What is a Valuation Reset
[vc_row][vc_column][vc_video link="https://www.youtube.com/watch?v=MvBaTfE-oAU"][vc_column_text]PURPLE CHIPS TUTORIAL VALUATION RESET
Welcome to the Purple Chips tutorial webinar; I am John Schwinghamer, the author of Purple Chips published by John Wiley & Sons and available everywhere.
Our webinar today is about valuation resets. How do you know when a valuation reset occurs?
There are a few key points;
First of all the EPS trends usually continues and the valuation changes dramatically. I will show you this in a few minutes. This is likely when a stock trades at a high valuation or multiple.
Also valuation resets can be very common in a bear market. Investors will pay less for every dollar of earnings and hence a valuation reset.
Let’s take a look at a couple of stocks. We are going to use in our example;
Baidu (BIDU)
Green Mountain Coffee (GMCR)
In the case of Baidu (BIDU) what you are seeing here is the long term monthly chart with the earnings per share (EPS) overlay. The white line is the earnings per share line. In this case we see that there is a valuation reset. I will just draw in what happened here. When we reached this point here which I just highlighted, around $100 in effect the earnings line was down here so this is what the earnings line would have looked like at that time. This was a valuation reset because it was a much lower than the previous range which had been up here. So normally Baidu had been trading somewhere between let’s say here, the earnings line had been there and up till here and then all of sudden we broke down and this became the new trading range. So going forward this is what we expected as a trading range so that was a valuation reset.
I will show you that what the chart of Baidu looked like when we were back in April here. So I will change the settings on the chart and you will actually see how it looked at that time. Here you can see that this doesn’t look like anything extra ordinary because there was no valuation reset at this point. Normally on the Purple Chips model it would have expected the high valuation would be somewhere in this zone and of course this would have been considered the low valuation. That’s actually not what happened because what happened just after this is that the stock went down and actually traded down to $100 and so the earnings line would be like this. So that is what a valuation reset is.
Now, I will bring this back to today and you can see this is what it looks like now. So, what happens when you have the valuation reset? The valuation range changes and so we went from being at a new low valuation and now I would consider this to be a high end of the valuation.
It does not mean that the stock can’t move higher but it does mean that we have a new valuation range going forward so the stock, in this case Baidu, could go up to $150 but that would constitute a lower valuation then the last time when it was over here it should have been a much higher valuation.
In the case of Green Mountain Coffee (GMCR); let’s have a look at the Green Mountain Coffee; here is what it looks like. Again we had a valuation reset. Green Mountain Coffee went from being at a low valuation zone over here and then it actually fell down and this is when you had the valuation reset there. I will go back again and I will go back to the period just prior to the valuation resets. We will go back to April 2012 again and we will see what it looked like at that time.
So what does the Green Mountain Coffee looked like in April? You can see Green Mountain looked pretty normal back then and this was a growth company. Now, what I mean to point is that when the stocks have very high P/E values like at this time it had a 22 P/E and the Green Mountain Coffee was trading around $48 or so and it is still fairly high; much higher than the market; S & P was trading around 15 times the earnings and Green Mountain was considered a growth stock. What happened after this was that the Green Mountain went down based on the disappointing earnings outlook and the EPS line actually shifted down to here. So, the stock traded down actually to around $20 below. So, that’s what happens when there is a valuation resets.
That’s the thing about valuation resets; I am John Schwinghamer and that’s all for today’s little tutorial on valuation resets. If you have any questions about these please feel free to contact me, email me or give me a call; my numbers are on the website.
I am John Schwinghamer, the author of Purple Chips and thank you for watching today.[/vc_column_text][/vc_column][/vc_row]