Moody's and Subprime Crisis

Moody’s main business model

It rates commercial and government entities based on their credit worthiness. It also performs rankings on such entities using a standardized ratings scale. It has a 40% market share worldwide in the ratings business.

Background

During the 2003 to 2006, mortgages based credit securities became an important source for profits. Profits soared as the Moody’s began to rate such securities to feed the growing appetite of investors who sought higher returns.

After the bursting of the Internet bubble in 2000 and the events on September 11, the US economy seemed to be bad shape. The Federal Reserve sought to lower interest rates in order to simulate enterprises and make it easier for people to borrow money to invest in businesses. Hence, during the early 2000s, interests rate fell to about 1% and this soon began to create a massive liquidity bubble

The cheap money was soon used by entities such as hedge funds, banks, insurance companies and mutual funds to buy assets. Similarly, central banks across the world followed suited and soon a massive bubble began to form globally. During this time, the spread between the junk bonds and treasury bonds began to narrow, fuelling a boom in leverage buy outs led by a host of private equity firms.

Mortagages and Securitization

Investment bankers securitized mortgages and loan them as packages to investors. Ratings firms such as Moody’s played a part by rating them using their models to make it easier to sell them.

With the growing appetite of investors (i.e. hedge funds) who were willing to purchase such mortgage backed securities, mortgage lenders soon began chasing customers who had a poor credit histories and more likely to default by offering loans with variable rates. During this period, interest rates were low so customers were able to afford the interest on the loan. Some of the mortgage lenders were even more aggressive and introduced deferred payment schemes which offered low initial monthly payments and pushed interest further away into the future. Such aggressive practices allowed high risk customers who were likely to default to borrow money for acquiring new homes.

Subprime mortgage lenders then packaged such these loans and securitized them to generate revenue. However, one of the problems for Moody was how to rate such mortgage backed securities…

Moody’s devised several complex financial models to help rate such securities. However, this proved to be a Herculean task as many of these financial models use past historical data and assumed historical volatilities would be the same. Moreover, such complex models are difficult to understand and could never be 100% accurate as it’s often difficult to take in all the information especially in a dynamic marketplace. Lastly, financial models fail to take in account that much of the markets movements are driven by psychology (i.e. fear and greed) which can never be truly reflected in financial models. Hence, due to the mispricing of risk in these financial models, many of the mortgage backed securities were awarded dubious ratings.

Hedge funds, hungry for returns especially in the competitive world of money management, had scooped loads of such securities using leverage in order to juice their profits. Many of these funds had relied on ratings firms such as Moody’s to rate such bonds and tended to buy those of higher investment grade (especially in the sub prime market) for safety. Using leverage on such risky investment products only made the situation. Unbeknown to the rating firms, subprime mortgage lenders had adopted aggressive practices to boost securitization revenue.

In my next article, I will touch more on Moody’s and look at its financials.

Cheers,

Manpreet

How to get Super Returns?

Hi all,i came across this interesting article from the Business times,which is a local daily newspaper that reports about the ongoings in the local stock market and regional happenings.In this article, the author describes how one can use a simple ratio such as ROE/Price to Book to generate excellent returns.The method is actually a variation of Greenblatt's magic formula.

The article

"But without any detailed analysis other than simply grouping stocks based on ROE/PTB, I found that investors can actually generate super returns.

By investing in the 10 per cent of stocks with the highest ROE/PTB every year between 1990 and 2006, and holding each portfolio for a year, one could have turned $100 into $34,000 over the past 17 years. That's a compounded return of 41 per cent a year. All the calculations exclude transaction costs.

If we assume that the investor had lost 10 per cent of the portfolio value to transaction costs every year, the return is still a respectable 27 per cent a year. But in absolute terms the portfolio value today, at $5,678, is significantly less than the $34,000 which excludes transaction costs."

The full article is here

Cheers,
Manpreet

Dell updates

I wouldn't say that Dell has been performing off late but it is undergoing an overhaul as led by founder and CEO , Michael Dell right now and is sure worth a second look.

