Most Basic and Conservative (probably) Way of Valuing a Company

This may contain many pictures for discussion purposes. Simple math knowledge is needed.

If you have read this before scroll down to the last part and read through the ADDENDUM for updates made on 9/19/2015.

Start

Seeking the value of a company may be a struggle depending on the person looking for it. It can be some form of trying to solve a maze or a math problem too-elementary math that is.

One may rely on drawings (technical analysis) and put most, if not, all his savings in that drawing; others may decide for themselves and learn more about the company their interested in. If not satisfied with the company of interest, then you’d learn to move on.

Anyhow, so much for lecturing.

Seth Klarman (The Baupost Group, a $6 Billion hedge fund-world’s 11th largest) once said, “Since investors cannot predict when values will rise or fall; valuation should always be performed conservatively, giving considerable weight to worst-case liquidation value as well as to other methods.”

I assumed (after studying and applying most technical drawings etc. for years) that NO ONE can predict the market price tomorrow, the following two days, the following month, etc. Only upon through mergers and acquisitions (M&A) that a specific market price may reflect and catch the spread (difference between the offer price and market price) depending on the date of execution (this may be another worthy article) and other contributory aspects of the deal, unless the deal itself fell through the cracks.

Anyhow, never mind all that.

If you can predict and can prove to anyone that you had been consistently able to predict the market price of any company, bond, gold price, etc. in any given point of time requested, then STOP READING this article. Maybe you can set up your own hedge fund and get the smart money to invest with you.

There are plenty of ways in seeking the valuation of a company.

Terms are also interchangeable: fair value, intrinsic value, discounted cash flow value, (author’s name) value, Graham’s number, and the list goes on. For simplicity, we will use valuation/value in this article/blog.

What we’ll use is the price to earnings (PE) way of valuing a company.

I’m sharing this as this is what I use most of the time, there may be tweaking here and there when I use it, but generally this is the most basic and conservative (probably) of all the methods I have encountered so far.

What do we need to get this value of the company?

  1. The company’s current market price (MP)
  2. The company’s earnings per share (EPS)
  3. An assumed number (we’ll discuss this later).

First, MP.

In the Philippines, a person can easily find the PE ratio in the website (http://pse.com.ph/stockMarket/home.html) or from Bloomberg website.

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Type in the company’s name then search (For simplicity, we’ll just use the first company listed in the All shares index and that is the 2GO Group (2GO).

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Now, you get the MP from the Last Trade Price. Interestingly PSE already provided its PE ratio at 25.

On our checklist,

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There are two ways in finding the EPS of a company. One is the easy way (calculator), the other one is looking it up from company filings.

First the ‘hard’ way, go to (http://edge.pse.com.ph/)

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Look for the company’s filings.

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You can then easily browse through the company’s description to get a better understanding of its operation.

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Next, go to Financial reports. Yes, you are now an ‘expert’ =)

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Now, you are finally able to get the company’s EPS for this year’s and previous’.

That had a lot of mouse clicks in it, right?

Other (easier) way to figure it out is pulling up your computer’s calculator and simply solve for EPS from the already given values of PE and MP.

This is the Formula:

Price over earnings equals PE.

Ergo, with given

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This is the formula to solve for the EPS.

8.5 divided by EPS equals 25.

Simple transposition (or whichever term the elementary math teacher’s use). Solving for X (EPS), results into the following:

8.5 divided by 25 equals EPS.

So, EPS is 0.34.

Scroll up, it’s almost the same with company’s report-just differs with 0.01 cent. I wouldn’t care for such a small discrepancy, would you?

Now we have,

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There’s no stopping you figuring out what’s the most simple/conservative way of figuring out a company’s value once you have the EPS number. Because the only thing left that we need to figure out is the ASSIGNED NUMBER. This is usually called the Multiple.

You’d hear this often in Bloomberg or CNBC or whichever you tune in to to get your daily news. Pundits would state, “the current price of Netflix is trading at 220 multiples of its earnings.”

This just means that, if you multiplied (hence multiple) 220 to Netflix’s EPS, you’d get its current price. Let’s sidetrack for a little bit and apply the elementary math on Netflix. (http://www.bloomberg.com/quote/NFLX:US)

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Solving:

Price divided by EPS equals PE

Price divided by 0.44 equals 220.

