Last week, I shared with you one of the techniques that companies use to boost their earnings per share (EPS) results and give the appearance of a business that is firing better than may be the case. Towards the end, I raised the question about what this means for price to earnings (P/E) ratios, which I???m sure you recognize as one of the easiest valuation metrics to use, but also one that is fraught with issues. That???s why in order to get really comfortable recommending a company to subscribers of my PowerTrend Profits newsletter, I need to triangulate the target price and the downside risk. That???s right, I need to understand the net upside for a recommendation, and normally I can???t get behind one that doesn???t have at least 25% net upside.
Just like a professional golfer utilizes various clubs based on the situation, I too have valuation metrics for different situations. What situations, you may be asking yourself, could I be referring to? Well, what if a company doesn???t generate EPS? What if a company pays a dividend? What if the company has no debt? What if it has no earnings, but strong cash flow?
Now, I could go on and on, but I think you get the idea. Depending on where a golfer lands, he or she breaks out a wood, an iron, a wedge or a putter. The same goes for us investors — depending on the company, we need to use the right set of valuation tools for both the company and its peers in order to assess its fair value.
Read more about the various valuation tools available to investors at Eagle Daily Investor.