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

To: Paul Senior who wrote (61735)	2/20/2019 10:13:11 AM
From: Graham Osborn	Read Replies (1) \| Respond to of 78715

To be sure, no metric is perfect. The only gold standard is to calculate the liquidation value of the business today and then add the discounted value of anticipated future cash flows (leaving a massive margin for error). The problem is that very few accounting quantities mean the same thing in all situations. Net income can be overstated for a host of reasons including non-operating income, high CapEx, or improper reserve development. Operating cash flow can be distorted by neglect of economic amortization charges, neglect of stock-based compensation, and then of course any distortions on the net income side of things. Free cash flow suffers from all the above plus the question of how investment and financing cash flows should be treated (for example, if SBC is neglected, perhaps buybacks should be deducted from free cash flow numbers instead). On the balance sheet side, book value may reflect large historic capital requirements for the business that have little to do with current ability to generate returns on capital. Relatedly, book value in recent years has tended to be heavily weighted towards goodwill and intangibles for asset-light businesses. Personally, I think the price/ tangible book values of Facebook and Google are among the most reliable indicators of their true valuation. You will note that book value and tangible book value are not widely disparate for either company, with is an indication they are being managed for organic growth rather than through serial acquisitions. Of the 4 metrics I typically screen with - EV/ Rev, EV/ EBITDA, P/ TB, and P/ E - P/ TB is probably the most reliable. EV/ Rev neglects margins, EV/ EBITDA and P/ E neglect CapEx. P/ TB is probably the metric least susceptible to distortion for industrial companies, partly because it's not a metric widely followed by analysts and therefore not widely manipulated by managements. The second most useful metric is probably EV/ Rev, again because both of the inputs are fairly objective quantities. In the case of Facebook and Google, you will note these 2 metrics provide similar indications of current valuation: P/ TB: FB 7X, GOOGL 5X EV/ Rev: FB 8X, GOOGL 5X You might wonder why I don't screen with EV/ FCF if FCF is the gold standard. For one thing, FCF tends to be highly variable from year to year in companies with large orders coming in (e.g. semi/ semi equip) or inventory management issues. Also FCF nearly always needs to be adjusted based on individual judgements. This subjectivity doesn't lend itself well to stock screening.