MEG Stock Review: Why I Invested In Megaworld Corporation?
What makes stock market investing enjoyable for me is the job of valuing a company myself I’m interested in investing with.
Back then I don’t know anything about financial statements. If you’ll ask me to interpret a financial statement, I will be at a total loss.
But if you’ll ask me to design and build a structure’s electrical system, I can do it, and I’m good at it.But interpreting it isn’t that hard as I expected. I just read a book about Warren Buffet’s investing principles, applied it and now I feel that I’m more than confident enough to trust my own valuation rather than totally relying on an experts stock picks.
What I do is that I value a company myself then compare it to COL’s Investment Guide then I make a decision to buy it or not.Starting today, I’ll share how I do it.
I’m not an expert on these stuff. I’m just some guy starting out applying Warren Buffet’s investing principles so there might be errors which I’ll try to improve on the coming days.
So to begin, I’ll start from the first company I invested in, Megaworld Corporation (MEG). Let’s see if MEG has a durable competitive advantage.
First of all, check the Revenue, Net Income, Retained Earnings, Inventory and Cash & Short Term Investments. Make sure that the figures are increasing in value every year. If not, then there’s no point in continuing through.
Historical Data (in Mil of PHP)
Cash & Short-Term Investments
In this example, you can see that all of the figures are increasing in value every year. This means that there is some kind of durable advantage working in the company’s favor. The Cash & Short Term Investments is erratic but it’s fine as long as it doesn’t show a consistent decline in value. The figures above tells me that these are good signs of a company that I should invest with in the long term.
Now let’s see the income statement and let’s compute and evaluate the ratios below;
Income Statement Ratios
Gross profit margin
SG&A to gross profit
R&D to operating income
D&A to gross profit
Interest expense to operating income
Net income to total revenue
Take note of this pointers:
- Gross Profit Margin greater than 40% is best. Avoid companies with less than 20%.
- SGA to Gross Profit less than 30% is best. Avoid anything higher than that.
- The lower the R&D to Operating Income ratio, the better.
- The lower the Depreciation to Gross Profit ratio, the better.
- Interest Expense to Operating Income lower than 15% is best.
- Net Income to Total Revenue of greater than 20% is best. Avoid anything lower than 20%. An exception to this are banks and financial companies since they are sometimes highly leveraged institutions.
As you can see, MEG passed all these indicators of a company with a durable competitive advantage. All the figures on the chart passed all the indicators above.
Now let’s see the Earnings Per Share or EPS.
Earnings Per Share
EPS should be on a constant upward trend. As you can see, it slightly dipped on 2012 but all in all it shows a continuous upward trend so that’s good.
Now let’s see the balance sheet and evaluate the ratios below.
Balance Sheet Ratios
Receivables to gross profit
Return on assets
True return on equity
Return on equity
Take note of this pointers:
- The lower the Total Receivables to Gross Profit, the better.
- Current Ratio of greater than 100% is best.
- Net Income to Total Assets must be high.
- True Return to Equity of greater than 20% is best.
Total Receivables to Gross Profit shows a high percentage but it eventually goes to a downtrend so we can expect a lower percentage for the next couple of years if this continues.
The Current Ratio is good but the Net Income to Total Assets and True Return on Equity shows a low percentage but that’s still okay because all other indicators passed the minimum thresholds. In conclusion, MEG still passed this evaluation.
Now for the Cash flow Statement, we only need to evaluate the Net Income to Capital Expenditures for a 5-yr period. We are looking for a percentage lower than 25% or if it goes above 25%, it should not be greater than 50%. In MEG’s case, it’s 49% so it’s good.
We also need to look into the Issuance (Retirement) of Stock, Net. If you see negative figures on this column, it means that the company is buying back its shares and that is a good sign.
Now if the company is proven to have a durable competitive advantage based on the financial indicators above, then it’s time to know if the price of the stock is undervalued or not. We use the Equity Bond Theory.
We now compute for the %Rate of Return to know if it’s undervalued or not. A %RoR of greater than 10% is what we are looking for.
Assuming stock closing price of 4.85 Php today and a 5-Yr Gov’t bond yield of 3.8717%;
%RoR = (Net Income / Market Capitalization) x 100
%RoR = (21,220,000,000.00 / 156,324,468,853) x 100
%RoR = 13.57%
With this percentage, we now conclude that MEG is a much better investment if we were to compare it to a gov’t bond today. It is also undervalued because %RoR is greater than 10%.
To put it in a perspective, a stock price of 4.85 Php today can be approximately 9.16 Php five years from now.
So that’s it! It may sound so overwhelming but that’s a good start nonetheless. Definitely for newbies.
Have fun investing!