Monday 2 November 2015

IPO Analysis

  1. "Read the offer document carefully" is a joke! It's a document with more than 100 pages.
  2. Focus on what's important. The game is anyways stacked against you (in most cases).
    1. Key Risk which the business & industry faces - it's easy to miss this segment in a bull market when IPO "promise" listing gains.
    2. Some risk are meaningful - incurred losses, the debt level, etc.. - avoid buying business that carry big risk.
    3. You can get good insights about the business if you dig deep and read.
    4. Understanding the industry - it is equally important as understanding the business.
      1. Market Overview - Statistic \ Market Structure \ Market Size
    5. Understand the business 
      1. When it start operate?
      2. Who is the customer?
      3. What's the target segment?
    6. Key Shareholding info prior to the IPO
    7. How the company use the IPO money? How many years it will take to spend IPO money?
      1. Business Growth Related
      2. Balance Sheet Related  (e.g. repayment of pass debt) 
    8. Basic of issue price - often, there is no basis for the offer price, but they still have to mention something.
    9. The management - people who run the show
    10. Financial Statement
      1. Read the balance sheet as you would do of any listed company, except Equity & Borrowings when the company will be repaying part of its borrowings using the money raised through the IPO
      2. Calculate the key ratios like D/E, current ratio, Receivables Days, Inventory Days, Payables Days, Cash Conversion Cycle, etc and compare with a listed peer.
      3. Income Statement - calculate key ratios like sales growth, gross margins, pbt growth & margins, interest coverage, net profit growth & margin... and compare it with a listed peer
      4. Cash Flow Statement - check if company is generating cash from operations. OCF/Sales can be a useful ratio to compare with a listed peer.
  3. Other key note
    1. The "base rate" of making money (even in the long run) is low, so be very careful and understand clearly if the business is worth buying into.
    2. Most IPOs are high on propaganda. Avoid that and focus on the important info about the business that lies inside the IPO document.
    3. Ask
      1. Why is the company raising money? Is it to fund future growth, pay off past loans, or to give exit to other investors?
      2. If the business is incurring losses, how does the management plans to make it profitable in the future (and if profit is really part of the plan)?
      3. In the absense of profits, how would you justify the IPO price? How does it look on P/B value vis-a-vis its listed peers?
      4. How does the company stack against is listed peers (if any)?
      5. What's been the management's track record and promoter's history?
      6. Is the promoter also involved in other related / unrelated business? If yes, why?
      7. Does the company really have growth potential and/or competitive advantage against peer as the IPO document may suggest?
      8. Does the management have a good capital allocation record, and how prudent have they been on this front?
      9. Do you understand the business and its potential after reading the IPO document, or are you suffering from "Oh, it's an IPO!" syndrome?
      10. If this was as already listed business and everything else remains same - like financial performance - would you buy?

And, what's the great guru says about an IPO?
[An] intelligent investor in common stocks will do better in the secondary market than he will do buying new issues…[IPO] market is ruled by controlling stockholders and corporations, who can usually select the timing of offerings or, if the market looks unfavourable, can avoid an offering altogether. Understandably, these sellers are not going to offer any bargains, either by way of public offering or in a negotiated transaction. - Warren Buffett
An IPO is like a negotiated transaction – the seller chooses when to come public – and it’s unlikely to be a time that’s favorable to you. So, by scanning 100 IPOs, you’re way less likely to find anything interesting than scanning an average group of 100 stocks. - Warren Buffett

It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors). - Warren Buffett 

Our one recommendation is that all investors should be wary of new issues—which means, simply, that these should be subjected to careful examination and unusually severe tests before they are purchased. There are two reasons for this double caveat. The first is that new issues[IPO] have special salesmanship behind them, which calls therefore for a special degree of sales resistance. The second is that most new issues are sold under “favorable market conditions”—which means favorable for the seller and consequently less favorable for the buyer. - Benjamin Graham

It is entirely possible that you could use our mental models to find good IPOs to buy. There are countless IPOs every year, and I’m sure that there are a few cinches that you could jump on. But the average person is going to get creamed. So if you’re talented, good luck. - Charlie Munger


It’s safe to conclude that IPOs, which seem like a good investment vehicle are, in reality, not so. In fact an IPO is a product which is against investor interest, as it is mostly offered to investors when they are willing to pay a higher and outrageous valuation in boom times. - Parag Parikh

Any kind of rational comparison of long-term returns in the IPO market and the secondary market would show that investors do far better in the latter than in the former…IPOs are one of the surest way of losing money in the long run.

