Download Excel PDF
Now that we’ve gone through the first three steps of my stock analysis process our next job is to put the numbers together, compare & analyze the data and then determine a valuation that represents a fair value (per share) that as a shareholder we would be willing to pay.
On page 81 of IGM’s annual report I pointed to a ten-year summary of financial data. Remember that we’re keeping things simple in this exercise and as an investor you can choose how far back you want to go into the financial history of a company and what information you want to use in your analysis. For IGM I have data in a spreadsheet dating back as far as 1988, but right now I’ll simply share the past ten years for readers to get a reasonable sense of what we’re looking at.
To highlight the spreadsheet these are the 10 year averages for the following data:
ROE: 21.5%
Yield: 2.82%
Payout: 50.83%
P/E: 18.8x
P/B: 3.17
BV Growth: 10%
Div Growth: 18.8%
Now what I want to do is compare the historical numbers we’ve gathered to IGM’s current numbers to gain a sense of its relative value at today’s price (is it more expensive or cheaper than in the past). For sake of this exercise I’ll set the current share price at $38 which is the price I paid for more shares that I bought on July 14th, 2008.
Current Data:
ROE: 22%
Yield: 5.1%
Payout: 58.6%
P/E: <11x>
P/B: 2.4x
We can see that IGM is currently trading above its historical dividend yield of 2.82%, below its average P/E of 18.8x, the payout of dividends is slightly higher at 58.6% and P/B is well below the 10-year average of 3.17x.
What does this give us for a relative valuation? Is IGM is a buy, sell or hold? At what price would IGM be a good investment?
There are multiple ways to determine valuations on stocks and some investors simply buy good companies when they have the cash available. In your process of learning to invest you should practice a few techniques to give you a sense of what valuation method you find easiest to understand and implement. In my Value Portfolio for instance I use a combination of various techniques to contrast valuations on a stock to give me better insight into its fair value. As a value investor I look for a specific margin of safety in a stock price before I make a purchase in an attempt to minimize my exposure to potential losses.
If you haven’t read a post before on why I use a margin of safety (MoS), the basic principle behind the idea is to buffer your investment with a built in safety net. I can’t be right 100% of the time in my stock analysis and a MoS is the difference between the intrinsic value of an investment and the market price. Intrinsic value differs from book value in a big way and I’ll try to explain.
Intrinsic value is usually defined as either the present value of all net future cashflows of a company or the value of a business based on the underlying value of the company (both tangible and intangible assets). That means that I’m looking to calculate the future value of a businesses’ ability to generate future cash and earnings and its present value of operations with a discount built into my purchase price.
When we look at book value we’re determining the value of a company’s net assets, but intrinsic value looks at how much the entire operating business will be worth at some point in the future. If Company ABC has a book value of $5 per share for its net assets, calculating the intrinsic value helps you to get a sense of what the rest of the business is worth. In a company such as IGM their P/B is much higher than stocks in other sectors because their business doesn’t require a massive capital investment into assets to generate returns. The book value of the company might be worth $16, but the intrinsic value (the rest of the business and future cashflow/earnings) is worth much more and that’s how IGM trades at a higher P/B than other companies.
A margin of safety (MoS) is my attempt to mitigate risk in stock analysis and concentrate on one of my foremost objectives when investing: preservation of capital. I don’t like losing money. No investor can bat .500 all the time and a margin of safety helps to protect an investor from making a poor decision on an investment. I have to consider that through all my analysis there is the possibility that I missed something fundamental that holds the potential to send an investment down 20%. I might feel the fair value of IGM is $50 per share, but the market could trade it down to $38. A MoS gives me a range of movement in the stock price that I feel comfortable holding a stock through over a period of time. This is also called the discount rate and investors use it in a discounted cashflow analysis (DCF).
For my dividend growth portfolio (DivG) I use a dividend discount model (similar to a DCF).
