Showing posts with label changing fundamentals. Show all posts
Showing posts with label changing fundamentals. Show all posts

Monday 27 April 2020

When is a bargain not a bargain?

Once you have assembled a list of likely bargain candidates, you have to determine

  • which to put your money into and 
  • which to avoid and move on.


Many of the companies in your initial list are cheap for a reason;; they have fundamental problems that make them decidedly not valuable.

On the list of value candidates whose stock price had fallen significantly in the past were Enron, Global Crossing, MCI, US Airlines and Pacific Gas and Electric.   These companies ended up filing for bankruptcy and shareholders lost a significant portion of their investment if not all their money.


To achieve your wealth-building goals, you have to determine 

  • why a company's shares are cheap and 
  • which ones have little chance of recovery.



1.  Too much debt

The first and most toxic reason that stocks become cheap is too much debt.  In good times, companies with decent cash flow may borrow large amounts of money on the theory that if they continue to grow, they can meet the interest and principal payments in the future.  UNFORTUNATELY, the future is unknowable, and companies with with too much debt have a much smaller chance of surviving an economic downturn.  

Ben Graham explained that he used a simple yardstick to measure health.  A company should own twice as much as it owes.  This philosophy can help you avoid companies that owe too much to survive.


2.  Company falls short of analysts' earnings estimates.

Analysts seem to be more focused on short-term earnings gains than future long-term success   These quarterly or yearly earnings estimates have been proven to be notoriously unreliable.  Routinely, large and good companies get pushed to new stock price lows because they missed the estimates of the thundering herd of Wall Street  Missing earnings is not fatal, and it tends to create opportunity for the value buyer; if the trend continues, however, the shares will likely continue to fall.


3.  Cyclical stocks

Some cyclical stocks may show up on your list of potential bargains.  They are highly dependent on how the economy is doing.  Industries like automobiles, large appliances, steel and construction will experience lean times and stock prices are likely to reflect this fact.   Although we have had recessions of varying lengths and depths, the economies of industrialised nations have always rebounded.  It is important to note that in the bad times, cyclical companies with heavy debt loads may well face insurmountable problems.  Adhering to a policy of avoiding overly leveraged companies will serve you well.


4.  Labour contracts

Stocks may also fall because of labour contracts.  During good times, some companies and industries cave into labour union demands that were affordable at the time.  Little did they realize that they were mortgaging their future.  As new competition unburdened by costly labour contracts enters their industries, their profits disappear.  In many cases, the unions have been unwilling to grant concessions.   It is never easy to give back something you have, even if not doing so threatens the very existence of the company you work for.  Although holding on to expensive contracts may or may not benefit management or the unions in the long run, the one person that most assuredly does not benefit is the stockholder.  

Many large corporations (old-line industrial companies) have pension liabilities - benefits promised to workers - that they simply will be unable to pay  Generally speaking, if a company has excessive pension liabilities or there exists a contentious labour environment, it may be best to put these companies' shares on the no-thank-you list.


5.  Increased competition

Highly profitable industries attract new competition.  The most serious form of this comes when an industry in one country has high-priced labour or expensive regulatory rules.  Other nations unburdened by such costs can often produce and export the same goods cheaper.  Think China.  Throughout the world, countries have seen foreign manufacturers of automobiles, appliances and other goods make significant inroads into their market.  If a company is facing strong competition from a more efficient competitor with lower costs, it is perhaps best to utter those comforting words "no, thank you" and move on to the next candidate.


6.  Obsolescence

Obsolescence is another potentially fatal cause for falling prices.

Although the last large scale manufacturer of buggy whips or hand-cranked automobile starters made a very fine product, there was simply no longer a need for its product.  There may be some small demand for these products, but a company that depended on them for most of its sales would soon be out of business

Consider the field of technology.  The rate of "creative destruction" has never been faster.  Newer and better products turn up every day making the older products obsolete  The new products are a boon to the consumer but the bane of the legacy company.  

Today, we can go online and order any movie from NetFlicks and never have to leave the comfort of your own home.  For this reason, you should avoid companies that are subject to technological obsolescence.  The world is simply changing too fast to depend on products and services that someone else can deliver better and for less cost.  Avoid these.


7.  Corporate or accounting frauds

These are perhaps one of the most dangerous reasons for share price drops is corporate or accounting fraud.

Although these crimes against investors are the exception and not the rule, and most CEOs are dedicated leaders who care about their companies and their shareholders, fraud does happen.  In recent years, the world has experienced some of the largest cases in history, Enron, Parmalat, Tyco, WorldCom and others.  Regulators have since done much to help prevent future occurrences but there will always be some form of shenanigans.

