How Do You Analyze Individual Stocks? – Part 2 – The Periodic Check-In

If you’ve been reading MPFJ for a while, you’ve probably heard me mention before that I am not a big advocate of people investing large amounts of their own money in active management, either through the buying and selling of individual stocks yourself, following the advice of a newsletter, with the help of a “professional” investment advisor, or through an actively managed mutual fund.

Why do I shy away from large investments in individual stocks? Simple. Because the track record of individuals (even professionals) selecting individual stocks does not show proof positive that it is worth the cost involved. In fact, 70% of the stock professionals fail to beat out the market, so why would I think I can do this consistently?

Having said that, I do, however, think that analyzing individual stocks for investing using smaller amounts of play money is a fascinating exercise, and it’s something that I would like to believe in. I just haven’t seen proof that it can be done consistently in an efficient manner, but maybe someone will prove me wrong one day and cause me to switch from my current approach of passive investing using index mutual funds and ETFs.

Anyhow, back in February of this year, I did a post sharing my strategy for how I perform the preliminary analysis of individual stocks for potential buying opportunities, using the specific stock, MGT Capital Investments, Inc. (AMEX/NYSE symbol: MGT), as an example. 

Today, I wanted to continue this series/investigation by sharing the method that I use for another very important part of the individual stock investing process, the periodic check-in. Again, I’ll be using the stock, MGT Capital Investments, as an example for consistency. 

Basically, what we want to do with the periodic check-in process is to compare where the company is now vs. where it was when the preliminary analysis was performed to determine if it still makes sense for you to be holding the stock.

As a brief recap, in my preliminary analysis of MGT’s stock, my conclusion was that since the company has a good business model, strong leader in their CEO, and the recent key financial number change trends were pointing upwards, MGT would be a speculative “buy” when the 3 technical indicators I use turned positive.

 

Step 1 – 30,000 Foot Elevation View of the Company and Price Performance

To get a very high level overview/update on how the company is doing, I first turn to Google Finance and look up the ticker symbol.

On Google Finance, I specifically am looking at 3 things – 1) price history since I last analyzed the stock and 2) the current financials. I like to use Google Finance for this purpose because all of these items are displayed on a single page, making it very easy to navigate.

Shown below are these two items for the stock that I’m using as an example, MGT, as well as the appropriate screen shots from Google Finance. I’ve also left in the February 2013 screen shots for comparison as well.

  • Since I first assessed this stock on Feb 20th, 2013, MGT has experienced quite a run up in price.
    • Between February and now in July 2013, the stock price has increased from $2.85 to $4.37 per share, a growth of close to 60%!
    • While this growth was hard to predict exactly, it is not totally surprising, considering the things mentioned in my preliminary analysis about the company having good recent financial change trends.
  • Regarding the high-level financial figures, the overall change seems to be positive / in the correct direction.
    • Although EPS has decreased, pretty much all of the financials seem to have improved in the past 5 months or so – with market cap, trading volume, shares outstanding, margins, ROE, and ROA all increasing.
    • In addition, it also appears that they have downsized two employees, since they now have 7 employees, down from 9 previously. This will be something I want to investigate from a qualitative perspective as well.
    • It is also worthwhile to note that MGT still has a very small number of shares outstanding (only 3 million). What this means is that the stock is potentially very ill-liquid / volatile.

 

mgt since feb 20th
MGT Stock Price History
MGT Financials

 

Step 2 – See If There Have Been Any Changes Regarding How the Stock Fits Within Phil Town’s Rule # 1 Investing Analysis System 

As I mentioned previously in my 6 month test run of Phil Town’s Rule # 1 investing system (which showed that its usage did not deliver a market beating return due to the trading commissions involved), I do not believe that Phil’s system is the “magic formula” for beating the market. However, Phil’s approach does involve some very prudent technical and fundamental analysis which I feel can give me a deeper understanding of how the company is functioning as an investment.

