Professional Documents
Culture Documents
FUNDAMENTAL
Analysis
Please read carefully the important disclosures at the end of this publication.
Contents
Chapter 1 Introduction 3
Chapter 9 Checklist 42
Fundamental analysis uses underlying qualitative and quantitative factors such as financial performance and
indicators to value a stocks share price and earnings in prospective periods.
Examples of questions one might ask while doing fundamental analysis are:
1) Is the company able to maintain its current revenue growth?
2) Will the company be profitable?
3) Does the company have superior margins to its peers?
4) Does the company have enough cash reserves and cash flow to pay off debts?
5) Is the company in a business with high barriers to entry?
Step 2: After getting a rough idea of what the company does, analyse the companys prospects and earnings
drivers.
Step 3: For the more adventurous, try charting out its historical earnings on a Microsoft Excel sheet and examine
earnings and cost trends. You could even build your own forecasts and compare them with the actual
results to see whether you are more accurate than the analysts!
Step 4: If you have industry contacts, talk to them on a frequent basis and find out what is happening in the
industry. Perhaps you could even take a drive and peek at the companys operations as a picture paints a
thousand words. Along the way, you may even pick up useful information from the employees in the
company.
As fundamental analysis involves the study of many fundamental factors, lets make things easier by breaking
down these factors into two segments:
1) Quantitative as the name suggests, such factors can be expressed in numerical terms.
2) Qualitative anything else that is non-numerical!
While numbers form the basis of analysis, qualitative factors such as management quality and brand value are
also important and these typically manifest themselves in the companys earnings quality, superior margins
compared with peers or better ROEs (returns on equity).
As an example, when looking at Singapore Airlines, you may like to check quantitative factors such as its earnings
per share, price-to-book ratio, dividend yield etc. to determine if its valuation is attractive. However, how does one
value the brand name of Singapore Airlines, which is one of the worlds leading commercial passenger airlines?
The fact that many associate a great flying experience with the airline contributes to the success of SIA.
Intrinsic value is the true value of a stock after evaluating its quantitative and qualitative factors. This concept is
grounded in the assumption that the share price does not entirely reflect a stocks true value.
Investors would want to buy stocks that are trading below their intrinsic value.
However, the key concern for most investors is when the stock price will reach the intrinsic value? Alas, we do not
have an answer as markets react to ongoing developments. It could be a day, a month, a year or even never as
the environment is fluid.
By studying both quantitative and qualitative factors, an investor can estimate the intrinsic value of a stock and
take the chance to buy the stock at a discount to that. If all goes according to plan, gains should be realized over
time as the market catches up with fundamentals.
Qualitative Factors
Before jumping into quantitative jargon, lets first take a look at the qualitative factors of a company. Qualitative
factors tend to be difficult to quantify, such as goodwill.
Quality of Management
If in the past five years, whenever Company As management gives earnings guidance for a financial period, the
company never fails to meet the target given, such credibility in issuing earnings guidance could potentially
translate to a higher valuation as opposed to similar peers as investors ascribe a price premium for uncertainty.
Numbers are perplexing to many. So, it is no surprise that many investors do not know how to read financial
statements and even find them intimidating. However, financial statements can offer you a world of information
and help paint a clearer picture of the company. For a start, lets get acquainted with the different types of financial
statements.
Definition
The Income Statement (also known as Profit & Loss Statement) is a financial statement that summarises a
companys revenues, costs and expenses incurred during a period of time. It also provides information on the
companys ability to generate earnings and its cost structure.
The Income Statement is generally presented in a format shown below, that begins with an entry for revenue and
subtracts from revenue the costs of running the business (i.e. cost of goods sold) to form the Gross Profit.
This is typically followed by Operating Expenses and Interest Expense is then netted off to derive the Pretax Profit.
Net Profit, otherwise known as the bottom line, is the final derivative in the Income Statement after deducting Tax
Expense.
Revenue
Revenue, otherwise known as sales, is generally the easiest part of the income statement to comprehend. Usually,
it is just a single number that represents the total amount of money earned during a certain time period. Larger
companies may break down the revenue figure into business segments or geographical sources in the Notes to
the Financial Statements.
