# Facebook Inc (FB) Investment Valuation

December 28th, 2012 Posted by No Comment yet

Facebook Inc (FB) was founded in 2004 by Mark Zuckerberg. Headquartered in 1 Hacker Way, Menlo Park, California 94025. FB had 1.52 billion daily average users as of December 2018.

The method of valuation approach for Facebook Inc was based on Discounted Model.  The historical data were gathered and then I came up with the forecast financial data and ratios to come up with the net present value of the  6th year period. Net present value is one way to decide if an investment is worthwhile by looking at the projected cash inflows and outflows.  Cash inflows are the expected cash that the company can be generated for the period. Cash outflows are the expenditures to be incurred from generating cash inflows.

## Discounted Model

This model will show us how to calculate the value. I will walk you through every step of the calculation. The table below shows the historical value of Facebook Inc.  The formula is:

Where:

• Vo is the value of the equity of a business today.
• CF1 to CFn represents the expected cash flows (or benefits) to be derived for periods 1 to n.  The discounted cash flow model is based on time periods of time of equal length.  Because forecasts are often made on an annual basis in practice, we use the terms “periods” and “years” almost interchangeably for purposes of this theoretical discussion.
• r is the discount rate that converts future dollars of CF into present dollars of value.

The equation above is the basic discounted cash flow (DCF) model.

#### Discounted Model without Terminal Value

The data show the historical data of income and expense for Facebook Inc from 2007 to 2012.  The net income is cash inflows.  The present value was also calculated by net income over 1 plus capital rate to the power of n.

The table above will show us the historical equity of Facebook Inc as well as the return on equity. The return on equity was calculated by net income over equity.  The average return on equity was \$0.17 for every dollar of earnings.  The average ROE was 0.17. On the other hand, the earnings per share were calculated by net income over the number of outstanding shares for every period. Since Facebook Inc was new in IPO, the only available market price were 2011 and in 2012, therefore price to earnings was calculated only in 2011 and in 2012, which is seen above at \$38 and \$27.07 per share. Therefore, the price to earnings was calculated at market price over earning per share. I have used forward price to earnings ratio of 48.

#### Income on the sixth year

In the table shown above, we want to get the income for the 6th year as well as the present value of net income.  On the other hand, the value of Facebook Inc of the 6th year was also calculated.  How did I do that? First, I have to calculate the net income in the 6th year. The calculation of net income at year N was, the last projected equity multiplied by the average return on equity and we get the projected net income at \$5.8 billion.

The projected equity from 2007 to 2017 was also calculated simply by multiplying the projected equity per share to the number of shares outstanding from 2013 to 2017. Moreover, the present value of net income was \$2.5 billion calculated as net income on year N over 1 + capital rate on the power of 6. While the value of the entire business of Facebook Inc at the 6th time periods was \$ 121 billion discounted today. The value of Facebook at \$121 was calculated by net income multiplied by the multiplier of 48. From here, we get the value of the 6th year discounted today at present date.

## Equity and Earnings Model

This spreadsheet shows the historical equity, net earnings, and the retained earnings, as well as the projected for the five-year period. The return on investment can also be seen and the income growth for Facebook Inc.

The data shows us the future equity and earnings per share for Year 1 to Year 5. The projected retained earnings were calculated as well as by adding earnings and deducting dividends to the equity. The average ratio was calculated as well.

The present value of equity per share was \$5.61 at a rate of 17 percent, you would have \$14.39 at the end of 6 time periods, which is the future value. In other words, a future value of \$14.39 is equal to a present value of only \$5.61.  This means, having a choice of taking an amount higher than \$5.61 today and taking \$14.39 at the end of the 6 year period, you would have been taken the money today.  By doing so, you will have a chance to invest the higher amount at 17 percent for the same 6 year period, which will give you at the end more than \$14.39. The net income in Year 5 was \$2.45 per share discounted today at the present time.

## Benjamin Graham’s Intrinsic Value

One of the strategy by Benjamin Graham in investing is by using the intrinsic value. Graham created the formula for intrinsic value and used to value stocks. In the finance world, he is famous for his margin of safety. Most investors required a margin of safety which is the measure of risk equal to the amount by which stock price is below intrinsic value.

The formula for Intrinsic Value is:

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

The explanation in the calculation of intrinsic value is the following:
EPS or the company’s last 12-month earnings per share;  G is the company’s long-term (five years) sustainable growth estimate; 9 is the constant represents 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); and 2 as the average yield of high-grade corporate bonds.

#### Intrinsic Value Table

The earnings per share average were 0.15, while the growth which is the return on equity was 1.85 percent average. The average ratios of Facebook were not that impressive, because, during its first two years, 2007 and 2008, the company suffered losses as return on equity factors net income. Annual growth, on the side note, was \$9.04 average. Moreover, the intrinsic value was \$1.42 average. If I consider only the last three years, the average intrinsic value was \$2.75.

#### Explanation

The graph above shows us how the true value of the stocks of Facebook Inc is moving. The intrinsic value was below the linear trend line in 2007 and 2008. For reason the intrinsic value was negative, meaning there was zero value of Facebook Inc’s during those periods. It started to soar in 2009 where the point of intersection was, until 2011 but falls down in 2012 at a rate of 57 percent. The net margins in 2012 dropped to 4 percent from 18 percent in 2011. The margin of safety is measured at 40-50 percent of the intrinsic value as the requirement of Graham in buying stocks. Buying at this level, you put an allowance to future unseen risks.

Since there was a zero margin of safety for Facebook Inc the stock price is greater than the true value of the stock. This also means that the stock of FB is trading at an overvalued price.

#### The Enterprise Value

If you were internet savvy, you would’ve known that FB was new in IPO. As a result, the enterprise value was calculated for the period 2012. The enterprise value per share was \$19.79. The cash and cash equivalent represent 20 percent of the enterprise value, thus the enterprise value was lesser by 20 percent against the market price. For investors who are buying the entire business of Facebook Inc to date, December 21, 2012, will cost you \$51.7 billion at \$19.79 per share.

#### Conclusion

The value of Facebook at the 6th time periods was \$121 billion discounted today at the present time. The projected net income at year N was \$5.8 billion and \$2.5 billion valued at present. While, the average return on equity was 0.17 from 2010 to 2012 ratios, but the actual was 0.10 from 2007 to 2012 ratios. The reason is that Facebook Inc suffered losses in the first two periods. Thus, we include the last three year period only and the result was 0.17. The price to earnings ratio was \$48.  I think the losses are on Facebook.

Moreover, the present value of equity per share was \$5.61 at a rate of 17 percent, you would have \$14.39 at the end of 6 time periods, which is the future value. In other words, a future value of \$14.39 is equal to a present value of only \$5.61.

#### The margin of Safety (MOS)

The margin of safety by Benjamin Graham, Facebook Inc has zero margins of safety in 2012. The intrinsic value was very low because the growth of Facebook deteriorates in 2012 and negative growth during the first two years; between 2007 and 2008.  The intrinsic value average was \$1.42 from its 5 year period, in 2012 it was \$1.73.

The enterprise value was \$51,748 at \$19.79 per share. Enterprise Value is the cost of buying the entire business to date, December 21, 2012. The market price to date was at \$27.71 per share. Facebook has zero debt and its cash and cash equivalent represent 20 percent of the enterprise value. Thus the enterprise value was lesser by 20 percent against market value.

Overview, Facebook has great potential in many areas and with its huge opportunity for advancement. Therefore, I recommend a BUY on the stock of Facebook Inc (FB) because of its huge potential.

Research and Written by Criselda

# Microsoft Corporation (MSFT) A Stable Company

December 26th, 2012 Posted by No Comment yet

Microsoft Corporation (MSFT) is an American multinational technology company with headquarters in Redmond, Washington. It develops, manufactures, licenses supports and sells computer software, consumer electronics, personal computers, and related services. Wikipedia

## Microsoft Balance Sheet

### Liquidity

Liquidity ratios help financial statement users evaluate a company’s ability to meet its current obligations. In other words, liquidity ratios evaluate the ability of a company to convert its current assets into cash and pay current obligations. Thanks to Rio for that brief description. But the question now is, how liquid was Microsoft Corporation from 2008 to 2012 and last quarter using the following ratio: working capital ratio, current ratio, and quick ratio?

#### Facts

• The working capital ratio of the company was 0.18, 0.29, 0.34, 0.42,  0.43 and 0.33 for the latest quarter. This is the percentage of networking capital against the company’s total asset.
• The current ratio was 1.45, 1.82, 2.13, 2.6, 2.6 and 2.68 for the latest quarter.  It shows that current asset was 268 percent of current liabilities, meaning the company’s current resources was greater than its current obligation.
• And the quick ratio was 1.25, 1.58, 1.9, 2.35, 2.41 and 2.44 for the latest quarter. This also tells us that the company’s monetary asset (current minus inventory) was also greater than its current liability.

Above data show how financially stable Microsoft Corporation is as far as its current resources are concerned. Working capital as of the latest quarter shows its capability to continue running its business well.

### Asset Management

Asset management ratios are the key to analyzing how effectively and efficiency your business in managing its assets to produce sales. The asset management ratios are also called turnover ratios or efficiency ratios.

Shown below are the efficiency ratios of Microsoft Corporation from 2008 to 2012:

• Inventory turnover ratio was 14 times average. This measures the number of times business sells its stock in a 12-month period.
• The company’s receivable turnover ratio was 5 times average. This shows how long, on average, a business takes to collect the debts owed to it by customers who have purchased their goods on credit.
• The payable turnover ratio was 16 times on average. This number reveals how quickly the company pays its bills. The payable turnover ratio reveals how often MSFT’s payable turn over during the year.
• And the asset turnover ratio got.71 average. This measures the productivity of the business (i.e. how much worth of sales revenue can be generated from the assets employed). This means that for every \$1 of the net asset, the business generates \$0.71 of sales revenue.

#### Explanation

If we convert the inventory turnover of 14 times average in days, it is 26 days, while the company’s receivable turnover ratio of 5 times average will be 73 days and the payable turnover ratio of 16 times average was 22 days. Based on the above performance, Microsoft Corporation is efficiently managed.

### Debt Management/Leverage

For Microsoft Corporation, leverage ratios from 2008 to 2012 are detailed below. This will give us if the company is high leverage or not.

• The company’s debt ratio was .50, .49, .46, .47, 45 and .48 average in five years period. This is the comparison between the total liabilities against total assets. It shows that MSFT’s debt ratio did not exceed 50 percent wherein .45 in 2012 was its lowest so far.
• Debt to equity ratio measures total liabilities against its total equity. For Microsoft Corporation, it was 1.01, 0.97, 0.86, 0.90, 0.83 and an average of .91. The year 2008 was over by 100 percent but it is slowly reduced that in 2012 it dropped to .83.
• Solvency is the company’s ability to pay its total debt when becomes due. The company had 0.54, 0.45, 0.54, 0.50, 0.36 and 0.48 average in five years. As a rule of thumb, 0.20 ratio is good enough.

#### Explanation

When it comes to debt management or leverage, the company observed fulofcontrol on its long-term investments on credit. As shown above, its debt ratio was up to 50 percent only while its debt to equity was managed to reduce to 0.83 in 2012. The company is also able to pay off its total obligations as they become due at 0.48 average solvency.

### Property, Plant & Equipment

This category consists of assets that are tangible and relatively long-lived. The firm has acquired these assets in order to use them to produce goods and services that will generate future cash inflows. These are recorded at cost upon acquisition of these assets.

For MSFT, its investment on property, plant, and equipment from 2008 to 2012 is shown below:

• The company’s gross PPE was \$16,221 average. As shown in the above table its fixed asset expanded per year,  its lowest investment was in 2008 at \$12,544  and its highest was in 2012 at \$19,231.
• Accumulated depreciation was \$8,654 average or 53 percent in five years period.
• And net PPE was \$7,568 average which is equivalent to 47 percent.

Based on the above table, the average used life of the PPE investment is 2.7 years and the remaining useful life of the PPE investment would now be 2.3 years. This is based on the estimated five years shelf life of the property.

## Income Statement

A financial statement that measures a company’s financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year.

### Income

I guess most of us knew what an income is. But to have some refreshment here, it is the amount of money, as defined, a company actually receives during a specific period, including discounts and deductions for returned merchandise.

MSFT’s income from 2008 to 2012 is shown below:

• Revenue of the company was increasing except in 2009 which was lower by 3 percent, however in the succeeding years it continues to increase, its trailing twelve months was \$72,359. It grew 5 percent on average.
• Gross profit was 48,822, 46,282, 50,089, 54,366 and 56,193, with ttm (trailing twelve months) of 54,438.
• The company’s operating income was 22,492, 20,363, 24,098, 27,161 and 21,763. Its ttm was \$19,868.
• Its income before tax 23,814, 19,821, 25,013, 28,071 and 22,267. It has a ttm of \$20,495.
• And finally, income after tax of MSFT has a trailing twelve months of 15706 which is 22 percent of total revenue.

#### Explanation

Overall income of MSFT is doing well, its revenue and gross profit have the same trend of growth rate while its operating income in 2012 dropped down by  20 percent due to increase in operating expenses within the same year. Income before tax and after-tax income are 28 and 22 percent respectively. There’s no negative balance throughout the five years period.

### Expenses

These are money spent or cost incurred in an organization’s efforts to generate revenue, representing the cost of doing business. In five years period, from 2008 to 2012, the following are the expenses of Microsoft Corporation:

• MSFT’s cost of revenue was 11,598, 12,155, 12,395, 15,577 and 17,530.  It had an increased each year for 5 years with an average growth of 11 percent. MSFT’s cost of revenue trailing twelve months was 25 percent of total revenue
• Operating expense’s trailing twelve months was 34570. This was equivalent to 48 percent of revenue.
• Other expense was 4,811, 5,794, 5,338, 4,011 and 4,785. TTM was 4,162 or 6 percent of revenue.
• Total expense was 31,141, 31,713, 31,329, 31,216 and 39,215 which was 64, 69, 63, 57 and 70 percent of revenue.

### Margins

This ratio looks at how well a company controls the cost of its inventory and the manufacturing of its products and subsequently pass on the costs to its customers. Let’s take a look at the margin of MSFT from 2008 to 2012:

• Gross margin of Microsoft Corporation was up and down trend, showing an average fluctuation of 1.5 percent.
• Its operating margin has no movement in 2008 and 2009, dropped by 2 and 3 percent in 2010 to 2011 and recovered by 8 points in 2012.
• The company’s pretax margin was low in 2012 at 30 percent but marked its highest percentage in 2010 and 2011 at 40 percent.
• Finally, its net profit margin was 29, 25, 30, 33 and 23 percent, with the highest percentage in 2011 at 33 percent and its lowest was 23 percent in 2012.

