The Buy Scan | November 16, 2022

Published on 11/16/22 | Saurav Sen | 8,030 Words

The BuyGist:

  • We released a beta version of The Buycaster – our latest creation – to select subscribers last week. Previews below.
  • The Buycaster will be released to all subscribers by the end of November.
  • The Buycaster is the best (read as most actionable) valuation tool in the market. It zooms into the salient fundamental factors that actually drive stock prices over the long run.
  • It covers over 3,000 stocks traded in American exchanges. Data, analysis, and insights – actionable insights – are updated daily.
  • In this article we delineate the philosophical and tactical assumptions that run The Buycaster behind the scenes.
  • We end the article with examples – Apple, Meta, and TSMC – that highlight how The Buycaster works.

Buycasting Basics: Principles

If you find yourself in a time crunch or suddenly hear your brain begging for an Instagram dopamine hit, please take home this message if nothing else:

“Buy Low; Sell High” is not an actionable strategy. It assumes you know what “the right price” for a stock is. We (and some legends of investing) claim that it’s impossible to know “the right price”. Intrinsic Value is a mirage. So, don’t fret over it. Instead try this: “Buy Low Expectations; Sell High Expectations”. They Buycaster is built to help you do just that. Never overpay for a stock again.

Last week we released to the Beta Version of The Buycaster to select subscribers who’ve been with us for a while. They’re already playing around with it. By the end of November, the Buycaster – the best number-crunching tool for equity investors that we know of – will be our core service. And it will be available to anyone who’s concerned about their portfolio or their investing journey. This is the equity investing tool we needed but never had. So, we built it. Here’s a snapshot of the top half of the dashboard:

Here are some of the basic features:

  1. It covers over 3,000 stocks traded in US exchanges.
  2. The Buycaster’s main purpose is Analysis, not regurgitating facts.
  3. The Buycaster goes much deeper than rudimentary statistics or valuation ratios – into salient factors – fundamental factors – that actually drive stock prices in the real world.
  4. The Buycaster answers one question above all: “what do I need to believe about the future of the business to consider buying the stock today?”
  5. When combined with good, old-fashioned Qualitative Analysis, The Buycaster’s Quantitative Analysis turn into Actionable Insights.
  6. The Buycaster’s mission is: Never overpay for a stock again.

The Buycaster is built upon certain investing principles that we have learned both the easy way and the hard way. The easy way is when someone tells you how to do something…and it actually works in the real world! This could happen in school, through an interaction with someone, or by reading books written by legends. The hard way is when you stumble upon a piece of wisdom or nuance by doing something wrong and taking the punches. In investing, that could mean doing something “by the book” only to realize that it doesn’t work in the real world. In this business, nothing teaches us like watching our hard-earned savings burn in flames because we overpaid for a stock.

Over the last few years, both the easy way and the hard way have battled it out in our minds (and in our brokerage accounts). What’s shaken out of these daily battles is a set of unshakeable, timeless principles that we have seen work in the real world. Here are 10+1 (somewhat unconventional) philosophical principles of investing upon which we’ve built The Buycaster:

