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Price/earnings
ratio. Take the stock Earnings yield. This ratio is simply P/E
turned upside down as E/P that is, earnings divided by price. Analysts
use this form because it allows for interesting historical comparisons
with dividend yields. The English also use earnings yield sometimes
because they're, well, English. Take the annual dividend rate
and divide by the share price.-there's a trailing figure based on
dividends paid over the past 12 months and a projected figure
calculated by taking the most recent announced quarterly payment and
converting it to an annual figure (on the theory that in the future
the company will continue with any recent dividend increases or cuts)
. Sometimes analysts will project a dividend rate for the corning
year. But since dividend increases are fairly small from market's
2.5%, but it would have been below average in the last couple of
recessions.
Compare a stock to
its industry. Has the entire industry been getting cheaper, like drug
Stocks during the early part of the Clinton administration, when kooky
health care plans were the rage? lf so, ask yourself whether you think
a stock group's decline is over. What signs would show that the group
has naturally hit bottom? If in doubt, wait. You'll get a higher
annualized return if you're a little late than too early.
Take a hard look at
the company's financials. Especially if a stock is a lot cheaper than
its industry, check the company's financial Strength carefully. it's
entirely possible that the firm will be in trouble. Often a stock will
carry a high yield on paper because no one believes the full dividend
will be paid.
WHAT THE IMPORTANT VALUE MEASURES MEAN
At this point you may
be wondering whether you can analyze value stocks by yourself, what
with all the calculations you have to do and the judgments you have to
make. And that's a fair question. Many stock analysts would disagree
with me, but if your only source of information is the Wall Street
journal, I think it's a lot easier to pick a big growth stock or an
attractive income stock than to select a solid undervalued company at
the right time. After all, you could have made a fortune in technology
growth stocks such as Microsoft or Intel just from knowing about
computers who cares if you weren't really sure how to calculate those
companies' net asset values per share.
The reality is that
when it comes to value investing, you have to have some source of
reliable information whether it's a broker or research services such
as The Standard & Poor's. At a minimum, you need a Source that can
analyze year to year, analysts usually do this only with utility
stocks, where small differences in total return matter a lot.
Price/dividend ratio.
This is the dividend yield turned upside down (from D/P to P/D). Like
earnings yield, it's used mostly for historical market analysis. For
example, one naught want to compare the market's average P/E ratio to
its P/D ratio over the past 60 years to look for significant patterns.
Price/book-value
ratio.
This is the third of the essential trio of value measures (after P/E
and yield) .To figure it, you subtract all of a company's liabilities
from its assets to get shareholders' equity also known as book value.
Then you divide the share price by this number. Basically this is
similar to the net net asset calculation .The salient difference is that the net
net asset calculation is based only on cash or assets that could be
converted to cash relatively easily, while book value is based on all
assets- including a company's property, plant, and equipment. Further,
since manufacturing assets and the like can't necessarily be converted
into cash, they are valued at their actual historical cost, less
whatever allowances have been made for depreciation. This may sound
like a minor technical point, but it actually makes book value a
highly unreliable number.
For starters, there's no
guarantee that the amount of money a company spent on an asset has any
relationship to what the asset is worth now. Second, because inflation
has been so enormous over the past 30 years, the historical cost of
assets depends a lot on when they were bought. A factory built last
year could be on the books at four times the value of one built in
1969. But that difference would consist almost entirely of inflation;
in real terms they would have cost roughly the same amount.
Moreover, you can't
even fairly compare the book values of the same company at two
different times. Nonetheless, despite these profound laws, some
analysts like to use book value as a measure for one simple reason: it
works. Studies have shown that companies with price/book-value ratios
far below the market average outperform the average blue chip by
a big margin. In one study, Stocks with the lowest price/book-value
ratios did twice as well as those with the highest.
Price/cash-flow
Examples include the
depreciation of property, plant, and equipment and the amortization of
certain costs. In some industries, such as oil exploration ration, or
in cases where a company has made major acquisitions, these accounting
adjustments can thoroughly foul up earnings calculations. When this
happens, analysts look at cash flow-the amount of cash a company
generates each year Instead of earnings. Sometimes they use another
variation known as free cash flow, which consists of the cash a
company generates plus capital expenditures the firm has to make to
maintain operations at their current level. Accounting rules require
companies fig- to Subtract certain theoretical costs that 5, when 1
ratio. 1 touched on P/CF ratios in Chapter how to read an income
statement. An argument for cash flow is sort of the opposite of that
for book value. Cash flow is a more accurate measure than earnings but
in practice can be subject to a lot of judgment calls. lf you want to
figure cash flow the quick, sloppy way, take a company's earnings per
Share and add back its depreciation and amortization per share. Since
cash low is almost always higher than earnings, P/CF ratios are lower
than P7Es. So a P/CF ratio of 13 is highest, while it would be a cheap
P/E nowadays. |
