Monday, October 30, 2006

Earnings yield

Earnings yield is the reciprocal of the Price Earnings Ratio or P/E Ratio or PER. For those mathematically inclined, well you know what's a reciprocal, as in not "you love someone and someone love you back" that kind lah.

For those who thought that it was "you love someone and someone love you back", umm ok you are wrong and here's the correct formula:

P/E Ratio = Share price / Earnings per share (EPS)
Earnings yield = Earnings per share (EPS) / Share price


P/E Ratio = Mkt cap / Net Profit
Earnings yield = Net Profit / Market cap

If you still having problems, try reading a few related posts below.
1) Price Earnings Ratio
2) Market Cap
3) Net Profit

Ok, now that we know what is Earnings Yield, let's try to examine it further. Now if you think about it, Earnings Yield is actually the return that you can get by investing in this stock. Say if a stock has an Earnings Yield of 10%, it means that by investing $100 in the stock, you would get $110 back by the end of the year.

Now if you get this, cheaper P/E means higher return right? Because Earnings Yield of 10% would mean that the P/E of the stock is 10x. (10% = 0.1 and reciprocal of 0.1 = 10.) And P/E of 10x is damn bloody cheap because it means that the stock can give you 10% return p.a. and as we all know (hopefully) investment on average earns you 5-8% over the long run.

Consider NOL, which trades at P/E of 3x, it means that its earnings yield is 33%. Sounds like a screaming buy right? Actually, it is a huge debate right now, nobody knows the answer. This is because no one is sure that the P/E can remain at 3x, say 5 yrs from now. This means that some players in the market think that NOL may lose truckloads of money in the next 5 yrs. And he is not willing to buy it now, even if NOL is super cheap today.

As with intrinsic value and forward PER (i.e. P/E ratio in the future) guesswork is involved here. And the guesswork is the usually the one thing that determines whether you will lose truckloads of money or not. Well investing is not easy, I guess. Earnings yield is just another tool to try to make solving a 10 trillion step equation 1 step easier.

See also What drives stock prices
and Expectations vs Reality

Tuesday, October 24, 2006

What the heck drives stock prices?

Now this is the million dollar question isn't it? I am delighted to inform you that there are a million answers. Below is a non-exhaustive list of the most relevant answers.

1) The weather
2) Coffeeshop talk on stocks
3) Greenspan's or now Bernanke's facial expressions
4) Fart from sell-side analysts
5) This blog (when MoneyMind features it in 6 yrs time)

There are another 999,993 answers that drive stock prices in the short run which I will omit for obvious reason of space constraint. And two answers that drive stock prices in the long run. By long run, I do not mean 24 hours, or 2 weeks, or 3 months. Sorry, 2 yr with your steady also not long enough. Long run means 5 to 10 to 30 years. Yes, really really LONG RUN.

The answer is consistent earnings growth and valuations. If a company can consistently grow its earnings for the next 30 yrs, AND, further if current stock price has not factor that in, then the stock is a buy.

Now if you really think about it, how many co.s 30 yrs ago grew their earnings for 30 straight yrs? And if they did, wouldn't their earnings probably be like a gozillion times larger since it is compounded over 30 yrs. Well you are right and the answer is, maybe about 5 co.s, globally.

This illustrates how hard it is to find a good company and how harder it is to find one that actually trades below its intrinsic value. This is the truth. And this is value investing. But it is not impossible and the prove is Warren Buffett.

Now just for the fun of it, I have included a list of irrelevant stuff that will drive a lot of monkeys on Wall Street crazy. Be careful when you show this list, sometimes they will be delighted and shit bananas and sometimes they will run wild without their shirts.

1) Quarterly earnings announcement
2) Recommendation change from sell-side analysts
3) Technical outbreaks on stock charts
4) Update on economic indicators
5) News on stocks like M&A, new product launch, CEO change, dividend increase, share buyback, alliance with competitors, entry into new businesses etc

See also Good company but not a good buy
and SWOT analysis

Thursday, October 19, 2006


As I have mentioned before, on Wall Street, when one no. is divided by the other, cults are formed. This ratio is behind one of the biggest, most controversial cult around. Why is it so? First, because it is very difficult to pronounce. It has 5 syllabus. There are only about 10 words in Singlish with 5 syllabus, so most Singaporeans won't be able to pronounce it, including the blogger who writes this blog.

EV/EBITDA, pronounced as (EE-VEE-EE-BIT-DAH) tries to measure the cheapness of a stock. i.e. similar to other valuation metrics like PER or PBR. Pls do not try to pronounce it as EVITA, I know it is very tempting but pls don't. Regardless of whether you are a fan of Madonna or Britney Spears.

EV stands for Enterprise Value which is the value of the entire firm to both shareholders and debtholders. Its formula is shown below:

EV = Market Cap + Net Debt
Market Cap = Read this post
Net Debt = Total Debt - Cash

And EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortization. Whatever that means. Well for those really interested, read this post. For those really not interested, well let's just say EBITDA tries really hard to measure some kind of profit (not the kind most good old value investors would like lah).