So, when solving for Price, we should (transpose) 0.44 and multiply it with 220.

Price equals 0.44 x 220.

Price = $96.8 per share

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Almost the same, right?

Now,

What is the assigned number/multiple??

YOU’RE THE ONE WHO WOULD GIVE THAT NUMBER.

YES, you decide what MULTIPLE you’d give a company.  It can be 1, 2, 3, 4, 5, heck 220 for NETFLIX—which I say is just RIDICULOUS.

Personally, I use the numbers between 10 and 15.

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A reminder, if you have your OWN MULTIPLE, you will be able to figure out at what MP the company SHOULD be trading before you PRESS YOUR BUY BUTTON. Or at least, you have performed your research about the company and gave you a compelling conclusion that it is worthy of your investment.

Benjamin Graham (professor of Warren Buffett in business school) was not comfortable buying company/ies with multiples more than 15. Ergo, I personally set a range of 10 to 15.

Let’s do this in MS EXCEL (best tool an investor could have and it’s free-I think).

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Now, this states that the current price of 2GO 8.50 is OVERPRICED in the most conservative terms and speaking in multiples. If you average these market prices you’d get 4.25 Peso per share.

So, how much overvalued? 100% OVERVALUED.

Should you buy 2GO? It depends on you. If you think the company will grow its earnings, continues to run with excellent management, etc. (this would take another article). Then, maybe its market price would then catch up to its earnings (considering other aspects of its business runs well) *I have not assessed 2GO’s management etc. and just used it as an example in this article.

But as was stated in my previous article, “As of June 19, 2015, the forward-PE ratio of the top 30 companies of the Philippine composite is at 19.5. The Philippine composite is considered the third most expensive stock exchange in the world.” (https://perennialinvesting.wordpress.com/2015/09/07/maxs-or-jollibee-which-is-better/)

So, if we use the 19.5 multiple with 2GO’s earnings of just 0.34 cents we get a 6.63 peso/share market price. Giving a 28.21% premium or overvaluation to today’s market price of 8.50. Are you willing to pay that 28.21% premium just to have 2GO in your portfolio?

Remember, the 19.5 is the multiple (average) of the top 30 companies and currently 2GO is at 25 multiple (scroll up). My unsolicited advice is, at least if you would not want to be too much conservative with the 10 to 15 multiple, at least find a company that has less than the current market multiple a country has. That would be less than 19.5 for the Philippines and less than 19.76 for U.S (I used S&P 500’s current multiple, and not DJIA).

In some similar and hypothetical aspect, are you willing to pay 25.64 pesos for a 1.5 Liter Coke Bottle whereby you can find a 20 peso deal in another store (28.21% premium)?

Now,

What are your limitations for the numbers to be used as multiple? NONE. For fun, try NETFLIX’s multiple of 220.

220 times 0.34 equals 74.8 peso per share. Ha! This is exactly how NETFLIX is priced right now (220 times 0.44 earnings = $96.8/share), yet investors are buying in because of the ‘cord-cutting revolution’ that is taking place. According to Google, cord cutting is the practice of canceling or forgoing a cable television subscription or landline telephone connection in favor of an alternative Internet-based or wireless service.

Ergo, more business for NETFLIX, but is this company worth 220 times its earnings? YOU DECIDE.

Anyhow, main goal of this article was to give insights on how to conservatively value a company. I hope it made its point. If anyone would ask me at what value would I then be interested in buying NETFLIX (given it met my extensive checklist). It would be at $5.5 per share.

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Its current price of $97.51 a share is 1,672.91% over this 5.5 valuation that I have. That is why I am not touching its shares even with a 10-foot pole.

My dare for you:

Apply this simple math throughout your portfolio, see which company/ies you have overpaid and see who the undervalued ones are. Finally, you get the sense on how to value a company in the most conservative way (at least for me).

Maybe you can leave your comments here or make your own private list about your most overvalued and most undervalued company. Just for fun.

Disclosure: I do not have shares in any of the companies mentioned in this article and don’t plan to initiate purchase within the next 24 hours. I would not receive any compensation for doing this article. I am not a professional financial analyst. This is just a hobby. Lastly, my work is not error-free, but I strive for it to be. Do not consider as a buy or sell advice. Invest at your own risk.

