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Fundamental Research Tools

Fundamental Research Tools

The Value Filter

The value filter is a very powerful tool to help you make informed decisions. It is a semi-quantitative live model that analyses and values companies per sector. The model works according to sector and is geared toward financial and industrial shares. Fundamental features used are based on profitability and include EPS growth and return on equity (ROE).

Although it includes various price multiples, this is a forward-looking model. This leads to medium- to longer-term forecasts that result in live valuations. The value filter should, however, only be used as a tool to highlight shares with value. Further research is necessary before making investment decisions.

The model is updated within a day of a company’s report. Although all care is taken when compiling the data and it is received from reliable sources, computations by our fundamental research team are not guaranteed by us and may not be complete.

Long Term Valuation Financial Risk
Interest Cover
Overvalued High Debt
Fairlyvalued Low Debt
Undervalued No Debt
Speculative


Code Price (c) HEPS
Growth (%) Forecast
P/E PEG
(P/E) (%)
ROE (%)
Forecast

P/NAV PEG
(NAV) (%)
P/TNAV P/Cash flow

P/Sales Div yield
(%)
Interest Cover
Mngmnt
Comment
AAA 100 5 10.0 200 7 0.7 203 1.6 9.8 3 2.0 7 Positive
BBB 100 20 10.0 50 25 2.5 52 2.5 18 1.2 No DIV 2 Neutral
CCC 100 Loss-making: Avoid
DDD 100 10 10.0 100 20 3.0 101 3.0 12 2 3.0 No Debt Positive
EEE 100 10 5.0 50 13 0.7 52 0.7 6 1.5 5.0 No Debt Positive


The above ratios are the five-year average forecast for each company. The two long-term valuations are all based on the PEG. The lower the PEG, the better value the company shows.

The PEG ratio is calculated by dividing the normalised historic P/E ratio by forecast sustainable average growth over next five years. It helps to identify companies that not only have low P/E ratios, but have P/E ratios that are low relative to their EPS growth. PEG ratios above 140 will be displayed in red, pointing to a possible overvalued situation. PEG ratios of between 75 and 140 will display in yellow, illustrating a fairly valued position. Green is used for PEG ratios between 35 and 75 and this is where the best values can be found. PEG ratios of below 35 times indicate that the share is either very cheap or insiders know of bad news that has not yet been announced (thus not reflecting in our valuation). This is why we classify these shares as speculative. Investors should ensure that they have a lot of knowledge about shares classified as speculative before investing.

These ranges are stated as an indication only. Although widely used, the PEG method is unstable when applied to companies showing volatile EPS trends.

Interpretation
Based on the two PEG methods AAA is grossly overvalued, DDD is at fair value and BBB as well as EEE are undervalued. CCC is currently in a loss-making position

Other Price Related Ratios

We also include P/TNAV (price to net tangible assets, to be compared to the P/NAV), P/Cash flow (to be compared to the P/E), P/Sales and the current dividend yield.

As the long-term valuation only includes information on longer-term profitability, other measures are needed for factors such as financial risk and the short-term fundamental outlook of each share.

Interpretation
Although BBB seems undervalued, the much higher P/Cash flow ratio of 18 (compared to a P/E of 10) is cause for concern. BBB also does not pay out any dividends.

Financial Risk

Long-term Valuation
Financial risk is addressed by the interest cover of each company. For a detailed explanation on interest cover and its application, please refer to our tutorials. If the company has no or negligible debt, this is stated and the share gets a green light. Where interest cover is above three times, we believe financial risk is relatively low. This will be shown in yellow, denoting low debt. Companies with interest cover below three times will not be able to handle a drop in profitability. Red highlights the high debt position and increased financial risk of investing in the company.

Interpretation
A further problem with BBB is its low interest cover.

Management Comment

When you invest in a company, you want its management to be optimistic. They may not always be right when they are optimistic, but they are always right when they are pessimistic.

The most recent management comment is classified as either positive, neutral or negative. There is no use in buying a share where the management is negative on future short-term earnings. Nine out of ten times the share price will first go lower before it goes higher. We also believe in the cockroach principle: If you find one cockroach in the cupboard there are bound to be more. A company normally has more than one bad set of results before things start getting better. And many times it never gets better. We would not buy any share where management is negative on future economic performance.

Interpretation

EEE seems like the best buy at current levels as it is undervalued, its other ratios all seem fine, the company has no debt and management is positive.

The Quality Filter

The quality filter is a very powerful tool to help you make informed decisions. It works according to sector and quantifies certain financial ratios to result in quality ratings for companies in that sector.

Long Term Valuation Quality Rating
Over-Valued Lowest
Fairly Valued Average
Undervalued Highest
Speculative

We look at the following ratios: ROE (return on equity), ROTNAV (return on tangible net asset value, operating margin and cash flow per share/EPS for the last three reporting periods, and dividend/EPS and interest cover for the last reporting period. (A quality rating will thus not be calculated for companies with a listed track record of shorter than three years.) These ratios ensure that we look at profitability, quality of reported earnings, dividend policies and financial structures. They are weighted to result in a mark out of 100 and. All ratios used are also colour coded, so that you can see which were responsible for a higher or lower rating.

