Great analysis KC. PE ratio is by far the best strategy to spot a winner. Of course, one has to do a thorough analysis on why a company is valued so cheaply. It can be due to excessive debt, a turnaround story, negative sentiment surrounding the industry, distortion due to non-recurring item or just shitty management. After identifying the cause, an investor will have to evaluate if such valuation is justifiable and if its earnings is sustainable and then invest accordingly. By doing that, one can separate out the 3 baggers from the shitty ones.
This article shows another simple way of applying a PE investment strategy by Peter Lynch. In this method, a max ceiling of P/E of 15x is applied and the stock is bought whenever the price drops below that P/E. The method may only apply to blue chips tough which have stable earnings.
Posted by soojinhou > Oct 30, 2014 08:18 AM | Report Abuse
Great analysis KC. PE ratio is by far the best strategy to spot a winner. Of course, one has to do a thorough analysis on why a company is valued so cheaply. It can be due to excessive debt, a turnaround story, negative sentiment surrounding the industry, distortion due to non-recurring item or just shitty management. After identifying the cause, an investor will have to evaluate if such valuation is justifiable and if its earnings is sustainable and then invest accordingly. By doing that, one can separate out the 3 baggers from the shitty ones.
kcchongnz, Thanks for the superb write-up. Please advise the maximum debt equity ratio which you consider as healthy under current benign interest rate invironment. If interest rate is to double, what is the max debt equity ratio that you will consider as healthy mix?
Posted by sunztzhe > Oct 30, 2014 11:54 AM | Report Abuse
kcchongnz, Thanks for the superb write-up. Please advise the maximum debt equity ratio which you consider as healthy under current benign interest rate invironment. If interest rate is to double, is the max debt equity ratio that you will consider as healthy mix?
sunztzhe, good question. You see for me finance and investment is an art. There is no fixed rule embedded in stone, though there are some guidelines. I am no expert in answering your question. But since you asked, I just provide my personal novice opinion here.
To me, interest environment is not that important for how much a company's maximum debt is. Imagine you are a banker and a corporation asks you to lend money. What would you think?
For me at high interest rate, take as much loan as you want as I can earn more interest from you if you borrow more. But make sure you can pay my annual or month interest. That I would judge from how stable is your income, how much do you earn and if you can cover my interest payment, and may be how much cash flow you make each year. If your operations can make more than 5 times my interest payment, take as much loan as you want.
Of course if you owe me say more what your net worth is, and your business is not doing well with not enough earnings or cash flow to pay my interest, then I will get worried.
kcchongnz, what is your view of using PEG (<1) as a yardstick for valuation. Growth rate is based on the average of past 5 years sustainable growth rate formula [ROE x(1-Div Payout)].
Another ratio is the incremental net earning (PATAMI)over the incremental average owner equity. This is to check on the incremental return on equity reinvested.
Is the operation cash flow over PATAMI a good indicator on earning quality?
kcchongnz, thanks for your good response and I appreciate it very much. I agree with you that the most important info for the owner of the business and the banker as well is whether the cashflow generated can be consistent in paying off the interest and principal sum over a certain time period.
Gd sharing. My personal thought of picking those safe bet counter to invest. 1st - filter those company with PE < 10, mkt cap 100-500m n stock price can't higher by NTA >5% 2nd - track yoy rev, profit n margin trending at least 2-4 qtr. if u done a Gd work then 2 qtr trending is where d stock start moving aggressive ( make sure d gain is not one off selling assets ) 3rd - avoid those stock that high politic link 4th - avoid those stock that debt level not dropping ( mean can't pair down debt by qtr or every 6 mths ) 5th - after all d analysis n filter. Choose those left that r in d right growing industry, stable management n unique or leadership in the mkt
If time allow then do some homework on volume n price movement to enter the counter in the right time. Gd to have analysis bcoz will only impact few %. The formula is for 6 mths to 2 yrs with 50 - 300% return. When liquid, do phase approach 1/3 or 1/4 each
Posted by Pika Chan > Oct 30, 2014 09:44 PM | Report Abuse kcchongnz, your article never fails to inspire me and educate the ignorant vast majority, you are one of the truly shining sifu in i3investor .
Pika, Thanks for your kind words, and many others too which I did not express for certain reasons in this type of forum to avoid misunderstanding. You are expert in your own field too. That is something I need to learn from you too.
Posted by Alphabeta > Oct 30, 2014 10:14 PM | Report Abuse kcchongnz, what is your view of using PEG (<1) as a yardstick for valuation. Growth rate is based on the average of past 5 years sustainable growth rate formula [ROE x(1-Div Payout)]. Another ratio is the incremental net earning (PATAMI)over the incremental average owner equity. This is to check on the incremental return on equity reinvested. Is the operation cash flow over PATAMI a good indicator on earning quality?
