SIAL is a company that develops, manufactures and distributes the broadest range of high quality biochemicals and organic chemicals available in the world. These chemical products and kits are used in scientific and genomic research, biotechnology, pharmaceutical development, the diagnosis of disease and as key components in pharmaceutical and other high technology manufacturing. The Company operates in 35 countries, offers over 100,000 chemical and 30,000 equipment products and sells these products into over 150 countries.
The interesting thing about SIAL is that no single product generates more than 3% of its sales. The majority of the companies orders ( around 70% ) are for labs around the world and are $400 or lower. The company derives about 60%+ sales outside the United States.
SIAL's business is viable and has growth potential. The recent decline in the US dollar should help the company improve its bottom line. In the next segment, we will look at the SIAL financials.
First, we will look at the return on equity and return on asset numbers for SIAL. The ten year averages for both the numbers are 20.88 and 14.5% respectively. Both these numbers are impressive and point to very strong fundamentals and operations at the company.
The revenue growth at the company has averaged about 5.35% for the past ten years but the EPS has grown at a faster pace of 10% per year. The key ingredient causing the increase in EPS is the decrease in outstanding shares. The outstanding shares the company has declined from 99 million to 67 million in the past ten years. In the ten year period, the cash flow from operations has almost doubled and free cash flow has increased by about 3.5 times. The dividends per share have increased by about 11.7%/year for the past five years.
SIAL is a good stock with steady ( ~10-11% earnings growth/year ) and is not cheap. The stock is currently selling for about 10% discount to its fair value. This stock is a strong buy when its price drops becuase of the market fluctuations or variations.
Saturday, November 25, 2006
Thursday, November 23, 2006
Indian Equities
We came across a presentation on the Indian equities and the tax laws in India. This presentation makes a bull case for Indian equities in the next five years because of the following reasons.
- The Indian economy is growing at a fast pace and it is unlikely to slow down in the next several years
- Indian tax laws favor the investor - there are no taxes on long term capital gains or dividends. Short term capital gains are taxed at 10%
- Indian population is not exposed to equities - this should correct itself in the next several years
- The fundamentals of top two hundred Indian companies is getting better. The ROE of the companies is at 22% and ROA is at 15%.
- The slide deck also talks about the likely scenario for Indian stocks to be in the 19,000 - 23,000 range by 2010. This comes to a growth in the range of 9 % per year for the next four years.
As we have done in our previous articles, we will focus on the investment vehicles available to US residents to invest in India.
The Indian stock market - BSE Sensex has gained 45.5% thus far this year and the index is seemingly moving upwards. This comes on the heals of a 42% gain in equities in 2005. The returns are quite extra ordinary and one can be certain that this kind of returns can't be maintained to perpetuity. The returns have to go down sooner or later - the longer this lasts, the more severe will be the correction.
Let us look at the different instruments one can use to invest in India and see which ones are attractive at the moment.
EEM is the iShares emerging market fund and has returned about 17.39% YTD. If one bought the ETF at the low 80's in the second quarter, the ETF has returned more than 30%. EEM has an expense ratio of 0.77%. EEM had 5.8% exposure to India at the end of October.
VWO is the Vanguard emerging market fund and has returned about 15.88% YTD. This correlates highly with EEM but has a lower expense ratio of 0.3%. VWO has a 7.07% exposure to India.
IIF is Morgan Stanley India Investment Fund, Inc. is a non-diversified, closed-end management investment company. The Fund's investment objective is long-term capital appreciations, which it seeks to achieve by investing primarily in equity securities of Indian issuers. The Fund will invest at least 65% of its total assets in equity securities of Indian issuers; which for this purpose means common and preferred stock bonds, notes and debentures convertible into common or preferred stock, stock purchase warrants and rights, equity interests in trusts and partnerships and American , Global and other types of Depositary Receipts. The Fund may invest up to 25% of its total assets in unlisted equity securities of Indian issuers.Currently IIF sells for about 2.48% premium to the net asset value. The management fees for this stock is 1.27%. The total return of IIF is 42% compared to the BSE Sensex Index return of 45%. Interestingly enough, the fund is trading at a slight premium of ~1% to its NAV.
IFN India Fund is a closed-end management investment company. The fund seeks long-term capital appreciation through primarily investing in the equity securities of Indian companies. The fund will invest at least 80% of its total assets in the equity securities of Indian Companies. The management fees for this stock is 1.47%. The fund has returned 25% compared to the BSE Sensex index of 45%. To top it off, the fund is selling at 10% premium to its NAV.
MINDX Mathews India Fund is a relative new comer to the block. The fund carries an expense ratio of 2.75% has returned 25% YTD. This compares to the BSE Sensex index gain of 45%.
ETGIX It has an initiation fee of 5.75% for small sums of money that declines to zero if the capital is greater than a million dollars. This is not targeted for individual investors but is targeted more towards institutional investors that want an exposure to India. The fund also has an expense ratio of 2.75% on top of the initiation fee. This fund has returned 33% YTD.
EEB ( Claymore/BNY BRIC ETF ) - This is a new ETF targeting only the BRIC countries - Brazil, Russia, India and China. The fund doesnt have the assets divided equally with all the four countries but it only specializes in these four emerging markets. The fund carries an expense ratio of 0.65% and returned 8.7% since inception.Although both India and China look expensive at the moment compared to other markets, the growth in these markets make it look as though there is still upside for companies in these countries.
To summarize, EEM/VWO provide partial exposure to India with lower expense ratios. Among the pure plays, IIF is the best by far followed by MINDX. EEB is a newcomer and not enough information is available regarding per country investment break down.
Coca Cola (KO) and Google (GOOG)
In this blog, we have been somewhat bearish on Google from the very beginning. The seasonal trends are putting a tail wind into the internet stocks from Google to Amazon.com. One might argue that we are in a bull market now and every stock has gone up. While this is true, let us compare two companies, KO and GOOG and see where they stand from the balance sheet perspective.
Almost all the readers here should be familiar with Coke and Google. Coke is an old world company that has been around for more than hundred years. It has with stood competition and idiotic management over the course of its existence. Google on the other hand is an internet darling and has been growing revenues and earnings at an exponential rate. Google is a young company with smart founders with a new business model.
Coca Cola is fully valued at the moment when compared to the long bond. Google on the other hand fully valued against its future (2007/2008) earnings. In this segment we will look at some financial ratios to see which offers enduring competitive advantage and a long term buy opportunity. In the short term, Google definitely has more upside as momentum investors jump in to make a quick buck.
First comparison of earning yield. Based on the long bond ratios, Coke is fairly valued at today's market. Google has to earn ~$23 to be on par with Coke regarding price compared to the long bond. Google is not expected to earn $23/share till about 2009-2010.
Coke is a slowly growing company. In the last ten years, its EPS has increased from 1.40/share to 2.24/share. The EPS has grown at 4.8%/year in that period. The total outstanding shares have decreased somewhat. The dividends have increased by 55% in the past five years and the company roughly gives out about 50% of its earnings in dividends. The operating cash flow in Coke has increased from 3.43 billion to about 5.77 billion in the ten year period - a 5.3% increase per year. The free cash flow has increased at the rate of about 6.3% per year in the same period. The return on equity and return on assets have been in the double digits in that time.
Google is a fast growing company. The EPS for Google went from 41 cents a share in 2003 and is on track to hit almost $10 a share this year. The revenue growth rate in the past two years has been 100% and 70% respectively. The growth is slowing to about 40% range next year and will probably go to the 30% range in the year after. Googles cash flow has increased from 218 million in 2003 to 1.5 billion in 2006. The cash flow in 2006 is less than that of 2005 because of larger capital expenditures. Googles return on equity is less than that of Coke in the last two years whereas the return on assets is higher by a couple of points.
The return on equity is an important metric. If we look back at the 1977 Berkshire Hathaway annual letters, Warren Buffett has this to say about earning per share and managerial performance. "Except for special cases, we believe a more appropriate measure of managerial economic performance to be return on equity capital. In 1977 our operating earnings on beginning equity capital amounted to 19%, slightly better than last year and above both our own long-term average and that of American industry in aggregate. But, while our operating earning per share were up 37% from the year before, our beginning capital was up 24%, making the gain in earnings per share considerably less impressive than it might appear at first glance" He goes on to discuss why return on equity is an important metric in the subsequent annual letters.
To sumarize the above points, KO has a free cash flow of 4.5 billion where as Google has a free cash flow of 1.5 billion. Coke's return on equity is higher than that of Google whereas Google has a slightly higher return on assets compared to Coke. Coke's return on equity is better than that of Google by about 10 percentage points. However, Cokes market cap is 110 billion compared to Google's market cap of 155 billion.
We will finish off this article by looking at the various valuation ratios of the two companies. The trailing PE for Google is 74, price to book is 11.6, price to sales is 19 and price to cashflow is 52. The forward PE for Google is 50.
Coke on the other hand has a P/E of 21, price to book of 6, price to sales 5, price to cash flow ratio of 29.5. The forward PE for Coke is 18.6.
Based on these factors, each investor can make a decision for themselves which business is superior and which business is cheaper at the moment.
Almost all the readers here should be familiar with Coke and Google. Coke is an old world company that has been around for more than hundred years. It has with stood competition and idiotic management over the course of its existence. Google on the other hand is an internet darling and has been growing revenues and earnings at an exponential rate. Google is a young company with smart founders with a new business model.
Coca Cola is fully valued at the moment when compared to the long bond. Google on the other hand fully valued against its future (2007/2008) earnings. In this segment we will look at some financial ratios to see which offers enduring competitive advantage and a long term buy opportunity. In the short term, Google definitely has more upside as momentum investors jump in to make a quick buck.
First comparison of earning yield. Based on the long bond ratios, Coke is fairly valued at today's market. Google has to earn ~$23 to be on par with Coke regarding price compared to the long bond. Google is not expected to earn $23/share till about 2009-2010.
Coke is a slowly growing company. In the last ten years, its EPS has increased from 1.40/share to 2.24/share. The EPS has grown at 4.8%/year in that period. The total outstanding shares have decreased somewhat. The dividends have increased by 55% in the past five years and the company roughly gives out about 50% of its earnings in dividends. The operating cash flow in Coke has increased from 3.43 billion to about 5.77 billion in the ten year period - a 5.3% increase per year. The free cash flow has increased at the rate of about 6.3% per year in the same period. The return on equity and return on assets have been in the double digits in that time.
Google is a fast growing company. The EPS for Google went from 41 cents a share in 2003 and is on track to hit almost $10 a share this year. The revenue growth rate in the past two years has been 100% and 70% respectively. The growth is slowing to about 40% range next year and will probably go to the 30% range in the year after. Googles cash flow has increased from 218 million in 2003 to 1.5 billion in 2006. The cash flow in 2006 is less than that of 2005 because of larger capital expenditures. Googles return on equity is less than that of Coke in the last two years whereas the return on assets is higher by a couple of points.
