How to use financial websites to speed up the search process and direct you towards the stocks most worthy of further investigation.
(Editor’s note: I wrote this blog post in 2018. At the time, Morningstar offered an excellent free source of comprehensive 10 year financial data. Today, it’s free offering is far more limited. Many people are now using TIKR.com although to get more than just the basics, you have to pay a subscription fee. Personally, I’m using a site called GuruFocus. By the time you read this post, perhaps there will be a new kid on the block. I have left this post mostly unchanged even though its Morningstar references are out of date, because it illustrates the kind of process I go through in trying to narrow down a long list of candidates to a more manageable short list of companies that I can research in greater detail using the company’s own financial reports.)
1 in 100
Truly undervalued stocks are rare. You have to turn over an awful lot of rocks to find the occasional undiscovered gem. Typically, out of every 100 stocks I look at I’m hoping to find one that I think is worth investing in.
In my series of tutorials on value investing, I lay out the steps I follow to analyze a new potential stock investment. I’ll download the latest financial reports and read them from cover to cover, pore through news releases, put together charts of the company’s past results and peruse the company’s website. The whole process will often take the better part of a day.
Clearly, I can’t be doing this with 100 different stocks in the hopes of unearthing one overlooked bargain that I decide to buy. If I did, I’d never escape the unhealthy glow of my computer screen!
Instead, I rely on third party financial websites to give me a broad overview of the companies I’m considering, showing me how key financial metrics (things like sales, earnings and book value) have evolved over the years. Using those summaries, I can winnow down an initial list of 100 stocks to a more manageable 5 or 10 that I can then take the time to review more accurately and in far greater depth using the company’s own financial reports.
Always keep in mind that any information you find on these sites is subject to human (or computer) error and interpretation. Some of the sites attempt to report a cleaned-up version of earnings before “extraordinary items” but what one investor considers to be extraordinary, another might not. Total debt is another item that is open to interpretation. Do you include finance lease obligations? Pension fund shortfalls? Do you include short term debt or do you just consider longer term liabilities? Not only is there interpretation involved in reporting financial results, but plain old human error is frequent too. Financial reporting is not standardized, so at the end of the day there has to be a human being collating all the data and humans make mistakes. And if there are no humans involved, you’re relying on a computer algorithm which can just as easily be led astray.
So please never ever rely on this data to actually make a final investment decision. Use it as a screening tool to narrow down your focus to a few of the most promising looking prospects and then download the company’s financial reports and calculate the numbers yourself.
As well, the numbers only tell half the story. To form a complete assessment of a company you always need to know the background narrative behind those numbers.
For a quick and dirty, initial assessment, though, these sites can be very useful.
Let’s walk through an example of how we might approach doing an initial assessment of a company using the Morningstar website. For this example, I’m going to be using the “mispriced markets” methodology that I use to value stocks. You can find a summary of the value categories I use in part 4 of my series on value investing, “building a valuation framework“.
To begin this exercise, we need a stock to evaluate. I just surfed on over to the Globe and Mail’s website to see if there were any interesting sounding companies in the news lately. An article entitled “These three stocks score highly on a model inspired by Warren Buffett’s bridge philosophy” caught my eye. Anything that invokes the name of the Oracle of Omaha is like catnip for value investors. The first stock in their list is one called Johnson Outdoors, listed on the Nasdaq. I’ve never looked at this company before so it seems like a good candidate for an initial exploration.
When we search for Johnson Outdoors on the Morningstar website, the first thing that shows up near the top of the page is the stock price chart and a table of key statistics. But before we look at those, we need to know what this company does, in order to frame our opinion of it. Scrolling down a little further on the page takes you to the company profile.
According to Morningstar…
“Johnson Outdoors Inc is a global manufacturer and marketer of branded seasonal, outdoor recreation products. It offers products under Watercraft, Diving, Marine Electronics and Outdoor Gear. Business activity of the company is functioned through United States, Europe, Canada and other countries.”
