A Few Beers with Max Price
Board: Buffett Small Cap Investing

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By earslookin
May 4, 2007

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Recently Maxie and I sat down for a few beers, watched A.C Milan kick butt (sorry, Trev), and got to know each other. Here are a few things about our friend Max Price that I found interesting.

1. The asset minus liability part of Max Price is kinda worthless.

Max Price has two components

Component 1 is made up of cash plus securities plus other current assets minus short term debt and other current liabilities. This number is then divided by 2, and then divided again by diluted shares.

Component 2 is a projection of next years revenue times a projection of next years gross margin. This result is then multiplied by a 'magic multiplier' of 4.

For about � of the companies in the database that don't have flaky data, component 2 determines at least 95% of Max Price. For the remainder, component 2 determines at least 80% of Max Price. To say this another way, the impact of component 1 on Max Price is miniscule for almost all of the companies in the database.

2. Price to next year's revenue per share explains almost all the variability of Max Price.

We created a custom field called RevNextYrDilShare which, surprisingly enough, calculates a projection of revenue per diluted share for next year.

Try this. Create a new custom field -call it "PriceToSalesNextYr" -- where you divide Price (standard SIPRO field) by RevNextYrDilShare. In the Mike Klein 'Classic' screen, get rid of the test for Price < MaxPrice, and substitute PriceToSalesNextYr < 3.

You get the same result as if Max Price was there. That's because most of the impact of Max Price has to do with the current price of the stock in relation to our estimate of next year's revenue, and the impact of some previous tests with gross income and operating income.

Actually, you don't get the same exact result. You get two additional companies. More on this in another post.

3. Max has a serious character flaw, IMO.

Compare Vicon (VII) and Weyco (WEYS). They both have about the same gross margin. Vicon is projected to increase revenue faster - 22% projected increase for Vicon versus 12% for Weyco. But look at their earnings yield, as calculated using Greenblatt's formula (approximately). Vicon's earnings yield is 1.3 whereas Weyco's is 11.3. Big, big difference. That's because even though they have roughly the same gross margin, and estimated gross margin increase, they have very different cost structures for their operating expenses. Vicon's is 38% of sales. Weyco's is 24% of sales. Huge difference.

I know, I know. We're going to get some chaff with the wheat. But actually, Vicon's gone up in price, so what do I know?

Now my old pappy, gumsflappin, used to say, "Son, don't be critical if you don't have an alternative". Well, I don't yet, but I'm working on it.

More later.


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