Q&A: SSGR, CFO vs PAT, Margin of Safety & Valuation Analysis

Modified on July 13, 2018

The current article in this series provides responses related to:

Query

Hi Sir,

Thanks for the very detailed writing on SSGR — Very powerful tool to be used for investing.

Read:

While trying to practice (based on Container Corporation of India Limited using Screener data), I have following questions:

  1. SSGR is calculated using stand-alone instead of consolidated numbers? Any reason why we’re doing that.
  2. Dividend payout in screener comes as % now. While comparing that with the data of Container Corporation of India in the SSGR article, it looks very different.

Would appreciate all your great effort to teach every investor. Looking forward.

Regards,

Author’s Response:

Hi,

Thanks for writing to me!

1) There is no specific reason for using standalone financials. SSGR works well for both standalone as well as consolidated financials. I would advise the investors to prefer using consolidated financials, wherever consolidated financials are available.

2) You are right that the data of Container Corporation of India, currently shown by screener is different than what is reflecting in the above article. However, it is due to the update/change in data presentation at the end of screener. The data used in the article is the data taken from screener in June 2015. Subsequently, screener has undergone an overhaul from Aug 2015 to Feb 2016. I understand that it has undergone a lot of updations in terms of data collation and presentation. This might be a reason for change in the current financial data of Container Corporation provided by screener from the past data.

This is one of the reasons that I advise investors to use public sources of data only for preliminary analysis and use the data from annual reports for final analysis before making the investment decision.

Read: Understanding the Annual Report of a Company

Hope it clarifies your concern.

All the best for your investing journey!

Regards,

Vijay

 

Query

Hi,

I am trying to discuss Krishna Kumar’s question in the following article:

Readers’ Queries: DHFL, KRBL, HMVL, Shilpi Cables & Others

(I may be completely wrong here because I am from non-finance background and hence have very limited knowledge.)

The way I would reason why interest and depreciation are added back is something like this:

  1. First the company earns OP (operating profit).
  2. From that they set aside money for meeting debt obligations (interest and principal repayments), money for replacing machinery (depreciation- I have over simplified it a lot here), taxes, dividends and any others.
  3. So CFO should be ideally close to OP. if you look at the Cash Flow statement, CFO starts with adding back things to PBT. (I guess the P/L, BS and CF statements follow some accounting standards and that is what tweaks the picture a lot. Again I am guessing the auditing guys use some ledger entries to decide where each entry should go like CFO or CFF).
  4. The part that always trips me is the fixed assets and investments. For e.g. look at the Cash flow statement of MUL in this article. Sale of Fixed assets: there is one entry that goes into CFO and one goes into CFF. Same is the case for Interest income which appears once in CFO and once in CFF. (The nature of the expense as differentiated by ledger entries decides which fixed assets go where? I don’t know. )

The way I look at CFO is: I try to see how close or far CFO is from OP. Again I am just a beginner, so you can completely ignore my reasoning

Author’s Response:

Hi,

Thanks for sharing your valuable inputs. I appreciate the time and effort spent by you while sharing your feedback with the readers and the author.

If you notice that in MUL’s cash flow statement, sale of investments is shown as part of CFO as well as CFI. The reason is that profit from sale of investments has been included in calculation of PAT, whereas the sale of investment is not an operating activity, therefore, this profit has been deducted (negative entry) from PAT while arriving at CFO. As sale or purchase of investments is investing activity, the entire sum received from sale of investment is shown as part of inflow (positive entry) under CFI.

Similarly, income from interest on the investments, which is included in the PAT, has been deducted to arrive at CFO as the interest income is not an operating income but an investment income. The same has been included in the CFI segment as a positive entry.

Hope it clarifies your query.

All the best for your investing journey!

Regards,

Vijay

 

Query

Hello Vijay,

I know it is very basic question but could you please explain me:

Why we are considering CFO vs PAT? Why not sales VS money received from customer?

We receive money from customer against our sales not against profit then why we are comparing PAT vs CFO?

What is CFO?

As per your statement money received from customer. Which means we receive money against our sales then why we are comparing PAT that is only the profit.

I know I am confused a lot so please explain me to calculate CFO.

Also please explain, suppose company sold 1000 INR worth of product but company not received the amount from customer, is it still include in operating profit and net profit?

Thank you for your help and knowledge sharing.

Author’s Response:

Hi,

Thanks for writing to me!

