Would you like me to value your stocks?

Having read Roger Montgomery's book Value.able I have created an online spreadsheet using his formula to value shares. If interested to have a look at the spreadsheet then feel free to follow the link from my earlier November post 'Which of these stocks is currently attractive?'

Alternatively if you have any shares which you want me to value using their 2011 annual report then please feel free to let me know via a reply below.

With the current state of global economy such as European sovereign debt crisis and rehypothecation, I believe shares will continue to become even more attractive in coming months.

For example, JB Hi-Fi (ASX:JBH) is currently trading at $11.34 (28/12/11) after a surprise downgrade of their profit forecast for 2012. Could this be the chance to buy that value investors have been waiting for? I've updated my online calculator to include an estimated 10% drop in profit for JBH: https://docs.google.com/spreadsheet/ccc?key=0AoGU3QVjAi2tdEZxTVBEZzc3bUtxa0RCaWJnTDBTcVE#gid=7

Value investors around the world would currently be on high alert for opportunities. For example, Orbis Investment Management (Australia) has recently announced they are now a significant shareholder of Matrix Composites and Engineering (ASX:MCE) with a 5.48% share.

Those unfamiliar with Orbis will find this Forbes article an interesting read. The article explains their contrarian, Buffett-style value investing principles: http://www.forbes.com/global/2001/0820/036.html

The basic valuation formula is: ROE / ROR x Equity per share.

ROE = Return on equity
ROR = Required rate of return

However Roger improves on the basic formula by breaking the first part of the equation (ROE/ROR) into two parts: 1. Profit retained 2. Profit paid out as dividend.

By doing this the dividend payout ratio of the company is taken into account. Basically if you had a company with high sustainable ROE you would benefit from retaining the profit so it can grow to an even larger amount than paying it out in dividends.

For individual stock requests I'll discuss the further assumptions used in the formula and also the variables such as required rate of return.

Again, I'm also on the look out for good value shares at the moment and willing to value them if you want to let me know a stock you are interested in! 


Cheers
Sterling

Sovereign debt, Gold and Hypothecation

"Capitalism without bankruptcy is like Christianity without hell" Borman

Over the last two days I've been watching some videos on Youtube showing interviews by Kyle Bass the founder of Hayman Capital. Bass is probably most famous for the gains he made by betting against the US housing market by hedging his positions through the purchase credit default swaps (CDS). These CDS acted as insurance against market price falls of the collateralized debt obligations (CDO) being widely marketed at that time.

When speaking in a 15/11/2011 BBC interview Bass was questioned on the morality of investors of making gains from the US subprime mortgage crisis. Basically the interviewer asked if it was right or wrong to profit from the misfortunes of people who over-borrowed and lost their homes in the US. He quite succinctly replied that the such events would occur regardless of his involvement and that he had a fiduciary duty to protect his client's funds. He gave the following quote: "Capitalism without bankruptcy is Christianity without hell." I must admit that it was the first time I had heard that quote before!

Currently I'm reading his latest letter to Hayman Capital shareholders where he is extremely certain of a Japanese sovereign debt default following the default of EU nations. He paints the following picture of the current situation:

"Imagine a team of mountain climbers all strapped together for safety as they ascend a treacherous peak. While they are all holding on to the mountain there is no additional strain placed on each other. Now consider what happens if one climber, let’s call him Stavros, slips and loses his grip. He places added strain on the remaining climbers. One climber might no make a difference, but as Seamus, Pablo and Jose each lose their grip they not only add extra total dead weight to the team but also increase the amount each other climber has to carry, until finally Francois, Luigi and Takehiro let go and poor Jurgen, and Uncle Sam are left trying to keep the whole team on the mountain."

In particular he is speaking about the unsustainable sovereign debts positions of Greece, Italy, Ireland, Iceland, Spain, Belgium, Japan, Portugal, France and Japan. To quote Bass again: "We believe the debts of the following nations, among others, are not sustainable in the current economic environment: Greece, Italy, Japan, Ireland, Iceland, Japan, Spain, Belgium, Japan, Portugal, France, and have we mentioned Japan?"

So where to for cautious investors - Cash, guns or gold? We all know the implications of holding cash with all the money 'printing' being done by the world's central banks. As for guns well known financial commentators such as Robert Kiyosaki have been frequently talking about the possibility of social upheaval and alluding to the insurance policy offered by buying a gun to protect one's assets from upcoming unemployed and desperate masses! Although I do believe Kiyosaki is a very successful investor he has been know to make repeated alarmist comments in his most recent posts on his site www.conspiracyoftherich.com

As for gold the question I want to discuss is between physical or paper? In my personal opinion investing a portion of ones fund in gold is always going to be a smart move. Throughout history regardless of country or upbringing man has always had used the metal as a store of wealth and hedge against fiat currency manipulation. Dylan Grice of Societe Generale has written about the timing of gold purchases and sales in Popular Delusions. Those interested in reading the full article can find it within the 2010 annual report from Platinum Asset Management (PTM) which is where I read it.

Those of you with Australian self-managed super funds (SMSF) looking to invest in gold would mostly likely be looking at exchange traded funds such as Betashares Gold Bullion ETF (ASX code QAU). However with the recent issues surrounding hypothecation I became slightly wary of gold ETFs when I read the following article on Zero Hedge: http://www.zerohedge.com/news/gold-rehypotecation-unwind-begins-hsbc-sues-mf-global-over-disputed-ownership-physical-gold The article talks about HSBC suing MF Global over disputed ownership of physical gold that was re-hypothecated. The underlying worry for investors is whether MF Global used re-hypothecated client gold to satisfy liabilities and whether there are other occurrences of this occurring at other financial institutions.

