Monday, October 15, 2018

A Value Opportunity in Bausch Health


Bausch Health Cos., Inc. engages in the development, manufacture, and market of a range of branded, generic and branded generic pharmaceuticals, medical devices and over-the-counter products. It operates through the following segments: The Bausch + Lomb/International, Branded Rx, and U.S. Diversified Products.

The Bausch + Lomb/International segment consists of the sale of pharmaceutical products, over-the-counter products, and medical devices products. The Branded Rx segment comprises of pharmaceutical products related to the Salix product portfolio; dermatological product portfolio; branded pharmaceutical products, branded generic pharmaceutical products; over-the-counter products; medical device products; Bausch + Lomb products sold in Canada; and the oncology, dentistry, and health products for women. The U.S. Diversified Products segment refers to the sales in the U.S. of pharmaceutical products, over-the-counter products, and medical device products in the areas of neurology and certain other therapeutics classes, including aesthetics and generic products in the U.S.

Founded: 1994
Number of Employees: 20,700
Headquarters: Laval CA
CEO: Joseph C. Papa, MBA


Valeant, BHC's predecessor, is notorious in an industry rumoured to be one of the most cut-throat and crime-ridden.(1)

It lost over 70% of its market value in approximately 100 days in Q2/Q3 of 2015, eventually bottoming out at $11.20 from a high of $347.84.  Lawsuits, investigations, criminal charges followed.  It replaced CEO Michael Pearson and installed Joseph Papa.  Papa has divested some of the purchases made under his predecessor, reduced debt and changed the company's name to Bausch Health.

Analysis Hypothesis:

I believe that much of Valeant's problems stemmed from its culture.  When a company falls in such a spectacular fashion, more likely than not, there's a management component and in a situation like this, when a new company rises from the ashes of the old one, we need to know if there is still rot at the core.

Has BHC fundamentally changed from Valeant and does its future look promising?


This analysis will review the board of directors and management team, the company's financial health, R&D investment, debt, growth potential, valuation and income outlook.

Board of Directors and Management Team

A Globe and Mail article, published on July 30, 2015 less than a week before the beginning of the Valeant crash, unintentionally and ironically wrote a treatise on what was probably at the core of Valeant's issues, a policy of aligning management rewards with share performance, to the determinant of building long-term value.

There are currently ten members on the board of directors, only one remains from its days as Valeant.  It is also a reasonably diversified group, drawing on people with different backgrounds and expertise.  It's also a largely independent.

The Management Team is likewise very diverse and probably has a good blend of new blood while still preserving the knowledge base of people from its Valeant days.

Both elements of leadership look strong.

Financial Health

We'll look at BHC's quality of earnings to determine company's financial health.

It is a fact that earnings can be manipulated and they can be improved by accounting-driven decisions.  We want earnings that are persistent, can be expected to repeat and aren't the result of one-off events or management tinkering.  I use an nine part quality of earnings framework based off the work of two academics, Lev & Thiagarajan.  You can read their original paper here.  You can read my adaptation here.

The framework looks at nine areas in the financial statements: inventories, receivables, capital expenditures, research & development, gross income, selling-general-administrative expenses, sales per employees, tax rate and audit opinion.  The first two, the fourth, fifth and six are compared to sales levels, capex and/or r&d are compared to industry averages (I use a peer group average as a proxy), the tax rate measures seeks to remove the effect of an earnings bump from a reduction in the tax rate and the a last one looks for a clean audit opinion.  When any of these measures give a favourable signal, I give it a score of one.  All the scores are summed to get a total out of nine, the higher the better.

BHC scored a three out of nine, an abysmal score.  The company has recently announced a return to profitability, and the graph below demonstrates it.  However given their quality of earnings score and a simple review of their declining gross margin and revenue (accelerating decline in revenue's case) it looks though they managed it with manipulation, but I need to be clear.  I don't mean they created fictitious sales or anything like that.  I just mean they made accounting choices that goosed their earnings.

