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kcchongnz blog

Author: kcchongnz   |   Latest post: Thu, 21 Jun 2018, 08:24 PM

 

Stock Market Investing strategy: Buying good companies kcchongnz

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I read an interesting article recently written by a e-friend titled, “How You Can Become A Successful Full Time Investor”. It is a good article as despite that catching title, the writer though confident, yet not over-confident, shared his knowledge and experience. Despite of the “bold” title, the writer did responsibly imply that it is not a “sure thing”. This is definitely a good guidance for the young investors, unlike some unhealthy touting of stocks and encouraging the use of margin finance to the public to get rich quick. The writer has some principles to follow, and those principles are basically following the fundamental approach of investing. That is to me the most important point to become a successful investor.

Why do I consider fundamental investing the “right path” of investing?

A friend of mine who is a very successful investor in the stock market for decades told me he has talked to scores of remisiers to find out how have their retail clients been doing in the stock market. Invariably, everyone told him that more than 90% have under-performed and most of them lost money in the stock market. When asked what kind of stocks they bought, and the answers were the same; most of them speculated in the stock market in buying rubbish stocks touted by the media, their friends and relatives, analysts and investment bankers, individuals they have trusted, all with their own agenda. Hence my article “Never buy any stock by anybody” in the link below,

https://klse.i3investor.com/blogs/kcchongnz/157367.jsp

In my opinion, to be successful in investing in the stock market, “The Most Important Thing” is avoid speculating in the stock market as above but by treating investing in a stock as akin to investing in part of a business, or to become a small partner of the business.

The pertinent question then is; what is a good, or bad business or company?

 

  1. The Business

“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” Warren Buffett

To look from the business angle, or what some term it as “business sense” is consider a few things regarding the business such as the durability of the business, its stability in earnings and cash flows, return on capitals, financial health, growth prospect etc.

  1. Durability of a business

A good business should be one which produces goods and services which are in good demand; food, household products, packaging products, rubber gloves, music, games, data, courier and logistic services, etc. It is even much better if there is a high demand of the products in the markets all over the world. The company has a competitive edge and be able to produce better similar goods and services than its competitors either through quality or cost advantage. More importantly, the demand of the products and services, and the competitive advantage is durable, and will likely to persist in the future. In this case, the company would likely to have a favorable future prospect.

Investing is about the future, not the past. But no one can predict the future of a business or the company. Understanding the business as above will enhance the probability of success in investing in the business.

In this aspect, for example provider of household electrical products, Panasonic Malaysia Berhad, or Panamy, with its established brands and record of quality home electrical products selling locally, in the fast growing Asean and Arab countries, would likely to have a durable business and a competitive edge, some kind of a moat.

 

  1. Stability of earnings and cash flows

The historical performance of the company is a reasonable proxy for the future of the company. If the company has been able to weather storms in the past and perform consistently well in different operating environments, then it will likely continue to do so in the future and will able to survive no matter how tough the environment. Good cash flows indicate the good quality of earnings, not something just illusional, but real. Without free cash flows, a company will not be able to grow, distribute dividends to its shareholders, but have to continue to borrow money for preservation of its business.

Take Panamy with its past performance as shown in Table 1 in the Appendix as an example. Panamy has a long record of more than 30 years of operating history in Malaysia and in the Asean, Arabian and other countries. It has been making profit and good cash flows for all these years. It still did so during the financial crisis 10 years ago, in fact, even increasing profit during that time as shown in Table 1.

 

  1. Return on capital

Another major criterion of a good company is one which provides a high return of capital.

A $100 of additional capital created by a business A employing $500 of capital, or 20% return, is undoubtedly more impressive than a business B employing $5000 and returning $250 of additional capital, or just a return of 5%.

One major metric is the return on equity (ROE), the net profit achieved with the equity, or the net asset belonging to the common shareholders. Companies that boast a high ROE with little or no debt are able to grow without large capital expenditures, allowing the owners of the business to withdrawal cash and reinvest it elsewhere.

ROE is often used to compare with the cost of equity, or the required return of the money of the shareholders, Re. A common Re is about 10%, considerably higher than the return of fixed deposit of banks, considering the risks involved investing in a stock.

Panamy’s ROE has been consistently above 15% in the recent years as shown in Table 1, way above the normal required return of shareholders of 10%.

 

  1. Financial health

A company with solid financial position (and those with good cash flows) can weather through any form of economic and financial crisis with more certainty of survival.

