Dividends are good

The next section of chapter 29 examines the practice of retaining profits to build up the business.  The issue here is that if you owned the business you could take 100% of the profit because the profit is what is left over after everyone else has been paid.  However, most companies will retain part of the profit on the basis that it will enable management to build up the business and maintain the dividend rate in future.

I briefly discussed dividends when establishing my stock screening criteria (See "Selecting Stocks - Take Two" from January 2009).  Based on the premise that the value of the unpaid amount is added to the company value (because a share is a portion of the company), I said I preferred companies that don’t pay dividends because individuals receive a 50% deduction on tax due on capital gains (ie the change in the share price) and it is paid only when you sell (if you are not classified as a day trader by the ATO and hold the shares for over a year) but pay full tax on income (ie the dividend) and pay it annually.  (At least that is my understanding, tax law is always changing and I could simply have it wrong).  Also, there are no brokerage charges associated with reinvesting your dividends if they are just retained by the company (although this is not an issue if the company offers a dividend reinvestment plan).

Graham and Dodd question the practice of retaining earnings (ie withholding dividends) on the basis that:

1. if two companies are similar in all respects except the size of the dividend paid, the one with the higher dividend will have the higher share price.
2. withholding profits lowers the return.
3. it rarely succeeds in maintaining the dividend rate in terms of $ per share.
4. any increase in share price generated by withholding dividends will not necessarily compensate the shareholders for the dividends withheld – particularly if you take into account the interest that would have otherwise been earned on the funds.  I had a go at trying to test this using the data I’ve complied for the NAB, but given the volatility of the share market, seven years is too short a period.
5. they believe a study would show that the earning power of a corporation does not expand in proportion with the dividends withheld, although they are assuming the company is retaining the majority of the earnings, say 70% to 90%.
6. individuals in charge of companies have a vested interest in withholding dividends – they will want to retain the cash in the company where they have control over it and they will want to increase the size of the company for self aggrandizement and to generate a higher salary.  They may also withhold dividends to depress the share price so they can purchase more shares or to minimise their tax bill.

In relation to point 3, I have replicated an exercise Graham and Dodd performed on United States Steel, in my case using figures for National Australia Bank over the period 2003 to 2008:

Sum of earnings per share for the period:    $14.455

Dividends paid to shareholders                   $10.380

Dividends withheld:                                  $  4.075

In 2009, after earnings fell to $1.975 per share from $2.373 per share the year before, NAB reduced its dividend to $1.46 per share from $1.94 per share the year before.  With over $4 per share “saved up” in the previous six years (and more if I went back further), there seems little justification for reducing the dividend. I scanned through the annual report to find any discussion on how NAB determines the amount of the dividend and found nothing.

Graham and Dodd’s conclusions are:

• Any dividend not paid out loses value for the investor.
• The major proportion of earnings should be distributed and any earnings withheld should be justified by management.
• You should look for both an adequate return and an adequate dividend when investing.

Diversion: A Wordle

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And the winner is ... dividends!

In Chapter 29 of Security Analysis, Graham and Dodd make the comment “Until recent years the dividend return was the overshadowing factor in common-stock investment”. (These words come from the 1940 edition of the book.)

To illustrate this they present two tables, one for American Sugar Refining Company (ASR) and one for Atchison Topeka and Santa Fe Railway Company (ATSR). Each table shows for a number of years, the price range of the stock, the earnings per share and the dividends per share.

ASR had quite volatile earnings, for example going from $18.92 per share in 1911 to $5.31 per share in 1912, but maintained a constant dividend of $7 per share over the period of the table (1907 – 1913). According to Graham and Dodd, the volatility of its share price was low, suggesting that it was the dividends driving the price rather than earnings.

The table for ATSR covers the years 1916 to 1925. The dividend paid was $6 per share each year except for the last when it rose to $7 per share. Earnings per share, while exhibiting some volatility, had a general upward trend. The price range again was relatively steady and level, but jumped in the final year when dividends were raised. So again, dividends seem to be driving the price.

