Components

Example – REA Sales Growth

Source: REA 2022 Annual Report – page 117

REA’s average growth in revenue from continuing operations over the 5 years is 12.1%. There is one negative year however that is explained by the Covid pandemic which started in 2020.

Based on average sales growth, REA appears to be a high-quality company.

Example – Finding Financial Statements Online

The 3 main financial statements can be found in the:

• Annual report
• Full year report
• Half year reports

There are different places you can look for these reports:

• The Investor Relations or Shareholders section of a company’s website.
• The Prices, Research and Announcements section of the ASX website: www.asx.com.au
• The Company Announcements section of your online broker’s website.

Method 2 – What if the required return is reduced to 10%?

Step 1: Intrinsic value if 100% profit retained

Equity per share is $10.31 x multiplier of 7.225 = $74.48

Step 2: Intrinsic value if 100% payout ratio

Equity per share is $10.31 x multiplier of 3.000 = $30.93

Step 3: Calculate

First, multiply the result of step 1 by (1 minus the payout ratio}.
Second, multiply the result of step 2 by the payout ratio.

So, $74.48 x .564 = $42.00
And $30.93 x .436 = $13.48

Step 4: Add the results from Step 3 together

The intrinsic value is $42.00 + $13.48 = $55.48

John Neff

John Neff’s Windsor fund followed the same investment style no matter what the market was doing. During his 31 years at the helm, Windsor beat the market 22 times. As a result, it became the largest managed fund in the United States.

Here are the principal elements of John Neff’s investment style:

• Low P/E ratio – Windsor usually bought stocks with P/E ratios that were 40% to 60% below the market average.
• Earnings growth in excess of 7% – an increase in earnings can multiply the benefits of P/E expansion.
• Yield protection – besides growth in earnings, John Neff also looked for stocks with above average dividend yields.
• Favour stocks with a high total return relative to the P/E at the time of purchase – the total expected return is equal to the earnings growth plus a dividend yield.
• Buy cyclical stocks when earnings are at a low point in the cycle – cyclical stocks made up about 1/3 of the Windsor fund, but were only purchased when earnings were depressed.
• Solid companies in growing sectors – companies should have a solid if not leading market position, with further room to grow.
• Strong financials – on top of key fundamental criteria such as the P/E, EPS growth and yield, John Neff also looked for companies with growing sales, strong cash flow, and high return on equity.

You can read more about John Neff’s investment style in his book John Neff on Investing. Pay close attention to the Market Journal (Part 3) – as this shows how a world class value investor thinks about the market.

Key Points

• Financial statements provide a window into the inner workings of a company – they tell you whether the business is strong or weak, and how the management is performing.
• To be a successful stock picker you must be able to read financial statements.
• The 3 most important financial statements are:
• The Profit and Loss Statement tells you if the company made or lost money in the period being reported.
• The Balance Sheet tells you what a company owns, how much it owes, and how much is then left for shareholders.
• The Cash Flow Statement tells you whether a company is generating or consuming cash.

[1] Paul Nojin and Matthew Brooks (2010) Stock Market Strategies That Work In Australia. First Edition. Major St Publishing.