Saturday, May 25, 2013

What? Are we already in a late stage bull market?


You would think that we’re just about to enter the good economic times and then there are people talking about the upcoming crash. I have barely recovered and finally start to enjoy some gains and people start calling me a ‘pig about to get slaughtered’. What is going on?

Well it is true that the Dow and S&P500 are approaching all-time highs. But this is not so for Europe, Japan (which is finally coming out of an underperforming stock market), nor for resource heavy Canada and Australia. But yes the U.S. has experienced some pretty good appreciation.   In August 2011, this blog did a quick analysis of bull and bear markets going back to 1932. We learned that the average stock market rise after bottoming ranges from 20 to 142% and averages 72%. The Dow bottomed in February 2009 around 7065 and an average subsequent rise would make it peak at around 12690. If we were experiencing a 140% rise then the Dow should peak around 16920. These are of course very crude numbers, but you can see that several experts have taking note of the substantial rise of the Dow.

The time it typically takes from bottom to peak is between 2.3 and 5.1 years – with the shortest time being just a quarter (3 months). And we were worried about a double dip! Thus, since we bottomed around February 2009 then we are now due for a crash. For 5 years now, investors have climbed a wall of worry and now they are becoming increasingly bullish and don’t want to be reminded of the rough years that preceded today’s ‘good market’ feeling. One could speak of a starting mood of Euphoria in the U.S. markets and things start looking up big time with a housing market on fire in parts of the U.S. Also, Mr. Ben Bernanke has been greasing the economy with quantitative easing and record low interest rates.

Yet we have not achieved Bernanke’s stated targets of 6% unemployment and inflation is not exceeding 2%. Most Pundits feel that that is still a year or two away. Yet, others start to worry about ‘tapering down’ the bond buyback programs pioneered by the U.S. Central Banks and copied by Europe and lately by Japan. Government debts have been ballooning and gold bugs have predicted sky high inflation and sky rocketing gold prices which have not materialized (yet!). There is no doubt that western governments will not be able to repay their debts, but as pointed out in an earlier post, it has never in history been the intend of governments to repay their debts. In the end they will inflate their debts away. Quantitative easing is nothing more than inflating and devaluing the U.S. dollar which results in reducing debt as a percentage of GDP!

So, yes we’re looking at the return of inflation, the devaluation of government debt and increased asset prices such as recovering real estate, stock market and even art, gold and silver prices. In my opinion the U.S. markets are in the latter stages of a bull market when prices rise to exuberant levels. That does not mean a crash is eminent, but it is a time to become cautious on buying U.S. stocks. Also, the U.S. economy and government have the wind in their back thanks to the energy revolution. The U.S. government has just issued another permit to export LNG (natural gas). Their oil production has been sky-rocketing and they don’t know what to do with the associated gas they produce along with the oil – so they flaring it off! With so much energy, the U.S. does not need to import that much oil and gas anymore thus reducing their dependence on foreign suppliers and… reducing the trade balance and federal debt!

Other stock markets, in particular commodity based stock markets, have fared much less well than that of the U.S. because overall economies, including that of the U.S. have not particularly been booming and neither has market psychology improved a lot in most markets. Now, it should be understood that stock market performance is not directly related to economic performance. Apart from the psychological mood of investors, stock markets over the long run are driven by corporate earnings and that makes up a significant but not the major part of an economy. It is not without reason that many income earners in western economies work typical 6 month or longer to pay their taxes each year. Thus government makes out a very large part of the economy as well, just ask the French :).

I suspect that the U.S. market is in for a breather. But other markets will have better days ahead. So, these warnings about a crash coming soon in a market near you are a bit exaggerated. But not so much that we should ignore these signs of topping markets. There are lots of questions out there that cannot be answered, in particular about the reliability of Chinese economic data. However, if an economy of barely the size of 25% of the U.S. could affect commodity prices in the 2000-2008 years when it grew at 10% per year, then the world’s 2nd largest economy of 2013 growing at 7 to 8% should help increase demand for commodities as well – even if this second largest economy happens to a be ChinaJ.  The European debt crisis has all but blown over and the rising European stock markets indicate a recovery in the making.

