A company ranked 1-Star in Business Predictability may prove difficult to value. For a visual learner, deciphering income statement information may be even more challenging.
A low ranked company will have earnings that fluctuate so much that projecting out value based on earnings will often be impossible. Some years may be so difficult earnings are negative. Other years may be so successful that earnings are unsustainably high. Therefore, the astute investor must find other financial statistics to determine the margin of safety. Plotting these statistics on a chart will allow the visual learner to become a better analyst. Not only does it take the stress away for those that do not enjoy number crunching, it actually may even display the margin of safety in a more simple way.
Some investors prefer studying historical revenue. They study the historical range of sales in good and bad conditions. They understand at a certain point, for a company that manufactures tires such as Goodyear Tire & Rubber Company, there is a point where the market becomes saturated.
The analysts study the demand of tires and calculate times when too much product is being produced. At those times they may estimate sales will gravitate towards their natural equilibrium where the market is supplied the proper amount of tires. Other times, like 2009 when sales dropped further than the demand for tires, analysts may predict an upturn in sales in the near future, as what happened from 2010 to 2012.
After studying the range in sales these enterprising investors would study the price paid for those sales. For the visual analyst, they would plot a chart of market capitalization next to annual revenue. This divergence between the two will show the margin of safety the market is giving. The closer the two lines means the market is paying more for revenue. The further market cap is from revenue, with a larger the margin of safety, the market is pricing Goodyear's revenue at a larger discount. Next, the enterprising investor should determine how often the market prices revenue so cheap or expensive.
Another way to visualize this margin of safety is through plotting a chart of price versus sales. This ratio, called the Price to Sales ratio, or P/S ratio is simply those same numbers displayed above shown in a different way. Once again, the visual learner may find plotting a chart of the P/S ratio easier and more enjoyable than data crunching. For those that do enjoy numbers, combining the visual method with excel analysis could be even more profitable.
Displayed as a fraction, the price divided by sales line it is very easy to see years when Goodyear revenue was on sale. Both 2003 and 2009 were years when $1.00 of revenue was price below $0.10. As seen in the chart below, those were great years for the value investor to buy GT.
For growth investors buying GT in 1999 when $1.00 of revenue was being priced at $0.80, the returns were not as good. The chart below shows the importance of finding the margin of safety. Astute investors, visual or not, must identify what they are buying and what the market has priced it in the past. Cycles do repeat, ignoring them may lead to financial loss.
Do not ignore the numbers. If you fear data crunching, make it easy and plot them on a chart.
Thanks to Gurufocus.com for providing the Interactive Charts.
