Update valuation on Bank of America after 2011 Q3 Result

I have to say it is pretty disastrous across the board in Bank of America Corp. There is no sign of improvement anywhere except a slightly downward delinquency ratio in loans and mortgages. Net interest margin got compressed to 2.32%, which is at a very dangerous level. With the operation twist from the Fed in place, I can see no improvement on net interest margin going forward.

Fire sale of China Construction Bank stake, accepting unfavorable term on capital raised from Berkshire Hathaway, fail to raise fees on debit card transaction, capital raise at fire sale stock price to repay subordinate debt are all negative signs of the health in BAC. In addition, negative press is keep coming to haunt the bank.

Despite all these negatives, I believe BAC still has a wonderful retail franchise. The chance of bank failure is remote giving its stronger capital position now. However, I would use a much more conservative stands to valuate the stock to make me comfortable in buying its shares.

Valuation
The CEO is not as reliable as I first thought in here. I have to start my number from somewhere, so I still start from the 45 billion pre-provision pre-tax number he suggested. Then I add my 20% cut for safety margin and10 billion provision that gives pre-tax income estimate of 45*0.8-10 = $26 billion. With tax rate of 35%, that gives net income of $16.9 billion. After deducting 1.2 billion in preferred dividend, that gives net income for common shareholders $15.7 billion. I would use 11 billion diluted shares as my estimate for 2014. That gives my estimate of 2014 earning per share at $1.427. I use 9 times earning as the fair valuation because BAC will probably need to allocate a little of its earning to strengthen its capital even after 2014. That gives fair value of BAC in 2014 at $12.843 per share. My required return on BAC is changed to 19% since it has significant risk involved. Discounted this required return 3 times due to the fact that today is in 2011. The fair value and my buy limit of bac is $7.62 per share. I would be extremely comfortable buying the shares below this price.

JPM update on valuation after 2011 Q3 earning

This is an update on the valuation of my last brief analysis.

• Annual earning estimate by the CEO in 2010 annual report is probably too optimistic. I would use $20 billion as the normalized earning, then deducting it by $4 billion on mortgage related losses annually gives $16 billion annual earning for valuation purpose.
• 2011 Q3 weighted average diluted shares outstanding is 3,872.2 million.
• EPS for valuation purpose hence is updated to $4.132. Fair value and my buy limit is $41.32.
  

Hewlett-Packard Company brief analysis

Hewlett-Packard Company (HPQ) is a household name in PCs and printers. It also provides storage and networking services, servers, IT solutions and various technology products to enterprises, small and medium businesses and governments. The company increases its revenue, operating income, net income and operating cash flow over last 10 years although it experienced fluctuation in the bottom line in the last two years. Despite all the negatives in the headline, HP has a positive trend in operating margin, net margin. Its return on invested capital is also respectable at around 14-15%. It dipped in 2009, but coming back up in 2010.

The company only has a narrow economic moat overall, however. Its brand is good in the PC business but PC is a commodity product which means the margin is thin. Its printing business has a large moat but that segment is not a big one in the overall company. The enterprise business gives HP good growth but HP does not really stand out in it due to other big players like IBM and Oracle. Fortunately, enterprises and governments tend to stick with the existing business relationships and the resistance to change give HP a thin moat due to the nature of the industry. The company tries to restructure itself in recent years and it gives the company a lot of execution risk. For now, the management seems to be incompetent in determining the direction of the company. While the management is bad, the overall HP company is good because of its long established brand image. I believe the company has a lot of headwind but giving a price that is low enough, it can be still a good buy.

Valuation
Because of the great execution risk of the company, my required return of HPQ is 17% (more than the 15% I use usually). With inflation and the narrow moat gives the company perpetual 5% growth, the earning yield needs to be at least 12%. That gives a roughly 8 times earning valuation of the company. Its free cash flow (deducts the stock-based compensation) in 2010 is $7,121 million. With weighted average of 2080 million diluted shares in 2011 Q3, the free cash flow per share is $3.423. The buy limit is thus $3.423*8 = $27.38 per share.

Despite the company has low debt (under 3 times free cash flow), I do not add the potential value to be extracted from the company in my buy limit because of its pending big acquisition of Autonomy Inc. and various restructuring that will consume the company's valuable cash.

