Sunday, 26 February 2012

Evaluating a Company (Methodology)

August 08, 2011

Evaluating a company

In this post, I will share with you my approach in evaluating companies whose stocks are listed on the Malaysian stock exchange.

My method for evaluation is based on what I have read from a few books, mainly:

1. The Intelligent Investor - by Benjamin Graham
2. How to Make Money from Your Stock Investment Even in a Falling Market - by Ho Kok Mun
3. Secrets of Millionaire Investors - Adam Khoo and Conrad Alvin Lim

I invest in Malaysian stocks for the long term and for dividends. I do not use a trading approach.

To hold for the long term, it is important that the company has good financial strength and profitability.

I use the following criteria to determine financial strength, which can be calculated based on the data from the latest quarterly report:

1. Current ratio > 1.5

where current ratio = Net current assets / net current liabilities

2. Working capital - LTD > 0

where Working capital = net current assets- net current liabilities
and LTD refers to long term debts or non-current liabilities

3. DE ratio < 0.5

where debt-to-equity (DE) ratio = non-current liabilities / shareholder equity

4. LTD/PAT < 3

where LTD means long term debts or non-current liabilities
and PAT means profit after tax ( I use the net profit attributable to shareholders, rolling over the past 4 quarters )

5. cash/debt > 0.3

where cash is the "cash and cash equivalents" in the balance sheet and debt = total liabilities (current and non-current)

The more of these criteria are fulfilled the better it is.

For profitability, I would prefer the following:

1. No deficit in last 5 years i.e. the company did not have a loss in the past 5 years

2. Annualized earnings growth of over 15%.
I would look at the earnings for the past 5 years. If there is a year or two when the profits dipped (e.g. due to the global financial crisis), that is alright, as long as the overall trend is increasing profits. I tend to avoid companies with cyclical earnings.

3. Increasing operating cash flow

Next, I will also look at the companies average return-on-equity (ROE) and return-on-revenue (ROR) of the past 5 years. I prefer the company to have better ROE and ROR compared to its peers in the same industry. According to Benjamin Graham, it is advisable to have ROE of over 15%.

For dividends I prefer the company pays out dividends every year. I would keep a few stocks that have a track record of paying dividends higher than FD rate for every year in the past.

Finally, if I think the company is good to buy based on my evaluation, I will then check the annual reports of the company for the past few years. I will try to understand the company's business and products, it's business segments and markets, it's director's compensation and it's shareholders. This part is rather subjective and I am still learning.


Cement Producers

August 13, 2011

cement producers

The top 3 cement producers listed on the KLSE are LaFarge Malaysia (LMCEMNT), YTL Cement (YTLCMT) and Tasek (TASEK). LMCEMNT has the largest market capitalization and revenue, followed by YTLCMT and TASEK. However, YTLCMT actually currently makes more profit than LMCEMNT, based on the rolling profit of the previous 4 quarters. LMCEMNT is a subsidiary of the world's biggest cement maker Lafarge SA, traded on the Paris bourse.

The following table compares them (using data from the lastest quarterly and annual reports.)

It can be seen that both YTLCMT and TASEK fulfill all our 5 criteria of financial strength (see my previous post). YTLCMT has the highest return on equity (ROE) while TASEK has the highest return on revenue (ROR). Note that both these figures are 5 year averages.

TASEK tends to have the lower historical PE ratio,perhaps due to its low trading volume and liquidity. The company is a subsidiary of Hong Leong Asia (which is owned by Tan Sri Quek), which holds something like 72% of the shares.

At current stock prices, YTLCMT and TASEK are trading below their average historical PE ratio. However TASEK had a gain on disposal of property amounting to 43m in 4QFY10. Without this one-time gain, it is trading at its historical average PER.

The catalyst for cement producers would be construction activities from the ETP govt projects. Risks include ceiling price by government and energy costs (coal, electricity, diesel).

As I am only sharing information, I will not make any recommendations. I also make no guarantee to the accuracy of the information given.

*Note that the historical PE ratio is calculated based on the financial year end's closing price.


eehyun lee said...

hello, wanna ask the book you have read "how to make money in stock market even in falling market", is it useful?
in those 3 books, which you more recommended?

eehyun lee said...

hello, wanna ask the book you have read "how to make money in stock market even in falling market", is it useful?
in those 3 books, which you more recommended?

Investbullbear Investbullbear said...

I read his first and second books. The first book is the better one. Just saw his third book in the bookshop yesterday. Browsed through it and seems a good book for a young investor to start with too.