I decided to undertake a similar exercise on a current ASX listed company. I chose National Australia Bank Limited (NAB) because I thought a long established bank would have steady dividends but volatile earnings and because, due to accidents of history, I own some (a very little some) NAB shares.

Instead of replicating the tables, I created two graphs: one plotting earnings per share against closing price on the day the full year results were announced and one plotting dividends per share for the year against closing price on the day the full year results were announced.

Here’s the graph of earnings against closing price for the years 2003 to 2007 inclusive. Closing prices were taken from Yahoo’s finance site, which only goes back to 2003. The R-square figure of 0.163 is a measure of how well the movement of earnings per share affects the closing price. A R-squared of 1 would mean that a change in the earnings per share would result in the exact same change in the closing price. A R-squared of 0 would mean that a change in the earnings per share would result in absolutely no change in the closing price. A R-squared of 0.163 is very low suggesting earnings per share has little influence on price.





What I see when I look at the graph is a squiggle – it folds back on itself. In this case I think the R-squared is meaningless and earnings do not directly affect the share price.

In contrast, when I look at the graph of closing price against dividends per share for the same period, things are a bit clearer. Each rise in dividends paid has lead to a rise in the share price. The R-squared of 0.664 suggests a reasonable correlation. So although there are not many data points here and no doubt a statistician would draw no conclusions from this, it would appear dividends directly affect share prices and earnings do not.




The impact of dividends could also be seen in the market reaction to Qantas’s decision to cut its interim dividend for the FY2010 half year despite the profit result being in line with company guidance. Its share price fell 8% in one day.

You may be wondering why I only took the graphs out to 2007. It’s because 2008 is when the global financial crisis hit and things went awry. When I extend the graphs out to 2009, it all goes horribly wrong.





Now both graphs are squiggles. So from this I conclude when it all goes wrong, it all goes wrong and hopefully when it happens again, I will have already switched my portfolio into cash.

What is a share?

Typically the answer to the question "what is a share?" runs along the lines of "a share is part ownership in a company". This definition is almost entirely unhelpful because it does not explain what ownership means.

If you own an ipod you can download music to it, you can listen to it, you can put a cover on it, you can stick it in a blender and turn it into dust like in that YouTube video, but you can do none of these things to a share.

The best definition of ownership that I have come across is that ownership is a bundle of rights. The rights associated with a share are quite limited. From what I can tell these are the rights available to shareholders:

- you can sell your shares
- you are entitled to dividends in proportion to the number of shares you own, that is, the cents per share paid as dividends will be the same for your shares as for everybody elses (unless there are different classes of shares with different rights, in which case, all shares in a class will receive the same dividends)
- you have the right to attend and vote at the annual general meeting (which, if you work full-time, you will be unlikely to be able to attend)

This does not look like ownership of a company to me. This looks like ownership of a financial instrument and the point of a financial instrument is to move money around from where it is not needed to where it is needed so that everyone benefits.

Why is this important?

It is important because it has a bearing on how you value a company and if you don't value a company you can't tell whether you are paying too much for the shares or not.

If you take the view that a share is part ownership of a company then you would value the company by forecasting its earnings, discounting them to present value (see note below) and dividing by the number of shares. If you take the view that a share gives you the right to receive dividends, you would deduct the proportion of earnings that will be retained by the company from the earnings to determine the dividends then discount the dividends to present value. This adds an extra element of risk, which means you would use a higher discount rate, which would give a lower value.

Why am I thinking about this now?

I am thinking about this now because Graham and Dodd point out the existence of the conflict between ownership of a financial instrument vs part ownership of a company in Chapter 29 of Security Analysis. They only mention it in passing before going on to look at dividends in detail, but I needed to get my thoughts straight.


A note on discounting

Discounting can be thought of as the opposite of earning interest. If you have $1,000 and you put it in a term deposit at 5% interest, in a year's time it will be worth $1,050. So the present value is $1,000 and the future value is $1,050. If you were saving for something that costs $1,050 and you wanted to buy it in a years time, you would 'discount' the $1,050 by 5% to find out how much you had to put in the term deposit now to have $1,050 in a years time.

