MERALCO: Running Some Numbers.

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Manila Electric Company. Source: Google.

Using three different, but related valuation models. I arrived at some very conservative MER intrinsic values.

Manila Electric Company (MERALCO; PSE ticker: MER)

“Ang liwanag ng bukas.”

-Some facts-

As of 11/26/2015

124 year old company

The Philippines’ largest distributor of electrical power

65 Billion Php in market capitalization

5,766 employees

P/E ratio 17

Some of the known competitors: Aboitiz Power Corp. (ticker AP), First Gen Corp. (FGEN), SPC Power Corp. (SPC),  and Energy Development Corp. (EDC).

A recent Business Mirror (Philippine newspaper) article stated the following:

“POWER distributor Manila Electric Co. said it will spend P154 billion in capital expenditures (capex) from next year through 2020 as part of business expansion and the improvement of its infrastructure to withstand inclement weather.”

Let’s compare that with its (MER) historical capital expenditure numbers:

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8-year average stands at: 7 Billion Php CAPEX annually, while 8-year median stands at: 9 Billion Php CAPEX annually.

Approximately, that should at least ensue to another 35 to 45 Billion Php CAPEX annually for 2016-2020. (7 x 5 years; 9 x 5 years).

BUT! MER wants to do 154 Billion Php instead. And that is roughly 3 to 4 times my expected CAPEX budget.

Holding some exposure to MER as I have held for the past three years, I’m wondering how much this CAPEX budget (if successfully implemented) affect its owner’s earnings (or free cash flow).

Owner’s earnings is a critical number when performing discounted cash flow model or when trying to figure out the intrinsic value of a company is.

*Owner’s earnings or Free cash flow is calculated by deducting CAPEX from cash flow from operations.

Before heading straight to discounted cash flow, let’s see how my ‘most-basic’ method of valuing company values MER based on its current earnings per share (EPS).

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Php 211.90/share will be at P/E ratio of 12. So using this simple model, I’d be buying MER only in the range of Php 212-265 and holding it for >3-5 years as long as the fundamentals are intact.

-numbers-

Let’s see how MER’s profits and owner’s earnings have grown over time using computed annual growth (CAGR):

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Looks just right, comparing it with other growth numbers that can be found in its financial statements brings a different picture:

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MER’s revenue appear to have minimal to moderate growth at only ~5% in the 7-year CAGR, while CAPEX outgrown each metric at ~33%.

This just means that MER is in a very high capital-intensive business and profits may regress further if other companies became more successful in reducing MER’s market share–which I certainly doubt.

-competitors-

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Looking at MER’s competitors’ numbers, it seems that only EDC had demonstrated a better second choice whenever MER would not meet my investment checklist.

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In addition, it does look like EDC is demonstrating good growth numbers (such as tamed CAPEX growth and amazing profit growth over the past 7 years).

Interestingly, EDC had spent 87% of its cash flow in CAPEX for the past 7 years while FGEN had spent 76% in the past 4 years, AP with 63% in the past 6 years, and MER with just 24% in the past 7 years.

Although EDC’s ‘minimal’ CAPEX growth in the chart above–it’s MER who is the ‘most conservative’ capital spender among its peers. Next will be AP, FGEN, and EDC for last.

Now, let’s just take a peek on their D/E ratios:

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I struggled to look for AP and FGEN’s D/E numbers for this years (2015), but overall it appears that only MER is well below this group’s average followed by AP.

Interestingly, for the past nine years, MER and AP has just been trailing the local bourse’s (Philippine Composite) performance:

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While EDC and especially FGEN have been laggards.

-Discounted cash flow-

I’ll be doing the Discount Cash Flow Model using Capital Asset Pricing Model (CAPM):

Using Investopedia’s outline:

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it will be easier to identify these variables prior to running the company’s (MER) numbers:

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Further,

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Earlier, the most-basic valuation formula provided a Php 212/share value (scroll up).

With Php 271/share resulting from my calculation using a CAPM discounted cashflow approach, that gives me roughly PhP241.50/share.

