Some Fundamental Analysis
PICL
Jim Mueller, Financial Partner
October 13, 2002
We are going to use Sportsman’s Guide, Inc. (SGDE) as an example for this lesson. This is a
stock which I own and did analysis on for the TMF on-line seminar/class When To Sell. So I
know it more thoroughly than most of my stocks (unfortunately for the rest of my holdings, but
I’m getting better).
I reserve the right to have mistakes in this document, though I have done my best to avoid them.
If you find a mistake or a different definition than what is given for a term, please let me know,
so we can all learn together.
Throughout this are little Evaluation Notes. These are things to think about or watch out for on
particular topics as they come up. You will notice a lot of “in general” phrases. Stock and
company evaluation is more an art than a science, since much of it is subjective, especially when
future values are estimated. There are no hard and fast rules (except how to calculate some of
the numbers), but there are a lot of guidelines.
Where to find information about a stock:
There are many websites out there which contain information of different types (see note near
the end). The one we will use for this example is www.yahoo.com. Go to that website, and in
the list of all the other sub-sites, such as Shop: Auctions, Autos and Connect: Chat, Geocities,
find the one that says Info: Finance and click on that link. You can also reach this via
http://finance.yahoo.com/?u.
In the “search” box, enter the stock symbol, SGDE, and click Get. This pulls up a real simple
page, giving the last trade price and the amount of change from the opening. Under that
information is a list of links, including Chart. Click that to reach this page:
http://finance.yahoo.com/q?s=sgde&d=c.
Charts:
The charts are usually semi-log, that is the x-axis is time (linear) and the y-axis is share price
(log). The price is shown on a log scale, so that the same vertical linear distance represents the
same factor of change. For instance, on this chart, the distance from 2 to 4 is the same as from 4
to 8, a two-fold increase in price each time. The horizontal lines help in tracking this.
Underneath the price/time graph is an activity/time graph, showing the number of shares traded
on any given day.
Underneath that is a table containing some numbers. These are what they are, though I reserve
the right to be mistaken. This is for Yahoo. Other websites will show similar information.
Reading each column downwards, left to right:
Last trade – the last trade price, usually delayed by 15 – 20 minutes (thanks to Oct 1987).
Day’s range – range of prices stock has traded at during the day
52-wk range – range of prices stock has had during the last year, starting back from today
1 y target estimate – the future stock price a year from now, taken from a consensus of
several analysts. Take this with a grain of salt.
Change – amount of change in stock price, in dollars and percent, from the closing price
of the day before
Bid and Ask – the most recent buy and sell prices. The difference between the two
represents the cut the stock exchange gets.
Bid Size and Ask Size – size of block of shares used in the above
EPS (ttm) – Earnings Per Share (trailing twelve months): company net earnings, summed
for the most recent four quarters (which is how often companies report this data), divided by the
number of shares outstanding. Usually in the range of cents to a few dollars and sometimes
negative.
EPS Est – estimated EPS for the future 12 months (I think)
Prev Cls – the previous closing price (at 4 pm Eastern – when the markets close). Used
in the “change” calculation.
P/E – the famous “price to earnings” ratio. Only reported if EPS is positive. Take the
Prev Cls share price and divide by the EPS (ttm). Can also take the Mkt Cap and divide by the
total net earnings to get the same number. The former is on a ”per share” basis, the latter is on a
“total company” basis.
Evaluation note: In general, to buy a stock this should be low. It should be compared to
something, such as the P/E for the stock market as a whole (S&P500 is one indicator) or to the
industry the company belongs to or to its competitors.
P/S – it’s “price to xxxxxx” and I’m not sure what “S” stands for. Oh, S means Sales. I
think it is the Mkt Cap divided by the Gross Sales (ttm)
PEG – “price to earnings growth”. Not sure how this is figured. (I think)
Open – the opening price of the stock for the current day’s trading. Note that this can
vary from Prev Cls due to after hours trading.
Mkt Cap – “Market Capitalization” is the current value of the company. Take the stock
price and multiply by the number of outstanding shares. M stands for million, B for billion.
