Value investors purchase stocks at relatively low prices, as indicated by low price-to-earnings (P/E), price-to-book (P/B), and price-to-sales (P/S) ratios, and high dividend yields (DY). Investing for "growth" results in just the opposite -- high P/E, P/B, and P/S ratios, and low DY. There are valid reasons why investors are willing to pay a higher price for growth stocks.
A firm with a higher growth will grow its earnings at an accelerated rate compared to a low growth firm. Assuming a firm A earns 10 sen a share a year now and it pays no dividend, with all its earnings reinvested into the business with the same return. Assuming its earnings grows at 10% a year. In 5 years time, its EPS will grow to 16 sen (10*(1+10%)^5). If the growth rate is 30%, EPS after 5 years will be 37 sen, more than double that of the growth at 10%. Table 1 below shows the EPS at different growth rate.
Table 1: Earnings growth rates
Earnings growth 5% 10% 15% 20% 30%
EPS in 5 years $0.13 $0.16 $0.20 $0.25 $0.37
So shouldn’t a stock with higher expected growth rate sell at a higher valuation, and how much should it be? This brings us to the concept that “The value of a firm is the sum of expected future cash flows generated by the firm discounted to the present value”.
Assuming stock A above is selling at $1.00 and hence at a PE ratio of 10. Let’s say my required return investing in A is 10%. In 5 years time A’s EPS grows to 16 sen. Further assume that A is still selling at a PE of 10 in 5 years time, or $1.60. The present value of this future cash flow is also $1 (1.6/(1+10%)^5). So if you have bought the share at $1, you are paying a fair price. If you pay 1.50 for the stock now, or at a PE of 15, you are paying a high price; but you pay 50 sen for it, or at a PE of 5, you got a real bargain.
Now let us look at a stock B with present EPS of 10 sen also but a high expected growth rate of earnings of 20%. Its EPS will grow to 25 sen in 5 years time. Assuming you pay a higher price at $2 to buy B now, or a PE of 20 and after 5 years, it is still selling at a PE of 20, the price then will be $5.00 (20*0.25). If you discount this price at 10% back to the present value, it is $3.10, more than 50% above the price you pay. You got a great deal even if you pay a higher price of PE of 20 for a stock B growing at 20% for the next 5 years. Table 2 below shows the effect of growth rate and PE ratios on the fair prices of stocks.
Table 2: Effect of growth and PE ratio on stock prices
Earnings Growth PER
$1.00 5.0 10 15 20 25 30
5.0% $0.40 $0.79 $1.19 $1.58 $1.98 $2.38
10.0% $0.50 $1.00 $1.50 $2.00 $2.50 $3.00
15.0% $0.62 $1.25 $1.87 $2.50 $3.12 $3.75
20.0% $0.77 $1.55 $2.32 $3.09 $3.86 $4.64
25.0% $0.95 $1.89 $2.84 $3.79 $4.74 $5.68
30.0% $1.15 $2.31 $3.46 $4.61 $5.76 $6.92
We have seen that it is justified to pay a higher price for stock B which has a higher growth than A. If investors see the consistency of the growth in B, they may be willing to pay a higher valuation for it 5 years later. As shown from Table 2, if the rate of growth is maintained at 20%, and valuation expanded to a PE of 30, the present value of stock B is worth $4.64.
The problem is the “growth” we are talking about is the future expected growth, a forecast figure which is not easy to predict. The growth estimate, especially those with very high rates often do not last long enough to justify the high PE. In the case of stock B, if the forecast growth rate is lower than expected, say at 10%, instead of 20%, and that the PE ratio contracted to 15 as a result, investors who have paid $2.00 initially, would have its present value dropped to $1.50 after 5 years as shown in Table 2.
So there is a price to pay for growth. Paying a fair price for growth expectation may earn an extra-ordinary return for investors; but paying too much for growth is detrimental to the return of investment. Of course the best thing to do for investor is paying a good price for a growth stock. Do you have some stocks in mind to share?
KC Chong (7/4/2013)
I think there are two major reasons for the undervaluation of Mudajaya; one was the poor credibility of its management which investors have not forgotten yet. Secondly, I have doubt about its power plant in India. There are many political, social, economical, etc issues about this power plant development in India.
kcchongnz,thanks for your analysis. Why Mudajaya have poor credibility of its management which investors have not forgotten?
seedarren, "Why Mudajaya have poor credibility of its management which investors have not forgotten?"
Long story. Mudajaya share price went into a free fall some time in middle of year 2012 due to the query by Bursa on its funding for the IPP project in India. Go google the news in newspapers and financial papers around that time.
