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Arguably the most difficult thing about being a stock-picker is knowing when to trim (or sell) a position.
There are many ways to do this.
I’d like to show you a simple method that can be useful for you:
[Thread]
There are many ways to do this.
I’d like to show you a simple method that can be useful for you:
[Thread]
For consistently profitable companies, a useful valuation metric is P/E Ratio.
P = Price (share price or market cap)
E = Earnings
P/E = x (the earnings multiple)
You can use a historical earnings multiple and work backwards to determine what the future share price SHOULD be
P = Price (share price or market cap)
E = Earnings
P/E = x (the earnings multiple)
You can use a historical earnings multiple and work backwards to determine what the future share price SHOULD be
Example: $NVDA currently trades at ~98x earnings (TTM)
Historically, the 10-year avg. = 29.14
Courtesy of @KoyfinCharts, you can see that 2023 EPS estimates for $NVDA = $13.66
Historically, the 10-year avg. = 29.14
Courtesy of @KoyfinCharts, you can see that 2023 EPS estimates for $NVDA = $13.66
If we work backwards using the historical average P/E Ratio and earnings estimates for $NVDA, we can determine what the share price SHOULD be in 2023:
If P/E = x
using basic algebra, we determine that
P = E * x
so if P = 13.66 * 29.14
then P = $398.05
If P/E = x
using basic algebra, we determine that
P = E * x
so if P = 13.66 * 29.14
then P = $398.05
You might be laughing right now considering $NVDA closed at $598.45 on Friday.
If you believe the market will eventually return to historical valuations then you might be selling your shares to avoid the risk of a 33% eventual drawdown.
If you believe the market will eventually return to historical valuations then you might be selling your shares to avoid the risk of a 33% eventual drawdown.
Let’s say you wanted to play it less conservatively and use a 50x earnings multiple (which was ~ what it traded for the last few quarters before the pandemic.
P = 13.66 * 50 = $683
With that multiple you can see you’d still have 14% upside from here.
P = 13.66 * 50 = $683
With that multiple you can see you’d still have 14% upside from here.
It all depends on how you want to value a company.
The “napkin math” is still applicable.
If you’re investing for the long-term, you might prefer to hold it even if it’s richly valued.
Just know that future returns might be capped for awhile.
Again, depends on your outlook.
The “napkin math” is still applicable.
If you’re investing for the long-term, you might prefer to hold it even if it’s richly valued.
Just know that future returns might be capped for awhile.
Again, depends on your outlook.
Of course, P/E ratio isn’t applicable for many growth stocks.
Here you can use the P/S Ratio.
Only problem is you might have difficulty finding Revenue-per-Share estimates.
If you use full 12-month revenue estimates,then you’d have to use market cap for the price numerator.
Here you can use the P/S Ratio.
Only problem is you might have difficulty finding Revenue-per-Share estimates.
If you use full 12-month revenue estimates,then you’d have to use market cap for the price numerator.
Example: $ROKU currently trades at ~38x sales (TTM)
Historically, the 10-year avg. = 10.38
Courtesy of @KoyfinCharts, you can see that 2022 Revenue estimates for $ROKU = $3.36B
Historically, the 10-year avg. = 10.38
Courtesy of @KoyfinCharts, you can see that 2022 Revenue estimates for $ROKU = $3.36B
If we work backwards using the historical average P/S Ratio and earnings estimates for $ROKU, we can determine what the share price SHOULD be in 2022:
If P/S = x
using basic algebra, we determine that
P = S * x
so if P = 3.36B * 10.38
then P = $34.88B
If P/S = x
using basic algebra, we determine that
P = S * x
so if P = 3.36B * 10.38
then P = $34.88B
Remember, I used full-year revenue estimates for 2022 so P will represent the market cap (not share price).
Current $ROKU market cap = $59.5B
You can see that in historical context, it is also richly valued at the moment.
Current $ROKU market cap = $59.5B
You can see that in historical context, it is also richly valued at the moment.
Let’s say you wanted to play it less conservatively and use a 14x sales multiple (which was ~ what it traded for the last couple quarters before the pandemic.
P = $3.36B * 14 = $47B
With that multiple you can see it’s still richly valued using these variables.
P = $3.36B * 14 = $47B
With that multiple you can see it’s still richly valued using these variables.
At the end of the day, this is all a tool that you can use however you’d like.
Ultimately, you will need to make your own decisions based on whatever investing philosophy and strategy you have chosen.
If you have any questions, feel free to reach out. My DM’s are always open!
Ultimately, you will need to make your own decisions based on whatever investing philosophy and strategy you have chosen.
If you have any questions, feel free to reach out. My DM’s are always open!
Disclaimer: this is not investing advice. This information is intended for educational purposes only.
