" How The Market Values Stocks "...........................
Wall street spends billions of dollars each in an attempt to determine the future value of stocks. The market itself ( made up of people like you and me ) look into the future trying to anticipate what is going to happen to the price of any given stock. When a company is actually producing earnings the analyst can plug those numbers into various economic models to derive a value. What happens when there are no company earnings available to project valuation. The analyst must then determine the "Anticipated Market Value" for the product as well as the project "Share Of The Market" that the company may capture.
Lets take a look at the Internet stocks in relation to valuation. We all know that the internet is the wave of the future, so what should you be willing to pay for it ? With only a few exceptions these stock do not make any money, in fact they are losing money year over year. If you look at their valuations using the standard measurements they seem outrageously overvalued. The interesting thing is that these stocks are followed and recommended by Wall Street analyst. Stocks are considered to be at full valuation when their price/sales is a 4, price/book at 5-8, PE is equal to the EPS growth rate, R.O.E. is equal to the growth rate. Let's take a look at where these internet stocks are in relation to those valuation levels.
Symbol--Price----Est.EPS--P.E.--R.O.E.--Price/book
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AMZN--65 3/4----(1.11)---0----(126)---107
AOL---85 1/8-----.50----247-----36-----39
LCOS--53 1/2----(.22)----0----(236)----19
XCIT--64 -------(.56)----0----(103)----45
YHOO--115 1/4----.45-----O------15-----38
NSCP--23 13/16--(.53-----0------20------5
ATHM--34 3/4----(.31)----0----(368)----37
As you will notice only one company has a PE because the rest of them don't have earnings. You can't compare their PE to their EPS growth rate because it doesn't exist. ROE is the return on their equity, they don't have a return on their equity. (this is the same as having money in the bank and not earning anything on that money ) The Price to Book ratios are out of this world. Most of these companies are projected by Zacks to have loses for 1998.
Would any self respecting Wall Street brokerage firm recommend these stocks. Well here are the buy recommendations on those stocks, I have listed how many are recommending a buy and how many analyst are covering the stock so that you can see the relationship.
AMZN - 8 out of 9
AOL - 21 out of 22
LCOS - 9 out of 10
XCIT - 8 out of 9
YHOO - 10 out of 14
NSCP - 4 out of 13
ATHM - 4 out of 6
So Wall Street is recommending that investors buy these companies. Did you know that the SEC follows these recommendations and monitors them. The media follows these recommendations and comments on them. You can read article after article with people discussing these recommendations, some will say that they are correct while others will say they are ridiculous. Most people know that the valuations in relation to normal valuations are way out of line. So what is going on, why doesn't the SEC come in and make them stop recommending these overvalued stocks to the public.
These analyst and the market are not deriving a value based upon what has taken place up to this point in their history. The valuations are derived from "Anticipated Value". How big is the market, what will their share be. If you have been in the market for any length of time you have always heard the term that the market is discounting mechanism looking out into the future 9 -18 months. If you buy a stock based upon it's past history you will always be blind sided by the future. That's right as an investor you are required to make a projection as to what will occur in your investment if you want to stay up with the rest of the world.
So how does this relate to SGNC ! If you take a look at any charts on SGNC you will see that they stock traded between $2.00 and $3.00 a share during 1994 & 1995 it then declined to the 1/4 to 1/2 level in 1996 where it based since that time. In 1995 with the stock at $3 it had no funding soon to be announced, no agreement with Battelle to do the animal testing. It did have plenty of competitors at that time however. Here we are in 1998 the company has funding lined up and soon to be announced, they have an agreement with Battelle to do the animal testing, they're competitors have dropped off one by one and the market is estimated as a $20 billion dollar market.
Let's talk about "Anticipated Market Value". The market for the product has been estimated at $20 billion. There are 21 million shares outstanding on this company, that's $95 per share in revenues. What will SGNC's market share be ? Right now it looks like they will have the whole market unless someone comes along with a better product than they have right now. But just for the sake of being conservative let's say they get just 10% of the market, that is $9.50 in revenues per share. The cost to produce this product is minimal so margins should be very high, conservatively they should have a 50% Margin. $9.50 per share in revenues at a 50% margin would create $4.25 in EPS. $4.25 in EPS with a PE of 20 equals a market valuation of $85.00.
Dr. Drees has estimated that it will take approximately 2 - 2 1/2 years before they will see the first revenues. The market is always anticipating the future valuation TODAY. Go back and look at the internet stocks valuations and you will see that they are looking into the future to derive their valuations today.
You can each do your own evaluation on this company and use whatever figures you wish. The figures I have presented are not meant to say that the stock is going to $85 a share, it was presented so that you can see how analyst ascertain a valuation for a comapny with no current earnings, but I think you get the point. The market is anticipating a value for that $20 billion market today. Is it anymore outlandish than what the WALL STREET analyst are projecting for the internet.
I personally believe that the stocks current valuation of under $1 is cheap based upon it's "Anticipated value". SGNC can not be valued like a K-mart or a Citicorp, it has to be valued based upon the potential it has for the future. Each one of you will have to decide what that value is, no one can do it for you.
Good Luck
Gwolf |
