and they're going to have relative value. So we talk about the coffee shop analogy in qav and if people can think about their local coffee shop, it's made up of the assets and it's made up of the earnings when they come to think about what it's worth. And you know the saying in the stock market is price is what you pay and value is what you get. So if your local coffee shop puts a for sale sign up and you think you might want to be a barista and get into the coffee shop business, you've got to work out whether the asking price for that coffee shop is overvalued or undervalued. And so you've got to have a good idea of what the value of that coffee shop is to you. So the first thing to note is does the coffee shop actually own the premises? And if it does, that's an asset and then what's that worth? And so you can say, well, it's a retail shop in this particular area with this per square meterage, here are three or four other ones which have sold recently. And therefore I can work out what the assets are, uh, of the coffee shop. You also have other assets like the coffee machine, the tables and chairs, the stock that's on hand, that kind of thing. And again, you can assign values to each of those things based on perhaps what they were purchase for less the wear and tear on that. You can again look at comparable sales. You can go ono marketplace and have a look at what coffee machines are selling for and assign a value to it, add up all those things and then you can say, okay, that's one valuation for what I'm buying. But then there's Also the business side of

00:05:00

Tony: what you're buying and the traditional way of looking at the valuation of the business side, not including the assets, is to look at what it's earning and how long you think you might get those earnings for. And that kind of valuation is traditionally called a discounted cash flow, which is a kind of technical way of saying that the coffee shops making X number of dollars now, and if I extrapolate that out into the future, how long will it take me to get back the asking price on the coffee shop? So obviously we want that multiple to be as low as possible. So I would like to give you say one year or two years income as my bid to buy your business. But you might be asking five or six times. And so again you've got a number of ways of looking at that valuation and it's all comparable. So my offering one or two might be based on the fact that I know from a bit of research that there's been two or three coffee shops in the area which have sold recently at that kind of two or three times earnings. You might be have been working in the coffee shop business for a long time and think your business is worth more than that because you have low customers, you have good supply contracts, etter, etc. And so in a one on one transaction we're going to negotiate that doesn't happen in the stock market when you're talking about a coffee shop business that's listed. Unless you look at it over time and think that uh, the current multiple of earnings for that coffee shop business that's listed is currently more than what you want to pay for it at six times earnings. But at some stage coffee beans will rise in price, uh, retail will go into a bit of a recession or whatever. It may come down to be two times earnings. And that's when you might want to buy a coffee shop business based on your experience of what the value is for that business.

But in all those things there's a couple of concepts. One is the uh, relatables. So that's often called the hurdle rate. If you're reading about valuations or you're listening to people talk about valuations in a stock market sense, the hurdle rate is often compared back to the, what's called the risk free hurdle rate. And that's the yield on um, government bonds, oftentimes 10 years, sometimes five year bonds, depending on where they sit in their cycles as well. So it's called risk free because you've got to park your money somewhere. If you're an investor putting it in the bank and receiving an interest payment is probably the least risky way of doing it. If you have, uh, enough money to go and buy a government bond, that's kind of equivalent risk. And you usually get a little bit more out of a government bond than the bank's prepared to pay you because they've got to make a margin. So the government bond yield, if you invert it, say for example, the government bond Yield is currently 5%. So if you buy a US government bond or an Australian government bond and you get 5%, then you're paying 20 times that, uh, as the price of the bond because you're getting a 5% coupon. So that's the valuation metric for the risk free investment. And so the P is 20. So then in the market, the stock market, we say, well, what's is the company I'm, um, buying riskier than the government bond? Well, yes, it's not you. The government isn't listed and companies can go broke or they can have downturns or whatever. So you want something better than that price to invest in that company. And so you're always moving up, you're.

Phil: Moving up the risk curve. Uh, aren't you here, Corre? At this point?

