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Strategies & Market Trends : Gorilla Game Investing in the eWorld -- Ignore unavailable to you. Want to Upgrade?

To: Poet who wrote (802)	11/21/1999 4:52:00 PM
From: Mike Buckley	Read Replies (3) \| Respond to of 1817

Poet, My favorite tool for evaluating a small-cap stock is the Fool Ratio, one version of a PEG ratio. There are many PEG ratios that differ in the data used to calculate expected growth rates and earnings. For the PE component of the ratio, the Fool Ratio uses the trailing PE excluding one-time accounting events. If you are not absolutely sure that the source you use for trailing earnings excludes those events, it's important that you determine that. (Zack's does exclude one-time events.) For the growth component, the Fool Ratio calculates the annualized growth rate between trailing earnings (excluding one-time events) and the furthest estimated earnings. Having divided the PE by the G (growth) the ratio is rendered. In theory, a ratio of 1.0 sez a stock is fairly priced because the PE equals the growth rate. A ratio of 0.5 to 0.6 would indicate a dramatically undervalued stock (which is what Gemstar was when I first became aware of the company) because the PE is about half the estimated growth rate. Similarly, a ratio of 1.5 indicates the stock might be overvalued because the PE far exceeds the anticipated growth rate. However, no valuation tool should be used in a vacuum. Industries' stocks that are commodity-based with razor-thin margins may rarely be valued with the PE as high as the growth. Conversely, gorilla-like stocks in industries with massive growth exhibiting huge profit margins are typically priced by the market with the PE well above the estimated growth. Also, for the stocks you are considering, I'm not sure that any of them would be considered small-cap stocks. The larger-cap stocks whose companies have a long history of proven performance tend to garner PEs in excess of the growth rate. In this bull market of emerging industries, however, many of those large-cap stocks don't have a long-term proven history. When a large-cap stock used to get that way after proving itself over time to the market, these days many companies become large-cap stocks by 2:00pm on the day of their IPO. So for me, the high valuations become especially circumspect and is part of the reason Moore & Company suggest buying a basket of competing companies. One final point I'd like to make. (I see you saying, "Yes! The guy's almost done!) I always look at the Fool Ratio when looking at small- or smaller-cap stocks because I prefer when possible (and it's not always possible in this market) to buy when there is at least a small margin for error built in to my buying decision. As an example, if all things are equal (industry growth, company management, quality of the balance sheet and cash flow statement, etc.) I would much rather buy a stock whose Fool Ratio is 0.5 than 1.0, or one whose ratio is 1.0 rather than the one that is 1.5. So even when I don't find absolute value, appreciating relative value gives me a little piece of mind in the event something goes wrong, not to mention my judgement. Such was the case when I saw Qualcomm in late March sporting a Fool Ratio close to 1.0 when all fundamentals were in place pointing to a much higher ratio; that market inefficiency is what prompted me to allocate an unusually high portion of my portfolio for my initial purchase of the stock. Make sense? To use the Fool Ratio, go to their website and look for it. You'll find a couple other calculators there as well. If you use a Windows-based machine, PM me your e-mail and I'll send you a PEGulator file distributed for free by the Fool. It's so simple to use that it comes with no instructions, and justifiably so. If you really get into valuation, somewhere at the Fool is a complete discourse of many valuation tools at investors' disposal. Hope this helps. And thanks for putting up with my inability to understand why so many investors are willing to buy stocks these days without a clue as to what today's fair value might be. They don't buy apples, cars or homes that way, but they sure do buy stocks that way. End of rant! --Mike Buckley