Deciphering Company's Profit/Loss

It always feel exhilarating to see an increase in a company's profit and demoralising to see a decrease or a loss. However, before you make any decision to purchase or sell the share of the
company, it is important to take a closer look at the details that attribute to their profit/loss.

1) Before we even look at Profit/Loss meaningfully, one should always exclude any extraordinary gain or loss.

For example, a divestment of the company's asset will definitely increased its profit. In fact, you might even downgrade the company if the asset is one of the revenue churning asset in its core business. One recent example is the Ascott group where it divest its properties to its REIT.
Likewise, acquisition will significantly reduced a company's earning or might even cause them to go into the reds. Similarly we should exclude them, adding the amount from acquisitions back into Profit/Loss Statement. Strategic acquisitons lead to growth and will increase a company's future earnings.

2) Seasonal effect on Profit/Loss.

Sometimes it is just normal for a company to achieve marginal profit or even be in the red for certain seasons. There appears to be a drop in earnings from the previous quarter, but it might be a rise in profit compare to the same quarter last year. One example for this is Brookstone where it has first 3 quarters of loss and last quarter of profit that is more than sum of its losses. As it deals with lifestyle products and partly because of Americans expenditure pattern, The Americans only buy these products for their loved ones during festive seasons, mainly Christmas.

3) Profit due to cost cutting

It will be a very good news if the increased in profit due largely to the company ability to cut production/operating cost. Improved cost effectiveness will always stay with the company even if during the bad times. They will have a competitive advantage over its peer and sometimes be able to whether a storm when its peers struggles and ultimately fades out of the competition - a bonus: getting bigger market share without doing a thing.

4) Profit increase at the expense of decreasing profit margin.

A company might be able to increase its market share by decreasing the retail price of its products and hence lowering its profit margin. The question is can they sustain this advantage? What if there is a sudden surge in the cost price of its raw material and was caught off guard? For example, the company has went into a contractual agreement with its customer to supply the products at a better-than-market price by sacrificing its profit margin. The company's profit margin might become negative if there is an unexpected surge in its raw material price during this period.

Of course, there are much more cases not consider. So the main point is to take a closer look at Profit/Loss Statement and not take them as they are present to you.

Welcome again

Hi Mr Danny and my_comfort_zone!!!

Welcome to the stock community. Have a pleasant stay and hope you benefit for it. Care to introduce yourself to the rest?

To all: If you have any friends interested in joining the stock community or you want to recommend to your friend, do email devil_bliss, hannie_the_bannie or tradingdiary to tell us or you can simply post an entry to tell us. So that we can invite your friends on board the cruise to fun trading!

Our Stock Community: 11 members and counting.

Valuing a stock

This is the last step of the 7 Stock Screens and what I am going to write on is out of the book "Sun Tsu on investing" context.

How should you value a stock? In other words, is this stock expensive.

Wrong Method
A classic example:
My mother came into my room.

Mum: GH (my bro) tell me to buy Thomson Medical
Me: Hei Mum, HTL is a relatively cheap stock compare to Thomson Medical
Mum: How much?
Me: $1.32
Mum: Thats expensive, Thomson Medical is only 39 cents

And this is my explaination to her....

A stock price is not an indicator of a stock's "expensiveness". The right way should be using P/E ratio, where P is the current price of the stock and E the annual earning. Therefore P/E ratio = (current price of stock) divided by the (annual earning of the stock). As this ratio tells you what price you are paying "relative" to the company's earning capability.

Right Method

Using P/E ratio. However, even if you have done your research on the company (e.g. management, products, business structure etc) there are still a lot of factors to consider.

1)Updating P/E ratio.

This was mentioned by Yuanhan
"P/E ratio should be calcuated using the most recent 4 quarters earnings(that means it might be 1st quarter of 2006 + 3 quarters of 2005) instead of just 2005 earnings"

Yes, this method will give us a more up to date "expensiveness" of the stocks as their earnings ability are updated. After researching on this method, I discover others have already been using it. This "most recent 4 quarters" is also known as trailing twelve months (TTM) and is used in some stock analyst site like Morningstar.com (US site). However, I do not think the business times use this method to update a stock's P/E ratio.

