Investment Analysis Minimum

Investment Analysis

For personal investors to beat the market average

Yao @ RBS

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Amazon’s Up-Swing 2023

How would you know AMZN will come back rather than continue to decline?

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Tesla’s Down-Swing 2022

How would you know Tesla will decline substantially rather than continue to rise?

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Personal investors hope to beat the stock market average while controlling risk.

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Why

Investing

in Stocks?

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Why

Investment

Analysis?

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Disclaimer

The information or service provided is for informational purposes only and is not intended to be personal financial advice. There's an inherent risk involved with financial decisions and the course instructor shall not be held liable for decisions others make.

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Lynch: “A share of stock is not a lottery ticket. It’s part ownership of a business.”

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Personal Investors: Value > Speculative Investing

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Market Transits Slowly

You got time to make investment decisions.

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Stock Price Follows A Random Walk

Can’t predict tomorrow’s price change by today’s price change.

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Value Investing of Buffett

Rules

"Focus your investment on a few great opportunities that you understand well.”
Identify companies with “superior economic prospects”.
Buy them at a “sensible price”.

Plan

Maintain and update a list of great opportunities (companies).
Estimate and update their intrinsic values.
Wait for the right time (price) to strike.

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Industry Analysis

Identify promising industries to invest

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Industry Analysis

Factors driving industry market cap?

Which industries to invest or avoid?

Which countries to focus?

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KPI Examination - Choose Your Own KPIs examination

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An example for the financial and market terminologies.

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KPI Examination - Choose Your Own KPIs examination

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An example for the financial and market terminologies.

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Total market cap (industry total)

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Largest industry by market cap is IT, followed by consumer discretionary, ...

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Total revenue (industry total)

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Largest industry by revenue is consumer discretionary, followed by consumer staple / IT, ...

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Total Net income (industry total)

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Industry Total Market Cap Correlates to total net income.

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Total Operating Cash Flow (industry total)

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Industry Total Market Cap Correlates to total operating cash flow.

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Market cap, 2022 (industry median)

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Market cap, 2022. Market cap cannot be negative.

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Net income, 2022 (industry median)

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Market cap ~ net income, 2022. The sequence is consistent.

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Operating cash flow, 2022 (industry median)

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Market cap ~ operating cash flow, 2022. Market cap cannot be negative. But the sequence is consistent.

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Financial Performance Does Drive Market Cap

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Industry Analysis

Factors driving industry market cap?

Which industries to invest or avoid?

Which countries to focus?

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Type of Industry

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Different P/E for different Industries: Which Do You prefer?

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(1) Very different P/E for different sectors: IT highest 30-40, industrial high 20-30, utilities surprisingly high, consumer discretionary low 10-20, energy lowest. (2) Up to 2022, P/E ratios are not extremely high yet overall. Given historical average P/E of SP500, 30-40 is high. But overall it is not too high. (3) Does P/E depend on net income growth rate as many claimed? Not clear. Why is IT constantly higher P/E than industrials? Does net income growth drive P/E ratio? No clear answer.

SP500~All, except energy has a spike in 2020, due to lack of data.

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Find industries with constantly increasing market cap?

What does market cap growth depend on?

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Industries with constantly high market cap growth? I (industry total)

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Choose industries with constantly high market cap growth? Hard to find any. industry net income growth may be a good indicator.

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Market cap growth by industry 2022

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from 2021 to 2022, only energy mkt cap increased. utilities not shown? 0.

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Net income growth by industry 2022

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from 2021 to 2022, energy net income increased, as well as industrials, real estate and utilities.

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Bad news: No industry has constantly growing market cap.

Good news: Market cap growth ~ Net income growth

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Avoid constantly declining industries

Different region (country) may have different ones

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China Real Estate (industry total)

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Add: liability, debts, ... ??
Revenue, net income, market cap, cash flow (health).

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China Real Estate (industry median)

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Revenue, net income, market cap, liabilities (health). While total revenue is stable, net income constantly went down as market cap. Meanwhile liabilities maintain at high level.

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US Department Stores (Industry total)

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Total revenue is going down constantly. Net income and cash flow fluctuated and clearly suffered substantially from the pandemic. Market cap is constantly going down even after the pandemic, the market is not buying the rebound.

