McDonald’s

Fundamental analysis of McDonald’s (MCD), June 24, 2017

White picture of McDonald's logo with McDonald's text

Update: July 26, 2017

McDonald’s had an earnings call yesterday and even if they had a reduction in sales last quarter compared to the same quarter last year of 3.5 per cent, they managed to increase their earnings per share by 30 per cent. The current earnings per share is $1.70.

The current P/E ratio is still very high at 28.9 with a forward P/E ratio of 26.2. The Book value is negative due to the high proportion of intangible assets.

If you buy the stock now, you believe that their earnings will continue to grow indefinitely.

It doesn’t make sense to buy McDonald’s stock at these prices.

 

 

Description:

McDonald’s is not a small-cap stock, but nevertheless a value proposition that fits into this article.

The company is one of the world’s leading fast food chains with more than 36,000 restaurants around the world.

 

Valuation:

McDonald’s is not cheap at 28.4 times earnings. Average earnings of the past three years come in at 5.02 which gives a P/E ratio of 30.8. Because of the high Goodwill, the Book value is negative. The company has $1.4 billion in Working capital which means that it is able to pay its short-term bills.

 

Balance sheet:

The company has a negative equity which in theory means that a shareholder owes money to creditors if the company goes bankrupt. This does not look good.

 

Free cash flow and dividend:

McDonald’s has a Free cash flow of $4.2bn which allows the company to pay out a nice dividend of $3.61 per share. Furthermore, the company is part of the Dividend Aristocrats which means that they have paid out uninterrupted and increasing dividends over the past 20 years. The dividend yield, on the other hand, is low at 2.3%.

 

Conclusion:

At $154.64 the McDonald’s stock is too expensive for me.

 

 

 If you would like to learn more about fundamental analysis you can do that here.

Pepsico, Inc.

Fundamental analysis of Pepsico, July 10, 2017

Blue figure with Pepsi icon and text about Pepsico

Update:

The day after publishing this we figured out that the company presented their earnings.

The earnings came in better than anticipated and we can now make estimated guesses for next year’s earnings.

We think they will come in around $4.50 per share which equates to a forward P/E of 25.3.

That is still far too expensive for my taste.

Yesterday interestingly the share went down 0.5 per cent to $113.74.

Valuation:

At $115 and a trailing P/E value of 26.5 the PepsiCo share is expensive. Over a period of three years, the P/E ratio is even higher at 28.2. Because of their high degree of intangible assets the Book value is negative so a measure like Price to book does not make sense.

 

Balance sheet:

PepsiCo has a Working capital of $6 billion but the Working capital to debt is low at only 0.1. The Debt to equity ratio is extraordinarily high at 5.6.

In all, PepsiCo’s balance sheet could look better.

 

Free cash flow and dividend:

The company has a Free cash flow of $7.4 billion which equates to $5 per share. Of this they both buy back outstanding shares and pay a good dividend of $2.96 (2.6 per cent). The earnings look stable.

PepsiCo has been paying out uninterrupted and increasing dividends for more than 25 consecutive years.

 

Conclusion:

At 26.5 times trailing earnings PepsiCo is too expensive for my taste. At these prices I would call it a SELL.

 

If you would like to learn more about fundamental analysis you can do that here.

Concentrating on a few companies is a great way to learn investing

You want to start investing, but you have no idea of where to start. Where do you begin to learn investing?

Blue picture with text about following a handful of companies

In the beginning it can seem overwhelming.

Should you invest in bonds, stocks or a combination of both?

If you begin with equities should you start with bigger companies or smaller?

How do you pick the stocks in which you want to invest in the first place?

The default option is to invest in an index fund – I’ve been talking about that solution before.

There is a small problem with that solution though and that is that it is boring.

Therefore I suggest that you choose three to five stocks that are publicly traded and you begin to follow them.

The good news is that you only need to look at this four times a year.

Set up a spreadsheet where you track key numbers like Price, Earnings, Current/Total Assets and Current/Total Liabilities.

You can do it like this:

Key numbers of a hypothetical company, ABC Corp., for the four quarters of 2017.

Figure 1. Key numbers of a hypothetical company, ABC Corp., for the four quarters of 2017.

With just these five indicators you will be able to draw conclusions about the financial health of the companies that you are following.