Panamy has zero debt and huge amount of cash of RM650m, or RM10.70 per share in its bank account. It distributes a total of RM2.33 per share of dividend for the current year, or a dividend yield of more than 6% at the present price of RM38.10. With a healthy balance sheet (and excellent cash flows), it is envisaged that good dividend will persist.

 

In comparison of all the attributes of a business above, Eversendai is involved in a dog-eat-dog highly competitive construction industry. Its operating history as shown in Table 2 in the Appendix is short, with jagged and volatile earnings of a few years completely wiped out by a single year of losses in 2016. ROE has not been good in most years.  In fact, ROE has been way below the required return of rational investors. Cash flows, especially free flows have been poor and in huge negative numbers. Its debts, as a result, has been building up and ballooning to RM1.15 billion now. Certainly, Sendai can’t be defined as a good company.

 

  1. Growth

What about growth of the company? Is it important? Certainly, as a growing company will earn increasing profits going forward and shareholders will gain more and more from the business in the future.

The revenue of Panamy has been growing at a compounded annual growth rate, CAGR of 5.3% for the last twelve years. Its net profit grew at a much faster pace at CAGR of 11.5%. Last two years, it has spent RM100m, considerable more than it did before in capital expenses, and it has shown the benefit of the capex from the growth in revenue and profit in the last couple of years as shown in Table 1. It is likely that its business will continue to grow for the next few years.

Sendai appears to be having higher order book in the next couple of years too. The question is will it be able to break through the past losing streak and emerge a winner in the future? Increase in revenue and jobs are important but increase in profit, and profit turns to cash flows, and earning higher return than capital employed are more important. Time will tell as future is inherently unpredictable.

 

Aren’t the above all about so-called “business sense”? If not, what is “business sense” then?

Yet, many investors emphasize on the quality of its management before investing in its stock.

 

  1. Smart and capable, honest and credible management

“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.” Warren Buffett

A capable management is generally smart and competent in running the business in increasing long-term shareholder value. He has achieved many accomplishments and performed well relative to the company’s status and competitive position in its industry.  A good management is with sufficient quality will take the company forward in the right direction.

The capability of a management can often be gauged from what they have said, what they have accomplished and done through the years as reviewed through the annual reports and the past performance of its business.

A good management keeps in mind the interest of the shareholders who are the owners of the company. He rewards the minority shareholders with good dividend when affordable and carry out own stock repurchases when they are selling cheap. A good management is rationale in allocation of the capital of the company, by reinvesting the free cash flows well to earn return higher than the cost of capital and increasing shareholder value.

Honesty and credibility of the management is more important than smart and capable so that they are unlikely to put their hands in the till and shareholders are not short-changed. On the hand, a smart management is more dangerous to the financial health of the minority shareholders if he is dishonest.

Haven’t you heard of companies which their businesses have been deteriorating, and no dividend has been given for years, and instead, multiple cash calls were made in a short period of time to carry out value destroying projects or acquisitions, and yet the management is living in big house and drive luxurious cars, not only one car, but many sport and luxurious cars? Is that a signal of a good management and good company to invest in?

 

Conclusions

Now you have read about what a good business or company is, are you ready to invest in some good companies and its stocks to build long-term wealth safely, slowly but surely?

I do not think so, not until you have acquired the language of a business on how to identify a good company.  Moreover, finding a good company is just part of the puzzle. There are other aspects which are prerequisite to be successful in investing such as having an estimate of the value of the companies to compare with the price, the psychology and behavioral aspect of investing etc.

We can discuss about this next time.

Yes, hoping to build long-term wealth is not easy as just following a simple rule, follow the tips of others, leverage up with margin and hope to make it in a short term as propagated in the internet space. There is no such big frog jumping around. कोई नहीं.

To be successful in building long-term wealth (forget about quick road to riches), one must have the knowledge, the general knowledge about business and industries, the specific knowledge about the companies, and confidence (not over-confidence). Confidence can only come with knowledge and experience, and not just a slogan. All these require time and effort. There is really no free lunch in this world.

Meanwhile, if you wish to learn about all these with the aim of building long-term wealth in a more predictable manner, with some effort, you may email me at,

ckc14invest@gmail.com

Note: The companies used in this article are merely for illustration purpose. They are not meant as examples in any advice for sale or purchase.

KC Chong

 

Appendix

Table 1: Past performance of Panamy

 

Table 2: Past performance of Eversendai

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  2 people like this.
 
abang_misai Mau cari gaduh kah? Write like a professor but Hevea promoted is dying.
16/06/2018 21:06
Chanteckfai abang_misai still charging subscription fee for poor investment advise while creating many many fake account to attack your own subscriber?
17/06/2018 00:41
3iii Once again, thanks for sharing another excellent article.

