Fundamental analysis of Target Corporation (TGT), July 17, 2017
Target is valued at 11.6 times 2016 earnings which is cheap enough to make it interesting. If we assume that the company will make $4.50 for the whole of 2017 – which is in line with the earnings reported so far – the P/E ratio comes in at 12.1. This number is not cheap, but not extremely expensive either.
The problem is of course that it is a retailer – a business model that is under heavy attack from e-commerce competitors. However, for the time being Target is making real money which potentially makes it an interesting value proposition.
Target Corporation operates a household retail business in the United States. It is based in Minneapolis, MN.
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.
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.
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.
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%).
Because the company is reasonably priced, I’m tempted to dip my toes in the company. The only problem is the high debt levels.
Since we last visited Target the stock has advanced another 30 per cent. If I was tempted this summer, I’m no longer. By all means, if you already own the stock don’t get rid of it, but would I buy new stock at this point? No.
The reason for this is the same as last summer: Target has very high debt levels and a negative working capital. On the positive side the free cash flow yield is almost 9 per cent which means that they can afford the dividend of $2.46 this year. But in summary, the stock is too pricey for me.
Walgreen Boots Alliance is an American pharmacy chain with many business areas in the health sector.
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.
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.
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.
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.
Walgreen Boots is valued at 21 times last year’s earnings. If we assume that the company will make $4.00 in 2017, the forward P/E ratio comes in at 20.
Because the company has a lot of intangible assets the Price to Book comes in at 19.7, which is very high.
In summary, I would not buy shares in Walgreen Boots at this time.
Since we last looked at Walgreen-Boots, the share has gotten marginally cheaper but at an earnings multiple of 19 the stock is still expensive if you look at the earnings alone.
On the other hand, Free cash flow yield for last year comes in at 7.6 per cent which is better than its peers.
There is nothing wrong with company. Debt seems manageable and Return on equity looks good at 14 per cent last year. The company also has a healthy $1.2bn in cash.
Had the stock only been 30 per cent cheaper I would be a buyer. Now it’s a HOLD.
At almost 27 times 2016 earnings, Colgate Palmolive is still expensive. If current trends continue, the company will approximately make $2.55 for 2017 which gives a forward P/E ratio of 28.4.
Because the company has a lot of intangible assets its book value is negative which makes for a difficult Price to book valuation. Colgate’s cash flow yield is 4 per cent which is in line with its competitors.
The stock is still too expensive for my taste.
Colgate-Palmolive is an American consumer products manufacturer with a global business. It is based in New York City, New York.
The company is expensive at 27 times last year’s earnings. Looking at the past three years’ earnings it is even more expensive at 33 times average earnings.
Because the company has a lot of intangible assets – which are supposed to be subtracted from the equity when calculating the book value – the book value is very low and even negative.
Therefore it does not make sense to calculate a Price to Book value ratio.
Colgate-Palmolive has a working capital of $1 billion which is a lot of cash in the bank.
When looking at the Balance sheet in detail it becomes apparent that their liabilities are almost as great as their assets and that the equity portion is very low.
Nevertheless, people seem quite happy to pay for their ability to make money out of the equity.
The company had a Free cash flow last year of $2.5 billion which equates to $2.84 per share. Of this they are paying out a dividend of $1.50 which equates to 2.1 per cent.
Colgate-Palmolive is also involved in buying back shares which in general makes the shareholders who are selling their shares richer.
The company is a part of the Dividend aristocrats which have a history of paying out uninterrupted and increasing dividends for at least 25 years.
At these prices I would not be buyer of Colgate-Palmolive. For me to be interested prices would need to fall by at least 50 per cent.
Fundamenal analysis of S & W Seed Company (ticker: SANW), May 19, 2017
The company made a loss of $11.8 million last year which equates to -$0.67 per share. Despite of that the share is traded at $3.175 which is a lot of money. Last year the stock was trading at over $5.00. I’m not really sure that S&W Seed constitutes good value at present.