### Profitability

I’m not that familiar with different terminologies so I asked Rio for the definition of profitability and this is what I’ve learned. Profitability ratios show a company’s overall efficiency and performance. We can divide profitability ratios into two types: margins and returns. Ratios that show margins represent the firm’s ability to translate sales dollars into profits at various stages of measurement. On the other hand, ratios that show returns represent the firm’s ability to measure the overall efficiency of the firm in generating returns for its shareholders.

#### Explanation

• The company’s average net margin was 9 percent, with 10 percent marked in 2009 while 7 percent in 2011. This is the bottom line result of the day to day normal business transactions.
• Asset turnover has an average of 71 percent. It is a measure of how effectively a company converts its assets into sales. It is inversely related to net profit margin, the higher the net profit margin the lower the asset turnover.
• Return on asset was 0.33, 0.25, 0.29, 0.26 and 0.18 in 2012. Its average was 0.26. It measures the amount of profit earned relative to the firm’s level of investment in total assets. A Higher percentage is better because the company is doing a good job using its assets to generate sales.
• Return on equity was 0.66, 0.50, 0.54, 0.49 and 0.34, with an average of 0.51. It is perhaps the most important of all the financial ratios to investors in the company. It measures the return on the money the investors have put into the company. This is the ratio potential investors look at when deciding whether or not to invest in the company.
• Financial leverage was 2.01, 1.97, 1.86, 1.90, and 1.83, with an average of  1.91. It is useful to the investor, it allows to see what portion of the ROE is the result of debt.
• Return on invested capital was .49, .34, .37, .34 and .22. with an average of .35. It is the percentage result of net income over invested capital. For MSFT, its return on invested capital was 35 percent.

As far as its profitability ratios are a concern, the results of MSFT is quite good, there’s no mark of a negative result, so the company is doing good in its business.

## Cash Flow

Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. It has three categories: operating cash flow, investing cash flow and financing cash flow.

### Cash Flow from Operating Activities

Operating cash flows are cash received or expended as a result of the company’s internal business activities. It includes cash earnings plus changes to working capital. Over the medium term, this must be net positive if the company is to remain solvent.

Related transactions of MSFT’s operating cash flow from 2008 to 2012 are wrapped up below:

#### Explanation

• Net income of Microsoft Corporation was 17,681, 14,569, 18,760, 23,150 and 16,978; ttm of 15706. This is the result of the company’s day to day business transactions. It consistently showed positive results.
• Depreciation and amortization was 2,056, 2,562, 2,673, 2,766 and 2,967; ttm was 2951.
• Its investments losses (gains) was 683,  -208, -362 and -200; ttm of -159. In 2009, the company incurred an investment loss of 683 but thereafter its investments resulted in having gains.
• Deferred income taxes was 935, 762, -220, 2 and 954, with ttm of 590.
• Other working capital was -2,435, -2,393, 2,899, -1,049 and 829. ttm was -205. It shows negative in the year 2008-2009 and 2011, however, a positive result in 2010 and 2012.
• So, its net cash provided by operating activities was 21,612, 19037, 24073, 26994 and 31626. Its ttm was 31617. It shows consistent positive results.

The cash flow from operating activities of MSFT tells us that the company has funds to retire additional debts, pay dividends and expand through investment in another line of business.

### Cash Flow from Investing Activities

Cash received from the sale of long-life assets or spent on capital expenditure (investments, acquisitions, and long-life assets).

• Total cash inflow was 27,729, 25,997, 22,578, 22,777 and 45,275, with ttm of 49,480. This represents sales/maturities of investment.
• Total cash outflow was -32,316, -41,767, -33,892, -37,393 and -70,061. These were an investment in PPE, acquisitions, purchase of investment and other investing activities.
• So, net cash used for investing activities was -4587, -15770, -11314, -14616 and -24786 which showed a negative balance because transactions affecting cash outlays exceeded cash inflows.

Cash flow from investing activities of Microsoft Corporation incurred a negative balance because cash outflows are more than cash inflows. It involves the only transaction on sales/maturities of investment.

### Cash Flow from Financing Activities

Financing cash flows refer to cash received from the issue of debt and equity or paid out as dividends, share repurchases or debt repayments.

• MSFT’s total inflow was 3,494, 6,657, 6,523, 9,213 and 2,006. Included here were debt issued, common stock issued and the excess tax benefit from a stock base.
• Total cash outflow was negative 12,934, -7,463, 13,291, 8,376 and 9,408. It included debt repayment repurchased of common stock, dividends paid and other financing activities. This also showed negative results because outflows transactions were more than cash received by the company.

The company’s financing cash flow was a consistent negative balance because cash outflows exceeded cash inflows.

### Free Cash Flow

The graph below will reveal the free cash flow of Microsoft Corporation from 2008 to 2012:

• Free cash flow of MSFT from 2008 to 2012 was 18,430, 15918, 22096, 24639 and 29,321. Its ttm was 29,145. It showed a consistent high running balance throughout its five years of operation.
• Free cash flow shows that the company had huge funds to pay its obligations; current, long term and dividends to its stockholders and even enough to invest new lines of business.

### Cash Flow Ratios

Cash flow analysis uses ratios that focus on cash flow and how solvent, liquid, and viable the company is. Here are the most important cash flow ratios that Rio used with her calculations and interpretation on Microsoft Corporation.

• Cash flow margin was 0.36, 0.33, 0.39, .39 and 0.43;  its ttm  was .44. Cash flow margin measures how efficiently a company converts its sales dollars to cash.
• Operating cash flow was 0.72, 0.70, 0.92, 0.94 and 0.97. ttm of .85. It measures how well current liabilities are covered by the cash flow generated from a company’s operations.
• Free cash flow was 0.85, 0.84, 0.92, 0.91 and 0.93.  It shows that the company has excess funds after paying expenses and dividends.
• Capital expenditure was 6.79, 6.10, 12.18, 11.46 and 13.72. with ttm of 12.79. A ratio that measures a company’s ability to acquire long-term assets using free cash flow. The cash flow to capital expenditures (CF to CAPEX) ratio will often fluctuate as businesses go through cycles of large and small capital expenditures.
• Total debt ratio was 0.59, 0.50, 0.60, 0.52 and 0.58; ttm of 0.56. This ratio provides an indication of a company’s ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company’s ability to carry its total debt.

#### Explanation

Cash flow ratios of MSFT show that the company’s cash flow margin has a ttm of .44. Therefore, the company is efficient in converting its sales in dollars to cash. Operating cash flow is also impressive at 0.85. Its capital expenditure is also high which means that the company is able to acquire long-term assets using its free cash flow. Finally, the total debt ratio is 50 percent and above, so the company has the ability to carry its total debt up to 50 percent.

Written by Rio
Edited by Cris

December 21st, 2012 Posted by No Comment yet

## Great Northern Iron Ore Balance Sheet

### Financial Liquidity

Liquidity is a firm’s ability to pay its short-term debt obligations. Its financial ratios, this will help us determine how liquid the firm is or how successful it will be in meeting its short-term obligations.

The table relays the following:

• The current ratio is the result of dividing current assets by current liabilities. This showed a downward trend in 2008 and 2011, with a growth ratio of -17.3 percent, 7.5, consistent at 2.0 times but in 2011 it decrease again to -22 percent and has an average of 1.93 times.
• The quick ratio, on the other hand, is the result of dividing quick asset (current asset minus inventory) over current liabilities. GNI don’t hold any inventory on iron ore.
• And their net working capital ratio, the result of working capital over the total asset. This indicated an up and down trend with a growth ratio of 7.1 percent, -20, 45.8, -31.4 and an average of 0.28.

Great Northern Iron Ore has the same good current and quick ratios results because they don’t hold any inventory but only a  trust leases land to major mining corporations. This indicated that they had sufficient funds or current asset to pay off their current debts and liabilities meaning they are financially liquid. Looking into their net working capital, they depicted sufficient funds needed to run the business thus, they have operational liquidity. And with their total asset, it resulted to a favorable and average ratio of 28 percent for the continuity of their business.

### Efficiency

The concept of efficiency ratios is to analyze how well a company uses its assets and liabilities internally. These ratios are meaningful when compared to peers in the same industry and can identify a business that is better managed relative to the others. They are important because any improvement in ratios usually translate to improved profitability.

Wondering if the result is in favor of Great Northern Iron Ore Properties? Nelly wrapped up things for us.

• The receivable turnover ratio measures the number of times average receivables are collected during the period. This was computed as net sales over average receivable and resulted in an up and down trend with a growth ratio of -10 percent, -35, 54, -8 and an average of 3.93 times.
• The payable turnover ratio is a short-term liquidity measure used to quantify the rate at which a company pays off its suppliers. This is calculated by taking the total purchases made from suppliers and dividing it by the average accounts payable amount during the same period. They don’t maintain payables and showed only payable turnover ratio in 2007 and 2008 which was decreasing trend of -3.89 percent in growth.
• Fixed asset turnover ratio measures a company’s ability to generate net sales from fixed-asset investments — specifically property, plant and equipment (PP&E) – net of depreciation. This showed an increasing trend but a slight dipped happened in 2009 with a growth ratio of 41 percent, -16.7, 40, and 92.9, with an average of 7.15.
• Asset turnover ratio was a number of sales generated for every dollar’s worth of assets. Wherein this showed an up and down trend with a growth ratio of 16.8 percent, -27, 50.6, 14.8 and average of 1.10 for GNI.

The company as a trust leases properties to major mining corporation does not hold much receivable nor payables and they do not have any inventories to maintain in their operations. Therefore they have a low receivable turnover which averages 4 times a year. And it has a payable turnover that averages 6 times a year which is not bad for this kind of firm. They also had a higher and increasing trend fixed-asset turnover ratio which dips 16.7 percent in 2009 due to US financial crisis that had greatly affected mining companies.

GNI had been more effective in using the investment in fixed assets to generate revenues. Same as to the result of their asset turnover which was up and down too in 2009. The higher the number, the better for this will indicates pricing strategy.

### Cash Conversion Period

Cash conversion cycle or CCC measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand business revenues. Thus, it is a measure of the liquidity risk entailed by growth.

• Receivable conversion period measures the number of days it takes a company to collect its credit accounts from its customers. GNI showed at least two to three months average except for 2009 wherein it reach more than 4 months to collect.
• While payable conversion period measures how the company pays its suppliers in relation to the sales volume being transacted.  The company only have credit in 2007 to 2009 which averages one to two months before it was paid
• Cash conversion period or cycle refers to the time span between a firm’s disbursing and collecting cash. GNI showed an average of two months.

Their receivable conversion period has an average of 96 number of days implies the company should re-assess its credit policies in order to ensure the timely collection of impart credit that is not earning interest for the firm, especially trust leases, are bounded by lease contract. While payable conversion, they have minimal to nil business transaction done in credit only in 2007 to 2009 which averages one to two months before it was paid. And total conversion period takes more than two months to turn credit to cash needed in the business.

### Leverage

• Debt ratio indicates what proportion of debt a company has relative to its assets. This showed an up and down trend and it has an average of 41.2 percent.
• The debt-to-equity ratio is a measure of the relationship between the capital contributed by creditors and the capital contributed by shareholders. This showed an upward trend with an abrupt dip of 33.5 percent in 2009 and has an average of 73.3.
• Solvency ratio determines how well the GNI is able to meet its debts as well as obligations, both long-term and short-term. This attributed that in 2007 and 2008, it has a long-term debt wherein it was 1400 and 950 percent more than its obligations.

Great Northern Iron Ore Properties showed that it has more assets than liabilities. This means the company was not highly leveraged or financed by debts, since ratio it less than 50 percent except in 2011. Debt to equity indicated that it has high ratios meaning they were taking advantage of the increased profits that financial leverage may bring. And solvency ratio depicted how solvent and financially sound the company is.

### Major Control of the Company Based on Total Assets

• Current liabilities to total assets identifies how much will be claimed by the creditor against total assets. This showed an up and down trend with an average of 31.8 percent.
•  While long-term debt to total assets is to make out how much claim has the banks or the bond holder against its total assets. The banks and bondholders have claimed on their total assets the first two years but three years after they don’t have any long-term debt.
• Then, stockholders equity to total assets is to know how much the owner can claim in its total assets. This showed an average of 58.8 percent.

Based on their total five years of operation, the majority in control of their total asset are their stockholders at 58.8 percent, then their creditors of 31.8 and last to their bank/bond holders at 3.1 percent average.

### Plant, Property & Equipment

The idea of analyzing this is to look through its fixed assets, plant, property & equipment and see if it still have a useful life in their business operations.

• Gross plant, property, and equipment is the gross total of fixed assets cost, this shows a trend that was constant for the first four years and a slight increase in 2011.
• Accumulated depreciation is to reduce the carrying value of an assets to reflect the loss of value due to wear,  tear and usage. This showed a trend of gradual increase every two years.
• The net plant, property, and equipment is the result after deducting the accumulated depreciation from gross PPE, wherein it indicated a lesser value left in their PPE.

Based on the above data, the remaining book value of the PPE of Great Norther Iron Ore Properties was 7.65 percent, using the percentage method of depreciation. This means it has 0.38 useful years remaining which is very much lower and may often increase in value depending on local real-estate conditions.

## Great Northern Iron Ore Income Statement

Great Northern Iron Ore Properties income statement shows whether the company made or lost money from  2007 to 2011.

### Profitability

Every firm is most concerned with its profitability. One of the most frequently used tools of financial ratio analysis is profitability ratios which are used to determine the company’s bottom line and its return to its investors.

• Their net margins which simply is the after-tax profit a company generated for each dollar of sales. This has a growth ratio of 1 percent, -9, 8.4, 2.9 and an average of 83.21.
• Their asset turnover which measures the effectiveness of the company to convert its assets into revenues. This showed an upward trend with a slight dip in 2009. It has a growth ratio of 16.8 percent, -27, 50.6, 14.8 and an average of 1.10.
• The return on assets, this tells us how much profit the company generated for each dollar of total assets. This indicated an upward trend except for 2009, with growth ratios of 17.4 percent, -33.6, 64, 17.4 and an average of 91.9.
• The company’s financial leverage this measures the financial structure ratio of the company base on total assets against total stockholders equity. This showed an increasing trend with a growth ratio of 23.2 percent, -16.1, 13.9, 18 and an average of 1.70.
•  Their return on equity the company could return such profit percent for every dollar of equity. Still, this showed increasing results with a growth ratio of 33.19 percent, -32.3, 59.4, 36.8 and as the average of 153.28.
• Their return on invested capital, this is the financial measure that quantifies how well a company generates cash flow relative to the capital it has invested in its business. This has generated returns same as their return on equity.

