A random stock screening exercise shared!

Today I decided to do a random stock screening process to pick some strong fundamental medium to small cap stocks (market cap less than 5b) with relative low P/E ratio (<= 20) in order to test my stock picking methodology:

Here are my screening criteria via Yahoo finance stock screener:

(1) Market cap <= 5b  - to filter out large cap stocks

(2) Forward P/E <= 20 - to filter out high P/E ratio stocks
(3) Return on Equity >= 15% - to identify strong growth stock
(4) Earning growth past 5 years >= 10% - to identify strong growth stock
(5) Quick Ratio >= 1 - to find out financial sound companies
(6) Total Debt / Equity <= 0.5 - to find out financial sound companies

Below are the screening results total 12 stocks which can fulfil above criteria:

AAON , AAON, Inc. , 24.55

CGA , China Green Agric , 7.35  Stock price less than $10.00
CNU , Continucare Corp. , 4.5    Stock price less than $10.00
DORM , Dorman Products,  , 36.49
FSIN , Fushi Copperweld, , 9.32   Stock price less than $10.00
HANS , Hansen Natural Co , 51.21
IDCC , InterDigital, Inc , 33.57
KEI , Keithley Instrume , 21.58
LANC , Lancaster Colony  , 49.92
MMS , Maximus, Inc. Com , 60.63
OMPI , Obagi Medical Pro , 11.41
PTI , Patni Computer Sy , 20.9

Three of them current price less than $10.00 per share I will not take them into consideration, I prefer to trade stocks within $10.00 - $100.00 range.

I also filtered out another 5 stocks due to their inconsistent earnings or a relative low average ROE rate (<15%) for the past 5 years.

IDCC    KEI   OMPI - inconsistent EPSGR for the past 5 years

DORM  MMS - past 5 years average ROE less than 15%

Now only left AAON, HANS, LANC, and PTI; I will estimate their intrinsic value.

AAON
Sector	Industry	ROE (5 yrs)	GM (5 yrs)
Industrial Materials	Building Materials	24.67%	23.86%
EPS (2010)	EPSGR (5 yrs)	EPS (2015)	P/E (5 yrs)
$1.44	9.86%	$2.30	15.60
P(2015)	P(2010)	P(current)	P(52-Week )
$35.94	$17.87	$24.55	18.00-26.13
HANS
Sector	Industry	ROE (5 yrs)	GM (5 yrs)
Consumer Goods	Beverages - Soft Drinks	40.33%	52.56%
EPS (2010)	EPSGR (5 yrs)	EPS (2015)	P/E (5 yrs)
$2.21	17.40%	$4.93	15.50
P(2015)	P(2010)	P(current)	P(52-Week )
$76.42	$38.00	$51.21	24.01-52.84
LANC
Sector	Industry	ROE (5 yrs)	GM (5 yrs)
Consumer Goods	Packaged Foods	18.86%	21.01%
EPS (2010)	EPSGR (5 yrs)	EPS (2015)	P/E (5 yrs)
$4.07	22.93%	$11.42	15.50
P(2015)	P(2010)	P(current)	P(52-Week )
$177.01	$88.02	$49.92	43.28-61.60
PTI
Sector	Industry	ROE (5 yrs)	GM (5 yrs)
Software	Software - Application	17.14%	34.56%
EPS (2010)	EPSGR (5 yrs)	EPS (2015)	P/E (5 yrs)
$2.12	19.78%	$5.23	11.68
P(2015)	P(2010)	P(current)	P(52-Week )
$61.09	$30.38	$20.90	18.11-28.33

  Note:

1. 5 years average data were calculated from 2006 - 2010.
2. If 5 years average P/E higher than S&P 500 5 years average P/E, S&P 500 P/E ratio will be applied.
3. P(2015): estimated stock price in 2015 - this if stock price Future Value (FV).
4. P(2010): estimated stock price after applied annual discount rate of 15% in today's value - this is the intrinsic value or Present Value (PV) of the stock price.
5. P(52-week): 52 weeks stock price movement range range.

You can see from above table currently AAON & HANS are over-valued, I will put it under my watch list and wait for the market correction in order to get the real bargain deal.

