A reader of the blog contacted me regarding my previous post on Nintendo. What he had to say was helpful and most importantly he pointed out my likely double-accounting error:
As I recall, what I wanted to say about Nintendo is that I think you may be making a double-counting error in calculating your owner earnings estimate 2. Generally, cash from operations (CFO) consists of net income + depreciation expense and other addbacks for working capital adjustments. Since no business can survive without maintenance cap-ex, which depreciation expense relates to, it does not really make sense to subtract depreciation if one wants to know what owner earnings are. It is therefore an OK method to take CFO – depreciation to calculate owner earnings. Another method might be to take CFO minus capital expenditures on property, plant, and equipment, which will be found under the cash from financing activities line, below CFO. This does not separate cap-ex into maintenance and non-maintenance, however, but it may be rougly right.
However, in your second owner earnings calculation you subtract R&D and advertising from CFO. This may be double counting because, presumably, Nintendo’s net income already is net of R&D and advertising expense, and since net income is an input into CFO and since CFO does not add back R&D or advertising, you have already considered them in your CFO figure.
The possibly exceptions to this are if either R&D or advertising are capitalized / amortized over a period of time. Some companies do this for advertising, typically if their customers sign long-term contracts or buy multi-year subscriptions. I don’t think Nintendo would do this. If R&D and advertising expenses are already fully reflected in net income and CFO, then you needn’t subtract them a second time to get owner earnings. That means your first owner earnings figure is likely the correct one, and that Nintendo at a current market cap of $35.78B and 2009 owner earnings of Y440B or $4.89B is trading at < 8x earnings. Not bad.
Indeed. The possibility of purchasing Nintendo at less than 8 times earnings sounds pretty good to me. As always, do your own due diligence when making an investing decision and do not rely upon the work of others as they may have committed errors (like I did) or what they may have said is just false and misleading.
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