Wednesday, March 14, 2012

Fair Value Measures

There are many ways to be a "Value Investor". There are people who uses deep quantitative statistical methods. There are people who use qualitative methods only. There are people who use a mixture of both.

Using a Relative Analysis
I use fair value as a way to feel more confident about the selection I have made. It is an arbitrary, relative measure best looked at as a range of price values; Not a line in the sand, hard black or white number used to trigger actions, but as an estimation of relative value to the sector. I use Benjamin Graham's Number to measure the bottom-line. The P/E is the current S&P average P/E and the P/Bv is the top 20% percentile. Currently that's an average P/E of 14.8. Other metric can be employed. You can experiment. For example, use Shiller's 10 year historical average P/E as the average metric.

Stocks that have no earnings or that have negative book value are not measurable. You can take a historic 5 year average earnings. The negative book value is hard to get around. Skip down to the next experiment below.

Benjamin Graham never intended his formula to be used as a gauge to measure how valuable a stock has become. It was to be a guide, which he actually abandoned later. But the one thing Graham had was an adaptable, flexible outlook that changed with time. He loved to experiment.

Expanding your scope
What if you wanted to expand this small universe of stocks.
How does your stock stand-up compared to its peers in revenues? Does your company not have any earnings for the last few years?

Let's use the same principle on the top-line figure. Using P/S and P/Bv. I am using the top 20% percentile of both P/S & P/Bv as the top-line fair value figure.

Now you have the bottom-line and  top-line figures covered.

No revenues? What about EBITDA? EBIT? enterprise value?

Sometimes the Value is Still Unknown
OK. Take the housing sector. The earnings are terrible and the book values have been decimated. But you know there is value there because the housing market volume is at historical 50 year lows.
OK. Back to the other value analysis methods. Statistically, the relative financial values don't stack up with the potential value.

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