Wednesday July 8, 2009
Two fined for involvement in multiple IPO share applications
KUALA LUMPUR: The Kuala Lumpur Session Courts yesterday fined Yunus M. Haniff and Ramly Hussain RM25,000 each for using third party names in a multiple initial public offering (IPO) share application scheme.
In a statement, the Securities Commission (SC) said both Yunus and Ramly were fined after having pleaded guilty to offences under Section 9 (1) of the Securities Industry (Central Depositories) Act 1991 for failing to comply with Rule 26.02 of the Malaysian Central Depository Sdn Bhd rules.
The said rule provides that no person shall maintain more than one CDS account at any authorised depository agent/stockbroking company, the SC said.
The prosecution against Yunus and Ramly was initiated in 2005 after their failure to pay a compound meted by the SC, it added. — Bernama
Wednesday, 8 July 2009
Investors must analyse data, mere headline numbers may deceive
Wednesday July 8, 2009
Investors must analyse data, mere headline numbers may deceive
The Real Matter - By Pankaj Kumar
WHAT is the difference between a stock that is down 90% versus a stock that was down 80%, then halved? If you were quick enough, you would have the answer right away.
Yes, they are both the same! Some readers would have thought that the stock which was down 90% is in a worse situation compared with the stock which was down 80% earlier but later halved in value.
However, there could be readers who would have thought that the stock which was down 80% and then halved was worse than a stock that is down 90%. In any case, we all now know that the answer is the same and perhaps it is how the question or statement is phrased that matters.
It is also similar to looking at a glass of water and whether it is half full or half empty depends on one’s confidence level, when in actual fact if the glass was exactly 50% filled, it is either half empty or half full.
Moving towards the current economic indicators, it is also interesting to note how one economic figure can be misconstrued as good by some and bad by others when in reality it may well be saying something else.
The issue here is that as most fund managers are busy keeping track of economic data out of the US, Europe and Asia practically on a daily basis, are we seeing the trees from the forest or mainly just looking at headline numbers?
Most economic data are measured either on a month-on-month or year-on-year basis. There are two ways to measure the data points; either by absolute difference (for example consumer confidence data), which to me is more reflective of the real situation, or by percentage change, which can sometimes be misconstrued by investors.
For example, let’s take the durable goods order data out of the US.
The latest reading for May suggests that total durable goods orders stood at US$163.38bil, which compared with the preceding month was higher by 1.8%.
Of course, the headline that we see in the media as well as economic research reports is on the month-on-month change, i.e. the rise of 1.8% and we have seen how positive the market takes these data point as signs that the worst economic recession in living memory is indeed over.
However, if we were to analyse the data deeper, there are several other observations that we can make.First, on a year-on-year basis, the durable goods order contracted by 23.5% and in terms of absolute level, the May total orders were still hovering at levels last seen in 2002/2003!
They say a picture tells a thousand words. Now, let’s look at the above data points in terms of charts.
The chart on the left is the total durable goods orders in absolute form and the chart on the right is based on the widely accepted, month-on-month change. The two charts clearly show two different pictures of the same time frame!
While it can still be argued whether the durable goods orders are recovering or otherwise, it is noteworthy to take into account what a particular chart really means.
Hence, it is imperative for investors to dissect data before coming to a conclusion whether the economic data points released by regulators are in actual fact telling the right story or otherwise.
This is what we call a numbers game and how these data points are communicated to the market has very different interpretations.
Perhaps economists and market analysts need to be more detailed in analysing data points as mere headline numbers may not tell the real story.
Pankaj C Kumar is chief investment officer at Kurnia Insurans (M) Bhd. Readers’ feedback to this article is welcome. Please e-mail to
starbiz@thestar.com.my
S'pore bans 10 brokers from structured notes sales
Published: Wednesday July 8, 2009 MYT 9:05:00 AM
S'pore bans 10 brokers from structured notes sales
SINGAPORE: Singapore's central bank banned 10 financial institutions from selling structured notes for improperly marketing US$655 million of the bonds that were linked to U.S. brokerage Lehman Brothers Holdings Inc.
The banks and brokerages can't sell structured notes for between six months and two years, the central bank, known as the Monetary Authority of Singapore, said in a statement late Tuesday.
The bank said some of the financial institutions assigned risk ratings that were inconsistent with warnings stated in the notes' prospectus, and salespeople were ill-trained to sell the notes.
The structured notes were linked to the risk of a bankruptcy occurring to one of the reference entities, such as Lehman.
The Lehman collapse last fall led to a default on the dividend payment of some of the bonds, most of which had a maturity of 5 to 7 years and a yield of about 5 percent.
About 10,000 investors bought the notes, and financial institutions have compensated about 4,000 of them, the bank said.
Similar structured notes were sold in Hong Kong, Taiwan and Indonesia.
The 10 financial institutions banned by the central bank are DBS Group, UOB Kay Hian, OCBC Securities, ABN AMRO's Singapore branch, Maybank Singapore, CIMB-GK Securities, Hong Leong Finance, DMG & Partners, Phillip Securities and Kim Eng Securities. - AP
S'pore bans 10 brokers from structured notes sales
SINGAPORE: Singapore's central bank banned 10 financial institutions from selling structured notes for improperly marketing US$655 million of the bonds that were linked to U.S. brokerage Lehman Brothers Holdings Inc.
The banks and brokerages can't sell structured notes for between six months and two years, the central bank, known as the Monetary Authority of Singapore, said in a statement late Tuesday.
The bank said some of the financial institutions assigned risk ratings that were inconsistent with warnings stated in the notes' prospectus, and salespeople were ill-trained to sell the notes.
The structured notes were linked to the risk of a bankruptcy occurring to one of the reference entities, such as Lehman.
The Lehman collapse last fall led to a default on the dividend payment of some of the bonds, most of which had a maturity of 5 to 7 years and a yield of about 5 percent.
About 10,000 investors bought the notes, and financial institutions have compensated about 4,000 of them, the bank said.
Similar structured notes were sold in Hong Kong, Taiwan and Indonesia.
The 10 financial institutions banned by the central bank are DBS Group, UOB Kay Hian, OCBC Securities, ABN AMRO's Singapore branch, Maybank Singapore, CIMB-GK Securities, Hong Leong Finance, DMG & Partners, Phillip Securities and Kim Eng Securities. - AP
Book value and Intrinsic value
Warren Buffett observed that book value is the sum of what investor put into (or leave in) the business, while intrinsic value is what investors can take out of the business.
Book value or net worth is a key component of a company's intrinsic value.
But another and perhaps the more important component of intrinsic value is the net present and future income stream that a company can earn for the investor.
Therefore, the importance of looking at the balance sheet and also looking closely at income and income reporting, in your intrinsic valuation.
-----
Here is another Warren Buffett observation.
Apparently tired of answering questions about how to use book value to make investment decisions. Buffett pointed out the differrence between book value and intrinsic value: "Book value is what the owners put into the business, intrinsic value is what they take out of it."
In another explanation offered in a 1996 Berkshire Hathaway annual report, he likened book value to college tuition paid, with intrinsic value being the income resulting from the education. The education and the dollars spent on an education mean ntohing unless there is a resulting financial return.
The point: It is easy for investors to put too much emphasis on book value and not enough on intrinsic value.
Book value or net worth is a key component of a company's intrinsic value.
But another and perhaps the more important component of intrinsic value is the net present and future income stream that a company can earn for the investor.
Therefore, the importance of looking at the balance sheet and also looking closely at income and income reporting, in your intrinsic valuation.
-----
Here is another Warren Buffett observation.
Apparently tired of answering questions about how to use book value to make investment decisions. Buffett pointed out the differrence between book value and intrinsic value: "Book value is what the owners put into the business, intrinsic value is what they take out of it."
In another explanation offered in a 1996 Berkshire Hathaway annual report, he likened book value to college tuition paid, with intrinsic value being the income resulting from the education. The education and the dollars spent on an education mean ntohing unless there is a resulting financial return.
The point: It is easy for investors to put too much emphasis on book value and not enough on intrinsic value.
What to look for: Quality
Important attributes to look for in an earnings statement - QUALITY
As the market exerts ever-increasing pressure on companies to perform to a stringent set of expectations, the idea of accounting "stretch" enters the picture.
Even in complying with the rules, companies have latitude to apply accounting principles in ways that make performance look better.
This lattitude can affect the quality of earnings reports.
Recent legislation and standardizations like the Sarbanes-Oxley Act, have brought financial reporting generally more in line with reality.
As the market exerts ever-increasing pressure on companies to perform to a stringent set of expectations, the idea of accounting "stretch" enters the picture.
Even in complying with the rules, companies have latitude to apply accounting principles in ways that make performance look better.
This lattitude can affect the quality of earnings reports.
Recent legislation and standardizations like the Sarbanes-Oxley Act, have brought financial reporting generally more in line with reality.
What to look for: Healthy Components in the Earnings Statement
Important attributes to look for in an earnings statement - HEALTY COMPONENTS: COMPARATIVE and TRENDS
Value investors look at individual lines in the earnings statement, not just the bottom line.
Improving gross margins - especially sustained improvement - signal strong business improvement.
Costs are under control, and the company is improving its market position.
Likewise, improving operating margins can show better cost control, greater efficiency, and rewards from earlier expansion cycles.
And value investors constantly compare companies in similar industries.
Gross margins of competing computer manufacturers, for instance, tell a lot about who has the
Value investors look at individual lines in the earnings statement, not just the bottom line.
