From the balance sheet to the income statement, it’s time for part II of the physical exam of UEPS.
Step 1: Revenue is listed for 2004 through 2006, and increased each year. 11.2% in 2006, and 34.5% in 2005. It is not particularly encouraging that revenue growth declined. Have they made the largest gains in market penetration (really, creation, given what they do)? This is probably why they are looking to diversify into new countries.
Step 2: The cost of goods sold increased by ~20% in 2005, but remained unchanged in 2006. As they grow as a company, does this indicate that they are streamlining production? Have they found cheaper labor or materials or products? It is perhaps a network effect: once the network is in place, there are perhaps only smaller charges to maintain it.
Step 3: Gross profit is revenue minus the cost of goods sold. 2006 - $146M; 2005 - $126M; 2004 - $92M. So, gross profit is increasing yearly. Browne says that he likes for this number to be stable, but clearly it isn’t. I suspect that is typically for a more mature company, but who knows?
Step 4: Determine operating profit by subtracting SG&A from gross profit. 2006 - $97M; 2005 - $80M; 2004 - $52M. As a % of gross revenue: 2006 – 32%; 2005 – 37%; 2004 – 43%. So with this number coming down percentagewise, this is probably a good thing. Browne says that this is the earnings before interest and taxes, EBIT, that is so important for the MFI, actually, and, Browne continues, this is the number that is used to value the company, including people looking to acquire it. The UEPS income statement includes depreciation and amortization in calculating the operating profit, as well as reorganization charges in 2004 and costs associated with the IPO and continued Nasdaq listing. The Nasdaq charge is probably more or less recurring, but it seems to me that the IPO cost and the reorganization charges should probably be ignored for calculating EBIT. And when depreciation and amortization are included, it becomes EBITDA. I’ve heard elsewhere that EBIT is more important than EBITDA.
Step 5: Calculate EPS. It took a little searching in the annual report to find a clear statement of the number of shares outstanding, but finally, the “Total weighted average number of outstanding shares used to calculate earnings per share – diluted” is 57.3M. So, using EBIT as earnings, EPS is 97 / 57.3 = $1.69. Using nondiluted shares EPS = $1.72, not a big difference at all. And looking at the other 2 years: 2005 – dil, $1.43, nondil, $1.46; 2004 – dil, $1.50, nondil, $1.56. A large number of shares were issued in 2005, increasing the number of shares 60%. So that explains the drop in EPS in 2005, but now in 2006, the EPS has more than made up for the dilution of ownership.
Step 6: Calculate the ROC: Divide the earnings of any year by the beginning year’s capital (ie, the end of the previous year), which is the shareholder’s equity and total liabilities. In this case, then the EBIT for 2006 is $97M, while the capital is $182M. ROC is 53%. ROC is of course one of the two measures for identifying MFI stocks, and this is a pretty high number for ROC. I’m encouraged that I came up with a number that seems appropriate for a MFI stock.
Step 7: The net profit margin is the earnings divided by the total revenues, presumably using EBIT as earnings. 2006 – 49%; 2005 – 45%; 2004 – 40%. So profit margins are increasing, which means that reinvesting cash in the company is leveraging sales.
Coming up is taking the stock to the mayo clinic. This one has more to do with everything the company has to say about their business, and less to do with the balance sheet and the income statement. This part is harder, and I’ll wait a little for it.
One last thing: I bought UEPS at $24.64. With EPS of $1.69, this gives an earnings yield of 7%. This sounds low for a MFI stock. When I get back the Little Book That Beats the Market, I’ll have to double check how EY is calculated for MFI.
But overall – that wasn’t so hard. Really.
Step 1: Revenue is listed for 2004 through 2006, and increased each year. 11.2% in 2006, and 34.5% in 2005. It is not particularly encouraging that revenue growth declined. Have they made the largest gains in market penetration (really, creation, given what they do)? This is probably why they are looking to diversify into new countries.
Step 2: The cost of goods sold increased by ~20% in 2005, but remained unchanged in 2006. As they grow as a company, does this indicate that they are streamlining production? Have they found cheaper labor or materials or products? It is perhaps a network effect: once the network is in place, there are perhaps only smaller charges to maintain it.
Step 3: Gross profit is revenue minus the cost of goods sold. 2006 - $146M; 2005 - $126M; 2004 - $92M. So, gross profit is increasing yearly. Browne says that he likes for this number to be stable, but clearly it isn’t. I suspect that is typically for a more mature company, but who knows?
Step 4: Determine operating profit by subtracting SG&A from gross profit. 2006 - $97M; 2005 - $80M; 2004 - $52M. As a % of gross revenue: 2006 – 32%; 2005 – 37%; 2004 – 43%. So with this number coming down percentagewise, this is probably a good thing. Browne says that this is the earnings before interest and taxes, EBIT, that is so important for the MFI, actually, and, Browne continues, this is the number that is used to value the company, including people looking to acquire it. The UEPS income statement includes depreciation and amortization in calculating the operating profit, as well as reorganization charges in 2004 and costs associated with the IPO and continued Nasdaq listing. The Nasdaq charge is probably more or less recurring, but it seems to me that the IPO cost and the reorganization charges should probably be ignored for calculating EBIT. And when depreciation and amortization are included, it becomes EBITDA. I’ve heard elsewhere that EBIT is more important than EBITDA.
Step 5: Calculate EPS. It took a little searching in the annual report to find a clear statement of the number of shares outstanding, but finally, the “Total weighted average number of outstanding shares used to calculate earnings per share – diluted” is 57.3M. So, using EBIT as earnings, EPS is 97 / 57.3 = $1.69. Using nondiluted shares EPS = $1.72, not a big difference at all. And looking at the other 2 years: 2005 – dil, $1.43, nondil, $1.46; 2004 – dil, $1.50, nondil, $1.56. A large number of shares were issued in 2005, increasing the number of shares 60%. So that explains the drop in EPS in 2005, but now in 2006, the EPS has more than made up for the dilution of ownership.
Step 6: Calculate the ROC: Divide the earnings of any year by the beginning year’s capital (ie, the end of the previous year), which is the shareholder’s equity and total liabilities. In this case, then the EBIT for 2006 is $97M, while the capital is $182M. ROC is 53%. ROC is of course one of the two measures for identifying MFI stocks, and this is a pretty high number for ROC. I’m encouraged that I came up with a number that seems appropriate for a MFI stock.
Step 7: The net profit margin is the earnings divided by the total revenues, presumably using EBIT as earnings. 2006 – 49%; 2005 – 45%; 2004 – 40%. So profit margins are increasing, which means that reinvesting cash in the company is leveraging sales.
Coming up is taking the stock to the mayo clinic. This one has more to do with everything the company has to say about their business, and less to do with the balance sheet and the income statement. This part is harder, and I’ll wait a little for it.
One last thing: I bought UEPS at $24.64. With EPS of $1.69, this gives an earnings yield of 7%. This sounds low for a MFI stock. When I get back the Little Book That Beats the Market, I’ll have to double check how EY is calculated for MFI.
But overall – that wasn’t so hard. Really.
2 comments:
Good stuff as always. I saw that little green book... I might have to pick up a copy though I am a believer in JG's book.
I think that the two are complementary. They're both about finding value; unlike the magic formula, this one goes into more depth. The real question is whether more analysis will improbe the MFI method.
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