Stock Valuation using the SMP Model
Disclaimer:Please note that I do not necessarily purchase, own, or partake of any of the securities or other financial instruments mentioned in this article. I also do not take any responsibility for any actions resulting from any actions taken by anyone who reads this article. You are responsible for your own finances - no one else. Do your yown due diligence when researching financial matters.
The SMP (Stock Market Plus) Stock Valuation Model is founded on the idea that in any market, on average, an investor will beat the market by purchasing undervalued securities at bargain prices. The model suggests building a diversified portfolio of securities that will (theoretically) surpass their current value even in a dismal bear market over a period of 10 years. The SMP Model is extremely sensible. It takes a stock's NTA (Net Tangible Assets), factors in projected growth, and flavors the results with a little market pessimism for good measure. The model is simple enough, but requires research that you can't obtain with your average stock screener.
How do I know that the SMP Model works? In early 2004, tired of my losses that arose from trying to play the market's short-term ups and downs, I came up with an idea for long-term investing. I reasoned that a security's intrinsic value was its current NTA per share, plus its projected Earnings Per Share (EPS) growth, year-over-year going forward, tempered by the realistic possibility of an extended bear market. Those stocks that could come out ahead of their current prices over time, even in a bad market, were the ones that I wanted to consider. I cut the projections off at ten years, because that provided me with a realistic long-term timeline to watch the stocks under consideration. This idea about stock valuation is probably not unique, and I do not claim to be the first person to ever think of stocks in this light. What I like about the model is that it takes away the guesswork. You plug in the numbers, and let the projections speak for themselves.
What kind of performance has the Model returned? In February, 2004, I started tracking a portfolio of 10 stocks, selected by the SMP Model. By April, 2005, that portfolio had produced over a 17% gain, in a little over a year. Now, again, if you're looking for 200% gains, go try Vegas or the racetrack. Realistic, long-term gains are slow and steady, and require diversification of assets for self-preservation. By, comparison, the stock markets have been pretty even (zero gain) over that time, with the S & P outperforming the Dow and Nasdaq.
What kind of stocks does the model like? Well, I'll share some that it doesn't like...Walmart, Microsoft, Gateway, EBAY, Oracle...some real heavyweights. Now, for ones that the SMP Model projects to be worth more than their current prices in ten years...Providian, Washington Mutual, LJ International, Ford, General Motors. I'll give you a larger list later. But, now, I want to give you the formula for the SMP Model so you can build a sensible portfolio today...
First, a couple of definitions:
NTA = Net Tangible Assets = (Total Assets - Intangible Assets - Liabilities)
EPS = Earnings Per Share = Total Net Income/Outstanding Shares
EPS(0) = EPS(current year) = projected EPS (current year) * discount rate (I use .12)
GRW = Projected EPS Growth Rate (use 5-yr or 10-yr if available)
Now here's the formula...
SMP(value) = current NTA/share + EPS(0) + [EPS(0) * (1 + GRW * discount (.12))](= EPS(1)) + [EPS(1) * (1 + GRW * discount (.12))](= EPS(2)) + [EPS(3) + EPS(4) + ... + EPS(10)
OK, the formula's a little nasty, but if you plug it in to a spreadsheet, it works quite well. Just so you know that you're on target with your math, here's a sample computation for (WM) Washington Mutual (these numbers may be slightly different than current values):
NTA = 13.951 (in billions)Shares = .873NTA/Share = 13.951/.873 = 15.98 (that means WM has current NTA of $15.98)EPS = 3.70GRW = .10Discount rate = .12 (using such a high rate builds in the possibility of a bear market/inflation)
EPS(0) = 3.70 * (1 - .12) = 3.26
EPS(1) = 3.26 * (1 + .10 - .12) = 3.19
EPS(2) = 3.19 * (1 + .10 - .12) = 3.13
EPS(10) = EPS(9) + (1 + .10 - .12) = 2.71
NTA/Share + EPS(0...10) = $45.76
So, we arrive at a SMP Model value for WM of $45.76, with the current share price around $39. Thus, WM would pass the SMP test, and I would recommend this stock as part of a diversified portfolio.
As a side note, I am not seeking any kind of contribution or fee for this knowledge. I hope it benefits you as I think it will.
Prosperous investing to you!