Tips to Identify Undervalued Stocks

How do we know which stocks are undervalued? 

I usually use these tips below to determine valuation to a certain degree:

1. Price-to-book < 1
2. Forward P/E < 15
3. Price/Free-cash-flow < 5
4. Decent EPS growth for the last 5 years
5. EPS forcast for next 5 years > 0%
6. Payout ratio is below 20%

Sometimes you can get all the information out there. Most commonly i use P/E ratio to judge whether the stock is being overbought or oversold. These values are usually available on the web, but if you are like me, you may build an excel spreadsheet to easily tabulate all the information using the simple equations below:

Price to book ratio = (Stock price)/(Total Assets - Intangible Assets & Liabilities)

 

Forward P/E = (Market Price per share)/(Expected earning per share)

 

EPS = (Net Income-Dividends on preferred stock)/(Average outstanding shares)

 

Payout Ratio= (Dividend per share)/(Earnings per share)

 

Over the last 2 years, I have learned how to value stocks properly without having to pay hundred of $$$ to financial courses. Anyone can learn how to do it for themselves!

 

Market Direction Mar'2013

Nobody can tell which way market is going to head in the future but one can make reasonable judgements. Investors usually have a general idea which way market is headed like during a bear or bull market trend. But its fascinating to observe what "financial experts" are saying on TV, writing on major news websites and what bloggers are writing about. It gets really interesting when we reach changing point in market direction, in my opinion, majority of analysts on TV state too little too late. If you are forming your opinions on market direction and reacting to news on a daily basis, you are probably guaranteed to get caught up in a trade you regret making. 

March Market Update:

No doubt, US market has had a great run from mid 2012 till now. China stocks have climbed as must as they can, now going through a healthy correction. Singapore market is at very healthy levels but needs to go through minor consolidation before it can move higher. 

Wall street rose again last night. But i am worried. In fact whenever I see penny stocks in Singapore and US being hyped up, time to be a little careful. Its true what Warren Buffett once said : "Be Fearful when other are Greedy". 

I also get very worried when Jim Rogers start showing up on the radar again, nothing against him personally. The situation in Cyprus is just a distraction, nothing else.

How can we tell if market it going to change direction? What are the indicators? Here is a few:

1. Penny stocks will start flying

2. Jim Rogers start appearing on every show

3. Put Warrants/Options become popular

4. When Motley Fool publishes articles like "America's next boom"

Of course in all seriousness, I don't actually think we have reached a turning point in the market now. Good News is that: Most companies in US are at healthy P/E ratios, expenditures and jobs are being cut, earnings estimates are within reach, its mostly looking good but it is creating a complex situation which kind of throws me off balance.

Anyway you should be alright if you make investments based on valuation, shift money to companies that do well in bear markets. It is inevitable that market will lose steam, change direction and head lower, the million dollar question is WHEN?     

Future prospects of Mondelez (MDLZ)

I had a good run with Kraft Foods(KFT) previously, then it split into its slow but high dividend paying grocery business (KRFT) and fast growing snack foods business, Mondelez (MDLZ). At that time I took profit and got out just before the split since i didnt actually have alot invested in it. The formation of Mondelez was a strategic one by Kraft Management. Since the split however, MDLZ has gone nowhere while KRFT is up 14.5%. 

Recently though there have been some rumours floating around which might change things for Mondelez. They might be interested in acquiring Pepsi's snack businesses, including Frito-Lay, which will make MDLZ an even stronger food company. One has to take into account that same Irene Rosendfeld once ran Frito-Lay for Pepsi. Sale of Frito-Lay stakes to Mondelez would allow Pepsi to focus on their drinks business which i think is good. Look at Coca-Cola for instance, they ONLY do drinks, nothing else. It looks like a win-win situation for both companies and their shareholders too. 

The future prospects for Mondelez was already looking strong before this because of the incredible potential for growth in Asia, Latin America and Africa. As with everything else, give it some time, all the money spent on marketing their products will eventually pay off. currently trading @ $29.88, In the medium-long term, I value MDLZ @  around $41-44 range with an upside potential of 37%.

Disclaimer: I currently hold long positions in MDLZ.

