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Invest Like a Guru – How to generate higher returns at reduced risk with value investing 2017(Charlie Tian)
https://bbs.pinggu.org/thread-6755810-1-1.html (Page 142-167)
How to Evaluate Companies
阅读到的有价值的内容段落摘录
Valuation approaches can be divided into three categories: (1) valuation ratios, (2) intrinsic values, and (3) rate of return.
In real business, earnings never stay unchanged. If a company grows its earnings, it takes fewer years for the investor to earn back the cost of buying the stock. If a company’s earnings decline, it takes additional years. As a shareholder, you want the company to earn back the price that you paid as quickly as possible. Therefore, lower P/E stocks are more attractive than higher P/E stocks, as long as the P/E ratio is positive. Also, for the stocks with the same P/E
ratio, the faster-growing business is more attractive. The fair P/E ratio of a stock is about the growth rate of the company, according to Peter Lynch. Related to P/E ratio, Lynch likes to superpose the price chart with a line that is at 15 times trailing-12-month earnings and compare the relative positions of the two lines. He called this line the earnings line, which is now better known as the Peter Lynch Earnings Line. The chart with the price line and the earnings line is now known as the Peter Lynch Chart, as popularized by GuruFocus.com. In his excellent book, One Up on Wall Street, Lynch used many of these charts to illustrate the valuation of stocks.
Price/Sales Ratio is an excellent valuation indicator if you want to compare a stock with its historical valuations or with other stocks in the same industry. It does not measure how long it takes for investors to get paid back like P/E ratio does; it gives only a relative valuation. P/S ratio is a great tool for evaluating cyclical businesses where P/E ratio works poorly. It works better for cyclical companies when, over time, the company’s profit margin reverts to the mean. Again, in the example of Southwest Airlines, although its earnings have had many ups and downs, like a rollercoaster, the company’s revenue has been going up relatively steadily. If we replace the median P/E earnings line with the median P/S earnings line in the Peter Lynch Chart, the chart clearly shows when it is a good time to buy the stock and when it is a good time to get out. Unlike the valuation ratios P/E and P/S, which are the price relative to the earnings power, P/B ratio measures the valuation of the stock relative to the equity of the company. It does not suggest anything about the operation of the company. Instead, it compares the price and the underlying assets of the company. Benjamin Graham liked to compare the stock price with the book value of the shares and buy the ones that were sold at below book value, that is, P/B < 1. P/B ratio works well for the companies that are asset heavy and whose earnings power comes mainly from the business’s tangible assets. For financial services companies such as banks and insurance agencies, the most useful valuation parameter is price/book ratio. Financial companies follow mark-to-market accounting rules. They are required to record their assets at the fair values traded in the market. Most of the assets of financial companies are traded in the market and have market prices. The balance sheet items such as assets and liabilities reflect their current market values. Therefore, the shareholders’ equity on the balance sheet of financial companies is very close to the net worth of the companies’ assets in the current market. One can also try to value a bank or insurance company based on its earnings power. But for financial companies, it’s very hard to distinguish the items that are needed for calculation: the change of working capital, capital expenditures, debt, and so on. Furthermore, banks and insurance companies’ true profit and loss can be very different from their reported earnings. The provision for loan loss in banks and the loss reserve with insurance companies are quite subjective, and they drastically affect the reported earnings. The true earnings from their current business activities are usually unknown until many years later, when the loan default or insurance loss happens during bad economic times.
Although it seems that we don’t value the earnings power of financial companies if we just look at their book values, in fact most of their earnings power is already reflected in the prices of their assets, whether they are bonds, stocks, mortgages, or other marketable securities. A bond can sell at above or below its face value depending on changes in the interest rate and credit quality. Mortgages are sold from one bank to another at the prices that reflect their ability to generate profit.
阅读到的有价值信息的自我思考点评感想
For investment returns we are looking forward returns then historical returns. Forward rate of return is a method that Don Yacktman applies in his investment approach. He defines forward rate of return as the normalized free cash flow yield plus real growth plus inflation. He views stocks as bonds, so it makes more sense to value an investment by the potential rate of return, just like with bonds. Forward rate of return is calculated as:
Forward Rate of Return = Normalized Free Cash Flow ∕ Price + Growth Rate
Both earnings yield (forward looking) and forward rate of return calculations can also be applied to the overall stock market. The results can be used to compare it with the returns on certificate of deposits, money market funds, and bonds. An equity risk premium over risk-free rate from short-term government bonds is usually required by investors because of the volatility and uncertainty of stock investments. This is also how the interest rate affects the attractiveness of the stock market from the aspect of the potential rate of return.
Investors should not be obsessed with the valuation calculations. All calculations involve assumptions. They are valid only if the underlying businesses perform as expected. Over the long term, investment return is more a function of business performance than the valuation, unless the valuation goes extreme. More effort should be put into identifying good businesses and buying them at reasonable valuations.
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