Now let's look at LANC & PTI in deeper details:

LANC - Lancaster Colony manufactures food products, automotive accessories, glass products, and candles. The company's largest division, which produces specialty foods, markets condiments, baked goods, and pasta under brand names such as Girard's, Pfeiffer, and Marzetti. Its automotive division produces floor mats, truck splash guards, and other parts, which it sells to auto manufacturers and retail stores.

Current stock price $49.92 was within lower band of 52-week price range and also about 44% discount to it's intrinsic value price $88.02.

The intrinsic value was calculated base on past 5 years (2006 - 2010) EPS data 1.45, 1.28, 3.18, 4.07, 4.07 to work out growth rate @ 22.93% per annum.

But if we look at the EPS data from 2000 - 2005 2.49, 3.11, 2.24, 2.67, 2.48 it seems that the EPS growth was inconsistent and also without any clear trends.

If we take more conservative estimation, let's say the growth rate for next 5 years will be 15% per annum (since 5 years average ROE was about 18.86%) which worked out the intrinsic value is about $63 per share. Current stock price is about 21% lower than intrinsic stock price and we should take this opportunity to buy this stock and wait for market to recognise it's true value.

PTI - Patni Computer Systems, an offshore-centric IT service provider from India, is known for its long history of managing large client relationships and its strong domain expertise in the select industries of insurance, manufacturing, financial services, and telecommunications. However, Patni does suffer from high client concentration and a limited global presence. In our opinion, Patni is a relatively weak player in a good industry.

Current stock price $20.90 was also close to the lower band of 52-week price range and it was about 31% discount to it's intrinsic value price $30.38.

But same findings can be derived from past 10 years EPS data.

2001 - 2005: 0.48, 0.64, 0.66, 0.92, 0.96 - growth rate @ 14.87%
2006 - 2010: 0.86, 1.64, 1.50, 1.84, 2.12 - growth rate @ 19.78%

We can find that past 5 years earning growth was much faster than previous 5 years period. Since the average ROE (for past 5 years) was about 17%, we can take a conservative estimation the next 5 years EPS will be increasing about 15% per annum which work out the new intrinsic value is $24.63.

Current price $20.90 was about 15% lower than the intrinsic value. To me 15% was not a clear margin of safety I will put it under my watch-list and wait for the stock price drop to below $19.70 (80% of the intrinsic value $24.63) then start to buy it.

Another value investing tool

The basic concept is to compare current year's financial performance signals against last year's signals. There are total 7 variable to measure these performance-related factors, each variable stand for one mark if a firm can score 7 marks it means the firm have a strong fundamentals:

(1) Profitability (3 variables)

ROA = net income before extraordinary items / beginning of the year total assets
If current year's ROA is better than prior year's score one mark, zero otherwise.

CFO - cash flow from operations
If current year's CFO less prior year's CFO is positive score one mark, zero otherwise.

Accrual = current year's CFO - net income before extraordinary items
Accrual > 0 score one mark, zero otherwise.

(2) Leverage & liquidity (2 variables)

Two of the seven financial signals are designed to measure changes in capital structure and the firm's ability to meet future debt service obligations. An increase in leverage or a deterioration of liquidity is a bad signal about financial risk.

Financial leverage = total long-term debt / beginning of the year total assets
An decrease in financial leverage as a positive sign and score one mark, zero otherwise.

Liquidity - measures the historical change in the firm's current ratio between the current and prior year, where an improvement in liquidity score one mark, zero otherwise.
(current ratio = current assets / current liability)

(3) Operating efficiency (2 variable)

The remaining two signals are designed to measure changes in the efficiency of the firm's operations.

Gross Margin - If the firm's current gross margin is better than last year score one mark, zero otherwise.

Turnover ratio = total sales / beginning of the year total asset
If current year turnover ration is better than last year score one mark, zero otherwise.
An improvement in asset turnover signifies greater productivity from the asset base.

