My desire for improvement has lead me to search for better metrics for value investing.
My belief in the power of value investing is unchanged but the metrics I look at have evolved.
Most people instinctively want to buy things on sale to get a great deal. But for some reason there is an exception when it comes to investing–people tend to buy stocks that are expensive.
Value investing takes the principle of finding a great deal and applies it to the stock market.
The the goal of value investing is to find profitable companies trading at a discount.
I’ve written in the past about value investing metrics and how it is one of the ways I grow and protect my wealth.
But if I can find a better and more reliable way to find a great deal I’m going to use that method.
The first reason I questioned the metrics I had been using was an article by Jason Rivera: “Why The P/E Ratio Is Useless – And How To Calculate EV” which is an excellent read.
The second was a video by Simon Black of SovereignMan.com: “How to identify the most compelling investments on the planet“.
Better Value Investing Metrics
So what metrics am I using to find great deals on stocks?
1) Enterprise Value to Market Capitalization (EV/Market Cap)
2) Enterprise Value to Free Cash Flow (EV/FCF)
3) Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)
4) Enterprise Value to Owners’ Cash Profits (EV/OCP)
5) Operating Margin
6) Dividend Yield
7) Return on Equity (ROE)
If you aren’t familiar with some of these terms, no worries, just click on the word to view the definition in the glossary.
The Metrics
Enterprise Value to Market Capitalization (EV/Market Cap)
This ratio indicates if a company has more cash than debt. I look for a value of less than 1, the lower the better.
If a companies EV or TEV is less than its market cap its means that the company has more cash than debt. And may be undervalued. Inverse is true as well.
Source: https://www.quora.com/What-does-it-mean-when-enterprise-value-is-more-than-market-cap
Enterprise Value to Free Cash Flow (EV/FCF)
This is a more reliable metric than price to earnings (PE) (more on that in a subsequent article). It takes the enterprise value and divides it by free cashflow. I want this to be as low as possible.
A lower number indicates one is paying less for a stream of cash flowing into a company than compared to a higher number.
Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)
Another metric that is more reliable than PE. It’s a way to double check the cost of a cashflow stream. The lower the better.
Enterprise Value to Owners’ Cash Profits
A third replacement for PE.
If EV/FCF, EV/EBIT, and EV/OCP are all low, that is several metrics that indicate the stock is trading at a discount relative to peers with a higher ratio.
Operating Margin
This is a measure of efficiently. A higher operating margin is better than a lower one.
Dividend Yield
A company can’t fake dividends. The dividend is money that goes directly to a shareholder and the yield is how much the dividend costs as a function of the share price. Investing in a stock with a dividend yield is also a way to collect income while waiting for the company’s share price to rise in value to reflect the fundamental indicators.
The higher the dividend yield the better–all else equal.
Return on Equity over 8%
This is another metric that indicates if a company is profitable. Relying on multiple metrics versus one or two provides multiple failsafes to increase the likelihood one is purchasing a valuable company at a discount.
The Stocks I Like Based on These Metrics
I list my Value Stock Picks, which are based on the value investing metrics I use.
Subscribers to the HowIGrowMyWealth Email Newsletter know that I’ve been selling a fair amount of stock as a result of these refined metrics.
Some of that is profit taking, but these metrics have also enabled me to see problems with certain stocks that I otherwise thought were a great value.
HIGMW Email Subscribers also learned of my latest value stock picks back on the 2nd of February.