How to determine a "Reasonable Price" for stocks.?

[deaddog]

This probably deserves it’s own thread. I don’t want to hi-jack the Dividend thread.

I think Calian is selling at a reasonable price, the debt is insignificant, and looking at the figures they seem to be a well run organization. Lots of cash flow from operations and very little in the way of capital expenditures.

I’d be interested in knowing what metrics one uses to determine if a stock is selling at a reasonable price.

Not only from Taggart but anyone else that uses fundamentals to aid in their stock selection.

Although I use TA to enter and exit stock positions I do use FA to determine if I want to trade certain stocks.

I am looking for growth companies: What I look for is:
Earnings growth greater than 25%
Profit margin Greater than 20%
ROE greater than 25%
Low debt/equity less than 1
I also look at PEG Ratio and like to see it less than 1

I also have minimum price and volume requirements but that is because I want to be able to get in or out of a position quickly.

When I find a company that meets my criteria I compare it with others in the same industry to see if there might be another opportunity in the group.

I prefer to buy companies with excellent fundamentals so that someone will want to buy the stock from me somewhere down the road.

[Peculiar_Investor]

Perhaps the moderator could move this viewtopic.php?p=346082#346082 into this topic, as it also hi-jacks the dividend thread.

Also, there was discussion started here, viewtopic.php?p=344467#344467

[Taggart]

This probably deserves it’s own thread. I don’t want to hi-jack the Dividend thread.

I think Calian is selling at a reasonable price, the debt is insignificant, and looking at the figures they seem to be a well run organization. Lots of cash flow from operations and very little in the way of capital expenditures.

I’d be interested in knowing what metrics one uses to determine if a stock is selling at a reasonable price.

Not only from Taggart but anyone else that uses fundamentals to aid in their stock selection.

Although I use TA to enter and exit stock positions I do use FA to determine if I want to trade certain stocks.

I am looking for growth companies: What I look for is:
Earnings growth greater than 25%
Profit margin Greater than 20%
ROE greater than 25%
Low debt/equity less than 1
I also look at PEG Ratio and like to see it less than 1

I also have minimum price and volume requirements but that is because I want to be able to get in or out of a position quickly.

When I find a company that meets my criteria I compare it with others in the same industry to see if there might be another opportunity in the group.

I prefer to buy companies with excellent fundamentals so that someone will want to buy the stock from me somewhere down the road.

I find pricing to be very subjective. There's been times over the last twenty years, where I've seen what Buffett has paid for a company and I've asked myself, "why is he paying that much".

Perhaps part of the answer comes from Peter Hodson, portfolio manager at Sprott Asset Management.

"Two points here: One, a company growing fast enough can quickly make an "expensive" valuation look cheap as earnings accelerate.

Two, often, but not always, the best companies are usually expensive. You frequently need to pay up for quality management and a competitive advantage. Don't be afraid of expensive stocks, as long as the price is justifiable."

Back to Buffett. Recently he bought Burlington Northern Santa Fe. Did he pay too much? Looking at the Canadian Railroads. Just last week, one portfolio manager's opinion:Mr. Tynkaluk, who has been in the investment business for 52 years, also has his eye on railways “but not at these prices.” From another portfolio manager:Canadian National Railway The Montreal-based rail line is considered a "stalwart" by my Lynch model because of its moderate 15.8-per-cent growth rate (I use an average of the three-, four-, and five-year historical earnings-per-share figures) and high annual sales of $7.2-billion. The $23-billion-market-cap firm has a strong yield-adjusted P/E/G of 0.75, and a moderate debt/equity ratio of 57.9 per cent, two reasons my Lynch model is high on it. Take your pick.

[ghariton]

I find pricing to be very subjective.

I strongly agree.

If one uses the Gordon model, at least conceptually, to think about the proper price for a security, one has to estimate future cash flows (dividends, capital appreciation, etc) and the proper discount rate (real risk-free rates, risk premium for this security). Opinions will differ, usually sharply. And, as you pointed out elsewhere, that is more work than an individual investor can usually take on.

So what to do? When I was young, a neighbour worked as a real estate appraiser. I was puzzled by this black art until I finally realized that, at the heart of what he did, was comparison with what other similar properties had sold for recently.

