The Coca-Cola Company (KO), USA Mobility Inc (USMO) – Price-to-Earnings Ratio: An Alternative View

This last company, which is a provider of paging products and services for the healthcare sector, maintains its margins at a relatively stable level (between 14% and 11%) but looks condemned to die. Then, is a P/E multiple of 12 times a fair P/E ratio?

Let’s suppose the company can somewhat sustain its business and its EPS decline rate falls to 4%. Then, applying the numbers to our formula gives us an implied cost of capital of 4.35%. Of course this is ridiculously low. Hence, USA Mobility Inc (NASDAQ:USMO), given my expectations, seems deeply overvalued.

The P/E for unpredictable businesses

Many acclaimed investors (such as Bill Miller from Legg Mason) erred when estimating Research In Motion Ltd (NASDAQ:BBRY)‘s value before it started to plunge back in 2011 (the company lost 80% of its value since 2011 started). Research In Motion Ltd (NASDAQ:BBRY)’s P/E multiple looked low at 10.5 when the company was starting to fall. After having lost most of its value, the company trades at a P/E ratio which as low as 4.6. Research In Motion Ltd (NASDAQ:BBRY)’s value is related to patents, acquired users and strategic positioning (many big companies still use blackberry). Those assets could be valuable for a bigger company such as Samsung or Nokia Corporation (ADR) (NYSE:NOK). Its impossible to use any simple formula when thinking of the value of a company that is losing sales at a 36% annual rate. Sum-of-the-parts or a very complex discounted dash flow analysis could help but most definitely, ratios are not the way to look at this company nor none of its kind.

Bottom line

By applying your own intellect, you can decipher whether the market is being reasonable regarding growth and cost of capital. The market is all about expectations. Knowing when multiples are reasonable valuation shortcuts is extremely relevant as is knowing how to extract as much information as possible from the data that we already have.

The article Price-to-Earnings Ratio: An Alternative View originally appeared on Fool.com and is written by Federico Zaldua.

Federico Zaldua has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola. Federico is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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