Four characteristics of the IPO market makes it a market where it is far more profitable to be a seller than to be a buyer. First, in the IPO market, there are many buyers and a only a handful of sellers. Second, the sellers, being insiders, always know more about the company whose shares are to be sold, than the buyers. Third, the sellers hold an extremely valuable option of deciding the timing of the sale. Naturally, they would choose to sell only when they get high prices for the shares. Finally, the quantity of shares being offered is flexible and can be “managed” by the merchant bankers to attain the optimum price from the sellers’ viewpoint.

But, what is “optimum” from the sellers’ viewpoint is not the “optimum” from the buyers’ viewpoint. This is an important point to note: Companies want to raise capital at the lowest possible cost, which from their viewpoint means issuance of shares at high prices. That is why bull markets are always accompanied by an surge in the issuance of shares. - Prof. Sanjay Bakshi
References:-

KLSE - Financial Data (Free)

Fundmental investors like me love to look at the company's financial results to make an investment decisions. It is because I believe "History doesn't repeat but it does rhyme." and "In the business world, the rearview mirror is always clearer than the windshield."

In order to perform a thorough analysis on the financial statement, I not only read one or two year of the results, but I prefer to take at least 5 years (and preferable 10 years) as input.

But, before I download the annual report to dig out the result 1 by 1. Below is some of the good tools that can help me to take a peek on the result before I decided to jump into details.
 I am using PADINI (7052) to retrieve its financial information from various website.
  1. Morning Star
    1. http://financials.morningstar.com/income-statement/is.html?t=7052&region=mys&culture=en-US
    2. Replace padini stock code - 7052 with the company you want 
    3. Or, google  "<Company Name> morningstar quote"
    4.  It provide 5 years financial data (the data can be exported to CSV), and you can pay USD199 a year for full 10 years data. 
  2.  klse.my
    1.  Annual Result - http://www.klse.my/stock/result/qr/annualResultUnaudited/7052.jsp#stockDetailDiv - 10 Year Financial Data
    2.  Quarter Result - http://www.klse.my/stock/result/qr/quarter/7052.jsp#stockDetailDiv
    3. Financial Overview - http://www.klse.my/stock/result/financial/7052.jsp#stockDetailDiv
    4. Replace padini stock code - 7052 with the company you want 
    5. Or, key in your company name on the "Search Stock" box on top right
      1. Choose the stock from the "Search Stock" dropdown
      2. Select the information you want under the Financial Menu under the stock page.
  3. ft.com
    1. http://markets.ft.com/research/Markets/Tearsheets/Financials?s=PADINI:KLS&subview=BalanceSheet
    2.  Replace padini with the company you want 
    3. It provide 3 years financial data
  4. reuters.com
    1. http://www.reuters.com/finance/stocks/incomeStatement/detail?stmtType=INC&perType=ANN&symbol=PDNI.KL
    2. It provide 5 years financial data
    3. You need to create an account (free of charge)
    4.  Key in your company name on the "Search Stock" on the web page to change company
  5. wsj.com
    1. http://quotes.wsj.com/MY/XKLS/PADINI/financials
    2. It only provide the recent year data

If I want to perform a detail research, I will  download the annual report and start to extract the data to my excel template for further study.

## To get the annual report for a company, one can get it from bursa announcement, but I prefer to get it from klse.my stock's Annual result page where it will show me list of annual report in a table format. E.g. http://www.klse.my/stock/result/annual/7052.jsp#stockDetailDiv (as usual, replace padini stock code - 7052 with the company you want).

Padini Annual Report

Monday 5 October 2015

How Buffett Interprets the Cash Flow Statement

  • Capital Expenditures
    • Never invest in telephone companies because of big capital outlays 
    • Important: company with durable competitive advantage uses a smaller portion of earnings for capital expenditure for continuing operations than those without. 
    • To compare capex to net earnings, add up total capex for ten-yr period and compare with total net earnings over the same period 
    • Important: if historically using less than 50%, then good place to look for durable competitive advantage. If less than 25%, probably has a competitive advantage.
The Cash Flow Statement Summary Table
Capital Expenditureshistorically using
< 50% then good place to look for d.c.a.
< 25% probably has d.c.a.
Add up total cap exp for ten-yr period and compare
w/ total net earnings over period.
Stock Buybacksindicator of d.c.a. is a history of repurchasing/retiring its sharesLook at cash from investment activities. “Issuance
(Retirement) of Stock, Net”
 Read more on the Cash Flow Statement Analysis  on my previous post - http://intelligentinvestor8.blogspot.my/2014/06/cash-flow-statement-analysis.html