  1. “Invert, always invert.” – Charlie Munger
    • Munger encourages investors (and everyone else, really) to approach problems by inverting the question. Instead of asking “what happens if we assume…?”, try asking, “what needs to be assumed if we want XYZ to happen…?” Try back solving from the desired result. Go backwards and forwards and back again to solve a problem. Dance a little.
  2. Avoid forecasting or listening to “professional” forecasts. But by all means, Buycast.
    • Forecasting markets, stock prices, revenue or other cash flow numbers is futile. It’s good entertainment but doesn’t usually make money for anyone.
    • “Forecasting: the attempt to predict the unknowable by measuring the irrelevant; this task employs most people on Wall Street.”  – Jason Zweig in The Devil’s Financial Dictionary
    • “Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)” – Warren Buffett
    • “Market forecasters will fill your ear but will never fill your wallet.” – Warren Buffett
    • So, we decided to make Buycasting the core of our investing process. We back solve for “what needs to happen in the business to consider buying the stock?”
  3. All investment theses are wrong.
    • We need to have the humility to know (and remember) that our investment theses are almost always wrong…to some degree. The best we (or even legends like Buffett and Soros) can shoot for is to be kinda, sorta, approximately right.
    • “In my investing career I operated on the assumption that all investment theses are flawed…The fact that a thesis is flawed does not mean that we should not invest in it as long as other people believe in it and there is a large group of people left to be convinced. The point was made by John Maynard Keynes when he compared the stock market to a beauty contest where the winner is not the most beautiful contestant but the one whom the greatest number of people consider beautiful.” – George Soros
    • To Soros’s quote above, we’d like to add that it’s better to bet that the market can be fooled in the short term, but in the long term (we won’t be dead in 3-5 years, we hope) the market tends to award the beauty queen title to stocks of companies that demonstrate tremendous cash generating power. Over the long term, outer beauty and inner beauty tend to converge.
  4. Keep Calm and Minimize Speculation.
    • All investing involves some level of speculation. We should minimize the speculation component of our thesis as much as possible. That’s the best we can do. We cannot get rid of it.
    • It’s better to bet on rationality rather than irrationality in the markets when investing for the long-term. The emotional pendulum of the markets will swing from crazy pessimism to crazy optimism and back. But it must always pass through the zone of rationality.
    • “The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.” - WB
  5. Intrinsic Value is a mirage.
    • The “Intrinsic Value” of a business or stock is unknowable. So, we must work with ranges and probabilities, not with (the pretense of) certainties.
    • “I can proclaim what I call the "human uncertainty principle". That principle holds that people's understanding of the world in which they live cannot correspond to the facts and be complete and coherent at the same time. Insofar as people's thinking is confined to the facts, it is not sufficient to reach decisions; and insofar as it serves as the basis of decisions, it cannot be confined to the facts. The human uncertainty principle applies to both thinking and reality. It ensures that our understanding is often incoherent and always incomplete and introduces an element of genuine uncertainty - as distinct from randomness - into the course of events.” – George Soros
  6. Nobody knows anything in the short term, but equity markets are somewhat rational over the long-term.
    • In our experience, equity markets are reasonably efficient (rational) in the long run (3-5 years). They are often irrational and myopic in the short term. That presents buying and selling opportunities.
    • “Of course, the best part of [Benjamin Graham's approach] was his concept of "Mr. Market". Instead of thinking the market was efficient, Graham treated it as a manic-depressive who comes by every day. And some days "Mr. Market" says, "I'll sell you some of my interest for way less than you think is worth." And other days, he comes by and says "I'll buy your interest at a price that's way higher than what you think it's worth." And you get the option of deciding whether you want to buy more, sell part of what you already have, or do nothing at all. To Graham, it was a blessing to be in a business with a manic-depressive who gave you this series of options all the time. That was a very significant mental construct. And it's been very useful to Buffett, for instance, over his whole adult lifetime.” – Charlie Munger
  7. Changes in Expectations of growth (of lack thereof) drive stock prices. 
    • Over the long term, “the way things are” in the underlying business doesn’t drive stock prices. The difference between the way things are, and the EXPECTATIONS of the way things will be in the business drive stock prices. We need to have a grip on what expectations are priced into a stock. This is – strangely – still unconventional among professional money-managers. But it is the basis of The Buycaster.
    • “Perhaps the single greatest error in the investment business is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.” – Michael Mauboussin in More Than You Know
    • “Wall Street’s method of using accounting ratios to determine value may capture the here and now but does a woefully poor job of calculating sustainable long-term growth. Or, put differently, more often than not, sustainable long-term growth is mispriced by the market.” – Robert Hagstrom from The Warren Buffett Way
    • “...many investors will give heavy weight to the per-share earnings of the past five years in trying to decide whether a stock should be bought. To look at the per-share earnings by themselves and give the earnings of four or five years ago any significance is like trying to get useful work from an engine which is unconnected to any device to which that engine's power is supposed to be applied. Just knowing, by itself, that four or five years ago a company's per-share earnings were either four times or a quarter of this year's earnings has almost no significance in indicating whether a particular stock should be bought or sold.” – Phil Fisher in Common Stocks & Uncommon Profits
  8. Focus on the soft stuff – the qualitative aspects of the business…the story.
    • It’s better to spend most of the time ruminating on the business – its competitive advantage, management strategy, market size etc. – as opposed to using fancy (often nonsensical) statistical techniques on stock price charts. Don’t worry too much about the numbers. The Buycaster’s got your back when it comes to number crunching.
    • If the choice is between a questionable business at a comfortable price or a comfortable business at a questionable price, we much prefer the latter.” - WB
    • Be a business analyst, not a market, macroeconomic, or security analyst.” – Charlie Munger
    • Use The Buycaster as a supplementary tool. But we’d wager it is the most powerful supplementary tool out there.
  9. When parsing through numbers , always work with CASH numbers. We do.
    • Accounting numbers reported by companies are often not useful in gauging the future profitability of a company. Focus on cash numbers.
    • “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows.” – Jeff Bezos
  10. Don’t depend on valuation metrics to find “cheap” stocks.
    • First of all, always look to invest in a growing company. Avoid companies with stagnating or declining revenues – even if they appear “cheap” on certain popular valuation metrics. They’re usually “falling knives” – they’re cheap for a good reason.
    • Most investors misunderstand the term “Value Investing” – it doesn’t mean buying bad stories at fire-sale prices. It means buying good stories at relatively cheap prices. First, the story needs to be good. Value and Growth Investing are two sides of the same coin.
    • “Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business. Indeed, growth can destroy value if it requires cash inputs in the early years of a project or enterprise that exceed the discounted value of the cash that those assets will generate in later years. Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component usually a plus, sometimes a minus in the value equation. Alas, though Aesop’s proposition and the third variable that is, interest rates are simple, plugging in numbers for the other two variables is a difficult task. Using precise numbers is, in fact, foolish; working with a range of possibilities is the better approach.” – Warren Buffett in the Berkshire Hathaway Shareholder Letters.
  11. Risk = Permanent Loss of Capital. Every other definition is theoretical and/or useless.
    • The only definition of Risk that matters is “permanent loss of capital” – it’s probability and its magnitude. And permanent loss happens when we grossly overpay for something. Never overpay for a stock.
    • “The greatest risk doesn’t come from low quality or high volatility. It comes from paying prices that are too high. This isn’t a theoretical risk; it’s very real.” – Howard Marks
    • “The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.” – WB

