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Strategies & Market Trends : Value Investing

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To: Micah Lance who wrote (57556)	7/18/2016 12:23:40 PM
From: Graham Osborn	1 Recommendation Read Replies (2) of 78954

Just realize that Graham Numbers suffer from the same limitations as the component ratios, i.e. P/B and P/E - both ignore the effect of debt on the capital structure. For example, cyclical industries like railroads or oil producers will sell at a discount to their GN at peak cycle, only to sell exhibit much higher GNs (but much lower prices) during the slowdown. The more leverage a co has, the more volatile its GN will be. I prefer to use the EV method: MC = EV - LT Debt + Cash Where EV can be deduced using historic comps plus a margin of safety: EV = (EV/ Operating Metric)* X TTM Operating Metric * = comps multiple +/- a margin of safety eg from historic market lows/ highs My usual TTM operating metrics are Rev or EBITDA (EBITDA is misleading or difficult to compare in some industries) The most difficult part of all this is selecting the appropriate comps universe. You want comps with similar growth rates/ prospects and margins, but the detailed criteria will always be highly dependent on the situation and how much of a margin of safety you require. If the comps are poorly selected the valuation will be meaningless. The usual analyst practice is to take a set of standard industry comps at face value, but if you do that you have zero margin of safety of the valuation of the entire sector (or market) is recalibrated - real risk at any time. The problem with the Gordon Growth Model is it assume a uniform growth rate for the business and for real interest rates - both bogus assumptions. Buffett happened to be applying the formula during a multi decade bull market in bonds for which the long bond figures were actually conservative. Applying that formula now, after 2 rounds of QE that have only begun to enter the general money supply, is a good example of the saying "what wise men do in the beginning, fools do in the end."

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