Fundamental Analysis Fundamental analysis is a combination of quantitative and qualitative analysis that determines a stock’s value by focusing on a company's actual business and its future prospects.
Fundamental Analysis
Two Most Important Questions: 1.
What is is be beiing pr priced in?
2.
What is mispriced?
Stocks will make money over the long term provided provided that earnings are on an uptrend and valuations are cheap.
Fundamental Analysis Process of forecasting corporate earnings (using a “top down” approach) Macro-economic analysis Industry analysis (industry lifecycle, competitive environment) Company analysis (strategy, (strategy, financial statement analysis)
Fundamental Analysis How to identify strong companies (The Five P’s) People Product Predictability Potential P/E (Valuation)
Fundamental Analysis Benchmarking 1.
Alternatives
2.
Competitive ad advantag age e
Fundamental Analysis Puregold Pure gold
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Rustans
Robinsons
Revenues Rev enues
1000
1500
500
250
Gross Margins
15%
12%
10%
8%
Operating Margins
10%
8%
5%
3%
Fundamental Analysis Inputting numbers through commonly used valuation methods DCF or Discounted Cash Flow Method NAV or Net Asset Value Method Relative Valuation Method
Commonly used methods for determining Fair Value Value DCF or Discounted Cash Flow •
Present value of future free cash flows
•
FV = CF1/(1+r1 ) + CF2/(1+r2 )2 + CF3/(1+r3 )3 + . . .
•
Higher earnings will lead to higher fair value
•
Lower Low er interest rates will lead to higher fair value
•
Can be used on all stocks
Commonly used methods for determining Fair Value Value Example: DCF Method Required Rate or Return:
10%
Required Rate or Return:
8%
Year
Cash Flow
PV of Cash Flow
Year
0
500.0
500.0
0
500.0
500.0
1
600.0
545.5
1
600.0
545.5
2
700.0
578.5
2
700.0
578.5
3
800.0
601.1
3
800.0
601.1
4
900.0
614.7
4
900.0
614.7
5
1,000.0
620.9
5
1,000.0
620.9
6 and onward
1,100.0
6,830.1
Total O/S FV per share
10,290.8 1,000.0 10.3
Cash Flow PV of Cash Flow
6 and onward 1,100.0 Total O/S FV per share
8,382.4 11,843.1 1,000.0 11.8
Commonly used methods for determining Fair Value Value NAV NA V or Net Asset A sset Value •
Sum of the fair value of assets
•
Commonly used for property companies and holding companies
Commonly used methods for determining Fair Value Value Example: NAV Method Asset
PhpMil
Php/sh
% of Total
Valuation Method
BPI (33%)
62,630
126.25
23.4%
P/BV multiple
Globe (30%)
33,906
68.35
12.7%
DCF
Manila Water (43.3%)
20,832
41.99
7.8%
DCF
Ayala Ayala Land (53.5%)
136,714 136,71 4
276
51.1%
NAV NAV based
IMI (67.7%)
10,626
21
4.0%
DCF
Total for listed subs/affil
264,708
534
99.0%
Ayala Ayala Automotive
6,844
13.80
2.6%
Book value
AG Holdings
4,856
9.79
1.8%
Book value
Minus net debt
(9,124)
(18.39)
3.4%
NAV NAV
267,283
538.78
100.0%
Outstanding sh (Mil)
496.09
Value per shae
538.78
Fair value estimate
443.00
(15% discount to NAV) NAV)
Commonly used methods for determining Fair Value Value Relative Valuation Method •
An analyst chooses c hooses a target valuation multiple and uses that to value stock
•
Ex. 15X P/E, 1.5X P/BV
•
Target multiples are a re usually based on industry average, average, historical average, adjusted up or down based on EPS growth or ROE
Relative Valuation Measures P/E & EPS Growth •
P/E = Price/Earnings per share (EPS)
•
EPS = Net income to common/Outstanding shares
•
General rule: Companies with higher EPS growth deserve to trade at higher P/E
Relative Valuation Measures Example •
Which stock looks cheap? c heap?
•
Which stock looks expensive? expensive?
•
Company B looks cheap
•
Company D looks expensiv expensive e
Company
EPS Growth
P/E
A
10%
10.0
B
20%
8.0
C
15%
12.0
D
8%
15.0
Relative Valuation Measures P/BV & ROE •
P/BV = Price/Book value per share (BV)
•
BV = Stockholders Stoc kholders equity/Outstanding shares
•
ROE or Return on equity
•
ROE = Net income/Stockholders equity
•
General rules: Banks are usually valued using ROE and P/BV P/BV;; Companies that deliver higher ROE deserve to trade at higher P/BV
Relative Valuation Measures Example •
Which stock looks cheap? c heap?