Closer to home in Australia I'm wondering whether the same thing could occur if I purhased Australian listed ETF backed by gold bullion? As central bankers continue printing more money to reduce imminent volatility they are only causing the eventual consequences to be worse. Read The Black Swan of Cairo by Taleb & Blyth for details. However if I expect to protect myself from their actions by buying gold the last thing I would want is to find out my gold has been used as collateral for another parties transactions!

If you have any comments or find any errors in my post please feel free to let me know.

Are you a Cornucopian?

If we look at popular media and listen to interest groups we could easily become dismayed at the economic problems occurring especially from the European debt crisis. However after listening to Matt Ridley's audiobook The Rational Optimist I am reminded that we are living in the best times ever for the majority of the people on the planet. Short term economics issues and problems aside, the majority of people now have a better standard of living than any other time in history. His argument that this has come from the unique human trait of specialisation and trade is solidly backed up by a range of research spanning the entire span of human history.

The main theme of the Ridley's book is that trade is the driving force of human advancement by encouraging specialisation. For those unfamiliar with Matt Ridley I can tell you that he comes highly recommended by Charlie Munger. In fact Munger recommends Ridley's earlier book Genome in his list of recommended readings found within Poor Charlie's Almanac. Having seen one of Ridley's talks online at TED videos I finally decided to check out this work.

As I listened to his work I am reminded of other books I've read before along similar themes. In particular Paul Zane Pilzer's ideas come to mind. If I compare Ridley and Pilzer side by side then Ridley believes the engine of human progress has been the meeting and mating of ideas to make new ideas while Pilzer believes human progress was due to increases in the speed in which individuals could communication. Both authors are basically saying the same thing - that as a species humans have progressed beyond other forms of life because increases in speed and access of communication has allowed the sharing of ideas promoting economic advancement.

Bjørn Lomborg is the another author whose work I believe Ridley was highly influenced by. Although Lomborg's book The Skeptical Environmentalist is quite detailed with numerous graphs and charts it is well worth the effort as it powerfully dispels any notion that humans today are worse off than our ancestors. Lomborg shows with detailed research the improvements in: Life expectancy and health, Food and hunger; Prosperity; pollution, just to name a few.

I later realised why Ridley's arguments sounded so similar to Lomborg's - Ridley actually writes a recommendation for Lomborg's book which is found on the book cover! "The Skeptical Environmentalist should be read by every environmentalist, so that the appalling errors of fact the environmental movement has made in the past are not repeated. A brilliant and powerful book." Matt Ridley - Author of Genome.

So is The Rational Optimist a worthwhile read? Even if you have read the works of other rational optimists and don't wish to reread similar theories, his ideas on oils vs biofuels is compelling enough to give your time. The original founder of the Cornucopian theory Julian Simon would be proud of this work. I am still amused whenever I see in the newspapers an article about the impending end of life as we know it - global warming, peak oil approaching, and so forth. I found Ridley's work very refreshing and highly recommend it, especially those dooms day alarmist that still exist out there.

Piotroski Score

I always enjoy finding out more about Australian value investors and was recently reading the 2011 Platinum Asset Management (PTM) annual report. Those who don't usually read annual reports may find the PTM annual reports a pleasant surprise as at the end of each annual report are articles that value investors would appreciate. In the 2011 report there was an interesting article by Dylan Grice of Societe Generale titled Cheap Stocks for An Expensive World. In it he referenced the work of Joseph D. Piotroski who is a Stanford University Graduate School of Business professor who specializes in accounting and financial reporting issues.

Basically the Piotroski score is a ranking system based on nine criteria that calculates varios ratios from historical account information. The values range from 0 (lowest score) to 9 (highest score) with higher scores suggesting firms in better long-term financial health. First published in 2000, Piotroski’s scoring system (F_Score) has been found by a variety of researchers including himself to identify stocks that consistently outperform market indexes.
The nine criteria are:

1. Net Income: Bottom line. Score 1 if last year net income is positive.
2. Operating Cash Flow: A better earnings gauge. Score 1 if last year cash flow is positive.
3. Return On Assets: Measures Profitability. Score 1 if last year ROA exceeds prior-year ROA.
4. Quality of Earnings: Warns of Accounting Tricks. Score 1 if last year operating cash flow exceeds net income.
5. Long-Term Debt vs. Assets: Is Debt decreasing? Score 1 if the ratio of long-term debt to assets is down from the year-ago value. (If LTD is zero but assets are increasing, score 1 anyway.)
6. Current Ratio:  Measures increasing working capital. Score 1 if CR has increased from the prior year.
7. Shares Outstanding: A Measure of potential dilution. Score 1 if the number of shares outstanding is no greater than the year-ago figure.
8. Gross Margin: A measure of improving competitive position. Score 1 if full-year GM exceeds the prior-year GM.
9. Asset Turnover: Measures productivity. Score 1 if the percentage increase in sales exceeds the percentage increase in total assets.

A company's F_Score is determined by summing up the results of each test (one point if a stock passes each test and zero if it doesn’t). Therefore a company's score can range from 0 (worst score) to a maximum score is 9 (best score). Those interested in reading the award winning paper can follow this link or google to find it:

I have recently finished Roger Montgomery's book on value investing and was considering including it in my online valuation spreadsheet based on his book. Those interest can follow the link here: https://docs.google.com/spreadsheet/ccc?key=0AoGU3QVjAi2tdF9zcTUxbjBISWx3QzE5eDEzeW1oSUE

I'm interested to know your opinion of whether Piotroski's score has relevance for the current Australian ASX market?