Fundamental Analysis

Fundamental analysis is a combination of quantitative and qualitative analysis that determines a stocks value by focusing on a company's actual business and its future prospects.

Fundamental Analysis

Two Most Important Questions: 1. 2. What is being priced in? What is mispriced?

Stocks will make money over the long term provided that earnings are on an uptrend and valuations are cheap.

Fundamental Analysis
Process of forecasting corporate earnings (using a top down approach) Macro-economic analysis Industry analysis (industry lifecycle, competitive environment) Company analysis (strategy, financial statement analysis)

Fundamental Analysis
How to identify strong companies (The Five Ps) People Product Predictability Potential P/E (Valuation)

Fundamental Analysis
Benchmarking 1. 2. Alternatives Competitive advantage

Fundamental Analysis
Puregold Revenues Gross Margins Operating Margins 1000 15% 10% Savemore 1500 12% 8% Rustans 500 10% 5% Robinsons 250 8% 3%

Fundamental Analysis
Inputting numbers through commonly used valuation methods DCF or Discounted Cash Flow Method NAV or Net Asset Value Method Relative Valuation Method

Commonly used methods for determining Fair Value

DCF or Discounted Cash Flow Present value of future free cash flows FV = CF1/(1+r1) + CF2/(1+r2)2 + CF3/(1+r3)3 + . . . Higher earnings will lead to higher fair value Lower interest rates will lead to higher fair value Can be used on all stocks

Commonly used methods for determining Fair Value

Example: DCF Method
Required Rate or Return: Year 0 1 2 3 4 5 6 and onward Total O/S FV per share Cash Flow 500.0 600.0 700.0 800.0 900.0 1,000.0 1,100.0 10% PV of Cash Flow 500.0 545.5 578.5 601.1 614.7 620.9 6,830.1 10,290.8 1,000.0 10.3 Total O/S FV per share Required Rate or Return: Year 0 1 2 3 4 5 500.0 600.0 700.0 800.0 900.0 1,000.0 8% 500.0 545.5 578.5 601.1 614.7 620.9 8,382.4 11,843.1 1,000.0 11.8 Cash Flow PV of Cash Flow

6 and onward 1,100.0

Commonly used methods for determining Fair Value

NAV or Net Asset Value Sum of the fair value of assets Commonly used for property companies and holding companies

Commonly used methods for determining Fair Value

Example: NAV Method
Asset BPI (33%) Globe (30%) Manila Water (43.3%) Ayala Land (53.5%) IMI (67.7%) Total for listed subs/affil Ayala Automotive AG Holdings Minus net debt NAV Outstanding sh (Mil) Value per shae Fair value estimate PhpMil 62,630 33,906 20,832 136,714 10,626 264,708 6,844 4,856 (9,124) 267,283 496.09 538.78 443.00 (15% discount to NAV) Php/sh 126.25 68.35 41.99 276 21 534 13.80 9.79 (18.39) 538.78 % of Total 23.4% 12.7% 7.8% 51.1% 4.0% 99.0% 2.6% 1.8% 3.4% 100.0% Book value Book value Valuation Method P/BV multiple DCF DCF NAV based DCF

Commonly used methods for determining Fair Value

Relative Valuation Method An analyst chooses a target valuation multiple and uses that to value stock Ex. 15X P/E, 1.5X P/BV Target multiples are usually based on industry average, historical average, adjusted up or down based on EPS growth or ROE

Relative Valuation Measures

P/E & EPS Growth P/E = Price/Earnings per share (EPS) EPS = Net income to common/Outstanding shares General rule: Companies with higher EPS growth deserve to trade at higher P/E

Relative Valuation Measures

Example Which stock looks cheap? Which stock looks expensive? Company B looks cheap Company D looks expensive

Company A B C D

EPS Growth 10% 20% 15% 8%

P/E 10.0 8.0 12.0 15.0

Relative Valuation Measures

P/BV & ROE P/BV = Price/Book value per share (BV) BV = Stockholders equity/Outstanding shares ROE or Return on equity ROE = Net income/Stockholders equity General rules: Banks are usually valued using ROE and P/BV; Companies that deliver higher ROE deserve to trade at higher P/BV