Points to note:
1. The best type of revenue is of a recurring nature, which means revenue that comes in regularly. One-off project
wins or extraordinary gains that result in temporary increases in revenue are usually viewed less favourably.
2. Lumpy sales recognition makes earnings vary significantly from period to period. As such, one could see profit
swings every year and this distorts P/E and P/E-to-growth valuations.
3. Look for sales growth in local-currency terms to see how the well the company is doing. A company could be
selling in US$ and reporting good US$ sales growth but seeing revenue declines in S$ terms due to translation
effects.
4. Also, analysts are interested to know the companys average capacity utilisation, quantity produced and sold,
as well as average selling price (ASP) trends.
There are many kinds of expenses, but the two most common are cost of goods sold (COGS) and selling, general
and administrative expenses (SG&A). Cost of goods sold is the expense most directly involved in creating
revenue. It represents the cost of producing or purchasing the goods or services sold by the company. For
example, if NTUC pays a supplier $2 for a carton of milk, which it sells to customers for $5, NTUCs cost of goods
sold for the carton of milk would be $2.
Next, costs involved in operating the business are classified under SG&A. This category includes marketing costs,
salaries, utility bills, technology expenses and other general costs associated with running a business.
There are also financial costs, notably taxes and interest payments, which need to be considered.
Points to note:
1. Investors need to adjust expenses to see what the companys core profit from operations is. Given that
exchange gains/losses and other non-core items such as gains from the sale of stocks and shares are now
booked above the net profit line, there is a need to back out these numbers to see how the company is actually
performing.
2. If times are bad and sales are decreasing, keep a close watch on the companys costs by looking at the yoy
growth in expense.
3. Costs should also exhibit some relationship to sales (costs as a percentage of sales).
4. If similar listed peers are available, it would be useful to compare their cost structures.
5. Keep a tab on raw material cost trends, minimum wage laws and the supply/demand conditions of skilled
workers.
Profit, most simply put, is equal to total revenue minus total expenses. However, there are several commonly used
profit benchmarks that can tell investors how well or badly the company is performing. Gross profit is calculated as
revenue minus cost of sales. Returning to the NTUC example, the gross profit from the sale of the milk would have
been $3 ($5 sales price less $2 cost of goods sold = $3 gross profit).
Gross
Gross Profit
Profit Margin
Margin == Gross
Gross Prof
Profitit// Sales
Sales
Companies with high gross margins (expressed in percentage terms) will have substantial sums of money left over
to spend on other business operations, such as R&D or marketing. However, do look out for margin erosion over
time as this is usually the first symptom of stress to the bottom line, also known as net profit. When cost of goods
sold rises rapidly, the rise is likely to lower gross profit margins - unless, of course, the company can pass on
these costs to customers in the form of higher prices.
Points to note:
1. A companys ability to defend its margins by passing on costs to customers reflects the extent of its economic
moat. If customers have no choice but to buy from a certain supplier and this supplier can enjoy price increases
every year, its earnings model is strong.
2. This could mean a lack of substitute product or a high switching cost for customers.
Operating profit is equal to revenue minus the cost of sales, SG&A and other operating expenses. This number
represents the profit a company makes from its actual operations, and typically, we would back out non-core
items.
High operating margins can mean the company has effective control of costs, or that sales are increasing faster
than operating costs.
Net profit, also known as net income, generally represents the company's profit after all expenses, including
financial expenses such as interest and taxes, have been paid.
Definition
The Balance Sheet is a financial statement that summarises a company's assets, liabilities and shareholders'
equity at a specified point in time. These three segments give investors an idea on what the company owns and
owes, as well as the amount invested by shareholders. The balance sheet has to always abide by the following
formula:
Asset
Assetss == Liabilit
Liabilities
ies ++ Shareholders'
Shareholders' Equit
Equityy
Each of the three segments will have many accounts that document the value of each account. Accounts such as
cash, inventory and property are on the assets side of the balance sheet, while on the liabilities side, there are
accounts such as accounts payable or long-term debt. The exact accounts on a balance sheet will differ by
company and by industry.
Assets, liabilities and equity are the three main components of the balance sheet. When analysed together
carefully, they can tell investors a lot about a company's fundamentals.
Assets
There are two main types of assets: current assets and non-current assets.