The return on equity is an important metric. If we look back at the 1977 Berkshire Hathaway annual letters, Warren Buffett has this to say about earning per share and managerial performance. "Except for special cases, we believe a more appropriate measure of managerial economic performance to be return on equity capital. In 1977 our operating earnings on beginning equity capital amounted to 19%, slightly better than last year and above both our own long-term average and that of American industry in aggregate. But, while our operating earning per share were up 37% from the year before, our beginning capital was up 24%, making the gain in earnings per share considerably less impressive than it might appear at first glance" He goes on to discuss why return on equity is an important metric in the subsequent annual letters.
To sumarize the above points, KO has a free cash flow of 4.5 billion where as Google has a free cash flow of 1.5 billion. Coke's return on equity is higher than that of Google whereas Google has a slightly higher return on assets compared to Coke. Coke's return on equity is better than that of Google by about 10 percentage points. However, Cokes market cap is 110 billion compared to Google's market cap of 155 billion.
We will finish off this article by looking at the various valuation ratios of the two companies. The trailing PE for Google is 74, price to book is 11.6, price to sales is 19 and price to cashflow is 52. The forward PE for Google is 50.
Coke on the other hand has a P/E of 21, price to book of 6, price to sales 5, price to cash flow ratio of 29.5. The forward PE for Coke is 18.6.
Based on these factors, each investor can make a decision for themselves which business is superior and which business is cheaper at the moment.
Sunday, November 19, 2006
DR Horton Inc Analysis
D.R. Horton, Inc. is the largest homebuilding company in the United States, based on our domestic homes closed during the twelve months ended September 30, 2005. DR Horton constructs and sells high quality single-family homes through its operating divisions in 25 states and 74 metropolitan markets of the United States, primarily under the name of D.R. Horton, America’s Builder. D.R. Horton, Inc. is a Fortune 500 company, and its common stock is included in the S&P 500 Index and listed on the New York Stock Exchange under the ticker symbol “DHI.”
The home builders have taken a beating in the second half of this year and are trading for low P/E ratios. The main reason for the low price is the decline in the U.S housing market. One interesting phenomenon is that the recent bad news on housing starts didnt depress the home builders and the wall board manufacturers. We will look into the home builders - especially DHI to see if they have hit a bottom and if the stock is a buy at the current prices.
DHI primarily has two businesses. The first one is the one that specializes in building single family homes. The second part of the business specializes in doing mortgages and financial services. The home building business accounts for 98% of the revenue whereas the financial services account for 2% of DHI's revenue. The majority of DHI's revenue comes from the six states of California, Arizona, Colarado, Texas, Florida and Nevada. One should also note that the housing bubble has been the strongest in California, Florida and Nevada.
The housing market is the strongest in spring and summer months - consequently, the sales and revenues from homes is also the strongest in those months.
Let us move forward to the latest quarterly report. The cash and cash equivalents have declined from 1.1 billion to about 100 million. The inventory of finished homes and land under development has increased sharply from the year ago period. Although the company says it is monitoring the housing industry carefully, the increased inventory in a down market is definitely going to erode the profit margins.
The analysts are expecting the EPS to improve in 2008 for DHI while expecting steep slow down in the March quarter and fiscal year 2007.
The book value of the stock is in the finished houses and the land it has under its name. Since the company uses debt to finance its operations, the decline in housing prices or new homes will erode the book value. So a book value of $21/share is not what is made out to be.
Looking at DHI's balance sheet, cash from operations and free cash flow have both been negative for the past ten years except 2003. Cash from financing has been positive primarily because of the issuance of a lot of debt. The company does sport good return on equity and return on asset numbers. Since the company doesnt have a positive free cash flow and has a heavy growth in inventory, it may be prudent to stay away from the stock till early next year. It may also be prudent to stay away till the time the inventory/accounts receivable situation improves on the balance sheet compared to the existing housing market conditions.
The home builders have taken a beating in the second half of this year and are trading for low P/E ratios. The main reason for the low price is the decline in the U.S housing market. One interesting phenomenon is that the recent bad news on housing starts didnt depress the home builders and the wall board manufacturers. We will look into the home builders - especially DHI to see if they have hit a bottom and if the stock is a buy at the current prices.
DHI primarily has two businesses. The first one is the one that specializes in building single family homes. The second part of the business specializes in doing mortgages and financial services. The home building business accounts for 98% of the revenue whereas the financial services account for 2% of DHI's revenue. The majority of DHI's revenue comes from the six states of California, Arizona, Colarado, Texas, Florida and Nevada. One should also note that the housing bubble has been the strongest in California, Florida and Nevada.
The housing market is the strongest in spring and summer months - consequently, the sales and revenues from homes is also the strongest in those months.
Let us move forward to the latest quarterly report. The cash and cash equivalents have declined from 1.1 billion to about 100 million. The inventory of finished homes and land under development has increased sharply from the year ago period. Although the company says it is monitoring the housing industry carefully, the increased inventory in a down market is definitely going to erode the profit margins.
The analysts are expecting the EPS to improve in 2008 for DHI while expecting steep slow down in the March quarter and fiscal year 2007.
The book value of the stock is in the finished houses and the land it has under its name. Since the company uses debt to finance its operations, the decline in housing prices or new homes will erode the book value. So a book value of $21/share is not what is made out to be.
Looking at DHI's balance sheet, cash from operations and free cash flow have both been negative for the past ten years except 2003. Cash from financing has been positive primarily because of the issuance of a lot of debt. The company does sport good return on equity and return on asset numbers. Since the company doesnt have a positive free cash flow and has a heavy growth in inventory, it may be prudent to stay away from the stock till early next year. It may also be prudent to stay away till the time the inventory/accounts receivable situation improves on the balance sheet compared to the existing housing market conditions.
Saturday, November 11, 2006
UPS Analysis
In the previous article we looked at Fedex Corporation, a company that has specialized in overnight delivery. We have two other companies in the same business - UPS and DHL. UPS is a public company that has specialized in delivering large and small packages around the world. DHL is a privately held company that specializes in international delivery of couriers.
The package delivery and handling business is interesting for several reasons. The growing trend of globalization and commerce needs more shipping and delivery across the world. Another factor aiding this industry in the growing wealth around the world. A third factor in favor of this business is the increasing demographic trends and e-commerce in the US needing the services of these companies.
Currently this sector is looking a bit attractive. The attractiveness is primarily because of the expected economic downturn and people expecting slow down in growth in this segment. The recent price increases by UPS and Fedex show that the companies have pricing power and the market is fairly robust. In the rest of the article, we will analyze UPS and consider its pros/cons.
UPS's competitive strength is the built up infrastructure in North America and Europe. UPS is currently building up its network in China as well. A con of UPS is that the labor force is unionized and the record of companies with unions is dismal.
Now that we are convinced that UPS has potential as a business, let us look into the financials. We will also look into the TA ( technical analysis ) to verify the trend for UPS.
Since we dont have the trends for the full ten years ( a preferred period ), we will only look at the trends for the last six years for which public data is available. UPS stock price hasnt increased significantly since its IPO but we have seen compression of its P/E ratio. The revenues have increased at the rate of 8.7% per year for the past six years. The EPS has grown at the rate of 29% in the same period though the 1999 numbers were comparitively a bit lower. The number of shares has remained steady - so the buy backs have stemmed further dilution in shares. The free cash flow has seen steady and impressive growth in this period.
The return on equity has averaged about 20% in the last five years for UPS. Approximately 40% of the income is paid out in dividends. If the current ROE holds, the EPS should be about $8 in about ten years. This would result in a divident yield of 3.25 dollars/share up from the current value of $1.55/share. If the P/E of 20 holds, the stock should be worth about $160 in that time frame. In that time, $15 would have been paid out in dividends. This would make the total return about $175 dollars at a cumulative rate of about 9%. If the stock goes further, it is a good time to accumulate UPS.
The package delivery and handling business is interesting for several reasons. The growing trend of globalization and commerce needs more shipping and delivery across the world. Another factor aiding this industry in the growing wealth around the world. A third factor in favor of this business is the increasing demographic trends and e-commerce in the US needing the services of these companies.
Currently this sector is looking a bit attractive. The attractiveness is primarily because of the expected economic downturn and people expecting slow down in growth in this segment. The recent price increases by UPS and Fedex show that the companies have pricing power and the market is fairly robust. In the rest of the article, we will analyze UPS and consider its pros/cons.
UPS's competitive strength is the built up infrastructure in North America and Europe. UPS is currently building up its network in China as well. A con of UPS is that the labor force is unionized and the record of companies with unions is dismal.
Now that we are convinced that UPS has potential as a business, let us look into the financials. We will also look into the TA ( technical analysis ) to verify the trend for UPS.
Since we dont have the trends for the full ten years ( a preferred period ), we will only look at the trends for the last six years for which public data is available. UPS stock price hasnt increased significantly since its IPO but we have seen compression of its P/E ratio. The revenues have increased at the rate of 8.7% per year for the past six years. The EPS has grown at the rate of 29% in the same period though the 1999 numbers were comparitively a bit lower. The number of shares has remained steady - so the buy backs have stemmed further dilution in shares. The free cash flow has seen steady and impressive growth in this period.
The return on equity has averaged about 20% in the last five years for UPS. Approximately 40% of the income is paid out in dividends. If the current ROE holds, the EPS should be about $8 in about ten years. This would result in a divident yield of 3.25 dollars/share up from the current value of $1.55/share. If the P/E of 20 holds, the stock should be worth about $160 in that time frame. In that time, $15 would have been paid out in dividends. This would make the total return about $175 dollars at a cumulative rate of about 9%. If the stock goes further, it is a good time to accumulate UPS.
GEHL Analysis
Gehl recently came under the radar because of the considerable amount of insider trading in its stock. Let us take a look at its stock to see if it is a buy at the current prices. First, overview of its business from its website.
Gehl has been producing agriculture implements for nearly 150 years. Today, it is the leading non-tractor manufacturer of agricultural equipment in North America, offering a broad line of implements for the farm equipment industry.
In 1986, Gehl aggressively moved into the light construction equipment market as it established a separate construction sales division. Gehl serves small contractors, sub-contractors and owner-operators with dirt, lifting and paving equipment.
While Gehl has has a presence in international markets for over 50 years, in 1991 it focused its efforts through one group; Gehl International. Gehl International was formed to tap growing worldwide opportunities.
Some of the other big competitors in this field are CAT and AG. It is safe to say that GEHL operates in a niche environment.
Let us dive into the balance sheets to understand GEHL better.
