Usefulness of market multiples

Stock Market Investment Partner has been recommending that you do your own detailed research when selecting stocks. While we still believe that this is a very good idea, we can't blindly pretend that every single investor does it. Some investors prefer looking at market multiples like the price earings ratio. Hence, using market multiples must not be rejected, and here are the two main reasons why:

- Price earnings (P/E), price to book (P/B), price to sales (P/S) and other market multiples are very simple and available. Using them as a part of stock analysis is less complicated and faster than doing a discounted cash flow model (DCF) for example. Market multiples provide a quick overview of the valuation of a stock and can quickly guide investment decisions.

- Market multiples often are self-fulfilling prophecies. Indeed, since they are so simple to find and to use, lots of investors use them. Since lots of people use them, others don't have a choice to use them also because they feel that multiples now explain (at least part of) market valuations. A chain reaction is created and the majority ends up using them.

For those two reasons, multiples become relevant for stock market investment analysis and should be combined with more complete research.

Low-coverage stock brings high return

Well it didn't take very long for me to find a good example to illustrate what I suggested in my last blog "The relative value of stock analysis". Just a few hours after posting, I made a very nice gain because of my analysis of a "low-coverage" stock, ADF Group (ticker: DRX on the Toronto Stock Exchange). After reading everything I could find about this company, I came to the conclusion that I had just found a highly undervalued stock. This company isn't often in the media and isn't covered by any of the major research firms. It seems to be covered mainly by three analysts of smaller firms. Today, ADF Group announced fantastic second quarter results and the stock climbed 12.31%.

Here's some things I liked about it after finishing my research:
-Fast growing order backlog
-Backlog gives revenue visibility for many quarters to come
-Operates in a niche
-Qualified workforce
-Using most recent technology
-Management is financially involved through stock ownership
-High profile contracts which help the company's reputation (Freedom Towers, Encana building, Miami International Airport, etc.)
-Lowering debt brings flinancial flexibility in case of slowdown
-Room to grow since about 50% of capacity is used
-Market punished non-residential construction even if it's situation isn't like residential construction.
-Opportunities to grab new contracts in Western Canada and all over North America (infrastructure needs).
-Currently in the final stages of negociation for big contract(s).

I then found my own price target with 4 methods: DCF, multiples, RIM and EVA. My results indicated that ADF Group was mispriced and I bought some shares.

Today, my well hidden secret was revealed to more market participants through a news release and a conference call. Those participants rewarded my research efforts by pushing the stock price up. By performing what I call value-adding analysis, I was able to find an underpriced company with a great future and have an impressive 12.31% gain once the market discovered my hidden gem.

Stock Market Investment Partner encourages you to take a look at ADF Group and any potentially attractive low-coverage stocks and decide by yourself if they are worth the investment.

The relative value of stock analysis

You will never catch me saying that stock analysis is useless in the investment process. It is an important part of every decision and should always be done. However, is it possible that analyzing certain stocks adds more value to your decisions? I believe so and I will explain why.

Researching potential (and current) investments boils down to extracting information. If you wish to make great amounts of money, I suggest extracting usefull information and, most importantly, information unknown by most investors. In general, information is traveling very fast and is reflected rapidly in stock prices. One of your missions as a greedy and intelligent investor is to uncover situations where information travels slowly and prices do not reflect all the available information. Doing that is the definition of value-adding analysis because you're reading and crunching numbers about stuff that most of the market hasn't had the time or the desire to look at. You're not analyzing information that has been known for a week by the people of Wall Street, their brothers, their sisters, their friends, and their gardeners.

Value-adding analysis is performed on the "forgotten" stocks - i.e. the stocks that aren't followed by the big firms' research analysts and those followed by only a few small firms' analysts. The less coverage a company receives, the bigger comparative advantage you can gain by doing a complete analysis. Indeed, the stock prices of companies with low coverage have a greater chance of not representing all the information. Information travels slowly so such mispricings will eventually end. It is your role to profit from these mispricings while they last. You just have to be ready to read anything (and I really mean anything) you can find about your low-coverage companies of choice and hope to find that precious piece of information that hasn't been digested by the market yet.

While analysis of some stocks has "higher" value, analysis of any stock is valuable and Stock Market Investment Partner recommands serious analysis in all investing decisions.