Or, take a look on How Buffett read other financial statements:-

References:-

How Buffett Interprets the Balance Sheet

  • Cash and Equivalents:  
    • A high number means either:
    1. The company has competitive advantage generating lots of cash 
    2. Just sold a business or bonds (not necessarily good)
    3. A low stockpile of cash usually means poor to mediocre economics. 
    •  There are 3 ways to create large cash reserve. 
      1. Sell new bonds or equity to public 
      2.  Sell business or asset 
      3.  It has an ongoing business generating more cash than it burns (usually means durable competitive advantage)
    • When a company is suffering a short term problem, Buffett looks at cash or marketable securities to see whether it has the financial strength to ride it out. 
    • Important: Lots of cash and marketable securities + little debt = good chance that the business will sail on through tough times.
    • Test to see what is creating cash by looking at past 7 yrs of balance sheets. This will reveal how the cash was created.
  • Inventory
  • Manufacturers with durable competitive advantages have the advantage that the products they sell do not change, and therefore will never become obsolete. Buffett likes this advantage.
  • When identifying manufacturers with durable competitive advantage, look for inventory and net earnings that rise correspondingly. This indicates that the company is finding profitable ways to increase sales which called for an increase in inventory.
  • Manufacturers with inventories that spike up and down are indicative of competitive industries subject to boom and bust.
  • Net Receivables 
    • Net receivables tells us a great deal about the different competitors in the same industry. 
    • In competitive industries, some attempt to gain advantage by offering better credit terms, causing increase in sales and receivables.
    • If company consistently shows lower % Net receivables to gross sales than competitors, then it usually has some kind of competitive advantage which requires further digging.
  • Property, Plant & Equipment
  • A company with durable competitive advantage doesn’t need to constantly upgrade its equipment to stay competitive. The company replaces when it wears out. 
  • On the other hand, a company without any advantages must replace to keep pace.
  • Difference between a company with a moat and one without is that the company with the competitive advantage finances new equipment through internal cash flows, whereas the no advantage company requires debt to finance.
  • Producing a consistent product that doesn’t change equates to consistent profits. There is no need to upgrade plants which frees up cash for other ventures. Think Coca Cola, Johnson & Johnson etc.
  • Goodwill
    • Whenever you see an increase in goodwill over a number of years, you can assume it’s because the company is out buying other businesses above book value. 
    • GOOD if buying businesses with durable competitive advantage.
    • If goodwill stays the same, the company when acquiring other companies is either paying less than book value or not acquiring. Businesses with moats never sell for less than book value.
  • Intangible Assets
  • Intangibles acquired are on balance sheet at fair value.
  • Internally developed brand names (Coke, Wrigleys, Band-Aid) however are not reflected on the balance sheet.
  • One of the reasons competitive advantage power can remain hidden for so long.
  • Total Assets & Return on Total Assets
  • Measure efficiency using ROA
  • Capital is barrier to entry. One of things that make a competitive advantage durable is the cost of assets needed to get in. This is why we calculate the Asset Reproduction Value along with the EPV.
  • Many analysts argue the higher return the better. Buffett states that really high ROA may indicate vulnerability in the durability of the competitive advantage.
  • E.g. Raising $43b to take on KO is impossible, but $1.7b to take on Moody’s is. Although Moody’s ROA and underlying economics is far superior to Coca Cola, the durability is far weaker because of lower entry cost.
  • Current Liabilities
    • Includes accounts payable, accrued expenses, other current liabilities and short term debt.
      • Stay away from companies that ‘roll over the debt’ e.g. Bear Stearns
    • When investing in financial institutions, Buffett shies from those who are bigger borrowers of short term than long term debt.
      • His favorite ‘Wells Fargo’ has 57 cents short term debt for every dollar of long term
      • Aggressive banks (like Bank of America) has $2.09 short term for every dollar long term
    • Durability equates to the stability of being conservative.
  • Long Term Debt coming Due
    • Some companies lump their yearly long term debt due with short term debt on the balance sheet. This makes it seem like there is more short term debt than the real amount. 
    • Important: Companies with durable comparable advantages need little or no LT debt to maintain operations. 
    • Too much debt coming due in a single year spooks investors and can offer attractive entry points.
    • However, a mediocre company in problems with too much debt due leads to cash flow problems and certain bankruptcy.
  • Long Term Debt
  • Buffett says that durable competitive advantages carry little to no LT debt because the company is so profitable that even expansions or acquisitions are self financed.
  • We are interested in long term debt load for the last ten years. If the ten yrs of operation show little to no long term debt, then the company has some kind of strong competitive advantage.
