Examination Question ... Fundamental Analysis

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hilarius

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Sunday, June 24, 2007 - 01:25 pm:

Which fundamental factor, or combination of fundamental factors, is most predictive of strong future price increases?

Support your answer with statistical evidence, and ongoing monitoring of specific examples using the chosen principles

Marks will be awarded for the best answers

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

007

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Sunday, June 24, 2007 - 01:37 pm:

My answer is: earnings growth.

Unfortunately I have no statistical evidence or time to monitor specific examples

I guess I failed then ha?

Hillsong : At the Cross
Hillsong : Mighty to Save
Millions in Lagos

hilarius

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Sunday, June 24, 2007 - 01:51 pm:

007

Please read the question and consider your answers carefully

Multiple answers will be accepted any time between now and Christmas

Marks will be awarded on the basis of completeness of answers

So far you are top of the class :-)

Please give careful thought to maintaining that position :-)

Hilarius

PS 007 your homework seems to have been lost in the mail

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

hilarius

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Sunday, June 24, 2007 - 02:22 pm:

Good Afternoon

Here is a Model Answer

As a member of the Board of Examiners I am only able to provide this example as an illustration :-

I propose that the relationship of the average of the 2008 and 2009 Prospective Earnings Yield to the average of the 2006 and 2007 Retrospective Earnings Yield (using a best estimate for 2007) will act as a leading indicator of price gain when compared to the same ratio for other stocks in the same sector

Examples of stocks in 2 sectors PNA and QGC with ratios of 2571 % and 989 %

Details of calculations, comparison to other stocks in the relevant sectors and ongoing monitoring to follow

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

rederob

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Sunday, June 24, 2007 - 08:32 pm:

Dr Hilarius
There seems a lot of work to do!
But is the formula always successful?
My uncle eblode likes to kiss and make up.
Keep it simple, simple!
My simple formula involves energy, recycling and water.
Find good equities that leverage into these sectors and there should be long term success.
Nightstalker bought into PDN from 7cents upwards a few years ago and I believe he still holds this equity.
I think its still safe to buy into PDN today and get a lot more out of it.
The point is that when Nightstalker was buying PDN there was nothing to suggest you could do this exercise on it!
Even today there is not enough data to get a good idea of potential earnings yield.
Here's a roughie for the books - unlisted WHL.
Sorry Dr Hilarius, I can't do any sums on WHL yet, but it's the type of IPO I am looking for.
Humbly
rederob

(Message edited by rederob on June 24, 2007)

kate

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Monday, June 25, 2007 - 11:07 am:

Rederob,
Is it a case of great minds think alike or fools never differ? Energy, renewables and water are the next long term bull market along with good agricultural land. Food, water and energy prices are going up.

I'm considering subscribing to Wind Hydrogen too. Have you done much research, my main concern is how much water they'll need.

Hilarius

I totally disagree with Rederob, if you can access those figures without too much hard work, it appears to be simplicity itself.
Also, it seems to be completely logical. The only problem I could forsee would be with resource stocks, not so much with QGC which has a constant market but PNA which is dependent on the price of gold.

Regards
Kate

rederob

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Monday, June 25, 2007 - 09:57 pm:

Kate
Our examiner is awol.

ps, given that I posted first, I hereby accuse you of cheating. That goes doubly for suggesting the humble peeler was proposing a logical approach to his search for the holy grail. Buy the whey, dug had a tip for Telstra: "Dyesol".

hilarius

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Monday, June 25, 2007 - 10:21 pm:

Good Evening

I expect students to exercise ingenuity and initiative while I am preparing details of suggested answers

My experience is that His Readiness has ample supplies of reason with which to prepare his homework

It is of course very distracting for him when persons of the feminine persuasion cross his path with other ideas, but no doubt both of you will gather your mental resources and come up with some suggested methodologies and examples without having to write out 1000 times "I must not daydream in class when researching questions of fundamental importance"

A hint for Kate you need access to a research site which shows EPS for stocks for 2006, 2007, 2008 and 2008

Calculation of the actual and prospective earnings yields using these EPS figures and dividing by today's price then becomes a snack. The resulting Earnings Yield percentage should give some interesting surprises.

Try it with QGC and PNA. You may be surprised.

Then try it with some other stocks and you may possibly jump to the top of the class

As Kate has rightly said it simplicity itself to compare the average EY for 2008/9 with that for 2006/7

Please continue your search for the Holy Grail zealously and anyone throwing paper darts instead will be dealt with severely

Hilarius (is considering bringing back the cane if his able and intelligent students continue to misbehave)

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

kate

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Tuesday, June 26, 2007 - 09:35 am:

Hilarius,

I do my best work when I'm daydreaming!

