Sunday, June 22, 2014

Short Term Price Movements Are Not Indicative of Value

In late February I posted a stock analysis over at Seeking Alpha where my conclusion was to wait for lower prices.  The company was undervalued on a relative basis against its competitors but it seemed a bit overvalued on its' own merits based on my analysis.  It wasn't grossly overvalued but it was trading higher than my fair value calculation and I felt that there were better values to be had at the time.  Thus my conclusion was to wait for a small retreat in the share price to give better value for the long term investor.

I've received a bit of criticism because between then and now the share price has increased about 16%.  Ooops!  Now don't get me wrong I can take criticism and I want each of you to question everything you see here and anywhere else for that matter.  We're all looking to improve our investing skills and an open forum for that is the best way.  Discussion breeds improvement.  Due to that criticism I decided to take a look at some common metrics for the company to see whether the value has gotten better in conjunction with the increase in share price.


On every one of these metrics the company is now more expensive despite essentially nothing changing at the company.  Analyst estimates for five year earnings per share growth were 6.90% in February versus 7.20% now with revenue growth forecasts of 0.70% then and 0.80% now for FY 2014.  Growth forecasts have increased slightly but in my opinion it's not enough to justify the 16% rise in share price.  Although it's still offering better value relative to its competitors.

Obviously I was completely wrong about the merits of the stock from a short term perspective, but I never claimed to have any idea about short term movements in the market.  To judge short term opportunities you're most likely going to need to know a lot more about technical indicators (whether those are reliable is for someone else to answer) and a lot of luck.

When you read my stock analysis reports remember that it's a starting point.  I'm presenting the facts and where I see the company on both a quantitative and qualitative level.  My fair value calculations are not values that are set in stone.  They are approximate price targets for where I would deem the company cheap and should therefore accumulate lots of shares or fairly valued or over valued.  I don't have a hard and fast rule about only purchasing shares at valuations less than my fair value price and I don't always go on a buying spree when the shares are undervalued; asset allocation and other values present in the market determine that.  As an accumulator of long term assets it's important to remember that lower prices for the same business equals higher value for the long term.

16 comments:

  1. Out of curiosity, which stock was this? The market prices are getting out of hand because of the widespread euphoria. Having a run-up of 16% for a short-term gain is probably a good move for traders, but not for long term investors.

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    1. R2R,

      Like a lot of people guessed it was DPS. A 16% gain is great for anyone but for long-term investors if you're still looking to accumulate it's definitely not ideal. I just wanted to vent a bit but I'm not concerned about it because it was one single person and the overwhelming majority of comments about my stock analysis posts are positive.

      Thanks for stopping by!

      Delete
  2. I hear you JC. I have also had people tell me that I wasn't early, I was WRONG. I don't mind being wrong, and we all are from time to time......but in the short term the market is just a voting machine......(to borrow a Buffett). I think it's also very important to remember another Buffett-ism....."Rule number one is never loose money, rule number two is never forget rule number one". Protecting our capital is very important, and I for one applaud you for sticking to your guns (and metrics).

    I am doing the same and it has served me well :)
    -Bryan

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    1. Bryan,

      What really irked me about it is that it wasn't critiquing the actual analysis to try and be constructive. It was solely based on the short term price movement. If you think a company is a buy at $50 then wouldn't the same company be a better buy at $48? The focus of the comments were all based on the short-term price change. I have a feeling if the price had declined passed my buy price and stayed there the same criticism would have been dished except now it's why were you saying buy.

      I think the most annoying part is that the commenter was completely wrong in his criticism. One comment "why was he (PIP) telling people to sell when he should have been telling people to buy". Right then I knew the person had no clue what I was talking about in the article because I never said to sell all I said was for me I'd wait for the price to come down some.

      Thanks for stopping by!

      Delete
  3. I'm in agreement that openly discussing these things is important to our collective investment education. It's smart to question each other and decide for ourselves what's best.

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    1. Addison,

      That's what I love about this blogging community. I don't think I've come across anyone that hasn't been a fan of open discussion, although I guess you kind of have to if you want to write for everyone to see. It's the collective education and knowledge that will help to push us all to be better investors.