  • Buffett’s historic purchases indicate that on any given year, the company should have sufficient yearly net earnings to pay all long term within 3 or 4 year earnings period. (e.g. Coke + Moody’s = 1yr)
  • Companies with enough earning power to pay long term debt in less than 3 or 4 years is a good candidate in our search for long term competitive advantage. 
    • BUT, these companies are targets for leveraged buy outs, which saddles the business with long term debt
    • If all else indicates the company has a moat, but it has ton of debt, a leveraged buyout may have created the debt. In these cases the company’s bonds offer the better bet, in that the company’s earnings power is focused on paying off the debt and not growth. 
  • Important: little or no long term debt often means a Good Long Term Bet
  • Total Liabilities & Debt to Shareholders Equity Ratio
  • Debt to shareholders equity ratio helps identify whether the company uses debt or equity (includes retained earnings) to finance operations.
  • Company with a moat uses earning power and should show higher levels of equity and lower level of liabilities.
  • Debt to Shareholders Equity Ratio : Total Liabilities / Shareholders Equity
  • Problem with using as identifier is that economics of companies with durable competitive advantages are so great they don’t need large amount of equity or retained earnings on the balance sheet to get the job done. 
  • Important: if the Treasury Share Adjusted Debt to Shareholder Equity Ratio is less than 0.8, the company has a durable competitive advantage.
  • Retained Earnings: Buffett’s Secret
  • One of the most important indicators of durable competitive advantage. Net earnings can be paid out as dividends, used to buy back shares or retained for growth.
  • If the company loses more than it has accumulated, retained earnings is negative.
    • If a company isn’t adding to its retained earnings, it isn’t growing its net worth.
    • Rate of growth of retained earnings is good indicator whether it’s benefiting from a competitive advantage.
    • Microsoft is negative because it chose to buyback stock and pay dividends
    • The more earnings retained, the faster it grows and increases growth rate for future earnings.
  • Treasury Stock
    • Carried on the balance sheet as a negative value because it represents a reduction in shareholders equity.
    • Companies with moats have free cash, so treasury shares are hallmark of durable competitive advantages.
    • When shares are bought back and held as treasury stock, it is effectively decreasing the company equity. This increases return on shareholders equity.
    • High return is a sign of competitive advantage. It’s good to know if it’s generated by financial engineering or exceptional business economics or combination.
    • To see which is which, convert negative value of treasury shares into a positive and add it to shareholders equity. Then divide net earnings by new shareholders equity. This will give the return on equity minus effects of window dressing.
  • Important: presence of treasury shares and a history of buyback are good indicators that company has competitive advantage
The Balance Sheet Summary Table
To continue seeing the full summary tables for the balance sheet and cash flow statement, just click any of the social buttons to unlock the content immediately.
Cash and Equivalentslots of cash and marketable securities + little debtTest to see what is creating cash by looking at past 7 yrs of balance sheets
InventoryLook for an inventory and net earnings that are on a corresponding riseinventories that spike up/down are indicative of  competitive industries prone to (boom/bust)
Net Receivablesconsistently shows lower % net receivables to gross sales than competitorsd.c.a. no need to offer generous credit
Goodwillincrease in goodwill over number of years assume because company out buying companies >BVd.c.a.’s never sell for less than BV
LT Investmentscan have valuable assets on books at valuation < market price (booked at lowest price)tells us about investment mindset of management
(Looking for d.c.a.?)
Intangible AssetsInternally developed brands not reflected on BS
Total Assets + ROA
(Measure efficiency using ROA)
Higher return the better (but: really high ROA may indicate vulnerability in durability of c.a.)Capital = barrier to entry
ST Debtfinancial institutions. Buffett shies from those who are bigger borrowers of ST than LT debt
LT Debt Dued.c.a. need little or no LT debt to maintain operations
Total CL + Current Ratiohigher the ratio, the more liquid, the greater its ability to pay CLd.c.a.’s don’t need ‘liquidity cushion’ so may have <1
LT DebtLT debt load for last ten yrs. ten yrs w/ little LT debt = d.c.a.earning power to pay their LT debt in <3/4 yrs = good candidates
Total Liabilities + Treasury Share-Adjusted debt to Shareholder Eq Ratio If <.80, Good chance company has d.c.a.
Preferred + Common Stock in search for d.c.a. we look for absence of preferred stock
Retained Earnings Rate of growth of RE is good indicator
Treasury Stockpresence of treasury shares and a history of buyback are good indicators that company has d.c.a.convert –ve value of treasury shares into +ve and add shareholder eq.
Divide net earnings by new shareholders eq. give us return on equity minus dressing.
Return on Shareholder equityd.c.a. show higher than average returns on shareholders equityIf company shows history of strong net earnings, but shows –ve sholder equity, probably d.c.a. because strong companies don’t need to retain
Read more on the Balance Sheet Analysis  on my previous post - http://intelligentinvestor8.blogspot.my/2014/05/balance-sheet-analysis.html

