Some stuff I bought last week

[Evan]

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If anyone's wondering why I call P/E a "completely flawed metric", you should go compare a bunch of companies in similar businesses with varying debt levels. You will almost always "determine" that the higher levered companies are the most undervalued. P/E uses a firm value and compares it to an equity cash flow; that makes companies with excess debt appear deceptively "cheap".

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Well, the best way to value a company is EV/FCF, wouldn't you agree? But if I use those terms here, half the audience won't understand. So I often use PE and market cap when writing about a stock just to be more easily understood.

When I'm doing my own analysis, I don't have a screener that understands FCF or EV, so I use PE and market cap to screen with. Then I have to do the dirty work of calculating EV and FCF by hand for anything that looks interesting. But before I get there I'm using PE as a shortcut until I figure out whether FCF is wildly different than E.

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You can screen for EV/FCF on Yahoo. I don't really know if I trust the way Yahoo calculates FCF (mostly because I don't know how they do it). I thougt you could also screen for EV/EDBIDA on Yahoo, but it looks like you can't. I'm sure you can somewhere though. Either way, comparing firm values to equity cash flows is just misleading. If you make sure you're comparing two like metrics you'll get much more meaningful results.

[Evan]

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Secondly, when an analyst starts talking about "forward PE", I immediately regard them as a retarted moran.

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Since the value of a share of stock is at the very least highly dependent on future earnings why is an analyst that discusses "forward PE" (i.e. future earnings) a moron?


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While this is not that far from the truth, it is still wrong. Stock prices are based on future free cash flows, not future earnings. This may sound trival to some, but it's not.

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We can quibble about what "at the very least highly dependent on" vs. "based on" but to me they do mean something different thus I used "at the very least highly dependent on" vs. "based on." You more or less imply that they're synonomous but they're not in my mind.

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Okay, I'll agree that they're usually corrlated. I would guess that price and earnings have a high beta but significantly different alphas (at least in some cases). If that's all you're saying than I misunderstood your post.

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By the way, the analyst is sort of a moron anyway if he valued the firm based on any type of P/E (I haven't read this report and I don't even know what analyst we're talking about, just so we're clear, this is just a general statement).

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I don't agree with this at all. Future earning imply something about future free cash flow if that's how you prefer to value equity.

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Yes, they do imply something.

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Why a completely flawed metric has become the gold standard for people that know just enough about finance to hurt themselves, I don't know, but I sure get a kick out of it.

If anyone's wondering why I call P/E a "completely flawed metric", you should go compare a bunch of companies in similar businesses with varying debt levels. You will almost always "determine" that the higher levered companies are the most undervalued. P/E uses a firm value and compares it to an equity cash flow; that makes companies with excess debt appear deceptively "cheap".

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What studies back this up out of curiosity? It should be easy to identify such companies and compile data on investment returns.

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Studies? For what? Companies A and B have PE's of 20 and the same market cap. Company A has twice as much debt as company B. Do you think these these firms are fairly valued (assuming all else is equal)? I don't know of any study that proves this, or even where I'd look to find one, but it's basically just common sense.

The long term weekly chart.

[adios]

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Studies? For what?

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To indicate that picking company A referred to below has inferior returns for investors compared to company B below.

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Companies A and B have PE's of 20 and the same market cap. Company A has twice as much debt as company B. Do you think these these firms are fairly valued (assuming all else is equal)? I don't know of any study that proves this, or even where I'd look to find one, but it's basically just common sense.

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Just because you say it's common sense doesn't mean that buying stock in company A will provide inferior investment returns than buying company B stock. Again this is a fairly easy set of criteria to enumerate and track investment returns for. What I'm chiding you about is that IMO you're more or less arguing that there's a market ineffeciency of some sort.

Here's what you wrote in the post I responded to:

If anyone's wondering why I call P/E a "completely flawed metric", you should go compare a bunch of companies in similar businesses with varying debt levels. You will almost always "determine" that the higher levered companies are the most undervalued. P/E uses a firm value and compares it to an equity cash flow; that makes companies with excess debt appear deceptively "cheap".

If a company is deceptively "cheap" then this implies to me that it's a worse investment i.e. will have inferior returns for the investor buying the stock than another compnay with a similar business but less debt. I'm a little confused with your point here because in the post I responeded to I think you implied that the companies in similar businesses have different PE's as the higher leveraged company has a lower PE and thus is "deceptively cheap." But in your next response they have the same PE's so why would the higher levered company be "deceptively cheap" if they have the same PE's? Put another way when you wrote:

You will almost always "determine" that the higher levered companies are the most undervalued.

I assumed you meant the higher levered companies would have lower PEs. Is that wrong and if so could you elaborate on the criteria that you were referring to that one would use to "determine" that the higher levered company is undervalued?