Tuesday, December 08, 2009

BAGAKOAA December 8, 2009 Pick Stocks Redux


December 8, 2009 Pick Stocks Redux

This is a reprint of a Nov 29 post adjusted for a new information source.  Morningstar has turned out to be a very user friendly source for all value investing data.  Please feel free to follow along using Morningstar and CVX.  Keep in mind that many of the ratios are recalculated everyday so they might not match what is presented here.  If you complete this exercise before the end of December 2009, most of the numbers will be close.  It might take you about 15 minutes to follow along, but as you become familiar with the various tabs, you can quickly kick the tires on almost any stock.  Good luck and have fun and make some money. 

So there you are pumping gas on I-15 (for our int’l readers, that is a major highway in the western US) and you look up and see the Chevron logo and think that you are paying more for gas than you did 3 months ago. Then you hear Cramer pontificating about how great Chevron is. Then you read an article in the Wall Street Journal about oil shortages and possible oil price increases. So you know this is sign from above to buy, buy, buy Right? NO NO NO. Let’s do about 10 minutes of homework on the stock first to confirm our feelings.

Go to http://www.morningstar.com/ and click on the Tab labeled Stocks.  At the top of the page you will see a box with stock/fund in the box.  Type in the ticker CVX. Ooo It currently at $US76.75 a share. This is not a cheap stock. FIRST Mistake, the price of a stock has nothing to do with the relative value of the stock. The price of a stock is the result of its comparison to its earning per share and the demand for that stock.  More about that in a minute.  To the right of the current price, you see a bunch of other numbers.  You see the opening price, the days range, 52 week range, (noting where a stock is in that range can be relevant), Projected Yield, (this is the annual dividend per share divided by the current price and displayed as a percentage.  In this case the yield is 3.55%.  You would compare that to other stocks or any investment you might have.), market cap is the total value of all of the outstanding shares time the current price, volume is the number of shares traded so far this day, and average volume is the number of shares normally traded on any given day, forward P/E (forward looking price to earnings ratio) which we get to in a minute, P/B or price to book ratio can tell a person what they are paying for a company’s assets based upon past valuations (It is determined by taking all the assets, subtracting all that is owed, and dividing the result by the number of shares.  In a perfect world you would want a 1.0 PB.  Anything below that is considered a bargain anything above that is considered a premium.  Typically there is an inherent premium in well known brands like Disney, Coke, McDonalds.), P/S or price to sales which is determined by dividing the company’s last twelve month of sales by the number of outstanding shares, and lastly P/CF which is price to cash flow meaning the current price divided by the per share value of the company’s 12 month cash flow.  BTW, one of the great things about Morningstar is its glossary function.

 So lets take a quick look at the forward PE ratio. You calculate this by taking the analysts earnings estimates and dividing into the current price of the stock. In CVX's case you can see a Forward PE ratio of 10.00 and down towards the bottom of the page you see Wall Street Recommendations?  Just to the right of that you see more. . .  Click on more.  Here you see what all the brainiacs think the CVX will do on a per share profit basis next year.  You can see from the chart we have 19 analysts reporting and the mean earnings per share are $7.67.  Just do the math. ($7.67 X 10.00= $76.67 or $76.67/$7.67 = 10.00.  That multiple is what Cramer is always babbling about.  That multiple gives you a basis to compare to other stocks.  Typically the lower the P\E, the cheaper the stock, regardless of the current price.

Now go down the screen to the right hand side and see all of CVX’s peers. You got XOM, Royal Dutch, BP, and COP to name a few.  No you know that CVX’s PE is 10 so you just go to each of theses company’s quote page and take a quick look at the other PEs.  I’ll save you the time.   XOM 12.5, RDS.A 22.9,  BP 19.00, and COP 8.2. So out of that list CVX is the one of the cheapest stock regardless of the price. So now you want to BUY BUY BUY. NOT.

We do a little more homework. Like I said, know how your company makes money. You think Chevron would be easy, because they sell gas. Scan down the page and you will see the Profile. Give it a read and you’ll be impressed with what else your company does. You will see a complete profile on Chevron. Now you know how your company makes money and you might be able to figure out what other factors influence the value of that stock.  As a premier reader you would get all of the analyst’s reports.  It’s about 300 dollars for a two year description.  If you think that is rich and have a specific question about an equity, send me a note.

Now scroll down to Key Stats.  The first thing you see is P/E TTM.  That means price to earnings ratio for the last 12 months (Twelve Trailing Months) versus our forward looking P/E ratio.  As you can see the past twelve month P/E is 12.72.  What you want to see is how it compares to others in the industry.  You can see that industry average is 26.0.  So CVX is selling at a 48% discount from the industry average.  It’s like a sweater being on sale so now you BUY BUY BUY, NOT. Let's look at few more numbers.

Remember at the top of the page we mentioned projected yield.  CVX throws a 3.5% dividend, always a good thing. Recently I have been looking for stocks throwing dividend above 4%. Thanks TIM, I am a slow learner. Now you can anguish over all those number, but I like to look at just couple that most value investors consider important.

