I've completed the consolidation I wrote about yesterday. IFFF, IEER and LTAM are no more. IEEM is welcomed to the portfolio. I've also substantially added to my BDI holding to bring it up to a similar level to MXM and QDG.
My portfolio now looks like this:
GNK: 14.5%
IAPD: 13.6%
IDVY: 12.8%
TSCO: 9.0%
RBS: 8.4%
BDI: 7.8%
IEEM: 7.7%
NXT: 7.5%
ZRX: 7.3%
MXM: 5.4%
QDG: 5.0%
TW: 0.9%
Monday, 24 November 2008
Sunday, 23 November 2008
Consolidation
Due to the vagaries of the market, some of my investments are looking very paltry indeed. In particular, BDI, IFFF, IEER, LTAM and TW are looking very anaemic. I'm going to take a few different approaches:
- Sell IFFF, IEER, LTAM, and instead buy IEEM, a general emerging markets tracker fund. IFFF, IEER, LTAM broadly track IEEM, and I see little point holding three different shares where one will do. Of course the transaction costs are annoying, but better to consolidate earlier rather than later. At least I won't pay stamp duty (since ishares are listed in Ireland). I'll probably top up to the holding to be slightly larger at the same time.
- Invest further in BDI, taking it up to a similar level as QDG, MXM.
- Leave TW alone for now. If they agree more relaxed covenants then it might recover to a more reasonable holding size in short order. If they doesn't, it will be worthless.
Berkshire Hathaway
I'm slightly incredulous, but it appears that Berkshire Hathaway shares are moving into value territory. The B shares traded below $2700 for much of Friday, although they closed at $2900. It's slightly tricky to work out a fair value for Berkshire, but worth having a stab. If you can buy $1 for 80 cents and have it managed by the world's most successful investor for free, then you're doing well.
A and B shares
The Berkshire B shares are worth 1/30 of the economic value of the A shares, but hold 1/200 of the voting rights. A shares can be converted into 30 B shares, but not vice versa. Owing to the lower face value, the B shares are far more liquid.
There are 1.08m A shares and 14m B shares, so an equivalent of 1.55m A shares.
Pots of value
Warren Buffett lays out the basis for his own valuation of Berkshire in his annual report. There are two "pots of value". Firstly investments in stocks, bonds and cash, partly funded by "float" from Berkshire's insurance operation. The second pot of value is Berkshire's wholly owned businesses, which appear on the balance sheet at far below fair value.
At 2007 year-end, Berkshire report $141bn of investments, funded by $59bn of float. This works out to $90343 per share. Pre-tax earnings per share for wholly owned businesses were $4093.
Float
How you calculate the float liability is debatable, but since Berkshire has historically made money on its insurance operation, the float has been better than free. An interest-free loan that never needs to be repaid is worth precisely the value of the loan. An interest-free loan that never needs to be repaid and grows over time is worth even more - but let's be cautious and assume float will remain at approximately $59bn, so simply write this off as a liability when considering value.
Balance sheet
It's important to check out the balance sheet to see whether Berkshire are fibbing about their two pots of value. Shareholder equity is $120bn. Writing off goodwill leaves $87bn. That's roughly what you'd expect from the $141bn of investments minus $59bn of float.
Value calculation
Valuing Berkshire's wholly-owned businesses is a bit tricky, but I'm going to put a pre-tax P/E ratio of 10 on them. That equates to about 15 after tax, reflecting the fact that I think they are largely high return-on-equity, strongly cash-generative, stable, successful businesses with a good moat. I don't think Buffett buys any other sort.
I'll value the investments at their face-value (although we'll need to adjust for the current state of the market) and write off the float as a liability, on the basis that it costs nothing and will not need to be repaid in the foreseeable future.
Before adjusting for 2008's changes in value, that leaves us with a value per-share of $90343 + $40930 = $131273. That's $4375 per B share. At the end of 2007, the actual share price was $141000, so pretty close to fair value. Since 2002 Berkshire has traded within about 10% (plus or minus) my idea of fair value.
Book value multiplier
We may be able to approximate the change in value of Berkshire by the change in book value. In order to study this I've pulled data from their annual reports since 2001. My fair value calculation has been fairly consistent at 1.6 times their book value. That makes a handy proxy for current value.
