A touch of Finnies...

So, today I was asked about the type of valuation to consider when looking at companies. I definitely used to be all about the financial valuation, company outlook, and companies business model etc. However, after trying valuate companies with cash flow calcs and trying to estimate future values of cash flows etc, I was given an awakening...ALL OF THIS ESTIMATION IS IN THE PAST! Now, don't get me wrong...you definitely need to know where you've been to know where you're going. So, some of these types of financial valuations are necessary in a normal market. But I've definitely been swayed to use alot simpler "back of the envelope" ratios and numbers that are already given so as not to take away from the psychological and economic aspect of evaluation (which inevitably proves to be the most useful in the short-term)...

Here are the 3 categories that I want to evaluate quickly:

Profitability:
-ROA -- net profit margin * asset turnover (which should be ~net income / total averaged assets of a period) -- this basically shows the profitability per measurement of asset for a company and is (to me) the most accurate/important profit measurement for a company

-ROE -- net profit / average shareholder equity -- this is a % measurement of returns to the shareholder...if we use both the ROA and ROE together, we can definitely understand a company's profitability and how it respects its shareholders

Financial Current Liquidity:
Long-Term Debt / Equity Ratio (<40% is best on average) -- compares debt on-hand to equity available. Especially from this mortgage crisis, we know that debt/leverage is dangerous. In general the more debt, the worse off...to a point. HOWEVER, there are two things that we could use to offset that reasoning. The first would be if ROE is strong (continuous strength)...this means that the debt is returning a higher rate than what is paid for. The second would be below (WC / Dollar Sales) which if high could mean debt is about to be paid off or that it is continuously being paid off.

-Working Capital / Dollar Sales -- (Current Assets - Current Liabilities) / Avg Total Sales -- working capital is by far (to me) the best liquidity (for near future expansion or debt repayment) that is easily accessible. If we compare this to the total sales, we can see what the company has available for use at this specific time compared to its sales and comparing it to the Inventory Turns...we can measure how much liquidity it would actually need (bc we want to know how many times / yr it gets rid of its inventory to figure out if the WC / Sales measurement is good)

Management Efficiency
Inventory Turns -- Cost of Goods Sold / Avg Inventory for period -- used per above reasoning AND for management efficiency. Within its same industry...the more efficient this company, the faster the turnover rate of its goods (lower the ratio)...This measurement is also very good for determining if the cost of goods is very expensive compared to how much of it is being sold.

Anyway, let me know what you think. I think those are good decision points for stocks. I don't want to believe in PEG ratios and P/E to initially evaluate stocks. After getting these values (the 1st 3 can be found and the rest can be easily calculated), we can determine at least the current status of the company...which companies are good. Then, we can delve down a little deeper into the history of the company etc. Bottomline is that if a company is a good company with a bad quarter, it will still have a relatively good strength even though EPS or P/E etc are not quite there. I'd say we take the time to look a little closer initially...and decrease the effort spent panning through countless conference calls and 10Q/K forms.


Now I'm definitely not saying that this is going to be the best way to evaluate anything in this market or any market. In fact, I would tell you to shun away in general from this type of evaluation until company assets can be valued with low risk and high certainty. Otherwise, they will be guessing just as much as you...

(NOTE: THIS BLOG WAS WRITTEN TO GIVE AN OVERVIEW OF WHAT I THINK ARE THE MOST IMPORTANT QUICK CALC VALUATIONS WHEN TRYING TO GET A SNAPSHOT OF A COMPANY)