So, in essence, EV/EBITDA tries to measure the intrinsic value or cheapness of a company, just like PER or PBR. But it looks at it from the perspective of both the shareholder and the debtor. (The other two ratios only look at it from the shareholder's perspective.)

On top (the numerator), it takes into account both market value (or market cap) of the company, and its debt. At the bottom (the denominator), it looks at profits before interest, tax and even depreciation. Well from this ratio's creator's point of view, this is profit attributable to both the shareholder and the debtholder.

So, there you have it, a new ingenious ratio, and a cult is born. EV/EBITDA followers now flood the markets. Rituals are performed now and then when analysts hold hands and chant EV/EBITDA 20 times, and the leader shouts "hip hip", and the rest let out "hurray". Like Singapore secondary schools' sports day.

Ok, just kidding, shit like this don't happen anymore. Singapore secondary schools have moved on to Queen's "We'll Rock You", which used to be a JC thingy. But here's what's really important. EV/EBITDA ranges from 5-25x nowadays with fair value usually at 10-15x.

See also Financial Ratios
and SWOT analysis

Saturday, October 14, 2006

Intrinsic Value - Part 2

This post is updated in 2013.

The intrinsic value is determined by the future cashflows that an asset earns. In the case of stocks, it is earnings and is partially transferred to investors via dividends. In the case of property, it's the future cashflows coming from the rental income. In bonds, it is interest income. In businesses, it is real cash generated. When an asset has no cashflow, we can safely say that it has no value. This means that in today’s context, there are many things actually being masqueraded as investments such as wine, art, watches and some may even consider gold.

The ways and means to calculate intrinsic value is called Valuation. In the purest form, it is by discounting all the future cashflows back to the present and that determines the intrinsic value. This methodology is known as discounted cashflow or DCF. This is very high level stuff and for those who are really, really interested, please continue to read my 1,500 word thesis under the Value Investing Page.

Luckily, for the rest of us, I have updated this simple methodology to determine a stock's intrinsic value right here, in this post. For an earlier tongue-in-cheek discussion, please refer to my previous post on intrinsic value. In this post, I shall attempt to calculate the intrinsic value of some stock using PER and EPS. Now please understand this is really cutting really big and round corners.

Anyway, the idea behind is actually quite simple. Basically you must first have an idea of what is the true PER of the stock, and what is its sustainable EPS, say 5 to 10 years in the future. PER stands for price earnings ratio and it represents a multiple that we should pay when buying something based on its earnings power. EPS, which stands for earnings per share, is one simple way to measure that earnings power.

A simple analogy is property, Singaporeans' favourite topic. The equivalent of EPS would be the rental income and the equivalent of the multiple is the inverse of the rental yield that we are prepared to pay. Say Sky Habitat (my favourite property in Bishan) has an annual rental of $48,000 (or $4,000 per month) and the right rental yield should be 4%, or inversely a "mulitple" of 1/0.04 = 25x. This means that the price of this Sky Habitat condo should be 48k x 25 which gives us $1,200,000. Today Sky Habitat condo sells for $1,500,000 to $2,000,000. What does this says about its price vs intrinsic value? :)

In the case of stocks, we can use the same methodology by multiplying the PER with EPS and get the intrinsic value. For those still blur, don't worry, here's the formula:

PER = Share price / Earnings per share (EPS)

if we swap the formula around,

Intrinsic value = true PER x sustainable EPS

Simple right? But do take note of the words in italics: true and sustainable.

So, how do we know what is the true PER of the stock? The true PER isn't next year's PER as it is commonly used in today's market. It is a reflection of the really correct multiple that we should use. This has to be determined by looking at the historical multiple of the stock in question, or by comparing with peers, or by thinking in terms of the growth, stability of the business etc. Usually, the multiple ranges from 12-18x. Personally, I would be very reluctant to pay for anything more than 18x PER. There is a lot more in-depth discussion on this and it can really intellectual simulating and interesting. I am not kidding. Interested parties please continue to read my 1,500 word thesis under the Value Investing Page.

Next we need to determine its sustainable EPS. Again this is not the current EPS, or next year's EPS. It has to be a sustainable EPS over a decent time period, say, 5 to 10 years. In fact, for most value investors, they would be looking for sustainable EPS over much longer periods, like 10 or even 20 years. Of course it is almost impossible to be able to determine with accuracy over such time frame. Which is why Buffett has a tendency to invest in certain kinds of businesses which allows for some predictability over long time frames.

Ok let's use a real stock to illustrate this intrinsic value thing. I would like to use Singtel, our largest stock that has the longest history.

Singtel has managed an average EPS of 22c to 28c over the last 10 years. So assuming that it can maintain this, we can say that it's sustainable EPS is probably 25c. Now we need to determine its true PER. Again looking at its own history, it has traded around 12x to 17x.  Globally telcos have also traded around 8x to 20x PE. So what's the right number to use? There isn't really much science here, I would use 15x.

So Singtel's intrinsic value should be 0.25 x 15 = $3.75. Today it is trading at $3.60. So it's a buy?