How would you feel about doing the ratios if I give you a list of companies I feel may do well over the next few years? Rederob may have more knowledge about oil companies than me so he could do that although he'll probably only give you OSH and BPT?! I spend a lot of time researching big picture/trends but know next to nothing about fundamental analysis.

Rederob
Dyesol is on my list. Did I tell you about ADY?

hilarius

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Tuesday, June 26, 2007 - 10:32 am:

Kate

I suppose a good teacher should be willing to help a student with her homework ... especially when she asks so nicely

If you post your list of stocks I will see what I can do to post a spreadsheet with the ratios

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

kate

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Tuesday, June 26, 2007 - 10:59 am:

Hilarius,

The first four - ARU, LYC, ADY and ORG.
I'm sure Rederob would be grateful if you could include DYE and you may be amused by its comparison to SCE.

I will look back over my research and find the others which may have potential.

Kind regards
Kate

hilarius

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Wednesday, June 27, 2007 - 05:38 am:

Kate

I was looking around near DYE and found DUE with rising earnings and an interesting chart

Test Question
DUE forecast earnings yield for 2008 and 2009 appears to be 76% higher than 2006 and 2007. Is this a bargain? Give reasons fundamentally and technically for your answer

This will keep you busy while I sort out DYE and the others you mentioned

:-)

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

kate

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Wednesday, June 27, 2007 - 09:38 am:

Hilarius,

An interesting piece of homework. So I don't have to type vast quantities of information I've included a link to DUE's portfolio.
http://www.duet.net.au/duet/assetportfolio/overview.htm

That is just background information. The graph and company's information "appear" to be excellent, however there are several things to note. First, UED have calculated their average growth rate between 2004-2010 to be 1.16, in fact they expect a slight drop over the next 2-3 years. Second, the merger between Duquesne and Macquarie has been completed but I can't find out what percentage DUE now hold. I'll try and find out more today. Finally, the company's interest in the Dampier-Bunbury pipeline will be slightly reduced in the future.

Even taking the potential constraints into consideration, it appears to be a stock well worth considering, the fact that it is a tripled stapled security with a distribution of 11% (from memory) is not to be sneezed at, any growth is an added bonus.

From a big picture perspective, I think that the 70% gas transmission and distribution will be the winning part of the business, natural gas produces less carbon emissions and Australia has 150 years supply, it will be the interim energy source of choice while the renewable energy industries gear up.

I don't think there is much point commenting on the graph at the moment, only to say that there seems to be quite a lot of interest which may be because people think its a great stock or want to move into something more defensive.
One of your squeezes on a weekly chart might be a nice entry point. Bear in mind DUE has risen between 20-25% in the last 6 months.

Regards
Kate

PS It would be a nice complimentary stock to ORG

resillent1

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Wednesday, June 27, 2007 - 11:20 am:

Hilaruis,

Analyse DUE? You set hard homework.

Perhaps a hint would be appropriate. (determine how accounting standards for depreciation affect earnings)

kate

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Thursday, June 28, 2007 - 09:33 am:

Resillent 1

When I hear things like "how accounting standards for depreciation affect earnings" I know why I prefer looking at charts!

Hilarius
Good teachers should set an example to their students, Where is your homework?!!!!

Regards
Kate

resillent1

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Thursday, June 28, 2007 - 01:30 pm:

Kate

You have got to love those charts. Our brains seem to work so much better processing visual information.

But sometimes I can’t resist having a fundamental moment, so my take on DUE

They have got something going on in their Minority/Associate Interests that accounts for a large part of the jump in earnings. I’m to lazy investigating so I will just have to flunk on this one.

In general Infrastructure (large asset base) companies reported earnings rise as depreciation decreases. Depreciation will decrease when the diminishing value method is used. Earning increases can be just a figment of the accountant’s imagination.

For a better quick and dirty on infrastructure company earnings growth you would be better looking at EBITDA. DUE’s is 540.6 for 2007F and 572.2 for 2008F suggesting a growth rate of 5.8%

This is the Halarius’ FA thread so I won’t comment on the chart other than to mention the marked acceleration in trend this year. As I have flunked this FA Exam I don’t know if this is justified or a Bull Market influence.

DUE is another one for my overflowing too hard basket.

kate

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Thursday, June 28, 2007 - 02:07 pm:

Resillent
Even with a growth rate of only 5.8% (and its 11% distribution) doesn't that make it a pretty good defensive play........if you like that sort of thing?

I am presuming that the 5.8% factors in the distribution, it does, doesn't it?

