Within the recent months, those who have mostly invested in Australian stocks such as ボーイフレンド and myself would have seen returns come up mostly flat whilst watching US stocks soar well past their February peaks.
Stacked atop each other, it is very striking to see the differences in how far the ASX200, S&P500 and NASDAQ have performed since the March crash. If you had invested in NASDAQ at the start of the year, you would currently be up 31.7% whilst you would still be down 12.8% if you were solely in ASX 200.
For those who have followed the news, it has been apparent that most of the gains made in the US markets are largely attributable to the tech sector. By way of illustration, the following charts show the current year to date return on the ASX, S&P when compared to Tesla, Microsoft, Amazon and Zoom.
As a value investor, whether or not a stock is worth purchasing depends largely on whether it represents good value when considering its growth and return prospects. So this is what we will attempt to discern for the aforementioned stocks by use of the Discounted Cash Flow method for security analysis with specific reference to the current PE ratios of said securities.
Discounted Cash Flow
Discounted cash flow is a method to calculate the value of an investment based upon the sum of its' total future cash flows and applying net present value of the total of the cash flows. The formula is as follows:
The formula provides a framework to determine what the fair value of the investment is, thereby aiding the determination of whether or not the current pricing is above or below fair value, showing whether or not it is a good buy.
Usually when calculating DCF, projected cash flows are estimated for the upcoming five years with every year subsequent estimated at the standard 3% being standard GDP growth indefinitely.
In applying this model, you arrive at a total expected value for the company, which can be divided by the current amount of shares to determine a fair value of the share given it's projected growth (in the next five years).
Application to PE Ratio
As mentioned earlier, PE ratio is determined by price divided by earnings. This can be utilised by the DCF model to show what the anticipated growth of a company is based on what the PE ratio currently is.
Without using actual earnings figures, if you assume the first year's earnings to be one and project the next five year's growth and then apply DCF, the resulting figure is the fair PE ratio for anticipated growth.
By way of example, take the current Australian CAPE ratio, which sits at 17.5 per StarCapital as at 31 August 2020. With an inflation rate of 1.25% and risk free rate of 7.5% it shows that with a PE of 17.5 is fair value if earnings are expected to grow at 3% per year to perpetuity.
In contrast, we can take a quick look at TSLA, ZM and APPL figures as they are now:
To justify a PE of 472, Zoom would need to grow at 250% per year for the next five years.
To justify a PE of 1083, Tesla will need to grow at 300% per year for the next five years.
To justify a PE of 36.7, Apple needs to grow at 25% per year for the next five years.
The question then as to whether or not these securities are worth purchasing depends on whether the investor considers the expected growth to be in line with the potential growth of the company. In looking at the above three companies, it would not be unfair to say that TSLA and ZM are very unlikely to be able to achieve the growth required to justify their PE ratio, whereas it could be plausible that APPL could achieve it. Given the uncertainties surrounding the tech sector though, these are still not securities that I would really be in a rush to purchase.
by 小福