The company's net income seems to be decreasing over the years even with higher revenue suggesting tightening margins. The lower net income was achieved despite the fact that pulp prices (their main raw material) remained low for the past 2 years. Where is this margin compreession coming from ? The minimum wave policy is also expected to have an impact on margins in future. The FCF is also much lower possibly due to overseas expansion indicated in higher capex ? Dividend payout is good but the past 2 years, dividend payment exceeded the free cashflow suggesting that it is actually digging into the cash reserves to pay the dividend... Has anyone projected NTPM intrinsic value ? Appreciate some feedback here...
We'll only be seeing real growth value in stocks when you rid them of cronnies and fund manipulators that always play trap games with the public with their IPOs and frying.
NTPM did very well from 2006 to 2010 when both revenue and profits grew in double digits. ROE and ROIC were great in the twenties. Plenty of FCFs then. Since then due to competition and the after effect of the global financial crisis, margins contracted and hence profits adversely affected, and hence lowering ROE and ROIC to about 16% and 12% respectively which are still acceptable. FCF were greatly reduced, partly due to decreased profit, and partly due to capital expenses, which hopefully will produce future benefits. I like NTPM because of its durable business; both in paper products and the newly health care products like diapers, sanitary pads etc. The new products seem to be have good growth and margins. The future of NTPM may have to depend more of the latter introduction.
The last few quarters seem to show improved profits. If NTPM's performance can return to its former glory in 2009 and 2010, which is likely, then it has good future prospects.
My valuation of NTPM shows an intrinsic value of 55 sen to 60 sen per share, or a margin of safety of 15% to 20%, ok lah for a durable business like that of NTPM. My assumptions are a required return of 10%, a growth of 12% for the next 5 years and 3% thereafter.
when u say(for NTPM) u required a growth of 12% for the next 5 years and 3% thereafter do u mean every year grow by 12%? Isn't that a bit too optimistic? How about 8-10%.
faberlicious, Good question. I have tabulated a table for various growth assumptions and NTPM's intrinsic values of its business from my analysis. Please note this is just an analysis of the business, nothing to do with the share price of NTPM, now or the future.
To me FCF is the most important thing a company produces from its business. It is from this FCF that a company can pay investors dividend without having to rely on borrowing to do that. It is FCF that a company can utilize to reduce its debts, to buy back shares and to invest in other business for shareholder profit maximization. Very surprisingly, hardly read anybody writing about FCF in this supposedly investment blog.
Investopedia has a good explanation of FCF as appended. You can see how house calculated FCF in his NTPM example.
Thanks kc.Still do not fully understand all these accounting terms but e'day learn a bit more,hopefully "sikit sikit lama lama jadi expert" like u. When I read quarterly rpts I only read how much cash a company has, it's receivables,borrowings that's all !
For some funds investing in ethical businesses, they don't buy companies selling liquor, cigarettes, gambling etc. For me I see companies heavily controlled by political parties or their cronies, I just avoid and don't even want to look at it as I think I would be short-changed, unless under certain special circumstances.
bro kc,since u have such strong views about CMSB,then we discuss some other stocks ok.Where did I find this "gem or bomb"? It was recommended by RHB Investment Research.
SkpRese produced 19.1m of FCF last year which is equivalent to 3.2 sen per share. If you invest in a company with RM3000 (10000 shares in SKPRes) and each year it earns RM320 in hard cash, after spending some money for buying some new machinery and other capital expenses, isn't that a reasonable good business?
If FCF/Revenue>5%, ok If CFFO/net income >100%, good
kcchong, thanks. from the financial report, i can find CFFO but couldn't find capex (capital expenses), from cash flow section. i can only see - investment activities - 6276 - financial activities - 14967 - net cash - 7998 - cash b/f - 53809 - cash and bank balance - 8989 - deposit - 0 - overdraft - 3 - cash c/f - 61886
Steve Jub, the cash of 61886 you are talking about is the cash it has in its balance sheet, not the cash flows from operations (CFFO),nor free cash flow (FCF). Think about it, the cash it has amount to 10 sen per share, or more than 30% of its net asset backing per share of 30 sen. Incidentally, the share price is also 30 sen now. Think about it, with its past growth of 20% for the last 5 years, Return of equity of 21%, return of invested capital of 29%, but selling at a PE of just 5, and its enterprise value just 2.6 times its EBIT, if you say this is not cheap, I really don't know what to say.
You can find capital expenses from its cash flow statement under "cash flow from investment activities". It is the amount spend on purchasing property, plant and equipment. For plantation company, you may have to also include procurement of biological assets.
okay, actually i send order at 0.28 hehe ... but maybe that's not realistic..maybe i will try to q higher like 0.295. btw, what do you think of MBL? i had a quick look of it, seem not bad.