Relative Valuation Measures

Example Which stock looks cheap? Which stock looks expensive? Company A looks cheap Company C looks expensive

Company A B C D

ROE 10% 12% 8% 15%

P/BV 0.8 1.4 2.0 1.7

Determining Fair Value using Relative Valuation Method

Example: Relative Valuation Method If a company is expected to earn Php5.25 per share next year and its historical average P/E is 9X, the fair value of the stock is: P = P/E x EPS = 9 x 5.25 = 47.25 If a company is expected to have a BV of Php15.00 per share next year and its historical average P/BV is 1.5X while it is expected to maintain an ROE of 12%, the fair value of the stock is: P = P/BV x BV = 1.5 x 15.00 = 22.50

Valuation Measures
DIV Yield Div Yield = Dividend per share/Price Salary as an investor Stocks with high dividend yield are usually considered attractive for conservative investors looking for income, assuming that the companys earnings outlook is positive Most high dividend yielding stocks are utility companies with slower earnings growth

High Dividend Yielding Stocks

High Dividend Yielding Stocks* Ticker MER SCC AEV GLO TEL Company Meralco Semirara Aboitiz Equity Globe Telecom PLDT Div Yield 4.70% 4.50% 3.30% 5.50% 7.00%

*Regularly check investment guide for updates

Where to get Information

Strategy Reports Investment Guide

Strategy Reports
Discuss the factors affecting the stock market Answer the question Should I be bullish or bearish and why? Provide suggestions on how investors should respond to these factors Ex. Buy aggressively; wait for pullbacks; sell Provide an opinion on which sectors and stocks would be most affected by factors affecting the market Ex. Focus on growth stocks; avoid mining stocks; list of best picks

Strategy Reports
COLing the Shots Monthly strategy reports Focused on relevant issues for the month Philippine Market Strategy Semi-annual strategy reports Focused on longer term relevant issues (past six months, next six to twelve months)

How to find the Strategy Reports

Investment Guide
The investment guide is appropriate for investors who prefer to use a bottom up approach A guide that provides most of the important fundamental information needed by investors on companies that are part of COLs coverage list Information included: Current stock information (Price, Outstanding Shares, Market Capitalization) Recommendation (Rating, Fair Vale Estimate) Earnings (Revenues, Net Income, EPS, Growth) Financial Ratios (Net Margin, ROE, LTD/E) Valuation (P/E, P/BV, Dividend Yield, PEG)

How to find the Investment Guide

How to use Investment Guide

Most important pieces of information Market Cap COL Rating / Target Price P/E & EPS Growth P/BV & ROE Div Yield

Market Cap
Market Cap or Market Capitalization Price x outstanding shares Measure of size Important because larger companies are usually more liquid compared to smaller companies Liquid stocks can be easily bought or sold, size of portfolio will not be a problem Ex. Ayala Land vs. Vista Land

COL Rating / Target Price

COL Rating / Target Price Analyst recommendation on the stock, either BUY, SELL or HOLD Determined by estimating the fair value of a company in light of its future earnings potential (evaluation of earnings growth outlook and valuation)

Two types of stocks generally earn a BUY rating in our Investment Guide
Earnings Valuation Cheap Expensive Up BUY (Type 1) HOLD Down BUY (Type 2) SELL

Cheap Stocks with growing earnings

Type 1: This type of stock usually trades at low relative P/E despite high EPS growth, or low relative P/BV despite high ROE; upside to the target price is high This is the most preferred type of stock to buy Ex. DMCI (2009), ICTSI (2005), Security Bank (2005)

Cheap Stocks with growing earnings

Type 2: This type of stock trades at very attractive valuations, but earnings are usually weak in the short term Ex. Semirara (SCC), Philippine market (2008) There are pros and cons in buying this type of stocks

