Jason writes:
What number or numbers do you look at when making a purchase decision? Is there any one valuation model that you consider most often? More precisely, how do YOU compare Gorillas, Kings, or W&W stocks when you have capital to invest? (A semi-simplistic answer is what I'm looking for. I am not a master of valuations)
A semi-simplistic answer? From me?
I'll give you some thoughts.
A few things come into play when considering valuation. The 'core' thought would be how a stock's share price trades or 'tracks' in relationship to the forward earnings projections by the analysts (not the trailing twelve months, but the forward twelve months). Is it trading above, in line or below those projections? How does that compare to the historical trend of where it has traded over the years? The other elements that come into play include possible higher growth than consensus projections indicated as well as the illusive element of momentum. Either can increase the share price from it's historical trend. Based on the economic expansion from 1995 to this year, a lot of things have traded well above the growth projections by analysts. If we breeze through the market multiples of P/E, PSR, PEG/YPEG, ?X estimated earnings, etc... - we find confirmation of this.
As we've learned in our 'manual', traditionally the gorillas have traded above their projected growth rates. But how much higher? You can call this CAP/GAP, a price premium for ownership or some other term. You can apply this to any of the gorillas, royalty plays or basket candidates using a forward 12 month earnings estimate. What gets difficult in some of this is that high growth companies continue to adjust and up their guidance which adjusts the analysts 12 month projections (companies with estimated forward P/E's of 100 to 200+ in hypergrowth both on a sequential and y/y basis). However, knowing what the historic norm for each equity in terms of trading in relationship to the forward 12 months earnings projections by the analysts can help you identify possible entry points that are more in line with the historical range. That being said, one could have actually 'not' been invested since about 1997 in a stock like Cisco using just this criteria and waiting because they were above their norms. Even though the share prices have come down for a gorilla and a king we all know, not being invested in Cisco or EMC since 1997 because the price had started to rise above the forward 12 month earnings estimates historical tracking means that one would have missed out on a 770% return for Cisco and a 1,700% for EMC using the 1997 to current date time frame. What does that mean going forward? Time will tell. Will all companies return back closer to their historic trends in terms of tracking the forward estimates? Likewise, we can see how the interest rate/bond rate and economic conditions added air into the CAP balloon during the 1997 to 2000 time frame because the economic expansion was real. As I mentioned in a previous post, these are now being adjusted because the economic situation and slowing growth demand it. It doesn't mean our companies are worthless or that gorilla gaming is a fluke theory that worked for a few years, it just means the market is adjusting the valuations due to the economic conditions. That's a very normal process. I don't call that doom and gloom or see any reason to jump out the window because of it.
I have additional money to invest every few weeks and would like to have a MORE scientific approach to entry points. Right now I purchase using gut instinct and try and buy the best company among my list that is MOST attractively priced, at that time. Now I know that LTB&H will smooth out "good" and "bad" entry points, but improving my entry/selection process over the course of what will hopefully be a very long investment career could improve my portfolios value significantly over time.
That's why the age old saying of 'buy low, sell high' is used. The gut will usually reverse that saying and have one buying high and selling low. Even though the market is correcting and adjusting the valuations, the gut kicks in and actually 'forces' some to sell at the wrong point. The reverse is true when things all seem euphoric and momentum buying kicks in where the gut takes over and buys. As in the past, if we project out a few years to many years from now, we will probably come up with the conclusion that not selling or buying at what might appear a 'too high price' would have worked out just fine. Hard to convince one's gut or mind of that in the heat of battle, but it does give pause for thought. There will be economic expansion again - just as there will be contraction again. None of that is to be taken as advice to do anything one way or another, by the way. I'm just providing thought. Knowing where your equity is trading in relationship to the growth rate projections currently as well has historically can be beneficial at times when choosing times to add additional money from your monthly/quarterly savings.
What happens far too often in times like these are that people have money in the stock market that they need in less than a three year time frame even though they know that conservative wisdom would caution against this. This forces them to sell and the market drops even more. Likewise, those on margin are 'forced' to sell and we get those capitulation, blow-off sale days. Will that happen on Monday/Tuesday? Who knows? Eventually that all gets settled and the cycle turns in the other direction. How much time that takes is anyone's guess. In addition, there is an awful lot of short term trading that has increased since the Internet came along as well as the quick processing of information.
One last food for thought. Even though we've heard about Cisco having significant drops in share price once or twice in it's history (1991, 1994, 1997) the stock only touched or dipped ever so slightly below the forward looking 12 months earnings projections by the analysts in terms of tracking. It only stayed below that for a few months in 1994.
BB |