Tony: Yes. And so in that particular case, I would be looking for something on a Lower multiple than 20 times to try and take that risk into account. And so you're looking for something cheaper than 20 times earnings, depending on how risky the company is. Now if it's a small coffee shop, it's probably a lot more risky than the Australian government or the US government. So you're looking for a much lower PE than 20 times. So that's kind of, I guess, an overview of how you value things. You're always relating it back to how much risk you're taking on or how much the assets are worth.

Phil: Okay, so just to clarify, there's three concepts that you spoke about in that answer. The first one is the value of an asset, which is like your house. Then the value of a business, which is to do with its cash flow, and then how much risk you would be taking on, which means that you want to pay a lower valuation for a company that's got more risk. Is that a fair assessment of those three concepts?

Tony: It's a very good assessment. Yeah. And that's why I say valuation is always kind of a heat map because there are a number of moving parts there. And I think the other thing to touch on as well is what I'll call prediction, which is always the Hardest part of valuation. And so, uh, if you think about the risk of buying something like a coffee shop business, I want to get my money back as quickly as possible as a way of lowering my risk of having my money invested. And in the stock market world that relates to having a low price to earnings ratio, if you think of it that way. So I want to be repaid by the business quickly. That lowers my risk for having the money invested. And then

00:10:00

Tony: after that, if the business breaks even for a while, okay, I've got my money back. If it makes money, great, I'm getting a good return. If it loses money for a little bit, I can write it out because I've got my money back. So that's the risk side of things. If you're using, I guess a spreadsheet or EV valuation metric called a discounted cash flow, what you're trying to do is to say again, if I hold a government bond for 10 years until it matures and I get my money back, I will have made 10 times the premium the government's paying me for loaning them money plus my money back. So that equals this over 10 years. And then I compared that to the coffee shop and I suddenly start to think, well, in 10 years time I don't know how much this coffee shops going to earn. The owner is telling me for the last 10 years it's gone great, but I've got to start making assessments about is there going to be a, uh, McDonald's moving into the area soon and they're going to have a maafe which might interfere with my market share. Is Starbucks coming into the area, Starbucks closing and I'll do better. So you're starting to have to try and understand a lot of what's going on in the industry and the market and with competitors and with things like what's the coffee bean price going to be in 10 years time. And so it becomes a very difficult thing to do the longer you have to extrapolate out into the future for a discounted cash flow. Much harder than looking at a government bond and saying, I get 10 years worth of a 5% coupon or dividend for lendting the government my money for 10 years and then I get it back at the end. So in your discounted cash flow, you've got to put what's called a higher hurdle rate for the unknown, um, in there to take into account not just the risk of the business, but also the risk of you not knowing what's going to happen to the business in the future. And so you'll hear the concept of a hurdle rate when you're talking about discounted cash flows. And that's oftentimes where valuations come proper. Because if you think back to my experience with the dot com boom, people would say that uh, this company is going to go to the moon. It's going to um, you know the number of eyeballs looking at this website is in the billions and they just have to monetize that. Well again that's a lot of predictions in there. And as it turned out uh, the predictions were wrong and for the companies went broke when the dot com bubble burst because they had these cash flows which said, you know, we've got so many people looking at the website now, if we can just get a dollar from them in earnings going forward we'be rich. But they couldn't do that. So again you've got to be very careful of what the predictions are being based on when you're buying something in the stock market and do your own sort of assessment on risk and um, on what you know about the industry or what you think might happen in the industry. From a QAV point of view I try and bring all that back to the foreseeable future. So I'm looking at the current earnings of the business and if there is a forecast one year earnings I'm looking at that. Not trying to go out any uh, further into the future than that and forecasting and just come up with a multiple basede on a hurdle rate uh to get a value for the company based on the sort of things I can know about and the sort of things which have a short term play out rather than trying to stick my wet finger in the air and work ah out what's going to happen in 10 years to this business.

Phil: Is there a difference in the risk free rate or the hurdle rate for a company say like Procter and Gamble have got a long history strong brands as opposed to say a tech startup company A I mean what's the variance there?

