Reading Benjamin Graham's The Intelligent Investor, Chapter 14: Stock Selection for the Defensive Investor, we take a look at a real life sample and apply the principles stated by Graham.
Let's look at the 10 year data for Ayala Corp. one of the Philippines' largest conglomerates, a certified "blue chip" or leading company for sure.
The 10 year data that I compiled is:
AYALA CORPORATION
Book Value per Share Earnings Per Share Dividends
2015 298.80 33.38 5.76
2014 261.63 29.35 4.80
2013 230.68 20.39 4.80
2012 208.78 16.92 4.00
2011 183.98 14.43 4.00,20%
2010 17.01 4.00
2009 11.77 4.00
2008 15.17 4.00,20%
2007 31.47 8.00,20%
2006 23.89 4.00
2005 19.82 0.06
1) Adequate size of the Enterprise - PASSED
One of the biggest companies in the Philippines, it definitely fits this criterion. This is definitely not a small company "subject to more than average vicissitudes."
2) A Sufficiently Strong Financial Condition
A - For Industrial Companies, Current Assets should be Twice Current Liabilities. Let us take a look at the latest 2015 Annual Report: - FAILED
Total current assets - 262,850,558,000
Total current liabilities - 205,967,464,000
To meet this criterion, Total current assets must at least be - 411,934,928,000
Although Ayala Corporation may not be fully considered an industrial company, it has also stakes in Real estate, utilities, education and infrastructure.
B - Long-term debt should not exceed the net current assets or working capital: - FAILED
In my understanding, net current assets mean total current assets less total current liabilities:
Total current assets - 262,850,558,000
Total current liabilities - 205,967,464,000
=Net current assets - 56,883,094,000
Total non-current liabilities - 259,563,276,000
To meet this criterion, Net current assets or working capital must be > Total non-current liabilities.
However, this criterion is another for an industrial company, of which Ayala Corporation, a conglomerate, cannot be fully classified.
C - For public utilities, the debt should not exceed twice the stock equity at book value: - PASSED
Total Liabilities - 465,530,740,000
Total Equity - 328,543,983,000
Total Liabilities did not exceed twice the total equity or 657,087,966,000
3) Earnings stability - PASSED
"Some earnings for the common stock in each of the past ten years."
4) Dividend Record - PASSED
"Uninterrupted payments for at least the past 20 years."
5) Earnings Growth - FAILED
A - "A minimum increase of at least one-third in per-share earnings in the past ten years using three-year averages at the beginning and end."
That means to say at least 33.3% increase in earnings per share for the beginning and ending 3-year averages of the 10 year period.
Let's do the yer 2005 to 2015:
2007 31.47
2006 23.89
2005 19.82
3-year average for the beginning: 25.06
2015 33.38
2014 29.35
2013 20.39
3-year average for the ending: 27.71
From ending to beginning of the 10 year period, that is only an increase of 10.57%
To pass this criterion, increase in earnings per share in the 10 year period must be at least 33.3%
6) Moderate Price/Earnings Ratio - FAILED
"Current price should not be more than 15 times average earnings of the past 3 years."
Earnings per share in the past 3 years:
2015 33.38
2014 29.35
2013 20.39
3-year average: Php 27.71
Current price as of November 17, 2016: Php 762
Price / Earnings Ratio: 762 / 27.71 = 27.5 times earnings
To pass this criterion, current price must be, at the most, 15 times latest earnings per share or Php 408.15.
7) Moderate Ratio of Price to Assets - FAILED
"Current price should not be more than 1 1/2 times the book value last reported."
Book Value per Share Earnings Per Share Dividends
2015 298.80 33.38 5.76
Book Value per Share: Php 298.80
Current price as of November 17, 2016: Php 762
1.5x Book Value per Share: Php 448.2
To pass this criterion, Current price (Php 762) must not exceed (Php 448.2).
***"However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb we suggest that the product of the multiplier (15) times the ratio of price to book value (1.5) shall not exceed 22.5."
P.s. Some modern versions of this rule make use of the formula called the Graham Number:
Square root of 22.5 times earnings times book value to arrive at a specific figure in between the two
___________________________
/
\/ (earnings x 15) X (book value x 1.5)
OR
___________________________
/
\/ 22.5 X earnings X book value
=
___________________________
/
\/ (Php 408.15) X (Php 448.2)
**See #6 and #7 above
OR
___________________________
/
\/ 22.5 X Php 27.21 X Php 298.80
=
Php 427.71 Value, with respect to latest 3 year earnings and book value at the prescribed multipliers
>>As you can see Graham uses EARNINGS in the form of historical averages and Net ASSETS in the form of book value to gauge the VALUE in the market price.
>>He also gauges SAFETY by applying certain financial ratios to the debt, equity and current accounts.
The Graham Number, as seen in our previous post: (http://pilifinance.blogspot.com/2016/05/the-graham-number.html)
takes into account the square between these two factors.
However, as Pilifinance prescribed in our post on The Graham Number, we used an even more conservative multiplier of P/E ratio of 10, and an less than or equal book value of 1.
That changes Benjamin Graham's multiplier from 22.5 to 10.
Using 10 as a multiplier, we arrive at the figure:
___________________________
/
\/ 10 X Php 27.21 X Php 298.80
=
Php 285.14 Value, with respect to latest 3 year earnings and book value at the Pilifinance multipliers
IN CONCLUSION:
Current market price as of November 17, 2016 (Php 762) is too high a price to pay for Ayala Corporation shares for the conservative investor, as prescribed by Benjamin Graham.
Not only did it fail certain tests such as the minimum 33.3% 10 year earnings growth, and certain tests for the industrial company, which may warrant a higher safety net or risk premium, but the current market price of P762 is too high even if these tests were met.
For Pilifinance, it may be wiser to wait for the prices to go down the following levels:
TARGET or BUY Prices for AYALA CORPORATION based on 2015 Financial Statements:
(BUY ON OR BELOW THESE PRICES)
Following suggested multipliers by Benjamin Graham:
EARNINGS WISE: P 408.15
ASSETS WISE: P 448.2
COMBINED: P 427.71
Following suggested multipliers by Pilifinance:
EARNINGS WISE: P 272.1
ASSETS WISE: P 298.8
COMBINED: P 285.14
Average of both suggestions: P 356.43
>>>>>>>>>
or ROUGHLY
A price of P300 OR BELOW would be a sure BUY for AYALA CORPORATION SHARES
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