Or, take a look on How Buffett read other financial statements:-

References:-

How Buffett Interprets the Income Statement

It is important to investigate further & drill down to detect what the quality of earnings are made up of and what the numbers intepret.

  • Gross Profit Margin: firms with excellent long term economics tend to have consistently higher margins
  • Durable competitive advantage creates  a high margin because of the freedom to price in excess of cost
  • Greater than 40% = Durable competitive advantage
  • Less than 40% = competition eroding margins
  • Less than 20% = no sustainable competitive advantage
  • Consistency is key 
  • Sales Goods and Administration: Consistency is key. Companies with no durable competitive advantage show wild variation in SG&A as % of gross profit
  • Less than 30% is fantastic
  • Nearing 100% is in highly competitive industry
  • R&D: if competitive advantage is created by a patent or tech advantage, at some point it will disappear.
  • High R&D usually dictates high SG&A which threatens the competitive advantage
  • Depreciation: Using EBITDA as a measure of cash flow is very misleading
    • Companies with durable competitive advantages tend to have lower depreciation costs as a % of gross profit
  • Interest Expenses: Companies with high interest expenses relative to operating income tend to be either: 1) in a fiercely competitive industry where large capital expenditure required to stay competitive 2) a company with excellent business economics that acquired debt in leveraged buyout
  • Companies with durable competitive advantages often carry little or no interest expense.
  • Warren’s favorites in the consumer products category all have less than 15% of operating income.
  • Interest expenses varies widely between industries.
  • Interest ratios can be very informative of level of economic danger. 
  • Important: In any industry, the company with the lowest ratio of interest to Operating Income is usually the one with the competitive advantage.
  • Net Earnings
  • Look for consistency and upward long term trend.
  • Because of share repurchase it is possible for net earnings trend to differ from EPS trend.
  • Preferred over EPS
  • Durable competitive advantage companies report higher % net earnings to total revenues. 
  • Important: If a company is showing net earnings history greater than 20% on total revenues, it is probably benefiting from a long term competitive advantage.
  • If net earnings is less than 10%, likely to be in a highly competitive business

The Income Statement Summary Table
(DCA = Durable Competitive Advantage)Comments
Gross Profit Margin>40% = D.C.A.
< 40% = competition eroding margins
< 20% = no sustainable competitive
advantage
Consistency is Key
SG&A
(SGA as % of gross profit)
< 30% is fantastic
Nearing 100% is in highly competitive
industry
Consistency is Key
Depreciation
(depreciation costs as a % of gross profit)
Company with moat tend to have lower %
Interest Expenses
(interest expenses relative to
operating income)
Durable competitive advantages carry little
or no interest expense.
Buffett’s favorite consumer products have
<15%
Company with lowest ratio of interest to Operating
Income = competitive advantage.
Varies widely between industries.
Net Earnings
(% net earnings to total
revenues)
Net earnings history >20% = Long Term
moat
< 10% = in highly competitive business
consistency and upward LT trend
 EPS10-year period showing consistency and
upward trend.
Avoid erratic earnings pictures.
Consistency = sign products don’t need to change.
Upward trend = strong

Read more on the Income Statement Analysis  on my previous post - http://intelligentinvestor8.blogspot.my/2014/05/income-statement-analysis.html

Or, take a look on How Buffett read other financial statements:-

References:-

Tuesday 1 September 2015

Buying Good Companies when the price is cheap.....

Emily suggested to buy good companies when the price is cheap.....



I think companies that met following condition might be a good candidates..
- Good Companies - ROE >= 15, Net Profit Margin >= 15
- Cheap? P/E <=8, P/NAPS <= 1.5, DY >= 3%

http://www.klse.my/stock/screener.jsp?Type=S&T4QROE-1=15&T4QNPM-1=15&T4QPEPS-2=8&T4QPNAPS-2=1.5&LFYDY-1=3



http://www.klse.my/stock/screener.jsp?Type=S&T4QROE-1=15&T4QNPM-1=15&T4QPEPS-2=8&T4QPNAPS-2=1.5&LFYDY-1=3