Steve, I have written a lot about MBL in i3. If you are interested in my opinion on it, just Google it in i3. Again it is about the business, not about the share price. Sorry, I can't tell about its share price, now or future.
Posted by kcchongnz > Mar 6, 2013 03:37 PM | Report Abuse X
[Keck Seng is an asset play. It's NTA is RM5.10 made out by RM3.46 of hard cash. Besides other valuable assets which book values of 65 sen per share is much lower than the current value such as land held under development and investment properties. Hey, I have not talked about its property, plant and equipment, Property development costs, inventories, receivables etc of about 800m yet. Whereas its total liabilities is only 108m. It is definitely a Graham net-net counter. Besides it has a profitable palm oil manufacturing work and plantation, property development, hotels etc and other business which are doing quite ok with positive free cash flows. It has about RM1.00 per share dividend which is tax imputable and has to be given out by this year. It seems it won't go wrong investing in this stock at current price now. You don't have to follow me. ]
house, when I first posted this, Keck Seng was trading at about 4.20. and I was hoping for the 1.00 dividend because Keck Seng has that amount of dividend which is tax deductible. However recent announcement of the normal 6 sen dividend is a big disappointment. The major shareholders/management is not one who takes care of the interest of minority shareholders.
faberlicious, That financial statements were for financial year ended 31/3/2012. At that time there were 60m shares. A 1 bonus for two shares held issues were executed mid June 2012 and hence then only no. of shares increased to 90m. So the 3.2 sen per share of FCF for financial year ended 31/3/2012 is correct.
If you talk about the financial year ending 31/3/2013 which is not announced yet, the FCF per share seems to be higher, even with 90m shares outstanding now. As at 9 months ended 31/12/2012, the CFFO is 44.2m. After deducting 6.9m in capex, the FCF is 37.4m, or 4.2 sen per share (37400/90000).
iyah, faberlicious, I don't know so much about MBSB lah. Anyway, I give a try here.
The loan growth and the growth of its bottom line is nothing short of spectacular. Operating income has risen up from 177m in 2008 to 1.1 b in 2012. Seemingly fantastic model too; get loan cost funds and loan it to government servants, direct debit from their salary, and hence unlikely on loan default. I don't know if it is true in long term because many government servants borrow a lot of money and way beyond their ability to pay back. Hopefully really no bad debt, and the government doesn't come in with stricter regulations to clamp this unhealthy practice of borrowing too much money of the government servants.
Valuation wise, if I use a required return of 12%, last year's ROE of 30% and its net asset backing per share of 1.26, its intrinsic value is 30%/12%*1.26= 3.15 per share. ROE valuation is appropriate for finance company.
I am almost fully invested already. I did not cash out before election. But how do you know market will fall on Monday? Most local funds left the market two years ago because of election fear. But did the market fall, even until the last day before election?
Even the market falls and if you buy good company stocks with sound fundamentals at good price, do you have to worry about it so much?
Most if not all academic researches have shown that there is no evidence that market timing can earn you extra-ordinary return.
kc, i'm not worried at all,not the slightest.On the contrary,I've been buying if the price is good.Of course Monday's market up/down depends on GE results.Same like u I never cash out. Look beyond mah! There's a saying "all things will come to pass" n so GE13 will soon be a distant memory.
See, it is so difficult to time the market. Local funds have been holding cash for so long for fear of the election and this has just passed. What is the problem? They have missed a few percent gain already. This one-day rise is equal to may be 30% of the normal rise of the market in a year. Ever wonder why fund managers under-perform the market? This is one of the reasons; trying to be smart to time the market.
does this means the foreign funds have correctly "time" the market? every winner come a loser in stock market, it is whose strategy is more appropriate at given time.
anyway, no one know for sure if missing local funds "made a big round" to enter the market :D :D :D
At 2.89 now for MBSB, and CM at 14.5 sen, the call warrant is trading at a discount of 3.5%, with a gearing of 10. It means that if you keep CM to expiry in 7 months time, and the price of MBSB stays at 2.89, you make 35%. Of course one can sell it before it expires. Incredible, but why like that one ah?
My home is still in Malaysia. Nothing compare with home. We will be back soon. Yeah, too back, Pakatan didn't make it this time again. But it is getting there.
freecooper, I know hapseng and canone are good companies; just don't know if they are good investments. You know lah, I am just a small retail investor who sometimes rant a bit, not an analyst of investment banks, especially not from Kenanga. And I bullshit a bit here and there. I am happy that you you do appreciate some of them.