I usually feel strongly about good quality of earnings, but should it be overlooked in this case?  I imagine righting a ship that capsized in a maelstrom is tough work.  Maybe Papa should be the given the benefit of the doubt, at least for a time.

Research and Development

One of the features of the company's Valeant days was little spending in R&D.  Let's look at BHC's R&D spend as a percentage to sales.

It's good to see R&D going up (although keep in mind that revenue has been declining for the past couple of years.  However even at it's peak of 4.35% of sales, it's a small number.  When I look at the R&D to Sales spend of some of BHC's competitors, we can see that they are below the average of 10%, but within the range.


The company has been lauded for reducing debt and streamlining its focus, undoing part of what boosted its price before August 2015.

Let's say we're from Missouri and want to see for ourselves.

Indeed the debt has come down relative to it's peek, however it's still well above it's 2013/2014 levels and what it's paying out in interest is concerning.  The pre-tax interest coverage ratio, EBIT/interest, is still declining. meaning its debt burden is getting worse (although at a slower pace).


I believe that if there's an investment opportunity, it'll be either a growth, income or value story.  You might even have two out of the three.  So, is BHC a potential growth company?

There's not a lot of data for Papa's tenure at BHC and the stock hasn't returned to the highs it experienced when Papa was first brought on.

However we'll look at how many times the company has increased its quarterly EPS over the past seven quarters.  Usually I would work with annual results, but there isn't enough information in this case.  These are the quarterly values:

Q (June 2018)
BHC has increased it's quarterly EPS three out of a possible six times.  This doesn't look like a growth story and coupled with the poor quality of earnings results I wouldn't buy the stock for growth.


We're going to look at several valuation measures - the Ohlson Clean Surplus (OCS), Enterprise Value/Earnings before Interest, Taxes, Depreciation and Amortization (EV/EBITDA), the PE ratio, and the Discounted Cash Flow Model.


The OCS is an interesting valuation model that calculates a theoretical stock value.  While I don't hold it out to be an exact value, it can give a decent ball park or at least an indication whether the stock is over, under or fairly valued.  For a detailed explanation of the model, please review this article.   Academic testing demonstrates that the model has predictive results two to three years out.

Using the OCS, BHC does appear to be undervalued.  Using a discount rate of 15% (the calculated rate is strange owing to its negative beta) and the current return on equity of 43% gives a theoretical price of $94.  However that's a fairly high return on equity.  Reducing it by 55% bring the price of the stock into fair valuation territory.  So provided the future ROE is something greater than 24%, the stock is undervalued.


The EV/EBITDA for the most recent year is 10.46, dropping from 18.16 in Y-3.    Looking at BHC's peers we can see an average EV/EBITDA of 14, another clue BHC might be undervalued.

PE Ratio

BHC's TTM PE ratio of 2.9 is quite low.


I put together a quick and dirty DCF using the firm's rate of 15% used in the OCS, free cash flow per share and growth equal to zero.  The calculation of 7.41/.15 = $49.42, a premium of 45%.


BHC is not currently offering a dividend so this is not an income story.


The analysis suggests BHC could be a value play.  Although I don't like a situation with a bad quality of earnings score, I would consider forgiving it for the reasons above.  However this company's predecessor was involved in activities that could have destroyed it.  The market may not be so forgiving and I don't just mean the stock market.  The company has a lot of work ahead of it to regain the trust it lost with its customers.


Part of intelligent investing involves taking on risk levels appropriate to one's circumstances.  We don't know what your's are and this analysis should not be construed as investment advice.  INVRS, its parent company, its officers, directors and employees cannot be held responsible for any investment decisions you make.

Research Notes


Sales Pitch

You can do amazing things with INVRS - build investment models, do peer based analysis and create investment reports.  Wouldn't you like to see for yourself?  Sign up for a free two-week trial and put the effort into learning the software using our myriad of learning tools.  If you're a numbers geek with a curious and creative mind, we're your ticket to unique investment insight.

