How Much Is Your Neighborhood Store Worth?

Our neighborhood convenience store was sold recently. My kids go there frequently for some of their favorite foods, so they are familiar with the assortment and prices. I asked my 10-year-old son, Ben, “How much do you think they sold the store for?”

When you approach investing in the stock market, there are two general approaches you can take. The first, favored by most, is some version of trying to figure out what others will pay for the stock at some future point. This can range all the way from good old-fashioned chart-reading to a pretense at a fundamental value approach a-la “the stock has traded at X multiple of Y metric in the past, so let’s use that and call it good.”

But what if there is no stock market? What if there is no chart, no historical valuation metrics for the business and no conveniently available Wall Street earnings estimates? What if there are no readily available comparable transactions? What if you had to actually think for yourself about what a business is worth to a private owner who would operate it not to flip it to some other buyer, but to derive the return from the future cash flow stream?

Then you would have to practice what is known as the intrinsic value approach. That’s the alternative to the “greater fool” method, a term coined by Warren Buffett to describe the above, all too common, approach that most participants use in the public markets.

When Benjamin Graham famously said that in the short term the stock market is a voting machine but in the long-term it’s a weighing machine – this is what he meant. In the short term you are at the mercy of what others think the stock should trade for, just as in a beauty pageant the judges’ subjective opinion is all that matters. In the long-term, however, the magnitude and timing of the cash flows that the business produces are what will determine your rate of return.

Ben shrugged and threw out some wild guess. We were in the car with his siblings, and the conversation quickly shifted to something else. I let it go.

The next time the topic came up, we were driving with just the two of us. I decided to explain the basics of retail to Ben – terms such as mark-up, gross margin, average check per person, and so on. By the time we got home, I thought Ben had a very basic understanding of how a store would make money and the type of costs it would have to bear in the process.

Days later, I decided to up the stakes a bit. I teach all my kids math every week, and so I had a special assignment in mind for Ben when it came time for us to sit down for that week’s session.

Ben looked a bit puzzled when I handed him my old laptop. “This week’s math assignment is going to be different. You can use Excel and anything that you find on the internet to estimate how much money does our Market make in a typical year, and what you think the store got sold for.”

To make the exercise more interesting, I told him that I would do the same thing he was doing in parallel. That way we could compare how we approached it and the answers we got in the end. Neither one of us, of course, knew the actual profits of the store nor was the transaction price available online. So we would have access to the same set of potential inputs in performing our analysis.

At this point I want you to pause reading. No, don’t peek at what Ben and I came up with. Instead, I want you to think about a local store that you know well, in your own town or neighborhood. Now go on and take a few minutes to come up with a rough estimate of what that store makes and what you think it’s worth. Trust me, in investing you learn far more by doing than by passively reading about what others have done.

My approach was as follows:

• I found data about the number of houses in our town, and used that as the basis for estimating the number of shopping trips per month
• The Market is not your typical store, but rather a unique combination of prepared ethnic foods, imported foreign food items, as well as some normal grocery and convenience items, so I thought it is likely to have above-average mark-ups/Gross Margins
• I estimated operating expenses based on my observations about the size of the store and the number of employees
• I assumed no to modest growth in profits and that someone buying the store would want a double-digit annual return on their equity

Looking at the mini-model above, there are a few points that I think are instructive:

• The range is wide, but it should be wide. This is true even had I known the company’s historical financials, but it is especially so when I have to estimate even that
• The model is simple, yet making it much more complicated would not increase the accuracy of the forecast. I have only so much insight into the inputs, and that is the limiting factor in how detailed I can make the model while keeping it useful
• The output passes a quick “sanity check,” since it makes sense that a store such as this would be worth somewhere around a few million dollars. Had the output been tens of millions or less than a hundred thousand dollars it would have likely been indicative of a mistake on my part

What about Ben? How did he approach this exercise?

• He started with a number of shoppers per week that he thought was reasonable based on how many people he had seen in the store at different times
• He made an assumption about the average check size based on how much he has paid for items himself when doing the shopping there
• He did his best to estimate various expenses such as labor and utilities
• His estimate was that the store’s annual after-tax profits were $123.5K, certainly plausible and inside the range of my estimates above
• He didn’t know how translate that into a potential value of the business, for which I, rather than he, am to blame since I hadn’t taught him that yet

Ironically, in doing this exercise my 10-year old son did more intrinsic value investing than most people who buy stocks in the stock market. It’s tempting to see the market as a giant competitive casino where you and others can make “bets” or “plays.” The dopamine release from quick victories and the short feedback loop from gamifying investing is quite addictive.

On the other hand, real research is laborious. The feedback loop is long – you can do everything right and yet the market might choose to disagree with you for a long time. For most, it’s simply not fun, so they don’t do it.

Don’t be one of those people. Or at least don’t do it with other people’s money or for stakes that matter to you with your own.

If you truly feel like you need the dopamine release and the excitement of the investment “game,” I just finished listening to an earnings call of a gaming company that is about to release a new online casino game called “Stock Market Live.” My initial thought was that such a game would seem rather redundant given the way most people treat the real stock market. But then again, if you really need to get your kicks somewhere, it’s probably best to play that game for very small stakes to help you maintain the discipline to keep your gambling out of your serious investing.

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About the author

Gary Mishuris, CFA is the Managing Partner and Chief Investment Officer of Silver Ring Value Partners , an investment firm that seeks to apply its intrinsic value approach to safely compound capital over the long-term. He also teaches the Value Investing Seminar at the F.W. Olin Graduate School of Business.

Note: An earlier version of this article was published on the Behavioral Value Investor Substack