Case Study

Countering The Simple PE Ratio

The simple PE ratio, an extremely basic calculation, is a measure of valuation which is easily comprehensible to many retail investors. It is simply the price per share divided by the earnings per share. One could also take the market capitalisation of equity and divide it by the total net income of the company and get a similar figure.

A PE that is too high is an indication of overvaluation. A PE that is too low may mean undervaluation. But this is not true in every instance. A high PE stock may still be undervalued while a low PE stock may very well be overvalued. The value of a company is dependent on the future cash flows that the company can produce going forward from this point in time to the future. As such it is important to assess the value of a company by looking at things wholistically.

The corporate actions and decisions of management, the sustainability of earnings or the earnings power and the ability of the company to earn a return in excess of market rates of return all have a part to play in determining the value of a company.

A company whose earnings are cyclical may show up as a low PE stock in your screen. If you were to buy that company today, you may have overpaid for the company. Typically, cyclical companies appear cheapest when they are at the peak of their earnings cycle and expensive when they are near the trough of their earnings cycle.

One way to counter this is using a cyclically adjusted price to earnings ratio which adjusts the PE for these ebbs and flows in the earnings of a company.

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Charlie Munger

Risk & The Permanent Loss Of Capital

All investors are exposed to risk when investing in any form of asset class, be it equities, bonds or  property. Risk is not this unknowable, esotheric concept that so many amongst us fail to recognise. Risk, according to Warren Buffet, really is defined as the probability of a permanent loss of capital. And taking a lesson from the world's greatest investor, I would think it unwise to define risk in any another manner. Perhaps, an example at this point would suffice to drive home a message on risk.

Company A & Company B

Let us focus on a thought experiment for a moment here. There are 2 companies, Company A and Company B. Company A has little to no debt . Company B however is a highly indebted company with a debt to equity value of more than 200%, decreasing revenue and operating income as a ratio to interest expense has deteriorated in the last couple of years . Company A has a price to book value of 0.7 while Company B has a price to book value of approximately 0.6 as well.

Would you buy Company A or B at this point? Now, bear in mind that Company B gives dividends while Company A also gives dividends. So which company would you buy? So on a dividend basis, let's take it that both companies differ only slightly and these differences are negligible. Since this is a thought experiment, let us simplify things that way.

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Contrarianism

Qian Hu Reversion To Mean

At some point recently, I looked on interestingly at Qian Hu. At a price of 9 cents, many investors felt uncomfortable with it. Well for one, its profitability had decreased drastically over the last 3 years from 0.39 million to 0.07 million. On a price to earnings basis, investors would have been turned off by Qian Hu, looking instead to blue chips such as SIA,Singtel, Starhub and maybe SPH. SPH by the way is having the time of their life right now. Maybe, I will detail this in another article. Do look out for it.

In another article, I spoke about glamour stocks versus beaten down stocks. This is an apt example of what I was trying to convey. Buying beaten down stocks, if you have the mettle and the stomach for it, may prove more profitable than buying the blue chips, the well known and the well loved by all.

So what happened?

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Case Study

Disney’s Star Wars Acquisition Was Brilliant!

Disney's Amazing Purchase

I find it hard to fathom that an idea in someone's mind could blossom into a business empire spanning more than 4 decades. That idea of a quirky universe filled with 17000 characters and a few thousand planets was borne out of the legendary film maker's mind, George Lucas. Like Harry Porter, its success would be considered by any means a positive black swan.

George Lucas's Big Bet

At a point in time when movie executives did not believe in the power of the franchise and its characters, George Lucas took a bet, and a big one at that . In 1973, instead of a pay raise offered to him, he opted to receive $50,000 and all the rights to all the sequels of star wars plus all the rights to the merchandising.

What fascinates me about George Lucas was that he wasn't in it for the money. He was thinking about protecting the creative integrity of his project from what I believe. As I read these articles about George Lucas, it sure reminds me of the "why" that one should stay true to himself and not be a follower merely another has attained success in a particular way. Those values sure do speak to me as a person, as an investor.

Back to George Lucas. Those decisions made a huge dent to his life. As the franchise of star wars grew exponentially, so did the sale of merchandise, earning George Lucas hundreds of millions of dollars. The moral of this short story so far is thus this : Stay true to yourself and express yourself honestly.

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Eddie Lampert

The Failure Of Sears, FJ Benjamin & The Future Of Retail

If one were to step foot into a Sears store today, one might find a truly sad state of affairs for the retailer, run by once former high flyer and billionaire, Eddie Lampert of ESL Investments.  Empty carparks, chaotic arrangement of goods that are in no demand and a sparse density of people will greet you as you walk in. And we wonder what the heck is going on? Afterall, this wunderkid, Eddie Lampert, used to have the midas touch. Whatever he touched used to turn to gold. Not so anymore!  And a company  spokesperson mentions that they are still in the midst of turning operations around. Is that a joke and who are they kidding? This is the chart of Sears Holdings from the year 2004. And it isn't a pretty picture for shareholders. The share price has been languishing from 2007. To find out what had been happening to Sears, let us examine some of the numbers reported by the company. Now revenues are the lifeblood of a retailer. Falling revenues mean serious trouble. This of course can be attributed in part to the  closure of retail outlets. And partly, Sears no longer carries the kind of products that its customers value. This has been exacerbated by the fact that retail is dying, largely due to the effects of ecommerce. I think Eddie didn't see that coming ten years ago. More on the effects on ecommerce later. (more…)