Tony: Well it's huge. I mean one of the other things which QAV helps with is we're looking at the past performance of the business. So uh, a Proctor and Gamble has been around for a long time. It's been throwing off a lot of cash. We have a higher degree of confidence that's going to be there into the future. I still can't predict what Proctor and Gamble earnings will be into the future but we know it's a cash producing business that's um, been around for a long time. Often called the blue chip company. And so the market generally ascribes it a higher price earnings multiple because of that. So if the risk free bond is 20 times PE, Procter and Gamble is going to possibly trade around that. I don't know what the PE is for Proctor and Gamble, but it's going to be seen as closer to the risk free rate than a, uh, startup because a startup is, even though it might be exciting and have great prospects and a good story, it's still going to actually do something and produce cash and go through all kinds of headaches that a startup can do. And so if I was valuing a startup, first of all, I'd find it very hard because I look at the cash flow of a business and it's probably not producing any cash. So I tend not to invest in startups. I'll wait for it to prove itself. But if someone wanted to look at it, you'd want to have some kind of discount to other what uses of your money to compensate you for the risk, which is oftentimes the reverse. Generally you'll have to pay a lot for a startup based on its story, which is kind of counterintuitive

00:15:00

Tony: in my opinion.

Phil: And then sometimes you've got to pay a lot for quality. Well, hopefully not as a quality of value. Yeah, but there are so many great companies that spit out cash year after year. But getting it at the right time, that's the trick, isn't it?

Tony: Well that's why you've got to have it in your own mind what you're prepared to pay for it. The market's always going to offer your price, but you don't have to accept it. And then one day you will. And that might be in a recession or in a GFC or just on a down day in the market or after uh, a quarterly earnings update which wasn't good or whatever. Then you've got to decide, yep, that a good price for Procter and Gamble, that's a good price for the startup and I'm going to pay that because it's closer to my value than what it was trading for last week or last month or last year.

QAV uses two metrics to come up with intrinsic value

Phil: Okay, so let's focus on intrinsic value, which uh, of course is only one measure amongst many. But how do you define intrinsic value and where does it sit in your valuation heat map?

Tony: Yeah, so it's one part of the heat map and I use, I called a shorthand calculation in QAV to come up with intrinsic value and I use two metrics. I call one intrinsic value number one and the second one, intrinsic value number two, nothing groundbreaking there. Intrinsic value number one is the current earnings per share for the company over a high hurdle rate which is currently 19 and.5%. So I'm looking for stocks that are deeply discounted based on their current earnings and that's one element of the heat map. And an iv number two is more like um, how a traditional stock market analysts would look at it. It's the forecast earnings per share. So what's this company going to do next year? And I put it over a lower hurdle rate which is the risk free cash rate plus 6% which is called the risk premium. So at the moment you're probably looking at that hurdle rate being about 11%. And it's based on the forecast earnings per share. Because one of the issues with valuation is if whatever number we use is probably going to be wrong whether it's current or forecast. So it's better off to use two and then compare and contrast them. There's been plenty of companies which look good to buy based on their current earnings, but their forecast earnings are going backwards. So you need to take both into account when calculating your IV and my simple calculation which I got from a book called the Warren Buffett Workbook, which is worth reading out there if people are interested in the detail behind all this. But's ah, I guess it's a quick and dirty calculation that summarisees a discounted cash flow. So rather than saying here's my 10 year forecast or 5 year forecast for earnings and then I've got a discounted, so I've got to say that in terms of what a dollar is worth today, in 10 years time I've got a discount for inflation or risk or whatever else. So a dollar earned today to me right now might be worth 50 cents in 10 years time because of inflation or because of all the things that could happen to that dollar along the way and then uh, if I discount, well I think the earnings will be in 10 years time, 9 years time, 8 years time, add them all up and then divide by 10 in rough terms. It's like putting the current or the forecast earnings per share over a hurdle rate. And that hurdle rate, if it's close to the discount rate you're using your dcf, you're getting a very similar sort of valuation for the company. So I'd prefer to do a quick and douty calculation like that, um, based on the two metrics we know and hurdle rates which are number one commonly used and number two, a higher Benchmark, because I'm looking to put deeper value into the portfolio and then use both of those as part of a checklist on valuation. Then I can arrive at a sort of overall calculation for whether it's red or green on the heat map for buy on not.