I think that the principle carries over to stocks. The best guide to the value of a stock is its price in a deep, liquid market (if such exists). That doesn't measn this price is "right", but it does mean that it incorporates the judgment of an awful lot of people, smart and not so smart.

So I only buy individual securities if I can do so in a liquid market. I pay the current price. (I also index a lot, as you know.

George

[Peculiar_Investor]

I find pricing to be very subjective.

I strongly agree.

If one uses the Gordon model, at least conceptually, to think about the proper price for a security, one has to estimate future cash flows (dividends, capital appreciation, etc) and the proper discount rate (real risk-free rates, risk premium for this security). Opinions will differ, usually sharply. And, as you pointed out elsewhere, that is more work than an individual investor can usually take on.

So what to do? When I was young, a neighbour worked as a real estate appraiser. I was puzzled by this black art until I finally realized that, at the heart of what he did, was comparison with what other similar properties had sold for recently.

I think that the principle carries over to stocks. The best guide to the value of a stock is its price in a deep, liquid market (if such exists). That doesn't measn this price is "right", but it does mean that it incorporates the judgment of an awful lot of people, smart and not so smart.

So I only buy individual securities if I can do so in a liquid market. I pay the current price. (I also index a lot, as you know.

George

Mr. Market offers you a price everyday, most days he offers a rational price, but not always. The critical question in my mind is reaching your own determination of a value at which you will accept Mr. Market's offer, hopefully catching him when his offer give you a change to maximize your future return.

[deaddog]

I find pricing to be very subjective.

I’m trying to determine is what lead you to CTY?
Did you get a hot tip and research from there or was there some kind of scan involved.
What criteria did you use to choose that stock?
Can you be more specific as to what metrics you used to determine that it was reasonably priced?

[deaddog]

The critical question in my mind is reaching your own determination of a value at which you will accept Mr. Market's offer, hopefully catching him when his offer give you a change to maximize your future return.

How do you do that?

[Peculiar_Investor]

The critical question in my mind is reaching your own determination of a value at which you will accept Mr. Market's offer, hopefully catching him when his offer give you a change to maximize your future return.

How do you do that?

viewtopic.php?p=346082#346082 provides an overview of my valuation methodology. It is not perfect and I'm always tinkering with it to see what has worked for me and what hasn't.

I find that many posters here, while they may not know it, challenge my understanding, techniques and viewpoints. I find this extremely useful and it underlies my participation here.

[NormR]

Isn't the key problem one of finding stocks trading at unreasonable prices? As an added bonus, it also happens to be an easier problem to solve.

[Taggart]

I find pricing to be very subjective.

I strongly agree.

If one uses the Gordon model, at least conceptually, to think about the proper price for a security, one has to estimate future cash flows (dividends, capital appreciation, etc) and the proper discount rate (real risk-free rates, risk premium for this security). Opinions will differ, usually sharply. And, as you pointed out elsewhere, that is more work than an individual investor can usually take on.

So what to do? When I was young, a neighbour worked as a real estate appraiser. I was puzzled by this black art until I finally realized that, at the heart of what he did, was comparison with what other similar properties had sold for recently.

I think that the principle carries over to stocks. The best guide to the value of a stock is its price in a deep, liquid market (if such exists). That doesn't measn this price is "right", but it does mean that it incorporates the judgment of an awful lot of people, smart and not so smart.

So I only buy individual securities if I can do so in a liquid market. I pay the current price. (I also index a lot, as you know.

George

In their book "Value Investing", Bruce Greenwald, et al, talk about net present valuations. They say, "Unfortunately, this approach has two defects: (1) it lumps together estimates based on good information with those based on very uncertain assumptions, tainting the lot; and (2) it relies on making accurate estimates of events that are a long way in the future.

[Taggart]

I find pricing to be very subjective.

I’m trying to determine is what lead you to CTY?
Did you get a hot tip and research from there or was there some kind of scan involved.
What criteria did you use to choose that stock?
Can you be more specific as to what metrics you used to determine that it was reasonably priced?

