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primus
Re: Making Value Work

That's the magic question . . .


Indeed. I am generally not satisfied with conventional approaches, two of which are enumerated here. However, I think a lot of the relevant information required of smarter approximations is readily available through a historical examination of the three basic accounting statements. For example, we can observe:

i, DD&A

ii. Capitalized assets

iii. Historical patterns in sales/earnings/cash-flow growth

iv. Historical patterns in reinvestment.

But what's still missing here is a clear distinction between growth and maintenance CapEx (i.e., the amount of spending which would have been required for zero growth). While in theory DD&A approximates maintenance CapEx, we know this is moreso an accounting tool. Moreover, we can readily observe how companies can shrink (grow) if they invest above (below) stated DD&A.

Anyway, I think that deriving a better approximation of historical maintenance spending should be tractable.

"The world is. The world is. Love and life are deep maybe as his eyes are wide." - Rush, "Tom Sawyer"

Jan 31, 2018 1:53:06 PM       
Edit 1 times, last edit by primus at Jan 31, 2018 1:54:52 PM
Jrinne
Re: Making Value Work


i, DD&A…... While in theory DD&A approximates maintenance CapEx, we know this is moreso an accounting tool.

Thanks David,

Similar to what I was alluding to with EV and depreciation I think. Maybe EV is a little comparable if depreciation is similar between two companies. Otherwise, not so much is your point I think (I agree).

But anyway, my question is DD&A: depreciation and amortization, I would guess. What is the other D?

Edit: Debt? Perhaps longterm debt is assumed to have gone toward CapEx?

Thanks in advance.

-Jim

Great theory, "and yet it moves."
-Quote attributed to Galileo Galilei (1564-1642) gets my personal award for the best real-world use of an indirect proof or reductio ad absurdum.
`

Jan 31, 2018 2:26:57 PM       
Edit 1 times, last edit by Jrinne at Jan 31, 2018 2:57:34 PM
yuvaltaylor
Re: Making Value Work


I first encountered EBITDA/EV in Greenblatt's "The Magic Formula." And Ross et. al. make similar arguments in their text "Fundamentals of Corporate Finance." As Greenblatt points out this makes sense if you are considering buying a company. EV is one measure of how much you would have to pay to own a company. And why are you buying a company in the first place? To get the earnings (or EBITDA). The information is all there if you are going to purchase all of the company (including the debt obligation). And it is both simple and intuitive: the larger the ratio the more earnings for each dollar you invests. If nothing will change in the future just buy the company with the largest EBITDA/EV. Or maybe you prefer something a little different than EBITDA (insert your own preferred metric for discussion purposes).

If I am going to purchase a few stocks is there an additional question that I need to incorporate into my port? Do I have to try to figure out what part of the earnings or EBITDA goes to the stock holders vs the bond holders? Or does that all get factored out in some "identity" that I missed in the Ross text book or in the "Magic Formula?"

Edit: It could be a simple identity. Perhaps the reduced revenue stream to the equity holders— instead, going to the bond holders--is fully accounted for by the increased cost over and above the purchase of the stock which is incorporated in the EV. The EV in the denominator—which is greater than the market cap—may reflect this perfectly. Maybe the numerical value of this ratio is reduced by just the right amount and reflects the decreased revenue stream to the stock holders perfectly. That would be my guess at this point.

The above does leave out the question of differences in CAPEX between companies, I think. If you assume similar depreciation between the companies then CAPEX is incorporated—to a large extent—in the EV. Of course, this assumption could be very wrong in some instances. But I would be happy, for now, to understand the effect of revenue to bond holders.

Thanks for any ideas.

-Jim


I'm not sure I'm answering your questions here, but this is my off-the-cuff take.

A company with low EV multiples is far more likely to be acquired--at a premium--by another company, thereby making your shares worth a lot more than face value. A lot of the big money I've made in the market has happened when a company I own shares in suddenly gets acquired (I made a 50% return on KTEC last week, and late last year YUME paid me a huge one-time dividend immediately prior to being acquired). That's one reason why looking at equity multiples alone is not enough. The second reason to use unlevered free cash flow to EV is that free cash flow can be an excellent forecaster of growth PROVIDED that it's not all spent paying down excessive debt.

Yuval Taylor
Product Manager, Portfolio123
invest(igations)
Any opinions or recommendations in this message are not opinions or recommendations of Portfolio123 Securities LLC.

Jan 31, 2018 2:34:39 PM       
yuvaltaylor
Re: Making Value Work


How do you model for clues to future growth? That's the challenge. If I knew the answer, I'd be rich enough to own the world. But I suggest ways to move models in the right direction is to focus on clues provided by fundamental capacity for growth (returns on capital, etc.) and sentiment measures that let you tap into investment community expectations such as estimate revision, projections and good solid technical analysis. What about historical growth rates? I've had so-soi success at this, but it's fertile ground for testing (Are growth rates persistent? If not, what might you discover and measure that might allow you to decide some growth rates are likely to be more persistent than others?)