The advantage of this method is that it rates all industries and companies under the same criteria. The major disadvantage is that only the latest year-end results are used, and volatility of results is therefore ignored. Furthermore, certain industries (such as banking and assurance) use different ratings and the quality rating cannot apply to them.

As with the value filter, we believe that the quality filter must only be used as a guideline and should not be used in isolation. It should rather serve as a tool to enhance the investment process and further research is necessary before making investment decisions. If you own a certain share and the latest results show its 'quality' has dropped, you should first investigate further before selling out. A drop in cash flow might be a once-off experience for reasons explained by the company. These are cold figures and you should always investigate further to ensure the sustainability of the current rating.

Furthermore as the highest-quality company is not always the best investment. The idea is to get a high-quality company at a reasonable price. The most important of this information are the EPS growth forecast, PEG ratio and the management comment.

  • The EPS growth forecast is the five-year average for each company.
  • The valuation is based on the PEG (for detailed information on the PEG, refer to our tutorials ). PEG ratios above 140 will be displayed in red, pointing to a possible overvalued situation. PEG ratios of between 75 and 140 will display in yellow, illustrating a fairly valued position. Green is used for PEG ratios between 35 and 75 and this is where the best values can be found. PEG ratios of below 35 times indicate that the share is either very cheap or insiders know of bad news that has not yet been announced (thus not reflecting in our valuation). This is why we classify these shares as speculative. Investors should ensure that they have a lot of knowledge about shares classified as speculative before investing.
  • The latest management comment is classified as either positive, neutral or negative. There is no use in buying a share if management is negative on future short-term earnings.

Although all care is taken when compiling the data and it is received from reliable sources, computations by our fundamental research team are not guaranteed by us and may not be complete.

Search Function

How to use the search function:

You can use the search function to shorten your list of potential investments. Most investors have certain requirements that their shares must fulfil before contemplating an investment. It can take a lot of effort to determine which shares may fulfil these criteria. By making use of our search function you can save valuable time. For example, if you prefer high-quality companies with low price multiples, you can search for all companies with quality ratings of above 75 and P/NAV ratios of below 1. You can then rank these shares in order of P/E. The resulting number of shares serves as your investment population and you can then take the time to determine which of these shares you should finally buy.

The strength of this search facility is that you can now spend more time on detailed analyses of potential shares, and less time on finding shares with potential.

Pre-Defined Search

For easier explanation we include three types of default searches:
Example 1: Undervalued quality shares

Undervalued shares with quality ratings above 70 and PEG ratios of greater than 35% and lower than 75%.

  • quality Rating (%) >= 70
  • and PEG (P/E) (%) >= 35
  • and PEG (P/E) (%) <= 75

Example 2: Investing for dividends

All shares with a high dividend pay-out ratio. To ensure quality this rating must be above 70 and the share must be trading at below 1.5 times its NAV.

  • div/HEPS >= 30
  • and Quality Rating (%) >= 70
  • and P/NAV <= 1,5

Example 3: Growth at a reasonable price

Companies with HEPS forecasts above 15% and PEG ratios below 100. Quality ratings should also be at least 80.

  • HEPS Growth (%) Forecast >= 15
  • PEG (P/E) (%) <= 100
  • and Quality Rating (%) >= 70

Top Ten Large and Small Company Recommendations

The top ten large companies selected are all companies that are either in the ALSI 40 or Midmarket Cap indices (therefore from the top 100 companies measured by size on the JSE). The top ten small companies are from the rest of the share population. These companies currently seem undervalued in terms of fundamental analysis. Furthermore they do not have large or unmanageable debt positions, and financial risk is low. They have not recently issued profit warnings and, in the most recent communication with investors, management was positive on future profitability.

There is no guarantee that all of these companies will outperform. A few of them will more than likely underperform. As a whole, however, they display below-average risk and are fundamentally undervalued. As a group, their future investment returns should therefore be more than satisfactory. The top ten selections are updated and published twice a month when circumstances allow, otherwise at least monthly.

Consensus Forecasts

Consensus information is provided by McGregor BFA. Individual forecasts are received from all major stockbrokers, and McGregor BFA then calculates a consensus forecast and consensus recommendation for each share. Our fundamental research team uses this raw information provided by McGregor BFA to calculate the forecast growth rates per year for three years, as well as the annualised three-year compound growth rate. We also calculate the current P/E and dividend yield (DY), as well as the forward rates for one, two and three years. A further calculation is the PEG based on the current P/E ratio and the annualised three-year compound growth rate. We also add information on financial year-end dates, the latest actual HEPS and latest dividend figures. The consensus forecast is updated weekly.

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