Using Charting to Find Undervalued Stocks

Using-Charting-to-Find-Undervalued-Stocks-featured.jpgToday I’ll be talking about something that you don’t often see in value investing, and that’s charting. Using charting to find undervalued stocks, or to look for trends in value stocks and patterns that may help you to determine value. 

Using Charting to Find Undervalued Stocks

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If you’d like to test out STRIDE’s charting tool for yourself, just schedule a free live demo below and get charting.

The following content is transcribed from the video above on STRIDE's charting engine to find undervalued stocks. 

Let’s start with American Express.

We’re first going to look at their Revenue Per Share.

When we apply this filter to our chart, we can see that the business has had consistent growth, bar a few obvious dips (in 2004 and 2010).

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Now, if we turn the labels off and put the price in, we can compare the price to the revenue.

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While we see the same revenue curve, we now see the share price beside it and the relationship they have with one another. You can easily see where the price is below the Revenue Per Share, and where it’s above the RPS. Obviously, if you’re looking for undervalued stocks, you’ll want the price to be below RPS.

However, what’s important to note on a graph represented like this is that you’re looking at a 2:1 scale. That means that, if you look to the values up the left of the graph opposed to the values up the right of the graph, you’ll notice that the right is twice the left’s value. The price is following the right-hand values, while the RPS is following the left-hand values.

So you can follow a stock’s value quite effectively, but how can you use this effectively to find value or compare businesses? Well, although it’s a good start to give you a beginning picture, you probably don’t want to be looking at revenue in this case.

So let’s take revenue away, and look at something a little more meaningful (in terms of value).

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I’ve added in Earnings Per Share (EPS), and now we’re looking at the profit that the business makes. In the chart, the EPS is on the left, and the price is on the right. So, everytime the black line is above the blue line, you’re paying more than 20x earnings, and everytime it’s below the blue line, you’re paying less than 20x earnings.

What this shows us is that in the Dot Com boom people were paying way too much, in relation to earnings. A few years later, though, you see that the black line is below the blue line and this represents a much more sensible buying opportunity. But even further along the chart, just after 2010, we see that a rather big disparity between price and earnings begin to appear. This is exactly what value investors are looking for.

Something else that’s good to look at is Free Cash Flow.

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What we can see is that the free cash flow of this business has been quite erratic. An erratic free cash flow isn’t what you want to see, but nevertheless, you can still try to ascertain good buying opportunities within it. Looking at this chart now, we can see that the best opportunity hit in 2016, where the free cash being generating at almost $10 per share and the share price is $52,80 (a 5,2x free cash flow ratio multiple).

Now let’s look at another company, Salesforce.

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This is a really interesting example, because it’s in the software space. In the above chart, we’re looking at Revenue Per Share again, and we can see that they have an ubelievable run of growth. Revenue specifically has consistently tracked at 10:1, which as a multiple of sales of revenue is extremely high!

So let’s add another business in and compare this against a competitor.

We’ll go with Oracle.

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Okay, I’ve split the charts by each security here so what you can see in the bottom chart is that Oracle has only a 5:1 ratio for price to RPS. That’s much more average of what you expect to see, and Oracle has also been having relatively good growth throughout its life. Perhaps not as steep a curve as Salesforce, but remember that it’s an established business working with several times the revenue that Salesforce is.

So let’s take RPS away and place Earnings Per Share in.

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What we’ll see is that Salesforce has often made a loss, for a start. Now, when you’re buying a business, you’re buying the hope of future profits. It’s the simple truth. We can see some areas of profitability, but that was back in 2008 and unless you got in there… you’ve missed the train (for now).

When we look at Oracle, we can first see the difference in scale. Where Salesforce is 250:1, Oracle is only 20:1. While the Dot Com era was crazy, and 2008 brought a discount just like Salesforce, we can also see that there’s even a greater discount that came around 2014. These are the opportunities that we’re looking for. But, we’re also looking for steady growing businesses. In this chart, we can see that Oracle’s  revenue has consistently grown and the price has stabilised accordingly. In addition, you’re looking at a 20:1 ratio with more than one great discount in the past decade.

So what is it about Salesforce that’s got everyone so excited?

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We’re looking now at our last measure, and applying the Free Cash Flow per Share ratio to this chart shows something interesting. Salesforce should be able to just throw off free cash and earnings. In this chart, we can see that Salesforce has consistently generated quite a lot of free cash, making this multiple look a lot better than the last (50:1 instead of 250:1). There’s even been discounts on this from time to time. The consistently growing free cash is what’s interesting though. Because, the expectation of this is that once Salesforce gets to a certain point, a critical mass point one might say, it should be able to throw off earnings and free cash extensively.

The problem is, in my opinion, that the market has gotten way ahead of itself. Paying 50x free cash means you expect this growth curve to continue well into the future, where the truth is that it’s looking to slow and plateau already. In addition, the business doesn’t make a profit yet.

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Now, looking at Oracle we see that the business has always paid more than 10x free cash multiple. There’s been times where it’s come closer to 10x and others where it’s moved further away, but the average is 10:1. This is a much more reasonable multiple to pay.

Lastly, I would just like to throw in a business that was a STRIDE target and is no longer: Microsoft.

Screen Shot 2017-02-16 at 15.18.06.pngWe’re looking at a 20:1 ratio here. But, what’s interesting is that Microsoft dipped so far below free cash in 2012 (when this business was a STRIDE target) that actually at this point you had a price of $30 and a Free Cash Flow per Share of $3,50. If we were to look at earnings in this time, we’d see something similar.

My point being, you can use charts to determine how the market has paid historically, to see what sort of multiples the market has paid, and what it’s paying currently. In essence, you really can use a charting engine to find undervalued stocks. I hope this has been helpful. While I would never base my decision off this alone, I find charts exceptionally helpful to look at to understand patterns in the market and why a certain business might be trading at the multiples they are.

If you’d like to test out STRIDE’s charting tool for yourself, just schedule a free live demo below and get charting.

Topics: Valuation, STRIDE


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