Alternative Ways Retail Investors Can Value Stocks

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The second module, Based on Experience, lets you evaluate the expectations currently priced into a stock, based on comparisons with the actual achievements of a broad array of relevant companies over time. This helps you decide whether a company's stock price has gotten ahead of itself. For example, to gauge Starbucks' (SBUX) growth potential, you would look at its annual earnings base, which is roughly $800 million. The program finds all the companies with a similar earnings base—adjusted for inflation—going back 20 years, then calculates the rate at which each company was able to increase its earnings base over the next 10 years and how their dividend policies evolved over those periods. Based on Experience also shows how stocks with risk and fundamentals profile similar to a given stock today would have been priced historically. If the current price of a stock is below the average of these historically implied prices, it might suggest that this is a good time to buy it.

apply discipline to valuation process

The analysis that Market Topographer provides about how each risk-assessment factor contributes, positively or negatively, to a stock's valuation generally accords with common sense. For instance, there's logic in the market's willingness to pay more for a company with little or no debt than for one with a lot of debt. Greenberg concedes the need, when doing credit research on companies, to distinguish between different uses of debt and the various maturities and coupon rates companies are paying. Statistically, he's found that the most significant common denominator among companies is the simple measure of net debt as a percentage of total capitalization.

"Asset managers are looking for more objective ways to bring discipline to their valuation process," says Greenberg. "They're already looking carefully at companies' particular situations, expansion plans, and credit quality."

He adds that Market Topographer is only providing benchmark prices to help users understand the big-picture rationality of stock prices and "not giving them recommendations or providing price targets the way a third-party research firm does in telling you where a stock should trade."

EVA Dimensions is working on the next-generation version of PRVit, aiming to make it possible to calculate a consensus estimate of EVA among market analysts. Stewart expects this to be available in roughly a year. "I would like to ultimately change the dialogue on Wall Street so that instead of talking about consensus [earnings per share], they're talking about consensus EVA," he says.

Skeptics argue that methodology isn't the issue when it comes to identifying mispriced stocks. "You've got to find some information that the market isn't incorporating into its price or its expected return," says Espen Eckbo, a finance professor at the Tuck School of Business at Dartmouth College.

As seductive as new tools may seem, it's worth keeping in mind the weight of historical data that concludes that active managers hardly ever outperform the market—certainly not consistently over time.

"Active management can work, but it takes a lot of time and it's hard to do," says Jack Rader, executive director of the Financial Management Association International in Tampa, Fla. Since he believes people should invest only in industries that they fully understand, "there will be times when everything in the industries I understand is fairly priced or overpriced. I've got to be willing to sit on the sidelines when that's happening and I've got to be willing to do an immense amount of work."

Consequently, Rader says, he's an advocate of index investing for practical purposes. "Most of us are not willing to do all the hard work."

Bogoslaw is a reporter for Bloomberg BusinessWeek's Finance channel.

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