The Value of Our Business
In 2020 the value of our business increased 48%.
We calculate our business value using the Discounted Cash Flow model. This gives us the ‘intrinsic’ value of the business (as opposed to market value which can vary wildly.
In making this estimate, we must also make a few assumptions:
- We believe that over the course of the next five years, we have a reasonable chance to increase our earnings by 5% per year. We believe this based on actual plans we already have in progress and our conservative estimates of the profits they will bring us.
- After five years, even though we have big dreams, we do not feel we can predict the future. Therefore, we assume (the unlikely) event that all earnings growth will stop forever
- We also assume (Here is an even less likely event) that the government will create a risk-free investment that pays 8% per year forever.
We do this because we feel it will give us a conservative value for our company. We would much rather be pleasantly surprised by the growth of our value rather than horrified by it.
We are damn proud of that 48%
Not-so-humble brag time: that 48% is actually much better than it looks. Why?
2020 was a terrible year. Cue collective eyeroll. No duh, right? Let me explain.
No, it is too long. Let me sum up.
First the big one: The Covid pandemic. This was a global crisis that you really don’t need me to explain.
But on top of the pandemic, Leslie and I also (In chronological order):
- Had our day-job salaries cut by $12,000 or about 15% (To make ends meet we had to rely on business income more than normal)
- Had to replace our refrigerator
- Had to replace our furnace
- Lost our wonderful Chevy Volt when someone pulled out in front of Leslie (To anyone in the market: We both believe that car saved her life. We loved that car. )
I do not know what we would have done this year if not for the safety net that our businesses provided us. I don’t think I ever thought of our business as a safety net before this year, but now I certainly do. Leslie and I are deeply thankful that we could fall back on the extra income in this, the most dumpsterfire of years.
Goals for the Future
We have an ongoing, long-term goal of growing our business value by 15% per year. We believe this to be attainable (but not easily so).
We are adding a new goal of accomplishing that 15% annual growth while working less than three months per year. We built this business over our summer vacations, so why not leave it that way? (We plan to spread this out over the year by never working more than 2 hours–one for me and one for Leslie–per day). Wish us luck.
When we started our LLC, our goal was to earn an extra $600 per month that we could invest. Doing so would likely (given projections about the stock market) give us $1 million extra dollars at the time of retirement.
That goal is now our worst-case scenario.
It’s incredible to think how much has changed. I mean we were able to maintain that level of saving through a global crisis and all the furnace/fridge/fiascoes listed above. Not to tempt fate, but it would take quite a lot to knock us down that far. (Seriously Fates, we know you could do it if you wanted to, but please don’t).
We are also working to increase our share of earnings from the stocks we own. We want a better balance than what we have now. Ideally, we want one dollar of earnings from stocks for every two dollars of earnings from our businesses.
Why?
It has been our experience that (on average and over time) every $1 earned by the S&P 500 translates into about $2 of actual market value.
There’s a lot going on under the hood there, but the short version is this: The best of the companies in the index reinvest in themselves to increase their earnings (release new products, invent new things). There’s a tax-efficient compounding effect at work.
If we manage this 2-for-1 balance it would mean that (again, on average and over time) half of our wealth would come from business earnings and half from stock market appreciation.
Look-Through Earnings
As of December, our look-through earnings (remember, that is our operational earnings plus our share of earnings from the stocks we own) was around $27,000 for the year.
This is a good deal higher than our goal and we are pumped.
But…
We also expect growth to slow quite a bit, mostly due to covid. Therefore we are adjusting our intrinsic value calculation to reflect our new growth estimate.
We are now expecting about 5% growth for each of the next five years.
So even though our look-through earnings was way up, our intrinsic value did not increase the same way.
Using the Discounted Cashflow Method and the above criteria, we calculate our intrinsic value to be about: $417,000.
Don’t get me wrong, that’s still great and we still met our goal. It’s just not as great as it could have been, sans covid.
By this time next year, we hope for our look-through earnings to grow to $31,000 and our intrinsic value to grow to just shy of $480,000.
Wish us luck!
