Comparing Different Shares Based on Fundamentals

[SharonK]

I am a Commsec user and have been researching different shares but am now sure how to compare the value and return from each one. I believe the dividend yield is a comparison of the return of income over the cost of the share so could be compared to say an interest rate on cash in a bank account. However this doesn't include capital growth.

any hints on what to look for would be appreciated

cheers
Sharon

 

[bullmarket]

Re: Comparing Different Shares

Hi and welcome SharonK

I am a Commsec user and have been researching different shares but am now sure how to compare the value and return from each one. I believe the dividend yield is a comparison of the return of income over the cost of the share so could be compared to say an interest rate on cash in a bank account. However this doesn't include capital growth.

any hints on what to look for would be appreciated

cheers
Sharon

Looks like we think along similar lines re determining the potential value/return of an investment. A similar theme was discussed in another thread and below is one of my posts in that thread.

My 4) and 5) tests I describe below seem to be along the lines of what you are asking about. Basically I calculate a potential total value in 2 years (share price rise + dividends) and then discount that back using a 'risk free' rate back to Nett Present Value (NPV) to see if the current share price is above or below the NPV.

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
This test has a 25% weighting to the final score.

2) I look at various financial ratios including, working capital ratio, Debt/Equity, Gearing, ROA, ROE, interest cover, dividend cover, EBIT margin etc
This test has a 22% weighting to the final score.

3) I then look at the PER and PEG ratios to make sure they are within reasonable limits.
PER and PEG each have a 10% weighting to the final score.

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.
This test has a 23% weighting to the final score.

5) I then discount that total return back to NPV to see if the current share price is above/below the NPV.
This test has a 10% weighting to the final score.

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 at least 10% below the NPV. The current share price having to be 10% below NPV is my risk premium as compensation for buying the shares and not simply investing the funds at the 'risk free' interest rate.

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.

Hope this helps.

bullmarket

 

[SharonK]

Re: Comparing Different Shares

Bullmarket,

Thanks so much for the trouble you've gone to explaining all of that too me, I will it has certainly given me a much better idea on what to look for and a starting point to value and assess any future investments I may make.

I will have to put it to the test on a few shares I'm looking at to see how they hold up.

This is my first time on this site only signed up today, had no idea this site existed, and am very impressed, I'm sure I will gain alot of information here.

appreciate your input.

thanks
Sharon

 

[bullmarket]

Re: Comparing Different Shares

no problem SharonK

If you have any more queries or would like to throw your into any discussions just fire away and join in

cheers

bullmarket

 

[StockyBailx]

Re: Comparing Different Shares

Hi Sharon ,

That is a interesting theory Bullmarket has devised there, I've never tryed it and don't know if it will work or give you the answers you are looking for, but good luck with your tests.

I would just like to add, with out getting in to Mr Bullmarkets way that a big/strong Market Cap and a profitable compound percentage of over 40% is a very good indercation of the momemtum of the stock, and the dirrection it is heading.

I know you can calculate a percentage of the stocks profit or loss, but I believe it is impossible to predict the stocks future based on fundermentals.

Just sum helpful advise. Happy Trading


Stock'ie'Bailz

 

[michael_selway]

Re: Comparing Different Shares

Bullmarket,

Thanks so much for the trouble you've gone to explaining all of that too me, I will it has certainly given me a much better idea on what to look for and a starting point to value and assess any future investments I may make.

I will have to put it to the test on a few shares I'm looking at to see how they hold up.

This is my first time on this site only signed up today, had no idea this site existed, and am very impressed, I'm sure I will gain alot of information here.

appreciate your input.

thanks
Sharon

yep those tests are pretty interesting indeed.

Btw what stocks/sectors/cap u looking to get into? any particulars?

thx

MS

 

[bullmarket]

Re: Comparing Different Shares

Hi michael

My number 1 priority nowadays is income with cap gains a secondary concern.

I am full invested in 'low risk' listed property trusts (LPTs) and energy/infrastructure trusts for their higher yields. I am steering away from LPT's that have any significant exposure to property development....but that is just part of my risk management strategy.

Regarding ordinary companies I have always stuck to the so called 'bluechips'.......ie.....including but not restricted to the 4 major banks, major retailers (WOW, CML,DJS), TLS (although not so bluechip nowadays ), major resources (BHP, RIO, WPL, STO) FGL, LEI, AGL.....etc

But to be honest, I don't see any real bargains atm at the big end of the market.

I uploaded my Average Market PER spreadsheet in another thread recently and from the results in the spreadsheet, my view is that at best our market is at fair value overall atm with a bias to being expensive.

cheers

bullmarket

 

[SharonK]

Re: Comparing Different Shares

Hi Michael,

Thanks also for your response, not sure what the btw stands for but I assume your question was directed at me.

