How to Value a stock
We received a one - two punch this week.
We've been hit but we are not knocked out just yet. Most of our holdings do not have high correlation with the general market (by design). If you read my past notes you kow that I was not very hot on 2nd & 3rd quarter of this year. The last six (6) trading days erased all of this years gains. Nasdaq is now in the red (negative). This was brutal and no one saw it coming. In fact, just last week Wall Street cheered ALL TIME high for the Dow30 index (new record).
The one punch was MATK. During May it went from $30 to $22 as of today. This is a bit too much. People are very nervous on this stock. Someone else is trying to move into the DHA market (MATK has enjoyed monopoly in this area so far). But please know that MATK has numerous patents in this. Customers has to pay royalty (3%) to MATK even if they don't buy DHA from Martek. As of today, I still believe that Martek's DHA is far superior to the fish oil DHA. Thus I bought more yesterday. If & when I change my views (if this goes below $20), I will let you know pronto.
The second punch was BTYH. Now, this one moved for no reason. I even called the company's investors relation guy (named AL); he said someone sold in the last hour and there was no one to pick it up. This happens to low volume stock like BTYH (avg daily volume of about 30K). Since I like the company's strategy and there seems to be no negative issues with the company, I have decided to buy more and lower my average cost. Just remember that this stock went from $0.60 to $$2.48 in two months (Nov - Jan 06). Let's see what happens.
I thought this was a good time to talk about how to value a company & it's stock. Let me begin by asking you a question. "If you have two identical houses built: one in New York and one in New Mexico, do they sell at the same price?". Of course not. The home value is relative to its neighborhood. That's why you need to know what prices homes go for in the area you wish to buy before you buy. Every thing is relative.
The MBA's use NPV (net present value) of all future cash flow model to calculate the value of a stock using risk free discount rate in the process. This is a bit too complicated for most people so I am not going to bore you with formulas (hated doing home works in this class). There are far more simple way to value a stock. Let me give you three:
Price to Sales Ratio (PSR): Generally stocks sell for 1-2 times its annual sales amount. Of course if a company is growing fast, it is going to fetch higher multiples. Example: IBM (PSR = 1.4) GE (PSR = 2.4) Coca-Cola (PSR = 4.5) Google (PSR of 16). Under 1 times annual sales is a great value.
Price to Earnings Ratio (PE): Always use next 12 months worth of earnings (net profit that is). Generally stocks sell for 15-20 times its net earnings. Example: IBM (PE = 13) GE (PE = 15) Coca-Cola (PE = 18) Google (PE = 30). Under 15 times earnings represent value. Obviously you need to estimate or the company gives you it's projections for next 12 months.
Price to Cash Flow (PC): I mean net operating cash flow for the last 12 months. Generally stocks sell for 6-10 times cash flow. Example: IBM (PC = 8) GE (PC = 10) Coca-Cola (PC = 17) Google (PC = 40). You get the picture. If a stock sells for under 6 times cash flow it is considered value (assuming the business is profitable and growing).
Now that you have some basis to work with, let me tell you why I have bought the stocks we have in our portfolios:
RICK: PSR=1.1 / PE=12 / PC=11
BTYH: PSR=0.45 / PE=4.5 / PC=3.5
Eric Langan (CEO of RICK) owns 26% of the RICK stock.
Eric's salary is $344K/year & owns 1.2 million shares.
Larry Lunan (CEO of BTYH) owns 36% of the BTYH stock.
Larry's salary is $72K/year & owns over 8 million shares.
Knowing this, what do you think? Do you think they are interested in making the stock go higher in the long run? I certainly think so. Remember, these are relatively new companies. There will be some growing pains. But I can tell you this. They are growing and they are profitable. Now you tell me what you want to do. Buy? or Sell? Hmmmm ....
One more time: Same business, the stock goes for 30% off sale. What do you do?
Hmmmm ... !
