May 3, 2019

# What's behind the Obermatt Value Rank?

How is the Obermatt consolidated Value Rank calculated and how can it be traced back to the detailed Value Ranks? Value Ranks compare the size of a company with its share price. So the crucial question is: How do we measure the size of a company (the share price is already determined by the stock market)?

The first detailed Value Rank relates the share price to the sales revenues of a company. This is also referred to as the "sales multiple": The higher the price in relation to sales, the higher the sales multiple. A multiple of 2 means: The share price (calculated on all shares) is twice as high as revenues. Is a sales multiple of 2 good? That depends entirely on the alternatives. That’s why we compare the sales multiple of the assessed company with the sales multiple of other comparable companies. The higher the rank, the lower the sales multiple. With multiples, the scale behaves inverted: it is better to pay a low price, so a lower sales multiple is more desirable than a high one and therefore receives a higher Value Rank in terms of sales. Concrete example: A Price/Sales Rank of 50 represents an average multiple, whereas a rank of 75 means that the sales multiple is lower than 75% of comparable shares.

Another Obermatt Value Rank is the price/earnings ratio. We perform a similar calculation as for the Price/Sales Rank: Here we divide the market value of the company (share price times the number of shares) by the profit. The result is a profit multiple, known as the price/earnings ratio. The higher the price compared to the profit, the higher the ratio and the lower the Obermatt rank, because high ratios mean expensive - i.e. little "value".

In addition, we are interested in the price in relation to assets (invested capital/book capital): This shows how much book capital the company has in terms of machinery, equipment, real estate, and other assets compared to the market value of the shares.

Similarly relevant is the ratio of price to dividend which is called the dividend yield: For example, is a dividend yield of 3% good? That also depends on the alternatives in the stock market. We convert absolute values into ranking values: The higher the rank, the better the value. If a dividend yield of 3% has a dividend rank of 50, then this is an average dividend yield. A rank of 75, on the other hand, would mean that the dividend of 3% is better than 75% of all cases of comparable shares. Not the absolute dividend yield plays a role in the dividend rank, but the comparison to other shares.

## How the consolidation process works

All these discussed value ratios flow into the consolidated Value Rank used for the Obermatt Top 10 lists. This means that the Value Rank is made up of other, more detailed Value Ranks. To establish the consolidated rank, we calculate an average value from the four already mentioned detailed Value Ranks (sales, profit, book value, and dividend yield). In the next step, we analyze how good this average value actually is by comparing it with the same average value of comparable other shares. The share with the highest average is given an Obermatt Value Rank of 100. Lower multiples result in lower consolidated values. The company with the lowest average gets the rank 1 of 100.

## How are detail Value Ranks used?

Not all Value Ranks are created equal. To understand this, you need some basic financial analysis and stock valuation knowledge: sales and invested capital are quite stable size indicators and therefore reliable in most cases. And yet they also have a few pitfalls. For example, in retail companies: They show much more sales than manufacturing companies, which can impact the sales rank. The valuation of assets (book values, invested capital) can also be misleading if other accounting practices are used or if intangible assets such as patents, brand names, and licenses play a major role, as these assets are often only insufficiently represented in the balance sheet.

From an investor's point of view, profit and dividends are the most important indicators of size, since investors are most interested in their stake of the profit and their dividend payout. Unfortunately, however, profits and dividends fluctuate much more than the above two indicators, which makes them less reliable.

Over time, you will learn to work effectively with all Obermatt Value Ranks. Here are selected cases that will give you a knowledge advantage:

## The crisis situation

In crises, a company's share price and profit is low, sales are usually still normal and the invested capital is still there. The Value Ranks for sales and capital are therefore good, the Value Rank for profit probably low. This constellation is not unusual in the business world. Nor does it really pose a problem, because the profits of such companies rarely remain low over a long period of time. Warren Buffett, for example, bought Coca Cola in exactly such a situation when they changed the recipe for their cola and nobody liked it. In such a situation, the price/earnings ratio, i.e. the Obermatt Value Rank of profit, is of a short-term nature. The other Value Ranks can give an indication that the company is cheap to buy.

## The cash cow case

The cash cow case is Coca Cola today. The company has low profit in relation to the share price, but the dividends are quite high, i.e. a poor P/E ratio with a good dividend yield. This tells us how the cash cow is milked. Profits are used to pay high dividends to sustain the share price. This is sometimes also a sign that the management doesn't really know what to do with all the money. They are not creative when it comes to new investments. Despite high dividends, this is not really a good sign.

## The future star

The opposite of the cash cow situation are potential future high-flyers. These are companies that report high profits and pay out low dividends at the same time (think "Microsoft" in the 90ties). In the future star case, we have exactly the opposite to Coca Cola: The company has many reasons to invest their profits and pays out no or only small dividends. This is an interesting case because it means that the management doesn’t need the dividends to sustain the share price. What they do is attractive enough for investors: They put their profits to work.

## The balanced case

In a balanced situation, all detailed Value Ranks are good, which is a sign of a low priced business. Although such companies sometimes find themselves in regulated markets and will not evolve much, this should not be a special cause for concern, as dividends justify the investment when the dividend rank is high.

As you can see, the Value Ranks reflect the facts. The important thing is how you yourself assess the future of companies - better or worse than their facts. Take a look at our other Obermatt videos to learn more about how you can work with the Value Ranks.

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