Thursday, June 21, 2012

Value Indicators: Capital Structure

In this indicator, we want to see long term debt (LTD) including preferred stock be less than 50% of total capitalization.

In Verdasis, set up an analysis template and pull four pieces of financial statement information, all from the balance sheet:
  • Redeemable Preferred Share Stock,
  • Preferred Stock - Non Redeemable, Net,
  • Total Debt,
  • Total Equity.
All items are for the current annual period or Y.

Apply the template to the portfolio and export to the spreadsheet application of your choice.  The formula is:

Where the F and G column are the two preferred stocks line items, H2 is total debt; all of which is divided by the sum that makes up the total capitalization.

The Rating formula is:

 =if(J2<50%, 1, -1)

You can see the spread sheet here.

Thanks for reading, be back early next week.

Monday, June 11, 2012

Value Indicators: Accounting Changes, Discontinued Ops, Extra-Ordinary Items

For this indicator I'm using a new feature in Verdasis called "Fast Exports" where you can down-load entire financial statements into excel. I could have accomplished the same thing with the analysis templates, but I don't know, I felt like shaking things up.  There are so few opportunities to pierce your eye-brow and dye your hair pink, figuratively speaking, when you're doing investment analysis.

The How-To:
1) I took my list of securities that I'm analyzing, the US Integrated Oil & Gas ones, and then clicked open the "fast exports" tab on the left.  I then clicked "Financial Statements (beta)",
2) I entered my first security, PBR into the security field and choose "PBR:NYSE" from the list.  The financial statement is "Income Statement", reporting interval is yearly, I selected all of the available years by choosing the bottom year, holding the "shift" key down, then clicking the top year.
3) Click "OK" when the pop-up window asks if you want to open with Microsoft excel.  Click "enable" on the next box.
4) After clicking in the affirmative on those above mentioned pop-up windows you'll wind up with an excel spreadsheet that will display several years of income statements for the security you entered.
5) Scroll down and see if there are any entries for Accounting Changes, Discontinued Ops or EO Items.  They will be in rows 23, 24 and 25 respectively.

For this indicator, I'm just eye-balling the results, rather than writing an logic equation.  Why? Just faster for the purposes of this blog analysis.  There are advantages to writing the logic equation, number one being that it will always stay up to date.  So for that reason, I probably should, but I'm not.  I won't apologize. 

Ideally, you want to see all zeros from B23 to F25.  This indicator is rather akin to the quality of earning indicator in that it gives you a sense of how much faith you can put into the statements themselves.  These three classifications open up the possibility of abuse as they can mask and manipulate actual results.  Let me give you a couple of examples:
 1) Management decides to reduce the rate at which capital items are amortized.  Now, the reason could be perfectly legitimate - it could be more reflective of what the industry as a whole does or it could be more indicative of their actual consumption.  Or it could be an effort to reduce expenses and pump up earnings.
2) "Unusual" transactions that have a detrimental effect on earnings are classified as extra-ordinary whereas similar type transactions that have a positive effect on earnings are classified as operational.

However, sometimes management should use those categories.  Sometimes accounting changes are mandated by GAAP, sometimes you really do discontinue operations and sometimes there are acts of God.

So, arbitrarily, I make the following rules:

The company can earn a rating of one if all of the following are true:
  • The company records one or zero items in the past three years,
  • The company records one or zeros items in years Y-3 or Y-5,
  • The company records no more than two items is years > Y-6.
The company can earn a rating of zero if the following is true:
  • The company records two items in the past three years,
  • The company records two items in the years Y-3 to Y-5,
  • The company records no more than three items in years > Y-6.
If everything is false, then the company earns a rating of -1.

To see the spreadsheet click here.

Saturday, June 9, 2012

Value Indicators:  Growth in Cash Flow from Operations

As a bit of background to financial statement analysis, let me share a truth: profit is an accounting construct and cash is king.