•
Which stock stoc k looks expensive? expensive?
Company
ROE
P/BV
A
10%
0.8
B
12%
1.4
•
Company A looks cheap
C
8%
2.0
•
Company C looks expensive
D
15%
1.7
Determining Fair Value using Relative Valuation Method Example: Relative Valuation Method •
•
If a company c ompany is expected expected to earn Php5.25 per share next year and its historical average P/E is 9X, the fair value of the stock is: •
P = P/E x EPS
•
= 9 x 5.25
•
= 47.25
If a company c ompany is expected expected to have a BV of Php15.00 Php 15.00 per share next year and its historical average average P/BV is 1.5X while it is expected to maintain an ROE of 12%, the fair value of the stock is: •
P = P/BV x BV
•
= 1.5 x 15.00
•
= 22.50
Valuation Measures
DIV Yield •
Div Yield = Dividend per share/Price
•
Salary as an investor
•
Stocks with high dividend yield are usually considered attractive for conservative investors looking for income, assuming that the company’ company’ss earnings outlook is positive
•
Most high dividend yielding stocks are utility companies with slower slower earnings grow growth th
High Dividend Yielding Stocks High Dividend Yielding Stocks* Ticker
Company
Div Yield
MER
Meralco
4.70%
SCC
Semirara
4.50%
AEV
Aboitiz Equity
3.30%
GLO
Globe Telecom
5.50%
TEL
PLDT
7.00%
*Regularly check investment guide for updates
Where to get Information
Strategy Reports Investment Guide
Strategy Repor Reports ts Discuss the factors affecting the stock market
Answer the question “Should I be bullish or bearish and why? ”
Provide suggestions on how investors investors should respond to these factors Ex. Buy aggressively; wait for pullbacks; sell
Provide an opinion on which whic h sectors and stocks stoc ks would be most affected by factors affecting the market Ex. Focus on growth growth stocks; avoid mining stocks; list of best picks pic ks
Strategy Repor Reports ts COLing the Shots •
Monthly strategy reports
•
Focused on relevant issues for the month
Philippine Market Strategy •
•
Semi-annual strategy reports Focused on longer term relevant issues (past six months, next six to twelve months)
How to find the Strategy Reports
Investment Guide The investment guide is appropriate for investors who prefer to use a “bottom up” approach A guide that provides most of the important fundamental information needed by investors on companies that are part pa rt of COL COL’s ’s coverage list Information included: •
Current stock information (Price, (Price, Outstanding Shares, Market Capitalization)
•
Recommendation (Rating, Fair Vale Estimate)
•
Earnings (Revenues, Net Income, EPS, Growth)
•
Financial Ratios (Net Margin, ROE, LTD/E)
•
Valuation (P/E, P/BV, Dividend Yield, PEG)
How to find the Investment Guide
How to use Investment Guide Most important pieces of information Market Cap COL Rating / Target Price P/E & EPS Growth P/BV & ROE Div Yield
Market Cap Market Cap or Market Mar ket Capitalization •
Price x outstanding shares
•
Measure of size
•
Important because larger companies are usually more liquid compared to smaller companies
•
Liquid stocks can be easily ea sily bought or sold, size of portfolio will not be a problem
•
Ex. Ayala Land vs. Vista Land
COL Rating Rating / Target Price COL Rating / Target Price •
Analyst recommendation on the stock, either BUY, BUY, SELL or HOLD
•
Determined by estimating the fair value of a company in light of its future earnings potential (evaluation of earnings growth outlook and valuation)
Two types of stocks generally earn a “BUY” rating in our Investment Guide
Earnings Valuation
Up
Down
Cheap
BUY (Type 1)
BUY (Type 2)
Expensive
HOLD
SELL
Cheap Stocks with growing earnings Type 1: This type of stock usually trades at low relative P/E despite high
EPS growth, or low relative P/BV despite high ROE; upside to the target price is high
This is the most preferred type of stock stoc k to buy
Ex. DMCI (2009), ICTSI (2005), Security Bank (2005)
Cheap Stocks with growing earnings valuations, but earnings Type 2: This type of stock trades at very attractive valuations, are usually weak in the short term
Ex. Semirara (SCC), Philippine market (2008)
There are pros and cons in buying this type of stocks stoc ks
Cheap Stocks with growing earnings Pros: •
Earnings weakness usually only short term in nature •
Ex. Demand drops due to cyclical reasons such as bear market, mar ket, high raw material prices, negative impact of weather disturbances, temporary delays in operations
•
Valuations are usually very attractive (significant upside to fair value estimate)
•
Can be accumulated over a long period of time
Cheap Stocks with growing earnings Cons: •
Prices might take a while to recover
•
Negative news news flow might lead to further drop in share prices in the short term ter m
•
Actual developments could be much m uch worse than expected (ex. Cebu Cebu Pacific)
Using the Invest Guide
Step 1: Create a shortlist of stocks to buy •
Ex. List down all the stocks stoc ks that have a BUY rating and still have an upside potential of >20%
Step 2: Diversify •
Choose companies that belong to different sectors
•
Ex. One property stock, stoc k, one bank, one power, power, etc.
