One of the important concept of value investing is intrinsic value. We need to determine the actual value of an enterprise such that whether it is worth to invest in. In the Annual Report of Berkshire Hathaway 2005, Warren Buffet, the great follower of value investing, has clearly defined intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life. To be more simple, it is the discounted cash flow method we have learned in our accounting course. The general use of discounted cash flow is to evaluate the feasibility of a business project. If you don't know what it is, you may just pick an accounting textbook in the book store and all the details will be presented very clearly. Howver, though the method is simple, it is very difficult to apply the basic estimations in making actual calculations. To be correct, one has to understand the future of the industry and company very clearly such that he can correctly estimate the percentage growth in cash flow of the company in its remaining life or a long period of time eg 10 to 30 years. Therefore, Warren Buffet usually invest in companies with business which is easily understood and forecasted. On the other hand, the percentage used to calculate the present value of cash flow generated is also very important. Warren Buffet usually use the interest rate of 30 year US bond as the risk free rate in calculation. After we have successfully calculated the intrinsic value of a company, we can compare it with market value of the company to see whether we have the safety margin when buying its stock.
Book Value vs. Intrinsic Value
Someone may argue that looking at the book value can be a good method in evaluating the value of a company. For example, many analysts usually use the Price to Book Ratio (PB ratio) to compare the value of banks. However, book value can only tell you the present value of the company and the intrinsic value derived from the discounted cash flow method is more forward looking which has taken into account the future performance of a company. Therefore, intrinsic value should be more safe and accurate in evaluating valuable investment opportunities.
Monday, August 28, 2006
Monday, August 21, 2006
Foundations of Value Investing - a brief history
The foundations of value investing were set by Benjamin Graham who wrote the book "Security Analysis" together with David Dodd. The book outlined the foundamentals of value investing as a successful stategy in the modern stock market. Though Benjamin Graham has not been very successful in the stock market, his methodology has influenced many of his students to make use of value investing in the stock market to achieve great successes. The most famous two are Warren Buffett and John Templeton. Of course, in order to achieve great successes, they have finetuned value investing from the time of Benjamin Graham to cope with the actual market situation and making value investing to be more forward looking. John Templeton has been very famous with his successful investing in the emerging market and Warren Buffet is great in investing in the most promising enterprises to become the best investor in history. Both of them have not clearly stated sytematically how value investing work in evaluating investment opportunities. However, I will summarize their publicly anouncements and annual reports to get a closer look of their ways of successful value investing in the coming blogs.
Thursday, August 17, 2006
Analysis of Chinese Banks Listed in Hong Kong
Banking is an important industry in modern economy. With the fast economic growth in China, the investment value of banks in China has become a major topic for investors who want to share the economic benefits from the growth of Chinese market. According to the policies in China, the largest banks are still state owned enterprise. The largest stake could be taken up by foreign investors should not be more than 20%. This is why HSBC could only take up a 19.99% share in the Bank of Communications. Up to now, the four major state owned banks are Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China, China Construction Bank (CCB) and Bank of China (BOC). The fifth one is Bank of Communications but of much smaller size than the big four. For the top five banks, three of them have been listed in Hong Kong Stock Exchange. Below are the comparisons of the three listed banks for their investing values . Major data was taken from their annual reports and prospectus in 2005. In order to give a more comprehensive idea of their performance, I also abstract some important figures from HSBC annual report 2005 which represent an internation performance standard for banks :
1. Major Business Focus
China Construction Bank (stock code : 939)
CCB develop their major business within China and their major loans are for infrastructure contruction and real estates within China. Therefore, their profits are closely related to the economics development of China.
Bank of China (stock code : 3988)
BOC is the best known chinese bank in the world as their major focus is foreign exchange service. Besides china, they also set up branches around the world. About 40% of their profit is from BOC Hong Kong. Therefore, the bank is expected to be more stable in profit but will face higher exchange risk and gets less benefits from the RMB currency rise.
Bank of Communications (stock code : 3328)
Bank of Communictions is operating in a smaller size than the big four and offers more general and customized banking services to the public. With their strategic cooperation with HSBC, the bank is improving their working effeciencies to give a better performance.
2. Size of Business
Loans / Deposits (RMB in Millions)
China Construction Bank : 2,395,313 / 4,006,046
Bank of China : 2,152,112 / 3,699,464
Bank of Communications : 758,773 / 1,220,839
Note : From the above, the China Construction Bank is operating at a higher loans and deposits from which they are more likely to generate more profits and better economy of scale.
3. Key Operating Figures
ROE (Return of Average Equity)
China Construction Bank : 17.99%
Bank of China : 12.14%
Bank of Communications : 13.68%
HSBC : 16.8%
Note : For the ROE, China Construction Bank gives the best performance which is higher than HSBC. Such outcome is reasonable as China is a fast growing economy. The performance of banks in such market should be better than the banks in mature economy. The performances of BOC and Bank of Comunications are quite unacceptable in such case.