The most recent announcement states that it will cut approximately 10% of their work force. 10% of the workforce would amount to 8800 jobs. Based on 8800 jobs, assuming each job pays USD 2000 a month, the jobs cut will effect a savings of $211,200,000 a year. Do take note that this is just a proxy to how much they can save. $2000 per month may be either too high or low a figure and may not be accurate. Despite this, some analyst have done some figures and claim that the 8800 job cuts can help the company save approximately 600 million per year. Based on such claims, the assumption is that each worker in Dell earns on average $5681.81 per month.
Whatever the assumption, i am sure you do get the picture, Dell's restructuting efforts will lead to cost savings which in turn will lead to better profit after tax figures asumming other factors constant.

Using 2006 fiscal year financial statements, Dell had an EBIT of 4.3 billion approximately. Projecting a growth of 15%(I am being ultra conservative as 22% is the CAGR for the last 3 years) from 2006, 2008's EBIT would be approximately 4.9 billion and with a 200 million savings and 1 billion in taxes would produce a net income of approximately 4.1 billion compared to 2006 income of and its eps will be approximately $1.80 with 2.27 billion shares outstanding.

With a current PE of approximately 20, it should trade at a price of conservatively $36 in 2008.

With the more aggressive assumption of 600 million in cost savings a year, its 2008 net income would be 4.9 billion + 600 million - 1 billion in taxes = 4.5 billion in net profit after tax and its eps would be approximately $2.

Currently trading at a PE of 20, it should trade at $40 in 2008.

However, i do have to disclaim myself that these figures are ball park figures and will not be accurate and this is the quick and dirty method of calculating target prices. If you want figures with greater accuracy, do try to work it out on a spread sheet.The most important thing is that when it comes to financial modelling, do try as best as possible to be conservative. In my opinion, using a dcf analysis, it should trade at around $35 - $42. And Manpreet and I agree that barring any unforseen circumstances, the catalyst is Michael Dell and his new found strategies.

And finally, one point to note is that Mason Hawkins a value manager is a substantial shareholder holding greater than 5% of the company.

Do your own homework ladies and gentlemen. You might find yourself disagreeing with me.

Remember Apollo?

Dear readers!

Remember Apollo???!!! The article i wrote a while back. Do refer to my previous article on Apollo.

For the recent quater, they have beaten analyst estimates. And what i did not expect was the stock shooting up till $58 . I woke up one morning in Hong Kong amazed to find out that the price has shot up and it made me tremendously happy to know that my hypothesis was right. Usually, when there is lots of pessimism surrounding a stock, analysts will place over conservative estimates on the company. But this time the analysts were wrong and the market responded enthusiastically.

No one's valuation is ever correct. That being said, i am prepared to sell it when it reaches my intrinsic value of around $70.

On hindsight though, do allow me to critique my investing skills and be completely honest with everyone. I feel that compared to strayer education, this company generally has a poorer set of management. They are trying right now to diversify into other companies which i feel may not be aligned to their main business as online educators and may be willing to over pay for an acquisition. Clearly, management lacks a certain focus in their directions.

Online education in my opinion is set to grow in the years to come. The world needs to reach out to such an audience and Apollo is well positioned to do just that. However, with its recent options back dating woes and its inability to read the market, management just does not seem to know their real growth potential and despite its excellent cash flow, may be allocating capital in the wrong manner.

On hindsight, i know i did buy the wrong company as there were better candidates around.


Oh well, everyone learns don't they?? :)



Better and better,
Lucas

Sarin Technologies in Singapore!

I generally feel that this company is still undervalued possibly by a substantial margin of safety. For investors, this companys is listed in the Singapore Stock market. You can go to www.sgx.com to have a look at some of its filings.

My opinions are such:

1) This company has got one heck of a moat. It is in an industry where there are relatively few players and its closest competitor is an israeli company which is not public listed.