Now that we’ve gone through the first three steps of my stock analysis process our next job is to put the numbers together, compare & analyze the data and then determine a valuation that represents a fair value (per share) that as a shareholder we would be willing to pay.
On page 81 of IGM’s annual report I pointed to a ten-year summary of financial data. Remember that we’re keeping things simple in this exercise and as an investor you can choose how far back you want to go into the financial history of a company and what information you want to use in your analysis. For IGM I have data in a spreadsheet dating back as far as 1988, but right now I’ll simply share the past ten years for readers to get a reasonable sense of what we’re looking at.
To highlight the spreadsheet these are the 10 year averages for the following data:
ROE: 21.5%
Yield: 2.82%
Payout: 50.83%
P/E: 18.8x
P/B: 3.17
BV Growth: 10%
Div Growth: 18.8%
Now what I want to do is compare the historical numbers we’ve gathered to IGM’s current numbers to gain a sense of its relative value at today’s price (is it more expensive or cheaper than in the past). For sake of this exercise I’ll set the current share price at $38 which is the price I paid for more shares that I bought on July 14th, 2008.
Current Data:
ROE: 22%
Yield: 5.1%
Payout: 58.6%
P/E: <11x>
P/B: 2.4x
We can see that IGM is currently trading above its historical dividend yield of 2.82%, below its average P/E of 18.8x, the payout of dividends is slightly higher at 58.6% and P/B is well below the 10-year average of 3.17x.
What does this give us for a relative valuation? Is IGM is a buy, sell or hold? At what price would IGM be a good investment?
There are multiple ways to determine valuations on stocks and some investors simply buy good companies when they have the cash available. In your process of learning to invest you should practice a few techniques to give you a sense of what valuation method you find easiest to understand and implement. In my Value Portfolio for instance I use a combination of various techniques to contrast valuations on a stock to give me better insight into its fair value. As a value investor I look for a specific margin of safety in a stock price before I make a purchase in an attempt to minimize my exposure to potential losses.
If you haven’t read a post before on why I use a margin of safety (MoS), the basic principle behind the idea is to buffer your investment with a built in safety net. I can’t be right 100% of the time in my stock analysis and a MoS is the difference between the intrinsic value of an investment and the market price. Intrinsic value differs from book value in a big way and I’ll try to explain.
Intrinsic value is usually defined as either the present value of all net future cashflows of a company or the value of a business based on the underlying value of the company (both tangible and intangible assets). That means that I’m looking to calculate the future value of a businesses’ ability to generate future cash and earnings and its present value of operations with a discount built into my purchase price.
When we look at book value we’re determining the value of a company’s net assets, but intrinsic value looks at how much the entire operating business will be worth at some point in the future. If Company ABC has a book value of $5 per share for its net assets, calculating the intrinsic value helps you to get a sense of what the rest of the business is worth. In a company such as IGM their P/B is much higher than stocks in other sectors because their business doesn’t require a massive capital investment into assets to generate returns. The book value of the company might be worth $16, but the intrinsic value (the rest of the business and future cashflow/earnings) is worth much more and that’s how IGM trades at a higher P/B than other companies.
A margin of safety (MoS) is my attempt to mitigate risk in stock analysis and concentrate on one of my foremost objectives when investing: preservation of capital. I don’t like losing money. No investor can bat .500 all the time and a margin of safety helps to protect an investor from making a poor decision on an investment. I have to consider that through all my analysis there is the possibility that I missed something fundamental that holds the potential to send an investment down 20%. I might feel the fair value of IGM is $50 per share, but the market could trade it down to $38. A MoS gives me a range of movement in the stock price that I feel comfortable holding a stock through over a period of time. This is also called the discount rate and investors use it in a discounted cashflow analysis (DCF).
For my dividend growth portfolio (DivG) I use a dividend discount model (similar to a DCF).
Go to http://www.gummy-stuff.org/dividend-discount.htm and scroll down until you see the following picture.