If you are interested in this similar approach to investing and would seek updates, I wish to invite you to this Facebook group

SEEKING VALUE

(https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

A quote to go by to finish this article,

In this game, the market has to keep pitching, but you don’t have to swing. You can stand there with the bat on your shoulder for six months until you get a fat pitch.” Warren Buffett

Addendum:

(Addendum 1: sometimes you still cannot retrieve the current year’s EPS data secondary to different filing dates of the company; search in Google fiscal year for better info).

(Addendum 2: On the other hand, I prefer using the DILUTED earnings per share. According to Investopedia, Diluted Earnings Per Share (or Diluted EPS) is a performance metric used to gauge the quality of a company’s earnings per share (EPS) if all convertible securities were exercised. So being conservative, DILUTED is better to be used rather then BASIC EPS. Furthermore, EPS measures the amount of a company’s profit on a per share basis. Unlike diluted EPS, basic EPS does not take into account any dilutive effects that convertible securities have on its EPS.)

Happy investing.

Mark Y.

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MAXS or Jollibee, which is better?

Part 3

Disclosure: I do not have shares in any of the companies mentioned in this article and don’t plan to initiate purchase within the next 24 hours. I would not receive any compensation for doing this article. I am not a professional financial analyst. This is just a hobby. Lastly, my work is not error-free, but I strive for it to be.

If you are interested in this similar approach to investing I wish to invite you to this Facebook group

(https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Start

If you’ve missed my previous articles or on how I arrived with this comparison see the following links:

Part 1 Jollibee or McDonald’s shares, which is better?

(https://perennialinvesting.wordpress.com/2015/09/07/jollibee-or-mcdonalds-shares-which-is-better/)

Part 2 MCD in the Philippines, Jollibee, and the others

(https://perennialinvesting.wordpress.com/2015/09/07/mcd-in-the-philippines-jollibee-and-the-others/)

Okay, let’s dissect and compare JFC’s and MAXS’ financial numbers over the past five years (2010-2014).

Warning: these may be a lengthy discussion and may take few more minutes to digest.

Let’s start with Net Income.

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JFC clearly won this. This would trickle down when we discussed the amount of dividends returned to shareholders later.

Next, Gross Profit Margin.

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It appears that MAXS is a little bit more volatile when compared to JFC, but both are almost at par. Remember, Buffett requires >40.

Next, Operating Margin.

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MAXS clearly lags JFC’s ratio on this one.

Next, Net Profit Margin.

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JFC still > MAXS, I prefer seeing >8% (lucky number). But for the mean time, I guess JFC has this in the bag too.

Next, Return on Equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested (Investopedia).

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Buffett (in 1972) stated that he required at least 14%. MAXS was on its way, but had underformed recently.


Next, Debt to Equity ratio. The lower the better. Lesser debt is better.

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JFC is clearly a winner on this one too.

Next, Dividends paid.

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A company can provide dividends from its earnings or by borrowing outside to fund it. With net income of about 5 Billion pesos, JFC could clearly provide its shareholders more dividend than MAXS can. Nevertheless, dividends return by JFC is inconsistent and fluctuating year over year. I prersonally look for steady and increasing amount of dividend over the years so I can see that there is actual dividend growth taking place.

In summation, JFC had given 10,937 Million pesos (as dividends) to its shareholders over the past five years, while MAXS had given 194 Million pesos.

Now, should you purchase JFC shares right now? That is the tough question. I guess the right question would be, are you willing to pay the price?

Warren Buffett once said, “price is what you pay, value is what you get.”

At the current price of JFC, would you have the value you are seeking for? Or you’ve purchased a Samsung S6 Edge a day before a nation-wide sale with 30% discount off. I am not saying tomorrow or soon JFC’s market price will go into a discount from today’s price, but hopefully you understand what I’m trying to say.

According to Robert Shiller, no one can exactly predict were the market price would go, and only hindsight would prove one correct.

As of September 7, 2015 11:30 AM, JFC’s share price is at 188 pesos per share. This correponds to a PE ratio of 37.

Benjamin Graham (professor of Warren Buffett) would only purchase a company at <15 PE ratio. This means he is willing to pay less than 15 times a company’s earnings for it to be included in his portfolio.

