hi i'm jimmy in this video we're going
to look at
some of the best ways we can value
stocks from the communication
services sector so my plan is to create
a video
for each of these 11 sectors and try to
come up with the best way to value
stocks within each sector
now i already did a video on how to
value some financial stocks
and i recently did a video on how to
value stocks from the information
technology sector
so i'll leave a link to those videos in
the description below if you're curious
but the goal here is for us to better
be able to better understand how to
value companies
that way we can identify companies that
look undervalued and hopefully
improve our investment portfolio okay so
let's jump right in
so the communication services sector
includes companies like
alphabet facebook disney netflix
at t and verizon so clearly
a ton of different types of companies
all within the same sector
so as you can imagine well there's quite
a few different ways that we can value
we can come up with a fair value for
these stocks now in the name of full
disclosure i actually personally own
shares of disney
and we're going to use that as some with
some of our examples
throughout this video just because i
know the company fairly well
so full disclosure okay so i'm going to
focus on four different valuation
methods
that work for many different types of
companies within the industry
and surely there are other ones that we
could use as well but
these four are for some of the more
popular ways to value companies
and then i've actually got one that i'm
super excited one of the four i'm super
excited about
from evaluation method perspective
because i've never done it i've never
done a video on it and it's actually a
fun way to value stocks
but we'll come back to that in a second
okay so i think the simplest place to
start
is to use the very popular price to
earnings ratio the price to earnings
ratio or the p e ratio for short
is very popular and can be very it's
fairly reliable in
large well-established companies
companies with steady earnings
now to calculate the price to earnings
ratio well you take
the current price per share and you
divide that by the earnings per share
earnings per share is the same thing as
profit per share another way we can look
at this
is that the p e ratio is
you could look at it as a multiple so if
a company if we were to pay let's say
ten dollars for a company
and that company earns one dollar per
share in profit
over the past year well we paid a
multiple of 10x
so clearly we want our p e ratio to be
as low as possible
the higher the p e ratio that means the
more you're paying for a single dollar
of earnings
now one of the weaknesses of something
like the p e ratio
is 2020 is a perfect example of that
let's pretend a company's earnings
fall apart over something crazy that
happens something temporary
something like the coronavirus a perfect
example of that
is disney these are disney's earnings
per share over the past four quarters
and over the past four quarters they
have negative earnings or negative
profits
and we know that's how that has happened
for a lot of different reasons
but either way that makes using a pe
multiple
virtually useless with this company even
though
a year ago two years ago a p multiple
for disney
would have been fairly reliable now i
should also point out with this example
with disney's earnings per share here if
you were to go look up their financial
statements you might see different
earnings per share
and that is because i have adjusted
their earnings per share to
take out some one-time impairments that
the company had and
should really be removed from more
common earnings per share
so if you see these versus comp uh
versus financial statement numbers
well mine are adjusted theirs are not
there's a u.s gaap numbers
so if there's a discrepancy that's why
it happened but either way
that still it doesn't negate the point
the fact that pe doesn't work for disney
as a perfect example
over the past 12 months now one of my
preferred methods
to value a stock which would still very
much work for a company like disney
is discounted free cash flow and anybody
who's been watching this channel for a
while
might know that discounted free cash
flow is my personal favorite way
to value companies so even after a bad
year like 2020 for many companies will
discount a free cash flow
still works for companies like disney at
t
or verizon it could also be used for a
company like
alphabet facebook or netflix but
it's a bit trickier when the company
that we're looking at has
faster growth so with a company like
disney or even a t
well our projections our growth rates
going to be fairly reasonable
and the more reasonable and stable that
growth rate is
the easier it is to project out with a
company like
facebook or netflix or uh alphabet well
the growth rate is likely to be much
higher at this point
so projecting accurately far into the
future is going to get a bit trickier
now i recognize that i'm not really
explaining how to do discounted free
cash flow
and if you're curious i actually did a
whole video on how to do it but
basically the concept is you take free
cash flow going out the next few years
we can see
disney's free cash flow here well we
take free cash flow we project it out
and then we determine how much all of
that is worth
today that works where something like
price to earnings
might not work because the past 12
months in price to earnings
were negative but free cash flow is very
unlikely to stay negative
for an extended period of time at least
with the larger well-established company
like disney
now a company like netflix or facebook
well
their free cash flow it depends where
you get them
in their s in the phase of their growth
those three companies you could easily
do free cash flow
assuming we were somewhat confident with
our projections but just to illustrate
where
discounted free cash flow might not be
the best one if we look at netflix going
past going back the past few years well
we can see that not long ago netflix had
a run where free cash flow
was negative well clearly during that