The Buycaster doesn’t forecast. It buycasts. It back solves into what one needs to believe about the underlying business to justify buying the stock at its current price. This method – pioneered by Michael Mauboussin as Expectations Investing – is totally congruent with the 10+1 principles listed above. We’ve taken his work and combined it with our experience to build The Buycaster.

In the following sections, we’ll dig into some of the technical assumptions we’ve made behind The Buycaster. This might be a boring set of sections for you, so feel free to skip to the sections where we walk through the Buycasts for:

  1. Apple
  2. Meta
  3. TSMC

These examples will give you a good sense of how to use The Buycaster to your advantage.

Buycasting Technicalities

We’ll keep this section as short as possible because it will be an on-going discussion over the next few months. There are 3 types of variables that we need to talk about:

  1. Assumed
  2. Implied
  3. Output

In the interest of time (and attention span), in this article we’ll mostly discus the Assumed Variables. In the subsequent sections, we’ll tackle each of our main assumptions one by one, as briefly as possible. Feel free to skip the following sections to go straight to our discussions on Apple, Meta, and TSMC.

Remember that the whole point of The Buycaster is to quantify “what we need to believe about the business to consider buying the stock”. That’s the OUTPUT. To get to that, we need to put down some markers (reasonable assumptions). These assumptions initiate the back-solving process from our DESIRED RETURN to THE BUYCAST.

Starting Point: Desired Return

Ending Point: The Buycast: What do we need to believe about the business to – reasonably – expect our desired return?

Needless to say, that the GIVEN variable in this process is the current stock price. No disputes there. Given that, we make 4 key assumptions to start our estimations:

  1. Desired Return
  2. Time period
  3. Exit Multiple
  4. Cost Structure

With each of these inputs, we arrive at our desired output: Revenue Growth that needs to happen to justify buying the stock at its current price. This is what we call THE BUYCAST.