I currently have shares in AMP, Onesteel, PMP, Paperlinx, Tabcorp and Ten Network, I just wanted to add to this portfolio. When I save up around the $5000 I usually try and buy some more shares and I suppose I was just after some advice on how to pick the better blue chip shares to go for as there are so many to choose from. I'm probably looking more at long term investment at this stage although not too far down the track I want to create an income stream as I have a business which I'm selling and with the proceeds I'd like to set myself up so I don't have to work!! Well don't mind doing a couple of days here and there but would like to generate an income from investing.

I mainly use Commsec as my source of information and it gives me all the details on different companies I suppose I have trouble understanding it all. I'd like to compare the return on the shares to say a more secure return of interest which I currently get 5.55% and am not sure which ratio's I should be looking at.

hope this makes sense,
cheers
Sharon

 

[happytrader]

Re: Comparing Different Shares

Hi and welcome Sharon

I notice you don't have any banks in your porfolio. These have been consistent performers and also recovered quickly after Sept 11 2001 and quickly after the start of the WMD Iraq war. If you check out a yearly chart you will also notice a nice steady incline. Nice dividends and stockholder discounts too. Check out best time to buy by looking at quarterly charts.

Cheers
Happytrader

 

[bullmarket]

Re: Comparing Different Shares

Hi sharon

btw = by the way

Don't worry, it took me a while to work out what all the codes meant in chatroom speak but at least we have icons for smilies here so it's a lot easier

Anyway, re comparing returns from investments that are more secure than shares I assume you are looking at things like:.......cash, gov't bonds, non gov't bonds/hybrids, debentures, property (direct and indirect).

Historically shares have returned ~10-13%pa on average if you include dividends. 10 year bonds are at ~5.5% atm which is about the same as you can get for cash in products like esanda saver, ing direct etc etc. Non gov't bonds/hybrids returns are at ~7-10% from what I have seen.

The Listed Property Trust sector (index XPJ) is yielding ~7% atm. Direct property is yielding about half that on average after expenses.

I hope this gives you a broad idea of approximate returns from other types of investments apart from direct ordinary shares.

If you would like to discuss further please fire away, but I will be away until at least next weekend and so won't be able to respond before then and besides I'm sure there are many others in here who are willing to help as well.

cheers

bullmarket

 

[RichKid]

Re: Comparing Different Shares

I am a Commsec user and have been researching different shares but am now sure how to compare the value and return from each one. I believe the dividend yield is a comparison of the return of income over the cost of the share so could be compared to say an interest rate on cash in a bank account. However this doesn't include capital growth.

any hints on what to look for would be appreciated

cheers
Sharon

Welcome to Aussie Stock Forums Sharon!

I am somewhat of a novice at fundamental analysis, most of what I do is based around technical analysis so take what I say in that context. Have a look at the following books by people who use fundamental data to 'filter' out the stocks they think have the best prospects.

Martin Roth (Top Stocks 2006), Colin Richardson (Aggressive Investor) and some of William O'Neill's books.

Plenty of ideas in those books. Roth especially has been publishing his picks for a few years now so you can check the older editions too.

We had a great poster here named 'Investor' some time ago but, alas, he has not posted for quite awhile. If you use the search tool at the top of this page you can find all his posts, he had lots of good tips on fundamentals.

Feel free to share any of the info you come across as it should stimulate debate. There are threads dedicated to specific stocks so you can post in those threads if your posts are on that stock alone.

 

[Julia]

Hello Sharon,

I'd echo Richkid's endorsement of Martin Roth's "Top Stocks". This provides you with the fundamental essentials on the top companies and can save you a huge amount of research.

Agree, too, with Happytrader's comments about your having so far none of the banks in your portfolio. Don't ignore the regional banks either. The smaller players like Wide Bay Australia, Bank of Qld, Bendigo Bank etc., have provided steady growth and good yield with 100% franking.

At the beginning of this year I rebalanced my portfolio away from primarily high yield stocks to those offering (I hope) greater likelihood of capital growth. I am happy with the results so far, but have to say I do rather miss the large dividend deposits!
So that's the other factor you don't mention: are you looking for SP growth, or rather to provide yourself with income?

I see you have TEN. Whilst this an excellent stock for yield, the fundamentals for at least the medium term are looking less than great.
TEN did very well for a while, but appears to have fallen in favour in comparison with Channel Seven at present.

All the best.

Julia

 

[michael_selway]

Re: Comparing Different Shares

Hi Michael,

Thanks also for your response, not sure what the btw stands for but I assume your question was directed at me.

I currently have shares in AMP, Onesteel, PMP, Paperlinx, Tabcorp and Ten Network, I just wanted to add to this portfolio. When I save up around the $5000 I usually try and buy some more shares and I suppose I was just after some advice on how to pick the better blue chip shares to go for as there are so many to choose from. I'm probably looking more at long term investment at this stage although not too far down the track I want to create an income stream as I have a business which I'm selling and with the proceeds I'd like to set myself up so I don't have to work!! Well don't mind doing a couple of days here and there but would like to generate an income from investing.