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US Department Stores (Industry Median)

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Except fluctuated net income, much similar to China Real Estate.

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Industry Analysis

Factors driving industry market cap?

Which industries to invest or avoid?

Which countries to focus?

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Industrial Trend - Choose Your Own KPIs (Industry Total)

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US companies has largest market cap as a whole. followed by China, Japan, India ~ Germany.

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Industrial Trend - Choose Your Own KPIs (Industry Median)

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India has fewer data in 2017, not representative - remove.
Typical US company also has the largest market cap. Followed by China.
Indian company median market cap surpass Japan for the first time in 2022, but still much smaller than German companies on an individual basis.

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Company Analysis

Identify individual companies / stocks to invest

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Why Invest in Individual Stocks?

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Individual stocks may outperform industry average by far

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Why Investing in Individual Stocks? II

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Individual Stock Investing: Challenging but Feasible, because market cap strongly ~ net income. Example, IT SP500 USA.

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SP500 Companies

Mid-large cap

Well known

Plenty of Choices

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Where to Look for Opportunities?

Three

Exploding

Stocks

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Outstanding Business

Superior economic prospects

Stable & healthy short / long-term
Large market cap & revenue
Decent growth
Profitable
Efficient
Moat
Team

Greedily expensive.
Wait for either whole or industry-specific market crash.

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Rebound / Turnaround / Hiccups

Was an outstanding business.
Recently in financial trouble: profit loss, negative growth, ...
Panically cheap.
Requires deep fundamental analysis.

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Smaller but High Growth

Outstanding business except not large, less stable, higher risk
High growth: revenue, net income, stockholder equity, ...
Huge price fluctuation.
Requires deep fundamental analysis.

Wish you bought Apple in the 1980s?

You may find yourself invested in WeWork in 2022!

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Determine Fair Price (Intrinsic Value)

When to sell or buy?
Compare actual price to the fair price.

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Data analysis shows:

Popular formulas

on the right are

neither Robust

nor Significant

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Robust &

Quite Significant

in Data

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An example for the regression model: price vs. eps

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An example: for US, SP500, Consumer Discretionary. The Slope = 10.72: On average, $1 of EPS change led to $10.72 change in stock price. Const = $115.04: If EPS=0, the average stock price for this industry is $115.04.

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Intuition / Principle

If we knew EPS in the future, then the stock price is a fixed number:
Price = Net Present Value (NPV) of all EPS in the future

But we don’t know, so the market guesses wildly and the price is random.
Regression model: 𝑃𝑟𝑖𝑐𝑒=𝑆𝑙𝑜𝑝𝑒×𝐸𝑃𝑆+𝐶𝑜𝑛𝑠𝑡, iron-out randomness
- Slope: Average price change in response to EPS change.
- Const: Average price at EPS=0 or stockholder equity / shares.

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Usage of the Regression Model (RM)

Slope: Estimated by RM, individual company or industry.

Estimated EPS: Fundamental analysis for possible scenarios.

Const: Intercept (estimated by RM) or stockholder equity / shares.

RM works if (1) make sense: positive correlation (2) statistically significant.
Significant (>50%). Moderately significant (30-50%), Not significant (<30%).

Predicting stock prices becomes predicting firms’ financials (EPS).

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Fair Price Range

The fair price is a range, width defined by safety margin, updated over time.

Slope is a range but not a single value.
Estimated EPS is a range based on different scenarios.
Equity and shares may change over time.

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Regression Model (RM) vs. Just P/E Ratio

A bit more effort for a better result

Estimate Slope and Const (price at EPS=0) by a regression analysis
More precise
Model significance and confidence

Estimate the P/E ratio by taking average or median.
Rough estimate
Model significance is unknown.

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Compare the actual stock price to the fair price range

Handling

Different

Cases

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Case

Studies

Semiconductors: Intel, AMD, TXN.
Retailing: AMZN, Nordstrom, TJX.
Pharma / Biotech: Pfizer, JnJ, Merck.
Automobile: Ford, GM, Tesla.
Capital Goods: GE, Boeing, Deere.