GEHL operates in a capital intensive and cyclical business. In the second half of 2005, GEHL did a secondary public offering of its stock where it raised approximately $46 million to pay out its debt. GEHL operates in two segments - construction and agricultaral equipment category respectively. The construction segment accounts for 71% of the companies business and agricultural segment accounts for the remaining 29% of its business. The construction equipment segment is more profitable accounting for 84% of the profits whereas the agricultural division accounts for the remaining 16% of the profits.
The business is very capital intensive. In 2005, the company spent 7.5 billion in capital expenditures and had about 4.9 billion in amortization. What this figure shows is that the industry is very capital intensive and continuous capital expenditure is needed to keep the competitive position. The huge capital expenditure undermines the free cash flow generation. Even much larger competitors such as Caterpillar see huge swings in their free cash flow from year after year because of these trends.
Despite the stock dilution, the book value in the company increased in 2005 by almost 25%. This seems to be a one time event as this year the growth in book value has been more normal this year and the best case estimate would probably be around 10% gain.
Let us look at some of the ratios in the balance sheet over longer periods of time. Morningstar provides some very useful data and we can analyze the data provided by Morningstar. Ten year analysis of the earning per share shows that GEHL grew at a 8% pace compared to much more impressive 10.6% rate for caterpillar. Caterpillar also provides a dividend to put the full return at around 13%. Clearly, caterpillar is a better business to own than GEHL.
The next thing to look at is the current discount/premium compared to its peers to see if GEHL is a buy. The key factor in favor of GEHL is its price/book ratio. Caterpillar has a P/B of 4 where as GEHL has a better ratio of 1.48. Caterpillar however has a better earning yield compared to GEHL. GEHL has negative free cash flow where as Caterpillar is cash flow positive.
The short term technical analysis shows that the 100 day moving average is below the 200 day moving average - meaning the downtrend in the stock is not over. The insider buying is a clear indication that the stock is undervalued as there has been more insider buying than selling of late. As noted, the company is profitable and is probably worth about $36 a share. The estimates for next year's earnings are good but there are a lot of wild cards about next year - especially the way the economy is going to go. If those earnings estimates are met, it would provide the stock with an impetus to move higher.
Gehl has been producing agriculture implements for nearly 150 years. Today, it is the leading non-tractor manufacturer of agricultural equipment in North America, offering a broad line of implements for the farm equipment industry.
In 1986, Gehl aggressively moved into the light construction equipment market as it established a separate construction sales division. Gehl serves small contractors, sub-contractors and owner-operators with dirt, lifting and paving equipment.
While Gehl has has a presence in international markets for over 50 years, in 1991 it focused its efforts through one group; Gehl International. Gehl International was formed to tap growing worldwide opportunities.
Some of the other big competitors in this field are CAT and AG. It is safe to say that GEHL operates in a niche environment.
Let us dive into the balance sheets to understand GEHL better.
GEHL operates in a capital intensive and cyclical business. In the second half of 2005, GEHL did a secondary public offering of its stock where it raised approximately $46 million to pay out its debt. GEHL operates in two segments - construction and agricultaral equipment category respectively. The construction segment accounts for 71% of the companies business and agricultural segment accounts for the remaining 29% of its business. The construction equipment segment is more profitable accounting for 84% of the profits whereas the agricultural division accounts for the remaining 16% of the profits.
The business is very capital intensive. In 2005, the company spent 7.5 billion in capital expenditures and had about 4.9 billion in amortization. What this figure shows is that the industry is very capital intensive and continuous capital expenditure is needed to keep the competitive position. The huge capital expenditure undermines the free cash flow generation. Even much larger competitors such as Caterpillar see huge swings in their free cash flow from year after year because of these trends.
Despite the stock dilution, the book value in the company increased in 2005 by almost 25%. This seems to be a one time event as this year the growth in book value has been more normal this year and the best case estimate would probably be around 10% gain.
Let us look at some of the ratios in the balance sheet over longer periods of time. Morningstar provides some very useful data and we can analyze the data provided by Morningstar. Ten year analysis of the earning per share shows that GEHL grew at a 8% pace compared to much more impressive 10.6% rate for caterpillar. Caterpillar also provides a dividend to put the full return at around 13%. Clearly, caterpillar is a better business to own than GEHL.
The next thing to look at is the current discount/premium compared to its peers to see if GEHL is a buy. The key factor in favor of GEHL is its price/book ratio. Caterpillar has a P/B of 4 where as GEHL has a better ratio of 1.48. Caterpillar however has a better earning yield compared to GEHL. GEHL has negative free cash flow where as Caterpillar is cash flow positive.
The short term technical analysis shows that the 100 day moving average is below the 200 day moving average - meaning the downtrend in the stock is not over. The insider buying is a clear indication that the stock is undervalued as there has been more insider buying than selling of late. As noted, the company is profitable and is probably worth about $36 a share. The estimates for next year's earnings are good but there are a lot of wild cards about next year - especially the way the economy is going to go. If those earnings estimates are met, it would provide the stock with an impetus to move higher.
Friday, November 03, 2006
Berkshire Hathaway (BRK.A/BRK.B) Q3 Report
In this segment, we will look at Berkshire Hathaway quarterly earnings and see the various segments to see how the different businesses are doing.
First, BRK did extremely well this quarter. The book value increased by 5% from the second quarter. The increase in book value was partially helped by the increase in the equity portfolio.
Let us first analyze the different segments by revenue. The insurance premiums increased by 10% year over year for the third quarter. The primary reason for the big surge in insurance income was the reduced adjustment for insurance losses and loss adjustment accounts compared to the same quarter last year.
The increase in revenues year over year (Q3 of 05 vs Q3 of 06 ) in the various segments is as follows:
Geico - 9.35%
GenRe - -0.05%
Berkshire ReInsurance - 31%
Berkshire Primary Group - 8%
Investment Income - 22%
Total Insurance Group - increased by 11.69%.
The apparel group revenues increased by 44.7%.
The building products group increased by 4.9%
Finance products increased by 6.4%
Flight Services increased by 31%
McLane company increased by 4.4%
Retail increased by 10.4%
Shaw Industries was constant
Utilities increased by 2.85 billion this year compared to the prior year.
Other businesses increased by 87%. This includes the Iscar acquisition.
The revenues in operating businesses increased by 26% year over year.
The one segment that performed a bit below last years level is investment/derivative gains. This caused the EPS to come in below 2K level for this quarter.
The net differential in income from the insurance businesses was 3.427 billion. The income from operating businesses sky rocketed by 52% year over year to 1771 million dollars from 1032 million dollars. The new acquisitions definitely contributed to this phenomenal rise. Almost all the analysts have overlooked this part.
The cash flows from operating activities increased by 39% year over year. Cash and equivalents were at 39 billion dollars. About 7 billion out of this amount is spoken for in the equitas deal in the form of additional reserves to be kept aside. Subtracting the ten billion needed for catastrophic events, there is 22 billion available for general investments.
The quarter was very strong. The net earning came in at 4301 million before income taxes. Both the revenues and net earnings from insurance and other operating businesses have beaten the whisper numbers. The earnings per share beat the wallstreet consensus estimates by a wide margin.
The intrinsic value of BRKA is some where in the 125-131K range from a very conservative view point. If the shares dont go up further this year, investors can expect 10%+ growth in stock price in 2007 and 2008. BRKA is still a cheap stock and a bargain compared to the more popular dot.com stocks of the type of Google, Apple variety.
First, BRK did extremely well this quarter. The book value increased by 5% from the second quarter. The increase in book value was partially helped by the increase in the equity portfolio.
Let us first analyze the different segments by revenue. The insurance premiums increased by 10% year over year for the third quarter. The primary reason for the big surge in insurance income was the reduced adjustment for insurance losses and loss adjustment accounts compared to the same quarter last year.
The increase in revenues year over year (Q3 of 05 vs Q3 of 06 ) in the various segments is as follows:
Geico - 9.35%
GenRe - -0.05%
Berkshire ReInsurance - 31%
Berkshire Primary Group - 8%
Investment Income - 22%
Total Insurance Group - increased by 11.69%.
The apparel group revenues increased by 44.7%.
The building products group increased by 4.9%
Finance products increased by 6.4%
Flight Services increased by 31%
McLane company increased by 4.4%
Retail increased by 10.4%
Shaw Industries was constant
Utilities increased by 2.85 billion this year compared to the prior year.
Other businesses increased by 87%. This includes the Iscar acquisition.
The revenues in operating businesses increased by 26% year over year.
The one segment that performed a bit below last years level is investment/derivative gains. This caused the EPS to come in below 2K level for this quarter.
The net differential in income from the insurance businesses was 3.427 billion. The income from operating businesses sky rocketed by 52% year over year to 1771 million dollars from 1032 million dollars. The new acquisitions definitely contributed to this phenomenal rise. Almost all the analysts have overlooked this part.
The cash flows from operating activities increased by 39% year over year. Cash and equivalents were at 39 billion dollars. About 7 billion out of this amount is spoken for in the equitas deal in the form of additional reserves to be kept aside. Subtracting the ten billion needed for catastrophic events, there is 22 billion available for general investments.
The quarter was very strong. The net earning came in at 4301 million before income taxes. Both the revenues and net earnings from insurance and other operating businesses have beaten the whisper numbers. The earnings per share beat the wallstreet consensus estimates by a wide margin.
The intrinsic value of BRKA is some where in the 125-131K range from a very conservative view point. If the shares dont go up further this year, investors can expect 10%+ growth in stock price in 2007 and 2008. BRKA is still a cheap stock and a bargain compared to the more popular dot.com stocks of the type of Google, Apple variety.
Thursday, October 26, 2006
Microsoft Q1 Result Analysis
Microsoft reported its first quarter earnings today. The earnings report can be viewed at the Microsoft website. Let us take a quick look at the earnings to see how the MSFT prospects look like.
The top line revenue increased by 11% this quarter compared to the previous years quarter. The break down in revenue in different divisions is as follows. Out of the one billion increase in revenue, XBox contributed about 400 million. Since XBox is selling at a loss, the top line growth in core businesses was 6.9%. The growth in each of the sub groups was as follows. Client grew by 2.7%, server grew by 17.5%, Office grew by 4.3%. The Online business saw a decline with more losses in the pipeline for the rest of the year.
Since XBox doesnt generate profits, let us look at the rest of the balance sheet to see how the operating margin looks like for this quarter. The operating income margin was still decent without significant deterioration and comparable to the FY06 Q1 levels. The R&D costs and sales, marketing costs increased by 17% and 12% respectively. If the same number of shares were outstanding as last year, the earnings would have come in at 32 cents a share. The share buy backs helped boost the earnings by three cents to 45 cents.
Surprisingly, the cash flow from operations declined year over year. The decline is about 6-7% compared to the same quarter from the prior year. This is despite the decrease in stock option expense and increase in receivables. The capital expenditures increased by 93% year over year. It looks as though the cash flows for the entire year will probably decline compared to the same period last year.
