Intrinsic Value

  • 01 Aug
    Will buying TPX let you sleep at night – or make you toss and turn?

    Will buying TPX let you sleep at night – or make you toss and turn?

    Getting a good night’s worth of sleep is important for good health – physical, mental and emotional. I’ve used the same idea throughout my investing career to help guide the investment decisions I make. If putting my hard-earned dollars into a stock is going to keep me up at night, it doesn’t matter what other people, or the market at large think about it – the smart thing for me to do is to move on and find something else. That doesn’t mean that I’m so risk-adverse that I can’t take advantage of opportunities when I see them, but it does mean that the opportunity I do choose to pursue must be clearly superior to the level of risk involved.

    Tempur Sealy International Inc (TPX) is an interesting play on that concept, if for no other reason than the fact that a good night’s sleep is what this company is all about. And a quick look at the stock’s chart shows that the stock is more than 27% below its 52-week high, but could be showing some bullish strength right now. Does that mean there is a great opportunity to be had? It’s a little hard to say definitively. There are certainly a number of positives about the business to be seen, including solid earnings growth over the past year, and an improving Book Value. There are also things to be concerned about, like a very high debt level, mostly flat sales, and a narrow operating margin. Ultimately, the value picture is probably in the eye of the beholder, so I’ll outline what I’ve found so far and let you make your own decision.



    Fundamental and Value Profile

    Tempur Sealy International, Inc. is a bedding manufacturer. The Company develops, manufactures, markets and distributes bedding products. The Company operates in two segments: North America and International. The North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in the United States and Canada. Its International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. Its brand portfolio includes TEMPUR, Tempur-Pedic, Sealy, Sealy Posturepedic, and Stearns & Foster. It offers its products in over two categories, including Bedding, which includes mattresses, foundations and adjustable foundations, and Other, which includes pillows, mattress covers, sheets, cushions and various other comfort products. As of December 31, 2016, it sold its products across the globe in approximately 100 countries. TPX has a market cap of $5.7 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings declined by about 15.5%, while sales increased at a modest rate of about 1.5%. The story is similar in the most recent quarter, as TPX saw an earnings improvement of nearly 24% against sales growth of 3.3%. The company operates with pretty narrow margins, as Net Income was about 5% of Revenues for the last twelve months. In the last quarter, however, Net Income relative to Revenues narrowed to only about 3.4%. I take this as a red flag that the company is becoming less efficient despite the acceleration in earnings growth.
    • Free Cash Flow: TPX’s free cash flow is marginal, at only $72.5 million.
    • Debt to Equity: TPX has a debt/equity ratio of 10.8, a very high number that makes them one of the most highly leveraged companies in the Household Durables industry. That is a red flag, however the company’s balance sheet indicates that operating profits are sufficient to service their debt.
    • Dividend: TPX does not pay a dividend.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for TPX is $2.90 and translates to a Price/Book ratio of 16.98. The industry average is only 2.9, implying the stock is significantly overvalued. The company’s Book Value was actually 0 until a year ago, but has improved steadily from the end of the first quarter of 2017 until now. The lack of a historical Book Value makes it a little difficult to compare the current Price/Book to anything, however we can also use the stock Price/Cash Flow and Price/Sales ratios in a similar way. The stock is currently trading a little more than 10% below its historical Price/Cash Flow average, and nearly 35% below its Price/Sales ratio. That could put the stock’s long-term target price in the $54 to $65 range, depending on how optimistic you want to be. The absence of useful Book Value information is a concern to me, however and makes me lean more to the conservative side of things, so I have to admit that I have a hard time seeing an intrinsic reason that the stock should be worth more than $54; a 10% upside is a little more limited than I would prefer to work with.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s downward trend beginning in January of this year and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock has shown some bullish momentum since late April, rising from a trend low of about $41 to the current level; however it has dropped back from a recent pivot high around $54.50 in just the last couple of weeks and is only a couple of dollars below the 38.2% retracement line at around $51 per share. A break above that line would be required to give the short-term upward trend any validation and a real chance to extend further. Otherwise I expect the trading range between about $47 for support and $51 for resistance to hold sway. A break below $47 would mark a short-term trend reversal to the downside and could see the stock challenge its trend low price at $41.
    • Near-term Keys: If you like to work with trend-based, momentum-focused trading methods, look for a break above $51 to confirm the short-term trend’s strength and provide a decent bullish signal to buy the stock or start working with call options. If the stock breaks down, wait for a push below $47 before trying to short the stock or start buying put options.