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Semiconductors

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Semiconductors, SP500, stock price vs. EPS

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Industry-wise, the correlation is not significant if we combine all years of 2018-2022. Slope vary significantly from year to year, reflecting market prospects and sentiments, from 6.58 to 37.34. The significance also varies, from 0.01 to 0.7.

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Enterprise Trend - Choose Your Own KPIs

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We retrieve company data: INTC, AMD, TXN. Eyeballing EPS and stock price data for each company, we notice strong correlations.

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Value Driver Analysis

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Value driver analysis confirms the significance of the regression model for Intel, AMD and TXN. Here, I only show the result for Intel. Change Intel to AMD and TXN, you will get similar results.

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Primary Opinion (Company Model)

Individual Company	INTC	AMD	TXN
Slope	10.34	49	14
Intercept	$4.09	$19.45	$55.20
Significance, R square	0.86	0.91	0.4
EPS min $	2	0.3	5
EPS max $	5	4	10
Fair price min $	$24.77	$34.15	$125.20
Fair price max $	$55.79	$215.45	$195.20
Actual price in 1-3/2023	$25~30	$60~100	$170~180
	Within, low side	Within	Within, high side

AMD has a much bigger slope of 49, implying $1 change in EPS, stock price changes in $49 on average.

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Under-Valued vs. Over-Valued

Is Intel under-valued?
If intel’s EPS returns to $4~5, stock price may be $45~$55.
Causes of Intel’s slip? Will Intel rebound?
- See CI analysis: problems & causes.
- See MI analysis: turnaround strategy.
A strong buy case.

Is TXN over-valued?
Price back-track to EPS:
- Individual model: Need an EPS of $8.5 to achieve the price of $175.
- Given TXN EPS trend, it achieved $8.38 in 2021, $9.51 in 2022, it may achieve $8.5 again.
Not a strong sell case.

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Comparative Valuation

INTC vs. AMD / TXN:

INTC has much bigger revenue, net income and stockholder equity,

But same or smaller market cap!

Either INTC is under-valued or AMD / TXN are over-valued.

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Enterprise Trend - Choose Your Own KPIs

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Comparative analysis on valuation: revenue much bigger, net income much bigger, equity much larger but same or smaller market cap? Either INTC is under valued or AMD / TXN is over valued.

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Intel's Come Back 2023

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Retailing

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Value Driver Analysis

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US, SP500, retailing, 5 years show a consistent slope! All significant.

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Enterprise Trend - Size

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Then we retrieve company data: AMZN, JWN, TJX. Eyeballing EPS and stock price data for each company, we notice strong correlations.

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Value Driver Analysis

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value driver analysis confirms the strong correlation for Amazon, Nordstrom and TJX.

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Primary Opinion (Company Model)

Individual Company	AMZN	JWN	TJX
Slope	31.33	2.88	8
Intercept	$78.71	$26.47	$52.90
Significance, R square	0.7	0.56	0.49
EPS min $	0.3	1	2
EPS max $	4	4	4
Fair price min $	$88.11	$29.35	$68.90
Fair price max $	$204.03	$37.99	$84.90
Actual price in 1-3/2023	$90-100	$15~26	$78~82
	Within, low side	Below	Within

Amazon has the highest slope of $31, implying $1 change in EPS will result in $31 change in stock price on average.

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Under-Valued vs. Over-Valued

Is AMZN under-valued?
If AMZN EPS returns to $1-3, stock price may be $110~170.
Causes for AMZN slip? Will AMZN rebound?
- Over-expansion in pandemic --> labor productivity dropped & net income loss …
- Massive lay-off & re-org. early 2023 …
A strong buy case.

Is JWN under-valued?
If JWN EPS returns to $2-4, stock price may be $32~38.
Causes for JWN slip? Will JWN rebound?
- Pandemic hit hard but net income rebounded afterwards.
- Industry outlook for department stores is bleak …
Not a strong buy case.

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Amazon 2022 Fundamental Analysis (Brief)

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Amazon’s Come-Back 2023

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Nordstrom's No Come-Back 2023

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Pharmaceutical / Bio-Tech

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Value Driver Analysis

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bio-tech companies can have a much higher EPS and stock price than pharma. However, pharma seems to have a higher slope, 20.33, than bio-tech, 10.12. regression model of bio-tech is more significant than that of pharma.