Current assets are those likely to be converted into cash or its equivalent usually within a year. Three very
important current asset items found on the balance sheet are: cash, inventory and accounts receivables.
Non-current assets are defined as anything not classified as a current asset. They include items that are fixed,
such as property, plant and equipment (PP&E). Such assets are usually carried at historical cost on the balance
sheet less accumulated depreciation.
Investors normally are attracted to companies with plenty of cash on their balance sheets or are in net-cash
positions (i.e. net cash = cash and its equivalents all interest bearing borrowings). After all, cash offers protection
in recessionary times, and gives companies more options to grow.
Strong cash reserves are often a signal of good financial health. That said, if loads of cash are more or less a
permanent feature of a company's balance sheet, investors would need to ask why the money is not being put to
good use. Cash could be there because management has run out of investment opportunities or is too short-
sighted to know what to do with the money. On the other hand, a depleting cash pile could be a sign of trouble.
Points to note:
1. A key disincentive for a company to hold cash is that returns from cash are low, resulting in a drag on the
companys ROE. The best example of this is the scores of Japanese companies which are sitting on lots of
cash and doing little with it.
2. Another worry about holding too much cash is that pressure from shareholders to do something could send
management into hasty mergers and acquisitions that offer little benefit for the company or tempt management
to venture outside its core businesses into unrelated businesses where they have no expertise.
3. Recently, for many S-chips, the issue of whether reported cash on the balance sheet is actually there has been
raised. Other than auditors who have the duty to check if the cash is in the bank and the amounts are accurate,
investors can perform a simple check by seeing if the interest income earned in relation to the cash balance
makes sense.
4. One must also be careful about looking at the cash balance as the cash may be used for capital expenditure or
have been ear-marked as deposits against bank borrowings.
5. Lastly, while one can understandably get excited over companies with huge cash (or net cash) as a percentage
of market cap, usually as minority shareholders, one is not in a position to access this cash flow. As such, the
unlocking of value typically comes from activist funds, corporate raiders or shareholders with substantial stakes
in the company.
Inventories are finished products that haven't yet been sold. As an investor, you would want to know if a company
has too much money tied up in its inventory. Companies have limited funds available to invest in inventories. To
generate the cash to pay bills and return a profit, they must sell the merchandise they have purchased from
suppliers. Inventory turnover (i.e. inventory turnover = cost of goods sold divided by average inventory) measures
how quickly the company is moving merchandise through the warehouse to customers. If inventory grows faster
than sales, it is almost always a sign of deteriorating fundamentals.
Inventory represents a holding cost to the company as it means cash is tied up in products at its warehouse. When
looking at inventories, one should pay attention to such aspects as shelf life (how long the inventory can be kept
before it deteriorates), whether the inventory is generic and can be easily sold or specific and cannot be
transferred to another customer (for example, the casing for a Nokia phone cannot be used in a Motorola phone)
and the risk that the company needs to make a substantial provision for the inventory.
Receivables are outstanding cash waiting to be collected. The pace at which a company collects what it is owed
can tell you a lot about the management of its credit policy. If a company's collection period is growing longer, it
could mean problems ahead. The company may be letting customers stretch their credit in order to recognise
greater sales and that can spell trouble later on, especially if customers face a cash crunch. Getting money right
away is preferable to waiting for it - since some of what is owed may never get paid. The quicker a company gets
its customers to make payments, the sooner it has cash to pay for salaries, merchandise, equipment, loans, and
best of all, dividends and growth opportunities.
A commonly used measure is average receivable days outstanding.
Average
Average receivables
receivables days
days out
outst
standing
anding == Average
Average receivables/
receivables/ Sales
Sales xx 365
365
Points to note:
Long receivable days were a regular feature of many S-Chips. While this raises discomfort, the risk that these
receivables may not be collected is lower when the weather is fair. However, with the global financial tsunami, one
should look for companies actively shortening their credit policies and diligently collecting their receivables.
1. We should also look at related party transactions to analyse if the receivables are due from parties related to
the major shareholders as this could be a mean to siphon cash from the listed entity.
2. Another area to look at is changes in other receivables. Investigate any significant increase in other
receivables.
3. Also, take a look at the notes to the accounts in the annual report to see if the company has revealed the
customer breakdown for its receivables as well as the aging of the receivables. In some cases, a company
may have half of its receivables due from only one customer, significantly increasing its credit exposure risk.