Tuesday, October 2, 2018

An Income Opportunity in UPS

Shielded Dividend Stream?

Analysis Origin & Methodology

We created this analysis on request.  Analyses of this sort are general -we don't know the requester's circumstances and we don't know what kind of an opportunity, if any, the stock presents.

Therefore, we look broadly at the stock including quality, value, growth and income.  In this analysis, we looked at UPS with a group of peers.

Some areas will have additional notes.  This will be indicated at the conclusion of the section and can be found at the end of the report.

Company Overview

United Parcel Service, Inc. is a logistics and package delivery company, which provides supply chain management services. Its logistics services include transportation, distribution, contract logistics, ground freight, ocean freight, air freight, customs brokerage, insurance, and financing.

The company operates through the following segments: U.S. Domestic Package, International Package, and Supply Chain and Freight. The U.S. Domestic Package segment offers a full spectrum of U.S. domestic guaranteed ground and air package transportation services. The International Package segment includes small package operations in Europe, Asia-Pacific, Canada and Latin America, Indian sub-continent, and the Middle East and Africa. The Supply Chain and Freight segment offers transportation, distribution, and international trade and brokerage services.

The company was founded by James E. Casey and Claude Ryan on August 28, 1907 and is headquartered in Atlanta, GA.

Number of Employees: 280,000

CEO: David P. Abney

Peer Group

Stock Name (Symbol)Last Price (as at Sep 17, 2018)Market Cap
FedEx Corporation(FDX:XNYS)$255.8965.4095B
Brink's Company(BCO:XNYS)$70.403.6746B
Hub Group, Inc. Class A(HUBG:XNAS)$47.551.6519B
Forward Air Corporation(FWRD:XNAS)$68.121.9052B
Expeditors International of Washington, Inc.(EXPD:XNAS)$73.7812.9853B
C.H. Robinson Worldwide, Inc.(CHRW:XNAS)$96.7113.3805B
Air Transport Services Group, Inc.(ATSG:XNAS)$22.321.2123B
Atlas Air Worldwide Holdings, Inc.(AAWW:XNAS)$63.551.5793B
ZTO Express (Cayman) Inc. Sponsored ADR Class A(ZTO:XNYS)$17.1410.4481B
United Parcel Service, Inc. Class B(UPS:XNYS)$119.09105.7714B

Earnings Quality

It is a fact that earnings can be manipulated and they can be changed by accounting-driven decisions.  We want earnings that are persistent and grow and that aren't the result of management tinkering.

I use an eight part quality of earnings framework based off the work of two academics, Lev & Thiagarajan.  You can read their original paper here.  You can read my adaptation here.

The framework looks at eight (or nine) areas in the financial statements: inventories, receivables, capital expenditures (and/or research & development which is not used in this analysis), gross income, selling-general-administrative expenses, sales per employees, tax rate and audit opinion.

The first two, the fourth, fifth and six are compared to sales levels, capex and/or r&d are compared to industry averages (I use the peer group average as a proxy), the tax rate measures seeks to remove the effect of an earnings bump from a reduction in the tax rate and the a last one looks for a clean audit opinion.

When any of these measures give a favourable signal, I give it a score of one.  All the scores are summed to get a total out of eight, the higher the better.

Here are the results:

UPS's score of four is mediocre. Brinks and Air Transport Services are quite good. See analysis notes for more details.

Earnings Growth

This measure looks at the number of years the companies have been able to achieve year over year growth.  I'm looking at a six year time period so the maximum occurrence is five.

UPS is not a growth story with a score of three.

How about HUBG with a perfect score of five?  I am skeptical of their results given they achieved the worst score of all the companies in the quality of earnings category.  I wouldn't consider a long position in a company with a score of two.

There are notes to this section.

Earnings Growth Relative to Price Change

This measure is similar to the earnings yield (which is the inverse of the PE ratio), but I tweaked it to compare growth rates in earnings and price, rather than values at a single point in time.