We've been hit but we are not knocked out just yet. Most of our holdings do not have high correlation with the general market (by design). If you read my past notes you kow that I was not very hot on 2nd & 3rd quarter of this year. The last six (6) trading days erased all of this years gains. Nasdaq is now in the red (negative). This was brutal and no one saw it coming. In fact, just last week Wall Street cheered ALL TIME high for the Dow30 index (new record).
The one punch was MATK. During May it went from $30 to $22 as of today. This is a bit too much. People are very nervous on this stock. Someone else is trying to move into the DHA market (MATK has enjoyed monopoly in this area so far). But please know that MATK has numerous patents in this. Customers has to pay royalty (3%) to MATK even if they don't buy DHA from Martek. As of today, I still believe that Martek's DHA is far superior to the fish oil DHA. Thus I bought more yesterday. If & when I change my views (if this goes below $20), I will let you know pronto.
The second punch was BTYH. Now, this one moved for no reason. I even called the company's investors relation guy (named AL); he said someone sold in the last hour and there was no one to pick it up. This happens to low volume stock like BTYH (avg daily volume of about 30K). Since I like the company's strategy and there seems to be no negative issues with the company, I have decided to buy more and lower my average cost. Just remember that this stock went from $0.60 to $$2.48 in two months (Nov - Jan 06). Let's see what happens.
I thought this was a good time to talk about how to value a company & it's stock. Let me begin by asking you a question. "If you have two identical houses built: one in New York and one in New Mexico, do they sell at the same price?". Of course not. The home value is relative to its neighborhood. That's why you need to know what prices homes go for in the area you wish to buy before you buy. Every thing is relative.
The MBA's use NPV (net present value) of all future cash flow model to calculate the value of a stock using risk free discount rate in the process. This is a bit too complicated for most people so I am not going to bore you with formulas (hated doing home works in this class). There are far more simple way to value a stock. Let me give you three:
Price to Sales Ratio (PSR): Generally stocks sell for 1-2 times its annual sales amount. Of course if a company is growing fast, it is going to fetch higher multiples. Example: IBM (PSR = 1.4) GE (PSR = 2.4) Coca-Cola (PSR = 4.5) Google (PSR of 16). Under 1 times annual sales is a great value.
Price to Earnings Ratio (PE): Always use next 12 months worth of earnings (net profit that is). Generally stocks sell for 15-20 times its net earnings. Example: IBM (PE = 13) GE (PE = 15) Coca-Cola (PE = 18) Google (PE = 30). Under 15 times earnings represent value. Obviously you need to estimate or the company gives you it's projections for next 12 months.
Price to Cash Flow (PC): I mean net operating cash flow for the last 12 months. Generally stocks sell for 6-10 times cash flow. Example: IBM (PC = 8) GE (PC = 10) Coca-Cola (PC = 17) Google (PC = 40). You get the picture. If a stock sells for under 6 times cash flow it is considered value (assuming the business is profitable and growing).
Now that you have some basis to work with, let me tell you why I have bought the stocks we have in our portfolios:
RICK: PSR=1.1 / PE=12 / PC=11
BTYH: PSR=0.45 / PE=4.5 / PC=3.5
Eric Langan (CEO of RICK) owns 26% of the RICK stock.
Eric's salary is $344K/year & owns 1.2 million shares.
Larry Lunan (CEO of BTYH) owns 36% of the BTYH stock.
Larry's salary is $72K/year & owns over 8 million shares.
Knowing this, what do you think? Do you think they are interested in making the stock go higher in the long run? I certainly think so. Remember, these are relatively new companies. There will be some growing pains. But I can tell you this. They are growing and they are profitable. Now you tell me what you want to do. Buy? or Sell? Hmmmm ....
One more time: Same business, the stock goes for 30% off sale. What do you do?
Hmmmm ... !
posted by Jaewoo | 11:41 PM
1 Comments:
Having a reserve sounds nice.
Take advantage of short term mispricing by buying when stocks sell at a discount. But let's say you have a reserve $ and saw the opportunity to jump in on a stock. Now, where is your reserve?
Reserve sounds nice but money we need is endless :-)
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