There are companies like UPM that grow their earnings quarter after quarter, with money flowing in from all directions, favored by megatrends and sustainability, seeing growth opportunities for their business, having a debt-free balance sheet, and paying a good dividend. And they are valued at a P/E of 15, with analysts saying the valuation is a bit tight, so we’ll wait for buying opportunities.
Then there are companies like Nokia, which make losses quarter after quarter with negative cash flow, and whose results, looking back, are not exactly a surprise. A billion left the cash register, revenue is falling, the balance sheet is weakening, but surely sometime in the future, expectations will be met, so this P/E of 20 is cheap.
Nobody knows the future. Why are people willing to pay a huge premium for painting positive scenarios? It reminds me of an episode of the Finnish version of Dragon’s Den, where startup entrepreneurs bring a couple of PowerPoints to investors and value their company at a seven-figure sum. Surely, experienced investors understand that even if everything goes perfectly, at that valuation, taking the risk yields no return. You only bear the risk that something goes wrong.
Shouldn’t the valuation multiples in these cases be precisely the opposite, where the price paid for a lower-risk investment is higher, i.e., the return is lower?
Come on, Inderes boys, give a good answer to Juipi’s question above. There’s a bunch of us P/E fundamentalist laymen reaching for the company with the lowest P/E ratio:)))
Generally speaking, the market tends to anticipate things 6-12 months in advance. A company that looks cheap now, “into which money flows through doors and windows,” might be in a mature phase of the cycle, and the market no longer believes in earnings improvements and instead starts to price in, in part, a decline in earnings (note: the company itself may still communicate growth, but the market doesn’t always swallow management’s words). Instead, a cyclical company that looks expensive now (based on earnings multiples) might only be at the beginning of the cycle (case: online markets & Nokia), in which case the market is already pricing in earnings normalization in advance.
Of course, the company’s turnaround must be credible, naturally. When trust in a turnaround company is lost, the outcome is ugly.
But in general, it’s worth considering earnings growth expectations, earnings sustainability, etc. Usually, the market is smart about these things, especially with large companies.
UPM just keeps sliding more and more. Luckily, I hedged for today with BEAR X5S (for UPM shares).
If you feel uncertain about the market and valuations are under such heavy pressure, it’s sometimes smart to make these hedges. Without exceeding the value of your own position. However, it’s worth targeting this hedge for a single trading day and not using too much leverage… So you don’t have to pay those carrying costs, etc…
Then I would like to ask what a recession exactly means for companies. UPM’s revenue, i.e., demand for its products, has remained stable over the last ten years. This period includes the financial crisis and recession, so it should represent weak times. In 2009, it was 7766 million. In other years, it has been around 10000 million. The profit has been made through business efficiency, i.e., increased margins.
Doesn’t a macroeconomic recession then hit almost all companies? Is there any reason to believe that sales volumes of home appliances will grow in Verkkokauppa (online store) when consumers’ general willingness to buy decreases? The products should belong to the inferior good category, where demand increases as customers’ incomes decrease. The market’s effective recession prediction only applies to some companies. A higher price should be paid for a debt-free company because its Enterprise Value would otherwise be low and because the risks of a debt-free company are lower.
Well, that’s quite a broad question; no one knows for sure, especially since we don’t even know if a recession will happen. The market seems to have taken a cautious stance towards more cyclical companies at the moment (see the share price development of engineering companies and other cyclicals this year).
In UPM’s case, it’s good to note that the company aims for a long-term ROE of 10% (currently earning well over that), while its P/B is still 1.5x, so the current price may not be such an attractive “entry point” into the company.
I’d love to comment too, it’s certainly been a busy week.