It has been a good July for ITM Power (LSE: ITM). Shares in the fuel cell company have risen in value by a fifth. However, they remain 47% lower than they were at this time last year. With the price showing strong positive momentum in the past month, though, could now be the time for me to add ITM Power to my portfolio?
How to value shares
Just because a price is rising (or falling) does not make it time to buy the share concerned, in my view.
Instead of looking just at price when building my share portfolio, I try to focus on the real value of a company. There are many different ways to value shares. For example, many investors use a price-to-earnings ratio while for growth companies a price-to-sales ratio is also sometimes applied.
The problem, though, is that ITM has no earnings, having made a loss of £28m last year. It does have sales, but they came in at only £4.3m last year.
The company almost did that much business in the first half of its current financial year alone, recording revenues of £4.2m. If it does as well in the second half, that would mean annual revenues of £8.4m. But the market capitalisation of ITM Power is a dizzying £1.3bn. So the price-to-sales ratio, using the £8.4m figure for the year, comes out at over 150. That looks very expensive to me.
Is the ITM Power share price good value?
But what if those approaches are not the right way to value a company like ITM Power? After all, it is a growth company still working hard to develop and commercialise its technology at scale. Such companies often spend heavily in their early days and struggle to make sales. The hope is that, as they learn and grow, sales can boom while the initial investment on research and development is spread over much larger revenues. That could be good for profits.
One way to value companies like that is to use a discounted cash flow model. That looks at the hard cash a company is expected to generate in future once it has paid all its expenses. That is then compared to the current company valuation, allowing for the fact that the value of money in future is lower than it is today, due to inflation.
But this makes it even harder to value ITM Power shares, in my view. The market is unproven and demand for the company’s product line is growing but remains largely unknown. It is also hard to know what the economics of production will look like in future. There are so many estimates involved in valuing ITM Power using discounted cash flow that I do not think I could come up with a useful valuation that way to inform my investment decisions.
If I cannot value the company, I do not know whether or not the ITM Power share price is good value. So I will not be buying it for my portfolio.
The post The ITM Power share price jumped a fifth this month. Time to buy? appeared first on The Motley Fool UK.
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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.