What indicators to use to evaluate shares

The essence of value investment is to buy shares cheap. About which multipliers to use for evaluation, read in the next material of the cycle “cost investing in faces and principles”, which for The Bell was prepared by the Movchan's Group partner, associate professor of the Faculty of Finance of the Faculty of Economics of the Higher School of Economics, Elena Chirkova.

The main cost indicators

The founder of the Templeton Growth Foundation John Templeton once said: "I never liked the company-only promotions." In my opinion, this is aphorism with a very deep meaning that I would decipher this way: the price of buying shares is very important. Since the company itself cannot like, it means that all its advantages are not enough for the investment in it to be attractive. And the action can like - it has a market price at which this action can be bought.

Cost investors offer to buy shares cheap. John Nefsor wrote in his book of memoirs that he never bought stocks if they were not on sale. Walter & Edwin Schloss Associates formulated his approach as follows: “We buy promotions like fruits and vegetables, and not like perfumes.” He had in mind that the cost of perfume is determined not so much by its real value as by advertising, fashion and glamor - and with an extent to fashion, he is not ready to take shares.

By what animators to evaluate the papers to determine how expensive or cheap are they? The opinions of supporters of the cost approach are expanded. Usually they prefer some one indicator of value. Currently, they are chosen mainly between P/E (price/profit), Peg (P/E value divided into growth) and P/BV (price/net value of assets).

P/E and P/BV began to be used earlier than PEG, which was invented only in 1969, when there were investments in growing promotions.

P/E or P/BV?

Many investors use P/E, but most are still inclined to P/BV. At first glance, this approach seems outdated. So, in the very famous assessment textbook - Investment Valving Asvat Damodaran (the name is translated into Russian as an “investment assessment”, although I would say “investment assessment”) - it says that P/BV is applicable for industrial companies, and for service will be better than P/E, since the assets do not play such a big role in the generation of profit. At the same time, the share of the services sector in the GDP of developed countries is very high and grows, so that, it would seem, p/e comes first. But value investors would argue. And we are not only about those who spoke on this subject several decades ago.

For P/E, Benjamin Graham and Templeton voted in explicitly from value investors in explicitly. True, the latter proposes to use the modified indicator - P/E5, where the denominator is expected profitable company's profit in five years. In other words, Templeton tries to take into account the future growth in the assessment (and in this sense it is a departure from the position of Graham). In its meaning, P/E5 is close to PEG. I see no problems using this indicator, but the question is the correctness of forecasts.

Schloss preferred the P/BV indicator P/E for the reason that it is easy to manipulate profit, the profits are changeable, and BV - the balance value of assets - cannot change sharply. The Third Avenue Value Fund is arguing with Graham and his like -minded David Dodd openly, explaining why he prefers p/BV: no company is strictly Going Concern.

Going Concern is rather an accounting term that translates as "assumption of continuous activity." Whitman has in mind that the cost of the company is influenced not only by its operating activities, but also by its transactions for the redemption and issue of shares, mergers and acquisitions, the sale of assets or parts of the business and the like, and the size of assets is more important to assess the potential of such transactions. Yes, and Hitman calls such transactions the transactions on the conversion of assets.

According to Whitman, net profit more affects the quotes of the company's shares in the near future, while the balance value of assets determines its long -term prospects. Balance value - a measure of resources available to business, and a measure of potential liquidity (we are talking about the possible sale of assets). In addition, according to Whitman, the company's ability to earn profit is often determined by its retained earnings, that is, with assets, therefore, assets are more important for predicting future profit than current profit. And it is with them that you need to start an analysis of the attractiveness of paper.

Threshold values

What specific cost indicators do investors offer? Whitman has the most stringent approach to the selection of shares according to the P/BV indicator (he calls it p/nav; p/nav - price/net value of assets), even tougher than that of a very conservative Graham. It requires a discount of 20% with NAV, that is, it is satisfied with the 0.8 indicator. And the Graham rule is as follows: P/E is not higher than 15, P/BV is not higher than 1.5 - or their work is not higher than 22.5. Graham proposed his own rule when it was not a question of investments in growing shares, but today it is not too limited. In fact, Graham allows the purchase of shares on the average historical P/E market as a whole (I wrote about these average here ).

Schloss allows even higher values. Only ideally, it should have a P/BV less than one, and P/BV is less than three. But there are additional indicators of cheapness: firstly, the market itself at the time of purchase is at a low level, and secondly, the company is on average for this multiplier over the past 20 years. Successful Schloss will also consider the purchase, if the price is at a minimum over the past five years.

Let us now consider more complex measures that take into account growth. These are more modern indicators answering the question of how not to overpay when buying growth. Templeton says that you need to buy those shares whose price is lower than their value. Significantly below their value. And nothing if these are not fast -growing promotions. And if there is growth potential, then this is even better. What is “much cheaper” in his understanding? Templeton, using the P/E5 multiplier, offers an extremely conservative measure - the multiplier should not be higher than 5, but this is a profit in five years.

It is quite easy to count on which p/e the promotion should be traded now, so that its p/e in five years is 5, depending on the growth rate. This means that a share for which will grow a growth rate of 10% in the next five years can be bought by the current p/e = 8. If the expected profit growth rate is 15% - according to the P/E 10. This criterion is very tough. As I already mentioned, the average market p/e in the entire history of observations was about 14, and the profit of the corporations included in the index grows at a lower pace: from 1928 to 2018, it grew 5.1%. A share for which will grow by a pace of 5.1%, according to the criterion of Templeton, can be bought by P/E 6.4 - this is approximately 46% of the average value. In other words, he offers to buy shares two times cheaper than they are usually evaluated by the market.

