Presents

“Fundamental Analysis: Finding the

Right Stock”

Presented by:
April L. Tan
CitisecOnline.com Inc.
What makes a good stock?

Price and Earnings

 Earnings – Up or Down?

“If a business does well, the stock

eventually follows.”
- Warren Buffett
 A tale of two companies
EPS comparison of PX and LC
1.2

0.8

0.6

LEPANTO
0.4
PHILEX

0.2

0
99

00

01

02

03

04

05

06

07

08
19

20

20

20

20

20

20

20

20

20
-0.2

-0.4
 -1000.0%
1000.0%
2000.0%
3000.0%
4000.0%
5000.0%
6000.0%
7000.0%
8000.0%

0.0%
3/16/2000
9/16/2000
3/16/2001
9/16/2001
3/16/2002
9/16/2002
3/16/2003
9/16/2003
3/16/2004
9/16/2004

PX
3/16/2005
9/16/2005

LC
3/16/2006
9/16/2006

3/16/2007
Price comparison of PX and LC

9/16/2007
3/16/2008
A tale of two companies

9/16/2008
3/16/2009
9/16/2009
3/16/2010
 Factors that affect earnings

 Demographics
 Economy
 Stage of the industry life cycle
 Competitive environment
 Management capability
 Demographics – A growing or shrinking market?

US Population Ages 40-49

50000

40000
In Thousands

30000

20000

10000

0
1985 1990 1995 2000 2005 2010 2015 2020
Year
 Demographics – A growing or shrinking market?

Harley Davidson EPS Trend

4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
-0.5 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
 Demographics – A growing or shrinking market?

Harley Davidson Share Price Performance

90

80

70

60

50

40

30

20

10

0
1/3/2000 1/3/2001 1/3/2002 1/3/2003 1/3/2004 1/3/2005 1/3/2006 1/3/2007 1/3/2008 1/3/2009 1/3/2010
 Demographics – A growing or shrinking market?

US Population Ages 20-29

48000
46000
In Thousands

44000
42000
40000
38000
36000
34000
1985 1990 1995 2000 2005 2010 2015 2020
Year
 Demographics – A growing or shrinking market?

DeVry EPS Trend

2.5

1.5

0.5

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
 Demographics – A growing or shrinking market?

DeVry Share Price Performance

80

70

60

50

40

30

20

10

0
1/3/2000 1/3/2001 1/3/2002 1/3/2003 1/3/2004 1/3/2005 1/3/2006 1/3/2007 1/3/2008 1/3/2009 1/3/2010
 Economy – A tailwind or a headwind?
Monetary policy

Economy
External demand Fiscal policy
(exports, OFW
deployments)

Investments
 Economy – A tailwind or a headwind?

How will the following developments

affect the profits of companies?

Fallinginterest rates
Global economic slowdown
Rising OFW remittances
Rising oil prices
Economy – A tailwind or a headwind?

Business Confidence vs Ad Revenue Growth

50.00% 25.00%

40.00%
20.00%

30.00%
15.00%
20.00%
10.00%
10.00%

5.00%
0.00%
2005 2006 2007 2008 2009 2010*
-10.00% 0.00%

Business Confidence Advertising Revenues Growth

 Industry life cycle analysis – measuring growth
potential

Earnings Trend vs Industry Life Cycle Stage

Expansion
Maturity
Earnings

Developmental Declining

Stage of Industry Life Cycle

 Industry life cycle analysis – measuring growth
potential

Industry Life Cycle: Summary of Major Characteristics

Developmental Expansion Maturity Declining

Sales and profit Small, but prospects In line with the Slower than the
>30%
growth are high economy economy

Market penetration Below 10% 10-90% 90% or more -N/A-

May still be Positive, growing

Free cash flow Negative Large
negative faster than profits
Example Mining exploration Broadband Cellular phone Film camera
Industry life cycle analysis – measuring growth
potential

Which industries and companies have better

growth prospects?

