Why WDC was Cheap at 40.x

From time to time, the market offers you a company with discounts.
Some of it is opportunity and some of it isn't. I feel that the following is worthy to think about
(a) if the sell-down is due to rational reasons that will hurt earnings. Prices follow earnings in the short term
(b) if the company is already a decent company without the crisis. Disregarding the price, is the company doing well?
-are share holder equity increasing?
-is return of invested capital increasing?
-is debt larger than equity? You might make a mistake, or the market might become inefficient for a long time.
-is dividend history steady?
(c) perform valuation and see if the discount is worth it.

Do note that WDC has a high beta of 1.6 (which means it moves up or down 1.6 times the rate of the market as a whole).

However, it doesn't matter what type of companies it is, or if the beta is high/low. What matters is if they are cheap and performing fine as a business.

The Selldown

Due to a large sell down by Seagate of 25% on 13-April-2016, investors panic and sold down WDC by 6.6%, and a further 3.2% the next day. The reasons given by Seagate's management was difficult PC market

Market usually affects sector movements, and the entire sector usually moves in tandem. Hence a price movement like this is not unusual, given that WDC and Seagate are #1 and #2 in the market. I first read this from Jesse Livermore's Tandem Trading ideas.

This represent a support (which is the price-level where stocks seems to _not_ fall under) level at roughly 40-ish. This support is tested in mid Feb 2016, during which the markets rally together as a whole. Hence, it would be irreliable to mark this as a credible support given that it is untested.

Looking at its Financial Statements

So how is WDC performing as a company? Let's take a quick look at Morningstar figures, which cost nothing to view. The first thing you want to look at is cashflow

As you can see, cashflow isn't spectacular, but decent.

Next, we look at how the company is performing under key ratios

I looked at the revenues and it has pretty good years till 2015. But the key thing is to look at gross and operating margins, since revenues can be propped by acquiring companies. I noted that gross and operating margins are very healthy, increasing even.

From the same page, I can see the Cost of Goods and Services (COGS) is going down. Assets turnover and return of assets is going down. Return of equity is going down, but still respectable at 12%. This means we should pay attention to it from quarter to quarter.

Interest coverage represents how well the company is repaying its loans. Company servicing its loans pretty well at 25.34.

Moving on to Income Statements, I tend to look at percentages instead of actual figures as it make sense. There is a "%" button to click on within Morningstar.

I can see that cost of revenue is kept well control, and gross profits are high. Company devotes money on R&D steadily. Again, note the low interest expense.

Next Balance Sheet

What I saw is about 30% of current assets in cash, but what pleases me is the ability of this company to get payments. Receivables is reducing since 2011.

Increasing receivables could present the company booking unpaid money as revenue. Be careful.

Inventory does not hold a great percentage of this company's balance sheet. You can take the the inventory figure, in exact cash figures, and compute it as a figure of revenues. This is known as asset turnover and represent the number of times a company turn over its assets. A increasing figure means efficiency.


Moving down to liabilities,

We can see that liabilities begin to lower... long term and short term (payable < 1 year) debt is kept low at less than 20%

Finally, when you subtract assets with liabilities, you get equity.

Equity fell from an incredible 2011 of 67.6% of the balance sheet to 53.98%. However, it has been increasing since. Lovely.

And finally, dividends history offers a clue if the company has shareholders' interests at heart.

Now that we are pretty happy with the company, it is time to check if the price is good.
Immediately I start to do my cashflow valuation on this stock and for a very modest rate of 3% growth, off a reduced free cashflow of 1.6 billion, and a 12 percent discount rate, I get a figure of about 40.4 dollars. I bought the stock at 40.75 on the 15-April and went to bed. Unfortunately I do miss out on the lowest price of 40.18, but you can never time the market.. this deal is almost a no brainer. Note again that I reduce free cash flow by 100 million dollars.

It doesn't matter if it is a technology or a brick-and-mortar business. WDC is a fairly decent company with a very decent discounts. It has pretty low debts as a company. However, WDC isn't a company with any sort of moat and needs to be monitored carefully.

Update: WDC announced lesser than expected earnings per share of 1.21 to the expected 1.28, with less revenue compared to the same quarter last year. The price fell by some 4 percent on after-market sales. I have liquidated my position at 47.2 earlier after noticing a huge resistance intra-day..

Cheap, Riskless Blue-chips.

You have definitely heard this line somewhere:

Invest in blue chips. They are less risky.

This is one of the most dangerous belief to adopt.

Whether one should inject capital into a company depend largely on two main factors:

• Is it good?
• Right price?

There are good companies with bad prices. There are drowning companies with great-looking, seductive prices. Both can be equally dangerous, although I think if you have the tenacity, usually you won't make huge losses with the former, unless you are terribly ignorant.

For instance, let's take a look at a company like Helwett Packard Incorporated (NYSE:HPQ). You definitely have seen a HP printer somewhere, or used their laptops even. To be honest, I like their products. I am even holding a small amount of its stock.

I hope you recall that this blog is about sharing my mistakes!

One of the metrics used by investors is the Price-to-Book ratio. It basically means looking into the balance sheet, and taking the value of total assets minus total liabilities. What you get is call net asset, or equity.

Divide that value with the number of shares, and you get a figure known as book value per share. The ratio between the price and book value per share is known as P/B ratio. If it is lesser than one, it is generally considered cheap.

It basically means you paying less than 1 dollar for 1 dollar of assets.

Companies often report earnings every quarter, and a figure call Earnings Per Share, popularly abbreviated as eps. The ratio between price and eps is known as Price to Earnings, also popularly known as P/E ratio.

