Last month we were pondering over what to do with all the mixed signals coming from the world economies and the fact that our holdings (currently mostly in cash) were not generating much (if any) return. We decided to look at buying strong companies cheaply. So how to do that?
What does a strong company with cheap valuation look like? How can we measure it? Early last month Aston Martin the UK luxury sports car maker was floated on the London Stock exchange at a valuation of approximately £5bn. Should we buy the shares? Strong brand with a global appeal that is long established. Firstly, we need a comparison with a like company to see of the Aston Martin price looks reasonable. Ferrari might be said to have similar traits, strong brand, long established with a global appeal so this might seem to be a reasonable starting point. Ferrari is listed on the New York Stock Exchange so we can see its valuation which is around 40 times earnings. By comparison the Aston Martin float price valued the business at around 65 times earnings a whopping 62% higher than Ferrari. So we need to ask ourselves where are we going to find value at this price? Is the probability that the shares are going to advance from here and thus going further ahead of Ferrari or not? Is the probability that the shares price is going to decline to come more into line with Ferrari?
These are the questions that investors need to ask themselves and we will delve more into this next month. Company valuations are tricky but the clues are available.