[ ] C ellular phones [ ] B road B and

[ ] F ilm cameras [ ] Digital cameras
[ ] C hina [ ] US A
[ ] Amazon.com [ ] National B ook S tore
Competitive environment – promotes or hinders
profitability

Potential
Entrants

Threat of New Entrants

Industry Competitors
Bargaining Power of Suppliers Bargaining Power of Buyers

Suppliers Buyers
Rivalry Among Existing
Firms

Threat of Substitute Products or Services

Substitutes
Competitive environment – promotes or hinders
profitability

Competitive Environment of Different Industries

F avorable Unfavorable
P ower Dis tribution L iquor
Malls F ood
W ater Dis tribution C lothing
Management capability – ability to execute

Factors

• Size
• Financial Strength
• Experience
• Financial track record
Management capability – ability to execute

Fort Bonifacio

Before After
 Measuring Financial Strength

D/E ratio
Debt / Stock Holder’s Equity
Ability to borrow
Ideally <1
 Measuring Financial Strength

EBITDA
 Earnings before interest, tax,
depreciation & amortization
 Ability to generate cash flow
 Positive & growing
 Measuring Financial Strength

Theme: Privatization of power plants

Co. A Co. B
EBITDA (PhpMil) 5,453.00 7,661.00
D/E 2.53 0.54
 Measuring Financial Track Record

Business Model
Current business
New business Similar
Measuring Financial Track Record

SMC’s investment in mining – good or bad?

 Measuring Financial Track Record

ROE
Return on equity
Ability to generate profits on investments
Net income / stock holder’s equity
 > 10%
Stable or growing
 Measuring Financial Track Record

ROE drivers
Asset turnover
Sales / Assets
Efficient use of assets
Margin expansion
Cost management
Increasing leverage
Suppliercredit
Bank credit
 ROE Driver – Asset Turnover
Equity 9,000
Pepe Sales 3,300

1,000 1,100 1,200

vs

Equity 9,000
Sales 3,000
Pilar

1,000 1,000 1,000

 ROE Driver – Margin
Equity 9,000
Pepe Sales 3,300
NI 1,485
ROE 16.5%
1,000 1,100 1,200
vs
Net Margin: 45%

Equity 9,000
Sales 3,000
Pilar
NI 1,500
ROE 16.7%
1,000 1,000 1,000
Net Margin: 50%
 ROE Driver – Leverage
Equity 9,000
Pepe Sales 3,300
NI 1,485
ROE 16.5%
1,000 1,100 1,200
vs
Net Margin: 45%

Equity 9,000
Sales 4,000
Pilar
EBI 2,000
Int (10%) 300
1,000 1,000 1,000 1,000
NI 1,700
Net Margin: 50%
ROE 18.9%
Measuring Financial Track Record

Google vs. Tencent

GOOG 2005 2006 2007 2008 2009
EBIT Margin 34.33 33.48 30.64 30.43 31.50
Asset T/O 0.90 0.74 0.76 0.76 0.65
Leverage 1.10 1.09 1.10 1.12 1.12

ROE 23.7% 23.3% 21.2% 16.6% 20.3%

EPS Growth 243.8% 98.0% 33.7% 0.2% 53.2%

Tencent 2005 2006 2007 2008 2009

EBIT Margin 29.57 40.08 41.85 44.44 68.73
Asset T/O 0.45 0.69 0.66 0.85 0.91
Leverage 1.13 1.22 1.30 1.38 1.42

ROE 17.4% 32.0% 35.2% 45.7% 53.7%

EPS Growth -6.0% 119.1% 45.8% 77.5% 84.4%
 -1000.0%
1000.0%
2000.0%
3000.0%
4000.0%
5000.0%

0.0%
8/18/2004

12/18/2004

4/18/2005

8/18/2005

12/18/2005

4/18/2006

8/18/2006

12/18/2006

Google
4/18/2007

8/18/2007

12/18/2007

Tencent
4/18/2008

8/18/2008

12/18/2008

4/18/2009

8/18/2009
Measuring Financial Track Record

12/18/2009
Price comparison of Google and Tencent
 Price - Cheap or Expensive?