In the case of a bank account, it is fairly straight forward because you know the interest rate. In the case of shares you have to work out for yourself what dividends you think you will recieve in future and what level of return you want to compensate you for investing in the shares and taking the risk of not recieving those dividends either at that level or at all. This amount should be higher than what you can recieve by putting money in the bank because you can be fairly confident that you will be paid the interest by the bank and be able to get your principal back.

Starting Over

State of Play: Way back in August, when I wrote my last post, I was looking at Nomad Building Solution as a potential investment. Or more correctly, I was concluding that they were not a potential investment due to their lack of transparancy on an issue that was never fully explained.

My position on this might seem a bit over the top to some people, but it is based on my training as a banker. The first question a banker is supposed to ask themselves before considering anyone for a loan is "does this borrower have integrity?". Nomad's lack of info about the issue, plus their trumpeting of double-digit revenue growth and leaving the fact this was due to the aquisition of two businesses for inclusion in the fine print, leads me to question their integrity. Banks take mortgages and charges so they can force repayment of loans, share investors are at the mercy of the market when it comes to getting their money back. This is why I'm passing over Nomad.

I also said, in my last post, that I would look at their next set of results, just out of interest to see where the story went. However, my laptop has been stolen with all my blogs and workings, so I'm not going to go back and recreate excel files just for the sake of curisoity. I did take a look at how their share prices has moved over the last year however. They reached a high of $1.23 per share on 9 Sep 2009 and closed at 26c on 3 Feb 2010. My guess is they rode the market up but reality hit them in the end.

Nomad originally came to my attention as a result of judging every listed company against a set of critera. I developed the criteria after reading a couple of books on investing (see previous posts). This was done in January 2010. You will note that a year has passed since then. [You may also note that my postings in this blog can best be described as intermittant. My only defence is that I have had a baby in November and being pregnant and then looking after a new born are not condusive to blogging or investing.]

Anyway, to recap what has happened since my last post in August 2009, I re-ran the criteria on the 30 June 2009 financial statements. Only one company made it to the shortlist - ALE (they own pubs which they rent out to others to operate). Unfortunately, about that time I attended a conflicts of interest course at work and learned that I am not allowed to trade any shares in my industry sector (property) regardless of whether they are clients or not. So, ALE are disqualified.

At that point I decided its was time for a new approach, which means a new book. The Snowball, the biography of Warren Buffet, details how he read Graham & Dodd's book Security Ananlysis, then went to Columbia University to study with them and later joined Graham's investment firm. Has ever a book come so highly recommended on any topic?

So I headed to Readers Feast in Melbourne, which always has a good selection of books on finance and investment and indeed found a copy of Security Analysis (6th edition). My first impression is that it is a very big book at 2.5 inches thick with an accompanying CD containing additional chapters and appendices. It covers both bonds and shares, so fortunately I don't have to read the whole thing (but being a Virgo I probably will).

Anyway, back to the content. The issue I am currently grappling with (which I admit might not appear entirely obvious) is how do I select companies to invest in? The short answer to this is provided in Chapter 28 - Newer Cannons of Common Stock Investment.

I have to admit, that I did not find this chapter an entirely easy read, but this is what I believe it is saying:

• there are four approaches to share investing
• first approach - create a portfolio of "carefully selected, diversified group of common stock purchased at reasonable prices". This approach is discounted on the basis that investors cannot count on a general market wide increase in earnings or profit. I would have thought this would be taken care of by the careful selection, but maybe they are just saying there's no guarantee the market will go up.
• second approach - select growth stocks. This approach is discounted on the basis that by the time you can be certain a stock is a growth stock it may have matured and will not grow further or, even if it is a growth stock the price will contain a premium taking this into account.
• third approach - exploit market swings through buying when the market is low and selling whent he market is high. This approach is discounted on the basis that it is too difficult to pick the market turning points.
• fourth approach - buy undervalued shares. Graham and Dodd contend that although it is rare for a good stock to sell at a low price, it is common to find stock that have average prospects for the future and appear cheap on quantitative measures. This is because most investors focus on companies with unusually good prospects. "Because of this emphasis on the growth factor, quite a number of enterprises that are long established, well financed, important in their industries and presumable destined to stay in business make profits indefinitely in the future, but have no speculative or growth appeal, tend to be discriminated against by the stock market - especially in years of subnormal profits - and to sell for considerably less than the business would be worth to a private owner."

This fourth approach is the margin of safety principal and is considered the best by Graham and Dodd. Unfortunately, it appears I cannot just set a few criteria and bingo - there's a portfolio. It appears I must do a fair bit of analysis to form a view on the value and discover whether a certain share is trading at a discount to value. So from this point I think all I can do is plow on with the book and see where it takes me.

The BS uncovered

State of Play: Having found five potential companies to invest in, I have started analysing the financials of one of them, Nomad Building Solutions. Last post looked at the income statement; this post looks at the balance sheet with guidance from “The Motley Fool Investment Guide” (‘MFIG’ / “the book”) by David and Tom Gardner (aka “the Fools”).

The pointers from the book are as follows:

1. Cash is “very, very, likable” and “we like to see lots of it.”

The Motley Fool boys like cash because it:
- indicates company is generating cash, which is a fairly important part of being a company (alternatively, they’ve done a share raising)
- gives an indication of the absolute floor price of the shares (although I tend to believe that cash is too easy to spend and just because a company had cash in the bank at 30 June doesn’t mean it was still there by close of business on 1 July)
- provides the ability to pay off debt
- provides the ability to acquire other businesses including competitors

They don’t actually define what “lots” is. At 30 June 2008, Nomad had $22m in cash, which was 19% of their net assets. This seems like lots to me. At 31 December 2008, they had $21m in cash, still 19% of net assets. So still lots although reducing.

Cash per share at 31 December 2008 was 15 cents, which, interestingly, was the low the share price reached on 27 January 2009. The $21m in cash was 1.6x the current borrowings, so if they couldn’t refinance they could just pay the bank back, which is a good position to be in.

I think we can conclude that the cash position is OK.


2. Avoid too much debt.

Again, no definition of “too much” provided. Lets look at whether they can pay their interest bill each year, as banks tend to get annoyed when businesses don’t pay their interest and start doing nasty things to them.

The interest cover ratio, aka, ICR (net profit before interest, tax, depreciation and amortisation or “EBITDA” divided by finance costs) for FY2008 was 16.0 times. That is, they can pay their interest or “finance costs” 16 times over from the cash they generated over the year. So, it seems to me that they do not have “too much” debt.

For the half year to 31 Dec 2008, the ICR had fallen to 6.1 (ignoring the impairment of goodwill), which still seems a quite healthy figure by itself, although the significant drop is a bad sign. I’ve ignored the impairment of goodwill because, like depreciation and amortisation, it is a non-cash item and does not affect their ability to fork out cash to the bank.

3. Make sure growth in accounts receivable and inventory approximates sales growth.

The Fools see accounts receivable and inventory as being more like liabilities than assets because they represent a (temporary) failure to generate cash. For the half-year to 31 December 2008, revenue had increased 62% compared to the same period in the year before, whereas, accounts receivable and inventories had gone down 14% over the six months. So Nomad are getting better at generating cash. On the surface seems good.

4. Do whatever ratios catch your fancy.

Examples provided in the book include:

Current Ratio: current assets divided by current liabilities. It is a test of short term liquidity, in other words, can they pay their bills and can they protect themselves from unforeseen circumstances? The Fools like this ratio to be above 2. For small caps, they like it higher still.