The evidence of markets becoming gradually more euphoric can be found in investors abandoning gold. This is probably a mistake. If fiat currency represents the cash in investor pockets that is backed by highly indebted governments, then gold is the universal currency not affected by government debt and that should be the most reliable form of cash. So in a world where we expect stock markets to achieve a state of euphoric optimism over the next year or two and with an ever declining level of confidence in fiat currencies, gold may become the preferred denomination of cash.

That is what our investment strategy should be aiming for the coming year or two: take profits in our stock holdings, prepare for inflation by accumulating assets and if too expensive to buy said assets then build up your cash holdings (a combination of gold and short term liquid money market funds which will protect you a bit against inflation). Using an analog from past blogs: the stock market traffic lights are mostly on green, one more light that switches and things get euphoric. At that point, the lights can only switch to red.

Monday, May 20, 2013

What is going on with gold? - Correction

A quick update regarding Porter Stansberry's ideas on gold.  I misunderstood him. Porter says exactly the same about gold as I did in my post - he probably did so a lot earlier than my post yesterday too.

We both say that Gold is nothing more than a means of exchange and that it is impossible to put an intrinsic value on gold. Porter also says that gold is the most universally accepted form of money whether you are in the jungles of South America or the gold coin store in the city you live.

"Why", asks Porter, "would you use someone else's liabilities (currency) when you can have gold?" "gold is the preserver of net worth not an investment".

Canada's real estate market overheated! Are you kidding? There is no such market in the first place!


I haven’t written about real estate for a while. That is not because it is not profitable. To the contrary, investing in real estate is fine and once a rental operation is on track it is a bit boring. But then the best businesses are often boring.
In fact, most of the time, the longer you own your property the more profitable. Say you own a paid-off house that you bought 30 years ago for around $100,000 near the center of a large city. Chances are that over the years your property has quintupled in value, i.e. the place is worth $500,000 or more. Even better you can probably rent it out for close to $2300 per month if not more.
That means that per year your rental income is close to $27,600 After you paid, say $3,000, in property taxes and another $1500 for maintenance you hold close to $23,600 per year of cash in your hand… and with build-inflation protection!.  How does that compare to your Canada Pension Plan?  Hmmm.. and did you know that you can defer your taxes on that rental income using depreciation?
So if you wanted to retire with an annual income of a bit over $100,000 all you’d need is ownership of five(5) such properties!  Of course, you can make it fancy and play Reichman or Pocklinton using oodles of leverage and end up somewhat bruised (too say it nicely) or, if lucky, you’ll become the next ‘The Donald’.
Yes, if you’re greedy or don’t think long term things get a lot more complex. If you’d read the newspapers you’d think right now that Canada’s real estate is about to go into collapse or at least is going through a soft or hard landing depending on the day or brand of news paper you read. In reality this is far from the truth. Yes, things may be a bit top heavy in Toronto and in Vancouver’s condominium markets but that is not Canada’s entire real estate market!
Real estate is driven by local economic growth, population growth (natural growth and by immigration) and of course it is driven by how friendly the local governments are towards real estate. All these factors vary greatly across Canada’s provinces, territories, cities and rural areas. Canada is not one real estate market – it is highly fragmented and there are quite different rules, regulations and even tax regimes across our country.
Yes, Vancouver and Toronto are our largest markets, but conditions in Waterloo are quite different than in Toronto and conditions in the small towns and cities of the lower mainland away from Vancouver proper differ significantly as well.  In Calgary the market is different than in Edmonton while both cities have ‘balanced’ real estate markets without transfer taxes and provincial sales taxes; with reasonable landlord or tenancy regulations; no rent controls and low vacancy rates.  Compare that to Ontario!
So next time you read those hysterical headlines in our national newspapers, ask yourself, what market are those guys talking about?  Do these guys even know what they’re talking about or are they just trying to scare you into buying a newspaper or turn on the news channel?
Talk to realtors in your neighborhood or in the area you’re interested to invest. Don’t talk to one; talk to several. There are all kinds of realtors – some specialize in family homes (most do); some actually understand small investors; others specialize in commercial real estate; some know about the inner city; others know about condominiums; yet others sell you strip malls or recreational properties. Find the right realtor for you and then learn about your market of interest. Avoid bidding wars – they involve overpriced properties more often than not. Don’t buy from developers  - these guys are often very good at selling you own-sided (and I am not talking your side) deals that are mostly speculative in nature. Then, once you know your market make your move and buy that property that one day will be a cornerstone of your own private pension plan.

