Visual fundamental analysis

[i4value]

Over the past few months, I have been working with a social investment platform to visually present the results of a fundamental analysis of Bursa companies.

This Fundamental Mapper plots the comparative fundamental performance of companies within a sector on the horizonal axis and the margin of safety (difference between intrinsic value and market price) on the vertical axis. 

The pin illustrates this

https://www.pinterest.com/pin/797840890268685690/

This is meant for the fundamental investor so that he can quickly get a sense of a stock position. It is base on the past 6 years financial data of companies. The idea is that with this picture, the investor can then spent his time on the qualitative analysis.

I would be interest to get feedback and comments on this Fundamental Mapper - what else can be improved, what is wrong with it, etc 

It is currently at the Beta testing stage but will be unveiled soon.  

[dzwm87]

Anything that is a single chart is just too simplistic against something that is dynamic and constantly changing.

It is like my former colleague who wants to rank the entire stock universe from 1 to N. Very good to market but real business owners probably laugh and dismiss it.

Maybe an incremental improvement is to do it across different meaningful fundamental metrics such as per key input efficiency rather than headline profit margin and backward revenue growth numbers. The challenge is in parsing it and maintaining it regularly.

[weijian]

hi i4value,

My 2 cents' worth:

(1) I disagree that MOS is the difference between market price and intrinsic value. MOS comes from the quality of the company, not valuations. Valuations determine the quantum of returns.
I have seen growth folks overpaying for quality - Do they have MOS? Yes. Are they going to underperform? Yes.
I have seen value folks overpaying for underquality - Do they have MOS? No. Are they going to underperform? Probably Yes.

(2) Based on my personal experience, the "Low-Poor" quadrant is more like "value traps" than "turn-arounds" as you euphemistically termed. The only time "value-traps" turnaround, are when they have/plan some sort of actions. These actions are dynamic, subjective and may not be captured quantitatively. So a 2-axis scatterplot may be overly simplistic, IMO.

(3) And based on your experience, have you seen any "Low-Good" quadrant goldmine?

[i4value]

hi i4value,

My 2 cents' worth:

(1) I disagree that MOS is the difference between market price and intrinsic value. MOS comes from the quality of the company, not valuations. Valuations determine the quantum of returns.
I have seen growth folks overpaying for quality - Do they have MOS? Yes. Are they going to underperform? Yes.
I have seen value folks overpaying for underquality - Do they have MOS? No. Are they going to underperform? Probably Yes.

(2) Based on my personal experience, the "Low-Poor" quadrant is more like "value traps" than "turn-arounds" as you euphemistically termed. The only time "value-traps" turnaround, are when they have/plan some sort of actions. These actions are dynamic, subjective and may not be captured quantitatively. So a 2-axis scatterplot may be overly simplistic, IMO.

(3) And based on your experience, have you seen any "Low-Good" quadrant goldmine?

I thought that the MOS was a terminology from Graham to illustrate the difference between the market price and the business value. And while I would agree that that there is some link between quality and margin of safety, I think that the link flows from valuation. Based a DCF approach, a high quality company would probably have lower discount rate (lower risk), lower Reinvestment rate and better profitability. The last 2 items flow into the free cash flow.  

I tend to think that the key driver for the margin of safety is market sentiments. For a company, if Mr Market is fearful, you will have a bigger margin of safety than when Mr Market becomes greedy and start chasing the company.  That is why in the Fundamental Mapper I have the margin of safety (Investment risk) as a another dimension than business performance. 

As for turnarounds, I am looking from the business angle ie improvements in business performance rather than from a market sentiments perspective. Value traps is focussing on the pricing perspective. A value trap is cheap because it has fundamental performance issue. At turnaround is cheap because the market has yet to recognize the improvements it had made. 

But you make an interesting point - there are two types of investors. Those that focus on business performance first and those that focus on price first.

[weijian]

I thought that the MOS was a terminology from Graham to illustrate the difference between the market price and the business value. And while I would agree that that there is some link between quality and margin of safety, I think that the link flows from valuation. Based a DCF approach, a high quality company would probably have lower discount rate (lower risk), lower Reinvestment rate and better profitability. The last 2 items flow into the free cash flow.  

I tend to think that the key driver for the margin of safety is market sentiments. For a company, if Mr Market is fearful, you will have a bigger margin of safety than when Mr Market becomes greedy and start chasing the company.  That is why in the Fundamental Mapper I have the margin of safety (Investment risk) as a another dimension than business performance. 

As for turnarounds, I am looking from the business angle ie improvements in business performance rather than from a market sentiments perspective. Value traps is focussing on the pricing perspective. A value trap is cheap because it has fundamental performance issue. At turnaround is cheap because the market has yet to recognize the improvements it had made. 

But you make an interesting point - there are two types of investors. Those that focus on business performance first and those that focus on price first.

hi i4value,

It has been ~75years since Graham first wrote The Intelligent Investor in 1949. There are certainly many timeless principles written in the book. As for the definition of margin of safety (MOS), I will leave it to you to decide whether the book's definition still make sense in the current age - an age where one doesn't need to get their Moody's manual from the mailbox, one where there weren't hundred of thousands worth of CFAs and one where it costs a few hundred basis points to trade stock over the counter.

Maybe we can have a simple thought experiment below:

Let's say a company has market value<intrinsic value by 20%. In the next 5 years, the company had its intrinsic value decline by 5% every year and in response, Mr Market decides to reduce its market price by 10% every year. Would you think that the MOS is getting larger every year?

Your definition of MOS is defined by difference between intrinsic value and market price. So as per this definition, the MOS is improving every year. Would this stand the test of common sense?