Alphabeta, nice to hear from you again. You are a good fundamental investor yourself. But since you asked, I will try to give my two sen. PEG popularized by Peter Lynch in his book “One Up On Wall Street”, has been a very popular investing metric before the turn of the Century. Good book to read. In general, if a stock is trading at a PEG of less than 1, it is cheap. For example a stock trading at a PE of 10, has an expected rate of growth of 10%, its PEG is 1. Go buy it.
kcchongnz, thanks for your reply. I like to read your articles whenever i am free. PATAMI is a short form for owner's earning. Profit after tax after minority interests. I read this valuation method in Share Fundamental website. It is using this a check on earning quality (some company like to use financial engineering to prop up profit but operating cash flow is poor, for example sudden jump on debtor or inventory level etc.)
I would like to seek your view on Intrinsic Value, “Intrinsic value is the present value of all cash that will be distributed from now until judgment day”.
One of my measurement of Intrinsic Value is based on applying a discounting factor (my expected return) on total shareholder return (TSR). In order to project future cash flow on TSR, i need to ascertain over the passed 5 years the P/E ratio, sustainable growth and dividend payout %. I will get the average of these three parameters for my TSR projection and discounted with my expected return (minimum 10%)
TSR Projection
A> EPS x sustainable growth (average growth rate) B> then multiply with average P/E to get the future market price C> Apply average dividend payout % on the projected EPS and accumulate this over the year. D> Add B+C = TSR E> Apply the discounted factor on D to get the present market price.
kcchongnz, is there any flaw on this calculation? In current scenario, very difficult to select stock with the desired price using this method unless i lower expected return or increase the growth rate on positive news flow and better quarterly result.
Will appreciation your comments on room for improvement.
I would prefer a liberal approach on valuation whereby Different methods of Valuation is applied so much so that different aspects of business operation is examined and inspected to generate a Fair range of Pricing in different circumstances.
There is another approach mentioned in "Intelligent Investor" for defensive investor using P/E x PBV < 22.5. The logic of this approach not to pay for P/E exceeding 15 and PBV <= 1.5.
good then we would surely try to examine the Business and valuation from different angles and perspectives. Knowing that no business is the same and evolving, method could be slightly different.
End of Day, what is your confidence level and your competency and how well you know the Business is very important.
Like it Or not, i perceive lots of small cap might fail in their Growth stage and Down Business cycle.
So sometimes it will be frustrating to analyze them too much as their operations has yet to gain footings.
And certain Business is Not easy to understand at all.
So I think we can Only analyze the Business that we can understand and which are more sizable and stable.
Having said that we are shunning ourselves from the more upside from small cap. To strike a good balance, it is worth to look at mid cap which has good chance to become Blue Chip.
Alphabeta kcchongnz, I would like to seek your view on Intrinsic Value, “Intrinsic value is the present value of all cash that will be distributed from now until judgment day”.
One of my measurement of Intrinsic Value is based on applying a discounting factor (my expected return) on total shareholder return (TSR). In order to project future cash flow on TSR, i need to ascertain over the passed 5 years the P/E ratio, sustainable growth and dividend payout %. I will get the average of these three parameters for my TSR projection and discounted with my expected return (minimum 10%)
kcchongnz, is there any flaw on this calculation? In current scenario, very difficult to select stock with the desired price using this method unless i lower expected return or increase the growth rate on positive news flow and better quarterly result.
Will appreciation your comments on room for improvement.
Alphabeta,
You are basically using a hybrid method to get your intrinsic value, or specifically more of a relative valuation like a PE ratio, EV/Ebit that sort of valuation because you are replying most part of your cash flow from the expected price of the share at certain future date. The cash flow from the annual dividends just make up a small part of your intrinsic value. This is not exactly like what your opening statement mentioning about what intrinsic value is.
This valuation method is not favoured by those investment guru such as Seth Klarman.
kc, TSR is based on the capital gain and dividend yield. The former is a product future market price less the entry price. The assumptions here are the P/E will prevail and the sustainable earning growth rate will propel the market price into the future.
If you disposed the share after 5 or 10 years later, the total proceeds from disposal (say X) plus cumulative dividend received (say Y) minus initial price (P) will give a compounding return of 10%. Frankly speaking, 5% is required to take care of inflation rate and transaction costs. The real return is only 5%.
P*(1+10%)^5=X+Y P = (X+Y)/(1+1.1)^5
These depend on a> sustainable growth rate ROE*(1-dividend payout), b> dividend payout ratio, c> the current average P/E continue to be prevailed into future.
Like stockoperator mentioned earlier, beside this mechanical calculation as a guide, we need to look for other indicators which is the key drivers for future top -line and earning growth. Its current financial health etc.
Let me repeat my opinion on your valuation method.
You are basically using a hybrid method to get your intrinsic value, or specifically more of a relative valuation like a PE ratio, EV/Ebit that sort of valuation because you are replying most part of your cash flow from the expected price of the share at certain future date. The cash flow from the annual dividends just make up a small part of your intrinsic value. This is not exactly like what your opening statement mentioning about what intrinsic value is.
This valuation method is not favoured by those investment guru such as Seth Klarman.
Posted by Alphabeta > Oct 31, 2014 10:13 PM | Report Abuse
There is another approach mentioned in "Intelligent Investor" for defensive investor using P/E x PBV < 22.5. The logic of this approach not to pay for P/E exceeding 15 and PBV <= 1.5.
