First Solar, Inc (FSLR) is an American photovoltaic manufacturer of rigid thin film modules, or solar panels, and a provider of utility-scale PV power plants and supporting services that include finance, construction, maintenance and end-of-life panel recycling. Wikipedia
FSLR has developed, financed, engineered, constructed and currently operates many of the world’s largest grid-connected PV power plants.
FSLR Value Investing Approach
This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.
The Investment in Enterprise Value
The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company. Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.
Formula: Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
The value of FLSR was dropping at a percentage of -48, 3, -4, -72 and -57 percent with an average of -36% from 2008 to 2012 TTM, respectively. Net debt was -5 percent average, meaning cash was greater than debt by 5 percent. The distribution of the purchased price is as follows:
|Average||Total operating assets 100%||Equity 95% + Net debt 5%|
|TTM||Total operating assets 100%||Equity 91% + Net debt 9%|
If you have noticed in the table, the EV price was lesser than the market price, this means the cash item exceed debt. Buying the entire business at current date will cost an investor $1237 at $14 per share, inclusive of debt.
Enterprise value, as what our Pricing team has told me, is the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company’s debt but would pocket its cash. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm’s value. The value of a firm’s debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation.
Benjamin Graham’s Stock Test
Net Current Asset Value (NCAV) Approach
The Net Current Asset Value (NCAV) is a method from Benjamin Graham to identify whether the stock is trading below the company’s net current asset value per share, specifically two-thirds or 66 percent of net current asset value. Meaning they are essentially trading below the company’s liquidation value and therefore, the stocks are trading in a bargain, and it is worth buying.
Net Current Asset Value (NCAV) Method
Current Assets – Current Liabilities = Net Current Asset Value
Net Current Asset Value (NCAV) / number of shares outstanding = Net Current Asset Value per Share
NCAVPS * 66% = (result) compare to Share Price.
The 66% result must not be higher than the share price.
Illustrated in the table above, the computed 66 percent of the NCAVPS was lesser than EV price by 93 percent average. This indicates that price is trading above the liquidation value, therefore it did not pass the stock test of Graham. The price is overvalued.
Graham would consider buying if the share price does not exceed the result of 66%. The reason according to Graham is when a stock is trading below the net current asset value per share, they are essentially trading below the company’s liquidation value and therefore, the stock is trading in the bargain, and it is worth buying.
Market Value/Net Current Asset Value (MV/NCAV) Method
The ratio shows that it is greater than 1.2 except in the trailing twelve months, therefore indicate that it passes the stock test.
Benjamin Graham’s Margin of Safety
The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies – the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between the two values is called the margin of safety. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because I think it is a much more accurate measure of the company’s true market value than market capitalization.
The table shows that there were zero margins of safety for First Solar during 2007 and 2011, but during 2008, 2009, 2010 and the trailing twelve months the margin of safety was 52, 76, 70 and 90 percent with an average of 48 percent from its five years of operation. The stock of First Solar pass the requirement of Benjamin Graham of 40-50 percent below the intrinsic value, therefore the price is trading at an undervalued price. Furthermore, the table below will show you how the intrinsic value was calculated. Intrinsic value factors earning per share and sustainable growth rate. I will walk you through the calculation and the explanation to the growth of FSLR, please let us go further below.
Here is the explanation for the formula: EPS, the company’s last 12-month earnings per share. G: the company’s long-term (five years) sustainable growth estimate. 9: the constant representing the appropriate P-E ratio for a no-growth company as proposed by Graham (Graham proposed an 8.5, but we changed it to 9) 2: the average yield of high-grade corporate bonds.
Calculation for Growth Rate
As you can see in the table above, we have replaced Graham’s EPS growth to a sustainable growth rate. The company’s profitability is measured by its return on equity. We also need to know the dividend payout ratio. FSLR does not pay cash dividends to the investors. therefore no dividends payout ratio.