Somewhere in November 2015, HP split into two companies, HPQ (printers, desktops and laptops) and HPE (deals with cloud computer and server stuff). HPQ reported earnings and it was bad. The market pull the price down from 14.x to 12.x

The book value per share, ladies and gentlemen, is 15.75 then. This brings P/B to 0.8.
The P/E ratio, was less than 6. You will find this to be an attractive value. Generally, most people will consider a P/E of less than 20, cheap.

And so I went in. On the benefit of hindsight and new knowledge, I regretted.

During the great correction between late Decemeber 2015 and Feb 2016, HPQ dropped to almost the low 9 dollars. If you have done cashflow valuation (I will share this in a latter post), 9 bucks is a very very safe price.

That was Feb 2016 then. We are now in late April 2016, with the Dow at almost 18000 today, HPQ is still only around my buy price, and I am suffering a loss due to a less favorable currency rate.

There were two mistakes that I learnt from this trade.
(a) HPQ was carrying a lot of goodwill in its balance sheet.
(b) P/E and P/B are not great indicators of cheap companies.

Earnings can be largely doctored, and we are usually looking at last twelve months of earnings. What about future earnings? If it plunges, the P/E goes right up.

P/B ... well... rich asset does not translate into money-making, generally. Investors who largely invest in this kind of stock will hold a large basket of stock. This is not a wrong strategy. But you need to be an expert of the balance sheet.

Some assets such as

1. goodwill (excessive amount paid when companies are acquired are considered assets and stored here)
2. intangibles
3. accounts receivable (amount of money customers still owe the company)
4. inventory (stuff that are sold to customers)
5. plants, properties and equipment (assets that are used to create the products or services)

ALL of the above have subjective value.

1. HPQ acquired Compaq in the past and paid too dearly for it. That bulk ends up in goodwill.
2. It is tough to value intangibles.
3. You depending on the good faith of those debtors to pay up in Accounts Receivable
4. Inventory can go seriously out of fashion. Items such as a dental floss will probably de-value slower than the latest iPad. You have to judge...
5. Plants, properties.... well.... good luck selling them when the company liquidates..

Summary: it is what you think that you know, but just aint so, that kills you.
When the price goes up, you make money and nobody asks any questions. It is when you are losing money that doubts creeps in and kills you.

There are a lot of companies listed in indexes that are no doubt good companies but usually they are over-valued. P/E and P/B are useful, but cashflow valuation is still king.

Introduction

There are no safe investments in this world.

Investing in stocks is a risky operation for the uneducated. It takes more than simple common sense and can be emotionally draining.

My first attempt in investing was done based on chart reading, and like every first investment, it was deceptively easy. To quote Bill Gates, you usually don't learn much from successes. Easy successes in the stock market are usually pre-cursors to large, daunting failures.

This is a game which you are going to make lots of mistakes. But yet it is a game that most small to median income earners are forced to play (I can't speak for high net-worth individuals). After my early failed attempts at trading, I have adopted value investing as it suits my temperament and lifestyle.

There are successful traders out there, but mathematically they will probably methodically cut losses in 7/10 trades and win 3 in order to be profitable. It also must involve leverage (borrowings) in order to make sense in trading. If you are looking to earn 3-5K USD with trading, it is possible. It takes a lot of heart to trade, and an apprenticeship is necessary. I possess neither.

It is very fair, you need huge money to earn money, be it investing or trading. And within each field, only the best earn spectacular returns. Life is unfair in many ways but this is the exception.

I have many, and I expect more along the way. These failures rewarded me with lessons that hopefully will serve me well in the future.

This blog shall serve as a collection of the lessons that the stock market offered to me, as well as my thoughts.

Recommended Books

I believe in simplification-- the human brain can only pay attention to 3-5 items at most. The books are listed in the order in which I believe will make sense. I will also offer reasons why you have to read the next book in order (which is, what is offered in the next book and not the one before).

#1: The Five Rules for Successful Stock Investing

This should be the first book that you read. In fact, the book is so good that you can probably read just half of it and be better than the average joe.

Why you should read this book:

• This book explains the financial statements (income, balance sheet and ultimately cashflow) clearly for the layman. 
• Pay attention of the discounted cash flow method in valuating a stock.
• Red flags to look out for when investing in a company
• Discuss characteristics of a durable competitive advantage, otherwise popularly known as moat.
• Valuable discussion on how various industries work

ISBN: 0471686174

Amazon
Book Depository

#2: The Intelligent Investor

Why you should read this book:

• explains the difference between an enterprising investor and a defensive investor.
• prevents you from investing in mutual/hedge funds, stupid bond funds and IPOs
• general investment principles. 
• commentary, by Jason Zweig, on recent cases at the end of each chapter

ISBN: 0060555661
Amazon 
Book Depository 

#3: F Wall Street

Why you should read this book:

• Discuss another way of Discounted Cash Flow valuation
• Talk about special situations, namely mergers and acquisitions, which to me appears to be risk-free
• Bond laddering

This book is no longer printed, feel free to check out your local library or download the e-book here.

#4: Getting Started in Candlestick Charting

Before you carry on, make sure that you have digested #1-#3. Reading this book beforehand will encourage you to trade blindly. If you do make money, great... no questions asked.
But if you lose, doubts will cloud your mind.

I studied candlesticks to understand when to take profits.

Why you should read this book:

• explains the minimal amount of candle stick patterns to look out for in reversals. It is better to understand a handful of stuff than to skim through a hundred patterns

ISBN:  0470182008
Amazon
Book Depository