What do you look for when finding value companies?

[borat]

Hi all,

When looking and doing research when trying to find an undervalued stock/company, what criteria do you look for?

Market Cap
PE
Stock Price
Announcements etc...?

Would like to hear your thoughts and suggestions on what you consider important and effective methods when looking for undervalued stock that have SP growth potential...

Thanks.

B.

 

[Realist]

Quite simply I look for a low price to average earnings over the past few years. Particularly for a company with slow and consistent growth.

A low price to current earnings can be misleading - one bad or good year sways figures, a low price to forecasted future earnings is prediction and should be avoided.

 

[ducati916]

Quite simply I look for a low price to average earnings over the past few years. Particularly for a company with slow and consistent growth.

A low price to current earnings can be misleading - one bad or good year sways figures, a low price to forecasted future earnings is prediction and should be avoided.

Agreed, up to a point.
The quality of those earnings requires analysis to provide a true margin of safety. Poor quality earnings can even over the aggregate, mislead the unwary.

jog on
d998

 

[Realist]

Actually I forgot to mention you also need to work out what the companies Net Tangible Assets are as well.

Simply their Assets minus their Liabilities.

There's no point in buying a company that makes $1M in profit each year but owes $50M in debt.

But a company with $50M in assets that made a small loss last year, but has a market cap of only $30M is probably well worth buying.

 

[ducati916]

Actually I forgot to mention you also need to work out what the companies Net Tangible Assets are as well.

Simply their Assets minus their Liabilities.

There's no point in buying a company that makes $1M in profit each year but owes $50M in debt.

But a company with $50M in assets that made a small loss last year, but has a market cap of only $30M is probably well worth buying.

On superficial examination, this would seem to make good sense. However, without an understanding of the Capital structure, and the cost of capital, you can miss out, as highly leveraged businesses can make for very profitable investments. For example, in Australia, and on these boards, the majority would feel comfortable holding say CBA or NAB, banks however are massively leveraged common stocks.

Using NAB as an example of a highly leveraged common stock, against VCR, a 100% common stock capitalization. VCR is a speculative common stock, while NAB is considered as a blue chip common stock.

The composition of the assets/liabilities is a further consideration. Assets recorded at Book Value, may bear no resemblance to actual realizable value, they may understate or overstate the value by a very wide margin, as they are recorded at cost, and depreciated, or, amortized, depending on the asset. The liquidity of the asset/liability would also be an important consideration, although in dislocations, otherwise high liquidity can dry up.

Again, to reiterate, the quality of earnings & cash-flow are the prerequisites to an analysis of a leveraged, or unleveraged capital structure, not GAAP earnings, that can be manipulated a dozen different ways. Banks, are especially prone to off-the-balance sheet liabilities, that increase their leverage at most inopportune moments, and thus complicate even further the superficial methodology advocated in the previous post.

jog on
d998

 

[tech/a]

Duc.

Your no Dumby.

How is it then that you have been able to find a company/s which are/is undervalued (in your exercise) and they fall a further 50% in SP?

Now while I'm using your example in no way am I saying its isolated to yourself.

 

[TheRage]

On superficial examination, this would seem to make good sense. However, without an understanding of the Capital structure, and the cost of capital, you can miss out, as highly leveraged businesses can make for very profitable investments. For example, in Australia, and on these boards, the majority would feel comfortable holding say CBA or NAB, banks however are massively leveraged common stocks.

Using NAB as an example of a highly leveraged common stock, against VCR, a 100% common stock capitalization. VCR is a speculative common stock, while NAB is considered as a blue chip common stock.

The composition of the assets/liabilities is a further consideration. Assets recorded at Book Value, may bear no resemblance to actual realizable value, they may understate or overstate the value by a very wide margin, as they are recorded at cost, and depreciated, or, amortized, depending on the asset. The liquidity of the asset/liability would also be an important consideration, although in dislocations, otherwise high liquidity can dry up.

Again, to reiterate, the quality of earnings & cash-flow are the prerequisites to an analysis of a leveraged, or unleveraged capital structure, not GAAP earnings, that can be manipulated a dozen different ways. Banks, are especially prone to off-the-balance sheet liabilities, that increase their leverage at most inopportune moments, and thus complicate even further the superficial methodology advocated in the previous post.

jog on
d998

Very True analysis and sometimes hard to grasp the above concept. I smell an accountant in our midst.

 

[ducati916]

Duc.

Your no Dumby.

How is it then that you have been able to find a company/s which are/is undervalued (in your exercise) and they fall a further 50% in SP?

Now while I'm using your example in no way am I saying its isolated to yourself.

Simply as not all the portfolio would classify as undervalued. Some are examples of relatively cheap growth [OFIX] and some are turnarounds, [SGTL, KND, CQB, CTT, FORD] some are legitimate undervaluations [CAR, WON,] and some are undervaluations that have become increasingly undervalued [CALL, TOL, EVCI,]

But to answer the question directly, the market is made up of a number of disparate trading & investing strategies, thus, the market price can at any given time diverge widely to the high, or low, of a rational economic valuation. However, given time, economic forces will result in a fair value for a period, even if it is only in passing.

Thus, undervaluations will rise, and overvaluations will fall. The "when" becomes the unknown factor, investors in undervaluations can still earn a return via dividends while they wait for that revaluation. Technical traders however trade time and price, which is an alternate reality.