Criminals exist in every walk of life.  There is almost no way to uncover fraud before it becomes public.  By the time it is discovered, it is too late  The best the investor can do is to steer clear of financial reports that seem overly complicated.


8.  Companies you do not understand or are not comfortable with

If there is something you do not understand or are not comfortable with, put these in the no-thank-you pile.   If a company has too many problems - too much debt, union and pension problems, stiff foreign competition, they too go to the no-thank-you pile.  You have the luxury of filling your portfolio with stocks you are comfortable with and want to own for the long term wealth building it offers.



Summary

You should approach your list of investment candidates with a healthy dose of scepticism.

You should stick to businesses you understand and for which there is an ongoing need (products or services).

You should also like food, beverage, and consumer staples like detergents, toothpaste, pens, and pencils - the stuff you consume on a daily basis. Many of these products engender brand loyalty that keeps the same product day after day, week after week.  We are all creatures of habit, and we will usually repeat our consumer preference when we go shopping.

Your best friend in the whole investing world is your no-thank-you pile.  Knowing your no-thank-you pile gives you the value investing opportunities to build your wealth building portfolio.

Sunday 15 January 2017

Look at FUNDAMENTALS and POTENTIAL CATALYSTS when making investment decisions

Look at Fundamentals

Value investors who paid attention to fundamentals (e.g. strong businesses masked by unprofitable divisions, or companies trading at discounts to cash etc.) reaped enormous profits.




Look for potential catalysts

Investors should look for potential catalysts when making investment decisions.   Catalysts are events that cause a stock's value to be recognised, thus resulting in immediate returns to investors who purchased at a discount. 
  • A liquidation is an example of a catalyst, and there are some companies where such events have returned generous - and quick - positive results for investors (e.g. during bankruptcy events, where securities generally trade at a discount to their recoverable values).
  • Share buybacks and asset sales also represent partial catalysts, as they can cause a stock to inch closer to its underlying value.  More importantly, such events signal that management is interested in returning value to shareholders, which bodes well for the future.
Some areas where value investors can indeed find value include: 
  • liquidations, 
  • complex securities (i.e. securities institutions can't purchase because they don't fit set categories), 
  • rights offerings (often offering prices lower than current market value), 
  • spinoffs (as they are usually sold by holders of the parents, thus depressing prices immediately) and 
  • risk arbitrage (depending on the market's mood, as sometimes the market's exuberance can erode returns).




Read also:

Monday 19 December 2016

Why understanding fundamental analysis is important for investing in stocks?

Fundamental analysis:

Why understanding FA is important? 

FA cannot offer you the magic keys to sudden or instant wealth. If that were true, the Professors of Finance will all be fabulously rich! What FA can do is to provide sound principles for formulating a successful long-range investment program. FA are proven methods that have been used by millions of successful investors.

The motivation for investing in stocks is obvious. It is to watch your money grow.

Why then, for every story of great success in the market, there are dozens more that don't end so well!!!!

More often than not, most of those investment flops can be traced to:

1. Bad timing
2. Poor planning
3. Failure to use common sense in making investment decisions.



Intrinsic Value

The entire concept of stock valuation is based on the idea that all securities possess an intrinsic value that their market value will approach over time.

Security analysis consists of gathering information, organizing it into a logical framework, and then using the information to determine the intrinsic value of common stock.

Given a rate of return that's compatible with the amount of risk involved in a proposed transaction, intrinsic value provides a measure of the underlying worth of a share of stock. It provides a standard for helping you judge whether a particular stock is undervalued, fairly priced or overvalued.



Main message

The aims of fundamental analysis are to determine the asset's intrinsic value and its future growth potential.

Tuesday 19 January 2016

When to buy? Great companies that ran into temporary corporate troubles and those with yet to be recognised worthwhile improvement in earnings, maybe buying opportunities.

1.  Great companies that ran into temporary corporate troubles maybe buying opportunities.

In short, the company into which the investor should be buying is the company which is doing things under the guidance of exceptionally able management.

A few of these things are bound to fail.

Others will from time to time produce unexpected troubles before they succeed.

The investor should be thoroughly sure in his own mind that these troubles are temporary rather than permanent.

# Then if these troubles have produced a significant decline in the price of the affected stock and give promise of being solved in a matter of months rather than years, he will probably be on a pretty safe ground in considering that this is a time when the stock may be bought.