Profitability, based on the ratio that showed returns representing the firm’s ability to measure the overall efficiency in generating earnings for its shareholders, marked a favorable result for five years. But due to US financial crisis, there was a slight declined in 2009.

Dupont Model is used to summarize above ratios and to show where the component parts of the return on asset (ROA) comes from as well as the return on equity (ROE). This is very helpful in determining where financial adjustments need to be made. In Great Northern Iron Ore Properties, they have higher net margins and low volume of asset turnover, this tends to be inversely related. This means they earned more from converting revenue to earnings than assets itself. Return on assets depicted satisfactory earnings for every dollar of total assets due to their net income upward trend except in 2009. Thus, the higher the percentage, the better, because that means the company is doing a good job using its assets to generate sales.

With regards to their return on equity, it shows high increasing returns except in 2009 declined. And financial leverage showed likewise an increasing trend and a dip in 2009. But the bulk of the returns comes from profit margin and sales.

### Income

Of course, we all know that income plays a vital role in running a business. This will help sustain the company in long run. For Great Northern Iron Ore Properties, the table will reflect us their earnings generated from 2007 to 2011 business operations.

• Their revenue is how much money a company has brought in yearly. This showed a growth ratio of 23.5 percent, -28.6, 40, 28.6 and an average of 20.
• Operating income is the best indicator of a company’s true performance in their operations. This showed a growth ratio 28.6 percent, -38.8, 54.5, 35.2 and average 16.6.
• Net income is what’s left over for a company after all expenses have been accounted for, and this amounted just the same with their operating income.

The company’s income growth ratio indicated that business was doing good, in 2009 decreased in revenue due to US financial crisis was compensated in 2010 increase in revenues of 40 percent. This was caused by delayed in lease collections from mining companies affected by the crises. Their operating and net income were both the same because this means that they don’t have any transactions on non-operating income or expense. In addition, the two showed good results because they have minimal total cost and expenses to gain a favorable profit.

### Expenses

This is the cost and expenses incurred during the course of their business.

• The cost of revenue was the amount the company paid for the goods that were sold during the year. This showed that they only have cost from 2007 and 2008. Last three years no cost was incurred.
• Total operating expense was the expenses incurred in conducting their regular operations of the business. This composed sales, general and administrative and the depreciation expense involving their properties. Overall total expenses showed a growth ratio of 33 percent, -25, and remain consistent at 3 percent with an average of 3.4.

Great Northern Iron Ore total expenses account an average of 17 percent of revenue. Wherein cost of revenue was 2 percent, sales, general and administrative was 10 percent and depreciation expense was 5 percent. This showed a minimal percentage of total expenses.

### Modified Income Statement

The company deals in property lease to mining companies and as indicated in the graph revenue was increasing except for 2009. And total expenses which were only 17 percent of average revenue indicated that they had minimal expenses incurred. So, net income leftover was good at a higher margin of 83 percent.

### Margins

Ratios that show margins represent the firm’s ability to translate sales dollars into profits at various stages of measurement.

The overall margins showed how efficient GNI’s management was. They were able to sustain their profits despite the decline in 2009 since they were able to recover in 2010. This reflected an impressive operating and net margins which were very high and profitable as well as their returns.

## Great Northern Iron Ore Cash Flow Statement

### Cash from Operating Activities

Cash flow from operating activities comes from their net income adding back depreciation and amortization, other working capital and other noncash items to get the net cash provided by operations. This showed a growth ratio of -12.5, 14.2, -6.3, 40 and an average of 16.4 percent for GNI. They had a good cash flow from operations except for declined in 2008 and 2010 due to other working capital.

### Cash from Investing Activities

Cash flow from investing activities comes from their purchases of investments, sales/maturities of investments and other investing activities to get the net cash used in investing activities. Wherein this showed a growth ratio of 600 percent, -50, 300, -100 and an average of -.40. They don’t have purchases transaction in investments for the first two years only other investing activities. And it purchases average a -4.4 percent, sales, and maturities of investments average 4.0 percent and other investing activities of 0.20 thus, leaving a net cash used for investments average of -0.40.

### Cash from Financing Activities

Cash flow from financing activities comes from cash dividend paid to get net cash used for financing activities. Wherein this depicted a growth ratio of -6.25 percent, 0, 13, 17.6 and an average of -16.6. This means they had used cash flow in financing activities to pay off cash dividend and they don’t have financing activities from other sources.

### Net Change in Cash

The cash flow of Great Northern Iron Ore Properties had a good operating cash flow with slight decreases in 2008 and 2010 due to US financial crisis. And in their investing activities resulting from gains (losses) from investments in the financial markets and operating subsidiaries, and changes from amounts spent on investments in capital assets showed minimal change. While financing activities measure the flow of cash between the company, its owners, and creditors. This indicated negative numbers meaning the company is servicing debt, but it can also mean the company is making dividend payments which investors might be glad to see.

### Free Cash Flow

Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value.

The table above showed that Great Northern Ore Properties was not investing much on capital expenditure thus indicating an operating cash flow equivalent to its free cash flow. While free cash flow doesn’t receive as much media coverage as earnings do, it is considered by some experts to be a better indicator of a company’s financial health.

### Cash Flow Efficiency

Cash flow efficiency is a cash flow metrics in variations of the results from its sales, liabilities,  available capital expenditures, free cash flow and the results of operating. In view thereof, the following formula shows how the resulting percentage come out for GNI.

Cash flow analysis uses ratios that focuses on cash flow and how solvent, liquid, and viable the company is. Here are the most important cash flow ratios as well as the results after analyzing Great Northern Iron Ore Properties:

• Operating cash flow to sales ratio measures how much cash generated from its revenue for the period and gives investors an idea of the company’s ability to turn sales into cash. This had an up and down trend for GNI’s  past five years and a growth ratio of -28.7 percent, 58.2, -33, 9.85 with an average of 83. This is an important indicator of its creditworthiness and productivity, wherein a high percentage means the company will be able to grow for it has sufficient cash flow to finance additional production and a lower ratio indicates the opposite.
• Operating cash flow ratio measures how much cash left after considering short debt by using the result of operating cash flow from operations over current liabilities. This showed an up and down trend with a growth ratio of -50 percent, 100, -37.5, -8 and an average of 290 for five years. This indicated how liquid GNI was despite the declining growth, so they still have the ability to meet current liabilities without having to sell assets.
• Free cash ratio helps us conclude if the company will grow in the future. GNI had no capital expenditure for the five years of operations, therefore they had a free cash flow ratio of 100 percent of operating cash flow. A Higher value of free cash flow to operating cash flow indicates a better financial strength.
• Capital expenditure ratio measures company sustainability in maintaining their assets. The company does not have expenditures creating future benefits or to add to the value of an existing fixed asset with a useful life extending beyond the taxable year.
• Total debt ratio measures company efficiency, the result of operating cash flow over total liabilities. This showed an up and down trend with growth of -42 percent, 72, -19.8, -11.2 with an average of 218. This means the company has sufficient operating cash flow to pay off total liabilities.
• And current coverage ratio measures how much cash available after paying all its current debt. In this case, the company experienced a varied changes year after year with the growth ratio -78 percent, 705, -99, 25.8 and an average of 103 for five years. These changes were caused by a number of cash dividend payments made to shareholders.

Written by Nelly
Edited by Cris

# Great Northern Iron Ore Properties (GNI) Investment Valuation

December 20th, 2012 Posted by No Comment yet

Great Northern Iron Ore Properties (GNI) was founded in 1906 and was headquartered in Saint Paul, Minnesota. This investment valuation on Great Northern Iron Ore Properties shows that the company has a very impressive gross margin and net margin.

## GNI 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.

## GNI Investment in Enterprise Value

The whole concept of enterprise value is to calculate how much it would cost for an investor to purchase an entire business. Enterprise Value (EV) is the present value of the entire company.

The total debt was zero percent in the last five years and its cash and cash equivalent were averaging 6 percent. As a result, the enterprise value was lesser by 5 percent against the market capitalization. If an investor buys the entire business of GNI, the investor will be paying for 100 percent equity with no debt.

The purchase price of the entire business of Great Northern Iron Ore Properties to date, December 10, 2012, will be \$101 million at \$50.50 per share. The market price to date was \$73.30 per share.

## Benjamin Graham’s Stock Test

### Net Current Asset Value (NCAV) Method

Benjamin Graham is looking for firms trading with an undervalued price. The reason according to Graham is when a stock trades below the Net Current Asset Value Per Share, they are essentially trading below the company’s liquidation value. So, therefore, the stock is considered a bargain, and it is worth buying. The concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value.

#### Explanation

The net current asset value approach of Benjamin Graham tells us that the stock price of GNI was overvalued from 2007 to the trailing twelve months because the market value was greater than the 66 percent ratio. The 66 percent ratio represents only 1.4 percent of the market value, therefore, the price was so expensive.

It shows that the stock of GNI was trading above the liquidation value from 2007 to the trailing twelve months of 2012 which brings us to the conclusion that it did not pass Benjamin Graham’s stock test.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

MC/NCAV is another stock test by Graham. The bottom line here is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying.

The MC/NCAV valuation shows that the stock price of Great Northern Iron Ore Properties was overvalued from 2007 up to trailing twelve months 2012 because the ratio exceeded the 1.2 ratios. It shows that the price was expensive and therefore, the stock did not pass the stock test of Benjamin Graham.

### Benjamin Graham’s Margin of Safety (MOS)

The margin of safety is used to identify the difference between company value and price. The difference between market value and the true value is called the intrinsic value.

Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. “In my calculation, I used the enterprise value because it takes into account the balance sheet so it is a much more accurate measure of the company’s true market value than market capitalization.

Let’s see what the table below would bring us about GNI’s margin of safety.

#### Explanation

The average margin of safety was 53 percent or \$227 average while the intrinsic value was \$105 average. For 2007 and 2010, there was a zero margin of safety for GNI because the intrinsic value was below zero. The company’s growth during 2007 and 2010 was negative, thus resulted in negative intrinsic value.

The formula for intrinsic value is given below.

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)

#### Explanation

The explanation in the calculation of intrinsic value is as follows:

EPS: the company’s last 12-month earnings per share; G: the company’s long-term (five years) sustainable growth estimate; 9: the constant represents the appropriate P-E ratio for a no-growth company(Graham  proposed an 8.5, but we changed it to 9); and 2: the average yield of high-grade corporate bonds.

The earning per share was averaging \$11.98. In addition, the earnings per share (EPS) and the sustainable growth rate (SGR) factor intrinsic value.

#### Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity. In calculating this, you need to know how profitable the company is as measured by its return on equity (ROE). You also need to know what percentage of a company’s earnings per share is paid out in dividends, which is called the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. The formula: Sustainable growth rate = ROE x (1 – dividend-payout ratio).

#### Explanation

The return on equity was 158 percent average while the payout ratio was 98 percent average. Return on equity (ROE) is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. Return on Equity formula is:

Return on equity shows how many dollars of earnings result from each dollar of equity. There are two approaches in calculating the sustainable growth rate, these are the relative ratio approach and the average ratio approach.

#### Relative and Average Approaches

Results given in the table above shows that the margin of safety was greater by one percent in the average approach.

During 2007 and 2010, there was no margin of safety because the intrinsic value line was below the enterprise value line. There was a margin of safety because the IV line was on top of the EV line. The difference between the two lines is the margin of safety.

## GNI Relative Valuation Methods

Relative valuation methods’ core concept for valuing a stock, is to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

### Price to Earnings/Earning Per Share (P/E*EPS)

This valuation will help us 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. This will answer our question as to “What’s the status of the stock price?”

The P/E*EPS valuation shows that the stock price of GNI was undervalued. The enterprise value represents 67 percent of the P/E*EPS ratio. Thus, the price was cheap as a result of this valuation.

#### Relative and Average Approaches

Another way of calculating this valuation is by using the average approach.  The table below will show us the difference between using the two approaches.

By using the average approach, the price to earnings ratio was greater by \$1 and the percentage of P/E*EPS ratio was greater by 27 percent.

### The Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS)

The use of EV/EPS ratio is to separate price and earnings in the enterprise value by dividing the enterprise value of projected earnings (EPS). The result represents the price (P/E) and the difference represents the earnings (EPS).

The EV/EPS valuation, tells us that the price (P/E) was 9 percent and the earnings (EPS) was a 91 percent average. This might indicate that the price was cheap because it represents only nearly one-tenth of the enterprise value per share.

#### GNI EV/EPS Graph

The price was high than the earnings from 2007 to the trailing twelve months of 2012.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

The result of EV/EBITDA valuations tells us that it will take 8 years to cover the costs of buying the entire business.  In other words,  it will take 8 times of GNI’s cash earnings to cover the purchase price. Eight years is a long period of waiting. EBITDA represents only 13 percent of the enterprise value.

The company’s gross margin was 98.98 percent average while its net margin was 83.68 percent average. A very impressive ratio.

In conclusion,

The market capitalization of Great Northern Iron Ore Properties was stable. The company has a zero debt and its cash and cash equivalent were a 5 percent average. Thus, the enterprise value was lesser of 5 percent of the market capitalization. The cost of buying the entire business to date, December 10, 2012, was \$ 101 million at \$50.50 per share.  The market price to date was \$73.30 per share.

#### Net Current Asset Value

The net current asset value approach tells us that the stock price was overvalued from 2007 to 2012. It indicates that the stock was trading above the liquidation value of the company. Therefore, it did not pass the stock test of Benjamin Graham. On the other hand, the MC/NCAV valuation shows that the price was overvalued because the ratio exceeded the 1.2 ratios. Therefore the stock did not pass the stock test as well.

Further, the margin of safety by Benjamin Graham shows a 53 percent average margin of safety. The intrinsic value was averaging \$105 in the last five years. While the earning per share was \$11.98 and the return on equity was 158 percent average. And the payout ratio was 98 percent.

#### Relative Valuation

The price was undervalued and the enterprise value represents 67 percent of the P/E*EPS ratio. Therefore, the price was cheap. On the other hand, the price (P/E) was 9 percent and the earnings (EPS) was a 91 percent average.

#### EV/EBITDA

The EV/EBITDA indicates that it will take 8 years to cover the cost of buying the entire business. The gross margin of the company was a 98.98 percent average. While its net margins were 83.68 percent average, a very impressive ratio.