Sunday, May 19, 2013

What is going on with gold?

Warren Buffett once said that all the World’s physical gold fits in a nice cube sitting on a baseball field and you could buy with that gold 400 million acres of U.S. farmland plus 16 Exxon Mobils with an extra trillion dollars for pocket money. A decade or so later, you’d have still a cube of gold but the farmland and 16 Exxon Mobils would have created a lot of profits over that time not to mention what was done with the pocket money. 

The gold bugs don’t agree with this premise and point to gold’s price performance over the last decade or so. And it is true, I owned a couple of gold coins that I bought in the 1990s for around $280 each and sold them in 2011 for close to $1850 each. So are the gold bugs right and is Mr. Buffett wrong? Well, gold was close to $1000 per ounce in 1982 and it was $280 in the early 1990s. Was Mr. Buffett right and were the Gold Bugs way off base? What are we making of the gold price lately, now that it has ‘crashed’ from $1880 down to around $1400? Does that make Rick Rule and Eric Sprott the biggest losers ever? 

People that make all those predictions about gold demand and supply and quote the ever presence of a conspiracy of the world’s central banks do they even have a clue what they’re talking about?  What happened to the thesis that QE1 through 3 and all of its clones will lead to ever higher inflation and that gold is the only form of protection against it? How come that George Soros has lightened his gold holdings… is he losing the Faith? 

These days, I am a fan of Porter Stansberry and his friends. Porter claims that gold is the only true form of money; one of the few things in the world that are a gauge for true value and the only means of exchange that is truly trusted now that people lose faith in fiat money. Although I am a fan, I have my doubts about Porter’s assumption that gold has an absolute value. Yes, we need a means of exchange otherwise we may fall back to barter – can you imagine mortgages and other financial instruments in a barter based economy?  So we need a means of exchange but does that imply that the value of this means of exchange is unassailable?  Do we really need a currency that is backed up by the world economy? 400 million acres of US farmland and 16 Exon Mobils do not represent the value of the overall world economy – probably not even the value of the entire U.S. economy (but here I am sticking my neck out). If the world economy is not the backing of gold, than what is its value? The cost of mining it?
I think Warren is right. We own assets so that those assets may provide us income and so that they may appreciate when we reinvest profits. You may seriously doubt the inflation statistics of various governments, including that of the U.S., but really I don’t invest just to break even on my net worth, in other words ‘to keep up with inflation’. I invest to grow my net worth in real terms. Gold doesn’t grow it is that simple.  Even if at one time gold may have been equivalent to the value of the entire world economy, over time the value of all that gold will make up an ever smaller portion of that economy.
Yes, Porter is right, as long as people believe that gold has an inherent value, just like fiat money, it is a means of economic exchange. But how do you define the value of the Canadian dollar or the U.S. dollar or of gold? It is a matter of people’s confidence. That is why some go to the extreme of ‘bit coins’ – but what is the difference with something that can be created by a random programmer and fiat money and for that matter gold?  There really is none but trust. In spite of all its debt, the U.S. dollar is still one of the most trusted means of economic exchange.  An IOU backed by the U.S. government is still good enough for most people in the world. No matter how hard the Chinese want to change it.  

