kcchongnz blog
MyFirstPortfolio Which stock to sell and what to keep? kcchongnz
“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.”– Warren Buffett 1992 Berkshire Hathaway Shareholder Letter
“"Price is what you pay. Value is what you get." Benjamin Graham
I wrote about my 3 portfolios based on the principles of fundamental value investing, in particular the Greenblatt Magic Formula as published in i3investor for the last two years in this article of “A New Year Reflection of Returns of My portfolios”.
http://klse.i3investor.com/blogs/kcchongnz/67547.jsp
As many of stocks have risen in prices substantially, some of them have their business deteriorated, We will examine them one by one using the principles of the Magic Formula to see which should remain in my portfolio this year.
The Magic Formula
We will start with My First Portfolio as shown in Table 1 in the Appendix. Here is a revision on the principles of the Greenblatt Magic Formula which you have learned.
http://klse.i3investor.com/blogs/kcchongnz/51631.jsp
Earnings Yield = EBIT / Enterprise Value
Return on Capital = EBIT / (Fixed Assets + Net Working Capital)
- Enterprise value = Market capitalization + total debts + MI – excess cash
- Fixed assets generally is the property, plant and equipment
- Net working capital = Receivables + Inventories – Payable
- Ebit is earnings before interest and tax, or operating profit
- MI is minority interest if any
The Magic Formula for Pintaras and Kimlun
I am taking these two construction companies as examples for the discussion as both of them appeared in My First Portfolio. I compute the two components of the Magic Formula with their closing share price of RM3.73 and RM1.19 respectively at the end of the year 2014.
There are a few adjustments I have made. First for the formula I use after-tax Ebit, or NOPAT for ROIC, such that I can compare with the cost of capital, also worked out on after-tax basis. For the financial statements of Pintaras, I have isolated the incomes from its managed funds and interest from cash in banks from its “Other operating Incomes” as cash and cash equivalent has different risk and return profile as that of its foundation business and metal can fabrications. Likewise, this cash and cash equivalent has been excluded from its invested capital.
Table 2 in the Appendix shows the computations of EY and ROIC from the latest financial statements of Pintaras and Kimlun. It is shown that despite Pintaras’s share price has risen by 151% since two years ago, its earnings has also increased resulting its EY still high at 14.7%, substantially above my requirement of 10%. Its ROIC remains high at 29.7%, one which you won’t be able to find in any construction company in Bursa. Its ROIC has been increasing steadily from 17.4% since 6 years ago. Pintaras has been paying more than 40% of its earnings for the last few years as dividends, it has shown that it “over an extended period can employ large amounts of incremental capital at very high rates of return” for the past.
Pintaras appear to be the kind of stocks what Buffett said should hold forever. What about Kimlun?
Table 2 in the appendix shows that based on the latest financial statement of Kimlun, its EY at 11.2%, passes my minimum requirement of 10%, but just. However, its ROIC fails as at 9.2%, it is below my minimum of 10%. Something is seriously wrong with Kimlun as its ROIC has been falling unabated from 30%+ five years ago to less than 10% now. This shows that whatever money retained has been earning lower and lower marginal return year after year which is below its costs of capital.
I disliked Kimlun more of its deteriorating margins, increasing debts and most of all, and extremely poor cash flows. It never has any free cash flow for the last three years. Its cash flows from operations were even negative for the last three years. However, this seems to be improving in the recent quarters, but I have long discarded this stock from My First Portfolio
The Updated Magic Formula for Other Stocks in My First Portfolio
Again I refer you to Table 1 in the Appendix which shows the metrics of the Magic Formula and their total stock returns so far. Please note that you won’t get the exact numbers as mine as I have done a lot of approximations, some may be basing on outdated data. However, I do not think it changes my decision that much.
