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Hello Victor,
It’s about some feedback after watching video of PE valuation on VICOM. Please allow me to recap using Cash-adjusted PE (logic behind should be similar)
If I understand valuation model correctly, Victor has compare price-adjusted PE with average PE of 2012 – 2017. So I try to summarize data captured from video as below –
Share Price = \$5.85
EPS = \$0.318
Net cash per share = \$1.19

Average PE (non-cash-adjusted i assume) = 17.8
Non-cash-adjusted current PE = 5.85/0.318 = 18.4
Cash-adjusted PE = (5.85-1.19)/0.318 = 14.7

Margin of Safety = (17.8-14.7)/17.8 = 17.4%
I assume model somehow similar to yours as i am getting ~17% mos which about the same. If it’s true then intrinsic value and cash-adjusted-PE both reflecting similar valuation level just from different perspective.
So my questions are –

1. Is it fair to compare cash-adjusted with non-cash adjusted PE as two are different variables?
2. Why not to compare PEs strictly based on either cash-adjusted or non-cash-adjusted basis ?
3. In the video, Victor mentioned that PE is best to use for company with predictable earning but also can be used for non-recurrences earning company but there’s differences. May I ask in what scenario PE can be used for latter and how would it applies?

Thank you.

Victor Chng answered 5 years ago

Hi Jeff,

The method we use are similar to the Enterprise Value to EBITDA valuation. Based on my experience most people focus are on the earnings only.

Personally, I think there is no double account of cash position. For instance, Enterprise value (EV) is what most investors used to value the company. For instance if the company share price is \$1, having a net cash position of \$0.6 and a EPS of \$0.04. So most investor will used the EV over the profit. The EV of the company is \$1 share price minus \$0.6 cash which give \$0.4. Hence, what the investor see is what they are truly paying for the company which is just 10x earnings (\$0.4/\$0.04). For my case, I just did the reverse instead of subtracting it from share price I added it back to the intrinsic value. For the cash position, I take the cash and the current investment. When we say cash & cash equivalent means liquid asset which means they can turn in to cash fast.

Valuation are subjected based on individual conservativeness. If you want to be conservative with your approach on investing then you can do both cash adjusted and non-cash adjusted figure.

Company that are less predictable usually trade below 10x PE or have high PE when they are during the down time. The important things is to find out the non-predictable company normalised PE and try to be below it.

Jeff replied 5 years ago

Thank you Victor for swift response and comprehensive explanation.

If I understand you correctly in VICOM case study the valuation approach used is similar to concept of EV/EPS which serves purpose of including cash/debt position in multiples calculation, which PE doesn’t takes care of.

Therefore it seems interesting and new to me that EV/EPS is used compared with market PE.

Regarding finding normalized PE for non-predictable company maybe is too much ask for example here, but is it possible if you could guide us what’re essential step of determining normalized PE?

Then maybe i can prepare more data based on some non-predictable companies for further discussion.

Victor Chng answered 5 years ago

Hi Jeff,

To find normalised PE is rather similar to average PE , first you need to find the company’s yearly EPS. For instance, the company have 10 years EPS, take the sum of 10 years EPS divided by 10 and you will get the average EPS or sometime people called it normalised EPS. The key is to take as many years as possible and make sure that those years you have taken, the company had been through up and down cycle.

Next is to find out the average PE trading range of the company. Once you get the figure, take the normalised/average EPS multiply by the average PE to compute an intrinsic value.

Jeff replied 5 years ago

Thanks Victor. Will you take 5 or 10 years data for company which has demonstrated growing and predictable(?) profit, for example Scientex?

Victor Chng answered 5 years ago

Hi Jeff,

I will do both of them and see which one have the lower figure. The key to valuation is to project the worst case scenario. If your company share price reach the worst case scenario and still give you margin of safety, your downside is much protected already.