You’ll need to clear the numbers in the calculator so we can input the new information we have for IGM. We’ll enter the current dividend of $1.95 per share, current EPS of $3.33 and enter 5 for the number of years (N). (N) is the minimum time frame that I intend to hold shares in a company for this specific portfolio. This leaves us with three remaining spots.
For the Estimate P/E Ratio (in N years) we could use a wide range of numbers and this is the drawback to this model of determining a valuation since its completely subjective. The numbers you use will directly impact the fair value estimate of an investment and you need to be careful what you choose. As a value investor I tend to be conservative. If stock A is trading at a P/E of 15x and stock B is trading at 20x then this tells me that investors in the market are willing to pay more for stock B’s current earnings based on a variety of factors. For IGM we have a 10-year P/E of 18.8x but we need to put that in some sort of context.
Look back to the spreadsheet through the period of 1998-2001 and what do you notice about the P/E for IGM during that time? We have a P/E ranging from nearly 30x to 18.4x earnings. Over a long period of time (say 25 years) these numbers will be smoothed out into an average, but by only looking at 10 years of data we’re only getting a brief glimpse of what has happened in IGM’s past. What if that period for IGM was of very high growth and the market was willing to pay a higher P/E, but now that growth has normalized investors might be willing to pay much less. The 5-year P/E is only 16.4 in contrast to 18.8 for the 10-year. That’s a big difference. If IGM’s EPS for this year was $3.33 that means the stock could reasonably trade between $54.61 to $62.61. When determining inputs I always try to be as conservative as possible and would rather shoot too low than too high due to my priority of preserving my capital when I invest. To be more conservative I’ll enter a P/E of 15.
The Discount Rate I’ve already explained, but each investor has to determine what margin of safety they want to build into their valuation model to represent what amount of risk they are willing to take. Some investors use 5%, others might use 50%. I like to use 25% as my benchmark because of my conservative stance as an investor. We’ll enter 25 into that space.
Because we’re attempting to determine the value of a stock today for where it will be in the future, the Earnings Growth Rate is very important. A growth rate isn’t an arbitrary number that you input for each and every stock; it will depend on the individual company, sector, economic environment and historical ability of a company to achieve results. There are a number of growth rates that an investor can use that include items such as EPS growth or revenue growth. Let’s remember back to my discussion on ROE and BV Growth though. I consider both of these to be very important in my analysis because of what they both demonstrate to me as an investor in a company. I have a value bias and I don’t want to over pay for something that is realistically only worth so much. If I can determine a way to combine both ROE and BV growth together then that represents one of the best available options for determining a growth rate that I can assess for a company.
How I do this:
I’ll first disclose that this wasn’t something I came up with on my own. One of my investing mentors explained this idea to me some time ago and I found that it made sense to me and was something that fit well into my investing discipline. The first step is to determine the long-term BV growth of the company which for IGM is 10%. Next I take ROE (21.5) and divide it by the current price to book of the company (2.4). The reason I divide ROE by the current P/B is because the price to book gives me an indication of how expensive it would be to replace the net assets of a company. If a company had to settle all its liabilities and was left with only tangible assets, then what return (ROE) would I get if I invested equity into the stock? When I take the BV growth of 10% and add in the ROE adjustment I get 18.95% for my growth rate. Notice if I had simply added 10% (BVG) and 21.5% (ROE) I would have gotten 31.5%. Adjusting ROE for the P/B of the company again gives me a conservative stance for growth of the company that protects my downside to an investment. On an absolute basis the company can return just under 19% to me as a shareholder over the years that I intend to hold the stock.
Now enter 18.95 into the calculator for the growth rate and we’re ready to press the magic button.
Notice that I didn’t use the growth of the dividend in any of my analysis. The reason for this is because I view dividends as excess gains from a company that they place in my hands for my own use. Since those assets aren’t reinvested by management into the company on their own and I may not reinvest them myself into more shares of the specific company I don’t want to skew the growth rate. If you reinvested all the dividends back into the company (DRIP or SPP) then you can adjust the growth rate accordingly to your own preference.