We’d buy the stock at current price IF the Buycast is reasonably low. That would mean that we don’t need to believe in ludicrous growth numbers to get to our desired return. The Buycaster does not tell you whether the Buycast is indeed low. That’s a subjective call based on your qualitative opinion of the business – things like competitive advantage, moat, growth strategy etc. But The Buycaster does give you historical context – it provides actual historical annualized revenue growth numbers of the company.

The Buycaster also gives you another type of context: The Downcast. This is us painting a scenario where the company’s revenue growth falls short of The Buycast. The Downcast is pulled further down by the historical context – actual revenue growth numbers over the last 5 years. We’ll dig into the Downcast later. But first, let’s discuss the assumption we need to get to the Buycast.

Feel free to skip to the sections on Apple (iCasting), Meta (Metacasting) or TSMC (ChipCasting).

Buycaster Assumption 1: Desired Return

If you’re doing any sort of “active investing” – putting in the work to select individual companies/stocks rather than just indexing – you’ll probably want at least 10% in annualized returns. The S&P 500 Index has traditionally generated about 8% in annualized returns (about 11% if you assume all dividends were judiciously reinvested).

So, in The Buycaster, we’ve provided 3 return scenarios:

  1. 60% cumulative return in <5 years – this works out to roughly 10% annualized.
  2. 80% cumulative return in <5 years – this works out to roughly 12.5% annualized.
  3. 100% cumulative return in <5 years – this works out to roughly 15% annualized.

This list of return choices is bound to expand in future iterations of The Buycaster. Theoretically, desired returns can be infinite, but we’ll always keep things reasonable and attainable. Now, you may be wondering why we chose 5 years.

Buycaster Assumption 2: Time Period

This is a more touchy-feely section than you probably imagine.

We’re long-term investors, and The Buycaster reflects that. There is no standard measure of “long term”, but experience has taught us that in the stock market 3-5 years is just about enough time for a “long term” investment thesis to play out. Yes, we realize that there’s a big difference between 3 and 5 years. But in the stock market, it’s impossible to discover a “law of nature” that’s true no matter what. Some theses take about 3 years to play out; others will take 5 years or more.

A long-term investment thesis means painting a picture of management strategy (based on what they say) that aims to change or improve a business. Such investments normally take at least 3 years to bear fruit. One could argue that it takes less time nowadays than it did, say, 20 years ago. Fair enough. But…

It’s also hard to model when Mr. Market will reward (or penalize) a company’s stock for said strategy. In our experience, the stock market’s “futurescope” goes as far as about 2 years. Again, there is no way to model this. For some stocks, Mr. Market could value a company and its stock based on an outlook just 1 year out. In fact, the most commonly used “forward” valuation ratios, like P/E Forward 1 Year, are…well…1 year out. But the market is notoriously short term oriented anyway.

Our desired return of 60% or 80% could materialize in 3 years! That could happen if the capital investments made today (e.g., in a new AI chip) bear better-than-expected fruits in just 3 years. In that case, the stock could shoot up 50% in a year! There is just no way to model this. Well, maybe, there is a way to model this for individual companies/stocks, but we highly doubt the model will have much predictive value. So, we’d wager it’s a futile exercise albeit with good entertainment value.

We’ve kept the cap at 5 years. We give any company 5 years to manifest its growth strategy. In our experience, this is a reasonable assumption. The stock, however, could get rewarded by Mr. Market much sooner than 5 years. We expect that to happen. But we don’t preoccupy ourselves by trying to estimate the number of months that Mr. Market will foresee the “inevitable” change in a company’s business prospects.

Honestly, if most of our investments generate 60% returns in, say, 4 years, we’ll be very happy. 60% in a full 5 years? We’ll take it, but that’s our minimum threshold.

Buycaster Implied Variable 1: Desired Market Value

This is an easy one. Desired Market Value is basically current Market Value plus the Desired Market Return. So, a $100 billion current market cap with a 60% desired return will result in a $160 billion Desired Market Value.

Implicit in this, well, implied variable is the assumption that the company will not dilute existing shareholders over the next few years. We don’t assume any share buybacks either. However, we are planning on adding a Dilution Risk Scenario in the next few weeks.

