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How to Access A Company's Fundamental - Lesson from Private Equity Fund Practices:

livingston
Publish date: Sun, 03 Jan 2016, 05:12 PM
livingston
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Dear Members,


Today's article, I would like to share some of the practices use by Private Equity Fund Investment. It is generally not being exposed and shared to the public as it is kept for investment strategies.

Generally, in drilling a Company's Fundamental Health, we are looking at 2 different set of datas:

1. Financial Health Analysis - To know whether the company is in good health or insolvent.

If the company pass the Financial Health Ratios then we only will go to step 2 which is Pricing. Everything that sells in Bursa comes with a Price (price is what you pay, value is what you get):

2. Pricing Analysis - To know the price is cheap or expensive.

For PE Fund requirement before entering an investment, basically we will drill further the Company's Health by looking at ADDITIONAL INFORMATION normally Private Equity Fund House received and not by retailers. Some information structure requested from the PE would be like below:  
 
Preliminary Information Required by PE Fund House in addition on the Annual Reports/Quarterly Reports:  
 
 
1.         Background information of the business and future plans:
a.          Details of future contracts to be obtained / in the process of bidding
 
b.         Future business plans and business strategy including capital expenditure requirements
 
2.         Financials:
a.         Management’s projections for minimum the next 3 years including monthly cash flows and expenses
 
b.         Latest banking facilities obtained from Financial Institutions / in the process of approval 
c.         Top 10 clients/suppliers/vendors for the latest three years with the transaction values and new lists of 
            targeted potential clients
 
3.         Regulatory matters:
a.         List of all licenses, permits, consents and regulatory approvals required to enable the Group / Company to conduct businesses
b.         List of all patents, trademarks, service marks, copyrights and other form of intellectual property owned by the Company or in the process to be patented/approved.

Look at ITEM NO. 2 : Financials: 

What are the additional information PE House get that retailers don't and that info really makes a difference?
'The next 3 YEARS OF CASH FLOW AND EXPENSES PROJECTION.'

Different no. 1 

All listed entities do have their own 3 years Internal Forecast for their P&L, CASH FLOW and CLIENTS/PROJECTS POTENTIALLY TO BE SECURED and some even do it projection for 5 years. Don't you think with the info guided to them, the PE Fund should have a SUPERIOR RETURN with all the numbers in their hand? So for the retailers who only rely on Quarterly Report, Annual Report and Investor's Briefing keeps on bragging how much they know about the company and their bosses, perhaps you need to think twice before blowing your own trumpet.

How Private Equity Fund Works?

Generally PE Funds will target for 24 Months till 36 Months Investment Period. Rarely it will exit 3 years as they need to conclude the investment return to present their report card to shareholders with the visible earnings. For 3 years of investment, the TARGETED RETURN SHALL BE 30% (IRR 30%), HENCE 36 months of investment shall yield PE Fund a 100% return (assuming monies received from 3 years to be reinvested under FD deposits).

IRR for 3 years = (30% + 30% + 30%) + 2 years FD rate (assuming 1st year and 2nd year return to be parked in FD to enjoy 3.5% interests)= 100%

Different No. 2 

Do take note that PE Funds are the BIGGER BOYS who take HIGHER RISKS in expectant of RETURN OF CAPITAL 30% Per Annum. Next what would PE House do extra to know that the 30% is achievable?

Now we are revealing their Investment Strategies, please be noted you can only read it at Bursa Blue Ocean Group. Base on their 3 years / 5 years historical track record, PE House will use Quantitative Method to Calculate The Probability of The Future Earnings and bench them against the potential company to be invested. PE House will compare their analysis with the potential to be invested Company's own forecast to gauge the Probability of the Future Outcome. Now your question will be, what are the analysis normally they use? 

They are few but not exhausted to: Probability Concept, Decision Analysis, Regression, Forecasting Models. I do not want to touch in details as it is more on Quantitative Models and Studies. By the way, those Technical Chart Indicators by using Exponential or Moving Average are all computed using Quantitative Method. It is a method to calculate the Probability of the Model.