Thus I am quite prepared to sit the downturn out, confident that within the timeframe allotted, the stated profit will materialise.

jog on
d998

 

[bvbfan]

Since I trade commodity based stocks I look at the targetted commodity. I also look at the market cap, number of shares (diluted)
Location helps too, especially nearlogy to big finds.

If they have proven reserves/resourcse that are JORC compliant that helps too. With this you could calculate a rough in situ value which I use to try and work out a value for the company.

Past picks using this
OXR @ 10c
PNA @ 4.5c
CNT @ 25c
AIM @ 4.5c
AGS @ 25c
MMN @ 10c
EQN sub 50c
CMR sub 50c
BSG sub 50c
PEM sub $1c

Of those, some I never got filled on shares

Worst shares I've got through this are
PAS -30%
RNG -25%
TTR -50%
BDG -40%
KGL -50%

At the moment I'm holding or looking at
ADY, ARE, CGM(O), COE, CYL, DML, GUN, HER, IBR, MOL

The ones in bold are the ones I'm particularly keen on and naturally hold

 

[Knobby22]

Look for sectors out of favour.

Look for companies not infested by traders yet (I got on APG, look at it now, completely infested, so much so that it goes down on good news!).

Look for where traders have panicked and buy in.

Look for small companies with good businesses that get overlooked (especially if they are not very liquid).

Look at a three year time horizon when looking at value. Inveasting with a medium term horizon is such an easy way to make money.

Look at earnings growth and debt impairment.

Generally I ignore assets as irrelevant.

The game is to understand how a company works and see where short termism provides an obvious buy. An easy example is buying insurance companies during 9/11. Have a look at the Australian ones and how much money you have to make.

Also it is good to understand the traders as they make more of the market now, you can see their actions and can beat them at their own game. One thing I love doing is buying before the traders buy, sell at the peak which are pretty consistant and then buy back in a week or two later.

Be smart! Don't be egotistical. If it is not going as planned you may not know something, don't be afraid to look again.

 

[Sean K]

Price to Sales Ratio seems to be a clear indication of value. Recommend 'What Works on Wall Street' by James O'Shaughnessy.

 

[nizar]

and some are undervaluations that have become increasingly undervalued

...always a problem isnt it....
Duc, why not find an undervalued company as per your strategy, but only buy it after the share price has stopped going down?

 

[Freeballinginawetsuit]

...always a problem isnt it....
Duc, why not find an undervalued company as per your strategy, but only buy it after the share price has stopped going down?

And bottomed to a proven support!

 

[Realist]

why not find an undervalued company as per your strategy, but only buy it after the share price has stopped going down?

Haha, how can you possibly know when a share has bottomed?

Let me guess, wait for it to hit bottom and to recover - but recover how much before you are sure 1% or 15% or what exactly?

You can't hit the exact bottom in my opinion, and you can not tell if a share has "stopped going down" either. You could buy a share and a massive terrorist bomb goes off the next minute and all shares plummet.

The answer of course is the margin of safety. As long as you are sure the odds are in your favour, ie the share is cheap enough with margin to spare, then you should buy the share regardless of whether others think it has hit rock bottom, or whether astrologers believe it is going up or down.

 

[Judd]

See if the co is financially stable so check the long-term debt and reasonably stable or rising earings. If the lenders effectively own the company, walk away.

If it makes a profit, look for dividends and the pay-out ratio. 60% pay-out generally Ok. If the ratio is more than 100% them ummm, unless it is a special.

Do not like the idea of company retaining all profits and saying Look at the share price! Just let's the CEO and management stuff up with all my cash in their hands - BHP, AMP spring to mind. It has been estimated that BHP has wasted more than $30 billion in shareholder funds through poor mangement decisions (eg, selling its holdings in Woodside, Magna copper, HBI, etc) Fortunately the co survived.

Not adhering by the first two sentences cost dearly. Fortunately, we also survived.

 

[ezyTrader]

Hi guys,

Wondering how do you calculate "value" w.r.t. market cap? Where can you find the info about number of shares diluted and undiluted?

Cheers!

 

[sunlover]

Hi Borat

I use my own spreadsheet model to determine if a company is good vakue according to my own criteria.

I look at:

1) The financial health of a copmany using the Altman Z-Factor (plenty of info on the www if you google it)

2) Companies also have to have a minimum ROA, minimun ROE, minimun EBIT margin, minimum working capital ratio, maximun debt to equity, stable profits/dividends and a minimum dividend cover.

3) PEG must be less than 1 and PER must be less than what I consider to be a fair PER.

4) I then look at the potential 2 - 3 years return (capital + dividends) and it must be at least 10% greater than my risk-free return for the 2-3 years.

My spreadsheet determines whether a company passes or fails each of the above tests which are weighted according to my view of importance.

The model then spits out a buy or sell recommendation based solely on my fundamental criteria. If the recco is "buy" I then look at the price chart to determine a hopefully optimum buy price.

In summary, my spreadsheet model operates on similar concepts to the Lincoln Indicators.

 

[ubid]

Has anyone mentioned good management? or proven management?

Its no good having a undervalued stock with crooks running it!

Ubid

 

[ceasar73]

Has anyone mentioned good management? or proven management?

Its no good having a undervalued stock with crooks running it!

Ubid

True. Hard to do this. Lynch suggests investing in companies that an idiot could run b/c it is likely an idiot will be running it one day .

ceasar73.