Another good reflection about the PE ratio is that, A stock that has a P/E ratio of 15, for example, tells you that it will take 15 years of the company’s earnings at the current rate to add up to your original purchase price. See link (https://discoveroptions.com/mixed/content/education/articles/peratio.html)

As of June 19, 2015, the forward-PE ratio of the top 30 companies of the Philippine composite is at 19.5. Now, compare that with JFC’s. The Philippine composite is considered the third most expensive stock exchange in the world. See link (http://www.cnbc.com/2015/06/18/this-may-be-the-worlds-most-overpriced-market.html)

If Graham was alive today and for all the right reasons had considered whether to invest in JFC or not just by looking at the PE ratio alone. He would frankly reject this entire research I made. With PE ratio of <15 (let us say 14), JFC share price is to be at 70.7 per share.

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One may say that this is impossible! Even at 2011 levels, JFC’s market price was hovering in the 90 peso mark. Nevertheless, this is the most conservative approach in buying shares of the company. I may soon make articles about applying weighted average cost of capital or WACC approach or maybe earnings before interest, tax, depreciation and amortization or EBITDA approach on certain companies.
But, for now, I would (personally) stay away from JFC until it offers a good discount from today’s share price.

Thanks for reading. Happy investing!

Mark Y.

Part 1 Jollibee or McDonald’s shares, which is better?

(https://perennialinvesting.wordpress.com/2015/09/07/jollibee-or-mcdonalds-shares-which-is-better/)

Part 2 MCD in the Philippines, Jollibee, and the others

(https://perennialinvesting.wordpress.com/2015/09/07/mcd-in-the-philippines-jollibee-and-the-others/)

If you are interested in this similar approach to investing I wish to invite you to this Facebook group

(https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

MCD in the Philippines, Jollibee, and the others

Part 2

Disclosure: I do not have shares in any of the companies mentioned in this article and don’t plan to initiate purchase within the next 24 hours. I would not receive any compensation for doing this article. I am not a professional financial analyst. This is just a hobby. Lastly, my work is not error-free, but I strive for it to be.

If you are interested in this similar approach to investing I wish to invite you to this Facebook group

(https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Start

Seeking financial information for McDonald’s (MCD) operation in the Philippines can be tricky. MCD operations in the Philippines is being run by two companies. These two companies are the Alliance Global Incorporation (AGI) with 44% and by the Golden Arches Development Corporation (GADC) with 56% ownership.

There are over 408 (as of 2013’s annual report) MCD restaurants in the Philippines compared to Jollibee’s (JFC) 2,301. Thus, MCD-Philippines would definitely be overshadowed by JFC’s revenue and net income numbers.

With the aforementioned information, it is definitely not enticing to invest in AGI just to have ‘some’ exposure in the MCD operation in the Philippines. AGI is a conglomerate. It owns several other companies that would reflect in its consolidated financial statements. See this AGI’s 2013 annual report to see the breakdown of its companies (http://www.allianceglobalinc.com/Portals/0/pdfs/AGI2013-AR-FINAL.pdf).

For fun, on August 20, 2014, GADC (56% owner of MCD in the Philippines) reported a 15.25% decline in net profit for the first six months to 322 Million pesos. That would be roughly 644 Million pesos for MCD Philippines while JFC had 5,362 Million pesos that FY year.

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(CORRECTION: GADC has 56% ownership that represents the 644 Million net profit, upon estimation with AGI’s 44%, total net profit should be at 1,150 Million or see chart)

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Okay, I guess MCD does not have that much clout in the Philippines as I had initially assumed. Maybe I can now safely assume that Pinoys do really want their Chickenjoys over Big Macs. Maybe that’s why I also had to pay ‘premium’ price just to have its 2 piece chicken for dinner priced at $6.99 when in a trip in LA, CA.

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I tried to find what company/ies would be good to compare JFC with given its dominance in the Philippines’ fast food industry. This led me to Max’s Group Incorporated (MAXS). (Unless provided with better company to compare with).

A review, as of December 31, 2014, JFC operated 2,301 restaurants in the country under the brands Jollibee, Chowking, Greenwich, Red Ribbon, Mang Inasal and Burger King.

MAXS, on the other hand, has more brand/restaurants under its name. These are Max’s Restaurant, Pancake House, Dencio’s, Kabisera ng Dencio’s, Teriyaki Boy, Sizzlin’ Pepper Steak, Le Coeur De France, Maple, Yellow Cab, Krispy Kreme, Jamba Juice, and The Chicken Rice Shop.