My remisier and stockbroker, too shared that the majority (90%) of players lose money in the stock market.

For those not knowledgeable in stocks, please get educated or get a mentor. Do not invest in stocks without a sound philosophy and method.

This article shares a safe philosophy and method, but you need to know a lot more before involving in shares in a big way for the long term.

Good luck.
17/06/2018 02:35
pjseow Buying fundamentally good stocks are very important for consistent returns . Warren Buffet;s first rule is not to lose money in the first place . Good stocks with good records should be the key selections for first timers as the risk is very small. I started investing in 1998 during the once in a life time big crash when the CI index was between 250 to 600 .I started with RM 170 k using my housing overdraft . Stock investment had given me an average of 18 % ( inclusive of dividend ) annually compounded return . I bought Public Finance , Public bank,Malakoff , KMLoong , WCT , MOX , Maybank, Supermax , Elsoft , Inari ,Penta ,Airasia , Superln . I do not keep the stocks forever . I had sold most of them when it hit my targets or when the quarterly result turn negative . Some stocks gave a return of more than 20 % if you had hold it for more than 10 years . Stocks like Elsoft, Inari, Public Bank, Penta ,Top Glove , Supermx, Kossans , Hartalega ,JHM are good examples .
17/06/2018 11:30
3iii pjseow. Thks for sharing.

abang_misai and Chanteckfai do not know what they are missing. They probably will never know, given their denial or ignorance.
17/06/2018 11:44
pjseow 3iii, I do have my fair share of buying wrong stocks like Megan Media and Protasco . I lost more than 60k on Megan media alone . These stocks appear to make huge profits with low PE . When their cash started to go down unreasonably , we need to cut loss quickly. Fortunately ,such stocks are a small percentage of what I bought . THe other stock which was my favourite for the last 15 years was Uchitech which has consistently deliver good dividend .
17/06/2018 19:31
kcchongnz 3iii,

Thanks for the motivation.


pjseow,

You should be doing well in the long-term in investing. I have no doubt about that. Kudos.
17/06/2018 20:13
pjseow Thanks KC Chong .
The young investors tend to underestimate the annual return of 18 % .They want super fast return like those in the money games ( promise of 20 % return per month ). More than 90 % of investors got burned due to unrealistic promise of such returns . Many are inpatient and can't see the power of compounding . USing the rule of 72 , it takes 4 years ( 4x18 = 72) for the initial capital to double . Take RM 170k as initial capital , 4 years later the RM 170k becomes RM 340 k. A 20 years of consistent 18% return per year compounding will yield 32 x ( 2 to the power of 5 ) of original capital . It is a solid RM 5.44 million after 20 years of investment with RM 170 k initial capital . If you select good stocks ( slim chance of losing money ) to invest with an average 4 % dividend yield , what it takes is for you to make a 14 % capital gain only to get a cumulative 18 % . If you study the records of last 15 to 20 years for Dutch Lady , Nestle , Panamy , Public Banks , the top 4 gloves companies and the few electronic and semiconductor companies , they had such returns . The key words are "dont lose money "and be patience . The Malay saying " Sedikit sedikit , lama lama jadi bukit " is the best proverb to describe such investment .
17/06/2018 21:01
lengleng legend sendai would always be used as an example in your article when its share price surge on a sudden... what a strange coincidence... by the way, still agree with what it is written in the article..
17/06/2018 21:14
qqq3 DickyMe "Eversendai Corp Bhd's first completed liftboat Vahana Aryan will be delivered by the first week of June, and will be fully commissioned by mid-June."
This means they will get payment for that delivery and

"Nathan said its second liftboat is at 35% completion but currently put on hold. We expect to restart the work by next three to six months," he added,"
With payment coming in, no need to source for funding.

Currently, the group is tendering for about RM20 billion worth of contracts, split equally between structure steel and oil and gas segments. The group foresees a more sizeable contracts going forward. Year to date, the group has secured about RM716 million worth of job wins."

