Sunday, February 3, 2019

NextEra - Good Dividend in the Renewable Energy Sector


  • NextEra had good results relative to a group of peers in a factor-based analysis.
  • NextEra has an appealing profitability and income profile.
  • Its price momentum looks decent, with a caveat.
  • Its relatively small size (a small mid-cap) coupled with its industry (renewable energy) further weight the odds that this company could be a strong performer in the future.
Good Dividend Stock
If you want in on renewable energy, we recommend NextEra.

The Analysis Overview


I created a portfolio of stocks in the alternative energy sector, looking specifically for companies with a market cap over $1B but less than $4B.  This is a sweet spot that offers strong potential for growth but is also substantial enough not to be too speculative.

It's my believe that alternative energy is on the ascendance, where as fossil fuels will inevitably decline (NextEra isn't a pure play in this regard however, natural gas assets are part of its portfolio).  If you share this belief and you want exposure to this market, NextEra looks like a good bet.

This is a factor-based analysis on seven companies in the alternative energy sector.  It looks at momentum, quality, growth, income, value and profitability.

Each factor includes several metrics.  Each metric is rated from 1 to 7 with 7 representing the best result.  The sum of each metric rank is calculated and the result is ranked again.  The highest ranking indicates the company with the best result for the particular factor.

The Peer Group


Here is the group of candidates and a brief overview of each one.

Stock Name (Symbol)Last Price
Jan 28, 2019
Market Cap
Northland Power Inc.(NPIFF:OOTC)$17.803.1554B
TerraForm Power, Inc. Class A(TERP:XNAS)$11.392.3821B
NextEra Energy Partners LP(NEP:XNYS)$41.382.3214B
Ormat Technologies, Inc.(ORA:XNYS)$55.592.8169B
Pattern Energy Group, Inc. Class A(PEGI:XNAS)$21.042.0639B
Innergex Renewable Energy Inc.(INGXF:OOTC)$10.881.4444B
Atlantica Yield plc(AY:XNAS)$18.491.8530B

Northland Power Inc. develops, builds, owns, and manages wind facilities. It operates through the following segments: Offshore Wind, Thermal, On-shore Renewables, and Other. The Offshore Wind segment comprises Gemini, Nordsee One, and Deutsche Bucht projects. The Other segment includes investment income and administration activities. The company was founded by James C. Temerty in 1987 and is headquartered in Toronto, Canada.

TerraForm Power, Inc.  acquires renewable energy assets. It operates through Solar and Wind segments. The Solar segment consists of Distributed Generation, North America Utility, and International Utility. The Wind segment comprises of Northeast Wind, Central Wind and Hawaii Wind. The company was founded on January 15, 2014 and is headquartered in Bethesda, MD.

NextEra Energy Partners LP  acquires, manages and owns contracted clean energy projects with long-term cash flows. It owns interests in wind and solar projects in North America, as well as natural gas infrastructure assets in Texas. The company was founded on March 6, 2014 and is headquartered in Juno Beach, FL.

Ormat Technologies, Inc. is a holding company in the geothermal and recovered energy power business. It operates through the Electricity and Products segments. The Electricity segment develops, builds, owns, and operates geothermal and recovered energy-based power plants in the U.S. and geothermal power plants in other countries.  It provides energy storage, demand response, and energy management related services through its Viridity business. The Product segment designs, manufactures, and sells equipment for geothermal and recovered energy-based electricity generation and remote power units.  It also provides services related to the engineering, procurement, construction, operation and maintenance of geothermal and recovered energy-based power plants. The company was founded in 1965 and is headquartered in Reno, NV.

Pattern Energy Group, Inc. is an independent power company, which owns and operates wind and solar power facilities sales contracts. It operates through the following geographical segments: United States, Canada, and Chile. The company was founded on October 2, 2012 and is headquartered in San Francisco, CA.

Innergex Renewable Energy, Inc. develops, acquires, owns and operates run-of-river hydroelectric facilities, wind farms, solar photovoltaic farms and geothermal power generation plants. The company conducts operations in Canada, the United States, France and Iceland. It operates through the following segments: Hydroelectric Generation, Wind Power Generation, Solar Power Generation, and Site Development. The company was founded on October 25, 2002 and is headquartered in Longueuil, Canada.

Atlantica Yield Plc owns, manages and acquires renewable energy.  It specializes in Renewable Energy, Natural Gas, Electrical Transmission and Water. The Renewable Energy segment includes production electricity from solar power and wind plants. The Natural Gas segment is the production of electricity and steam from natural gas. The Electric Transmission segment relates to the operation of electric transmission lines. The Water segment is responsible for desalination plants related activities. It operates through the following geographical segments: North America; South Africa; and Europe, the Middle East and Africa. The company was founded on December 17, 2013 and is headquartered in Brentford, United Kingdom.

The Analysis


The following section describes the analysis process and objective observations of the results.  Head down to the "Putting It All Together" if you just want to read the synthesis and why I think NEP is the strongest contender of the group.

Market & Sector Price Momentum


Let's start by getting a visual perspective on how the market and sector have been performing.




A quick calculation reveals that the broader market increased about 30% compared to the utility sector increased 22% with less volatility over this randomly chosen time period.

Momentum




Longer term -
% price change over 2 years
Medium term -
12 month less 1 month price change
Short term -
Price less three month moving average
Market16%-11%-1%
Utilities Sector10%4%-1%


 Looking at the market over the longer time frame, momentum is positive. Over the medium term, there's a wave of negative momentum rolling through but it looks to be slowing down, as the short term price momentum is barely negative.

In the utilities sector, we see strong positive price momentum weakening as we move into the medium term, yet still remaining positive. In the short term the momentum is weakly bearish, similar to the market.

Price Momentum of the Group


Let's look at the price momentum for the group. We're using the following three metrics that reflect a long, medium and short-term perspective:

  1. Percentage price change over two years,
  2. 12 month less one month price change,
  3. Price less 10 week moving average change.


Long-term
Value and rank
Medium term
Value and rank
Short term
Value and rank
SumFinal
Rank
NPIFF-1%
2
-14%
3
7%
6
114
TERP-4%
1
3%
6
1%
3
103
NEP31%
6
-4%
5
-5%
1
125
ORA4%
4
-25%
1
4%
4
92
PEGI7%
5
-10%
4
5%
5
146
INGXF3%
3
-18%
2
11%
7
125
AY nana-4%
2
21

PEGI got the best overall score, however each investor should consider other momentum profiles for ones that might be more suited to their investing objectives.

I find NEP to be more attractive with its very strong long term momentum. It is negative in the medium and short term and be aware that the short-term is more negative than the medium term, possibly indicating the negative momentum could be accelerating.

