Tuesday, November 8, 2011

Value or Not?

Analyst Barry Cooper believes Barrick Gold (ABX), a gold miner, is a value stock. He cites the stock's P/E ratio, which is under 10, and argues that "value investors will either step into the stock or there are no value investors left in the market". But intelligent investing is not just about isolating low multiples; for this reason, Cooper is wrong about his assertion on so many levels.

For one thing, earnings estimates are only as good as the assumptions underlying them. In Cooper's estimates of Barrick, a whopper of an assumption is that the price of gold will remain at $1750/oz. Of course, it's possible that the price of gold will stay at or even rise above $1750/oz, but it may be just as likely that it will fall considerably. Over the last few hundred years, the price of gold was at the $1750/oz level in just one of those years - this one! Though many readers of this blog believe we are in a new era for gold, ten years ago the price of gold was just $300/oz...do you really think it can't happen again? What would the current P/E be worth then?

Another issue here is leverage. Focusing on a P/E number tells you nothing about risk due to leverage. With its $10.5 billion of net debt, Barrick has an enterprise value of about $60 billion. This gives it an EV/EBIT ratio of about 8 (even at the current price of gold!) which is nothing spectacular. Considering how sensitive that EBIT is to the price of gold, that ratio could change very quickly.

Finally, if you're going to base an analysis on the P/E ratio, you should at least look at its oft-forgotten cousin, the P/B ratio. Barrick trades at almost 2.5x book value, suggesting there will be a lot of businesses (other miners) expanding to take advantage of the profits that are out there. But Barrick has no monopoly here; this is a commodity product, and therefore competitors are free to compete by driving up the cost of land/labour/supplies and increasing the supply of gold on the market. All of these are bad for Barrick, especially if there is an inherent expectation (like there was during the housing bubble) that prices can only go up. Barrick is already seeing this competitive pressure, as "costs are rising amid inflationary pressures in the industry".

On average, low P/E stocks will outperform the market. But not all of them! An understanding of risk is essential to avoid getting taken by Mr. Market.

What's your take on this stock, value or not?

Disclosure: No position

5 comments:

Paul said...

Good analysis, Saj. thanks, man!

Blaise said...

wow i dont even know where to begin here.... ill start with this, you say:

"For one thing, earnings estimates are only as good as the assumptions underlying them. In Cooper's estimates of Barrick, a whopper of an assumption is that the price of gold will remain at $1750/oz. Of course, it's possible that the price of gold will stay at or even rise above $1750/oz, but it may be just as likely that it will fall considerably. Over the last few hundred years, the price of gold was at the $1750/oz level in just one of those years - this one!"

No. It is not "just as likely" that gold will go down. its not 50 - 50. What in your opinion is the main reason why gold is going up? whatever your reason is, is there more of it happening or less. i dont even need to know your answer to know that there's more of it going on. You know what also hasn't happened over the last few hundred years? printing trillions of dollars to bailout a bankrupt, corrupt banking system.

instead of spewing value investing slogans and phrases you have to focus on a much better understanding of money, monetary systems and their pros/cons. and you won't learn this from neoclassical economics.

Anonymous said...

What in your opinion is the main reason why gold is going up?

Irrational people such as yourself bidding up the price.

Blaise said...

yes, i am the one printing trillions of dollars and driving interest rates to 0% forcing speculation.

sorry i thought i was being rational there. i`ll stop that now

Blaise said...

Do as i say NOT as i do

oh man the headline says it all "Central bank gold buying at 40-year high"

http://www.ft.com/intl/cms/s/0/c0025500-10ef-11e1-a95c-00144feabdc0.html#axzz1e0mcAwQE

and yet the supposed "value investors" (how can you value something if your unit of measurement is changing continually, on the downside i might add?) cover their ears and repeat out loud all the talking points, phrases and one liners all the way over the edge.

a sight to behold (and profit from!)

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