Books of the Year

IHS Offers Possible Short Opportunity

Disclosure: I have no position in IHS. I may initial a short position within the next 72 hours.

I'm typically not one for shorting stock and must admit I have limited experience doing it, but I couldn't help but notice the opportunity that IHS Inc, a market research company, is providing. After undergoing a huge price correction from around $115 per share to about $91 per share in September, I still think there is room further downside.

First let's consider the 12 month trailing P/E ratio. As of market close today, the P/E ratio was 47 and change. Typically, when I see 12 month trailing P/E ratios over 25 alarm bells start going off in my head, so I decided to pull high and low P/E ratio since the company became incorperated in 2005.

As you can see from the chart, the company has only overcome the 47 threshold once in it's 6 year history. It is also the highest the company has been since the 2008-2009 housing bubble collapsed.

The second thing I looked at was insider activity. Since July, insiders have sold more than 1.2M shares while only purchasing 50K. While this differential clearly shows insiders think the company is overvalued, I think what is more important is that insiders didn't jump back in at the mid-90 share price. To me this suggests they might be expecting some further downside.

The last thing I looked at was the book value per share which was $23.79. At the current price of 96.29, your getting approximately $0.24 for every dollar you invest. With such low earnings (relative to price), it is hard to overcome the 4:1 price to book value.

Investment Portfolio: Week of 10/1/2012

No changes in my investment portfolio this week. Currently my investment portfolio contains five equities: Discover Financial Services (DFS), Intel Corp (INTC), Medtronic, Inc (MDT), Microsoft (MSFT), and Wells Fargo & Co (WFC).

Depending how Intel does this week, I might exit a small position I had in U.S. Silica Holdings (SLCA) and bring Intel's weight in the investment portfolio to approximately 22%. 

Last Thursday Discover Financial Services released Q3 results. I'm planning to evaluate the stock this weekend and confirm the investment theory is still sound. Mr. Market decided the news was enough to jump the price of the stock 7% when the news broke on Thursday, so I'm expecting the underlying fundamentals to still look good. Look for my analysis early next week. 

Interesting Read: Advice from Warren Buffett

While catching up with Greg Speicher’s blog, Ideas for Intelligent Investing, I stumbled upon the notes from a meeting between Warren E. Buffett and the MBA students at the Richard Ivey School of Business. The legendary value investor spent two hours on March 30^th, 2012 with the students on a variety of topics. Below are my two key take-aways from the discussion. For those interested in reading the complete notes, they can be found here.

Follow your passion

Throughout the dialogue, this idea came up repeatedly. I’ve heard this from a number of successful people, but this is my first time hearing it from Warren. When asked directly, “What is the most important thing you have learned in your life?” his answer was “Find your passion.” Warren told the audience he doesn’t know anyone who is passionate and doesn’t have a good life. For the students still looking, he suggested ask themselves the question “Where am I going to have the most fun?”

Opportunities are still out there

Many investors at some point ask themselves if the opportunities that were there for Warren Buffett are still out there today. His response was a resounding YES. Warren acknowledged that the internet has provided people with better information than ever before, but people still act irrationally. He re-iterates that with a little hard work the good deals can still be found. 

Stock Valuation: Intel (INTC)

Disclosure: I am long INTC.

The PC industry has been under a lot of scrutiny lately. Many investors have concerns as to what the burgeoning tablet market will do to the PC and chip manufacturers. This is apparent by looking at the stalk contrast in share performance of companies like Dell (DELL), Hewlet-Packard (HPQ), and Advance Micro Devices (AMD) in contrast to companies like Apple (AAPL) and QUALCOMM (QCOM). One company that I think the market is presently undervaluing is Intel (INTC).

Intel is the world’s largest semi-conductor chip maker by revenue and by units shipped. According to the market research conducted by IHS iSuppli, Intel held 16% of the market share in 2011 with closest competitors being Samsung (SMSN) at 9% and Texas Instruments (TXN) at 5%. While its future might be uncertain, it is a cash cow today and it will continue to be for at least another five years as the tablet market becomes more established.

Based on my valuation which considered the business, financial, and valuation risk, I would consider this stock very low risk and give it a BUY recommendation at the price of 24.83. Investors should expect an average CAGR between 17% and 34% over a period of ten years. I would recommend reviewing fundamentals quarterly and when reaches a P/E of 16. I would recommend selling if it reaches a P/E of 30.  

Business Risk:

The business risk takes into account metrics that can be used to project the future profitability of the business.

Here we are looking for strong upwards trends in revenue, net earnings, cash flow, dividends, and book value. In the case of Intel, despite a period of flatness between 2005 and 2009, we see growth in net earnings, cash, and dividends with average growth rates over the period of 20%, 12% and 28% respectively. From 2006-2009 revenue dropped (mostly due to macro factors) yet revenue, cash, book value, and dividends grew indicating strong management. Revenue has since turned around.

The major concern on the chart above is the drop in book value from 2010 to 2011. This arises from an outlay of cash for the acquisition of Infineon Technologies Wireless Business Solutions (results in a debt to goodwill, a non-tangible asset, and a credit of cash, a tangible asset). Despite this recent acquisition, tangible book value is up 2.8%. Without the acquisition, book value would be up 7%.

It is also worth noting, gross margin, SGA to gross profit, R&D expense to gross profit, and net income have averaged 57%, 28%, 28%, and 18% respectively over the past 5 years.
    

Overall, Intel looks to be in good health and has little business risk. The primary risk being a decline of revenue due to soft PC demand, however the company has shown it can manage its expenses and still return profit to shareholders in the event of temporary revenue decline.

Financial Risk:

Under financial risk we are looking to see if a company has the means to pay of it’s immediate debt. Below is a chart which shows Intel’s cash, short term debt, and long term debt.

It is very clear that from the chart above that Intel could pay off its debt entirely today with its cash reserves. Below indicates the percentage of total debt to operating income.

From the chart above we see that Intel could pay off its debt in entirety using just over 40% of its 2011 operating income. Due to the large cash reserves and high cash flow, Intel has no financial risk.

Valuation risk:

Here are we want to make sure we are not over paying for our shares. All returns are going to be based on the price that you lock in at, so it is important to lock in at a price where you will get the return you want if the company does well. To do this we look at P/E and dividend yield over time.

In relation to its earnings Intel’s shares near the lowest they have ever been in the history of the company. Average High and Low P/E for the last 9 years is 30 and 16 respectively.  

The dividend yield of the company has been growing consistently over the last nine years with an average growth rate of 28%. 

Recommendation: BUY

New Focus on Investment

It's been five months since my last post, but now I'm back. The new focus will be on business and investing, with a specific interest in valuation. In writing this blog I hope to learn more about investment and create one unique website that has all the information I'm looking for.

So... let's get started!