Common question that we have during valuation are about comparison. What is the right PE or ROE to follow? How low a PE is low and how high ROE should be to be consider good?
Absolute Comparison (For Stock Pick)
Absolute comparison are method that compare using fix value. Let say I set a value 160 cm, anyone that have height lower than 160 cm are consider short. Absolute comparison are more suitable to use in Stock Pick instead of Stock Valuation. Example, for Company with "Debt To Equity" lower than 25% are consider low debt. Other stock pick indicator that can use this comparison are ROE , Debt to Equity, Current Ratio, Cash Ratio and etc. This is because these indicator share the similar standard to define the company financial state. No one will say a company with 200% Debt to Equity are low debt company. Nobody will say company with 5% ROE are high growth company.
Why never try to use Absolute comparison in Stock Valuation? Let say PE = 20 for bank stock are consider overvalue, but PE = 20 for technology stock can still be undervalue, thus absolute comparison not really useful for Stock Valuation.
Relative Comparison(For Stock Valuation)
Relative comparison are method to compare using a set of sample. Instead of set a fix value, I select 10 person and get their average height, then any value lower than average are consider short. Thus, Relative comparison are suitable for Stock Valuation indicator like PE (Price to Earnings), PS (Price to Sales), DY and etc.2 common way in doing relative comparison are horizontal comparison and vertical comparison.
Horizontal Comparison are compare the company with other company in same industry. Example, when investing Inari, I can compare the indicator with Vitrox or MPI. However, we still need to be careful even though they are in same industry in some scenario. For example, Riverstone and Hartalega both are Glove Manufacturer, but the glove they created are for different industry. Small differentiation like this need to be consider when using horizontal comparison.
Vertical Comparison are comparison by company itself with the history data. Example for Bursa Malaysia historical PE fall around 22-27 from 2015-2020. So i can make a conclusion that any PE below 22 are consider undervalue. Instead of PE, we can also compare other thing like Cashflow, Debt, Revenue and etc. Anyway when working on Vertical Comparison, we need to be careful with extreme high/low value, because those maybe one off item. Example Air Asia have a one-off gain by selling the company assets (airplane) and give out a special dividend. We need to exclude these one-off item when working on our research.