Real Case
In its FY07 annual report, Company A highlighted that 47% of its receivables were due from one customer and
another 28% were also due from one single customer.
Collections from the above customers are very much dependent on market acceptance of the Groups products
and these customers ability to pay is dependent on their ability to collect from their debtors. Additionally, Customer
B is also a customer of Customer A. Accordingly, Customer As ability to pay is also dependent on its ability to
collect from Customer B.
There were events occurring after the balance sheet date (Note 38) which may have a direct impact on the ability
of the above customers to pay their debts in future.
Subsequently. Company A announced that its major customer had defaulted on its payments. This resulted in
bankers calling in their loans and Company As ability to continue as a going concern came into question.
Average
Average Payables
Payables Days
Days == Average
Average Payables/
Payables/ Sales
Sales xx 365
365
Investors usually want to see a manageable amount of debt. When debt levels are falling, that's a good sign.
Generally speaking, if a company has more assets than liabilities, it is in a decent condition. By contrast, a
company with a large amount of liabilities relative to assets ought to be examined with more diligence. Having too
much debt relative to the cash flows required to pay for interest and debt repayments is one way a company can
go insolvent.
Current
Current Asset
Assetss
Current
Current Rat
Ratio
io =
Current
Current Liabilit
Liabilities
ies
A ratio greater than 1.0x is desired as that means the current assets exceed current liabilities.
A further derivative of the Current Ratio is the Quick Ratio. This ratio is calculated by subtracting inventory from
current assets and then dividing by current liabilities. If the ratio is 1 or higher, the company has enough cash and
liquid assets to cover its short-term debt obligations.
The rationale for subtracting inventories is that inventories may not be liquid and may be forced-sold at lower
prices.
All
All int
interest
erest bearing
bearing debt
debt-cash
-cash
Net
Net Gearing
Gearing (x)
(x) =
Equit
Equityy
A net gearing of more than 1.0x is a warning sign. The key risk is that bankers may not refinance the company
when its loans are due.
Company B
Based on its 1HFY6/08 balance sheet, net gearing was 0.52x which was not particularly alarming.
Cash and fixed deposits = Rmb 1.0bn
Short-term interest bearing debt = Rmb 2.3bn
Long term interest bearing debt = Rmb 2.2bn
Equity = Rmb6.7bbn
In this case, we should back out goodwill from the equity which yields an equity of Rmb2.9bn. If the goodwill was
not backed out, equity would have been Rmb6.7bn and net gearing would have been 0.5x.
This companys problem started when its cash flow was not sufficient to repay its bankers who pulled back their
loans. This led to a suspension of trading in its shares as the companys ability to continue as a going concern was
thrown into question.
In addition, the company was on thin ice with a current ratio of 1.0x and a quick ratio of 0.6x. A demand for faster
repayments by its suppliers would have easily toppled the company.
Net
Net Gearing
Gearing == (2.3+2.2-1.0)/
(2.3+2.2-1.0)/ 2.9
2.9 == 1.2x
1.2x
Equity represents what shareholders own, so it is often called shareholders equity. As described previously, equity
is the residual value after total liabilities is subtracted from total assets.
Equit
Equityy == Tot
Total Assetss Tot
al Asset Total
al Liabilit
Liabilities
ies
The two important equity items are paid-in capital and retained earnings. Paid-in capital is the amount of money
shareholders inject into a company. Retained earnings are a tally of the money the company has reinvested in the
business rather than pay to its shareholders. Investors should look closely at how a company puts retained capital
to use and how it generates a return on it.
The Cash Flow statement shows whether a company is generating positive cash from operations, how the cash
generated is being used or how the cash deficit is being financed.
Looking at the cash flow statement can help us determine if the company needs financing.
The cash coming into the business is called cash inflow, and the cash going out is called cash outflow. The
statement shows how changes in the Balance Sheet and Income Statement affect cash, and breaks the analysis
down to operating, investing, and financing activities. As an analytical tool, the statement of cash flows is useful in
determining the short-term viability of a company, particularly its ability to pay bills.
Cash flow is akin to blood in humans and as such, particular attention should be paid to the cash flow statement.