Despite the lackluster balance sheet, the stock will probably stabilize around the current price for FY07. The upside for Microsoft stock ( if any ) is going to be in fiscal FY08 when revenues from vista and office start kicking in and XBox losses decline further or make a slight profit.
The top line revenue increased by 11% this quarter compared to the previous years quarter. The break down in revenue in different divisions is as follows. Out of the one billion increase in revenue, XBox contributed about 400 million. Since XBox is selling at a loss, the top line growth in core businesses was 6.9%. The growth in each of the sub groups was as follows. Client grew by 2.7%, server grew by 17.5%, Office grew by 4.3%. The Online business saw a decline with more losses in the pipeline for the rest of the year.
Since XBox doesnt generate profits, let us look at the rest of the balance sheet to see how the operating margin looks like for this quarter. The operating income margin was still decent without significant deterioration and comparable to the FY06 Q1 levels. The R&D costs and sales, marketing costs increased by 17% and 12% respectively. If the same number of shares were outstanding as last year, the earnings would have come in at 32 cents a share. The share buy backs helped boost the earnings by three cents to 45 cents.
Surprisingly, the cash flow from operations declined year over year. The decline is about 6-7% compared to the same quarter from the prior year. This is despite the decrease in stock option expense and increase in receivables. The capital expenditures increased by 93% year over year. It looks as though the cash flows for the entire year will probably decline compared to the same period last year.
Despite the lackluster balance sheet, the stock will probably stabilize around the current price for FY07. The upside for Microsoft stock ( if any ) is going to be in fiscal FY08 when revenues from vista and office start kicking in and XBox losses decline further or make a slight profit.
Sunday, October 22, 2006
SanDisk (SNDK) Analysis
We looked at Sandisk and other flash manufacturers in the attached article. In that article, we noted
"In this article, we take a quick look at some of the flash memory manufacturers
and the trends in this area. Some of the companies in the flash memory area are
- Sandisk (SNDK), Micron Technology (MU), Lexar Media Inc ( LEXR ), Infineon,
Samsung and Toshiba. Samsung mainly makes deals with OEMs and doesnt deal with
retail marketing. We will analyze a couple of companies and SNDK in this
article."
In the intervening months, the usage of flash memory has increased. It is used more commonly now and the volume is growing. Along with the volume, the cost per memory unit is declining. Meanwhile, the industry is consolidating. This is a very competitive business with many players. Meanwhile, the business is also consolidating with Lexar going private and Sandisk buying the Israeli based M Systems. Eli Harari, the CEO of SNDK estimates a growth of 200% in flash memory volume in 2006 compared to 2005.
Most of the electronic equipments get sold in the holiday season. Consequently the last quarter of the year is a big one for flash/memory manufacturers as well. As much as 40% of Sandisk's business occurs in the fourth quarter. Sandisk as a company is the leading provider of flash memory in the world and has done well to expand its base. SNDK has diversified into MP3 players and have cornered 10% of the market - a market dominated by Apple's iPod.
Next we will look into SanDisk's operarting margins. For the three months ended in July, the operating margin was 13.29%. ( net income/total revenues ). This was about 13.69% for the same period the year before. For the first six months, the operating margin is 13.89% - this compares to a margin of 22.73% in the same period the year before. Now let us move to this quarter - the operating margin this quarter was 13.74% where as the margin was 18.22% in the same quarter a year before. So clearly, the trend is for the margins to go down year over year. The cause for the margins to decline is primarily attributed to a glut in the Flash market where one of the manufacturers oversupplied the market.
Another important metric is the free cash flow. The company's free cash flow has been going up and down over the past ten years. Specifically, in the past four years, the numbers are 217 million, 101 million, 347 million and 241 million for this year respectively. So the cash flows are erratic and this typically means the company doesnt have market dominating power.
"In this article, we take a quick look at some of the flash memory manufacturers
and the trends in this area. Some of the companies in the flash memory area are
- Sandisk (SNDK), Micron Technology (MU), Lexar Media Inc ( LEXR ), Infineon,
Samsung and Toshiba. Samsung mainly makes deals with OEMs and doesnt deal with
retail marketing. We will analyze a couple of companies and SNDK in this
article."
In the intervening months, the usage of flash memory has increased. It is used more commonly now and the volume is growing. Along with the volume, the cost per memory unit is declining. Meanwhile, the industry is consolidating. This is a very competitive business with many players. Meanwhile, the business is also consolidating with Lexar going private and Sandisk buying the Israeli based M Systems. Eli Harari, the CEO of SNDK estimates a growth of 200% in flash memory volume in 2006 compared to 2005.
Most of the electronic equipments get sold in the holiday season. Consequently the last quarter of the year is a big one for flash/memory manufacturers as well. As much as 40% of Sandisk's business occurs in the fourth quarter. Sandisk as a company is the leading provider of flash memory in the world and has done well to expand its base. SNDK has diversified into MP3 players and have cornered 10% of the market - a market dominated by Apple's iPod.
Next we will look into SanDisk's operarting margins. For the three months ended in July, the operating margin was 13.29%. ( net income/total revenues ). This was about 13.69% for the same period the year before. For the first six months, the operating margin is 13.89% - this compares to a margin of 22.73% in the same period the year before. Now let us move to this quarter - the operating margin this quarter was 13.74% where as the margin was 18.22% in the same quarter a year before. So clearly, the trend is for the margins to go down year over year. The cause for the margins to decline is primarily attributed to a glut in the Flash market where one of the manufacturers oversupplied the market.
Another important metric is the free cash flow. The company's free cash flow has been going up and down over the past ten years. Specifically, in the past four years, the numbers are 217 million, 101 million, 347 million and 241 million for this year respectively. So the cash flows are erratic and this typically means the company doesnt have market dominating power.
Another metric of interest in the high tech companies is the stock dilution year over year. Year over year, the dilution is about 4% and is expected to be much higher once the all stock deal closes for Israeli based MSystems Limited.
The stock dropped by over 20% on Friday last week because of the declining margins sited by the CEO - Eli Harari. There are two types of valuations that can be done - one is relative valuation where a company is compared to its peers in the same sector and the second is by looking at the future discounted cash flows to see the intrinsic value. In the technology sector, primarily the relative valuation approach works best. The intrinsic valuation approach doesnt work as well as one would find that the stocks are typically overpriced with huge expectations for future growth.
Doing relative analysis, one finds that SNDK is fairly priced with Friday's drop and probably can go up a bit to the $56 range. The comparison of SNDK is with Micron Technology and SNDK should enjoy a slight premium because of bette margins and its market leading position.
Sunday, October 15, 2006
Fedex Corporation Analysis
FedEx business can be described as follows, from the 10-K,
FedEx Corporation (“FedEx”) provides a broad portfolio of transportation, e-commerce and business services through companies operating independently, competing collectively and managed collaboratively under the respected FedEx brand. These operating companies are primarily represented by Federal Express Corporation (“FedEx Express”), the world’s largest express transportation company; FedEx Ground Package System, Inc. (“FedEx Ground”), a leading provider of small-package ground delivery services; FedEx Freight Corporation (“FedEx Freight”), a leading U.S. provider of regional less-than-truckload (“LTL”) freight services; and FedEx Kinko’s Office and Print Services, Inc. (“FedEx Kinko’s”), a leading provider of document solutions and business services. These companies form the core of our reportable segments.
Other business units in the FedEx portfolio are FedEx Trade Networks, Inc. (“FedEx Trade Networks”), a global trade services company; FedEx SmartPost, Inc. (“FedEx SmartPost”), a small-parcel consolidator; FedEx Supply Chain Services, Inc. (“FedEx Supply Chain Services”), a contract logistics provider; FedEx Custom Critical, Inc. (“FedEx Custom Critical”), a critical-shipment carrier; Caribbean Transportation Services, Inc. (“Caribbean Transportation Services”), a provider of airfreight forwarding services, and FedEx Corporate Services, Inc. (“FedEx Services”), a provider of customer-facing sales, marketing and information technology functions, primarily for FedEx Express and FedEx Ground.
FedEx Corporation (“FedEx”) provides a broad portfolio of transportation, e-commerce and business services through companies operating independently, competing collectively and managed collaboratively under the respected FedEx brand. These operating companies are primarily represented by Federal Express Corporation (“FedEx Express”), the world’s largest express transportation company; FedEx Ground Package System, Inc. (“FedEx Ground”), a leading provider of small-package ground delivery services; FedEx Freight Corporation (“FedEx Freight”), a leading U.S. provider of regional less-than-truckload (“LTL”) freight services; and FedEx Kinko’s Office and Print Services, Inc. (“FedEx Kinko’s”), a leading provider of document solutions and business services. These companies form the core of our reportable segments.
Other business units in the FedEx portfolio are FedEx Trade Networks, Inc. (“FedEx Trade Networks”), a global trade services company; FedEx SmartPost, Inc. (“FedEx SmartPost”), a small-parcel consolidator; FedEx Supply Chain Services, Inc. (“FedEx Supply Chain Services”), a contract logistics provider; FedEx Custom Critical, Inc. (“FedEx Custom Critical”), a critical-shipment carrier; Caribbean Transportation Services, Inc. (“Caribbean Transportation Services”), a provider of airfreight forwarding services, and FedEx Corporate Services, Inc. (“FedEx Services”), a provider of customer-facing sales, marketing and information technology functions, primarily for FedEx Express and FedEx Ground.
Fedex revenue break down by segment is as follows:
Fedex Express - 66%
Fedex Ground - 16%
Fedex Freight - 11%
Kinkos - 6.6%
From volume growth point of view, Fedex express saw a one percent decline, Fedex ground increased by 13%. The latest 1o-Q provides more details:
Revenue growth for the first quarter of 2007 was primarily attributable to yield improvement across all of our transportation segments, volume growth at FedEx Ground and FedEx Freight and package volume growth in our International Priority (“IP”) services at FedEx Express. Yield improvements were principally due to higher fuel surcharges and rate increases. Volume increases at FedEx Ground resulted from increases in both commercial business and FedEx Home Delivery service, which helped mitigate the impact of domestic volume declines at FedEx Express. Shipment volumes grew 8% at FedEx Freight in the first quarter of 2007, while IP package volumes at FedEx Express grew 6% for the quarter. Revenues at FedEx Kinko’s decreased during the first quarter of 2007 primarily due to a continued competitive environment for copy services.
Operating income increased in the first quarter of 2007 primarily due to revenue growth and improved margins at FedEx Express and was slightly offset by reduced operating income at FedEx Kinko’s. Effective cost controls and revenue management actions contributed to increased operating margin at FedEx Express in the first quarter of 2007. FedEx Express operating income in the first quarter of 2006 included a $75 million charge described below.