Using Margin of Safety of 30% discount approach strictly, I’d start buying around Php170/share. Something to take note of is that MER has not even touched the Php200/share mark since 2010.

Finally, factoring in the Php154 Billion CAPEX budget for the next five years may be a little bit challenging, but obviously it will reduce MER’s value.

Points to remember prior to diving into another DCF:

I am doing a 10-year DCF, so technically that will be a period of year 2016 to 2025. 2016-2020 CAPEX has already been provided by the company (154 Billion Php). To calculate 2021-2025’s CAPEX I used a 9% CAPEX growth (yup, pretty conservative). In addition, I used cash flow from operations CAGR growth of 12% for 2016-2025 period and WACC of 11.32%.

Resulting intrinsic value is Php181.87/share.

This is just a low valuation, but that’s how I see MER if it were to continue its business operations and deliver its average historical growth for the next decade.

If I were to average all those three intrinsic value calculation I’d get Php221.62/share of intrinsic value.

With 30% discount, my then preferred buying price today will be at Php155/share, that’ll just be too conservative, right?

I guess this is when an investor decides for himself whether or not to jump on Meralco’s shares at its current daily price.

Disclosure: I have shares in MER, but 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 or share ideas, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Happy investing.

Mark Y.

-End-

 

 

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American Express: To Buy or Not to Buy (Part 4: DCF part B)

Previously, I had ran three different basic models to determine AMEX’s intrinsic value of $80/share.

Now, I will use the WACC discount rate instead of just relying on Cost of Equity (6.28%) alone (see this link for prior blog)

According to Investopedia, this is the entire formula of WACC:

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Pretty complicated, and yes it is.

To outline and give number to these variables:

Re=6.28%

Rd=4.33%*

E=73,730 million USD

D=51,813 million USD

V= 125,543 million USD

E/V=59%

D/V=41%

Tc=34%

WACC=4.84%

*I believe this Youtube video by Matt Kermode best explains how to perform a WACC application to any company–so long as an investor is able to determine at what required rate of return a company’s debt has to offer (Rd). Link: https://www.youtube.com/watch?v=EZw-Ca0A37Q

Proceeding to a no growth (0%)  rate with 10-year period. I arrived at $129/share.

Involving the previous three IVs calculated averaging them, I arrived at an intrinsic value of $92.25/share. Whereby, the current price of $72.42 is at a 27% discount—nearing my threshold of 30% margin of safety.

$92.25/share would give a current PE valuation of 16, which is a overvalued in terms of AMEX’s industry peers of 13 according to Yahoo Finance.

-End-

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 or share ideas, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Happy investing.

Mark Y.

 

 

AMEX: To Buy or Not to Buy (Part 3: DCF)

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Using Discounted Cash Flow (DCF) with no growth in determining AMEX’s intrinsic value.

I only used Capital Asset Pricing Model‘s (CAPM) cost of equity as the discount rate and not the Weighted average cost of capital (WACC) in this case.

Cost of equity discount rate is solved by this formula: cost of equity = risk-free + beta * (equity risk premium)

These are my variables:

Time period: 5 years

Risk Free (10-year): 2.26

Beta: 0.87

Equity Risk Premium: 4.65

Free Cash Flow: 9,795 USD million (2014’s owner’s earnings)

Growth rate: 0%

Cost of Equity: 6.28%

Deducting 2014’s total debt from the market value I had already computed gave me a net present value of $87,684 million USD.

Dividing that number with remaining shares outstanding in 2014 gave me an intrinsic value of $83.43. A 17% premium from today’s $72.41 market price (11/21/2015).

Although I use 52-different models (before 41) now to determine a company’s intrinsic value, I guess just adding a couple of easy calculations in determining the intrinsic value of a company would not hurt:

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PE IV determination and Graham’s Number. Author’s calculation

Now, let’s get the average: (93+64+83) divided by 3 = $80/share. That is a 10% premium to today’s AMEX price.

Also consider that AMEX, has dividends and buybacks attached to it, which can further stimulate shareholder return.

But, with my previous discussions, it appears that I still think management should think about budgeting those especially after the Costco-breakup that’ll take effect in 2016.