Okay, good. Obviously, we’d need to find out a lot more if we decided to actually buy the company, but this little blurb gives us a basic idea of what the company does. Something to do with boats, by the sounds of it. I immediately like their line of business. They’re not involved in some flavor-of-the-month like artificial intelligence or lithium mining. They’re in an ordinary, unexciting line of business and that means their stock may have been overlooked by the investment community.
Scrolling back up now, let’s take a closer look at that share price chart. The graph that is displayed by default is for the current day only. If you click on the “show full chart” phrase, it brings you to a more detailed graph. You can select “10Y” to get the bird’s eye view of what this stock has done over the last 10 years. If we do that we see that it has been a fairly lackluster performer, trading virtually sideways for 8 years from 2008 to 2016 before rocketing higher over the past 2 years. You could have tripled your money if you had bought into this stock 2 years ago, but does it still make sense to own it now?
Next up, let’s focus on that table of key statistics beside the share price graph.
One of the first things I want to know is how big the company is. Larger companies often command higher prices and very small companies come with their own unique set of risks, so it is useful to know where your prospective company sits. Morningstar lists this company’s market cap as $645 million, putting it squarely in the “small-cap” segment of the market. I like smaller companies for a number of reasons, so this stock is getting another plus in my book.
My initial assumption is always that any company I am looking at is probably average. I call them “perfectly average” because there is nothing wrong with sitting comfortably in the middle of the pack. Making boats seems like a perfectly average sort of a business, although their share price has performed at a well above average rate over the past 2 years, so we’ll want to check that assumption. But for now, let’s assume the company is average. In my most recent review, I was finding that average, small-cap companies were trading at p:e ratios of around 19.
Helpfully, Morningstar gives us their opinion of what the p:e ratio of this company is right there in that first table of statistics. Keep in mind, I said “opinion”. This is how I would view any p:e ratio you see quoted on the internet or in the newspaper. It is someone’s opinion based on their interpretation of what the company’s earnings are. Even if they are using “as reported” earnings those numbers are still an opinion of sorts, although it is the auditor’s opinion so should carry some weight. Still, your opinion could be very different. But let’s go with Morningstar’s version for now. They are saying that the p:e ratio for Johnson Outdoors is 19.96, almost exactly what you’d expect the p:e ratio of a typical, small-cap company to be right now.
Shoot. And here I was starting to get excited. A p:e of almost 20 is not typically what I am looking for in my hunt for deeply undervalued stocks. Something more like 11 or 12 would really make me sit up and take notice but a 20 doesn’t usually get the juices flowing.
All hope is not lost, though. Supposedly Warren Buffett would have liked this stock, so maybe we should keep digging. After all, that p:e ratio could be way off. Maybe the company lost some money last year because of a litigation settlement related to some inebriated boaters misusing their equipment. Maybe earnings are back on track now and the p:e ratio as calculated using ongoing earnings will look much better. Or maybe the company is in high growth mode. After all, the stock price has tripled in the past 2 years. Have earnings tripled as well? If so, perhaps this is a high flyer and deserves a significantly higher p:e.
Before we dive into their historical earnings numbers, let’s take note of a couple of other ratios in that first table. They list the p:b ratio (price to book) at 2.58. Not particularly noteworthy. If it was below 1, I’d be wondering if there might be the possibility of an asset play or turnaround situation, but at 2.58 that doesn’t seem likely. The price to sales ratio of 1.21 is potentially intriguing. Whenever the price to sales ratio is below 1, I start to wonder if there might be some value there lurking under the hood.
But really, it usually all comes down to earnings in the end (for me, at least). So how do we get some more information about those earnings numbers? If you click on the “ratios” tab at the top of that first table, it will expose a phrase underneath the table labelled “Full Key Ratios Data” that you can click on. This will bring up another page with a wealth of information going back 10 years.