“I don't look to jump over 7-foot

bars: I look around for 1-foot bars
that I can step over.”
-Warren Buffett
Price - Cheap or Expensive?

A Good Company…
 Price - Cheap or Expensive?

… is not always a good stock

Price – Reason why good companies become bad
stocks

Fair Value – Present value of future free cash

flows

 If Market Price > Fair Value, then bad stock

 If Market Price < Fair Value, then good stock
 Is it a 7-foot bar or a 1-foot bar?

*Determine market expectation reflected in the price

High Expectations Low Expectations

AP at Php18.50 FPH at Php56.00
Combined market value of its
LT ave. WESM price at Php5.00 26% effective stake in EDC and
(vs. historical ave. of Php4.00+) 6.7% stake in MER is higher than
the market value of the company
Company also has a net cash of
Php5.5 Bil
 Valuations: Commonly used

P/E
 Price / EPS
P/BV
 Price / Book value per share (BVPS)
 BVPS = Stockholder’s Equity / OS
 Commonly used for banks and financials
 Valuations: Commonly used

DCF
 Present value of future free cash flows
 FV = CF1/(1+r1) + CF2/(1+r2)2 + CF3/(1+r3)3 + . . .
 Can be used on all stocks
NAV
 Sum of the fair value of assets
 Commonly used for property companies and holding
companies
 Valuations: High or Low Expectations

P/E
 Higher growth, higher P/E
 P/E < 7X is cheap
 Valuations: High or Low Expectations

11E P/E EPS Growth

Banks 13.1 13%
Commercial & Industrial 10.9 8%
Consumer 15.0 3%
Telecoms 10.1 3%

Which has high expectation?

Valuations: High or Low Expectations

11E P/E EPS Growth

AC 17.2 9%
AGI 8.5 20%
SM 16.5 10%

Which has low expectation?

 Valuations: High or Low Expectations

P/BV
 Higher ROE, higher P/BV
 P/BV < 1X is cheap if ROE > 15%
Valuations: High or Low Expectations

11E ROE 11E P/BV

BDO 9.6% 1.4
BPI 14.1% 2.1
MBT 10.7% 1.3
SECB 16.1% 1.2
Which has high expectation?
Which has low expectation?
 Valuations: High or Low Expectations

NAV
 Market value < 50% of NAV is cheap
 Valuations: High or Low Expectations
80%

60%

40%

20% +2 stdev

0% +1 stdev
-20% Mean

-40%
-1 stdev
-60%
-2 stdev
-80%
FLI
Dec-95

Dec-00

Dec-05
Mar-92

Sep-94

Mar-97

Sep-99

Mar-02

Sep-04

Mar-07

Sep-09
Jun-93

Jun-98

Jun-03

Jun-08
ALI
 Valuations: High or Low Expectations
-20%

-30%
+2 stdev
+1 stdev
-40%

-50% Mean
-60%
-1 stdev
-70%
-2 stdev
-80%
Dec-06

Dec-07

Dec-08

Dec-09
Mar-07

Jun-07

Mar-08

Jun-08

Mar-09

Jun-09

Mar-10
Sep-06

Sep-07

Sep-08

Sep-09
MEG
0%

-10% +2 stdev
-20%

RLC -30% +1 stdev

-40%
Mean
-50%

-60% -1 stdev
-70%
-2 stdev
-80%
Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10
 Summary

 Price and earnings determine a stock’s direction

 Demographics, economic conditions, stage of the
industry life cycle, the competitive environment, and
management capability drive earnings
 Good companies become bad stocks when prices
reflect unrealistically bullish expectations
 Thank you and have
great day!

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