Dell brief analysis

Dell Inc. (DELL) provides integrated technology solution in the IT industry worldwide. Its main business is mobility products such as smartphones, laptops, tablets; desktop PCs; servers; and computer necessaries. Although it has brand recognition and mature distribution network, its moat is considered to be narrow because the products are commodity. Recently, it has used its brand to expand to the software side which provides complete integrated technology solution to customers. It is pretty new to Dell and it has some uncertainties involved.

Valuation

The growth of Dell is very small, so I would use a 8-time free cash flow valuation. Its 2011 fiscal year free cash flow is 3193 million (operating cash flow - capital expenditure - stock-based compensation). Weighted diluted average shares outstanding in 2011 Q2 is 1871 million. That gives free cash flow per share of $1.706. Since the debt of the company is lower than three times free cash flow, there is value can be extracted from the company. The value is min(working capital, equity, cash+short-term investments) = working capital = 29658-20194 = 9464 million. Using half of that, it results in $2.52 per share. The fair value and my buy limit for Dell is $1.706*8 + $2.52 = $16.16.

Portfolio update 2011/8/15 (final update)

I added Wal-Mart (WMT) to my portfolio today. A brief analysis is here. I have also added Pfizer a few days earlier that makes my current holding has four stocks: PTNR, CHL, PFE and WMT. I decide not to update my portfolio any more due to privacy concern and I am lazy.

Walmart brief analysis

Wal-Mart Stores Inc. (WMT) is the biggest retailer in the world. It sells both consumer stables and consumer discretionary goods. It also engages in providing financial services and products comprising money orders, wire transfers, check cashing, and bill payment in the US. In US, Walmart has discount stores, supercenters, and neighborhood markets, as well as through walmart.com. In the international segment, Walmart has various formats of retail stores, discount stores, supermarkets, supercenters, hypermarkets, restaurants, apparel stores, Sam’s Clubs, and online retail operations. This segment also operates banks that focus on consumer lending, as well as consumer credit products.

As a low cost retailer, its net margin is thin at little over 6% but it's already above industry average. Its return on investment is high at around 14% above industry average (the number is even higher at around 19% using the metrics of the company, mainly adding back depreciation and amortization and rent on the numerator while adding accumulated depreciation and amortization, eight times rent to the denominator).

Its giant size creates a big economic moat in additional to its established technology on data mining and logistics.

Valuation
The free cash flow of Walmart cannot accurately reflects Walmart's earning power since a lot of capital expenditure is used for expanding its retail network instead of simply maintenance. I decide to use its net income from continuing operation as the basis for valuation. For Walmart, I would also use a eleven times earning for its valuation because its international footprint (earning foreign currency vs declining US dollars), inflation resistance, its potential of growth coming from the expense of other online retailers because of the potential tax implication on online shopping in US (especially California), and mainly its potential fully entrance of US banking business. As a retailer with the greatest number of customers, entering the banking business will be a big threat of the existing banks and that's the reason that heavy lobbying prevents Walmart from doing it fully. This may change in the future and will be a big boost of Walmart business. In 2010, Walmart's earning from continuing operation is 15,959 million US dollars. Since it is buying back shares continuously, using the most recent quarter (2011 Q1) number on diluted average outstanding, 3513 million, is conservative enough. EPS is $4.542. Fair value and the buy limit is $49.94.

Partner Communications Company Ltd. 2011 Q2 update

Not much update since my last brief analysis. However, the data came out in the earning is much less than I expected, and it did not look like a temporary situation. I would lower my free cash flow estimate of the company. Last time I used a 20% discount on 2010 free cash flow, but now I decided to use a 40% discount since it's more inline with the company's data. The discount is less than the report in this quarter: 40% vs ~50% while it is much higher in terms of net income which declined 30%. There is timing issue of the free cash flow because of the change of inventory mix of the company, so I believe the 40% is appropriate.

The new free cash flow for valuation purpose is now 1295 million NIS * 0.6 = 777. It translates to 4.9712 NIS per share. Using exchange rate of 3.72 NIS / USD, it's $1.336 per ADR. With a 8-time free cash flow valuation, the buy limit is $10.68. It is significantly lower than my last estimate and it shows that I was not conservative enough.