2) The nature of the business is that of improving the yield of diamonds. It creates machines that help cut the diamond in a way that allows the diamond to be sold at a higher price. With little competition, its growth rates within the industry is pretty darned high and its net margins are more than impressive at 26.74%.

3) A while back, insiders were furiously scooping shares in the open market and these insiders were the heavy weights of the company.

4) It is an early bird within the industry and has got many patents surrounding its inventions. Unlike other products, this product relies heavily on its patents. The greater the ability of the product and inventions for value add to the price of the diamond, the greater the eventual market share of the product in the market. It's products are even endorsed by the gemological institute in the US.

5) Recently, Halibis Capital management increased their stake from From 7.942 % To 8.001 % through an open market purchase

6) The price right now is about 63.5 cents. It went up to 76 cents recently. Insiders scooped it up around such a price. Hence, it has a high probability of still being undervalued.

7) Its products are not one hit wonders, like Taser Guns. As long as diamonds are still around and women still love them, Sarin will have a good hold of the industry.


Hence, i still think that Sarin has a while to go in terms of realising its intrinsic value. Check it out people and do give us your feedback on the company.

You can contact us at valueinvestorhaven@gmail.com


Better and better,
Lucas

MMM undervalued?

Take a look at the charts. Nothing much has been going on for the past 2 years and the share price has been hovering. Right now, it is at a share price of around $78.

Is it a possible undervaluation. Possibly?

According to moneycentral, it has a a net profit growth of 22.4% compared to 12.5% for the industry. Also 5 year average profit margins are greater than the average of the industry which is 10.5%.Its earnings per share has been growing from $3.83 to $5.16 from fiscal year 2004 to fiscal year 2006.And it is trading at a PE of 15.3 compared with the industry norm which is 18.4.

Other financials include:

Book Value/ Share Debt/ Equity Return on Equity (%) Return on Assets (%) Interest Coverage
12/06 $13.56 0.36 38.7 18.1 46.7
12/05 $13.78 0.23 30.3 15.3 59.2
12/04 $13.42 0.27 27.4 13.7 62.7
12/03 $10.06 0.37 30.5 13.7 44.2
12/02 $7.68 0.56 32.9 12.9 38.1
12/01 $7.78 0.48 23.5 9.8 18.3
12/00 $8.24 0.43 28.4 12.8 27.5
12/99 $7.89 0.42 28.0 12.7 27.1
12/98 $7.38 0.52 20.4 8.6 14.7
12/97 $7.32 0.42 35.8 16.0 28.5

As you can see book value has been growing steadily which is indicative of good management.

On top of that, gurus have also bought it. Hence, is it undervalued? We leave that to you to decide!!!

Dell Inc

Dell has been beaten down pretty badly in recent times. This proves to be an exciting opportunity for investors as it may be of value to certain groups of investors.

Its current share price is $25 and it once traded as high as $43 in '05.

Without doing any form of DCF calculation, Michael Dell bought 70 million dollars worth of Dell's shares in the open market at a price of $23.99. You can verify this by looking at www.secform4.com . This serves as an indicator that this chap is confident that it is undervalued.

Other indicators of it being undervalued is when investing geniuses buy it as well. The gurus who bought it include Ron Baron, Charles Brandes, Richard Pzena and more.

With the slew of corporate actions taking place in Dell possibly serving as catalyst for a up shoot in the stock price, Dell is definitely worth taking a closer look at.

Trading at a PE ratio of 18.79 and with current earnings per share at 1.46 for 2006. Projecting eps to grow at an approximate rate of 10% a year which is lower than the annual compounded growth of 22% a year, Dell might be trading at a price of $44.18 in 5 years. Please bear in mind that this is just preliminary analysis. With Dell's decreasing moat due to competition from Hewlett Packard, one can forsee a slight decrease in intrinsic value too. If Dell does trade at 44.18 in 5 years time, that's a Compounded annual growth rate of 13% a year.

Undervaluation in apollo group (apol)

Apollo group is a company that provides online education. Its business models have been very successful and it is even the owner of the University of Phoenix and a host of other universities. Through, these platforms, apollo hopes to deliver top notch education through the internet.

