Streetwise for Friday, April 26, 2019

It seems that investors continually worry about market volatility and how to counteract it. Look, investing should not be about turning you into a candidate for Prozac. 

As I have often said and written, you need to take volatility in stride. Certainly, it can be gut wrenching in the short-term. So, relax and wait for the dust to settle before making any decision. Never let yourself be placed in circumstances where decisions are made under stress or in a panic.

To recount my often-repeated mantra, trying to determine the direction and depth of daily market moves is a lesson in futility. Stock prices are the result of subjective evaluations by two parties. They are therefore subjective evaluations and subject to change without notice – and for no apparent reason. In mathematical terms the results are random.

When any form of trade occurs, it is because the parties disagree as to the utility of what is being traded. For a trade to come to culmination, it must be viewed subjectively as being advantageous for both. The notion of current market prices is fictional. Prices are neither current, nor of the market. Trades are historical facts and occur only between the two parties to the trade.

In some respects, investing is like an athletic competition. To be successful, you must have absolute confidence in your own abilities. Consider the plight of the late great tennis professional Vitas Gerulatis. Jimmy Connors had beaten Gerulatis sixteen matches in a row. Did Gerulatis give up? He did not. On the seventeenth try Gerulatis was victorious over Connors. Gerulatis’ comment after the match…”Nobody beats me seventeen straight games.”

While it is unlikely you will need seventeen tries to invest successfully, you will not win your investment match overnight. Rather, you must be comfortable with a two to three-year investment horizon. Furthermore, no athlete or investor, no matter how skillful, wins every time.

To select investments that are immune from short-term market fluctuations is an impossible task. The trick is to never become discouraged. If the corporate fundamentals of your investments are solid, then stay the course and you will likely be victorious.

Regular readers of this column know that I continually espouse dividends as a key factor to consider when evaluating a potential equity investment. The key reason is that companies that consistently raise dividends have the financial fundamentals in place to outperform the market. 

However, dividends should not be used alone. You need to utilize one or more statistics that incorporate earnings and/or earnings growth. Those two factors are the hallmark of corporate success.

For example, consider the enterprise multiple. It measures a company’s valuation based on the ratio of its enterprise value (EV) to earnings before interest, taxes, depreciation and amortization or EBITDA. EV includes not only the market value of equity but also debt less cash. Think of it as the cost to acquire a company.

In other words, EV/EBITDA answers the question, “What is the value of a company per each dollar of EBITDA?” A high (low) EV/EBITDA means the company is potentially overvalued (undervalued).

Using EBITDA measures of the true cash operating profit of a company since depreciation and amortization are non-cash items and taxes and interest are not considered part of the operations of the company, although both items impact earnings.

To calculate EBITDA, begin with operating profit and add back depreciation and amortization. EBITDA can be used to analyze profitability without the effects of financing and accounting decisions.

Enterprise ratios are used to quickly ascertain and compare potential corporate valuations. All things being equal, the lower a ratio such as EV/EBITDA is, the better. 

Screening dividend paying companies in such a manner separates the wheat from the chaff. Your final selection process needs to utilize subjective factors such as management strength and franchise in the marketplace.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.