Economic Rigor

Been continuing my series on Billabong in conjunction with my CFA Level 2 Equity revision. The next part of Equity valuation is all about Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE). These values refer to the amount of cash available to all capital holders (FCFF) or just to equity holders (FCFE...with Debt Repayments and increases removed) The formulas are as follows FCFF = Cash flow from operations + (Interest expense*(1- Effective tax rate)) - Cash Flow from Investments FCFE = FCFF + Debt increases - Debt repayments Once you have FCFE, you can then use a DCF model to find the intrinsic value of equity and then divide by the number of shares on issue to get a value per share. the DCF model used : Price = FCFE*(1*SustainableGrowthRatio)/(Rate of return - SustainableGrowthRatio) Sustainable growth ration = ROE*(1- DividendPayoutratio) So using all these formula's brings us to the following FCFE over the years for Billabong 2012  ...

Time for another update on the Market Risk Premium for the ASX. Using my customary 2.5 years of individual returns for the ASX200, we have a market return (Capital Gain) of 3.27% p.a. Adding the average dividend yield over this time of 4.6%, means we have a market return of 7.87% (down from August 2012 by around 2%). Risk free rate (10 year Commonwealth Bond) average of 4.15% means our market risk premium = 7.87%-4.15% =3.72% (down from 5.13% in August). Which makes sense I guess as interest rates have fallen, you would expect the cost of capital of equity to go down a little as well.

Still studying for my CFA Level 2 Exam (rapidly approaching in June) and came across that old friend, The Gordon Growth Model formula. What was new however, is using it to value indexes. So I decided to apply it to the ASX200. As most of you know, the GGM formula is (Price today) = (Dividend Next Year)/((Rate of Return)-(Growth)) Using RBA figures, we have the average dividend yield over the last 2.5 years as being 4.6%. Applying that to the 1 April value of the ASX200 = 4931 we have a dividend today of 231.80. Assuming a growth rate of 3.25% (OECD forecast), that means next years dividend = 239.33. Now to our rate of return. Using ASX200 daily returns since November 2010 (the usual 2.5 years), we have an average daily return of 0.0128%. Multiplied by the 256 trading days, we have an yearly return of 3.26%. Add on that dividend yield and we get 7.86% being our total market return. 10 year bond rate average over that same 2.5 yearly period gives us a risk free rate...

I'm amazed by the cutting of the HECS-HELP 10% discount announced by the Gillard Government. Talk about short sighted. If you take away the discount, which according to the Gratton Institute report on Higher Education is only worth $40 million a year, you take away any incentive for people to pay university fees upfront. That means people will take on HELP debt and so add to the rapidly increasing stock pile of outstanding money (currently at $26.3 Billion). The problem with this is that some of this debt is never re payed (approx $6.2 billion is estimated as doubtful debt) So that is a doubtful debt ratio of 23.6%. Let's do a little exercise. If we assume $40 million represents the 10% discount, then 100% = $400 million. Thus $360 million would be the amount of money received by the government for upfront payments. Lets assume that with the reduction of the discount, only 20% of people who currently pay up front, do so now. Therefore the amount that goes onto the Gover...

Been running the ruler over the sad story of Billabong. What a disaster. A share price that tanked from the highs of 2007 ($16 odd) to it's current price of $0.53. When you look at the chart, there is an awful lot of value destruction. So I decided to have a look at the fundamentals to see if there were any red flags a long the way. And as far as I can see, there were four areas that would concern me. 1. Net Margin Decline NPAT/Revenue went from 13.7% in 2007, to 13% (2008), to 9.13% (2009), to  9.75% (2010), to 6.9% (2011). Besides the brief uptick in 2010, it's been all downhill 2. Quality of Earnings Accruals ratio went from 12.58% in 2008 to 19.78% in 2009. It then decreased to 2.78% in 2010, but jumped again in 2011 to 15% Clearly some inconsistancies in relation to cash management. 3. Asset Quality Using my favourite ratio of ROA, we have it at 12% in 2007, but then a steady degredation to 11% (2008), 7% in 2009, 6.5% in 2010 to...

Been running the ruler over Cochlear as it appears to have been shunned by investors. Not exactly sure why. But the share price has fallen though the floor in recent times. Sure there have been some downside surprises on the earnings front, but a lot of the negativity comes from the product recall which is now in the rear view mirror! Due to my CFA Exam 2 studies, I have been focusing on quality of earnings, specifically the Balance Sheet Accruals ratio. This gives you some insight into how much of the earnings are cash vs how much is accruals. Cash earnings are a lot more robust and sustainable than Accruals. It involves calculating the change in the Net Operating assets over the years (also known as Aggregate Accruals) and then dividing that number by the Average Net operating assets over the years. Using the annual reports, I have the following figures for Cochlear 2009-2010 - BS Accruals ratio = 15.5% 2010 - 2011 - BS Accruals ratio = 15% 2011 - 2012 - BS Accruals rat...

Once again, I think the Reserve will propose a "Wait and See" approach to the Australian Economy, especially with the whole Cyprus situation. This means the Australian Dollar will probably stay high for the foreseeable future.