Equities in 2008
Now we come to the interesting bit. Sticking Berkshire's shares into a Yahoo finance portfolio, I reckon their current value is approximate $50bn, vs. $75bn at the start of the year. So barring any changes to the portfolio, Berkshire is down a massive $25bn so far this year. Crucially, rather a lot of that has come since the end of September, so wasn't reported in the last quarterly report. I'd estimate that around $15bn has been wiped off Berkshire's equity portfolio since the end of September. Their quarterly report estimates $9bn by the end of October, and things have got somewhat worse since then, so that tallies.
Current fair value
Based on the latest estimates share prices, book value per A share is about 67750. Applying the same 1.6 multiplier and extrapolating to the B shares, fair value is about $3610.
Alternatively estimating current investments and assuming no earnings change for wholly-owned companies, fair value is about $3910.
The divergence here is because in one valuation method $15bn is wiped off investments, and counts once, and in the other it is wiped off book value and multiplied by 1.6.
Let's call current fair value $3750 as a compromise.
Desirability of investing in the US market
Despite my calculations suggesting fair value has declined from $4200 to $3750 in the last 2 months, I don't think the "actual" value has changed much. The US market has been overvalued and is only now approaching a reasonable level. In the last year or two I would have looked for a very substantial discount before buying, I'm now prepared to accept a more modest discount. So my buying price has probably changed little - a 30% discount at end-2007 is the same as a 16% discount now.
$3000 is a 20% discount to my current fair value. $2600 is a 30% discount.
To buy or not to buy
Right now I have way too much US$ exposure, so I'm not a buyer yet. But in 1 month my dollar exposure will be halved, and at that point I would definitely be a buyer at $2600, possibly even at $3000.
A and B shares
The Berkshire B shares are worth 1/30 of the economic value of the A shares, but hold 1/200 of the voting rights. A shares can be converted into 30 B shares, but not vice versa. Owing to the lower face value, the B shares are far more liquid.
There are 1.08m A shares and 14m B shares, so an equivalent of 1.55m A shares.
Pots of value
Warren Buffett lays out the basis for his own valuation of Berkshire in his annual report. There are two "pots of value". Firstly investments in stocks, bonds and cash, partly funded by "float" from Berkshire's insurance operation. The second pot of value is Berkshire's wholly owned businesses, which appear on the balance sheet at far below fair value.
At 2007 year-end, Berkshire report $141bn of investments, funded by $59bn of float. This works out to $90343 per share. Pre-tax earnings per share for wholly owned businesses were $4093.
Float
How you calculate the float liability is debatable, but since Berkshire has historically made money on its insurance operation, the float has been better than free. An interest-free loan that never needs to be repaid is worth precisely the value of the loan. An interest-free loan that never needs to be repaid and grows over time is worth even more - but let's be cautious and assume float will remain at approximately $59bn, so simply write this off as a liability when considering value.
Balance sheet
It's important to check out the balance sheet to see whether Berkshire are fibbing about their two pots of value. Shareholder equity is $120bn. Writing off goodwill leaves $87bn. That's roughly what you'd expect from the $141bn of investments minus $59bn of float.
Value calculation
Valuing Berkshire's wholly-owned businesses is a bit tricky, but I'm going to put a pre-tax P/E ratio of 10 on them. That equates to about 15 after tax, reflecting the fact that I think they are largely high return-on-equity, strongly cash-generative, stable, successful businesses with a good moat. I don't think Buffett buys any other sort.
I'll value the investments at their face-value (although we'll need to adjust for the current state of the market) and write off the float as a liability, on the basis that it costs nothing and will not need to be repaid in the foreseeable future.
Before adjusting for 2008's changes in value, that leaves us with a value per-share of $90343 + $40930 = $131273. That's $4375 per B share. At the end of 2007, the actual share price was $141000, so pretty close to fair value. Since 2002 Berkshire has traded within about 10% (plus or minus) my idea of fair value.
Book value multiplier
We may be able to approximate the change in value of Berkshire by the change in book value. In order to study this I've pulled data from their annual reports since 2001. My fair value calculation has been fairly consistent at 1.6 times their book value. That makes a handy proxy for current value.
