A simple walkthrough on comparing companies in my stocks portfolio (Part 1 of 2)

Why analysing business fundamentals matter to the bona fide investor?

I had earlier exposed myself to some fundamental analysis during this year from my previous post on looking at return on equity (ROE). I have heard before comments from some investors or should I say market players that it may be futile to look at fundamentals of companies when doing investments. These "market players" some who are experienced with the stocks market adopt a technical view when dealing with the stocks market. To them, making profits is simply about investing at the right time just before a particular stocks is foresee to rise significantly in price. It does not matter whether the underlying business of the company is profitable or not. What matters is that the stock price must rise or fall in a short time period for such market players to make their gains (from going long or short). As such, technical analysis by looking at charts and indicators is paramount to their decision to buy into or sell out of a particular stocks at particular opportunate times when the signal for action is clear.

I am not in a position to comment on the merits or demerits of adopting such a methodology to secure gains from the stocks market. Some investors that use technical analysis protray strongly that this method boasts of excellent consistent returns over a long period of time. How true is it? Only the investors themselves who practise investing by technical analysis know it best. My purpose here is not to challenge the method of technical analysis nor to compare between technical analysis and fundamental analysis. I believe there are different investment philosophies that investors can naturally use according to their own personality. As such, it is one's own free will to choose whichever method, be it fundamental analysis or technical analysis or both together to use it according to own investment style.

For me, I adopt a fundamental approach to stocks investing. In one of Warren Buffet's famous investment quotes, the "stock price eventually follows the business", this shows strongly that the price of a stock does regress towards the intrinsic value of the business underlying the stock. As to the time required for a stock to be fairly valued either from an undervalued or overvalued price, it may take weeks, months or even years. Because the stock market is not efficient, prices of securities do get undervalued or overvalued at different periods of time (e.g. bear market or bull market). An astute investor will try to buy stocks at undervalued prices and sell stocks at overvalued prices to make the largest returns on their investments. However, investing can be made most profitable if an investor views investing as long term riding on excellent economics of selected businesses that really make good consistent returns for their shareholders over a long period of time.

There are already examples of such businesses as Coca Cola and Wal-Mart in Warren Buffet's holdings. An examination of our local context reveals businesses such as Wilmar International that have grown in their intrinsic value through the years into a giant enterprise now and is no longer the once "ikan billis" (small fry) that is not heard of. So, are fundamentals of businesses relevant to investing? The answer is yes. If an investor can invest in such companies that have consistent good business economics in their favour, the value of the company will increase many folds over a period of time as the company gains market share and economic moat. By then, an investor's original investment will increase many folds in value when the business has increased in intrinsic value over time. I examine one such company in my portfolio, SembCorp which has a historic low price of around $0.80 per share. I can only hope in my wildest dream that it's stock price may have a chance of revisiting such lows in future which is almost impossible. This company is worth far more in intrinsic value than $0.80 per share (my estimated intrinsic value is $4.55 per share - see earlier post). So, a patient investor who still holds onto shares of SembCorp bought at such low price years back is already seeing high current earnings yield (about 37%) and future earnings yield as long as SembCorp continues to grow in profitability of their businesses in future years. Such an investor has also secured a high current dividend yield and future dividend yield of around 13% assuming SembCorp provides the same amount of dividends per share in future years.

Thus, by looking at fundamentals and going long with a business that is really worthy, an investor can receive excellent returns on investment especially if the investor has invested at such businesses at low undervalued prices. When the intrinsic value of such businesses continue to grow, the investor's capital investment also grows in value as well. A caution though that holding investment of such long nature focuses solely on the growth of the selected business's intrinsic value and ignores market fluctuations in prices over the years.

Net income and revenue trends of companies in my portfolio

As discussed in my previous post on the metric return on equity (ROE), I shall continue to evaluate a few companies in my portfolio based on metrics such as net income and revenue trends, net margin, asset turnover, financial leverage, return on assets (ROA) and return on equity (ROE). Before I begin my discussion, one should note that these metrics provide only some comparison and evaluation on the profitability of companies. Fundamental analysis is simply a broad topic of investment interest that involves so many ways to evaluate a business. Different investors and analysts may adopt different ways to evaluate a business. Every investor has his own unique ways to evaluate a company and the ways may change too. One should never rely heavily on any particular metric or way to evaluate a company, but should always be as objective as possible and is aware that there is always the possibility of misjudging a company.

For me, the above mentioned metrics provide an overview into the evaluation of companies in my portfolio. I shall present the collected data from the various companies' financial statements (found in their annual reports). I do not guarantee the completeness or accuracy of these collected data. Readers are advised to practise caution when reading and using the data.

I will only provide the trends I observed for net income and revenue in these companies over a period of 8 to 10 years. Net income and revenue should grow together consistently for a good business. I personally places more emphasis on a business's ability to generate growth in operating cashflows and free cashflows more than looking at net income and revenue growth because cashflow is more important determinant of a company's ability to generate real cash. Nevertheless, net income and revenue growth are also important as they reveal whether a business is making more sales and earnings through the years.

There is steady net income growth and revenue growth over the years.

There is steady net income growth over the years except the most recent year when there is an impairment loss on trades receivables for Parkway Holdings due to a default on payment for hospital services. As this is a one-off problem, it will not affect future net income of Parkway Holdings. There is steady growth in revenue over the years.

There is steady growth in revenue over the years. There is steady growth in net income over the years expect for most recent year mainly due to foreign transaction losses. As this is a one-off problem due to change in exchange rates of foreign currencies, it may not affect future net incomes.

There is steady growth in net income and revenue over the years.

Discussion points:- It is important to evaluate business fundamentals of a company when investing in the stock of a company. This ensures an investor can potentially invest in good businesses that increase their intrinsic values over time.

All companies evaluated here shows a steady growth in both net income and revenue over the years. This suggests that their businesses are generally stable and consistently profitable over a period of time. Examining trend over a number of years is important as it checks for consistency in the economics of a business.

I will provide comparison on the net margin, asset turnover, financial leverage, return on asset and return on equity for these companies in a later post.