The most interesting part of the 10-Q is the outlook statement:
While our growth rate is expected to moderate in comparison to our strong growth in 2006, we expect revenue and earnings improvement across all transportation segments in 2007. Our outlook is based on solid global economic growth, with the U.S. economy growing at a moderate, sustainable rate. We anticipate revenue growth in our high-margin services, productivity improvements and continued focus on yield management.
We anticipate growth in total U.S. domestic package volumes and yields, as well as continued growth in FedEx Express IP shipments and yields. We also anticipate year-over-year increases in volumes and yields at FedEx Freight as that segment continues to expand its LTL network and service offerings.
FedEx Kinko’s will focus on key strategies related to adding new locations, improving customer service and increasing investments in employee development and training, which we expect to result in decreased profitability in the short-term. In the first quarter of 2007, FedEx Kinko’s announced the model for new centers, which will be approximately one-third the size of a traditional center and will include enhanced pack-and-ship stations and a doubling of the number of office products offered. FedEx Kinko’s plans to open approximately 200 new centers across the United States during 2007, which will bring the total number of domestic centers to over 1,500.
We expect to continue to make investments to expand our networks and broaden our service offerings, in part through the integration and expansion of FedEx National LTL and our investments overseas. We anticipate that our new FedEx National LTL business will extend our leadership position in the heavy freight sector and provide new growth opportunities for our LTL operations in 2007 and beyond.
On September 25, 2006, we announced a $2.6 billion multi-year program to acquire and modify approximately 90 Boeing 757-200 aircraft to replace our narrow body fleet of Boeing 727-200 aircraft. We expect to bring the new aircraft into service during the eight-year period between calendar years 2008 and 2016 contingent upon identification and purchase of suitable 757 aircraft. The impact to 2007 of this program has been reflected in our expected 2007 capital expenditures of approximately $3 billion.
All of our transportation businesses operate in a competitive pricing environment, exacerbated by continuing high fuel prices. While our fuel surcharges have been sufficient to offset increased fuel prices, we cannot predict the impact on the overall economy if fuel costs significantly fluctuate from current levels. Volatility in fuel costs may also impact quarterly earnings because adjustments to our fuel surcharges lag changes in actual fuel prices paid. Therefore, the trailing impact of adjustments to FedEx Express and FedEx Ground fuel surcharges can significantly affect earnings in the short-term.
The pilots of FedEx Express, which represent a small number of FedEx Express total employees, are employed under a collective bargaining agreement that became amendable on May 31, 2004. In August 2006, FedEx Express and the pilots’ union reached a tentative agreement on a new labor contract. The proposed new contract includes signing bonuses and other compensation that would result in a charge in the period of ratification of approximately $145 million. Contract ratification is expected during the second quarter of 2007 but cannot be assured. If ratified, the new four-year contract will become amendable in 2010.
In July 2006, FedEx Express entered into a new seven-year transportation agreement with the United States Postal Service (“USPS”) under which FedEx Express will continue to provide domestic air transportation services to the USPS, including for its First Class, Priority and Express Mail. The agreement is expected to generate more than $8 billion in revenue for FedEx Express over its term, which begins on September 25, 2006, and ends on September 30, 2013. The agreement will replace the existing seven-year transportation agreement between FedEx Express and the USPS.
Interesting facts on Fedex are as follows:
The earning yield on Fedex ( at trailing P/E ) is 5.5 - which is slightly better than the long bond yield of 4.7%. On the forward P/E basis, the yield is 5.9% for FY07. However, FDX is growing at a brisk pace of about 10% per year along with cash flows and the growth rate will continue for the next several years. From the discount cash flow point of view, Fedex is definitely looking good at current prices with upside in the future. The demographics in the US and increasing wealth around the world will always need Fedex service for decades to come.
Saturday, October 07, 2006
Google - a strong sell?
In this article, we will look at two analysis of Google. One is based on the earning yield and comparing it to the long bond. The second one is based on discount cash flow analysis done by Aswath Damodaran.
At this years earnings of $10.00 and next years earnings of $13.50, the earning yield for Google in the next two years at today's price is 2.4% and 3.21% respectively. The ten year bond is currently trading at 4.6%.
Let us do a quick comparison to Microsoft and Yahoo! Googles top two competitors. Yahoo! has an earning yield of 1.9% and 2.56% respectively. Microsoft on the other hand has an earning yield of 5.15% and 5.99% respectively. On a comparative basis, one can see Microsoft, Google and then Yahoo! as the stocks to buy from the perspective of stability.
Aswath Damodar has done a discount cash flow analysis of Google. His analysis in his website based on discount cash flows puts a value of $110.00 for Google based on discount cash flow analysis.
The summary of these analysis shows that Google is a great momentum play. Google is likely do well in the short term but longer term the stock is likely remain stagnant or go down in value. One can definitely expect wild swings in Google stock in the upcoming months.
At this years earnings of $10.00 and next years earnings of $13.50, the earning yield for Google in the next two years at today's price is 2.4% and 3.21% respectively. The ten year bond is currently trading at 4.6%.
Let us do a quick comparison to Microsoft and Yahoo! Googles top two competitors. Yahoo! has an earning yield of 1.9% and 2.56% respectively. Microsoft on the other hand has an earning yield of 5.15% and 5.99% respectively. On a comparative basis, one can see Microsoft, Google and then Yahoo! as the stocks to buy from the perspective of stability.
Aswath Damodar has done a discount cash flow analysis of Google. His analysis in his website based on discount cash flows puts a value of $110.00 for Google based on discount cash flow analysis.
The summary of these analysis shows that Google is a great momentum play. Google is likely do well in the short term but longer term the stock is likely remain stagnant or go down in value. One can definitely expect wild swings in Google stock in the upcoming months.
Sunday, October 01, 2006
Overview of Indian Markets and Funds
We have looked at emerging markets and BRIC stocks quite a few times in this blog. We will look at the Indian economy, the returns in BSE Sensex thus far this year and look at the India funds and the outlook for the sector in the coming several months.
First an outlook of the Indian economy. The Indian economy was expected to grow at ~7% rate this year and next. This is higher than the world wide economic growth prediction of 5.1% and 4.9% repsectively for this year and next. Financial Times reported that Indian economy grew at the rate of 8.9% in the first quarter of 06-07 fiscal year. This was above the analysts estimates of 8.5% growth. The inflation rate is going around 5-5.5% and the RBI is expected to increase the interest rates to 6.25% as a result. The interest rates are already much higher than that in China.
The Wallstreet Journal reports that the BSE Sensex Index has grown by 32.5% this year and on the average sports a P/E of 21. Of all the stock markets in the world, the Chinese and Indian markets are on the higher end of the valuation spectrum with a P/E of 21.
The prognosis for Indian economy is good and the economy is expected to grow at around 8% for the next three-four years. India runs a trade deficit with the rest of the world like the U.S. India has a very high degree of domestic consumption unlike the other Asian Tigers whose economy is propelled by export to the United States. At this rate of growth, the Indian companies will probably continue to grow at very fast rates making the current P/E not that high.
Now, let us take a look at India funds. We start by looking at the generic emerging market funds and then look at Indian funds in particular.
EEM is the iShares emerging market fund and has returned about 9.7% YTD. If one bought the ETF at the low 80's in the second quarter, the ETF has returned more than 20%. EEM has an expense ratio of 0.77%. EEM has approximately 5% exposure to India.
VWO is the Vanguard emerging market fund and has returned about 10.3% YTD. This correlates highly with EEM but has a lower expense ratio of 0.3%. VWO has a 7.1% exposure to India and it has done better than EEM recently.
IIF is Morgan Stanley India Investment Fund, Inc. is a non-diversified, closed-end management investment company. The Fund's investment objective is long-term capital appreciations, which it seeks to achieve by investing primarily in equity securities of Indian issuers. The Fund will invest at least 65% of its total assets in equity securities of Indian issuers; which for this purpose means common and preferred stock bonds, notes and debentures convertible into common or preferred stock, stock purchase warrants and rights, equity interests in trusts and partnerships and American , Global and other types of Depositary Receipts. The Fund may invest up to 25% of its total assets in unlisted equity securities of Indian issuers.
Currently IIF sells for about 2.48% premium to the net asset value. The management fees for this stock is 1.27%. The total return of IIF is 14.2% compared to the BSE Sensex Index return of 32.5%.
IFN India Fund is a closed-end management investment company. The fund seeks long-term capital appreciation through primarily investing in the equity securities of Indian companies. The fund will invest at least 80% of its total assets in the equity securities of Indian Companies. The management fees for this stock is 1.47%. The fund has returned 8.2% compared to the BSE Sensex index of 32.5%.
MINDX Mathews India Fund is a relative new comer to the block. The fund carries an expense ratio of 2.75% has returned 18.82% YTD.
ETGIX It has an initiation fee of 5.75% for small sums of money that declines to zero if the capital is greater than a million dollars. This is not targeted for individual investors but is targeted more towards institutional investors that want an exposure to India. The fund also has an expense ratio of 2.75% on top of the initiation fee. This fund has returned 19.67% YTD.
EEB ( Claymore/BNY BRIC ETF ) - This is a new ETF targeting only the BRIC countries - Brazil, Russia, India and China. The fund doesnt have the assets divided equally with all the four countries but it only specializes in these four emerging markets. The fund carries an expense ratio of 0.65% and returned 3% since inception.
Although both India and China look expensive at the moment compared to other markets, the growth in these markets make it look as though there is still upside for these companies.
First an outlook of the Indian economy. The Indian economy was expected to grow at ~7% rate this year and next. This is higher than the world wide economic growth prediction of 5.1% and 4.9% repsectively for this year and next. Financial Times reported that Indian economy grew at the rate of 8.9% in the first quarter of 06-07 fiscal year. This was above the analysts estimates of 8.5% growth. The inflation rate is going around 5-5.5% and the RBI is expected to increase the interest rates to 6.25% as a result. The interest rates are already much higher than that in China.
The Wallstreet Journal reports that the BSE Sensex Index has grown by 32.5% this year and on the average sports a P/E of 21. Of all the stock markets in the world, the Chinese and Indian markets are on the higher end of the valuation spectrum with a P/E of 21.
The prognosis for Indian economy is good and the economy is expected to grow at around 8% for the next three-four years. India runs a trade deficit with the rest of the world like the U.S. India has a very high degree of domestic consumption unlike the other Asian Tigers whose economy is propelled by export to the United States. At this rate of growth, the Indian companies will probably continue to grow at very fast rates making the current P/E not that high.
Now, let us take a look at India funds. We start by looking at the generic emerging market funds and then look at Indian funds in particular.
EEM is the iShares emerging market fund and has returned about 9.7% YTD. If one bought the ETF at the low 80's in the second quarter, the ETF has returned more than 20%. EEM has an expense ratio of 0.77%. EEM has approximately 5% exposure to India.