Equities in 2008
Now we come to the interesting bit. Sticking Berkshire's shares into a Yahoo finance portfolio, I reckon their current value is approximate $50bn, vs. $75bn at the start of the year. So barring any changes to the portfolio, Berkshire is down a massive $25bn so far this year. Crucially, rather a lot of that has come since the end of September, so wasn't reported in the last quarterly report. I'd estimate that around $15bn has been wiped off Berkshire's equity portfolio since the end of September. Their quarterly report estimates $9bn by the end of October, and things have got somewhat worse since then, so that tallies.
Current fair value
Based on the latest estimates share prices, book value per A share is about 67750. Applying the same 1.6 multiplier and extrapolating to the B shares, fair value is about $3610.
Alternatively estimating current investments and assuming no earnings change for wholly-owned companies, fair value is about $3910.
The divergence here is because in one valuation method $15bn is wiped off investments, and counts once, and in the other it is wiped off book value and multiplied by 1.6.
Let's call current fair value $3750 as a compromise.
Desirability of investing in the US market
Despite my calculations suggesting fair value has declined from $4200 to $3750 in the last 2 months, I don't think the "actual" value has changed much. The US market has been overvalued and is only now approaching a reasonable level. In the last year or two I would have looked for a very substantial discount before buying, I'm now prepared to accept a more modest discount. So my buying price has probably changed little - a 30% discount at end-2007 is the same as a 16% discount now.
$3000 is a 20% discount to my current fair value. $2600 is a 30% discount.
To buy or not to buy
Right now I have way too much US$ exposure, so I'm not a buyer yet. But in 1 month my dollar exposure will be halved, and at that point I would definitely be a buyer at $2600, possibly even at $3000.
Tuesday, 18 November 2008
Tesco - further detail
I thought I would post some extra information on the motivation for my purchase of Tesco shares.
Return on equity
The interesting thing about return on equity, or RoE, is as a multiplier on reinvested earnings. If company A earns £100, reinvests it at a RoE of 10%, it could expect (ceteris paribus) to earn £110 the following year. If company B also earns £100 but reinvests it at a RoE of 20%, it could expect to earn £120 the following year. At low rates of RoE, reinvestment becomes uneconomic and the company should logically pay all its earnings out as dividends.
Calculating RoE first requires a reliable figure for earnings. To avoid tax clouding the picture, I assumed tax of 30% and calculated earnings as (Operating Profit - Interest payments) * 0.7.
Inflation clouds the RoE picture by silently increasing the value of assets. The equity figure quoted by the company is therefore too low. To account for this I assumed 3% inflation of Tesco's equity per year from the start of my 14 year period.
With these adjustments, Tesco's RoE figure is remarkably consistent at between 11.5% and 13.5%. It averages 12.2%.
Consistent earnings growth
Tesco's turnover has increased by an average of 13% per year. In only one year out of 14 was it less than 8%. Margin (operating profit divided by turnover) has been consistently between 5 and 6%, averaging 5.6%.
Of course Tesco has operated in a benign retail climate over the last 14 years, but I think we can assume that it will at least weather the storm, if not continue with quite the same stupendous growth record.
Having said that, turnover has tracked inflation-adjusted equity remarkably closely. It has been between 3 and 3.75 times equity every year, averaging 3.29.
Conservative capital structure
For a company pursuing such an extraordinary growth path, Tesco has remained very lightly geared. With such amazingly consistent profitability, it would not be unreasonably for Tesco to gear up to the point of pre-tax earnings covering interest by, say, 3 times. At 6% yield that would suggest a sustainable net debt of £16bn. In fact they operate with only £8bn of debt, offset by £2bn of cash to leave only £6bn net debt.
This extremely conservative capital structure gives Tesco shares a level of security that is rare in today's highly geared market.
Annual return
Tesco pays a dividend of 3.1% on their current share price of 320p. They reinvest a further 5%, generating 7.7% earnings growth (based on RoE of 12.2%). Their earnings increase with inflation, adding 3%. This leaves Tesco generating a total shareholder return of about 13.8%, or 10.8% in real terms.
Numbers schmumbers
Of course, all of this is really just a mathematical parlour game. There is no guarantee that these numbers will hold in the future. On the other hand, I think they're as good a base as any. They've held true very consistently for 14 years. And a return of almost 14% leaves a good margin of safety.