The company just made 2 cents per share last quarter. If this trend continues and S & W Seed makes 10 cents for the whole of 2017 the forward P/E ratio 34.5. The Price to Book value is still high at 2.5.
Looking at the Balance sheet things look a little better. The company has a Book value of $21 million which equates to $1.40 per share. The Working capital is $16 million which is good.
The company has a Free cash flow of $4.1 million which equals 27 cents per share. No dividends are paid out.
Given the erratic earnings I would not be a buyer of S & W Seed at these prices.
S&W Seed Company is an agricultural company that is specializing in the breeding, growing and commercialization of alfalfa seeds.
SANW is expensive at trailing a P/E of 172. The average earnings over the past three years is looking even worse at a negative 6 cents.
Consequently the P/E ratio over the average three years is negative.
The Price to Book value is 2.5 which is high.
The earnings are to say the least erratic over the years. Last year they 2 cents per share and the year before the company had a loss of 25 cents per share.
The Shiller earnings since 2009 are a negative 4 cents.
Then we come to the balance sheet and here things looks a little better.
The Working capital is a solid $16,000,000 which equates to $1.08 per share.
The company has a Debt to equity ratio of 0.9 and a Current assets to Current liabilities ratio of 1.4.
The company has a good Free cash flow of $4,000,000, but they do not pay out any dividend which seems reasonable given their non-existent earnings.
S & W Seed has great potential, but it is not an investment for me at current prices.
Tesla had another quarterly earnings call yesterday and the stock gained 6 per cent.
The market is now willing to pay $347.86 for the Tesla stock. This seems to be ludicrous and comes with a lot of hype around the brand.
Now, the reason why I keep on writing about the company is that I believe that the internal combustion engine is dead and that Tesla is going eat the lunch of all the other car companies around the world. Having said that, the company has a lot of government loans which makes it very difficult to turn around the current situation.
The company has not made a profit for a single year in which they have been operating
This quarter, which ended on June 30, 2017, Tesla lost another $2.04. They are now up for a loss of at least $8 for the whole of 2017.
I do like Elon Musk, but the Tesla stock is not for me.
Tesla, Inc. is in the business of manufacturing and selling electric vehicles, solar panels and energy storage solutions in the United States. It is based in Palo Alto, California.
Since we last visited with Tesla on February 23, 2017, the stock has advanced another $100 and now sits at $361.61.
Now, there are obviously reasons for this price – bullish analysts tend to focus on the future for electric vehicles and that the potential market for EV:s is immense – but if you are looking at the current value that you are getting for those $362, it is not much at all.
In fact, I would say that you getting nothing at all.
The company has a Debt to equity ratio of 2.83 which is exceedingly high.
I would not touch such a risky asset even with a ten foot pole.
Having said that, Tesla’s Working capital is $434 million which seems reasonable but the ratio between the Working capital and the Operating expenses is only 0.2 which is very risky.
What it means is that the company needs to raise cash sometime during the year.
Tesla does not have a positive Free cash flow and it goes without saying that it does not pay any dividend.
There may be a great future ahead of Tesla, but the stock is not for me.
The reason for this is that I’ve recently been watching a Youtube channel called Now You Know that show a lot of news about Tesla Motors.
So I thought that I should look into the hype and see for myself if there was anything to it.
What I did was that I went to Tesla’s website and I downloaded their financial reports.
The numbers are shocking.
Tesla has been in business for almost ten years and in none of those they have made any money.
Granted, the loss last year was less than the year before, but still the second largest loss out of these ten years.
Looking at the balance sheet it’s very much the same story.
Its total debt is a staggering 16.8 billion dollars and the free cash flow is a negative 1.4 billion.
No wonder that the stock is losing more than 5 percent as I write this.
Who in their right mind would want to invest in something like that?
It’s clear that if you buy Tesla stock you hope that the earnings will materialize in the future.
At $259 those hopes are very expensive.
