A Primer On Valuation (Part 2 of 2)

In Investment Theory on October 26, 2009 at 7:35 pm


Books a Million (Nasdaq: BAMM)

Books a Million is a small chain of retail bookstores located in the South Eastern United States. The company operates 200 superstores and 20 traditional stores. BAMM was founded in 1917 and is based in Birmingham, Alabama.

Step 1

In order to determine free cash flow I start with cash flow from operations (from the cash flow statement) and deduct capital expenditures. The average FCF for the 2004-2008 period is $21.2m. I like to use an average from a few years and then adjust it to get a starting figure. My starting figure going forward is $22.8m for 2008.

Step 2

Let’s make some assumptions and then apply our formula.

I will assume a growth rate of only 2%. This is because although the past growth rate is higher, the book industry is very competitive and faces stiff alternatives from and other sources. I will also assume a required rate of return on 15%. Some analysts spend a great deal of time fussing about trying to determine the right rate of return. I believe 15% is more than adequate to compensate the common shareholder.

So let’s apply our growing perpetuity formula:

22.8 (1.02)
(.15 – .02)        = $178.9m

Shares outstanding = 16,302

Per share = 171m / 16,305 = $10.97

Step 3

We have determined that the shares are worth around $10.97

So how much does BAMM sell for?

BAMM stock chart

As we can see the price has fluctuated widely over the years. Many companies have much more unpredictable economic characteristics and would be much harder to value than BAMM. Yet even this simple bookstore chain’s shares have resulted in very low and very high valuations for the business. The shares have fallen as low as $1.38 and risen as high as $29.50.

I picked up my shares on October 17 2008 at for $3 and they rose dramatically in August of this year to north of $13. The large increase was due in part of the release of the latest Harry Potter book which is a boon to booksellers. But more significantly the rise was due to increased confidence in the economy and the perceived prospects for this and other businesses. At the end of July I happily unloaded my shares for $11.56

Some related links

Discounted cash flow valuation from Investopedia

1992 Chairman’s letter

Discounted cash flow analysis


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: