Republic Cement as an Equity Bond with an Expanding Coupon

It's just a cement bag. No! For me, it's an equity bond with a powerful compounding/expanding coupon!

This is Part 2 of a Series. Go to Part 1: How to Quickly Assess a Likely Long-term Rate of Return Given a Stock’s Current Price

We turn ourselves to Republic Cement (PSE: RCM), a company I was able to purchase three years back then (and still holding) when it was still selling below book value.

Fast facts: It’s been in the business of manufacturing and selling cement for decades. It’s currently the market leader; majority holder is that worldwide leading French cement company called Lafarge. Catastrophe risk is almost minimal.

So let’s try to apply the simple appraisal steps noted earlier...

How to Quickly Assess a Likely Long-term Rate of Return Given a Stock’s Current Price

Foresight? In stocks, hindsight is clearer and easier. While we know by hindsight what the excellent business is capable of performing, we downplay our prospects of it, and content ourselves with the more likely, easily achievable, conservative scenario.

This is Part 1 of a Series.

I’m starting to be more inclined towards fast but very conservative approaches in rate of return and intrinsic value appraisals. Because no matter how detailed, elaborate, or complex our models are, if the assumptions, programming, or the projections themselves are too optimistic and aggressive, then the likelihood of achieving these forecasts would be thinner. And the same thing goes with achieving superior returns.

What we simply want to do is downplay our prospects, minimize our expectations, and be happy and content ourselves with the safe, very achievable, conservative scenario, and pay a reasonable price for that—all these despite knowing by hindsight that the business is much more capable and can offer more!

Intrinsic Value and the Equity Bond Theory

This is Part 2 of a Series. Go to Part 1: Intrinsic Value and Bond Valuation

Equity Bond. A stock can likewise be thought of as a bond whose worth is just the sum of all its discounted free cash flows. The difference from your regular bond being: the equity bond yields expanding coupons!

Following the line of rational thinking usually applied in bond valuation, a business, in the same manner, is only worth all the discounted future cash flows it can provide. A business, therefore, can be thought of as an “equity” bond. The question now is: which cash flows should we consider and discount?

An extreme take on this paradigm is the Dividend Discount model. Taking on the assumption that the significant cash flows are only those dividends actually paid to the shareholders, the model intends to value a stock based only on these dividends. The immediate problem on this extreme view is how detached it is from the real, internal cash-generating capacity of the business. For one, it can be deceptive since dividends by themselves say nothing of the operating realities of the underlying asset—they can even be financed through externally sourced debt at the immediate pleasure of naive, detached “owners”, but at the immense detriment of long-term, business sustainability. Another reason is that, there's also those companies which are really good at making money but are not in the habit of disbursing them as cash dividends. It's not that they don't want to share the profits, but that even the board of directors and the shareholders favor income retention because management is capable of further deploying these profits in investments that would further compound wealth.

Intrinsic Value and Bond Valuation

This is Part 1 of a Series

The intrinsic value of an asset is only worth the sum of the present values of all the future cash flows it provides. This is the assumption of bond analysis and valuation. When you buy a bond, you are offered interest or coupon payments which you receive in varying intervals (e.g. monthly, quarterly, semi-annually, annually, etc.). You pay upfront for the principal, receive interest payments, and finally receive that principal you initially paid for upon maturity (i.e. expiration date of the bond).

Coupon Bonds. In bond analysis, a bond is only worth the sum of the present values of all its coupon payments and principal upon maturity.

What is Present Value? It is the discounted value of a cash you’d be receiving in the future. It is based on the premise that as rational capitalists, we give more value to cash we can hold, spend, or invest now (at the present time) than the same cash amount we would receive in the future. It does make sense if we observe an extreme example: were you offered a million pesos, would you rather have it now or have it 10 years later? Most definitely, that Php1M is worth more to you now than it is (at the same amount) 10 years after!

How about Discounting? Discounting is a technical, finance-slang term akin to your more familiar, layman’s interest rate. Say you have a Php100 and you offered it to me as a loan with 10% interest per annum. After a year, assuming I stay true and make good our original terms, your Php100 would be worth Php110.