Conclusion
It is noted that each valuation indicator has its own characteristics which give it advantages and disadvantages. While the PER and the yield can be useful in a first approach, they are clearly insufficient.
I believe that to have a good view of the company, it is appropriate to use at least 2 valuation indicators (in addition to an analysis of the quality of its fundamentals). We must first obtain an image of the "static" value of the company, via a snapshot of its balance sheet. To do this, we use the price / book value ratio. Then we seek to determine its more "dynamic" value, via the statement of its results or its cash flows. To do this, we use the price / sales ratio and / or the price / free cash flow ratio. These three ratios have clearly proven themselves.
However, as we have already pointed out, it is important not only to look at valuation but also at fundamentals, such as liquidity, debt, margin development, the ability to pay interest and meet other financial obligations. If we do not do this, we run the risk of finding a "value trap", a value trap, in short a false good idea...
Finance, despite what one might believe, is not an exact science. It remains a human science, even if computer science has rushed into it without restraint. All these ratios are there to help us make the best possible choice, but in the end we cannot be certain of the result. That's a good thing, otherwise it would mean that anyone could make money on the stock market without taking any risk... and suddenly the returns would become close to zero.
It is therefore advisable to put all weapons on your side by buying stocks with good fundamentals at a reasonable price. In doing so, you limit the risks as much as possible while achieving good performance. You can make mistakes from time to time, but with a minimum of diversification you ensure that the impact of your mistakes remains marginal compared to the overall result.
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Very good series of articles! The summary is understandable despite the mass of information. Thank you for sharing your knowledge!
Thank you soso
Looking back at stock valuation methods, shortly after the deadline for filing your 2019 tax return, I observe that the tax administration (in Switzerland) indicates the following for the valuation of unlisted securities:
– The wealth is assessed at market value (which corresponds to the price that would be obtained in the event of the sale of the property on the market on the date of the assessment, under normal circumstances).
– For unlisted securities for which no price is known, the market value corresponds to the intrinsic value determined according to the instructions of the tax administration.
– It is the so-called practitioner method that is applied.
– The value of the company is determined by taking the weighted average between the yield value (which is doubled) and the substantial value. The formula applied is therefore: E = (2 Vr + Vs) / 3.
– The annual accounts therefore serve as the basis for the calculation.
– Two models are available: (1) the annual accounts (n) and (n-1) serve as the basis for the calculation, with profit (n) being counted twice and (n-1) once; (2) the annual accounts (n), (n-1) and (n-2) serve as the basis for the calculation, with each annual profit being counted once. Each canton chooses one of these models, with the company being assessed being able to request the application of the other model (but the model must remain the same for at least 5 years before it can be changed).
– The yield value is obtained by capitalizing the net profit of the determining financial years, increased or decreased by recoveries or deductions.
– The following are added to the profits: expenses not admitted for tax purposes (e.g. acquisition, production or improvement costs of fixed assets, depreciation and constitution of additional provisions for replacement purposes, allocation to reserve funds, open or concealed distributions of profits, etc.), income that has not been carried to the profit and loss account (e.g. advance payment of profits), one-off and extraordinary expenses (e.g. extraordinary depreciation for loss of capital, constitution of provisions for exceptional risks), advance payments and other extraordinary allocations to provident institutions and extraordinary contributions to public utility institutions.
– The following are deducted from the profit: one-off and extraordinary income (e.g. capital gains, dissolution of reserves and provisions relating to expenses not admitted for tax purposes and which have been corrected, allocation to tax-exempt pension institutions if they relate to the financial years in question.
– The capitalization rate is composed of the interest rate on risk-free investments and a premium for fixed risks.
– The risk-free investment interest rate corresponds to the average of the 5-year CHF swap reference rate, calculated on a quarterly basis for the fiscal period, rounded up to the nearest half percent. The risk premium, at a fixed rate of 7 percentage points, is added to the aforementioned average.
– The determining capitalization rate is published each year (it was 7% as of December 31, 2019).
– The substantial value is based on the annual accounts (n). It takes into account assets and liabilities in their entirety. Only the paid-up share capital is taken into account.
Note that with the practitioners' method, there is always something to tax, even if the company is sustainably loss-making and a buyer would logically value it at zero...
This method has the advantage of being simple to use. But it puts aside all reflection.
This method is focused on the past. It incorporates the substance value for a third party, which is economically unjustifiable.
This method is never used for merger or acquisition transactions, for which the profitability multiples method or the discounted future cash flow (DCF) method are generally used.
In any case, while performing a valuation using the practitioners' method is interesting for comparison purposes, it is not correct for an investor.
Thank you for this interesting feedback. Be careful, however, to take into account the fact that listed securities are traded at a premium precisely because they can be easily negotiated. We cannot therefore compare the two approaches.