OV Metrics and Their Use in Portfolio Valuation Analysis
Is a Stock Pulling Its 'Weight'?
Determining the sales, earnings, cash flow, and common stock equity of each portfolio holding is an important step in the evaluation and analysis of a common stock portfolio.
OV Metrics introduced a proprietary portfolio analytic tool that generates a true "Ownership View." First, the OV Tool calculates the portfolio's % ownership of each company, then multiplies that ownership factor times the company's total results for sales, earnings, cash flow, and book, and last, cumulates those individual company ownership interests to establish the portfolio's total ownership interest in the financial results of the companies owned.
The OV Tool makes it possible to calculate average portfolio valuation ratios based on the actual portfolio's ownership interests in the companies' financial results. This is a method very different from calculating, for instance, a portfolio's weighted-average P/E ratio.
Here is an example of how the OV method defines the portfolio's valuation ratio to earnings:
OV Valuation Method
Name of Company Company A
Total Shares 1,000,000
Price per Share $10.00
Shares Owned 12,000
Ownership % 1.20%
Earnings $400,000
EPS $0.40
P/E Ratio 25.0x's
In this example, the portfolio's "Ownership Interest" in the earnings of Company A may be calculated in two ways:
1) Multiplying Ownership % times Earnings
.012($400,000)=$4,800
or
2) Multiplying Shares Owned by EPS
12,000($.40)=$4,800
In both cases, the owner of 12,000 shares has an Ownership Interest of $4,800 in the earnings of Company A.
The next step is to calculate the portfolio's ownership interest in other companies in the portfolio. To demonstrate the potential uses of the OV Valuation Method, we will assume there is a second common stock held in the portfolio:
Name of Company Company B
Total Shares 8,000,000
Price per Share $10.00
Shares Owned 8,000
Ownership % 0.10%
Earnings $10,000,000
EPS $1.25
P/E Ratio 8.0x's
The portfolio's Ownership Interest in Company B's earnings is $10,000. Therefore, the portfolio's total Ownership Interest in the earnings from Companies A and B is $14,800:
.012($400,000) + .001($10,000,000) = $14,800
Now that the portfolio's Ownership Interest in the earnings of its holdings has been established, the owner may evaluate the portfolio as follows:
Total Portfolio Market Value $200,000
Ownership Interest in Earnings 14,800
OV Valuation Ratio of Earnings 13.51x's
It is fair to say that the owner is paying 13.51x's for the underlying earnings of Companies A and B, based on the share positions held. Moreover, the Ownership View makes clear, in dollars, that the owner's interest in the earnings of Companies A and B is $14,800.
Also, the OV Tool calculates each company's % share of the portfolio's total Ownership Interest in earnings and compares those % shares to the respective portfolio weights of each company:
Company A: accounts for 32.4% of the portfolio's ownership interest in total earnings
vs. its 60.0% portfolio weight
or 46.0% lower than its portfolio weight
Company B: accounts for 67.6% of the portfolio's ownership interest in total earnings
vs. its 40.0% portfolio weight
or 69.0% higher than its portfolio weight
By comparing the portfolio's Ownership Interest in each company's earnings, the owner may see which holdings are pulling their 'weight'. The OV Tool creates an instant "drill-down" view to study portfolio risks and opportunities; and it offers ways to sort and display data to identify relative company performance.
OV Valuation Method and Standard Practice
Portfolio theorists have many ways of calculating what is commonly known as the Weighted-Average P/E Ratio for a common stock portfolio. For purposes of this discussion, however, let's consider only the standard method of calculating the Weighted-Average P/E Ratio for a portfolio, using the same portfolio example as above.
The formula for calculating the Portfolio's Weighted-Average P/E Ratio follows:
.60(25.0x's) + .40(8.0x's) =18.20x's
Note how the above "Standard Ratio" of 18.20x's is 34.7% higher than the OV Valuation Ratio of 13.51x's. The difference is explained by the fact that the OV Ratio is valuing actual cumulated ownership interests in the companies' as-reported earnings, whereas the Standard Ratio uses the portfolio weights of individual stocks to weight their respective P/E ratios.
The OV analytic method does not weight ratios at all. It simply divides the portfolio's total market value by the total Ownership Interest in earnings from the portfolio companies. OV Metrics were developed to generate an Ownership View, seeing what you really own in terms of the portfolio companies' financial results. The OV version 3.0 generates results for Sales, Earnings, Cash Flow, and Common Stock Equity.
OV Screening Modes
Since portfolio valuation ratios can be highly skewed by massive company losses, the OV analytic tool provides three standard screening modes:
Mode I: All portfolio companies
Mode II: Profit-reporting companies and loss-reporting companies, provided that the portfolio's Ownership Interest in such company's losses is less than the related stock position's market value
Mode III: Only profit-reporting companies
However, there are also built-in override functions that allow the user to deselect certain holdings from valuation. Also, financial results may be adjusted to reflect projected results or other qualitative adjustments.
Unlike portfolio analytic tools that automatically exclude loss-reporting companies due to the invalid negative ratios' effect, the OV method allows the inclusion of loss-reporting companies in the valuation. The results are generally not skewed, since negative values are simply deducted from positive values; and thereby, the denominator is reduced and the ratio is increased proportionally. However, companies on occasion report extraordinarily large losses, making the portfolio's ownership interest in those losses even larger than the related portfolio's stock position. In this extreme case, the second or third display mode would be selected to create a more realistic valuation of average portfolio characteristics.