Improving gross margins - especially sustained improvement - signal strong business improvement.
Costs are under control, and the company is improving its market position.
Likewise, improving operating margins can show better cost control, greater efficiency, and rewards from earlier expansion cycles.
And value investors constantly compare companies in similar industries.
Gross margins of competing computer manufacturers, for instance, tell a lot about who has the
- best market position,
- production and delivery process, and
- business model.
Comparing the incomparable is an all-too-common investing pitfall. With earnings statements, this error takes three forms:
1. Earnings statements are not always broken down the same way.
- Although the bottom line is the bottom line, the intermediate steps may be different.
- One company's operating earnings may include marketing costs, while another's may not.
- Typically, statements from firms in the same industry are comparable, but not always.
- Commercial and industrial suppliers, such as Honeywell, have consumer divisions, while consumer businesses, such as Procter & Gamble, have industrial divisions.
- Many businesses supply a mix of products in a mix of categories to a mix of customers.
- "Pure plays" in a business or industry are not always easy to find.
- The upshot: You must understand businesses before comparing them.
- Before comparing operating or net profit numbers, consider whether there have been write-offs for discontinued businesses or impaired assets that may be causing one-time distortions in the numbers.
What to look for: Consistency
Important attributes to look for in an earnings statement - CONSISTENCY
Long-term growth should be sustainable and consistent.
Look for sustained growth across business cycles.
A big pop in earnings one year followed by malaise for the next two does not paint a pretty picture. Long, consistent successful earnings track records get the A grades.
Beyond earnings, consistency is a desired feature for other parts of the earnings statement.
Consistency is highly prized in:
Long-term growth should be sustainable and consistent.
Look for sustained growth across business cycles.
A big pop in earnings one year followed by malaise for the next two does not paint a pretty picture. Long, consistent successful earnings track records get the A grades.
Beyond earnings, consistency is a desired feature for other parts of the earnings statement.
Consistency is highly prized in:
- sales and sales growth,
- profit margins and margin growth, and
- operating expense and expense trends.
The less consistency, the more difficult to predict the future five or ten years and beyond, and the less attractive a company looks to value investors.
What to look for: Growth
Important attributes to look for in an earnings statement - GROWTH
After all is said and done, the long-term growth of a stock price is driven by growth in the business.
Growth in the business means growth in the earnings - there is no other way to sustain business growth without infusions of additional owner capital.
Sure, you can acquire, merge, or sell more stocks to make a business larger by common definitions, but has the business really "grown"?
The value investor works to obtain a deep understanding of business growth, growth trends, and the quality of growth.
A business' ability to grow on its own, through its own success and resulting earnings, is known as organic growth.
Growth through acquisition or other capital infusions are not "organic" and thus does not suggest growth in true business value.
After all is said and done, the long-term growth of a stock price is driven by growth in the business.
Growth in the business means growth in the earnings - there is no other way to sustain business growth without infusions of additional owner capital.
Sure, you can acquire, merge, or sell more stocks to make a business larger by common definitions, but has the business really "grown"?
The value investor works to obtain a deep understanding of business growth, growth trends, and the quality of growth.
- Is reported growth based on internal core competencies?
- Or is it acquired or speculative growth based on unproven ventures?
A business' ability to grow on its own, through its own success and resulting earnings, is known as organic growth.
Growth through acquisition or other capital infusions are not "organic" and thus does not suggest growth in true business value.
The Importance of Earnings
Business and economic activity are undertaken with the idea of generating a profit.
Profit is simply the gross revenue of an enterprise, minus the cost of producing that income, over a defined period of time. For businesses, it's important to measure the profit and allocate capital resources in such a way as to maximise it.
It is the earnings that make the world go round.
So much is made of earnings and earnings reports. Do you hear much about a company's cash balance, accumulated depreciation, or owner's equity during CNBC and other financial shows?
Does everyone salivate four times a year for "asset season?"
No, but there's a definite "earnings season" at the end of each calendar quarter, giving financial analysts, journalists, and pundits plenty to talk about.
On an ongoing basis, earnings are the driving force and "macro" indicator of a company's success.
If a company is earning money, and particularly if it earns it at a growing rate, that's a good thing. As Warren Buffett says, "If the business does well, the stock always follows."
Earnings tell us how well a business manages its operations, while the balance sheet tells us how well it manages its resources.
Profit is simply the gross revenue of an enterprise, minus the cost of producing that income, over a defined period of time. For businesses, it's important to measure the profit and allocate capital resources in such a way as to maximise it.
It is the earnings that make the world go round.
So much is made of earnings and earnings reports. Do you hear much about a company's cash balance, accumulated depreciation, or owner's equity during CNBC and other financial shows?
Does everyone salivate four times a year for "asset season?"
No, but there's a definite "earnings season" at the end of each calendar quarter, giving financial analysts, journalists, and pundits plenty to talk about.
On an ongoing basis, earnings are the driving force and "macro" indicator of a company's success.
- If earnings are growing, the financial press doesn't worry much about the other stuff.
- Conversely, serve up a couple of double faults on the earnings front, and everybody is all over asset impairment, write-offs, debt, weak cash positions, and the other similar "disasters."
If a company is earning money, and particularly if it earns it at a growing rate, that's a good thing. As Warren Buffett says, "If the business does well, the stock always follows."
Earnings tell us how well a business manages its operations, while the balance sheet tells us how well it manages its resources.
Stick to what you need to know as an investor, avoiding deep accounting technicalities
Just as life cannot be measured or evaluated by a single snapshot, neither can a business.
Balance sheet gives a snapshot view of business resources (assets) and how they are contributed to the business (liabilities and owner's equity). Comparison of one snapshot to another tells you something changed. But what happened between shots, and why?
This is where earnings and cash flow statements come in. The balance sheet is critical in evaluating the financial state of a business; the income and cash flow statements together measure business activity and results.
Earnings and cash flow statements show the pulse of the business and explain changes in balance sheet snapshots. With these statements, the business analyst or investor can assemble a complete moving picture showing flows into and out of the business, successes and failures, growth and decline.
You need to stick to what you need to know as an investor, avoiding deep accounting technicalities.
Balance sheet gives a snapshot view of business resources (assets) and how they are contributed to the business (liabilities and owner's equity). Comparison of one snapshot to another tells you something changed. But what happened between shots, and why?
This is where earnings and cash flow statements come in. The balance sheet is critical in evaluating the financial state of a business; the income and cash flow statements together measure business activity and results.
Earnings and cash flow statements show the pulse of the business and explain changes in balance sheet snapshots. With these statements, the business analyst or investor can assemble a complete moving picture showing flows into and out of the business, successes and failures, growth and decline.
You need to stick to what you need to know as an investor, avoiding deep accounting technicalities.
Tuesday, 7 July 2009
Bottom lines and other lines
Revenue
less COGS
-----------
Gross Profit
less Operating Expenses
-SGA
-R&D
-Depreciation & Amortization
-Impairment, Investments & Write Downs
-Goodwill amortization
-----------
less or add interest
-----------
PBT
less tax
-----------
Operating Income or Income from continuing operations
less or add extraordinaries
-----------
Net Income
The bottom line, refers to the net earnings or income after all expenses, taxes, and extraordinary items are factored in. The bottom line is the final "net" measure of all business activity.
----
Gross profit:
This is simply the sales less the direct cost of producing the company's product or service.
Direct cost includes:
Gross profit, often called gross margin, is the purest indicator of business productivity, because each cost dollar is directly generated by production and sale of the product.
Value investors closely watch gross margin trends as an indicator of market dominance, price control, and future profitability.
----
Operating Income:
This term refers to gross profit less period expenses, such as overhead or marketing costs not directly attributable to product production.
Selling, general, and administrative expenses (SG&A) usually cover all headquarters functions, information technology, marketing, and other indirect costs.
It generally includes financing costs, such as interest, and taxes.
Amortization is usually included, because cost recovery for property, plant and equipment is part of operating expense.
Items deemed extraordinary are not included.
Operating profit gives a more complete picture of how the business is performing on a day-to-day basis.
It sometimes appears as operating income, earnings from operations, or something similar.
----
Net Income:
This represents the net result of all revenues, expenses, interest, and taxes.
----
There are other supplemental earnings measures, such as free cash flow and "EBITDA."
The point is that there are many ways to measure income.
Each reveals an important layer of business performance, both for determining intrinsic value and also for comparing companies.
less COGS
-----------
Gross Profit
less Operating Expenses
-SGA
-R&D
-Depreciation & Amortization
-Impairment, Investments & Write Downs
-Goodwill amortization
-----------
less or add interest
-----------
PBT
less tax
-----------
Operating Income or Income from continuing operations
less or add extraordinaries
-----------
Net Income
The bottom line, refers to the net earnings or income after all expenses, taxes, and extraordinary items are factored in. The bottom line is the final "net" measure of all business activity.
----
Gross profit:
This is simply the sales less the direct cost of producing the company's product or service.
Direct cost includes:
- labor,
- material, and
- expenses directly attributable to producing it.
Gross profit, often called gross margin, is the purest indicator of business productivity, because each cost dollar is directly generated by production and sale of the product.
Value investors closely watch gross margin trends as an indicator of market dominance, price control, and future profitability.
----
Operating Income:
This term refers to gross profit less period expenses, such as overhead or marketing costs not directly attributable to product production.