Net Interest Spread / Net Interest Margin
China Construction Bank : 2.7% / 2.78%
Bank of China : 2.21% / 2.33%
Bank of Communications : 2.58% / 2.64%
HSBC : 2.84% / 3.14%
Note : The interest rate in China is controlled by the People's Bank of China which is the central bank. However, under such circumstances, China Construction Bank managed to give the best Net Interest performance within the three. In the coming year, the chinese banks are expected to give a higher Net Interest Spread and Net Interest Margin as the central bank has raised the loan rate but maintain the deposit rate unchanged.
Non-performing Loan Ratio
China Construction Bank : 3.84%
Bank of China : 4.9%
Bank of Communications : 2.8%
HSBC : 1.16%
Note : The non-performing loan ratio is one of the major issues concerned by investors as some of the loans have been political loans which may not be executed according to general economic rules. Therefore, the NLR of the three banks are relatively higher than that of HSBC. But Bank of Communications is the best performer among the three.
Cost to Income Ratio
China Construction Bank : 45.13%
Bank of China : 47.95%
Bank of Communications : 51.24%
HSBC : 51.2%
Note : The two large banks has a better percentage than HSBC due to the lower running cost such as lower salaries for staff and lower rent in China. However, Bank of Communication got a higher figure which may be due to their smaller size in operation. In this aspect, China Construction Bank gives the best performance.
From the above analysis, it is obvious that China Construction Bank gives a better performance than the other two and its share performance is more likely to outperform the other two in the long run.
1. Major Business Focus
China Construction Bank (stock code : 939)
CCB develop their major business within China and their major loans are for infrastructure contruction and real estates within China. Therefore, their profits are closely related to the economics development of China.
Bank of China (stock code : 3988)
BOC is the best known chinese bank in the world as their major focus is foreign exchange service. Besides china, they also set up branches around the world. About 40% of their profit is from BOC Hong Kong. Therefore, the bank is expected to be more stable in profit but will face higher exchange risk and gets less benefits from the RMB currency rise.
Bank of Communications (stock code : 3328)
Bank of Communictions is operating in a smaller size than the big four and offers more general and customized banking services to the public. With their strategic cooperation with HSBC, the bank is improving their working effeciencies to give a better performance.
2. Size of Business
Loans / Deposits (RMB in Millions)
China Construction Bank : 2,395,313 / 4,006,046
Bank of China : 2,152,112 / 3,699,464
Bank of Communications : 758,773 / 1,220,839
Note : From the above, the China Construction Bank is operating at a higher loans and deposits from which they are more likely to generate more profits and better economy of scale.
3. Key Operating Figures
ROE (Return of Average Equity)
China Construction Bank : 17.99%
Bank of China : 12.14%
Bank of Communications : 13.68%
HSBC : 16.8%
Note : For the ROE, China Construction Bank gives the best performance which is higher than HSBC. Such outcome is reasonable as China is a fast growing economy. The performance of banks in such market should be better than the banks in mature economy. The performances of BOC and Bank of Comunications are quite unacceptable in such case.
Net Interest Spread / Net Interest Margin
China Construction Bank : 2.7% / 2.78%
Bank of China : 2.21% / 2.33%
Bank of Communications : 2.58% / 2.64%
HSBC : 2.84% / 3.14%
Note : The interest rate in China is controlled by the People's Bank of China which is the central bank. However, under such circumstances, China Construction Bank managed to give the best Net Interest performance within the three. In the coming year, the chinese banks are expected to give a higher Net Interest Spread and Net Interest Margin as the central bank has raised the loan rate but maintain the deposit rate unchanged.
Non-performing Loan Ratio
China Construction Bank : 3.84%
Bank of China : 4.9%
Bank of Communications : 2.8%
HSBC : 1.16%
Note : The non-performing loan ratio is one of the major issues concerned by investors as some of the loans have been political loans which may not be executed according to general economic rules. Therefore, the NLR of the three banks are relatively higher than that of HSBC. But Bank of Communications is the best performer among the three.
Cost to Income Ratio
China Construction Bank : 45.13%
Bank of China : 47.95%
Bank of Communications : 51.24%
HSBC : 51.2%
Note : The two large banks has a better percentage than HSBC due to the lower running cost such as lower salaries for staff and lower rent in China. However, Bank of Communication got a higher figure which may be due to their smaller size in operation. In this aspect, China Construction Bank gives the best performance.
From the above analysis, it is obvious that China Construction Bank gives a better performance than the other two and its share performance is more likely to outperform the other two in the long run.
Monday, August 07, 2006
Hong Kong Stock Blog
I am an amateur stock investor in Hong Kong and have been investing in Hong Kong stocks for more than twenty years. After years of loss in the stock market, I have shifted my beliefs from technical investing to foundamental investing strategy. Such shift has turned me into a more profitable investor. My favourite investing strategy is value investing and my favourite investor is Warren Buffet. I started this blog to discuss the general issues in Hong Kong stock market and the application of value investing in Hong Kong as Hong Kong stock market has become the step stone for chinese state own enterprise to raise capital for their future development which has created a lot of investment opportunities for value investors. Good luck, everybody!
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