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Alexis Evidente
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Alexis oversees the investment process and operations for CR Investor. Alexis’ expertise is in financial valuations. He specializes in buy/sell considerations and employee stock options. Alexis participates as an Executive Director for Research Connect. He has worked for multiple bulge bracket... More
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  • Understanding the Revenue Multiple

    One of my favorite topics when it comes to the stock market is how to value a stock. I always felt there was something mysterious about pricing a stock, and if understood well will lead to winning investment ideas. Well, we are in the business of finding winners. The key to valuing a stock is understanding the basics of the various methods to price stocks. So today I want to dig into one of the very first valuation metrics I learned: The Revenue Multiple.

    The great thing about the revenue multiple is its simplicity. On the other hand, it could also lead to poor valuation work. Before we jump the gun here, lets define what a revenue multiple is.

    Definition of Revenue Multiple

    There are two basic revenue multiples that every investor needs to be made aware of. The first, and most popular, is Price to Sales or simply P/S. The second, and the more robust metric of the two, is the Enterprise Value (Equity + Debt - Cash) to Sales or EV/S.

    Price to Sales Ratio = Market Value of Equity/Revenue

    Enterprise Value to Sales Ratio = (Market Value of Equity + Debt – Cash)/Revenue

    The EV/S multiple is more robust than the P/S multiple because it is more accurate to look at a company’s total capital structure rather than just its equity portion. For a more detailed discussion of this please click on the below link:

    EBITDA: The Holy Grail of Stock Valuation

    Ok, let’s look at how the P/S and EV/S can lead to different valuation outcomes. We will look at a firm with a lot of debt: Duke Energy (NYSE:DUK).


    In this example since DUK is highly levered, it leads to a lower value for the equity portion (equity is what the holders of the stock get).

    When you look at a company with minimal debt like Electronic Arts (ERTS), you see a profound difference.


    The difference is quite large and can lead to different valuation outcomes. Take your time and closely study the P/S and EV/S multiples. The driver is the debt. Duke (DUK) had quite a bit of debt. On the other side of spectrum, Electronic Arts (ERTS) carries zero debt. When you look at the P/S and EV/S you can see how debt affected the pricing of the equity.

    So what else is this telling us? Well if you look at the P/S ratio of Electronic Arts, it is telling us that investors are willing to pay $1.80 (rounded) for every $1 of revenue that ERTS generates. Is that a reasonable multiple to pay? It depends. This is when you need to put on your analysis cap and do some historical analysis to get a good grasp on whether the multiple today is truly a value multiple.

    Pros and Cons of Revenue Multiple

    Pros

    Unlike earnings and book value multiples, which can become negative for many companies, the revenue multiple is available for most firms. This includes startup and distressed companies. Another strength of the revenue multiple is being less susceptible to accounting tricks. Accounting plays a big role in determining net income and book value, and these values are influenced by accounting decisions on depreciation, inventory, R&D, acquisition accounting and extraordinary charges. Furthermore, revenue multiples are less volatile than earnings multiples and hence are less likely to be affected by year-to-year swings in a firm’s fortune. For instance, the price-earnings ratio (P/E) of a cyclical firm changes much more than its price-sales ratios (P/S), because earnings are much more sensitive to economic changes than revenues.

    Cons

    The biggest disadvantage of focusing on revenue is that it can lull you into assigning tremendous amounts of value to firms that are generating high revenue growth while actually losing significant amounts of money. Ultimately, a firm has to generate earnings and cash flows for it to have value. The revenue multiple fails in this regard quite miserably.

    Overall, we at CR Investor don’t depend too heavily on the revenue multiple because our focus is on free cash flow, because this is what the shareholders are entitled to. However, the revenue multiple is an insightful data point that should be looked at and considered in the overall analysis and valuation. Furthermore, when using any type of market multiple please compare apples to apples. This means compares market multiples such as the revenue multiple to companies that are in the same line of business.

    If you want to learn more about valuation please visit CRInvestor.net.

    Happy Investing,

    Alexis Evidente

    aevidente@clearresearch.net

    www.CRInvestor.net

    Facebook: ClearResearch

    Twitter: CR_Investor

    If you really want to see our investment process in action please go to our site CRInvestor.net. You will find unbelievable research and reports that captures the true essence of value investing and education. We show our members how to become better stock pickers by sharpening their valuation skills. Our reports provide institutional level research never seen before on the retail level. We found Joe’s Jeans (JOEZ) at $0.22 which yielded an 845% return, and Hi-Shear Technology (HSR) that returned over 199% before being bought out. Not to mention that our results in 2009 outperformed the S&P by 69.6% and we have the brokerage statements to prove it!


     



    Disclosure: no position
    Tags: JOEZ, HSR, EA, DUK
    Apr 25 9:51 PM | Link | Comment!
  • Coldwater Creek (CWTR) Saves The Day

    A couple weekends ago I was told by my girlfriend that I was going to assist her in her search for a birthday present for her mother. Of course, I greeted this news with a smile but was dreading the thought of driving around congested Los Angeles looking for the perfect gift when I could be at home in front of my big screen T.V. watching the latest sporting events.