Elon Musk may be an excellent visionary, but his abilities as a CEO of Tesla Motors are not as good.
In this guide we will lay out the basics of why you want to invest your money based on the value that you get from your investment and why an approach like Warren Buffet’s almost always outperform in the long run. We will talk about value investing in the broad sense as well as the traps you want to avoid. We will not get too deep into technicalities like return on equity and working capital although we will briefly mention them. We will especially talk about how you as an investor can manage your money for the better and how you can build your nest egg – slowly.
(Note: If you would like to know more about the financials of Tesla Motors please read this article.)
To invest your money is both easy and hard at the same time. If you just want to invest somewhere you can do that with the click of a button, but if you want to invest wisely it’s a little bit harder. To invest wisely you have to go through the financial statements that are found in the quarterly or annual reports of the companies that you are interested in. When that is done, you need a framework for telling if the stock is worth buying or not.
When we first started investing many years ago and then sold our holdings at a profit, we thought that we ruled the world. There was nothing stopping us from making a killing in the stock market. We bought shares like there was no tomorrow. The only question that was relevant to us was how much money we could possibly deploy for our next speculation.
But then something happened. The market fell.
When it did there was no bottom to our losses. Everything that we had gained during the previous years was now lost and then some.
Wise from our experiences we laid out another strategy, one that was based on value instead of spectacular growth. One where a steady cash flow was more important than spikes in earnings.
This is why we write this guide. To prevent others from making our mistakes and to teach them how to be prudent with their hard earned money. This is especially true if you like sleeping well at night without any financial worries.
We caution you to take a more prudent approach with your cash and do your due diligence before you buy or sell any security. Never buy securities without asking for advice from a qualified adviser. You should always ask yourself if the investment decision you are about to make is justified by the fundamentals. If it is then go ahead, if it’s not then wait until it is.
There are many examples of occasions where the market has been severely wrong. We see them almost every day. These occasions ultimately create good buying and selling points for every shrewd investor out there. But you have to remember being patient.
Here we are going to talk about allocating your portfolio. What proportion of stocks to bonds you should keep and how to deal with the urge to speculate.
There is nothing giving you more thrill than seeing the ball fall at the right number when you’re at roulette table at the casino. This feeling of exhilaration is very strong and also very addictive. But it deceives you. The next time you will not be that lucky and when looking at it objectively, you have the odds stacked against you. After all, that is how the casinos around the world are making their money, by making sure that they will win more times than they will lose.
The same is true for investing. You can see a speculative stock go up two or three times in price over a short period of time. But to believe that you are consistently able to time the market so that you always buy low and sell high is just unrealistic. Sure you may be able to have a few quick wins, but they will almost invariably be accompanied with losses that exceed your gains.
You therefore have to have a system in place that prevents you from speculating. Keep a proportion of your portfolio – the smaller the better – aside for your speculation, but never mix money you gain from speculation with money for investment. What we suggest is keeping a proportion of 10 per cent or less aside for speculation. That way you can participate in the excitement, but you will never let it overtake your life.
Furthermore, there is a misconception out in the public that says that investing is like betting in the casino. We would like take a different view. Where betting is ultimately dependent on luck, the same cannot be said about investment. Investing is about putting money to work and getting a reasonable reward in return.
The safer this return is the better.
Regarding portfolio allocation it depends on the where in the market we are. In normal times the prices of bonds are the opposite of the prices of stocks. Therefore you should try to keep an equal balance between the two.
However, at times the prices of stocks are depressed while the prices of bonds are high. In such a situation it makes sense to increase the stock proportion in your portfolio. We suggest that you never exceed 90 per cent stocks when they are undervalued and that you don’t exceed 90 per cent bonds when stocks are overvalued. That way you will keep an even balance in your portfolio at all times.
Ultimately it depends on how high corporate- and treasury bond yields are compared to the average yield on stocks. As we write this interest rates are chillingly low. In fact they are so low that treasury bonds do not correspond to our of a good investment. Instead you have to look into the world of investment grade corporate bonds. These are rated by rating agencies according to how likely they are to continue paying out their return. An investment grade bond has at least a rating of BBB.