Have they had an exceptionally bad/good quarter and why is that?

Then after a few quarters you will understand the Balance sheet better.

You will know how the companies are making their money and you will be able to calculate ratios like Working capital (Current assets – Current liabilities), Equity (using the Fundamental accounting equation) and the Price to earnings ratio.

Conclusion:

One of the best ways to start investing is to follow a handful of companies. In the US companies traded on the stock exchange are required by law to submit a financial report every quarter.

Just keep track of the companies’ earnings, their assets and their liabilities and you are on your way to become a financial analyst.

 

 

 

Treatt plc

Monday, March 13, 2017

Today I would like to look at fundamental analysis of one the best ran british companies, Treatt plc.

Valuation

As always I prefer first to look at the valuation numbers and here it becomes clear that the stock is expensive.

You have to pay a hefty 28.8 times the trailing earnings for the stock.

When you look at the average three preceding years, the stock is even more expensive at 32.7 times trailing earnings.

Already here I would hesitate, but it gets worse. At these market prices, you are paying 5.2 times Book Value which obviously is not cheap.

Balance Sheet

The Balance Sheet looks far better. The Debt to Equity ratio is 0.9 and the Working Capital to Debt is 1.1.

The ratio between Current Assets and Current Liabilities is 3.3 which is very good.

Treatt Plc. has a Net Working Capital of £21,000,000 which equates to about 40p per share.

Dividends

The dividend history looks good with more than 15 years of non-interrupted and increasing dividends.

The current dividend yield is only 1.3 percent which obviously is a reflection of the high price.

Conclusion:

If you already own Treatt Plc. by all means keep the stock, but if you do not I wouldn’t buy it at these prices.

The Balance Sheet looks very good, but I would not buy the assets at this price.

The company has a good dividend history, but the feeble yield is a reflection of the price.

 

If you would like to learn more about fundamental analysis you can do that here.

Target Corporation (TGT)

Fundamental analysis of Target Corporation (TGT), July 17, 2017

Description:

Target Corporation operates a household retail business in the United States. It is based in Minneapolis, MN.

 

Valuation:

Given the strength of its business, the company is reasonably priced at 11.5 times earnings. Average earnings over the past three years are low with one year of loss. Price to forward earnings comes in at 11.8.

Price to book value is high at 2.9.

 

Income items:

The earnings history seems a little bit erratic with 2014 being a year with a loss. They actually lost $1.6 billion that year which equates to a loss of $2.56 per share. Hopefully, Target Corporation will stay away from those years in the future.

 

Balance sheet:

The company’s current liabilities are greater than its current assets so the net working capital is negative.

The Debt to equity ratio is 2.4, a number which usually is associated with high risk.

 

Free cash flow and dividends:

The company last year had a Free cash flow of $3.9 billion which equates to $6.70 per share. Of this they are paying out a dividend of $2.36 (2.8%).

 

Conclusion:

Because the company is reasonably priced, I’m tempted to dip my toes in the company. The only problem is the high debt levels.

 If you would like to learn more about fundamental analysis you can do that here.

 

Get rich slowly

To get rich slowly is both easy and difficult.

Blue picture of dollar coins with text "get rich slowly"

Today I want to talk about getting rich, but not in the sense of winning the lottery, but rather the kind where you are stacking one brick on the other and see your wealth accumulate over time.

We all know that investing requires a good amount of patience.

It’s not for everyone.

Some people are naturally inclined to bet everything they own on just one horse – and that is perfectly fine – while others prefer to save their money.

We could not all be savers. Not only would that be boring, but also the economy needs some of us to spend while others can save.

If you want to get rich slowly you need to be able to stay calm when the wind blows and you see your securities tumble in value.

Investors vs. speculators

To put this into perspective, there are two different categories of people in the market: the investors and the speculators.

While the speculators are betting their money on a particular stock very much like people do on the racetrack, an investor is taking action from conclusions and hard numbers.

He or she is not moved by flings or hypes about a certain business idea or technology that may or may not be founded in reality.

To an investor what matters are the fundamentals.

It’s those that make investing such an interesting endeavor.

Legendary investor Benjamin Graham defined what investments are like this in his book Security analysis from 1934:

An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.

That definition is still valid today.

So what is investing all about?