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Enterprise Trend - Choose Your Own KPIs

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Pfizer, jnj, Merck. Eyeballing EPS and price, moderate or strong correlation.

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Value Driver Analysis

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moderately significant correlation is observed for Pfizer, JnJ and Merck.

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Primary Opinion (Company Model)

Individual Company	Pfizer	JnJ	Merck
Slope	7.19	14.48	6.69
Intercept	$21.10	$68.02	$55.89
Significance R square	0.46	0.56	0.34
EPS min $	1.5	5	2
EPS max $	6	8	6
Fair price min $	$31.89	$140.42	$69.27
Fair price max $	$64.24	$183.86	$96.03
Actual price in 1-3/2023	$40-45	$150-170	$103-114
	Within	Within	Above

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Under-Valued vs. Over-Valued

Is Merck Over-valued?
Over-value analysis:
- Price back-track to EPS: by individual RM, Merck needs an EPS of $8 to achieve the price of $109.
- EPS × Shares --> Net Income ≥ $20.3B.
- Net Income / Net Margin --> Total Revenue ≥ $81B.
Is this feasible?

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Over-Value Analysis of Merck: Not Infeasible but Challenging

Since the RM model is only moderately significant, either sell or hold is fine but sell may be a better choice.

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Merck: A Laggard For Seven Months*

* https://www.investors.com/news/technology/merck-stock-is-it-finally-time-for-this-2023-laggard-to-stage-a-comeback/

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Automobile

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Automobile, SP500, US, 2018-22

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As EPS increases, stock price went down?!

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Automobile, SP500, US, 2018-22, remove Tesla

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Tesla stock price behaved differently than others. After removing Tesla, we have a positive and significant correlation.

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Enterprise Trend - Choose Your Own KPIs

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Ford / GM: stock price went nicely with EPS. Tesla: increasingly better EPS, but its price first went skyrocketed and then plummeted – speculative market behaviors.

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Primary Opinion (Company Model)

Individual Company	GM	Ford
Slope	4.52	2.28
Intercept	$16.54	$9.72
Significance R square	0.21	0.73
EPS min $	4	0
EPS max $	7	4.5
Fair price min $	$34.62	$9.72
Fair price max $	$48.18	$19.98
Actual price in 1-3/2023	$33-43	$11~14
	Within	Within

The regression model for GM is not significant.

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Comparative Valuation

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Market’s Over-Reaction to Tesla

Tesla was a smaller but high growth company. The market over-reacted to the rise of Tesla in 2020-21 and made a correction in 2022. The regression model does not work for Tesla due to market speculations.

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Tesla’s Down-Swing 2022

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High Growth vs. Rebound

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Capital Goods

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Capital Goods, SP500, US, 2022

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Quite significant Slope

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Enterprise Trend - Choose Your Own KPIs

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Primary Opinion (Company Model)

Individual Company	GE	BA	Deere
Slope	1.33	4.11	15.18
Intercept	$81.04	$264.27	$65.70
Significance R square	0.59	0.8	0.85
EPS min $	0	0	7
EPS max $	5	20	25
Fair price min $	$81.04	$264.27	$171.96
Fair price max $	$87.69	$346.47	$445.20
Actual price in 1-3/2023	$70-95	$200-210	$400-430
	Overlap	Below	Within

I use 0 as the min EPS even if the company had negative EPS in the data

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Under-Valued vs. Over-Valued

Is Boeing under-valued?
If Boeing can stop losing, EPS=0, stock price may be $260+.
Causes for Boeing slip? Will Boeing rebound?
- 737 Max crashes, whistleblower found dead, 8 incidents in 2 weeks, …
- Too big to fail, the only military & civil aviation manufacturer, …
Actionable plan to turnaround?
Not a strong buy case.

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The Market Hasn’t Figured Out … Neither Did I

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Word of Caution

No models / formulas always work in stock markets!
Even if the regression models work (positive correlation, significant), they only reflect the past.
The regression models ignore many factors; so if they don’t work, do not use them.
There are always exceptions to the comparative valuation.

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Despite all odds, there are patterns in data that we can discover & use to beat the market average as a personal investor while controlling risk.

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Investment Analysis Minimum

Primary Modal