Here, you’ll see how sales, earnings and book value have grown over the past 10 years. How consistent have their earnings been? Did they lose money in the last recession? Have profits been climbing recently or falling? You can see if the company has paid a dividend and if so, how reliably. You can see how many shares the company has had outstanding and see if they have been steadily buying back their shares or have been busily issuing new shares. If you click on the “financial health” tab of the key ratios section on the bottom half of the page, you’ll get information on how the company’s cash balances and debt have evolved over time. Have they been goosing their growth by taking on a bunch more debt or have they been steadily building up a growing pile of cash?
The first thing I look at is how sales and earnings have grown over time. For Johnson Outdoors, their track record is not great. Sales have grown from $421 million in 2008 to $491 million in 2017 for a long- term growth rate of only 1.7% per year. Very underwhelming. My hopes that this might turn out to be a high growth situation are starting to fade.
The number of shares has been fairly constant at around 9-10 million, so the total earnings and earnings per share numbers are going to give us a similar story. If we look at earnings per share, we see that the company lost money in the recession of 2008/2009. Not knowing anything about the company-specific details, I’d be inclined to give them a pass on that. Small cap companies often lose money during recessions. Profits recovered in 2010 as the recession ended and they did quite well in 2011 with EPS of $3.36. In fact, they did so well that year compared to their results both before and after that, that I would wonder if perhaps there was a one-time gain in 2011 that goosed their results. The sale of a division maybe? Or the reversal of a previous write-down? From 2012 to 2016, earnings were pretty stable, drifting between the $1 and $2 mark. If you compare those earnings to the current share price of $65, this looks like it could be a very pricey stock.
But wait! In 2017, earnings jumped to $3.51. And in the most recent 12 month period (TTM), the company has earned $3.13. That number gives us the p:e of 20 that Morningstar quoted on its front page. So earnings have more than doubled in the past year. If we thought that earnings might double again over the next year or even the next several years then this company would qualify as a high growth company and be deserving of a significantly higher p:e ratio. In which case, it might be undervalued even at a p:e of 20. (I recognize that as the market moves higher, I have to adjust my valuation goalposts, but this makes me uncomfortable. In the past, when markets were less expensive, I’d be selling my high growth companies at a p:e of 20, not thinking about buying them! Still, in light of the times, I guess I have to play along.)
It is often helpful to look at sales to give added colour to the story that earnings are telling you. In Johnson Outdoors’ case, sales and earnings were both basically flat for 9 years and then in year 10, earnings suddenly took off. Did sales take off as well? If not, then the earnings boost was probably due to a one-time event. But if sales did jump in tandem with the earnings growth then there might be something real here. Sales did grow in 2017 but they only increased by 14%. EPS on the other hand, vaulted higher by 162%. So if I had to guess, I would guess that the earnings boost in 2017 was either temporary, due to a one-time gain or else was due to some sort of change in the business that improved profit margins. If it was the latter (say the sale of a money losing division or some intense cost cutting) then maybe profit margins will stay high, but without significant sales growth to back that up, won’t continue to double every year.
Taking a quick look at book value, it has roughly doubled in the past 10 years, about what you would expect for the average company. They have paid some dividends over the years, but these haven’t been a big factor in the overall picture.
So at the moment, we’re dealing with either a “perfectly average” company in which case the p:e of 20 is uninteresting to us as bargain hunters and would not merit any further investigation or else we are dealing with a high growth company in which case perhaps there could be some argument to be made for buying in at a relatively lofty p:e of 20 if the growth story was convincing enough.
Before we go any further in our investigations, it is worth checking on the debt levels. Many companies carry an unhealthy amount of debt and this can be a quick way to move a prospective stock into the discard pile. If you scroll down to the second half of the page and click on the “Financial Health” tab this will bring up a chart showing the evolution of the company’s balance sheet over time.
Nothing to complain about here. The company has been paying down debt and building up cash. Wonderful! Using the latest quarter’s numbers, I get cash of $22 million and no short or long-term debt. If there are about 10 million shares outstanding that means the company is sitting on $2.20 per share in cash. When you compare that to the current share price of $65, that is relatively immaterial. Still, it is nice to see that their recent growth spurt was not funded by some massive infusion of debt. Bottom line: the balance sheet looks strong.
