Saturday, May 8, 2010

New Era Value Investing: Chapter 4

As the chief investment officer at Fremont Investment Advisors, Nancy Tengler employed the value approach she describes in her book, New Era Value Investing.

Though Tengler claims the method described in Chapter 3 works, it is heavily reliant on the dividend. But as the market has evolved, the magnitude of the dividend as well as the number of companies paying a dividend has declined. As productivity has increased, companies have found more profitable areas in which to invest their earnings, and as competition has increased in what were previously slow-growth industries (e.g. telecom), investment in future technologies has become a key success factor. As such, to expand the investment universe, Tengler developed a valuation method that would not be dependent on the dividend.

The obvious and most commonly used factor associated with a stock is earnings. However, Tengler avoids using earnings due to the fact that it is subject to judgement (by management, in its determination) and because it can fluctuate tremendously (particularly for cyclical companies). Therefore, the factor Tengler prefers to use in her value approach is sales. Sales cannot be manipulated, and are also subject to far less fluctuation than are earnings.

The valuation method Tengler uses is therefore Relative Price to Sales Ratio (RPSR). A company's price to sales ratio compared to the market's price to sales ratio is computed on a historical basis. When the company trades at a low price to sales ratio as compared to the market's price to sales ratio on a historical basis, it becomes a buy candidate.

Tengler recognizes that these "relative" value approaches differ from the original Graham and Dodd "absolute" approaches. But she has found using relative valuation approaches more useful, as they can be employed during any market environment. In this way, she argues that the spirit of value investing can be employed to a much larger universe of stocks.

1 comment:

Iowa said...

One comment I'd like to make and open for quick discussion is the manipulation of sales. Sales can be 'manipulated,' if that's the correct term, somewhat due to management decisions to discount products or services to maintain customer engagement. In the retail industry most of us can identify with. These discounts have a direct effect on gross margins & earnings as well. Also involved could be new expenses that historically were not part of operations, such as new/increased taxes (especially for some casinos) that must be taken into account. I'm sure there are more, but something to think about or weigh in if sales is one of the inputs to value calculations.