A Comparison of Four Listed Companies

One of Benjamin Graham’s teaching method was to do case studies which he would examined the financial and operating data as part of his lectures and in his books. Often, he would compared companies and discussed with his students which company was a better investment and discussed on the reasons why it was. Sometimes he even made it more interesting by comparing the same business but at a different time frame, without informing the students beforehand. So his students was like the blind men touching different part of the same elephant.

In The Intelligent Investor, chapter 13, he presented security analysis of 4 companies from the NYSE. Following this tradition, I like to do the same for 4 listed companies in the local stock market and using same criteria in reviewing. Also to make it interesting, I will not disclose the name of the companies and their market capitalization at this time. So that this will not influence you in valuing these companies.

Some basic info:
- The 4 companies are from different industries as shown.
- All the 4 companies market cap are less than $1b.
- The financials data shown are in S$m.
- The table shows a few figures of the 4 companies’ 2018 operations, and also the past 5 years reported earnings. Certain key ratios related to their performance are also presented.

1) Profitability
A has negative earnings for the past 5 years while the other 3 have all positive earnings. For the total 5 years earnings, C is almost doubled of B and D is also almost doubled of C.

B & C have high Return on Equity, ROE > 15%. B has impressive gross and net margins which is usually an indication of comparative strength, ie strong moat. C & D net margins are in the single-digit. This can indicate that they don’t have strong competitive advantage over their competitors and they might face difficult to raise price without losing market share. But they are not extremely low and quite typical for most profitable companies.

2) Stability
A losses are getting from bad to worse. For the other 3 companies, we can observe a poor year in 2016 where the earnings dropped by a moderate 20-30%. C & D recovered well in 2017 and looked to be back on track with their 2018 results.

3) Growth
Over the 3 years, 2016-2018, B & C has solid >20% earning growth and D is still impressive with almost 15%. If look at past 5 years, only D has maintained the same rate. However, I need to point out that this depends greatly on the year that we select as the starting point. It can be misleading if we start with a year with low earning and then some moderate growth afterward might be magnified to huge numbers.

4) Financial Position
A & B current ratio are below 2 which can mean they might face problem to meet short-term financial obligations, while C & D shouldn’t have any issue looking at the cash in their books.

B, C & D are almost debt free. A is carrying huge debts in the balance sheet and with losses for many years, they will face with problems in paying back their debt and also if they need to raise needed cash. D has a large working capital and they are holding a relatively large amount of cash. This can mean that they are not very capital efficient in managing their asset.

5) Dividends
Obviously, A will not be able to pay any dividend for the 5 years looking at their poor earning record.

While B has only started paying dividends from 2017, C & D have history of continuance without interruption for > 10 years. D current dividend yield of 6.9% is almost double of the STI ETF index fund.

So based on these data, what would be the fair valuations of these 4 companies, ie how much are you willing to pay for them if you are buying the entire company, $50m, $100m, $250m? Try it as an exercise and present how you derive the numbers with the methods you used. When I will disclose the company and their market cap, you can compare if they are undervalued or overvalued based on your calculation.

Edit 9 June - One mistake - The Gross, Ops, and Net Margins shown in the table are based on the TTM (Trailing 12 months) and not 2018 result margin.

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43 comments
kc2024

Reply to @GrowthInvestor : Already revealed. See his reply below.

NinjaStars

Quality content! Better than anyhow call up and down in stock prices okie ... !!!

theintelligentinvestor

These are the 4 companies in this case study.

I mentioned Graham used to make his case studies interesting. I admit I also trying to do something like that by selecting 4 companies with almost the same market cap. As can see, they ranges from $81m to $88m.

There are several reasons; one is to compare the market with our valuation. More importantly is to share how 4 companies with vast differences in their earnings and financials can be valued at so closed market capitalisation.

Some may be surprised by this. For the past 5 year earnings, D has 4x of B, paying twice the dividends and the equity is 8x! but yet the market cap is the same. It is as if the market is saying that having higher shareholder equity is a negative impact on its stock price. Similar with B & C comparison with C having twice the earnings and equity. But yet book value is useful in some instance as in the case of A being supported by its book value. Or maybe the book value has little influence on the intrinsic value or the stock price. Maybe the predominant factors are just earnings/FCF, growth and ROE.

From observation, most has valued B and C almost on par and with D higher. There is no right or wrong answer here. Thanks to all who shared and hope this exercise has bring some values to the folks here.

TUBInvesting

Reply to @theintelligentinvestor : Great exercise. I was right abt C&D. You made a point that I never thought abt, looking at market cap and using that as reference.

You PE commons that 10 is conservative, 12 is ok, 16 is for growth.

Made sense, but I tend to go lower. haha

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theintelligentinvestor

Before I disclose the 4 companies, this is my valuation:

A - I think most will agree this is not an investment grade business. I would use the book or liquidation value as the basis for valuation. Assuming total asset of 450m, I will use 40% of that as the liquidation value and less the debt of 100m. Come up to $80m.

For B, C & D, I will use the average of past 3 year earnings.

B - This is probably the most promising of the 4 companies in terms of having the highest margins and returns on equity which indicates a strong economic moat, strong CF and potentially better future growth. If they can increase their sales from the current $16m without adding much to the capital employed, then they can grow at a high rate. Growth stocks are difficult to value and often investors would use the DCF model with higher rates in trying to justify the higher price. Using 3 year average earnings and multiple of 16, I will get a value of $43m.