Cheap Stocks with growing earnings

Pros: Earnings weakness usually only short term in nature Ex. Demand drops due to cyclical reasons such as bear market, high raw material prices, negative impact of weather disturbances, temporary delays in operations Valuations are usually very attractive (significant upside to fair value estimate) Can be accumulated over a long period of time

Cheap Stocks with growing earnings

Cons: Prices might take a while to recover Negative news flow might lead to further drop in share prices in the short term Actual developments could be much worse than expected (ex. Cebu Pacific)

Using the Invest Guide

Step 1: Create a shortlist of stocks to buy Ex. List down all the stocks that have a BUY rating and still have an upside potential of >20%

Step 2: Diversify Choose companies that belong to different sectors Ex. One property stock, one bank, one power, etc.

Using the Invest Guide

Step 3: Determine your preferences Growth, value or income Growth high EPS growth Value high capital appreciation potential, low P/E, low P/BV Income - high dividend yield Active traders with large portfolio go for larger market cap stocks Long term investors can invest in smaller market cap stocks Major shareholders (Ayala, Aboitiz, Sy, Gokongwei, MVP, etc.) Brands (Jollibee, SM, Meralco, etc.)

Liquidity

Names

Using the Invest Guide

Step 4: Validate your preferences Questions that you need to answer: What does the company do? How does it generate profits? If it has numerous lines of business, how are revenues/operating profits broken down? Who are its major shareholders? What is its earnings track record? What are the drivers of future earnings growth? Does the company have the resources to execute its growth plans? By how much will earnings grow in the next few years? Is there anything that I should be worried about?

How to find the Company Snapshots

How to find the Company Snapshots

Example: Company Snapshot of SM Prime

How to find the Company Reports

Analyzing stocks that are not part of COLs average list

Questions that you need to answer: What does the company do? How does it generate profits? If it has numerous lines of business, how are revenues/operating profits broken down? Who are its major shareholders? What is their reputation? What is its earnings track record? What are the drivers of earnings growth? Does the company have the resources to execute its growth plans? By how much will earnings grow in the next few years? Is there anything that I should be worried about? Is the companys valuation cheap or expensive relative to the market and its peers?

Sources of Information
PSE Website Focus on company disclosure, especially 17A (annual report) and 17Q (quarterly report) Company Website Learn more about what the company does Sometimes, the company would have press releases, presentations available Newspaper Reports

How to Stay Updated

Continuously read COL research products Morning notes Summary of important news that could affect the market or certain stocks updated on a daily basis Also include new reports on stocks that we cover (updates, or analysis of the impact of new developments on profitability and valuation, change in recommendation) New buy or sell ideas are shared Weekly Strategy reports

Appendix

Definition of Financial Terms

Market Cap or Market Capitalization Market Cap = Price x Outstanding shares Measure of size Usually, larger companies are more liquid (easier to buy and sell)

EPS or Earnings Per Share EPS = Net income/Outstanding shares

P/E = Price/ EPS The lower the better, although companies with higher EPS growth can justify trading at higher P/E

Definition of Financial Terms

PEG = P/E EPS Growth Although technically flawed, it is commonly used as a short cut way to make P/E comparable to growth The lower the better

Div Yield or Dividend Yield Div Yield = Dividend per share/Price Similar to interest on deposits, the higher the better

Definition of Financial Terms

P/BV or Price to Book Value BV = Stockholders equity/Outstanding shares P/BV = Price/BV Commonly used in valuing banks The lower the better, although companies with higher ROEs can justify higher P/BV

ROE or Return on Equity ROE = Net income/Stockholders equity The higher the better

Definition of Financial Terms

Net Profit Margin = Net income/Revenues The higher the better

CFO or Cash Flow from Operations CFO = Net income + Depreciation and other non cash expenses (income) Change in working capital Has to be positive

LTD/E or Long Term Debt to Equity Ratio LTD/E = Long term debt/Stockholders equity The lower, the more conservative; Should be compared to other peers in the industry

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