Their tangible assets were about £20bn in February '08 (using their estimate of the value of their property rather than the lower book value). That will have suffered due to lower appetite for commercial property, but even so it leaves a comparatively small valuation in their £25bn market cap for their superb brand.
Downsides
Tesco faces a number of risks. Competition concerns are likely to stifle UK growth to some extent. A prolonged recession would lead to reduced margins and probably a loss of market share. Their global growth is meeting competition from Wal-Mart and others.
The risk with extrapolating from past trends is that you double-count. A fall in Tesco's margins will lead to a corresponding fall in their RoE, their earnings, and their potential for growth. A fall in margin to 3% would leave them with a P/E ratio of 24 and comparatively poor growth prospects. With no growth prospects a P/E ratio of 8 might be more appropriate, and in one fell swoop the shares would lose two thirds of their value.
Conclusion
Clearly, since I just bought a bunch of shares, I'm optimistic. I think Tesco have proved their growth credentials, and I have high hopes for Tesco Personal Finance taking market share from the discredited big banks. Their future growth might not come from ever more UK stores, but it doesn't need to.
Return on equity
The interesting thing about return on equity, or RoE, is as a multiplier on reinvested earnings. If company A earns £100, reinvests it at a RoE of 10%, it could expect (ceteris paribus) to earn £110 the following year. If company B also earns £100 but reinvests it at a RoE of 20%, it could expect to earn £120 the following year. At low rates of RoE, reinvestment becomes uneconomic and the company should logically pay all its earnings out as dividends.
Calculating RoE first requires a reliable figure for earnings. To avoid tax clouding the picture, I assumed tax of 30% and calculated earnings as (Operating Profit - Interest payments) * 0.7.
Inflation clouds the RoE picture by silently increasing the value of assets. The equity figure quoted by the company is therefore too low. To account for this I assumed 3% inflation of Tesco's equity per year from the start of my 14 year period.
With these adjustments, Tesco's RoE figure is remarkably consistent at between 11.5% and 13.5%. It averages 12.2%.
Consistent earnings growth
Tesco's turnover has increased by an average of 13% per year. In only one year out of 14 was it less than 8%. Margin (operating profit divided by turnover) has been consistently between 5 and 6%, averaging 5.6%.
Of course Tesco has operated in a benign retail climate over the last 14 years, but I think we can assume that it will at least weather the storm, if not continue with quite the same stupendous growth record.
Having said that, turnover has tracked inflation-adjusted equity remarkably closely. It has been between 3 and 3.75 times equity every year, averaging 3.29.
Conservative capital structure
For a company pursuing such an extraordinary growth path, Tesco has remained very lightly geared. With such amazingly consistent profitability, it would not be unreasonably for Tesco to gear up to the point of pre-tax earnings covering interest by, say, 3 times. At 6% yield that would suggest a sustainable net debt of £16bn. In fact they operate with only £8bn of debt, offset by £2bn of cash to leave only £6bn net debt.
This extremely conservative capital structure gives Tesco shares a level of security that is rare in today's highly geared market.
Annual return
Tesco pays a dividend of 3.1% on their current share price of 320p. They reinvest a further 5%, generating 7.7% earnings growth (based on RoE of 12.2%). Their earnings increase with inflation, adding 3%. This leaves Tesco generating a total shareholder return of about 13.8%, or 10.8% in real terms.
Numbers schmumbers
Of course, all of this is really just a mathematical parlour game. There is no guarantee that these numbers will hold in the future. On the other hand, I think they're as good a base as any. They've held true very consistently for 14 years. And a return of almost 14% leaves a good margin of safety.
Their tangible assets were about £20bn in February '08 (using their estimate of the value of their property rather than the lower book value). That will have suffered due to lower appetite for commercial property, but even so it leaves a comparatively small valuation in their £25bn market cap for their superb brand.
Downsides
Tesco faces a number of risks. Competition concerns are likely to stifle UK growth to some extent. A prolonged recession would lead to reduced margins and probably a loss of market share. Their global growth is meeting competition from Wal-Mart and others.
The risk with extrapolating from past trends is that you double-count. A fall in Tesco's margins will lead to a corresponding fall in their RoE, their earnings, and their potential for growth. A fall in margin to 3% would leave them with a P/E ratio of 24 and comparatively poor growth prospects. With no growth prospects a P/E ratio of 8 might be more appropriate, and in one fell swoop the shares would lose two thirds of their value.
