Monday, May 7, 2007

How to find the key focus to value a business?

Is P/E ratio really as important as people usually think?

For simple businesses, (little changes, the type Buffett plays)
P/E is important to value the business.

But for fast changing businesses, high growth, cyclic, turnaround, asset play,you should downplay the importance of P/E (a lot).

Let's take a look at cyclic businesses. You actually look for high(comparing with its historical data) TTM P/E business especially at the end of the down cycle and the start of the new up cycle.

For high growth businesses, you need to focus on its growth story's sustainability. check my post on JMBA and URGI.

For fast changing ones, you don't do it all together. Or if you still think you have edges because of your education/job/experience/insider connection, you have to make yourself an expert on all the issues related to those possible changes regarding future business outlooks and its competitor landscape. OVTI for me is a good example, I probably cannot call myself an expert, however I do have access to information not widely known.

For Asset play, it is actually not bad to value it, check the oil/coal reserve(HNR/JRCC), and check the future discounted cash flow (ASPV)

For turnaround business, you really need to focus on its balance sheet to evaluate the credit risk. With two turning around companies with similar background and future outlook, I will surely pick the one with more cash /less debt or better debt structure even if its products are less revolutionary.

I got all the above knowledge from reading Peter Lynch.


If a business switches from one category to another, the valuation focus will also shift. Theoretically this will create huge momentum.

For example, ASPV is now an asset player, the valuation is purely on cash+DCF or future earning with very good certainty. So if it can announce a new partnership, it will be placed in high-growth or at least fast changing category, the upside price movement will be huge.

HNR, on the other hand, is a distressed turnaround play discounted by the political risk and uncertainty, if it gets approved, it is now asset play to be valued by its reserve.

OVTI is fast changing and distressed technology company in an earning downtrend. If it can prove its future earning ability, it will be first placed in turnaround play(which I believe), and then high growth(which I hope). Therefore it will have great upside room when those changes happen.

However, you don't have to bet those key developments beforehand. You pick the sure money once it is announced and do it quickly before the majority think about it and react, because you already have this knowledge and insight from here and are fully prepared.

No comments: