## Value = present value of cash flows, not

I am tired of people citing Coke's P/E ratio as proof that Coke is "overvalued." The only way to determine a company's true value is to compute the present value of its future cash flows. Using Coke's 1997 numbers, Coke's intrinsic value is as follows:

Cash flow = net income + noncash charges (depreciation and amortization) - capital expenditures (purchases of property, plant, and equipment).

So Coke's 1997 cash flow = $4,129 mil. + $626 mil. - $1,093 mil. = $3,662 mil. Being very conservative, assume Coke can grow this figure 5% a year forever. (The average since 1990 has been around 19%, so 5% is safe.)

Then, to compute the intrinsic value, use the 30-year bond rate as the discount rate in the formula for a growing perpetuity. As Buffet does, add a correction factor to the 30-year bond rate if it is cyclically, as it now is. I'll add 1% as a correction factor. Today's closing bond yield was 5.843%, so I'll use 6.843% as the discount rate.

Growing perpetuity formula: Present value of growing perpetuity = Cash flow / (discount rate - cash flow's growth rate)

= $3,662 mil. / (0.06843 - 0.05) = $190.7292 bil.

NOTE: $190.7292 bil. is the intrinsic value of Coke for 1996, not 1997, since the growing perpetuity formula calculates the intrinsic value for the year PRIOR TO the beginning of the cash flows. To find the 1997 intrinsic value figure, just use the future value formula with a discount rate of 5% to move the value ahead one year in time:

Value in 1997 = Value in 1996 * (1.05) = $190.7292 bil. * 1.05 = $200.2656 billion. This was the intrinsic value of Coke at

the end of 1997. At that time, Coke had 2,470.718 bil. shares outstanding. So the Intrinsic (or true) price per share of Coke at

that time was $200.2656 bil. / 2,470.718 bil. shares = $81.05564. On Dec. 31, 1997, Coke's closing price was $66.6875. So Coke

was selling at a 17.7% margin of safety or discount to the intrinsic value: ($81.005564 - $66.6875) / $81.005564 = 17.7%.

But actually the margin of safety is actually greater, since we used a conservative 5% as the cash flows' growth rate. In actuality, Coke's cash flow growth rate has averaged 19% since 1990. So $81 is on the low side of Coke's possible RANGE of intrinsic values.