C - This is financially sound company with good earnings stability and adequate dividend yield. Using a multiple of 12, the value is $56m.

D - With the ROE below 10%, the stock will likely be below book value. Also the single-digit net margin and ROE is usually an indication of below average competitive advantage. However, this looks to be a stable business with strong financial condition and good dividends yield to be a reasonably protected investment. But I feel the growth will be limited and using a conservative multiple of 10, the value is $105m.

theintelligentinvestor

@TUBInvesting

Thanks! I think in a forum like this, there should be more interests in discussing about business valuation. Unfortunately, most are only interested in whether the stock they buy will increase in price, or how will the macroeconomy with the expected monetary or fiscal policy going to affect the stock market etc

I think you have covered some of these companies. You mentioned prefence for B based on number, what do you think will be a fair value to pay for this business?

TUBInvesting

Reply to @theintelligentinvestor : A will be based on PB because has been making losses. And even at 0.5 PB, we need to look at its business if its viable.

B, C and D - will be looking at a combination of PE, PB, PFCF, rather than solely based on a single metric (since I use scorecard metric and I am use to it and its always a combination). PB will be expected to be more than 1. but if I am not wrong, D is a currently NCAV.

Having said that if I am willingly to pay a premium for B, it must be below 12x PE and PFCF AND provided the business and the improvement is sustainable.

TUBInvesting

This is a very good exercise. Allows people to look at the companies, business model, instead of share price. I did it before too, if i am not wrong, during one of my course.

Just to share, if I solely based on the numbers, I will choose B. However, in reality, I will have gone for C&D BECAUSE B share price will have sored significantly in 2018/TTM. C&D share price will fluctate and there will be mispricing and also its profit margin will be more stable.

However, if I am right, I am vested in one of the company while another one has been in my watchlist for the longest time.

layers

in terms of biz.

A depends on project which is not recurring in nature

C has hight expenses cost while D is asset heavy biz.

B on the other hand looks asset light or high profitability generating due to high gross margin. plus biz is recurring in nature.

Base on abv A is definitely the worst. B is my choice.

Base of FCF generation, FCF/Equity

B = 35%
C = 15%
D = 5%

D is out.

Debt wise is B and C is below 0.5x debt/equity. with current ratio >1. so i see no issue.

I Will buy B out of the 4. C I would like to see the operating margin over the years n type of food to decide.

theintelligentinvestor

Reply to @layers : Good thinking process in terms of potential earning power.

B having asset-light business model and if they can show some substaning growth for 1-2 more year, I expect many will jump into it and push the stock price way high. I agree that D is not as appealing but the dividends sort of make up for the lack of being a glamorous business.

theintelligentinvestor

@sivas

You have good thinking process and able to produce sensible judgement just based on the financials data. I don't think many investors have this level of thinking.

In general I agree with your assessment, just some comments to add:

Company C - a huge portion of the cost is from the Selling and distribution expenses which accounts for about 70% of sales.

Company D - Their Cash Conversion Cycle is about 176 days over the past 10 years and has been pretty consistent throughout. The bulk of it is from Inventory turnoverdays of 112 days, Receviables 90 days and Payables 25 days. It looks that there can be some improvment in their cash conversion cycle. The long cycle is probably due to the production cycle, credit terms with their clients etc. They could be keeping big amount cash because of this.

theintelligentinvestor

Reply to @sivas : This is very smart of you to reverse the dividend yield to guess the current market cap.

When I was posting this, I was thinking whether to show the yield as this is the only numbers shown that is depending on the price of the stock. But I went ahead as there was still the variable of the payout ratio. I was thinking maybe someone who is smart enough, can try to figure out which you did.

In fact, one of your estimation hits the mark, well done!

D is a steady company but it does have some negatives that some may view it as a value trap, cash hoarding, having low ROE/Margin.

C has some characterisitcs that is inbetween B & D. I think the net margin makes it difficult to justify investment.

B will be the type of growth stocks that typically will run up for some period when good results are annouced. But once the growth stops or reverse, then the stock price can also drop a lot as we have seen many times. B can be a good investment if it can be bought at low mutipler, eg PE <10 but often it is trading more than that.

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Simpleinvestorsg

A - $90 mil, depends on what makes up book value.
B - $50 mil
C - $50 mil
D - $110 mil

Always ask for a bargain.
The best buy is the one that provides the best value.

Simpleinvestorsg

Reply to @theintelligentinvestor : B has a higher P/E because of it's growth and certain level of moat, and 11x may represent a bargain. However, investors should think about how much revenue is tied to key personnel and how much profit will flow to the shareholders.

C is valued at the same price as B even though it has more book value because the results are due to well execution rather than an industry moat. Manpower issue can seriously impair it's ability to grow and maintain cost.

D must definitely be bought undervalued because of it's lack of growth and the industry its in. If not one would not be able to achieve an accpetable level of return. One must remember a sizable amount of capital must be retained for capex and working capital just to fight inflation.

A really depends on how liquid the book is. There are many other undervalued and profit making companies in Singapore. I don't like to sit on a sinking ship, big or small.

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