We compare CFO to PAT, as the CFO just like PAT is after deduction of all the expenses incurred to earn the profits like: cost of raw material, employee salaries, advertisement expenses, fuel expenses etc. You can notice in CFO calculation in any annual report that it is calculated from PAT/PBT.

Read: Understanding the Annual Report of a Company

Comparing CFO to Sales would be comparing apples to oranges.

Hope it help in resolution of your query!

Regards,

Vijay

 

Query

Hello Dr. Malik

I have a specific query that I can’t seem to figure out by myself and would appreciate your help in sorting the issue:

What is the correlation between market capitalization of a company and its balance sheet/sales/profitability?

Specifically, if there are two companies (unrelated and perhaps in different sectors) with same market capitalization but different sales turnover/different profitability; does it have anything to do with the net worth or the book value or retained earnings/reserves or anything for that matter on the balance sheet?

My reason for asking is perhaps this could help find mispriced or undervalued securities in the markets while applying your principles for stock selection and evaluating between candidates for investments.

I hope I have tried to explain my question clearly and look forward to hearing from you.

Also I would like to take this opportunity to nudge you to please post more articles like you were doing before.

Thank you.

Regards

Author’s Response:

Hi,

Thanks for writing to me!

Your query is related to the presence of ratio of market capitalization (MCap) with balance sheet/sales/profitability and their usage.

Such ratios already exist and are in wide usage:

MCap to balance sheet ratio: the most common used ratio is price to book value, which is effectively market cap to net worth (current share price * number of share)/ (book value * number of shares)

MCap to sales ratio: this ratio is already widely used by investors by the same name.

MCap to profitability: the very famous price to earnings (P/E) ratio is derived from it: (current share price * no. of shares)/ (earnings per share * no. of shares).

These are parts of valuation analysis of stocks and you may read more about them in the following article:

How to do Valuation Analysis of a Stock

I am not able to devote much time to blog due to other personal and professional engagements which are taking a bit of time. I would write more articles whenever I get some time to spare.

All the best for your investing journey!

Regards,

Vijay

 

Query

Hi Vijay,

3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of StockInvesting

As always great article. Thanks for sharing wisdom in such simple and easy to understand way.

I have a doubt here which arose as I was reading an interesting article from Anil Tulasiram who did a great study on correlation of growth and returns.

So my question is how important role does growth play in margin of safety (MoS)?

I understand that Self Sustainable Growth Rate (SSGR) covers it well, but how can we anticipate future growth of a company and build it in margin of safety when it’s in huge capes which will give FCF in future down the line.

Read: Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

Thanks

Author’s Response:

Hi,

Thanks for writing to me!

I do not use future growth, cash flow projections/DCF in my analysis. SSGR uses the past performance data to have an idea of the potential growth that a company is capable of generating. Whether the company will achieve this growth rate (SSGR) or not, will depend upon the management using its resources well.

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

I do not advise investors to use any future projection in the assessment of margin of safety (MoS). Multiple times, it has been proved in the markets that future projections do not hold true and the MoS which supposedly existed on excel did not prove right in the real world.

Hope it clarifies your doubt.

All the best for your investing journey!

Regards,

Vijay

 

Query

Dear Sir,

I want to know that how to a value loss making company like United Spirits Limited (USL).

For example, when we use price to sales (P/S) ratio for a loss making company, the fair value arrived for USL is Rs 1,800. But my concern is that the company has been making profits for last three quarters. Total EPS is Rs 18 so if we see P/E, it’s available at 100 P/E, so I am confused now.

Please help me out, how to solve this problem?

Author’s Response:

Hi,

Thanks for writing to me!

We do not prefer to invest in loss making companies. Therefore, would not be able to help you in this query.

Read: Final Checklist for Buying Stocks

All the best for your investing journey!

Regards,

Vijay

 

Query

Hello Vijay,

Your blog is really very helpful for new investors for like me.

I have a question, while reading below analysis statements I am unable to interpret the below:

When a report says stock trades at 30.6x FY18E, what does it exactly say, is it like it would be 30 PE or it Earnings yield and how is it calculated. I know it may a very basic question, but could you please help me on this.

However the stock trades at 30.6x FY18E earnings and we would advise to wait for better buying opportunity. We retain HOLD with revised target price of Rs 229.

I have taken above Information from this link

Author’s Response:

Hi,

Thanks for writing to me!

30.6x FY2018E means that the current stock price is 30.6 times of the earnings that the analyst expects the company to earn in FY2018.

Read: How to do Valuation Analysis of a Company

Regards,

Vijay

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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