Phil: Okay, so just to clarify, on IV2, the second IV calculation, this means that you're looking at just the forecast that's provided in the company numbers one year out. Is that the first part of it?

Tony: Correct. And that's. Normally a lot of companies will do that. Some companies won't give an earnings per share forecast, but you can generally go online and look at what the analysts think the forecast earnings per share will be as a market consensus.

Phil: Okay, so then you take that number and then you discount it based on the risk free rate and then with a 6% buffer. Is that how it works? I mean, just give us a practical example.

Tony: Yeah, yeah, sure. So if the forecast earnings per share for the coffee shop is 10 cents and then the risk free rate is 6%, that's the sort of standard in the accounting world. And then I add the cash rate, which is currently, uh, 4.35, 4.15. I think in Australia I could have that wrong. But anyway, I'm just making numbers up here anyway. But it gets too about, let's just say to make the numbers easy. Gets the 10, 10%. So I put 10 cents over 10% and I'm getting a dollar as the price I want to pay for that coffee shop. I getting one.

Phil: So that has to be deeply

00:20:00

Phil: discounted. The market value of a company has to be deeply discounted as opposed to the intrinsic value, doesn't it then for it to actually even show up on your radar?

Tony: Uh, well, it is a valuation screen for sure. But the IV2 calculation generally gives you about the market sort of forecast for, for the price of that company or the valuation for that company. Doesn't mean the company's trading at that, but that's kind of what the market thinks it should trade at. Whereas the IV1 calculation say it earned 5 cents this year and we're putting that over 19.5%. Then you want to pay 50 cents for the company rather than, uh, a dollar. Hope I got the math. Ro. I'm just doing it on the fly. But the one with the higher hurdle rate discounts what you pay for the company more than the one with the lower hurdle rate. The lower hurdle rate is what most analysts will use. And so that gives me what I think the market consensus is for valuation and then I also use a deeply discounted one by having an increased hurdle rate and then I put them both into as part of the checklist on valuation.

Phil: So many analysts who work in this, they, the high powered, high paid analysts, they will spend a lot more time and they will put together an intrinsic value based on discounted cash flow. And as you're referring to looking out 10 years into the future, um, this doesn't sound like a particularly accurate way of looking things because no one's going to be able to look at the price of a company in 10 years time or how much it's going to be earning, can they?

Tony: Yeah, correct. Uh, I will sort of put one caveat on that. If you have a good stock analyst who knows a company well or who knows an well and there are stock analysts out there who just work on banks or who just work on retail, who just work on mining, then they'll know if pick the mining analysts, they'll know the cycles in the mining industry, in the commodity they're looking at, they'll know the players in the market, they'll know what M and A deals are coming along, etcetera, etcetera. And so they'll have a much better feel for a 10 year discounted cash flow then a general analyst looking at it. So yeah, so there are analysts out there who are pretty good at doing discount of cash flows. But uh, even then they'll be the first people to admit that it's a forecast on the spreadsheet and things can go wrong next year. So uh, they like me, will want to buy things when the price is discounted to even what they think the price is worth because they understand the risk of uh, the industry they're working in.

Phil: It's interesting, before I started this interview today, I was just having a quick browse of Investopedia and about intrinsic value and they said one of the measures that some people use is governance as well, which um, I wasn't aware of. And they showed the example of a company where the CEO ended up in jail and that's when the share price went down, down, down, down. And then another analyst comes along and has a look at the intrinsic value and goes oh, okay. Despite the CEO, uh being in Chail, it's actually worth this original amount of money before it went down. So I know this's qualitative parts of it as well, but you wouldn't say qualitative or how much you perceive a company to be worth as having any relevance here at all, would you?

Tony: Well if you're talking about what's called the government's discount. I don't use that in my valuation.

Phil: So I've never heard about this. There is a governance discount, is it? Yeah.

