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No. of Recommendations: 10
Hi Eddie.

"I wanted to learn how to determine if the price I pay when I buy this stock is cheap, reasonably priced, or wildly priced..."

I think you'll get a lot of different answers from different people. I am speaking for myself here, not for Saul or for TMF itself (I am an independent contractor, not an employee).

I like to create a spreadsheet where one tab holds historical stock prices, going back about four years (I use 1,000 days). In another tab, I track various financial metrics that MIGHT drive stock prices. These are things like sales, GAAP earnings, adjusted earnings, operating cash flow, free cash flow, and EBITDA. For each day that I have a closing price, I calculate the ratio that the price implies, based on the sales (earnings, etc) that were publicly known on that day. This results in a data base of historical ratios. Let's say you're looking at a company and you know that the current PE ratio is 25.73x. Is that good or bad? Well, a lot depends on industry and the company's growth rate. But I can look in my spreadsheet and see what the range has been for the past four years. If the range is from 18x-26x, that tells you one thing about the current value of 25.73x. If the range is 24x-37x, that tells a different story. If the range is 23x-29x, you get a third message.

What I'll often do is try to determine which ratio(s) send(s) the strongest statistical signal, and pay the most attention to that/those. I don't want to start a GAAP v. non-GAAP war here... Although I generally favor GAAP, there are some companies I follow where I completely ignore GAAP earnings because the signal that the GAAP-based PE ratio sends approximates the signal of a random number! For a couple of companies I've invested in, the strongest signal was sent by EV/EBITDA, which is a little tough to shoehorn into the spreadsheet, but can be made to work.

The biggest problems with this approach are (1) this is entirely backwards-looking and markets are forwards-looking, and (2) companies can change over time. A new product or an acquisition might render older ratios useless. Another issue that sometimes comes up -- and this would certainly be the case for AYX -- is that recent IPOs don't have four years of trading history.

I'm happy to answer any questions about this approach, but please recognize that we're a little off topic here compared to what Saul prefers... I'm pretty sure that there are services available where one can chart, say, a company's PE ratio rather than its stock price. But so far I've chosen not to pay for anything like that.

I hope this helps!

Fool on!
Thanks and best wishes,
See my holdings here:
Peace on Earth

Please note: I am not a member of any newsletter team. My opinions are my own and do not necessarily reflect those of the TMF advisers. I am not an investment professional, merely an investor.
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