Is there a single, silver bullet valuation metric that you can use to accurately evaluate any stock in the market? An interesting recent piece from Barron’s looks at a couple of attempts to develop one.
Deutsche Bank has developed the “Croci” metric, which stands for cash return on invested capital, reports Lewis Braham. The Croci metric attempts to compensate for differences among countries and industries, in order to compare different types of stocks. “Consider a pharmaceutical maker’s research and development costs,” Braham writes. “In European accounting, R&D is considered an asset that depreciates over time. But in the U.S., R&D costs are written off in the year in which they occur. That makes the valuations of U.S. drug producers seem higher when compared with those of pharmaceutical manufacturers overseas, or companies in other industries.”
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“If you’re running Caterpillar, you’ve got to spend a lot of money building manufacturing plants,” said Joe Hall, managing director of DB’s Croci Americas. “But if you’re running Pfizer, you’re spending billions of dollars a year on R&D, which will produce revenues for the next 15 to 20 years. In economic terms, it’s the same type of expenditure as Caterpillar’s.” As part of their process, analysts for DB’s Croci team calculate an “economic P/E”, which factors in debt, off-balance-sheet variables, patents, pension-fund liabilities, and store leases.
Another strategist, Wesley Gray of Alpha Architect, uses a different approach to try to find a silver bullet value metric. He divides a company’s earnings before interest, taxes, depreciation, and amortization by its enterprise value (stock market value plus debt, minus cash on the balance sheet). Gray’s research found that the EBIT/EV metric was the most effective value metric over the past four decades, Braham writes.
Braham also looks at some of the drawbacks of using a single valuation metric, and the difficulty in evaluating bank stocks.