Peter Lynch -Important Stock Numbers

Numbers to Watch-Peter Lynch

Though i have directed most of my energy in trading, my long term philosophy is to put aside small profits to invest long term in future.
Therefore i will also be sharing some investing insight which can be helpful for people looking to invest long term.
This article is all about the important numbers which you have to analyze before investing. Though investing is a tedious process which require huge time and effort, this article is restricted to the perspective of one of the greatest investor Peter Lynch.Some of the parameters for his investing philosophy are:

1. P/E ratio
Peter stressed the importance of looking for companies whose growth in earning is greater than their P/E ratio.
If you are investing in Indian companies, you can use scanner.in to find the above mentioned companies.

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2. Cash Position
When you are analyzing any company, look for its cash position net long term debt.
There is a good possibility that you may find a company which have good amount of +ve cash reserves and the stock price is not discounting it.

for example, let XYZ company is available at 25$ per share.
You did the calculation and found that the company has excess cash reserves of 5$ per share, which means that when you are buying it share you are actually getting bonus of 5$ with the purchase of 25$ regular stock.

3. Debt Numbers
Every company goes through tough times, it is important to know which company can survive and which don’t.
Debt/Equity is a good ratio to decide the financial health of the company.
A good company will have 75% of equity and 25% of debt.

Example Analysis:
Company with 100M Debt
Has only 3M cash
Inventory is 60M (but you will only get the disounted price if you sell the inventory)
Verdict: Not a good prospect to invest

Company with 15M debt
has 30M Cash

Verdict: Good propsect to Buy

4. Book Value
Most people buy if book value>stock price, thinking it is a bargain.
The flaw is that book value bears little relationship to the actual worth of the company.
Penn Central had book value of more than 60$ a share when it bankrupt

Example:
A company had stated book value of 32 million but it filed for bankruptcy.
Because its new facility perhaps around 30 million on paper was not properly planned. To pay off its debt the plant was sold around only 5 million.

Overvalued assets can be treacherous when there is lot of debt on the balance sheet.
Lets say a company has 400M of assets and 300 M of debt; hence +book value of 100M
But when you sold the assets you will get only 200 M, now you are at -ve book value of 100

When you buy stock for its book value, you have to have detailed understanding of what the actual values are.

5. Hidden Assets

A. Companies that own natural resources such as land, oil, timber etc carry those assets on their book at a fraction of the true value

Example:
Handy, manufacture of precious metal, had book value of 8$ per share
But the inventory of raw material was booked when it was purchased 30 year ago
now the inventory price is much more
At today’s price it is worth more than 18$ per share.
Stock is selling at 17$; hence we get discount

B. Sometime oil company keep inventory  ground for 40 years and booked at the original cost of acquisition. The oil current price is alone worth more than the stock price

C. Channel 5 had a station that was booked at 2.5 million.
1M for tower, 1M for license and 0.5M for paperwork.
But it was sold at 250M.

The purchaser will also keep 2.5M in books
and rest of 247.5 as goodwill, which will be depreciated with time and is vanished to 0, creating another opportunity of assets play.
The goodwill will only increase

Example 2:
Coc Cola Botteling Enterprise carries 2.7 billion worth of goodwinll in books
The goodwill will be depreciated as per accounting standards, reducing the book value.
But in actuality the goodwill (brand value increases with time) hence creating hidden asssets

D. Research and Development

E. Owing Subsidiary Business

Seagram owned 25% of Dupont
IF you were interested in Dupont, you can got it cheaper by buying seagram

Raymond was selling at 12
And its each share prepresented 18$ of Teleco
you are virtually buying teleco for free


F. Tax Breaks
Because of tax loss carry forward, when Penn came out of bankruptcy it did not have to pay any taxes, hence its earning doubled


6. Cash Flow

It is the amount of money a company taken in as a result of doing business. All companies take in cash, but some have to spend more than others..
Company A sells its entire inventory at 100M, but it has to spend 80M to keep the furnace up to date, that’s bad.
That’s why i prefer to invest in companies that dont depend on capital spending.
Free cash flow is what’s left over  after the normal capital spending is taken out

Occasionally, i find a company that has modest earnings and yet is a great investment because of free cash flow. Usually its a company with a huge depreciation allowance for old equipment that doesnot need to be replaced in immediate future, hence huge tax breaks.

7. Growth Rate
The only growth rate that really counts: Earnings
If you find industry where one can raise prices it can be good investment (eg cigarettes)
Reducing cost is another way to increase earnings


8. Pretax Profit Margin
Profit after depreciation and interest
you can compare pretax profit margin of companies in same industry.
The one with more margin is a good choice
Look for consistence, not for one time improvement

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