How to Use GuruFocus as the 1st Step in Stock Research

Always do your own work and always rely on primary sources

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Feb 01, 2017
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Someone emailed me this question:

"I have a question for you about how you gather financial data. I like to input data into an Excel workbook for analysis, and historically I have done this from 10-Ks. However, I know that some websites such as Morningstar have 10 years of historical financials, ratios, etc. available for free. Do you use websites like Morningstar to compile data, or do you manually pull it from the 10-K?

"I see the risks of using a website such as Morningstar being that the data would be inaccurate or incomplete, and you would miss something important that is clear from the 10-K. On the flip side, being able to analyze EBIT ratios and such for 10 years at a quick glance seems valuable to me. I would like to be able to rely upon information from Morningstar, but I do not want to do so if it means potentially unreliable or misleading data. Gathering accurate data is so crucial in the investing process, and I want to get your thoughts on the most efficient way to gather accurate data."

It’s fine to use websites like GuruFocus or Morningstar to gather financial data on a company. Sites like GuruFocus are useful in the early stages of investigating a stock idea. They are useful because they have screens. They are also useful because you can simply type in a ticker symbol and look at the general pattern of the last 10 years or so. GuruFocus has – for premium members at least – some very long-term financial data. I have a conflict in recommending GuruFocus because it publishes my articles, but it’s a fine site. So is Morningstar.

There are other sites that are OK, too. Yahoo Finance is fine for quickly checking a company’s enterprise value. There are certain situations in which some of these sites may not be especially reliable. You will always need to be careful in cases where a company has recently been spun off (I’m talking even a year or more later) or has more than one class of stock or is a foreign stock or is listed in more than one country (for example, it has ADRs). A lot of stocks don’t have any of these problems. If you were interested in something like Kroger (KR, Financial) or Cheesecake Factory (CAKE, Financial), using a site like GuruFocus or Morningstar for the first part of your research would be fine. You could trust the 10-year financial data to be roughly right enough to give you a good idea whether you should investigate the stock further or not.

The advantage of websites like GuruFocus and Morningstar is that they present financial data in a comparable form. This is also the advantage of GAAP and IFRS. In theory, you could compare something like Kroger to something like Southwest Airlines (LUV, Financial) to something like Omnicom (OMC, Financial) to something like Prosperity Bancshares (PB, Financial).

In reality, it’s not that simple. For an investor, the numbers that really matter – the numbers that drive future economic performance – aren’t captured by generally accepted accounting principles. For Kroger, the enterprise value to sales level is the best way to evaluate the company. Websites will have that. Then you need to look at same-store sales performance. Same-store sales is the critical driver of economic performance at chains – especially mature chains – of restaurants, supermarkets, etc. It’s also very, very important that you adjust for changes in price within the stuff a company sells. For example, if Kroger has same-store growth of even 0.5% in a year when food prices away from home fall 5% in the U.S. – that’s actually an excellent performance.

No website – not GuruFocus, not Morningstar – is going to give you any idea what Kroger’s real same-store sales growth or decay was this past year. That’s probably the key number you need to know. It can help you with other numbers. You can see the gross profit margin, you can see SG&A as a percent of sales (the overhead burden) and things like that. That’s all useful information, but it’s general information.

I would be most interested in figures like same-store sales – either put in real terms or shown in comparison to competitors – and especially numbers like sales per store, gross profit per store and sales and gross profit per square foot. You can create comps using peers you find on a site like GuruFocus or Morningstar, but it’s very important to know whether the average Kroger store is 30,000 square feet or 60,000 square feet and whether it averages sales per square foot of $400 or $800 or $1,200. For Southwest Airlines, it’s important to know what the company’s cost per seat mile is. It’s important to know how much costs are separate from fuel (this is absolutely critical because an airline can’t control its fuel costs so the economics ex-fuel are what you need to know). It’s also important to know whether an airline leases or owns its aircraft. This kind of information is easy to find, but it’s easiest to find in the company’s 10-K rather than on a website like GuruFocus or Morningstar.

Banks are very, very hard to analyze based on information at websites like GuruFocus and Morningstar. The same is true of insurers. The business model of a financial company is different from that of other types of businesses. Low-cost liabilities are an economic asset. Almost all of the numbers I care about when analyzing a bank aren’t readily available at websites like GuruFocus or Morningstar. Or, at least, they aren’t easier and more reliable to calculate from those websites than by simply using the 10-K.