Cash is used and accumulated by a company in many ways. As such, the cash flow statement is divided into three
sections: 1) cash flows from operations; 2) cash flows from financing; 3) cash flows from investing.
Basically, the sections on operations and financing show how the company gets its cash, while the investing
section shows how the company spends its cash.
Cash flows from operating activities, also known as operating cash flows show how much cash comes from the
sale of the company's goods and services, less the amount of cash needed to make and sell those goods and
services. Investors tend to prefer companies that produce a net positive cash flow from operating activities. High-
growth companies, such as technology firms, tend to show negative cash flow from operations in their formative
years. At the same time, changes in cash flow from operations typically offer a preview of changes in net future
income. Normally, it's a good sign when it goes up. Do look out for a burgeoning gap between a company's net
income and its cash flow from operating activities. If net income is much higher than cash flow, the company may
be speeding or slowing its booking of income or costs.
Cash flows from investing activities largely reflect the amount of cash the company is spending on capex
expenditures, such as new property, plant and equipment or anything else that is needed to keep the business
going. It also encompasses the acquisitions of other businesses and monetary investments such as money market
funds. As an investor, you would want to see a company re-invest capital in its business by at least the rate of
depreciation expenses each year. If no re-investment is made, the companys cash flows may show artificially high
cash inflows in the current year which may not be sustainable.
Cash flows from financing activities describe the movement of cash associated with outside financing activities.
Typical sources of cash inflow would be cash raised by selling stock and bonds or by bank borrowings. Likewise,
paying back a bank loan would show up as a use of cash flow, as would dividend payments and common stock
repurchases.
Many fund managers and financially-attuned investors are attracted to companies that produce positive free cash
flows (FCF). Free cash flow signals a company's ability to pay debt, pay dividends, buy back stock and facilitate
the growth of the business. Free cash flow, which is essentially the excess cash produced by a company, can be
returned to shareholders or invested in new growth opportunities without hurting existing operations. The most
common method of calculating free cash flow is:
Net
Net Income
Income
++ Amort
Amortizat
ization
ion // Depreciat
Depreciation
ion
Change in Working Capit
Change in Working Capit al al
Capit
Capital
al Expendit
Expenditureure
== Free
Free Cash
Cash Flow
Flow
Ideally, investors would like to see that a company can pay for its investments without the need to rely on outside
financing. A company's ability to pay for its own operations and growth signals to investors that it has very strong
fundamentals.
Points to note:
1. Balance sheet and cash flow were given less importance before the Asian Financial Crisis as investors were
looking for earnings growth driven by capacity and economic expansion. The Asian Financial Crisis jolted the
investment community into giving more respect to balance-sheet strength and cash-flow-generating capability.
2. A key difference to note is the operating cash flow before and after working capital requirements. Typically,
distributors suffer from a poor cash cycle. It takes them a long time to collect payments from customers, they
are saddled with inventory by their suppliers and at the same time, suppliers demand to be paid fast. As such,
distributors tend to have glowing operating cash flow before working capital and less flattering operating cash
flow after working capital.
3. Since cash flow is usually derived from pretax profit, a prerequisite for strong cash flow is strong profitability,
which is in turn driven by higher sales and lower costs.
4. Look for companies with sustainable free cash flow as this provides the foundation for a consistent dividend
payout policy and can be used to check if attractive dividend yields are sustainable or just one-off.
This section usually comes right after the Financial Statements. They serve to tie up the loose ends and complete
the jigsaw puzzle. The Notes help link up ones understanding of the three financial statements Income
Statement, Balance Sheet and Cash Flow Statement. If you dont read them, you could be missing out on a big
part of the picture. For example, they may show you the breakdown of revenue from different countries or
segments as well as the maturity date of outstanding debt, sensitivity analysis, depreciation policies, how sales are
recognised etc.
Auditors report
The auditors' job is to express an opinion on whether the financial statements are reasonably accurate and provide
adequate disclosure. This is the purpose behind the auditor's report. An auditor's report is meant to scrutinize the
company and identify anything that might undermine the integrity of the financial statements. While the auditor's
report won't uncover any financial bombshells, audits give credibility to the figures reported by management.
Investors should exercise caution if the financial statements have not been given the green light by the auditors.