The margin of safety was averaging 53 percent therefore, the price was cheap. In addition, the gross margin and the net margin of GNI was very impressive. Therefore, I recommend a BUY on the stock of Great Northern Iron Ore Properties (GNI).

Research and written by Cris

# It is a Buy for Great Northern Iron Ore (GNI) Properties

December 20th, 2012 Posted by No Comment yet

This investment valuation on Great Northern Iron Ore (GNI) Properties shows that the company has a very impressive gross margin and net margin.

## Value Investing Approach on GNI

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 on GNI

The whole concept of enterprise value is to calculate how much it would cost for an investor to purchase an entire business. Enterprise Value (EV) is the present value of the entire company.

The total debt was zero percent in the last five years and its cash and cash equivalent were averaging 6 percent. As a result, the enterprise value was lesser by 5 percent against the market capitalization. If an investor buys the entire business of GNI, the investor will be paying for 100 percent equity with no debt.

The purchase price of the entire business of Great Northern Iron Ore Properties to date, December 10, 2012, will be \$101 million at \$50.50 per share. The market price to date was \$73.30 per share.

## Benjamin Graham’s Stock Test

### Net Current Asset Value (NCAV) Method

Benjamin Graham is looking for firms trading with an undervalued price. The reason according to Graham is when a stock trades below the Net Current Asset Value Per Share, they are essentially trading below the company’s liquidation value. So, therefore, the stock is considered a bargain, and it is worth buying. The concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value.

The net current asset value approach of Benjamin Graham tells us that the stock price of GNI was overvalued from 2007 to the trailing twelve months because the market value was greater than the 66 percent ratio. The 66 percent ratio represents only 1.4 percent of the market value, therefore, the price was so expensive.

It shows that the stock of GNI was trading above the liquidation value from 2007 to the trailing twelve months of 2012 which brings us to the conclusion that it did not pass Benjamin Graham’s stock test.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

MC/NCAV is another stock test by Graham. The bottom line here is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying.

The MC/NCAV valuation shows that the stock price of Great Northern Iron Ore Properties was overvalued from 2007 up to trailing twelve months 2012 because the ratio exceeded the 1.2 ratios. It shows that the price was expensive and therefore, the stock did not pass the stock test of Benjamin Graham.

### Benjamin Graham’s Margin of Safety (MOS)

The margin of safety is used to identify the difference between company value and price. The difference between market value and the true value is called the intrinsic value.

Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. “In my calculation, I used the enterprise value because it takes into account the balance sheet so it is a much more accurate measure of the company’s true market value than market capitalization.

Let’s see what the table below would bring us about GNI’s margin of safety.

The average margin of safety was 53 percent or \$227 average while the intrinsic value was \$105 average. For 2007 and 2010, there was a zero margin of safety for GNI because the intrinsic value was below zero. The company’s growth during 2007 and 2010 was negative, thus resulted in negative intrinsic value.

##### Intrinsic Value

The formula for intrinsic value is given below.

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)

The explanation in the calculation of intrinsic value is as follows:

EPS: the company’s last 12-month earnings per share; G: the company’s long-term (five years) sustainable growth estimate; 9: the constant represents the appropriate P-E ratio for a no-growth company(Graham  proposed an 8.5, but we changed it to 9); and 2: the average yield of high-grade corporate bonds.

##### Earnings per Share

The earning per share was averaging \$11.98. In addition, the earnings per share (EPS) and the sustainable growth rate (SGR) factor intrinsic value. The term earnings per share (EPS) represent the portion of a company’s earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock. The figure can be calculated simply by dividing net income earned in a given reporting period by the total number of shares outstanding during the same term. Because the number of shares outstanding can fluctuate, a weighted average is typically used.

##### Sustainable Growth Rate

Sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity. In calculating this, you need to know how profitable the company is as measured by its return on equity (ROE). You also need to know what percentage of a company’s earnings per share is paid out in dividends, which is called the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. The formula: Sustainable growth rate = ROE x (1 – dividend-payout ratio).

The return on equity was 158 percent average while the payout ratio was 98 percent average. Return on equity (ROE) is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. Return on Equity formula is:

Return on equity shows how many dollars of earnings result from each dollar of equity. There are two approaches in calculating the sustainable growth rate, these are the relative ratio approach and the average ratio approach.

##### Relative and Average Method

Results given in the table above shows that the margin of safety was greater by one percent in the average approach.

During 2007 and 2010, there was no margin of safety because the intrinsic value line was below the enterprise value line. The margin of safety can be seen in the period 2008, 2009, 2011 and the trailing twelve months because the IV line was on top of the EV line. The difference between the two lines is the margin of safety.

## GNI Relative Valuation Methods

Relative valuation methods’ core concept for valuing a stock, is to compare market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

### Price to Earnings/Earning Per Share (P/E*EPS)

This valuation will help us 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. This will answer our question as to “What’s the status of the stock price?”

The P/E*EPS valuation shows that the stock price of GNI was undervalued from 2007 to the trailing twelve months 2012. The enterprise value represents 67 percent of the P/E*EPS ratio, thus, the price was cheap as a result of this valuation.

Another way of calculating this valuation is by using the average approach.  The table below will show us the difference between using the two approaches.

By using the average approach, the price to earnings ratio was greater by \$1 and the percentage of P/E*EPS ratio was greater by 27 percent.

### The Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS)

The use of EV/EPS ratio is to separate price and earnings in the enterprise value by dividing the enterprise value of projected earnings (EPS). The result represents the price (P/E) and the difference represents the earnings (EPS). If the analysts think that the appropriate ratio is greater or lower than the result, then the stock is either over or undervalued.

The EV/EPS valuation, tells us that the price (P/E) that was separated from the enterprise value was 9 percent and the earnings (EPS) was a 91 percent average.  This might indicate that the price was cheap because it represents only nearly one-tenth of the enterprise value per share.

This valuation depends upon the discretion of the analyst whether he thinks the ratio was appropriate or not, so it is either over or undervalued. The graph below will show us how was the enterprise value was separated into price and earnings.

As it is seen, the price was really high than the earnings from 2007 to the trailing twelve months of 2012. It shows how the price was divided into two ratios.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

The EV/EBITDA metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. It gives us an idea of how long it would take the earnings of the company to recover the price of buying the entire business, including debt.

The result of EV/EBITDA valuations tells us that it will take 8 years to cover the costs of buying the entire business of GNI.  In other words,  it will take 8 times of GNI’s cash earnings to cover the purchase price. Eight years is a long period of waiting. EBITDA represents only 13 percent of the enterprise value.

This valuation also shows the profitability of the company. The company’s gross margin was 98.98 percent average while its net margin was 83.68 percent average, shows a very impressive ratio.

#### In conclusion

The market capitalization of Great Northern Iron Ore Properties was stable. The company has a zero debt and its cash and cash equivalent were a 5 percent average, thus, the enterprise value was lesser of 5 percent of the market capitalization. The cost of buying the entire business to date, December 10, 2012, was \$ 101 million at \$50.50 per share.  The market price to date was \$73.30 per share.

The net current asset value approach of Benjamin Graham tells us that the stock price of GNI was overvalued from 2007 to the trailing twelve months 2012. It indicates that the stock was trading above the liquidation value of the company; therefore, it did not pass the stock test of Benjamin Graham. On the other hand, the MC/NCAV valuation shows that the price was overvalued because the ratio exceeded the 1.2 ratios, therefore the stock did not pass the stock test as well.

##### Margin of Safety

Further, the margin of safety by Benjamin Graham shows a 53 percent average margin of safety. The intrinsic value was averaging \$105 in the last five years while the earning per share was \$11.98 and the return on equity was 158 percent average and the payout ratio was 98 percent.

Furthermore, the relative valuation shows that in the P/E*EPS valuation, the price was undervalued from 2007 to the trailing twelve months. The enterprise value represents 67 percent of the P/E*EPS ratio, therefore, the price was cheap. On the other hand, the EV/EPS valuation shows that the price (P/E) that was separated from the enterprise value was 9 percent and the earnings (EPS) was a 91 percent average.  This might indicate that the price was cheap because the price was only nearly one-tenth of the EV.

##### EV/EBITDA

The EV/EBITDA indicates that it will take 8 years to cover the cost of buying the entire business of Great Northern Iron Ore. The gross margin of the company was a 98.98 percent average while its net margins were 83.68 percent average, a very impressive ratio.

The margin of safety was averaging 53 percent and the relative valuation shows that the price was cheap, in addition, the gross margin and the net margin of GNI was very impressive, therefore, a BUY  position is recommended on the stock of Great Northern Iron Ore  (GNI) Properties.

Research and written by Cris

# Point Blank Solutions Inc (PBSOQ) is Suffering from Losses

December 19th, 2012 Posted by No Comment yet

Point Blank Solutions, Inc. (PBSOQ), through its subsidiaries, manufactures and provides bullet- and projectile resistant garments, fragmentation protective vests, slash and stab protective armor and related ballistic accessories. The company is based in Pompano Beach, FL 33069, United States. Source: Bloomberg

## Value Investing Approach on Point Blank

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. Moreover, 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 on Point Blank

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.  The formula is given below:

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

The market capitalization for Point Blank went down by 61 percent during 2008. Total debt was 14 percent average. The same with cash and cash equivalent at 14 percent as well. Why did it happen?  The market value and the enterprise value were of the same amount because the total was added to market capitalization and the cash and cash equivalent were deducted.

Buying the entire business of Point Blank to date December 11, 2012, will cost \$15.76 million at \$0.32 per share. The market cap of PBSOQ to date was \$13.66 million and the market price was \$0.28 per share.

### Net Current Asset Value (NCAV) Method

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.

The net current asset value approach shows that the company’s stock price was overvalued from 2005 to the trailing twelve months 2009 because the market value was greater than the 66 percent ratio of NCAV. The 66 percent ratio represents only 9 percent of the market price.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

By calculating the market capitalization over the net current asset value of the company, we will know if the stocks are trading over or undervalued. The results should be less than 1.2 ratios for Graham to buy a stock.

The price was overvalued using the MC/NCAV valuation except only in 2008 where the price was undervalued. The stock did not pass the stock test because the ratio exceeded the 1.2 ratios. Overall, the stock of Point Blank was considered expensive.

### The margin of Safety (MOS)

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.

#### Explanation

The margin of safety was 9 percent average. There was a zero margin of safety from 2006 to the trailing twelve months 2009. This indicates that the company’s stock was not a candidate for buying because it did not pass the requirement of at least 40-50 percent margin of safety.

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable  Growth Rate)

#### Explanation

The explanation in the calculation of intrinsic value was as follows:

EPS is the company’s last 12-month earnings per share.  G stands for the company’s long-term (five years) sustainable growth estimate.   9 is the constant that represents the appropriate P-E ratio for a no-growth company. And 2 is the average yield of high-grade corporate bonds.

#### Earnings per Share (EPS)

Based on the table above, earning per share was -\$0.16 average while the sustainable growth rate was -3.34 percent. Further, the annual growth rate was \$2.32 and the intrinsic value was \$1.59 average.

On the side note, earnings per share (EPS) and the sustainable growth rate (SGR) factors intrinsic value.

#### Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. Simplifying this, we will arrive at this formula: Sustainable growth rate = ROE x (1 – dividend-payout ratio)

#### Explanation

The average return on equity of Point Blank was -3.34 percent and the payout ratio was zero because the company did not pay cash dividends to its shareholders.

Return on equity shows how many dollars of earnings result from each dollar of equity.  There are two approaches in calculating the sustainable growth rate, these are the relative ratio approach and the average ratio approach. I have summarized the difference between these two approaches in the table given below:

#### Explanation

The margin of safety was 9 percent in relative approach, while in the average approach it has zero margins of safety.

The graph above shows the enterprise value line was higher than the enterprise value line in 2005. It dropped by 97 percent in 2006 and the line continued to be lower than the EV line. It means that there was no margin of safety during these periods.

### Price to Earnings/Earnings Per Share (P/E*EPS)

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 Earnings per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.

The P/E*EPS valuation conveys that the price was a fair value from 2005 to the trailing twelve months 2009. The P/E*EPS was 99 percent of the enterprise value per share, nearly 100 percent.

There are investors that would consider buying at fair valued stock but this depends on the status of the company. There are two approaches in calculating this valuation; the relative and average approaches. The relative approach uses relative price to earnings and the average approach uses the average price to earnings ratio. Please take a look at the table below. By comparing the results, we can definitely say that the relative approach result of P/E*EPS ratio was higher compared to the average approach.

### The Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS)

The use of this ratio is to separate price and earnings in the enterprise value by dividing the enterprise value of projected earnings (EPS). The result represents the price (P/E) and the difference represents the earnings (EPS).

#### Explanation

The price (P/E) that was separated from the enterprise value was -178 percent. While the earnings (EPS) were 278 percent, summing up to 100 percent. Moreover, the price was negative because the company has suffered losses all through the years except in 2007 and the number of shares was greater than net earnings.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.

It will take -8 years to cover the costs of buying the entire business of Point Blank.  This means, that there was no definite period to cover the costs of the purchase price since the company is suffering from losses. In addition, it shows the company was unprofitable since Point Blank suffered from losses.

In conclusion,

The market capitalization for Point Blank went down by 61 percent during 2008. The total debt represents 14 percent average while cash and cash equivalent represent 14 percent as well. Moreover, buying the entire business of Point Blank to date December 11, 2012, will cost \$15.76 million at \$0.32 per share. The market cap of Point Blank to date was \$13.66 million and the market price was \$0.28 per share.

The net current asset value approach tells us that the stock price was trading above the liquidation value and therefore expensive. While the margin of safety was 9 percent average. The growth of the company was zero percent.

#### Relative Valuation

The price was fair valued in P/E*EPS valuation and overvalued in EV/EPS valuation. The EV/EBITDA indicates that there is no definite period to cover the cost of buying the entire business.

The company was very unprofitable and was suffering from losses. Therefore, I recommend a SELL in the stock of Point Blank Solutions Inc.

Research and Written by Cris

# Landauer (LDR) Investment Valuation

December 14th, 2012 Posted by No Comment yet

LANDAUER (LDR) has been providing state-of-the-art technology and unparalleled customer service within the radiation safety industry to better understand and document information related to occupational, environmental and healthcare-related exposure to ionizing radiation since 1954.

## Value Investing Approach on LDR

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.

## LDR 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.  The formula is given below:

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

The average market capitalization for Landauer Inc was \$557 and moving up and down at a rate of 5 percent average. The total debt was 5 percent and the cash and cash equivalent was a 4 percent average. The enterprise value was greater by 1 percent against the market value. Purchasing the entire business of LDR would be paying 99 percent of its equity and 1 percent total debt

The costs of buying the entire business of Landauer Inc to date, November 9, 2012, would be \$630 at \$70 per share.   While the market price to date was at \$56.19 per share.