Intrinsic Value Graph
The graph above shows us the relationship between price and the intrinsic value (true value) of the stocks. As we can see, the true value line (red) was above the enterprise value line in 2008-2010 and TTM, meaning there was the margin of safety and the stock is selling at a discount and the investor is purchasing with security. Buying the stock at current date will give an investor a 90 percent margin of safety, this is really cheap. The intrinsic line is only at 130 compared to 2009 of 540, the value of FSLR deteriorates in the current date, thus giving us a high margin of safety.
Moving on, I will introduce you to the Relative Valuation Method. It compares the market value of the stocks with the fundamentals.
FSLR Relative Valuation Method
This method will determine whether the stocks are undervalued or overvalued by multiplying the price to earnings (P/E) ratio with the company’s relative earning per share (EPS) and comparing it to the enterprise value per share.
Price to Earning*Earning per Share (P/E*EPS)
The P/E*EPS ratio in the table above indicates that the trading price was lesser than the result of PE*EPS. Meaning the price was undervalued in the period of 2007 to 2010 and the trailing twelve months. While 2011 shows a fair value price for the result is the same with price. As you will notice the price to earning and the earning per share of FSLR in 2011 and the trailing twelve months was negative, meaning there were no earnings during those periods.
Price to earning (P/E) ratio indicates the multiple that an investor is willing to pay for a dollar of a company’s earning. It shows the number of times that a stock price is trading relative to its earnings, the stock price fluctuates, so this ratio. EPS serves as an indicator of a company’s profitability.
From the table above, it shows that the stocks of FSLR is cheap and maybe a buy candidate. Of course, this is only one tool in evaluating the stock. We also have to consider other valuation in this model. So, let us walk through the EV/EPS valuation.
Enterprise Value/Earning per Share (EV/EPS)
The use of this ratio is to separate the enterprise value per share by its projected Earnings Per Share (EPS). By dividing enterprise value per share to earnings per share, the result represents the price (P/E) and the difference represents the earnings (EPS). These separate the price to earnings ratio and the earning per share.
Enterprise Value / Earnings per Share = Separated Price
Enterprise Value – Separated Price = Earnings
The price represents 15 percent average and the earning is 85 percent average of the enterprise value. Now, it is up for the investor’s own discretion whether the price is expensive or cheap. If an investor is buying stocks, one will know how much you paying for the price and how much you are paying for the earnings. This is the price you are willing to pay.
Enterprise Value (EV)/Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) or (EV/EBITDA)
EBITDA = Income before Tax + Interest Expense + Depreciation + Amortization
The result tells us that if you are buying the entire business it will take you -4 years to cover up the costs of buying. Meaning there is no definite period of how long you will cover the purchase price because there was no income during the trailing twelve months. Buying the entire business may not be profitable at this period because there were no earnings and there was no definite period to cover the costs of buying.
FSLR’s value was dropping at a 36 percent average. Benjamin Graham’s stock test shows that the stock did not pass the stock test because the stock was trading above its liquidation value. Therefore, the price is overvalued. The MV/NCAV valuation, on the other hand, indicates that from 2007 to 2011 the price was overvalued and did not pass the stock test of Graham. However, in the trailing twelve months, it passed the test because the ratio was lower than 1.2. Further, the margin of safety was zero in 2007 and 2011, because the price was higher than the intrinsic value. While, in the trailing twelve months, the margin of safety was 90 percent, the price was cheap.
FSLR Relative Value Method
On the other hand, the relative value method tells us that the price was undervalued or cheap P/E*EPS. The EV/EPS valuation showed that the price was 15 percent and the earnings were 85 percent average. While the (EV)/EBITDA valuation shows a -4 results. There is no definite period for an investor to cover the cost of buying the entire business since earnings were negative. The present value of the stock at this time, 8/8/2012 was $20.86 per share, it went up in the last quarter from $14 per share.
The margin of safety was averaging 48 percent and buying the stock at the trailing twelve months will give you a margin of safety at 90 percent. Therefore, the stocks of First Solar Inc (FSLR) is best recommended for a BUY.
Researched and Written by Criselda