For Nomad, we get the following results:
FY2008 1.18
HY2009 1.05

Doesn’t quite pass muster, particularly as it is falling. Looking at the balance sheet, we see that current liabilities stayed virtually the same over the 6 months at $87.8m. Current assets however fell from $103.4m to $93.4m. So they have met criteria 3 above, but it has all gone towards meeting the cost blow-out, so perhaps was driven by necessity. If the cost issue continues, they could be in real trouble.

Quick Ratio: current assets minus inventory divided by current liabilities. It is a harsher test of liquidity because its looking only at cash and receivables to meet short term liabilities.

For Nomad, we get the following results:

FY2007 1.19
FY2008 0.88
HY2009 0.82

So, the movement over FY2008 was not good and the six months to Dec 2008 made things worse. This is basically saying that Nomad are dependent on selling inventory to be able to pay their bills. Note 1 of the financial statements says that inventory includes (i) Raw materials and stores, work in progress and finished goods and (ii) Construction work in progress less progress billings. It represents about 20% of the net assets. I don’t really understand why a building company has such a high inventory. It appears they are building buildings and then looking for buyers later, rather than finding the buyers and building later. This strikes me as a risky way of doing things.

Debt-to-Equity Ratio: The book calculates this as long term debt divided by shareholder’s equity, but I am going to include both long and short term debt, because it is trouble in getting maturing debt refinanced that brings companies undone (think Centro, a company now virtually owned by its banks). A low ratio is good because debt payments have to be met and, as stated above, banks get nasty when businesses miss payments. A low ratio also indicates that a company will be able to raise debt easily if they need it.

For Nomad, we get the following results:
FY2008 32%
HY2009 42%

Its hard to assess what constitutes a “low” debt-to-equity ratio without comparing companies across an industry, but a jump from 32% up to 42% cannot be good. Looking at the details we see that debt increased from $38m to $47m and equity decreased from $119m to $113m over the six months to 31 Dec 2009. So the cost blow out hit both sides of the ratio.

Return on Equity: net income divided by equity, ie the amount of money generated relative to the amount of money put into the company.

Here are the results for Nomad:
FY2007 28%
FY2008 20%
HY2009 before impairment of goodwill 15%
HY2009 after impairment of goodwill 2%

So with all their trumpeting about increasing revenue and net profit at 30 June 2008, they kept very quiet about the fact that their return on equity dropped a whole 8%. Meanwhile, the events of the last half of calendar year 2008 just made everything worse.

Having done all this I’m not feeling much confidence in the management of Nomad. They bought to companies that worsened their results and they have issues within their Nomad Modular Building subsidiary which they don’t appear to fully explain anywhere, not in the financial statements and not in ASX announcements. I don’t like the lack of transparency on this issue.

Nomad’s full year results should be released to the ASX this week (all companies have until the end of August to report), so I’ll be interested to see whether they have managed to turn things around, but they are not gearing up as a buy in my book.

What a difference a P&L makes

State of Play: I have a shortlist of five companies I want to analyse to determine whether I should invest my hard-earned cash into them. I have “The Motley Fool Investment Guide” (‘MFIG’ / “the book”) by David and Tom Gardner. It’s time to get into some serious number crunching, starting with Nomad Building Solutions.

Nomad shares were trading at 17.5 cents when I first checked their price on 30 January 2009. They closed at 75 cents on Friday 14 August 2009. An increase of 429%. That’s equivalent to around 800% per annum. Phenomenal, so what do the financials tell us?

As per the blog I wrote way back on 26 January 2008, Chapter 14 of the MFIG looks at how to analyse a company’s income statements (otherwise known to oldies like me as the Profit and Loss Statement, or just the P&L).

D&T’s first piece of advice is to “make sure margins remain at consistent levels if they are not actually rising”. Nomad’s net profit margin for the financial years ending 30 June 2007 and 2008 are:

FY2007 7.8%

FY2008 7.1%

Oh dear. They have failed the first test.

Net profit margin is net profit after tax divided by revenue. The book explains that shares trade off expectations and those expectations are based on trends. This trend is going the wrong way. We want the net profit margin either to stay the same or go up.

