The price to book ratio has always been a default metric with which many value investors start to get a sense of the intrinsic valuation of a business before engaging in more in-depth research.
Benjamin Graham and his seminal work The Intelligent Investor has been the go-to book for individuals who are serious about learning the art of value investing and will remain so for a long time to come due to it’s evergreen content (timeless advice).
All too often I come across people who just want the ‘quick fix’ to stock market riches as if they could only master one ‘magic formula’ or strategy and soon their financial troubles will be washed away.
Clearly such a mindset is an impediment to adopting a value investing strategy which is why I wrote How To Start Value Investing In 30 Days to try and bridge the gap between short term thinking and a successful value investing strategy.
Every once in a while however I come across individuals with a value-orientated mindset and have gone beyond simply relying on ratios to value a stock.
A long time reader and Benjamin Graham fan recently got in touch to offer his valuation on a stock and what I though about it.
Here’s what he had to say:
And my reply which sums up how my own investing process does not just simply rely upon value ratios
Below you will see how Manoz ‘digs deeper’ into Stadium Group (LSE: SDM) edited into short-form for expediency:
The Stadium group plc
- It borrowed £5M from the bank and it increased the shareholder’s funds due to an acquisition of SUW by issuing new shares from 1478M to 1554M.
- The Long term borrowing £7750M in 2015 compared to £2540M in 2014.
- Goodwill increased reflecting the recent acquisition of SUW (The wireless technology) in their umbrella sectors.
- Intangible asset is high due to development cost, research development costs, etc but the intangible assets shall be amortised over the time.
- It has the outstanding long term debt £3M and the new load repayment shall be paid in 2019. It explains why the debt to equity ratio is high.
- Administration expense in 2015 looked high
- Price TBVPS – Negative [Failed] (Price TBVPS <=1)
Since Ben Graham’s valuing the stock approach could not be used in this stock because of its negative PTBVPS plus Graham’s method does not take the growth into the account.
Hence I use Jim Slater’s Zulu Principle approach and I could see it has a potential growth
- PEG Factor – 0.3 [Passed] (PEG EPS – 4.90>4.80 [Passed]
- PE Ratio – Too high [Failed] (PER target =10%)
- ROA (10 years) – 6.51% [Failed] (ROA >= 10%)
- ROE (10 years) – 20.25% [Passed] (ROE >= 10%)
- Director hold shares – Yes [Passed]
- Debt to Equity Ratio – 1.86 [Failed] (Debt to Equity Ratio <= 0.4)
I would not invest in this company because PER is too high, a heavy Debt to Equity Ratio is beyond 0.4 and the EPS growth rate in the 10 years is pretty poor. If the company bankrupt, the shareholders shall have no protection because the assets is piratically non-existent,
To answer your question of assessing the management performance, looking at the ROA in the last ten years is pretty poor in my opinion as it is way below 10%.
In Graham sense, the intrinsic valuation, I think, is zero.
However it has fairly steady cash flow in the 10 years and on that basis, I use intrinsic value based projected FCF to determine its intrinsic value. From Gurufocus website, the price to intrinsic value: project FCF is £3.31. The current share is about £1.23. It looks bargain but I am very reserved with the calculation to be honest with you.
And there you have it folks; a concise, common sense approach to intrinsic valuation drilled down to the most basic of assessments the beauty of which means that a stock – in this case Stadium Group – can be quickly eliminated from the search for value.
Whether the valuation of zero is right or wrong is almost irrelevant (it’s actually not far wrong at all).
I love how some value guys will want to write a 5,000 thesis on the potential of a stock before they part with their money to invest in one. Good luck to them and if it earns them money then so much the better.
It uses the balance sheet as a pivot from which all intrinsic value research is conducted after which the quality of earnings is assessed, primarily to see if earnings are being inflated by ‘unscrupulous’ means.
It urges you to adopt a common sense and simple (not simplistic) approach to get to a conservative estimate of intrinsic value?
Manoz has done a good job in covering many of the aspects I look at when determining intrinsic valuation: debt, price to earnings, price to tangible book and little look beyond these metrics for a more rounded initial assessment of a stock.
I would personally have a look at the last 18 months worth of RNS’s for a complete intrinsic valuation picture and often I only need to go though about 10 of these at the most to know that a stock should simply be eliminated from the valuation process.
For more articles on the value approach check this out.