Russ Fischer had an interesting article out yesterday, in which he explained a simple valuation model anyone could use to quickly value all kinds of stocks.
This model was built upon the price/sales multiple derived from just two easy-to-get variables: net profit margin and revenue growth. We'd long have known that these were the two most powerful factors behind the price/sales multiples, but Russ Fischer took it further by operationalizing the model.
I am now making my own contribution. I built a small Google Docs spreadsheet based on Russ Fischer's work. This spreadsheet takes the ticker, net margin, revenue growth, and revenues: It automatically gets the quote for the inserted ticker, finds the number of outstanding shares and calculates a fair value estimate using Russ Fischer's model.
To calculate this fair value I followed Russ Fischer's table, transforming his first multiplier into a simple m1 = net margin * 0.16 equation. The second multiplier was a bit trickier, I had to use a 3rd order polynomial to fit it, coming up with m2 = 0.00004 * rev growth^3 - 0.0024 * rev growth^2 + 0.0756 * rev growth + 0.6322.
Using these two equations the spreadsheet can easily calculate the fair value for any stock. The spreadsheet for public use can be found here. A warning, though, the formula breaks down for negative margins and deep revenue contraction, returning 0.01 price/sales.
Here are a few examples of the spreadsheet's usage:
Just to see how it compared to Russ's calculation. It came reasonably close, much like in all other tests I did.
I had to calculate this one because of the ongoing debate on AMZN's price/sales. The result is no surprise. I even threw in a 1% net profit margin (while TTM Amazon is running at 0.07%) to no avail, the resulting price/sales is 0.27, very close to other what other online retailers such as PC Connection (NASDAQ:PCCC) achieve. Obviously, this would imply a monstrous decline for Amazon.com shares.
Using another retailer as an example, the model comes quite close to Wal-Mart's actual market quote.
Rackspace Hosting (NYSE:RAX)
I selected Rackspace to test this out with a fast-growing company. The low profitability still puts RAX at a wild premium, though much smaller than AMZN's. Russ' formula is not very kind to any companies whose net margin is somewhat low for their valuation. Or maybe the model doesn't like the new fad of giving huge multiples to companies that while growing revenues quite fast, leave a lot to be desired in terms of profits when compared to past profitable stars such as Microsoft (NASDAQ:MSFT).
The model proposed by Russ Fischer seems quite useful to quickly compare the overvaluation/undervaluation of wildly different companies. The model does break down for low profitability (especially temporarily low profitability) or steep revenue declines and should be used with care when considering those types of situation.
Disclosure: I am short AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am also long PCCC.