The ultimate aim of fundamental analysis is to project a fair value price of the stock of a company.
Important Website for Fundamental Analysis
zacks.com > Price, Consensus and EPS Surprise > enter tickers
zacks.com > enter tickers > detailed estimates
|Consensus by Analysts
|News (Daily Sector Wrap)|
|Important Economy Events|
|Treasury Bonds Yield|
sugar, cocoa, gold/silver
Housing Defense, Agriculture, Metals, HMO
Website for fundamental analysis
P/E ratio (Price/Earning) – Price people willing to pay for a company’s share each dollar of the company’s earnings. 15 is the typical value. >15 is over value. <15 is undervalued.
NAV – Is the asset value of the company. (total assets – liabilities) / total number of shares.
Studying of the Business Accounting Report
- Profit and Loss Statement
- Balance Sheet
- Cash Flow Statement (Free Cash Flow, free cash available for use)
Profit and Loss Statement
Gross Income is the profit made after deducting the cost of the sale but not yet deduct the fixed cost (overhead cost) + tax.
Gross Income (gross profit) = sales revenue – the cost of sales.
Operating profit = Gross profit – fixed overhead cost.
Net profit (pure profit) = Operating profit – tax
A snapshot of the business account.
How much the company worth, how much a company owe?
To check if the revenue and cash collected from the revenue are not a big gap.
Cash Flow Statement
It shows where the business is.
1) R.O.E (Return On Equality) (Most Important)
ROE is the amount of income generated (Net Income) from each dollar unit invested (Company’s equality). ROE should be 10-40% > than its peer in the industry.
= NetIncome / Equality = NetIncome / NetAsset
= [NetIncome / Sales] x [Sales / Assets] x [Assets / Equality]
NetIncome / Sales (turning the sales into profitability)
Sales / Assets (how efficiently are we using the assets to create sales)
Assets / Equality (how well are those assets turning into value for the owner of the company)
2) Gearing Ratio
How much debt is required to generate the income (gearing)?
ROE can be magnified (cheated), by borrowing money (debt), increasing the asset/resources to generate more sales.
A large number in the ROE may not be good. We need to check the debt, or leverage that the company took. Is the company taking a big risk?
Gearing Ratio = Debt / Equality
3) P/E Ratio
P/E = Price per share / Earning per share
P/E = 14 (is a fair value), meaning it will take 14 years for the company to earn back the money put in.
It also means that the earning is about 1/14% of the investment. The lower the number the cheaper is the price of the share.
P/E ratio is different for each of the company. It also indicates the people’s willingness to hold the stock (with respect to the company’s earning).
4) Free Cash Flow
Free cash flow can be used as an alarm whether the company is ok or not. It can be used as check against
- Test Earnings Per Share (0.8x EPS)
- Check if company can afford the Dividends payout (1.6x Dividend)
- FCF Yield (cash flow generated base on the share price)
FCFPS (free cash flow per share), cash available for use
EPS (earning per share)
FCFPS should be close to EPS, not too far apart. FCFPS = 0.8 of Earnings is still ok. Free cash flow available should be close to the Earnings. If earning is reported, but the cash available is very low (suspicious. where is the cash? what is going on behind), there is a chance of a business problem, fake accounting to boost earning per share, or poor in managing cash. Need to investigate further.
Earnings can be accounted when it is invoiced, but the cash may not be collected or cannot be collected.
Cash flow should be more than the dividend payout. 1.6x is considered OK.
Ten signs a company’s in trouble – MoneyWeek Investment Tutorials
The director wants you to see the Profit & Loss account. What investor need to take note of is the Balance Sheet.
The number the directors don’t want you to find – MoneyWeek Investment Tutorial
Profit & Loss account cannot be trusted. The invoices can be issued but cash not received. The expense to generate the profit may be breakdown through depreciation but the cash is already out. Need to check the cash flow statement.
Determine the Future Stock Price
A trading plan requires us to establish a direction of a stock. It can be up, down or sideway.
The following introduce ways to estimate the price of a stock.
Estimate base on consensus forward guidance on P/E
P/E ratio = Price / Earnings
P/E ratio provides us with a reference relating to how much the market is willing to pay for the stock for the earnings that it brings. A stock P/E ratio of 20 means that people are willing to buy at a price of $20 for every $1 earnings.