Quality


There are six metrics for quality:

  1. Earnings volatility (measured as the standard deviation of six years of earnings),
  2. Gross margin (gross profit divided by sales),
  3. Net margin (net profit divided by sales)
  4. Total asset turnover (sales divided by total assets),
  5. Financial leverage (debt as a percentage of total capital)
  6. Operating leverage 


Earnings Volatility
Value & Rank
Gross Margin
Value & Rank
Net Margin
Value & Rank
Asset Turnover
Value & Rank
Financial Leverage
Value & Rank
Operating Leverage
Value & Rank
SumFinal
Rank
NPIFF.54
6
.63
6
.20
5
.13
6
.84
1
1.55
6
305
TERP1.51
2
.28
2
-.37
1
.10
4
.6
4
10.62
2
151
NEP1.24
3
.40
4
.35
7
.08
1
.38
7
1.86
4
264
ORA2.44
1
.39
3
.25
6
.27
7
.41
6
1.26
7
305
PEGI.81
5
.15
1
-.20
2
.09
3
.45
5
10.96
1
172
INGXF.37
7
.53
5
-.20
3
.09
2
.83
2
1.76
5
243
AY.81
4
.66
7
-.10
4
.10
5
.76
3
2.23
3
264

 NPIFF and ORA tied for the highest quality score, followed by NEP and AY.

It's important to note that the lower the leverage (both financial and operational) the better the score.  That's the quality consideration, but that isn't necessarily what you might want as an investor.

My opinion is some leverage is good.  Looking at the top four candidates, they all had a decent blend of leverage.

Growth


There are four metrics for the factor growth:

  1. Total revenue change over 1 year
  2. EBITDA change over 1 year
  3. Free cash flow change over 1 year
  4. Gross margin change over 1 year


Revenue d
Value & Rank
EBITDA d
Value & Rank
FCF d
Value & Rank
GM d
Value & Rank
SumFinal
Rank
NPIFF28%
7
38%
7
78%
6
5%
7
277
TERP-6%
2
-28%
1
-60%
4
-24%
3
102
NEP-4%
3
-8%
3
427%
7
-1%
4
17

6
ORA5%
5
4%
6
-286%
1
-5%
4
154
PEGI9%
6

2%
4
9%
5
-49%
2
165
INGXF-12%
1
-12%
2
-114%
2
1%
6
113
AY4%
4
3%
5
nana91

NPIFF is clearly the stock with the best growth.

Income


I looked at three income factors:
  1. Dividend yield
  2. Dividend/share 3 year CAGR
  3. Dividend/share 1 year change.
Not every share offers a dividend, and dividends aren't important to every investor.  Weight this factor as you will.

Here's the results:



Dividend Yield
Value & Rank
Dividend/share 3yr CAGR
Value & Rank
Dividend/share 1yr d
Value & Rank
SumFinal
Rank
NPIFF5%
4
0%
3
3%
3
105
TERP0%
1
na

na11
NEP4%
3
10%
5
15%
5
136
ORA1%
2
16%
6
-21%
1
93
PEGI8%
7
5%
4
6%
4
157
INGXF6%
6
-5%
2
-11%
2
104
AY5%
5


52

PEGI has the best score for income.

Value


We'll look at four value factors:

  1. Price to book
  2. Price to sales
  3. Price to earning
  4. Enterprise value over EBITDA.


PB
Value & Rank
PS
Value & Rank
PE
Value & Rank
EV/EBITDA
Value & Rank
SumFinal
Rank
NPIFF.05
1
3.1
5
28
1
12
6
134
TERP.01
6
2.0
7
-3
na
18
3
166
NEP.01
5
4.2
4
14
3
21
2
14

5

ORA.02
3
4.7
2
19
2
13
5
123
PEGI.02
4
4.9
1
-106
na
24
1
6

1

INGXF.04
2
4.3
3
-38
na
16
4
92
AY.01
7
2.1
6
-16
0
11
7
207


AY has the highest score for value, however it has negative earnings. Some investors might wish to confine their search to companies with positive earnings, in which case NEP would be the best candidate.

Profitability


There are six profitability factors:
  1. Gross profits to assets
  2. Net profit margin
  3. 5 year average pretax return on assets
  4. 3 year average ROE
  5. Net operating income margin
  6. Free cash flow yield

Here are the results:



GP/A
Value & Rank
NPM
Value & Rank
5yr avg ROA
Value & Rank
3yr avg ROE
Value & Rank
Net OIM
Value & Rank
FCF Yield
Value & Rank
SumFinal
Rank
NPIFF.08
6
.20
5
.02
5
.12
7
.44
7
-.09
3
336
TERP.03
2
-.37
1
-.02
1
-.19
1
.04
2
-.18
2
91
NEP.03
3
.35
7
.03
6
.04
5
.38
5
.01
5
315
ORA.10
7
.25
6
.05
7
.12
6
.30
3
-.01
4
336
PEGI.01
1
-.20
2
-.01
3
-.03
3
.02
1
.02
6
162
INGXF.05
4
-.20
3
-.01
2
-.05
2
.44
6
-.24
1
183
AY.06
5
-.10
4
0.00
4
-.02
4
.37
4
.16
7
284

NIPFF and ORA are tied for the most profitable companies.

Putting It All Together


Let's summarize what we've learned.  This is more than the score, this is interpreting the results and bringing our personal observations and preferences into the mix.

The utilities sector displays less price volatility than the overall market and is showing less negative price momentum.

PEGI received the best momentum score, but I preferred the NEP's results with the very strong long term momentum. It was bearish in the medium & short term, but it was fairly weak. However, the trend in it's momentum could be deteriorating.

AY had the highest quality score, but looking at the next two, NEP and NPIFF (with a tied score), I like the look of NEP. Some leverage is a good thing, but maybe not a high degree in both operating and financial. NPIFF is highly leveraged in both categories, but NEP only in operating. It was actually the most conservative from a financial leverage perspective.

NPIFF is showing excellent growth results. It came in number one and I like it more than I like the next highest growth company (NEP) as it didn't grow consistently across all categories.

In the income cagtegory, PEGI is the best. NEP is good too, but I want to look at income in conjunction with profitability, which we'll get to shortly.

AY offers the best value, but if you need positive earnings, NEP is the obvious choice. Note, in the world of factor investing, value tends to outperform growth over the long term. NEP scores well in both.

As mentioned, NPIFF and ORA are the most profitable. PEGI, with the best income score was the second worst company from a profitability perspective. NEP, which scored well in income, is actually the second most profitable company (after the two that tied). If income is an important consideration then NEP is a better bet.

NEP didn't come out with the top score in any of the categories, but when I look deeper into the numbers, it's appealing to me as an investor and I find interesting that it performed well across most of the factors interesting.

Final Notes


This model was created in INVRS.  Create anything you want in INVRS, have fun doing it and get insight no one else has.  Sign up for a free trial today.

Wednesday, January 9, 2019

Omnicell - No Stand-Out Features

No Compelling Hypothesis

This analysis was created on December 29, 2018 using closing prices from December 28, 2018 with the goal to determine if there is a viable investment strategy in Omnicell (OMCL).

