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Over 20 years experience and counting...

Hedge Fund Analyst 101

Posted on July 27, 2019

Hi Everyone,
 
This week I shared a new stock idea with Trading Club members using our Company Analysis Checklist to cut through the noise and reveal the true fundamental value of the business. Although I cannot disclose the name publicly just yet (out of courtesy to our paying members), I can reveal the steps I followed in the process to analyse this particular stock. For those of you who may not have seen my recent blog posts featuring the likes of Disney, Visa, Microsoft and Facebook, this is the model showing the 5 factors that Lex explains fully in our Million Dollar Traders online course.
 
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As you may notice from the top of the following screenshot showing the excel sheet we refer to, this is a health care company operating in the Pharmaceuticals industry (thats the last hint I’m allowed to give I’m afraid!). As will become apparent as we go through the other sections, we are mainly interested in the trend (2009 - 2021 estimate) and whether the current (‘Last’) value is above or below the 5-year average (‘5-Yr’) and index average (‘Index’). Green is good, and red is bad, in comparison to each.
 
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It’s easy to get caught up in all the numbers, so lets take things step-by-step, beginning with the first section on our Checklist - the Company’s Management. Things definitely look positive here, as the ROA is high double-digits and stable, and there is an attractive dividend policy showing average growth of 13% (increasing dividends). I discuss everything in greater detail in the video, but this is definitely +1 on our Checklsit.
 

 

Next up, the products. Sales are growing at a healthy rate of 6%, whilst profit margins are robust and being maintained (even, expanding slightly). Without labouring the point, this is also what we hope to see as investors. Very good!
 
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For a growing business with healthy margins under good stewardship, we would expect to see free cash flow growth - as we clearly see here averaging 6%. With things so far looking great, we want to check that the company isn’t overly reliant on debt to finance its operations and expansion. For this reason we always check the Total Debt to Equity ratio - and as you can see here, the company has no debt with a ratio of 0! This means that its business model is self-sustaining, without reliance on external creditors. 35 billion in free cash flow and no debt? Thats a +1!
 
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So it looks as though we have found a great company in an established sector, but what price are we expected to pay for it as investors? The best stock in the world might trade at a ridiculously high valuation and still lose money if you buy it, so we need to make sure that we still pay a reasonable price based on the company’s merit. Whilst there are several ways to approach this, my preferred measure for a stock of this kind is the earnings yield, or specifically EBIT / EV (higher is better). At 6.8% this is attractive in absolute terms, and also represents good value compared to the stock’s recent trading history (6.2) and the average stock index constituent (5.2). The free cash flow yield also offers far better value than the market, and is pretty much in line with the 5-year average. Elsewhere, with a 2.5% dividend yield and buyback yield of 2%, the total yield that investors today would receive before the market price ever moves would be 4.5% - good luck getting that in a savings account or an investment grade bond!
 
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So the valuation is also +1 on our Checklist, and everything is looking great. But is this known to the consensus? After all, if everyone has the same idea and has already bought, then it might be difficult for the stock to appreciate significantly. But in this case, as shown in the Bloomberg screen below, the analysts are far from unanimously bullish - just as I was hoping to see! This means that there are still a bunch of analysts who will be scrambling to upgrade the stock when they wake up to the story as the fundamentals begin to transpire and the smart money have already bought. What's more, the most historically ‘accurate’ (relevant?) analysts all currently have buy ratings, which makes me all the more convinced that the rest of the herd will soon follow...
 
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Finally then, let's have a look at the chart. You might expect to see this in a 45 degree uptrend, but what we actually see is something of a range (currently at the low end, which is the end you would rather be buying!). This follows a nice ‘pop’ on news the previous day, which suggests that the stock may have bottomed in the short term.
 
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Longer term, you can see that we may be about to break out from a 5 year consolidation (prior to this, the stock was in that '45 degree uptrend’ I referred to earlier). Now, currency risk will be a factor for international investors, but I see this as a consolidation that is most likely about to be resolved with an upside breakout in the near future...
 

 

Time will tell how this plays out, but with the weight of fundamental evidence behind our process, I have conviction that this will be a name to watch closely.
 
Be better informed than retail investors who do not employ the same tools that we do as professional fund managers by joining us at the Academy to become a member of our Trading Club, or learn from Lex himself with our Million Dollar Traders Online Course.
 
Have a great weekend,
 
James
 
 
 
James Helliwell | Chief Investment Strategist
 

Disclaimer: Our service is intended for educational and informational purposes only and should not be considered investment advice. Do not make any decisions based on the articles and material presented on www.lexvandam.com and never trade with money you cannot afford to lose. We cannot be held responsible for your trading results. For more information, please check Risk Disclosure - T&C.

 

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