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At $1.68, Is ARA Cheap Or Expensive?
Corporate Digest, Featured | 04 December 2014
By: Shane Goh
Articles (99) Profile

In his annual letter to shareholders in 1989, Warren Buffett said: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. But, what is a fair price?

For this case study, we will look at ARA Asset Management, an Asian real estate fund management company that manages public-listed real estate investment trusts and private real estate funds. In our previous articles, we touched on ARA’s business, management and financial aspects.

Those were the first three of four tenets that Warren Buffett employs when looking at investments. In this article, we’ll look at the final piece of the puzzle: Market. Simply put, the market tenet looks at the price you pay for the stock.

Valuation Techniques To Choose From

We have a few ways to estimate a stock’s value. Common methods include price-to-earning and price-to-book value ratios comparison, both historically and relative, as well as discounted cash flow (DCF).

Let’s understand how each technique is calculated.

DCF attempts to value a stock using the concept of the time value of money. It is a present value of forecasted future cash flow for the next five to 10 years and a terminal value, discounted by a risk free rate. This method is suitable for companies or projects where future income and expenses is known and guaranteed

In the ratios comparison, price-to-book value (PB) ratio is calculated by dividing the share price over its shareholders’ equity. Price-to-earnings (PE) ratio is dividing the share price by a 12-month earnings-per-share (EPS). This could be its latest fiscal year, the previous 12 months, or a forecasted 12 months.

Choosing The Appropriate Technique

DCF requires multiple assumptions, some of which can change the valuation drastically if you shift it by one or two percentage points. I’m not sure about you but I don’t even know what I want for lunch tomorrow, much less what a company will make in five years’ time.

Although ARA’s business means that most of their revenue is recurring in nature, I can’t tell for sure what the amount is going to be next year. As such, I would exclude this method from the discussion.

We know that PB ratio is based on shareholders’ equity. While ARA manages property funds, the properties are not held on its balance sheet. This means that the debt is not reflected on it either. Thus, a balance sheet approach may not be suitable.

Lastly, we have PE ratio. From our analysis on its income statement, we know that revenue has been growing steadily over the past five years while operating and net margins have been fairly resilient, coming in at 65.7 percent and 52.9 percent respectively in FY13. I would prefer to use a valuation technique where the input, in this case EPS, charts a consistent path.

So Is ARA Cheap Or Expensive?

To calculate EPS, we divide the company’s net profit by its weighted average number of shares over the fiscal period. For FY13, ARA posted an EPS of $0.0879. Based on its closing price of $1.68 on 3 December, this means that its PE ratio stands at 19.1.

Over the past five years, on a previous 12 months basis, its PE ratio has ranged from a high of 24.9 to a low of 10.8 with an average of 17.9. At 19.1, its present PE ratio leans towards to higher end of the range.

On a relative basis, we will need to compare ARA with peers that have similar businesses. However, I was unable to find a pure property fund manager on the Singapore Exchange. Looking elsewhere might result in difference in country risks.

While we do a direct relative comparison, we can use our local stock market barometer, the Straits Times Index (STI), as a benchmark. Based on the SPDR STI ETF managed by State Street Global Advisors Singapore, the index’s PE ratio stood at 13.4 as of 3 December, or 5.7 points below ARA’s.

SI Research Takeaway

The entry price is ultimately determined by the individual investor’s risk-to-reward appetite. Risk adverse investors would err to the side of caution and wait for a cheaper price while risk hungry investors could pounce at a higher price. Neither is right, but we can argue that a cheaper price could provide better upside potential.

Currently pursuing his Chartered Financial Analyst qualification, Shane provides coverage on the property, consumer and environmental sectors at Shares Investment.

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