2.  Buying the right sort of company with a worthwhile improving  in earnings that has not yet produced an upward move in its price.

All buying points do not arise out of corporate troubles.

Another type of opportunity sometimes occurs.

What is the common denominator?

# It is that a worthwhile improvement in earnings coming in the right sort of company, but that this particular increase in earnings has not yet produced an upward move in the price of that company's shares.

Whenever this situation occurs the right sort of investment may be considered to be in a buying range.

Conversely, when it does not occur, an investor will still in the long  run make money if he buys into outstanding companies.

However, he had then better have a somewhat greater degree of patience for it will take him longer to make this money and percentage-wise it will be a considerably smaller profit on his original investment.



----------------------


Additional notes:

Questions:

Does this mean that if a person has some money to invest he should completely ignore what the future trend of the business cycle may be and invest 100% of this fund the moment he has found the right stocks and located a good buying point, as indicated above?

A depression might strike right after he has made his investment.

Since a decline of 40 to 50% from its peak is not at all uncommon for even the best stock in a normal business depression, is not completely ignoring the business cycle rather a risky policy?

Saturday 22 December 2012

Beware that the worse a company performs, the better value its stock will appear to be.

The worse a company performs, the better value its stock will appear to be.

Because declining fundamentals will prompt a company's shareholders to sell, the price will decline.  This will cause all the value indicators to show that the price has become a bargain.  It's not.

Wednesday 22 February 2012

Security Prices Move Up and Down for Two Basic Reasons: Business Reality or Supply and Demand

Security prices move up and down for two basic reasons:
  • to reflect business reality (or investor perceptions of that reality) or 
  • to reflect short-term variations in supply and demand. 

Reality can change in a number of ways,
  • some company-specific, 
  • others macroeconomic in nature. 


Company-specific factors
  • If Coca-Cola's business expands or prospects improve and the stock price increases proportionally, the rise may simply reflect an increase in business value. 
  • If Aetna's share price plunges when a hurricane causes billions of dollars in catastrophic losses, a decline in total market value approximately equal to the estimated losses may be appropriate. 
  • When the shares of Fund American Companies , Inc., surge as a result of the unexpected announcement of the sale of its major subsidiary, Fireman's Fund Insurance Company, at a very high price, the price increase reflects the sudden and nearly complete realization of underlying value. 


On a macroeconomic level

These factors could each precipitate a general increase in security prices:
  • a broad-based decline in interest rates, 
  • a drop in corporate tax rates, or 
  • a rise in the expected rate of economic growth.

Friday 17 February 2012

Investors should expect prices to fluctuate


The Relevance of Temporary Price Fluctuations

In addition to the probability of permanent loss attached to investment, there is also the possibility of interim price fluctuations that are unrelated to underlying value.

Many investors consider price fluctuations to be a significant risk:  if the price goes down, the investment is seen as risky regardless of the fundamentals.

But are temporary price fluctuations really a risk?

  • Not in the way that permanent value impairments are and 
  • then only for certain investors in specific situations.

It is, of course, not always easy for investors to distinguish temporary price volatility, related to the short-term forces of supply and demand, from price movements related to business fundamentals.  The reality may only become apparent after the fact.

While investors should obviously try to avoid overpaying for investments or buying into businesses that subsequently decline in value due to deteriorating results, it is not possible to avoid random short-term market volatility.  

Indeed, investors should expect prices to fluctuate and should not invest in securities if they cannot tolerate some volatility.

Monday 6 February 2012

A Subnormal P/E

When a stock is selling at a P/E significantly lower than that of its competitors, an investor will want to know why?

A low P/E does not necessarily mean higher risk, though the company should be studied with that possibility in mind.

  • The low P/E stock may be selected anyway if, for example, it is a cyclical stock at a low in its cycle.   Cyclical stocks - automobile manufacturers are the most notorious among them - periodically develop fire-sale P/E ratios.  
  • Other out-of-favour stocks also can drop to surprisingly low P/Es.

On the other hand, if a stock is cheap in terms of its multiple for a troubling reason (or permanent deterioration of  business  fundamentals), such as pending depletion of oil or mineral reserves or a patent expiration, the value investor may want to shop elsewhere.




Comment:
Often the low P/E is appropriate for the stock as it is perceived to have poor potential for growth or its earnings are poor, volatile and less stable.