Here we will discuss what to do when the market plummets and the need to resist any urge to sell good investments just because the market has been going down. Similarly, we will also discuss the psychological urge to buy more stock when prices have been going up.
When the market goes up it is very easy to buy more securities in the hope that they will continue to go up. That may very well happen for a while. But then reality sets in and the security that you bought for dear money will sense gravity and eventually fall to the ground.
The lesson learned over and over again is that there is always a fair price of the securities that you buy. This means that it is wrong to look at a rising price in the market as a vindication of having made the correct decisions regarding a security. If anything, a rising price signify that what you are about to buy has become more expensive and that you will get less value out of it in the long run.
In the same way, a falling price signify a cheaper security and gives you the opportunity to buy more of the stock than before. The only reason to buy or sell any security is if the fundamentals of that security have changed. If they have then, by all means, go ahead and buy or sell. If the fundamental situation does not change then you are better off holding onto your securities.
The financial media is to blame for much of the hype that has surrounded the stock market in recent years. Often media don’t reflect that investing in essence is a rather boring activity. This is especially true when we are talking about value stocks.
The average investor would actually be better off had the securities in his or her portfolio been unquoted. That way he or she would be sure not to fall into the mass hunt that has proliferated in the financial media. The media often portray the business of investing as a kind of safari where it is all about killing big animals.
The true business of investing is very different. It is not a question about winning against the pros, it is about beating yourself in your own game. If you take a long term view and buy stock at a regular basis and reinvest your dividends in a disciplined manner, you are almost certain to succeed.
That is not to say that you should forget about the ups and downs of the stock market all together. If you see that your stock plummets, you need to sit down and harshly once again check the fundamentals. Are the steady earnings constant or are they slipping? Has the company taken on more debt? Does it finance its dividends with borrowed money? If it does then the market is right and you have to sell, but if it isn’t then you should take advantage of the low prices and buy more stock.
This is why we recommend holding on to your stocks for at least 5 years. That way with the dividends reinvested you should see a real accretion of your wealth during this period.
To sum this up: the more the market falls, the more value you will get out of your securities. Do not fall into the trap of selling just because everybody else is selling.
Here we will discuss the merits of mutual funds and index funds and how they can help the lay investor to grow his/her wealth.
One of the most common ways of investing is to leave the hassle of finding investment-worthy stocks to others. There were more than nine thousand different mutual funds in the US alone in 2014. As an aggregate they are almost perfect, but only just. Their biggest drawback is that they charge a hefty fee for the sake of looking after your money. You can pay anywhere from 0.25 percent all the way up 1.5 percent depending on what type of mutual fund it is.
This brings us to another aspect of stock picking which is that past performance almost never is a good guide for future rewards. A mutual fund may start out small, but inevitably, as the fund grows in size, it will attract more money. When the fund attracts more money it has a set of bad decisions to make:
Thus, there simply are no good options for the money managers who manage big accounts. So what they tend to do is that they indulge in the process of “herding” which means that most mutual funds buy the same kinds of stocks and at similar proportions as everyone else.
Another thing that may affect the long-term performance of the fund is that a top stock picking manager may be recruited to a competing fund. Good managers with good track records are almost always sought after, which is another reason that these are paid so well.
For the lay investor there is another possibility which is to buy an index fund. The upside to these is that management fees are low – it is not very complicated to buy equal amounts of the S&P 500, for instance. Another positive is that the fund will always follow the index – no worse or no better – which is good because it is fiendishly difficult to beat the index over time. Another plus is that you will always receive the aggregate dividend yield that the index pays. For somebody who is not very interested in stocks this is an almost ideal solution.
