More considerations on Bottom-Up Investing
DEN SOMERA
Of all the considerations behind the use of bottom-up investing is the argument that it will lead you to companies that perform well regardless of developmental shifts in the economy and macroeconomic landscape.
It will help you find companies even in industries hard-pressed by bad economic times but with healthy fundamentals that continually provide profit returns.
In this regard, bottom-up investing is anchored in the use of fundamental analysis. By its concept, the focus of bottom-up investing is on details of an individual stock, especially with its company’s “products and services, financial status and other qualitative considerations.”
And fundamental analysis does just that – it “simply seek fundamentally healthy companies.”
Owing to the above considerations, only a few stock categories respond to selection requirements of bottom-up investing. These are the so-called dividend-paying, growth and/or value stocks.
Dividend-paying stocks are those whose companies with long established business record and provide regular income. They are also known for high market capitalization. In our case, they are the likes of holding firm Ayala Corporation (AC), telco companies PLDT, Inc. (TEL) and Globe Telecom, Inc. (GLO), food and beverage conglomerate San Miguel Corporation (SMC), oil company Petron Corporation (PCOR), banking institutions Bank of the Philippine Islands (BPI), BDO Unibank, Inc., Metropolitan Bank & Trust Company (MBT), Security Bank Corporation (SECB), among others.
Next are the so-called growth stocks. Growth stocks are those whose companies are relatively smaller and younger than dividend-paying firms, with higher risk profile but with big potential to grow more.
Specifically, growth stocks are successful companies whose “earnings are expected to continue growing at above-average rate relative to the market. As such, they generally have high price-to-earnings (P/E) ratios and high price-to-book (P/B) ratios.
The P/E ratio is the market value per share divided by the current year’s earnings per share.
For example, if a stock is currently trading at the share price of P65, and the company’s earnings over the last 12 months have been equivalent to P3 per share, the stock is trading at the P/E ratio of 21.67x.
The P/B ratio is the share price divided by the book value per share. A company’s book value is the “net asset value” of a company calculated as total assets minus intangible assets (i.e. patents, goodwill, etc.) and liabilities.
The main incentive in buying growth stocks is the prospect of realizing a higher return from capital appreciation which is basically the amount one will make out of the difference between the amount paid for a stock and its current market price.
Growth companies don’t generally give out cash or stock dividends. They instead reinvest their earnings in capital projects. The impact of these projects, however, to overall earnings usually takes time. For this reason, some investors will prefer value stocks.
Value stocks are those that tend to trade at a lower price relative to their fundamentals, particularly on the dividends they pay or by the amount of their earnings and revenue performance.
Moreover, value stocks are sometimes those that fall out of favor for some reason notwithstanding their good fundamentals and whose prices become considerably lower – as in a bargain – compared to their counterparts in the market.
Value stocks could also be those trading below their historic levels or simply overlooked as they are associated with new companies investors are hardly acquainted with. They can be, furthermore, the companies whose long-term prospects are wrongly judged by common investors.
As a rule of thumb, value stocks are those with a price-to-book (P/B) ratio of less than one, which basically indicates they are sold at a discount compared with their stated value in the balance sheet of the company.
The key sources of information for bottom-up investing analysis are from the financials of the company as follows: balance sheets; income statements; cash-flow statements and statements of owners’ equity.
These reports reveal the true strength of companies, regardless of the stocks’ current technical trends.
First three days of Week 25
The first three days of Week 25 in the virtual stock trading game was somewhat different. Tuesday was declared a holiday, leaving the market open only last Monday and Wednesday.
Trading on Monday ended in negative territory. The benchmark Philippine Stock Exchange index (PSEi) closed at 7,500.53, down 69.99 points or 1.09 percent. Total value turnover was P5.4 billion with volume of 1.42 billion shares. Foreign investors’ trading activities were more largely buying than selling. They also accounted for about 56 percent of total market transactions.
Interestingly, total block sale was quite satisfactory at P1.5 billion. By current standards, this could be considered a favorable sign of the market’s good health despite low turnover regimen of just over P5 billion.
Wednesday was a little exciting. With relatively the same factors affecting the market, it turned more positive. The PSEi bounced back and ended with a daily gain of 131.73 points or 1.73 percent at 7,632.26, with all counters up.
Total value turnover was also up by 20 percent at P6.48 billion and foreign investors transactions eclipsed their previous day’s business of 57 percent of overall market transactions and, at the same time, ended as net buyers for the day.
Pixiu, who had been a source of excitement in the game, was a little subdued. She submitted three trading orders last Monday, and stayed quiet thereafter. Her trading orders were to sell her total holdings of 100,000 shares in Philippine Realty and Holdings Corporation (RLT) at P0.50 per share to buy 100,000 shares of the Gatchalian-led companies Wellex Industries, Incorporated (WIN) at P0.34 and 50,000 shares of Waterfront Philippines, Incorporated (WPI) at P0.77 apiece. All of the trading orders were deemed “Done” in their stated prices.
Trying hard to put up a good fight for the number one position in the leaderboard is young Play Hard. He submitted three trading orders for execution last Wednesday. These were to sell the following: 100 shares of Manila Electric Company (MER) at P375.00; 35,000 shares of A. Brown Company, Inc. (BRN) at P43.60 apiece.
Unfortunately, his prices were just all too high that none came through.
Bottom line
Going over the explanations in what it does, the major goal of bottom-up investing is the following: To determine the current worth of the company and, more importantly, to understand how the market is valuing the stock.
The main objectives of bottom-up investing, on the other hand, are: “to make sound decisions based on thorough review of the company (by becoming familiar with the products and services of the company, its financial stability and its development activities); and to have a comparative knowledge on the company’s numbers and circumstances to that of the competition, and ultimately to have a grasp which of these stocks under review offers more upside potential.”
Don’t miss the conclusion of the review on bottom-up investing.
Den Somera is a licensed stockbroker. The article has been prepared for general circulation for the reading public and must not be construed as an offer, or solicitation of an offer to buy or sell any securities or financial instruments whether referred to herein or otherwise. Moreover, the public should be aware that the writer or any investing parties mentioned in the column may have a conflict of interest that could affect the objectivity of their reported or mentioned investment activity. E-mail address of the writer is den.somera@manilatimes.net
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