Its not a popular idea but it has proved very profitable for me over the years.
The thought is simple; companies that do the same thing should be valued in a similar range of sales.
Profits are important, but if a company sells the same as a competitor but cant make it pay, it will get bought and rationalized.
A Telco is a Telco, a super market is a super market. While a great supermarket might get a nice premium on a laggard, it shouldn’t be too great.
Clearly a software house is not a gold mine so there can be wildly different valuations between those companies, but even then ranges like P/E apply. Who doesn’t sweat a high valuation when its over 40 p/e, who doesn’t wonder about buying a solid company with a p/e under 10.
Ultimately all valuations are relative.
Sales however is an often discounted number when it comes to valuation. Somehow the concrete matter of selling things is considered less fundamental than more academic numbers. This could be because many highly valued speculative companies have sketchy sales but no shortage of promise.
Yet when there is a wild divergence in valuations between similar companies with different sales I have found it a profitable area to get researching in.
It is not a common cry that when similar companies have very different sales to market capitalizations one must be either too high or one too low. There is especially silence when a ratio appears sky high.
Overly high valuations are common and frequently take a very long time, perhaps years, to correct, so there is no point fighting sky high prices. It is much better to look at a company with a strangely low valuation. Low prices don’t tend to stick around for so long.
So when I see a company whose close peers have sky high prices but are themselves lowly rated by comparison, I buy.
You could make this argument for Yahoo. Internet properties are famously highly valued, but not Yahoo. Its equity assets, holdings in Alibaba and Yahoo Japan are worth more than its current valuation. Meanwhile its Yahoo sites have top 10 global traffic and $4 billion in sales which other properties in the internet space would get a valuation of 5 to 10 times sales for. For Yahoo its with a market cap below the value of its investment assets it suggests its web properties are a liability not an asset at all. At face value Yahoo.com and its international sites have negative value.
If Yahoo was a loved member of the internet firmament it would be twice its current price. But it is not, it is the ‘dog’ of the internet space and is therefore trading at a fat discount.
Yahoo.com is up for sale, with Verizon and the UK’s daily mail Newspaper group as two parties in the race. The Yahoo website is clearly a massive asset and will sell and consequentially free up the value of its investment portfolios.
I’ve bought into the situation but it is not clear sailing.
Alibaba stock which is the back bone of its investments, could crater and spoil the whole picture and companies trading at discount to their investments are common. The situation is a bit too opaque to get overweight in the situation. There should be fat percentages upside to me made in this opportunity but not multiples. It is the general vagueness of the Yahoo situation that keeps the price in check till the offers for the media properties come in. then there should be a spike in the price or we will be left scratching our heads wondering why 2x2 still doesn’t equal 4.
So lets take another look at the idea of price anomalies amongst sector peers.
Take a look at this chart of the main ‘stock exchange’ groups of the west.
When valuing it against its competitors, the market seems to be looking at the Nasdaq’s p/e, rather than its sales. However this is a sector that has been consolidating, so the valuation should also be about sales and synergies.
Nasdaq is the laggard as far as this roll up game is concerned. It tried to be the winner in the first round years ago but ended up only buying the Scandinavian OMX exchanges. Its not the straggler at the back of the herd.
Will it stand alone forever at its low rating or will it fall prey?
To me Nasdaq’s valuation stands out like a sore thumb, a mere third by sales to market cap comparison with the CME.
But why buy cheap sales?
The exchange that bought the Nasdaq would be the winner of the roll up game, almost double the bulk of the other two groups. The aquired $10 billion in sales is plenty to squeeze profits from in a rationalization.
The three $30bn groups could easily pay $15 billion to win the exchange consolidation war, a price in line with the sales multiple of the other laggard Euronext and a big discount to their own.
Lets not forget this sectors valuations are already fat and while this might seem worrying to a value based investor, it also means that the highly valued companies on the list have high growth expectations baked in. The only way that growth is going to occur is through consolidation and synergies, so for the top guns, CME, ICE and Deutsche Boerse/LSE, the takeover game must go on. Which is why I have Nasdaq in my portfolio alongside Yahoo.