Price to earnings 1

I always look for values, and I tend to be an value investor. That`s why I have been written about Twitter and their IPO share price lately. That doesn`t mean I always look for a low price-to-earnings ratio stocks. I think that is a mistake many investors do when they are investing.

This approach has generated above the average returns over a long periode of time, but it is not the ideal solution to find the right stock. Twitter was trading down -2,33% yesterday, closing at a share price of 41,9. Value investors are selling at the moment. What is the value?

I look for the intrinsic value of all the assets in a company. The important thing is the cash flows that will be generated by that asset discounted back to the present moment at a rate that factors in opportunity cost and infation. You can measure the opportunity cost against the risk-free U.S Treasury.

Different companies deserve different valuations. That is how you understand the intrinsic value. It is difficult to try to figure out how to use this for individual stocks. It depends on the economics, the nature and what business the company are operating in.

You have many different businesses out there. You only need a computer to start a new web building company. Starting a new steel mill requires tens of thousands of dollars in startup capital. What a difference?

The web builder deserve a higher price to earnings multiple because the shareholders doesnt need to spend more money to maintain the property and other equipments. This is why intelligent investors distinguish between the net income figure and true and “economic” profit (Warren Buffet call it: “owner” earnings).

This represent the amount of cash they can spend on other investments by reinvesting it.

Reported net income is not the most important thing, but how many computers the owner can buy relative to his investment is more interesting.

The investors net worth is limited to the return on aquity generated by the underlying company. On the other side; you can hope for another “fool” to buy your share for a higher price or a great bull market, but that is very speculative and seems to be very risky.

As you can see, two different businesses might have identical earnings of $10 million, but Company A may gererate about $5 million and company B, $20 million in “owner earnings”, which means company B can have a price-to-earnings ratio that is four times higher than company A yet still be trading at the same value.

News today: FED chairman Ben Bernanke speaks at 7pm.

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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Shiny bull. The author has made every effort to ensure accuracy of information provided; however, neither Shiny bull nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Shiny bull and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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