The growth period is over three years and the calculation for the numerator is the earnings for the current period (Y) divided by earnings for the for the period three years ago (Y-3), minus one.  The calculation for the denominator is current price divided by price 36 months ago, minus one.

A value greater than one indicates that earnings have grown more than the price has grown, a favourable signal, especially if it is coupled with high quality of earnings.

Here are the results:
Great numbers for FDX and UPS, their earnings growth has outstripped the growth in their price (on a percentage basis.  As mentioned, HUBG is no longer a consideration.

See the Analysis Notes section for more details.


I like to look at multiple valuation measures in order to confirm a consistent valuation message.  We'll look at PE ratio, enterprise value over EBITDA and Ohlson's Clean Surplus (OSC).

For more information on the OCS, please see this article.

PE Ratio

The average of 23 is fairly high.  UPS is below average at just under 20.


UPS is basically equivalent to the group average of 12. By traditional measures it is somewhat high.


The OCS is an interesting valuation model that calculates a theoretical stock value.  While I don't hold it out to be an exact value, it can give a decent ball park or at least an indication whether the stock is over, under or fairly valued.

Stock    Theoretical Price    Actual Price  (Premium)/Discount
FDX         182.60                255.89                 (29%)
BCO             6.15                  70.40                 (91%)
HUBG           41.81                  47.55                 (12%)
FWRD           31.56                  68.12                 (54%)
EXPD           29.27                  73.78                 (60%)
CHRW           37.89                   96.71                 (61%)
ATSG             5.91                   22.32                  (74%)
AAWW         100.45                   63.55                    58%
ZTO             8.77                   17.14                  (49%)
UPS       4171.26                   119.9               (3,403%)

Most of the group is over-valued with the exception of AAWW and UPS. 

In the case of UPS, the theoretical price and the indicated discount is rather ridiculous, but when I examine the model I can see it has a very high ROE.  One of the assumptions in the model is that it uses the most recent ROE and it will persist into the future (another similar assumption is used for the dividend payout ratio).

I examined UPS's ROE over the past few years - it's been consistently high.  Using the average ROE over five years reduces the theoretical price to $936.  Cutting the ROE in half turns the theoretical price to $246, still a 107% premium.

It's also possible the dividend payout ratio will increase.  UPS isn't a growth story and so returning money back to shareholders seems reasonable.

A higher dividend payout ratio brings the valuation down quite quickly.  Increasing the payout ratio by 52% brings the stock into fair valued territory (without adjusting for ROE).

Regardless, according to this valuation technique, UPS seems to be undervalued.

Bonus - Quick and Dirty Discounted Cash Flow (DCF)

I wanted to see the results of the DCF model.  I only put it together for UPS and I made a number of simplifying assumptions - I used dividends as the cash flow proxy, and I only used the most recent year's.

For the discount rate I used the firm's rate calculated in the OCS and I used a growth rate of 6%, which is lower than the past three years of dividend growth for UPS (7%, 9% and 8%).

The quick and dirty DCF calculation is 3.32/(.0635-.06) = $949.  This is very close the value arrived at using the OCS when the average ROE is used.

It's a bit of a mixed story on whether UPS is under or over-valued. There seems to be more indicators that it is undervalued, however.


Not all the companies in this analysis offer a dividend.  The ones who do are FDX, BCO, FWRD, EXPD, CHRW and UPS.

We'll look at the current dividend yield, dividends per share and the dividend payout ratio.  We'll also look at the free cash flow trend.  Although this can't definitely say how secure the dividend is, it can give us a clue.

Dividend Yield

UPS has the highest yield and we can see that it keeps its dividend in a range, as do the other companies.

Dividends Per Share

Strong dividend growth for UPS.

Dividend Payout Payout Ratio

With the exception of one year, UPS pays out a consistent portion of its earnings as a dividend.  The other companies are similar in that respect as well.