VWO is the Vanguard emerging market fund and has returned about 10.3% YTD. This correlates highly with EEM but has a lower expense ratio of 0.3%. VWO has a 7.1% exposure to India and it has done better than EEM recently.
IIF is Morgan Stanley India Investment Fund, Inc. is a non-diversified, closed-end management investment company. The Fund's investment objective is long-term capital appreciations, which it seeks to achieve by investing primarily in equity securities of Indian issuers. The Fund will invest at least 65% of its total assets in equity securities of Indian issuers; which for this purpose means common and preferred stock bonds, notes and debentures convertible into common or preferred stock, stock purchase warrants and rights, equity interests in trusts and partnerships and American , Global and other types of Depositary Receipts. The Fund may invest up to 25% of its total assets in unlisted equity securities of Indian issuers.
Currently IIF sells for about 2.48% premium to the net asset value. The management fees for this stock is 1.27%. The total return of IIF is 14.2% compared to the BSE Sensex Index return of 32.5%.
IFN India Fund is a closed-end management investment company. The fund seeks long-term capital appreciation through primarily investing in the equity securities of Indian companies. The fund will invest at least 80% of its total assets in the equity securities of Indian Companies. The management fees for this stock is 1.47%. The fund has returned 8.2% compared to the BSE Sensex index of 32.5%.
MINDX Mathews India Fund is a relative new comer to the block. The fund carries an expense ratio of 2.75% has returned 18.82% YTD.
ETGIX It has an initiation fee of 5.75% for small sums of money that declines to zero if the capital is greater than a million dollars. This is not targeted for individual investors but is targeted more towards institutional investors that want an exposure to India. The fund also has an expense ratio of 2.75% on top of the initiation fee. This fund has returned 19.67% YTD.
EEB ( Claymore/BNY BRIC ETF ) - This is a new ETF targeting only the BRIC countries - Brazil, Russia, India and China. The fund doesnt have the assets divided equally with all the four countries but it only specializes in these four emerging markets. The fund carries an expense ratio of 0.65% and returned 3% since inception.
Although both India and China look expensive at the moment compared to other markets, the growth in these markets make it look as though there is still upside for these companies.
Saturday, September 30, 2006
Valuing Berkshire Hathaway using cash flows
We have looked at Berkshire Hathaway many times in this blog. BRKA/B is always a good stock to analyze as it is run by the best investor in the world - Warren Buffettt. In this segment, we estimate the current value of Berkshire Hathaway using its book value and its cash flows.
For the purposes of this analysis, we will take 2005 annual report as the basis. Taking the 2005 report gives us a conservative basis as the company was impacted by massive gulf hurricanes - Karina, Rita and Wilma.
Total berkshire hathaway share holder equity at the end of 2005 was 91,484 million dollars. The share holder equity is up significanly this year and is likely increase by 10% or more this year.
The next thing to look at is the cash flows. The cash flows in Berkshire balance sheet is divided into three segments. Cash flows from operating acitivities, cash flows from investing activities and cash flows from financing activities.
Cash flows from operating activities in 2005 was 9446 million dollars. The cash flows from operating activities were 7311 million dollars and 8341 million in the previous two years respectively. The average cash flow for the past three years is 8344 million dollars. We will take this value for our analysis purposes.
We are going to leave the cash flows from investing activities alone as this should be in the negative territoty for a while as Warren Buffett and Charlie Munger find home for the boatloads of cash on Berkshire balance sheet.
Earnings from financing activities is expected to be the positive category in the future for Berkshire Hathaway. We will take the low end of this figure and estimate gains of about a billion dollars per year till perpetuity.
Adding these two figures gives a net cash flow per year of 9344 billion dollars a year. Using the infinite geometric series with a discount rate of 11%, the intrinsic value of Berkshire Hathaway through cash flows is 94180 million dollars.
Adding the book value and the value of future cash flows gives an intrinsic value of 185664 million dollars to Berkshire Hathaway. This puts Berkshire Hathaways current stock price at a 25% discount to its intrinsic value.
This valuation puts Berkshires intrinsic value at 119750 as per the financial statements from the 2005 annual report. The cash flows used for this valuation are extremely conservative. Giventhe growth and improvement this year, the intrinsic value is significantly higher - more likely in the 130-140K range by end of 2006.
For the purposes of this analysis, we will take 2005 annual report as the basis. Taking the 2005 report gives us a conservative basis as the company was impacted by massive gulf hurricanes - Karina, Rita and Wilma.
Total berkshire hathaway share holder equity at the end of 2005 was 91,484 million dollars. The share holder equity is up significanly this year and is likely increase by 10% or more this year.
The next thing to look at is the cash flows. The cash flows in Berkshire balance sheet is divided into three segments. Cash flows from operating acitivities, cash flows from investing activities and cash flows from financing activities.
Cash flows from operating activities in 2005 was 9446 million dollars. The cash flows from operating activities were 7311 million dollars and 8341 million in the previous two years respectively. The average cash flow for the past three years is 8344 million dollars. We will take this value for our analysis purposes.
We are going to leave the cash flows from investing activities alone as this should be in the negative territoty for a while as Warren Buffett and Charlie Munger find home for the boatloads of cash on Berkshire balance sheet.
Earnings from financing activities is expected to be the positive category in the future for Berkshire Hathaway. We will take the low end of this figure and estimate gains of about a billion dollars per year till perpetuity.
Adding these two figures gives a net cash flow per year of 9344 billion dollars a year. Using the infinite geometric series with a discount rate of 11%, the intrinsic value of Berkshire Hathaway through cash flows is 94180 million dollars.
Adding the book value and the value of future cash flows gives an intrinsic value of 185664 million dollars to Berkshire Hathaway. This puts Berkshire Hathaways current stock price at a 25% discount to its intrinsic value.
This valuation puts Berkshires intrinsic value at 119750 as per the financial statements from the 2005 annual report. The cash flows used for this valuation are extremely conservative. Giventhe growth and improvement this year, the intrinsic value is significantly higher - more likely in the 130-140K range by end of 2006.
Saturday, September 23, 2006
Ways to value a company
When one is buying a company, an ETF or a mutual fund - there are two things to make sure of. The first one is if the right security is being bought and the second thing to make sure is that the securities are bought at an appropriate price. Two types of investing has been known to work - momentum investing and value investing. In this article, we look at methods that may be used to value a security using different approaches.
Momentum investing is typically done over a short period of time typically over a few months or a few years. The number of years for momentum investing is typically less than three and definitely not more than five. One example of this showed itself during the .com boom which lasted for about four years from 1996-2000. Recently we have had the commodities boom which also is not likely to last over longer than five years. In other words, performance in each sector is bound to revert to its mean over long periods of time.
First, there is the problem of finding the right security. The right security can be obtained by screening message boards, reading business magazines and or using the "magic formula". Joel Greenblatt in his book the little book that beats the market introduced the so called magic formula. The formula involves
Momentum investing is typically done over a short period of time typically over a few months or a few years. The number of years for momentum investing is typically less than three and definitely not more than five. One example of this showed itself during the .com boom which lasted for about four years from 1996-2000. Recently we have had the commodities boom which also is not likely to last over longer than five years. In other words, performance in each sector is bound to revert to its mean over long periods of time.
First, there is the problem of finding the right security. The right security can be obtained by screening message boards, reading business magazines and or using the "magic formula". Joel Greenblatt in his book the little book that beats the market introduced the so called magic formula. The formula involves
- Buying stocks that rank highest in a combination of
- Earnings yield (the inverse of the price-to-earnings [P/E] ratio) and
- Return on capital.have doubled the market's returns
This system can be used as an effective screen but the mechanical screen itself will not identify great businesses at attractive prices.
It is always good to apply the basics that Charlie Munger talks about in Poor Charlies Almanac to the stocks selected. The basic principles that Charlie talks about are.
- Answer the no brainer questions first.
- Apply mathematical models to assert scientific reality.
- Think problems forward and backward - or "invert, always invert".
- Apply fundamentals from different disciplines to analyze the company further.
- Really big effects, lallapalooza effects will often come only from large combination of factors.
In this article we look at possible mathematical models that can be applied to value a company. One should always value a company conservatively so that a margin of safety is built into the company that prevents the downside during market downturns.
The book "Value Investing from Graham to Buffett and Beyond", Bruce Greenwald et.al describe a few methods to value a company. Some of the methods they describe are:
- Valuing the asset value that is required to produce the necessary goods or service. This model assumes no competitive advantage - i.e., another market entrant can produce the same goods and service by investing similar capital.
- Earning power value - this minus the asset value of the company gives the franchise value because of competitive advantages.
- The value of growth is the value of the company on top of EPV.
Needless to say, the Munger factors kick in before one can value the company properly using these approaches. Typically, calculating the EPV involves taking the net income and adding a part of R&D and sales budget and dividing by the cost of capital. Adjusting the net income is a complicated process and involves significant guess work. Any calculation that involves significant guess work is likely prone to errors.
Another way to calculate the intrinsic value of a company is to take the book value of a company and add to it the discounted cash flow for the next ten years. This model is simple and works fairly well. For a company with no growth with 11% discount rate, this value can be calculated as book value + 7 x cash flow + 0.3 terminal cash flow. Appropriate adjustments can be made to value the company appropriately. If one can be reasonably sure the company is going to be around for the next next one hundred years, the value of the company can be calculated as book value + 10 x cash flow.
In future segments, we will use of the afore mentioned methods to value a company and we will specify the model used.
Sunday, September 17, 2006
Valuing Microsoft
Microsoft is a software services and hardware games company. In this segment, we will look at Microsoft's earnings and estimate Microsoft's intrinsic value. We take a variant of the approach described in "Value Investing - from Grahamto Buffett and Beyond" written by Bruce C. N. Greenwald et. al.
Microsoft is a very profitable company. In FY2006, Microsoft had 28.5 cents of net income on every dollar of revenue. The total net income at Microsoft has remained stagnant at 12.5 billion dollar range for the past couple of years. The investments in less profitable ventures such as XBox and MSN have compensated the lack of revenue growth.
It is natural that a business that is very profitable attracts competition. Microsoft has attracted competition in a variety of forms from free software (Linux) and that includes government intervention from places like the European Union and Korea. The one time charges that Microsoft has been taking is endless and is not likely to subside anytime soon.