I mainly use Commsec as my source of information and it gives me all the details on different companies I suppose I have trouble understanding it all. I'd like to compare the return on the shares to say a more secure return of interest which I currently get 5.55% and am not sure which ratio's I should be looking at.

hope this makes sense,
cheers
Sharon

Hi Sharon, np

out of those stocks u mentioned there OST i like the best imo, low pe, with good forecast growth in EPS. Bit like TIM currently. PPX is ok as well although chart looks volatile in recent times, not sure what the news was.

See the thing its not necessary about Dividend Yield/Income, but more about EPS growth (low forward pe), which means dividend yield will naturally grow (as DPS is paid as a % of EPS) as well capital growth.

Whats the point of current high yield, but the share price falls much more in the furture? eg telstra

The All Ords is very toppy imo, so one should be more selective. Buying stocks for dividend yeild alone is quite risky atm.

Any stocks in particluar u looking to buy atm?

thx

MS

 

[SharonK]

I have considered the banks although I suppose I've been reluctant to purchase higher costing shares as I can only buy smaller parcels. I have also looked at the commsec share packs you get 6 shares in a particular catagorie ie growth, income can't remember the other 2 all for $66 brokerage which didn't seem like a bad option but I would have to wait until I obviously had abit more money to invest.

I've actually just put $15000 into my super into Credit Suisse International and Platinum Internations under a financial advisors advice which has cleared out most of my cash at the moment. But as I previously said I have a business on the market worth approx $450000 and no debts so when I sell it I would like to travel around Australia maybe do abit of seasonal work and invest the sale proceeds into income & capital growth investments to hopefully see me out. I'm 40 and feel ready to retire, worn out and am hoping I'll have enough money to live off if I invest wisely!!

Not sure if I'm being unrealistic? Don't really know how much you need to retire on?

Oh Michael just wondering is there anywhere where they give you the abbreviations to your dialect, I'm having an awful time interpretting it! Please don't take offence to me saying that as I know its due to my inexperience.

I'm currently reading a book called Active Retirement by Alan Hull only in the early stages and am hoping this will help. I have noted many of the other books that have been suggested throughout the site for future reference. Alan Hull promotes looking after your money youself as apposed to using financial advisors which sounds good as it cuts out more fees, but it is also scary taking responsibility as well as I don't want to stuff it up and lose everything I've worked so hard for.

anyway thanks again for everyones feedback, really think this is a brilliant site only wish I had more time to go through all the information on here, when my business sells I would like to get right into investing.

cheers
Sharon

 

[bullmarket]

Hi sharon

re:

............Not sure if I'm being unrealistic? Don't really know how much you need to retire on?............

you can get a reasonably good estimate by doing the following:

I am assuming you would prefer to not draw down on your investment capital and that you own your own home.

1) Put together an accurate and extensive yearly budget based on your desired life style in retirement...my advice would be to err on the side of caution when estimating expenses.

2) Add a few thousand for tax and this will depend largely on how you set yourself up in retirement. Your financial and/or tax adviser should be able to help you more there to best suit your circumstances.

3) divide the pre-tax yearly income (sum of 1 & 2 above) by the anticipated yield you expect to get from your investment portfolio (and you again have to be realistic with estimating yields/returns) to get a reasonably good estimate of how much capital you will need to retire comfortably based on your lifestyle in 1)

eg.....if your budget says you will need $40,000 pretax income annually and you expect an average yield of say 6% then you will need ~$667,000.00

The investment capital you will need will depend on your annual budget, whether you want to draw down on your capital at all and the way you set yourself up financially in relation to minimising tax and the proportion of income and growth investments.

Anyway, I hope this gives you some food for thought at least

cheers

bullmarket

ps....I will be back next weekend if you would like to discuss further - I'm not ignoring you if I don't respond before then.

 

[Julia]

Hello Sharon,

Bullmarket has supplied the mechanics of calculating the income you will need.

Unlike Bullmarket, I didn't assume from your post that you owned your own home. I guess I thought if you are planning to travel for some years and you quoted the basis for your calculations as the sale price of your business, then ownership of a home wasn't included. If that is wrong and you do own a house which you are able to rent then obviously that makes a considerable difference in deciding if your remaining capital is enough to retire on.
If you are getting $300+ p.w. in rent(for example) that will substantially reduce the amount you need to withdraw from the income of your invested capital.

The amount required to retire on is a hugely subjective decision.

If you were unemployed, then the government say that you should be able to live on less than $11,000 per annum!

Some people are happy with a quite modest life style, while others feel the need for a new car every year, designer clothes, and lots of overseas holidays.

