Friday, 9 November 2012

Companies Focus – Global 11 VM Positioning – Revisiting Coupled Ratio Assessment

Investment analysis can range from the most simplistic 'rule of thumb' measures to the most complex of analytical methodologies. The spectrum of course spans top-down interpretation of the 'macro' that so heavily guides 'Event-driven' funds to the bottom-up 'micro' in which the financial fundamentals of company accounts play such an important role.

The macro tends to speak for itself, the obviousness of news reports from the outbreak of wars to environmental disasters (ie Hurricane Sandy) directing the general investment sentiment of many investor types into commercial sectors which will very probably directly and indirectly benefit from such happenings.

Interpretation of the 'fundamentals', whilst undoubtedly understood by individual private investors in its shallower waters who have spent years examining capital markets, understandably tends to be the remit of specialists when it comes to delving into its deeper waters; a numbers based science or artform which itself can become ultimately inadvertently problematic taken to extremes when seeking 'holy grail' methods.

Thus, whilst economic theory once upon a time posited capital markets as 'efficient systems' (EMH etc) the fact that such a disparate range of analysis methods are applied by a multitude of investment actors with varying informational access and behaviours, means that the market itself is never truly an efficient mechanism; hence the very idea of arbitrage.

Yet undoubtedly, thanks to a mixture of personal web access, ever improving (obviously commercially driven) informational availability and an immense lost public trust in 'faceless' pension/asset management schemes, those people fortunate enough to have a middling to good income are becoming more self-involved regards how to best invest what is today very precious personal finance.

Slowly, but progressively, the chasm between 'public' and 'professional' worlds is shrinking, and as the individual takes greater interest and responsibility in moulding his/her financial future, so far greater two-way mutuality evolves between individuals and institutions.

To better enable individuals and institutions alike, simple yet powerful investment methods must be created. With this ambition in mind, in mid 2012 investment-auto-motives (ie Turan Ahmed) sought to combine some of the prime individual, standard valuation metrics so as to create the tool of 'Coupled Ratios'.

In Addition To Given Practice -

This method may be viewed as a natural evolutionary development of normative practice, whereby a greater level of investment criteria may be mapped, and thus an expansion of what is typically reductive calculations - such as P/E, PEG the EV/EBITDA measure – and critically seeks to visually map the plotted results to provide better analytical comparison.

The Use of Coupled Ratios -

This is little more than a common sense manner by which to picture the 'investment standing' of publicly listed companies, using basic intelligence to plot the performance and financial fundamentals of a corporation vis a vis sector competitors – in this instance for the automotive industry – presented graphically for far easier interpretation and investment guidance.

The four (x,y) graphs previously shown presented :

1. Market Valuation Ratios :
Price / Earnings vs Price / Book

2. Profitability Ratios :
Profit Margin % vs Return on Equity %

3. Liquidity Ratios :
Current Ratio vs Operational Cash-Flow Ratio

4 Debt Ratios :
Total Cash vs Total Debt

[NB Though various metrics are available, only the most basic/popular used].

Each of these graphs contains what may be described as an optimal theoretical 'investment window' which provides basic guidance regards those best positioned companies.

Previous Global 11 VM Standing Q1 2012 -

Before viewing the present-day positions of the 'Global 11' volume vehicle manufacturers, relative to their Q3 2012 results - as will be conveyed in the following web-log - it is well worth re-visiting the results of the previous exercise from Q1 2012, so that the general picture may be formed as to how each company has faired / performed.

Results -

It was clear from the previous weblog that of the 11 VMs, only Volkswagen and Hyundai were able to present a sound investment case based on the 'basic' (yet simplistically sound) view that married the micro-perspective of P/E with the macro-perspective of global PESTEL conditions.

To recap that commentary:

"As regards Market Valuation, Daimler, GM show themselves as reflecting fully “priced in” market valuations by virtue of their P/E and P/B standing. their share-price being at or marginally over respective book-value. BMW sits higher still whilst Honda and Toyota sat in the metaphoric stratosphere. All these then essentially rely upon future earnings growth to maintain and grow share-price. Conversely VW, FIAT, Renault, PSA and Hyundai were increasingly under their book values, reflecting what a mixture of constrained investment liquidity for all – taking a specific toll on VW - and the severe concern about the time it will take to see French and Italian manufacturers rebound, whilst the S.Korean producer is seen to sit at a lowly price because it has been overlooked on the Xetra exchange because it is only accessible by GDR / EDR. Hence the two that stand out as probable opportunities are VW and Hyundai.

