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Post of the Day
October 11, 1999

Board Name:
NetBank, Inc.

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light.

Subject:  The value of Netbank
Author:  packardj

I have seen lots of postings about possible earnings, possible buyouts, whether one should buy now or get out of Netbank, etc, etc.

One classic way to measure the worth of a company is to calculate the present value of its future earnings discounted with some factor that represents the risk (and expected return) one takes in making an investment in the company.

This approach is not often taken with Internet companies because they typically have no earnings and even if they do, their valuations are much higher than what discounted earnings models suggest. This means the market is basing their valuation on something else.

What I like about Netbank is that for a relatively young company it does have earnings. What I also like is that since it has disappointed the expectations of many folks, it may be one of the few internet stocks that is reasonably valued according to a discounted earnings model.

"What I like about Netbank is that for a relatively young company it does have earnings."

There are other things I like about Netbank, but I'll save them for later messages. What I want to do with this post is to give Fools a flavor of what expectations are built into Netbank's current stock price so that they can perhaps make a more informed decision regarding whether to buy, sell, or hold.

Fools should be cautioned that this approach is very approximate. There is some fine analysis of Netbank to be found in earlier MF columns. Fools should read or reread these once again.

First let's start by visiting Quicken's finance site and the intrinsic evaluator within this site

http://www.quicken.com/investments/stkeval/?symbol=NTBK&cmetric=intrinsic

Whoa!! What a shock. The evaluator says the value of Netbank is 69 cents!

Don't worry. This result is based on a projected growth rate of Netbank's earnings of 19.78% for the next ten years. Fools who believe this should walk away from Netbank now without looking back. For a (possibly) more informed estimate click on over to the analysts estimates for Netbank

http://www.quicken.com/investments/estimates/?symbol=NTBK

Near the bottom of the page we see long term growth rate estimates ranging from 40% to 75%

If we go back to the evaluator and plug in the low end growth rate estimate of 40% (select the blank space under earnings growth rate and enter 40; then click the recalculate button), then bingo the new intrinsic value comes up as $23.65 - pretty darn close to today's price.

What does this tell us?

It says that built into Netbank's current stock price is the expectation that earnings will grow at a rate of around 40% for the next ten years if one uses a discount rate of 20% for this period and then changes the growth rate and discount assumptions to 11% and 15% for years beyond 10 years.

What is the discount rate? This is the annual return an investor would receive if the stock continues to follow this model - in this case 20% each year. This is a fairly high hurdle rate although many of us would agree that Netbank is in a pretty risky stage of its life now.

"...many of us would agree that Netbank is in a pretty risky stage of its life now."

What does all this mean? Should one buy Netbank or if you already own it, should you hold on to it?

The model says that Netbank's current valuation can be thought of as one which might return 20% a year if its earnings growth rate is on the low end of analysts current estimates (40%/yr). This is encouraging, especially since we can observe from various press releases that Netbank's customer base is now growing more like 100% per year. Of course it won't always grow this fast and at the same time Netbank is spending a lot of marketing dollars to get these new customers, ($62/new customer per a recent interview with the CEO).

Let me add that while the above analysis is encouraging about today's price, there are many assumptions built into the Quicken model. Most important is that it assumes Netbank will be a mature company ten years from now and that the earnings growth rate will drop to 11% after ten years and the discount rate used drops to 15%. While these assumptions are in the right direction, one could decide to use different ones with justification and that could change in a big way the result for today's valuation.

What I am saying is please don't decide to invest or not just on this one quick look at current valuation.

However, for those Sherlock Holmes fans who remember the tale of the dog who didn't bark, I will have more comments on Netbank in a later post that may also aid in making an investment (or disinvestment) decision.

Stay tuned, Packardj