I don't remember when I first put it on my watch list, but I did post back on May 7th, in the Dividend and Distribution Hikes - 2009 thread, that Calian had increased it's dividend by 13% at that time. Nothing elaborate as far as pricing. Just used the information available on the stock at the Reuters website. I wouldn't even have mentioned the fact that I'd bought it, if it were not for the announced special dividend a few days ago.

[Taggart]

Isn't the key problem one of finding stocks trading at unreasonable prices? As an added bonus, it also happens to be an easier problem to solve.

I've still got a few shares of JDS Uniphase from 1999 to remind me of that.

[scomac]

If we assume that the market is reasonably efficient over the long term, then we can quickly and easily determine a fair market price level for any security with 10 years of trading history. From this, we can deduce whether or not the current price is reasonable, cheap or expensive.

1) Calculate the 10 yr. ave. P/E multiple
2) Calculate the 10 yr. ave. P/B multiple
3) Determine the current EPS and BPS
4) Insert these figures in the following equation:

FMV$=√¯(P/E10*P/B10 * EPS * BPS)

The above will give you a pretty accurate estimate of the fair value of the security incorporating all available information while discounting any short-term emotional biases.

This works best for large, stable, mature companies rather than those that are experiencing trending changes in operating performance.

[kcowan]

... From this, we can deduce whether or not the current price is reasonable, cheap or expensive.

1) Calculate the 10 yr. ave. P/E multiple
2) Calculate the 10 yr. ave. P/B multiple
3) Determine the current EPS and BPS
4) Insert these figures in the following equation:

FMV$=√¯(P/E10*P/B10 * EPS * BPS).

Can you provide a recent screen using this?

[scomac]

FMV$=√¯(P/E10*P/B10 * EPS * BPS).

Can you provide a recent screen using this?

No I can't. This is a manual calculation that I conduct on a stock or group of stocks that I am investigating. The problem with trying to screen to this sort multi-factor model is that it would require maintaining and updating a database of all publicly traded stocks with their running 10 yr. ave. P/E and P/B ratios. If anyone has the time and inclination to set-up and maintain such a database, they're more than welcome to use the algebra.

[Peculiar_Investor]

If we assume that the market is reasonably efficient over the long term, then we can quickly and easily determine a fair market price level for any security with 10 years of trading history. From this, we can deduce whether or not the current price is reasonable, cheap or expensive.

1) Calculate the 10 yr. ave. P/E multiple
2) Calculate the 10 yr. ave. P/B multiple
3) Determine the current EPS and BPS
4) Insert these figures in the following equation:

FMV$=√¯(P/E10*P/B10 * EPS * BPS)

The above will give you a pretty accurate estimate of the fair value of the security incorporating all available information while discounting any short-term emotional biases.

This works best for large, stable, mature companies rather than those that are experiencing trending changes in operating performance.

You have me curious, again! What is the math behind this formula. It sort of looks like the PEG ratio calculation, but brings Price-to-Book into the equation.

[scomac]

You have me curious, again! What is the math behind this formula. It sort of looks like the PEG ratio calculation, but brings Price-to-Book into the equation.

That is the math -- a square root of a four factor multiple.

P/E x EPS=$/sh
P/B x BPS=$/sh

In the equation you square the share price, therefore, you must derive the root in order to get back to a $/sh figure.

[Michael D]

That is the math -- a square root of a four factor multiple.

P/E x EPS=$/sh
P/B x BPS=$/sh

In the equation you square the share price, therefore, you must derive the root in order to get back to a $/sh figure.

This puts equal weight on P/E and P/B. Are there examples in certain industries or market conditions where this equation would fall apart? I'm thinking knowledge/technology companies with high P/B; high-capital industrials with low P/B, etc.

For my quick input to this thread, I would say that I am most likely to make a value decision based on historical P/E range.

[Peculiar_Investor]

You have me curious, again! What is the math behind this formula. It sort of looks like the PEG ratio calculation, but brings Price-to-Book into the equation.

That is the math -- a square root of a four factor multiple.

P/E x EPS=$/sh
P/B x BPS=$/sh

In the equation you square the share price, therefore, you must derive the root in order to get back to a $/sh figure.