Some of the things that kept me from buying AMEX shares as of this time:

  1. Payout ratio as of 2014 (including buybacks) is almost at 100%
  2. Recent Costco breakup that may result into lower profits
  3. Recent San Francisco court decision that may cost ‘billions’
  4. High D/E ratio among its top peers (Visa and Mastercard)
  5. Recent share buybacks (2012-2013) in high valuations

If someone were to ask me, what will be my buy price for this great company. I’d say 30% will be my required Margin of Safety.

Benjamin Graham, father of value investing, usually bought stocks with 50% margin of safety from its intrinsic value. As I’ve read in most books, margin of safety is the cornerstone of value investing, therefore I should apply it every time I can.

Therefore, my buying price will be at $56/share, and I would basically be holding onto those AMEX shares (whenever it reached that point) and probably sell it only if it would be selling at new HIGHS and if not, just hold it for long term.

To read more on Capital Asset Pricing Model (CAPM) visit this Investopedia link: http://www.investopedia.com/terms/c/capm.asp

I believe they have had explained very well the concept.

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 or share ideas, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Happy investing.

Mark Y.

Top Female CEOs

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Marissa Mayer. Yahoo CEO. Source: Google.

Data as of 12/4/2015

Stock price performance since being the CEO highlighted by yellow mark.

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IBM stock. Source: Google.

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Ginni Rometty. IBM CEO. Source: Google.

International Business Machine (IBM; ticker: IBM)

CEO: Virginia Rometty, 57 years old, since 2012

Market Cap: $135 Billion USD

TTM Revenue: $84 Billion USD

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Yahoo stock. Source: Google.

CEO: Marissa Mayer, 39 years old, since 2012

Market Cap: $32 Billion USD

TTM Revenue: $5 Billion USD

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Meg Whitman. Hewlett Packard Enterprise CEO (newly split Hewlett Packard company). Source: Google

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Hewlett Packard. Source: Yahoo Finance.

CEO: Meg Whitman, 59 years old, since 2011

Market Cap: ~$47 Billion USD (HPQ+HPI)

TTM Revenue: $106 Billion USD

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Elizabeth Holmes. Theranos CEO. Founder. Since 2003.

Theranos, private company

Elizabeth Holmes, 31 years old, founded the company in 2003.

Market Cap: ~9 Billion USD

TTM Revenue: No data available.

-End-

 

American Express: To Buy or Not to Buy? (Part 2: Numbers)

Alright,

Now the exciting part: Numbers for the past decade.

**historical performance does not predict future performance, but may serve as a guide–at least for me, that’s how I see it.

The Gross Overview:

Profit and Profit Growth

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Profit and Profit growth. Author’s Calculation.

Owner’s earnings (free cash flow) and growth:

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Owner’s Earnings. Author’s calculation.

It appears that even though AMEX had not perform quite consistently in growth, it had ups and down years but in the long-term it still was able to manage to grow its profit and owner’s earnings—a definitely positive sign.

Debt to Equity Ratio (Author prefers <0.5):

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D/E ratio.

Fail on this metric. But let us compare this with AMEX other top peers.

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DE comparison.

It appears that for the past decade, AMEX would have been my LEAST favorite in the group because of this D/E metric.

The company basically carries a lot of debt with it.

Visa and Mastercard, on the other hand, has no debt at all. Investors had well-rewarded these two granting them PE of 30 each. AMEX currently sells for only 13 times earnings. A 50% discount from these two top peers at the DE aspect.

Nevertheless, I can observe that AMEX is trying to lessen its debt since the Great Recession (scroll up to see the chart again).

Next, Dividend and growth:

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Dividend and growth. Author’s calculation

This is just weird. A sudden 88% upswing in dividend in 2014. Now, AMEX is faced with series of problems, which may have a small or big impact in its profits (we’re going there shortly); that may bring me to question its commitment to the dividend-performance in the future.

Remember there may be ~7% decline in profit (author’s estimate) in 2016 and onwards, of course only if AMEX fails to cover its Costco break-up.