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Max’s restaurant started to open its first store in Quezon City, Philippines in 1945. Yup, older than JFC and MCD. JFC started in 1978, while MCD started serving its first customers in 1955.

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In addition to these facts, the Max’s restaurant has only 159 stores nationwide as of 2014. Looking at its 2014 annual report, information revealed that the MAXS group had a total of 542 stores in operation nationwide. This is only 23.55% of JFC’s 2,301 stores in the Philippines. Talk about JFC’s dominance.

Although JFC appears to be aesthetically better than MAXS, an investor would be interested in learning the value behind each company.

Sadly, this will end part 2’s article. Click on Part 3 to see comparison between JFC’s and MAXS’ financial performance within the past five years.

Part 1 Jollibee or McDonald’s shares, which is better?

(https://perennialinvesting.wordpress.com/2015/09/07/jollibee-or-mcdonalds-shares-which-is-better/)

Part 3 MAXS or Jollibee,  which is better?

(https://perennialinvesting.wordpress.com/2015/09/07/maxs-or-jollibee-which-is-better/)

If you are interested in this similar approach to investing I wish to invite you to this Facebook group

(https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Mark Y.

Jollibee or McDonald’s shares, which is better?

Disclosure: I do not have shares in any of the companies mentioned in this article and don’t plan to initiate purchase within the next 24 hours. I would not receive any compensation for doing this article. I am not a professional financial analyst. This is just a hobby. Lastly, my work is not error-free, but I strive for it to be.

If you are interested in this similar approach to investing I wish to invite you to this Facebook group

(https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Start

Eating Chickenjoy on a ‘once-a-week’ basis in the Philippines and now feasting on Big Mac’s at least once a week in the U.S and out of curiosity, it would be fun to compare the Philippines’ largest fast food chain versus the world’s largest.

Plainly, McDonald’s (MCD) easily is a better choice in terms of size when compared to Jollibee (JFC). As of 9/6/2015, MCD’s market capitalization is $89.3 Billion, while JFC has $4.3 Billion or 204 Billion pesos. Starting from here I will convert the Philippine peso values into USD (in today’s exchange rate of 46.94 pesos per 1 USD) for ease of reading.

Comparing revenue and net income values would put JFC into MCD’s shadow too. JFC had $1,932 Million while MCD had $27,441 Million last fiscal year (FY) 2014.

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JFC’s net income in FY 2014 was $117 USD Million, while MCD had $4,758 USD Million.

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Now, what should draw the line as a point (or series) of comparison are not these bold numbers, BUT operating efficiency. How much is being given back to shareholders and what are the respective profitability margins. These are percentages and easily compared.

A brief history, MCD was founded on April 15, 1955 (60 years old at present), while JFC was founded on January 28, 1978 (a 37-year-old Filipino fast food giant). Nevertheless, MCD’s has developed a massive clout overtime. Maybe JFC would too! Who knows? It has 23 years to play catch up with MCD (and other giant fast food chains-which I may pick on next time) =)
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Let us now dive into the juicy part.

First, let us compare both companies’ profitability margins through ocular inspection (using five-year (FY 2010-2014) historical performance to see whether there is improvement or not).

Gross profit margin. This is money left over from revenues after accounting for the cost of goods sold (Investopedia). Buffett likes this number >40.

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Both parties are at a constant pace. JFC maintaining a near 20 range while MCD had a slight decline from 40 range.

Operating Margin. Operating margin is a measurement of what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc (Investopedia).

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JFC had a previous steady performance in the 5-10 range, while MCD had a minor challenging 2014 FY year (maybe because of all the tooth-in-the-fries and other product issues). Despite this MCD’s numbers hovers 3x than JFCs.

Net Margin. How much income the company makes from its revenues. More than 8% is my (personal) requirement.

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I should just take a pass with considering JFC as a suitable investment. But the preceding comparisons are unfair, but at the same time justifiable.

These are the facts:

JFC mainly operates in the Philippines and as of December 31, 2014, JFC operated 2,301 restaurants in the country under the brands Jollibee, Chowking, Greenwich, Red Ribbon, Mang Inasal and Burger King. The firm is also operating 612 stores overseas, more than 400 of which are in China. LINK (http://www.abs-cbnnews.com/business/02/23/15/jollibee-group-open-330-new-stores).

