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Phil Town's 10 Cap Stock Valuation Method - Value Stocks Like Warren Buffett - YouTube
Channel: Learn to Invest - Investors Grow
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hi i'm jimmy in this video we're going
to walk through
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a unique way to value stocks known as
the 10 cap method
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and towards the end of the video i'm
actually going to apply this method
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to all 30 stocks in the dow jones
industrial average
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to see if there are any stocks that look
like they could be worth a deeper dive
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or at least could be inter interesting
to perhaps they're undervalued the goal
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with this video
is to try to give us another valuation
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method in our toolbox
and hopefully use this information to
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get us closer to our goal of achieving
financial freedom
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okay so this valuation method is used by
a lot of very famous investors
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warren buffett is said to use versions
of it and i actually came across this
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stock valuation method
from one of our subscribers on this
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channel who asked if I could do a review
of Phil Town's valuation method Phil Town
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is an investor
and he's written a few books and he has
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a big youtube following at least bigger
than we have
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okay so let's jump right in and see how
it works and see if it's a good
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valuation method to use
now this method is very similar to the
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capitalization rate
that's used to value real estate or to
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use to analyze the
potential profit of a real estate
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investment
often we'll have capitalization rates
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shortened to the cap rate
and basically what this is for real
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estate
specifically for investment properties
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is we want to know
how much rents are we going to collect
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on an annual basis
then we subtract expenses expenses would
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be things like
taxes or insurance or repairs to
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maintain the property
this is called net operating income so
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we take that and we divide that
by the cost of the property the cost to
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purchase the property
so let's imagine that we're going to
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collect let's say fifteen thousand
dollars a year
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in rent also let's imagine that that
property has five thousand a year in
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expenses
to maintain the property taxes insurance
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things like that
this leaves us with ten thousand a year
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in profits
now for this example i'm ignoring some
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things like uh how we're financing the
property
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things like that i'm sure there's a few
things that are missing it's really the
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concept rafter
okay so now our question is what are we
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paying for the property
well if we pay a hundred thousand
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dollars for the property well our cap
rate is ten percent that's a ten
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thousand dollars in profit divided by a
hundred thousand dollars that we're
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paying
but what if we were to pay a hundred and
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twenty thousand well our cap rate falls
to eight point three percent
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and if we're able to get a good deal
maybe we only pay 80 000 well our cap
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rate
jumps to 12.5 so clearly the higher the
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better
for the cap rate and i'm sure we're all
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seeing how the price influences
our potential return on an overall basis
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now obviously there are a lot of
variables being left
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out of this this example things like uh
what happens if the value of the
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property goes up things like that we're
ignoring that
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it's just the concept of what are we
willing to pay for the property itself
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okay now let's switch back to stocks so
it's pretty much the same method so the
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first thing we do
and again this is according to filltown
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so we take
cash flow from operations and we
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subtract maintenance
capital expenditures now the theory here
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is that this is very close to what
warren buffett calls
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owner earnings warren buffett back in
his 1986 letter to shareholders
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well he came up with he put out a
formula for calculating owner earnings
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this is what his owner earnings formula
looks like so we take our net income
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we add back depreciation depletion and
amortization
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and then we offset any other non-cash
charges
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and then we subtract maintenance capital
expenditures
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this is the formula that buffett gave us
in that shareholder letter now this part
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of the formula is essentially
cash from operations and this is very
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simple for us to find
because companies are required to list
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cash from operations
on their cash flow statement and don't
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forget we want annual numbers here
so when we do it try to pull down the
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most recent annual report
or if we want you can add up the past
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four quarters whichever way you want to
do it now when we consider maintenance
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capex
well this number is a bit trickier for
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us to find because
most companies don't list maintenance
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capex
by itself they do list capital
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expenditures
but they list total capital expenditures
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they don't break it out
for how much is going towards growth and
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how much is going towards just
maintaining the business by the way you
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might also hear this called property
plant and equipment that's the same
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thing as capital expenditures
or you can shorten it to capex like i
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have been so let's imagine that a
company that is based in the united
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states
well they want to expand into europe
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well maybe they build a plant in europe
to kick off those expansion plans
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well though that plant the cost of that
plant will fall
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under capital expenditures but in theory
that plant is being built
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to fuel growth not to maintain the
current business
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and that's the key with what maintenance
capex
