Giving Each Dollar A Job

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Source: Investopedia

There's many methods of valuation out there as well as many methods of modeling.

These usually help us to determine if it is expensive or cheap, in other words, buy or not to buy, and even buy or sell.

My method of valuation for entries (I'm still struggling with exits, other than if the stock fundamentals has changed beyond my original expections, cutting losses or trading the counter) is kinda simple (probably even oversimplistic and lazy ^^").

It is very similar to a blogger's post here (Thanks XL!).

Here's the summarised post if you're lazy to click the link:
These are the 3 main valuation tools that people use when trying to quantify the value of a stock.
P/E - (Price to earnings)
It can be seen as how may multiples are you willing to pay for one years worth of earnings (earnings per share). This is the most widely used multiple which is used for companies with constant earnings, which can be found by seeing whether your stock falls under any of the 3 categories below
  1. make money by selling inventory (i.e. Thai Bev, Breadtalk, Super Coffee, SPH, Osim)
  2. Has a 'moat' in a mature industry (i.e. SGX, Dairy Farm, Comfortdelgro)
  3. provide constant services (i.e. SIA Engineering, ST Engineering, Kingsman, Silverlake, Raffles Medical)
Even such the P/E for all these companies shouldn't be compared to one another (For example Osim P/E is about 14x while SGX is 20+)
In general the more resilient the stock is to downturns + the larger its moat the higher the P/E
So F&B stocks with a good brand name (Thai Bev), Medical stocks which are resilient to downturns and have a moat (Raffles Medical) can easily trade up to 20x.
P/B - (Price to book)
The multiple that you are willing to pay for the book (net asset value of the firm). This is mainly used for firms that rely on their book (net assets) to generate profits.
These firms usually make rely on their long-term fixed assets to make money. This is unlike firms that use P/E where they rely on the stuff they make/services to earn.
This involves having a expensive/huge asset that the firm mainly relies on to generate its earnings, or a backlog it has (projects that the firm won but will take 5 years to complete) which can be converted to earnings in the future.
These stocks include Airlines, Offshore & Marine, Property, Banks and Commodities.
Here's the shocker, in general most firms are supposed to trade at a discount to P/B (except for banks). So everytime you see a stock that has 0.8x P/B please don't rush in and buy it.
EV/EBITDA - (Enterprise value to Earnings before Interest, Tax, Depreciation and Amortization)
To be honest, only people the want to look all sophisticated use this when valuing a stock. Anyway its mainly used for companies that have high start up costs and then have very little costs afterwards (and can afk while making money)
Generally used for telcos and casinos, where you spent a huge amount of cash building up a network or casino, and life after that is pretty much on autopilot.

However, instead of EV/EBITDA, I use another metric. Why?

Three Reasons:
  1. Due to Buffett words on EBITDA in his AGM 2002 and 2003.
  2. I am lazy. EV is a pain to calculate on the fly, then to reverse it to get the price I am looking for is also a pain (just imagine, intraday, the share plunges, I can't see it and immediately give a good estimate on whether it is a buy or not)
  3. It doesn't work well with my valuation strategy which is more focused on price at the moment.
That means Price/EBITDA (an alternative metric to EV/EBITDA) is also out of the question due to point 1.

So I decided to consult Google on other metrics which was used in place of EV/EBITDA. Sure enough, I found another metric:

P/CF - Price to CashFlow
Based on my uses, the only type of company that uses EV/EBITDA multiples is a telco, which this ratio is another good alternative. The sources for the suggestions are here and here. Do note that it is Operating CashFlow and not Free CashFlow.
Kinda like a proxy to EPS, where I use OCF per share instead. This is also easier for me as I use Earnings Yield (in addition to dividend yield) for easy comparison against other instruments (such as bonds and CPF).

But will it work? Time will tell I guess (so you might not want to follow me on this ^^").

Do also note that I don't really determine intrinsic value (I'm not a value investor), I'm more about just determining empirically whether it is cheap, expensive or fair.
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So, now we have the tools, how do we determine whether a particular counter is undervalued or not?

One way is to compare it across the sector/industry (best method I feel), but so troublesome ^^".
So being lazy, I decided to use something similar to an oscillator in technical analysis (think Stochastics/Relative Strength Index/Commodity Channel Index)
Courtesy of StockCharts.com
(Just a note: Don't bother using all of them they show more or less the same picture, it is natural for them to confirm each other despite the slight differences in calculations)

I use historical valuation ranges to determine undervalued (in TA sense, oversold) and overvalued (overbought) prices.

This is based on the idea I got from a book, "Dividends Still Don't Lie", where the dividend stocks I picked are mostly large stable companies which will tend to swing within a range of prices.

So using this idea, I created an example using Comfort Delgro (I used the price at the point of the annual report for each year, actual price will actually bounce much more between the ranges).


So, this kinda works as a proxy of value to determine where the current price is at the moment from historical ranges. As a side note, one can theoretically buy and sell at each extreme ranges in a trading system (a possible suggestion too in the book "Dividends Still Don't Lie").

Of course, as my strategy goes, my technical analysis must trigger a entry which then would be confirmed by this method.

Hopefully it prevents me from buying at tops while allowing me to bottom fish at decent prices. :)


And we are done with this long post. :)

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