MCD, on the other hand, has roughly more than 14,000 locations nationwide Link (http://www.slate.com/blogs/moneybox/2015/06/19/mcdonald_s_to_shrink_u_s_restaurants_in_2015_for_first_time_in_decades.html).

It is TOUGH to maintain a food quality worldwide in serving (not the least) food. A fries served in Los Angeles, CA should be at par with taste and quality when served in the streets of Binondo, Manila. Same as a Chickenjoy served in Tayuman, Manila should be at par with crispiness-quality when served in Chicago, IL. Not to mention, culture barriers, satisfying employees/customers, adjusting to customer taste preferences, etc.

Credits should be given to MCD as it was able to maintain outstanding margins and for surmounting the inevitable geographical barrier (limited to being compared with JFC as of the moment). However, MCD should still be compared among other peers’ performance, such as the KFCs, Pizza Hut’s, etc., before considering to invest (at least, this is how I would approach this potential investment opportunity).

Overall, MCD would be a better selection over JFC. But this ‘finding’ brings a better research as you read through this article. (Almost done by the way).

I wish not to discredit JFC as a qualifiable investment because of its major consumer role and as it rose as one of the top companies in the Philippine industrial sector review I made this past week. See (https://perennialinvesting.wordpress.com/2015/09/01/a-brief-review-of-the-philippine-industrial-sector/).

JFC definitely is one of the top companies in the Philippines by size and operation and it is worth taking a further look at this company.

Another fact, a Filipino resident, unless having a social security number (SSN), may have difficulty investing in MCD shares since a U.S. broker is needed to access these shares.

Foreigners, on the other hand, can easily invest in JFC buy buying American Depositary Receipts (ADRs) with any U.S. brokerage firm.

One must ask, why not just get the MCD’s financial numbers in the Philippines and compare it with JFC? Great idea!

That will be the Part 2 of this article.

Part 2: MCD in the Philippines, Jollibee, and the others 

(https://perennialinvesting.wordpress.com/2015/09/07/mcd-in-the-philippines-jollibee-and-the-others/)

Part 3: MAXS or Jollibee,  which is better?

(https://perennialinvesting.wordpress.com/2015/09/07/maxs-or-jollibee-which-is-better/)

If you are interested in this similar approach to investing I wish to invite you to this Facebook group

(https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Mark Y.

Value/activist investors taking a beating on year to date (YTD) performance.

David Einhorn’s Greenlight Capital down 14% YTD (~$1.4 Billion)

Bill Ackman’s Pershing Square down 4.3% YTD (~$621 Million)

Leon G. Cooperman’s Omega Advisors down 11%-August month alone

Buffett loses $11 Billion USD

Ray Dalio loses $3 Billion USD in his All Weather Fund ($80 Billion or half of the total $160 Billion AUM in Bridgewater Associates)

-Despite these unforeseen events, Buffett made two huge transactions weeks before.

1. Acquisition of Precision Castparts (metal fabricator) worth $32 Billion
2. Added 296% in his Phillips 66 (oil refiner) stake worth $4.5 Billion (Buffett increased his % ownership from 0.55% of his portfolio to 2.18% representing 296% jump.)

Prior to this, Buffett had been sitting on Cash (as noted in the Forbes article) of $55 Billion on December 2014.

Just proves his the shrewd quote, “be fearful when others are greedy, and be greedy when others are fearful.”

References

http://www.nytimes.com/2015/09/01/business/dealbook/greenlight-capital-down-14-for-year-david-einhorn-surveys-investors.html?_r=2

http://www.wsj.com/articles/david-einhorns-greenlight-takes-a-beating-in-august-1441063824

http://www.wsj.com/articles/why-warren-buffett-isnt-buying-into-phillips-at-the-top-1441029418

http://www.wsj.com/articles/berkshire-hathaway-builds-stake-in-refiner-phillips-66-1440881284

http://www.wsj.com/articles/in-precision-castparts-deal-warren-buffett-finds-his-type-of-ceo-1439243049

http://www.reuters.com/article/2015/09/03/us-hedgefunds-bridgewater-idUSKCN0R328620150903

http://fortune.com/2015/09/03/warren-buffett-lost-11-billion/?xid=nl_daily

http://www.forbes.com/sites/investor/2014/08/12/five-stock-ideas-for-buffetts-55-billion-in-cash/

A Brief review of the Philippine Industrial Sector

Disclosure: I am long Meralco and PLDT. In addition, I am not a professional financial analyst/advisor. I am not getting paid to do this research and only consider this as a hobby. This article was made on 8/31/2015.