Kate

resillent1

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Thursday, June 28, 2007 - 02:28 pm:

Kate

My FA Data provider has 2006A yield at 6% and 2007F at 6.4% both unfranked – Not sure if that or 11% is correct.

I should stress the 5.8% growth is a quick and dirty calc. But is probably a better guide than the EPS growth.

If you do like a defensive play (I don’t) than the potential of 6% div and 5% growth is probably worthy of investigating.

If you wanted to manage the trade on FA grounds rather than TA, I think some pretty in-depth digging would be required to know what you are really getting into.

Cheers

hilarius

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Friday, June 29, 2007 - 07:40 am:

Dear Resillent

Are you suggesting that any member of the accounting profession would choose any but the most truthful method of reporting?

Would any Company conscious of its duty to shareholders choose any but the most truthful course of action?

With Best Wishes

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

hilarius

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Friday, June 29, 2007 - 08:13 am:

Kate

There is a special place for you to stand in a corner of the class room for asking trick questions :-)

On the other hand I am most appreciative of your comments on DUE which I will be considering carefully

Returning to your suggested homework for your humble examiner :-

4 out of the 6 stocks you mentioned have negative earnings and no forward earnings forecasts that I could locate

Another with small earnings per share has no forward forecasts and only ORG has a forward earnings view

In the case of ORG each year shows higher EPS through to 2009

The ratio of 2008 & 2009 EPS to 2006 & 2007 is around 1.3 to 1

This is extremely healthy but modest by comparison with some forecasts for other stocks

I am returning the ball to your court

Apart from ORG what fundamental information do you consider will drive the earnings forward for any of the stocks you mentioned?

When do you expect that information might translate into tangible data and useful earnings forecasts?

Since this examination question is about fundamentals alone no reference to technical analysis is permitted

Technical points & a willingness to monitor future performance against current indications may be entered with fundamental information in the FATA examination room or with charts alone in the TA examination room

Teasing your teacher with stocks that have no FA forecasts would normally attract a potato peeling penalty of enormous proportions, but your interest in DUE and helpful comments have saved you on this occasion

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

resillent1

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Friday, June 29, 2007 - 10:34 am:

Hilarius

No disrespect to accountants was intended.

The accounting standards they work to however are not very useful at times in providing me, a shareholder, the information that is relevant.

One example: The written down (whether by diminishing value or prime cost) value of historically priced fixed assets is not useful to me. I want to know the current replacement cost of fixed assets utilised. The historical cost and depreciation conventions distort both P&L and the balance sheet in a way that is not meaningful to me.

The headline figures are often meaningless and the pertinent information has to be dug out of the detail and calculated for oneself.

Where flexibility exists within the standards, managements desired outcomes influence the choices made by accountants. Different desired outcomes can deliver different headline results.

Management acting in shareholders best interests does not always occur. It is often hard to tell wether this is deliberate or a lack of ability.

Alignment of management and shareholders interest does not always occur. Unless there is an active majority shareholder, management has scope in the range of objectives it pursues.

hilarius

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Friday, June 29, 2007 - 11:31 am:

Good Morning Resillent

Very diplomatically expressed :-)

Sorry if I deterred you from saying there are rogues and vagabonds in abundance !!

One of the FA issues that is often neglected is the question of management calibre

I believe a web-site that graded corporate managers would be an enormous asset to the investment/trading community

On the question of depreciation I would offer the thought that even with conventional depreciation accounting if there is strongly growing cash flow then future equipment needs will be relatively easily funded

Institutions will lap up placements in quality stocks at prices that are not too dilutive

The other question of course is the likely life of the existing assets

It would be useful if Boards would publish commercially sensitive equipment replacement schedules

Generally if earnings growth is strong I would not see equipment costs as an insurmountable obstacle to investment

Have you struck cases where the non-disclosure of equipment replacement costs has made a big difference?

Perhaps interest cover would be a good proxy for showing whether a company has been overburdened with capital expenditure in the past and might be likely to be so overburdened again?

Your points were all extremely well expressed and I take each one of them to heart

I'm all in favour of greater transparency in reporting

Can you think of a company that does its capital expenditure budgets in a well prepared and public format?

I agree that a "notional" depreciation based on replacement costs would be helpful, as a separate disclosure, but the timing of likely replacement is a key point. I prefer a method for the published accounts that neither under nor over states the costs of current operation ... with qualifying information about future costs shown separately

Some indication of whether replacement is overdue would also be extremely helpful, if it is in clearly quantified form

What are the circumstances where you think current accounts should be adjusted?

Is there special reason to be concerned in the case we have been considering?