Selling, general, and administrative expenses (SG&A) usually cover all headquarters functions, information technology, marketing, and other indirect costs.
It generally includes financing costs, such as interest, and taxes.
Amortization is usually included, because cost recovery for property, plant and equipment is part of operating expense.
Items deemed extraordinary are not included.
Operating profit gives a more complete picture of how the business is performing on a day-to-day basis.
It sometimes appears as operating income, earnings from operations, or something similar.
----
Net Income:
This represents the net result of all revenues, expenses, interest, and taxes.
----
There are other supplemental earnings measures, such as free cash flow and "EBITDA."
The point is that there are many ways to measure income.
Each reveals an important layer of business performance, both for determining intrinsic value and also for comparing companies.
Cash Flow from Financing Activities
Investing activities tell what a firm does with cash to increase or decrease fixed assets and assets not directly related to operations.
Financing activities tell where a firm has obtained capital in the form of cash to fund the business.
Bottom line: Company X is using surplus cash generated from operations to give something back to shareholders. That's a good thing.
Financing activities tell where a firm has obtained capital in the form of cash to fund the business.
Source of cash for financing: Proceeds from the:
- sale of company shares or
- sale of bonds (long-term debt).
Use of cash for financing: If a company:
- pays off a bond issue,
- pays a dividend, or
- buys back its own stock.
A consistent cash flow from financing activities indicates excessive dependence on credit or equity markets. Typically, this figure oscillates between negative and positive.
A big positive spike reflects a big bond issue or stock sale. In such a case, check to see whether the resulting cash is used:
- for investments in the business (probably okay) or
- to make up for a shortfall in operating cash flow (probably not okay), or,
- if the generated cash flows straight to the cash balance, you should wonder why a company is selling shares or debt just to increase cash, although often the reasons are difficult to know. Perhaps an acquisition?
An illustration:
Company X's statement shows a happy story for investors:
- $15.4 m paid to investors as dividends
- $8.2 m paid out in "Sale Purchase of Stock" (- this is most likely for a share buyback. In fact, the company X actually repurchased $17.2 million in its own stock on the market; then issued $8.9 million in stock, most likely for employee stock options ESOS, and compensation.)
Bottom line: Company X is using surplus cash generated from operations to give something back to shareholders. That's a good thing.
Free Cash Flow
Free cash flow is a good indication of what a company really has left over after meeting obligations, and thus could theoretically return to shareholders.
Free cash flow is sometimes called "owners' earnings."
Free cash flow is defined as net after tax-earnings, plus depreciation and amortization and other noncash items, less annual capital expenditures, less (or plus) changes in working capital (current assets and liabilities).
It is surplus cash that is really free, not waiting for a bill to come for a big capital purchase or inventory increase.
Earn income, pay for costs of doing business, and what's left over is yours to keep as an owner.
Free cash flow is a much more realistic long-term view of business success and potential owner proceeds than EBITDA and is used by many value investors as the basis for calculating intrinsic value.
Free cash flow is sometimes called "owners' earnings."
Free cash flow is defined as net after tax-earnings, plus depreciation and amortization and other noncash items, less annual capital expenditures, less (or plus) changes in working capital (current assets and liabilities).
It is surplus cash that is really free, not waiting for a bill to come for a big capital purchase or inventory increase.
Earn income, pay for costs of doing business, and what's left over is yours to keep as an owner.
Free cash flow is a much more realistic long-term view of business success and potential owner proceeds than EBITDA and is used by many value investors as the basis for calculating intrinsic value.
Cash Flow from Investing Activities
Cash flow from operations tells what cash was generated in the normal course of business and by changes in current asset and liability (working capital) accounts on the balance sheet.
This section shows, among other things: cash used for investments in the business, including
Why? Because growing companies need more physical investments - property, plant, and equipment (PP&E) - to sustain growth.
It is possible to generate positive cash flows in this part of the statement either
TIP: By comparing net cash flows from operations and net cash flows from investing activities, you can get a first glance at whether a business is productive and healthy.
If positive CFO > negative CFI, then the business produces more cash than it consumes.
But don't jump to a favourable conclusion too quickly - you may be looking at an airline (e.g. Air Asia ?) that's about to pay for five new jets in the next quarter. A surplus cash situation must be sustained to be meaningful.
- But what about cash used to invest in the business?
- Invest in other businesses?
- What about cash acquired by selling investments in other businesses?
This section shows, among other things: cash used for investments in the business, including
- capital expenditures for plant, equipment, and
- other longer-term product assets.
Why? Because growing companies need more physical investments - property, plant, and equipment (PP&E) - to sustain growth.
It is possible to generate positive cash flows in this part of the statement either
- by selling PP&E or
- by selling investments owned by the company.
TIP: By comparing net cash flows from operations and net cash flows from investing activities, you can get a first glance at whether a business is productive and healthy.
If positive CFO > negative CFI, then the business produces more cash than it consumes.
But don't jump to a favourable conclusion too quickly - you may be looking at an airline (e.g. Air Asia ?) that's about to pay for five new jets in the next quarter. A surplus cash situation must be sustained to be meaningful.
How changes in Working Capital affect Cash
How changes in Current Liabilities affect cash
Increase in accounts payable (a bigger liability) generates cash.
Increase in accounts payable (a bigger liability) generates cash.
- Suppose the company you're watching has a $45 million increase in cash from accounts payable.
- There is $45 million in cash floating around in the business that didn't show up in net income.
- Let's suppose that one large item was purchased for $45 million. An accounting expense was incurred when the payable was created, but no cash has yet been used to pay the bill. It's still in the bank.
- So while the expense was incurred, reducing earnings, the cash wasn't paid and, at least for now, there's more cash in the business.
Increase in current liabilities provide cash.
Decrease in current liabilities use cash.
How changes in Current Assets affect cash
In different financial statements, it is common to see account receivable, inventories and accounts payables either providing or using cash.
Increases in current assets (other than cash) use cash.
Decreases in current assets (as in a net decrease in inventory) provide cash.
Cash Flow from Operations
Net Income
----------
Operating Activities, Cash Flows Provided By or Used In:
Depreciation
Adjustment to Net Income
Changes in Accounts Receivable
Changes in Liabilities
Changes in Inventories
Changes in Other Operation Activities
----------
Total Cash Flow from Operating Activities
Cash flow from operations, CFO, tells what cash is generated from, or provided by, normal business operations, and what cash is consumed, or used in the business.
Net income from continuing operations is the starting point, to which cash adjustments are made.
To that figure, add (or subtract) what was called the "adjustments to reconcile net income to net cash provided by operating activities."
The first adjustment item is depreciation.
Finally, you arrive at a total "Total Cash Flow from Operating Activities," derived by netting the adjustments to toal income.
----------
Operating Activities, Cash Flows Provided By or Used In:
Depreciation
Adjustment to Net Income
Changes in Accounts Receivable
Changes in Liabilities
Changes in Inventories
Changes in Other Operation Activities
----------
Total Cash Flow from Operating Activities
Cash flow from operations, CFO, tells what cash is generated from, or provided by, normal business operations, and what cash is consumed, or used in the business.
Net income from continuing operations is the starting point, to which cash adjustments are made.
To that figure, add (or subtract) what was called the "adjustments to reconcile net income to net cash provided by operating activities."
The first adjustment item is depreciation.
- For example, depreciation in Company X was $24 million. So, we known that without other adjustments, $24 millionn more in cash was generated than reported as net income, because depreciation was subtracted from net income, but not from cash flow because it isn't a cash expense.
Then a catch-all "Adjustments to Net Income" category.
After this, comes:
- "Changes In Accounts Receivables"
- "Changes in Liabilities"
- "Changes in Inventories"
Finally, you arrive at a total "Total Cash Flow from Operating Activities," derived by netting the adjustments to toal income.
- This is a very important figure. Essentially, this is cash generated by ongoing day-t0-day business activities.
- If this amount is negative, that's bad, because it means that the business isn't even supporting itself on a day-to-day basis and requires an infusion of cash.
- If it's positive - we're still not out of the woods yet - capital investments may still require more cash than the business is producing.
A bit of EBITDA
EBITDA measures operating cash generated before:
In a sense, EBITDA is operating income before:
- non-operating interest,
- taxes, and,
- noncash depreciation & amortization.
In a sense, EBITDA is operating income before:
- bankers (non-operating interest), and
- government (taxes), and
- accountants (noncash depreciation & amortization).
EBITDA is also sometimes looked at as a liquidity measure:
- Positive-EBITDA companies can service their debt, while
- Negative-EBITDA companies must borrow more.
Income from continuing operations versus EBITDA
Revenue
less COGS
-----------
Gross Profit
less Operating Expenses
-SGA
-R&D
-Depreciation & Amortization
-Impairment, Investments & Write Downs
-Goodwill amortization
-----------
less or add interest
-----------
PBT
less tax
-----------
Operating Income or Income from continuing operations
less or add extraordinaries
-----------
Net Income
----
EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization
EBITDA measures operating cash generated before:
less COGS
-----------
Gross Profit
less Operating Expenses
-SGA
-R&D
-Depreciation & Amortization
-Impairment, Investments & Write Downs
-Goodwill amortization
-----------
less or add interest
-----------
PBT
less tax
-----------
Operating Income or Income from continuing operations
less or add extraordinaries
-----------
Net Income
----
EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization
EBITDA measures operating cash generated before:
- non-operating interest,
- taxes and
- noncash depreciation and amortization.