Buycaster Assumption 3: Exit Multiple

Oh Boy!

This is often a controversial topic. We’ve discussed this topic before, and that certainly needs an update. But in this article, we won’t dive deep into philosophical arguments – that needs a separate discussion. We’ll stick to mechanics here, as much as possible.

Our assumed “Exit Multiple” is 15X Free Cash Flow. We define Exit Multiple as what the market is likely to pay IF the company’s revenue grows at the rate of The Buycast. 15X is our baseline assumption. However, this number is tempered by low current Price to Free Cash Flow or Price to Earnings multiples for some stocks. 3M – the giant Industrial company – is a good example. 3M’s assumed Exit Multiple in The Buycaster is 12.1X. Aluminum giant Alcoa is another example – its assumed Exit Multiple is 7X, tempered by its industry’s current Price to Free Cash Flow Ratio of 5.7X.

There’s now shortage of philosophical arguments about slapping on Multiples to arrive at an “intrinsic value” of a company. On many occasions, multiples are used for valuation just out of pure laziness. We’ve been guilty of this too during our analyst days. But if we give these tired analysts the benefit of the doubt, we’d say that they have thought deeply about the Cost of Capital of the company. That informs the Multiple. This is the point where Finance professors start rolling up their sleeves. Sorry Sirs and Madams, but we won’t be calculating cost of capital here. We’ve done enough of that in school, thank you very much.

Cost of Capital is the denominator that would be used to discount a series of future free cash flows back to the present – to estimate the value of a company. It usually has 2 components: Cost of Debt and Cost of Equity. This is basic Finance 101. But in practice, Cost of Capital is a contentious topic because there is no right answer, and there is no perfect way to calculate it. If there is no right answer to Cost of Capital, there is no right Multiple. The culprit is Cost of Equity and the questionable formulas used to calculate it. Cost of Debt, in contrast, is an easy calculation – it’s simply the Cash Interest paid by the company. That’s a fact stated in (most) cash flow statements. Cost of Equity is a philosophical concept representing the notion that equities should be riskier than debt. Fair enough. But the formulas to estimate Cost of Equity are, well, GIGO: Garbage in, garbage out. They’re based on theories (like the Modern Portfolio Theory) that don’t necessarily hold water in the real world.

“Beta and Modern Portfolio Theory and the like – none of it makes any sense to me…how can professors spread this? I’ve been waiting for this craziness to end for decades. It’s been dented and it’s still out there.” Charlie Munger in Poor Charlie’s Almanack

Michael Mauboussin – the person whose ideas form the bedrock of The Buycaster – has said many times that “you have to earn the use of multiples”. We’d like to think that we have – this discussion delineates why we’ve historically used a 20X multiple. In our Buycaster tool, we use a maximum of 15X. Why the change? Because we realized that the goal of The Buycaster is not to accurately value a company (that’s an impossible and futile task). The Buycaster is here to depict a picture of what we need to believe about the future of the business to consider buying the stock today. So, will 15X be the right multiple for most companies? Yes, if the Buycast comes to pass! But if we think – based on our subjective view of the business – that the Buycast will NOT come to pass, then we don’t care about the Exit Multiple (and consequently we don’t care about dubious cost of equity formulas)! Because we won’t invest in such a company anyway!

We’ve also triangulated on 15X by applying concepts from the somewhat debunked Modern Portfolio Theory about expected Risk Free Rates, Beta, and Equity Risk Premia. But that requires a separate discussion. In short, we’ve earned our 15X – for now you’ll have to take our word for it. At least we temper it with what Mr. Market currently ascribes to each company and its industry, which lowers exit multiples for many stocks. That’s good enough for us.

We will have more to say on this topic. If you’re interested, we have one question: WHY? Just kidding. Sort of.

Buycaster Implied Variable 2: Desired Free Cash Flow

This is easy…

Desired Free Cash Flow = Desired Market value divided by Assumed Exit Multiple (usually 15X)

OK. Now the hard work begins…

Buycaster Assumption 4: Cost Structure

Now we get into the meat of the discussion. This section can get a bit financy as well, so feel free to skip it and go right to “iCasting” where we talk about Apple.