Tony: Stock analysts will talk about it. So we tend to use the term red flag. So there are certain companies that we won't buy because we think they're, uh, governance has been poor. And a good example of that is that they've surprised when they've released their results. It's been worse than they've been flagging to the market or the market has thought, or much worse than their past results have been. So something's out of sync there. But they haven't told us until they are forced to drop their numbers. So that's a red flag governance for us. And we'll put a red flag and park them until we see an improvement in that dimension. But some analysts will actually, you know, put a value on what the governance'discount is.

Other ones that are similar to that is sovereign risk and governance discount

Other ones that are similar to that is I'll talk about sovereign risk. So what you see in the Australian market is that, uh, say a mining company that has a mine in Kalgoulie in Western Australia will trade on a higher price earnings multiple than a mining company that has a similar gold mine, but it's in West Africa. And they'll call that the governance discount because whether it's right or wrong, they'll say West Africa is more risky from a government point of view than Western Australia. Now you. How much is that discount worth and what's the correct valuation for that discount is worth? Comes down to opinion really, but it is worth something. So, um, it is worth something.

Phil: It's a way of building an margin of safety, I would assume, corre into your intrinsic value calculation.

Tony: But it's also. Well, I've tended to find in my experience as an investor is

00:25:00

Tony: if you can buy the West African gold miner at a discount valuation, and then there's no sovereign risk event much better than buying the Australian gold miner at a higher price. So sometimes the valuation is actually overdone as well, or the valuation discount is overdone. And if you, you can again, it might be correct. But if I probably take this to the extremes, if you look at the company working in West Africa and you look at what they're doing and how they're embedded, they are in the community, et cetera, et cetera, to me it looks pretty safe. Yes, it can change, but so can Australia change. I mean, we're going through an election now and there's no policy to change the mining sector. But we could wake up tomorrow in Australia and find out there's a royalty on gold mines that wasn't there yesterday. So there's sovereign risk everywhere as well.

Phil: And of course, by the time this goes out, uh, we'll know the result of the elections, hopefully. Who knows anything about that future? Yes, that's right.

Tony: I think that's a really important point too, when you're talking about EV valuation. Um, who knows anything about the future? Uh, the last sort of little while has taught us a lot about our inability to predict. We've had worldwide epidemics, we've had regime change in stable countries, we've had all sorts of turmoil in trade agreements, etc. So it's very hard to predict the future. That's why I like to sort of, let's just look at the current numbers and maybe look, sneak in the forecast earnings per share for a short period of time into EV valuation and just try and work on that. And my rationale for that is, as you said before, Procter and Gamble has been, you know, producing earnings for a long time and it's likely that their management knows how to deal with all these curveballs that get thrown to them and they'll continue to produce earnings in the future. So that's kind of our test on management. It's part of the quality of the company. The fact that it's been able to have cash flow for a reasonable period of time that's positive compared to a company which is starting up or going up and down in terms of its profit, you know, has, uh, to be a discount on the valuation for that company compared to Procter and Campbell.

Phil: And I also recall the time we were chatting around the time of the COVID crisis and stocks were plummeting. And your response to me was two words, situation normal.

Tony: That's right, situation normal. You can't forget that. What we're talking about here is a market where it's you and me deciding on what to pay and buy and sell a company for. And we're both humans. And even though they might be more tech involved these days and high frequency trading, et cetera, et cetera, it was all set up by humans. It's a human market and it's not dissimilar to going down to Vic Markets or if you're in the US going to the pike street market in Seattle and watching the traders shout the price of fish or whatever else, and you can decide to walk by or you can decide to, to pay the markets, uh, are going to open every day, they're going to trade every day. You can browse or you can buy or you can sell, but it's all. There's as much a human element to it as there is a spreadsheet element to it, or a DCF or an IV or a valuation element to it. I think what that means is I've got to keep my emotions in check and I've been sort of, I guess, evolved to do that using a framework which we call qav. But it's really important in my mind to have your methodology evaluation set in rules before the curve ball gets thrown and you have to make a quick decision about whether you're a buyer or a seller rather than try and sit down and work all all out from first principles when a new situation presents itself.