2) Comparing P/E ratio within an industry.

The average P/E of property sector might be 15 but that of Medical sector might be 20, therefore it a medical stock at P/E 17 is cheap compare to its own industry but expensive when it is compare to the average P/E of Singapore stocks.

However, you might also want to subdivide the sector such as property sector to "the developers" and "contractors". This becomes a very gray area. Of course subdividing it will give you a more accurate average P/E for you to compare with but doing too much reduce the sample size for you to calculate the average.

3) Paying premium P/E for niche market.

If a company can carve out a niche market within its own industry, you should be willing to pay a slightly higher P/E for their stock. It is actually an extension of point 2, sometimes the company is doing things so differently from its competitors (and must benefit from this difference), that you think it should be subdivided into a subsector by itself. The right way to do it is continue comparing with its closest competitors but you ask yourself if it is worth it to pay the premium (its P/E - Average P/E) for it.

This premium can be considered for these as well:

• Strong Consumer Brand
• Monopoly

4) Estimating P/E (forward P/E) by predicting the results of the coming 1 or 2 quarters.

The P/E might be expensive now as people are estimating the coming results to be excellent, greatly improving the TTM earnings and greatly reduced the P/E. You can say that they estimate the forward P/E to be very low.

Caution: this is very dangerous as high expectation of the company to be performing very good in the near future and yet with the company not producing the result will cause the stock price to get a double blow.

Sometimes it is easy to predict the forward P/E if the company has keep and always release the updates of their order book. For example, Sembmarine and Keppel Corp did that. It will be a bonus if you buy a stock that is trading at an average P/E but you estimate its forward P/E to be very low.

5) Comparing P/E with the company Compounded Annual Growth Rate (CAGR)

This is similar to point number 4, just that you are looking longer term. You should be willing to pay more (high P/E) for a company with consistent/predictable growth rate and high CAGR that is calculated over at 4-5 years. Although historical data on performance is not equivalent to future performance, but it is the best indicator you can find. It indicates that the company is able to perform irregardless of the economic climate. If the company is able to achieve the high growth year after year, the P/E will be revised downwards year after year and stock price will rise after each revision.

7 Stock Screens

I wrote a summary of the 7 Stock Screens from Sun Tsu on Investing. It is in my personal trading blog, www.xanga.com/tradingdiary . Have a look.

New Members

Hei,

Welcome aboard!!! You have just join our stock community. Let me introduce all the new members to the rest.

Ojusti - Hongliang, is my friend I met in Youth Expedition Project in China, Hainan. Graduated fromNUS Engineering and now serving NS. He also invest in stocks

Divingd - Lihui, friend I knew through Danny. Currently studying in NUS Economics and studying about stocks and derivatives now (all the Monte Carlos and Black Scholes stuff). Interested in stocks and want to know more about it.

Kel - Kelly, classmate in NUS Mathematics but only knew her when she sat beside me for commencement. Oops.... Interested in stocks and want to know more about it.

So these are the 3 new members. Say Hi to them and maybe we can introduce ourselves in the comments. More will be joining us.

2 more new members!!! Micheal Tay and HY. Welcome.

Bob's Stock Pick

If anyone is wondering how should he/she writes a stock pick, this is a veteran in writing about stocks.

http://www.xanga.com/bobsadviceforstocks

He is a fundamentalist cum technicalist who writes about US stocks. However, Its hard to see what guideline he uses to pick stocks.

Im not implying to follow his stock picks (which is American anyway) but can study his review style.

OSIM

Information from OSIM international is taken from its Financial Highlights section in its annual report dated March 2005.
Current Quarterly Earnings:
Comparing the first quarter of 2003 and 2004, there is a 31% growth in turnover. This is the most growth of all quarters. The least growth was in the third quater, where, compared to 2003, 2004's growth was merely 3%.