We need to make some assumptions about the cost structure of the company to back solve from Free Cash Flow to Revenue Growth. Let’s back up here for a minute. So far, here’s our train of thought (and calculations).

  1. Desired Return gives us…
  2. …Desired Stock Price, which gives us…
  3. …Desired Market Value, which gives us…
  4. …Desired Free Cash Flow, based on…
  5. …Our Assumed Exit Multiple…

In our very first Economics classes we were taught that there are 2 kinds of costs:

  1. Fixed Costs
  2. Variable Costs

We need to make assumptions about these costs so that we can move UP the cash flow waterfall from Desired Free Cash Flow to Desired Revenue. To do this, we need to adjust our classification of costs:

  1. Operating Costs
    1. Variable: Cost of Goods Sold
    2. Fixed: Usually R&D Expense and Selling, General & Admin. Costs
  2. Capital Costs – Working Capital and Capital Expenditures
  3. Taxes – We assume a cash tax rate of 20% regardless of whether the company currently pays taxes or not.

The main assumptions in Operating Costs are:

  1. We assume that Gross Margin does not change – from the margin over the last 12 months to the one 5 years from now.
  2. We assume that Fixed Operating Costs (R&G and SG&A) grow at an annualized rate of 5% per year. We assume they grow at 10% per year for companies that still have negative EBITDA (they probably need more R&D and more staff to scale up).

The rationale behind these Operating Cost assumptions is: Operating Leverage. This is a financy way of saying that fixed costs, while not exactly “fixed”, will likely grow at a slow pace. Variable costs such as Cost of Goods Sold will continue to keep pace with Revenue. But costs like R&D could remain relatively stable.

A company with higher proportion of Fixed Costs is said to have higher Operating Leverage. If revenue grows fast enough, profit will grow even faster. That’s the “leverage”. Software businesses like Microsoft or Salesforce tend to have high operating leverage. Companies with a high proportion of variable costs have lower Operating Leverage. It takes a lot of revenue growth to see that growth trickle down to profit growth. Supermarkets like Walmart have low operating leverage because it takes a lot of cash on a recurring basis to generate revenue – maybe 90 to 95 cents for each dollar or revenue. Gross Margins are razor thin. Another way to call Operating Leverage is Scalability. Microsoft’s business model is inherently more scalable than Walmart’s.

For Capital Costs, here are the assumptions:

  1. Growth Capital Expenditures grow at a rate of 5% per year for 5 years.
  2. Increase in working Capital is generally mirror that of the last 12 months.
  3. Cash Interest charges increase by 5% per year for the next 5 years.

These (reasonably conservative) cost structure assumptions are essential to our Buycast estimates. So far, we know…

  1. Our Desired Return
  2. Our Desired Stock Price
  3. Our Desired Market Value
  4. Our Desired Free Cash Flow
  5. Our Future – Assumed – Cost Structure

We’re getting closer. The next stop is Desired Revenue.

Go up the waterfall!

To get to Desired Revenue, we need to back solve from Desired Free Cash Flow via our Costs Structure Assumptions. The math is simple, so we won’t draw it out. But here’s the reverse cash flow waterfall:

  1. Desired Free Cash Flow
  2. Assumed Tax Rate
  3. Desired Pre-Tax Free Cash Flow
  4. Add back Assumed Capital Costs
  5. Now we have our Desired EBIT (Earnings before Interest & Taxes)
  6. Now add back Assumed Fixed Operating Costs
  7. We get to our Desired Gross Profit
  8. Apply Assumed Gross Margin
  9. We get to our Desired Revenue

Voila! Basic primary school math. It’s the assumptions along the way that matter. We believe they are reasonable. However, we must always be mindful that there is no such thing as “one size fits all” in investing. So, we need to keep our assumptions on the conservative side so that “one size fits most”. This is a good first cut. When we do a deep dive on a company, our cost assumptions may change. They usually do. But as a way to parse through the fundamentals of the business and have a well-informed, actionable insight on whether to consider buying a stock or not, The Buycast is a very good first cut.