Income from Continuing Operations
Operating income is simply sales less cost of goods sold, less operating expenses.
Because it includes noncash amortizations, it is a "fully loaded" view of operating performance in the business. (Depreciation and amortization expenses are usually broken out on the earnings statement, but may also be buried in a consolidated SG&A, or other operating expense line.)
If you closely observe the effects of amortizations, special write-downs, and accounting changes, you can better understand operating income and operating income trends.
Income from continuing operations tell shareholders, in total, what their investment is returning, after everyone, including Uncle Sam and his brethren, is paid.
Income from continuing operations is a good indicator of total business performance, but be aware of truly extraordinary events driving expenses or income.
Because it includes noncash amortizations, it is a "fully loaded" view of operating performance in the business. (Depreciation and amortization expenses are usually broken out on the earnings statement, but may also be buried in a consolidated SG&A, or other operating expense line.)
If you closely observe the effects of amortizations, special write-downs, and accounting changes, you can better understand operating income and operating income trends.
Income from continuing operations tell shareholders, in total, what their investment is returning, after everyone, including Uncle Sam and his brethren, is paid.
Income from continuing operations is a good indicator of total business performance, but be aware of truly extraordinary events driving expenses or income.
Monday, 6 July 2009
Earnings Yield: Bond versus Growth Stock
PE Ratio and Growth
It would be nice if looking at price, P/E, and earnings yield was all there is to it. Find an earnings yield of 6% (PE of 17), beat the bond, and move on.
But you're buying equities, not bonds, right?
Less risk.
----
But suppose the $5 earnings "coupon" grows at 10% per year. What happens at the end of year 10?
If the price were to stay the same, your $100 investment would be returning $12.97 in year 10, which is almost 13% earnings yield, or an implied PE of 7.7 at today's price.
A pretty nice yield, which really means the price of your investment should go up, because it's worth more.
This spreadsheet shows future earnings yields realized in the case of a bond with no growth versus a stock with a 10% earnings growth.
http://spreadsheets.google.com/ccc?key=0AuRRzs61sKqRcjdfd19OVTZrVVRlTUJnb05naGo3TWc&hl=en
So you can see that assessing growth is a major factor in analysing a stock price through PE.
Above all else, earnings growth drives stock price growth.
So value investors look closely at what the earnings yield is today and what will it be in the future.
It would be nice if looking at price, P/E, and earnings yield was all there is to it. Find an earnings yield of 6% (PE of 17), beat the bond, and move on.
But you're buying equities, not bonds, right?
- Because you want to participate in company growth and success.
- Because, simply, you want to leave that static bond yield in the dust - if not today, sometime in the near future.
- And you want to keep up with - or better yet, beat - inflation.
- So to do that, you assume some risk that earnings won't happen, but you are hanging your hat on growth and a stock price that keeps up with it.
- Buy a bond for $100; receive $5 per year for 10, 20, 30 years; never look back.
or
- Buy a stock for $100, earnings per share constant at $5 for 10, 20, or 30 years with no change.
Less risk.
----
But suppose the $5 earnings "coupon" grows at 10% per year. What happens at the end of year 10?
If the price were to stay the same, your $100 investment would be returning $12.97 in year 10, which is almost 13% earnings yield, or an implied PE of 7.7 at today's price.
A pretty nice yield, which really means the price of your investment should go up, because it's worth more.
This spreadsheet shows future earnings yields realized in the case of a bond with no growth versus a stock with a 10% earnings growth.
http://spreadsheets.google.com/ccc?key=0AuRRzs61sKqRcjdfd19OVTZrVVRlTUJnb05naGo3TWc&hl=en
So you can see that assessing growth is a major factor in analysing a stock price through PE.
Above all else, earnings growth drives stock price growth.
So value investors look closely at what the earnings yield is today and what will it be in the future.
Risk - the most difficult to quantify element (II)
If you reflect on Buffett's approach, you realize that the risk isn't inherent in the stock's price, but rather on the clarity and consistency of a company's future prospects.
The more unpredictable (hard to understand) the company and its future, the greater the risk.
There is no way to easily quantify this kind of risk.
Generally, business risks are accounted for in the discount rate by making a conservative assumptions - a high discount, or hurdle, rate - to provide a margin of safety.
The more unpredictable (hard to understand) the company and its future, the greater the risk.
There is no way to easily quantify this kind of risk.
Generally, business risks are accounted for in the discount rate by making a conservative assumptions - a high discount, or hurdle, rate - to provide a margin of safety.
Risk - the most difficult to quantify element (I)
Risk is perhaps the most debated, theoretical, difficult to quantify element of all. There are many types of risk in the business and investing world.
Investment books mention high beta stocks are riskier and low beta stocks are safer. However, beta is relatively meaningless for value investors. Why?
Investment books mention high beta stocks are riskier and low beta stocks are safer. However, beta is relatively meaningless for value investors. Why?
- Because it measures the fluctuation of stock prices.
- As a value investor, you aren't concerned with stock price fluctuation, only whether the stock price is a bargain compared to long-term value.
- Value investors ignore the type of risk measured by beta.
- They're more interested in how the company performs, not how the stock performs relative to other stocks.
Beta is useful only in the sense that higher price volatility for an issue may reflect underlying uncertainty in the company itself, such as with many of the higher flying tech stocks in 2000 and 2001. But the risks associated with these stocks become apparent long before you examine beta.
Who is Mr. Market?
Who is Mr. Market?
Mr. Market is the character Benjamin Graham uses to explain illogical mindset of traders . The story goes something like this:
Imagine that you own 50% of a business, which you purchased for RM3,600 mil. Mr. Market approaches everyday to tell you what he thinks the business is worth based on latest news. And everyday, he offers to either buy your business for a price which he forms in his head, or, to sell you his share of the business for that price.
Each day, however, he quotes you a different price from the day before. Sometimes the price he quotes sounds about fair. Sometimes it’s high. Sometimes it’s low.
Let’s say the whole business is producing on average, RM 1,200 mil free cash flow with net profit of RM 600 mil. What is the value of the business to you?
By owning 50% of the business, you own RM 600 mil FCF and net profit of RM 300 mil per annum.You paid around RM 3,600 mil for this business a year ago. Hence, you bought this business for 6 times its FCF and 12 x earnings.Let’s say the nature of the business is stable and you anticipate the FCF and net profit will increase over time,you might not want to sell it unless Mr. Market offers you a ridiculously high price.
One day, Mr. Market offers you an additional 40% extra of what you paid a year ago. He offers RM 5,040 mil to for your holdings.Most of us will let go after making 40% profit per annum.
But if you are a sensible businessperson, you won’t let Mr. Market’s daily communication determine your view of the value of 50% interest in the business. He is a sweet talker and convince you with various economic prediction,charts,information and etc to create doubt and fear in you.
Most of us will be swayed by Mr Market ’s offer.
But as a sensible business owner, you may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
Remember, fluctuations in the market price for a given business don’t really affect the fundamental value of that business. If you own a share in a company, the value of each share is a function of the business ’s profitability/cash flow/management/branding and not a related to the price quoted in Bursa M’sia.
So, as long you understand the business you’re buying, today’s market price is totally irrelevant.
Ref:
Who is Mr. Market?
http://boyboycute.wordpress.com/2009/03/29/who-is-mr-market/
Mr. Market is the character Benjamin Graham uses to explain illogical mindset of traders . The story goes something like this:
Imagine that you own 50% of a business, which you purchased for RM3,600 mil. Mr. Market approaches everyday to tell you what he thinks the business is worth based on latest news. And everyday, he offers to either buy your business for a price which he forms in his head, or, to sell you his share of the business for that price.
Each day, however, he quotes you a different price from the day before. Sometimes the price he quotes sounds about fair. Sometimes it’s high. Sometimes it’s low.
Let’s say the whole business is producing on average, RM 1,200 mil free cash flow with net profit of RM 600 mil. What is the value of the business to you?
By owning 50% of the business, you own RM 600 mil FCF and net profit of RM 300 mil per annum.You paid around RM 3,600 mil for this business a year ago. Hence, you bought this business for 6 times its FCF and 12 x earnings.Let’s say the nature of the business is stable and you anticipate the FCF and net profit will increase over time,you might not want to sell it unless Mr. Market offers you a ridiculously high price.
One day, Mr. Market offers you an additional 40% extra of what you paid a year ago. He offers RM 5,040 mil to for your holdings.Most of us will let go after making 40% profit per annum.
But if you are a sensible businessperson, you won’t let Mr. Market’s daily communication determine your view of the value of 50% interest in the business. He is a sweet talker and convince you with various economic prediction,charts,information and etc to create doubt and fear in you.
Most of us will be swayed by Mr Market ’s offer.
But as a sensible business owner, you may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
Remember, fluctuations in the market price for a given business don’t really affect the fundamental value of that business. If you own a share in a company, the value of each share is a function of the business ’s profitability/cash flow/management/branding and not a related to the price quoted in Bursa M’sia.
So, as long you understand the business you’re buying, today’s market price is totally irrelevant.
Ref:
Who is Mr. Market?
http://boyboycute.wordpress.com/2009/03/29/who-is-mr-market/
Sunday, 5 July 2009
How to use PEG
Company Simpson:
Recent PE 17.6 based on:
- a share price of $33 and
- TTM earnings of 1.87.
Earnings yields would thus be 1/17.6, or 5.7%.