Well, the answer is no, because our calculations may be wrong. What if the true PER is 14x? Or what if the potential EPS is only 22c?. If you work if this new set of no.s, (0.22 x 14 = $3.08) Singtel is now 15% overvalued!

Intrinsic value is not just a single number, it has a range of probable values. It changes when we use different assumptions and nobody ever gets it right. And I really mean nobody, not even the Gahmen and definitely not the Korean pop group who declared "Nobody, Nobody but You".

Ok jokes aside. Since we can never be sure we got the intrinsiv value, that's where we need the margin of safety comes in. For those not-so-familiar, pls read the post on margin of safety.

However, if Singtel ever trades at $2.00. Then it is definitely a buy, because no matter how you tweak the two no.s (PER or EPS), you probably find it very hard to get Singtel's intrinsic value to go below 2 bucks. In fact, Singtel has only traded at 2 bucks for a brief period over the last 10 years, the recent bout during the Global Financial Crisis in 2008 which is like 5 years ago. In other words, it is damn bloody difficult to find great companies trading below its probable range of acceptable intrinsic values for long. This is the challenge and this is value investing.

Singtel's stock price from 2004 to 2013

See also Definition: Value investing
and Expectations vs Reality

Saturday, October 07, 2006

SWOT Analysis

SWOT Analysis is a method developed to analyse an individual company through a framework. It is much loved by Wall Street and you can usually find it in the Initiation Reports of companies by Wall Street analysts. This pretty much tells you that SWOT analysis is perhaps as useful as a piano is to a monkey who is hungry for bananas. i.e. quite useless. Nevertheless, let's take a look.

SWOT stands for Strengths, Weaknesses, Opportunities and Threats which is basically four aspects of looking at a certain company and see if it is worth investing. The words are probably self-explanatory but as an example, let's see how it works.

Strengths: Usually depicts the company's plus points, like having a high market share, or a competitive edge over its rivals, or the ability to raise prices despite public outcry, with the support from the Government (yup that's the right spelling, also don't forget the capital G).

Weaknesses: The company's minuses, like high operating costs, weak product pipeline, poor branding, poor customer service, zero disclosure to shareholders and/or potential investors, labelled as an ugly duckling on Wall Street (that's pretty bad, because Wall Street doesn't like swans either) etc.

Opportunities: Events that will affect the company positively, like a new market for its products, or potential for the firm to be acquired, or the ability to acquire other smaller competitors, or Gahmen, oops sorry, Government support etc.

Threats: Things that will threaten the company's position. E.g. unfavourable regulatory changes, entry of a formidable new competitor, technological evolution that will render the co's product useless, consolidation between suppliers or clients etc.

So that's how SWOT does it. Systematically analyze four aspects and determine the company's position in each of them. Perhaps the takeaway behind SWOT is not just looking at the four aspects but more to analyse a company using a framework or system. This will help one to see the company is a better light, and hopefully make a better investment decision.

PS: Takeaway literally means "da bao" i.e. taking some good food/good babe back home or taking away an important lesson to be remembered.

See also Expectations vs Reality
and Financial Ratios

Sunday, October 01, 2006

Is investing a zero-sum game?

This is one question that I would like to answer a long time ago but have always thought I don't have a good answer yet. Nevertheless, I shall attempt to answer that today. Is investing a zero-sum game? I think the answer is both yes and no.

BTW, this post is talking about investing in general, which include fixed deposits, bonds, stocks etc, so not just stock alone, ok hor?

The answer is partly yes, it is a zero-sum game, because whatever you buy, you will have to sell to make a real profit (as in not just paper gain), and whoever bought it from you would be deprived from the amount that you profited. So whatever you gained, he would have "lost" (or failed to gain).

However, we must understand that the world's economy has been growing on average 3-5% p.a. for the past 100 yrs and stocks have grown at roughly 10% p.a. while bonds roughly 5% p.a. So in aggregate, investors would have earned roughly 5-8% (Hence this blog is called 8% p.a., in case you haven't realized), depending on their portfolio mix and also assuming that whatever they invested in did not go bankrupt or go into default. (Actually if they diversify, even if some investments become zero, others would have made up for it. So in aggregate their portfolios will still earn a positive return)

So this is to say, even when you sold your stock at a profit to the next guy, he will not necessarily lose money, because in aggregate, everything will grow, at the very least, with the world economy. He will at least earn 3-5%, if he simply buy government bonds, or 10% if he put everything into stocks.

In other words, the "zero" in the zero-sum is actually 3-5% (which is also roughly the global GDP growth rate) and for stocks, the zero is maybe 8-10%, depending which market you invest in. Hence the "no": as in investing is not a zero-sum game, if someone earns money, it does not mean that someone else is losing money.

To conclude, in the game of investing when you make a realized profit, you deprived someone of that profit but if the next person holds it long enough, he will not lose money, because at the very worse, his investment will grow at the same rate with global economy.

See also The Greater Fool Theory
and Markowitz Portfolio Theory