As a preface to the financial statements, a company's management will typically spend a few pages talking about
the recent year and providing a background on the company. This is referred to as the MD&A. In addition to
providing investors with a clearer picture of what the company does, the MD&A points out some key areas in
which the company has performed well and more importantly, the outlook and strategies going forward.
Financial ratios are formula-based calculations using figures mainly from the financial statements. The ratios are
generally analysed for an idea of a company's valuation and financial performance.
The P/E ratio compares the market price of a stock to its earnings per share (EPS), usually over a 12-month
period.
The P/BV ratio compares the market price of a stock to its book value per share.
Points to note:
1. For P/E ratios, you need to have an E, that is, this method only works if the company is profitable. Also, as
there could be many Es, you need to understand what goes into the derivation of the earnings. At the same
time, if the company has substantial dilutive instruments such as convertible bonds, warrants etc, it would be a
good idea to determine the fully-diluted EPS as well.
2. For P/BV ratios, companies should generally trade above their book value. The exception is when the market
senses that the company is heading for a period of declining ROEs or an extended period of losses. If the
companys ROE cannot exceed its cost of equity, a case can be made for investors to pay less than book
value.
3. Also, be wary of companies with substantial intangibles such as goodwill since companies are required to test
their goodwill for impairment yearly. In such cases, it would be useful to determine the P/NTA ratio (price to net
tangible asset ratio).
4. In many cases, intangibles such as goodwill only occur in the case of an acquisition and it may be hard to
quantify if the goodwill is justifiable.
The P/E ratio is one of the most common ways of valuing equity. The ratio is also known by names such as price
multiple and earnings multiple. It can be calculated as:
For instance, if a company is trading at S$4 a share and its earnings per share (EPS) over the last 12 months
were S$0.50, its trailing P/E ratio would be 8x.
Investors typically look at prospective P/Es. For example, analysts will usually value a stock by pegging a P/E
multiple to their earnings forecasts (e.g. 5x FY09 or CY09 EPS).
Market
Market Value
Value Per
Per Share
Share
=
Earnings
Earnings Per
Per Share
Share (EPS)
(EPS)
Going deeper
A high P/E ratio implies that investors expect higher earnings growth in prospective periods from the company as
compared to one with a lower P/E. However, the P/E ratio is unable to provide a full picture. Typically, it is more
useful to compare the P/E ratio of a company with others in the same industry and of a similar market
capitalisation.
However, nothing is perfect in this world. Investors should note an important problem that can arise with the P/E
ratio. The denominator, EPS, is based on an accounting measure of earnings that is susceptible to forms of
manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.
P/E ratios are also compared to the sector average (peer valuation) as well as the companys own past trading
history to provide some sense of relative valuation.
The P/BV ratio is used to compare a stocks market value with its book value. It is calculated using the following
formula:
P/
P/ BV
BV == Market
Market Price
Price // Book
Book Value
Value Per
Per Share
Share
Equit
Equityy (ie. Assetss Liabilit
(ie. Asset Liabilities)
ies)
Where
Where Book
Book
Value
Value Per Share
Per Share
=
Number
Number of
of Shares
Shares Out
Outst
standing
anding
Going deeper
A lower P/BV ratio typically suggests that a stock is undervalued.
Market
Market Price
Price
P/
P/ NTA
NTA =
NTA
NTA Per
Per Share
Share
Net
Net Tangible
Tangible Asset
Assetss (ie.
(ie. Tangible Assetss Liabilit
Tangible Asset Liabilities)
ies)
Where
Where NTA
NTA Per
Per Share
Share =
Number
Number of
of Shares
Shares Out
Outst
standing
anding
Tangible assets exclude goodwill and other form of intangibles such as brand value etc.
Though the concept of DCF analysis is simple, its practical application is not. The premise of the discounted cash
flow method is that the current value of a company is simply the present value of its future cash flows that are
attributable to shareholders. Its calculation is as follows:
CF
CF11 CF
CF22 CF
CFnn
DCF
DCF = + ++
1 2 n
(1 r)1
(1 ++ r) (1 r)2
(1 ++ r) (1 r)n
(1 ++ r)
For example, if we know that Company A will generate $1 per share in cash flow for its shareholders every year
into the future, we can calculate how much this cash flow is worth today. This value is then compared to the
current value of the company to determine whether the company is a good investment, depending on whether it is
undervalued or overvalued.