Listed below is how the stock, MGT stacks up against Phil’s investing criteria, compared to 5 months ago:
  • Phil Town Criteria – Identify if the company has a “moat” – What he explains we are looking for here is >10% annual growth rate over 10 years for the following things: 1) Return on investment capital, 2) sales revenue, 3) EPS growth, 4) Equity per share, and 5) free cash flow growth. We also make sure that the company has enough current free cash flow to be able to pay back it’s long term debt in 3 years or less.
    • A great place to get all of this 10 year historical data in one place is Stock2Own.com. If you type in the ticker symbol of the stock you’d like to analyze in the box at the top, it will then automatically calculate all of these five financial ratios for you. These can be accessed by clicking the Annual Statements option on the left sidebar.
    • The data for MGT is shown in the attached screenshot below.
    • As I mentioned previously for MGT (and as is still the case), the 10-year average financial calculations above do not look very good because of all of the negative values it is carrying, and as such, are definitely NOT in line with Phil Town’s criteria. Return on investment capital (or ROE), EPS growth, and free cash flow growth are all either deeply negative or zero. Furthermore, the company has negative free cash flow,but at the same time, they still have no long term debt.
    • At ~31% annual growth over the past 10 years, sales revenue does fit the “moat” criteria.
    • At 11.9% annual growth over the past 9 years, Equity per share does fit the “moat” criteria.
    • These growth rates are a slight improvement from the way the company looked in February of 2013. 

Even though MGT still does not meet the Return on Investment Capital, EPS, and Free Cash Flow moat criteria set forth in the Phil Town method, this is not very surprising because it is a speculative play.

Because of this, we must again examine the CHANGE TRENDS in the ROE, EPS, and FCF financial figures over the past ten years in a more manual style. As you can clearly see in the chart below, many of the numbers are still negative for MGT, which is definitely a bad thing. However, if you examine the TRENDS closely from left to right, it can be seen that the company seems to be heading in the right direction in the regard that EPS, free cash flow, and ROE have all improved in the past 1-3 years, even though the numbers themselves are in fact negative. This is a good sign that this stock continues to be a solid speculative play.

 

  • Phil Town Criteria # 3 – Calculate the appropriate sticker price, or what the stock should be selling at given it’s current EPS and EPS growth rate. We then calculate the Margin of Safety price (MOS) to make sure that we buy the stock at a significant enough (50%) discount to shield ourselves from mistakes and be able to achieve higher returns.
    • Fortunately, the tool listed above, Stock2Own.com also has a handy feature that automatically calculates the sticker price (Value Price) and Margin of Safety (MOS) price.
    • To view this in Stock2Own, simply click the Value Price option in the left sidebar.
    • Unfortunately, for MGT, since their EPS is still negative (as it was back in Feb of this year), a MOS/Value Price cannot be calculated, so we don’t have this gauging point to base our decisions off of.
    • In the case of MGT, since their EPS is negative, we also cannot gauge effectively whether or not the stock is now “overvalued” now that the price has increased to around the $4 per share range. In fact, since the EPS is negative, this means that the stock has been OVERVALUED the entire time (even during the preliminary analysis! haha).
      • While this is unfortunate, there is not much else we can do but soldier on and make our decision with the other information available to us.
  • Phil Town Criteria # 4 – Use technical analysis tools to make sure you are either buying or selling at the right time. Phil recommends using three technical tools to make sure of this – 1) 8-17-9 MACD indicator, 2) 14K, 5D Slow Stochastic Oscillator, and the 3) 10-day moving average. Phil recommends that you only buy when all 3 of the tech. indicators say “buy.”
    • To generate these three graphs for a stock analysis, I again use Google Finance. To set it up, you simply click, “Technicals,” at the bottom of any Google Finance stock price history window, and fill out the fields as shown in the below screenshot:
    • Once you’ve set up the indicators, view the 3 month history graphs for the stock you’re analyzing. Three months seems to be a good time period in order to clearly see whether the technical indicators are saying “buy” or “sell.”
    • For analyzing MGT, the SMA, MACD, and SSTO technicals are all shown on the combined chart below:

mgt tecnicals

    • First, the 10 day simple moving average (red line), compared to the actual stock price (blue line). With the simple moving average, a “buy” signal is indicated by when the stock price line crosses above the moving average.
      • In the case of MGT, the stock price is currently below the moving average, indicating that we do not want to buy right now.
    • MGT’s 14K, 5D Slow Stochastic Oscillator. With the stochastic, the K line (blue) is the “buy” line, and the D line (red) is the “sell” line. With this technical indicator, a “buy” signal is indicated by when the buy/K line crosses above the sell/D.
      • In the case of MGT, the K line is currently below the D line, indicating that we do not want to buy right now.
    • MGT’s 8-17-9 MACD indicator is shown below. With this technical indicator, a “buy” signal is indicated by when the MACD line crosses above the EMA line.
      • In the case of MGT, the MACD appears to have decreased below the EMA, indicating that we do not want to buy right now.

 

Step 3 – Qualitative Research On The Company, The Management (CEO especially), Current News, and That No Insider Selling Is Happening

As the title above suggests, the next step I take in the periodic check-in is to analyze how the company I’m following is performing compared to when I last researched about it and check in on how the noteworthy events mentioned in my preliminary analysis unfolded. This is also a good time to research any questions that have popped up from the more quantitative investigations discussed above.