As for the multiplier, where growth is used in explicitly (PEG), Peter Lynch, Neff and Whitman adhere to the same criterion. This is PEG less than one, or P/E is not higher than the expected growth rate, which is mathematically identical. The same Whitman says about the P/CF (Price/Cash Flow - price/cash flow). It should also be no higher than growth rates. In other words, if you buy a share that will grow 5% per year, then it can be bought by p/e = 5 and lower, 10% - not higher than 10, 15%. The example of the Templaton criterion is clearly visible on this example: for shares with a low profit rate, the restriction is more rigid, and with high - more mild. Nevertheless, an increase of 15% in P/E 15 is very little compared to the historical prices of shares and reflects the theoretical approach of Whitman, who wrote that a reliable investment approach is to “buy and hold” with a focus to avoid investment risks through the purchase of growth without paying for it.

But what if the company is fast -growing?

Lynch and nepf went further in the construction of more complex measures of cheapness and high cost of shares and proposed to take into account not only growth, but also dividend profitability. There is an economic logic in this approach: the growth rate of profit per share depends on the profitability of assets (ROA, Return on Assets) and on which part of the profit is reinvest and which is paid in the form of dividends. The company can spur growth by reinvesting all profit, or maybe, on the contrary, pay dividends, which reduces future profit, but gives the investor the current profitability. Here is a direct analogy with macroeconomics. In the country - as, for example, in China - there may be a high norm of savings and low current consumption, but its GDP will grow rapidly. Or the country, on the contrary, will eat all its GDP - and then it will live richer now, but poorer in the future compared to the first model.

So, Lynch and Neffeen became recorded of what growth is achieved: high ROA or high reinvested profit. The first, of course, is better - this is growth and dividends. They offer the indicator this: (Div/p+G)/(p/e), where Div/P is a dividend yield that is already familiar to us.

The numerator of the Lynch and Neff formula is called general profitability despite the fact that one of the terms is the growth rate. I believe that this name contains a reference to the well-known formula for the total yield of shares, which is equal to the sum of dividend yield and growth in the course value: DIV/P0+(P1-P0)/P0. The logic here is this: the growth of the shares should be approximately correlated with an increase in profit, so the growth of profit can be taken at the proxy exchange rate. So, it turns out that in the numerator we have the total profitability of the investor, and in the denominator P/E. This is an inverted and modernized PEG - it is proposed to take into account not only growth, then dividend yield. This is a wise approach.

If you convert the formula a little, we get (DIV/P)/(P/E)+G/(P/E). The second piece of the formula is already familiar to us - this is PEG (p/e/g), only in an inverted form. And the first term is a dividend yield divided into p/e. I remind you that in the entire historical interval for the United States it is 4%, and the current one is 2%, but for individual shares it may be higher. In Lynch and Neffa, the lower boundary of tolerance in this indicator is 0.5. Ideally, they say, you need to strive for three. What does this mean in practice? To simplify, suppose the dividends are zero. Then the indicator comes down to an inverted PEG. If we are talking about five percent growth, with zero dividend payments to fulfill the lower boundary of tolerance, you need to buy a promotion by p/e = 10, and ideally - by p/e = 1.7. With a growth of 10% - 20 and 3.3. With growth by 15% - 30 and 5.

It seems that to achieve the ideal you need to buy stocks very cheaply, but Neff found such papers. So, in 1984, he discovered Yellow Freight, the dividend profitability of which was 3.5 %at that time, and the expected profit growth was 12 %. At the same time, the price of shares was equal to six times annual profit. As a result, its indicator was 2.6. Neff also applied this indicator for the market as a whole and cited such an example of the overvaluation of the market in 1999: the dividend yield was only 1.5%, and the expected profit growth was 8%. That is, Div/P+G was 9.5%. The r/e market reached 27, respectively, (Div/P+G)/(P/E) - only 0.35.

We talked about what cheap promotions are. But the opposite question - what are expensive shares? - It also has the right to exist. Perhaps Lynch gave him an excellent answer: “The price of any action that is 40 times higher than the predicted profit for this promotion this year is too high, and in most cases it is simply exorbitant. The elementary calculation shows that the action should have a r/e coefficient not exceeding the annual growth rate. Even the fastest growing companies very rarely reach a growth rate of 25% per year, and an increase of 40% is just outlandish. Such frantic progress cannot last long, so companies growing too quickly have a tendency to self -destruction. ”

Just keep in mind that all investors spoke in relation to the American market. Why do I need a discount for other markets, I explained here .

As a bridge to the next column, Neffa is good that the shares with a low r/e amount are the main part of the many underestimated shares, because most investors do not excite their profits and growth prospects. However, it is necessary to distinguish between promotions with good prospects that are in oblivion, and promotions with foggy prospects, which are the majority among cheap actions. But if the company's fundamental position is strong, then the low multiplier of the R/E is a purchase signal. So, Neff believes that of the cheap ones you need to buy only those promotions whose prospects are good, or, in other words, quality papers. I will write about what quality is the next time.

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