When we hit CALCULATE we get a current fair value of $47.83 for a share of IGM and with the stock trading at $38/share we get a discount of 20.6%. Next you can add in a consideration of how the dividend has grown over recent years and components of your situational analysis and you get a good sense of how under/overvalued the stock currently is. Based on your research, are you willing to buy this stock when it’s undervalued nearly 21%? What if their top competitors were trading at 25-30% discounts? These are questions only you as an investor can answer and part of the puzzle of stock analysis.
Clearly I believe that IGM is a good long-term investment at today’s prices largely because I’ve done my research, have confidence in my process and I know from my situational analysis that IGM does three things very well:
It sells mutual funds
It generates increasing fees
It grows its business
I like the company because the fundamentals are very simple and easy to understand. The company sells actively managed mutual funds and financial products to individuals who don’t have the time, the expertise or desire to manage their money themselves and are willing to pay the premium fees for this service. The company charges these fees, grows its business through acquisitions and only recently slipped to second in market share after RBC bought PH&N to increase their total assets under management.
Demographics favour the industry for the simple fact that baby boomers and retirees are becoming increasingly active in their lifestyles and they don’t have the time, desire or knowledge to manage their investments individually. Retirement assets, proceeds from the sale of property & assets and increases in individual wealth all need to be invested to generate returns or income to support the lifestyles of retirees.
IGM is a company with dominate market share in a competitive environment providing a historical growth rate in excess of 18% to its investors and growing a dividend in excess of 18% historically. It currently has over a 5% yield, low P/E and trades in sympathy with the cyclicality of the economic environment. This is usually a stock you don’t want to buy in a high market because of its relatively high P/E, but a great stock to purchase when the market is down. Add in competent management with consistent ROE over 20% and financial assets available through Power for future acquisitions and you have a company that returns value to its shareholders consistently over time.
(Disclosure: I hold common shares in IGM, RBC, TD, DW, MFC, SLF, BNS & indirectly to GWO & CM)
For the Estimate P/E Ratio (in N years) we could use a wide range of numbers and this is the drawback to this model of determining a valuation since its completely subjective. The numbers you use will directly impact the fair value estimate of an investment and you need to be careful what you choose. As a value investor I tend to be conservative. If stock A is trading at a P/E of 15x and stock B is trading at 20x then this tells me that investors in the market are willing to pay more for stock B’s current earnings based on a variety of factors. For IGM we have a 10-year P/E of 18.8x but we need to put that in some sort of context.
Look back to the spreadsheet through the period of 1998-2001 and what do you notice about the P/E for IGM during that time? We have a P/E ranging from nearly 30x to 18.4x earnings. Over a long period of time (say 25 years) these numbers will be smoothed out into an average, but by only looking at 10 years of data we’re only getting a brief glimpse of what has happened in IGM’s past. What if that period for IGM was of very high growth and the market was willing to pay a higher P/E, but now that growth has normalized investors might be willing to pay much less. The 5-year P/E is only 16.4 in contrast to 18.8 for the 10-year. That’s a big difference. If IGM’s EPS for this year was $3.33 that means the stock could reasonably trade between $54.61 to $62.61. When determining inputs I always try to be as conservative as possible and would rather shoot too low than too high due to my priority of preserving my capital when I invest. To be more conservative I’ll enter a P/E of 15.
The Discount Rate I’ve already explained, but each investor has to determine what margin of safety they want to build into their valuation model to represent what amount of risk they are willing to take. Some investors use 5%, others might use 50%. I like to use 25% as my benchmark because of my conservative stance as an investor. We’ll enter 25 into that space.
Because we’re attempting to determine the value of a stock today for where it will be in the future, the Earnings Growth Rate is very important. A growth rate isn’t an arbitrary number that you input for each and every stock; it will depend on the individual company, sector, economic environment and historical ability of a company to achieve results. There are a number of growth rates that an investor can use that include items such as EPS growth or revenue growth. Let’s remember back to my discussion on ROE and BV Growth though. I consider both of these to be very important in my analysis because of what they both demonstrate to me as an investor in a company. I have a value bias and I don’t want to over pay for something that is realistically only worth so much. If I can determine a way to combine both ROE and BV growth together then that represents one of the best available options for determining a growth rate that I can assess for a company.
