How to Value Equities Using Benjamin Grahams Simple Formula! - Example SATS Singapore

We just finished reading "The Intelligent Investor" by Benjamin Graham and we will distill the important points for our dear readers. Actually, we didn't really agree on some of Benjamin's methodology because some of it was purely rule of thumb. BUT....given that he has "reproduced" some pretty fine students, see below table and compare their performance with our Dear Aberdeen Fund Managers and Dear Fidelity Fund Managers from Fundsupermart Singapore, we have becomed believers. Shameful.....still taking management fees somemore!
Read here on what Warren Buffet say about such people.

Benjamin Graham came up with a simple rule of thumb formula to find the intrinsic value of a stock. (Seriously, don't ask us how its derived...its baffling! )

Intrinsic Value per share= Current ( Normal) Earnings per share X (8.5 + twice the expected annual growth rate of earnings per share)

Take note that (Normal ) means one-off , extraordinary items that inflate or deflate the earning for that year are excluded. These extraordinary items refers to, for example, currency gains, sale of property ( non-property company), or anything that is earned/loss from activities not in the normal course of a company's business. The expected annual growth rate of earnings is the growth expected over the next 7 to 10 years.

Let's use it on Singapore Airport Terminal Services shall we!

We pulled the data out from Reuters ( let's assume reuters is correct) You can get the reuters data from http://www.reuters.com/. ( thats if you believe in their data!) Look at Diluted EPS Excluding ExtraOrd Items. Note that we use Diluted EPS instead of Basic EPS as the former is a more accurate reflection on the ownership of a company. Read here for a better explanation.
This data has already excluded extra-ordinary items therefore it is "normal".

Expected Annual Growth rate of SATS earnings per share = 0! ( based on the above. It might be negative too.. but let's be good shall we! This is up to your assumptions. Garbage in Garbage out!)

Current (Normal) Earnings per share = 0.179

Intrinsic Value per share = 0.179 X ( 8.5 + 0) = $1.512

Current value now as of 24 Nov 2008 = $1.37

Wow...let's go chiong and buy! Wait. Benjamin Graham also mentioned about the Margin of Safety! So is $1.512 - $1.37 = $0.142 a good discount and sufficient as a Margin of Safety?? Use your own judgement!.

As Graham once wrote: " You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."

(Updated 25 Nov 2008, on a commenter's comments on using the weighted average of earnings per share for 3 years instead of just the most recent year's earnings per share, we thought about it, and we think it actually makes sense to use a weighted average, as some industries are highly cyclical. A weighted average will smooth earnings out through the years. Hmm maybe a simple average will suffice to keep it simple.... )

Important: The objective of the articles in this blog is to set you thinking about the company before you invest your hard-earned money. Do not invest solely based on this article. Unlike House or Instituitional Analysts who have to maintain relations with corporations due to investment banking relations, generating commissions,e.t.c, SGDividends say things as it is, factually. Unlike Analyst who have to be "uptight" and "cheem", we make it simplified and cheapskate. -The Vigilante Investor, SGDividends Team

How to See if a Bank might fail - Example: DBS Singapore

With all the gloom and doom about bank failures and with Citigroup going to $3+ dollars, what the heck is happening to the world! Let's look at a recently popularised ( its been around for sometime actually)ratio called the Texas ratio to see if a bank has a chance of failure. Before you read further, please take note that banks are one of the hardest entities to value or analyse. Admittedly, SGDividends are not experts at it. We can only try, using some logic and common sense.

The Texas ratio was developed as an early warning system to identify potential problem banks. It was originally applied to banks in Texas in the 1980s and proved useful for New England banks in the early 1990s. Below is a good video by CBS about this ratio. Apparently, its quite reliable.

Definition: The Texas ratio takes the amount of a bank's non-performing assets and loans and divides this number by the firm's tangible capital equity plus its loan loss reserve. A ratio of more than 100% (or 1:1) is considered a warning sign.

So what is a non-performing loan (NPL or as DBS calls it NPA)? A loan becomes non-performing after being in default for three months, but this can depend on the contract terms.

So let's look at our dear DBS ( yes the one embroiled in the High Notes case, the one who fired 900 employees without consulting the unions, the ones who "lost" clients safe deposit boxes).

From the most recent financial statements released in Nov 2008, DBS reported S$2,054 million non-performing loans. See below.

The non-performing loan amounts have to be divided by TANGIBLE capital equity PLUS loan loss reserve. The tangible capital equity is calculated as total equity ( S$24,333 million) minus Goodwill on consolidation ( S$5,847 million) which is equals S$18,486 million. See below.

Therefore, the Texas Ratio ( sounds like game Texas Hold'em!) = S$2054 / S$18,486 = 0.111=11%. ( we did not mention about the loss reserve as we can't find it and we suspect its been accounted for in the S$18,486 figure. )

Since the Texas Ratio of 11% is way lesser than 100%. DBS is considered safe. Can you sleep well tonight?

Important: The objective of the articles in this blog is to set you thinking about the company before you invest your hard-earned money. Do not invest solely based on this article. Unlike House or Instituitional Analysts who have to maintain relations with corporations due to investment banking relations, generating commissions,e.t.c, SGDividends say things as it is, factually. Unlike Analyst who have to be "uptight" and "cheem", we make it simplified and cheapskate. -The Vigilante Investor, SGDividends Team