It will be a peer based analysis, evaluating OMCL relative to companies in the same sector and industry and having a market cap within 65% of OMCL and over $950M.  When you subscribe to INVRS you can customize the peer group any way you wish. 

Why peer based? It gives the numbers context, you can benchmark and you might find another opportunity.  It provides you with another vital dimension upon which to evaluate your target company.  Once you've established your peer group, you can do analysis on the group as easily as you analyze a single stock. 

OMCL and its peer group will be analyzed on six factors:
  • Price momentum,
  • Quality,
  • Growth,
  • Income,
  • Value,
  • Profitability.
Each factor calculates several metrics each providing different insight.  For example the profitability factor looks at gross profit to assets, net profit margin, the five-year average pre-tax return on assets, the three year return on equity, net operating income margin and the free cash flow yield.

Each metric is ranked from highest to lowest with the best performing stock earning the highest score.  The scores for each metric are summed and re-ranked.  The stock with the highest ranking is the best performing company for that particular factor.

Overview:

Omnicell, Inc. engages in the provision of automation and business analytics software solutions for patient-centric medication and supply management. It operates through Automation and Analytics, and Medication Adherence segments. The Automation and Analytics segment designs, manufactures, and sells medication and supply dispensing systems, pharmacy inventory management systems, and related software. The Medication Adherence segment includes consumable medication blister cards, packaging equipment, medication synchronization platform, and ancillary products and services. The company was founded by Randall A. Lipps in September 1992 and is headquartered in Mountain View, CA.
Founded: 1992
Number of Employees: 2350
Headquarters: Mountain View US
CEO: Randall A. Lipps

Peer Group:

Stock Name (Symbol)Last PriceMarket Cap
HMS Holdings Corp.(HMSY:XNAS)$28.232.3692B
National Research Corporation Class A (NRCIA:XNAS)$38.67957.55447M
Allscripts Healthcare Solutions, Inc.(MDRX:XNAS)$9.461.6527B
Stericycle, Inc.(SRCL:XNAS)$36.603.3160B
Syneos Health Inc, Class A (SYNH:XNAS)$38.243.9473B
Healthcare Services Group, Inc.(HCSG:XNAS)$39.462.9117B
CompuGroup Medical SE Unsponsored ADR(CMPUY:OOTC)$29.401.4569B
Omnicell, Inc.(OMCL:XNAS)$60.482.3959B

Market and Sector Price Momentum Analysis

Let's start by getting a visual perspective on how the market and sector have been performing.

It's been quite a volatile year, coming off a couple years of pleasant growth. 

Let's look next at market and sector momentum.


Longer Term -
% Price Change over Two Years
Medium Term -
12 Month Less 1 Month Price Change
Short Term -
Price Less 3 Month Moving Average
Market - S&P 50011.03% (bullish)3.2% (weakly bullish)-11.07% (bearish)
Sector - S&P Health Care Select Sector23.91% (strongly bullish)14.69% (bullish)-8.14% (bearish)

It looks like both the market and the sector are at an inflection point with momentum possibly changing from positive to negative.  We'll keep this trend in mind as we evaluate the opportunity,

Price Momentum

Let's look at the price momentum for the group.  We're using the following three metrics that reflect a long, medium and short-term perspective:
  1. Percentage price change over two years,
  2. 12 month less one month price change,
  3. Price less 3 month moving average change.


Long Term -
% Price Change over Two Years
/Rank
Medium Term -
12 Month Less 1 Month Price Change
/ Rank
Short Term -
Price Less 3 Month Moving Average
/ Rank
SumFinal Rank
HMSY55%/6111%/8-14%/3176
NRCIA104%/87%/51%/8218
MDRX-7%/3-30%/1-9%/592
SRCL-52%/1-29%/2-18%/141
SYNH-27%/219%/6-17%/2103
HCSG1%/5-10%/3-8%/6144
CMPUY0%/40%/40%/7155
OMCL78%/759%/7-12%/4187

NRCIA had the best price momentum, OMCL has the second best score, but it is demonstrating a pattern similar to what we saw in the market and sector with a possible change in momentum turning from positive to negative.

Quality

There are five metrics for quality:
  1.   Earnings volatility (measured as the standard deviation of six years of earnings),
  2.   Gross margin (gross profit divided by sales),
  3.   Net margin (net profit divided by sales)
  4.   Total asset turnover (sales divided by total assets),
  5.   Financial leverage (debt as a percentage of total capital)


SD of Earnings
/ Rank
GM
/ Rank
NM
/ Rank
Asset Turnover
/ Rank
Financial
Leverage
/ Rank
Sum
/ Final
Rank
HMSY14%/830%/38%/753%/428%/628/7
NRCIA21%/754%/819%/892%/71%/838/8
MDRX44%/341%/6-9%/143%/250%/315/2
SRCL116%/241%/51%/351%/349%/417/3
SYNH131%/117%/2-1%/237%/150%/28/1
HCSG28%/414%/15%/5273%/88%/725/5
CMPUY21%/635%/45%/665%/561%/122/4
OMCL27%/545%/73%/473%/629%/527/6

NRCIA got the highest score for quality and OMCL came in third.

Growth

There are five metrics for the factor growth:
  1. Total revenue change over 1 year
  2. EBITDA change over 1 year
  3. Free cash flow change over 1 year
  4. Gross margin change over 1 year
  5. Number of year over year growth in earnings.


Revenue d
Over 1 Year 
/ Rank
EBITDA d
Over 1 Year
/ Rank
FCF d
Over 1 Year
/ Rank
GM d
Over 1 Year
/ Rank
Number of
Years Growth
/ Rank
(max score 6)
Sum
/ Final
Rank
HMSY6%/3-2%/3-8%/4-0%/64/723/5
NRCIA7%/510%/63%/6             -0%/7*3/630/7
MDRX17%/610%/7-0%/5-1%/52/528/6
SRCL1%/1-65%/1-11%/3-1%/43/615/3
SYNH66%/846%/898%/8-23%/1*3/631/8
HCSG19%/78%/5-94%/1-4%/25/823/5
CMPUY7%/42%/456%/74%/84/730/7
OMCL3%/2-21%/2-74%/2-1%/3 5/817/4

OMCL got the second to worst score.  SYNH got the best.

Income

Most of these companies including OMCL don't offer dividends so we won't be looking at this factor.

Value

We'll look at five value factors:
  1. Enterprise value over EBITDA
  2. Price to book
  3. Price to earnings
  4. Price to sales
  5. Price to theoretical price (as calculated using the Ohlson Clean Surplus (OCS), for more information on the valuation tool, please review this article).
Here are the results:


EV/EBITDA
/ Rank
P/B
/ Rank
P/E
/ Rank
P/S
/ Rank
P/TP
/ Rank
Sum
/ Final
Rank
HMSY15/8.04/560/42.8/34/424/6
NRCIA41/1.3/173/314/18/28/2
MDRX17/6.02/6na**/01.5/710/120/4
SRCL35/3.011/8513/11.6/62/826/7
SYNH16/7.014/7na**/01.2/83.1/628/8
HCSG29/4.07/233/62.1/53.3/522/5
CMPUY27/5.05/341/54.9/22.8/722/5
OMCL36/2.04/4114/22.6/46/315/3

OMCL is the second most expensive.