As regards Profitability, VW and Hyundai were clear winners offering 10% EBITDA and 20%+ RoE. BMW and Daimler maintained the mid-ground with 6-7% EBITDA and 15-20% RoE. GM offered 5% EBITDA with approximately 20% RoE, whilst Renault gave 5% EBITDA with approximately 10% RoE. The remaining companies fell well below the 5% demarkation. Level.

As regards Liquidity, it was Toyota that sat in an optimum position (well inside the investment window, whilst Renault, VW, BMW, Ford and Honda sat on the fringe in descending order of attractiveness. GM and FIAT showed extremely good cashflow rates, but these are viewed as a temporarily anomaly created by cash boosts incurred from GM's re-birth 'sweet-spot' and FIAT's deferred CapEx demands. Though diversely positioned both Daimler and Hyundai appear less attractive on a liquidity basis because of CapEx investments, Daimler especially so making use of the global downturn to heavily return cashflow into the business. Whilst PSA's standing is a direct result of local sales contraction.

As regards Debt, GM stood positively apart from its peers, well within the assigned 1:1 area. FIAT was the only firm to sit within the 1:2 area. Hyundai and VW sat within the 1:3 area. Honda and Renault sat within the 1:4 area. Ford sat just outside but effectively on the fringe of 1:4. Toyota, Daimler, BMW and PSA all sat well outside this specific determinant area".

Criteria Winners -

Market Valuation : Hyundai and VW
Profitability : VW and Hyundai
Liquidity : Toyota
Debt : GM
'Window' Consistency: VW and Renault

Performance -

By virtue of the exercise, these four companies were deemed best in class amongst the Global 11.

A review of share price performance in the 6 month period between 31st March and 31st September, so encompassing Q1 – Q3 (prior to latter's reporting), allows us to gauge the efficacy of the exercise.

GM -
$25.65 to $23.09
Loss of 10% across the period
(low of $18.80 on 25th July)

Ford -
$12.48 to $9.86
Loss of 21% across the period
(low of $8.92 on 2nd August)

VW Group –
E120.90 to E130.50
Gain of 8% across the period
(low of E109.65 on 23rd April)

BMW Group -
E67.43 to E56.91
Loss of 15% across the period
(low of E53.70 on 26th June)

Daimler -
E45.21 to E37.67
Loss of 16% across the period
(low of E33.40 on 26th June)

E4.35 to E4.16
Loss of 4% across the period
(low of E3.29 on 9th May)

Renault -
E39.53 to E36.52
Loss of 7% across the period
(low of 29.54 on 26th June)

E12.08 to $6.15
Loss of 50% across the period
(low of E5.74 on 5th September)

Toyota -
$86.82 to $76.51
Loss of 12% across the period
(low of $72.51 on 25th July)

Honda -
$38.43 to E30.90
Loss of 19% across the period
(low of $30.21 1st August)

Hyundai -
E22.95 to E24.98
Gain of 9% across the period
(low of E22.10 on 5th November)

An accompanying graphic to this web-log displays a simple bar graph highlighting company share performance.

Conclusion -

As can now be clearly seen, the 'coupled ratio' exercise highlighted VW and Hyundai as the dominant names relative to two of the four criteria: Market Valuation and Profitability, and their respective 8% and 9% share price improvement between Q1 and Q3 highlights the market's highly positive attitude toward these dominant investment players.

The other two criteria placed named respectively for Liquidity and Debt were Toyota and GM, and whilst these two companies saw share price declines they were at a lesser level than many peers at -12% and -10% respectively. However, it must be noted that these two identified players were in fact beaten by FIAT with -4% and Renault with -7%.

It should be seen that Renault (along with VW) appeared most consistently within the 'investment windows' shown in the exercise, so its relative 'low loss' performance, amongst the 9 fallers should be expected.

Of particular note is the better than analytically gauged performance of FIAT during the period, showing the smallest loss. This because of generally upbeat market macro sentiment relative to its positive North American exposure via Chrysler, the technocratic budget management of the Italian economy and the expectancy of the OMT liquidity boost across the EU.

To conclude, whilst the 'coupled ratios' exercise proved most useful in spotting powerful share price performers and least loss performers, it must be recognised that ultimately the right balance must be struck between 'bottom-up', 'fundamentals', 'micro' analysis and 'top-down', 'macro' analysis.

Whilst they must be viewed in unison, each will at various points in the broad economic cycle, ultimately take greater precedence over the other relative to the general investor mindset. Obviously, the 'macro-mindset' more dominant during socio-politically sensitive times such as the last 5 years, and the 'micro-mindset' more so as economic stabilisation improves and the competitive capabilities of the single firm becomes more prescient.

To Follow -

Having mapped out each of the Global 11 VM positions for Q1 2012, the next investment-auto-motive web-log will undertake the exercise once again based upon Q3 financial data to see how each stands today.