Let us take Microsoft's net earnings from FY2006 and assume no growth. This assumption makes sense for a conservative evaluation because of the many legal and competitive challenges Microsoft faces. FY2006 income came in at 12.5 billion. We will add 25% of R&D to net income as this expenditure will accrue to earnings. We will also add 10% of marketing revenue to the earnings. Marketing is less important at Microsoft because of its dominant position in the desktop and server markets. Putting these together puts Microsoft net earnings at 15.1 billion. Now we need to subtract capex and expense for stock based compensation and add back amortization/depreciation. Microsoft spent 1.6 billion in additions to property and equipment. So the total income after adding these in is 14.4 billion. At a cost of capital of 0.08, the earning power value of Microsoft comes in at 180 billion. However, we still have to substract the effects of stock based compensation of 1.8 billion. If we take into account the effects of stock based compensation, the earning power value declines to 157.5 billion. The effects of stock based compensation has been declining but will probably settle around 1.4 billion. In this case, the EPV of Microsoft comes in at 162.5 billion.
To this we need to add the cash in the balance sheets which was at 34 billion at the end of FY06. Adding these in, Microsoft's intrinsic value comes in around 194.5 billion dollars. Even if one completely negates the effects of stock based compensation, MSFT intrinsic value comes in at 214 billion dollars.
At the current market cap of 268 billion dollars, Microsoft is still over valued by about 20%. Given the world wide recognition of its brand name, executives and its software, Microsoft is trading at a premium and cant be considered a value stock at the moment.
Microsoft is a very profitable company. In FY2006, Microsoft had 28.5 cents of net income on every dollar of revenue. The total net income at Microsoft has remained stagnant at 12.5 billion dollar range for the past couple of years. The investments in less profitable ventures such as XBox and MSN have compensated the lack of revenue growth.
It is natural that a business that is very profitable attracts competition. Microsoft has attracted competition in a variety of forms from free software (Linux) and that includes government intervention from places like the European Union and Korea. The one time charges that Microsoft has been taking is endless and is not likely to subside anytime soon.
Let us take Microsoft's net earnings from FY2006 and assume no growth. This assumption makes sense for a conservative evaluation because of the many legal and competitive challenges Microsoft faces. FY2006 income came in at 12.5 billion. We will add 25% of R&D to net income as this expenditure will accrue to earnings. We will also add 10% of marketing revenue to the earnings. Marketing is less important at Microsoft because of its dominant position in the desktop and server markets. Putting these together puts Microsoft net earnings at 15.1 billion. Now we need to subtract capex and expense for stock based compensation and add back amortization/depreciation. Microsoft spent 1.6 billion in additions to property and equipment. So the total income after adding these in is 14.4 billion. At a cost of capital of 0.08, the earning power value of Microsoft comes in at 180 billion. However, we still have to substract the effects of stock based compensation of 1.8 billion. If we take into account the effects of stock based compensation, the earning power value declines to 157.5 billion. The effects of stock based compensation has been declining but will probably settle around 1.4 billion. In this case, the EPV of Microsoft comes in at 162.5 billion.
To this we need to add the cash in the balance sheets which was at 34 billion at the end of FY06. Adding these in, Microsoft's intrinsic value comes in around 194.5 billion dollars. Even if one completely negates the effects of stock based compensation, MSFT intrinsic value comes in at 214 billion dollars.
At the current market cap of 268 billion dollars, Microsoft is still over valued by about 20%. Given the world wide recognition of its brand name, executives and its software, Microsoft is trading at a premium and cant be considered a value stock at the moment.
Wednesday, September 13, 2006
COP Valuation
In the previous article we looked at COP as a company. In this article, we will try to put a off the cuff valuation for COP.
The average selling price for a barrel of crude was $50=00 and $6=00/mcf for natural gas in the first six months of the year respectively*. Net income in this period was 8.4 billion dollars. Subtracting capex and adding back depreciation and amortization to the net income produces a figure of 3.4 billion for the first six months of operation. Using a cost of capital of 0.08, this puts the earning power value of COP at 85 billion for an entire year. If one adds the book value to the EPV, the intrinsic value of COP with no growth is 68% undervalued compared to its market price today.
Let us assume lower selling prices for crude and natural gas as exploration and production constitutes 62% of COP's net income. Let us assume a 20% decline in prices for crude oil and natural gas. This puts the price of crude at $40=00 and $4.8/mcf for natural gas respectively. This reduction in crude and natural gas prices will put COP income at 7.4 billion for the first six months. Subtracting capex and adding back amortization and depreciation, we get an EPV of 60 billion. Adding in the book value gives a value of 137 billion. This is a 43% appreciation potential to intrinsic value.
This represents an intrinsic value for COP in the range of $83-$98. The current price of $58=00 represents a significant discount to the current trading value.
*The crude oil and natural gas prices are at the high end of the spectrum from COP 10-Q for the first six months and our estimate is very conservative.
The average selling price for a barrel of crude was $50=00 and $6=00/mcf for natural gas in the first six months of the year respectively*. Net income in this period was 8.4 billion dollars. Subtracting capex and adding back depreciation and amortization to the net income produces a figure of 3.4 billion for the first six months of operation. Using a cost of capital of 0.08, this puts the earning power value of COP at 85 billion for an entire year. If one adds the book value to the EPV, the intrinsic value of COP with no growth is 68% undervalued compared to its market price today.
Let us assume lower selling prices for crude and natural gas as exploration and production constitutes 62% of COP's net income. Let us assume a 20% decline in prices for crude oil and natural gas. This puts the price of crude at $40=00 and $4.8/mcf for natural gas respectively. This reduction in crude and natural gas prices will put COP income at 7.4 billion for the first six months. Subtracting capex and adding back amortization and depreciation, we get an EPV of 60 billion. Adding in the book value gives a value of 137 billion. This is a 43% appreciation potential to intrinsic value.
This represents an intrinsic value for COP in the range of $83-$98. The current price of $58=00 represents a significant discount to the current trading value.
*The crude oil and natural gas prices are at the high end of the spectrum from COP 10-Q for the first six months and our estimate is very conservative.
Sunday, September 10, 2006
Home Depot - trading at a discount?
In the previous article we looked at Lowes and found that it is trading at approximately 30% discount to market value. We have looked at Home Depot in the past but havent considered if it is trading at a discount to market value or not. In this segment, we will do this analysis using the same approach as Lowes.
If we estimate that Home Depot's net earnings this year will be 15% higher than last, Home Depot earnings will come in at 6700 million dollars. To this we will add amortization/depreciation and subtract capex. Amortization/depreciation is to the tune of 3.6 billion dollars a year and the capex is about 6 billion. Taking out two billion for new stores, the total amount is about 6300 million dollars. Putting the cost of capital at 8%, this gives an EPV of 78.5 billion with no growth. Adding in the cash and inventory gives HD a value of 92.7 billion. Assuming no growth, this shows that HD is 25% under valued compared to its market value at the moment.
If we estimate that Home Depot's net earnings this year will be 15% higher than last, Home Depot earnings will come in at 6700 million dollars. To this we will add amortization/depreciation and subtract capex. Amortization/depreciation is to the tune of 3.6 billion dollars a year and the capex is about 6 billion. Taking out two billion for new stores, the total amount is about 6300 million dollars. Putting the cost of capital at 8%, this gives an EPV of 78.5 billion with no growth. Adding in the cash and inventory gives HD a value of 92.7 billion. Assuming no growth, this shows that HD is 25% under valued compared to its market value at the moment.
Saturday, September 09, 2006
A view of financial markets
We finished a see-saw week for equities with ups and downs through out the week. We will update the indicators in this blog as things look right now.
The NYTimes reported that the construction spending is up 5.1% this year compared to the prior year. This growth has slowed down somewhat but has been increasing since 2001. The personal savings rate is negative and continues to be in that trend. The manufacturing index is also showing an expansion at 54.5 in August. This is down from July value of 54.7. The housing supply meanwhile has increased significantly in the meantime. This should mean continued good fortune at the construction related manufacturing such as USG.
The SP500 finished at 1300 at trailing P/E of 18. The US companies overall are doing well and index should have some upside in the next year. The emerging market index had a slow week with its value falling. It is currently trading at a slight discount to its NAV.
Among the BRICs, Indian market did well moving up on the back of optimistic prognosis for economic growth. The Brazilian index went down significantly similar to EEM. The Chinese index went up slightly. The Korean, Taiwan and Singapore exchanges all declined slightly last week.
From trailing P/E stand point, the different markets were priced as follows. This shows an upside for emerging market funds such as EEM and VWO.
India - BSE Sensex - 20
China - 21
Brazil - 10
Korea - 11
Taiwan - 11
Russia - 13
Singapore - 10
South Africa - 8
Israel - 14
Hongkong - 12
The canadian index also went down from a high of 12200 to a low of 11900 by Friday. The US index also had a down week.
Looking at everything in total, the downside correction last week looks like a temporary blip. The reduction in oil and commodity prices bodes well for growth in the emerging markets as it does in the developed countries. It doesnt look like the growth train is going to stop anytime soon.
The NYTimes reported that the construction spending is up 5.1% this year compared to the prior year. This growth has slowed down somewhat but has been increasing since 2001. The personal savings rate is negative and continues to be in that trend. The manufacturing index is also showing an expansion at 54.5 in August. This is down from July value of 54.7. The housing supply meanwhile has increased significantly in the meantime. This should mean continued good fortune at the construction related manufacturing such as USG.
The SP500 finished at 1300 at trailing P/E of 18. The US companies overall are doing well and index should have some upside in the next year. The emerging market index had a slow week with its value falling. It is currently trading at a slight discount to its NAV.
Among the BRICs, Indian market did well moving up on the back of optimistic prognosis for economic growth. The Brazilian index went down significantly similar to EEM. The Chinese index went up slightly. The Korean, Taiwan and Singapore exchanges all declined slightly last week.
From trailing P/E stand point, the different markets were priced as follows. This shows an upside for emerging market funds such as EEM and VWO.
India - BSE Sensex - 20
China - 21
Brazil - 10
Korea - 11
Taiwan - 11
Russia - 13
Singapore - 10
South Africa - 8
Israel - 14
Hongkong - 12
The canadian index also went down from a high of 12200 to a low of 11900 by Friday. The US index also had a down week.
Looking at everything in total, the downside correction last week looks like a temporary blip. The reduction in oil and commodity prices bodes well for growth in the emerging markets as it does in the developed countries. It doesnt look like the growth train is going to stop anytime soon.
Lowes (LOW) Analysis
Lowes Companies Inc. is the second largest business in the home improvement busisness with specific emphasis on retail do-it-yourself (DIY) customers, do-it-for-me (DIFM) customers who utilize our installation services, and Commercial Business Customers. It is growing at a faster pace than Home Depot, its largest competitor.
From the 10-K, Lowes describes its market as follows:
We estimate the size of the U.S. home improvement market to be approximately $700 billion, $550 billion of which comprises product demand, and $150 billion for the installed labor opportunity. Data from a variety of primary and secondary sources, including trade associations, government publications, industry participants and other sources was analyzed as the basis for our estimate. This estimate includes import and export data and key end-use markets, such as residential repair and remodeling, and nonresidential construction and maintenance. This data also includes a wide range of categories relevant to our business, including major appliances and garden supplies.
