Stock-valuation

I looked at Mr. Malloy's reply to my review and it is worth the potential reader's while to look carefully at the logical inference he notes in his reply regarding his valuation method because he underscores the heart of the matter. Concerning his reliance on book value and average price/book ratios to arrive at a valuation, he says:

1)While book value may be faulty because of problems with goodwill and other distorting factors....
2)This is no matter because the average price/book ratio assigned to the stock will adjust for that faultiness.

The problem is that sometimes it takes a long while for the market to come to its senses about an issue --Cisco, one of the darlings Malloy uses to illustrate his method, is a poignant example. If one had used Malloy's method in 1998 (the year this book was published), the average price/book "adjustment" for Cisco's surreal book value accumulation would be much less severe than the averaging "adjustment" given when the market came to its senses about Cisco's misleading accounting practices in 2001. Malloy's argument that the market automatically cancels out erroneous book value growth is simply misleading on the basis of experience.

Concerning his comment about Monte Carlo simulation, one can pick up any textbook on the process and compare it to what Malloy offers in his book/spreadsheet --and decide for oneself whether what he's doing is Monte Carlo or not (get his book from the library before purchasing it). There is a large body of literature on this topic, and some of it addresses the technical problems that arise from using tools such as Excel, which is not really even capable of generating truly random numbers, to perform Monte Carlo simulations.

The heart of the valuation technique employed by the author of this book is an enterprise's accumulation of book value. Unfortunately, the reader is offered nothing to decipher genuine and bogus accumulations of book value. Indeed, one of the book's primary examples is Cisco Systems, perhaps one of the last decade's most notorious examples of meaningless, or at any rate misleading, book value accumulation. Given the failure to discuss this point, this is a difficult book to endorse for use by the audience the author appears to target.

There are some other troublesome details about the book, and although the author claims to be accessible by email, he failed to answer any of my questions about the Monte Carlo approach he advocates. The Monte Carlo simulation scheme he suggests, which is included on a separate spreadsheet, is less than half-baked to say the least. True Monte Carlo simulation requires hundreds, and preferably thousands, of sampling iterations. The technique Malloy uses here does enough less that the reader is served an injustice by being taught that what he or she doing is "Monte Carlo simulation".

Summing up, the tools offered to novice stock investors in this book are interesting and really are useful with practice and understanding. The trouble is the reader really is not offered sufficient background or training to have a sound grasp on what any stock is "really worth" despite the book's claim, any more than someone reading a manual on surgical knots is ready to really assess a surgical case.

Stephen Schneider objects to my reliance on book value in his review of 'What Are Stocks Really Worth?'. Mr. Schneider misses the point. I use book value only as an index of the firm's size. Book value does not have to be accurate to be useful as an index. It only has to be calculated in a consistent way from one year to the next.

For example, a stock's price is book value per share multiplied by the price/book ratio. Suppose a firm overstates book value by 50 percent. That does not make the stock's price increase 50 percent. Instead, overstating book value causes a compensating error in the price/book ratio because the two factors multiplied together must equal the actual stock price.

In the same way, dividends are book value per share multiplied by the return on equity and then by the dividend payout fraction. Overstating book value 50 percent does not cause a 50 percent increase in dividends. There must be compensating errors in the return and in the payout fraction, because all three factors multiplied together must equal actual dividends.

Mr. Schneider also claims that the 'true Monte Carlo simulation requires hundreds, and preferably thousands, of sampling iterations.' Given the rough estimates of possible forecasting errors in valuing stocks, 'hundreds, and preferably thousands' of iterations is gross overkill. The average from as few as ten iterations gives investors a much more reliable value for a stock than a single estimate.

A good introduction to shareholder value -- despite its age. If Marakon Associates ever decides to update and revise the edition, I have a few suggestions: (1) add more graphical representations of the concepts, including strategic models; (2) add more case studies to the appropriate sections, and (3) provide a clearer description of the shareholder value calculations (particularly the cost of capital). If these critisisms don't deter you, you'll find "The Value Imperative" to be a helpful guide. As an independent consultant specializing in shareholder value, I would also recommend Young and O'Byrne's "EVA and Value-Based Management" as well as Marin and Petty's "Value Based Management."

Good ideas for day-to-day management to manage value as well as big ideas for strategy. There were interesting section on how budgeting strangles strategic planning and what to do with about it. I think this is a great book for executives managing large companies in mature industries. It shows how to focus on value creation at every level of the organization. It gave advice on how to take action and achieve results.

I consider this book the bible of all books on value creation and how to achieve it. It is eminently practical and should be on every financial practitioner's bookshelf. I also recommend reading it annually. It is a wonderful compliment to the other value-based managment books in the market which tend to go long on theory. They're also excellent; but this combines value-based managment and strategy superbly.

The main point of this book is a relatively simple model for the spot price of power based on stochastic supply and demand. The rationale for the model is presented along with description of an estimation procedure. Due to the lack of data the model is not fully estimated, which makes the whole exercise rather academic. that's the valuable 20 pages. the rest, imho, is filler