Money Matters

What Does the Future Hold for M1 Ltd?

(Source: www.fool.sg)

Over the last two years, M1 Ltd’s (SGX:B2F) stock has fallen by 35%. Investors are probably not all that happy with that performance and may be asking themselves whether it’s time to sell. At the same time, those that don’t own M1 could be wondering if it’s fallen into bargain territory. An analysis of the company could help us with these questions. If you ask me, there are two primary parts in a company analysis. There’s an analysis of the intangible factors and aspects of the company, along with an analysis of the key numbers and ratios. These analyses accomplish give us very…

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Over the last two years, M1 Ltd‘s (SGX:B2F) stock has fallen by 35%.

Investors are probably not all that happy with that performance and may be asking themselves whether it’s time to sell. At the same time, those that don’t own M1 could be wondering if it’s fallen into bargain territory.

An analysis of the company could help us with these questions.

If you ask me, there are two primary parts in a company analysis. There’s an analysis of the intangible factors and aspects of the company, along with an analysis of the key numbers and ratios.

These analyses accomplish give us very different viewpoints into a company, and we view both as essential. The analysis of the company from the non-numerical perspective can’t really give a full picture of the company without also digging in to the numbers. And vice versa.

Today we’re going to tackle part of this analysis and take a look at M1 with a focus on the numbers. Specifically, we’re going to be talking about the following key ratios: (1) Growth ratios (2) Profitability ratios (3) Debt ratios

M1’s growth ratios

We love to see growth at the companies that we invest in because a growing company can create a huge amount of value over the course of time. Research from the bank Credit Suisse goes as far as to say that “Sales growth is the most important driver of corporate value”.

Here are the current values for M1 Limited’s key growth ratios:

Source: S&P Global Market Intelligence

From quote above from Credit Suisse, our interest in revenue growth should be pretty clear. But, in short, we see revenue growth as the best overall view into whether a company is actually growing.

Of course profit growth is also important. Except when a company is still very young, we’d like to see that profits are growing in line with, if not faster than, revenue. If there’s strong revenue growth without profit growth, that could be a sign of a problem.

Finally, growth in book value can give us another lens to look at a company’s growth. As a company earns profits over time and (hopefully) experiences compounding growth on those profits, investors should see its book value grow.

Investors do, however, need to take notice of dividends and regular share buybacks, as both of these can slow the growth of book value, even though they can still be good for investors. M1’s stock, for instance, has a dividend yield of 5.7%, so that will have some impact on the growth of its book value.

M1’s Key Profitability Ratios

Revenue growth is only good for us as investors if it can actually bring in profits – whether that’s today, or in the case of young, fast-growing companies, in the future.

For me, there’s not a single best measure of profitability. What we see from one measure can be confirmed or better explained when we look at it in conjunction with another. Sometimes two ratios might even contradict each other and reveal where we need to focus our research on. In short, it’s great to look at more than one measure of profitability. What follows are three key measures for M1:

Source: S&P Global Market Intelligence

The two profit margins – the operating margin and net profit margin – help us understand how profitable the business is. That is, how many cents of profit remain of each dollar of revenue after the relevant expenses are deducted. Naturally, the higher they are, the better. Meanwhile, the return on equity tells us efficient the company is in generating a profit with the shareholders’ capital that it has.

M1’s Debt Ratios

Even when we find a company that is growing and is profitable, we still have to pay attention to the risks. And, a heavy debt load can be a big risk – sometimes it could even be a reason to avoid investing in a company.

The absolute value of the debt load is usually not all that helpful to us. So in our analyses, we start with two debt ratios.

The debt-to-equity ratio compares a company’s total debt to its book value and gives us a view on how large the debt burden is in comparison to the size of the company. Next, we look at EBITDA (earnings before interest, taxes, depreciation, and amortisation) versus interest expense. EBITDA is a quick-and-dirty measure of a company’s cash flow, and so the comparison between it and the interest expense helps us to see whether the company is able to easily cover its interest payments.

The average values over multiple years are less helpful to us here, so this time we’ll just look at the values in each of the past few years for M1:

Source: S&P Global Market Intelligence

What’s “good” or “not so good”? Of course that depends on the particular company, but my rule of thumb is that a debt-to-equity ratio of more than 100% is when I start to get concerned. Meanwhile, we generally like to see an EBITDA-to-interest ratio of above five – if the ratio’s below three, that’s when we really start to worry.

As with all ratios, the direction of movement is also important. If the ratios are improving over time, that often gives us more confidence in a company even if the current value isn’t where I’d like it to be. At the same time, if the current value is so-so, but has been deteriorating over time, we would likely want to dig in a bit further to see what’s driving that.

What now?

We’ve only focused on a few key ratios and a few areas here. It can give us a good start. But, a few financial ratios can only take us so far. So for each number, it’s important to go further and ask yourself “why?” and “ok, now what?”

We ask “why” because these ratios are a starting point for us to understand a company. To gain a full understanding, we need a grasp of both the numbers and the less tangible aspects of a company.

And we can use the numbers and ratios we’ve studied above as a jumping-off point to ask good “why” questions that will help us get to that understanding. For instance, if we see high profitability, asking why the company is able to earn that can help us figure out whether there’s something temporary that’s padding profits, or if the company has a really great competitive advantage.

And we ask “ok, now what?” because these figures are by their nature, history. As investors, we want to get an idea of what will happen of the next few years. Knowing historical numbers can help us with that, but only when we take them to that next step of “now what?”

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