Free Cash Flow

UPS's free cash flow had been terrific up to the most current year.  The reason's for the drop are several.  They paid almost $8.8 billion into their pension plan, a sizable increase over previous years'.  Capital expenditures were also up.  To pay for this, they took on debt and reduced their FCF.


Stocks have different stories - some are growth stories, some are value, some are income.  You won't find all three at once, but you can find a stock strong in one or two areas.  UPS may be undervalued and it certainly has an attractive dividend.  Although it's earnings quality is so-so, that could be cautiously overlooked.

Analysis Notes

Earnings Quality - HUBG, EXPD, CHRW and AAWW do not report inventories and FWRD and ATSG do not report SG & A expenses.  Therefore these six companies would actually have a score out of seven, rather than eight.

Earnings Growth - there is no EPS information for ZTO for the years prior to the fiscal year ending December 31, 2014, it's score is out of three.  It grew it's earnings three out three times (not four out of five).

Earnings Growth Relative to Price Change  - Price information for ZTO begins in 2016, so there is no value for this stock.


We hope you've enjoyed this analysis.  Please let us know if you have any questions or require clarification on any of the points.

This report does not constitute an investment recommendation.  INVRS, it's parent company, the employees, directors and officers cannot be held responsible for any investment decision you make, how so ever made.

Friday, September 21, 2018

Five Reasons to Build Your Own Investment Models

Would you choose a prefabricated house or something you designed yourself?  
Take pride in what you build.

There isn't a correct answer, it's situational.  Sometimes you need shelter quickly.  Sometimes you want to see your vision turned into reality.
Generally when you are first starting out, working with what's readily available makes perfect sense.  Why would you put a lot of time and effort into building something when you don't know what you want?
But as you grow in knowledge, you start to develop insight and preferences.  You see what materials you like, you know how a certain layout would be not only beautiful but highly functional and you know the neighbourhood where it would fit in perfectly.
I think something similar applies with investment analysis.  
When you start out, you work with ratios and statistics that were built by someone else.  The cost is low and they do the job, hopefully.
But as you work at it and are exposed to new ideas you realize there's a whole world beyond PE ratios and dividend yields. You see how different variations of a familiar ratio would give you more insight.  You learn about calculations you cannot find for free.  You develop your own vision and something else:
You want confidence in what you are working with.  Is the information you base your investment decisions put together correctly?  If you build it yourself you’ll know it’s right.
You want to know how it's built.  There are variations in even the simplest ratio.  Sometimes the quick and dirty option is OK, but sometimes subtly matters.
You want information no one else has.  You realize that if you rely on the same statics as everyone else you are condemned to wander forever in the world of the efficient market hypothesis.
It’s fun and rewarding to build and work with your own creations.
Creativity begets creativity.  The more you work your own concepts, the more fuel you have.  It unleashes further ideas.
You know where you are in your investment life cycle.  If it's time to start turning your vision into reality, there's only one place to do it: INVRS.

Thursday, September 20, 2018

Using Images in Your Investment Analyses

Visual content in your articles is a must nowadays. This post will provide some guidelines for incorporating images into your work.
1. The first image attracts.
investment information
These people are all consuming information.  Images help guide them to your's.

The first image you pick for your article should be eye-catching, draw readers in and make them curious.  Large, colourful or beautiful images are good choices, as are images of people – we’re drawn to pictures of other human faces.
A shocking image can also work but use with caution.  You might attract some people, but you can also alienating your readers.  If you go this route, make sure it’s relevant.

2. Use a meta-tag to tell search engines what your web-page is about.  Choose clear, simple language that will describe the image in terms of what people may be looking for.

3. Generic or stock photo images that you see everywhere aren't as powerful as unique, scarce or premium images.
4.  Use approximately one image to every 300 to 400 words.

5. Pictures, graphs, charts all count as images in your articles.
6. Speaking of graphs, they should illuminate, not obfuscate.  Help your reader – simply graphs by eliminating unnecessary clutter. 

There’s a lot of information on this chart.  Is all of it relevant?

