Saturday, July 28, 2012

Owner's Earnings


It has been over a month since I last posted, for which I apologize.

The next value indicator is Owners' Earnings, which is defined as Net Income less the costs of granting stock options, unusual, nonrecurring or extraordinary charges and income from pension funds. According to Ben Graham, it should grow at a steady 6 to 7% per year.

Now, there was a time when employee stock options weren't expensed, roughly before 2006.  So we don't need to worry about this one, as our analysis isn't going back that far.

As for pensions...this is information that needs to be extracted from the financial statement notes and is beyond the scope of this analysis.  Perhaps at some point Verdant will make that kind of information available and manipulable, but for today, we are going to have to content ourselves with a proxy figure for Owners' Earnings, Net Income Before Extraordinary Items.

This analysis is then very straightforward:
1) Set up an Analysis Template with Net Income Before Extraordinary Items for years Y, Y-1, Y-2, Y-3, Y-4, Y-5.
2) From the US Oil & Gas Integrated portfolio, click the Analyze button and select that template and export the results to Google Docs or Excel.
3) Calculate the growth between Y and Y-1, Y-1 and Y-2 etc. with the following formula:
 =(F2-G2)/G2
Where F2 is Y and G2 is Y-1 for the first security.
4) I create an average of all of the inter-years growth numbers with the following formula:
 =AVERAGE(L2:O2)
Note: some securities may not have data for every year.  If that is the case you'll get a divide by zero error (DIV/0).  To correct this, I manually shorten the average calculation to account for only the years that have a growth calculation.
4) To "rate" the results, I employ two "if" calculations:
 =if(P2>7%,1,0) and  =if(P2<0,-1,0),
5) When these two "if" statements are summed, we get the effect of applying a rating of 1 to securities that have been growing owners' earnings at an average rate of at least 7%, a rating of 0 for securities that have been growing at a rate of 0% to 7%, and a rating of -1 for securities with negative growth.

If you have to look at the data you'll notice that most of these companies have widely fluctuating changes in growth between years.  Welcome to the oil and gas industry - it is volatile and the volatility in reflected in the stock price.  It isn't an investment for everyone.  For that reason, I think that the value indicators are extra important, it can save you a lot of stress if you follow that very important maxim "buy low, sell high".

You can view the spreadsheet here.

The next piece of the analysis is a calculation that I really like, though it is rather long and complicated.  It is a stock valuation calculation and I use it to calculate out Ben Graham's "Margin of Safety".

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