  • 23 Jul
    HAS beats Street estimates, but its 12% overnight jump is a Red Herring

    HAS beats Street estimates, but its 12% overnight jump is a Red Herring

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    Read More

    Before the market opened this morning, toymaker Hasbro, Inc. (HAS) released its report of second quarter results, and the numbers prompted the market to push the stock up in a big way early in the trading session. After closing a little below $94 on Friday, the stock opened Monday’s trading session at nearly $105 per share and pushed as high as $107 in the early hours of the day. The report must have been really great, right? Well, not so fast.

    One of the interesting things about the stock market is watching the way it reacts to company reports. All things being equal, when a company can demonstrate that their business is growing, their stock should go up, and when it is shown that business is contracting, the stock should also go down. Of course, all things are not equal, and that means that the market, being an emotional animal, treats stocks differently. Sometimes the market’s immediate reaction is about something entirely different than whether a company’s business is growing or shrinking. Hasbro’s price action today is a pretty good example.

    Analysts and investors alike like to try to predict what a company’s report is going to look like. They analyze and measure all kinds of information and data and try to make their own educated guesses about what is going to happen. With HAS, one of the factors that everybody has been trying to account for is the effect that the collapse of U.S. toy store Toys ‘R’ Us, which of course was one of the toymaker’s biggest customers would have. Analysts had anticipated a drop in revenue of a little more than 14% versus the same quarter in 2017, and earnings to decline by more than 45%. Revenues actually declined by 7%, less than half of what was expected, and earnings only dropped by about 9.5%. Seeing both of those numbers come in better than expected led the market to respond with high enthusiasm. Clearly, the market seems to be treating the news as an indication that the effect of the liquidation of Toys ‘R’ Us was much less than expected.



    I’m not saying that the news in this case isn’t positive; being able to minimize the impact from a negative event like a major customer’s complete and utter collapse is a mark of strong management. But does it justify sending a stock 12% above its current price in a single day? That’s where my red herring reference comes into play. The market has always seemed to prefer to draw any kind of silver lining it can from news to drive a stock’s price higher, but the problem is that immediate boost often puts average investors at a disadvantage and increases their risk. The people that stand to benefit most clearly from that early surge, of course, are the investors that were already holding shares of the stock; but the probability any chance the stock will keep going up is less likely to be about emotion and more about the stock’s fundamentals.

    One of the short-term risks about jumping into a stock that is making a big overnight jump based on a news headline comes from the size of that overnight jump. If you’re an investor or trader that had the good fortune to buy HAS at any point in the last month or so when the stock was languishing in the $85 to $94 range, seeing the stock jump up more than $10 per share overnight would certainly be exciting; it would also automatically make you think about selling your shares back to the market to lock in that gain. That is exactly what I think a lot of folks are going to be doing in the next day or so; and while it isn’t a given that is going to drive the stock lower, the odds that it will drop are much greater than that it will keep going up. I’ll quantify exactly how much downside risk I think there is in that scenario later in this post. For now, let’s dive in into whether or not the stock should worth the $100-plus share price it carries at the moment.



    Fundamental and Value Profile

    Hasbro, Inc. (HAS) is a play and entertainment company. The Company’s operating segments include the U.S. and Canada, International, and Entertainment and Licensing. From toys and games to content development, including television programming, motion pictures, digital gaming and a consumer products licensing program, Hasbro fulfills the fundamental need for play and connection for children and families around the world. The Company’s U.S. and Canada segment is engaged in the marketing and sale of its products in the United States and Canada. The International segment is engaged in the marketing and sale of the Company’s product categories to retailers and wholesalers in most countries in Europe, Latin and South America, and the Asia Pacific region and through distributors in those countries where it has no direct presence. The Entertainment and Licensing segment includes the Company’s consumer products licensing, digital gaming, television and movie entertainment operations. HAS’ current market cap is $13.3 billion.

