Is ERAA cheap?

P/E, P/E and P/E ...

That's the most common valuation method I've heard lately.

For the layman, P/E stands for price to earnings ratio.

This ratio compares stock prices per share, with earnings per share of a company.

In other forms, P/E is identic to the market cap of net income.

In the current bull market period, many stocks have become expensive.

Having tired of searching for bargains in blue chip stocks without fruition, the market started moving downwards, looking for stocks that have relatively cheap valuations.

This is a normal phenomenon at the peak of the bull market.

And because the world's economic conditions are indeed relatively good, the company's earnings are inclined to grow up.

This makes the P/E valuation method popular in the bull market.

The market focuses on E. To be exact, the potential E.

And why not?

In addition to P/E looks tempting when the E trend is rising, this valuation method also the most easy to use.

You just compare the stock price you buy, with the potential EPS that you will get.

If playing stocks is as easy as this, poverty in the world has long gone. 

One of the investment ideas that surfaced at the moment is ERAA IJ.

ERAA distributes and retails cellular telephones. The company is licensed to distribute international brands of cell phones, and operates a chain of retail shops in Indonesia.

The company is majority owned by PT Eralink International (59.97%).

When the majority of liquid-stocks are valued in the range of mid-teens, at a glance ERAA does look cheap. Analysts predict ERAA may book a net profit of IDR 358 bio by the end of 2018, thus at current price (IDR 1,295) ERAA is trading at 10.46x E18.

However, is ERAA really cheap?

The main mistake of the market, often is too simplistic.

In the case of ERAA IJ, markets tend to focus on P/E only and simply justify that ERAA is cheap.

However, I see some disadvantages of using the P / E method:

1. In contrast to assets, earnings are fleeting. Lots of variables that can affect earnings. This causes the valuation method to use earnings to be less certain.
2. Let’s say the market has been able to guess the 2018 net income accurately, will this earnings survive or even grow in the years to come? Because otherwise the market will soon penalize the company’s stock price that experienced negative growth (especially if the stock price has flown before). Therefore, I believe, an investor should not invest only based on short-term earnings.
3. Comparing the value of a company without taking into account its capital structure is a mistake, in my view. In fact, market cap is not the most accurate measure of company value.

The current market cap ERAA is IDR 3.74 T. With projected net profit 2018 of IDR 358 bio, ERAA is trading at 10.46x E18. However, ERAA has a total debt of IDR 1.75T.

After taking into account its capital structure, the company’s real value is IDR 5.20 T, not IDR 3.74 T.

And if you divide ERAA’s real value with its earnings estimate 2018, then ERAA shares are trading at 14.54x its earning.

And if you compare ERAA's real value with a 2018 cash profit projection of IDR 699 bio, you'll get a 7.43x score. Not too expensive, but not cheap.

However, ERAA's cash profit is rather strange, because consistently, the number is very different from its operating cash flow.

Operating cash flows that are highly fluctuating and different from cash profit indicate that ERAA's accounting earnings are low quality. This may be due to poor management of working capital, or the nature of the business. Up here, an investor should know that he/she can not rely on accounting profit solely in determining the cheapness of ERAA stock price.

It would be very difficult to guess the cash flow of ERAA in the future. Therefore analysts also do not include P/CF projections in Bloomberg, let alone calculate the free cash flow (FCF) of ERAA.

With the poor cash flow trend of the past, I doubt the company can produce identical free cash flow with its net income. The most likely possibility, ERAA’s free cash flow will be less than the reported net income. This makes FCF yield ERAA small, which means ERAA will appear more expensive when viewed from the FCF yield method.

	P/E18	PBV18	EV/NP18	EV/cash profit	FCF yield
ERAA	10.46	0.98	14.54	7.43	< 6.88%

	5Y P/E	5Y PBV
ERAA	9.90	1.00

From the two tables above you can see, by P/E and PBV, ERAA has been traded on its average 5 year valuation.

With poor working capital management, huge debt and rather high valuation (from various method), I did not find ERAA cheap.
Of course I can be wrong. A stock can go up for different reasons. But at current levels, it is not attractive enough to buy, in my view. With low-quality accounting profit, ERAA is indeed worth trading with discount, not par with the market. 

Disclaimer: This article is not a recommendation to conduct transactions on the intended securities. Any consequences arising from this writing are beyond the responsibility of the author.