How I do this:
I’ll first disclose that this wasn’t something I came up with on my own. One of my investing mentors explained this idea to me some time ago and I found that it made sense to me and was something that fit well into my investing discipline. The first step is to determine the long-term BV growth of the company which for IGM is 10%. Next I take ROE (21.5) and divide it by the current price to book of the company (2.4). The reason I divide ROE by the current P/B is because the price to book gives me an indication of how expensive it would be to replace the net assets of a company. If a company had to settle all its liabilities and was left with only tangible assets, then what return (ROE) would I get if I invested equity into the stock? When I take the BV growth of 10% and add in the ROE adjustment I get 18.95% for my growth rate. Notice if I had simply added 10% (BVG) and 21.5% (ROE) I would have gotten 31.5%. Adjusting ROE for the P/B of the company again gives me a conservative stance for growth of the company that protects my downside to an investment. On an absolute basis the company can return just under 19% to me as a shareholder over the years that I intend to hold the stock.
Now enter 18.95 into the calculator for the growth rate and we’re ready to press the magic button.
Notice that I didn’t use the growth of the dividend in any of my analysis. The reason for this is because I view dividends as excess gains from a company that they place in my hands for my own use. Since those assets aren’t reinvested by management into the company on their own and I may not reinvest them myself into more shares of the specific company I don’t want to skew the growth rate. If you reinvested all the dividends back into the company (DRIP or SPP) then you can adjust the growth rate accordingly to your own preference.
When we hit CALCULATE we get a current fair value of $47.83 for a share of IGM and with the stock trading at $38/share we get a discount of 20.6%. Next you can add in a consideration of how the dividend has grown over recent years and components of your situational analysis and you get a good sense of how under/overvalued the stock currently is. Based on your research, are you willing to buy this stock when it’s undervalued nearly 21%? What if their top competitors were trading at 25-30% discounts? These are questions only you as an investor can answer and part of the puzzle of stock analysis.
Clearly I believe that IGM is a good long-term investment at today’s prices largely because I’ve done my research, have confidence in my process and I know from my situational analysis that IGM does three things very well:
It sells mutual funds
It generates increasing fees
It grows its business
I like the company because the fundamentals are very simple and easy to understand. The company sells actively managed mutual funds and financial products to individuals who don’t have the time, the expertise or desire to manage their money themselves and are willing to pay the premium fees for this service. The company charges these fees, grows its business through acquisitions and only recently slipped to second in market share after RBC bought PH&N to increase their total assets under management.
Demographics favour the industry for the simple fact that baby boomers and retirees are becoming increasingly active in their lifestyles and they don’t have the time, desire or knowledge to manage their investments individually. Retirement assets, proceeds from the sale of property & assets and increases in individual wealth all need to be invested to generate returns or income to support the lifestyles of retirees.
IGM is a company with dominate market share in a competitive environment providing a historical growth rate in excess of 18% to its investors and growing a dividend in excess of 18% historically. It currently has over a 5% yield, low P/E and trades in sympathy with the cyclicality of the economic environment. This is usually a stock you don’t want to buy in a high market because of its relatively high P/E, but a great stock to purchase when the market is down. Add in competent management with consistent ROE over 20% and financial assets available through Power for future acquisitions and you have a company that returns value to its shareholders consistently over time.
See Also:
Part I:
Part II:
Part III:
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11 comments:
It is hard to find fault with IGM as an investment when the market is really negative.
Wonderful job of committing to text the process of fully researching a stock. My first reaction is that it probably took you longer to compose and publish this series of articles than it does to perform the actual due dilligence on a company from the first time you begin to take a look at it. Well done!
Thanks you two!!
