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.