There are several techniques within DCF, depending on the type of cash flow used in the analysis. The dividend
discount model focuses on the dividends a company pays to shareholders, while the cash flow model looks at the
cash that can be paid to shareholders after all expenses, reinvestments and debt repayments have been made.
But conceptually, they are the same, as it is the present value of these streams that are taken into consideration.
The difficulty lies in the implementation of the model as it involves a lot of estimation and assumptions. Just
imagine, forecasting the revenue and expenses for a firm three or five years into the future is difficult enough, let
alone 10 years.
Basically, this valuation method involves valuing a company, which usually has many disparate business divisions,
by determining how much these individual divisions are worth should the company be broken up and spun off or
acquired by another company.
Different valuation methods can be applied to each division before a final value of the whole group is derived.
Example:
Investors investing in property stocks will usually come across the term RNAV. This is derived using the analysts
assumptions for construction costs per square foot, land cost, selling price per square foot, units sold and revenue
recognition schedule.
The RNAV measure allows analysts to adjust their earnings estimates for the property developers based on
whether the property market is hot or cold. It is useful as a tool to determine if there is greater value in buying
physical property or buying property stocks.
Before you scurry off to buy your next stock, remember that if you dont understand what a company does, dont
buy it.
The following are some guidelines before calling your broker to make the trade:
What is the business nature of the company
What are its principal business activities
Key products and services
Source of revenue
Where are its key markets and the economic outlook for the respective markets
Major customers and suppliers
Business environment
Where is its base of operations? Would the region be susceptible to any political risks or natural disasters?
Management quality
Major shareholders
While sell-side research is no doubt useful to help you keep abreast of key company and industry developments, it
should NEVER be taken as a substitute for independent analysis and assessment! All the best!
Look through the stock list and decide which stocks interest you. These will be the stocks that you aim to
specialise in. It would be ideal if you could match the stocks you pick to your personal interests as this would make
the understanding process a whole lot easier.
Another advantage is to invest in companies that are engaged in businesses you are familiar with. For example, if
you are a healthcare professional, you would probably have an idea how the healthcare business works. Thus,
stocks such as Parkway Holdings and Raffles Medical Holdings could be companies you may consider investing
in.
Step 2:
Strike off the stocks that are barely traded in the market as share prices work on the theory of demand and supply.
If no one buys and no one sells, the share prices will basically remain the same. Buying illiquid stocks can cause
you heartache when you need to sell in a hurry but there is no buyer.
Step 3:
Read relevant industry reports issued by the press and analysts reports to better understand the industry cycle
and the factors that move it. In addition, do spend some time checking the SGX website for company
announcements in the last few months to understand the companys latest focus and developments.
A good way to invest would be to keep a stock log or journal and pencil down the reasons you are buying a
particular stock, your exit price, course of action if the price falls after you have bought the stocks.
Recommendations from third parties should not be the sole consideration. Remember that at the end of the day,
you are putting in your hard-earned money. As such, you need to be aware of your own risk profile and cash-flow
requirements.
Scan the financial statements and check the key financial ratios to determine if a company is in a healthy position.
It would also be good to do a peer comparison with a similar company and see where each stands.
Understand that there is a difference between speculating (trading) and investing. If you are trading, you would be
going for concept plays, rumours, high volumes and establish strict take-profit and cut-loss levels.
If you are investing, you would be looking for companies with a strong balance sheet, growth, good dividend
yields, high ROEs etc.