Conclusion
Clearly, since I just bought a bunch of shares, I'm optimistic. I think Tesco have proved their growth credentials, and I have high hopes for Tesco Personal Finance taking market share from the discredited big banks. Their future growth might not come from ever more UK stores, but it doesn't need to.
Monday, 17 November 2008
Tesco purchase
I spent the weekend pondering Tesco, and studying their financials over the last 14 years. This morning I've made an initial purchase. Tesco now forms approximately 10% of my portfolio.
Briefly, the key points in Tesco's favour are:
Briefly, the key points in Tesco's favour are:
- A return on reinvested earnings of approximately 14%.
- Price/Earnings ratio of 12.
- Extraordinarily consistent profitability.
- Very moderate debt.
The earnings yield is approximately 8%. I think we can expect that to be boosted to about 10% by the superior RoE. We can also expect that to increase with inflation, so that suggests a real rate of return of 10%, nominal 13%.
I think Tesco is in an extremely secure position to weather any short-term downturns, and I think that is an excellent base for its future growth.
Saturday, 15 November 2008
MXM, BDI, QDG
These are the three technology shares that I currently hold. My holding in BDI was small to start with, and has declined about 65%, so it's currently only 1.4% of my portfolio. MXM is down 22% to make 6.8% of the portfolio; QDG is down 26% to 6.6%.
All of these are reliant to some extent on investment spending by UK corporations, and are therefore vulnerable to a recession. But their business models leave them exposed to very different extents.
Looking at their Cash Flow statements is educational. I've picked out the cash flow of the companies below, calculating this as (pre-tax profit + amortization - tax - development). Of course Maxima pursues growth by acquisition, while other companies do more development in-house, so you would expect Maxima to have stronger cash flow. Nonetheless, in a recession Maxima can simply put its acquisition strategy on-hold; it's harder for Bond to sack a bunch of developers.
Maxima
Pre-tax profit: £5208k
Amortization: £3410k
Tax: -£1861k
Development: -£432k
Total: £6325k
Market cap: £27m (at 110p)
Revenue: £46m
Bond
Pre-tax profit: £5250k
Amortization: £1883k
Tax: -£953k
Development: -£2849k
Total: £3331k
Market cap: £15m (at 48p)
Revenue: £30m
Quadnetics
Pre-tax profit: £4394k
Amortization: £160k
Tax: -£1037k
Development: -£1132k
Total: £2385k
Market cap: £19m (at 111p)
Revenue: £79m
Conclusion
Judging by these numbers, Maxima is better-placed to continue generating cash in adverse conditions. It converts about 14% of its revenue into cash, vs 11% for Bond and a mere 3% for Quadnetics. However, Bond came out of this stronger than I had expected. I'm not surprised at Quadnetics' superficially weak numbers, since its business model is fundamentally different.
All of these are reliant to some extent on investment spending by UK corporations, and are therefore vulnerable to a recession. But their business models leave them exposed to very different extents.
Looking at their Cash Flow statements is educational. I've picked out the cash flow of the companies below, calculating this as (pre-tax profit + amortization - tax - development). Of course Maxima pursues growth by acquisition, while other companies do more development in-house, so you would expect Maxima to have stronger cash flow. Nonetheless, in a recession Maxima can simply put its acquisition strategy on-hold; it's harder for Bond to sack a bunch of developers.
Maxima
Pre-tax profit: £5208k
Amortization: £3410k
Tax: -£1861k
Development: -£432k
Total: £6325k
Market cap: £27m (at 110p)
Revenue: £46m
Bond
Pre-tax profit: £5250k
Amortization: £1883k
Tax: -£953k
Development: -£2849k
Total: £3331k
Market cap: £15m (at 48p)
Revenue: £30m
Quadnetics
Pre-tax profit: £4394k
Amortization: £160k
Tax: -£1037k
Development: -£1132k
Total: £2385k
Market cap: £19m (at 111p)
Revenue: £79m
Conclusion
Judging by these numbers, Maxima is better-placed to continue generating cash in adverse conditions. It converts about 14% of its revenue into cash, vs 11% for Bond and a mere 3% for Quadnetics. However, Bond came out of this stronger than I had expected. I'm not surprised at Quadnetics' superficially weak numbers, since its business model is fundamentally different.
