bczad:

With regards to:

"However, Charlie Munger says that Buffett talks about this but has never seen him do it."

in that old post:

Mr. Buffett did present one worked valuation example in the 1991 annual report.

It looks like he's using the Gordon Stable Growth Discounted Dividend Equation.

[Excerpt from Chairman's Letter - 1991]

A few years ago the conventional wisdom held that a newspaper,

television or magazine property would forever increase its earnings

at 6% or so annually and would do so without the employment of

additional capital, for the reason that depreciation charges would

roughly match capital expenditures and working capital requirements

would be minor. Therefore, reported earnings (before amortization

of intangibles) were also freely-distributable earnings, which

meant that ownership of a media property could be construed as akin

to owning a perpetual annuity set to grow at 6% a year. Say, next,

that a discount rate of 10% was used to determine the present value

of that earnings stream. One could then calculate that it was

appropriate to pay a whopping $25 million for a property with

current after-tax earnings of $1 million. (This after-tax multiplier

of 25 translates to a multiplier on pre-tax earnings of about 16.)

Now change the assumption and posit that the $1 million

represents "normal earning power" and that earnings will bob around

this figure cyclically. A "bob-around" pattern is indeed the lot of

most businesses, whose income stream grows only if their owners are

willing to commit more capital (usually in the form of retained

earnings). Under our revised assumption, $1 million of earnings,

discounted by the same 10%, translates to a $10 million valuation.

Thus a seemingly modest shift in assumptions reduces the property's

valuation to 10 times after-tax earnings (or about 6 1/2 times

pre-tax earnings).

[End of excerpt - copyright: Warren E. Buffett, February 28, 1992]

Reference: {Remove the space}

http: //www.berkshirehathaway.com/letters/1991.html

The Gordon Stable Growth Discounted Dividend Equation:

Trailing dividend version:

V = D.o * ( 1 + g ) / ( r - g )

--- or ---

Forward dividend version:

V = D.1 / ( r - g )

Where:

V = Value of an infinite future dividend stream discounted back to the present.

D.o = trailing or previous year's actual annual dividend.

D.1 = forward or next year's estimated annual dividend.

Note that: D.1 = D.o * ( 1 + g ).

g = annual constant growth rate to infinity {expressed as a decimal, 6% = 0.0600}.

r = discount rate or desired return on investment {expressed as a decimal, 10% = 0.1000}.

In the excerpt, note how carefully Mr. Buffett defends his belief that the net earnings of this specific business are freely distributable, are not required for reinvestment (and necessary to sustain his assumed future growth rate) and therefore are an acceptable proxy for dividends.

Mr. Buffett�s first case {infinite 6% growth}:

V = D.1 / ( r - g ) = 1 MM$ / ( 0.1000 - 0.0600 ) = 25 MM$

Mr. Buffett�s second case {no growth}:

V = D.1 / ( r - g ) = 1 MM$ / ( 0.1000 - 0.0000 ) = 10 MM$

Note that if we had used the trailing dividend version then: D.o = D.1 / 1.06 = 0.943396 MM$

Just because Mr. Buffett doesn't do his math with pencil and paper does mean he isn't doing it. His mental math skills are phenomenal. Need proof? Reread page 113 of Hagstrom's book: "The Warren Buffett Portfolio".

Regards,

jad