The essence of investing is to compound the interest paid.

What this means is that you want to reinvest whatever yield you are getting back into the stock.

The goal is of course to see your capital grow, but it really grows much faster if you are compounding the interest.

To illustrate my point, let me show you an example:

Let’s say that we have 100 shares of a company, ABC Corp, and each share costs $100.

If the shares are increasing in value with 5 per cent a year then after five years they will be worth:

Screenshot of Microsoft Excel showing growth of 5 per cent a year of 100 shares that initially are worth $100.

Figure 1. Screenshot of Microsoft Excel showing growth of 5 per cent a year of 100 shares that initially are worth $100.

After 2 years the value of the stocks will be $11,025 and you’ve made a profit of $1,025.

On the other hand, if we reinvest the dividend in the same stock it will look like this instead:

Screenshot of Microsoft Excel showing compound growth of 5 per cent a year of 100 shares that initially are worth $100.

Figure 2. Screenshot of Microsoft Excel showing compound growth of 5 per cent a year of 100 shares that initially are worth $100.

If we then compare the numbers for Year 2 we can see that in Figure 1 our shares are worth $11,025 whilst in Figure 2 they are worth $11,466.

Depending on how much of your money you invest and the size of the growth these numbers will of course fluctuate. But if you buy back more stock you will compound your interest quicker.

This is in essence what investing is all about.

 

 

 

Walgreen Boots Alliance (WBA)

Fundamental analysis of Walgreen Boots Alliance (WBA), July 7, 2017

 

Description:

Walgreen Boots Alliance is an American pharmacy chain with many business areas in the health sector.

 

Valuation:

At $78 and a trailing P/E of 20.3, the company is expensive. Looking at an average of the past three years’ earnings, the P/E comes in at 23.7 which is not better. Because of their intangible assets the Price to Book value is also very high at 19.0.

 

Balance sheet:

The company has a Debt to equity ratio of 1.4 and a Working capital to debt ratio of 0.2 which is OK, but not extraordinary. The Net working capital is $8.9 bn which of course is a lot of cash.

Last year, the Return on equity was 14 per cent which was OK, but not extraordinary. A high Return on equity usually correlates with a high Free cash flow.

 

Free cash flow and dividend:

Last year Walgreen Boots had a Free cash flow of $6.5 bn which allows them to buy back a lot of the expensive shares that they have issued.

It also allows them to pay a dividend of 1.46 (1.9 per cent). The dividend has been uninterrupted and increasing for at least 25 years.

 

Conclusion:

The company is too expensive at these prices. Ideally I would like to see them fall by 50 per cent before dipping my toes.

There is nothing wrong with the company, but it is simply too expensive.

 

 If you would like to learn more about fundamental analysis you can do that here.

When is the market overvalued?

As an investor you have a certain responsibility towards yourself as to not buy stock of overvalued companies.

Blue picture of declining stock index with text about overvalued markets

Where does that lead us today when the market on all metrics is overvalued? Do you sell your stock and miss out on the spectacular gains of the final blow-out phase or do you buy more on the assumption that there will always be a greater fool to whom you can sell if things go wrong?

It may seem as though we have left the old paradigms about value behind us, but at the same time we cannot seem to work out a new one either.

The first thing that we need to conclude is that past performance is a very poor guide for the future. Just because the market has been going up with 270 per cent since the depths of the financial crisis there is nothing guaranteeing that this will continue. If you believe this, you also believe that the market will continue up indefinitely, for ever, and that all the declines in the market are just temporary.

Now, it is obvious that if a company repeatedly is showing good financial results, they are likely to continue. That is because a good financial result over time equates to a certain business advantage or “edge” in the market in which it operates. Thus, a good financial result is likely to engender higher prices of the stock.

In fact, the opposite is true. The longer the market has advanced, the higher the probability of it crashing down eventually. We all know that sooner or later this is what happens when prices fall spectacularly.

The second point about an overvalued market is that it matters. The assumption that the price of the general market is irrelevant is wrong. That assumes that you always be able to find cheap, bargain stocks, no matter what the price level of the market is. That is obviously not true. There are times when the market is so highly priced that it’s a fool’s errand to look for cheap value stocks.