 

A look at ExxonMobil

Previously I talked a little about commodity stocks. I came across this rather interesting article on Seekingalpha.com, which prompted me to share this information with my readers.

I have been long on Oil and Gas for some time but stayed out because it was too expensive, but the 2008 market crash gave me an opportunity to get into ExxonMobil (XOM).

Anyways the original author of the article has some very interesting graphs on energy demand and population growth predictions till 2040. See below graph 1-World energy Consumption and graph 2- World population growth:

Graph 1: World Energy Consumption

Graph 2: World population growth

There is a huge correlation and we have a reason to be bullish about companies such as ExxonMobil who are extracting and supplying these commodities. Over the last 100 years, world population has increased 7 times, and it is headed towards 9 Billion by 2040. Although I may not agree totally with this figure, I still agree that population is headed higher. 

Side note: I still remember while I was studying a Sustainable Engineering module in University, world population is expected to hit 10 Billion by 2030 then start declining. This is unsustainable, because Earth’s resources cannot continue to support such a large population; famine, draught, disease and war will eventually reduce population growth to a negative.

Back to topic, ExxonMobil published their 2013 Energy Outlook , which predicts 9 billion people by 2040 for some reason. Energy demand is going to increase exponentially because of two main drivers:

1. Population growth
2. Per Capita consumption growth

For a long term investor, it’s a clear cut decision to get on the bandwagon without worrying about day to day price fluctuations. However I suggest valuating energy companies such as ExxonMobil before taking any positions. I value XOM @ $94 currently but actually wouldn’t pay $90/share right now. It’s not worth the risk for me. I would rather wait and see if I can get in @ below $65/share.

Anyway WHY EXXONMOBIL? The original author also shared these graphs below comparing shareholder distributions among energy companies:

Graph 3: Comparison of Shartholder distributions

Graph 4: Distribution yield of ExxonMobil

ExxonMobil has a whopping! distribution yield of 7% over the past 5 years. Keeping in mind increasing energy demand over the next 30 years, and relative stability of XOM as a company makes it a good investment of choice. Just look at their historical chart below:

Very rarely does it drop tremendously low. in fact it has been trading in a parallel line since 1960s. I would suggest taking advantage of every market crash and accumulating its stocks over time. But of course, dont take my word for it...do your own research first. :)

Original Article by DevonShire can be found at address below:
http://seekingalpha.com/article/1293481-exxon-mobil-sports-a-juicy-and-reliable-total-distribution-yield-over-7

Disclaimer: I have a small position in ExxonMobil (XOM) and right now I am adopting a “hold and see” attitude. However I have no plans to initiate any positions within the next 72 hrs and highly recommend you do your own research to determine your own suitable entry and exit positions.

Is it time move into Healthcare sector?

If you recall my previous post, i estimate we are somewhere between a late stock market bull and peak of economic cycle. The chart recommends moving into consumer non-cyclicals and healthcare stocks. I am certainly more positive about consumer non-cyclicals such as Coca Cola, Pepsico, Krafts, Mondelez, Kelloggs. But what about healthcare stocks?

Last year, we saw pharmaceutical companies facing problems keeping hold of their patented drugs, some like Pfizer winning court cases to extend their licence to produce their blockbuster drug, Lipitor. But even if they lost the case, we as investors still could benefit from investing in generic drug manufacturers.
2013 looks like its going to be a bad year for large Pharma such as Eli Lilly. (LLY). Their full year revenues declined to $22.6 billion from $24.3 billion in 2011, total pharmaceutical sales were also down by 9% YOY. I believe their 2013 earning will continue to be lower than expected as their top grossing products loses patency. Having said that, they only give out a moderate dividend yield of $1.97/yr. I do think they are overvalued currently and i cant see their prices going beyong $60. Currently Eli Lilly is trading @ $54.66 and bouncing off top resistance level @$55.

I think its the same old story for Johnson & Johnson (JNJ). I had previous bought it @ below $65/share back in 2011 and held it till roughly end of 2012. I valued JNJ @ around $75, which it has actually exceeded. It has hit a huge resistance at $79.20 and many investors are getting out of it while its still overvalued. Actually JNJ is a great stock, their dividend payout is quite good (@ 3.2% annually). Like many investors, i think it was a good time to take profit and run.