Saturday 24 July 2010

Trend analysis of Company's Business Fundamentals



Trend Analysis

Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

Revenue: In general, slowly growing trend, but not consistent (down years in 2001 and 2002). The average revenue growth for last 10 years is 15.3% (with 12% standard deviation).
Cash Flows: Increasing trend for operating cash flow (except a dip in year 2008). The free cash flow very close to the net income. There is little flexibility in allocating cash for dividends.
EPS from continuing operation: In general, this follows revenue trends. Slowly growing trend (with dips in 2001 and 2002)
Dividends per share: Consistently growing dividends.


Quality of Dividends

This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

Dividend growth rate: The average dividend growth of 25.2% (stdev. 8.34%) is more than average EPS growth rate of 17.8% (stdev. 22%). The two years where EPS were negative, has effect this calculation. If we remove the two negative years, the dividends seem to be well covered. The low payout factors allow for this flexibility and help cover for dividends.
Duration of dividend growth: In recent times, dividends have grown only since last 10 years.
4 year rolling dividend growth rate for past ten years: More than 10%.
Payout factor: In the past 10 years, it has been consistently less than 50%. In 2008 it increased to 53%. This is an indicator to keeping watch for dividends reduction.
Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.6%; and (b) MMA yield is 3.4%. Considering the last 10 year average dividend growth rate of 25.2%, the stocks dividend cash flow at the end of 10 years is 4.27 times MMA income. However, with my projected dividend growth of 15.3%, the dividend cash flow is equal to 2.04 times MMA income.

http://seekingalpha.com/instablog/347787-dividend-tree/6165-trow-potential-dividend-growth-investment

Friday 22 January 2010

What drives prices to change?

In the long run, yes, definitely the fundamentals or value.

But between now and that distant tomorrow, the answer is supply and demand. 

And the balance of those forces is not always rationally based.

It is at market-negotiated prices, not values, where we sell (and buy) stocks. 

And markets reflect people, not fundamentals alone!

It is not the news itself that moves prices, but instead the response of investors and traders to that news. 

To the degree that news constitutes a surprise, price will move dramatically.

The extent of changes in opinion can be measured in trading volume.  That tells us the degree of surprise hitting the market and the urgency with which the affected traderss and investors feel they need to take action. 

What studying volume does, in effect , is to reveal
  • what the crowd is thinking and
  • how big that crowd is. 

Understanding the crowd's collective mind set is crucial to being on the right side of the price action. 

Watching the crowd and the trading volume it creates will add a new dimension to your market and stock analysis.

Friday 8 May 2009

It is the Business that Matters

IT IS THE BUSINESS THAT MATTERS

Analyst upgrades and chart patterns may be fine tools for traders who treat Wall Street like a casino, but they're of little use to investors who truly want to build wealth in the stock market. You have to get your hands dirty and understand the businesses of the stocks you own if you hope to be a successful long-term investor.

Over the long haul, stock prices tend to track the value of the business. When firms do well, so do their shares, and when business suffers, the stock will as well. Always focus on the company's fundamental financial performance.

Wal-Mart, for example, hit a speed bump in the mid-1990s when its growth rate slowed down a bit - and its share price was essentially flat during the same period. On the other hand, Colgate-Palmolive posted great results during the late 1990s as it cut fat from its supply chain and launched an innovative toothpaste that stole market share - and the company's stock saw dramatic gains at the same time. The message is clear: COMPANY FUNDAMENTALS HAVE A DIRECT EFFECT ON SHARE PRICES.

This principle applies only over a long time period - in the short term, stock prices can (and do) move around for a whole host of reasons that have nothing whatsoever to do with the underlying value of the company. We firmly advocate focussing on the LONG-TERM PERFORMANCE of businesses because the SHORT-TERM PRICE MOVEMENT of a stock is COMPLETELY UNPREDICTABLE. (Benjamin Graham: In the short term, the market is like a voting machine, however, in the long term it works like a weighing machine.)

Think back to the Internet mania of the late 1990s. Wonderful (but boring) businesses such as insurance companies, banks, and real estate stocks traded at incredibly low valuations, even though the intrinsic worth of these businesses hadn't really changed. At the same time, companies that had not a prayer of turning a profit wer being accorded billion-dollar valuations.

Friday 21 November 2008

Three Main Influences on Stock Prices

Three Main Influences on Stock Prices
By Ken Little, About.com

There are three main areas of influence that move a stock’s price up or down. If you understand these influences, it will help you decide whether the price movement is a buy, sell or sit tight signal.

Fundamentals

Clearly, the most direct influence on a stock’s price is a change in the economic fundamentals of the business.

If revenues and profits are on a steep upward trend with no indication of leveling off, you can expect to see the stock price rise as investors bid up this attractive company.

