As promised from the previous article, here is one real life example of applying our short discussion to real life scenarios:
Pepsi Cola Philippines Inc. (Ticker Symbol: PIP)
Listed on February 1, 2008 on the Philippine Stock Exchange, Pepsi Cola is a company most people are familiar with. It listed with an IPO (Initial Public Offering) price of P3.50. The Summarized Balance Sheet as of June 30, 2007 is as follows (figures are rounded off for simplicity):
Total Current Assets P2.3Billion
Total Non Current Assets 4.5Billion
TOTAL ASSETS P6.8Billion
Total Current Liabilities P3.2Billion
Total NonCurrent Liabilities 0.3Billion
TOTAL LIABILITIES 3.5Billion
Capital Stock P0.5Billion
Additional Paid in Capital 0.05Billion
Retained Earnings 2.75Billion
TOTAL STOCKHOLDERS’ EQUITY (Net Worth) P3.3Billion
Cash from the IPO 4.0Billion
TOTAL NET BOOK VALUE or Stockholders’ Equity After IPO P7.3Billion
Market Capitalization After IPO (P3.50 x 3.68Billion shares) P12.9B
Market Capitalization Formula=Price per share x Outstanding Shares
During the IPO: the Market Capitalization is larger than the Net Book Value It is selling about 1.8 times its recorded value on its balance sheet, as calculated below:
Price to Book: (12.9B/7.3B= 1.8x)
Price to Book Formula=Market Capitalization Divide by Net Book Value
Let’s look at the 2007 Net Income
NET INCOME (for one year ending June 30, 2007) P1Billion
Let’s compute for (trailing) P/E
P/E: P12.9B / P1B = 12.9x
P/E : stock price per share divided by earnings per share (or market cap divided by total net income)
This means that if we buy at the IPO price of P3.50 per share and we expect to have the same 2007 Net Income in the future years, we’ll recoup our investment in about 13 years. Or put in another way, this could give us a return of about 8% per year (1 divided by 13). This assumes that earnings do not grow or do not decrease per year.
Let’s now look at the dividends:
According to its IPO prospectus, it will have a dividend policy of paying off 50% of its net income as dividends. So in this case, if it makes 8% a year, it will pay about 4% a year in dividends. You could get 4% return on your investments. This is better than time deposits but less than most long term government bonds.
(An IPO prospectus or red herring tells the public the important information about the company to enable the public to decide whether the IPO is a good one. Of course, I rarely know of investors who read it beginning to end before subscribing. Reading it should give you an advantage.)
Based on the IPO price, it’s an average investment but not an excellent one.
On the day of the IPO, it opened at P3.30 and went as low as P2.90. It traded above P2 until September 2008. Then the sub-prime crisis came. Most investors panicked, selling irrationally the stocks they had bought just a few months ago. Starting October 2008 the price fell below P2, it even went below P0.70 and traded below P1 from late October 2008 to late April 2009. (Honestly, I didn’t think people would less likely to drink Pepsi products just because there’s a credit crunch going on.)
Although the prices went crazy, the business did not. Let’s look at the Financial Statements for the Fiscal year ending June 30, 2008. (A business year that ends on December 31 is called a Calendar Year when it ends any other month its called Fiscal Year)
Pepsi-Cola Products Philippines Inc.
June 30, 2008
Total Current Assets P2.5Billion
Total Non Current Assets 5.5Billion
TOTAL ASSETS P8Billion
Total Current Liabilities P2.3Billion
Total Non-Current Liabilities 0.40Billion
TOTAL LIABILITIES 2.7Billion
Capital Stock P0.5Billion
Additional Paid in Capital 1.2Billion
Retained Earnings 3.5Billion
TOTAL STOCKHOLDERS’ EQUITY (Net Worth) P5.3Billion
Market Capitalization at P1 (P1 x 3.68Billion shares) P3.68Billion
Price to Book (3.68B / 5.3B = 0.69x)
LOOKING AT THE NET ASSETS:
The company is selling P0.69 for every P1 you’ll get using recorded book values. Based on the book value you’ll get about 30% discount.
We can also observe that the company has basically no long term debt. Long term Debt to Total Assets is just about 5% (0.40B / 8B). Long-term debt to equity is just about 7.5% (0.4B / 5.38B)
NET INCOME (for one year ending June 30, 2008) P0.76Billion
P/E Ratio (3.68B/0.76B = 4.84x )
LOOKING AT THE RETURN ON YOUR INVESTMENT:
Although the Net Income went down, and assuming it stays low, you still get a good deal. Here’s why: It would take less than 5 years (about 4.84 years) to recoup your capital if you invest at current prices (in this case P1) and faster if earnings grow. Now based on the IPO prospectus the reason for the IPO was to pay off the company debt and to expand. A company would not normally expand if there would be no room for more demand that is foreseen.
Dividends: The company has a policy of distributing half of the income as dividends. This means you could get a dividend return of about 10% a year assuming stock prices don’t go up soon. You would be paid about P0.10 on your P1 while you wait for price to go back up to its right value.
The risks are:
- Since it’s a bottling company, it could have increased manufacturing costs that cannot be passed on to buyers immediately.
- Its license may be revoked. (This is unlikely since Quaker Global owns almost 30% of its shares)
- Poor management. (President owns about 20million shares and no changes in management is seen in the immediate term which means we could expect a similar performance from previous years. Net income should be about P600million to P1billion in the next few years)
- People stop drinking Pepsi Products (Although this could have big impact over the long term, in the next few years, consumers will typically have a similar consumption habits for the past years.)
Starting May of 2009, it traded above P1 and never looked back. On October of 2009 it went as high as P2.50. If you have bought the stock below or near P1 and held it, you could have made at least 100-160% of your investment in less than a year.
I know you might think it can’t be done. But you can do it too. With a little analysis and a commonsense approach, it’s doable. As a matter of inspiration, I did it and so can you!
P.S. Why I chose it: I understood the business. I understood the financial statements. I know the risks and the rewards. The sell-off was not due to the problems of the company but mainly systemic in nature. (Systemic means all stocks in the exchange are simply being sold. People just want to get out.) Of course, I could have picked other stocks which are cheaper and has more growth and better prospects. Although, I did pick some others I chose it for the abovementioned reasons.
Disclosure: I currently do not own stocks mentioned above anymore. This is not an advertisement of the product or the stock. )
About the contributor:
The writer is a financial planner, investor, speaker and a self confessed cheapaholic. (Cheapaholic- a term he invented to mean someone who is addicted to being very cheap). Send in your questions. He will try to answer any questions you might have, preferably on finance and money matters. Although he does not object to questions on love and relationships, he never had one and due to his extreme cheapness, will probably never have one (In case you’ll send it mistakenly, he promised to forward it to HeaRty).
Disclaimer: Advice posted in this portion is merely opinions and views of the writer. It does not constitute formal advice. The writer will not be responsible for any of your gains or losses. If symptoms persist, contact your trusted financial planner.