What is the significance?
This investment could be compared to a long-term Treasury security as a prospective investment.
Treasury security: today yielding about 4.5%.
Which investment is better?
An investment in Simpson returns more, and, although riskier, it affords the opportunity for gain through growth.
The difference in earnings yield illustrates the basic risk/return tradeoff between investing in corporate equities versus safe fixed-income Treasuries.
----
You still don't know whether Simpson's PE ratio of 17.6 is attractive or compelling.
Long-time tech high-flyer Cisco Systems is at PE ratio to 27.4.
While banking stalwart Bank of America is at PE ratio of 10.
Why the difference?
The primary reason is growth.
Investors pay higher PEs for companies with greater growth prospects.
Greater prospects mean greater earnings and greater earnings yields sooner.
So when comparing businesses, one popular way to "normalize" PEs is to compare them to their respective company's growth rate.
From this comparison, you get a ratio known as PE to growth, or PEG:
Price/Earnings to growth (PEG) = (PE)/(EPSGR)
If the earnings growth rate of :
- Cisco is 25%, while
- Simpson's is 10% and
- Bank of America's is 5%,
- 27.4/25 or 1.1 for Cisco,
- 17.6/10 or 1.76 for Simpson, and
- 10/5 or 2 for Bank of America.
----
So, the lower the PEG, the better.
But if the low PEG is driven by high growth rates, you'd better be confident in the growth rate assumption.
Nothing falls faster than a growth stock that suddenly stops growing.
For years, Starbucks had been a high PE and high growth story, with PE ratios exceeding 30 and growth rates exceeding 20%. When the growth rate slowed just a bit in early 2007, the stock lost a third of its value.
----
Projecting growth rates can be tricky, and for that reason, value investors tend to shy away from stocks where growth appears temporary or hard to justify long term.
What rate should you use?
What the company has already achieved?
What the analysts project it to do?
Over what period?
When will the growth rate run into the law-of-large numbers-wall?
What growth rate did those Krispy Kreme Investors use in the 2000 - 2004 period?
Most of them ended up with a sticky mess.
The big question , of course, in picking Cisco as the "best investment," is the sustainability of the growth rate.
Simpson, while trailing a bit, may be a safer and better long-term investment.
Summary: It is okay to assume a high growth rate, so long as it is sustainable growth, based on sustainable business and marketplace fundamentals.
The Right Valuation Ratios
The market decouples price from the value of the business.
As Warren Buffett says, price is what you pay, and value is what you get. If the markets were perfect, price and value would go hand in hand, but as we all know, markets aren't perfect.
Once you appraise the business value, look at price and use valuation ratios to connect the price to the business.
PE: This is where most investors start, but it doesn't tell the whole story.
EY: Value investors look at present and future earnings yield (1/PE).
PEG: Price earnings to growth relates PE to growth rates and tells you something about that earnings yield future.
P/S, Profit Margin, P/B, and ROE: The relationships between price and these are also important.
For example:
FD interest rate = 3%.
PE of FD = 33.3.
So a PE of 25 or less is good given today's alternative earnings yields, but it doesn't mean that much without looking at the other numbers.
As Warren Buffett says, price is what you pay, and value is what you get. If the markets were perfect, price and value would go hand in hand, but as we all know, markets aren't perfect.
Once you appraise the business value, look at price and use valuation ratios to connect the price to the business.
PE: This is where most investors start, but it doesn't tell the whole story.
EY: Value investors look at present and future earnings yield (1/PE).
PEG: Price earnings to growth relates PE to growth rates and tells you something about that earnings yield future.
P/S, Profit Margin, P/B, and ROE: The relationships between price and these are also important.
For example:
FD interest rate = 3%.
PE of FD = 33.3.
So a PE of 25 or less is good given today's alternative earnings yields, but it doesn't mean that much without looking at the other numbers.
----
These valuation ratios are good signs (of value) for growing companies:- a PEG of 2 or less,
- a P/S of 3 or less, and
- a P/B of 5 or less.
Lower figures of these valuation ratios can be expected for steady or transitioning companies.
----
Good Business, but Stock is too Expensive
Generalising is hard, but PE, PEG, P/S, and P/B well in excess of market or industry averages spell trouble in making the numbers, as does overdependence on abnormal margins.
These valuation ratios are signs of overcooked prices and raise questions of vulnerability and (un-)value:
PE: Look at PE compared to the market and the industry. A PE over 40 is hard to justify in any case. PE over 25 is hard to justify unless the growth story is there and intact.
EY: EY below 2.5%
PEG: PEG greater than 3
P/S: P/S greater than 3
P/B: greater than 10
Sam using PE
Samgoss said...
2 steed, i stated there nett asset,my nett asset is actually nett current asset which equal 2 current asset minus current liabilities.
What caused negative asset ? tak lain tak bukan is bcos of borrowing , come 2 NTA, NTA is nett tangible asset , tangible means something u can count n touch, what about goodwill ? all these depends on what type of biz they r involving.
WHen I said Low PE , u shouldnt just rely on its last year eps, u must look at its latest eps oso, that giving u a guide to know how she is doing now !?
That's y I always stressed there d importance of " past earning track records ".
Uncle sam using PE , do u know how 2 relate PE with others ? not just Low PE , from PE ..past , current n future eps + track records, all these r essential elements 4 u 2 forecast its future eps as well as PE.
as i said, it looks simple , u understand it doesnt mean u know how 2 apply it , it is just like financial crisis, some will take it as disaster but some may take it as opportunity , it depends on how well u understand on PE.
Yes, I am a PE man , but i can tell u, from PE , i can link lots of cause n effect into my PE.
One more thing , different industry has different PE , u cant compare PE of resorts with PE of Rcecap or Kfima , cos one is bluechip n d other one is penny stock. hence.. u must know what is d average PE 4 that industry !
Avg PE 4 banking is ard 15 to 20 , avg PE 4 penny stock is ard 12+- , hence when PBBor MBB dropped to PE ard 10+- , it is time to sailang , but u cant apply this to penny stock, cos it is not very cheap 4 penny stocks @ PE ard 10+_.
but one thing 4 sure , stock that traded with PE > 20 is no longer cheap !
D above is like telling u yr mom is a female , but i can assure that not many of them know how 2 apply it on shares invst, like what i always said , y d length of our fingers r not d same ^_-
July 3, 2009 7:26 PM
https://www.blogger.com/comment.g?blogID=2900671137131972978&postID=269801610029410286
2 steed, i stated there nett asset,my nett asset is actually nett current asset which equal 2 current asset minus current liabilities.
What caused negative asset ? tak lain tak bukan is bcos of borrowing , come 2 NTA, NTA is nett tangible asset , tangible means something u can count n touch, what about goodwill ? all these depends on what type of biz they r involving.
WHen I said Low PE , u shouldnt just rely on its last year eps, u must look at its latest eps oso, that giving u a guide to know how she is doing now !?
That's y I always stressed there d importance of " past earning track records ".
Uncle sam using PE , do u know how 2 relate PE with others ? not just Low PE , from PE ..past , current n future eps + track records, all these r essential elements 4 u 2 forecast its future eps as well as PE.
as i said, it looks simple , u understand it doesnt mean u know how 2 apply it , it is just like financial crisis, some will take it as disaster but some may take it as opportunity , it depends on how well u understand on PE.
Yes, I am a PE man , but i can tell u, from PE , i can link lots of cause n effect into my PE.
One more thing , different industry has different PE , u cant compare PE of resorts with PE of Rcecap or Kfima , cos one is bluechip n d other one is penny stock. hence.. u must know what is d average PE 4 that industry !
Avg PE 4 banking is ard 15 to 20 , avg PE 4 penny stock is ard 12+- , hence when PBBor MBB dropped to PE ard 10+- , it is time to sailang , but u cant apply this to penny stock, cos it is not very cheap 4 penny stocks @ PE ard 10+_.
but one thing 4 sure , stock that traded with PE > 20 is no longer cheap !
D above is like telling u yr mom is a female , but i can assure that not many of them know how 2 apply it on shares invst, like what i always said , y d length of our fingers r not d same ^_-
July 3, 2009 7:26 PM
https://www.blogger.com/comment.g?blogID=2900671137131972978&postID=269801610029410286
How Value Investors View the Markets and Market Performance
Value investors really don't care. Do value investors have an attitude problem?
The point is that value investors aren't that concerned about markets, trading processes, and trading behaviour.
The market is simply a place to buy a portion of a business - and perhaps not sell it for a long, long time. Value investors care little about whether an order is executed on the bid or ask price, nor do they care what regional market, ECN, or execution system was used.
The transaction is an investment, a long-term investment. The market simply provides a place to acquire the investment.
So, value investors generally don't talk much about markets. And if you're really a value investor (or want to become one), you yourself don't care about markets... except when they undervalue businesses.
Despite the academic rumblings of the "efficient market theory" (which holds that with good information and a sufficient number of players, markets will find the right price for a business), markets are not perfect. They are always bargains.
Stocks may be undervalued because of:
So, in this sense, value investors love the markets. The markets, through their imperfections, provide value investors their opportunity.
As Warren Buffett says, if markets were perfect, he'd be "standing on the corner holding a tin cup."
The point is that value investors aren't that concerned about markets, trading processes, and trading behaviour.
The market is simply a place to buy a portion of a business - and perhaps not sell it for a long, long time. Value investors care little about whether an order is executed on the bid or ask price, nor do they care what regional market, ECN, or execution system was used.