    • Earnings and Sales Growth: Over the trailing twelve-month period, earnings declined almost 77% while revenue dropped about 16%. Over the same period, HAS has operated with a very narrow margin profile of less than 5% that was actually negative over the last quarter.
    • Free Cash Flow: HAS’s free cash flow prior to the last quarter was healthy, at about $497 million. The company has about $1.1 billion in cash and liquid assets, a number that declined from almost $1.6 billion in the quarter prior.
    • Debt to Equity: HAS has a debt/equity ratio of .98 as of the quarter prior to today. Total long-term debt in the most recent was about the same, at about $1.64 billion.
    • Dividend: HAS pays an annual dividend of $2.52 per share, which translates to a yield of about 2.36% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for HAS is $12.58 and translates to a Price/Book ratio of 8.47 at the stock’s current price. That is quite high, well above the industry average of 3.2 and its own historical average of 5.22. A move to par with its historical average would put the stock at about $66 per share – more than 38% below the stock’s current price. I believe this is a pretty fair evaluation of what the stock’s long-term, fair market value should be. For a value-based investor, the stock would have to drop to at least this level before it would merit serious consideration.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

    • Current Price Action/Trends and Pivots: The dotted green line highlights the stock’s upward trend, dating back to early April. The stock has shown good bullish strength from this period, increasing about $10 per share before this morning’s big break higher. I’m using the dotted blue line for a couple of things. First, before today this was the stock’s most likely strong resistance level, and today’s clear break, with a huge gap between Friday’s close and this morning’s opening price above it is a clear technical indication of the stock’s current bullish momentum. The line is also useful when thinking about investor behavior as it relates to overnight gaps. Since gaps like this translates to large, unexpected but happy gains for people who bought in before the jump happened, it isn’t unusual to see an increasing in selling immediately after the gap, as profits are taken and locked in. An abundance of technical study suggests that gaps tend to fill themselves, which means that a bullish gap like the one we’re looking at now is very likely see the stock drop back down in the near term. One technical theory that I think has good anecdotal evidence behind it suggests the stock should fill approximately half of the distance covered by the initial gap. The blue line, sitting right around $99 per share, is right in that price area, and is further bolstered by repeated pivot highs in that same range, in February of this year and multiple points in 2017. That puts the stock’s minimum immediate downside risk in the $6 to $7 per share range now – far above what any near-term upside forecast is likely to be.
    • Near-term Keys: If the stock stabilizes in the $99 to $100 range, that could be a good indication the stock will push back to test the high it set today around $106 per share, which could offer a good signal for a short-term swing trade using call options or buying the stock outright. A break below the $99 support level should put you on notice to watch to see if the stock will find support along its intermediate trend line around $93. A break below that level would mark a reversal of that upward trend, and could easily see the stock drop all the way to the $83 level to test its 52-week low. A break below $93 could offer a nice signal to start working the bearish side of the market by shorting the stock or using put options.


  • 03 Jan
    Value Or Growth? Why Not Both

    Value Or Growth? Why Not Both

    • Many separate value and growth investing, but they are joined at the hip.
    • Growth creates value, but it can also destroy value.
    • Today, we’ll discuss how to apply growth when calculating the intrinsic value of a stock.



    Introduction

    There’s a lot of talk about the difference between growth and value investing. Even I’ve compared the two investing styles when discussing academic research on the subject showing how value stocks usually outperform growth stocks. Nevertheless, academic studies always talk in general and intelligent investors can be much more sophisticated than academics. More →

  • 25 Oct
    How To Calculate Intrinsic Value & Why You Need To

    How To Calculate Intrinsic Value & Why You Need To

    • Calculating the intrinsic value of a stock is essential for making any kind of buy or sell decision.
    • However, intrinsic value is different for everyone and depends on what you expect from the market.
    • Attaching a margin of safety to intrinsic value is all you need for low risk high return investments.



    Introduction

    99% of the what’s discussed about stocks is whether a stock is undervalued or overvalued and where will it go as you wouldn’t be a proper analyst without a price target on every stock you discuss.

    This is completely the wrong way to approach investing, but we as analysts will continue to deliver what the market wants. More →

  • 24 Mar
    Using Intrinsic Value To Measure Portfolio Performance

    Using Intrinsic Value To Measure Portfolio Performance

    • The market is irrational and can’t be used as the only measure of investment performance.
    • Imagine if all the businesses you own suddenly delisted, you’d look at their value in a different way.
    • Intrinsic value is based on the business owner perspective which is essential for reaching healthy long term returns.

    Introduction

    This past Tuesday was a bad day for stocks with both the Dow and the S&P 500 falling more than 1%. This isn’t very significant for now, apart from the fact that it broke the longest run the S&P 500 has ever seen without a 1% decline (64 days in comparison to 34 days in August 1995). However, it’s an excellent introduction to today’s topic on how we measure investment performance. More →