At this point, I’d need to make a decision. Do I roll up my sleeves and start to review this company in-depth or do I take a pass on it and move on to the next stock on my list? Clearly there is an awful lot about Johnson Outdoors that we don’t know. We don’t really know why earnings suddenly jumped last year or if this growth might be sustainable. We don’t really have a very clear idea of what the company does apart from it having something to do with boats. We don’t know how reliable those earnings figures are. We don’t know if any of them have been inflated or depressed by one-time gains or losses. But we can’t know everything about every stock. Is there enough there to make us dig any further?
I’d say, “yes, but…”. My suspicion is that this would not pan out as a new investment opportunity. I suspect it would ultimately wind up in my “perfectly average” category. 2017 was a good year for them but with their fairly uninspiring long-term track record of only 1.7% annual sales growth, I would be very reluctant to assume that this company had suddenly become a high flyer unless there had been some significant and permanent change in their underlying business. However, their balance sheet is strong, their line of business seems like it might appeal to me and profits did take a big jump recently. As a perfectly average company it would not be undervalued but it could have some merit as a high growth story.
So I would put this in the “possible” pile and come back to it. The next step would be to find the latest quarterly and annual reports and start calculating my own numbers to see if they agree with Morningstar’s figures. I’d want to read through the management discussion and analysis to see why earnings suddenly jumped higher in 2017 and get a sense of whether or not this growth seems likely to continue. The investment thesis for this stock would rest on whether or not its strong rate of growth in the last year was sustainable. And to make that determination I’d need a much more complete understanding of the company. With a p:e of 20 (assuming that that number holds up to scrutiny), the stock would be a very borderline buy, even if I thought it was a high growth situation and even in today’s overheated market. So I would be fairly quick to abandon my in-depth research if I wasn’t being convinced that profits were on track to double again in short order.
There is an overwhelming amount of additional information on the Morningstar site. It seems like we have only scratched the surface here. But the numbers I’ve talked about are pretty much all I use this website for. After you’ve covered the basics of market cap, sales, earnings, book value and debt you should be ready to make a final decision on whether to explore this idea further or move on to your next one. Remember that the numbers that are quoted on this website or on any financial website, are not reliable or may not be giving you the information you need. There is no sense in spending hours working from numbers that may ultimately prove to be wrong. If the stock still looks interesting after your initial quick overview, then it is better to go seek out the company’s own financial reports and continue your investigation from there.
The value of sites like this lie in their ability to give you a quick overview of a stock all in one convenient location. Often this will be enough to let you make a snap decision and either decide to take a pass and move on or dig in and do a more in-depth analysis. By focusing your time and energy, you can cover a lot more ground and turn over a lot more rocks. Turn over enough rocks and you are sure to find that undiscovered gem you’ve been looking for.
Addendum: If you’re like me, you’re dying at this point to know how the Johnson Outdoors saga played out. I did a little more digging, downloading the annual and quarterly reports from the EDGAR website. To my surprise, the story actually has gotten better the more I dig. This company’s main line of business is not boats per se but rather fishing accessories. They make a line of electric trolling motors as well as GPS enabled anchors and digital fish finders. They do their own in-house R+D and have launched a series of new products into the marketplace over the last two years that are being widely praised and are selling well. In fact, 60% of recent sales are from newly launched products. This could bode well for continued strong growth. Results in their most recent Q1 were stronger than the Morningstar figures suggest due to recent changes in the US tax code. In fact, if you use pre-tax earnings and then apply a universal 27% tax rate, you get trailing 12 month EPS of around $4.20 and a p:e of 15.5. With strong pre-season sales of their new line of fishing equipment going into their busy summer season, they could be on track for another very good year. This one is definitely worth investigating in more detail. Stay tuned. It just might end up appearing in the mispriced markets portfolio!