Using 'Mycroft' Method to Valuate Duoyuan Printing

I became a fan of Peter “Mycroft” Psaras when he first started publishing on SeekingAlpha. If you don’t yet know who he is, check out his instablogs, articles and profile.

The way he is different is that he clearly outlined a simple and effective framework for valuation. In what he called a "Main Street" view, he calculates a ratio called FROIC, Free Cash Flow over Invested Capital. If FROIC is above 20% consistently in the past several years, the business is very likely to be a good money-making business. He then buy such a business at a Price to Free Cash Flow ratio (PFCF) below 15 and sell at the ratio above 30, which is his "Wall Street" view. To make things easier for common investors, he simplifies the calculation of free cash flow to only adjust for depreciation and fixed assets investment.

PFCF = Market Price/ (Cash flow per share-Capital Spending per share)

FROIC = FCF per share/ (long term debt per share + shareholders equity per share)

I like his method. It is certainly not what I was taught in business school, but as Warren Buffett famously pointed out, you really should not use a scale to tell if a 300-pound person is over weight. A rough method like the "Mycroft" method lets you tell if a stock might be way over or way under valued at the first sight. This method is less error prone than the traditional ROE and P/E valuation because a company can ‘buy earnings’, but it can hardly buy free cash flow.

Duoyuan Printing (DYP) is the only one of the four IPO stocks last week that actually went down post-IPO. Ironically, it is the only one I liked and actually purchased on the weakness. I was willing to pay up to $11 per share for it, but I was fortunate enough to get it at a little over $8 per share.

Besides all other qualitative and quantitative methods I applied in analysis, I used the “Mycroft” method to double-check my thesis. I use a relatively conservative forward view of 20% growth in the top line and bottom line in 2010.

RFOIC has been consistently over 20% in the past 5 years except for 2007, when a relatively large investment was made. Financial Year 2009 (ended in June 2009) RFOIC adjusted using pre-IPO equity is 29%. So Duoyuan Printing passes the "Main Street" view test.

Its current PFCF ratio for 2010 is at 9. Using the entry ratio of 15 suggested by Peter leads to $13 per share, giving the current price 62% upside just leading into the entry price.

My calculation is summarized in the screenshot.


Disclosure: Long DYP. Readers should be aware of the substantial risks associated with an IPO. Reading through the whole prospectus to understand the business is extremely important.

Comments

[Robert Moreno:]

I just had an article published on RRD which is in a related space. Evaluated using traditional ratios.. going to do comparison using your metrics. Thanks.

Nov 10 11:31 AM

[Bill Haus:]

Hi Chimin, my name is Bill Haus, I too have been an investor in China for 5 years. Have Western New York roots (SUNY Fredonia) as well. I have no axe to grind, only curious if you would be open to a brief conversation. My email is [e-mail]. Understand if you are not interested, which is fine. Appreciate your writing and analysis - please keep it up. Thank you, Bill

Nov 11 04:30 PM

[berloe:]

if anyone can tell me where to find FCF/share easily mail to [e-mail] and thanks in advance

Nov 18 01:47 PM

[johnplaydoh:]

I do not know anything about the fundamental story on DYP. I trust you hav

e done your homework thoroughly. However, it is usually very negative sign that IPO stock breaks the deal price. In the DYP's case, it is now more than 30% below. Is there anything you are missing? Or perhaps it just lacks a support from institutions.

Nov 20 01:12 PM

[Chimin Sang:]

You do need to know a bit accounting and calculate by yourself. Don't trust any other source blindly.


On Nov 18 01:47 PM berloe wrote:

> if anyone can tell me where to find FCF/share easily mail to [e-mail]
> and thanks in advance

Nov 23 11:58 AM

[Chimin Sang:]

We will know in 6 months, which is the timeframe I am looking at now.


On Nov 20 01:12 PM johnplaydoh wrote:

>
I do not know anything about the fundamental story on DYP. I trust
> you hav

e done your homework thoroughly. However, it is usually
> very negative sign that IPO stock breaks the deal price. In the
> DYP's case, it is now more than 30% below. Is there anything you
> are missing? Or perhaps it just lacks a support from institutions.

Nov 23 12:01 PM