Small-cap, mid-cap, and large-cap comes from this value, dividing it into ranges, but I’m not
quite sure of the boundaries. I think small-cap is < $1 B. SGDE is definitely small-cap, might
even be called micro-cap.
Div/Shr – the amount of money paid to shareholders as dividends, per share that they
own. Done quarterly.
Yield – the TTM Div/Shr divided by the share price, expressed in percent. Usually a few
percent.
Volume – number of shares traded so far that day.
Avg Vol – average daily number of shares traded for that stock
Div Date – the date upon which the dividend will be / was paid out
Ex Date – the date upon which you must own shares of the stock if you want to receive
the dividend; always set before the Div Date
Profile:
Underneath this table is that list of other information links about a company. Click the one
marked Profile to reach this page: http://biz.yahoo.com/p/s/sgde.html.
This gives a snapshot view of the company, including a brief statement about what the company
does (Business Summary), a bit of information from the most recent SEC filing (Financial
Summary), who the officers are and what they are paid, some address information, etc. Down at
the bottom is another table, giving much of the same information given on the Charts page, but
in a bit more detail (Statistics At A Glance).
In the left column, underneath the miniature price chart, is an indication of the Shares
Outstanding (4.75M, or 4,750,000) and the Float (4.0M). The float is the number of shares
available for trading by the public (you and me).
In the right column is the Shares Short. As of Sep 9, 50.0K (50,000) shares were being sold
“short”. Percent of Float is next (1.2%). Then the prior month’s number is given. Shares Short
is only available on a monthly basis.
Evaluation note: Look for a relatively small number and stable or downward trend. A
20% short position should be considered as a strong sell signal, but other factors would also
need to be considered.
Short vs Long:
There are two types of positions on a stock, “short” and “long”. Long is the traditional view.
Buy a stock, hold it, hope the price goes up and/or lots of dividends are given, sell someday and
make your profit.
Short is a riskier way of making profit. Borrow someone else’s stock, sell it, wait for the
stock price to go down, buy the same number of shares at the lower price, give the shares back to
that person, pocket the difference. It is riskier because the stock does not always go down in
price, and at the end of the short contract, you are required to return the shares to the person you
borrowed them from, at whatever cost to you. If the stock price has increased a lot, you could
lose your shirt.
In a long position, the most you can lose is whatever you put into the stock in the first
place. In a short position, you can lose everything you own.
Generally, those who short stocks are among the more intelligent investors, but this is not
always true. There can be stupid decisions here, as well.
Financials:
At the top, just above Business Summary, is a list of links, the same list we have been using.
Choose Financials to get to this page: http://biz.yahoo.com/fin/l/s/sgde.html.
This displays the Income Statement, the Balance Sheet, or the Cash Flow Statement (“tabs” to
the left, just above all the $$ numbers) for either the last four quarters or the last three years
(toggle link to the right in the upper gray/blue bar).
Evaluation note: For quarterly data, it is best to compare the numbers from one quarter
to the same quarter of the previous year. This avoids changes due to seasonal fluctuations.
From the Income Statement:
(All dollar amounts in millions)
For the last three years, SGDE had the following sales (Total Revenues) and gross profits:
Sales
G Prof
2001
169.7
56.6
2000
154.9
51.5
1999
162.5
64.9
After Operating Expenses (primarily Research and Development, R&D, and Sales, General, and
Administrative, SG&E) are taken out, they have operating income of:
Op Inc
2001
4.3
2000
(2.4)
1999
1.1
(Remember that numbers in paranthesis are negative.)
After taxes and other charges, they had a net income of:
Net Inc
2001
2.7
2000
(3.2)
1999
0.01
Net Income is the same as “earnings”.
Evaluation note: You want to see very small and/or very few “Extraordinary Items” on
this statement. These usually mean that management has screwed up and had to write off
something as a loss.
Evaluation note: In some cases, companies report EBITDA (earnings before interest,
taxes, debt, and amoratization). This is a riskier number to use in evaluation because it is more
easily manipulated by the company. But it is used by companies to make themselves look better.
