The major US indexes have fallen into correction territory (10% from recent high) as of yesterday’s trading session. STI is even reaching bear territory (20% drop from recent high).
This is the second time this year that a correction happens in US. And to put things in perspective, this correction while painful, is still minor in absolute terms given how much the bull has run up since 2009.
I have warned that it is just a matter of time we will see the market crash, given the high Shiller PE ratio which is currently about 29.81.
And therefore, I have moved 50% of my portfolio to cash, waiting for the right opportunity to buy businesses cheaply.
Given the market volatility, what should we do? To me, the fundamental principles of value investing don’t change: (1) We look for wonderful businesses with a wide economic moat (2) We determine the intrinsic value of the company (3) We build in a margin of safety and buy when the stock is offered by Mr Market at a discount.
One such company with a strong moat is Facebook. and its share price has been beaten down 34% from the recent high, currently about $142 per share. Facebook is announcing its results on 30 October after trading hours.
So how do we determine the intrinsic value of Facebook?
There are perhaps two methods: (1) PEG ratio and (2) Discounted Cash Flow. Valuation is not an exact science and that’s where you can vary the parameters like growth rate, discount rate etc and see if it gives you that margin of safety relative to your desired risk reward ratio.
Using PEG method, and using growth rate of 30%, the ratio is almost 0.73. Using discounted cash flow method and I lowered the growth rates to 25% for the next 5 years and 15% subsequent 5 years, I got the following applying a high discount rate of 15%.
The analysis says Facebook is currently undervalued and there is even some margin of safety.
Facebook’s stock price is depressed now probably because of a few reasons: (1) concern about Fed’s interest rate increases; (2) China-US trade tension (3) Facebook’s data security issues. You need to determine if any of these will adversely impace Facebook’s business fundamentals over the long term.
If after all the analysis, you think you would like to own this business, what can you do given the current highly volatile market? From a technical point of view, it is still down-trend but we know anything can happen.
If I position size and would like to allocate $30K maximum to this position, I would probably divide it into 3 portions, and buy say $8k worth first, and see what happens next. If price drops further, I will then progressively buy more.
The following video is some additional perspective on Facebook.
At Journey With Money, we are practitioners of Value Investing for Singapore and US stocks. We are passionate about sharing our Stock Investment knowledge and experience but the materials we present do not constitute stock recommendations and readers are urged to do their own due diligence for any investment decisions.
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