We also need to look at what is going on to get this result, so first to revenue:

FY2007 $208.7m

FY2008 $335.7m

Yes, you’re reading right. Nomad lifted their revenue by $127m or 61% in only one year.

An extraordinary result.

How did they do it?

They did it by buying two businesses. So actually, we have no idea whether it is extraordinary or not. They don’t tell us how much revenue was derived from the parts of the business that was in place at 30 June 2009 and how much came from the new businesses. We don’t now how much revenue the two new businesses made last year, so we have no way of judging whether this is good or bad. Damn, that is annoying.

Moving on, lets look at the net profit after tax (‘NPAT’ or “the bottom line”) in both years:

FY2007 $16.3m

FY2008 $24.0m

An increase of 47%, which by itself again you would think is impressive, but we just have no way of judging. We also see why net profit margin has fallen. If revenue has increased by 61% but profit has increased by only 47%, then the increase in costs must have eaten up the difference.

So what can we conclude from this? Either, the two businesses bought are not as profitable as Nomad in its original form or Nomad in its original form has not performed as well over FY2008 or both.

I don’t like it.

The market did not seem too fussed about it, however. The 30 June 2008 results were released on 24 September 2008. On that day, 2.8m Nomad shares changed hands, over ten times the daily average for the year prior. In spite of this, the price only changed by 2c per share on the day, closing at $1.65, compared to $1.67 the day before.

D&T’s second piece of advice is “make sure research and development expenditures aren’t getting shortchanged”. Unfortunately, we can’t check this because Australian companies don’t itemise research and development expenditures on the P&L. So we just have to move on.

D&T’s third piece of advice is “make sure the company is paying full income taxes. They say to do this by dividing the tax paid by the earnings before tax.

For Nomad, these rates work out at:

FY2007 31%

FY2008 32%

Which is a tad odd given the Australian company tax rate is 30%. Fortunately, they have a note in the financials which reconciles the tax paid back to a straight 30%. The issue is there are some expenses which are not deductible for the purposes of calculating taxable income. These include “Share based payments”, “entertainment” and “other”. These total less than 0.2% of all costs, so I’m not going to worry about them.

The book explains that the point of this is that if a company has carry-forward losses which are diminishing their tax rate, then these need to be taken into account when examining margins. This does not apply here.

D&T’s last piece of advice is “keep an eye on growth in shares”. This is because its not so much the net profit after tax that counts, it the net profit after tax divided by the number of shares, because that’s what its worth to you as a shareholder.

There’s a whole note in the financial statements about this and it looks more complicated that I would like, but lets wade through it.

At 30 June 2007, the balance of the number of shares issued was 116,466,124. So, with a NPAT of $16.3m, the earnings per share (‘EPS’) were 14 cents.

This seems a fairly straightforward calculation to me, so why do Nomad report the EPS as 18.9 cents per share?


At 30 June 2008, the balance of the number of shares issued was 135,273,708. So the profit is being shared between 16% more shares and the EPS on my calculation was 17.7 cents per share.

So why do Nomad report the ‘basic’ EPS as 19.7 cents per share and the ‘diluted’ EPS as 19.5 cents per share (the ‘diluted’ figure takes into account options).

Nomad’s calculation is based on using the weighted average number of shares over the year, rather than the number outstanding at the end of the year. I’m sure this has been the topic of countless papers and committees on accounting practice and numerous very learned people have determined this is the best method, but I don’t see how this helps me. If I was holding 100 shares at 30 June 2009, unless the company gave me more shares for free over the year, I will still hold 100 shares at 30 June 2010 and if the company had made the exact same profit, my profit would be down almost 14% on the year before.

So lets look at what the changes are over FY2008 and see what happened.

- 6 Sep 07: Issued 673,401 shares in part payment for one of the businesses they bought

- 26 Oct 07: Issued 457,042 shares under the dividend reinvestment plan, ie some shareholders elected to give back the cash they received as a dividend in return for more shares.