There are too many companies in Bursa to look at. Unless you can tell me of some compelling reasons why hapseng and Canone, then may be I look in detail and we can share the information and analysis.
may I add my comments on MBSB. last quarter EPS almost doubled. They are strong competitor of Bank Rakyat now for personal loan financing. Previously concentrated much on mortgage loan I suppose. Personal loan financing is lucrative and repayment is tru salary deduction and hence NPL is low. For the last 2 years I think they are focusing on the right strategy istead of the mortgage market is saturated and keenly competing amongst the banks to have the larger market share with deteriorating interest margin.
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....
Posted by kcchongnz > 2013-04-07 08:45 | Report Abuse
Value investors purchase stocks at relatively low prices, as indicated by low price-to-earnings (P/E), price-to-book (P/B), and price-to-sales (P/S) ratios, and high dividend yields (DY). Investing for "growth" results in just the opposite -- high P/E, P/B, and P/S ratios, and low DY. There are valid reasons why investors are willing to pay a higher price for growth stocks. A firm with a higher growth will grow its earnings at an accelerated rate compared to a low growth firm. Assuming a firm A earns 10 sen a share a year now and it pays no dividend, with all its earnings reinvested into the business with the same return. Assuming its earnings grows at 10% a year. In 5 years time, its EPS will grow to 16 sen (10*(1+10%)^5). If the growth rate is 30%, EPS after 5 years will be 37 sen, more than double that of the growth at 10%. Table 1 below shows the EPS at different growth rate. Table 1: Earnings growth rates Earnings growth 5% 10% 15% 20% 30% EPS in 5 years $0.13 $0.16 $0.20 $0.25 $0.37 So shouldn’t a stock with higher expected growth rate sell at a higher valuation, and how much should it be? This brings us to the concept that “The value of a firm is the sum of expected future cash flows generated by the firm discounted to the present value”. Assuming stock A above is selling at $1.00 and hence at a PE ratio of 10. Let’s say my required return investing in A is 10%. In 5 years time A’s EPS grows to 16 sen. Further assume that A is still selling at a PE of 10 in 5 years time, or $1.60. The present value of this future cash flow is also $1 (1.6/(1+10%)^5). So if you have bought the share at $1, you are paying a fair price. If you pay 1.50 for the stock now, or at a PE of 15, you are paying a high price; but you pay 50 sen for it, or at a PE of 5, you got a real bargain. Now let us look at a stock B with present EPS of 10 sen also but a high expected growth rate of earnings of 20%. Its EPS will grow to 25 sen in 5 years time. Assuming you pay a higher price at $2 to buy B now, or a PE of 20 and after 5 years, it is still selling at a PE of 20, the price then will be $5.00 (20*0.25). If you discount this price at 10% back to the present value, it is $3.10, more than 50% above the price you pay. You got a great deal even if you pay a higher price of PE of 20 for a stock B growing at 20% for the next 5 years. Table 2 below shows the effect of growth rate and PE ratios on the fair prices of stocks. Table 2: Effect of growth and PE ratio on stock prices Earnings Growth PER $1.00 5.0 10 15 20 25 30 5.0% $0.40 $0.79 $1.19 $1.58 $1.98 $2.38 10.0% $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 15.0% $0.62 $1.25 $1.87 $2.50 $3.12 $3.75 20.0% $0.77 $1.55 $2.32 $3.09 $3.86 $4.64 25.0% $0.95 $1.89 $2.84 $3.79 $4.74 $5.68 30.0% $1.15 $2.31 $3.46 $4.61 $5.76 $6.92 We have seen that it is justified to pay a higher price for stock B which has a higher growth than A. If investors see the consistency of the growth in B, they may be willing to pay a higher valuation for it 5 years later. As shown from Table 2, if the rate of growth is maintained at 20%, and valuation expanded to a PE of 30, the present value of stock B is worth $4.64. The problem is the “growth” we are talking about is the future expected growth, a forecast figure which is not easy to predict. The growth estimate, especially those with very high rates often do not last long enough to justify the high PE. In the case of stock B, if the forecast growth rate is lower than expected, say at 10%, instead of 20%, and that the PE ratio contracted to 15 as a result, investors who have paid $2.00 initially, would have its present value dropped to $1.50 after 5 years as shown in Table 2. So there is a price to pay for growth. Paying a fair price for growth expectation may earn an extra-ordinary return for investors; but paying too much for growth is detrimental to the return of investment. Of course the best thing to do for investor is paying a good price for a growth stock. Do you have some stocks in mind to share? KC Chong (7/4/2013)