Friday 13 June 2014

Simple Valuation Techniques from kcchongnz

[1] Price to Book Ratio (P/B)

  • Book Value = Total Asset - Total Liabilities  It is net equity position left overwhen everthing in a company owes is taken away from what it owns.
  • Price to Book = Stock Price / Book Value per share.
  • Intangible asset wort nothing than its book value e.g. goodwill and patents. Some investor remove it and make the conservative Price to Net Tangible Asset
  • Book value doesn't rely on volatile measure like profits and has a hard accounting foundation in company's books - it is key barometer of value by academics
  • Most value investors try to buy stocks at a discount to their book value (P/Book ratio < 1). This may not applicable to asset liht company which its value depend on its earnign power.
  • [Note]: Further Readings: Benjamin Graham Net Net & Negative Enterprise Value.
 

[2] Price to Earning Ratio (P/E)

  • Price to Earning = Stock Price / Earning per share It show how expensive or cheap a share is compared with its profits
  • Some value investor's take on the Cyclically adjusted P/E (CAPE) - Stock Price/Average (EPS over a cycle of 7-10 years) Current earnings can be overly inflated due to a business boom
  • P/E < 10 = Good, < 5 fantastic, > 20 too expensive It all depends on the industry and growth prospect of the company
  • Shortcoming: P/E not consider debt. It is difficult to compare companies with different leverage

 

[3] Earning Yield (EY)

  • EY = The inverse of P/E = E/P
  • It is a great improvement - it can be compared with other investments more easily (e.g. FD)
  • Joel Greenblatt redefined EY and introduce the Magic Formula. EY = Operating Profit after Tax / Enterprise Value = EBIT*(1-Tax Rate)/(Maker Cap + MI + Total Debts - Excess Cash - Other Non Operating Assets)
  • EY = 10% ok, EY >=15% Good, EY > 20% = Fantastic
  • Shortcoming: It does not take into consideration of the growth of company.

[4] PE/Growth Ratio (PEG)

  • PEG = PE / Forecast EPS Growth Rate
  • It was popularised by Peter Lynch.
  • It tends to focus on the growth prospects of a company and buy it on cheap, which aren't necessarily vital to a value hunter.
  • PEG < 1 - a resonable price ofr a signifies growth.
  • Shortcoming:Earnings are just accounting numbers and they are subjective.

[5] Price to Free Cash Flow (P/FCF)

  • P/FCF = Stock Price/ Free Cash Flow
  • Looking at hard cash can prevent account manipulations.
  • Read Cash Flow Statement Analaysis to if you would like to know what is Free Cash Flow.
  • P/FCF = 20 is reasonalbe (as it is hard cash), P/FCF = 15 is good, P/FCF < 10 is fantastic price.

[6] Price to Sales Ratio (P/S)

  • P/S = Stock Price / Sales per share
  • For company that have no earnings e.g. Technology Company during dotcome euphoria @ late 1990s.
  • It have a bad name when it was misusd in dotcom bubble to justify nosebleed valuations.
  • Earning can vary from year to year, sales are much more sable.  It serve as a key indicator for isolating potential turnaround stocks.
  • Low P/S stocks (especially against their sector) can often be stocks that bounce back very quickly as they return to profitability.
  • Look out stock with historically reaonable margins trading on P/S < 0.75 wihtout much debt.

 

Which method to use?

  • P/E - consistently profitable company
  • P/FCF - more consistent cash flow than profit
  • P/S - company with no earning
  • P/B - no sale to speak of but do have hard assets 
  • PEG - pricier but cheap for their growth


References:-

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