Step 5:
Suggested books
The Intelligent Investor
Investing the Templeton Way
The Traders Guide to key Economic Indicators
Damodaran on Valuation
Bull! A history of the boom 1980 1999
Terms Definition
Terms Definition
Capital base Total capital less Investment in subsidiaries and holdings of other banking
institutions capital
Core capital ratio Tier 1 capital / Risk-weighted assets
Cost-income ratio Overheads / Total income
Cost of funds Interest expense / Average interest-bearing liabilities
General provisions General provisions made on total loan portfolio
Interest-earning assets Cash and short term funds, securities purchased under resale agreement,
deposits with FIs, dealing securities, investment securities, loans and advances
Interest-bearing liabilities Customer deposits, deposits and placements with FIs, obligation on securities
sold under repurchase agreements, bills payables, amount due to Cagamas,
subordinated bonds, borrowings
Interest-in-suspense (IIS) Interest in arrears for non-performing loans
Loan book Gross loans
Loan loss reserve Specific provisions + Interest-in-suspense + general provisions/ NPLs
Loan-deposit ratio Net loans / Total deposits
Loan loss provisions (LLP) General provisions + Specific provisions
Net interest margin (NIM) Net interest income / Average interest-earning assets
Non-performing loans (NPL) Loans (principal and interest) in arrears for specified time
Risk-weighted capital ratio Capital base / Risk-weighted assets
(RWCR)
Specific provisions Provisions made on specific accounts that are deemed sub-standard, doubtful
or bad
Statutory reserve requirement Amount (a percentage of eligible liabilities) maintained in the form of cash
(SRR) reserves with central bank
Tier-1 capital Paid-up capital, preference shares, share premium, statutory reserve fund,
general reserve fund, retained profits, surplus/loss arising from sale of fixed and
long-term investments and minority interests less goodwill
Tier-2 capital Hybrid capital instruments, minority interests arising from preference shares,
subordinated term debt, revaluation reserves and general provisions
Total capital Tier-1 capital + Eligible Tier-2 capital
Terms Definition
Expense rate Total expenses / Total premium income (excluding single premiums) & Annuity
premiums
Forfeiture rate Annual premiums forfeited in a year / Weighted average of new annual
premiums for that year and two preceding years
Net interest Returns on investments Rates & taxes
Net interest rate (2 x Net interest earnings) / (Policy owners fund brought forward + Policy
owners fund carried forward Net interest earnings)
Surrender rate Total sums insured discontinued by surrender Sums insured at beginning of
year
Claims ratio Net claims incurred / Earned premium income
Earned premiums Net premiums Provision for RUR at year-end + RUR at start of year
Gross direct premiums Premiums on original gross rate charged to clients before deduction of
commission or brokerage
Gross premiums Gross direct premiums + Reinsurance accepted premiums Reinsurance
within country
Incurred but not reported Losses that have occurred during a period but not reported to insurer by that
(IBNR) claims date
Net claims incurred Net claims paid Provisions for outstanding claims at start of year +
Provisions for outstanding claims at year-end
Net premiums Gross premiums Reinsurance premiums payable
Reserves for unexpired risks Premiums already received for risks still unexpired at end of period
(RUR)
Retention ratio Net premiums / Gross premiums
Underwriting gain/loss Earned premium income Net claims Commissions & management
expenses
CIMB Investment Bank CIMB Securities (S) PT CIMB Securities CIMB Securities (HK) CIMB Securities CIMB Securities (UK) CIMB Securities (USA)
Bhd Pte Ltd Indonesia Ltd (Thailand) Co Ltd Ltd Inc
(18417-M) (198701621D) (01.353.099.3-054.000) (290697) (0105542081800) (2719607) (52-1971703)
(A Participating Organisation of 50 Raffles Place The Indonesia Stock Units 7706-08 44 CIMB 27 Knightsbridge 540 Madison Avenue
Bursa Malaysia Securities Bhd)
10th Floor, Bangunan CIMB #19-00 Exchange Building, Level 77 Thai Bank Building London SW1X 7YB 11th Floor
Jalan Semantan Singapore Land Tower Tower II, 20th Floor International Commerce 24-25th Floor United Kingdom New York
Damansara Heights (S048623) Jl. Jend. Sudirman Centre Soi Langsuan N.Y. 10022
Singapore Kav. 52-53 1 Austin Road West Lumpini, Patumwan USA
50490 Kuala Lumpur
Malaysia Jakarta 12190 Kowloon, Hong Kong Bangkok 10330
Indonesia Thailand
T: +60 (3) 2084 8888 T: +65 6538-9889 T: +62 (21) 515-1330 T: +852 2868-0380 T: +66 (2) 657-9000 T: +44 (20) 7201-2199 T: +1 (212) 616 8600
F: +60 (3) 2084 8899 F: +65 6323-1176 F: +62 (21) 515-1335 F: +852 2537-1928 F: +66 (2) 657-9111 F: +44 (20) 7201-2191 F: +1 (212) 616 8639