Under the “What is value investing”
post, the 1st step to do is to analyse the company fundamentally (both quantitatively and qualitatively) by looking at the financial statements to determine the quantitative part and asking certain questions to determine the qualitative part of the company. The company must also have a wide moat or competitive advantage that will not be breached that easily, if not, at all. Wide moat can come from the brand name (eg. Coca Cola, McDonalds), monopoly position (eg. SMRT, SGX), pricing advantage, patented technology (eg. Pfizer). Just like in the picture above, the company must be guarded from its competitors with a huge moat. From Wikipedia, a moat is “a deep, broad ditch, either dry or filled with water, that surrounds a castle, building or town, historically to provide it with a preliminary line of defense. In some places moats evolved into more extensive water defenses, including natural or artificial lakes, dams and sluices. In later castles the moat or water defences may be largely ornamental”.
I’m going to do a case study on Thomson Medical Centre (TMC) just so you know how to analyse a company to determine if it’s a good buy. TMC is a near-perfect company (nothing is perfect in this world) that fits the value investing model and I’m happy to have found this gem. After reading this post, I hope you get a clearer understanding on what value investing really is and how to find gems like TMC.
TMC is a leading private hospital in Singapore catering to women and children. Located at Thomson Road, walking distance from Novena Church, it provides a comprehensive range of services with focus in Obstetrics and Gynaecology (O&G) and paediatric services.
Does TMC have a wide moat?
I believe TMC has a wide moat because it has won many awards including being in the top position in Customer Satisfaction Index in the healthcare sector in January 2010 and it was one of the 5 Singapore-listed companies to win the Forbes ‘Asia’s Best 200 Under A Billion’ award in September 2009.
TMC has the highest number of live births among all the private hospitals. It also has VIP rooms and premier wards that makes TMC look like a 5-star hotel. Many celebrities have chosen TMC to deliver their babies. 32.2% of the customers are repeat customers. This shows how much people value TMC and the services provided by TMC. It has become a brand name amongst people.
Now, we will analyse the financial statements.
Revenue and Net Profits
Revenue and net profit has to be increasing throughout the years. The revenue and net profit for TMC have been increasing consistently and the revenue growth rate is at 10.36%. When the revenue and net profit are increasing consistently, we know that the company is strong and most probably will be able to deliver in the future as well. Remember 2008 to 2009 was the financial crisis. However, this crisis did not damper the revenues. This shows that TMC has a defensive business.
Gross profit margin is above 40% all the way. This shows that for every 1 dollar in revenues, TMC has 40 cents after paying the basic expenses. Not many companies have a high GPM of above 40%. Net profit margin is at 18.87% for FY2009. Even though NPM preferably should be more than 20%, it can be seen that TMC’s has been increasing throughout the years from 12.94 to 18.87% consistently and I’m confident that within 2 years time, it will be above 20%.
Debt and cash in hand
I prefer companies with no debt or negligible debt. Just like how a person aspires to have very little debt, companies with very little debt and a lot of cash do well in times of crisis. TMC’s long term debt (payable after 1 year) is at $1.36 million. Their cash balances is at $9.84 million with $10.73 million in fixed deposits (not shown). From here, it can be seen that TMC is a cash-rich company. Reminds me of the saying “Cash is king”. Their debt/equity ratio is also very low at 0.013.
Current ratio is at 1.39. Current ratio is current assets divided by current liabilities. If the figure is more than 1, it shows that the company can meet its 1 year’s requirements without much problems.
The Return on Equity (ROE) is at 11.42% with reserved valuation. Without it, it’s 21.6%. ROE is calculated by dividing net earnings over shareholder’s equity. It shows how much the company is generating using the shareholder’s money. TMC’s ROE is low at 11.42% because every year, it re-valuates the freehold land the building is sitting on. Usually, for ROE calculation, the purchase price of the land is used instead of re-valuating it every year. I believe that the value of the land has been going up very significantly compared to its net profits. So, a not-so-big number divided by a huge number brings the percentage down. Without reserved valuation, the ROE is extremely high at 21.6%. Very few companies achieve high ROE. This means that TMC is doing a good job in investing the shareholder’s money for company growth.