Phil: And we've all heard of the concept of value traps and this is something we really need to guard against, isn't it? Because tooonyy times it's easy for a novice to go and go, oh, that company's fallen by 20%, 30%, 50%. It must be cheap. Now you really do have to have a framework, don't you?

Tony: We do. And some stocks are cheap for a reason. They've had problems or the industries in decline or whatever. So doing EV valuation for a business based on its current earnings and its immediate forecast earnings is one metric as part of a whole checklist to decide whether to buy or not. Sentiment is another one that we use and the QAV process. So, uh, what does the market think is going to happen to this stock or this industry? That's important to factor into things and also, I guess, do a bit of research and a bit of reading on the company. A good example is one that we did a deep analysis on about a month or two ago. A mining company in Australia that is throwing off lots of cash. You can buy it cheaply. It looks great. But they've recently came out and said we thought we'd need to spend X millions of dollars on extending the mine life. We're not going to

00:30:00

Tony: do that now, it's not worth it and the mine will shut next year. So looking at the numbers on the current basis, it looks great. You then need to go and look at the sentiment because the share price dropped dramatically when that announcement was made to say, okay, something's going on here, I don't want to buy it going, it's a falling knife, it's dropping in price.

So what advice would you have for beginners on how to implement intrinsic Value

Phil: So what advice would you have for beginners to be able to implement the concept of intrinsic Value without getting overwhelmed or too confused. I know you've explained it here before, but is there any way of simplifying it even further?

Tony: Oh gee, I don't know about simplifying it further. If you're a beginner, uh, yeah, you can use a system like QAV to give you a number. You can use your real world experience like buying and selling houses or apartments or cars or sofas, whatever else to get a feel for when you think something's worth what the price is on the sticker you can use. When I first started out I paid a lot of attention to the price earnings ratio and that's where valuation has always started in the stock market. And that's a um, quick way of looking, comparing the price you're being asked to pay for the company versus the market versus things like the risk free rate. And so you can look for below average market P ratios and do a screen based on that as a starting point. But what I found out was that that's one part of the story. So you've got to look at the, I uh, guess what you call the secondary effects. Why is it cheap? What I found was that earnings, which is one part of the price earnings ratio can be manipulated. And so I tend to look at, I focus on operating cash flow which is much higher up the earnings statement than the net profit that goes into calculating earnings per share. And when I say manipulated, it could be for valid reasons that the company has a very different sort of earnings profile to the cash it's producing. Could be that it's got to put a lot of money into capex, could be that it's got to pay a lot of tax, could be that it's heavily geared, et cetera, et cetera. So just looking at the earnings per share is the starting point. But that's certainly a good starting point for a beginner to start to get a feel for companies which are in the value side of the spectrum.

Phil: Yeah, it is a starting point but often beginners don't even understand that the P ratio means different things in different industries as well and due to different differing accounting standards even between different industries.

Tony: Yes, correct. And you know, a good example is the tech industry where you tend to have high PE E ratios or even the mining industry explorers will have astronomical P ratios because they're probably not selling much and that may or may not be a good time to buy them. I've met m plenty of mining analysts who say the best time to buy a mine is when it's on a high pe E ratio because it's just starting out and the PE ratio will come down as the sales go up. But again, at that stage in the cycle of a mine, you're reliant on the fact that they can actually scale up and produce. So I'd rather put that one aside and come back to it when it's producing cash, throwing off lots of cash and the price of the commodity is going up and I can have some confidence that if I buy it for this valuation, I'm going to get my money back from cash flows in the short term going forward or in the shortest term possible. Going forward.

Phil: That's all you want, the shortest term possible?

Tony: Well, that's how you mitigate risk, in my opinion. Get repaid quickly, get your money quickly. What's that old saying, it's money, not yoursill money in pocket. Um, that's what we're trying to do quickly.