The downside is of course that they are boring. You will be able to look at the performance of the index to tell yourself how much money you have made recently. There will be no excitement when a stock finally takes off and you see that its price increases by the day. Likewise you will probably not see your stocks go down too much in value either. If you just want to participate in the stock market without doing the extra work it takes to analyze individual stocks, this may be the solution for you. As we shall see, the work of a financial analyst is very different.
In this chapter we will look into what determines the value of a security. How the operational cash flow, the assets on the balance sheet and the debt ultimately decides what kind of return you will get from your security.
If you have ever seen an annual report you will see that it contains a lot of information. If it’s a retail company you will likely find sales volumes in different regions of the company, if it’s a mining company there are many pages about reserves and resources and if it is a technology company there are probably discussions about their recent technological advances.
But what we are interested in as investors are the financial statements. You will see that they are divided into three parts:
The income statement is about how much money the company has made in the period (1) and how much money it has paid in taxes (2). When you subtract (2) from (1) you end up with the Earnings that the company has made in the period.
This Earnings number is then divided by the total number of shares to find the Earnings per share during the reporting period.
When you then look at the current price of the stock and divide it with the Earnings per share, you will get the price to earnings ratio or the P/E ratio. If you on the other hand are using last year’s P/E number you are in effect calculating the trailing P/E ratio and similarly if you are using an estimate of analysts expectations of next year’s earnings, you are determining the forward P/E ratio.
What this all boils down to is that it tells you something about about how much profits a share in the company will buy. A common share in a company is nothing but a stake in the profits.
There is a problem with P/E ratio however and that is that the number does not take into account the earnings over time. To do that we have to calculate an average over the past years’ earnings and adjust for inflation. Then we can use this average number just as we did when we calculated the real P/E-ratio. This is called Cyclically Adjusted Price to Earnings (CAPE) ratio and was introduced by the economist Robert Shiller in his book Irrational Exuberance from 2000.
The balance sheet is where the company is stating all its belongings and debts. The belongings are called Assets and are further divided into Current- and Non-current assets where the current assets are assets that can be sold over the next 12 months and the non-current assets cannot. On the one hand you have the assets (a) and on another you have the liabilities (b). Then you subtract the liabilities from the assets to end up with the Shareholder’s equity which is precisely defined as the Total assets minus the Total liabilities.
Then we prefer to divide the short-term liabilities, the long-term liabilities and the total liabilities with the shareholders equity to figure out if the debt is sustainable or not. If it is not then the company runs the risk of seeing the debt eat in to their earnings due to amortization. This will of course create a vicious circle.
When is the debt too much?
The debt levels vary significantly across different sectors. Some types of businesses are very capital intense and therefore highly leveraged (or running on borrowed money). Other businesses don’t need so much money, but can rather start to churn out money with a laptop computer from home. So it’s difficult to make a definitive statement about much debt is too much. For a mining company or a shipping company which are very capital intensive may see debt levels (i.e. total liabilities to shareholders’ equity) of more that two whereas a startup tech company may have very low debt levels.
The cash flow statement is where the cash that has goes in and goes out of the company during the reporting period is reported. The statement is divided into three different categories. These are usually divided into cash flow from Operational activities, Investment activities and Financing activities. The free cash flow is the money that the company can use for discretionary purposes, i.e. paying out dividends to shareholders.
The free cash-flow is defined by subtracting Investment in plants and equipment (CAPEX) under Investment activities from the Operational cash flow. The formula looks like this:
Another thing that is important is how much the company pays out in dividends, i.e. the dividend yield. You want to look for companies that pay a good dividend, but also has a history of increasing that dividend over time. Most companies that are doing well in this respect also has good cash flow coverage of their dividend. It makes sense, otherwise they would not be able to sustain their dividends.
A warning here is in place. Just because the company has a high dividend does not mean that the dividend is safe. For instance, the major oil companies nowadays almost exclusively has a high dividend yield, but that is more a reflection of the risk that you are running when investing in those companies. One way to check this is to make sure that the dividend is fully covered by the free cash flow.