- 4 Mar 08: Issued 5.6m shares in part payment for one of the businesses they bought and on the same day, issued 105,076 shares under a share purchase plan

- 24 Apr 08: issued 706,992 shares under the dividend reinvestment plan.

So no-one got free shares (which is a good thing), and the EPS have increased 3.7 cents over the year for a person who held x shares at the start of the year and the same number at the end. This seems a good result to me, and quite a bit better than the 0.8 cents increase calculated under the weighted average method.

So the lesson here is, do your own EPS calculation.

What can we say at the end of it all. The company is generating slightly less revenue for the amount of money it is spending (return on cost has fallen), but in buying the new businesses, it took account of this in the price, so the net result to shareholders is positive? But how will this affect things going forward? Will Nomad bring the new companies up to speed or will they drag things down? Hard to say at this point.

Chapter 14 goes on to talk about P/E ratios. With an EPS of 17.7 cps (my calculation, lets call this the ‘spot EPS’) the P/E ratio at the sound of the closing bell on 24 Sep 2008 would have been 9.3. The book makes the point that the P/E ratio really doesn’t tell us much, but there is a rule of thumb that the P/E ratio should equal the percentage of the company’s earnings per share growth rate. So you can use this rule of thumb to determine whether a share is under- or over-valued. Unfortunately, you need to have a view on the growth rate. I don’t have a view, at least not yet. I also don’t have access (yet) to any analyst views, so I will just stick this in the back of my mind for now.

It all needs to be considered with a grain of salt, in any case. Going back to a year earlier, the 2007 results were released on 26 Sep 2007. With a closing price of $2.81, the P/E ratio based on earnings of 14 cps was 20. The actual growth in spot EPS was 26%. So using the rule of thumb, the shares were undervalued then at $2.81 and interestingly the shares reached a high of $3.40 on 31 October 2008, which gives a P/E ratio of 24. Unfortunately, it then started a steady decline, reaching a low of 15 cents on 27 January 2009, co-incidentally, just a couple of days before I checked the price. So, I don’t think this rule of thumb is going to be of great use to me.

Lets jump ahead and look at the 31 December 2008 results, where we find things have all gone horribly wrong. Firstly, there is a new expense item on the P&L called “Impairment of Goodwill”. Not being an accountant, just these words send shivers down my spine – what the hell is “impairment of goodwill”? Then it gets worse, the figure against it is $6.852 million. This is a big whack, leaving a bottom line of only $1.3m compared to $10.3m for the same period last year.

Looking through the note on this, it has to do with the valuation of goodwill, which they reassess every six months and as a result have come up with this figure of $6.852m. This says to me that they paid too much for the businesses they bought. But the share market was falling steadily during this same six months, so I'm not sure how much I can blame them for this.

Reading further we find out the even before the impairment of goodwill, profit is down 21%. The Net Profit Margin before the impairment of goodwill is 4.8%, quite a fall from 7.2% for the same period last year. Now this really is a big issue.


The fall in profit is attributed to “problems in the Nomad Modular Building division in WA” and the CEO of this division has “tendered his resignation”. Nomad Modular is not one of the new businesses they bought during the year, this is part of the original business, so it should be running like clockwork. The departure of the CEO just raises more questions than it answers. Is this just scapegoating for an event that was beyond anyone’s control? Are they letting required knowledge and experience walk out the door? They don’t provide enough detail to make an assessment.

So, in summary:

* the headline presentation of Nomad’s 2008 annual results, ie "we’ve made a 48% increase in profit", was misleading, it should have mentioned that the acquisition of two businesses contributed to this rather than leave it for the fine print, and

* based on the admittedly small window of performance I have assessed, I have no evidence that they can manage their business successfully. They made acquisitions that lead to write-offs and their costs have blown out cutting one third off their net profit margin.

These issues no doubt contributed to the fall in their share price from a high of $3.40 on 31 October 2007 to the low of 15 cents on 27 January 2009. But given the growth in the share price since then, something must now being going right for them. I will delve into this in a future post, however, in the next post I will go through their balance sheet.