Most Wall Street pundits are talking about the advance of the market since the depths of the financial crisis, they don’t mention that those advances have been from extremely depressed levels. That is another reason not to expect the market to continue up.

Another way of looking at the valuation of today’s stock market is to say that the nature of bull runs and subsequent crashes has not changed. In fact this has been the pattern throughout history and there is little to argue for that this situation has changed.

There are many people talking about the current price level of the market who are concluding that the current price of the market is a direct consequence of low interest rates and global central bank policy.

There may be policies that indirectly affect the market, but in the long run the market is a weighing machine that is at least trying to get things right.

The mere idea that the market was undervalued in March of 2009 and is overvalued now tells me that the probability of huge price gyrations are great also in the future.

So this is the take home message: The likelihood of huge swings in the market is always there and it is due to human nature.

 

This article is very much inspired by the wisdom of legendary investor Benjamin Graham and a talk he gave in San Francisco in 1962.

 

 

 

Valuation of gold stocks

In today’s post I want to look at valuation of gold stocks.

Green picture with text about valuation of gold stocks

The last few days I’ve been trying to wrap my head around how to value gold stocks.

It’s not as easy as just valuing a normal manufacturing company with Debt to equity, Price to earnings or by Price to book value.

This is because of the value of the resources in the ground.

This makes it inevitable to normalize all the values calculated according to either production or reserves.

We will then get a number of ratios that are similar, but not identical, to the P/E ratio.

The first thing that we will look at is how to calculate the cash cost per ounce produced.

Calculating the cash cost per ounce.

The cash cost is calculated by subtracting Operational cash flow from Total revenue:

Cash cost = Total revenue – Operational cash flow

To get to grips with what this means we can visualize the subtraction like this:

Total cash cost is calculated by deducting Operational cash flow from Total revenue.

Figure 1.Total cash cost is calculated by deducting Operational cash flow from Total revenue.

Which is equivalent to this identity which is used in a normal Income statement:

Net cash is calculated by deducting Cost of sales from Total revenue.

Figure 2. Net cash is calculated by deducting Cost of sales from Total revenue.

What we do in Figure 2 is that we simply subtract our Cost of sales from the Total revenue to arrive at Net cash.

Then to calculate the Cash cost per ounce produced we divide with the total production for the year:

Total cash cost per ounce = Total cash cost / Total production

The Total cash cost per ounce is then the number that we will use in the rest of our calculations.

The companies are doing the best they can to obfuscate this, but this is the true cost of producing an ounce of gold, silver or platinum.

 

Estimated operational cash flow

The next thing that we will look at is an estimate of how much money can come into the company through sales of the metal.

If we estimate that the company produces X ounces of metal in the year, the average cost of production is Y $ per ounce and that the average price of the metal is Z $ per ounce then the estimated operational cash flow of the company is:

Formula for calculating Estimated Operational Cash Flow (EOCF) in $. FMP is the Forecast Metal Price in $ per ounce, CPO is Cost Per Ounce Produced and EOP is the Estimated Ounces Produced in # of ounces.

Figure 3. Formula for calculating Estimated Operational Cash Flow (EOCF) in $. FMP is the Forecast Metal Price in $ per ounce, CPO is Cost Per Ounce Produced and EOP is the Estimated Ounces Produced in # of ounces.

Estimated operational cash flow (EOCF) = ( Y ($ per ounce) – Z ($ per ounce)) * X (ounces produced)

This number we will use in subsequent valuation calculations.

Price to Cash flow ratio

We can then use the Operational cash flow and calculate a Price to Cash flow ratio where a lower number indicates a cheaper stock.

If, for instance, the Price to Cash flow ratio is 5 then investors are paying $5 for each additional dollar of Cash flow.

Typically this number ranges from 3 x to 30 x and the lower the number the cheaper the stock.

Market cap to Forecast production ratio

We can also use the the Market cap to figure out a valuation to forecast production ratio.

Here again the lower this number gets, the lower the stock is valued in the market.

Typically this number ranges from about $1000 per ounce to $25,000 per ounce.

The lower the Market cap is per ounce of forecast production the cheaper the stock.

 

Market cap to reserves ratio

What we look at here is the Valuation (or the Market cap) and divide with the total number of ounces that the company has in reserves.

This number typically ranges from $100 to $1000 depending on the location of the resource.

