Monday, December 22, 2014

Random thoughts: silly's valuation method

There are tons of valuation methods out there. You name it you have it.

Do note what I am saying here is my own view, I am not insulating any view of the merits or lack of the valuation method.

PE and PB are child play when u look at reproduction cost basis, DCF, DDM, ROIC, WACC, EV etc... 

The convention wisdom is used a range of valuation metrics for the right category of investment.

What do I mean? 

If u doing asset play, most probably u need to break down all the balance sheet, look at intangibles etc, look at reproduction cost ( see B's blog post)

If u want stable yield, then FCF, DCF, DDM, etc

So what is my point?

I think it is important to have a story backed by numbers and not a story of numbers.

Why? Because numbers are highly dynamic, fluid. It is the story ( moat analysis, business anaylsis that is more stable) 

Is a business a lousy business just because it has a few quarters of poor results? Is the business doom to ridiculous valuation just because the industry outlook is bleak? 

Be careful of extrapolation pitfall. When a company is doing well, analysts like to extrapolate that it will continue to grow, just read aerospace analysis just 6 months ago. Similarly, when a sector is not doing well, analysis like to extrapolate the downward trend too. 

Not that it is wrong to know a industry outlook, but it is of vital
Important to realised that good news is negatively correlated with valuation. Vice versa.

A company, or a good one, with moat, do not disappear because it is facing business challenges.

Yes, profits might plunge and if u are purely looking at numbers, you will think hey, the valuation is not that fantastic. 

But, when the news is good and the profit  soaring, the valuation will be not fantastic too. The only time to get fantastic valuation is during severe bear, like the AFC or GFC, but by then, u need not valuation method. Like uncle temperament said: put up a dart board with solid blue chips ( strong balance sheet and still eking profits) , close your eyes and throw your darts. Keep your balls with you and buy. By then, all that is needed is capital and balls, not so much knowledge. 

When market is not at a bear, then valuation method is important. But the business is of paramount importance. The business makes the numbers, not the other way round. People make the business. 

So, when I look at a business. I only ask the following.

Is balance sheet strong?
What is the yield? 
How sustainable is the yield?
What is the foreseeable growth? ( growth can compensate yield, SPH need higher yield as growth is missing as compared to SSC) 
Can I average down with balls intact when correction happens? 

These are the broad questions. To answer these questions, you need numbers but also qualitative analysis which is equally important, such as customers analysis, competitors analysis. 

After looking at this, I ask myself, what is the bad case scenario yield? Worst case means bankrupt. Look long term. 

E.g. Lee metals. Iron ores and steel
Price is falling off the cliff, next quarter of it is still making profits, ( which I strongly believed it will, although margins might suffer) mean it should do ok in a competitive commodity environment, at least until 2020 with the boom of construction In singapore. Assume 1.5-2 cents dividends, yield is very decent. Multiple it by 5 years. What is the MoS for capital loss? And that price if dividend is maintain, what yield are one looking at? 

U might think then one might be better off buying bonds which guaranteed 3-4% and long term CARG of 30-40% in a decade.

In equities, I plan to not loss money, and hopefully in the process, pick up some bonus. 

My way might not beat the bonds or index investing. But I am comfortable with it, and I find company prospecting interesting and intellect stimulating. By analysis on company also go thro LDMR and in particularly the number part. The qualitative part is what intrigue me now. 

For example, when I am reading Keppel, MTQ, SCI, Sembmarine, i go straight to the business analysis and review than mugging the numbers. What is their strategy? What are their new products, what are their views? 

The new CEO of Keppel is less forthcoming than MTQ in details is how I feel when I read their AR. 

In short, look beyond numbers. Numbers are more misleading than reading a story with numbers. Numbers do not make a story, words do. 

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