• Australian (ASX) Stock Market Forum

Hello and welcome to Aussie Stock Forums!

To gain full access you must register. Registration is free and takes only a few seconds to complete.

Already a member? Log in here.

Fundamental Analysis Techniques

Discussion in 'Medium/Long Term Investing' started by carpets, Feb 6, 2006.

  1. carpets

    carpets

    Posts:
    68
    Likes Received:
    0
    Joined:
    Dec 1, 2005
    I thought I'd create this thread in response to the Technical V. Fundamental discussion. IMO a combination of both are essential to a good trading plan however, I mostly use technical analysis with some fundamental because i understand the indicators and have a few methods of technical anaylsis that have worked for me so far. I do some research into a company before buying and often consult various sources of information.
    I am interested to hear from those guys who use alot of fundamental analysis and if they could share some of their techniques that they use before buying/selling and also to interpret market trends.
    Conversly, I'd be interested to hear some of the indicators/techniques that people use in technical analysis.
    Carpetss.
     
  2. bullmarket

    bullmarket

    Posts:
    937
    Likes Received:
    0
    Joined:
    Dec 14, 2005
    Hi carpets

    I think a similar topic has been started elsewhere (but can't remember where).

    Anyway, I'm in the camp that use both fundamental and technical analysis and please bear in mind I am an investor and not a trader.

    Below is a summary of what I do to try to determine whether a company is fundamentally good value or not.

    Basically I go through a series of 5 tests and a company has to gain a score of 70%+ in these tests for me to rate it as ok to buy fundamentally. I've set up an Excel spreadsheet to model these 5 tests. Then I look at the company's price chart to help time buying points if the stock passes my funamental tests.

    1) I use the Altman-Z Factor to gauge whether a company is financially sound or not. For info on how the Altman-Z Factor model works, maybe have a look at http://www.nysscpa.org/cpajournal/old/16641866.htm if interested

    2) I look at various financial ratios including, working capital ratio, Debt/Equity, Gearing, ROA, ROE, interest cover, EBIT margin etc

    3) I then look at the PER and PEG ratios to make sure they are within reasonable limits.

    4) I then look at what total returns (cap gain + divs) I can expect in the next 2 years based on increased share price according to PER and EPS,DPS forcasts. I aim for at least 10%pa potential return.

    5) I then discount that total return back to NPV to see if the current share price is above/below the NPV.

    example:

    Company XYZ

    Current Share Price: $1.00
    Forcast EPS in 2 yrs: 7.5 cps
    Forcast Div in Yr 1: 3.0 cps
    Forcast Div in Yr 2: 3.2 cps
    'Fair' PER: 16.0
    Long term 'Risk Free' Return: 5.5%

    Therefore, potential price target = 0.075 x 16.0 = $1.20

    Potential TOTAL 2 yr return = $1.20 + 0.03 + 0.032 = $1.262

    Now I 'discount' this $1.262 total return back to NPV using a transposed compound interest formula:

    NPV = TR/((1+I)^n)

    Where

    NPV = Net Present value of the $1.262 total return
    TR = Total Return
    I = Discount Rate
    n = number of years
    ^ = to the power of

    NPV = 1.262/((1+0.055)^2) = $1.13

    Since the current share price at $1.00 is well below the $1.13 NPV of my total potential return then I would consider XYZ to be good value atm. But to pass my NPV test, the share price has to be more than 10% below the NPV.

    So although all this above doesn't actually value the company, it does value my expected returns in terms of what those returns are worth today (NPV).

    So after I have the results of the above 5 tests, the individually weighted test results need to add up to a score of 70%+ for the company to pass my fundamentals/valuation test overall. If the company passes then I look at the price chart to help time buying points.

    As far as charting goes, I tend keep to the KISS principle and look for support/resistance breaks, stocks that are in or show a high probability of going into an uptrend. I mainly look at volumes, MACD, MACD-H and the Stochastic indicators for confirmation of the price action.

    Good luck and hope this helps

    bullmarket :)
     
  3. carpets

    carpets

    Posts:
    68
    Likes Received:
    0
    Joined:
    Dec 1, 2005
    Bullmarket,
    thanks for your ideas, they where really helpful. I tend to be a bit of both, that is, a trader and investor. I can see value in both but trading seems a bit volatile and has more risk attached to it IMO.
    does anyone else have varying methods of analysis, possibly for day trades?