### Net Current Asset Value (NCAV) Method

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.

The net current asset value approach shows that the stock of LDR was trading at an overvalued price from 2007 to ttm6 2012 because 66 percent of NCAVPS was lesser than the market value.  The 66 percent ratio was only 0.3 percent of the market value.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Calculating the market capitalization over the net current asset value of the company, we will know if the stock is trading over or undervalued. The result should be less than 1.2 ratios for Graham to buy stocks.

The MC/NCAV valuation shows that the price was overvalued in 2007 to ttm6 2012 because the ratio exceeded the 1.2 ratios. This means that LDR’s stock did not pass the test because the price was expensive.

### The margin of Safety (MOS)

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. 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.

#### Explanation

There was a zero margin of safety for 2007 to ttm6 2012.  The intrinsic value was 72 percent of the enterprise value.

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable Growth Rate)

#### Explanation

EPS is the company’s last 12-month earnings per share.  G for the company’s long-term (five years) sustainable growth estimate. 9 as the constant which represents the appropriate P-E ratio for a no-growth company. And 2 for the average yield of high-grade corporate bonds.

The earnings per share (EPS) and the sustainable growth rate (SGR) factor intrinsic value.

#### Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. Please refer to the formula included in the table below:

#### Explanation

The sustainable growth rate was 4.60 percent average, while the return on equity was 31.99 percent average and the payout ratio was 86 on average. Landauer Inc is paying cash dividends to its common shareholders yearly from 2007 to ttm6 2012.

There are two approaches to calculating the sustainable growth rate. We need those to better understand the next topic. So what are those? The first one is by using the relative ratio and the other one is by using the average return on equity. The results of these approaches for LDR were summarized below.

There was a zero margin of safety for LDR since 2007 to ttm6 2012. The space in between these two lines represents the margin of safety since the EV line was higher than the IV line, this means a zero margin of safety.

### Price to Earnings/Earning Per Share (P/E*EPS)

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, we can determine the status of the stock price.

#### Explanation

P/E*EPS valuation for shows that Landauer Inc’s stock traded at an overvalued price. The reason behind is that enterprise value was greater than the P/E*EPS ratio. While in 2007 and 2009 the price was fair valued therefore undervalued. The enterprise value was 5 percent over the P/E*EPS ratio.

It indicates that the stock of Landauer Inc was expensive. The two approaches for calculating P/E*EPS is by using the relative price to earnings and the average price to earnings. And if you will look at the summary table below, you will see that both approaches results were almost the same.

### Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)

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). Then comparing it to the enterprise value per share, we can determine the status of the stock price.

The EV/EPS valuation for LDR indicates that the price (P/E) was 41 percent and the earnings (EPS) was 59 percent.  The discretion would depend on the analyst.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.

#### Explanation

The EV/EBITDA valuation tells us that it will take 13 years to cover the costs of buying the entire business of LDR.  In other words, it will take 13 times of the cash earnings of LDR to cover the costs of buying the entire LDR. Thirteen years is a very long period of waiting.

For additional bits of information, EV/EBITDA valuation is also a gauge for the profitability of the company. Digging into the finances of LDR, the company had an average of 22 percent net earnings.

In conclusion,

The average market capitalization for LDR was \$557 and it is moving up and downs at a rate of 5 percent average. The total debt was 5 percent, while the cash and cash equivalent were a 4 percent average. The enterprise value was greater by one percent against the market value. Buying the entire business would be paying 99 percent of its equity and one percent of its debt.

The cost of buying the entire LDR to date, November 9, 2012, would be \$630 at \$70 per share. The market price to date was \$56.19 per share.

#### Net Current Asset Value

The stock was trading at an overvalued price because the market value was greater than the 66 percent of NCAVPS. While the MC/NCAV method indicates that the price was overvalued since 2007 to ttm6 2012. Because the ratio exceeded 1.2, therefore it indicates that the price was expensive.

Furthermore, the margin of safety for LDR shows a zero percent while intrinsic value was \$45 average.  On the other hand, the SGR was 5. While the annual growth rate was 18 and the return on equity was 32 percent.

#### Relative Valuation

Moreover, the price was undervalued because the enterprise value was lesser than the P/E*EPS ratio. With EV/EPS,  the price (P/E) was 41 percent while the earnings (EPS) was a 59 percent average.

In addition, it will take 13 years to cover the costs of buying the entire business of LDR.

Since there was a zero margin of safety for LDR, therefore stock was trading at an overvalued price. EV/EBITDA not favorable, therefore a HOLD position is recommended on the stock of Landauer Inc.

Research and Written by Cris

# Freeport McMoRan Copper and Gold (FCX) Investment Valuation

December 13th, 2012 Posted by No Comment yet

Freeport-McMoRan Inc. (FCX) is a leading international mining company with headquarters in Phoenix, Arizona. The company operates large, long-lived, geographically diverse assets with significant proven and probable reserves of copper, gold, and molybdenum. FCX is the world’s largest publicly traded copper producer. FCX’s portfolio of assets includes the Grasberg minerals district in Indonesia, one of the world’s largest copper and gold deposits, and significant mining operations in North and South America, including the large-scale Morenci minerals district in Arizona and the Cerro Verde operation in Peru. Source: FCX website

## Value Investing Approach on FCX

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. 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 on FCX

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.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

The above table tells us that FCX has \$35 billion average with exceptions in 2008 where the market cap dropped to 76 percent.  The total debt represents 14 percent on average, while the cash and cash equivalent were an 8 percent average, thus the enterprise value was greater by 6 percent against the market value. The movement in the market was at a rate of 4 percent average.

The buying price of Freeport-McMoRan Copper and Gold Inc’s entire business to date, October 30, 2012, was \$42585 at \$53.63 per share. If you decided to buy this entire company, then you will be buying the equity for 94 percent and total debt for 6 percent. The market price to date was \$39.07 per share.

## Price-to-Ore Ratio

### Enterprise Value / Value of Proven and Probable Reserves (all Minerals)

This is the most powerful valuation for evaluating a company’s share price relative to its mineral resources since it takes into account all minerals.  The lower you get, the better.  There are changes daily that took place with the stock price and metal prices. This valuation is also useful in comparing companies with the same or different minerals.

The value of total mineral resources can be the same as the proven and probable reserves (all minerals). These reserves that we were talking are the principal assets of a mining company. The term as used in the reserve data presented here is the part of the mineral deposit which can be economically and legally extracted or produced at the time of the reserve determination.

#### Proven Reserves

According to Freeport-McMoRan Copper and Gold Inc, the term “proven reserves” means reserves for which (1) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; (2) grade and/or quality are computed from the result of detailed sampling; and (3) the sites for inspection, sampling and measurements are spaced so closely and the geologic character is sufficiently defined that size, shape, depth and mineral content of reserves are well-established.

#### Probable reserves

Likewise, the term “probable reserves” means reserves for which quantity and grade are computed from information similar to that used for proven reserves but the sites for sampling are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven reserves, is high enough to assume continuity between points of observation.

#### Explanation

We have already discussed the enterprise value in the first part of this valuation, now, let us analyze the value of proven and probable reserves, as it is seen in the table that the value was increasing at the rate of 21 percent average, impressive.  The EV/Total Resources or EV/Value of Proven and Probable Reserve shows, that in 2007 and 2010 the price was expensive because the enterprise value was greater than the value of total resources. While during the period of 2008, 2009 and 2011, the price was cheap because the enterprise value was lesser than the value of total resources.

#### Explanation

FCX determined reserves using the long-term average prices of \$2 per pound for copper, \$750 per ounce for gold and \$10 per pound for molybdenum.

### Net Current Asset Value (NCAV) Method

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 is trading in a bargain, and it is worth buying.

#### Explanation

The net current asset value (NCAV) approach for FCX indicates that the stock traded at an overvalued price because the market price was greater than the 66 percent result of the NCAV, therefore, the price was expensive. In other words,  the stock of Freeport-McMoRan Copper and Gold Inc did not pass the stock test of Benjamin Graham because the stock was trading above the liquidation value of the FCX.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Calculating the market capitalization over the net current asset value of the company, we will know if the stock is trading over or undervalued. The result should be less than 1.2 ratios for Graham to buy stocks.

The MC/NCAV valuation for FCX tells us that the stock was trading at a price that is overvalued from 2007 to ttm2012 because the ratio was greater than 1.2.  The net current asset value was 14 percent of the market price.

### The margin of Safety (MOS)

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.

#### Explanation

The margin of safety indicates that there was a margin of safety from 2007 to 2011, while the trailing twelve months (ttm), 2012 was a zero. The average margin of safety was 57 percent. Knowing how we arrive at those results is like a breath of fresh air. With that,  Cris shared to me the formula for intrinsic value below:

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

#### Explanation

EPS or the company’s last 12-month earnings per share; G or the company’s long-term (five years) sustainable growth estimate; 9 for the constant which represents the appropriate P-E ratio for a no-growth company, and 2 as the average yield on high-grade corporate bonds.

The average intrinsic value was \$879, the company suffered losses in its net earnings at a rate of 62 percent, this is the reason why it’s earnings per share was negative because of EPS factors net income.

#### Explanation

Return on equity and the payout ratio factors SGR.

The return on equity factors net income as well and the average shareholders’ equity. Since 2008 the net earning of FCX was negative at 62 percent, the result of ROE was negative also. This is the reason why the intrinsic value soared up very high at 1348 percent in 2008.

#### Explanation

We have already learned why the red line soared up so high in 2008 at that level as per our prior discussion. If we put in figures or in percentage, this distance is 57 percent average from 2007 to ttm2012. Buying the stock of FCX to date will have no margin of safety.

#### Explanation

There are other approaches in calculating the sustainable growth rate and this affects the intrinsic value and the margin of safety. This is by using the relative and the average return on equity. I have summarized the difference between using these two approaches as shown in the table above.

By comparing, we can say that the average method produces a higher result in the growth of the FCX.

## FCX Relative Valuation Methods

The relative valuation methods for valuing a stock is to compare the market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

#### Price to Earnings/Earning Per Share (P/E*EPS)

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, we can determine the status of the stock price.

In 2008 to 2012, the stock was trading at an overvalued price. Because the enterprise value was greater than the P/E*EPS ratio. The P/E*EPS ratio was 44 percent of the enterprise value, this means price was overvalued. The result of P/E*EPS indicates that the stock was expensive.

#### Relative and Average Approaches

The result in using the relative value was favorable with FCX because it doesn’t show a negative P/E*EPS ratio.

#### Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)

The price (P/E) was 29 percent and the earnings (EPS) was 71 percent. This indicates that the price was undervalued. The result of this valuation will depend on upon the discretion of the analyst’s, or whatever the analyst deemed appropriate

#### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings. This metric is useful for analyzing and comparing profitability between companies and industries.  It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business.

#### Explanation

EV/EBITDA valuation indicates that it will take 4 years or 4 times the cash earnings to cover the costs of buying the entire business.  Moreover, this valuation also shows the profitability of the company.  It tells us that the earning before income tax of FCX was negative during 2008 at a rate of 75 percent. On the other hand, its net earnings at 62 percent, but have recovered the succeeding periods with favorable margins.

#### In conclusion

The enterprise value was stable at \$35 billion, except in 2008, where the market drops at 76 percent.  While total debt was 14 percent and cash and cash equivalent was an 8 percent average. Thus, making the enterprise value greater by 6 percent than the market capitalization.

Buying the entire business to date, October 30, 2012, would be \$42585 at \$53.63 per share.  The market price to date was \$39.07 per share.

The EV/Value of Proven and Probable Reserves tells us that the price was expensive in 2007 and 2010. Because the enterprise value was greater than the value of total reserves.  While, during the period of 2008, 2009 and 2011. It shows that the price was cheap because the enterprise value was lesser than the value of total reserves.

#### Net Current Asset Value

On the other hand, the net current asset value approach indicates that the stock was trading at an overvalued price. Since the enterprise value was greater than the 66 percent of NCAV. Meaning, the stock was trading above the liquidation value of the FCX.  Moreover, the price was overvalued because the ratio was over 1.2, therefore, the price was expensive.

Further, the margin of safety tells us that there was a margin of safety from 207 to 2011. Howbeit in ttm2012, there was zero margins of safety. The average margin of safety from its 5 years of operation was 57 percent.  The intrinsic value soared up very high in 2008 at 1348 percent. While SGR was \$5, and the annual growth was \$18. In addition, the return on equity (ROE) was \$9, not impressive.

#### Relative Valuation

Likewise, the price was overvalued from 2008 to ttm2012. In 2007 the price was fair in the P/E*EPS valuation. The enterprise value was greater than the P/E*EPS result. The price to earnings ratio in relative approach was \$12 while using the average ratio, the result was -\$6.11.

While the EV/EPS valuation tells us that the price (P/E) was 29 percent and the earnings (EPS) was 71 percent. On the other hand, the EV/EBITDA valuation shows a result of 4 years or 4 times.  This means that buying the entire business will take 4 times the cash earnings to cover the costs of buying.

#### Overview

The EV/Value of Proven and Probable Reserves shows that the price was cheap, in general.  The margin of safety was 57 percent average. On the other hand, the P/E*EPS and the EV/EPS indicate price was undervalued. A BUY position is recommended on the stocks of Freeport-McMoRan Copper and Gold Inc (FCX).

Research and Written by Criselda

# Jinpan International Limited (JST) Financially Healthy

December 12th, 2012 Posted by No Comment yet

Jinpan International Limited (JST), through its subsidiaries, designs, manufactures and sells electrical power control and distribution equipment in China, the United States, and Europe. Source Bloomberg

## Balance Sheet

### Liquidity

• The current ratio of JST was 2.62, 2.18, 3.07, 2.38 and 2.20 with an average of 2.49. This shows that the company’s current resources were greater than its current liabilities by an average of 249 percent for the last five years period.
• Its quick ratio, which is current asset less inventory was 1.92, 1.60, 2.48, 1.97 and 1.81, an average of 1.96; also shows that it has an average of 196 percent for the same period.
• And JST’s net working capital ratio was .50, .40, .50, .44 and .41 or average of .45 in five years. We get this by dividing the networking capital by the total asset of the company.
• Finally, its working capital (in dollars) which is a current asset less current liabilities was 60, 65, 91, 101 and 114, its average was 86.2. There was a trending up of its business from 2007 to 2011 as clearly shown in the above table. There was an expansion of business seen as its working capital was increasing per year.

Looking up at the above data, the company is doing well in its business with sufficient current resources. The company is considered financially healthy according to Rio.