Profitability

There are six profitability factors:
  1. Gross profits to assets
  2. Net profit margin
  3. 5 year average pretax return on assets
  4. 3 year average ROE
  5. Net operating income margin
  6. Free cash flow yield
 Here are the results:


GP/Assets
/ Rank
NPM
/ Rank
5 yr avg
Pretax ROA
/ Rank
3 yr avg
ROE
/ Rank
Net
OIM
/ Rank
FCF
Yield
/ Rank
Sum
/ Final
Rank
HMSY16%/28%/75%/46%/410%/63%/427/5
NRCIA50%/819%/824%/825%/829%/80%/242/8
MDRX18%/3-9%/1-3%/1-6%/12%/314%/817/1
SRCL21%/41%/36%/55%/30%/111%/723/4
SYNH6%/1-5%/23%/224%/76%/45%/622/3
HCSG38%75%/517%/723%/67%/5-2%/131/6
CMPUY23%/55%/67%/619%/514%/74%/534/7
OMCL33%/63%/45%/34%/21%/20%/320/2

OMCL is the second least profitable, NRCIA is the most profitable.

Summary

OMCL is not demonstrating strength in any of the factors.  It came in third in quality and was second from the bottom in growth, value and profitability.  Its best showing was in price momentum in the number two position, but that number needs to be looked at in context.  In all levels of analysis - market, sector and security - it looks like momentum is changing from positive to negative.

Given these results, there is no investment hypothesis for OMCL at this time.

Disclaimer

Part of intelligent investing involves taking on risk levels appropriate to one's circumstances.  We don't know what yours 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.

Analysis Notes

* SYNH and NRCIA only had five years of EPS data.
**Negative number


Thursday, November 29, 2018

A 5-Factor Analysis of Square


Overview:

Square, Inc. engages in the provision of credit card payment processing solutions. The firm offers additional point-of-sale services, financial services, and marketing services. The company was founded by Jack Dorsey and Jim McKelvey in February 2009 and is headquartered in San Francisco, CA.

Number of Employees: 2,338
CEO: Jack Dorsey

Peer Group:

Stock Name (Symbol)Last PriceMarket Cap
CDW Corp.(CDW:XNAS)$87.8713.2596B
Cap Gemini SA(CAPMF:OOTC)$116.3719.5645B
Constellation Software Inc.(CNSWF:OOTC)$689.4014.6094B
Hexagon AB Unsponsored ADR Class B(HXGBY:OOTC)$48.8316.8305B
NTT DATA Corporation Unsponsored ADR(NTDTY:OOTC)$10.9915.4135B
Wipro Limited Sponsored ADR(WIT:XNYS)$5.0822.8726B
Workday, Inc. Class A(WDAY:XNYS)$135.2629.3514B
Vantiv, Inc. Class A(VNTV:XNYS) aka Worldpay (WP)$79.4923.9945B
ServiceNow, Inc.(NOW:XNYS)$160.6328.8018B
Shopify, Inc. Class A(SHOP:XNYS)$134.8114.4205B
Atlassian Corp. Plc Class A(TEAM:XNAS)$73.2017.2250B
Splunk Inc.(SPLK:XNAS)$92.5713.5718B
CGI Group Inc. Class A(GIB:XNYS)$62.5817.4416B
Square, Inc. Class A(SQ:XNYS)$63.4726.1733B

Analysis Methodology

The goal of this analysis is to determine if there is a viable investment strategy in the stock Square.
The analysis will begin by evaluating the price momentum of the market and industry using long, medium and short term measures.   We'll then follow with a peer-based analysis of Square using the following six factors:
  • Price Momentum
  • Quality
  • Growth
  • Income
  • Value
  • Profitability.
Each factor uses several metrics each providing different insight.  For example, the profitability factor looks at gross profit to assets, net profit margin, the 5 year average on the pretax return on assets, the 3 year average ROE, net operating income margin and the free cash flow yield. 

The company with the best metric value is given a score of 14 (as there are 14 companies in the group we are looking at), the second best a 13, and so on.  The ranking process is repeated for each metric and then all of the scores for the particular factor are summed.  The grand total is then re-ranked and the best company for the particular factor becomes apparent.

INVRS lets you analyze a company in any way you wish.  It's an extremely robust and flexible platform allowing you to easily accomplish two of the most difficult, yet profitable investment tasks: create investment models and perform peer based analysis.

Date: This analysis was performed on Sunday, November 25, 2018 and uses the closing prices from the 23rd.

Market and Sector Price Momentum Analysis

Let's start with an overview of the market and sector.  Let's look at a  year price graph and then review momentum.



Longer Term -
% Price Change over Two Years
Medium Term -
12 Month Less 1 Month Price Change
Short Term -
Price Less 3 Month Moving Average
Market (S&P 500)20 % - bullish2% - weakly bullish-7% - bearish
Sector (S&P Information Tech)41% - bullish10% - bullish-13% - bearish

Both the market and the sector are showing a similar pattern - positive price momentum in the long-term category, becoming weaker over the medium term and turning negative in the short term.  This trend is not favourable to a long position in the near term and a short could be premature.

Price Momentum for SQ and the Group



Long Term -
% Price Change over Two Years
/Rank
Medium Term -
12 Month Less 1 Month Price Change
/ Rank
Short Term -
Price Less 3 Month Moving Average
/ Rank
SumFinal Rank
SQ340% / 1487% /14-20% /12910
SHOP224% /1333% / 11-7% / 83213
TEAM170% / 1263% / 13-9% / 63112
NOW93% / 1147% / 12-11% / 4279
CDW71% /1029% / 92% / 143314
SPLK61% / 925% / 8-11% / 5227
WDAY60% / 829% / 100% / 123011
CAPMF48% / 75% / 3-3% / 9195
CNSWF48% / 618% / 6-1% / 11238
HXGBY     44% / 5                                                                       -2% / 2                                                                                              -7% / 7                                                                                       14         3                            
VNTV/WP41% / 422% / 7-15% / 3144
GIB32% / 317% / 50% / 13216
WIT-47% / 2-4% / 1-1% / 10132
NTDTY-57% / 19% / 4-17% / 271

From a purely ranking perspective, CDW has the best price momentum.  SQ is fifth.  However, we're seeing the same pattern we saw with the market and industry: long & medium term positive momentum turning negative in the short term.  We're also seeing that the company with the greatest positive long & medium term momentum also has the greatest negative short term momentum, which happens to be SQ.