Using the Invest Guide Step 3: Determine your preferences •
•
•
Growth, value or income •
Growth – high EPS growth
•
Value – high capital appreciation potential, low P/E, low P/BV
•
Income - high dividend yield
Liquidity •
Active traders with large portfolio – go for larger market cap stocks
•
Long term investors – can invest in smaller market cap stocks
Names •
Major shareholders (Ayala, Aboitiz, Sy, Gokongwei, MVP, etc.)
•
Brands (Jollibee, SM, Meralco, etc.)
Using the Invest Guide Step 4: Validate your preferences •
Questions that you need to answer: •
What does the company do?
•
How does it generate profits? If it has numerous lines of business, how how are revenues/oper revenues/operating ating profits broken down?
•
Who are its major shareholders?
•
What is its earnings track record?
•
What are the drivers of future earnings growth?
•
Does the company have the resources to execute its growth growth plans?
•
By how much muc h will earnings ear nings grow in the next next few years?
•
Is there anything that I should be worried about?
How to find the Company Snapshots
How to find the Company Snapshots
Example:
Company Snapshot of SM Prime
How to find the Company Reports
Analyzing stocks that are not part of COL’s average list •
Questions that you need to answer: •
•
What does the company do? How does it generate profits? If it has numerous lines of business, how how are revenues/oper revenues/operating ating profits broken down?
•
Who are its major shareholders? What is their reputation?
•
What is its earnings track record?
•
What are the drivers of earnings growth?
•
Does the company have the resources to execute its growth growth plans?
•
By how much muc h will earnings ear nings grow in the next next few years?
•
Is there anything that I should be worried about?
•
Is the company’s valuation cheap or expensive relative relative to the market and its peers?
Sources Sourc es of Inf Information ormation PSE Website •
Focus on company disclosure, disclosure, especially 17A (annual report) and 17Q (quarterly report)
Company Website •
Learn more about what the company does
•
Sometimes, the company would have press releases, presentations available available
Newspaper Reports
How to Stay Updated Continuously read COL research products Morning notes •
Summary of important impor tant news that could affect the market or certain stocks updated on a daily basis
•
Also include new reports on stocks stoc ks that we cover (updates, or analysis of the impact of new developments on profitability profitability and valuation, change in recommendation)
•
New buy or sell ideas are shared
Weekly Strategy reports
Appendix
Definition of Financial Terms Market Cap or Market Mar ket Capitalization •
Market Cap = Price x Outstanding shares
•
Measure of size
•
Usually,, larger companies are more liquid (easier to buy and sell) Usually
EPS or Earnings Ear nings Per Per Share •
EPS = Net income/Outstanding shares
P/E = Price/ EPS •
The lower the better, better, although companies with higher EPS growth can justify trading at higher P/E
Definition of Financial Terms PEG = P/E ÷ EPS Growth •
•
Although technically tec hnically flawed, it is commonly used as a short s hort cut way to make P/E comparable to gro growth wth The lower the better
Div Yield or Dividend Yield •
Div Yield = Dividend per share/Price
•
Similar to interest on deposits, the higher the better
Definition of Financial Terms P/BV or Price to Book Value •
BV = Stockholders Stoc kholders equity/Outstanding shares
•
P/BV = Price/BV
•
Commonly used in valuing banks
•
The lower the better, better, although companies with higher ROEs can justify higher P/BV
ROE or Return on Equity •
ROE = Net income/Stockholders equity
•
The higher the better
Definition of Financial Terms Net Profit Margin = Net income/Rev income/Revenues enues •
The higher the better
CFO or Cash Flow from Operations •
•
CFO = Net income + Depreciation and other non cash expenses (income) – Change in working capital Has to be positive
LTD/E or Long Term Debt to Equity Ratio •
LTD/E = Long term debt/Stockholders equity
The lower, lower, the more conservative; Should be compared to other peers in the industry •
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