What is a Lincoln Valuation?
A Lincoln Valuation is a theoretical share price value calculated by Lincoln’s Analyst team using forecast earnings figures, and is designed to give an indication of the true intrinsic value of a Star Stock in relation to its current share price.
The relationship between a company’s current share price and its true value can provide an indication of the underlying value of a company should they consistently meet (or exceed) forecast earnings figures.
How is a Lincoln Valuation calculated?
Each Lincoln Valuation is calculated by using a weighted combination of valuation methods (such as relative P/E, EV/ EBIT, discounted cash flow and dividend discount models). For example, it would be more appropriate to value REITs and infrastructure companies using a dividend discount model rather than a cashflow model. These methods have been back-tested and showed stronger correlation to share prices than consensus target prices.
The specific weightings attributed to each valuation method vary dependent upon the industry in which the company operates. To account for extraordinary circumstances, specific weighting criteria and/or thresholds may be altered at the discretion of Lincoln’s Analyst team.
Interpreting the Lincoln Valuation
Each Lincoln Valuation is a point in time, theoretical valuation of a company’s share price based on its forecast earnings expectations and risk profile. A company’s earnings are the strongest correlation factor to long term share price appreciation.
It is important to emphasise that a Lincoln Valuation is NOT a share price target to be relied upon as a buy or sell recommendation. It simply meets Golden Rule No. 5 of our Nine Golden Rules.
A Lincoln Valuation does not attempt to predict that the share price will reach a certain dollar value within a particular period of time. It is simply an indication of the underlying value of a stock based on numerous reasonable assumptions set by the analysts that may or may not come true.
Rather than using valuations as a sole buy / sell determinant, we believe it can be used successfully as a stock management tool to help with position sizing (taking profits) and your exit strategy (stop loss strategy).
Interpreting the Lincoln Valuation display
The Lincoln Valuation display within the Stock Doctor system is shown on the summary screen with a classification of discount, fair value or premium.
The Lincoln Valuation display appears under Golden Rule #5 on the Company Summary screen.
This display illustrates the relationship between Lincoln’s opinion of a Star Stock’s value based on its earnings expectations and risk profile relative to its current share price.
Note: The share price is expressed as a discount/premium to the Lincoln Valuation.
Here are some example scenarios to illustrate how to interpret the Lincoln Valuation display for companies in the Stock Doctor PC version. This classification system is also applied to Lincoln preferred income stocks and Lincoln covered stocks on the online Nine Golden Rules screen.
1. Share price at a discount
Share Price < Lincoln Valuation
For example, if a stock is currently trading at $6.52 per share and has a Lincoln Valuation of $9.00 per share, this suggests that based on earnings forecasts, when paying $6.52 per share you may actually be receiving $9.00 worth of value. Hence, this may be an attractive investment opportunity worthy of further investigation because the current share price is trading at a 28% discount to the Lincoln Valuation.
2. Share price at fair value
Share Price = Lincoln Valuation
Due to the high margin for error in calculating the fair value, Lincoln has assumed a 20% buffer above and below the calculated fair value as the “value range”. For example, if a company is currently trading at $1.79 per share and has a Lincoln Valuation of $1.59 per share, we would consider the stock to be trading within our fair value parameters even though it is technically trading at 12.5% above our valuation.
We allow a greater scope within the premium range because of the very nature of our Star Stock selection process where we are often looking at fundamentally superior stocks that usually command a premium relative to peers.
3. Share price at a premium
Lincoln Valuation < Share Price
For example, a company currently trading at $11.00 per share with a Lincoln Valuation of $8.83 per share, suggests that when paying $11.00 per share, you may only be receiving $8.83 worth of value. Hence, this may not be an attractive investment opportunity for capital appreciation unless earnings upgrades follow through in the near future. For investors holding the stock it may be worthwhile reducing your current exposure to the company back to equal weight, or some other level as dictated in your investment plan.
A company’s current share price may have already factored in a significant future event (such as merger/acquisition plans or the signing of a major contract). However, the event may not have been factored into the forward earnings estimates used to calculate the Lincoln Valuation. This is due to our preference to consider only ‘known’ outcomes rather than speculate on events.
To that end, it is not uncommon to find a share price significantly differ from the current Lincoln Valuation. While most analysts use valuations as their key buy/sell decision trigger, we do not. Therefore we are less likely to change our targets based on ‘keeping up with current prices.’