The lower the P/E-ratio and the higher the dividend yield is, the more value you will get out of your investment. In mature companies this may be difficult, but in the small-cap space finding so-called “double-sevens” is most definitely feasible. A “double-seven” is a a company with a P/E ratio of 7 as well as a dividend yield of 7. The trouble here is that the cash flow is not as stable for a small-cap stock and may vary a little bit more than for more bigger companies, but anyway they are worth looking into.
We also want to mention the Return on equity or the ROE. The ROE is defined as the companies’ net income over the period divided by the shareholders’ equity. This is a measure of how much profit the company makes per dollar of shareholder investment. For a good profitable business an ROE of at least 17 percent should be sought after.
The last thing that we want to mention is the net net working capital. The net net working capital has been popularized by legendary investor Benjamin Graham who figured out a good way of valuing stocks in the stock market. The method involves taking the Working capital (current assets less current liabilities) and then subtracting any additional debt.
We can then divide the net working capital with the total number of shares to end up with a number for the intrinsic value of the shares. In the 1920’s and 30’s these numbers were at times surprisingly close to the quoted value and extraordinary bargains could be found. In today’s stock market these extreme values are seldom found because, let’s face it, a stock that is priced for its net working capital is priced for liquidation. In today’s market liquidations are rare and the costs associated are huge. They also take a long time to unwind.
The upside of this is of course that if you buy a stock that is priced by its Net Working Capital you are protected by their assets value (like plants and buildings) which effectively puts a floor beneath the price.
To conclude we would like to emphasize that what matters is the consecutiveness of the earnings in relation to their price. We would therefore propose the following list when we select a stock:
This chapter will contain a few real life examples of what we are teaching. We will in particular look at some of the stocks that we picked out in our small-cap screen at the end of last year.
We will compare two small-cap stocks that trade on the New York Stock Echange: “The Buckle” (BKE), an apparel company and “Cummins Inc.”, a company that manufactures natural gas engines.
What we did here was that we used data from the annual reports, Yahoo and Morningstar to come up with this:
What is clear from the data is that the earnings are pretty constant over the three years. They are decreasing slightly, but not so much that it justifies the stock to go from 53.39 USD in December of 2014 to 24 USD on this Friday the third of October. That is a good sign.
If we then calculate the cyclical P/E ratio we see that the averaged earnings over the last three years puts cyclically adjusted price-to-earnings ratio (CAPE) at 7.32. We see that the dividend yield is OK and we have a good free cash flow to pay for the dividends.
In all, when we are analyzing the stock we conclude that the market has weighed too much importance to the decreased earnings in 2015. The prudent thing would therefore be to buy more of the stock rather than selling. Therefore our recommendation for this stock is BUY.
If we then look at Cummins Inc. instead we see this:
What we see here is that the earnings are increasing over the years, but are they increasing too much? We see that the price has gone from 89 USD to 128 USD over the last year while the earnings have increased from 3.70 USD per share to 4.5 USD per share. The increased earnings do not reflect such an explosive increase in the price and the cyclical P/E ratio is much higher today than at the beginning of the year.
Taken altogether we do not recommend buying this share at this point. It is simply too expensive. If you already own it, by all means keep it, and reinvest your dividends so that you will receive a higher dividend next time. Another possibility would be to take some profits so that you can invest in other companies. In the small-cap space there are plenty of stocks with sufficiently low P/E ratios at all times. Therefore, if you look at a sufficiently low P/E ratio and a good dividend yield, you will always be able to find good investment options in this field.
In this guide we have been trying lay out the basics of value investing. We have been trying to answer the questions of what a good investment is, what constitutes value in an investment and how to deal with your non-discretionary spending whilst investing them in the market.
Value investing is not something that will make you rich quickly, but rather a technique for the turtles. The power of it comes from the “compound interest” that you will experience when you reinvest your dividends in the same stock. If you have bought shares in a good value company with a steady earnings, you will see that your wealth increases exponentially with time.
To the questions of what to buy and when to buy we have given real life examples which makes it easier for you to follow along.