OFF TOPIC -- valuation/portfolio selection pros & cons
All right, let's forget "enterprise value." Your point seems well taken.
On to the next one:
..Valuation models don't work worth a damn!
Spoken in heat, no doubt, but you don't really subscribe to the above sentiment entirely. Otherwise, you would not use the peg ratio (derived from the p/e ratio, after all) in portfolio selection.
I would also submit the following thought for your consideration: valuation models CAN work even if they are all wrong. In other words, if everybody believed that present p/e ratios, price/sales ratios, and price/cash flow ratios should be rock-bottom low, then everybody would shun stocks with high ratios, even if everybody was wrong to assign so much importance to the ratios. In other words, if people act upon a misperception, on a "myth," as it were, that "myth" becomes reality.
And judging from the number of lances you have been breaking on the DELL thread lately, you are clearly aware of the threat posed by such "myths."
....The [valuation] models are incapable of incorporating multiperiod growth in cash flows, properly estimated risk-adjustments for discount rates, and cash inflows into the equity markets...
Question (simple & not invidious): is it possible to estimate the first two, and wouldn't "cash inflows into the equity markets" affect all stocks equally (and therefore be less useful in evaluating individual stocks)?
Now, on to the "Chuzzlewit method of investing."
No objections! (Fancy that!) But why not expand the first criterion -- long-term earnings growth -- to include long-term sales & cash flow growth as well. (If you run a screen to identify companies with just long-term earnings growth, you turn up quite a few weird -- that is, suspect -- outfits.) And as for "good free cash flow", let me point out only that the tech stars in your own portfolio do well even if you use the conventional method of estimating free cash flow -- especially, of course, DELL.
But...and be advised that I have now moved into Attack Mode...not all the stocks you have said you own conform to the standards you have laid out.
Actually, DELL, PSFT, HBOC, and TLAB ace your first four criteria. But where the PEG ratio is concerned, they have had such good price runs that they should now be considered "fairly valued" or even "over-valued," in relation to the over-all market as well as to their own industry. Let's take DELL as an example. Since Telescan uses "company growth ratio" rather than "peg ratio" (the same thing, but calculated in reverse), I will just give DELL's percentile rankings: peg ratio --38th percentile; peg ratio/industry peg ratio - 49th percentile; peg ratio/S&P peg ratio -- 33rd percentile.
Some folks sell (or say they sell) the stock of any company they own, no matter how good the company, once it reaches "fair value." Others hang on to the stock of a good company, arguing that investors should be -- and are -- willing to pay a premium for it. If you belong to the second category, then perhaps you should drop the PEG ratio as a criterion.
(Here follows a digression.) For me, this is a crucial issue. The absolutely best performer in my portfolio is Schering Plough. It was bought for me, not by me: I would probably never have bought SGP myself, because of its very high valuation ratios and its very low PEG (something like .4!).
So I'm looking at it, and wondering, why are people paying such a premium for this stock? It has a good growth rate, but not an outstanding one. It has real drawbacks (like the valuation ratios). What is it? Well, on checking it out, I see that it aces (by a mile) every other firm in its industry, and most others as well, on four things: gross margin, Return on Assets, Return on Equity, and EPS Consistency (it scores in the 99th percentile for 5-year and 10-year consistency -- extraordinary).
I then ran a screen to identify companies that had the highest possible EPS consistency, highest possible ROA, and highest possible ROE. SGP came out on top (first runner-up, MSFT; second runner-up, KO; TLAB -- in 12th place; DELL did not place -- only 85th percentile EPS consistency). And all but three of the 25 "finalists" had outstanding price performance over the years. Clearly, investors are willing to pay a premium for predictability, at least! So I am not about to sell SGP; the tax consequences alone would forbid it. (Running a screen just for ROA and ROE -- dropping the EPS consistency criterion -- produced a slew of "weird" companies, evidently recognized as such by investors, since they have peformed poorly pricewise.)
Now, back to your stocks.
ASCEND. How did this white crow end up in your flock? Unimpressive growth rate, negative free cash flow, and low peg (not to speak of price volatity -- when I owned it, everybody called it "DESCEND").
TYC. I bought TYC in 1986 for around $5 and it's now around $54 the last time I looked. So that has given me a 24% per annum yield (plus a small dividend), and I see no reason to sell after 11 years!
But when was the last time you looked at TYC's growth rate? Its 5-year growth rate is something like -35% (don't remember exactly), and although analysts apparently predict better days ahead, TYC is still sporting a negative p/e. So, wouldn't you say that its long-term growth story is compromised? (I wouldn't sell it either -- but only because of taxes.)
Eagerly awaiting your response!
jbe
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