I have an accounting background and tremendous respect for its symmetry.  I love the way the transactions get captured and each of the three statements flow into one another.  Its development, without a doubt, was inspired genius.  But it has weaknesses.  A lot of them stem from the rule framework (GAAP) that has developed in the past one hundred years or so.

GAAP offers discretion in certain policy choices that ultimately effect the number that we call "net income" or "profit" or "earnings".  Cash on the other hand is much more independent, much harder to manipulate.  In the Statement of Cash Flows, the movement of cash is separated into three areas: Cash from Operations, Cash from Financing and Cash from Investment.

Growth in cash from operations is indicative of how well the company is managing its operations and creating value.

According to Mr. Graham, we want to see growth of 6 to 7% per year.

To execute this analysis, build an analysis template in Verdant by selecting Cash Flow from Operations Activities for each of Y, Y-1, Y-2, Y-3 etc.

Go back into portfolios and choose US Integrated Oil & Gas.  Click the "Analyze" button and select the appropriate template.  Export to Google.  Once in Google build several growth equations.  We want to see the growth year over year, for example the growth in Y over Y-1.  The equation is


Where F2 is CFO in the current year G2 is CFO in the prior year.

There are different ways to determine the growth of 6 or 7% per year.  For expediency, I just took an average with this equation:

I then wrote two "if" equations.  One to give a rating of 1 if the average was greater than 7%, zero if not and the other to give a rating of -1 if the average was less than zero, zero if otherwise.  Here they are respectively:


Q2 is the average that was calculated above.

The final step is to sum the two ratings to get a final rating:

 That is it for this indicator!  To see the whole spreadsheet click here.

Tuesday, June 5, 2012

Value Indicators: Preamble and Ben Graham's P/E Ratio

I've been woefully lax on posting  for the last little while.  Let's jump right in and look at the value indicators for this sector (oil & gas, integrated).

The value indicators I use are:
1) The Ben Graham P/E ratio,
2) Growth in Cash Flow from Operations,
3) Accounting changes, Extra-ordinary earnings, special items,
4) Capital Structure,
5) Owners' Earnings,
6) Theoretical Price.

Those of you familiar with Ben Graham's work will no doubt recognize these indicators.  For the majority, I've taken his work verbatim (or at least intended too).  A couple of times I've tempered the measure a bit to make it fit the information I have access to and one, as you'll see, is most definitely NOT something that the eminent Mr. Graham bestowed upon us.  It is, however, a nifty calculation.  And even thought it uses beta, I still think it speaks to the spirit of the measure, if not the law.

Mr. Benjamin Graham.  Definitely one of the good guys.  Thank you for sharing your great mind.


Ben Graham's P/E Ratio

You know, for the "simplest" and most often cited financial ratio the P/E ratio has a lot of different ways it can be calculated.  I find that disturbing, or at the very least, a pet peeve.  It is like driving down a road that suddenly, for no apparent reason, changes name, or the analog of that, a road that continues in name, even though it ended somewhere else.  The point is, it is confusing.  And you can get lost.

Which is why Verdant Analysis is just so good, so useful.  You know exactly what financial ratios you are getting because you've built them yourself.  And we're going to develop more and more great stuff beyond the ability to do ratios that will be simple to use, yet powerful in scope.

Ben Graham P/E ratio takes the average of the last three earnings figures as its denominator and Mr. Graham's rule of thumb is to limit yourself to securities trading at 15 times earnings or less.

It is a simple and easy to do calculation.  
1) Build an analysis template in Verdant by requesting the diluted, normalized EPS for Y, Y-1 and Y-2.  This is found on the income statement.
2) Export to Google or excel
3) Calculate the PE ratio with the following formula: C2/(average(F2:H2)).  C2 is the security's price. F2, G2 and H2 are the three earnings.

The next step is to rate the results.  I used three "if" calculations in order give a rating of 1 to PEs greater than 0 and less than 15, -1 for PEs less than zero and greater than 25 and 0 for PEs between 15 and 25.  

You can see the spread sheet here

Thanks for reading and I'll be back with the second indicator in a couple of days!