Identifying fundamentally superior companies trading at a discount to their true value can maximise an investor’s capital growth potential. They are searching for a disconnect between the company’s fundamental quality and the market’s view on the current price
Stock Doctor includes a variety of valuation metrics for clients.
Lincoln Valuation – our proprietary valuation metric which was tested and showed the strongest correlation to share prices.
Consensus Valuation – the average of target prices provided by analysts in the industry.
P/E – Investors can determine value by comparing the price earnings multiple to its historical levels or to the Industry or market average.
PEG – the price earnings multiple to the forward growth rate. In theory, a company with a higher growth rate should have a higher P/E
The consensus valuation provides an indication of the anticipated stock price 12 months in advance for companies where consensus data is available. In addition, traditional price earnings (PE) and price earnings growth (PEG) ratios can be used to assess Share Price Value. A PE ratio of less than the industry average indicates the potential for share price appreciation if the first three Golden Rules are met.
Where the PE is greater than the industry average, the PEG ratio (PE/EPS Growth) is used to determine whether earnings growth justifies the premium price. Lincoln’s benchmark is a PEG ratio of less than one. An alternative is to use a company's forecast PEG which attempts to justify the premium currently being paid against the earnings expected of it.
Clicking the (i) icon displays when the valuation was last updated.
Relying on valuations alone as your buy and sell trigger is risky and is not an easy task because:
- Value is a subjective measure and valuation models rely on numerous assumptions.
- Stocks that trade at discounts to valuation tend to have higher risk to earnings and could be considered value traps.
Hence it is important for investors to fully understand the risks associated with investing in a stock that is trading at a discount to valuation.
There will also be times however, when a company’s share price trades at a premium to its valuation, particularly with Star Stocks, due to its strong corporate history, stability of earnings and/or its future growth prospects with the market attributing a value to management’s ability to keep the earnings momentum going. If the investor is confident that earnings momentum can continue then they may choose to purchase or to keep a full or a reduced holding in the stock even though it is considered overvalued.
Golden Rule #5 – Using valuation techniques on its own can be ominous for investors because of the high risk in selection stocks with fundamental problems. It is often better to use valuation techniques as a stock management tool to help with position sizing (taking profits) and your exit strategy (stop loss strategy). But our view remains that sometimes investors will need to pay a premium for high quality stocks that have strong outlooks.