Output: The Buycast

Once we have the “Revenue we need to believe”, getting “revenue growth we need to believe” is simple math. There are just 2 steps:

  1. Get Cumulative Revenue Growth. This is easy – just the percent difference between Desired Revenue and the current revenue number for the 12-month period as of the last reported quarter.
  2. Annualize (Geometric Mean if you remember your Stats 101) Cumulative Revenue Growth we need to believe.

The reason we annualize it is because it’s an easier number to digest AND because our brains are wired to read annual figures when it comes to cash flows.

Congratulations! You now know how we estimate a Buycast! Great! But what if it doesn’t come to pass? What’s the damage then? Will there be a permanent loss of capital? Good questions.

Risk: The Downcast

We’ve never been satisfied with the way the investment world normally (pun intended…for those who recognize it) measures Risk, let alone manage it. To us, Risk measurements should be tangible, practical, and actionable. The Investment Management business, egged on by academia, touts esoteric measures of Risk that aren’t practical in the real world. The basic problem with conventional measure of Investment Risk is twofold:

  1. Academic Finance has imported methods used by the natural sciences to come up with mathematically sound formulas for Risk.
  2. So, it treats historical returns of a stock as naturally occurring phenomena that can be modelled into a repeatable theory or law.

“Whereas the theorist thinks return and risk are two separate things, albeit correlated, the value investor thinks of high risk and low prospective return as nothing but two sides of the same coin, both stemming primarily from high prices.” – Howard Marks

We like a measure that’s deeply rooted in the fundamentals of the business – selling products and generating profits or losses. The primary measure of stock risk should be directly connected to business risk – both Operating and Financial. And then we need to transform that cash flow risk to stock price risk. We think this is much more logical than applying, say, dubious variance-covariance matrices on data sets of historical stock returns. Volatility is not Risk for a long-term investor; it’s often an opportunity to buy low.

So, here’s what we do:

  1. We compare the Buycast with the company’s historical revenue growth numbers.
  2. We take the minimum of those numbers (The Buycast, 5-year Annualized, 3-year Annualized, Latest Fiscal Year), and then apply a 20% discount to it. For example, if the minimum annualized growth number is 10%, then the Downcast – our realistic “risk scenario” – will be 8%.
  3. We take that 8% revenue growth number (or whatever the Downcast is) and apply it over 5 years to get to our “Downcast Revenue” number.
  4. We then go down the cash flow waterfall all the way down to the “Downcast Free Cash Flow”. In essence, we’re now reversing the back-solving. This is a dance.
  5. Then we apply the appropriate multiple (see Exit Multiple section) and get our “Downcast Scenario Price”. The difference between that and the current price is our most practical measure of Ex Ante Risk.

We have a few more ideas for measuring Risk with more sensitivity analysis. In time, we’ll add them to The Buycaster. Some of the ideas are:

  1. Add a more draconian Downcast.
  2. Add a Financial Risk filter – e.g. “can the company comfortably cover its cash obligations like interest payments?”

For now, enough of theory and philosophy. At this point, it makes sense to see The Buycaster in action with real world examples.


Apple is in almost everyone’s portfolio – if not because of pure fundamental analysis but just by virtue of being the largest holding in the S&P 500 index. We get questions about Apple all the time. That’s not surprising. Generally, their products are well-known and loved, so most of us feel like we have some “domain expertise” as consumers of their products. We can touch and feel what they do. It’s tougher to visualize what, say, Oracle or Snowflake or Palantir does.

We’ve held Apple for about 4 year. But The Buycaster now tells us that the stock may be too richly priced to keep holding. Right off the bat, the Apple Buycast seems too high.

The way to read this chart is: We need to believe that Apple’s revenue will grow at an average pace of 17.8% annually. Compared to historical numbers, this is clearly too high. So, to buy (or hold) AAPL today, one would need to believe in significant revenue growth acceleration. What’s the fundamental basis for it? Are the new iPhones going to grab market share from Android phones? Are the new Macs with their new in-house, awesome M1/M2 CPUs going to grab market share from PCs? Is their advertising business going to grow by 20-30% per year? The point is that we should always us the Buycast in tandem with good old fundamental analysis (aka common sense). Focus on the story. Leave the numbers to us.

