Fundamental Analysis -- 20th Apr 09

Mark Laudi, CEO of InvestorCentral gave an insight presentation about value investing during the ATIC on 18th - 19th April 2009. He has a 5 points checklist in selecting which stock is worth value investing and these 5 criteria should be a good guidance for those who is interested in value investing but has no clue of how and where to start from. The 5 criteria are :-

1. Book Value
Each stock has it own book value; the value of the company's asset. In value investing, one would like to purchase the stock when its share price is traded at a discount to its book value. By doing so, the investor will have a lower risk as compared with buying above its book value. Book value of the company can be found in their financial sheets easily. Baring from the company is not fundamentally strong situation, a purchase into a fundamentally strong company like DBS, UOB, SingTel, etc at a below book value price is not something that could be missed.

2. Yield
Yield in term of dividend the company is paying to shareholders. Comparing one putting money into bank earning interest from Fixed Deposit (FD), the interest return in best situation one can get at the moment is probably 1% yield. At that yield, it is rather impossible to offset the inflation hence investing in stock with a dividend yield that is higher than bank interest rate and able to offset inflation would be good for long term investing.

3. Cashflow
Cashfow is an essential component of a company's health. With a strong cashflow, the company will have the monies in hand to help them ride over difficult periods like the current global financial crisis. Normally cashflow information could be extracted from the balance sheet of the company. One can take the difference between net operating profit and expenses as the free cashflow a company has.

4. Managment
How well a company perform and hence turn shareholders investment into profit lies on the shoulder of the company CEO and his/her managment team. They are the one who make decision and direction for the company. This criteria is also one of the most difficult to decide on. Good corporate governer is definitely a must have as it provide transparency to the shareholders. There is a Governance & Transparency Index ( GTI ) recently launched which could be found in Business Times and the Corporate Governance & Financial Reporting Centre. This should give investor a guide of the company ranking in the index. In order to know the managment better, investors are strongly advisable to attend the company's AGM and speak to the managment team.

5. Outlook
In US, the company will announce its outlook for the remaining of the year after reporting its quarterly earnings. This is importance to investors as by doing so, the company is committed to shareholders of the company's performance and serve as a guidance for the company's profit level. Such outlook could be quoted in term of revenue earn or profit earn or earning per share earn. In Singapore, companies do not have this habit from their respective CEO to announce future outlook and this could really hinder investors in filtering off what is a good company with good management team among the rest.

As a rule of thumb, if the stock of a company one wanted to invest in could have a tick for all the 5 criteria, this could potentially reduce a lot of investment risk and able to separate what is a good and what is a bad stock.

Fundamental Analysis -- Current Ratio, Quick Ratio

The Current Ratio is a financial ratio that measures whether a company has enough resources to pay its debts over a short period of times say next 12 months. It is calculated as :-

Current Ratio = Current Assets / Current Liabilities

This ratio basically reveals how easily a company can deal with unexpected expenses or opportunities. Its Current Assets are things that are used up and replenished frequently such as cash, inventory, and accounts receivable. Its Current Liabilities are the ones usually due within one year. All these figure can be easily obtained in a company's balance sheet. Current Ratio at least 2:1 is usually considered to be acceptable; that is to say the company's assets are at least twice its liabilities; the company is considered to have good short-term financial strength to meet its creditor's demands. If the ratio is below 1, then the company may have problems meting its short-term obligations. Too high a current ratio doesn't mean good either as this may indicate the company is not efficiently using its current assets.

The Quick Ratio or Acid-Test or Liquid Ratio is very similar to Current Ratio. It measures the ability of a company to use its quick assets ( cash, cash equivalents such as marketable securities, accounts receivable ) to respond to a sudden/surprise bill/opportunity. This ratio indicates a company's capacity to maintain operations as usual with current cash/cash equivalents in bad periods. This is calculated as followed :-

Quick Ratio = ( Current Assets - Inventories ) / Current Liabilities

Current Assets - Inventories = Cash & Equivalents + Short-term Investment + Accounts Receivable

The Quick Ratio can be considered a much more conservative and stringent measurement as compared to Current Ratio in accessing a company short-term liquidity as it excludes the Inventories from its calculation. Inventories are excluded because some companies have difficulty turning their inventories into cash within short period of time to meet their obligations. In general a Quick Ratio at least 1:1 is acceptable.