One can see that Plenitude appears to be the most undervalued stock with an EY of 39.4% and a ROIC of 13.1%. Actually the earnings of Plenitude is erratic due to sales of land and the last year high earnings may not be representative. However, I continue to keep this share is more of because of its grossly undervalued assets of high quality using the Graham Net Current Asset Valuation:
http://klse.i3investor.com/blogs/kcchongnz/59102.jsp
Yes I know. Its share price has dropped substantially since I wrote about it last time. That happened to me not only the first time. My excuse is stock price often doesn’t reflect its value in the short term and we will just stop there. The other is Kumpulan Fima, up by only 3.5% compared with the index of 12.9% during the same period the last two years. With a high EY of 23.3, I won’t abandon Kfima as its ROIC of 13.2% is also way above its cost of capital, and it is able to deploy its capital efficiently.
You can see that ECS ICT is a good company with great price at RM1.18 with ROIC and EY at 21.4% and 27.4% respectively. I will definite keep this stock in the portfolio. I don’t know why, may be investors think that its margin is very low. But to me that is typical of trading business. it is ROIC which is important as shown in the opening quote.
Prestariang used to be one of my top favourite stocks with very high ROIC of more than 100%. This is because of its typical light asset kind of business. However, its share price has risen substantially by 164.5% since two years ago, rendering it expensive with EY at just 4.2%. Its latest few quarters results were not impressive at all too. This is what I always say that a good company is not necessary a good investment. Hence I have long discarded this stock from my portfolio. Similarly for SKP Resources which has risen by more than 100% resulting an EY of less than 10%. It is the same for NTPM as its ROIC and EY both at the borderline. I will still keep some Pantech shares as it has good EY of 15.1% at the present price of 77 sen, down from its peak of RM1.00+. Jobstreet has sold off its core business and it no longer fit the Magic formula and hence no longer in my portfolio.
Conclusion
So that is my thought process; when the stock still exhibit the principle of the Magic Formula, I keep and hopefully let the profit run. When the business has deteriorated with ROIC<10%, or its share price has risen up above its intrinsic value and hence has become too expensive with EY<10%, I sell and take profit, especially when their share prices have risen substantially. I have sold off half of those ten stocks in My First Portfolio, and looked for other opportunities, like what I found in My Second Portfolio, which we will discuss later.
For those who are interested to learn how to search for good companies to invest with reasonable price, please contact me at
ckc13invest@gmail.com
K C Chong ( 4th January 2015)
Disclaimer: This article is for sharing of knowledge. It is not a recommendation to buy or to sell a share.
Table 1: Stock returns and the Magic Formula
|
Stock |
Year-end Price |
Stock Return |
ROIC, % |
EY % |
|
Kfima |
1.93 |
3.5% |
13.2 |
23.3 |
|
Pintaras |
3.73 |
151.0% |
29.7 |
14.7 |
|
ECS |
1.18 |
23.6% |
21.4 |
27.4 |
|
Plenitude |
2.29 |
30.3% |
13.1 |
39.4 |
|
Jobstreet |
0.470 |
171.4% |
- |
- |
|
Pantech |
0.770 |
15.4% |
11.1 |
15.1 |
|
SKPRes |
0.640 |
102.9% |
21.3 |
8.1 |
|
NTPM |
0.620 |
46.8% |
12.6 |
9.4 |
|
Kimlun |
1.19 |
38.7% |
9.2 |
11.2 |
|
Prestariang |
1.44 |
164.5% |
120 |
4.2 |
|
|
|
|||
|
Average |
74.8% |
|
||
|
KLSE |
12.9% |
|
|
|
Stock Share still kept in My First Portfolio
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Discussions
8 people like this. Showing 50 of 65 comments
paper plane,
I looked at IQ group over the weekend, it has a good turn around story (Pitroski score 7-8 for the past 2 years) and might be the right play in 2015 due to its export exposure and positive net impact from strengthening USD. But my numbers are lower than yours based on TTM:-
@RM1.6
EV/EBIT = 6.3x
ROIC = 21.4%
As for cashflow the previous 2 years (2013 and 2014) was postive free cashflow.