Personally, I wouldn't be comfortable with the $450,000 as a buffer for the future, especially if there wasn't a house in addition. At 40, you are still looking at considerable longevity, barring illhealth etc. What will happen if you travel round for say 10 years, and then decide you want to buy a house and stay put? If you deduct the purchase price of a house, buy furniture etc, then depending on where you want to live, this could see the erosion of most of your capital unless the investment markets have been very kind to you.

Don't want to pour cold water on your idea - heaven knows I understand the desire to withdraw from the constant pressure of the work environment -but think it's important to follow the idea through in a financial and emotional sense before you make any irrevocable decisions.

Good luck.

Julia

 

[Boggo]

Sharon
Back to your original question re fundamentals.
If you get a chance go to the next free seminar held by Lincoln Indicators for their StockDoctor software.

They narrow the whole market down to a few hundred good stocks and (at the moment) 65 Star stocks. (See the charts and fundamentals of BOL, RCD, TIM, OKN etc for examples)

I have been using StockDoctor for nearly 3 years and I believe it has well and truly paid for itself many times over by keeping me out unsound stocks.

NOTE - I do not work for them, I am just a very happy client.

Mike

 

[RichKid]

----------
I'm currently reading a book called Active Retirement by Alan Hull only in the early stages and am hoping this will help. I have noted many of the other books that have been suggested throughout the site for future reference. Alan Hull promotes looking after your money youself as apposed to using financial advisors which sounds good as it cuts out more fees, but it is also scary taking responsibility as well as I don't want to stuff it up and lose everything I've worked so hard for.

anyway thanks again for everyones feedback, really think this is a brilliant site only wish I had more time to go through all the information on here, when my business sells I would like to get right into investing.

cheers
Sharon

Sharon,
Alan Hull also has another book called 'Active Investing', I should have mentioned that earlier, worth reading imo. Taking responsibility can be a psychological burden at first but it's better to lose some money yourself while learning how to make it than paying someone else to lose it for you imo.

Might be good to consult a good tax lawyer or estate planning professional to see how you can structure your various activities too since you are dealing with large sums of hard earned money.

In terms of spending time reading stuff here for free- it's probably one of the best 'investments' you can make! Be proactive and diligent and you will reap the rewards. There are no real shortcuts but you can create some good fortune for yourself! (pardon the pun!)

 

[SharonK]

Hi All,

Well again thanks so much by all your feedback, I'm actually blown away by the wealth of information I've found on this site and only wish I'd found it sooner.

Anyway a couple of things to clarrify, I won't actually own a home but my long term partner has a house in town which is currently rented at $130 per week. When my business sells which is where we are living (its a caravan park) we will move into my partners house for the next couple of years. Then we would like to travel, I really don't know how long we would last travelling but I doubt it would be 10 years maybe 3 ish, its really an unknown quantity I suppose. Whilst we were travelling we would rent my partners house. He has a mortgage on it of around $45000 which we may pay off when I sell the caravan park. My partner will continue to work part time and seasonal work. We are both happy to live with the basics in life and have no need to keep up with the Jones. For instance I do 90% of my clothes shopping in op shops and actually get a kick out of it, I don't do it because I cant afford to shop elsewhere. We live in rural NSW I've been here for 3 years and moved out of Melbourne for a lifestyle change, to me time is precious and I would rather go without buying takeaway which costs $20 and have the time it would take to earn that money with my family and friends! This is just a small example but I hope you get the idea of where I'm coming from.

Other question when talking about how much money you need to retire on Bullmarket used an average yeild of 6% as an example, wouldn't the return on funds invested have to average more than that ? I could put all my money in a bank account and earn more than 6% or am I interpretting that incorrectly?

I suppose I was thinking average return of 10% on $450 000 is $45 000 pre tax income, and I would of thought I could easily live on that, it would be more than what I've ever earn't in a year in the past and I won't have a mortgage!

cheers
Sharon

 

[Julia]

Sharon,

Re your expected rate of return of 10%, how did you derive that figure?
I've had a quick look at your existing shares and of these only TEN has a yield of more than 5%, but its SP has declined in the last year PPX is 5% but apparently no franking. Haven't looked at the chart for this.

Obtaining returns well in excess of 10% is obviously no problem in a bull market such as we have at present. Bullmarket will speak for himself, but I imagine his figure of 6% return on average, though conservative, is allowing for some periods when instead of gaining several thousand every day, your portfolio will lose a similar amount every day.

As has already been mentioned, buying stocks for yield can be self-defeating.
Not much point in getting excited about the yield if the value of your investment is declining, e.g. TEN in the past year, TLS and others.

If we all had more confidence in financial planners, I'd suggest you seek advice from one you feel you can trust re suitable income stream/tax implications etc.

Sorry not to be more helpful - just wouldn't like to see you make irrevocable decisions on the basis of the stock market always performing as it is at present.

Julia