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

To: jsabelko who wrote (86)	9/14/2006 7:01:51 AM
From: bruwin	Read Replies (1) \| Respond to of 4080

At the outset, let me say, joby, that I believe it’s constructive to discuss and debate the merits etc.. of the criteria that one uses for company evaluation. There have been such a proliferation of ratios and theories in recent years that you have to wonder as to the effectiveness, or otherwise, of some of them. We’ve seen P/S, P/BK, P/CF, P/just about everything, DCF etc.. etc.. IMO a ratio or formula needs to be looked at from not only a "business perspective", but also from a mathematical standpoint. The end result of a ratio or formula etc.., will depend on the nature of the data, or input, that is fed into it. This is a mathematical fact and needs to be considered when using any ratio or formula. Let’s consider the "formulation" of Enterprise Value ... "EV is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents" (See "Investopedia"). Now probably the most important and substantive component of that equation is Market Cap., which is derived from ‘Price x Shares in Issue’. Therefore, at any point in time, the EV is particularly sensitive to the PRICE of a share. And at any point in time, the PRICE of a share is the result of what a Seller is prepared to sell and what a Buyer is prepared to pay for that stock. So in the shorter term, we are relying on the "efficiency" of "the Market" to provide us with a realistic Takeover Value of a stock. Well ... here’s an example of the "efficiency" of "the Market". About 2 years ago (May to Oct. 2004), on another Discussion Board (populated by many T.A.’s) there was tremendous enthusiasm for a stock, AHFI. The stock was climbing and folk were buying it up. After looking at its Financial Statements I concluded that this was a load of "horse manure", and said so. But I got shouted down. The stock climbed from $1 to $5 over a 6 month period. Eventually the true nature of its Fundamentals became apparent and the stock plunged to a fraction of a dollar in no time. It currently trades at $0.0001c. So in the period May to Oct. 2004 you had a great EV value. But a month later it was worth "peanuts". Needless to say, one example could be considered as no proof. But it goes to show the vulnerability of the formula, and questions its relevance in stock evaluation. On the other hand, if we look at the ratio of EBITDA to Turnover of two companies and we get 30% for company A and 5% for company B, we can conclude that A has a lot more Revenue left over than B at this level of the Income Statement, with the distinct possibility that a lot more money could end up at the Bottom Line, where it really matters. It also means that A is probably less "sensitive" to changes in fortunes than B, as it has more of a "cushion" to counter a reduction in T/O. It also means that B will have to increase its T/O by a far greater percentage than A in order to boost its Bottom Line by any appreciable amount. An increase of, say, 10% in A’s T/O will do wonders for its Bottom Line, whereas it will hardly cause a ripple in B’s. A good example in this regard is WalMart, who’s price trend is down in the last 2 years. It sits with an Op. Margin of about 6% and a Bottom Line of about 3.5%, i.e. $11 BILLION, of its T/O of over $312 BILLION. To add only $1.5 Billion to its Bottom Line, it would have to add about $45 BILLION to its T./O. It’s not likely to do that in the USA in a 12 month period. There are several other percentage ratios, calculated from within a company’s Financial Statements, that one could put together that give one important information about a company’s ability to generate wealth. And these ratios are generally derived from Factual numbers and not Market sentiment or other possible inefficiencies. I, too, invest for the longer term and base my decisions on what I glean from within the Income Statement and Balance Sheet, as soon as they are published. Thanx, bruwin