I have given examples of 2 best Pharma companies in my opinion and both of them are not showing good opportunities. Sometimes one cannot follow the market cycle blindly too, do your own due dilligence before investing in any stock.
You might find a great healthcare stock that is undervalued, study it properly before investing. It seems to me, most healthcare stocks are overvalued right now. 

Market Cycles

Actually there are many cycle theories, Economic/Business Cycle, Market Cycle, Presidential Cycle, holiday cycle and so on. To me, stock market and the economy moves in tandem and it is the most relevant to investors today.

According to Investopedia, Market Cycle is defined as "Trends or patterns that may exist in a given market environment, allowing some securities or asset classes to outperform other". Everything in nature has a pattern, even man-made financial systems have a pattern. I would recommend the movie "Pi" for anyone interested to learn more about patterns in man-made systems and how they display similarity to nature. A very weird but interesting movie.

Getting back to the topic, the phenomenon of market cycles exist and we as investors should take advantage of it as much as we can. Its actually quite hard to pin-point exactly what stage we are in the market cycle because of the lack of specificity. There is no specific beginning or ending to a phase. However, as with most market professionals, I agree they exist and our Investment Strategy should include short to medium term swings within the cycle.






















The big question is: Where are we in the market cycle???
Well that depends on your own interpretations, you might disagree with the following. In my opinion we are in the Late Bull phase in the stock market cycle, which also corresponds to the middle of economic recovery. I am expecting a peak in Gold and commodities by 2015 but this bubble is not sustainable. It will eventually burst sometime in 2015 when we are in the middle of a recession.

Inflation and central bank interventions through monetary policy easing has actually distorted the market cycle and skewed my previous predictions. In fact, I initially anticipated a recession starting 2nd Quarter of 2013 and have made preparations for it already (by taking profits and having ready cash). Now it looks like it will be 6-12months before we get into a bear market.


Forget what investement bank guru's are telling you, they have a reputation of telling you things a little too late. It is better for you to decide for yourself. Where do you think we are in the market cycle?

My Past Performance

Being a small-time retail investor and actually quite inexperienced, its vital to keep track of your investments so that we can learn from our mistakes. 

I want to share my past performance, and the kind of lessons it has taught me.

Below is a table of my recent trades. As you can see, some trades were closed at a loss...this is because i really did not see the counter moving higher anytime soon(6-18months), therefore would not justify holding on to a losing stock/unit. 

SMART TIP #1: Its important to cut your losses early and shift the capital elsewhere.

SMART TIP #2: Always stick to your target price and get out of the trade. (No point regretting later, like for example: why did i close Starhub @ $3.14 when now its trading at $4.20! That just was not my target, i never anticipated or valued Starhub at anything more than $3.20) So i don't regret my decision.

SMART TIP #3: Shift your capital around as you see fit during the fiscal year. Financials do well from Oct to Feb. Telecom and Consumer Goods are defensive plays and good to hold from March to Sept. Pharmaceuticals generally do well from May to Sept.

***Following fiscal cycle (business cycle) is one thing, trying to match with general Market cycle and trend is another. Therefore you need to match business cycle with Market cycle and trend. I will talk about Market cycle in another post.   

 

Coca-Cola is set to rise again

Recent News about Coca-Cola:

Coca-Cola (KO) catches an upgrade from Credit Agricole to Outperform from Underperform. The stock has been a noticeable laggard during the bull run of 2013. 

Coca-Cola has always been a defensive stock with steady dividend payout rising by 7% annually for the past. It also happens to be my favourite stock, which i have been waiting patiently the past 3 years for an opportunity to get in. Recent stock split makes it cheaper for us small retail investors where price was adjusted from $80 to $40/share. Also KO has not been performing well in the past few months. I suspect this is due to people taking profit year end and moving into riskier assets like Bank Of America, JP Morgan and Goldman Sachs. (Which have all risen significantly, I personally took 40% profit from GS @ my set TP: $155)  

Back to Coca-cola, the stock price has been consolidating at around $37-38. To me, it looks like a great opportunity to pick this stock up @ current price below $39 with a target price $55. However, for me actually, this stock would fall under Warren Buffett scheme of buy and hold. Keep in mind that coca-cola has 42.8% market share, its a $74billion dollar brand, sells 1.7 billion servings per day. If they raise the price of each serving by 10 cents, they would  be earning $170 million profit/day. 