### Efficiency or Asset Management

• Inventory turnover ratio was 4.62, 4.97, 6.12, 4.90 and 6.08. The company has an average inventory turnover of 5.34 for the last five years. This is the number of times the inventory moved and replaced.
• The receivable turnover ratio of the company was 2.79, 2.69, 2.48, 1.93 and 2.03, with an average of 2.39 in five years. Receivables turnover looks at how fast we collect on our sales or how many times each year we clean up or totally collect our accounts receivable.
• Its payable turnover ratio was 20, 14.45, 15.90, 11.31 and 9.78. an average of 14.29. It reveals how often payables turn over during the year.  It shows that the company pays its supplier 14 average each period.
• Fixed asset turnover ratio was 10, 6.63, 5.48, 4.32 and 5.63. It has an average of 6.41 for the last five years.  It shows that the ratio is trending down so there’s a need to look closer into it.

### Leverage

Below is where you can see the debt ratio, debt to equity and solvency ratio of Jinpan International Limited from 2007 to 2011.

• Debt ratio of the company was .32, .34, .25, .33 and .35, with an average of .32. It shows that its leverage is below 50 percent.
• Debt to equity was .47, .51, .34, .49 and .54. an average of .47. It also shows that total obligation was 47 percent of equity.
• While solvency ratio was .44, .40, .72, .24 and .29. an average of .42, which shows that there’s a decrease in 2010 and 2011 because of the company’s increase in short-term debt during this period.

In order to determine who has the majority control of the company’s total assets, we also use the following ratios:

• Current liabilities to total asset was .30, .34, .24, .32 and .34. an average of .31. It tells us that the creditors, particular suppliers have 31 percent claims on the total asset of the company.
• Long-term liability to total asset was .01, 0, .02, .01 and .01. an average of .01. It shows that only 1 percent will go to banks or bondholders.
• Stockholders’ equity to total asset was .69, .66, .75, .67 and .65 average of .68 which shows that the stockholders or owners have 68 percent claims on the company’s total asset, so they are the major claimant of the company.

The above data shows that Jinpan International Limited ran its business with minimal debt; the sources of funds were internal. They have sufficient current resources to fund its business, the company is well managed and continue expanding.

### Property, Plant, and Equipment

• Investment in property, plant, and equipment of JST was 19, 34, 41, 51 and 61. Average of 41. It shows that the company expanded its investment every year with a percentage growth of 79, 20, 24, and 20 percent respectively.
• Accumulated depreciation was 7, 10, 13, 17 and 22, an average of 14. This is equivalent to 37, 29, 32, 33 and 36 percent of the gross PPE.
• Net property, plant, and equipment were 12, 24, 29, 34 and 40. with an average of 28 which is equivalent also to 63, 71, 71, 67 and 66 percent of the total cost.

With the above-given data, the remaining life of the company’s PPE would then be 3 years more before it would be fully depreciated.

## Income Statement

### Profitability

• Net margin was .13, .13, .18, .10 and .11, which shows that within two years it was the same, increased by 5 in 2009 but decline in 2010 by 8 percent and slightly went up in 2011. Its 5 years average was 13 percent.
• Asset turnover ratio was .99, .98, .87, .64 and .81, with an average of .86. It shows that the company is effective in converting its assets into sales. It also shows that the asset turnover ratio is inversely related to net profit margin if asset turnover is high net margin is low and vice versa.
• Return on asset was .13, .12, .16, .06 and .09. an average of .11.  It tells us that the average profit the company has generated for each \$1 dollar of the asset was \$0.11.
• Return on equity was .19, .19, .21, .09 and .13. an average of .16, which tells us the average profit a company earned in each \$1  of shareholder equity was \$0.16.
• Financial leverage was 1.46, 1.51, 1.34, 1.50 and 1.54. an average of 1.47. This is the ratio of assets to total stockholders’ equity.
• Return on invested capital was .19, .19, .21, .09  and .13. average of .16.

### Income

• Revenue was 120, 159, 159, 147 and 225. its ttm was 162.  The company’s revenue shows an up and downtrend in five years of operation. It increased by 32 percent in 2008, no growth in 2009, dropped by 7 percent in 2010, however it recovered and increased by 53 percent in 2011.
• Its gross profit was 42, 51, 67, 57 and 82, with ttm of 60.  It also shows an up and downtrend on its growth. In 2008, its growth was 21 percent, in 2009, 31 percent, however, in 2010 it decreased by 15 percent but immediately recovered and 44 percent increased in 2011.
• Operating income was 19, 23, 31, 15 and 27.  The trend of its growth was also the same with its revenue and gross profit wherein 2010 was its lowest and 2009 was its peak.
• Income before tax was 19, 24, 32, 18 and 28. This is the company’s income before deduction of income tax.
• Income after tax was 16, 20, 29, 14, and 24.  This is the net income of the company after applying the provision for income tax.

As noticed on the above data,  we have seen that its revenue grew year after year. Its peak was in 2011, the same trend was with Jinpan’s gross profit. However, operating income, income before tax and income after tax have the same trend of its growth, its peak was in 2009 while the lowest was in 2010.

### Expenses

• The cost of revenue of JST was 78, 109, 92, 90 and 142.  It represents 65, 68, 58, 61 and 63 percent of revenue.
• Selling, general and admin was 23, 27, 36, 42 and 56, which are 19, 17, 23, 29 and 25 percent of revenue.
• Income tax was 2, 3, 3, 4 and 3. It is 2, 2, 2, 3 and 1 percent of revenue.

Above table shows that the company’s expenses were within the normal level of each category. The business is satisfactorily handled and managed. It seems that Jinpan International Limited is on the good track.

### Margin

Gross margin was .35, .32, .42, .39 and .36. The total average was .37. The result showed an up and down per year. It decreased by 3 percent in 2008, increased by 10 percent in 2009 then decreased again by 3 percent in 2010 and another 3 percent in 2011.

• Operating margin was .16, .14, .19, .10 and .12.
• Pretax margin was .16, .15, .20, .12 and .12. This is the income of the company before tax expressed in percentage.
• Net profit margin was .13, .13, .18, .10 and .11. It is the net income of the company expressed in percentage. Its highest was in 2009 and the lowest in 2010 at 10 percent.

Based on records, the company’s highest gross margin was in 2009, and so with its operating margin, pretax margin and net profit margin. The least was in 2008 for gross margin and 2010 for operating margin, pretax margin and net profit margin.

### Modified IS

• The above table shows that its revenue was not going up always that during 2010 it went down. The highest revenue was in 2011. Its total expenses were also fluctuating with the highest record was in 2011.
• Resulted in a net income averaged of 21. Its peak record was in 2009 and with lowest in 2010.

JST company is well managed as far as its income statement is concerned. The company did not experience any negative result.

## Cash Flow

### Cash Flow from Operating Activities

• Net income was 16, 20, 29, 14  and 24. ttm of 21,  this is the result of the normal day to day operation of the business. Its peak was in 2009.
• Depreciation & amortization was 1, 2, 4, 4 and 4.
• Accounts receivable was 0, -13, -6, -10 and  -32. ttm was -26.
• Prepaid expenses were -3, 4, -5, -19 and 17. ttm of 21.
• Other working capital was -10, -2, -2, 17 and -14
• Other non-cash items was 1, 0, 0, 0 and 1.
• So, its net cash provided by operating activities was  0, 18, 22, 2  and 4.   It was zero in 2007 but have enough balance in 2008 and 2009,  however, due to adjustments on prepaid expenses, accounts receivable and other working capital it resulted to a minimum balance in 2010 and 2011.

As shown in the above table, operating cash flow was used up in 2007, however, it was good in 2008 and 2009  having a positive result but dropped to a minimum balance in 2010 to 2011.  Transactions affecting operating cash flow aside from the net income were accounts receivable, prepaid expenses and other working capital.

### Cash Flow from Investing Activities

• Investment in PPE  was -7, -14, -8, -8 and -8.
• Purchases of investments was -13, 0, 0, 0 and -2.
• Purchase of Intangibles  was  0, -5, 0, 0 and -5.
• And other investing in activities was 0.
• Net cash for investing activities was -19, -19, -8, -8 and -15.  It shows a negative result throughout its five years of operation.

Data of JST shows that investing cash flow of the company resulted in a negative balance of its transactions involved cash outflows.  What are those? These were an investment in PPE, purchase of investments, purchase of intangibles and other investing activities.

### Cash Flow from Financing Activities

• Debt issued was 0, 43, 12, 17 and 48.
• Debt repayment  was 0, -42, -17, -5 and -39
• Cash dividends paid was -2, -2, -2, -2 and -2.
• Other financing activities was 3, 0, 1, 0, 0.
• Net cash provided by financing activities was  1, -1, -6,  10 and  6.  Total cash inflow was 3, 43, 13, 17 and 48 which are debt issued other financing activities. While total cash outflow was -2, -44, -19, -7 and -41 consist of debt repayment and cash dividends paid which resulted in a net financing cash flow of 1, -1, -6, 10 and 6.

### Free Cash Flow

Free cash flow was the net amount after deducting capital expenditure from operating cash flow. For the past five years, Jinpan International Limited’s free cash flow was -7, -1, 14, -7 and -9.  It shows that the company incurred a negative free cash flow in 2007, 2008 2010 and 2011 while in 2009, however, the company incurred a positive free cash flow of 14.

Written by Rio
Edited by Cris

# Jinpan International Limited (JST) Investment Valuation

December 10th, 2012 Posted by No Comment yet

Jinpan International Limited (JST), a leading designer, manufacturer, and distributor of cast resin transformers for voltage distribution equipment.

## Value Investing Approach  on Jinpan

The essence value investing is that any investment should be worth substantially more than an investor has to pay for it. We believed in thorough analysis, which we call fundamental analysis.  We looked for companies with a strong balance sheet or those with little debt, above average profit margin and good cash flow.  Our valuation seeks out undervalued companies whose stock price are trading at a discount.

The basis in this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement.  In this model, we calculate the enterprise value as our first step in the valuation.  I considered this important because this is a great measure of the total value of a firm and is often great starting points for negotiation of a business.

## The Investment in Enterprise Value on Jinpan

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.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

The table above shows that the market capitalization of Jinpan International Limited was erratic in movement and trending at a rate of 13 percent average. The total debt was 12.4 percent of the enterprise value, while the cash and cash equivalent was 11 percent average, thus making the enterprise value greater by 1 percent against the market value.

Buying the entire business of Jinpan International Limited, the investor will be paying 99 percent of equity and 1 percent of its debt. And, the price to date December 4, 2012, will cost \$96 million at \$5.65 per share.  The market price to date was \$5.00 per share.

### Net Current Asset Value (NCAV) Method

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 is trading in a bargain, and it is worth buying.

#### Explanation

The net current asset value approach indicates that the price was overvalued from 2007 to the trailing twelve months 2012 because the market value was greater than the 66 percent of the net current asset value. The 66 percent of NCAV represents only 32 percent of the market value, therefore market value was greater and overvalued.

It tells us that the price was expensive because the stock was trading above the liquidation value of Jinpan International Limited.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Calculating the market capitalization over the net current asset value of the company, we will know if the stock is trading over or undervalued. The result should be less than 1.2 ratios for Graham to buy stocks.

It shows in the MC/NCAV valuation that the stock price was overvalued from 2007 to 2010 because the ratio was more than 1.2 ratio. While in 2011 to 2012, the stock price was undervalued because it doesn’t exceed the 1.2 ratios. The ratio represents 2.33 average, therefore, the stock was overvalued.

### The margin of Safety (MOS)

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.

#### Explanation

The margin of safety valuation as shown in the table was 74 percent average.

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

EPS is the company’s last 12-month earnings per share; G is the company’s long-term (five years) sustainable growth estimate;  9 is the constant represents the appropriate P-E ratio for a no-growth company as proposed, and 2 is the average yield of high-grade corporate bonds.

#### Explanation

The average intrinsic value was \$52, while the earning per share was \$1 average. The earnings per share (EPS) and the sustainable growth rate (SGR) factor intrinsic value.

#### Explanation

The average sustainable growth rate was 15 percent while the payout ratio was 10 percent. In addition, the return on equity was 17 percent average. It shows how fast a company can grow using internally generated assets without issuing additional debt or equity.

To be able to calculate this, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. Sustainable growth rate = ROE x (1 – dividend-payout ratio)

Return on Equity (ROE) is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. Return on Equity shows how many dollars of earnings result from each dollar of equity and the  formula is:

There are two approaches in calculating the sustainable growth rate, these are the relative ratio approach and the average ratio approach. I summarized the difference between these two approaches in the table given below:

#### Explanation

As we can notice, the average approach in calculating the sustainable growth rate produced greater results than by using the relative approach.  The margin of safety in the average approach was 76 percent which is 2 percent greater than the relative approach.

The graph below will make us fully understand the margin of safety.

#### Explanation

There was a margin of safety for Jinpan because the lines did not intersect with each other. The space between these two lines is the margin of safety. calculating the space in figures we get an average of 74 percent.

We simply get the difference of the enterprise value and the intrinsic value for each period and we divide it by the number of periods, then it will result in a 74 percent average. If the enterprise value line was higher than the intrinsic value line, then there will be a zero margin of safety, because the stock was trading above the true value.

### Price to Earnings/Earning Per Share (P/E*EPS)

Multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and compare it to the enterprise value per share, we can determine the status of the stock price.

#### Explanation

The P/E*EPS valuation tells us that the price was fair valued during the period of 2007 to 2009 because the P/E*EPS ratio was the same as the enterprise value. While in 2010 to 2012 price was overvalued, because the enterprise value was greater than the P/E*EPS ratio.

I used the relative approach in the above calculation. But we can also use the other way, which is the average approach.  I summarized the results of using these two approaches in the table below.

By using the average approach, we can definitely say that it gives us a higher result compared to the relative approach.

### The Enterprise value (EV) /Earning Per Share (EPS) or (EV/EPS)

The use of this ratio is to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

#### Explanation

The EV/EPS tells us that the price (P/E) represents 82 percent of the enterprise value, while the earnings (EPS) represents 18 percent of the enterprise value. This is the separation of price and earnings in the enterprise value.

The graph illustrated that the price (P/E) was really high than the earnings (EPS); these shows the gap between the two ratios. So, we might say that the price was expensive.

### Enterprise Value (EV) / Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

#### Explanation

The EV/EBITDA valuation tells us an average of 7 years or 7 times.  This means that it will take 7 years to cover the costs of buying.  Or in other words, it will take 7 times of the cash earnings to cover the cost of buying the entire business.

