Arbitrary value investing help

Sinner,

This probably isn't exactly what you are looking for (it does have some fuzziness --- estimation -- in it) but it might be worth having a look...

http://www.oldschoolvalue.com/blog/valuation-methods/value-stocks-like-a-pro-absolute-pe-model/

odds-on said:

Ves,

Do you think it is actually possible to "value" companies in the ASX20? IMO a company becomes so big it is actually impossible to value them due to the size and complexity of their business operations. Everytime I try and read a Big 4 annual report I get a headache. The larger a company becomes the more it becomes just a "stock" and bar a few cursory balance sheet checks (current ratio, debt levels) it really is a case of understanding how they fit into the ASX "system" and using the correct valuation ratio.

Personally I think dividend yield is very important in the ASX20, especially with the stable earners. Outside the ASX20 I reckon the Price to Sales Ratio used in conjunction with the Current Ratio is a very useful screen.

Cheers

Oddson

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It is possible, but obviously harder because there are so many factors involved in a large diversified company. In essence you have to break it down into its individual parts and value them separately. The main issue lies in the fact that there is so much information out there on the ASX20 that the market does not become irrational in selling them down very often - they are generally priced pretty well for the economic conditions, so very hard to get a big margin of safety.

I agree though - it is a headache. Most of my bank valuations are, as you said, "guessimates" presented on the basis of the sustainability of their dividend yield & earnings profile going forward. I think you could, as you said, potentially do the same with the other ASX20 industrials, perhaps not for the miners however as they do not seem to pay much out in the way of dividends.

sinner said:

Very good reply Ves, you have given me a few things to think of which I hadn't considered:

It seems like in your case, there is "a number", around 8 at which you would start getting interested, but then another multiplier is applied to the number to get a real opinion rating.

For example default value interest for you might be 8, and then for a company like MQG where one could easily think of a few obvious fundamental caveats we subtract one P multiple for each caveat (or divide by the total number of caveats) to get your "real value" opinion of P/E around 3-4.

That is a pretty interesting concept on its own.

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Sinner - this is something I have definitely thought about. However, in my reply to you was done moreso on intuition than any definite system.

Although, as you noted, I did consider quite a few caveats to each P/E ratio I came up with. You are correct, and in most of my investing a P/E of 8 sounds friendly with no major caveats to consider. Then obviously you work backwards from here and take into account capital structure, future growth and earnings risk, business risk and all that sort of thing. If any of these come up short obviously you require a lower P/E (or in my case some of these things mean that I instantly move on). Also possible for adjustments to be made upwards for quality businesses and so on in which you would be comfortable in taking on a riskier multiple. To me, it is almost like an inverse DCF or looking at the required rate of return in a different manner than most people. It means that the company has an earnings yield of 12.5%. As craft said, it is dangerous to just pick a ballpark figure of 8 and assume that means "undervalued" but I see potential in choosing a figure that sounds OK as a starting point and working from there. It's my version of the "back of the envelope" calculation.

The main issue is that a lot of the important issues (at least to me) that I mentioned are not quantitative in any way, so it may be hard to develop a precise system based on any sort of criteria that actually produces accurate results. For an example of one that does not work, check out Skaffold!!