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On Approximate Valuation Methods

The growth of corporations is always constrained by something.  The trick is figuring out what the “something” is.  Tonight, I am here to simplify it for you.

Financial businesses that are regulated

We value these via book value or tangible book value.  Capital levels constrain business growth, so look at the return on equity to help modify what the proper valuation level should be.  Book value and return on equity are what govern.

Non-financial businesses that are regulated, such as utilities 

Look to the rate base that the regulators use.  Book value might be a good substitute, but look to see how companies might invest to increase their “rate base.”  Market Cap as a ratio to what the regulators allow profits on would be ideal.

Unregulated businesses that are mature

These are governed by sales per share, calculating the price-to-sales ratio.  In general, it is wise to buy these when the P/S ratios are low, and sell them when they are high.

Unregulated businesses that are not mature

This is the complex part of valuation, but in this case the PEG Ratio makes sense.  Companies that grow their earnings rapidly can justify high P/E multiples, but in general they need to grow earnings more rapidly than their P/E ratio expressed in percentage terms.

I don’t invest in many immature businesses, so this is not so relevant to me.  I look for places where businesses are neglected, and I buy, while selling businesses that are more then fully valued.

Summary

Think about compounding.   Ask what will best compound the growth of your capital.  I suspect that it will resemble what I have written here.  Focus on compounding and ignore Modern Portfolio Theory.  Compounding is real business.  MPT is fakery from men who could not build a business.






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2 Responses to On Approximate Valuation Methods

  1. oldschoolvalue says:

    took me a while to figure out how to comment..

    Anyways, I did because although “rules of thumbs” are frowned upon in the investment community, I still feel it’s necessary for either new investors to gain some guidance.

    Even good for experienced investors since pattern recognition is a big time saver and alpha generator.

    Sharing on twitter on facebook :)

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


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