Hello fellow Filipino investor,
It appears that our mini-poll revealed more people interested in the Industrial sector of the Phil. Composite.

(Updated: see bottom page for addendum if you’ve read this article)

Mini-poll was conducted exlusively in this group (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

This is the method how I arrived with comparing the listed companies in the sector.

  1. I ranked the 29 listed companies in the sector from largest market cap to the least (http://pse.com.ph/stockMarket/marketInfo-marketActivity.html?tab=1&indexName=Industrial)
  2. I then selected the top 10 largest companies in the sector and began comparing their historical financial performance.

***A note or two before we proceed:
A. Ranking listed companies by market cap may not be the most optimal way in determining which are the best, but only gives us insight whether or not the companies included are liquid enough for buying shares when decided upon.
B. The comparison I will make is not an ‘apple to apple’ comparison but will be an ‘apple to orange’ kind of comparison given the nature of the selection process.

  1. Take every data information with skepticism as I may have incorrect calculations.
  2. This is my own ‘unique’ way of comparing companies, this ‘method’ is not proven, and it does not compare a specific company’s relative historical performance.
  3. Do your own due-diligence prior to purchasing or selling companies based on this brief research.
  4. Data used in this research came from the following: Gurufocus, Morningstar, and Financial Times, unless otherwise mentioned. Data used are the most updated as the author strived to put his best in researching these values. Some are the author’s calculations.

Let’s start:

a

These companies are the top 10.

Based on this finding, ocular inspection would reveal that some of the listed names are very familiar for us part-consumers.

Next, I would then find which company has the largest NET INCOME. According to Wikipedia, it is an entity’s income minus cost of goods sold, expenses and taxes for an accounting period.

TTM NET INCOME data revealed the following (According to Investopedia, TTM means Trailing Twelve Month; A company’s trailing 12 months is a representation of its financial performance for a 12-month period, but typically not at its fiscal year end): a

MERALCO had an oustanding PHP 18,466 Million income, followed by AP, URC, EDC, FPH, MWC, JFC, DNL, FGEN, and Andrew Tan’s EMP with negative 7 Million pesos.

This may be ‘unfair’ when we had to compare a fast food chain (JFC) and a snack food business (URC) against these giant power-producing firms (MER, AP, etc.), but that is the weakness of this research. Maybe it may bring some comfort starting from here that Tony Tan Caktiong’s JFC and John Gokongwei’s URC may be isolated in terms of comparison for those who are willing to since they are both in the ‘food consumer’ trail.

Next, let’s use Buffett’s TTM Return on Equity (ROE) criteria. The higher the better, but take caution. High ROE can be a result of a company increasing its debt. As a result, the company with a high ROE can be susceptible during cyclical downturns or recession. ROE is solved through Net Income/Shareholder’s Equity. TTM ROE provided:a

Despite URC and JFC lagging in the net income aspect, here it shows these companies are almost at par with its peers in the industry (generally comparing). EDC, DNL, and MER were outstanding while EMP is still in the RED.

Next, we will see these companies’ TTM debt to equity (DE) ratio. The lower, the better. In addition, this would justify if a company’s ROE is brought by increased debt. A better approach would be comparing ROE with Financial leverage, but we would skip that one today. According to Investopedia, debt ratio used to measure a company’s financial leverage, calculated by dividing a company’s total liabilities by its stockholders’ equity. However, in this scenario, I simply added short-term and long-term debt plus capital leases (if available) divided by total stockholder’s equity.a

As a result, FPH lead the group in debt (not good). This followed by the other listed power producers. On the other hand, EMP and DNL do not have any debt. (Makes me wonder what EMP is doing to increase their shareholder return—disappointing so far). JFC, URC, MER, and MWC appear to have the most conservative DE ratio in the industry.