You see, the world economy is not backed by money, whether it is gold or the U.S. dollar or the Rimbini for that matter. It is the other way around, these currencies are backed by (some) assets of the world economy and the moment we don’t believe that there is sufficient backing then these currencies will lose their usefulness. The gold currency brand is based on our historical trust in its value. It is, just like the bit coin claims, available in limited quantities and to produce more you’d have to spend a lot of money (if you believe the Barricks of the world). If we didn’t have faith in the U.S. economy’s ability to continue to grow and back the dollar then nobody would invest in its treasury bonds and currency.  

Whether it is fiat currency or gold, its function is just a means to transition from one productive asset into another. Thus, we could even use art or rare cars as a means of economic exchange… Oops that is already the case! Really, the world is about owning assets that produce profits. As long as you just see gold/money as a way to exchange assets such as labor into other assets then we’re fine. My objective as an investor is not to hold cash or gold, but rather to hold profitable assets.  Even food is a profitable asset because it provides me enjoyment and quality of life; it also provides the energy to work more. Some assets expire or are used up and it is your choice as to the asset you want to own and how it benefits for you – instant gratification or future asset growth. The first is called consumption the latter is investment.
So, I am holding cash (gold or fiat currency) to either consume or to buy an investment asset that generates more cash and/or appreciation. As an investor it is not my goal to hold cash and as such inflation, i.e. the purchase power of money is secondary. If you think about it, even gold may experience inflation!  For example, let’s look at an egg. How much effort would it have taken to find or produce an egg in terms of human effort 1000 years ago compared to producing an egg in today’s poultry farms? How much gold would you pay for 1 egg 1000 years ago versus today?  Did gold go up in value or did eggs fall in value? What about a pair of shorts? Really we’re not talking about something of absolute value! We cannot even begin to determine what the absolute value of an item is. What represents the value, the gold or the eggs or the shorts?  Gold and other currencies only hold their value for an instant in time – just long enough to make the exchange of assets possible. It is a bit like hydrogen or electricity. They are just means of transferring energy from one spot to another; they are not in itself energy, yet their price fluctuates. This is a very important distinction. 

During the financial crisis, people did not know what means of economic exchange to trust; neither did people trust that their assets (homes or stocks) would ever be profitable again. But they had to choose some place to ‘store’ their net worth and they choose gold. With gold demand increasing, its rising ‘value’ became a self-fulfilling prophecy and the price of gold visa vie other currencies and visa vie assets exploded. Not because of inflation but rather because of perceived trust in the fact that gold did preserve net worth and with a bit of luck it would even make a SPECULATIVE profit just like Dutch Tulips some centuries ago. Gold nor currencies have an inherent value, their momentary pricing are only an expression of people’s confidence in them as a valid means of exchange. 

 Today, now that the stock market and real estate are perceived as great bargains again, guess what… people simply are abandoning gold. ‘Yes it may preserve capital but really we want profits’ the thinking seems to be. Does that mean inflation is dead? Does that mean gold is no good? No not really, it is only that the average investor is becoming more risk tolerant and has converted his/her currency back into profitable assets. With increased confidence in the viability of stocks and real estate we will likely see gold drop in price compared to other currencies and assets. Of course, corporate profitability may decline if the central banks stop supporting low interest rates. This may also happen when we consume more than the economy is capable of supplying (i.e. inflation) and/or when inflation is further fed by increasing government debt and thus by increasing taxes (to pay for ever higher interest rates).  That is the risk recent stock market investors have chosen to take.

Value does not lie in gold but in profit generating assets whose value fluctuates based on profitability, demand, supply, their obsolescence and usefulness. We just don’t know what the instant value of our ‘means of exchange’ (exchange rate) is going to be and when all is said and done, it are the profit producing assets  you own that determine your capacity to generate continuous cash flow to do everything you want to do in life, i.e. net worth.

