In my last post I covered American Agency Capital Corp.’s (AGNC) dividend rate and record. You can read that post and catch up on my analysis of AGNC by clicking here: http://tinyurl.com/3624qch.
Words before we start our analysis of the income account – copied extensively from Security Analysis chapter 31.
I recommend that you value AGNC [and any company for that matter] as you would if you were going to purchase the entire company in a private transaction.
Given sufficient information you shouldn’t go astray in your valuation of AGNC. Their 2009 annual report, most recent 10-K filing with the SEC, and earnings conference call audio recordings should contain the information necessary for analysis of AGNC’s business.
<a href=”http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MzkxNzF8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1”>
AGNC 2009 annual report</a>
<a href=”http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTc1Mzl8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1”>AGNC 10-K filing for the 3 months ended June 30th, 2010</a>
<a href=”http://phx.corporate-ir.net/phoenix.zhtml?p=irol-eventDetails&c=219916&eventID=3227950”>Q2 2010 earnings conference call & presentation</a>
You should arrive at intrinsic values similar to that which bankers evaluating the credit worthiness of the enterprise would arrive at. Basically, I’m saying that you should analyze both corporate earnings and the corporation’s assets (balance sheet). We should not rely on a single earnings test to determine if an investment in AGNC it prudent. A single earnings test would be less dependable than the two fold earnings and balance sheet tests. Earnings statements are subject to more rapid and radical changes than the changes which occur on a balance sheet.
Lastly, earnings statements can be more misleading in their presentation by company management and can contain more mistaken inferences than the typical balance sheet when scrutinized by an experienced investor.
Keep in mind as we begin the analysis of the earnings statement that the meaning of AGNC’s income statement cannot be properly understood without reference to the balance sheet at the beginning and end of the earnings period.
Here is a simplified statement of Wall Street’s method of appraising common stocks:
1. Find out what the stock is earning. (This usually means the earnings per share as shown in the last report.) AGNC earned $1.23 per share in the most recent quarter.
2. Multiply these per-share-earnings by some suitable “coefficient of quality” which will reflect:
a. The dividend rate and record.
b. The standing of the company – its size, reputation, financial position, and prospects.
c. The type of business (e.g., a technology company will sell at a higher multiple of earnings than a slow growth consumer staples manufacturer).
d. The temper of the general market. (Bull market multipliers are larger than those used in bear markets.)
The foregoing may be summarized in the following formula:
Price = current earnings per share X quality coefficient.
Current price ($26.98) = current EPS last four quarters ($6.97) X quality coefficient (3.87)
Graham’s “quality coefficient” is commonly known as “price/earnings ratio” today.
The result of this procedure is that in most cases the “earnings per share” have attained a weight in determining value that is equivalent to the weight of all the other factors taken together. The truth of this is evident if it be remembered that the “quality coefficient” is itself largely determined by the earnings trend, which in turn is taken from the stated earnings over a period.
AGNC’s earnings not only fluctuate, but they are subject to arbitrary determination by the company’s management. It will be illuminating if I summarize at this point the various devices, legitimate or otherwise, by which per-share earnings may at the choice of those in control be made to appear either larger or smaller.
1. By allocating items to surplus (retained earnings) instead of to income, or vice versa.
2. By over-or understating amortization and other reverse charges.
3. By varying the capital structure, as between senior securities and common stock.
4. By the use made of large capital funds not employed in the conduct of the business.
I don’t know if AGNC’s management has manipulated any of their earnings statements yet. We will discover that as I perform analysis on AGNC’s income statements in upcoming posts.
Significance of the foregoing to the analyst and to you
These intricacies of corporate accounting and financial policies undoubtedly provide a broad field for the activities of the securities analyst (that’s me). There are unbounded opportunities for shrewd detective work, for critical comparisons, for discovering and pointing out a state of affairs quite different from that indicated by the publicized “per-share earnings”.
That this work may be of exceeding value cannot be denied. In a number of cases it will lead to a convincing conclusion that the market price for AGNC is far out of line with intrinsic or comparative worth and hence to profitable action based upon this sound foundation. But it is necessary to caution the analyst against over confidence in the practical utility of my findings [Graham is warning me]. It is always good to know the truth, but it may not always be wise to act upon it, particularly on Wall Street. And it must be remembered that the truth that I uncover if first of all not the whole truth and, secondly, not the immutable truth. The result of my study is only a more nearly correct version of the past. My information may have lost its relevance by the time I acquire it, or in any event by the time the market place is finally ready to respond to it.
With full allowance for these pitfalls, it goes without saying, nonetheless, that security analysis must devote thoroughgoing study to AGNC’s corporate income accounts. It will aid in our exposition if we classify this study under three headings:
1. The accounting aspect. Leading question: What are the true earnings of AGNC for the period studied?
2. The business aspect. Leading question: What indications does AGNC’s earnings record carry as to the future earning power of the company?
3. The aspect of investment finance. Leading question: What elements in AGNC’s earnings exhibit must be taken into account, and what standards followed, in endeavoring to arrive at a reasonable valuation of the shares?
Read all about my valuation of AGNC and other topics affecting your investment portfolio at <a href=”http://www.myhighdividendstocks.com”>MyHighDividendStocks.com Blog</a>
Be seeing you!
No comments:
Post a Comment