Insights On Commodity Stocks

Given the current inflationary environment, it is good to diverfisy your portfolio to include some commodity based stocks. Many companies benefit from rising commodity prices which we are observing over the past 12 years.

If you are bullish about certain commodities, you might want to purchase shares in companies that are involved in their production. But consider doing your own research into the company business structure before investing any money into it, like whether they have ownership of the commodities or provide services for the extraction and procurement of these commodities. For example Apache (APA) is involved in oil and gas exploration but they would hire other companies such as Haliburton (HAL) to drill for them. Haliburton will make money regardless of whether they find anything. However, Apache will benefit the most if they do something. Exxon Mobil (XOM) is one of the biggest player when it comes to Oil & Gas exploration, yet they would not actually compete with Apache (APA). On the other hand, Haliburton has to compete with say...Schlumberger (SLB) for drilling contracts. If oil prices were to rise, drilling companies do make more money but the competitive nature of drilling business would undermine their profits. (i.e. not making as much as they should because they compete on price and quality of service)

Lets look at another commodity, copper. Copper is one the most widely used commodity in the world, however companies producing this commodity is depending on other commodities. If oil and steel prices appreciate faster than copper prices, then a copper producing company may suffer even if copper prices rise. This is because they use oil-fueled machines built with steel to extract and ship copper. Therefore it is vital to assess the real situation before investing in commodity stocks. We need to choose which commodity companies will perform better, considering the risks properly, it will allow hedging against inflation with some capital gains. 

Few tips To Investment Planning

Investing requires discipline and I cannot stress enough the need to stick to certain set of rules. Lets look at a couple of rules I have agreed to before I began investing. Rule Number 1: Make use of Compounding Compounding is vital to grow your investments over time and anybody can do it as long as you stick to the following principles. In order to compound successfully, you need perseverance, knowledge of how it works and most importantly TIME. One should have the understanding of how compounding actually works so that he/she can stick to a savings and investment plan. I put TIME in bold because unfortunately this is no get-rich-quick scheme, compounding works only through time. But there is a catch, you MUST keep your investment money aside, that means no spending it. Although it may be boring, for people with itchy fingers want to move money around to riskier investment vehicles, just endure until such time as to when you really need the money. It should get a little more interesting after 8 to 10 years of continuous, uninterrupted compounding. Let us look at a typical example i picked out from the internet, you can just google "power of compounding" and get so many examples.  But here's one from ICMARC website:  http://www.icmarc.com/Images/investments/COTW/20080328startsavingearly.gif For someone who starts contributing (annually $4k) into his retirement plan 10 years earlier can expect to compound at least twice the amount if he were to start contributing at a later time. Another study done by Market Logic in US, shows how compounding magic can happen even if you stop contributing on a yearly basis. Let us assume investor (B) opening a retirement fund at age 19. For 7 consecutive years, he contributes $2000  at an average growth rate of 10% (7% + interest). Then he stops putting anymore money into his retirement fund. A second investor (A) makes no contributions until the age of 26 (same age at which investor B stops contributing to his retirement fund) but investor A starts to diligently contribute $2000 annually until he is 65 years old. (assuming the same 10% growth rate. Look at the incredible results in the table below. Investor B ends up with higher return on investment (ROI) than A but he only contributed for 7 years (total: $14,000). Investor B on the other hand kept contributing $2000/year for 40 years. (total of 2000x40 = $80,000). The only difference being that B has had 7 more early years of compounding than A which were worth more than all of investor A's 33 additional contributions.