It was very long process & took a few revisions to complete.
Hopefully more than a few new investors now have some better insight into what DD really means and how much time they should be taking in their analysis rather than just depending on analyst reviews.
This was obviously a very basic outline of my approach, but it should work as a useful tool and starting point for someone to add in their own preferences or changes
Brad:
Appreciate the lessons!
thanks,
RickT
How did you put together your book value numbers from the annual report? What other tools did you use?
I determine the tangible book value per share of a company (whether supplied on the annual report or not) for each company that I analyze. Tangible book value is what shareholders of the company can expect to receive if the company were to go bankrupt and takes out items such as goodwill that no one buys when assets are liquidated. Other information not supplied in the annual reports I do the old fashioned way: with a pen, paper & old accounting textbook/worksheet.
OK thanks. I noticed the figures for shareholder' equity of 4.2 billion for 2007 and 3.8 billion for 2006 in the report and later 4,162,983,000 3,817.673,000 (on PDF page 55 I think) but they weren't on the 10 year summary. Since 262.43 million outstanding shares times your figure of 14.41 BV/Share comes to 3781.61 (for 2006) and 262.43*15.76=4135.89 (for 2007) so I thought you might be using those rough estimate sorts of numbers.
Since you're in health care what do you think of Stryker ... not a dividend monster by any means but maybe some upside soon ? :)
Cheers and great site.
Can you explain the following section in a little more detail?
"Next I take ROE (21.5) and divide it by the current price to book of the company (2.4). The reason I divide ROE by the current P/B is because the price to book gives me an indication of how expensive it would be to replace the net assets of a company."
I just can't seem to make sense of your explaination (I'm a noob). To me it seems like you are taking the ROE - typically the ratio of net income to shareholder equity - and modifying it to take into account the current stock price (your invested equity). This is because when you buy shares the price you pay (equity invested) is typically different than the equity (book value) you are purchasing. You want to know the return on your invested equity.
Am I making any sense here? I know I've butchered it, but hopefully you can get the gist of what I'm saying.
ROE is my return on the equity I invest in a company and therefore a very important factor in the growth rate I want to calculate for a company. The problem that arises is that ROE can't be easily linked to the premium/discount of the bookvalue of the company. Since book value growth, as a value investor, is another of my top priorities what I'm trying to do with ROE is take out any premium in the market price of the stock (P/B) that would scew my numbers wildly in one direction.
When I divided ROE by the current P/B I am taking out any premium on the book value of the company so that when I add in historical book value growth I don't end up with a number that is drastically inflated. This methods gives me a conservative growth rate of the company for the market price I pay today and what return I can likely expect for this company based on its historical trends.
Does that help?
What do you think of recent downgrade by Dundee? Does IGM have sustainable competitive advantage? Despite their charge on their stake in GWO's big losses they still made 141 million in Q4 selling financial products in this market so I think they are doing something right. The Dundee rating seems like sour grapes since they have themselves racked up losses for 3 of 4 last Qs I think ....
26$ seems like a pretty awesome price fora piece of IGM: ust wondered if you were still as committed to the company given updates to the situational analsysis.
Anon - I don't pay too much attention to analyst recommendations usually because it's a sold opinion (conflict of interest) and nearly always late to the actions of the stock. Stating concerns about a company after it's already fallen to a 52 week low doesn't seem like excellent foresight if you catch my drift.
$26 is still under my revised target price and the fundamentals of the company haven't changed. This is a stock you want to buy in a down market because in an up market the premium valuation is almost always hard to swallow. They charge the highest fees in the industry, but most investors are too naive to know where to find them all or at what cost "advice" comes at. Fund redemptions are more reflective of the market sentiment then customer discontent with their products/services IMO.
I am still as committed to the company as I was before, but it won't ever represent more than 5% of my CDN Dividend Portfolio (DivG) because of the individual risk associated with any company. As part of a diversified portfolio I believe it has a place and will do well over my intended holding period of 10-15 years.
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