 

Sunday, May 12, 2013

Buy and hold is not the whole story


This year we have focused on building 4 stock portfolios. The first portfolio is a simple ETF portfolio with Canadian (40%), U.S. (40%) and European (20%) Market Index ETFs. The second portfolio is a Low P/E and moderate dividend portfolio which is updated once per year. Then we have a dividend portfolio, which is a true buy and hold portfolio and we have discussed how to select/value investments for this portfolio in our ‘intrinsic value’ posts. We also discussed that with debt free companies such as Microsoft in this last portfolio, we may use prudently borrowed money (LTV 50%) to enhance the performance of this portfolio.  The fourth and last stock portfolio is aimed at theme and cyclical investing.
Examples are investing in undervalued biotech companies who right now are in ’bull market’ mode. Investing in pipeline companies that are benefitting from a lack of oil and gas transport capacity. Or investing in natural gas producers in anticipation of a return of higher gas prices. The same for investments in light or heavy crude producers or uranium, gold, etc. Investing in such companies can be extremely profitable. But…. they also are boom and bust! Once you have made your money, it does not pay to hold on to them as such companies themselves become disrespectful of all the money investors throw at them during booms or due to the risk of oversupply and subsequent falling prices and… consequently falling profits.

Canada’s stock market is loaded with such thematic stocks, Potash, Canadian Natural Resources, Silver Wheaton, to name just a few. Looking back over my investment life, I have made my largest profits and losses with these stocks. My biggest mistake was trying to hold on to them as buy & hold companies.  Unfortunately, the hardest thing to do is to decide when to sell these, often volatile, investments.
Well, right now, we’re again in a down cycle for many commodity based companies. About a year  or two ago, I recommended to start nibbling at the natural gas producers. Although the natural gas prices have roughly doubled from the lows of last year, this has not yet been reflected in the share prices of many of the producers. My guess is, that over the coming two years natural gas prices will stabilize around $6 to $8 dollars per mcf or per 1 million BTU. This reflects current finding and production costs plus a modest profit margin. Other than in upcoming producers such as Peyto, this is just barely reflected in the stock prices of many natural gas producers so there is still plenty of opportunity to nibble.
Oil producers and their value are more difficult to gauge. In spite of the explosion in light crude production from low permeable resource plays and the lack of pipeline capacity, oil prices have been remarkably stable hovering now for the last number of years around $80 to $90 per barrel (WTI). This is a very good price for cheap conventional oil, but the new technologies are expensive and the oil industry is still dieting off the fat from the big resource boom of 2000-2008. Apart from being segmented into natural gas and oil producers, we’re now have also conventional oil, resource oil and heavy oil producers. Only the most diversified companies such as Canadian Natural Resources are sailing relatively unscathed through all the upheaval although that is not clearly reflected in its share price. The specialized companies are much more volatile and are difficult to assess.
Yet, with the new pipeline projects inching towards approval and the potential opening of export markets outside North America, things start to become somewhat clearer. I am not sure whether China will resume its astounding rate of economic growth; but even at 7% real GDP growth, Chinese and other large emerging markets combined with improving western economies should sooner or later result in additional demand for hydrocarbons. Thus, over the long term I am bullish on the petroleum industry and suggest to invest a-la ‘nibble-nibble’ in moderate dividend paying oil producers with solid balance sheets.
In the meantime, we should keep our focus on building up our dividend portfolio as long as we can find reasonably priced companies such as Cisco, Microsoft, Wells Fargo, Proctor and Gamble, Power Corp, Brookfield, etc.

Buy and Hold works for Warren Buffett stocks but not necessarily for many Canadian Stocks.

What is better Microsoft or Real Estate?

A month ago we started our discussion on intrinsic value of an investment. Next we used Microsoft as an example. We also discussed that the reliability of a cash flow forecast depends to a large degree on Warren Buffett’s moat around the business an we touched on leverage.

Normally, when using leverage, in particular mortgages, you think of real estate, for me it would be rental apartment units or a rental town house. But, really, there is a lot of leverage build into stocks and publicly traded companies as well. The difference being that you the investor are not in control of the debt load of a public company whose shares you bought, but you are in control of the debt load if you are a real estate owner.