The transaction is an investment, a long-term investment. The market simply provides a place to acquire the investment.
So, value investors generally don't talk much about markets. And if you're really a value investor (or want to become one), you yourself don't care about markets... except when they undervalue businesses.
Despite the academic rumblings of the "efficient market theory" (which holds that with good information and a sufficient number of players, markets will find the right price for a business), markets are not perfect. They are always bargains.
Stocks may be undervalued because of:
- lack of knowledge or
- lack of visibility, or
- perhaps they're part of a group that's out of favour altogether.
So, in this sense, value investors love the markets. The markets, through their imperfections, provide value investors their opportunity.
As Warren Buffett says, if markets were perfect, he'd be "standing on the corner holding a tin cup."
Long-term Stock Market Growth and GDP
A stock market represents the sum total of the public's perception of the business value of the companies trading in that market.
True business value, is the sum total of productive assets and, in particular, what those assets produce in the form of current and future earnings.
As long as companies produce more, it makes sense that their values rise.
And as long as the public perception matches true value, the stock value rises in lockstep.
GDP
You can and should expect, in aggregate, that the total value of all businesses would rise roughly in line with the increase in the size of the economy, as represented by gross domestic product (GDP). This is true.
Business value grows further through increases in productivity.
The value of market traded businesses could rise still more if the businesses grew their share of the total economy - as Borders Group and Barnes and Noble have grown their share of the total bookselling business.
Long-term stock market growth (by most measures of return, 10-11% annually) can be explained by adding together the following:
GDP growth of 3 to 5%
Productivity growth of 1 to 2%
Long-term inflation in the 3 to 6% range
In the short-term, depending on the value of alternative investments, such as bonds, real estate, and so on, market value may actually rise faster or slower than business value. And inflation also tampers with market valuations.
So can markets grow at 20% per year?
Not for long. It isn't impossible for the markets to rise 20% in a given year or two, but such growth year after year is hard to fathom if the economy at large is growing at only 3 to 5% annually.
But for a particular stock?
Sure, it's possible. If the company is building a new busines or is taking market share from existing businesses, 20% growth can be quite realistic.
But forever?
Doubtful. Some call this "reversion to the mean" - sooner or later, gravitational forces will take hold and a company will cease to grow at above-average rates. As an investor, you must realistically appraise when this will happen.
True business value, is the sum total of productive assets and, in particular, what those assets produce in the form of current and future earnings.
As long as companies produce more, it makes sense that their values rise.
And as long as the public perception matches true value, the stock value rises in lockstep.
GDP
You can and should expect, in aggregate, that the total value of all businesses would rise roughly in line with the increase in the size of the economy, as represented by gross domestic product (GDP). This is true.
Business value grows further through increases in productivity.
The value of market traded businesses could rise still more if the businesses grew their share of the total economy - as Borders Group and Barnes and Noble have grown their share of the total bookselling business.
Long-term stock market growth (by most measures of return, 10-11% annually) can be explained by adding together the following:
GDP growth of 3 to 5%
Productivity growth of 1 to 2%
Long-term inflation in the 3 to 6% range
In the short-term, depending on the value of alternative investments, such as bonds, real estate, and so on, market value may actually rise faster or slower than business value. And inflation also tampers with market valuations.
So can markets grow at 20% per year?
Not for long. It isn't impossible for the markets to rise 20% in a given year or two, but such growth year after year is hard to fathom if the economy at large is growing at only 3 to 5% annually.
But for a particular stock?
Sure, it's possible. If the company is building a new busines or is taking market share from existing businesses, 20% growth can be quite realistic.
But forever?
Doubtful. Some call this "reversion to the mean" - sooner or later, gravitational forces will take hold and a company will cease to grow at above-average rates. As an investor, you must realistically appraise when this will happen.
Intrinsic Value = (2g+8.5) x EPS
Dissecting Graham's Intrinsic Value Formula
Graham's formula:
V = (2g+8.5) E x 4.4/Y
where,
V= intrinsic value
g= growth rate of earnings
E= current EPS
Y= current interest rate (average rate of high grade corporate bonds)
V = (2g+8.5) x (4.4/Y) x E
V = (Multiple) x E
Therefore the Multiple of E is a multiple of 2 components as illustrated
Multiple = (2g+8.5) x (4.4/Y)
(I) If Y is equal to 4.4
(4.4/Y) = 1
Multiple = (2g + 8.5)
(II) If Y is less than 4.4
(4.4/Y) > 1
Multiple > (2g + 8.5)
(III) If Y is greater than 4.4
(4.4/Y) < 1
Multiple < (2g + 8.5)
As we are presently in a low interest environment, let us assume that Y is equal or less than 4.4. Therefore, the multiple should be equal or more than (2g + 8.5), as in (I) and (II) above.
To be on the conservative side, we can use (2g + 8.5) as the multiple of EPS as a simple quick test to check on the stock's price and true value (intrinsic value).
Simplified Graham's formula:
V = (2g + 8.5) x EPS
EPS can be derived by multiplying [(1/PE) x Price of stock], both are readily available in the local paper.
Reminder: You shouldn't go out and buy or sell stock based on this formula alone, of course, but it's a great "quick" test of a stock's price and true value.
Graham's formula:
V = (2g+8.5) E x 4.4/Y
where,
V= intrinsic value
g= growth rate of earnings
E= current EPS
Y= current interest rate (average rate of high grade corporate bonds)
V = (2g+8.5) x (4.4/Y) x E
V = (Multiple) x E
Therefore the Multiple of E is a multiple of 2 components as illustrated
Multiple = (2g+8.5) x (4.4/Y)
(I) If Y is equal to 4.4
(4.4/Y) = 1
Multiple = (2g + 8.5)
(II) If Y is less than 4.4
(4.4/Y) > 1
Multiple > (2g + 8.5)
(III) If Y is greater than 4.4
(4.4/Y) < 1
Multiple < (2g + 8.5)
As we are presently in a low interest environment, let us assume that Y is equal or less than 4.4. Therefore, the multiple should be equal or more than (2g + 8.5), as in (I) and (II) above.
To be on the conservative side, we can use (2g + 8.5) as the multiple of EPS as a simple quick test to check on the stock's price and true value (intrinsic value).
Simplified Graham's formula:
V = (2g + 8.5) x EPS
EPS can be derived by multiplying [(1/PE) x Price of stock], both are readily available in the local paper.
Reminder: You shouldn't go out and buy or sell stock based on this formula alone, of course, but it's a great "quick" test of a stock's price and true value.
Graham's Intrinsic Value Formula
Graham did create a very useful and easy-to-use intrinsic value formula.
Graham's formula: You take a current earnings, apply a base P/E ratio, add a growth factor if there is a growth, and adjust according to current bond yield. The result is an intrinsic value that the stock can be expected to achieve in the real world if growth targets are met.
Formula: Intrinsic value = E x (2g + 8.5) x 4.4/Y
E = current annual earnings per share
g = annual earnings growth rate. (Graham would have suggested using a conservative number for growth.)
8.5 = base P/E ratio for a stock with no growth
Y = current interest rate, represented as the average rate on high-grade corporate bonds. (Note that lower bond rates make the intrinsic value higher, as future earnings streams are worth more in a lower interest rate environment.)
Take Hewlett Packard as an example. With current earnings (trailing 12 months) of $2.30 per share, a growth rate of 10%, and a corporate bond interest rate of 6%, the intrinsic value is
= $2.30 x [(2 x 10) + 8.5] x (4.4/6)
= $48.07 per share
This value almost exactly matches the price at the time that these calculations were made. That suggests little potential price appreciation in the stock - unless per share earnings growth accelerates or bond yields dip.
Acceleration in the business would increase the earnings growth rate, and share repurchases would increase the earnings per share. Both changes, especially taken together, would stimulate growth in intrinsic value.
You shouldn't go out and buy or sell stock based on this formula alone, of course, but it's a great "quick" test of a stock's price and true value.
Graham's formula: You take a current earnings, apply a base P/E ratio, add a growth factor if there is a growth, and adjust according to current bond yield. The result is an intrinsic value that the stock can be expected to achieve in the real world if growth targets are met.
Formula: Intrinsic value = E x (2g + 8.5) x 4.4/Y
E = current annual earnings per share
g = annual earnings growth rate. (Graham would have suggested using a conservative number for growth.)
8.5 = base P/E ratio for a stock with no growth
Y = current interest rate, represented as the average rate on high-grade corporate bonds. (Note that lower bond rates make the intrinsic value higher, as future earnings streams are worth more in a lower interest rate environment.)
Take Hewlett Packard as an example. With current earnings (trailing 12 months) of $2.30 per share, a growth rate of 10%, and a corporate bond interest rate of 6%, the intrinsic value is
= $2.30 x [(2 x 10) + 8.5] x (4.4/6)
= $48.07 per share
This value almost exactly matches the price at the time that these calculations were made. That suggests little potential price appreciation in the stock - unless per share earnings growth accelerates or bond yields dip.
Acceleration in the business would increase the earnings growth rate, and share repurchases would increase the earnings per share. Both changes, especially taken together, would stimulate growth in intrinsic value.
You shouldn't go out and buy or sell stock based on this formula alone, of course, but it's a great "quick" test of a stock's price and true value.