Here's an experiment. Create a ranking system with, say, 50 or 100 factors. Weight one of them at 100% and the rest at 0%.

Then create a screen on the Russell 3000 universe using that ranking system with just two rules:

rankprev(52) > 80
eps%chgttm > 15

Press the "totals" key and write down the number. Then weight a different factor at 100% and repeat.

The factors with the highest totals will be the ones that have worked the best in the last year.

Repeat for a few previous "as of" dates to weed out flukes.

Does that seem like a sensible way to model for future growth? Obviously, the factors would have to make good financial sense.

If anyone has any suggestions for improving this experiment, I'd welcome them.

Yuval Taylor
Product Manager, Portfolio123
invest(igations)
Any opinions or recommendations in this message are not opinions or recommendations of Portfolio123 Securities LLC.

Jan 31, 2018 2:52:42 PM       
primus
Re: Making Value Work

Jim

What is the other D?


Depletion. It is usually only relevant for natural resource and extractive activities.

"The world is. The world is. Love and life are deep maybe as his eyes are wide." - Rush, "Tom Sawyer"

Jan 31, 2018 4:12:34 PM       
primus
Re: Making Value Work

My thoughts on EV vs MktCap:

(free cash flow to common equity) / MktCap === (free cash flow to all financial interests) / (EV + CashEquiv())

Expanding on that:

(CashFlow() - IntExp() - IncTax() - PfdDiv() - mii()) / MktCap === (CashFlow() - IntExp()*TxRt() - IncTax()) / (MktCap + MktValue_PfdEquity + MktValue_NoncontrollingInterests() + MktValue_Debt())

In p123, we cannot observe the market values for anything but common shares, so I usually opt for MktCap in the denominator. However, it is much easier to get a clean sense of free cash flow to all interests, so I also see merit in EV ratios.

"The world is. The world is. Love and life are deep maybe as his eyes are wide." - Rush, "Tom Sawyer"

Jan 31, 2018 4:23:28 PM       
Edit 1 times, last edit by primus at Jan 31, 2018 4:23:57 PM
SpacemanJones
Re: Making Value Work

See what happens when my favorite football team sucks and now have weekends free!!).


Marc, if I may ask, who's your football team? ;-)

Jan 31, 2018 6:23:35 PM       
yuvaltaylor
Re: Making Value Work

Well, I did my little experiment, and here are the top five ways to predict future growth.

1. Compare CurQEPSMean to the GAAP EPS for the same quarter last year.

2. Compare CurFYEPSMean to last year's GAAP EPS and/or NextFYEPSMean to CurFYEPSMean.

3. Look at volume-weighted momentum. I use VMA(15)/VMA(210), but you can probably vary that.

4. Compare the current quarter's operating income to the same quarter last year.

5. Look at industry momentum: Pr52W%ChgInd.

In sixth place was the best quality measure that I tested, and I tested about forty of them: the accrual ratio. Subtract operating cash flow from net income and then divide by total assets. The lower the better.

None of the other quality measures did that well. I had high expectations for free cash flow measures, but it turns out they're not that good indicators of future growth.

My method was to look at the top 20% of the Russell 3000 for each factor and see how many of those stocks had a subsequent one-year EPS growth of 15% or higher. I used 5 data points over the last ten years.

Yuval Taylor
Product Manager, Portfolio123
invest(igations)
Any opinions or recommendations in this message are not opinions or recommendations of Portfolio123 Securities LLC.

Feb 1, 2018 4:56:04 PM       
primus
Re: Making Value Work

Yuval,

You've got 4 forward look indicators based on analysts' estimate and price momentum and 1 measure based on precedent.

Is it fair to suggest then that stock price momentum leads the fundamentals?

If so, why even bother with fundamentals?

"The world is. The world is. Love and life are deep maybe as his eyes are wide." - Rush, "Tom Sawyer"

Feb 2, 2018 5:32:41 PM       
Edit 1 times, last edit by primus at Feb 2, 2018 5:33:09 PM
yuvaltaylor
Re: Making Value Work

Good question. I was looking at the efficacy of SINGLE factors. If I had combined several fundamental factors, I might have beat the momentum factors. But even if not, I wasn't attempting to predict the price rise of a stock, just to predict the increase in EPS. It turns out, to my considerable surprise, that analysts and other market participants (the folks who buy and sell stocks enough to influence their price) are better at predicting EPS growth than any other single factor I could find. But that doesn't mean we should pour fundamentals down the drain. After all, predicting EPS growth is only one small part of successful investing. Marc's original question was, given that choosing stocks based only on value means choosing quite a few stocks with little growth potential, how do you best guess growth potential. I think I answered that, and that was all I was trying to do.

Yuval Taylor
Product Manager, Portfolio123
invest(igations)
Any opinions or recommendations in this message are not opinions or recommendations of Portfolio123 Securities LLC.

Feb 2, 2018 11:54:11 PM       
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