time period
free cash flow would have it would have
been rough to use that because it's
tough
when free cash flow is negative for a
period of time which can often happen
with younger
faster growing companies well when that
happens
we're better off using a different
valuation method even back then for
netflix
a good valuation method would be
something like enterprise value
to ebitda ebitda is short for earnings
before
interest taxes depreciation and
amortization
so oftentimes with younger companies
something like price to earnings won't
work because maybe they're not
profitable
ebitda tends to be it's more likely that
number will be positive
which gives us another multiple a lot
like p e ratio
gives us another multiple to use so with
smaller faster growing companies
i would avoid discounted cash flow and i
would stick with something like ev to
ebitda
now let's imagine that ebitda is not
positive
if it is in fact negative because maybe
the company is so new that they haven't
even been able to create positive ebitda
yet
well if that's the case then it might
make sense to use something like
enterprise value to revenue revenue is
not going to be negative so if that's
the case
that enterprise value to revenue could
make sense
as a last resort for some younger faster
growing companies
and again just like discounted cash flow
i also did a video on ev to ebitda i'll
leave a link to that video in the
description below
as well and this brings us to our
somewhat unique way to value a stock
and this one is known as the sum of the
parts valuation method
and it is exactly like it sounds it is
you
break up the company to different let's
say business segments you value each
segment independently
and then you add them all up how much
what is the sum of all those values
well that's the value of the total
company now the usability of this
valuation method
is very much dependent on how much
information the company gives us
not every company publishes data for
their different segments
so if we were to look at a company like
google or alphabet
well these are the three segments that
they break down now this is where
because they give us revenue enterprise
value to revenue could be a smart
multiple d
to use in this example so perhaps we
think that their cloud business
is going to grow very fast and that
deserves a high multiple
maybe the more classic google business
well that business
might deserve a lower multiple their
other bet segment again
could be a higher multiple well again we
value those out
we can sum those up add all those up and
just like that we have the fair value
of google stock another example of a
company that might work even better than
this one
is disney and as we can see this is some
data that i was able to pull down
from disney's most recent annual report
they had it in their annual report they
had it in some
investor presentations that they had and
also some press releases that they
issued
and we can see that they give us a ton
of data
for each of their segments which really
helps with the sum of the parts
valuation method so this allows us to
use whatever valuation method we
want for each segment so perhaps we're
looking at their
parks uh their amusement parks segment
and with their amusement parks maybe we
want to compare it
to a company like uh six flags and we
say okay well you know what companies
you know how is other amusement parks
being valued
and maybe we use a discounted cash flow
over there or maybe
we use enterprise value to revenue or
enterprise value
to operating income there's a bunch of
choices then we can compare
their movies business to their to other
movie companies
and come up with a fair value there if
we look at their direct to consumer
business
well the direct to consumer business is
where they account for their disney plus
platform
maybe we want to compare that to netflix
what's maybe the pe multiple
of their of that platform we again come
up with a fair value for each segment
add them all up and just like that we
have a very
thorough in-depth analysis of what their
fair value is
now one thing we're going to want to
keep in the back of our minds as we do a
sum of the parts calculation
is something known as the conglomerate
discount which basically means that
when you combine a bunch of different
businesses they should be worth
slightly less than when each business
stands independently
or at least the stock market tends to
price them at slightly less
so this is known as the conglomerate
discount now i should also point out
when i'm talking about individual
businesses i'm not talking about
the same business if netflix went out
and bought
disney plus and hulu and whatever other
streaming platforms
well economies of scale should help them
scale up and they are likely to trade at
a
perhaps even a higher multiple because
of the increased growth rate
but if netflix went out and bought an
amusement park
well that's a that's a bit out of the
realm of what they do
now they're a conglomerate so now the
two businesses are likely when combined
to be trading at slightly less or at
least slightly less than they would have
been had they still been independent so
the value is probably still going to go
up because there's two businesses
but it will be it would have gone they
wouldn't go up dollar for dollar
or it's unlikely to go up for a dollar
now we're going to want to account
for this conglomerate discount in our
margin of safety when we're considering
buying the stock
so if we have the right margin of safety
well the sum of the parts valuation
method
could be a fantastic way to come up with
for
come up with the fair value for any
stock that gives us enough data
to calculate it and if you're not sure
how to come up with a reasonable margin
of safety
well i actually did a video called when
to buy a stock where i touch on this
exact topic
so if you're curious perhaps that could
be a good next video for you to watch
i got a link right here i got a link in
the description below and thank you so
so much for stick with me all the way to
the end of the video
i really appreciate it thank you and
i'll see in the next video