FYI: Recent comments of LMoss from AOL
Subject: Analyst methodology
Date: Fri, Apr 17, 1998 11:05 EDT
From: LMoss
Yesterday, as most of you already know, Doug Lind of Morgan Stanley downgraded AGPH from Strong Buy to Outperform, because "diversification of top line risk via in-licenses of currently marketed products has yet to materialize." Although he did not change his financial projections, he lowered the multiple on forward earnings in his discounted earnings valuation.
I disagree with the premise, because revenue and earnings from in-licenses of currently marketed products is likely to be small compared with those from Viracept, AG3340, and AG7088, each of which has billion-dollar-per year potential. Leaving this aside, however, the methodology is wrong.
"An increase in perceived risk should be accounted for by increasing the discount rate, not by decreasing the multiple." The discount rate should be the risk-free rate (that of short-term U.S. Treasury instruments) plus an increment to compensate for perceived risk. Said another way, the discount rate used should equal the returns expected from investments of comparable risk.
The multiple is determined mainly by the expected rate of growth in earnings. Since Doug Lind did not change his financial projections, the multiple should not have changed.
On another point, I've commented before about the habit of most analysts to give a 12-month valuation and then not change it as time goes by. When nothing else changes (perceived risk, financial projections), this is also faulty methodology. After six months, for example, the former 12-month target should be a 6-month target, or what is then a 12-month target should be raised.
LMoss |
