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Tuesday, 10 March 2015

A random theory of evaluating companies

This is a random thought and theory on how to evaluate and price stocks. It might have majors flaws and I have not done any back testing to certify the credibility and performance. Hence, the title of "random" and I wish to stimulate discussion amongst readers.

As I was sitting through a lecture, I suddenly had a thought of valuing companies by taking either their accounting averages in a business cycle or during their normalized performance year.

Assuming that the company production capabilities and maintains competitiveness, the company should always "bounce back" to normalized rate of operations once the industry or market revitalizes. As such, this might be a more effective of evaluating companies that are the market leaders operating in a down market, since history suggests that almost all markets will trend back to where it declined. Certain industries that are dealing with necessities such as utilities, transportation and F&B are possible targets of such evaluation because these markets have the highest probability of recovering or even expanding.

Assumptions or risks for this "theory"
1. The company is able to maintain competitiveness such that when demand returns, it is still able to retain its previous performance. Such companies are usually market leaders with strong reputation.

2. Industry will revitalize or the market will expand. However, this is not true for all markets. An example is the Japanese markets. It may not apply for industries experiencing technology shifts out where there are alternatives for it or being phased out, such as old TV boxes are being replaced by new LED screens.

3. Furthermore, the time to recover back to previous averages may take years and such has happened in the Great Depression. While this is still an infant theory full of loopholes, it is worth the post to encourage more discussions and stimulate further analysis.

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