Fig. 1. Microsoft Balance sheet courtesey GlobeInvestor Gold for 2012. (Click on table to magnify).
 Note that Microsoft’s current Assets such as cash, short term investments (due within one year) are close to $63 billion and that Microsoft’s debt and other liabilities such as income taxes are only $54 billion. Basically, Microsoft has no debt and about $9 billion in surplus cash (after settling all liabilities). That is like a real estate investment. There are many companies that use leverage as high as 30 to 40% of their total market value. Banks and insurance companies use often even higher leverage. But Microsoft has none! Its competitor Apple, for that matter, has no debt either.

So, just, like a piece of real estate, you could buy Microsoft shares with a ‘down payment’ and a ‘mortgage’. There really is no difference as long as Microsoft does not take on debt on its own accord. So in figure 2 below you see a simplified APOD (Annual Property Operating Data) for a typical 2 bedroom apartment in Calgary. We show rental income and operating costs without specifics. Subtracting Income from operating expenses, we have a Net Operating Income (NOI).
With Microsoft, we call the dividend payments NOI, in spite of the fact that Microsoft reinvests a significant portion of its net earnings back into its business and into share-buy-backs (which helps increase Earnings per Share). Hence we use the dividend income as NOI for stocks.
Fig 2. APOD of a typical apartment unit in Calgary. (Click on table to magnify)
The Apartment APOD shows your NOI as well as the purchase price ($200,000). Dividing NOI by the Purchase price results in the Cap Rate (3.9%) which is comparable to dividend yield. Now we have to finance the apartment – we’re using a mortgage with a Loan to Value ratio (LTV) of 63% resulting in a down Payment of $74,000 and monthly mortgage payments of $525.39. Part of this money goes toward paying down debt and is thus part of your net income. The rest ($ 4,460 per year) is interest payment using a 35 year amortization and 3.59% interest rate. Now assuming your property appreciates 4% per year, your Return on Investment (ROI) = 15% and your net cash flow (in your pocket is $1,521.34 per year) or 2.1% cash-in-your-hand/ down payment (the money YOU invested).

Let’s use the same logic to invest into Microsoft. Because the company has no debt, we can treat it as an unlevered investment where dividends represent your net operating income. Earnings not paid out as dividends and which are reinvested in the company will (hopefully) be reflected in the company’s annual appreciation.
Fig. 3. An APOD analyzing 1000 shares of Microsoft as if it were real estate. (Click on table to magnify).

In our calculations we ‘buy’ 1000 shares of Microsoft at $28.04 per share and with an annual dividend of $0.92 per share or a yield (cap rate) of 3.3%. Since we occur no other ‘operating costs’, our NOI = 1000 x 0.92 = $920.00. Our purchase price of the asset (1000 shares) was $28,040 and we’ll pay just like in the apartment example 37% down by taking out a loan amortized over 35 years at a 3.59% interest rate. The loan is renewed every 5 years. Our annual 'mortgage payments' are $883.91 of which $258.62 goes towards debt repayment (and the latter is thus part of net income). Since no other costs are involved, we keep $920 minus $883.91 = $36.09 in our pocket – this also goes towards net income.

Now, even if the stock would only appreciate at 5% per year, our annual appreciation is $1403.00. When this is combined with our other net income then our annual total net income is: $1403 plus $258.62 plus $36.09 or $1696.71 on an investment of $10,374.80 or an ROI = 16%. In the first 4 months of this year, Microsoft has already appreciated over 10%, so you can see that the upside potential is enormous.
Many investors claim that stock market investments are much more volatile than real estate. In earlier posts I have demonstrated that this is not the case. Just look at the recent real estate crash in the U.S. Stocks can fall 50% or so in a bear market and in 2008-2009, Microsoft traded as low as $18.00 – talking about a buying opportunity! But, I have seen real estate losing 50% of its value in under three months back in 1982 and many home-owners in the U.S. have recently experienced similar pain.
The big thing you have to keep in mind though is that many publicly traded companies already have significant leverage. So only use leverage on stocks such as Microsoft and rather than using a LTV= 63% use 50%. Especially since Microsoft is already trading at a low P/E, you have this way a lot of downside protection. Over time, Microsoft’s dividends, just like rent, will increase, while your loan not only is paid down but it will also lose in purchasing power due to inflation. So over time, your LTV will decrease, your net cash flow will increase and provide you cash flow at yields on your original investment price that is probably many times higher than you can imagine.
So, what is better, real estate or stocks? From an investor’s point of view they are two different investment classes both capable of creating excellent profits and contributing to a well-diversified investment portfolio. Both classes can produce similar losses and gains. Leverage will increase both.