Having been beaten down after disaapointing the analysts, it has dropped from a high of about $95 to approximately $48 right now. Furthermore, it is trading at a PE ratio of 20.11.

Being a growth company, some reknowned investors think that is is undervalued. Some of the investors that think it is undervalued include Ron Baron, Charles De Valux, David Dreman, Wallace Weitz & Ruane Cunniff.

A quick and dirty way of valuing the company is by looking at companies within similar industries and a company similar to Apollo is Strayer education. Strayer is also an online university on its own and trades at a PE ratio of 34.6.

Comparing a PE ratio of 20.11 of apollo to Strayer's 34.6, apollo group seems to me an undevalued entity that is worth a closer look.

Buffett’s purchase of Burlington Northern Santa Fe (BNI)

Recently, according to Sec filings, buffet purchased a wonderful company called Burlington Northern Santa Fe ticker symbol BNI.

For perspectives on the company, visit:

http://www.gurufocus.com/news.php?id=5386

http://www.gurufocus.com/news.php?id=5252

Signs that stocks are undervalued!

Investing is not all that difficult. What all investors need is a sound valuation technology, information surrounding the company of concern and the corporate actions of others.

Typically, one example that a stock is undervalued is when you see the insiders buying shares. You don't want to just see one insider buying shares in the open market. You want to see a significant level of purchases. You want to see purchases from the heavy weights of the company, namely the ceo, cfo & chairman of the company. For more regarding insider trading, you can read my previous posts on it(jan 15 monday 2007)http://valueinvestorhaven.blogspot.com/2007_01_01_archive.html

And for insider trading resources, one can use www.secform4.com , www.form4oracle.com or www.sec.gov and access form 4 filings of the company's insiders.

Another powerful indicator that a stock is undervalued is when investor greats are buying the shares of the company. If both the insiders and investing geniuses are buying up the company, it means there is a possible consensus that both the insiders and these investing geniuses agree that the stock is undervalued. Furthermore, if the investor is a value investor, one can assume to a certain extent(caveat emptor) that a sound valuation technology has already been applied to valuation of the company. In addition to that, one can investigate the investing genius further to find out if the investor conducts any form of inquiry with management. This will help boost one's confidence.

The last powerful indicator which can help an investor identify an undervalued stock is when the company is buying back its own shares in the open market. When a company buys back its shares in the open market, it not only means that the company is undervalued. Also, it serves as a sign that the company's executives are interested in increasing the wealth of its current shareholders. For example, if company A had 10 shares and $10 in earnings.Each share will garner $1 in earnings. Lets say the company buys back 5 shares. It then only has 5 shares left in the. With $10 in earnings, each share now gets $2. And the shareholders get richer and richer. So often times, a company buying back its stock not only a powerful indicator but also a catalyst.

A very recent example is Coca Cola (ticker KO). The company had a share buyback scheme and also its insiders and several gurus were buying the stock. Then, its share price was around $44. Now it is $51.75 and i believe it is worth quite a bit more. Herb Allen, a businessman with a privately held investment firm also bought into coke's shares. On top of that, Warren buffet still owns a huge stake in the company. With its growing moat and earnings projected, it isn't to hard to imagine then that coke was undervalued. A Wonderful company at a reasonable price!

Point 360 Spin Off

Company overview

Point.360 is a full-service audio-visual asset management company. It has a 30 year track record of providing media services and offers services such as "telecine, HDTV services, encoding, duplication, distribution and asset tracking for commercials, promotional spots and long-form programming".