Evaluation note: You generally want to see these numbers increase, year to year. You
can calculate their yearly change by the following (multiply by 100 to get %):
( (number @ year A) – (number @ year A-1) ) / (abs value of number @ year A-1)
Sales
% Growth
2001
169.7
9.51
2000
154.9
(17.6)
Net Inc
% Growth
2.7
186.3
(3.2)
(26675)
1999
162.5
--0.012
----
Yes, that is a negative 26,675% growth from 1999 to 2000. (NB: the percent numbers come
from using more significant digits than is presented here.)
From the Cash Flow Statement:
Click the Cash Flow Statement “tab” to go here: http://biz.yahoo.com/fin/l/s/sgde_ac.html.
Note that the first line is Net Income and is the same value as the last line from the Income
Statement (at least it better be).
Go down a few lines until you reach “Cash Flows From Operating Activities”. This value is also
called the “Operating Cash Flow” (OCF). The OCF is the amount of cash brought into the
business during the reported period.
OCF
% Growth
2001
13.0
27.4
2000
10.2
263.2
1999
(6.3)
----
OCF takes into account spending for things like R&D, SG&E, the office Christmas party bash,
etc. It does not take into account capital expenditures (CapExp -- buying office equipment,
buying new plants or new property; CapExp may also listed as PP&E, for plants, property and
equipment). To get Free Cash Flow (FCF), the amount of cash brought in that could
theoretically be returned to investors as a dividend, the amount spent on CapExp must be taken
out.
CapExp can be found not much further down the sheet and should always be negative. Adding
the (negative) CapExp to OCF results in FCF, which is always less than OCF.
OCF
CapExp
FCF
% Growth
2001
13.0
(0.56)
12.5
42.9
2000
10.2
(1.5)
8.7
196.7
1999
(6.3)
(2.8)
(9.1)
----
Now we can calculate P/FCF. Take FCF and divide by the number of shares outstanding (don’t
forget we’re working with millions of dollars). Then divide the Prev Cls by the FCF per share.
FCF = 12.5 M
ShrOut = 4.75 M
FCF/Shr = 12.5 / 4.75 = 2.63
P/FCF = 6.96 / 2.63 = 2.65 (used PrevCls price)
Evaluation note: This ratio can be used when P/E is not available (due to negative
earnings). It is generally smaller than P/E and some consider it a more reliable indicator than
P/E because cash is more difficult to manipulate than earnings on the statements. Just like P/E,
P/FCF should be compared to some group, either the market, the group of similar-sized
companies, the industry, or the competitors.
Evaluation note: One should generally look at a longer time line. Here we have 3
years, but can only calculate growth for the last two years. Therefore, Yahoo may not be the
best site for getting more historical numbers. For a short time “www.simplystocks.com” was
available for free, but that changed. “quote.fool.com” gives one more year’s worth of data (to
1998). “www.nasdaq.com” also gives 4 years worth of data (drop-down menu choice of
“fundamentals”). If one wanted to, one could go through the 10-Q and 10-K reports for the last
several years to pull out the numbers. A future seminar will cover where these numbers can be
found in those reports.
Finally, one should look at some information about the company. What has it been doing?
Where is it headed? What are management’s plans for the future? Is there anything serious
going on, such as an SEC investigation? How much debt is there and is there enough cash to
cover it? Much of this information can be found on-line and by reading parts of the SEC filings
(the 10-Q, quarterly, or 10-K, annual reports). Here is a summary review I made of SGDE back
in mid-August.
Review of Sportsman’s Guide:
Sportsman's Guide (SGDE) is a small ($32.5 M market cap) catalog / on-line retailer selling
clothing, outdoor gear and general merchandise aimed at the hunter, camper, outdoor enthusiast
and those who want to live that lifestyle. They use direct mail catalogs and two websites,
www.sportsmansguide.com and www.bargainoutfitters.com.
The company was founded in 1970, selling primarily to deer hunters. They have since expanded
to the outdoors person in general and have included government surplus (e.g. military) and
manufacturers' close-out lines. They aim to be a value-oriented supply for outdoors lifestyle
purchases.
Since 1992, with sales of $43 M, they have grown at an annualized rate of 16.5%, reaching sales
of $170 M in 2001.*
They have two main things going for them: a Buyer's Club and an increasing amount of sales
over the internet.