Conclusion
Knowing the weighted-average P/E ratio for a portfolio is a broad and valid valuation metric and is of real analytic value. However, without also knowing the portfolio's absolute and relative levels of Ownership Interest in company operating results, one may expose the portfolio to higher levels of risk than had been assumed. The OV Tool tries to spotlight the dynamic fundamental financial factors influencing portfolio valuation and analysis.
by Miles P. Jennings, Jr.
© 2009 OV Metrics, LLC
2) Multiplying Shares Owned by EPS
12,000($.40)=$4,800
In both cases, the owner of 12,000 shares has an Ownership Interest of $4,800 in the earnings of Company A.
The next step is to calculate the portfolio's ownership interest in other companies in the portfolio. To demonstrate the potential uses of the OV Valuation Method, we will assume there is a second common stock held in the portfolio:
Name of Company Company B
Total Shares 8,000,000
Price per Share $10.00
Shares Owned 8,000
Ownership % 0.10%
Earnings $10,000,000
EPS $1.25
P/E Ratio 8.0x's
The portfolio's Ownership Interest in Company B's earnings is $10,000. Therefore, the portfolio's total Ownership Interest in the earnings from Companies A and B is $14,800:
.012($400,000) + .001($10,000,000) = $14,800
Now that the portfolio's Ownership Interest in the earnings of its holdings has been established, the owner may evaluate the portfolio as follows:
Total Portfolio Market Value $200,000
Ownership Interest in Earnings 14,800
OV Valuation Ratio of Earnings 13.51x's
It is fair to say that the owner is paying 13.51x's for the underlying earnings of Companies A and B, based on the share positions held. Moreover, the Ownership View makes clear, in dollars, that the owner's interest in the earnings of Companies A and B is $14,800.
Also, the OV Tool calculates each company's % share of the portfolio's total Ownership Interest in earnings and compares those % shares to the respective portfolio weights of each company:
Company A: accounts for 32.4% of the portfolio's ownership interest in total earnings
vs. its 60.0% portfolio weight
or 46.0% lower than its portfolio weight
Company B: accounts for 67.6% of the portfolio's ownership interest in total earnings
vs. its 40.0% portfolio weight
or 69.0% higher than its portfolio weight
By comparing the portfolio's Ownership Interest in each company's earnings, the owner may see which holdings are pulling their 'weight'. The OV Tool creates an instant "drill-down" view to study portfolio risks and opportunities; and it offers ways to sort and display data to identify relative company performance.
OV Valuation Method and Standard Practice
Portfolio theorists have many ways of calculating what is commonly known as the Weighted-Average P/E Ratio for a common stock portfolio. For purposes of this discussion, however, let's consider only the standard method of calculating the Weighted-Average P/E Ratio for a portfolio, using the same portfolio example as above.
The formula for calculating the Portfolio's Weighted-Average P/E Ratio follows:
.60(25.0x's) + .40(8.0x's) =18.20x's
Note how the above "Standard Ratio" of 18.20x's is 34.7% higher than the OV Valuation Ratio of 13.51x's. The difference is explained by the fact that the OV Ratio is valuing actual cumulated ownership interests in the companies' as-reported earnings, whereas the Standard Ratio uses the portfolio weights of individual stocks to weight their respective P/E ratios.
The OV analytic method does not weight ratios at all. It simply divides the portfolio's total market value by the total Ownership Interest in earnings from the portfolio companies. OV Metrics were developed to generate an Ownership View, seeing what you really own in terms of the portfolio companies' financial results. The OV version 3.0 generates results for Sales, Earnings, Cash Flow, and Common Stock Equity.
OV Screening Modes
Since portfolio valuation ratios can be highly skewed by massive company losses, the OV analytic tool provides three standard screening modes:
Mode I: All portfolio companies
Mode II: Profit-reporting companies and loss-reporting companies, provided that the portfolio's Ownership Interest in such company's losses is less than the related stock position's market value
Mode III: Only profit-reporting companies
However, there are also built-in override functions that allow the user to deselect certain holdings from valuation. Also, financial results may be adjusted to reflect projected results or other qualitative adjustments.
Unlike portfolio analytic tools that automatically exclude loss-reporting companies due to the invalid negative ratios' effect, the OV method allows the inclusion of loss-reporting companies in the valuation. The results are generally not skewed, since negative values are simply deducted from positive values; and thereby, the denominator is reduced and the ratio is increased proportionally. However, companies on occasion report extraordinarily large losses, making the portfolio's ownership interest in those losses even larger than the related portfolio's stock position. In this extreme case, the second or third display mode would be selected to create a more realistic valuation of average portfolio characteristics.
Conclusion
Knowing the weighted-average P/E ratio for a portfolio is a broad and valid valuation metric and is of real analytic value. However, without also knowing the portfolio's absolute and relative levels of Ownership Interest in company operating results, one may expose the portfolio to higher levels of risk than had been assumed. The OV Tool tries to spotlight the dynamic fundamental financial factors influencing portfolio valuation and analysis.
by Miles P. Jennings, Jr.
© 2009 OV Metrics, LLC
