Looking beyond the PE
The February edition of MONEY magazine has an
article on stock valuation with the above title.
It does a nice job of describing the use of
dividend yield, price/sales, price/cash-flow
book value etc and my own favorite, return on
equity (ROE) which it characterises as one of the
more important valuation numbers. Further, it
emphasises the importance of the ratio of a
company's ROE to PE ratio - the bigger the
better. However, it gives two examples, Ford(F)
and Philip Morris(MO), which it describes as
'dirt cheap' on this basis... Let's compare and
discuss these numbers with GRIN's. (F and MO
numbers from article, GRIN's from YAHOO profile)
COMPANY__ROE(%)_____PE______ROE/PE
MO__________48________15.5______3.1
F____________25_________11_______2.3
GRIN_________26________5.3_______4.9
So GRIN is a clear winner on this basis (you
knew that would happen). BUT WAIT, IT GETS
BETTER !! Remember my earlier post#63 on valuation
of GRIN using ROE. What do we need to check before
we consider the ROE number to be believable and
robust ? That's right, long-term debt. OK, GRIN
has no long-term debt so the ROE is quite believable.
Now for MO... wow there, they are sitting with a
debt of $49B (that's BILLION !). Their debt/equity
ratio is a staggering 77% ! Maybe things are better
over at Ford..uh, oh, Ford has a debt of $61.9B (work
out what those interest payments are). Their 'big'
ROE numbers come from the small equity number
(equity = assets - liabilities) which results from
the big debt liabilities.
So what happens to these companies when a
business slow-down or recession arrives and the
cash-flows get crimped ? The normal response is to
cut-back on staff/expenses etc, but the only way to
cut-back on debt payments is with cold, hard cash.
Ah but, you say, F and MO have substantial cash
positions to weather these times. Let's see, at 9%
interest rate, F has cash for 12 months loan payments
and MO has 6 months payments and at the end of those
periods the debt remains unchanged.
I'd say people who follow this thread now know more
about basic stock valuation than MONEY magazine people.
My advice for Ford and Philip Morris ?... pray for
short recessions.
My 2c.
Frank |
