Philips: Quantitative Valuation
Long Only, Value, Banks, Retail
Seeking Alpha Analyst Since 2021
Non professional individual investor intrigued by intrinsic valuation. Studied quantitative finance, holder of Financial Risk Manager (FRM) certificate, working in a large European bank, but learned the most about investing from books of Benjamin Graham (human psychology never changes), Seth Klarman (market is irrational sometimes) and Aswath Damodaran (connecting stories and numbers). Started investing in developing economies in Europe almost ten years ago, survived one horrible market crash of 2020 and now mostly focusing on EU, Canada, Australia, New Zealand and USA. My goal is to invest in temporary undervalued companies that have predictable and at least average or above average medium term prospects, ultimately ensuring safety of my principal investment and satisfactory return. Apart from exclusive articles on Seeking Alpha, you can also read about what I do on my substack https://nicoper.substack.com
Summary
- Apart from intrinsic valuation, there are other tools I use to evaluate the stock.
- I base my investment decisions on a premise that market is efficient, hence modelling the stock.
- Based on the results, Philips still looks undervalued.
Analysis
Apart from the intrinsic valuation, prior to making any investment choice I try to estimate future prices based on historical price movements. Philips (NYSE:PHG), about which I wrote about recently, is no different. This I do only in the case if the narrative I am using for the company future cashflows is similar to past few years of its development (minimum of two is required). This way, I can be at least somewhat sure that historical data is representative enough. In case of Philips, although its business model is much different now than it was 10 years ago, I still consider it to follow the path it set upon itself even then.
Approach I use is simple if you have basic understanding of econometrics. Steps are the following:
1. I collect historical adjusted price time series data. In case of Philips, data as of January 2012 was used.
(Source: Author's Calculations)
2. Based on this data I estimate GARCH (1,1) model.
(Source: Author's Calculations)
3. Using this model and implied volatilities derived from it, I collect standardized residuals for each date in my time series. Think of this as the set of measured, unexplained volatility. I will use this later to add random shocks to forecasted price. Or in other words, I will create a population from which I will randomly draw historical shocks, and use them to perform Monte Carlo simulations.
(Source: Author's Calculations)
4. I then define the forecasting horizon and number of simulations I will run as a part of my Monte Carlo simulations. In case of Philips, I was running 10.000 simulations for 252 days in future (one year). Simulations would produce expected stock prices based starting from current market price, and for each day change the prior price for the conditional variance from the model and random shock drawn from the distribution of the standardized residuals I previously obtained.
(Source: Author's Calculations)
5. Finally, I would just plot the end of the forecasting period prices and observe the percentiles of the distribution.
(Source: Author's Calculations)
Although I don't consider this to be a substitute for intrinsic valuation, I find it useful in preparing me for the volatility up ahead. I use this as a tool to try and observe the volatility, and not only depend on its point-in-time measured value. With this, in case of Philips, I would not expect the price to drop to more than EUR 22. With my much higher potential upside calculated based on my intrinsic valuation, I will take the current the current situation as a temorary one, and I will tolerate price movements between EUR 28 and EUR 39 as normal expected high volatility as long as no new information is there to reduce the uncertainties surrounding Philips.
Hope you enjoyed this. If you have any comments, or you would like to see this analysis for one of your stocks, please leave a comment below.
Edit: 10/12/2021
On the article page, there was a discussion related to Philips buyback plan and capital reduction programme. I thought the chart below might be interesting to those seeking more information regarding this.
Figure below plots total share count through time, market capitalization, enterprise value and stock price. Hope you find it useful.
Analyst's Disclosure: I/we have a beneficial long position in the shares of PHG either through stock ownership, options, or other derivatives.
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