Important numbers at a bank are things like enterprise value divided by earning assets (or deposits), deposits (especially checking and savings) per branch, interest expense and net noninterest expense. Figures like revenue just aren’t meaningful at a bank. What a bank reports in revenue in a given year doesn’t matter. Some banks are interest rate sensitive. Other banks aren’t interest rate sensitive. Using Texas banks as an example, Prosperity is reporting earnings that are closer to “normal” than Frost (CFR, Financial) is now reporting. In a world of a 3% Fed Funds Rate, Frost would have much higher earnings than it does now. The Fed Funds Rate is much less important to Prosperity. The same thing can be true for insurers. There are insurers like Progressive (PGR, Financial) and Hiscox (LSE:HSX, Financial) that invest in much shorter-term securities than other insurers. Without knowing the duration of the bond portfolio of these companies, it would be easy to think an insurer that held longer-term bonds was cheaper than an insurer that held shorter-term bonds.

Cyclicality is also a problem when using websites like GuruFocus or Morningstar. Let’s say you are analyzing a commodity company like U.S. Lime (USLM, Financial). The most useful information is what the company’s proven (and probable) reserves are, what the long-term average real price per ton of limes is, etc. There are commodity companies that have 15 years or less of proven and probable reserves. There are other commodity companies that have 50 years or more of proven and probable reserves. What you need to know when analyzing a commodity company is how much future capex the company would need (especially to acquire or develop reserves), what a normal year of output would look like in unit terms (tons of production), and what the average real future gross profit per ton will be.

To do this, you need long-term data on the industry. It’s not hard to get this. You can use resources like the USGS website for most commodities. A site like GuruFocus or Morningstar just isn’t useful enough for a commodity company because the cycle is too long. For example, the period from 2007-2017 and even the period from 2002-2017 isn’t long enough to know what the average real price of oil should be. Oil is a tradeable commodity with speculative elements, the purchases are paid for in dollars, and the period from 2002-2017 may not have been normal for an asset like oil.

In terms of supply and demand, there’s a lot of useful information. That’s not the problem. The problem is oil as an asset. You would have to eliminate the influence of the dollar on the price of oil, and you’d have to eliminate the influence of oil as a financial asset. Doing this with data you have for only the last 10 to 15 years would be too complicated and too speculative. It would just involve too many arbitrary decisions on your part. Using very long-term price data for a commodity solves this problem. If you have 100-year data on the price of oil, copper and lime, you can find the average real price of these commodities.

You can also state the price of oil in terms of copper, the price of lime in terms of oil, etc. For example, you could see that historically the average real price of oil is say $50 per barrel in real terms and the average price of lime is $100 a ton. From that information, you could determine that on average a ton of lime buys two barrels of oil. This may seem like useless information. And it would be useless information if you could only compare lime to oil. But, you can also compare it to copper, silver, gold and just about anything else you want to price something against.

If oil is more expensive than it’s ever been against lime and copper and silver and gold – it’s clearly overvalued and a mistake to buy any oil company. Likewise, if oil is less expensive now than it’s ever been against lime and copper and silver and gold – then it’s clearly undervalued and it’s not a mistake to buy an oil company even if that oil company’s stock has a really, really high price-earnings (P/E) ratio on this year’s “E.” You can’t get this kind of info from GuruFocus or Morningstar, but it’s a cinch to get all this info and more from the USGS.

Why would you go through this trouble? Because it’s the most important piece of investing in a commodity stock. Speculation is different. Being a trader is different. If you want to buy a gold-producing company you absolutely need to know that you aren’t buying at a time when gold is two or three standard deviations from its long-term average real price. Now, sometimes, it may seem expensive because of something odd happening to the currency (U.S. dollars) in which it is priced. That shouldn’t happen if you can compare a commodity not just to how much paper money it can buy but also to how much it buys of other commodities. If there’s a copper producer in which you’re interested and it looks great based on what GuruFocus or Morningstar has to say, that doesn’t matter if copper is priced a couple of standard deviations from its long-term tendency in terms of real U.S. dollars and tons of lime and barrels of oil.

You simply can’t make an investment in an overvalued commodity. The reason for this is that if the commodity is priced differently now than it has been in the past, then future developments in production and consumption will be very, very different from what they were in the past. There’s no such thing as a certain long-term need for oil in the world. The world’s need for oil will be one thing at $50 a barrel and another thing at $150 a barrel. I think it’s pretty much useless to focus on GuruFocus or Morningstar data for a commodity stock – especially one with a long cycle. Anything with a long cycle is problematic. For example, the 10- to 15-year data on a shipbuilder is a lot less useful than the 10- to 15-year data on a semiconductor stock. The semiconductor industry has a very short cycle. The shipbuilding industry has a very long cycle.