Tuesday, 11 November 2008
Expectation of stock market returns
I've been thinking about the sort of returns that it is reasonable to expect from investing in the stock market. It's suprisingly easy to come up with a number, subject to a few reasonable assumptions.
Assume that listed corporate profits will remain roughly the same proportion of global GDP. This precludes any dramatic movement of unlisted firms onto the stockmarket, or any permanent systemic change to profit margins.
Assume that the amount of money reinvested by firms remains roughly the same. This means no permanent switch to forever paying higher or lower dividends as a percentage of profit.
Assume that P/E ratios remain roughly constant in the long run. This precludes any general re-rating, e.g. because of permanently higher or lower real interest rates.
Subject to these assumptions, the real return from investing in the stockmarket is (GDP growth + Dividend yield).
There are added complications when investing in the stockmarket of an individual country, since that country's firms may make profits abroad and therefore profits earnt on that country's stockmarket could rise as a proportion of GDP. But I would say the effect of that is likely to be minimal.
So, in the UK we could reasonably expect real returns of 6%, judged on GDP growth of 2.5% and a 3.5% yield. That would be 9% after adjusting for 3% inflation - better than a savings account, anyway.
Assume that listed corporate profits will remain roughly the same proportion of global GDP. This precludes any dramatic movement of unlisted firms onto the stockmarket, or any permanent systemic change to profit margins.
Assume that the amount of money reinvested by firms remains roughly the same. This means no permanent switch to forever paying higher or lower dividends as a percentage of profit.
Assume that P/E ratios remain roughly constant in the long run. This precludes any general re-rating, e.g. because of permanently higher or lower real interest rates.
Subject to these assumptions, the real return from investing in the stockmarket is (GDP growth + Dividend yield).
There are added complications when investing in the stockmarket of an individual country, since that country's firms may make profits abroad and therefore profits earnt on that country's stockmarket could rise as a proportion of GDP. But I would say the effect of that is likely to be minimal.
So, in the UK we could reasonably expect real returns of 6%, judged on GDP growth of 2.5% and a 3.5% yield. That would be 9% after adjusting for 3% inflation - better than a savings account, anyway.
Saturday, 8 November 2008
Bond
Bond's shares have fallen heavily since I bought. Are they a screaming bargain?
Current share price: 49.5p
Market cap: £16.3m
Yield: 3.2% (1.6p per share)
2007 EPS: 11.4p
H12008 EPS: 3.1p
2007 EBITDA: 21p
H12008 EBITDA: 8.2p
Net tangible assets: £0m
Net debt: £0m
Almost two thirds of revenue comes from recruitment software, which companies may not be keen to invest in during a recession.
Almost half of their revenue is recurring revenue, which should hold up reasonably well.
But let's take a look at their cash flow. Basically, they don't have any. Their operating profit goes straight into development expenses. They may find it unpalatable to lay off development teams during a recession, so essentially you could roll these into costs and see them as an unprofitable company.
Assuming they're reasonably accurate about the capitalized value of the products they are developing, I suppose we're left to conclude that they are a genuinely profitable company, but are not going to create growth without investment. Their Return on Equity is about 10%, which is not stellar.
Assuming Bond reinvested earnings of 10p per share generate future EPS of 1p, that gives them EPS growth of about 9%. Added to their dividend yield of 3.2%, that means a total shareholder return of about 12%. Which is pretty good, although not jaw-dropping.
Maxima's ROE is also about 10%. Their dividend is 5.7%. Their retained earnings should drive growth at about 6%. So their total shareholder return is also about 12%. So at these prices Bond and Maxima are similar in value.
Current share price: 49.5p
Market cap: £16.3m
Yield: 3.2% (1.6p per share)
2007 EPS: 11.4p
H12008 EPS: 3.1p
2007 EBITDA: 21p
H12008 EBITDA: 8.2p
Net tangible assets: £0m
Net debt: £0m
Almost two thirds of revenue comes from recruitment software, which companies may not be keen to invest in during a recession.
Almost half of their revenue is recurring revenue, which should hold up reasonably well.
