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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: Spekulatius who wrote (16359)	2/5/2003 3:36:47 AM
From: Paul Senior	Read Replies (2) \| Respond to of 78666

Spekulatius, (late night rambling): my ROE model is rather more backward looking than the forward looking NPV models are. I calculate an average ROE based on historical ten-year's data (if I can get it). I also use a discount rate; and as with you, 8%. But I vary it plus or minus 0.5% depending on the industry I'm looking at and how consistent ROE seems to be (judgment call). I've been considering dropping that 8% number as interest rates have come down, but I've not done that. That would result in the model giving higher estimates to the value of stocks being considered. I use the model as a screen and to check to see if I'm overpaying, so I keep the more conservative 8% number. One big shortfall of the model (that I use) is that it doesn't take account of debt/equity ratios. That ratio has got to be looked at separately. (We know that given two similar companies with the same ROE, the company with no long-term debt has to be valued more highly than the company where the earnings are supported by debt and assets.) The model might imply a certain cash usage, but if so, I'm not aware of it. There certainly is an implication that ROE going forward will be similar to the average historical ROE. I only use that average number as a point estimator. In other words, I could develop a range where I expect the ROE to fall (using standard deviations and such), but I don't do that. For me the beauty of the model is that it generally takes me no more than one minute to tell if a stock might be a candidate for me or not based on its current price and the results of a simple mental calculation with a few input variables. --------------------------------------- The problem that I have for using net present values calculations on dividends is that there are so few companies that pay dividends or that increase dividends that the subset of companies which could meet a NPV bogey is very small. Or perhaps I am not doing the calculations properly. Or maybe that small number is exactly what's required...all one might need are just a few good stocks. For dividend-paying companies I often employ a relative-dividend model. The idea being that when the dividend yield is relatively high, that signals a low stock price (and a buy). Similarly, when the stock rises and the dividend yield is lower than it usually is, it's time to sell. Dividend yields (stock prices) have fluctuated as interest interest rates have fluctuated. So a 7% dividend yield might not have been "high" for a particular stock when interest rates overall were at 8,9, or 10 percent). Therefore this model compares the stock's current yield to the relative yield of that stock to the S&P 500. My book reference here is "Relative Dividend Yield" by Anthony Spare. As an example, for Chevron from the 1960's through the early 1990's (a time when Chevron's dividend was increasing), it was a buy if you could get it when its dividend yield was about 160% or more of the S&P yield. And it was a sell in that timeframe when the dividend got down to 115% of what the S&P 500 yielded. Right now, CVX is a buy -- according to the model anyway -g- -- because its dividend yield (4.3%) is about 228% of the S&P 500 dividend yield (1.89%, per Barron's). Of course, one assumption is that the company isn't going to cut the dividend. What I find interesting about this model is that as the S&P yield increases because S&P stock prices drop (as is happening now), then Chevron becomes less of buy even if its dividend and its stock price remained unchanged.) Paul Senior