    We went from store to store in search of a gift but found none. Finally, we came upon an interesting store I had never heard of. So while my girlfriend was busy looking around I was busy checking out the square footage and watching the foot traffic. What I observed was that the store was very impressively busy.  Luckily, we found a gift there, but I was also able to pepper several staff members with questions and found out that the last 6 months have been great for the store. I also discovered that the new initiatives by management have started to show results.  So I left the store, Coldwater Creek (NASDAQ:CWTR), armed with a new stock to research.

    The story at CWTR is interesting. The company experienced a lot of success from 2003 to 2006 and saw revenue and earnings per share (NYSEARCA:EPS) grow at a compounded annual growth rate (OTCPK:CAGR) of 26% and 57%. As a result the company saw its stock price go from less than $5 a share to over $25.  The financial results and stock price are summed up below.


    Prior management got over confident and started deviating away from its roots and let expenses get out of control. This resulted in declining revenue, margins, and the collapse of the stock price.

    What I see here is opportunity for the entrepreneurial investor. There is new management in place and they are going back to the basics, refocusing on their established mail catalog business and their loyal customer base.

    The early results are promising. The 3rd and 4th quarter of 2009 were much better than 2008 3rd and 4th quarter results. Management expects the turn around to continue well into 2010.

    For more on CWTR including our full valuation please visit:

    http://CRInvestor.net

     

    Happy Investing,

    Alexis Evidente

    aevidente@clearresearch.net

    Facebook: ClearResearch

    Twitter: CR_Investor

    If you really want to see our investment process in action please go to our site CRInvestor.net. You will find unbelievable research and reports that captures the true essence of value investing and education. We show our members how to become better stock pickers by sharpening their valuation skills. Our reports provide institutional level research never seen before on the retail level. We found Joe’s Jeans (JOEZ) at $0.22 which yielded an 845% return, and Hi-Shear Technology (HSR) that returned over 199% before being bought out. Not to mention that our results in 2009 outperformed the S&P by 69.6% and we have the brokerage statements to prove it!





    Disclosure: No positions
    Apr 17 2:11 PM | Link | Comment!
  • Sturm, Ruger & Co. Inc: Buy The Guns, Not the Stock

    A couple weeks ago I wrote about Sturm, Ruger & Co (NYSE:RGR) as a potential stock for CR Investor (crinvestor.net) real money portfolio (click here to view  my past article). Well, after spending some time at my local gun range I couldn’t resist my urge to dig deeper into RGR.

     

    RGR as a company feels very much like an their SR9c model - smooth, compact and explosive with rising revenue, profit margins and free cash flow. When combined with a ultra low EV/EBITDA multiple I was ready to squeeze the trigger and issue a trade alert for CR Investor members.

     

    Recent financial results for RGR are summarized below.



    As much as I wanted to pull the trigger and issue a Buy rating, I knew I had to dig deeper and gain a better understanding of the company.

    The nice revenue growth in 2008 & 2009… Chalk that up to President Obama and the public’s perceived fear of a gun ban.  A key metric in determining demand for new guns is to track monthly background checks, and we have found that the number of new background checks per month is well off the highs of 2009.  To further compound the problem, RGR has no government or military contracts which are a good secure source of steady revenue for many gun manufacturers. Therefore, RGR is set to rely on civilian purchases and in our view peak buying has already occurred.

    Another negative about RGR is the declining economics of the industry itself. Gun regulation is becoming increasing more stringent which makes continued success difficult.  In essence, we can expect more adverse laws to gun ownership.  Also, RGR depends on new gun sales and has to compete against itself when a potential gun owner weighs the pros and cons of a buying a new or a used Ruger firearm.

    That low multiple for RGR was prevalent of the industry. More troublesome, is that RGR has found itself trading at an EV/EBITDA multiple of less than 5x in the past. Therefore, I can’t say with 100% confidence that today’s multiple is a result of an irrational market. But rather, the market was being irrational when RGR was trading above 10x. With that being said, I can easily see RGR trading at a EV/EBITDA multiple higher than 5x but less than 10x.



    After careful consideration, I see only 10% to 20% upside for RGR which is not a large enough margin of safety. Therefore, RGR will not be finding a home in the CR Investor model portfolio.   

    For access to our market beating real money portfolio and trade reports please visit www.CRInvestor.net.

    Happy Investing,


    Alexis Evidente

    www.CRInvestor.net

    Currently I do not hold a position in RGR,

    If you really want to see our investment process in action please go to our site www.CRInvestor.net. You will find unbelievable research and reports that captures the true essence of value investing and education. We show our members how to become better stock pickers by sharpening their valuation skills. Our reports provide institutional level research never seen before on the retail level. We found Joe’s Jeans (NASDAQ:JOEZ) at $0.22 which yielded an 845% return, and Hi-Shear Technology (HSR) that returned over 199% before being bought out. Not to mention that our results in 2009 outperformed the S&P by 69.6% and we have the brokerage statements to prove it!



    Disclosure: No position held
    Tags: JOEZ, HSR, RGR
    Apr 01 3:35 PM | Link | Comment!
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