Malaysian REITs
Malaysian REITs are:
- KPJ Reit
- Boustead Reit
- Amfirst Reit
- Axis Reit
- Hektar Reit
- Starhill Reit
and
- AHP
- AHP2,
- ARREIT,
- ATRIUM REIT
- QCAPITA REIT
- TWRREIT
- UOAREIT
Financial Year 2008
KPJ Reit
EPS: 7.4c
DPS: 7.7c
NAB/Share: 1.03
D/E Ratio: 0.53
Rental Income to Property Assets: 0.07
Nett Rental Margin: 94.52%
ROE 9.93%
DY range: 9.8% - 7.8%
Price range: 0.83 - 0.93
PE ratio range: 10.5 - 13.2
Financial Year 2008
Boustead Reit
EPS: 11.0
DPS: 10.9c
NAB/Share: 1.26
D/E Ratio: 0.14
Rental Income to Property Assets: 0.08
Nett Rental Margin: 97.77%
ROE 27.13%
DY range: 11.0% - 6.8%
Price range: 0.99 - 1.60
PE ratio range: 9.0 - 14.6
Financial Year 2008
AMFIRST Reit
EPS: 7.3c
DPS: 8.0c
NAB/Share: 1.03
D/E Ratio: 0.89
Rental Income to Property Assets: 0.07
Nett Rental Margin: 70.25%%
ROE 7.07%
DY range: 10.8% - 8.4%
Price range: 0.74 - 0.95
PE ratio range: 10.1 - 13
Financial Year 2008
AXIS Reit
EPS: 15.2c P
DPS: 14.9c
NAB/Share: 1.75
D/E Ratio: 0.07
Rental Income to Property Assets: 0.09
Nett Rental Margin: 84.41%
ROE 14.17%
DY range: 15% - 7.5%
Price range: 1.00 - 2.00
PE ratio range: 6.5 - 13.3
Financial Year 2008
HEXTAR Reit
EPS: 11.3c
DPS: 10.7c
NAB/Share: 1.26
D/E Ratio: 0.75
Rental Income to Property Assets: 0.12
Nett Rental Margin: 62.69%
ROE 15.01%
DY range: 14.7% - 7%
Price range: 0.73 - 1.54
PE ratio range: 6.4 - 13.4
Financial Year 2008
STARHILL Reit
EPS: 6.9c
DPS: 6.9c
NAB/Share: 0.97
D/E Ratio: 0.16
Rental Income to Property Assets: 0.08
Nett Rental Margin: 83.73%
ROE 7.09%
DY range: 9.8% - 7.5%
Price range: 0.70 - 0.93
PE ratio range: 10.2 - 13.4
Also read:
REITs - Selecting REITs
REITs - Selecting REITs
Choosing a good REIT is like choosing any other value investment.
Assets = Real Estate
Debt = Debt
Returns = Rents + other payments received on the portfolio.
An investor must analyze and compare a REIT's:
Assets = Real Estate
Debt = Debt
Returns = Rents + other payments received on the portfolio.
An investor must analyze and compare a REIT's:
- management quality,
- real and anticipated returns,
- yields, growth,
- reserves, and
- asset values.
Many of the techniques for common stock can be put to work here.
PE and price to FFO (funds from operations) ratios are examined as they would be for other businesses.
- Compare the PE and price to FFO for the different REITs.
- Relate these PE and price to FFO to their growth rates.
Also important is the price to book, or P/B ratio.
- A REIT trading below its per-share book value is essentially trading at a discount.
Remember also that REITs are not immune to :
- asset quality problems,
- bad management and management decisions,
- declining markets, or
- poor expense management.
Do the due diligence.
Malaysian REITs are:
- KPJ Reit
- Boustead Reit
- Amfirst Reit
- Axis Reit
- Hektar Reit
- Starhill Reit
and
- AHP
- AHP2
- ARREIT
- ATRIUM REIT
- QCAPITA REIT
- TWRREIT
- UOAREIT
Saturday, 4 July 2009
REITs - Property Portfolio
REIT investors should check out the property portfolio. This isn't easy, but it's easier than it used to be with online resources, usually provided by the REIT company itself.
Because real estate is not traded regularly, the ability to ascertain values is limited to:
Because real estate is not traded regularly, the ability to ascertain values is limited to:
- appraisals,
- replacement values, and,
- for income-producing properties, discounted cash flow analysis.
Appraisals are difficult to find.
Looking at the properties, and their locations, and assessing commonly reported local real estate price trends, occupancy rates, and economic trends, and whether the book value of a property is sustainable, is probably best.
If the REIT you choose is diversified with a number of different types of properties in different geographic regions, you will experience less volatility if an industry or locale experiences hard times.
If you are more concentrated, be sure that the type of property or the geographic area continues to be economically viable into the foreseeable future.
Occupancy rates for past and current years are available for most major and some smaller cities in the US from commercial real estate Web sites, and you may even wish to contact a local real estate professional.
REIT appraisal is difficult, but there is another way: REIT mutual and closed-ended funds, and there are even a few REIT ETFs. Many mutual fund families have funds built around REIT investments. REIT mutual funds are an easy way to get exposure to REITs without spending volumes of time researching the valuations of underlying holdings, vacancy rates, economic vibrancy, and so on. One way to find these funds is to enter "REIT mutual fund" in your search engine.
REITs - Debts and Leverage
Good REIT managers will typically hold debt levels to 35% or less of the total capitalization of the trust.
Some managers have long tenure and have weathered many storms.
The lower the level of debt, the more conservative management tends to be.
Also, look for managers investing their own funds in the REIT.
Some managers have long tenure and have weathered many storms.
The lower the level of debt, the more conservative management tends to be.
Also, look for managers investing their own funds in the REIT.
REITs - what and why
REITS are technically investment trusts that works like closed-ended funds holding real estate instead of stocks or bonds.
REITS pool investor money to allow average individual investors to invest in a portfolio of
Certain REIT characteristics make them attractive to the value investor.
REITS pool investor money to allow average individual investors to invest in a portfolio of
- commercial,
- residential, or
- specialized real estate properties.
Certain REIT characteristics make them attractive to the value investor.
- Like closed-ended funds, REITS trade on the exchanges, often at a discount to NAV.
- It is possible to focus on certain types of real estate or certain regions of the country.
- And, typically, they pay healthy yields, often in excess of 5%, while providing some downside protection.
In the US, there are about 190 publicly traded REITs with some $400 billion of assets.
- REITs performed very well during the 2000-2002 market correction, and continued to perform well as real estate prices boomed in the middle of the decade, with a gain of 35% as a group in 2006.
- But as the real estate market soured in 2007, REITs and particularly those in the mortgage business or with highly leveraged portfolios, tended to suffer.
Investors like REITs for:
- their yield,
- their ownership with hard physical assets,
- their stability, and
- for their long-term performance, estimated at over 13% annually during 1975-2005, which is better than most stock investments.
Many investors pick REITs for their negative correlation with stocks - when stocks are doing poorly, REITs are doing well or are holding their own.
Value Investing: Provide a Margin of Safety
The idea of buying a company at a bargain price to achieve a margin of safety, provides a buffer if business events don't turn out exactly as predicted (and they won't).
The value investing style calls for building in margins of safety by buying at a reasonable price.
The style also suggests finding margins of safety within the business itself, for instance:
The value investing style calls for building in margins of safety by buying at a reasonable price.
The style also suggests finding margins of safety within the business itself, for instance:
- so called "moats" or competitive advantages that differentiate the business from its competitors
- a large cash hoard, or,
- the absence of debt.
Value Investing: Focus on Intangibles
Today's value investors are as intently focussed on business intangibles, like brand and customer loyalty, as on the "hard" financials.
It is all about looking at what's behind the numbers, and moreover, what will create tangible value in the future.
So a look at the market or markets in which the company operates is important.
Therefore, it is so important to look at:
It is all about looking at what's behind the numbers, and moreover, what will create tangible value in the future.
So a look at the market or markets in which the company operates is important.
Therefore, it is so important to look at:
- products,
- market position,
- brand,
- public perception,
- customers and customer perception,
- supply chain,
- leadership,
- opinions, and
- a host of others factor.
Value investing: It's not about diversification
Is diversification the key to investing success?
Diversification provides safety in numbers and avoids the eggs-in-one-basket syndrome, so it protects the value of a portfolio.
But the masters of value investing have shown that diversification only serves to dilute returns.
If you are doing the value investing thing right, you are picking the right companies at the right prices, so there's no need to provide this extra insurance.
In fact, over-diversification only serves to dilute returns.
That said, perhaps diversification isn't a bad idea until you prove yourself a good value investor.
The point is that, somewhat counter to the conservative image, diversification per se is not a value investing technique.
Diversification provides safety in numbers and avoids the eggs-in-one-basket syndrome, so it protects the value of a portfolio.
But the masters of value investing have shown that diversification only serves to dilute returns.
If you are doing the value investing thing right, you are picking the right companies at the right prices, so there's no need to provide this extra insurance.
In fact, over-diversification only serves to dilute returns.
That said, perhaps diversification isn't a bad idea until you prove yourself a good value investor.
The point is that, somewhat counter to the conservative image, diversification per se is not a value investing technique.
Value investing: No magic formulas
Some people look for a magic formula in investing that guarantees success.
Value investing isn't quite that simple.
There are so many elements and nuances that go into a company's business that you can't know them all, let alone figure out how to weigh them in your model.
So rather than a recipe for success, you will instead have a list of ingredients that should be in every dish. But the art of cooking it up into a suitable vlue invstment is up to you.
