Friday, October 27, 2006

Quick Valuation - Legg Mason (LM)

Early in the month, Legg Mason warned investors that it would not be able to meet consensus estimates for the most recent quarter. They cited a rotation of assets under management into lower-fee fixed income funds due to market conditions and poor performance by a number of their large cap funds, including the LMVTX fund run by legendary Bill Miller. Miller's 15 year winning streak against the S&P index may finally be over this year. Investors are probably a bit short-sighted to abandon his fund because of this temporary setback. My bet is that Miller is still a great investor and Legg Mason is worthy of a spot on my watchlist.

Legg Mason has grown its free cash flow at a very healthy 27% clip to about $450 million this year in unencumbered cash. My inputs to the DCF are 20%, 10%, and 3% staged growth with a 11% discount rate. There isn't much share dilution, about 3% annual. This gives me an intrinsic value of $110 per share. At current prices, we have a 19% margin of safety. Let's keep watching this one. I'm not very comfortable with the assumed 20% growth over the next 5 years and probably need a larger margin of safety before I buy shares. A 35% margin of safety requirement would set a buy-below price of $71.50. I would wait for a better price.

At this point, I think USG and WU are better bargains than LM. Based on my previous valuations of $30 for WU and $71 for USG, we have a margin of safety of 25% and 28% margin of safety respectively. It's a shame both stocks did not give me enough time to load up. I am debating whether to buy these stocks at current prices. At a later time, I will re-evaluate WU and decide whether or not to make it a full-fledged WCS stock pick at current prices.

12 Comments:

Anonymous Anonymous said...

Private market valuation is probably higher than you dcf estimate. Sales price of asset managers is almost always in excess of 2% of assets. Even Putnam is getting sold fo rnorth of 2%. That would put LM fair value in the 120 area. A private buyer might even pay more imo.

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