Trying to decide when a company is a bargain has always been a challenging task I have struggled with over the years as I suspect most others have also. There are numerous examples of professional investors touting systems based on history or some formula that would beat the market only to be humbled by the markets emotions. I’m in the process of reading “The Intelligent Investor” by Benjamin Graham and he talks about three lessons that seem simple enough but much harder to achieve than meets the eye. They are:
- how you can minimize the odds of suffering irreversible losses;
- how you can maximize the chances of achieving sustainable gains;
- how you can control the self-defeating behavior that keeps most investors from reaching their full potential.
So with the above in mind I’ve decided to build a model to analyze a company from various views always keeping number one above in mind. It is based on company results and an eye on future performance. There will always be down markets but the idea is to buy in at attractive prices and be able to add to the positions when the markets inevitably swing downward.
The model looks at the company through different lenses. There is a discounted cash flow analysis and an earnings and growth analysis. The dividend is also important since it cushions the (psychological) blow in a down market and helps limit the decline vs a non dividend stock IMO. Finally if the fair value (FV) produced by combining the above generates to high of a PE the FV is reduced further (as of this date the maximum allowable PE would be 20 assuming it even gets that high with the previous analysis, in most cases it does not). Dividends are an important component based on number one above but the analysis can be performed on non dividend paying companies also. Obviously this type of analysis would ignore most hot stocks of the day like Google and others but in my mind that’s a good thing. This type of analysis would have saved me a lot of pain during the tech boom in the late nineties.
I can adjust the market sentiment by changing the maximum allowable PE that could limit the values produced by the analysis. Looking at the S&P 500, PE ratios ranged from under 10 to over 40 during the tech boom.
Whats interesting is if I put a PE below 10 as a constraint since most will sell thinking earnings are about to fall off a cliff for all with no exceptions the resulting FV’s that emerge explain the markets meltdown or at least make it easier to understand how the prices can drop looking like there is no end in sight.
I’m getting a little sidetracked but the point is not to avoid these meltdowns, although it would be nice if the extent of any meltdown could be known beforehand, anyone know this let me know, but to minimize the odds of suffering irreversible losses. Irreversible is the key word here.
Anyway I’ve run a list of companies through my beta version and will post these and updates at:
This page can also be accessed through the stock page at: http://kleincody.web.officelive.com/stocks.aspx
If anyone has any comments suggestions, etc., feel free to post or let me know.
The model is constantly adjusted/changed as I learn more. I still need to finish “The Intelligent Investor” and I hear another book worth reading is “The Essays of Warren Buffet”. So more changes to the analysis are probably coming for better or worse.