Like all othe investing approaches, value investing is both art and science. It is more scientific and methodical than some approaches, but it is by no means completely formulaic.
Value investing isn't quite that simple.
There are so many elements and nuances that go into a company's business that you can't know them all, let alone figure out how to weigh them in your model.
So rather than a recipe for success, you will instead have a list of ingredients that should be in every dish. But the art of cooking it up into a suitable vlue invstment is up to you.
Like all othe investing approaches, value investing is both art and science. It is more scientific and methodical than some approaches, but it is by no means completely formulaic.
Value Investing: A Quest for Consistency
Value investors have varying approaches to risk, some willing to accept greater risk for greater rewards.
However, almost all value investors like a degree of consistency in
It's the same consistency you would strive for if you bought that espresso cart or hardware store yourself.
Before agreeing to buy that hardware store, you'd probably want to know that the customer base is stable and that income flows are steady or at least predictable. If that's not the case, you would need to have a certain amount of additional capital to absorb the variations. Perhaps, you would need more for more advertising or promotion to bolster the customer base.
In short, there would be an uncetainty in the business, which, from the owner's point of view, translates to risk.
The value investor looks for consistency in an attempt to minimise risk and provide a margin of safety for his or her investment.
This is not to say the value investor won't invest in a risky enterprise; it's just to say that the price paid for earnings potential must correctly reflect the risk.
Consistency need not be absolute, but predictable performance is important.
However, almost all value investors like a degree of consistency in
- returns,
- profitability,
- growth,
- asset value,
- management effectiveness,
- customer base,
- supply chain, and
- most other aspects of the business.
It's the same consistency you would strive for if you bought that espresso cart or hardware store yourself.
Before agreeing to buy that hardware store, you'd probably want to know that the customer base is stable and that income flows are steady or at least predictable. If that's not the case, you would need to have a certain amount of additional capital to absorb the variations. Perhaps, you would need more for more advertising or promotion to bolster the customer base.
In short, there would be an uncetainty in the business, which, from the owner's point of view, translates to risk.
- The presence of risk requires additional capital and causes greater doubt about the success of the investment for you or any other investors in the business.
- As a result, the potential return required to accept this risk, and make you, the investor, look the other way is greater.
The value investor looks for consistency in an attempt to minimise risk and provide a margin of safety for his or her investment.
This is not to say the value investor won't invest in a risky enterprise; it's just to say that the price paid for earnings potential must correctly reflect the risk.
Consistency need not be absolute, but predictable performance is important.
Value Investing: Always do due diligence
This cannot be repeated enough.
The value investor must do the numbers and work to understand the company's value.
Although there are information sources and services that do some of the number crunching, you are not relieved of the duty of looking at, interpreting, and understanding the results.
Diligent value investors review the facts and don't act until they're confident in their understanding of the company, its value, and the relation between value and price.
With great discipline, the value investor does the work, applies sound judgement, and patiently waits for the right price. That is what separates the masters like Buffett from the rest.
Investing is no more than the allocation of capital for use by an enterprise with the idea of achieving a suitable return. He who allocates capital best wins!
The value investor must do the numbers and work to understand the company's value.
Although there are information sources and services that do some of the number crunching, you are not relieved of the duty of looking at, interpreting, and understanding the results.
Diligent value investors review the facts and don't act until they're confident in their understanding of the company, its value, and the relation between value and price.
With great discipline, the value investor does the work, applies sound judgement, and patiently waits for the right price. That is what separates the masters like Buffett from the rest.
Investing is no more than the allocation of capital for use by an enterprise with the idea of achieving a suitable return. He who allocates capital best wins!
Value Investing is a style of investing
Value investing is a style of investing. It is an approach to investing.
As an investor, you will adopt some of the principles of this style of investing, but not all of them.
You will develop a style and system that works for you.
Since blogging, this journey has been an interesting and rewarding discovery.
As an investor, you will adopt some of the principles of this style of investing, but not all of them.
You will develop a style and system that works for you.
Since blogging, this journey has been an interesting and rewarding discovery.
A blended approach for the Value Investor
If you decide to take up the value investing approach, know that it doesn't have to be an all-or-nothing commitment.
The value investing approach should serve you well if you use it for, say 80% or 90% of your stock portfolio. Be diligent, select the stocks, and sock them away for the long term as a portfolio foundation.
But that shouldn't exclude the occasional possibility of trying to enhance portfolio returns by using more aggressive short-term tactics, like buying call options.
The value investing approach should serve you well if you use it for, say 80% or 90% of your stock portfolio. Be diligent, select the stocks, and sock them away for the long term as a portfolio foundation.
But that shouldn't exclude the occasional possibility of trying to enhance portfolio returns by using more aggressive short-term tactics, like buying call options.
- These tactics work faster than traditional value investments, which may require years for the fruits to ripen.
- Of course, this doesn't mean taking unnecessary or silly risks, rather, it means that sometimes investments can perform well based on something other than long-term intrinsic value.
- It doesn't hurt to try to capitalize on that, so long as you understand the risks and are willing to face losses.
- In fact, it is best to think of a short-term trading opportunity as simply a very short-term value investment - a stock, for instance, is very temporarily on sale relative to its true value.
Likewise, it's perfectly okay to put capital away for short-term fixed returns. You don't have to work hard on "due diligence" for all parts of your portfolio at the same time.
- A solid base in bonds, money market funds, or similar investments (safe blue chips with sustainable dividend yield) will produce returns and allow you to focus your energy on the parts of your portfolio you do want to manage more actively.
You don't have to use the value investing approach for ALL your investments. Depending on your goals, it's okay to mix investing styles.
Throughout market history, much has been made of the different approaches to investing. There are:
- fundamental and technical analysis,
- momentum investing,
- trading,
- day trading,
- growth investing,
- income investing,
- speculating,
- story or concept investing
- theme play, and,
- academic treatment of security valuation and portfolio theory (institutional trading).
All styles make money some of the time, but no one style makes money all of the time. Each style suggests a different approach to markets, the valuation of companies, and the valuation of stocks.
Volatility: Use the dips to find value
Market volatility seems to be here to stay.
Markets will rise and fall in 5% or 10% increments in a given month - with no real change in business value to support the change.
Investors must, more than ever, be patient and try to separate real business change from market change.
And they will learn to use the dips to find value.
Markets will rise and fall in 5% or 10% increments in a given month - with no real change in business value to support the change.
Investors must, more than ever, be patient and try to separate real business change from market change.
And they will learn to use the dips to find value.
REITS and Returns
Funds from operations (FFO) is an important measure of a REIT's operating performance.
FFO includes all income after operating expenses, but before depreciation and amortization.
Growth in FFO typically comes from:
The National Association of REal Estate Trusts (NAREIT at www.nareit.com ) defines FFO as net income (excluding gains or losses from sales of property or debt restructuring) with the depreciation of real estate added back.
FFO includes all income after operating expenses, but before depreciation and amortization.
Growth in FFO typically comes from:
- higher revenues,
- lower costs, and,
- management's effective recognition of new business opportunities.
- to raise rents and
- keep occupancy stable.
The National Association of REal Estate Trusts (NAREIT at www.nareit.com ) defines FFO as net income (excluding gains or losses from sales of property or debt restructuring) with the depreciation of real estate added back.
- Most commercial real estate holds its value longer and more fully than other tangible equipment that a business may possess, such as tools or vehicles.
- The depreciation that the accounting process records each year is often overstated.
Current accounting processes may call for depreciation of a building (according to a certain formula) even though the real value of the building may have increased due to outside forces like
- increased demand or
- low supply of vacancies
in the area where the building is located. For this reason, adding back the depreciation is a clearer way to measure the operating profits of one REIT against another.
FFO is more like the cash flow measures used to evaluate other businesses, and in most cases more completely demonstrates annual performance.
How Value Investors Use Investment Products
To be honest, if you are an experienced investor with time on your hands and all the right information and tools at your fingertips, you may not need investment products. But if you're starting out, don't have time, or need to build out a portfolio, they may make sense.
Investment products have investor benefits and investing benefits.
- Selecting stocks can be a daunting chore for busy people.
- Although you may be a skilled and knowledgeable investor, you may not have the time or inclination to be actively involved in tracking detailed financial information and selecting stocks.
One popular strategy for getting started in value investing is to use all the tools and skills, that you pick up on this, to start picking stocks on a small scale.
- A few funds, like a core value-oriented fund or ETF, can put the remaining bulk of your investment dollars to work.
- Practice makes perfect. As you gain confidence with your stock selection skills, you can move more dollars into individual equities and allocate fewer dollars to funds.
Funds and investment products can also be a great tool to round out a stock portfolio.
- You may not feel comfortable choosing foreign stocks, small company stocks, or stocks in some other specialty area.
- You can get exposure to these areas while getting the help of professional money mangers.
Funds, and their choices, can also light the way to individual stock selections.
- Although some are reluctant to provide up-to-the-minute lists and selected stocks (they are required to twice a year), their investment lists, and top investments in particular, can initiate your own research into these companies.
- Most interesting is to follow the funds of value "gurus" like Bill Nygren and Bill Miller, and of course, Warren Buffett. Imitation is not only flattering, but it can give you good ideas and save a lot of time.
Some investment products are:
- open-ended and closed-ended mutual funds
- REITS, and,
- ETFs.
Whether or not you're a do-it-yourselfer, funds and other investment products have their place.
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