For decades, a company’s market cap was used in valuation ratios but it has a fatal flaw. It can be misleading for companies with piles of debt. So enterprise value emerged as an alternative.

The advantage of enterprise value is that it’s a closer approximation of what a business might cost if it was bought outright. When you buy a business, you get everything — the business, its assets, and its debts. So enterprise value includes the company’s market cap, plus its outstanding debts (including preferred stock), then subtracts out the cash.

Including debt can dramatically change the valuation of a company. A company might look cheap based on market cap alone. But if it’s sitting on piles of debt, it will look expensive based on enterprise value. It’s not perfect, but using enterprise value makes for a better comparison between different companies.

The value metrics below are built using enterprise value. All tests were run with the following setup: Continue Reading…

Investors have a long history of wanting to know what the market does next. And why wouldn’t they? It’s the quickest way to riches.

That demand has had a constant supply of people foretelling the future. cAnd what stories they sell. They weave confident tales around a few data points that prove what the stock market or the economy will do next.

Except, it’s never that simple.

Take inflation. Its rate is tied to billions of people making financial decisions every day. Decisions tied to the income they want to make versus what their job will pay. Decisions tied to the number of products a company makes versus how many their customers will buy. Decisions tied to the price a store charges versus what consumers will pay. Decisions tied to how wealthy they feel that day or healthy or safe or afraid.

It’s a complex mess. There are too many unknowns — the Fed can’t even predict it. Yet, there are folks arrogant enough to think they can not only predict inflation but what the Fed will do about it. And it doesn’t end there.

There are specialized soothsayers for everything. We got gold bugs, inflationistas, doomsayers, permabulls, and more offering their niche opinion on the future. And if you pay attention long enough, you’ll realize they repeat the same thing year after year. It’s like a broken record. Continue Reading…

Early value metrics were dependent on information that was easy to find. Price/Earnings and Price/Book came out of that era. Both did a decent job of capturing value’s outperformance.

But as financial statements became more widely available, it spawned other value metrics that performed even better. Cash flow-based value metrics are a good example of this.

The cash flow metrics tested below are built using market cap (enterprise value metrics will be next). All tests were run on the following assumptions:

• No OTC stocks or ADRs.
• No stocks trading below $1/share.
• No low-volume stocks.
• Market cap greater than $50 million.
• Deciles are equal-weighted, as is the Universe.
• Benchmarked against the Russel 3000 total return index (It’s a cap-weighted benchmark. The universe of qualifying stocks is included for a better comparison).
• Stocks are bought on January 1st of each year, held for one year, then sold. Rolling backtests are done at four-week intervals with a similar one-year holding period.
• Assume all metrics are based on trailing twelve months (TTM) unless indicated.
• Data are from 2000 to 2020, sourced from Portfolio123.

For the metrics below, higher is cheaper and lower is more expensive. Each one follows a similar pattern where the cheapest decile outperforms the most expensive by a wide margin. The cheapest decile also outperforms the universe and the benchmark. Though, some do a better job of it than others. Continue Reading…

Markets have a way of luring investors into doing things they shouldn’t. Be it innovative new products or promises of high returns, there’s always something to tempt an investor’s resolve. And it ends up being costly. As with many things in life, avoiding certain things often lead to the greatest results.

I was reminded of this while browsing Another Investor’s Anthology. Part of its collection is a chapter from an outdated book by Claude Rosenberg, Jr. It’s a list of investing rules that are more likely to cost you money than make it in the long run. So investing don’ts. His list pertains to stocks specifically but is true for most investments.

Here’s the thing. None of the rules are new. They’ve been repeated so many times that they should sound obvious. Which is the point.

Common investing mistakes are common because it’s so easy to fall back into the trap of making them. Sometimes we forget how it turned out the last time. Sometimes it’s a momentary lapse of judgment. Whatever the reason, hindsight reveals what we likely already knew — we never should have done it in the first place.

But that’s life. Mistakes will be made. The goal is to limit the damage. Timely reminders of the more obvious ones may save us from ourselves someday. Continue Reading…