Now we go to the juicy part, measuring the listed companies’ profitability. We will be using gross profit (GPM) and operating profit margin (OPM). According to Investopedia, GPM is calculated through deduction of cost of goods sold from revenue divided by total revenue. OPM is calculated by operating income over net sales. GPM is money left over from revenues after accounting for the cost of goods sold, while OPM is measurement of what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc. Thus GPM is a good criterion, while OPM is more stringent. Buffett usually asks for >40% in GPM. GPM is as follows:

a

This table revealed that EDC, MWC, AP, and EMP are above the 40 level. Technically, they get to ‘keep’ more than 40% of their revenue. OPM revealed the following:

a

Talk about efficiency, after paying wages, raw materials, etc. MWC and EDC still overcame the 40 mark.

Next part, we will use some of Benjamin Graham’s criteria, which is the earnings per share (EPS) growth. EPS is calculated by net income/average outstanding common shares. Moderate growth is okay (when compared among peers). For this, I used a Compound Annual Growth Rate or CAGR instead of averaging the companies’ EPS growth over the years. According to Investopedia, CAGR is the mean annual growth rate of an investment over a specified period of time longer than one year. This part is tricky since some company/ies were just listed in the Philippine Stock Exchange just a few years ago (EMP and DNL), while others were listed longer. Be skeptical about this data (as you should be in everything that was written in this article).

a

According to this data, URC performed the best and EMP performed the worst. Did Andrew Tan focus primarily on Megaworld and leaving EMP for good? (Very poor performance overall). Gokongwei’s Nova, V-cut, Mr. Chips, Piattos, and C2 drink served well to facilitate URC’s EPS growth.

Last but not the least, the dividend growth (DIV). I personally invest for dividends. I usually double-triple check a company’s historical financial performance (such as FCFE ratios, etc.) before purchasing (caution: historic performance does not translate to future performance). According to Investopedia, A dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.

Before heading onto the DIV CAGR, it’s interesting to know how much really these companies payout to their shareholders currently. See table for the dividend rate.

a

MER lead the group by giving out 22.61 PHP/share followed by JFC’s 6.60 PHP/share. EDC and FGEN, on the other hand, just gives out 10 cents (yup) a share since 2012 and 2013 respectively. While EMP has not given any (of course, no earnings).

a

This data above must be taken with caution. First, not all companies have been historically giving dividends (at least according to my sources). MER may be the highest DIV growth payer, but they just started giving out dividends just 2014. Most other companies, on the other hand, had just issued their dividends not more than three years ago. (A personal note, I remember when I was still preparing for the Securities Exchange Course in 2011, I assume that was the time when foreigners had been allowed to plow in more investments in the Philippine Stock Exchange-Nevertheless, I guess some companies then initiated to return some dividends to their shareholders as a courtesy to uplift shareholder return).

Anyhow, this concludes my brief review in the industry.

sec

(I failed the licensure exam back then and did not retake it)

ADDENDUM

After double checking with the listed company’s OWN ANNUAL REPORTS, it appears that some data did not match. That is why performing due diligence is important. However, if anyone is to ask me whether or not I should believe ALL of the data stated above, I would still. Because that’s how I perform my research. Invest at your own risk.

Here are some data that did not MATCH:
MERALCO’s dividend
According to the article, MER started dividend just last year (2014), however, checking MER’s annual report–dividend has been ongoing since 2006 (stopped at 2007), but still continued til present.

MER annual report (2010)

MER annual report (2010)

MER annual report (2014)

MER annual report (2014)

In addition, EMP (which I’ve accused of no earnings) had shown EARNINGS in its Phil. Stock Exchange FIlings.

EMP PSE Filings (2013-2014)

EMP PSE Filings (2013-2014)

Nevertheless, some data matches, like EDC’s ROE among others.

EDC's ROE (Company's website)

EDC’s ROE (Company’s website)

Again, I would still encourage due diligence among the avid investors. But for me, I would still believe my researched data.
Links to some of the information mentioned are as follows:

Meralco’s annual reports
a. http://corporate-downloadables-annual-reports.s3.amazonaws.com/e60ff93c694495affd9690a0d4ddca17.pdfb. http://corporate-downloadables-annual-reports.s3.amazonaws.com/1432791088.3c00154ee956f67bd538deee94adb618.pdf

EDC’s investor relation’s website

a. http://www.energy.com.ph/investor-relations/financial-reports/

EMP’s PSE filing

a. http://edge.pse.com.ph/openDiscViewer.do?edge_no=49045dd1c34534b31db82e377ee70f3b#sthash.Csogd2MX.dpbs