The other instance where data from sites like GuruFocus and Morningstar won’t be useful is when a company has multiple business segments that move independently from each other. GuruFocus and Morningstar are providing corporate-level financial results. When I was writing my newsletter, I picked two stocks where the financial data provided by websites like GuruFocus and Morningstar just wasn’t worth paying much attention to. One was John Wiley (JW.A, Financial). The other was Babcock & Wilcox (BW, Financial) (now two separate companies called BW Enterprises and BWXT Technologies [BWXT]). I’m simplifying here, but Babcock was basically three businesses: a development-stage modular nuclear reactor business, a builder and especially maintainer of boilers for coal power plants and a builder of nuclear reactors for U.S. Navy submarines and aircraft carriers.

Quan, my newsletter co-writer, and I put no P/E on the modular nuclear power business (it was worthless in our view), a low P/E on the coal power plant boiler business, and then a high P/E on the Navy nuclear reactor business. None of the information at GuruFocus or Morningstar had any value to us in researching Babcock. We used 10-Ks, company presentations, U.S. government information and information from competitors. Wiley was similar. Unlike Babcock, Wiley wasn’t planning to split into separate companies.

We still broke it down into three parts: books, education and academic journals. We put a very high P/E on the journal business, close to no value on the book business, and something in between on the education business. We really weren’t interested in anything but the academic journal business. We never would have picked Wiley if it didn’t have the academic journal business. We never would have picked Babcock if it didn’t have the U.S. Navy nuclear reactor business. There was no way to see the underlying economics of these business segments using GuruFocus or Morningstar. The corporate-level results were just a random hodgepodge of the segment-level results. The way to understand Babcock and Wiley was through 10-Ks or company presentations.

Finally, I will mention taxes. I mentioned two companies that could – I stress could – have important tax situations. One was U.S. Lime. The other is Babcock. Quan and I didn’t spend time talking about Babcock’s tax situation. However, Babcock before the split had a significant amount of business outside the U.S. while also having the U.S. Navy as its most important customer. It was our guess that Babcock was probably overpaying its corporate taxes related to foreign operations because it wanted to be especially careful about any negative publicity related to its dealings with the U.S. government. We assumed that once the company was split in two, the U.S. Navy business would have very high taxes, but the company that no longer dealt with the U.S. government might start finding ways to pay less in taxes. I don’t know if that will turn out to be the case.

In the case of U.S. Lime, it’s in an extractive business. As long as it generates its profit from the sale of lime it will pay less in taxes than other U.S. companies will. The difference is meaningful. U.S. Lime would have to trade at something like 11 times EBIT to have the same after-tax valuation as a normal U.S. company trading at 10 times EBIT. This has nothing to do with the company’s corporate structure; any owner would benefit from the tax-advantaged nature of extracting lime. Here the useful information comes from the IRS. The info is easy to understand, but there won’t be any note about it at GuruFocus or Morningstar. All you see is that the company’s tax rate seems low, but you’ll have no idea why it’s low until you read the relevant part of the tax code.

Some companies pay the same effective tax rates for different reasons. An extractive business and a tech business may have the same effective tax rate – but the extractive business is not being aggressive to achieve that tax rate while the tech company with the same tax rate is probably intentionally pushing its tax avoidance strategies really, really hard. All GuruFocus or Morningstar will show is that both companies are paying way less than a 35% tax rate each year. It won’t be clear whether they are paying less because they are favored by long-existing tax statutes or because they have a corporate culture where tax avoidance is highly prized.

As a rule, I think it’s fine to do your entire stock selection and winnowing process at a website like GuruFocus or Morningstar. These sites are excellent sources of information. They save you time, and they won’t generally produce “false positives” in the sense of bad stocks that appear to be good stocks. However, some of the most attractive situations – especially the most complex situations – won’t be obvious on a website like GuruFocus. Babcock looked pretty normal pre-spinoff on a site like GuruFocus or Morningstar. It was actually really cheap. Simply reading the company’s own presentation or 10-K – we’re talking no more than an hour of work here – would have shown Babcock to be an interesting situation. But, it would look perfectly forgettable at someplace like GuruFocus.

You will miss something by not reading 10-Ks and company presentations yourself. On the other hand, everybody has limited time to spend on stock selection. GuruFocus is a good way to save time. It’s not better than primary sources, but it’s an excellent time-saving secondary source. For a secondary source, it’s reliable. But, you should never buy a stock based just on what you read at GuruFocus. You should take what you learn and then go read the company presentation, 10-K, etc. yourself.

Ask Geoff a question.

Disclosure: Long BWXT Technologies, Babcock & Wilcox, Frost.

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