The EBITDA represents only 14 percent of the enterprise value of the company. This valuation also tells us the profitability of the company. The net margin of Jinpan International Limited was a 12 percent average.

#### In conclusion

The market capitalization of Jinpan was erratic in movement and was trending at 12 percent. While the enterprise value was trending at a 13 percent average. The total debt was 12.4 percent and the cash and cash equivalent was an 11 percent average. Thus making the enterprise value greater than 1 percent. The investor would be paying 99 percent of the equity and 1 percent debt if buying the entire business.  The purchase price for Jinpan to date, December 4, 2012 . would be \$96 million at \$5.65 per share.  The market price to date was \$5.00 per share.

#### Current Asset Value Approach

Further, the net current asset value approach shows, that the stock price was overvalued from 2007 to 2012. The 66 percent ratio represents only 32 percent of the enterprise value, therefore the price was expensive.  The stock was trading above the liquidation value of Jinpan and has not passed the stock test of Benjamin Graham.  On the other hand, the price was overvalued because the ratio 2.3 was over the 1.2 ratios. Therefore, the stock has not passed the stock test of Benjamin Graham.

#### The Margin of Safety

Furthermore, the margin of safety from 2007 to 2012 was averaging 74 percent. However, using the average approach, the MOS was 76 percent.  The intrinsic value was \$52 average and the earning per share was \$1.0  average. The growth represents 15 percent of the sustainable growth rate. And 39 percent of annual growth rate while the return on equity was 17 percent average. In addition, the payout ratio was 10 percent average.

#### Relative Valuation

On the other hand, the relative valuation shows that the price was fair valued from 2007 to 2009. While on 2010 to 2012, the price was overvalued.  The P/E*EPS ratio represents the 97 percent average of the enterprise value. While the enterprise value represents a 103 percent average of the P/E*EPS ratio. Therefore, using the P/E*EPS valuation stock price was overvalued.

The EV/EPS indicate that the price (P/E) was 82 percent and the earnings (EPS) was 18 percent.  This is the separation of price and earnings in the enterprise value per share. This might indicate that the price was expensive since the price was greater than the earnings.

The EV/EBITDA tells us that it will take 7 years to cover the costs of buying the business of Jinpan.  Or in other words, it will take 7 times of the cash earnings of Jinpan to cover the purchase price.

#### Overall

The margin of safety was 74 percent. The stock price was overvalued or expensive. Therefore, I recommend a HOLD on the stock of Jinpan International Limited.

Researched and Written by Cris

# Giant Interactive Group Inc (ADR) GA Is Profitable

December 5th, 2012 Posted by No Comment yet

Giant Interactive Group Inc (ADR) or simply GA is one of China’s leading online game developers and operators in terms of revenues. I want to find out how they manage to do that so let’s have a rundown on Dyne’s (from our Numbers team) value investing report.

## Giant Interactive Balance Sheet

Dyne said that we need to apply some metrics to determine a company’s liquidity, leverage, solvency and their effectiveness in handling their resources.

### Financial Liquidity

Financial liquidity will help us measures how liquid is the company in terms of their assets. Through different ratios such as current ratio, quick ratio, and net working capital, we can merely determine the status of the company when it comes to this matter.  I asked Dyne if GA can quickly turn their assets to pay its current obligations or through the results of operation will sustainable to roll out for another more years. And she presented to me the answer below.

GA financial liquidity results were very high. Current ratio turns out per total average had a ratio of 6 against 1 debt. They also quickly turned their asset at the ratio of 17:1. Or if we put this, it tells us that in every \$1 of debt they have free and available of 6 and 17 times of their short-term debt,  as per current and quick ratio output, respectively. Networking was very safe at an average of 72 percent. Sounds good for Giant Interactive Group Inc (ADR), right?

### Financial Leverage

Digging deeper, GA’s financial leverage was impressive with an average debt from current creditor and equity which were equivalent to 14 and 16 percent, respectively. They were very solvent at 117 percent average, meaning they have an available of 1.17 against their total obligation of \$1.

### Cash Conversion Cycle

Referring to the graph below, we can say that GA cash conversion cycle results per average were seven (7) days. It turns out that their collection cycle was 25 days in average against their disbursement which was only18 days cycle. It simply means that the company was paying more on cash than credit.

### Asset Management

Asset management also measures management effectiveness in handling their resources by using the result of receivable turnover which in terms of sales, payable turnover, and fixed asset turnover.

Giant Interactive Group Inc (ADR) ‘s asset management was efficiently managed with an average percentage of  351, 53 and 9 for the receivable, payable and fixed asset, respectively. It tells us that in every sale of 358 percent, they only had an equivalent of accounts receivable at 1%. In payable turnover, only 53 percent of sale was on credit. The same goes for fixed asset turnover, wherein every 9 percent of the sale, they had a 1 percent used of the asset life.

### Majority Holders

Based on GA’s total average on their five years of operation, the company was highly ruled and financed by equity holders itself with an equivalent of 86 percent compared to local creditors at 14 percent. It tells us, that in every \$1 of the asset, equity holders own \$.86 and the remaining was for local creditor at  \$.14.

## Giant Interactive Income Statement

The income statement is where you can determine if the company is profitable or their business was trending in the market.

### Modified Income Statement

GA revenue trend went upward except in 2009 because it dropped down by 22 percent per average. However, the company was able to make up and grew by 3 percent yearly. The same thing happened with expenses. It went down in 2009 by 8 percent but able to increase by 14 percent per average.

### Margins

• Gross margin was a result percentage from net revenue less cost of revenue equals to gross profit over revenue.
• While the operating margin was a result percentage from gross profit less operating expenses equals to operating income over the net revenue.
• Moreover, the EBIT margin was a result of an income before interest and taxes over the net revenue.
• And the pretax margin was the result of pretax income over net revenue
• Finally, the net margin was the percentage result from net income over the net revenue.

GA margin was very profitable but the trend was moving slightly downward; net margin declined annually from 2008 to 2011 by 1, 4, 5, and 12 percent, respectively. By seeing the graph, gross margin dropped down by 2 percent in 2009 and recovered in 2010 and 2011 by 1 percent. Compared to net margins, it continuously went downward from 2009 to 2011. It means, operating and interest expenses continued to grow.

### ROE DuPont method

ROE DuPont model was assessing the company’s return on equity which will help us determine in analyzing the three key affected areas:

• Operating efficiency, which is measured by net profit margin;
• While, asset use efficiency, which is measured by total asset turnover;
• In addition, financial leverage, which is measured by the equity multiplier.

ROE (DuPont formula) = (Net profit / Revenue) * (Revenue / Total assets) * (Total assets / Equity) = Net profit margin * Asset Turnover * Financial leverage

After analyzing GA ROE results using DuPont, showed that it slowed down by 3 percent in 2008 and continued to drop by 64 percent. But the good news is, ti recovered at 14 and 46 percent in 2010 and 2011, respectively or per TTM ROE equivalent was 285 percent. This means that in every \$1 of equity you have a return of \$2.85, very high.

### Revenue

By merely looking at the table below, you will see there is revenue per category itself. These are gross profit which a result of revenue less cost of revenue; operating income or the result of gross profit less operating expenses; the income before taxes which is the result of operating income less interest; and the net income or the result of income before tax fewer taxes.

GA revenue shows went down in 2009 by 22 percent but it was recovered in 2010 and continues in 2011 by 2 and 26 percent, respectively. Even if GA encountered a went down in 2009, their overall maintains a positive income every year.

### Expenses

GA expenses were very high with regards to their incurred in the operating. It dropped down by 54 percent but then again, it increased again by 39 percent in 2011.

So we are heading down to the last part of the financial statement…the cash flow

## Giant Interactive Cash Flow

Summary of Cash Flow

Summary of cash flow was the result of per activities from operating, investing, financing and net change in cash.

Moreover, it showed that Giant Interactive cash was high during 2007 and it indicates also high cash used during 2008. It also is shown that in 2009 it had the smallest cash used for the operation. Probably, this indicates that during this year, there was a  drop down cash provided in operating activities.

### Cash Flow from Operating

We are applying the reconciliation method which all cash collection fewer cash payments was net cash flow from operating activities.

NCFO went down from 2008 to 2009 at 48 percent and recovered in 2010 and 2011 at 27 and 19 percent, respectively. It had a decrease in the collection during 2009 and a lot of expenses paid. This mainly the reason why NCFO suddenly drop down.

### Cash Flow from Investing

GA NCFI had high cash used during 2008 in a purchase of investments. Small participation from the purchase of PPE dropped down in 2009. This is due to cash that came in from the sale of maturities of investments. It shows that it has a sale of investments high during in 2010, which results in net cash provided by the company.

### Cash flow from financing

For Giant Interactive Group Inc’s NCFF, the table above showed that there was cash coming in during 2007 from common stock issued. A high cash out was accounted during 2008 due to common stocks repurchased and the same thing happened in 2011 due to dividend payout.

### Cash Flow Efficiency

Cash flow efficiency is a cash flow metrics in variations of the results from its sales, liabilities. Available capital expenditures, free cash flow and the results of operating. The following formula will clear our minds on how the resulting percentage comes out.

• CC ratio (Current Coverage ratio) was the result of net operating cash flow over current liabilities.
• While the total debt ratio was based on net operating cash flow over total debt.
• Moreover, Capex ratio was the result of net operating cash flow over capital expenditures.
• On the other hand, the FCF ratio was a result of free cash flow over net operating cash flow.
• CFO ratio was a result of net operating cash flow over their current liabilities or current obligation.
• CFO to sales ratio was a result of net operating cash flow over its sales for the period.

Giant Interactive cash flow was financially healthy showing very high results on CAPEX  during 2010 at 2789 percent.  Next were  CFO and current coverage ratio both at 184 percent during 2008. Free cash flow was high during 2010 at 97 percent.

Written by Dyne
Edited by Cris

# VSE Corporation (VSEC) Investment Valuation

December 3rd, 2012 Posted by No Comment yet

VSE Corporation (VSEC) since 1959, provided engineering and technical services to the owners and operators of transportation and equipment assets and large, mission-critical fleets, including ships, vehicles, and aircraft.

## Value Investing Approach on VSE

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.

## VSE 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.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

After analyzing VSE Corporation, market capitalization was decreasing at a rate of nine percent average. The total debt represents 24 percent and the cash and cash equivalent were 1 percent of the enterprise value. Thus, the enterprise value was greater by 23 percent against market value. If you would buy the entire business of VSEC, you would be paying 87 percent equity and 23 percent of its total debt.

Buying the entire business of VSEC to date, November 10, 2012, would cost \$260.5 at \$52.10 per share.  The market price to date was \$21.81 per share.

## 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

#### Explanation

The net current asset value approach of Benjamin Graham tells us that the stock of VSEC was trading at an overvalued price from 2007 to ttm6 2012 because the market value per share was greater than the 66 percent of the NCAVPS. The 66 percent ratio was only 18 percent of the market value per share.

It tells us that the stock of VSEC has not passed the stock test by Benjamin Graham because the price was expensive.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV).  The idea is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying. So, let us see if the stock of VSEC passed the test.

MC/NCAV valuation shows that  VSEC stocks were trading at an overvalued price because the ratio exceeded the 1.2 ratios of 2007 to ttm 2012. What does this mean? It indicates that the price was expensive and therefore, it did not pass the stock test of Benjamin Graham.

### Benjamin Graham’s Margin of Safety (MOS)

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.

#### Explanation

Benjamin Graham’s margin of safety valuation shows that there was a margin of safety for VSEC from 2007 to ttm 2012 at an average of 76 percent.  In ttm 2012, the margin of safety resulted in 71 percent.

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

#### Explanation

EPS represents the company’s last 12-month earnings per share, G for the company’s long-term (five years) sustainable growth estimate,   9 is 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), and  2 is the average yield of high-grade corporate bonds.

Looking closely in the above table, there was an average of \$12 for the intrinsic value, while SGR was 22 and EPS was 4 percent.

#### Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio.  Formula: Sustainable growth rate = ROE x (1 – dividend-payout ratio)

#### Explanation

VSE Corporation’s Return on Equity got a  23 on average, while the payout ratio was 5.25 average.  There was a payout ratio from 2007 to ttm6 2012 because VSEC was paying cash dividends to its shareholders.

There are two approaches to calculating the sustainable growth rate. The first one is by using the relative ratio and the other one is by using the average return on equity.

As we can see, a higher result was produced using the average ratio. The margin of safety was higher also by 1 percent using the same ratio.

The space between the intrinsic value line and the enterprise value line is the margin of safety. Converting it to figures we got 76 percent, this is measured by the difference between the two lines as shown in the table of the margin of safety.

## VSE Relative Valuation Methods

The relative valuation methods for valuing a stock is to compare the market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

### Price to Earnings/Earning Per Share (P/E*EPS)

How to do this is by simply 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. From there we can determine the status of the stock price.

The P/E*EPS valuation shows that in 2007 and 2009, the stock of VSEC was fair valued while from 2008 to 2010 going forward, the price was overvalued. Because the enterprise value was greater than the P/E*EPS ratio.

The enterprise value per share was over by 34 percent against the P/E*EPS ratio, therefore, the price was overvalued.

Using the average price to earnings ratio in calculating this valuation, produced a higher ratio than by using the relative price to earnings ratio. The result was higher by 7 percent.

### Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)

The use of this ratio is to separate price and earnings in the enterprise value. The process of this is dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

#### Explanation

The EV/EPS valuation tells us that price (P/E) was 25 percent. On the other hand, the earnings (EPS) was  75 percent average out of the enterprise value per share. This indicates that the price was undervalued using the enterprise value. The discretion on this valuation depends on the analysts whether the ratio was appropriate or not.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

The EV/EBITDA valuation indicates that it will take 6 years to cover the costs of buying the entire business. In other words, it will take 6 times the cash earnings of the company to cover the purchase price. It will be a long period of waiting. VSEC has the free cash flow for 2008 to ttm6 2012.

Conclusion:

The market value of VSE Corporation was decreasing at a rate of nine percent average.  Total debt was 24 percent and the cash and cash equivalent was 1 percent of the enterprise value. Buying the entire business would be paying 87 percent of its equity and 23 percent of its total debt. Buying the entire business of VSEC to date, November 10, 2012, would cost \$260.5 at \$52.10 per share.  The market price to date was \$21.81 per share.

On the other hand, the net current asset value approach shows that the stock has traded at overvalued prices. For the reason, the stock was trading above the liquidation value of the company. While the MC/NCAV valuation shows that the ratio exceeded 1.2. Therefore the stock of the company did not pass the stock test.