I was about to reply before you edited to add information. It is clearer now. I understand how the math works. I'm still trying to grasp the theory behind the math. It looks to me that it uses 2 historical factors to derive an expected current price based on 10 year history. The factors are then multiplied and then the root is taken. Why won't you just take the average of the $/sh values? Why pick P/E and P/B to determine a fair market value, why not P/E and Div. Yield, or P/E and P/S? Have you ever tried comparing the FMV derived if a 5 year historical average is used rather than a 10 year average?

[scomac]

Are there examples in certain industries or market conditions where this equation would fall apart? I'm thinking knowledge/technology companies with high P/B; high-capital industrials with low P/B, etc.

Yes. As I've already indicated, the results work best for large, stable mature companies. Any company that is/has undergone a fundamental change in its business such that historical multiples are no longer appropriate would not be appropriately valued without making adjustments that bias toward the new reality.

By including the historic P/B metrics you actually improve the accuracy when assessing high or low multiple companies/industries versus a simple earnings or dividend based valuation model.

[scomac]

Why won't you just take the average of the $/sh values?

You could. It's the same difference. The equation just saves a few steps.

Why pick P/E and P/B to determine a fair market value, why not P/E and Div. Yield, or P/E and P/S?

A couple of reasons: First of all, BPS is more stable and it has less impact from the short term vagaries of earnings or other annual measures. It is also the best way to factor in the long term ROE of the business as consistently high ROE companies tend to trade at elevated P/B multiples. After all, this is what you are buying and thus your return will be determined by what you pay (int terms of P/B) for a given ROE.

Have you ever tried comparing the FMV derived if a 5 year historical average is used rather than a 10 year average?

Yes. It is one way to adjust for a stock that has a positive (or negative) trend in operational performance. You don't want to be guilty of undervaluing a company with an improving operational trend. You also don't want to be guilty of overvaluing a business with declining fundamentals. These errors could lead to incorrect investing decisions.

[Quebec]

1) Calculate the 10 yr. ave. P/E multiple
2) Calculate the 10 yr. ave. P/B multiple
3) Determine the current EPS and BPS
4) Insert these figures in the following equation:

FMV$=√¯(P/E10*P/B10 * EPS * BPS)

The above will give you a pretty accurate estimate of the fair value of the security incorporating all available information while discounting any short-term emotional biases.

Scomac, this is good stuff. Your combination of book value and EPS is similar to the Graham number formula except that instead of a fixed multiplier (22.5 in the Graham formula) applied to EPS * BPS in the square root, you take a different one for each company, i.e. P/E10*P/B10. I imagine that P/E10*P/B10 is larger than 22.5 in many cases.

I was looking for something like this (http://www.financialwebring.net/forum/viewtopic.php?f=40&t=110918) but I had two separate prices: the "High yield price" and the "Low P/E price" based on ten years of high yields and low P/E values (or five years, whichever is lowest). You also have two entry prices (implicitly), the "Average P/E price" and the "Average P/B price". The spirit of your formula is simply to average both.

Applying this to my "High yield price" and "Low P/E price", I can also simply average them too, which tells me that currently Canadian banks and lifecos are overvalued, but by 10% to 40% for the ones I follow rather than up to 800% (as per the "Low P/E price" alone).

Stocks that are "on special" with this new averaged "entry price" include BDX, CP, ENB, JNJ, MKC, PEP, PG, SC, SYY, TIH, WMT. I am tempted to buy some of these with available cash but unfortunately my target asset allocation tells me I need more fixed income investments in my portfolio (I am overweight on stocks after the run-up of the last few months) so I will have to prepay my mortgage instead with this available cash! Boring but safer...

Anyway if anyone else has a nice formula I'd like to see it...

[abose]

I don't want to hijack this thread but I have a related question -where can I find the historical data on canadian stocks like P/E10 I need to do these calculations? All the free sources I know only go back 3 to 5 yrs. If forced to use a paid service, can anyone recommend one? Globeinvestor Gold seems kinda pricey at $160 per year given how little I'll probably need to use it.

[augustabound]

msn and Morningstar are the only ones I can think of that have 10 years numbers.
http://moneycentral.msn.com/investor/in ... Symbol=JNJ

[abose]

Thanks AGB! I checked out Morningstar and they seem to have the data I am looking for, at least for two stocks.