crk, I wish there was a simple valuation model to use! I rely on my experience of looking at thousands of stocks over the years and seeing how they performed after a good earnings report. What made some of them go up while others were left in the dust?
There are many criteria to use when evaluating a stock. Even when investors have similar strategies, they can be equally excited about one stock and in total disagreement about another. For me, P/E ratio is the most important metric. When a company reports a sharp increase in profits, I ask myself where would this stock trade if they can sustain (or hopefully further improve) the numbers. I like to use an annualized P/E of 10 (trailing P/E would be better...but harder to find) for my projections. Others may prefer P/E's of 15 or 20, but I'd rather be conservative.
Then I modify my fair value target based on my factors. How fast is the company growing revenues and earnings? Obviously, companies with faster growth rates deserve higher P/E's. I think bottom line growth is more preferable to top line growth, as a big EPS improvement with minimal revenue change will still attract attention. The problem is when there is no growth in sales or earnings. In that case, a P/E of 10 is probably too ambitious.
Then you have to look at the balance sheet. What's the tangible book value (goodwill is meaningless)...how much cash per share? Companies with lots of cash on the books should trade at a premium to their balance sheet-challenged peers. Some people like to look at the debt/equity ratio, current ratio, etc. I haven't found those measures particularly useful, but if it's working for them...then great!
When determining if the last earnings report was sustainable or a 1-quarter wonder...what caused the sharp increase in the numbers? Did management provide some bullish commentary in the last earnings PR? If there was a conference call, did they offer any guidance? Any seasonality to the business? Any 1-time gains/losses? If backlog and/or new order rates are provided, how do they compare to the last few quarters?
Still so many things to look at. Where is the stock traded? Listed stocks almost always trade at a premium to their OTC:BB brethren. What sector are they in? This is less important than it used to be. The biggest winners typically came from the tech sector, but look at how apparel stocks like TRLG.OB and ISAC.OB have surged over the last year. Are the earnings taxed...if not, when will they be? Are insiders buying or selling? Any potential negatives buried in the SEC filings...such as a bunch of options now in the money that will dilute EPS? Are the upcoming comps going to be easy or tough?
That should be enough to get you started. Happy hunting! Let us know what you find...
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