Now I use Almost Family Inc. (AFAM) as a example to illustrate my concept:

                  2009        2010

ROA       14.27%    15.63%        --- 1 mark

CFO         27M        32M            ---  1 mark

Accrual = 32M - 29M = 3M > 0  --- 1 mark

            

                   2009         2010

Leverage     0.499       0.439           --- 1 mark      

Liquidity      2.57          3.18             --- 1mark

                              2009           2010

Gross Margin       53.48M      53.97M    --- 1 mark

Turnover ratio       1.73            1.75      --- 1 mark

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Total score 7 marks

My stock-picking methods shared

I would like to post my stock selecting processes here (a typical fundamental value investing approach), it will be served as my stock-picking method in both Singapore & US markets:

Step 1: Looks for stocks with strong fundamentals

     a. Profitability test:

         ROE > 15%
         Gross Profit Margin above industrial average

     b. Growth rate test:
         EPSGR > 10%

     c. Financial health test:
         Debit/Equity Ratio < 0.5
         Quick Ratio > 1
         (Quick Ratio = current asset - inventories / current liabilities)
         Long Term Debt < 3 times its annual net income

      d. Undervalue test:
          Current PE < Average PE
          Average PE = (historical highest PE + historical lowest PE) / 2
         
          Current PB ratio < industrial average

Step 2: To find a real bargain deal

      a. How to calculate Intrinsic Value - to determine P(a)

         a example to find P(a) Apple Inc.

         last 10 years EPSGR% = 23.61% (from 2000 to 2009)
         2009 EPS: $9.08
         2019 estimated EPS = $9.08 x (1.2361)^10 = $75.62

         last 10 years average PE ratio = 55.72 (from 2000 to 2009)
         S&P 500 average PE ratio = 18.39
         Since last 10 years PE ratio seems too high we will use S&P 500 PE ratio

         2019 estimated stock price = $75.62 x 18.39 = $1,390.65

         set IRR (internal rate of return) at 15%
         Intrinsic Value = $1,390.65 / (1.15) ^10 = $343.37
         P(a) = $343.37 x 75% = $257.53

     b. Calculate P(b)

         P(b) = P(52weeks low) + (P(52weeks high) - P(52weeks low)) / 3

         Use Apple Inc. as a example:
         P(b) = $185.55 + ($ 315 - $185.55)/3 = $228.70

     c. Identify the fair stock value P(fair):

         P(fair) = lower one of P(a) or P(b)
         So P(fair) for Apple Inc. = $228.70

     d. If P(current) < P(fair) is a indication to buy the undervalued stock

         Current price $315 are too high, we should not buy it at this moment.

Step 3: Always remember we are buying a Business, not a Stock - Economic Moat

      a. a strong management
      b. in a growing industry
      c. sustainable competitive advantage
          - A strong brand (eg. Coca-Cola, Exxon Mobil, McDonals's, Visa, Google)
          - Patents and trade secrets (eg. pharmaceutical companies like Pfizer)
          - Gigantic economies of scale (eg. GE, Wal-Mart, Amazon)
          - Market leadership that competitors very difficult to overtake (eg. GE, eBay)
          - High switching costs that lock in customers (eg. Adobe, Microsoft)
          - Monopoly status (eg. SPH, SGX, SMRT)
       

My Supplementary Retirement Scheme (SRS) account

Recently I opened a Supplementary Retirement Scheme (SRS) account with OCBC bank, at this moment no intention to contribute any amount into that account. But when close to year end period I may work out my estimated annual income in order to determine whether is worth to put some money into my SRS account or not.

SRS explained:

What is it?
SRS was established on 1st April 2001 to encourage individuals to save for their retirement by offering tax incentives. The SRS is open to all Singaporeans, Singapore Permanent Residents (PRs) and foreigners who are at least 21 years of age.

Benefits
Other than the benefit of having a larger pool of savings upon retirement, members can also claim tax relief for contributions made to the SRS. Investment gains in the SRS are tax free with the exception of Singapore dividends received, which are taxable. Tax will be payable only when SRS savings are withdrawn. If savings are withdrawn in its entirety upon retirement, only 50% will be subject to tax. Withdrawals may also be staggered over 10 years to enjoy greater tax savings.

How does it work?
All SRS contributions are to be made in cash at any time before 31st December each year.
To make a contribution, an SRS account must first be opened.  The amount of contribution is subject to a cap.  The SRS contribution cap is no longer based on the individual’s actual earned income but on a common absolute cap of $76,500 i.e. 17 months of the prevailing CPF salary ceiling of $4,500.   This amount is 15% of $76,500 or $11,475 for Singaporeans and Permanent Residents, and 35% of $76,500 or $26,775 for foreigners. 

Early withdrawals from SRS Account
Withdrawals can be made in any amounts, at any time. However, if the withdrawal is made before the statutory retirement age, 100% of the sum withdrawn will be subjected to the individual's marginal tax rate. On top of that, a 5% penalty will be imposed.