    (moderator, if this type of thread has already been started elsewhere feel free to move this info, i couldnt find anything on the topic)
     
  4. Milk Man

    Milk Man

    Posts:
    573
    Likes Received:
    2
    Joined:
    May 11, 2005
    Quantatative analysis may be of some use to you in this regard. www.Mrmarketishuge.com uses this process. Just go to Mr Market's homepage. Its only US stock based but could possibly be adapted to the ASX.
     
  5. Nick Radge

    Nick Radge

    Posts:
    758
    Likes Received:
    0
    Joined:
    Nov 20, 2005
    bullmarket,
    That's a neat little calculation. Would I be correct in saying that ANZ, currently trading at around $25.00, has a NPV of $29.31 and would therefore fit your criteria?
     
  6. Odysseus

    Odysseus

    Posts:
    19
    Likes Received:
    1
    Joined:
    Feb 4, 2006
    Some general ideas on fundamental and technical factors - for investors rather than traders.

    FUNDAMENTAL
    1. Consider the general economic situation ("top down").
    2. Is your company in a sector likely to benefit?
    3. Is the company GOOD ENOUGH te benefit? How good is management? What is the earnings per share ratio? Has the company been earning profitably for some time? What is the PE, or - more importantly - the PEG? (For a PE by itself can mean little.)
    4. If the company is in a winning position, sound, and not over-priced, buy. Pay a fair price for an excellent company rather than a "low" price for a mediocre one

    TECHNICAL
    1. If you have an inherently strong company volatility will bother you less.
    2. Even so, don't think that a company may not turn weak, and act quickly on any substantially bad news. DO WATCH THE CHARTS, AND TRY TO INTERPRET CHANGES IN PRICE.
    3. Sell at once if a (significant) profit downgrade occurs, or any other clearly bad news. As a general rule, if a company drops by more than 10% on COMPANY SPECIFIC news, get out. BE QUICK AND DECISIVE ABOUT CUTTIING LOSSES.
    4. Do NOT sell if the downfall results from a general CORRECTION (which may bring the whole market down by say 10-15%).
    5. Sell all clearly INFLATED stocks you have BEFORE a bear market occurs. The signs of a bear market are usually very clear. The key symptom is widespread, uncritical enthusiasm and optimism. But a fair people predict a huge and prolonged fall within a number of months, on the basis of demonstrable over-valuation of many major stocks. Volatility increases, in both directions. Sell at the least all those stocks which you know to be dear - not necessarily those you are happy to keep through thick and thin, like banks. TAKE A BEAR VERY SERIOIUSLY. IT CAN LOSE YOU A LOT OF MONEY, WHICH IS HARD TO RECOVER. DON'T LISTEN TOO MUCH TO THOSE WHO SAY "IT WILL ALL GO UP AGAIN".
    6. Do NOT be afriad of letting your profits run. THE BEST RESULTS ARE ACHIEVED BY PEOPLE WHO KEEP SELLING DUD STOCKS EARLY, BUT HANG ON INDEFINITELY SO LONG AS A QUALITY STOCK CONTINUES TO PERFORM, AS A COMPANY ESPECIALLY (MARKET RESULTS WILL FOLLOW). THE RISES WILL EASILY OUTSTRIP THE LOSSES, IF THIS POLICY IS ADOPTED.
     
  7. michael_selway

    michael_selway Coal & Phosphate, thats it!

    Posts:
    2,397
    Likes Received:
    1
    Joined:
    Oct 20, 2005
    Hi Nick, how did u get NPV for ANZ of 29.31

    Nick/Bullmarket, what would get for NPV of EXL and GTP?

    1) EXL = $7.60

    Earnings and Dividends Forecast (cents per share)
    2005 2006 2007 2008
    EPS 49.3 57.9 84.9 108.8
    DPS 24.0 30.0 43.2 58.0

    2) GTP = $3.69

    Earnings and Dividends Forecast (cents per share)
    2005 2006 2007 2008
    EPS 41.7 45.6 57.5 62.7
    DPS 14.0 16.5 21.5 23.5

    Thx

    MS
     
  8. bullmarket

    bullmarket

    Posts:
    937
    Likes Received:
    0
    Joined:
    Dec 14, 2005
    Hi Nick

    I'll use data from Commsec to see what NPV I would get for ANZ.