Conclusion

Points to Ponder: With the additional 3 Years Projected Numbers and Cash Flow Numbers on hand, they are targeting a 30% per annum (do note that some of their Projects Invested are Flunked). How could you not to use Fundamentals and Business Evaluation when you are investing a particular stock?

A company is listed for their Good Underlying Business Model. No company is listed because the stock are trad-able and to make you rich overnight. When you invest in a stock, you are buying a stake and investing in the growth of the business that you bought! It is not for you to treat it like gambling in Casino.

Thank you.


Regards,

Humble Pie 

Facebook Page: Bursa Blue Ocean

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Discussions
1 person likes this. Showing 7 of 7 comments

Desa20201956

all sounds nice ....
but do they say one thing do another thing.

investments by who knows who?

2016-01-03 17:39

livingston

Desa,

Agree on your point. Some owners do not honor/mismanage their company. When they want your monies, presentation will be done very well. When they get your monies, the table turned.

Generally I will use a mixture of 3 elements before deciding:
i. Fundamentals Analysis (health and pricing analysis).
ii. The Listed Company's Management Team (background, success stories and trustworthiness)
ii. Theme Play (are they on the right rotational play & Fund Manager's Radar)

If the Management have bad track record/cook their books and share price/inconsistent with their promises, I will avoid them irregardless on how good their Fundamentals to me.

Thank you for pointing out.

2016-01-03 17:52

JT Yeo

Hi Livingston, just seeking your advise.

As you are aware companies listed in bursa isnt like those on NYSE or Nasdaq, the disclosure is crap. You can add the information on quarter and annual report up and all you have is probably 2-3 pages of useful information.

All the solid information lies in the income statement, balance sheet and cash flow statement. Besides that if you really wants to get deeper like how do they win tender, target customers etc, it gets messy from there. Any advice how you dig those info?

2016-01-03 18:59

livingston

Hi Yeo,

There is no way retailers can know how the company submit the tender, price, margin etc. Even you are a staff with the company you may not be aware on the tender details. Only a handful of Senior Management Staffs have the information. If you are talking about Research Analyst having more information, this argument is valid . The information given to analyst is from Analysts Briefing or Company Visitation. Those info given also on the surface manner and Analysts have to come out with their own models to forecast the P&L.

2016-01-03 20:39

livingston

To add on on your details stated, from the Annual Report we see few more details to gauge the efficiency of the Management Team. Just to share some ideas you may use to screen through the companies you are following:

1. Chairman / MD's statement - If the statement is in contrast of what he says (year after year, he has no ability and sincerity to honor his words - RED FLAG)

2. Remuneration to the Directors - If the remunerations goes up much faster than the company's P&L, he is more interested to rewards himself than the shareholders -RED FLAG

3. ESOS & Placement of Shares - a lopsided ESOS quantity and exercise price. The Management rewarding themselves more than their effort given - RED FLAG

4. A higher profit recorded but worse of off cash flow / free cash flow and higher account receivable. Know how to do business but don't know how to collect money and later will appear as write off - RED FLAG

5. Active Right Issues with Free Warrants and Placement of Shares - Always raise but EPS, ROI, ROE does not move up in tandem - RED FLAG

6. Management appointed involved in unhealthy activities before; Bad track record ,Cook the share price, Cook the book, Problems with Authorities and Solicitors and Regulators - RED FLAG


There are many others to look at in the Annual Report but those are the serious one. In a nut shell, look at the Management Team and their track record before proceeding further. If they are tainted before for bad reasons there will be a chance they will do it again.

2016-01-03 20:54

JT Yeo

yea make sense, we can only try to make full use with the information we've got on hand and make decisions. Thanks for that.

2016-01-04 04:55

livingston

I believe as long as one is willing to learn the right way to analyze stocks and market, he or she should be able to earn some decent monies in the stock market.

2016-01-06 23:52

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