Annual Earnings
In 2003, the EPS for the year was 5.4, while the EPS for 2004 year end was 7.1. The group's net profit increased by 32%.

New Heights
OSIM recently introduced I-Gallop, a product that mimicks the action of horseback riding, aimed at consumers who want lose weight and have fun at the same time. The other products recently launched include I-Zap and I-Squeeze. The group also plans to open more stores and chair spas across the globe.

Supply and Demand
The trading volume of the stock on 13 April 2006 is 321,000 with an average 3 month volume of 519,074.

Leader or Laggard
OSIM's main competitors are OTO, and several companies emerging into the Asian market.

Institutional Sponsorship
I am not sure about this point, can anyone provide information on this?

Market Direction
According to the annual report, the group's turnover is up 16% with global franchise markets and China leading the growth at 46% and 42% respectively. They target to achieve $1 billion in profit by 2008. Are they still on track to achieve this? (Only time will tell.)

I find that using CANSLIM to look at companies is actually quite straight forward. Most information can be found directly in annual reports, quarter reports and in the newspapers. It takes a bit of research in order to understand "N", new heights, management, products, services. This information can be found on their websites, although OSIM's corporate website doesn't seem to be updated. The C and A portions of CANSLIM are pretty obvious. If we want a winning company, we ought to have C and A to be outstanding. Just like when we want to buy an apple, we need to pick one which is not rotten and looks fresh. In essence, they mean the same thing. I do not really know how to look out for sponsorship for the company, perhaps I didn't read the annual report thoroughly enough. "L" is pretty simple for OSIM, and "M" is something that we need to determine ourselves. I find it subjective in discussing aout the market direction of OSIM. Mainly because I do not enough knowledge of the market. However, I personally feel that with Osim's expansion across the globe, its name will be more popular and this is make Osim an internationally recognised brand for spa chairs and other health products.

Osim is currently holding a fair at Takashimaya basement 2.

www.xanga.com/tradingdiary

Hei guys,

This is a link to my own personal trading blog: www.xanga.com/tradingdiary , please feel free to take a look.

Petra AGM

The Annual General meeting of PETRA FOODS LIMITED will be held at Grand Hyatt Singapore, 10 Scotts Road, Magnolia 3, level 3 on Friday 28 April at 2pm.

Still checking if non-shareholder can attend the AGM. Will tell you all by next week.

Annual reports

Hei guys,

I got quite a few annual reports of companies. You might want to take a look if you are interested or we could just each do a exercise to analyse their balance sheet and business from the annual reports. These are the companies that I have:

StatsChipac
Ho Bee
NOL
Cosco
Sunpower
Capitaland
ST engineering (must check if its still around)

New
UTAC
Global Voice
Chip Eng Seng
HTL
Osim
MCL Land
Shanghai Allied Cement
East Gate

I think thats about it. And I have request for a company visit from Petra Foods but they have yet to reply me.

Petra Food

This company just appear in my "radar screen" of fundamentally good stock.

You can check the company out at http://www.petrafoods.com/

Why is it good?

1) Strong consumer brand:

or I should say it manufactures chocolate with strong consumer brand which includes

Nestle
Cadbury
The Mars Group
Arnott’s
A.B. Foods
Barry Callebaut and the
Meiji Group as our customers.

2) Leader in the field in South East Asia

This is what they claim and that is why all the chocolate brands listed above outsource their manufacturing to Petra Food

3) Large Distributing Network

Carrefour
Giant
Hero
Makro
Indomart

4) Consistent Historical growth from yr 2001 to yr 2004

with 38.3% compounded annual growth rate (CAGR) for revenue
and 30.4% CAGR for EBITDA (earnings before income tax, depreciation and amortization)
and 41.6% CAGR for NPAT (net profit after tax)

5) Large overseas market that they have not venture into.

That includes Europe and China.

6) PE ratio

A bit high at 17.6 but if it promises consistent growth rate at 41.6%, I guess this is a relatively cheap valuation.

Anyone interested in a company/factory visit?