Monday, September 10, 2007

What is Value Investing? - Part III

I think it is generally known how the word Value Investing can be interpreted many different ways by investors. I have decided to compile a list of things that I don’t consider indicative of value investing.

“The stock trades at a historical EV/EBITDA value of 8.1 and now trades at a EV/EBITDA of 7.5. Therefore, it is now undervalued.”

True value investors hate the word EBITDA. It makes their skin crawl. Many investors use the term interchangeably with cash flow, or God forbid, free cash flow. It is a word made up by Wall Street to justify deals and confuse investors. I am convinced that there is a special place in hell reserved for EBITDA, and one day it will be there.

“The stock trades at a PE of 6 while the market is at 15 times earnings.”

A low PE does not always mean that a stock is undervalued. If earnings are peaking, then a low PE actually gives a sell signal. This is why Home Builders had such a low PE for a while. As earnings come down faster than the price, then the PE will soar giving a perverse type of buy signal.

"The PE is at 15 times earnings and it usually trades at a multiple in the 20's, just look at the PE chart."

Is it possible that the earnings that you are using in your denominator are no longer accurate because the company just missed its earnings for the quarter? The new earnings numbers haven't flowed into whatever data source you are using, or maybe the market is assuming that it will be a lot worse than you do? Either way, that PE is realistic.

1 comment:

Jay Walker said...

In terms of your EBITDA comment, I couldn't agree more. Acting as if interest payments didn't have to be made, or heaven forbid, that depreciation didn't really exist.

If that were the case, I guess I'd still be throwing my '69 Datsun 510 around on two wheels.

Another fine piece of writing Eric - keep up the good work ...

The Confused Capitalist