Saturday, January 31, 2009

The Price Sales Ratio Revisited

The Price/Sales Ratio (PSR as commonly understood, is simply the subject company's market capitalization divided by its most recent twelve months sales. The PSR was first popularized in Super Stocks in 1984 by Kenneth Fisher, the son of legendary investor Phillip Fisher. In subsequent years, studies have demonstrated the superiority of price/sales over price/earnings.

To be sure, Fisher never advocated the use of price/sales as a stand alone indicator of value. It is just one tool to use when in conjunction with other tools to estimate a company's value. The PSR is particularly useful when looking at a company without earnings as the more commonly used P/E ratio is meaningless.

According to Fisher, the underlying strength of the PSR, when compared with the P/E ratio, is its consistency or predictability. Earnings can fluctuate widely as we know today. Sales, on the other hand, are more stable. Sales also have the advantage of being less likely to be manipulated. Earnings are, after all, estimates based on accounting assumptions. They fluctuate with one-time expenses, write-offs and short-term changes in margins.

Fisher has been a long time contributor to where he has advocated the use of the Price/Sales ratio. In a 1984 article in Forbes, Fisher provided an important and frequently overlooked modification to the PSR. In this article he introduced what he called the "Debt Adjustment Factor." As the name implies, Fisher found it necessary to adjust the PSR to reflect both short term and long debt. His DAF can profoundly effect our understanding of the basic PSR. For illustration purposes, we can look at some companies in the aerospace industry and compare PSR's with debt adjusted PSR's:

Company PSR Debt Adjusted PSR
Alliant Techsystems (ATK) 0.62 1.93
Boeing (BA) 0.46 3.29
Ceradyne (CRDN) 0.84 0.30
Honywell Int'l (HON) 0.63 1.98
Locheed Martin (LMT) 0.75 15.00

Fisher developed a range of PSR values to measure a company's popularity in the market. The ranges vary by size of company and between high margin businesses and companies operating industries with inherent thin margins such as supermarkets. Accordingly, small growth companies are unpopular if their PSR is under 0.75 and very popular when the PSR is over 3.00. Similarly, companies with multibillions in sales, such as LMT mentioned above, are unpopular when their PSR is below 0.20 and popular when they are over 0.80. Thin margin businesses are unpopular at the 0.03 level and popular at 0.12.

While the PSR is a key factor in Fisher's approach, it is clearly not the only factor to consider. Terrible companies can have a low PSR simply because the market sometimes recognizes a badly run company. The other things we need to consider are profit margins, earnings growth and free cash flow.

There is any number of ways to determine if a company's common shares are priced for positive future returns. Fisher offers us an insight to one such method.

Friday, January 30, 2009

For Profit Colleges

Earlier this week, there was a controversial article at Seeking Alpha on the topic of For-Profit education companies. The companies discussed in this posting were DeVry(DV), Strayer (STRA) and Apollo (APOL). I responded to tthe original article by posting the following comments:

As an administrator at a major public university, I can say that we do not accept degrees from any of the online distance learning schools in this discussion. The University will not accept credits for transfer and it does not accept a degree from such an institution as a qualification for any position requiring a college degree. It may be that my employer is behind the times in matters like this but it seems from other comments, that employers in the private sector are not anxious to accept them either.

Something else to consider. Enrollments trends are only part of the story when looking at an educational instition. We also study retention and completion levels which we consider as important, if not more important, than enrollment. Our focus is getting our students through our programs successfully. If they do not stay in school or do not complete their program, we have failed in our mission.

The for-profit schools also lose out if they do not retain and complete students. The high turnover of students, the cost of acquiring students all effect their bottom line."

I then expressed my own opinion of value.

I wanted to comment on the valuation issue around APOL. I use a different methodology than used by others who expressed an opinion here. However, in my opinion, APOL has an estimated value in the range of $40.36 to $55.77 with an average estimated value of $46.73. For the record, I use multi-factor analysis. Additionally, I would use $4.89 as an estimated FCF."

Someone responded with the following comment.

sommer, i think you may need to add a couple more factors to your analysis. i have no idea what methods you are using, but on the surface it sure seems hard to use a FCF estimate of 4.89 and get a value in the mid-40s. i guess you could be using a 15% rate of return or assuming negative growth or something. otherwise that does not seem to make sense. the only way this stock is worth $40 is if citron is correct and there is massive fraud and misrepresentation of data. could be true, but don't think any valuation model is going to tell you that."

