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By The Numbers

 May 17, 2011 07:34 PM


Valuation of individual stocks matters. Valuation is not at the top of my priority list but it does matter and for some investors valuation is at the top of the list and that is valid. There are different measures of valuation and people who consider themselves to be bottom up value investors have their own idea about the best measures of value and they can all be valid; obviously no one relies on a valuation metric they believe to be worthless, they only rely on what they believe to be useful and if they stick with it there must be some success thus any metric can be of value.

Consider the following group of related companies;

Company A:
PE ratio 13.74
Earnings estimated to grow 8%
Yield 5.18%
Payout ratio 72%

Company B:
PE ratio 11.72
Earnings estimated to grow 9%
Yield 6.08
Payout ratio 72%

Company C:
PE ratio 10.5
Earnings estimated to grow 19%
Yield 2.30%
Payout ratio 25%

Company D
PE ratio 12.2
Earnings estimated to grow 18%
Yield 3.81%
Payout ratio 48%

The group is a collection of utility stocks of varying attributes. For a bit of comparison, per the SPDR website the Sector SPDR Utility ETF (XLU) has a PE ratio of 13.61 which appears to be in line with the fund's history, a dividend yield of 3.85% and earnings expected grow at 4.18% for "3-5 years," the growth estimates above are just for one year.

Obviously a couple of the stocks have a better than average yield and the other two have better prospects for earnings growth. While there is clearly not enough information above to make a decision about buying any of the above names (pretend for a moment you knew the names and all you knew about them was those four data points) is the first impression absolutely not, no need to learn any more, those numbers stink the way you might with a company that will lose money for as far as estimates go out but still paying the dividend?

A couple of the yields are interesting but I'd say that the numbers are not particularly noteworthy as being cheap or expensive, actually the current PE ratios for all four appear to be a touch lower, but not meaningfully so, than where they were two years.

I'm sure some long time readers figured out a couple of paragraphs ago where this was headed. The four stocks are publicly traded Chinese toll road companies. They are four of the bigger stocks in the niche. I've said before that I think these are very much like utility stocks, I own one of them personally and for one or two clients but that they are too thin to buy across the board until Schwab offers direct access to Hong Kong.

For the last two years two them have performed in line with the Hang Seng Index, one has dramatically outperformed and one has lagged such that it is flat. From the 2007 peak to the March 2009 low the two with the higher yield fared better than the Hang Seng and the two growthier names did a little worse. For the last four years (so maybe an entire stock market cycle?) the Hang Seng is up 13%, two of them are down single digits, one is up 25% and the other is up more than 100%.

The reason for this post is that one reader jumped on me a little for yesterday's post about resource consumption in China and the various distortions in the country. The reader said "you recommend investing in toll roads etc. and you believe they can not get very, very overvalued in China or other countries?"

First, I never said they can't get overvalued. Anything can become overvalued but the potential to become overvalued in the future is not a reason to avoid a stock now. There are plenty of reasons to not buy Chinese toll roads but potential, not current mind you but potential, overvaluation is not one of them. The group is within its normal valuation range. If the prices went way up, throwing valuation metrics out of whack then selling would make sense.

One of the hang ups with foreign investing is incorrect perception of all sorts of things. All four stocks are profitable and have been trading for more than ten years. These are not insane holdings. They are stocks that may or may not work out as hoped for, similar to plenty of similarly valued US utility stocks.
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