Alphabeta, yes that is Graham number, don't pay for PE ratio and P/B more than 15 and 1.5 respectively. Good guideline for most people.
But is PE 15 and P/B 1.5 really that cheap? It depends actually. Other things may be more important, such as the difference in ROE, ROIC, enterprise value etc.
kc, thanks for your comments and recommendation. I will find time to read Seth Klarman principle on value investing.
One last question, when computing P/E ratio. Is it better to used volume weighted average price of a stock "VWAP" or the year end price.
For Uchitec, its VWAP for FYE 31/12/13 is 1.24 (P/E 12.0) whereas the adjusted year end price is 1.37 (P/E 13.2). Normally i will download from Yahoo Finance for the daily data to compute the VWAP.
When I look at a stock to see if it is worthwhile to invest or not, I am only concern about what it its price offered, and now. Why do you bother about whether it is VWAP or what, unless you are trying to do a research. Those PE ratio stated in my article are by the publication of Share Investment, a monthly publication sold in the book shop. Exactly which price in the month of October 2009 they base on I don't know, but it doesn't affect my conclusion.
The more important is the earnings, which earnings? Forecast earnings, ttm, historical or which one?. They all have their own merits and shortcoming as discussed in the article.
kc, you are right. Getting the right EPS, DPs is vital especially when there is a price adjustment events like bonus issue and share split or any price sensitivity event subsequent to year end may affect the EPS and P/E calculation.
I find that even in I3Investor, the current price has changed after announcement of bonus issue but the EPS, DPS of past years remained the same which reflect wrong P/E and Dividend yield results.
The reason i am asking this is because i am using the past 5 years average P/E ratio to project the future price. Using VWAP will iron-out the volatility issue if i just use the year end price to compute P/E.
"The reason i am asking this is because i am using the past 5 years average P/E ratio to project the future price. Using VWAP will iron-out the volatility issue if i just use the year end price to compute P/E."
Not sure how you can project future share price using PE ratio. You seem to deviate from your initial statement below:
“Intrinsic value is the present value of all cash that will be distributed from now until judgment day”.
kc, will you be interested to evaluate this if i email a copy of the template to you. If it is a fruitless exercise, i would not want to continue to use this as a yardstick.
Posted by sunztzhe > Oct 30, 2014 11:54 AM | Report Abuse
kcchongnz, Thanks for the superb write-up. Please advise the maximum debt equity ratio which you consider as healthy under current benign interest rate invironment. If interest rate is to double, what is the max debt equity ratio that you will consider as healthy mix?
Posted by sunztzhe > Oct 30, 2014 11:44 PM | Report Abuse
kcchongnz, thanks for your good response and I appreciate it very much. I agree with you that the most important info for the owner of the business and the banker as well is whether the cashflow generated can be consistent in paying off the interest and principal sum over a certain time period.
sunztzhe,
Welcome to the gang of the art of value investing. We really short of members here.
In my opinion, knowing that it is a good business at fair price and Continue holding on to that Great Business knowing that it will be doing reasonably well in good times and bad times is good enough.
Business in itself is our stronghold of Our Belief system. And investment is Acting on our Belief system. And we need to live out our Belief system. And most of the time it is Business as usual. Everything takes time and Time is on Our side.
Posted by sunztzhe > Nov 2, 2014 02:33 PM | Report Abuse
"Wealth is the slave of a wise man but Wealth is the Master of a fool."
Indeed from the mouth of a wise man. It is conventional wisdom.
I know of somebody who already has immense wealth in the order of may be more than hundred million. But instead of just invest wisely, for example put half in fixed income and half in equity investing in good companies at reasonable price, and that is enough to provide a steady recurrence incomes for a few generations, give to charities and leave a legacy etc, prefers to borrow another hundred million to leverage up his investment and hope to make a lot more money. He only knows the power of leverage, but not the potential pitfall. There isn't any black swan in the world, is it?
There are also a lot of people just work hard but not saving or invest, and whatever he saves is eroded by inflation. Or people instead of investing wisely following the proven value investing below, chose to speculate because they think that they are better than the insiders, syndicates and manipulators.
Agreed, but i like to explore new idea. When there is doubt can seek others opinion. kc past recommendations have been quite enlightening, that's the reason why i sought his opinion when i have doubt.
This book is the result of the author's many years of experience and observation throughout his 26 years in the stockbroking industry. It was written for general public to learn to invest based on facts and not on fantasies or hearsay....
soojinhou
869 posts
Posted by soojinhou > 2014-10-30 08:18 | Report Abuse
Great analysis KC. PE ratio is by far the best strategy to spot a winner. Of course, one has to do a thorough analysis on why a company is valued so cheaply. It can be due to excessive debt, a turnaround story, negative sentiment surrounding the industry, distortion due to non-recurring item or just shitty management. After identifying the cause, an investor will have to evaluate if such valuation is justifiable and if its earnings is sustainable and then invest accordingly. By doing that, one can separate out the 3 baggers from the shitty ones.