This chart expresses one idea clearly.
7. If you have no choice but to use a more complicated image, use annotations to draw your reader to the key point.

This chart is annotated with red circles to highlight relevant information.

If you are working with a multi-row, multi-column chart bold or highlight what you want your reader to focus on.
8. Use your images to communicate, reinforce or give more authority to an important idea.  Images tend to stick with us more than words and the combination even more so.

9. Do not confuse your reader or make them work too hard.  If your image has that effect, eliminate it.
10. Remember, images are important.  Choose them with the same care you take in creating your headline.
Bonus tip: part of the INVRS functionality is to create unique graphs, including ones based on your analyses.  Sign up for our free two week trial and learn what a difference our software can make to your work.
Thanks for reading.

Saturday, September 15, 2018

Using a Scientific Framework in Your Investing

It's fun.

What is a scientific framework for investing and how can it help you?
The scientific method is arguably the most important development in the history of humankind.  It's a creative structure that stimulates curiosity.  It pushes you to be objective, rather than emotional in your approach and it encourages you to look at the world with uncluttered senses.
It also gives you a decision-making system that, if you are faithful to it, should see you avoid pitfalls like buying high and selling low or following the crowd.
The scientific method
Incorporating a scientific framework starts with the scientific method.  Let’s revisit it:
Step 1~Be curious and observe the world around you~
Step 2~Ask a question when something intrigues you~
Step 3~Do background research~
Step 4~Build a hypothesis~
Step 5~Create an experiment to test your hypothesis and run It~
Step 6~Collect and analyze the data and draw a conclusion~
Step 7~Report your findings
That’s all there is to it.  Let’s see it action with a hypothetical example.
Step 1) Be curious and observe the world around you.
You notice that certain small cap bio-technology stocks periodically gap open and then continue to rise until their value has increased by at least 50%.
Step 2) Ask a question when something intrigues you.
Are there any indicators that might uncover one of these small-cap bio-tech stocks before their price begins to rise?
Step 3) Do background research
You notice in a couple of these stocks earnings drop one to three quarters before the price starts to rise.You investigate further and notice an increase in selling, general and administrative expense is the reason.
Step 4) Build a hypothesis
A small cap bio-tech company will increase its marketing spend approximately six to nine months before the release of a significant new drug or other major development.
Step 5) Create an experiment to test your hypothesis.
After careful deliberation, you decide on the following experiment:
  • Create a portfolio of small cap bio-tech stocks in INVRS,
  • Graph them based on price over the last five years and note the dates when prices started to increase significantly,
  • Research news stories and determine the reason for the increase.  Categorize the increases by reason.
  • Create a template to determine the average SG&A spend over an appropriate period and compare it to the spend in the three or four quarters prior to the price run-up.
Step 6) Collect and analyze the data and draw a conclusion
After collecting the results and analyzing it you make the following conclusion:
“Of the ten instances of price increases, 80% were related to a new drug or other significant technological development and other 20% were related to a take-over announcement.  Of the eight related to innovation and in the nine months leading to the price increase, one increased their SG&A spend by 5-10%, five increased it by 11-20% and two increase it by more than 20%.
Based on this evidence, I conclude that an increase in SG&A spending is a leading indicator of a price increase for small-cap bio-tech stocks.”
Step 7) Report your findings
Write a blog, article or white paper about your findings.
The process can be iterative
You don’t have to stop after the final step.  Whether you prove your hypothesis or not, you can go back and do more research, tweak your hypothesis, or refine your experiment.
In the example above, a next step might be to create a test for false positives.  Or in other words, measure the likelihood that an increase in SG&A doesn’t lead to a future price spike.
What about profit and market advantage?
Clearly the degree to which you publish your ideas might be limited by economic constraints. You might want to keep certain ideas to yourself, so the reporting might be to a small group or you might take a position first or put a paywall around your work.
I hope this article gives you some ideas about how you can use the scientific method in your investing.  We'd love to hear your stories about using it.