How often do you reassess intrinsic valuation? Is it during reporting season

Phil: How often do you reassess intrinsic valuation? Is it during reporting season when the numbers are actually published from companies?

Tony: That's the main one. When we're using forecast earnings per share, that can be updated quite frequently. So we run a buy list once a week and then the checklist goes through and recalculates. And if there's been an update to earnings per share from analysts and we get the consensus on that, then it will update. But obviously the current earnings per share is only updated once the earnings are released half yearly in Australia, quarterly in the U.S. and so that, um, number changes relatively infrequently. But the calculation that uses the forecast one can change in between. I guess that change in the overall checklist doesn't produce a material difference in the valuation. It's one part of the checklist. So, uh, you, a change in the forecast earnings per share may affect sentiment, um, more than it perhaps affects, uh, the checklist score.

Phil: So with stocks in the US with a quarterly earnings report cycle, is the frequency updated much more quickly in the QAV process?

Tony: Well, yesah. So like I said, we'll download a weekly checklist. So we're checking it weekly anyway because the stock price will change around and one of our key metrics is price to operate in cash flow. So that changes with a stock price. But yeah,

00:35:00

Tony: it means three monthly. You'll get earnings per share numbers to plug in and change. Haven't seen it be too different to the Australian methodology so far. So we get numbers every six months that change versus three months that change. I guess I'm going to draw a broad brush here and say that in Australia there's a thing called continuous disclosure. So you can get updates along the way in Australia which might change the forecast earnings per shares. You tend to get that in the quarterly earnings updates in the States. So yes, the numbers will change four times a year for their current and the numbers will probably change four times a year for their forecast. And that's about what it does in Australia as well if you sort of average it out across all the continuous disclosure that goes on.

Phil: So if listeners want to find out more and take advantage of Qav, where can they go and find you?

Tony: Ye qavodcast.com.au that's for the Australian show anyway, QavAmerica.com for the US version for US stocks. But yeah, that website will have all the sor of resources that we offer. You'll have lots of videos on what we do and how to understand what we do. And it will have the ability to sign up to be a club member or a light member or to download the free parth of our latest podcast which we do weekly.

Phil: Yeah, so the free part of the podcast actually gives you a good overview of how you'doing it and valuing particular companies and the methodology and insights into it, isn't it correct?

Tony: Yes. Um, and that's been going for six years now in Australia, so it's a bit of a track record there.

Phil: And if listeners are interested, we've got a coupon code which is for QAV club. There's a 20% discount if you use the code SFB or SFBLITE as the code for a free month of QAV Lite. What's the difference between QAV Lite and QAV Club?

Tony: So QAV Club is ah, I'll call the full membership. You get all the bells and whistles. So you get the full podcast where you can ask questions and I answer questions about stocks or about investing in the second half of our show. Uh, and you get access to the Facebook group where there's a community of like minded investors and they often help each other which is great and help us improve our tools to invest Using the QIV process, you get full access to um, the tools we use, the checklist, you can download uh, um, yourself and you don't have to wait for us to do it once a week on a Monday. If you want to buy a stock on a Thursday, you can download and run your own numbers yourself and produce a checklist and a buy list. You get access to what we call the three point trend line calculator, which is our sentiment checker, which gives us our buy and sell prices on stocks so you get access to the tools. That's the full membership. And then the L membership is. Basically, we set up, uh, portfolios and trade them using that QAV methodology. And then we'll put out an email saying, here are our buys and sells, and it's up to you whether you want to buy and sell to follow us, but at least you know what we're doing. And you can use that to inform your decisions for your own portfolio.

Phil: So you're not flying blind.

Tony: That's right, yes.

Phil: Fantastic.

Tony: And you can follow along, um, for a while, too, before you, you know, dip your toe in the water.

Phil: Yeah. Run a dummy portfolio or just see. Yeah. See how it's going. Fantastic. Tony, thank you very much for sharing your wisdom again.

Tony: Great. Well, good. Good to come back on the show. Thanks, Phil.

00:38:41

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