Quality 

We'll look at five metrics for the factor of quality:
  1. Earning volatility (as measured by the standard deviation of six years of earnings)
  2. Gross margin (gross profit divided by sales)
  3. Net margin (net profit divided by sales)
  4. Total asset turnover (sales divided by total assets)
  5. Financial leverage (debt as a percentage of total capital)


SD of Earnings / RankGross Margin / RankNet Margin / RankSales/Assets / RankFinancial Leverage / RankSumFinal Rank
CDW1.1 / 3.2 / 20 / 82.2 / 14.8 / 2295
CAPMF1.9 / 2.3 / 4.1 / 10.7 / 9.3 / 9348
CNSWF2.4 /1.3 / 5.1 / 111.1 / 13.4 / 7379
HXGBY.8 / 7.6 / 10.2 / 14.4 / 2.3 / 84111
NTDTY.2 / 11.2 / 30 / 7.9 / 10.4 / 6379
WIT.1 / 14.3 / 6.1 / 13.7 / 8.2 / 115214
WDAY.4 / 8.7 / 11-.1 / 2.4 / 3.5 / 4284
VNTV/WP.3 / 10.4 / 80 / 9.5 / 4.9 / 1327
NOW                .8 / 6                             .7 / 12                        -.1 / 4                       .6 / 5                          .7 / 3                                    30   6               
SHOP.2 / 13.6 / 9-.1 / 5.6 / 60 / 134613
TEAM.2 / 12.8 / 13-.1 / 3.4 / 1.5 / 5348
SPLK.9 / 4.8 / 14-.2 / 1.6 / 70 / 144010
GIB.8 / 5.1 / 1.1 / 121.0 / 11.2 / 124111
SQ.4 / 9.4 / 70 / 61.0 / 12.3 / 104412

Note: there were a couple of tied values in this factor, which is why it ranges from 14 to 4.
The highest quality stock is WIT,  SQ was the third highest.

Growth

There are five metrics for the factor growth:
  1. Total revenue change over 1 year
  2. EBITDA change over 1 year
  3. Free cash flow change over 1 year
  4. Gross margin change over 1 year
  5. Number of year over year growth in earnings.


Total revenue / RankEBTIDA / RankFCF / RankGM / Rank# of Year of
Growth / Rank
SumFinal Rank
CDW9% / 529% / 829% / 9-3% / 15 / 14378
CAPMF4% / 26% / 53% / 4-1% / 53 / 9254
CNSWF17% / 725% / 713% / 61% / 75 / 14419
HXGBY12% / 612% / 621% / 73% / 104 / 134210
NTDTY19% / 85% / 4-24% / 2-2% / 32 / 6233
WIT3% / 1-1% / 3-12% / 31% / 83 / 11265
WDAY37% / 1130% / 941% / 102% / 92 / 74612
VNTV/WP12% / 6-4% / 222% / 8-2% / 43 / 10306
NOW            39% / 12                              118% / 12             806% / 13 4% / 12          1 / 4                          53     13                    
SHOP73 % / 14-11% / 1-24% / 16% / 130 / 2317
TEAM41 % / 131,768% / 1453% / 11-3% / 21 / 34311
SPLK34% / 1032% / 1055% / 120% / 61 / 54311
GIB9% / 4114% / 1111% / 53% / 114 / 124311
SQ30% / 9161% / 134,514% / 1414% / 142 / 85814
*Dividing by a negative gives a nonsense result, however one can attempt to make sense of the number by making assumptions.  In this case, our assumption is if the numerator is positive and the denominator is negative, we convert the denominator into a positive number.   If both are negative, but the numerator is less than the denominator, we convert the quotient into a negative number
SQ has the highest growth rate.

Income

Although some of these companies in this peer group offer a dividend, SQ does not, so we won't look at this factor.

Value

We'll look at five value factors:
  1. Enterprise value over EBITDA
  2. Price to book
  3. Price to earnings
  4. Price to sales
  5. Theoretical price (as calculated using the Ohlson Clean Surplus (OCS), for more information on the valuation tool, please review this article) over current price.
Here are the results:


EV/EBITDA / RankP/B / RankP/E / RankP/S / RankP/TPSumFinal Rank
CDW13 / 914 / 827 /41 / 14.6 / 144911
CAPMF11 / 1012 / 1021 / 61 / 121.4 / 104810
CNSWF18 / 524 / 466 / 25 / 72.8 / 8268
HXGBY17 / 63 / 1223 / 55 / 8.9 / 11429
NTDTY6 /112 / 1429 / 31 / 131.4 / 95012
WIT14 / 73 / 1319 / 83 / 10.9 / 125012
WDAY*18 / 6*12 / 340.8 / 3122
VNTV/WP21 / 424 / 399 / 13 / 93.6 / 7247
NOW1,742 / 148 / 1*12 / 4164.1 /171
SHOP            *                          13 / 9             *            14 / 2             6.3 / 6      17     6                       
TEAM527 / 219 / 5*17 / 123.9 / 4123
SPLK*16 / 7*10 / 5108.8 / 2144
GIB13 / 83 / 1120 / 72 / 11.8 /135012
SQ252 / 332/ 2*6 / 614.3 / 5165

* negative denominator, nonsensical value.

SQ is showing poor value, the fifth lowest score.

Profitability

There are six profitability factors:
  1. Gross profits to assets
  2. Net profit margin
  3. 5 year average pretax return on assets
  4. 3 year average ROE
  5. Net operating income margin
  6. Free cash flow yield
 Here are the results:


GP TO ASSETS / RANKNET PROFIT MARGIN5 YEAR AVG PRETAX
RETURN ON ASSETS
3 YEAR AVG
ROE
NET OPERATING
INCOME MARGIN
FREE CASH
FLOW YIELD
SUMFINAL
RANK
CDW.35 / 113% / 88% / 1044% / 136% / 74% / 9589
CAPMF.19 / 26% / 106% / 914% / 911% / 95% / 11506
CNSWF.30 / 8 9% / 1112% / 1351% / 1418% / 133% / 76612
HXGBF.23 / 620% / 148% / 1114% / 8 22% / 144% / 86111
NTDTY.23 / 53% / 716% / 148% / 76% / 87% / 14558
WIT.21 / 415% / 134% / 717% / 1215% / 124% / 10589
WDAY.31 / 9-15% / 2-9% / 5-26% / 4-14% / 21% / 3251
VNTV.21 / 35% / 96% / 816% / 1013% / 105% / 12527
NOW.42 / 13-8% / 4-11% / 3-62% / 2-5% / 52% / 5325
SHOP .34 / 10                            -6% / 5                            -10% / 4                      -9% / 5          -7% / 3                     0% / 1           28   3         
TEAM.27 / 7-14% / 30% / 6-6% / 6-6% / 42% / 4304
SPLK.5 / 14-20% / 1-15% / 2-36% / 3-20% / 12% / 6272
GIB.13 / 110% / 1212% / 1217% / 1113% / 116% / 136010
SQ.37 / 12-3% / 6-19% / 166% / 11% / 60% / 2283

SQ profitability showing is poor at 3.