Please, NOTE that I do not recommend specific stocks, I am just showing you examples from the real world. I do own often the investments mentioned on this blog. You should do your own due-diligence prior to acquiring any investment. In the end it is your money and the buck stops with you. Any action you undertake based on ideas presented on this blog are done at your own risk. I do not take any responsibility for anyone’s investment performance other than my own.

Saturday, May 4, 2013

You see, these metrics are all part of the same beast? Microsoft Part II

To construct future cash flow, we’ll have to start with the purchase price of $28.04 per share, (this includes commission). As pointed out, the NPV calculations for years 1 through 5 are done at year’s end. The purchase the share is done at the start of year 1. The closest approximation of this would be a purchase at the end (Dec 31) of year 0.
Since the purchase is a negative cash flow event, Year 0 is set at minus $28.04. Dividend payments add to cash flow and are consequently positive. At $28.04 current dividend yield is 3.3%. Just like the P/E we assume that the yield does not change over the coming 5 years (a bit simplistic, but alas!). So dividends will increase with the share price. By multiplying the forecasted share price (column D) with the dividend yield we’re estimating our positive cash flows for years 1 through 5.
Apart from collecting dividends in year five (5), we also assume that we will sell our share for the forecasted share price of $39.09. For year 5 we then have a positive cash flow of $1.20 dividends plus $39.09 sales proceeds totaling $40.38. Voila! Our cash flow forecast!
Now we’re ready to calculate the NPV of the cash flow stream for each year. By adding up the NPV for all 5 years plus Year 0, we arrive at the investment’s NPV ($0.19). If the NPV is slightly positive, our investment will likely provide us a return that is slightly better than the Discount rate required by us (10%). If the NPV is negative, the ROI will be below the discount rate. If NPV is 0 then the forecasted cash flow will provide a return equal to the discount rate.
Fig 1. 5 year Cash flow forecast. Click image to magnify.

Well, you may ask, if a NPV of 0.19 indicates a return slightly better than the discount rate, could you tell me how much better? Yes, I could fiddle around with the discount rate until I have a NPV=0. This return is also called the Internal Rate of Return and it is 10.2% according to Excel’s IRR() function.
Yeah, and the intrinsic value? Well the intrinsic value is nothing more than the NPV plus the initial purchase price. In other words, the NPV of all cash flows without the investment capital that you, the investor, has to put up (i.e. the purchase price). Microsoft’s intrinsic value according to our spread sheet is $28.23. Guess what, if you subtract our $28.04 initial investment from the intrinsic value of $29.07 you’ll get the NPV=$0.19.
You see that these metrics are all part of the same beast? - Going around and around.
Now we’re doing one last metric: Pay-out time. This is the number of years it takes for your cash flow to break-even, i.e. when the total amount of cash flow (dividends) received equals your share purchase. For that you can extend our cash flow forecast to, say, 25 years. By calculating the cumulative cash flow in the column adjacent to the annual cash flow (Column C) you can observe that after 18 years you will have received a total of dividends that equal’s the initial purchase price of $28.04. In other words, pay-out is 18 years.

If you divide 1 by the dividend yield, you would learn that if the dividend did not change you pay-out time would have been 30.3 years, however, the continuous stream of dividend increases that are associated with earnings growth will accelerate your payout to around 18 years.

Fig. 2. Extended (25 years) Cash flow and Cumulative cash flow forecast. Note that cumulate cash flow is greater than zero (0) or turns positive in year 12, The investment's payout time is thus 18 years. Click on the image to magnify.