But let's take a look at their cash flow. Basically, they don't have any. Their operating profit goes straight into development expenses. They may find it unpalatable to lay off development teams during a recession, so essentially you could roll these into costs and see them as an unprofitable company.
Assuming they're reasonably accurate about the capitalized value of the products they are developing, I suppose we're left to conclude that they are a genuinely profitable company, but are not going to create growth without investment. Their Return on Equity is about 10%, which is not stellar.
Assuming Bond reinvested earnings of 10p per share generate future EPS of 1p, that gives them EPS growth of about 9%. Added to their dividend yield of 3.2%, that means a total shareholder return of about 12%. Which is pretty good, although not jaw-dropping.
Maxima's ROE is also about 10%. Their dividend is 5.7%. Their retained earnings should drive growth at about 6%. So their total shareholder return is also about 12%. So at these prices Bond and Maxima are similar in value.
Wednesday, 5 November 2008
RBS prospectus
I've been scrutinising the RBS prospectus for its placing and open offer, and trying to decide whether (and to what extent) to participate.
I don't think it's possible to simply read a bank's financial statements and come to a positive or negative conclusion, but thinking laterally may prove enlightening. So what conclusions can we come to?
Stephen Hester has hinted strongly that RBS may make a full-year loss, although I think he may be setting expectations low so that he can pull a trivial profit out of a hat to great acclaim. Let's assume they break even.
So - after possibly the greatest financial crisis the world has seen, RBS has one lean year. RBS has been forced to raise a lot of capital - but that money has actually boosted RBS's capital, it hasn't been swalled by subprime losses. RBS has successfully funded some massive losses out of profits - RBS was not in danger of running out of capital, but was in danger of running out of cash.
So what's different at the end of this year to the end of last year? RBS will have an 8% core tier 1 ratio. RBS will have access to plenty of liquidity. RBS will have regained the confidence of the financial community (i.e. have lower CDS spreads). Balanced against this, there is clearly a worsening economic climate.
Personally I think a recession can be dealt with. Yes, RBS will face problems from commercial property loan default, counterparty failure, sovereign debt default, further writedown in asset-backed securities, leveraged-loan default and rising impairments. But the recent changes to IAS 39 allow RBS to reclassify loans out of the held-for-trading category, which allows it to take losses as they come, rather than all at once. Hopefully RBS can continue to trade profitably, and cover writedowns out of profits rather than taking substantial hits to capital.
There's an interesting article at FT Alphaville that takes the opposite view:
http://ftalphaville.ft.com/blog/2008/11/04/17780/the-royally-rendered-bank-of-scotland/
I agree it's quite scary. But I think they're being a little bit one-sided.
I don't think it's possible to simply read a bank's financial statements and come to a positive or negative conclusion, but thinking laterally may prove enlightening. So what conclusions can we come to?
Stephen Hester has hinted strongly that RBS may make a full-year loss, although I think he may be setting expectations low so that he can pull a trivial profit out of a hat to great acclaim. Let's assume they break even.
So - after possibly the greatest financial crisis the world has seen, RBS has one lean year. RBS has been forced to raise a lot of capital - but that money has actually boosted RBS's capital, it hasn't been swalled by subprime losses. RBS has successfully funded some massive losses out of profits - RBS was not in danger of running out of capital, but was in danger of running out of cash.
So what's different at the end of this year to the end of last year? RBS will have an 8% core tier 1 ratio. RBS will have access to plenty of liquidity. RBS will have regained the confidence of the financial community (i.e. have lower CDS spreads). Balanced against this, there is clearly a worsening economic climate.
Personally I think a recession can be dealt with. Yes, RBS will face problems from commercial property loan default, counterparty failure, sovereign debt default, further writedown in asset-backed securities, leveraged-loan default and rising impairments. But the recent changes to IAS 39 allow RBS to reclassify loans out of the held-for-trading category, which allows it to take losses as they come, rather than all at once. Hopefully RBS can continue to trade profitably, and cover writedowns out of profits rather than taking substantial hits to capital.
There's an interesting article at FT Alphaville that takes the opposite view:
http://ftalphaville.ft.com/blog/2008/11/04/17780/the-royally-rendered-bank-of-scotland/
I agree it's quite scary. But I think they're being a little bit one-sided.
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