With Best Wishes

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

resillent1

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Wednesday, July 04, 2007 - 07:30 pm:

Hilarius

Calibre of Management and the board is key. Not only because of their influence on company performance but because they are best positioned to decipher accounting standards and restate the information in a relevant format for shareholders.

Too often directors allow accounting vagrancies to misinform, especially when it leads to a higher share price (short term) than if information was restated in a relevant format.

For an example of how directors communicate well with the shareholders you may as well go straight to the top and read the Berkshire Hathaway annual reports and other correspondence. (Both informative and educational)

Sadly this candid method of communication is largely absent from most companies. I’m not sure why directors like to leave shareholders in the dark, with only the dim light of accounting standards to guide us. Perhaps they think we like having to dig for the truth.

In relation to the case we have been considering (DUE) it would be interesting to see just how easy it is to get a simple and relevant explanation of what’s going on with Minority/Associate interests to cause the jump in earnings. Perhaps someone with money invested in this company may wish to take this on. (The exercise shouldn’t take more than a Few Minutes if directors have been keeping shareholder fully and relevantly informed).

Regards

Resillent1

resillent1

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Wednesday, July 04, 2007 - 08:48 pm:

SIP

It will be interesting to see how analyst’s estimates for this stock change over the next few weeks.

Sigma’s EPS reported 1/07 was 10.2, forecast EPS (prior to drop) for 08 was 13.0 and 09 was 15.1.

This gives forecast EPS growth of 27% for 1 year to 08 and 48% for 2 years to 09. These sort of figures wouldn’t really give you cause for concern, however a better indication of possible problems shows up in the graph below.

SIP

This chart tracks the changes in analyst’s estimates.

The earliest recipients of the analyst estimates quickly price the information into stocks, however by studying the trend of the estimates you can anticipate future estimates and pre-empt the market movement.

kate

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Friday, July 06, 2007 - 10:51 am:

Hilarius,
My apologies for not replying sooner.
My interest in the companies I mentioned have more to do with future trends and world shortages than company reports. Mention PE and I start yawning, add a G to the PE and I lapse into a state akin to narcolepsy!

ARU and LYC both mine REEs, ARU also mines Vanadium which makes it even more interesting. ORG you know about. ADY is off the radar at present until I do a bit more research.

I am forcing myself to learn more about fundamentals just on the off chance they might have some merit!!

Regards
Kate

No point threatening me with potato peeling, apart from being Irish I'm also vegetarian so I can peel potatoes in my sleep! Next week I'm at an alternative school of higher learning so any further homework will have to be postponed until I return.

resillent1

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Monday, July 09, 2007 - 05:19 pm:

Hilarius,

DUE

Following up on some of the previous post on this tread, I was just wondering if you had been able to get an understanding on what was behind the jump in EPS? (From memory you posted that you had taken a position)

Understanding the fundamentals has probably just become more crucial if you are still holding, as DUE made a lower trough today (weekly chart). On a daily chart it made a lower trough last Wednesday.

Noticed AMP & Macquarie managed to get a large performance fee last week.

Regards

Resillent1

hilarius

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Monday, July 09, 2007 - 07:07 pm:

Resillent

My chart based purchase and interest in analyst EPS forecasts has been severely dampened by a large performance fee based on market perception which may or may not accord with reality

I would be much more tolerant of a performance fee based on published earnings performance

Time to study fundamentals is at a premium ... I've quit my position in the hope of buying in again at lower levels when the optimism resumes

I would then need to sell before another performance fee wipes the optimistic smiles off investor faces

When earnings are announced I look forward to discovering whether actual earnings performance matches analyst and market optimism

It is too early to tell whether forecasts will be realised but I do note that gas distribution in WA is said to be a growing market

With Best Wishes

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

resillent1

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Monday, July 09, 2007 - 09:09 pm:

Hilarius

I have a suspicious mind and in the case of DUE I just can’t see enough transparency in the reports and correspondence to disprove my suspicions.

It looks like you traded this one in accordance to your plan. I would consider that a good trade, even if the outcome on this occasion was not ideal.

Cheers

resillent1

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Monday, July 23, 2007 - 07:23 pm:

Hilarius

I am re-reading Benjamin Graham’s book The Intelligent Investor. The start of chapter 12 is as follows.

"This chapter will begin with two pieces of advice to the investor that cannot avoid being contradictory in their implications. The first is: Don’t take a single year’s earnings seriously. The second is: If you do pay attention to short-term earnings, look out for booby traps in the per-share figures. If our first warning were followed strictly the second would be unnecessary. But it is too much to expect that most shareholders can relate all their common-stock decisions to the long-term record and the long-term prospects."

This advice seems as relevant today as it was back then.