      Thanks for stopping by!

      Delete
  4. I agree with you (which doesn't mean I always act like that). If you are, as you said, building a long term value, you want to choose stocks which are cheap at the time of purchase. I also when buying stocks skip those which I deem overvalued and look for new candidates which are fairly valued. Although from 20+ years perspective it may not seem important, I always try to look at it from the perspective of how much money you give away by purchasing expensive. That's why I like sell offs and even then I use my "conditional order strategy" to trail my purchase price down with the stock and buy at reversal only. Not 100% bullet proof, but many times I bought really cheap. I believe squeezing even a penny now can become nice dollars 20 years latter. Many times my contingency order helped me to buy 1 or 2 more stocks than if I have bought at the original price at the time of entering the order. Those two more shares can bring a significant savings or value (and dividends) which you would normally miss. With a proper valuation, it is the same. But harder to do, if you have no idea how to do it.

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  5. I think it's hard too when considering a single stock since it's absolute; e.g. if comparing Stock A which is considered overvalued with Stock B which is considered undervalued; in the same timeframe as your example, Stock B could have increased more than the 16% of Stock A. For me, that would be the point of the valuation, to force the question "is another better valued stock available?"

    But, from my very naïve perspective, I must admit that I struggle with valuation since I'm more about dividend income than total return. I don't know that valuation, based say on a calculation of future returns sought, tells me very much about a company's ability to consistently pay dividends with growth. What it does tell me is that I would get a higher dividend yield if I waited and the price came down, which is true for any stock. Can someone tell me what I'm missing?

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  6. As a buyer of stocks, I'm always hoping the price goes down even after I make the purchase. But there are some people who just like to call you out on everything. What can you do?

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  7. Curious to know which stock is this?
    With the market and most stocks at all time highs, it is becoming very difficult to find stocks at reasonable valuations.

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  8. I'm going to guess DPS or PEP

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  9. DGI is a long-term endeavor so I think it is wise to be evaluating stocks for long-term performance.

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  10. I don't spend much time worry about short term fluctuations. I don't know what analysis you are refering too, but with all that has happened in the world, I am somewhat surprised that the markets haven't gone down some. What would they be saying then? You were right, which would still be the wrong conclusion.

    Anyone who has payed attention to your blog knows you aren't day trading or short term oriented.

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  11. I'm going to go against the grain... You weren't wrong.
    Price action does not prove if you were right or wrong! If it did then people buying in 2007 and 2000 were right that those markets weren't overvalued.

    Guessing its PEP we are talking about from your Feb 21 posting date. Looking at its 10 year average P/E of 18 and that its 20 right now... yeah its overvalued. At BEST it was AT value in Feb.

    You did the RIGHT thing. You felt it was not the right time to buy and you didn't. It was based on your parameters and your risk tolerance. I see far too many dividend investors buy anything and everything with a yield at any price because they focus too much on dividends. Dividends can be your strategy but you have to be aware of how much you are paying. e.g. look at the mREIT investors in early 2013.
    Let the nay sayers put up their portfolios in a public venue. The vast majority of them probably don't own any stock at all and are just living vicariously through us. They are still arm chair quarterbacking their dreams instead of putting them into action.
    Sorry... its a sore spot for me commenters to criticize when they have no clue.

    Anyway again, you were not wrong. If we make the right decisions at the right time for our portfolios then profit is a guaranteed byproduct. If we go after profit as the primary motivator we'll blow up our accounts.

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  12. Your title says it all and all I can say is that Mr. Market will price a stock any which way despite income, cash flow, debt, sales, PE or any other valuation metric. Price swings come and go with each headline and seemingly wherever the wind blow. It is still wise to try and value a stock based on the financial information given but that by no means price action will follow suit. Thanks for sharing.

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  13. It's a nonsense to judge success of a recommendation based on 2-3 weeks of price action. Maybe that's a relevant metric if you are a trader. For someone who's holding for years, I'm not sure a 16% rise really matters, particularly if it's followed by, say a 30% decline in a few months (who knows??!!)

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