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is we're looking for what the company
needs to maintain
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the current business not necessarily to
grow the business
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sort of like maintenance on a house sure
we could put it on we could put an
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addition on the house
and perhaps charge more rent but that's
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not what we're considering with this
whole thing
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what we're considering is as different
parts of the house break and
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it needs to be maintained what does that
cost that's the cost
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we're looking for and the tough part is
that most companies don't list
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maintenance capex now Phil Town has come
out and said that he did some research
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and he says that most companies fall
somewhere between i believe it was 30
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and 80 percent of total capex
will be maintenance uh will be
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maintenance capac capex he suggests
using a 50 percent number to
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come up with what maintenance capex
could be now of course the more research
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we do the more thoroughly we know the
company the more accurate that number
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could get
which is a good thing but for now we'll
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just say we'll stick with 50
and then we take the result of this and
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we divide it by the total market cap of
the company
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and this will give us our cap rate for
whatever stock it is that we're
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analyzing
so how about we look at one quick
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example and then we'll go through the 30
dial companies so let's use coca-cola as
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our example
so in 2019 coke had cash from operations
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of about 10 and a half billion dollars
that's right from their cash flow
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statement now before we go any further
uh a good a fair warning for us to be
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aware of with this
is that we want to make sure that this
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10.5 billion dollar number is a
reasonable number
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so if we switch just for a moment to
coax historical cash from operations
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well we can see that their 2019 number
does in fact
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seem reasonable it seems to be about in
line
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with previous years but let's imagine
for a moment
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that this was a crazy high number for
some reason
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well we're going to want to find out
either why it's so high
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and if it's unreasonably high perhaps it
was
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some unusual situation that occurred
maybe it makes more sense to adjust this
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maybe
we use an average or something along
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those lines okay now switching back to
our 10 cap formula
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so we have a reasonable cash from
operations number now
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we want to get our total capex for 2019.
that number came in at about 2 billion
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dollars but don't forget that's the
entire number
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so sticking with phil towns 50
suggestion
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well we cut that number in half we end
up with a maintenance capex of about a
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billion dollars
now we can make the case that for coke
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coke is a very developed company
we think that more of their capex
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is tied to maintenance and less is tied
to growth if we wanted to we could up
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that 50
to a higher number the higher we
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increase that the more conservative our
valuation becomes but for now we'll just
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stick with the 50
because in this case it doesn't matter
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all that much we take this number we
divide it by the total market cap of the
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company
for coke that's a bit over 200 billion
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dollars
well when we do this quick math we end
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up with a cap rate for coca-cola
of about four and a half percent so is
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that good
well the reason they call this the
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10-cap method
is because we want the cap rate to be
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higher than 10 percent that's the reason
why i say it didn't matter all that much
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for coke
so in this case it would seem that coke
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is not
undervalued at this time so in theory if
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the stock price
falls well then our market cap would
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fall and our cap rate
would go up so if it fell far enough
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eventually
it's possible that coke's cap rate goes
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over 10 implying that
it could be a good buy okay now let's
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look at a quick calculation
for each of the stocks from the dow
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jones industrial average
now i used 2019 numbers for all of these
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companies to try to keep it even
and use 2019 capex and i just took 50
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of each of the companies even though if
i was applying a company by company if i
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was doing a more in-depth
dive i would probably adjust those
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numbers based on the research
but i think 50 is a very fair starting
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point
okay now with these companies one thing
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that i noticed
is that it doesn't seem to hold up too
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well for financial companies
and this is most likely because capital
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expenditures
is not really a true representation of
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the cost of maintaining business
in the case of many financial companies
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so for looking at financial companies
i'm more inclined
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to look at some other valuation methods
i marked each of those with asterisks
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there
but besides that companies like chevron
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dao
intel ibm verizon and walgreens could be
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worth a deeper dive
now i actually think it makes sense to
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pair the 10 cat method with
other valuation methods now if you're
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curious with
cures about different valuation methods
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that could work especially for financial
companies
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well i actually did a video just
recently where i walk through some of
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the more popular ways to value a stock
if you're curious perhaps that could be
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a good next video for you to watch
i'll get a link right here i've got a
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link in the description below and thank
you so much for sticking with me all the
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way to the end of the video
i really appreciate it thanks and i'll
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see in the next video
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