This brings me to my theory: that the current dividend rate would be under threat.

Next, Profit Margin (Author’s preference 8%):

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AMEX easily met this metric TOO.

Next, Profit/Owner’s earnings ratio:

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Profit/owner’s earnings. Author’s calculation.

This is a new ratio I made for this specific AMEX case. Basically, what I am trying to determine (assume) here is there is a possible correlation with profit and owner’s earnings growth.

For the math nerds, R-coefficient I calculated between the two is +0.62, which signifies a positive-large strength of association.

More importantly, it was only recently that profit had more than 50% contribution to owner’s earnings, which further strengthens my assumption that decline in profit may have an effect on AMEX’s capability of handing out dividends and buying back shares.

Money used for those are usually coming from Free cash flow or owner’s earnings.

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Share repurchase in USD millions

Interestingly, there are recent debates about how U.S. companies misuse their cash in share buybacks (repurchase). Here are some points:

  1. Is the company buying back shares at a lower valuation (P/BV or P/E)?
  2. Is the company doing this to massage their earnings?
  3. Has the company been spending too much in buying back their shares?
  4. and so on..

In this blog, I’ll just see whether AMEX is guilty buying back shares when its shareprice is overvalued. I compared the repurchase program to the ongoing P/BV valuation:

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PBV and sharebuyback program.

My conservative thoughts assume that AMEX should be at least buying lower than 10-year median of PBV of 4. In this case, it was guilty of ‘overspending’ during 2013 and 2014.

So, going back, will that 7% (hypothetical decline) be really a threat to the dividends AMEX shareholders are currently enjoying?

Let’s run some more numbers:

To just run a simple test and an easier way of finding out, I checked how much exactly is AMEX giving back to its shareholders with dividends.

  1. Dividends as a % of profit
  2. Dividends as a % of Owner’s earnings
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% Dividends/Profit and Dividends/Owner’s earnings. Author’s calculation.

And it seems that AMEX has been very CONSERVATIVE in giving out dividends, including that 88% increase in dividends in 2014.

Let’s include in the equation, the share repurchase expenses.

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Dividends + Buyback % of profit and owner’s earnings. author’s calculation.

This time, we see a different AMEX. Unless it decides to decrease its $ allocation to buybacks and/or dividends, AMEX would soon pass the 100% mark in profits being handed out to shareholders.

Imagine a company earning for the sake of just handing out profits while maintaining its operations. Will that be a prospective buy?

Now, this is a little conservative, but what if both profits and owner’s earnings declined by 7% as what I assumed to be possible in a worst case scenario (no growth, no Costco replacement–remember that AMEX has still a recent case possible ‘facing billions’ of charges.

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Looking retrospectively (2014) while applying a futuristic assumption (Costco’s possible -7% influence in profits and owner’s earnings), AMEX appears to be someone in a difficult position with its profits payout, but still dividends may still be sustainable in terms of the other (owner’s earnings).

This is where, I think AMEX may be a hold and not buy for now. This is because near 100% payout ratio is a little bit a concern to me.

Next blog will be a simple discount cash flow model for AMEX, so as I can determine its intrinsic value at No Growth rate.

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 or share ideas, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Happy investing.

Mark Y.

 

Value Stocks are Cheap Today vs. Historical Norm (Research Affiliates)

If-Factor-Returns-Are-Predictable_FIGURE-2-OVERLAY

Chart by Research Affiliates.

Quoted, “the procyclical or trend-chasing allocation accentuates the underlying economic shocks to various investment styles as flows push valuations. In the short run, this results in self-fulfilling prophecy and momentum. In the long run, it becomes self-defeating and gives rise to mean reversion.”

Reference

Research Affiliates

American Express: To Buy or Not to Buy? (Part 1)

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AMEX image. Source: Google

I use this blog (occasionally) to further enhance my skills in balancing my investment decision about a certain company.

In this case, I landed on American Express (AMEX). American Express trades on nine different foreign exchanges with one of them in the NYSE-ticker AXP.

