Being an investor and doing equity research isn't easy. Apples-to-apples comparisons, apples-to-oranges, oranges-to-apples. It gets fruity out there. One of the best things a beginning investor can do is separate the noise from what's really important. The most noise seems to surround earnings calls, where the focus is on the short term.
So, Wall Street's short-term expectations game began, and shares dropped about 10% the day after the release.
The great majority of all analysis in the mainstream financial press focused on palmOne's reduced guidance. So is this a reason for investors to run for the exits and dump their shares? Not necessarily. This is part of the noise.
Investors would be better served focusing on what's really important. What's important is what has always been important. Buy solid businesses you know and understand at attractive valuations. Don't forget sustainable competitive advantage. Nothing new -- this is Warren Buffett 101. And if you've made the decision to own palmOne using these sound analytical frameworks, you're less likely to be frightened off by quarterly bumps in the road.
Investors should know and understand palmOne's business model. What drives value? What drives sales, earnings? Did you learn about palmOne by using its products or by reading an analyst's report? Are you a consumer of the Treo smartphones and Zire and Tungsten handheld devices? Can't live without them? As Peter Lynch and others have said, the best stock ideas come from companies that make great products that you have experienced as a consumer.
After understanding the business, only then should you turn to valuation.
palmOne is trading at about 13 times its fiscal 2006 earnings (ending May 2006), well below the sector's P/E average of 24 from companies such as Motorola
Michael Mauboussin, a chief investment strategist and one of Bill Miller's deputies at Legg Mason, points out that "multiples are ubiquitous but remain, on balance, poorly understood" in his excellent series on strategy.
So as not to get overwhelmed, a good place to start in applying an analytical framework and screening tool is the 7 Steps to Finding Hidden Gems. With a market capitalization of around $1 billion, palmOne meets the small-cap criteria. The other metrics are:
- Enterprise value-to-free cash flow (EV/FCF)
- Historical and projected earnings growth
- Return on equity (ROE)
- Inside ownership
- Share dilution
Is palmOne a promising prospect? I can't answer that question. But by looking past the short term, focusing on what's important, and applying a few of the time-tested frameworks above, you'll be a lot closer to finding out for yourself.
Fool contributor Chris Cather owns none of the companies mentioned and has learned more about investing through other Fools than he did with his MBA.