Listed below is how I tackle this step, using the stock, MGT, as an example:

  • Management Analysis (done through Google Finance and Reuters.com) – As was the case in my preliminary analysis of MGT, the current CEO is still Robert Ladd. He joined the company in 2010 as a director and became CEO in early 2012. This occurred almost exactly the same time at which the stock price for the company increased from almost $0 to $4 per share. There was also a stock split at this same time. At a high level, this appears that the market took the news of a new CEO as good and that Mr. Ladd was assessed as a good leader. Ladd also has a long history of investment analysis, which is important in his role as head of a holding company where he is making investments as his primary business. I also found another article stating that Mr. Ladd is “responsible for rejuvenating the company. As far as I can tell, Ladd continues to do a stellar job at the head of MGT.
  • Insider Trading (done through company website or MSN Money)  – In looking at the recent transactions of company insiders, the CEO, Robert Ladd, sold off ~5% of his total shares (20,000 shares sold) during mid June 2013 (around $100k worth). This is not necessarily the best thing to see, since it might indicate that the CEO sees the current stock price as the highest it will get for a while. However, Robert Ladd continues to the largest shareholder (with ~400,000 shares), meaning that the management goals are indeed aligned with shareholder benefit. It is still encouraging to note that the management only have reported income that they pay themselves of $200 per year or so, so it appears that their salary is heavily weighted in stock options/stock performance.
  • Additional Clarity About What the Company Does/Its Current Position (find the “news” columns on Reuters, Yahoo/Google Finance, etc after you bring up the chart for a specific stock) –
    • In reading a May 2013 investor presentation, I found out that MGT acquired a majority stake in April 2013 in an online fantasy sports wagering platform called, Fan Throwdown. In addition, they purchased Hammercat Studios in May 2013, which will eventually give them exposure to earn money from a mobile platform for skills-based game wagering.
      • Both of these purchases are encouraging to see, as it represents good growth opportunity potential for the company.
      • It also represents a logical diversification stream of revenue in to the sports and skills-based wagering realms to complement their gambling side of the business.
    • I had found out during my preliminary February 2013 analysis that MGT is selling off its medical holdings because it did not fit and wasn’t profitable for them. They have decided only to focus on their gaming patent development for now.
      • In searching around online, I found out that the company has completed the sale of its medical imaging patents. They were sold to the Samsung Corporation for $1.5 MM. Of this, the company expects to report a gain on the sale of $750k. This is good progress to see!
      • This sale of MGT Medical is likely responsible for the decrease in employees from 9 previously to 7 now.
    • Finally, the company is still awaiting the Markman Hearing to see if they will get any money from potential patent infringement against one of their gambling patents they own. However, there has apparently been a court date decided. It will be June 5th, 2014, so quite a long time to wait! 
    • Overall, it seems that the company is at a point where they are building for long-term success. As such, the recent increase in price doesn’t seem to hinge on some high-risk project being undertaken by the company, which is a good thing.

 

Step 4 – Review and Decision Hold, Buy More, or Sell Your Current Positions

Having now completed all of the steps I do in the periodic check-in, it is time to review what has been seen and decide if I would hold or sell shares I already have or buy more shares.

Using our example of MGT, here are my conclusions:

  • MGT’s stock price has increased significantly (60%) since the preliminary analysis was performed 5 months ago in February 2013.
  • Unfortunately, since MGT’s EPS is/has been negative, we cannot calculate a margin of safety/sticker price to determine if the stock selling for a good price or not. Technically, since the EPS is negative, it has been and continues to be HIGHLY OVERVALUED.
  • Even though several of the important financials for MGT are in fact “in the red,” the change trends over the past 1-3 years continue to point towards that the company is heading in the right direction.
  • All three technical indicators dictate that now is NOT a good time to buy MGT shares.
  • From a qualitative perspective, the company still has a great CEO, has made some very nice (and logical) investments in recent months to expand their business in to skill-based and sports-wagering, and has made good progress with selling off their medical holdings.
  • Because of all these considerations, I would hold my current MGT shares and buy more when the 3 technical indicators mentioned above give the green light.

How about you all? What is your approach to periodically checking in on individual stocks for potential investment? How much of your money do you allocate to individual stocks vs. mutual funds?

Share your experiences by commenting below!

Comments

  1. I agree with your point of view on the large investments in individual stocks. It just seems too risky for me. As a result I have never done it. However, I do really like the idea of investing a small amount in individual stocks as “play money”. It could be both fun and educational.
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