On the other hand, if the profit picture is flat or, worse, declining with no change in sight, look for investors to abandon the stock and the price to fall.

These are simple examples of changes in fundamentals. Other, more complex and subtle changes can occur that may not dramatically affect the stock price immediately (increased debt, a poor acquisition and so on can also trigger price changes).

The point is that changes in the underlying business have a direct impact on the stock’s price. Smart investors spot the subtle changes before they become price-movers and take the appropriate action.

Sector Changes

Changes in the stock’s sector can have positive or negative affects on price too. Some sectors or industries are cyclical in nature and you should know that would affect price.

However, when whole sectors catch of fire (think dot.com stocks) or burn up (think dot.com stocks, again), even those companies that have solid fundamentals are pulled along with the rest of the sector.

You may hold a stock that is a victim of “guilt by association” when an industry falls out of favor. Likewise, stocks can see prices artificially inflated if they find themselves in the right industry at the right time.

Market Swings

The market goes up and the market goes down. That’s about all you can say with certainty concerning the stock market.

As the market moves up and down, your stock may move with or against it. Most large-cap stocks will follow the market to some degree, but smaller companies may not get the same push every time.

In general, a strong market move either up or down will carry more stocks with it than not, so your stock may be up or down for no other reason than the market was up or down.

Conclusion

How do you use this information?

A change in fundamentals may be an opportunity to buy more shares of a growing company or it may signal the time to sell if the changes are for the worse.

A change in the sector is usually temporary so most long-term investors will ride out dips due to these factors. However, if something drastically changes in the stock’s industry due to regulation or a new technology, for example, you may want to reevaluate your position. Is the company capable of adapting or do you own a dinosaur?

Market swings that move your stock’s price can be opportunities to buy additional shares (assuming all the company’s fundamentals still checkout). If the rising market pushes up your stock’s price, it may be time to take a profit on part of your holdings and wait for the price to come back down to earth to reinvest.

http://stocks.about.com/od/evaluatingstocks/a/0317threefact.htm

Monday 4 August 2008

Evaluating Changing Fundamentals (Part 3 of 5)

Stock
Selling
Guide

Company: ___________________
Ticker: ___________________
Prepared by: ___________________
Date: ___________________

Douglas Gerlach http://www.douglasgerlach.com


C. EVALUATING CHANGING FUNDAMENTALS

REASONS CONSIDERATIONS

o EPS or revenue growth is slowing or falling.
· Company may be entering a new stage of slower growth or stagnation.
· If considering additional purchase, use caution. The worse a company performs, the better a value it may appear on the SSG.

o Quarterly pre-tax profits are falling.
· Use PERT graph to evaluate PTP.
· Three quarters of consecutive declining PTP are a danger sign.
· Five consecutive declining quarters are usually a definitive sign to sell.

o Cash flow is diverging from net income.
· If free cash flow is falling while net income is stable or rising, company may be "propping up" profits.

o Other fundamentals are deteriorating.
· Accounts receivable rising faster than sales.
· Inventories rising faster than sales.

o There has been an uncertain change of management.
· Dynamic company leader retires, replacement has questionable qualifications.
· Senior executives leave en masse.
· Those responsible for past success are no longer with the company.

o Company faces direct or indirect competition.
· Competitors threaten to affect the company's long-term prosperity.
· Companies with very high profit margins are often susceptible to increased, cutthroat competition.

o Company faces uncertain product cycle.
· Company is too dependent on single product.
· No new products in pipeline (such as pharmaceutical companies).

o Company has uncontrolled raw material costs.
· Can harm profit margins.
· If company doesn't hedge, they may have no option but to pay higher prices for necessary materials.

o Company is the victim of fraud or "accounting irregularities."
· If the books are being cooked, investors will be last to know.
· No way for investors to know if management is lying, or auditors are covering up.
· Get out fast; these are not quality companies.

o Company's debt rating has been lowered.
· Can often be an early warning sign of greater problems in the future.



D. FINAL CONSIDERATIONS

· Don't hesitate to sell in retirement accounts where taxes aren't an issue.
·
Don't automatically buy because a stock falls in price; re-evaluate as if new.
·
If you won't purchase additional shares of a fallen stock, why would you continue to hold it?
·
Don't "wait to get your money back" from the stock – it doesn't know you own it.
· Don't be paralyzed by uncertainty.
· Don't be an ostrich with your head in the sand –
face up to the problem.
· Remember NAIC's Rule of Five.
· Use Challenge Tree to continually upgrade your portfolio.
· Think "replace," not "remove."