A few concerns I have are:-
1. 90% held by top 30 shareholders. Only a 10% free float. This makes the share easily manipulated.
2. Director made some disposals around the RM1.80 price range.
These are not major concerns but something to ponder about.
2015-01-05 17:34
If i read correctly, the profit is not real cash. It is just receivables.
2015-01-05 18:12
Thanks for all these intriguing discussions. I noticed that most of the taiko here are using the formula to "counter check" their stock-picks, rather than use it as screening tools to mine the undervalued stocks. I believe it is due to the unavailability of a screener based on magic formula for all KLSE counters. Perhaps it is rather impossible for one to calculate the EY, ROIC for all counters manually... Greenblatt's book has outlined a trading "procedure" for value investors to systematically manage and rebalance their portfolios in order to make profit in the long run (12m period)....
2015-01-05 18:27
Actuallu the latest version of intelligent investor has highlighted the weakness of using editda, ev. Warren buffett himself argue also, is not tax not something you have to pay also. Why not include in calculation.
2015-01-05 18:39
Noby, i like piotroski score also. So far the best to evaluate, but it has to be applied across 5yrs at least. Sometimes, one or 2yrs can be misleading, like huayang. And also have to be applied together with gross profit margin. I notice some case piotroski score beautiful, but profit margin keep dropping year by year.
2015-01-05 18:43
paperplane,
That is why Magic formula uses Ebit, not Ebitda. As weakness of EV as mentioned by you in the book, I doubt so as it is the more logical way to measure the total value of a company, not only equity, but other things like debts, minority interest, excess cash etc. You may counter-check what you have read,
As for the cash flow of IQ Group, I saw heaps of cash flow from operations, and huge free cash flows too.
2015-01-05 18:46
IQGROUP has a huge FCF, but it is not reflected as the cash goes into inventories and recievables, which is part of the business.
2015-01-05 19:20
That's the problem. Why cash not reflected as cash and hidden into receivables
2015-01-06 06:00
Posted by paperplane > Jan 6, 2015 06:00 AM | Report Abuse
That's the problem. Why cash not reflected as cash and hidden into receivables
I see their income statement making 11.6m as on 31st March 2014. Their cash flow from operations is even more at 15.2m. Their balance sheet also shows an increase in cash and cash equivalent of 10m in 2014.
So why do you say this?
Posted by paperplane > Jan 6, 2015 06:00 AM | Report Abuse
That's the problem. Why cash not reflected as cash and hidden into receivables
2015-01-06 08:23
I am referring to Q2 2015 report, is this not the latest?
From cashflow statement.
Profit=13,594
Operating profit/(loss) before working capital changes 18,749
Trade and other receivables ( 18,128)
ending----------
Net cash (used in)/generated from operating activities ( 1,413)
2015-01-06 08:37
Negative means increase in receivables. Income earned actually not earned yet. But they book it as income earned already.
2015-01-06 08:38
FCF is a lumpy thing, I was referring to previous 2 financial years and it looked healthy, Its hard to draw conclusion from 2 quarters of cash flow statement.
The point you mention is perfectly normal. The cash is not there yet as the receivables may be >6 months old. You are right as it is still stuck in receivables. But they can book it as accounting profit.
2015-01-06 08:48
Income statement is prepared based on accrued accounting basis and that is the accounting rule. So income is earned once transaction is done, though cash may not have been received yet. Say if you have completed a piece of work for your client, you book that as a revenue because it is completed. Your client may have a month more to pay you and hence you have not received the cash yet, but suppose to be in a month's time.
For me normally I don't take a particular year's cash flow statement as one to look at as representative of the true picture of cash flows but a few years because cash flow is lumpy. So I never consider two quarters cash flow as truly representative.
2015-01-06 08:48
but fishy thing can happen just in between you see. Out of no where, suddenly sales improved, hooray. Income improve, but maybe stuck in receivables.....
This is how accounting fraud unfold sometimes. As ppl tend to ignore small little things first and assume it is normal accounting.