    Current Share Price = $25.10
    Forcast 2006 Div = $ 1.19
    Forcast 2007 Div = $ 1.30
    Forcast 2007 EPS = $ 2.05
    'Fair' PER for ANZ = 15
    Risk Free Discount Rate = 5.5

    Calculation:

    Potential Price target = 15 x 2.05 = $30.75

    Potential TOTAL 2 yr Value of Investment (share price rise + divs)

    30.75 + 1.19 + 1.30 = $33.24

    Now I discount that $33.24 back to todays NPV using the 5.5% discount rate.

    NPV = TR/((1+I)^n)

    Where

    NPV = Net Present value of the $33.24 total return
    TR = Total Return
    I = Discount Rate
    n = number of years
    ^ = to the power of

    NPV = 33.24/((1+0.055)^2)

    My NPV for ANZ = $29.86 (so near enough to your $29.31 :))

    My personal criteria for this test to pass is that the current share price needs to be at least 10% below the NPV. Therefore since the current share price at $25.10 is 15.9% below my $29.86 NPV, ANZ would pass my NPV test.

    But please bear in mind, as I described in my original post, I do a series of 5 tests. My NPV has only a 10% weighting in the total score from the 5 tests and so I would not buy ANZ if it passed the NPV test but failed to get a sufficiently high enough score from the other tests to rate it as a buy overall on fundamentals.

    Hope this helps..

    bullmarket :)
     
  9. bullmarket

    bullmarket

    Posts:
    937
    Likes Received:
    0
    Joined:
    Dec 14, 2005
    Hi Michael

    geeeeee.....looks like you've done 90% of the work already by getting most of the data together :D

    All you still need is what you think a 'fair' PER would be for those 2 companies (and that's always the tricky bit using this method :( ) and you need to nominate your 'risk free' discount rate.

    I use a risk free discount rate of 5.55% since the cash component of my portfolio is kept in one of those online only bank accounts (like ING Direct, Esanda Saver etc etc) which currently pays 5.55%pa.

    cheers

    bullmarket :)
     
  10. michael_selway

    michael_selway Coal & Phosphate, thats it!

    Posts:
    2,397
    Likes Received:
    1
    Joined:
    Oct 20, 2005
    Ok risk free rate 6%
    Fair PE 12

    Btw u know forecast EPS, why only 2 yrs as opposed to 3+yrs or 1yr etc?

    thx

    MS
     
  11. bullmarket

    bullmarket

    Posts:
    937
    Likes Received:
    0
    Joined:
    Dec 14, 2005
    michael

    It's a personal preference. I don't place too much weight on forcasts that are more than 2 years out because especially in today's global political and economic environments there are too many unknowns and variables which could influence forcasts in the short term, let alone forcasts for 2+ years out.

    cheers

    bullmarket

    ps....now that you have all the data, maybe have a go at plugging them into the process I described earlier and see what NPV you come up with......shouldn't take you more than a few mins since you have all the input data now...:)
     
  12. michael_selway

    michael_selway Coal & Phosphate, thats it!

    Posts:
    2,397
    Likes Received:
    1
    Joined:
    Oct 20, 2005
    Yeah ok lol

    EXL

    Current Share Price = $7.60
    Forcast 2006 Div = $ 0.30
    Forcast 2007 Div = $ 0.43
    Forcast 2007 EPS = $ 0.85
    'Fair' PER for EXL = 12 (this is quite conservative imo)
    Risk Free Discount Rate = 6 (this is quite conservative imo)

    Calculation:

    Potential Price target = 12 x 0.85 = $10.20

    Potential TOTAL 2 yr Value of Investment (share price rise + divs)

    10.20 + 0.30 + 0.43 = $10.93

    Now I discount that $10.93 back to todays NPV using the 6% discount rate.

    NPV = TR/((1+I)^n)

    Where

    NPV = Net Present value of the $10.93 total return
    TR = Total Return
    I = Discount Rate
    n = number of years
    ^ = to the power of

    NPV = 10.93/((1+0.06)^2)

    My NPV for ANZ = $9.73 approx

    1- 7.6/9.73 = 21.89% below NPV

    Using Target conservative low PE 12 and high Risk Free Rate 6%

    -------------------------

    Also why 10% below NPV? is it better to just to make "Fair PE" lower instead?

    thx

    MS
     
  13. Nick Radge

    Nick Radge

    Posts:
    758
    Likes Received:
    0
    Joined:
    Nov 20, 2005
    I used a PE of 14.7 and a price of $24.91, therefore the slight difference.
     