AMEX had been on the hot seat lately-well since earlier this year when COSTCO (a big box retailer) decided not to exclusively accept AMEX for its transactions.

First event: COSTCO divorcing AMEX (by March 2016-probably)

It appears that most AMEX shareholders dump their shares upon news received during that time.

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AMEX shares. Source: Google.

So what’s at stake with this divorce after a 16-year exclusive relationship?

According to a WSJ article, 1 in every 10 AMEX card is a Costco card holder. Assuming that ALL of AMEX’s revenue comes from its card business. 1/10 is 10%. So 10% of its revenue would be at least reduced to a certain point–of course unless AMEX would be able to grow its top line as well as carry it over to its bottom line so as to negate this unfortunate happening, then I think my assumptions are JUST as very much CONSERVATIVE as it can be.

Previous year (2014), AMEX was able to garner 34,292 USD million of revenue and 5,885 USD Million in profits or a net margin of 17% (pretty high and very enticing to look at).

Let us apply if the Costco-effect took place with the same numbers without any growth at all in AMEX’s operations, AMEX would still have roughly  5, 247 USD million in profit (with 17% net margin).

This would mean a  -10.84% decrease in profits.

This is sad partnership ending indeed.

Further resources like Bloomberg stated that lost of Costco business represents a loss of 0.15 cents in AMEX’s EPS in 2015 by Morgan Stanley. Well, there are few more weeks before 2015’s end. So I’ll apply this rationale in 2014’s number (to be conservative–yet again).

***doing this approach eliminates any potential growth in profits that AMEX may have in 2015, but…. I just want to see****

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Author’s calculation.

There will just be -2.7% in profit loss to be recognized (take note: without growth).

This is far more uplifting for an AMEX shareholder than the very conservative -10.84% decrease in profits that I’ve calculated earlier.

Portales Partners LLC, on the other hand-same Bloomberg article, stated that it could be 20-30 cents loss-that translates to -4.5% profit loss at an average.

Anyhow, averaging both my estimate and theirs gives me roughly -7% profit drop when AMEX starts operating without Costco by March 2016.

Today (November 20, 2015), it is still too early to say what will be the future of AMEX in terms of sealing this profit-hole that’s just about to happen, maybe they’d be able to find a way to grow their profit once more.

Not to mention Warren Buffet has 151,610,700 AMEX shares in his portfolio as of 9/30/2015. AMEX is his number five best idea (top 5 in the portfolio). In addition, Jeffrey Ubben of Valueact ($17 Billion Hedge Fund) bought more of AMEX recently–having 11,300,000 shares (top 10 in his portfolio). ValueAct bought $1 USD Billion more of AMEX shares.

ValueAct wants to have ‘shareholder friendly changes‘ in response to this recent AMEX shares acquisition.

Okay, onto the next problem.

AMEX also lost a court decision whereby “AmEx’s rules are anticompetitive by not allowing merchants to promote other cards or offer certain discounts,” according to a WSJ article. However, the article further mentioned that, “The ruling doesn’t mean that AmEx must drop its rules immediately. The judge has asked both sides to submit a proposed remedy to the situation.”

Next,

For the most recent problem (published just yesterday (November 19, 2015) by Anne Steele of WSJ.

Quoted, “The city of San Francisco has sued  American Express Co.  for anticompetitive and alleged illegal merchant restraints.”

Further, “responsible for billions of dollars in excessive and improper costs,” and “the party is over for American Express, and the bill is coming due in California,” city attorney Dennis Herrera.”

These, in fact, are very strong words. And as an AMEX cardholder (not shareholder-still deciding) also worries me that I might lose some benefits in this good card of mine.

Going back,

I guess it’s just a string of bad luck for this wonderful 165-year-old company.

I guess that’ll do it for part one.

Next article would show a brief number simulation (profitability and a sample intrinsic value calculation) to see whether I’d buy AMEX shares or not.

References are already provided in the links above

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 or share ideas, I wish to invite you to this Facebook group SEEKING VALUE (https://www.facebook.com/groups/SeekingValue/?ref=bookmarks)

Happy investing.

Mark Y.