Okay, so this guy doesn't quite agree with me. I was actually using a rate of return of about 10%-11%, but what does it matter.

People seem to forget three things about valuations:

1. Valuations are estimates and not something carved in stone. There are multiple methodologies for calculation vale and they are all valid.
2. Valuations are all theoretical. The only true measure of value is what a willing buyer and and willing seller agree to when neither is acting under compulsion.
3. daily price movements are not about value. I happen to think that over time, prices move to value.

Based upon my own idiosyncratic methodology, I place a value of $45.93 on APOL and $14.77 on STRA. How Strayer can command a price of more than $200 is beyond me. The company is selling at nearly 30x free cash flow.


Tuesday, January 27, 2009

Amdocs Downgraded

Amdocs (NYSE:DOX) provides software and service for communications, media and entertainment industry service providers. It develops, implements, and manages software and services associated with the business support systems (BSS) and operational support systems (OSS). Its software systems cover the range of revenue management, customer management, service and resource management, digital commerce and service delivery, and information management. The Company’s services portfolio includes consulting and systems integration services, managed services, delivery services and product support services.

Globes Online reported that three investment houses downgraded their recommendations for Amdocs due to the company's reported results and forecast for continued difficulties. The investment houses, Oppenheimer, Cantor Fitzgerald and Wedbush Morgan all expect second quarter rwesults to lag.

Oppenheimer changed their recommendation from "Buy" to "Hold" and reduced their target price to $34. Cantor Fitzgerald also cut its recommendation to "Hold" from "Buy" and slashed its target price to $16 from $16. Wedbush Morgan had previously changed its recommendation from "Strong Buy" to "Buy." The latest change brings the recommendation to "Hold".

Amdoc's shares rose yesterday 1.8% to $17.35.

Sunday, January 25, 2009

EMCOR GROUP, INC. The Rebuilding Of America

President Obama's stimulus package includes substantial spending on infrastructure projects. One company that stands to gain from the stimulus spending is EMCOR Group, Inc. (NYSE - EME.) EMCOR operates in the engineering and construction space. It is an electrical and mechanical construction and facilities firm with operations in North America, the United Kingdom, and the Middle East.

The company provides services to a broad range of commercial, industrial, utility and institutional customers. They report operations in six market segments: (a) electrical construction and facility services within the U.S.; (b) mechanical construction and facilities services with the U.S.; (c) U.S. facilities services; (d) Canada construction services; (e) United Kingdom construction and facilities services; and, (f) Other international services. The electrical construction and facilities segment involves systems for electrical power transmission; premises electrical and lighting systems; low-voltage systems, such as alarm, security and process control; voice and data communication; roadway and transit lighting; and fiber optic lines. Mechanical construction and facilities services include systems for heating, ventilation, air conditioning, refrigeration and clean-room process ventilation, fire protection; plumbing, process and high purity piping; water and waste-water treatment and central plan heating and cooling.

Consensus estimates for sales ending 12/09 are projected to be $7,246.88 million. Consensus EPS estimates for the same period range from $2.28 to $2.65.

Sales growth is 24.8% YOY and EPS growth is 45.1% YOY. The historical five year growth rate for sales is 8.4% and for EPS it is 13.2%. The company reported positive earnings surprises for the quarters ending 10/08 and 07/08.


At its recent price of $20.72, EME is selling at 7.9X next year's estimated earnings. Operating margins have steadily expanded from 0.9% in 2004 to 4.2% currently. Similarly, net margins have grown to 2.5% from 0.7% in 2004. The company does not pay a dividend.

Our estimate of fair value is $29.97 to $48.96 with a mean value of $41.97. Using consensus EPS of $2.58, EME is valued at 11.6X to 18.9X earnings; the average fair value multiple is 16.27X earnings. The low end of our estimate provides a PRG ratio of 0.88, based on historical growth rate.

Saturday, January 24, 2009

Inaugural Post

Welcome to Measured Approach, a place where I intend to get up on my soapbox and expound upon my theories, perceptions, thoughts and hopes.

More to the point, I really want to discuss events as they occur and to raise questions on stock valuations, valuation methodologies and process. I am a self-taught private investor. I am not a financial industries professional and claim no particular expertise on the subject. However, I note that widely followed analysts and pundits have no better record than anyone else when it comes to prognosticating the future.

When evaluating stocks, I have a value bent and utilize multifactor analysis to augment the decision making process.

I invite all to vigorously critique any analysis presented on these pages.
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