Now let’s turn to Risk. What if Apple doesn’t clock in 17.8% revenue growth? Our Downcast scenario is a 6.2% growth rate, which is quite a far cry from the Buycast. But this number has been tempered down because of a comparatively tame “latest fiscal year” growth number of 7.8%.

How do we use this Downcast? Let’s convert all this to stock returns and risk. In the next chart, you can see that, according to The Buycaster, the Downcast scenario (of 6.2% annualized revenue growth) results in a negative return of about -19%. So, we run the risk of losing about 19% of our investment in AAPL if Apple grows much slower than it has in the recent past. Use this number with a grain of salt. The Buycaster is in the game of being approximately right, not precisely wrong. So, it’s probably better to read the -19% numbers as such: “There’s a high chance I won’t make any money by buying AAPL if the revenue growth slows down like it did last year….”

The charts below the Risk/Return chart in The Buycaster contain useful data as well. For example, the Valuation Ratios chart gives you a clear comparative picture of the multiples in all scenarios: Buycast, Downcast, and Current. So, you know that the Buycast or Downcast scenarios incorporate lower exit multiples. We’ll discuss these charts in the coming weeks. For now, let’s focus on the first 3 charts of The Buycaster.

Now on to the second-most requested stock…


Meta is a favorite nowadays with the stock price having fallen precipitously this year. The market, in general, is worried about a slowdown in advertising revenue, and a possible misfire when it comes to Mark Zuckerberg’s metaverse investments. What ROI does one ascribe to Zuck’s meta-investments?

The Buycaster tells us that we need to believe only an average of 8.5% annual revenue growth over the next 5 years for a sizeable (60%) return. Compared to historical numbers, that seems utterly believable. But believability lies in the eye of the beholder – it depends on one’s subjective take on Zuckerberg’s meta-strategy amidst a possible recession-induced slowdown in advertising.

We haven’t done a deep dive on Meta, so we don’t know whether this Buycast is a slam dunk. But the Downcast (6.8%) suggests that there is a low probability of losing money over the long-term with this bet. The Downcast Scenario Expected Return is about +18%. We don’t care so much about the precise number as much as the direction. A positive Downcast Scenario Expected Return suggests that it’s a low-risk bet. It certainly makes us want to dig deep into Meta’s strategy.


You can trust Warren Buffett to zag while others zig. When the rest of the market is generally afraid of semiconductor stocks because of China’s potential invasion of Taiwan, Uncle Warren bets on the one company that’s in the eye of the storm: TSMC (Taiwan Semiconductor Manufacturing Company). We’ve held this stock for more than 4 years. Check out our latest take on semiconductor stocks.

TSMC’s Buycast (16.5% annualized revenue growth) seems inconclusive. Compared to historical revenue growth numbers, it’s sort of in the middle of the pack. So, we’d need to believe that TSMC’s revenue would continue to grow at a similar pace over the next 5 years. Barring the big dragon in the room (what happens if China invades?), this looks like a reasonable bet. We can say that with confidence because we have done deep dives on TSMC – it’s competitive advantage, economic moat, growth strategy – a few times.

TSMC’s Downcast scenario (11.3% annualized revenue growth) seems to reaffirm Buffett’s bet. The Downcast Scenario Expected Return is quite benign, at about +8%. We don’t care much for the precise number as much as the sign in front of it. A positive Downcast Scenario Expected Return suggests a low-risk bet – that if TSMC grows at a slower pace than it has, the chances of our capital being permanently impaired are low.

Coming up…

We’re already working on several enhancements to The Buycaster, which is still in Beta mode. Here are some of them:

  1. Introduce a Stock Screener module that’s based on our Buycasting approach.
  2. Introduce a Comparative Tool that allows you to compare 2 or more stocks on the same page.
  3. Introduce more Risk Scenarios in the dashboard – such as Shareholder Dilution.
  4. More examples of how we use The Buycaster.

We’re striving to make The Buycaster the most useful, actionable, and intuitive valuation tool in the market. This is a long-term effort.

Never overpay for a stock again.

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