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Strategies & Market Trends : Bosco & Crossy's stock picks,talk area
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To: PuddleGlum who wrote (4077)9/23/2003 8:19:14 AM
From: Crossy  Read Replies (1) of 37387
 
PG, Cuda --
even forward PE's are problematic. It's not so much the predictive nature of forward ratios, the problem lies in the PE ratio as using EARNINGS as input.. Earnings are by definition a RESIDUAL figure..

now the market pre-empts any earnings "prediction" with it'S valuation - i.e. the market's "gauge" of forward PE is way better than any individual investor's IMHO.. This is the reason why PE's are useless - because updates are implicit into current stock valuations - the market preempts them..

however changes that LEAD TO FUTURE EARnINGS changes are not easily discounted by the market. That's why I use "boundary condition" tests to find my portfolio candidates.. One boundary is SALES PER SHARE.. By definition, Sales are top line items - they cannot be massaged by ´management as easily as earnings. OTOH, earnings can usually not be greater than sales (in ordinary companies <g>) so they are an upper boundary to FUTURE (!) earnings.. you can even extrapolate a growth rate into it.. Add Gross margin which gives you a Feeling of scale-independent earnings potential..

for example look at KYZN.OB (Kyzen). 50% gross margin, Price/Sales under 0.3. They would be highly protifable EPS wise if they just were a tad larger - say 3-5x as large because their SG&A eats away their gross margin leftovers. Or look at IMA or DADE - as soon as these companies delvererage their balance sheet (both started already) EPS growth will really kick in - even if they wouldn't be growing anymore (which they do anyway). The trick there is that interest payments ate away gross margins in the past. Smartmoney once contended accross similar lines that small companies lacking scale and heavily indebted companies have PE ratios that are pretty meaningless... True enough, for me these are just 2 examples..

My conclusion on this matter was to forget PE ratios. I even do not value profitability (not cashflow positive position !) very high. Companies that are somewhat profitable but revenue is down (not growing or at least stable) I do not like in my portfolio... the crumbs aren't what I'm looking for..

rgrds
CROSSY
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