An analyst may forecast an estimate P/E ratio (forward guidance, forward P/E) of 15 for its good performance. We can use this consensus to predict the future, assuming the people has the same willingness to buy the stock at the P/E of 20. This means that when the demand for the stock increases, the P/E ratio will change from 15 towards 20. This is about 1.33 times changed. Apply this to the stock price (assume currently priced at $50), the future stock price is projected at $50 x 1.33 which is equal to $66.67 (which gives back a P/E of 20).
Forward Price = Current P/E = Forward Earning Yield
Current Price Forward P/E Current Earning Yield
Forward Price = Current P/E x Current Price
= 20 x $50 = $66.67
Estimate using EPS Growth Capitalization Method
Intrinsic Value of a company is different from NAV (Net asset value, Book value), is the estimate of the company’s value base on future cash-flow, earning…
3 Steps to determine a fair value for the current stock price.
- Estimate the EPS (earnings per share) of the stock for the next 5 years.
Example: EPS for year 2011 to 2015 => $1.00 (2010), $1.10 (2011), $1.20 (2012), $1.30 (2013), $1.40 (2014), $1.50 (2015)
Projecting that the EPS grow from $1.00 to $1.50 for the next 5 years.
The EPS growth rate base on CAGR (compound annual growth rate) will be 8.45%.
You can use the CAGR calculator to compute.
EPS growth rate can also be found from the analyst’s consensus. Compare between various analyst’s EPS growth rate for a more objective overview of the market. Be sure to look through the historical EPS rate and the company’s economy situation to confirm if the computed EPS is a reasonable rate.
- Determine a future stock price.
Future stock price = Future EPS x Future P/E Ratio
Future EPS = Present EPS x (1+ EPS growth rate)^number of years
= $1 x (1 + 8.45%)^5 years
Future P/E Ratio is 20. (base on the historical P/E, how much people are willing to buy the stock base on its earnings performance)
Therefore, Future stock price = $1.50 x 20 = $30
- Calculate Today’s Intrinsic Value.
Working backwards to determine the value of the stock in today’s value (discounted rate, removing the growth projection).
First, you need to decide on a “minimum acceptable rate of return” (MARR) for your investment (10%-15%).
15% is used in this example. (A lower MARR will result in a higher stock intrinsic value).
Present Intrinsic Value = Future stock price / (1 + MARR)^number of years
= $30 / (1 + 15%)^5 years
In order for an investment target of 15% to work out, the entry stock price to purchase will be <= $14.92
- Apply a Margin of Safety (MOS). (typically 50% to 15%)
This safety margin is subjective depending on how confident your computed intrinsic value is. Do back-testing to check the historical EPS projection and stock price, to determine a closer MOS projection.
Example, if MOS is 15%, the maximum entry price will be $14.92 x 85% = $12.68
Estimate with Dividend Consideration
Estimate with Stock’s Volatility Factor In
Conrad Company’s Valuation
- Trade volume > 1 million (daily).
- Size of the company capitalization = Number of share x Share Price.
- P/E ratio 15 is the threshold. Above 18 is consider over brought. Below 15 is consider cheap. This is like investor looking for companies with an earning returns of at least 6.5% (1/15).
Conrad will not like it if it is above 20. Can also use the P/E ratio of the S&P as the benchmark when comparing to the company’s P/E.
- LT debt equity ratio. (long term debt equity ratio)
>1 don’t touch,
>5 very dangerous
1.5 to 2.0 -> Fast
1.2 to 1.5 -> Nice balance
1.0 to 1.2 -> Slow.
- Short Float,
if >10% don’t touch
Like NAV, track the Short Float over a period of time to have a feel how the money flowing in or flowing out of the stock.
Increasing Short Float indicates that it is unlikely that the price will go up. Short Float goes down, Stock Price goes up.
- Nice consist guidance record. Consensus from the analyst.
- Miss earning, miss small.
- Hit earning, hit big.
- Hit earning more than misses.
- List down all the news or factors that can affect the stock.
- eg. Weather, Oil inventory, Retail sales, etc…
- Interest Rate ↑, Financial and healthcare stock price ↑.
- Conrad don’t do fundemental analysis on NAV, intristic value, etc… Use more of technical analysis to project the stock price.