Summary


SQ's standout characteristic is its growth rate.  Out of a group of 14 peers, it achieved the highest combined score for growth as well as had the highest individual scores for free cash flow and gross margin.  It was also strong in quality, with the third highest position.  The bear story is that it's expensive and it doesn't have strong profitability.  Furthermore the price momentum for the stock, sector and the market appears to be at an inflection point -  possible changing from direction from upward to down.

My opinion is there is a lot of risk with a position in the stock at this time. I would remain on the sidelines until a clearer story emerges.

Disclaimer

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.

Saturday, November 24, 2018

Alibaba - The Time Isn't Now

The Magic is Real...except for price momentum.


Overview:

Alibaba Group Holding Ltd. provides online and mobile marketplaces in retail and wholesale trade. It operates through the following segments: Core Commerce; Cloud Computing; Digital Media and Entertainment; and Innovation Initiatives and Others. The Core Commerce segment comprises of platforms operating in retail and wholesale. The Cloud Computing segment consists of Alibaba Cloud, which offers elastic computing, database, storage and content delivery network, large scale computing, security, management and application, big data analytics, a machine learning platform, and other services provide for enterprises of different sizes across various industries. The Digital Media and Entertainment segment relates to the Youko Tudou and UC Browser business. The Innovation Initiatives and Others segment includes businesses such as AutoNavi, DingTalk, Tmall Genie, and others. The company was founded by Chung Tsai and Yun Ma on June 28, 1999 and is headquartered in Hangzhou, China.

Number of Employees: 66,421
CEO: Yong Zhang

Peer Group:

Stock Name (Symbol)Last PriceMarket Cap
eBay Inc(EBAY:XNAS)$28.4427.3877B
Amazon.com, Inc.(AMZN:XNAS)$1502.06734.5073B
JD.com, Inc. Sponsored ADR Class A(JD:XNAS)$19.2723.2008B
Alibaba Group Holding Ltd. Sponsored ADR(BABA:XNYS)$150.33386.6382B

Analysis Methodology

This is a peer-based analysis that will examine six factors in order to determine the merits of an investment in BABA:
  • Price Momentum
  • Quality
  • Growth
  • Income
  • Value
  • Profitability.
Each factor uses several metrics each providing different insight.  For example, the profitability factor looks at gross profit to assets, net profit margin, the 5 year average on the pretax return on assets, the 3 year average ROE, net operating income margin and the free cash flow yield. 

The company with the best metric value is given a score of 4 (as there are four companies in the group we are looking at), the second best a 3, the second worst a 2 and the worst a 1.  The ranking process is repeated for each metric and then all of the scores for the particular factor are summed.  The grand total is then re-ranked and the best company for the particular factor becomes apparent.
INVRS allows the user to analyze a company in any way they wish.  The analysis could be on any factor.  The metrics can be any metric.  Or you can create your own models that fall out of the factor-based purview.

Price Momentum

This factor has short to medium term utility.   The concept is that stocks will tend to trade in the momentum established, until the don't.  Some investors with a longer term horizon might not be interested in this, but we will run it regardless.   We'll use a negative scale to indicate companies with negative price momentum.

The metrics we're looking at are:
  • The percentage price change over two years,
  • The M-12 less M-1 percentage price change (or in other words, the price change over the past 12 months excluding the most recent month),
  • Price change relative to the 10 week moving average.
The results:


% change over
2 years
Rank12 months less 1
month price change
RankPrice change relative to the
10 week moving average
RankSumFinal
Rank
EBAY1%2-16%3-10%27-1
AMZN112%436%4-12%191
JD-14%1-37%1-5%35-2
BABA64%3-20%21%491

AMZN & BABA are the only two showing some positive price momentum, but both have two negative components.

EBAY and JD are showing negative price momentum, in my opinion JD more so.

Quality

We'll look at six metrics for the factor of quality:
  1. Earning volatility (as measured by the standard deviation of six years of earnings)
  2. Gross margin (gross profit divided by sales)
  3. Net margin (net profit divided by sales)
  4. Total asset turnover (sales divided by total assets)
  5. Financial leverage (debt as a percentage of total capital)
  6. Operating leverage (fixed assets as a percentage of total assets).


Metric 1/RankMetric 2/RankMetric 3/RankMetric 4/RankMetric 5/RankMetric 6/RankSumFinal
Rank
EBAY2.14/276%/4-11%/1.37/255%/2320%/2132
AMZN2.37/137%/22%/31.35/361%/111%/3132
JD.51/414%/10%/21.90/431%/30%/4184
BABA1.42/357%/325%/4.33/122%/41094%/1163

JD came out with the highest quality score, followed by BABA.*

Growth

We'll look at five metrics for growth:
  1. Total revenue change over 1 year
  2. EBITDA change over 1 year
  3. Free cash flow change over 1 year
  4. Gross margin change over 1 year
  5. Number of year over year growth in earnings.


Metric 1/RankMetric 2/RankMetric 3/RankMetric 4/RankMetric 5/RankSumFinal
Rank
EBAY7%/1-2%/113%/2-1%/23/182
AMZN31%/222%/2-33%/16%/44/3123
JD37%/352%/3179%/44%/34/2154
BABA61%/477%/455%/3-8%/14/3154

BABA and JD tied for this metric for the best growth stocks.**

Income

None of the companies under consideration offer a dividend.

Value

We'll look at five value factors:
  1. Enterprise value over EBITDA
  2. Price to book
  3. Price to earnings
  4. Price to sales
  5. Theoretical price (as calculated using the Ohlson Clean Surplus (OCS), for more information on the valuation tool, please review this article) over current price.***
Here are the results:


Metric 1/Rank
(avg 51.26)
Metric 2/Rank
(avg 10.09)
Metric 3/Rank
(avg 142)
Metric 4/Rank
(avg 5.3)
Metric 5/Rank
(avg 3.5)
SumFinal Rank
EBAY15.07/43.57/4Negative4.19/25.6/1112
AMZN38.57/226.42/1245.9/13.24/35.5/291
JD117.19/13.77/3Negative1.1/41.8/3112
BABA34.20/36.61/239.54/212.69/11/4123

BABA came in with the highest score for value, but be aware that we are dealing with some pretty high valuations, specifically a PE ratio of 40.  However according to the OCS, BABA is currently fairly valued, something I haven't seen in a while with tech stocks.

Profitability

We'll look at six profitability factors:
  1. Gross profits to assets
  2. Net profit margin
  3. 5 year average pretax return on assets
  4. 3 year average ROE
  5. Net operating income margin
  6. Free cash flow yield
 Here are the results:


Metric 1/RankMetric 2/RankMetric 3/RankMetric 4/RankMetric 5/RankMetric 6/RankSumFinal
Rank
EBAY.28/3-11%/110%/330%/424%/38%/3173
AMZN.50/42%/32%/211%/22%/21%/1142
JD.27/20%/2-3%/1-12%/10%/110%/4111
BABA.19/125%/417%/425%/328%/44%/2184

BABA comes out number one in terms of profitability.