The Company is expanding its service reach to include "the management and enhancement of digital formats, utilizing technologies for storage, digital asset management, transmission, access, streaming and viewing"

Current Price:$5.50

Book value per share:$4.30
Price to Cash flow ratio:8.83

LT Debt % of Total Capital: 8%
4 yr average ROE:5.20%
4 yr average Net Margin:2.77

The business has poor fundamentals and may not be an ideal investment.The profit margins are razor thin and 4 yr average ROE is abysmal.Still, there is something interesting to look at its lastest SEC filing .Recently, it has agreed to merge with DG FastChannel Inc.(NDAQ:DGFC). Under " the terms of the agreement, DGFC will acquire Point.360's spot advertising distribution business, and Point.360 will spin off its remaining businesses to its shareholder". Senior management plans to remain on board the spin off, which is clearly a good sign that management is confident about the long term prospect of the company.The spin offf is expected to "generate revenues of about $45 million to $50 million with EBITDA around $4 million to $6 million during the next 12 months".Lastly,shareholders of Point 360 will receive a cash payment(not yet disclosed) from DGFC and shares in the spin off.

Clearly,this is an interesting play and warrants closer inspection as spin offs tend to perform well after coming out of their parent companies.

USG

Lets take a look at the some of Buffett's previous investments and ponder over them..perhaps some of his wisdom can enlighten us.

USG.In 2001, Berkshire Hathaway bought USG stock for about $15 a share .A few months later, much to dismay,USG filed for bankruptcy.One underlying reason for this was the huge asbestos ligation that it faced. USG "faced more than 250,000 claims",which battered the stock and drove it to an all time low of $2.80. The CEO felt that bankruptcy would be the only alternative left as it would protect the business from claimants while it worked on settling the asbestos ligation.Such a strategy would keep the company from being forceably liquidated by claimants while giving it time to work out an arrangment with the claimants.

Buffet was sure that the stock would bounce back and even loaned USG stock to short sellers at an interest,knowing that the fundamentals of the company were strong and it was just a matter of time.

After its bankruptucy in 2001, the housing boom in the US meant strong growth for the company in the coming years and helped boost the company's revenues.Now, the stock current trades abt $54 and Buffett's stake is worth at abt 700 million,which is roughly abt 5 times his intial investment.

Here a key lesson is learnt.Ignore the pessimism surrounding the company and dig into its fundamentals to uncover its true potential.

Written by Manpreet

Recently, i did an evaluation on Sarin Technologies which is listed on SGX.Here is a summary from its annual report of its main businesses.

"Our products currently provide the diamond industry with technological solutions for five main areas:
(a) Planning the optimal utilization of the rough stones in order to cut the rough stones so as to achieve the maximum yield and value;
(b) Sawing, cutting and shaping of rough stones using advanced green laser technology, so as to significantly reduce the risk of stone breakage and reduce rough material waste;
(c) Polishing the facets on rough stones to transform them into polished gems, by using Sarin-developed disposable polishing discs, as source of recurring income for the Company;
(d) Measurement of two (Colour and Cut) of the four parameters of the polished diamond (Colour, Cut, Clarity and Carat) in order to help determine the value of the diamond, based on the quality grade of its colour and cut, as well as light performance measurement systems for enhancing a polished diamond’s certification; and
(e) Inscribing on polished diamonds with distinct marks like text, numerals and symbols, so as to aid in the diamond’s identification and personalisation.
Our business strategy is to consolidate our position as a market leader for the provision of high technology solutions in the diamond and gemstone industries"

Its largest market is India where 77.4% of its revenue comes from there.With the indian economy promising to maintain its stellar growth,this will continue to be a profitable source of operations.

Also, management has continued to maintain a large stake in the company,indicating their belief that the company will continue its growth

Ratios

Average net margin for last 5 yrs is 24.68


Current working capital ratio is 0.34 and stock is trading at a 20% premium
4 yr average ROA is 75.68%
4 yr average ROE is 156.9%
Current ratio is a healthy 2.98
Free cashflow per share after net capital expenditures is 0.14.So the stock is really selling at 0.41

Calculated intrinsic value is 0.75 USD. Buy price would be 0.56 USD

Assumptions:Using a 3 stage DCF,with growth rate of 20% for first 5 years, followed by 10% for the next 5 years and a terminal growth of 3%.Also assumed a debt level of 10% and discount rate 15% & a margin of safety of 25%

Written by Manpreet