Again this is a valuation metric where a lower number is cheaper.

 

Price to Earnings ratio

This is the classic valuation ratio where the price of the stock is divided by the earnings.

For gold stocks this number is usually higher than for ordinary stocks and a number of 50 is not unusual.

The lower the number the cheaper the stock.

The question then of course becomes:

How can it be that the Gold stocks are so expensive that investors are gladly paying 50 times earnings to get it?

The reason is that investors are paying for the gold reserves and the gold production that the company have.

The equity valuation is just a part of the value.

 

Examples

So that you better understand what I mean when I talk about the value of different gold stocks, I will now give some examples:

The first is of a hypothetical gold mine ABC Gold Inc. that has the following Cash flow and Income statement:

Screenshot of Microsoft Excel showing how to calculate Total cash cost by subtracting Operating cash flow from Total revenue.

Figure 4. Screenshot of Microsoft Excel showing how to calculate Total cash cost by subtracting Operating cash flow from Total revenue.

We then hit Enter and we get the result that we want in cell B6 ($1360,000,000).

Then we continue to calculate the Cash cost per ounce by dividing B6 with B5:

Screenshot of Microsoft Excel showing how to calculate Cash cost per ounce by dividing Total cash cost by Total gold production.

Figure 5. Screenshot of Microsoft Excel showing how to calculate Cash cost per ounce by dividing Total cash cost by Total gold production.

Here again we hit Enter and we get the Cash cost per ounce in cell B7:

Screenshot of Microsoft Excel showing how to final values of Total cash cost in cell B6 and Cash cost per ounce in cell B7.

Figure 6. Screenshot of Microsoft Excel showing how to final values of Total cash cost in cell B6 and Cash cost per ounce in cell B7.

So what do we do with these numbers?

Well the first thing we can do is to calculate the Estimated operational cash flow at a given gold price:

Let’s say that we estimate that the average gold price will be $1350 per ounce in 2017, the Total cash cost per ounce was $817 in 2016 and that the company forecasts a production of 1,725,000 ounces in 2017, then the Estimated operational cash flow per ounce will be:

Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow per ounce taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce

Figure 7. Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow per ounce taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce.

We then see that the Estimated cash flow per ounce is $533 and to get to the Estimated operational cash flow we multiply B12 with B10:

Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow by multiplying the Estimated cash flow per ounce with the Forecast production (B10).

Figure 8. Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow by multiplying the Estimated cash flow per ounce with the Forecast production (B10).

The result is of course as in Figure 9:

Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce.

Figure 9. Screenshot of Microsoft Excel showing how to calculate an Estimated operational cash flow taking into account the Forecast average gold price (B9), the Forecast production (B10) and Estimated cash flow at $1,350 per ounce.

 

Conclusion:

In today’s post we have been looking at the valuation of gold stocks as a function of their production and reserves in the ground.

 

 

 

A company wants to buy my site for $1.6m. I’m currently making between $8k and $11k a week with it. Should I take the deal?

Is this a good deal?

Blue picture of dollar with text about the offer

You have a website that is generating a good amount of cash.

You have been approached by a company that wants to buy your site. You have been offered $1.6m for it.

Now you are asking yourself if you should sell your precious business or if you should keep it and continue running it.

Because I don’t know anything about your situation I have to make a few assumptions.

First of all I’m going to assume that the $8K to $11K is pure profit and that all else is paid for.

Then I’m going to calculate a mean of the $8K and $11K to arrive at a figure per month. This turns out to be $9,500.

Then I’m going to multiply an average of $9,500 with the number of weeks in a year:

$9,500 x 52 = $494,000

So you are roughly making $500,000 a year.

From the point of view of an analyst looking into the offer this would represent a Payback period of 3.2 years.

From an investment perspective this would be considered good. The initial investment is rapidly being paid back. This means that the deal makes sense from the buyer’s perspective.

But you are asking if it’s also a good deal for you.

I would say go for it.

The thing about being an online entrepreneur is that there’s no shortage of ideas of how to make money.

Once you have made one company work it’s easy to make another one with just a slight change of the input parameters.

Even if you are signing a deal with the company not to participate in the exact same market again, you can easily find another niche where you can thrive.

Therefore I would accept the offer.