But yet I have to say, so far book in very healthy way without much liabilities, just some payables.
Receivables treated as an assets sometimes can be a killing things--like LIONFIB where all receivables are actually non recoverable owing by related parties. Which in turn shld be BAD DEBTS.
2015-01-06 08:54
you can look at their cash conversion cycle times over a extended period to understand if there is anything fishy. But cashflow cant be judged from 2 quarters, that I can tell you. Beneish M score is good way to look at manipulation of earnings
http://www.investopedia.com/terms/b/beneishmodel.asp
LIONFIB is valued based on NNWC whereby most of their assets are stuck in receivables to related parties (some hidden within trade receivables). The serious red flag for me in LIONFIB is that major shareholder keep selling the shares even though it looked very undervalued.
2015-01-06 09:00
haha, Noby, I agree few quarters of cashflow can't judge much. LionFIB case directors selling, and with high receivables, should raise the red flag. Yet even I have discount all receivables and inventories by 50% when I calculate, still get burnt. But I think it is totally undervalued now, assuming some amounts are recoverable, it will be extra bonus.
For IQ Group case, the directors also selling.....
2015-01-06 10:40
NNWC companies are easy to analyze but definitely hard to make money in short term. Sometimes we must take partial profit on any spike in price to reduce the opportunity cost.
2015-01-06 14:13
For personal investment, it often pays to invert, always invert. Instead of thinking of making big money in the short term, think about not losing big. Don't chase hypes and fads; Don't borrow to speculate. Margin financing for speculation is definitely a no no, and no. I can guess there are numerous margin calls the last few months for some people. It is definite.
"Head I win, tails I don't lose much".
Think of where is the investment pendulum now. I think that is the proper mind set of Noby.
2015-01-06 14:51
KC, agree with you. Again thanks for reminder on margin financing.. But for NNNWC types, I would only buy if there is a good chance value can be unlocked. If it pays a good dividend, I dont mind holding for long term but if tht is absent, I would trade it in the short term to realize some gain. Tk a look at Kuchai and PMcorp as examples.. its hard to make money here without some trading
2015-01-06 14:58
Noby,
You may think that I nag nag and nag. But I think my most useful contribution to i3investor, if any, will be this thingy.
http://klse.i3investor.com/blogs/kcchongnz/44344.jsp
http://klse.i3investor.com/blogs/kcchongnz/61822.jsp
2015-01-06 15:23
Hi guys,
Just passing though...I am very light on stocks at the moment...good FA stocks in bad times also depreciates albeit at slower rate than the the non FA types...perhaps the good FA stocks with biz minded shareholders, good management, good biz model, decent DY and with good cash flow management are worth holding onto... I will not be too gung ho about stocks now no matter how good it looks as KLSE is already in downtrend and will downtrend for a while longer...it had been on uptrend for the past 6 years and this downtrend will last for a while.....so chill out , relax and do a bit of homework...make yourself fitter for the next turnaround...there's still a lot of time though...
2015-01-06 15:45
Posted by kcchongnz > Jan 6, 2015 03:23 PM | Report Abuse
Noby,
You may think that I nag nag and nag. But I think my most useful contribution to i3investor, if any, will be this thingy.
http://klse.i3investor.com/blogs/kcchongnz/44344.jsp
http://klse.i3investor.com/blogs/kcchongnz/61822.jsp
KC, not at all. I see it as good reminder to keep me in check. I may have acquired a lot of FA knowledge from you but very far from your level in terms of investment psychology. This is something I cannot learn from books.
2015-01-06 17:01
Please forgive me for posing this stupid question.
I came across explanation of ROIC formula from oldschoolvalue.com by Jae Jun. His formula on Invested capital is quite similar to yours, but he minus Excess cash at the end of his formula. Is Excess cash important?
