Was reading an old article / interview where investment manager Murray Stahl briefly described a relative valuation (screening) method and I was confused about certain things.
How generally do you approach valuation?
MS: We estimate what we think earnings can be four to five years out, apply what we consider to be a reasonable multiple on those earnings, and then discount the result back to today using a 20% annual rate. If that’s less than the current price, implying a discount rate in excess of 20%, that’s something we’ll look at closely.
So I would think that looks something like...
Say EBIT in year 0 is e0 We project straightline annual growth of rate: p So: e5 = e0 x (1 + p)^5 Say we pick some reasonable EV/EBIT multiple by whatever means to be: m So we have EV @ year 5 being projected to be: e5 x m (say E5) Then by how I interpret the interview, we do: E5 / (1 + 0.2)^5 and we JUST want to see if LESS than the current price (or in this case EV)
I'm am confused about the logic of the last sentences. Is what I showed what they mean by "discounting back"? After you discount the price back to the present, why would you want to see it less than the current price (wouldn't that mean it's overvalued presently)? How does doing this "imply a discount rate of 20%"? Anything else I appear to be confused about here?