Now, let's have the 2nd thought experiment (in this case, turnaround) below:

Let's say a company has market value<intrinsic value by 20%. In the next 5 years, the company had its intrinsic value increase by 5% every year and in response, Mr Market decides to increase its market price by 10% every year. Would you think that the MOS is getting smaller every year?

Finally, you have mentioned that a key driver for margin of safety is market sentiment. The simple question I want to ask is Do "frauds or companies that eventually perish due to the economic downturn" make money for their investors based on their depressed market valuations? Obviously they don't. The big money makers from a market sentiment downturn are good companies that actually recover, and if they are great companies, take market share from their competitors in the recovery. This is how John Hempton made multiple times money from Meta or Marrott International (ie. mispriced large caps), when each had their respective downturns.

[Corgitator]

I thought that the MOS was a terminology from Graham to illustrate the difference between the market price and the business value. And while I would agree that that there is some link between quality and margin of safety, I think that the link flows from valuation. Based a DCF approach, a high quality company would probably have lower discount rate (lower risk), lower Reinvestment rate and better profitability. The last 2 items flow into the free cash flow.  

I tend to think that the key driver for the margin of safety is market sentiments. For a company, if Mr Market is fearful, you will have a bigger margin of safety than when Mr Market becomes greedy and start chasing the company.  That is why in the Fundamental Mapper I have the margin of safety (Investment risk) as a another dimension than business performance. 

As for turnarounds, I am looking from the business angle ie improvements in business performance rather than from a market sentiments perspective. Value traps is focussing on the pricing perspective. A value trap is cheap because it has fundamental performance issue. At turnaround is cheap because the market has yet to recognize the improvements it had made. 

But you make an interesting point - there are two types of investors. Those that focus on business performance first and those that focus on price first.

hi i4value,

It has been ~75years since Graham first wrote The Intelligent Investor in 1949. There are certainly many timeless principles written in the book. As for the definition of margin of safety (MOS), I will leave it to you to decide whether the book's definition still make sense in the current age - an age where one doesn't need to get their Moody's manual from the mailbox, one where there weren't hundred of thousands worth of CFAs and one where it costs a few hundred basis points to trade stock over the counter.

Maybe we can have a simple thought experiment below:

Let's say a company has market value<intrinsic value by 20%. In the next 5 years, the company had its intrinsic value decline by 5% every year and in response, Mr Market decides to reduce its market price by 10% every year. Would you think that the MOS is getting larger every year?

Your definition of MOS is defined by difference between intrinsic value and market price. So as per this definition, the MOS is improving every year. Would this stand the test of common sense?

Now, let's have the 2nd thought experiment (in this case, turnaround) below:

Let's say a company has market value<intrinsic value by 20%. In the next 5 years, the company had its intrinsic value increase by 5% every year and in response, Mr Market decides to increase its market price by 10% every year. Would you think that the MOS is getting smaller every year?

Finally, you have mentioned that a key driver for margin of safety is market sentiment. The simple question I want to ask is Do "frauds or companies that eventually perish due to the economic downturn" make money for their investors based on their depressed market valuations? Obviously they don't. The big money makers from a market sentiment downturn are good companies that actually recover, and if they are great companies, take market share from their competitors in the recovery. This is how John Hempton made multiple times money from Meta or Marrott International (ie. mispriced large caps), when each had their respective downturns.

Margin of safety can come in various forms - magnitude of undervaluation, underappreciated durability of ROIC, overlooked earnings inflection etc. In some sense, they are all related to some degree, but each is free to pick his own style so long as it provides great results. 

If one is better than the market at assessing turning points in market sentiment (itself a very difficult skill), then I actually think that the big money markers are the "lousier" businesses that saw a significant de-rating of valuation during the downturn. I won't give names since it's sensitive to call out the companies that are "lousier", but it's not hard to get a list of the best performing SGX stocks (in terms of 1-year return) coming out of GFC or the COVID crash, and majority of those aren't quality names. Admittedly, many of them do eventually crater again (because in the long run, it's very difficult for investment returns to deviate significantly from the rate of capital compounding in the company). But hey, if your are looking at maximizing 1 year returns, it's not a bad idea to look at the trash pile (that is, if you can assess sentiment turning points).

If you are looking to buy and hold for a long duration, then I agree that your best bet would be to identify companies that can compound earnings at attractive return on incremental equity for a long period. Investors who are better than the market at assessing durability of such rates should opt for this approach (itself also a very difficult skill), and it makes sense for them to pay less focus on valuation as long as the overvaluation is not over the top. If your asset is going to grow intrinsic value at 20% per year for 20 years, you will still get a 16% CAGR over 20 years if you pay double what's fair. For these investors, it's more important to get the growth of intrinsic value right rather than the degree of undervaluation.

Many ways to skin a cat, at the end of the day we are just trying to figure out an approach that works best for ourselves, taking into account our skill set and temperament, investment horizon etc.

[weijian]

Margin of safety can come in various forms - magnitude of undervaluation, underappreciated durability of ROIC, overlooked earnings inflection etc. In some sense, they are all related to some degree, but each is free to pick his own style so long as it provides great results. 

Hi Corgitator,

I think you hit the nail here. Because MOS can come in various forms - it confuses many people (me is an example) and hence in the process, become dogmatic.

Something needs to click within us, so that "style" will work uniquely for us. But if we hold onto this "my style" religiously - then we become dogmatic. On the extreme end if we don't have "any style", then we are just part of market sentiment.

The best personification of the stock market I have seen, came from the Founder of MicroCap, and he compared the stock market to UFC, where all of us are MMA fighters - Every martial art has their pros/cons, every fighter needs to put in the hard work, every fighter needs to keep evolving beyond their style, every fighter needs to keep improving....