#### The Margin of Safety

Further, the margin of safety indicates a 76 percent average margin of safety. The intrinsic value was \$212 average. The sustainable growth rate was 22 percent, and the annual growth rate was 53 percent. While the return on equity was 23 percent.

Furthermore, the relative valuation method tells us that the stock price was fairly valued in 2007 and 2009. While in 2008, 2010 onwards, the price was overvalued. The price to earnings using the relative ratio was 9 percent. While the average price to earnings ratio was 10 percent. Using the average ratio, the P/E*EPS ratio was 85 percent against the relative ratio of 78 percent.

#### Relative Valuation

EV/EPS valuation indicates a price (P/E) of 25 percent and earnings (EPS) of 75 percent. This might indicate that the price was cheap. While EV/EBITDA shows 6 years or 6 times for the earnings of VSE to cover the costs of buying VSE

Overall, the stock price was expensive. A HOLD position is recommended in the stock of VSE Corporation.

Researched and written by Criselda

# The First Marblehead Corporation (FMD) Stock Expensive

December 3rd, 2012 Posted by No Comment yet

The First Marblehead Corporation (FMD), a focus on finance company, education financing marketplace in the United States. Headquartered in Boston, MA and was founded in 1991.

# 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.

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

The market value of The First Marblehead Corporation was decreasing in value that during 2008, it was deteriorated by 91 percent and 1 percent of the succeeding periods thereafter. The total debt of the company was 88 percent average of the enterprise value, while its cash and cash equivalent were a 10 percent average, thus the enterprise value was greater by 78 percent against the market capitalization. Purchasing the entire business of FMD would be paying 22 percent of its equity and 78 percent of its total debt. This is the price that an investor is willing to pay in buying FMD.

The costs of buying the entire business of FMD to date, November 11, 2012, will cost \$0.00 because its cash and cash equivalent were greater than the market capitalization and there was zero debt in the current year ttm9 2012. I’m a bit confused so I asked Cris to further elaborate. And she said, “It is like buying at a discount or buying for free because the market capitalization is \$96 and the cash and cash equivalent is \$127. This means you pocketed the \$31 (\$127-\$96) cash. The market price to date was \$0.84 per share.”

## 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 is trading in a bargain, and it is worth buying.

### Net Current Asset Value (NCAV) Method

The net current asset value approach tells us that the stock of FMD was trading at an overvalued price for the period 2007 to ttm9 2012 because the market value was greater than the 66 percent ratio. The 66 percent represents only 19 percent of the market value, therefore, the price was expensive.

I tell us further that the stock was trading above the liquidation value of  The First Marblehead Corporation itself, therefore, the stock did not pass the stock test of Benjamin Graham.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV).  If the result does not exceed the ratio of 1.2, then the stock passes the test for buying. We gonna go moving and discuss the table below. Want to find out if the stock of VSEC passed the stock test.

The MC/NCAV valuation method indicates that the price was overvalued in 2007 to ttm9 2012 except in 2010 where the price was undervalued. The price was overvalued because it exceeded 1.2 ratios, while in 2010, the price showed the opposite. The First Marblehead Corporation didn’t pass the stock test and therefore the priced was considered expensive.

### Benjamin Graham’s Margin of Safety (MOS)

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.

#### Explanation

The First Marblehead Corporation’s margin of safety was 53 percent on average. During ttm9, the margin of safety was 100 percent because the enterprise value was zero dollars. There was a zero margin of safety for 2007 and 2010.

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

The explanation in the calculation of intrinsic value was as follows:

EPS: the company’s last 12-month earnings per share,  G: the company’s long-  term (five years) sustainable growth estimate, 9: the constant represents 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.

The table above showed that intrinsic value’s average was \$147, SGR was negative 24 and EPS was 2 percent.

#### Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its blowback ratio, which is equal to 1 minus the dividend payout ratio.

#### Explanation

The return on equity of FMS was negative 24 on average, same as the sustainable growth rate because there was no payout ratio for FMD. The company was not paying cash dividends to its shareholders.

There are two approaches in computing the sustainable growth rate and that is by using the relative return on equity and the other one is by using the average ratio. To make it clearer, she said she summarized the results of these two approaches in the table below.

By using the average approach, we get a higher percentage margin of safety at 69 percent against the relative approach which was about 53 percent.

#### The Intrinsic Value Graph

The intrinsic value line soared up very high in 2008 at 255 percent because the growth of FMD was negative and it’s earning per share was also negative. Its net earnings in 2008 were negative 827 percent. Then the following period, 2009 it slopes down at negative 76 percent, the net earnings were again negative at 125 percent. Until 2010, it was sloping down below zero at -20. Then, it started to raise up to 544 percent in 2011.

The space in between the two lines, the enterprise value line and the intrinsic value line is the margin of safety. The average margin of safety was 53 percent.

## FMD Relative Valuation Methods

The relative valuation methods for valuing a stock is to compare the market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

### Price to Earnings/Earning Per Share (P/E*EPS)

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, we can determine the status of the stock price.

The P/E*EPS valuation indicates that the price of FMD was overvalued. It was overvalued because the enterprise value per share was greater than the P/E*EPS ratio. The P/E*EPS ratio represents -36 percent of the enterprise value.

The price of FMD was expensive from 2007 to ttm9 2012. I used the relative approach in this valuation. But there is also another approach to calculating P/E*EPS valuation and this is by using the average price to earnings.

By using the average approach, it has a positive price to earnings ratio compared to by using the relative ratio where it produced a negative result.  In an average approach, we consider the previous performance of FMD.

### The Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS)

The use of this ratio is, to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

For EV/EPS valuation, the price (P/E) out of the enterprise value was negative 1 percent, while the earnings (EPS) were 101 percent. This might indicate that the price was expensive because the enterprise value represents 100 percent earnings.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.  It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

The EV/EBITDA valuation shows an average of negative 31 results for FMD. This means, there was no definite period to cover the cost of buying. However as mentioned earlier, enterprise value valuation indicates that buying FMD would be a discount or like buying for free.

One more idea about this valuation is this will also tell us the profitability of the company. Wherein, The First Marblehead Corporation shows that the financials of the company was not favorable. Since its net earnings were negative 1244 percent.  FMD suffered losses since 2007 for the trailing twelve months 2012.

In conclusion,

The market value of FMD was decreasing at a rate of 26 percent average.  The total debt represents 88 percent average and its cash and cash equivalent represent 10 percent average. Thus the enterprise value was greater by 78 percent against the market value. Purchasing the entire business of FMD would be paying 22 percent of its equity and 78 percent of its total debt.

Buying the entire business of FMD to date, November 11, 2012, will cost zero dollars. Because its cash and cash equivalent were greater than the market capitalization and the company has zero debt. It is like buying for free, the investor will pocket the remaining cash of \$31 (\$127-\$96).

#### Net Current Asset Value Approach

The net current asset value approach indicates that the stock of FMD has not passed the stock test. Because the stock was trading above the liquidation value of FMD.  While in MC/NCAV the result shows that the ratio exceeded the 1.2 ratios. Therefore the price was expensive.

The current MOS was 100 percent because the EV was zero value. The growth for FMD was negative, meaning zero. Moreover, the relative valuation shows that the price was expensive. Because the enterprise value was greater than the P/E*EPS ratio from 2007 to the ttm9 2012.  While in EV/EPS it also tells us that the price was -1 percent and the earnings were 101 percent average. Therefore the price was expensive.

#### EV/EBITDA

EV/EBITDA valuation shows an average of -31 times for the company. In other words, there was no definite period to cover the cost of buying the entire business. However, we can take into consideration the result of enterprise value valuation. Wherein, buying FMD is like buying for free, since, there was zero enterprise value. An investor will pocket the remaining cash of \$31 million.

Overall, the margin of safety was 53 percent average. Moreover, the stock was trading at an overvalued price. In other words, the price was expensive.  Therefore, I recommend a SELL in the stock of The First Marblehead Corporation (FMD).

Researched and Written by Cris

Interested to learn more about the company? Here’s investment guide for a quick view, company research to know more of its background and history; and value investing guide for the financial status.

# Coach Inc (COH) Investment Valuation

December 2nd, 2012 Posted by No Comment yet

Coach Inc (COH) is a accessories and lifestyle company. It designs and market clothes and accessories. Moreover, they market handbags, leather goods, footwear, fragrance, jewelry, outerwear, ready-to-wear, scarves, sun wear, travel accessories, and watches.

## Coach 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.

## Coach 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.  The formula is given below:

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)

#### Explanation

The table shows that the market capitalization for Coach Inc was quite stable at \$13 billion and was trending at about 4 percent average. The total debt represents 0.2 percent of the enterprise value and the cash and cash equivalent represent 6 percent, thus the enterprise value was lesser by 6 percent against the market value. This indicates that let’s say you would buy the entire business of Coach Inc, you would be paying 100 percent of its equity and no debt.

Buying the entire business of Coach Inc to date, November 14, 2012, will cost \$14462 at \$49.53 per share.  The market price is \$54.14 per share.

## 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 is trading in a bargain, and it is worth buying.

### Net Current Asset Value (NCAV) Method

The net current asset value approach shows that the stock of Coach Inc was trading at an overvalued price from 2007 to the trailing twelve months 2012 because the market value was greater than the 66 percent ratio of NCAVPS.  The 66 percent ratio represents 5 percent of the market value, thus it was overvalued.

Taking into consideration the statement above, it tells us that the stock of Coach Inc was trading above the liquidation value of the company, therefore the price was expensive and did not pass the stock test of Benjamin Graham.

### Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation

Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV).  The idea of this is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying. So, let us see if the stock of COH passed the stock test.

The MC/NCAV valuation tells us that the price was overvalued from 2007 until the trailing twelve months 2012 because the result of the ratio exceeded the 1.2 ratios.  It shows that the price was expensive. Hence, the stock of COH did not pass the stock test by Benjamin Graham since 2007 to the trailing twelve months.

### Benjamin Graham’s Margin of Safety (MOS)

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.

#### Explanation

The data above shows that there was a margin of safety for Coach Inc from 2007 to the trailing twelve months 2012. The average margin of safety was 84 percent average. The highest margin of safety was illustrated in 2008 at 89 percent.

Intrinsic Value =  Current Earnings x (9 + 2 x Sustainable  Growth Rate)

EPS: the company’s last 12-month earnings per share,  G: the company’s long-term (five years) sustainable growth estimate, 9: the constant represents 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), and 2: the average yield of high-grade corporate bonds.

Intrinsic value (IV) was \$253 on average. By the way, do you know what factors IV? These are the earnings per share (EPS) and sustainable growth rate (SGR).

#### Earnings per Share (EPS)

Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio.

#### Explanation

The sustainable growth rate of Coach Inc was 49 percent, while the return on equity ratio was 50 percent average and the payout ratio was 17 percent average. Return on Equity (ROE), as defined, is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners.

Return on Equity shows how many dollars of earnings result from each dollar of equity.  There are two approaches in calculating the sustainable growth rate, these are the relative ratio approach and the average ratio approach.  I have summarized the difference between these two approaches in the table given below:

#### Explanation

The table shows that using any of the two approaches for COH will produce the same percentage of the margin of safety. By using the average approach, we take into consideration the prior performance of the company.

The intrinsic value line was high above the enterprise value line, this means that there was a margin of safety. Hence, it was far above the price, it means the percentage of MOS was great.

## Coach Relative Valuation Methods

The relative valuation methods for valuing a stock is to compare the market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

### Price to Earnings/Earning Per Share (P/E*EPS)

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). Then comparing it to the enterprise value per share, we can determine the status of the stock price.

The P/E*EPS valuation indicates that the price was undervalued for 2007, 2009 to ttm9 2012. Because the enterprise value was lesser than the P/E*EPS ratio. The enterprise value represents 87 percent average of the P/E*EPS ratio.

Overall, it shows that the price was cheap from 2007 to the trailing twelve months of 2012. I have made a comparison between the two approaches in calculating the P/E*EPS ratio. By using the relative price to earnings ratio and the other one is by using the average price to earnings ratio.

By using the average ratio, it is more favorable because it shows a higher percentage of the P/E*EPS ratio.

### The Enterprise value (EV/Earning Per Share (EPS) or (EV/EPS)

The use of this ratio is, to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

The EV/EPS valuation tells us that the price (P/E) was 35 percent and the earnings (EPS) was a 65 percent average.  It indicates that the price was understated because the price is only 30 percent of the enterprise value.

### Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.  It gives us an idea of how long it would take the earnings of the company to pay off the price of buying including debt.

#### Explanation

The EV/EBITDA tells us that it will take 9 years to cover the costs of buying the entire business. In other words, it will take 9 times of the cash earnings of COH to cover the costs of purchasing.

The EBITDA represents 11 percent of the enterprise value. Digging into the Financials of Coach Inc, its net profit margin was 21.46 percent average, a fair percentage of profit. COH has a free cash flow of 2007 for the trailing twelve months 2012.

In conclusion,

The market value of Coach Inc was stable at \$13 billion and was trending at about 4 percent average.  The total debt represents 0.2 percent while the cash and cash equivalent were 6 percent of the enterprise value.  Thus, enterprise value was lesser by 6 percent against the market value. Buying the entire business of COH is paying 100 percent of its equity.

Buying the entire business to date, November 14, 2012, will cost \$14462 at \$49.53 per share. While the market price to date is \$54.14 per share.

The net current asset value approach indicates that the stock was overvalued from 2007 to 2012. Because the stock was trading above the liquidation value of the company.  While the MC/NCAV valuation shows that the price was overvalued too from 2007 to 2012. Because the ratio exceeded the 1.2 ratios. Therefore, it tells us that the price was expensive, therefore, did not pass the stock test of Benjamin Graham.

#### The margin of Safety (MOS)

The average MOS was 84 percent. The growth of COH was as follows: for the sustainable growth rate is 41 percent. While the annual growth rate was 91 percent average, and the return on equity was 50 percent average. The intrinsic value was \$253 average.

On the other hand, the PE*EPS valuation shows that the price was undervalued. Because the enterprise value was lesser by 3 percent against the P/E*EPS ratio. While the EV/EPS indicates that the price (P/E) was a 35 percent average. Moreover, the earnings (EPS) was a 65 percent average.

#### EV/EBITDA

EV/EBITDA valuation, it will take 9 years to cover the costs of buying the entire business of COH. In other words, it will take 9 times of the cash earnings of COH to cover the purchase price.

The margin of safety is 84 percent and the relative valuation shows that the price was cheap. Therefore, recommend a BUY on the stock of Coach Inc.

Research and Written by Cris

Interested to learn more about the company? Here’s company research to know more about its background and history; and value investing guide for the financial status.