What type of investments can I invest my SRS funds in?
Funds in the SRS account may be invested in a range of financial products. This includes fixed deposits, insurance products and unit trusts. Investments in direct property are not allowed.  As for life insurance products, only single premiums with life cover of not more than three times the single premium will be allowed. Critical illness, healthcare and long term care products are excluded from this scheme. All proceeds from the realization of SRS investments must be returned to the SRS account.

How to get the best deal?
Before start saving under the SRS scheme, it is advisable to do a simple cost-benefit analysis to review the potential tax benefits as well as earnings from investing your SRS funds. This should be weighed against the opportunity cost of tying down your funds till retirement age. There is a chance that if SRS savings are withdrawn in its entirety on retirement, you will end up paying more income tax on the withdrawals than what was gained in tax savings. However this may be mitigated by staggering withdrawals over a period of 10 years.

Identify potential accounting red flags

• Unexplained changes in accounting rule
• Increasing net profits accompanied by declining cash flow from operations
• A disproportionate increase in accounts receivables in relation to revenue increase
• EPS grows much faster than sales growth (a question of earning sustainability)
• EPS grows much faster than gross margin growth (a question of earning sustainability)
• EPS grows much faster than cash flow from operations (revenues have not materialised into cash)
• A growing gap between reported net earning and its cash flow from operations (generally CFO will be higher than net earnings)
• Unexpected large asset write-offs
• Large fourth-quarter adjustments
• Whether a company capitalised or expenses an item can make a big difference to its results

Practical Technical Analysis Seminar by SGX

Last Saturday (2nd Oct'10) I attended SGX Academy Practical Technical Analysis Seminar, I summarized the main ideas as below:


(1) Using SMA8, SMA21 & MA55 to identify the market trend

Moving Average is a trending signal by application of statistical concepts of average. The assumption is once price is above the average price of a certain period, the up trend is likely to maintain, while vice verse.

But MA is lagging indicator, only when market moves a lot, signal could then be spotted. Another weakness of it is when consolidating, MA becomes almost useless, and normally generating more false signals.

In addition, I will also using MA200 to identify the main market direction.

(2) Momentum Indicator Stochastic Oscillator using 20/80

The Stochastic Oscillator Indicator compares where a security’s price closed relative to its price range over a given time period. The Stochastic Oscillator is displayed as two lines. The main line is called %K. The second line, called %D, is a  Moving Average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line.

< 20 over sold, >80 over bought

Buy when the Oscillator falls below 20 and then rises above that level;
Sell when the Oscillator rises above 80 and then falls below that level.

(3) Relative Strength Index (RSI) using 40/60

The Relative Strength Index Technical Indicator (RSI) is a price-following oscillator that ranges between 0 and 100.

RSI < 40 probably bear, >60 probably bull

Tops and bottoms
The Relative Strength Index usually tops above 60 and bottoms below 40. It usually forms these tops and bottoms before the underlying price chart;

Divergences
Divergences occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the Relative Strength Index. Prices usually correct and move in the direction of the RSI.

(4) The strength and weakness of Indicators

Indicators are basically the study on price movement, by application of a certain mathematical concepts, especially those from statistics. This type of analysis tool is trying to figure out the principles and regularities behind market move.

Technical indicators are sensitive to price movement, sometimes, are very good reference at reversal or turning point. However, market behavior is in essence human behavior which could not be formulated by statistical formula, every indicator has a unique philosophy behind it, be it cycle, trending, oscillating assumption or others, which has a fatal weakness that market is not statistical in nature, it is fractal and chaotic.

In conclusion, I am still base on strong fundamental factors to picking wining stocks. Technical indicators can only be used as supporting tool to enter / exit the market at the right time.

Using Equity Risk Premium (ERP) to timing the market

How to calculate ERP:

ERP = (1 / PE - 1 year fixed deposit rate) x 100%

SG Market
ERP > 3.5% good time to invest, ERP < 0.6% stock price overshot;

STI PE: 15.2 (base on FSM 30 Sep data), fix deposite rate: OCBC 0.55%;
current SG market ERP = 6.03%

US Market
ERP > 1.0% good time to invest, ERP < -2.0% stock price overshot.

S&P500 PE: 13.7 (base FSM 30 Sep data), 1 year treasure bill: 0.26% (as  at 1st Oct)
current US maeket ERP = 7.05%