TENDERING FOR RM20 Billion worth of contracts. Dapat 10%, sudah RM2 Billion. Apa lagi mau?
06/06/2018 09:51
===============


what did I tell you? That this kcchong got lousy sense of timing.

sendai up 2 sen to $ 1.07...and this is only the beginning.
18/06/2018 10:08
Henly KYY said to KC "comes polish my shoe, I give u 1 millions rupee"
KC replied " Oh brother, no need I do for free "
KYY said " very kind of you, but you cannot do for free, I give you one tip, go buy eversendai "
KC " Oh my thousand thank you boss, i will be rich by just polish shoe, next lesson, the effective ways of shoe polish "

Lesson learned/
18/06/2018 12:20
hellbender good article. Thank you.
18/06/2018 16:04
myongcc5 Another good article...not to b missed.
Thanks KC
18/06/2018 16:09
qqq3 Posted by myongcc5 > Jun 18, 2018 04:09 PM | Report Abuse

Another good article...not to b missed.
Thanks KC


============
write is easy

decision that makes a man

its always the same problem.....

cup half full or half empty?
18/06/2018 17:23
moneykj You love Sendai like one love his young mistress...lol
18/06/2018 17:41
qqq3 Posted by moneykj > Jun 18, 2018 05:41 PM | Report Abuse

You love Sendai like one love his young mistress...lol
===============

well

write is easy
but have you developed your business sense to improve your timing and to tell whether cup half full or half empty?

since its low in March , Sendai has been a top performer in the KLSE....and the cup is filling up fast......
18/06/2018 19:25
kcchongnz Posted by qqq3 > Jun 18, 2018 07:25 PM | Report Abuse

but have you developed your business sense to improve your timing and to tell whether cup half full or half empty?

since its low in March , Sendai has been a top performer in the KLSE....and the cup is filling up fast......


Me: What does "market timing" has to do with "business sense"?
What kind of "business sense" is yours? Your "business sense" is market timing? OMG!

What does "business sense" have to do about "to tell whether cup half full or half empty?

What is "cup half full or half empty?
18/06/2018 23:47
qqq3 Mahathir has great sense of timing....Think he will do equally well in stock market as in politics.


Mahathir has great sense of timing....wrote his Malay Dilemma just at right time., resigned as PM just at right time, resigned from UMNO just at right time....comes back to politics just at the right time.




Mahathir has great sense of timing......born or cultivated? or just lucky? mathematically it is difficult to tell luck from born and cultivated.
19/06/2018 01:45
qqq3 people says stock market is about FA and TA.

I say BS to that.

I say stock market is about business sense and the ability to tell whether cup is half full or half empty....and the great sense of timing.
19/06/2018 01:54
qqq3 the reason why people say stock market is about FA and TA is because these are teachable skills. But , if that is necessary and sufficient , all the finance professors in the world would be highly successful. But we already know that is not true.

so, there are myths...and there are realities.

business sense and the ability to tell whether cup is half full or half empty....that would be the real necessary and sufficient conditions for success. ...but very difficult to teach.

Everyday, every transaction, sellers are negative and think it is half empty , buyers are positive and think it is half full and only one of the them is correct. The dilemma every one faces everyday, every transaction is ....whether it is really cup half full or half empty?

Wouldn't you want to be the one making the correct decisions?

Two highly trained fund managers , each with full knowledge of the situation and the said invested companies....one can be a seller, the other a buyer. But only one can be right.


Is it an innate skill or a cultivable skill? Nature or nurture?

Difficult questions.

More research is needed. Suffice to say, it is a thinking man's game. A thinking man's game in which luck plays a big and important part, yet a thinking man must try to improve his odds through constant practise and experiments.
19/06/2018 07:20
qqq3 when people says stock market is about FA and TA vs
when people says stock market is about business sense, about cup half full or cup half empty, about the great sense of timing

there is a great difference in the approach, in the thought process, and in the final outcome.

when people says stock market is about FA and TA....the tendency is to be too mathematical, the question becomes what PE or NTA should I sell/buy....the tendency is to take the human out of the equation, the tendency is to be too static and predictable, the tendency is to be inflexible, a portfolio full of shares sharing the same characteristics.


when people says stock market is about business sense....it is placing business sense at the top of the priority. The question then becomes what is the business sense of owning this particular share at this particular point in time. Its a great filter.

when people says stock market is about cup half full or cup half empty...it is recognising the dual nature of the stock market, that there are always pros and cons, the yin yang of the market, and that ultimately stock market is about choices and decisions....and the ability to make decisions based on imperfect information. Some people can make decisions , others cannot.

when people says stock market is about the great sense of timing, it emphasis that the sense of timing can be developed. That it is easier to swim down stream, easier to go with the flow than to swim upstream...that prices go up slowly and can drop quickly. That it is tough to go against the prevailing trend. They call this trend analysis.

In business, in politics and in stock market, some people have highly developed sense of timing.

In stock selection it is business sense first then followed by management quality and finally to review the available records and projections....not the other way round.
19/06/2018 17:50


 

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