  14. TheAnalyst

    TheAnalyst

    Posts:
    608
    Likes Received:
    3
    Joined:
    Jun 23, 2005
    Hi Bull

    Have you got a nice demonstration for mining stocks...bit harder as u need estimated cashflows...here is one of my little tricks because with out some guidance from the analyst reports in regards to cashflows and so many different assumptions i just get their p/e and realise that a mining stock p/e is just a indirect result of the dcf calculations brang back to NPV so i just consider the per as the life of the mine in yrs or how long it will be before all there known productive resources will be consumed.
     
  15. Double Six

    Double Six

    Posts:
    14
    Likes Received:
    0
    Joined:
    Oct 14, 2005
    the only 'fundamentals' which I suspect are of value is the Chairmans/Presidents statement.

    you have to read between the lines sometimes, but he is not going to hang himself out to dry.
     
  16. carpets

    carpets

    Posts:
    68
    Likes Received:
    0
    Joined:
    Dec 1, 2005
    Analyst, are you saying that bullmarkets technique can only be used within some sectors? Would you use his method in dealing with, say HDR WPL OSH STX COE etc? how would you factor in those variables that you talked about such as estimated cash flow?
     
  17. TheAnalyst

    TheAnalyst

    Posts:
    608
    Likes Received:
    3
    Joined:
    Jun 23, 2005
    Thats the big problem all you can do is go by analyst reports on the company web page....hdr is a problem as i said in the hdr thread...all you can really do is get an idea from the analyst reports as they have been given a bit more access to the company accounts and are aware of their costs. Most financial sections of the newspapers do not quote mining company P/E's as they are aware this is not the case but the herald sun.

    You must find a rough area that would be a correct price and then as new discoveries and the length of time before it becomes full operational and looking at spot prices as well as taking note of the hedge arrangements that each company has arranged on its resources then adjust the price accordingly e.g. when oil jumps a lot in value what does that mean to the company earnings and you have to look at what the analysts have previously valued the share price at and then go from there.

    See how difficult it is thats why you need estimates of each discovery and time estimation to actual production and everything else.
     
  18. bullmarket

    bullmarket

    Posts:
    937
    Likes Received:
    0
    Joined:
    Dec 14, 2005
    Hi michael

    The 10% below NPV is purely a personal preference in the context of it being seen as a 'risk premium'.

    The reasoning/logic behind this is that if the NPV of my calculated potential 2 yr return turns out to be equal to the current share price then there would be no point in my buying the shares at the NPV price, and so carry the inherent risk of investing in shares, when I could get the same return in 2 yrs time invested in cash or whatever at my 'risk free' rate with virtually no risk of my investment losing value.

    Hence I have a personal limit that the share price must be at least 10% below my NPV to compensate for the inherent risk of holding shares.

    Hope this helps.

    bullmarket :)
     
  19. Knobby22

    Knobby22 Mmmmmm 2nd breakfast

    Posts:
    5,647
    Likes Received:
    937
    Joined:
    Oct 13, 2004
    I like to look three years out precisely because many people stop at two for their analysis.

    This works particuarly where you know that mitigating factors negatively effect one of he first two years or when you know that something is planned to happen in the third year e.g. oil well comes on stream.

    There is also the fact that the estimate made is still a guess. I prefer to make my own estimate before checking analysts as they can often be too conservative.
     
  20. bullmarket

    bullmarket

    Posts:
    937
    Likes Received:
    0
    Joined:
    Dec 14, 2005
    Hi Analyst

    Unfortunately I don't have a demo for mining stocks.:(

    But to put things in perspective, the method I use to calculate my potential future total investment value

    ie....potential future value = (forcast EPS x 'fair PER') + dividends

    is highly dependent on having a good idea on what the market sees and/or will see as a fair PER for the stock and the quality of the EPS and DPS forcasts. (I tend to use Commsec's forcasts as they are generally an average of up to 7 brokers for some stocks).

    For mining and speculative stocks, forcasting future PER, DPS, EPS can obviously be highly subjective and open to debate and so you could easily have a large range in the potential future value estimations.

    I am basically a low risk investor, sticking to so called 'bluechips' and so their forcast EPS,DPS and PER are generally more easily predicted and less volatile everything else being equal. So the above method is a little more reliable for those type of stocks as opposed to speculative stocks.

    cheers

    bullmarket :)
     
Loading...

Share This Page