As we continue to monitor economic data and the home improvement marketplace, there are many indicators demonstrating continued strength in consumer demand for the products and services we offer. The key indicators that we monitor include personal income, employment growth, housing turnover and home ownership levels. Demographic and societal trends also remain supportive of home improvement industry growth.
Personal income continues to grow, which is supported by data from the February 2006 Blue Chip Economic Indicators™, which forecasts real disposable income growth of 3.4% for calendar 2006, compared with 1.4% in calendar 2005.
Employment growth is a strong indicator of home improvement sales. The relatively low unemployment rate suggests Americans will likely be more confident in calendar 2006 about employment prospects than in the past several years.
Housing turnover is expected to continue at a historically high pace according to The National Association of Realtors®, which forecasts calendar 2006 housing turnover to be the third strongest year on record.
Near-record U.S. homeownership levels provide an established customer base for home maintenance and repair projects. The vast majority of our customers are homeowners and they are not willing to let what is often their most valuable financial asset deteriorate.
Out of the factors mentioned above, the disposable income has increased at 6.8% rate this year while inflation has been creeping up at 4.1%. Employment growth is also strong with unemployment at record lows. Interestingly enough, housing turn over may be unaffected by the housing slow down and defaults. The only factor that may affect lowes is that less people will have the money to spend in their stores. This was evidenced recently as Lowes earnings missed the estimates by one cent.
There are several factors in favor of Lowes as noted in the Home Depot analysis. Some of the factors in play for Home Depot are true for Lowes as well. Just to recap, the factors in favor of Lowes are:
Management
Balance Sheet
Confluence of factors
In each of the above categories, Lowes is equal or better than Home Depot at the moment. It doesnt hurt that Lowes is growing at a faster pace.
Let us take a look at the balance sheets to compare Home Depot and Lowes. HD has a return on asset ratio of 13.5% and a forward earning yield of about 9%. Lowes on the other hand has an earnings yield of 8% and return on assets of 13.3%. HD has a larger per share in book value at 37.6% to Lowes 35%. However, Lowes is growing at a faster pace than Home Depot with the recent expansion to Candada being a good example. Lowes also carries a lower debt compared to Home Depot when normalized by market capitalization. In addition, Lowes has a higher per ticket average and increase in same store sales (3.3%) compared to lesser per ticket average and decline in same store sales in Home Depot.
Lowes balance sheet is sound and it spent a bundle of money buying back shares. This has helped stem the dilution through stock option offerings.
As noted in Lowes 10-K, the capital expenditure budget is as follows:
Our 2006 capital budget is $4.2 billion, inclusive of approximately $387 million of leases. Approximately 79% of this planned commitment is for store expansion and new distribution centers. Expansion plans for 2006 consist of 155 stores, including five relocations of older stores. This planned expansion is expected to increase sales floor square footage by approximately 12%. Approximately 63% of the 2006 projects will be owned and 37% will be ground-leased properties.
Depreciation and amortization will probably average around 2 billion dollars for 2006. Subtracting this amount from the capex budget, we see that approximately 55% of the earnings are deployed in maintenance. Some of this budget is used for expansion ( around 2 billion ) and the rest is used to buy inventory and other necessities.
Let us next look at the EPV of Lowes. Assuming no growth and the yearly profit to be around 4 billion in 2006. Subtracting capex and adding back depreciation and amortization ( not including the money used for expansion ) - one gets a value of around 3.8 billion. Adding 10% of the sales, general and adminstrative cost to keep/build the brand name, we have a value of 4.8 billion. Using a cost of capital of 8%, we get an EPV of 60 billion. Subtracting debt and adding cash and inventories, one gets a value of around 63 billion. This value indicates that the stock is selling at a 29% discount to its current market price.
Another approach where one takes the book value and puts a P/E multiple of ten to the current adjusted earnings will also put the value at around the same value as calculated above.
From the 10-K, Lowes describes its market as follows:
We estimate the size of the U.S. home improvement market to be approximately $700 billion, $550 billion of which comprises product demand, and $150 billion for the installed labor opportunity. Data from a variety of primary and secondary sources, including trade associations, government publications, industry participants and other sources was analyzed as the basis for our estimate. This estimate includes import and export data and key end-use markets, such as residential repair and remodeling, and nonresidential construction and maintenance. This data also includes a wide range of categories relevant to our business, including major appliances and garden supplies.
As we continue to monitor economic data and the home improvement marketplace, there are many indicators demonstrating continued strength in consumer demand for the products and services we offer. The key indicators that we monitor include personal income, employment growth, housing turnover and home ownership levels. Demographic and societal trends also remain supportive of home improvement industry growth.
Personal income continues to grow, which is supported by data from the February 2006 Blue Chip Economic Indicators™, which forecasts real disposable income growth of 3.4% for calendar 2006, compared with 1.4% in calendar 2005.
Employment growth is a strong indicator of home improvement sales. The relatively low unemployment rate suggests Americans will likely be more confident in calendar 2006 about employment prospects than in the past several years.
Housing turnover is expected to continue at a historically high pace according to The National Association of Realtors®, which forecasts calendar 2006 housing turnover to be the third strongest year on record.
Near-record U.S. homeownership levels provide an established customer base for home maintenance and repair projects. The vast majority of our customers are homeowners and they are not willing to let what is often their most valuable financial asset deteriorate.
Out of the factors mentioned above, the disposable income has increased at 6.8% rate this year while inflation has been creeping up at 4.1%. Employment growth is also strong with unemployment at record lows. Interestingly enough, housing turn over may be unaffected by the housing slow down and defaults. The only factor that may affect lowes is that less people will have the money to spend in their stores. This was evidenced recently as Lowes earnings missed the estimates by one cent.
There are several factors in favor of Lowes as noted in the Home Depot analysis. Some of the factors in play for Home Depot are true for Lowes as well. Just to recap, the factors in favor of Lowes are:
Management
Balance Sheet
Confluence of factors
In each of the above categories, Lowes is equal or better than Home Depot at the moment. It doesnt hurt that Lowes is growing at a faster pace.
Let us take a look at the balance sheets to compare Home Depot and Lowes. HD has a return on asset ratio of 13.5% and a forward earning yield of about 9%. Lowes on the other hand has an earnings yield of 8% and return on assets of 13.3%. HD has a larger per share in book value at 37.6% to Lowes 35%. However, Lowes is growing at a faster pace than Home Depot with the recent expansion to Candada being a good example. Lowes also carries a lower debt compared to Home Depot when normalized by market capitalization. In addition, Lowes has a higher per ticket average and increase in same store sales (3.3%) compared to lesser per ticket average and decline in same store sales in Home Depot.
Lowes balance sheet is sound and it spent a bundle of money buying back shares. This has helped stem the dilution through stock option offerings.
As noted in Lowes 10-K, the capital expenditure budget is as follows:
Our 2006 capital budget is $4.2 billion, inclusive of approximately $387 million of leases. Approximately 79% of this planned commitment is for store expansion and new distribution centers. Expansion plans for 2006 consist of 155 stores, including five relocations of older stores. This planned expansion is expected to increase sales floor square footage by approximately 12%. Approximately 63% of the 2006 projects will be owned and 37% will be ground-leased properties.
Depreciation and amortization will probably average around 2 billion dollars for 2006. Subtracting this amount from the capex budget, we see that approximately 55% of the earnings are deployed in maintenance. Some of this budget is used for expansion ( around 2 billion ) and the rest is used to buy inventory and other necessities.
Let us next look at the EPV of Lowes. Assuming no growth and the yearly profit to be around 4 billion in 2006. Subtracting capex and adding back depreciation and amortization ( not including the money used for expansion ) - one gets a value of around 3.8 billion. Adding 10% of the sales, general and adminstrative cost to keep/build the brand name, we have a value of 4.8 billion. Using a cost of capital of 8%, we get an EPV of 60 billion. Subtracting debt and adding cash and inventories, one gets a value of around 63 billion. This value indicates that the stock is selling at a 29% discount to its current market price.
Another approach where one takes the book value and puts a P/E multiple of ten to the current adjusted earnings will also put the value at around the same value as calculated above.
Tuesday, September 05, 2006
Growth in world stock indices
The stock market has enjoyed a couple of weeks of continuous upside momentum with falling oil prices and the fed sitting on the sidelines to cool off the inflation. In this article, we will look at the major stock indices in the world and see potential upside/downside in the coming months.
SP500 closed at 1313.25 today with a trailing P/E of 18. The index has an yield of 1.8% and has gone up by about 5% thus far this year. It looks as though the index has some room to run in the next six months despite a slowing economy. If the economy doesnt tank, it is my hunch that SP500 can grow between 2 and 4% for the rest of the year. This should provide a range of 1340 to 1375 for this index. The SP500 index is also off its peak value in May.
In North America, the commodities driven Canadian index is off of its April highs and has room to run. This is also true of the Brazilian index which is also off its highs.
Another important set of indices are in Asia. The Hang Seng index in Hong Kong has hit its yearly peak and is continuing to do well. The markets in India are off its peak as are the indices in Taiwan and Korea.
In Europe, the Swedish exchange is at all time highs and some of the other exchanges are off of their yearly highs.
The world GDP is expected to grow strongly this year with growth in the rest of the world surpassing the growth in the U.S. The decline in energy prices should continue to spur economic growth around the world. The current slowdown may be termed as a mid cycle slow down and the cycle has legs to run till 2009 or 2010. This is expected to show in superior stock market gains in the rest of the world, particularly in the emerging markets. It seems that the emerging markets have 5-10% upside from their current prices in the next three - six months.
SP500 closed at 1313.25 today with a trailing P/E of 18. The index has an yield of 1.8% and has gone up by about 5% thus far this year. It looks as though the index has some room to run in the next six months despite a slowing economy. If the economy doesnt tank, it is my hunch that SP500 can grow between 2 and 4% for the rest of the year. This should provide a range of 1340 to 1375 for this index. The SP500 index is also off its peak value in May.
In North America, the commodities driven Canadian index is off of its April highs and has room to run. This is also true of the Brazilian index which is also off its highs.
Another important set of indices are in Asia. The Hang Seng index in Hong Kong has hit its yearly peak and is continuing to do well. The markets in India are off its peak as are the indices in Taiwan and Korea.
In Europe, the Swedish exchange is at all time highs and some of the other exchanges are off of their yearly highs.
The world GDP is expected to grow strongly this year with growth in the rest of the world surpassing the growth in the U.S. The decline in energy prices should continue to spur economic growth around the world. The current slowdown may be termed as a mid cycle slow down and the cycle has legs to run till 2009 or 2010. This is expected to show in superior stock market gains in the rest of the world, particularly in the emerging markets. It seems that the emerging markets have 5-10% upside from their current prices in the next three - six months.
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