Summary of Results

From a quality perspective, BABA is a close second after JD.  It's tied for growth for the top position with JD and it holds the top position for value and profitability.  It therefore could be a candidate for a long position.  However, it appears that we are at an inflection point with respect to price momentum.  If it was me considering a long position, I would wait until a new price trend established itself - going long when it became clearly positive.

Sign up for a free trial with INVRS and keep an eye on the price momentum.

Analysis Notes

*In EBAY's calculation for operational leverage I had to use one previous year value as the current year wasn't available.
**I gave JD a lower rank than BABA for the fifth metric, even though they had the same number of year over year instances of growth.  This was a judgement call on my part to reflect the fact that JD's earnings have been negative every single year, whereas BABA's have been positive every year.
***Assumptions used: The near term market return will be -7%, ROE and the dividend payout ratio will remain unchanged, no growth factor included.

Disclaimer

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.

Monday, October 29, 2018

Google Inc. - Risk is High

Would you go out in this?

Overview:

Alphabet, Inc. is a holding company, which engages in the business of acquisition and operation of different companies. It operates through the Google and Other Bets segments. The Google segment includes its main Internet products such as Ads, Android, Chrome, Commerce, Google Cloud, Google Maps, Google Play, Hardware, Search, and YouTube. The Other B)ets segment includes businesses such as Access, Calico, CapitalG, GV, Nest, Verily, Waymo, and X. The company was founded by Lawrence E. Page and Sergey Mikhaylovich Brin on October 2, 2015 and is headquartered in Mountain View, CA.

Founded: 2015
Number of Employees: 80110
Headquarters: Mountain View US
CEO: Lawrence E. Page

Analysis Methodology:

This will be a general analysis reviewing the following areas: earnings quality, growth, value and dividends.  We'll also look at R&D investment as an indicator of potential competitive advantage, sales per employee as an indicator of efficiency and relative earnings growth compared to price growth.

It will be a peer based analysis as it's a good way to give the results context and an opportunity to uncover other opportunities.

We'll use as a peer group the group of stocks popularly known as FAANG, but we'll substitute in MSFT instead of NFLX.  These are the biggest companies in North America, if size was the only qualifying factor, we'd also include Berkshire Hathaway.  We're going to exclude it as this group is technologically focused.

Peer Group:

Stock Name (Symbol)Last Price (Oct 28, 2018)Market Cap
Microsoft Corporation(MSFT:XNAS)$106.96821.4528B
Facebook Inc(FB:XNAS)$145.37420.2647B
Amazon.com, Inc.(AMZN:XNAS)$1642.81800.0485B
Apple Inc.(AAPL:XNAS)$216.301.0475T
Google Inc.(GOOG:XNAS)$1071.47745.6853B

Quality of Earnings

It's a fact that earnings can be manipulated and changed 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, it gets a score of one.  All the scores are summed to get a total out of nine, the higher the better.

GOOG at 4/9 isn't good.  We have to be skeptical of their earnings results now.  FB is great, It's actually perfect - 8/8 as they don't carry inventories (everyone else does).  I almost never see perfect scores.

Growth

Year over Year Growth in Earnings

This metric calculates the number of times the company is able to grow its earnings compared to the previous year.  Each time the company increases its earnings relative to the previous year it earns a score of one.   We'll use seven years of data so the maximum score is six.  Here are the results in tabular form:

GOOG5/6
FB5/6 
AMZN4/6
MSFT4/6
AAPL3/5 - missing year seven data

These are all decent results, especially of course GOOG and FB.  As a point of interest, GOOG missed increasing earnings between the most recent year Y and the year previous Y-1 and FB missed between year six and seven.

Remember the quality of earnings, GOOG's aren't as trustworthy as FB's.

Earnings Growth Relative to Price Growth 

This measure is known as the earnings yield and it's the reciprocal of the PE ratio, however I tweak it so that rather than a static number, earning divided by price, I take the change in earnings over a period of time divided by the change in price over a period of time.  I'm looking to see if earnings growth has outpaced the growth in price of vice versa.  If the number is greater than one, I consider that a good sign, if it's between 1 and 0 I consider it less promising.  The period of time used to measure the change is three years.

The change in earnings and the change in price for GOOG is almost equivalent.  On the other two extremes, FB has seen more earnings increase than price and AMZN has seen more price increase than earnings change.

Value

We'll work with four value metrics - P/E ratio, EV/EBITDA, Ohlson Clean Surplus (OCS) and Discounted Cash Flow (DCF).  We're looking for consistency in the value story.

PE Ratio

I debated using this one because it's so similar to earnings yield we already used.  I decided to because it's so ubiquitous and its handy to know what a dollar of earnings cost.

GOOG trades at 47x earnings.  How do you feel about that?

EV/EBITDA

Similar to a PE ratio, this valuation model looks at what one dollar of earnings costs the investor, but using enterprise value and EBITDA instead of price and earnings strips out the effects of different capital structures and lease versus purchase decisions.  Since we've already got a PE ratio, I thought that looking at this metric over time would give us more information.   This metric is the current EV/EBITDA divided by the EV/EBITDA from three years ago.  A value greater than one means the stock has become relatively more expensive.  Between 0 and 1 and the stock has become less.

Except for FB, they've all become more expensive and GOOG has increased its dearness the most.

OCS

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.

All of these companies look over-priced.  There are tweaks that can be made to the model, but even with adjustments GOOG is still trading at a premium. 
The graph below shows by how much the stock is trading over its theoretical price.

Google is trading at 5x its theoretical price.

DCF

This model can get elaborate with individual rates for each future year.  I'm going to keep it simple.  I'm using the most current free cash flow per share figure, the firm's rate calculated for the OCS (which isn't a WAAC, it's just the risk free rate + the company's beta x the market premium using 7% as the expected rate of return for the market) and I'll do a range of terminal growth rates 0%, 1%, 2% and 3%.

SecurityFCF/ShareFirm's rate0%1%2%3%
FB5.91440.08302771.2380.9993.84111.54
AAPL7.30770.7521697.16112.05132.35161.62
AMZN13.14.084888154.82175.49202.53239.43
MSFT2.51.09155927.4030.7635.0640.75
GOOG33.98.091472371.47417.06475.42552.76
Again, on the surface, these stocks all appear over-valued, however we're used to seeing these companies command a large premium.

Income

GOOG doesn't offer a dividend so this analysis won't delve into income.  Just as information, AAPL and MSFT have dividend yields of 1.56% and 1.7% respectively.

Other Factors

We'll look at a couple of other factors in this analysis: R&D spend as a percentage of sales and sales per employee.  The former can inform us how "relevant" they may be in the future and the later gives us an idea how efficient the company is.