Return on Assets (ROA) shows how much the company is generating using its assets. It’s obtained by net earnings divided by total assets. TMC’s ROA is at 9.61%. This is good.
Cash Return On Invested Capital (CROIC) tells us how much cash our company can generates on every dollar it has invested into its operations. When a company generates cash, it has two choices—pay it out to shareholders or reinvest into the company for growth. CROIC tells us if our company is doing a good job reinvesting cash for growth, or if management is hording cash when it should be letting shareholders reinvest it elsewhere. CROIC for TMC is at 13.72% and shows that TMC is doing a good job reinvesting our money.
Equity and Retained Earnings
Shareholder’s equity and retained earnings has been increasing consistently and this is very pleasing. Equity, as discussed, is how much of the shareholder’s money is in the company. Retained earnings is how much of profits is retained by the company to be reinvested so far after paying off the dividends. The equity growth rate is at 9.57%.
Cashflow statement is very important when analyzing a company. Cashflow statement show how much a company is actually generating in terms of real cash. Cashflow statment is divided into three segments: Cashflow from operations, cashflow from investing and cashflow from financing. We will concentrate on cashflow from operations. Cashflow from operations has been increasing consistently and this is encouraging. Capex is the amount of money going into maintaining the buildings, furnishings and equipments. Capex should be as low as possible. Average free cashflow is how much cash there is after deducting the average capex. Free cashflow is used to generate profits for the company and the shareholders. This figure will be used to project the earnings over 10 years and to calculate the intrinsic value.
I found something very interesting. The number of babies delivered in TMC in FY2009 was 8,907. The number of total live births in Singapore in 2008 was 39,826 (obtained from Singapore Statistics website). This shows that TMC’s share is around 20% and that’s significant. The number of births in FY2009 is also the record number of births in TMC and it is breaking its own record year after year for 2 years already.
In summary, we want revenue, net profit, equity and free cashflow to be increasing consistently. The company should have low debts and lots of cash. The ROE, ROA and CROIC should be above the required percentages. It should also have very little Capex.
Now, we will look at the qualitative part of a company analysis. This is just a brief one.
Will product become obsolete twenty years from now? No. Child birth will still need hospitals.
Insider buying and/or Share buybacks (% of ownership): Executive chairman, Dr Cheng Wei Chen 36.19% ownership. Dr Cheng Li Chang, Dep Executive Chairman. Significant ownership by directors. The management decisions will be in-line with shareholders’ interests.
Strong Future Growth / Future plans: About 20% market share on live births. Opening up a hospital in Vietnam.
Management transparent and honest: Yes. Won Most Transparent Award 2008. CEO interviewed for the award. Stated in IPO prospectus that will look into overseas venture and did just that with Vietnam venture.
What I like about this business? Has hospital tours. Transparent management. Good management – 2009 ROE increased compared to 2008. Dividends increasing every yr (16% yoy GR). Deliver what they promise –Vietnam hospital. Innovative –Thomson Baby site, sponsoring events, TV shows, Thomson Women’s Cancer Clinic, VIP rooms.
What I don’t like about this business? Small hospital. But can extend to other places and with so much cash in hand and good management.
Thus, it can be seen that TMC is very profitable and has lots of growth possibilities, especially with the opening of the Vietnam hospital in the near future. Qualitatively, the important things I look for are having a management with solid integrity and future growth possibilities of company. A good management means having competent and honest management which runs the company in the interest of the shareholders and not only for personal gains. If the horse is good but the jockey is lousy, then the horse ain’t going to win. A honest management ensures that the financial statements are not peppered to make it look good.
This is how I analyse a company. It can be seen as a lot of work but as you get the hang of it, it becomes easier and it become fun as well. It’s like doing detective work, investigating if a company has been doing well for the past years and if it has not, finding out why is that so.