Back to the section on Key Stats and look at Net Margin % TTM (again twelve trailing months). Net Margin is 7.3% The industry average is 5.4%. Think about this, you can buy a stock at a 48% discount to the industry whose margin is 35% higher than the rest of the industry. So now we BUY BUY BUY, NOT. A little more homework.

I look at the ROE or return on equity. In a nutshell it is a measurement of how management is utilizing the resources of the company. The higher the number the better.  This shows a lackluster 13.9 compared to an industry average of 12.7.  I like an ROE of more than 25. If you click on Key Stats “more. . .”, you can see a 10 year history of their ROE.  If you do the math, their 5 year average ROE is 25.75.  That is a good number. Very nice. No don’t buy it yet.

Near the top of the Page you will see a tab called Financials.  Please click on that tab.  The first thing you see is a 10 year Income Statement.  All those numbers ooooh.  Its scary.  Not really. Here is what I look at and it only takes a couple of minutes. First, let’s look at the recent trends.  At the top of the financials section you will see another tab called quarterly results.  Click on it.  What are top line sales looking like?  Stocks rise short term when profits improve, they rise long term when you have both sales and profits headed up. You can see that in December 2008 they had 45 billion in revenues, 36 in March 09, 40 in June, and their last reporting in September was 46 Billion.  Keep in mind the price of oil when you look at the quarterly revenue. Now the next row of numbers is Earnings before taxes. AKA Profits. You can see a similar trend s as well from looking at the past 4 quarters.

Now back at the top there is a tab called “5-Yr restated”.  Please click on it. Instead of seeing 4 quarters of Income Statements you are seeing 5 years. You can see the ups and downs and you can see that they finish 2008 at 273 billion. If you go back to the quarterly numbers and add up the last 3 quarters, you know they will need a 100 billion dollar fourth quarter to hit their 2008 number. Now what is real pretty about their annual number is the growth of the Earnings before taxes. Look at that 5 year trend. That gets high points in my book. So we BUY BUY BUY, NOT.

Sales are good, profits are good, but cash is very important. Let’s take quick look at their annual trend of how they handle their checkbook.  Go to the tab called 10-Yr Cash Flows.   Go to the row of numbers labeled “cash from operations”. What you want to know is, do they make cash from running their company. There too you see a nice trend upward and they have gobs of cash. NO NOT YET BUT CLOSE

You got sales, you got profits you got cash. All set. The US Government has lots of cash and all they sales you could possibly imagine (Taxes). Would you buy stock in the US government? Let’s look at the debt of CVX.. The accountants out there are getting all excited right about now. At the top of the section you will see a tab called 10-Yr Balance Sheet.  What you are looking for is Long Term Debt. That would be anything they don’t plan on paying off in less than a year. OMG, they have 5.7 billion in long term debt. Terrible!  Well its not that bad. Think back to the Income Statement. They made 42 billion in 2008. So in essence they could pay off their long term debt in about a month and half out of most recent earnings. Not to Worry. Great Stock BUY BUY BUY. Yes.

But before you go buying, what is a good price to buy in at? $78.17 was the closing price on Friday. Its high was $78.73 its low was $77.26, but there is a bid price there of 74.44. I would watch the Asian indexes the night before and look at the Dow futures around 5:30 AM. If the market looks like it is going to head down, put in a LIMIT order just below the closing price. Let’s say 78.00.

Your not done yet because all you did was buy a good stock. You need to have an idea of where to get out. What if this whole Dubai thing gets really ugly and for what ever reason everyone feel safe with the US dollar and the dollar gets stronger sending all of the commodity prices in the toilet. Chevron starts heading down to $70, a 10% loss. Be sure to protect yourself the minute you own the stock. My rule is a stop order at 8% below my buy in.

Also determine where you might want to get out or at least take a profit. Where will that stock be in the spring or next year. You can kind of look into the future. Let me tell you how. Go back to the Reuter’s page and at the top left you will find a tab called Estimates. Click on it. There you will see what all the experts (remember I am not an expert. Just a cute, funny, chubby, guy who has no life.), think how CVX will perform over the next 3 6 9 and twelve months. I like to go to the end of the following year as these are the most complete and conservative estimates around. Now you can see there are 20 experts covering CVX. Their consensus for 2010 earnings per share is $7.53 a share. Now think about how we calculate PE Ratios. Earnings time the multiple determines the stock price. So 7.53 times current PE of 12.72 mean that CVX could be worth $95.72 a share in 2010. And if you use the industry standard PE ratio of 20.12 times the analysts estimates, or 7.53 time 20.12, you are looking at 151 a share. Is that possible, sure in May of 2009 this was a 100.00 a share stock.

So I would be looking for 92 around the first quarter of 2010. And 100 by years end. So go ahead and buy at the 78.00 price range, put a stop in at 70.00 and use a limit order to start taking profits next year around the 92.00 range.

Salve Lucrum



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