* If you are below the age of 25 and reading this, i urge you to go and start investing little by little in your own choice of blue-chip stocks. Its not too late for your kids too, I suggest starting early for your kids. It's a study which i wish i discovered earlier because i had a "poor dad" using the definition by Robert Kiyosaki in his popular book "Rich Dad, Poor Dad". Unfortunately my father did not feel that his kids needed to learn about money, he only taught us to save, get a good job and save some more. Having a saving plan running concurrently with your investment plan is very important too, but as a rule, i never keep more than 8 months living expenses in my bank account. Rule Number 2: Try Not to Lose Money This may sound funny to some but i think we should have the mentality of not losing money unnecessarily. If we want to preserve our capital and eventually grow it, we must aim not to lose big money. I have noticed that most people do end up losing money through gambling, ridiculous investment schemes, poorly executed business deals, greed and often times poor market timing. Over the years, there have been so many cases in Singapore where people lost money in the stock market, options, futures, in terrible loans, mindless gambling and in their own business. This rule may be simple, but we have to be disciplined in the way we spend our money and perform due dilligence enterning into any kind of investment. Rule Number 3: It takes Money to make Money  The wealthy investor has a major advantage over the smalltime amateur investor, they have the MONEY. One can argue that actually the wealthy investor does not need the market, somehow the market always moves in their favour. Understand the wealthy investor's mindset, he already has all the income he needs, not depending on the investment outcome, removing all emotions out of the equation. He probabaly has money invested in BONDS, Treasury-bills, Money market funds, Stocks, Real Estate and Other Business shareholdings. The wealthy investor is an expert is seeing VALUE. For example, he would invest in Bonds when its cheap and yields are high or move his money to Stocks when they are cheap with higher yields. With the ultimate goal of acquiring REAL ASSETS, eventually these investors buy real estate, physical gold, jewellery, expensive watches, diamonds and artwork; Things with great value. Another thing is when there is no opportunity presenting itself, they can afford to wait. We need to have patience. What about the little guy with little or no money? They feel pressurised to make money, or SAVE, SAVE, SAVE into a bank. This is madness at current interest rates less than 1%, being offered by banks. When the small investor is not buying overvalued stocks offerting 1-2% yields, he is off to gamble away his hard earned savings like buying lottery tickets or some ridiculous get-rich quick scheme. The small investor is always trying to force the market to do something for him, he is a guaranteed loser. Without understanding VALUES, he constantly overpays swayed by his/her emotions. I like this statement which i found on the internet : "He who understands interest - earns it. He who doesn't understand interest - pays it". The poor guy usually end up in huge debts, making payments on his house, electronic equipments (Thanks to COURTS easy installment plans), loses money gambling...in short always runs after money. So why is it that life is unfair, wealthy people always have the upper hand? I thought the poor always maintain a strict discipline of never overspending. Instead of taking his extra savings and compounding it in smart income producing securities, we always see them in debt. The usual answer is "I'm not making enough money". Although I symphathise on this situation, I know its possible to take two jobs, upgrade your skills, lower your monthly expenditure, do whatever it takes to work towards financial freedom. Be Positive. It makes alot of difference, both in one's mental attitude and in the way one actually handles one's money. Rule Number 4: Investment Value Usually I will suggest that one should stick to the basic compounding system and let it work over time. But if the opportunity arises when the market offer great value, Take it! [like post Dot.Com bubble (2001), Post-Subprime crisis (2008)] I would judge an investment to be of great value if it presents Lower Risk, Attractive Return(yield), Capital Appreciation. The key to making money is definitely to stay liquid, move your money from one market to another, follow the basic rule of buying undervalued investments.

The Hidden Investor

This is my first blog post for the Hidden Investor, created to share my knowledge and ideas on investing. I hope to post some interesting articles as well and keep track of my investment journey which happens to start in 2011. Since then i have made as many terrible decisions as good ones. Hopefully someone will learn from my mistakes and profit from my experiences. This blog is for the hidden investor, who just wants to make a decent return on his/her money.

Investing is for EVERYONE and each investor should have EQUAL CHANCES to make money. We live in an unfair world, the financial system receives plenty criticism BUT still presents ample opportunities to profit from it. Yes, the hidden investors are out there predicting which way the stock or bond markets are heading to figure out which stock or fund will bring back huge profits.

Need a Plan

The basic requirement to make money is that you need to PLAN for it. Majority of investors do have some kind of plan, self-discipline and desire. It does'nt take a genius to have some sort of investment plan. I will take about investment planning in upcoming blog entries.