R&D as a Percentage of Sales


GOOG's is the second highest spend of the group and it's spend has been increasing moderately over time, both factors are appealing.

Sales per Employee


GOOG looks good according to this metric.  Although it's middle of the road compared to its peers, it's been trending up over time.

Conclusion


The GOOG's potential investment story is growth, not income, not value.  Growth can be measured in different ways but I think the most pragmatic and important measure is earnings.  Earnings are what turns companies in their stock market firmament.   The question then becomes a) how good are those earnings and b) how expensive is that growth?  Let's start with the first question.

GOOG doesn't have the quality of earnings and it's earnings growth has been good, but I'm bothered by the fact that the one year it didn't grow was its most recent year.   If I'm making an investment decision based on earnings, I want to feel good about them.  I don't.  Not as good as I'd like if I was going to pay 47x earnings.

Which brings us to the second factor.   A aura has developed around these big tech players and it seems that the usual valuation laws don't apply to them.  I will concede that their cultures encourage innovation.  I will concede that they are very well managed.  And I will concede that they've changed the world at least once and may do so again.  Those three factors may allow for some valuation rules to be more flexibly applied.  What one is willing to pay for growth is a bit of a personal question.

Based on the information in this analysis, relative to its peers, GOOG is middle of the road on OCS, Price to Theoretical Price  and DCF.  But relative to three years ago, it's become 38% more expensive using the EV/EBITDA measure.  That's the biggest jump of the group.

This is a difficult conclusion to make so I'm only going to speak of what I would do.  I don't like the cost of those earnings when I question how good they are.  I wouldn't buy.  I would also take profits if I was long. 

This analysis indicates that FB might be a good candidate - it's got the high quality earnings and the stock is less expensive relative to the group.  I do want to point out that AAPL and MSFT may have merit that wasn't fully explored in this analysis because they both have an income component.

Disclaimer

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.

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Friday, October 26, 2018

Power Up Your Investment Analysis Using Probability

Investing & Probability
It's a numbers game, maybe like Bingo.

Nobody knows the future, but developing our skills in probability analysis will make us better at preparing for it.

We can use probability at any level - global, country, market, industry, company.  We can use it for an event, for example the probability of the price of gold increasing or the trend of interest rates.

For this example, we'll use probability at the U.S. market level.

The question we'll attempt to answer using probability is "does the bull market have more to run, or are we at the top?"

Step 1 - Identify the key factors


We'll begin by listing the factors that influence, not just any bull market, but this one.  Remember, the factors I choose and the probabilities I assign are my decisions.  You may come up with different factors and different probabilities.

In my opinion, this bull market was created in the aftermath of the global financial crisis.  It was built on earnings, incredibly loose monetary policy and a new tool called quantitative easing.  As those factors change the nature of the market will change.

In considering what I think are the key factors of this market, I'll look at other factors coming into play: fiscal stimulus, tariffs, a movement toward less globalization/more isolation and less friendly immigration policies.

Finally there is always a wild card, a black swan event - a surprise event that packs a wallop but seems obvious in hindsight.

Having selected the factors we want to use, we build an equation:

Market change = a(earnings) + b(monetary policy) + f(black swan)

Where a, b, c, are the probabilities associated with the factor they are attached to.

Step 2 - Assign Relative Weights


The next step is to relatively weight each factor.  For me, I think that monetary policy has been twice as important than earnings earnings and a black swan event could be twice as important as monetary policy.  I therefore give weights of 1, 2, and 4 for earnings, monetary policy and black swan respectively.

Step 3 - Evaluate and Assign Probabilities


The next step is to look at what could impact the factors.  Once the factors are evaluated, we must decide on a probability between -1 and 1.  A positive probability indicates that I believe the outlook for the factor is favorable to a continued bull run (in this example).  A negative probability indicates that the outlook is not favorable.

Earnings


Tax cuts may increase earnings.  Companies may be able to keep more of what they earn and their sales might increase if people have more disposable income.  Earnings might decrease because of rising inputs from tariffs and wages.  Out of country sales may drop in retaliation for tariffs and antagonistic international policies.  Population growth will slow if immigration becomes more difficult which indicates less demand for goods and services.

In my opinion, the earnings effect has run it's course.  There are more factors now to weigh on earnings than to support them.  The sign is therefore negative and I also feel the probability is relatively high.  Let's say -70%.

Monetary Policy


This past 10-year long cycle has been unique with it's use of quantitative easing.  The policy poured an enormous amount of liquidity into the market and kept interest rates very low.  It's in in the process of unwinding now; the bonds that were purchased during QE are maturing and not being replaced.  This reduction in bond demand is pushing up yields.  The federal reserve has also been raising it's benchmark rate and has signaled that further hikes are in the cards.

If stock market started to drop, could the Fed change course and re-instate QE?  Yes they could (not that they would) if inflation isn't a factor.  If it is, they will have to make that their priority, in my opinion.

Currently it looks like the Fed is doing a good job of normalizing monetary policy.  They've gotten rates up and inflation is under-control.  However, it would be imprudent to ignore the inflationary factors currently in play: tax cuts, tariffs, full-employment.  If inflation starts to kick in and I believe it will, they'll have to tighten things up.

I feel the probability of the monetary policy becoming more restrictive to be high and the effect to be negative.  I'll estimate -80%

Black Swan


A black swan event is by definition difficult to predict.  It could be anything, but is should have some relevance in what's going on now.  Here's some ideas: the collapse of sovereign monetary systems and the development of an international, gold backed cyber-currency.  Trade war that heats up to hot war. Trump's unconventional and unprecedented policies work out in a spectacular fashion.

You could give probabilities to all the black swans you identify or you can just work with the one you think is most important or likely.

I'll work with all three for this example.

Let's say they all warrant a relative "4" for strength of impact.  What counts next is the probabilities.  The first example, I'm going to give a probability of .5%.  The second 15%, the third 7%.  The signs are negative, negative, positive.  Because they all have the same weighting I can just sum the probabilities of the individual black swan events to get a black swan probability.  The probability of a black swan event in this example is -.5%-15%+7%=-8.5%.

Note, use a weighted average if you decided the strength of impact numbers should be different.  For example if you think the numbers are 3, 4 and 5, the formula would be -.5*(3/12) - 15*(4/12) + 7*(5/12).

Step 4 - Put It All Together


We then plug the numbers into the equation we already created:

Market Change = -.7 x 1 -.8 x 2 -.085 x 4 = -.7-1.6-.34 = -2.64

The model indicates that the bull market will change into a bear market.  It doesn't say "when" however, but the magnitude of the number is relevant.  This equation could range in theory from a value of -7 to +7, but you'll never have a probability of 100% on any of the factors so in reality the range is less than that, maybe -6.3 to 6.3

As you work with probability and get better at it, the final number's magnitude will begin to communicate something to you about the timing.

Thanks for reading.