The Buyer's Club, at $29.99 annual membership fee, gives members a 5 - 10% discount off of
merchandise, as well as the option to extend payments out for 4 billing cycles, interest free. They
have promoted heavily to add new members and the current (2Q2002) total is 270,000, up about
6% from 2001 ending total of 254,000 (which was up 91% from end of 2000). Through a study
of purchasing patterns, Club members are known to make two to three times more purchases
than non-members. As long as club member purchases do not exceed 10 times the revenue
generated by the membership fees ($81 M, or roughly 50% of their 2001 sales level), SGDE
makes money on the fees.
Internet sales, first launched in 1998, have grown rapidly since then. From a beginning of less
than 1% of total sales in 1998, it reached >21% of sales for 2001 and has continued to increase,
reaching 27% in 1Q2002 and 30% in 2Q2002.
In late 2000, they trimmed their catalog mailings to reduce those sent to non-buying people and
started heavily promoting their Buyer's Club. Starting in 4Q2000, they have seen a turnaround in
their profitablity, which has been increasing steadily. For 2Q2002, they realized net earnings of
$317,000, or $0.06 per fully diluted share, compared to a loss of $(207,000) or $(0.04) per
diluted share for the same quarter 2001. For the first half of 2002, the per share earnings were
$0.22 compared to $(0.08) a year ago.
Gross sales for the first two quarters of 2002 were up 6% and 10%, respectively, over the
previous years' quarters, and 2001 revenue was up 17.8% over 2000**. Considering that Q1 and
Q2 are historically their slowest quarters (fall and winter being best for hunting season and gifts),
this year's early growth is especially encouraging.
SGDE has no debt and a (2001) FCF of $12.5 M. As of Aug 8, the shares (at $6.84 per) were
trading at about 2.6 times FCF with a P/E of 8.8.
Pessimistically, assuming a 10% growth per year in sales, a 1.5% net profit margin (similar to
2001), and a P/E of 8.8 to 10, stock price would be $7.60 to $8.80 in 5 years (assuming no
increase in shares outstanding). On the other hand, assuming a 15% growth per year in sales
(closer to the last 9 years' average), same profit margin and P/E range, stock price would be
$9.50 to $10.75 in 5 years†.
If the P/E goes higher (the range of its competitors is 7.50 to 75.0, average of 34.2; 11 of 22
showing earnings for 2001), the stock price, of course, would go higher as well. If the P/E did
climb to the industry average, this stock would be a five-bagger††.
With no SEC investigations, a stock option grant rate of 5.25% (2001, compared to 0.5% in 2000
and 2.5% in 1999), just barely above the 5% limit goal for a small cap company‡, very few
institutions (10) interested, the paying off of the last of their debt (only $5000 at end of 2001),
and all of the above, this company looks pretty good (but keep an eye on those options granted).
Notes for this seminar:
* CAGR (compounded annualized growth rate) is calculated as follows:
( ( (number at later date) / (number at earlier date) ) ^ (1/number of years between them) ) – 1
( (170 / 43) ^ 1/9 ) – 1 = 0.165 or 16.5%
** I think that percent growth is wrong. According to the data we found above, it should be
9.5%. I must have misread a number from the spreadsheet I was using at the time.
†
This comes from some projection studies, using the CAGR formula (solving for “number at
later date”) and the assumed changes indicated, to calculate future stock prices. Net profit
margin is net income divided by gross revenue.
††
Five-bagger means the stock price will increase five-fold. Ten-bagger is a 10-fold increase. A
term popularized by Peter Lynch.
‡
Options granted come from Employee Stock Options programs. These give employees stock in
the company, which they can get at a (hopefully) lower price than the stock is trading for when
the options become vested (in the future, usually a couple of years). The employee could then
sell the stock and pocket the difference. The idea is to make the employees more loyal to the
company by giving them a “stake” in the company.
However, the effect of too many options is to dilute the number of shares out there (by
creating more), which lowers the value of each share. Doing this to excess can worsen the
dilution factor. The 5% per year value for a small, growing business is somewhat arbitrary, but
is reasonable in the light that such a company should be able to grow by 10 to 15% per year,
which overcomes the 5% dilution effect.