Example :-

With reference to SPH FY08 Annual Result

Current Liabilities = $367,444,000
Current Assets = $1,138,265,000
Inventories = $36,281,000

Current Ratio = $1,138,265,000 / $367,444,000 = 3.098
Quick Ratio = ( $1,138,265,000 - $36,281,000 ) / $367,444,000 = 3.00


With reference to Ferrochina FY07 Annual Report

Current Liabilities = RMB 5,416,344,000
Current Assets = RMB 5,149,406,000
Inventories = RMB 1,809,465,000

Current Ratio = RMB 5,149,406,000 / RMB 5,416,344,000 = 0.951
Quick Ratio = ( RMB 5,149,406,000 - RMB 1,809,465,000 ) / RMB 5,416,344,000 = 0.617

Fundamental Analysis -- Price-to-Book Ratio (P/B)

Price-to-Book ratio, P/B ratio, is a financial ratio used to compare a company book value to its current market price. Book value is an accounting term denoting the portion of the company held by the shareholders ( the company's total tangible assets less its total liabilities ). In short, it means how much the stock is worth right now if somebody liquidated the company. The formula to calculate the P/B ratio is as followed :-

P/B ratio = Stock Price / Book Value Per Share
= Market Capitalization / Book Value of Equity

Book Value Per Share = ( Stockholders Equity - Preferred Stock ) / (Average Outstanding Shares )
Market Capitalization = Shares Outstanding * Market Price per Share
Book Value of Equity = Book Value of Assets - Book Value of Liabilities = Shareholders Equity

A lower P/B ratio 2007 Annual Report

As of 17th Oct 08, DBS Share price = $13.00
Book Value Per Share = $13.20

P/B ratio = $13.00 / $13.20
= 0.98x

Fundamental Analysis -- Return on Equity ( ROE )

Return on Equity ( ROE ) shows the rate of return to shareholders by dividing net income by total shareholders' equity. Basically, it measures a company's efficiency at generating profits from every dollar of net assets ( assets minus liabilities), and shows how well a company uses investment dollars to generate earnings growth.

ROE = ( one year's earnings ) / shareholders' equity

The bigger the number is always better because this means the company is making a lot of money off the investments that shareholders have made. A good ROE is anything above 20%.

One has to note also not all high ROE companies make good investments. Take the case of a consulting firm, it may have high ROE as it requires no assets but another company like an oil refiner which required large infrastructure to be built before it could generate profit. As such one cannot conclude that the consulting company is of better investment due to its high ROE. ROE is at best to compare companies in the same sector/industry rather than generalize for all sectors/industries.

Example:

With reference to SPH Annual Report 2007
Profit attributable to shareholders ( one year's earnings ) = S$506,161,000
Shareholders' interests ( shareholders' equity ) = S$2,179,611,000
ROE = S$506,161,000 / S$2,179,611,000
= 23.2%

With reference to SIA Annual Report FY07/08
Profit attributable to equity holders of the Company ( one year's earnings ) = S$2,049,400
Equity attributable to equity holders of the Company ( shareholders' equity ) = S$15,125,200
ROE = S$2,049,400 / S$15,125,200
= 13.6%

Fundamental Analysis -- Earnings Per Share ( EPS )

Earnings Per Share, EPS is one of the most useful measurement in analyzing the fundamental of a stock of a company. It basically takes what a company earned and divides it by the number of stock shares outstanding. It is always reported in the company income statement and reflected the value for either last quarter or last year of the earnings. Without any doubts, the bigger the value, the better it is for the company. The use of EPS could potentially identify a growth company as for a growth company, its EPS will increase quarter after quarter at a faster rate. Also note that if a company bought back its own share from open market and even if its earnings is able to maintain the same from quarter to quarter, its EPS will also increase from quarter to quarter.

Take an example of SIA and with reference to its 1QFY09 earnings announcement dated 28th Jul 08

profit attributable to equity holders of the company = S$358,600
as of 30th Jun 08, SIA has an outstanding share = 1,183,391,373.

EPS = S$358,600/1,183,391,373
= S$0.303 or 30.3 Scents ( as it was reported in the income statement ).