And his formula on excess cash is so complicated that eventually he changed the formula of Invested capital to,
Invested Capital = Total Equity +Short Term Debt + Capital Lease Obligations + Long Term Debt
Can you shed some light on this? I was reading your article on ELSOFT evaluation by using ROIC, i am hoping that i can use the indicator as you did and yield the same value
2015-04-25 21:38
Buy and/or keep improving cyclical, turnaround, growth stocks and/or fundamental stocks with good biz model that empowers the company to continue to deliver increasing positive earnings year on year or stocks that is under valued versus its intrinsic worth.
Sell deteriorating cyclical, down trending, negative growth stocks and stocks with deteriorating fundamentals that results in losses,decreasing profits, decreasing earnings per share, deteriorating ROE, ROIC or stocks that exceed their intrinsic worth or sell existing stocks in your portfolio when you have discovered better undervalue stocks versus its intrinsic worth or stocks with better top and bottom line growth potential.
2015-04-25 22:48
Posted by Genw > Apr 25, 2015 09:38 PM | Report Abuse
Please forgive me for posing this stupid question.
I came across explanation of ROIC formula from oldschoolvalue.com by Jae Jun. His formula on Invested capital is quite similar to yours, but he minus Excess cash at the end of his formula. Is Excess cash important?
And his formula on excess cash is so complicated that eventually he changed the formula of Invested capital to,
Invested Capital = Total Equity +Short Term Debt + Capital Lease Obligations + Long Term Debt
Can you shed some light on this? I was reading your article on ELSOFT evaluation by using ROIC, i am hoping that i can use the indicator as you did and yield the same value
Financial statement analysis is an art. Many people do it differently. My opinion is Jae Jun has changed his concept that it makes a hell of difference for companies with a lot of excess cash, cash which they do not need for the core operations and can be distributed to shareholders without affecting its operations. It is also not appropriate for companies having other investments. It makes the ROIC much lower and not reflecting the true picture.
Risk and return for a business and non-operating asset say cash are totally different and shouldn't be lumped together.
I tend to use his previous concept.
2015-04-26 02:46
TOTAL ASSETS= SHAREHOLDERS FUNDS + TOTAL LIABILITIES
ASSETS= Current Assets + Non Current Assets
SHAREHOLDER FUNDS= IPO Capital + Rights issue + Private Placement + Retained Earnings(Accumulated Losses)
TOTAL LIABILITIES= Current Liabilities + Non Current Liabilities
ROA is a good performance measurement of how well any company manage its total assets. Of course the ROA figures varies across industry types and varies amongst companies in similar industry type
Any company on a going concern basis will utilize its total assets to grow its top and bottom line over time and in that process generate sufficient profits, free cash flows to distribute as dividends to its shareholders. A long term shareholder would like the company management to grow its assets in the future years and consequently generate increasing ROA, increasing free cash flows with above average dividends payout to its shareholders arising from competent management of its Total Assets. If the company management has run out of ideas to generate better returns on the excess cash above the weighted average cost of its capital then the excess cash is best returned to its shareholders.
2015-04-26 14:39
thanks for your reply kcchongnz. may i know what's the formual of Excess Cash that you are using?
2015-12-27 12:36
Posted by Genw > Dec 27, 2015 12:36 PM | Report Abuse
thanks for your reply kcchongnz. may i know what's the formual of Excess Cash that you are using?
Look at its non-cash net working capital. If positive, you may take the whole lot of cash in the balance sheet as excess cash. Or you may reserve a couple of percentage as part of the working capital requirement.
It is really an art.
2015-12-27 17:08
Very boring article...all is theory only..i wonder its work or not...not interested to read further
2015-12-27 17:17
Posted by koonbee9 > Dec 27, 2015 05:32 PM | Report Abuse
I prefer to read icon8888 and uncle Kyy article...both article benefit me
I like icon8888's articles too. the other one don't forget is YiStock
2015-12-27 17:45
I like to read KC Chong article, to learn the fundamental analysis, thank you KC, merry Christmas and happy new year
:)
2015-12-27 17:54
Posted by bluefun > Dec 27, 2015 05:54 PM | Report Abuse
I like to read KC Chong article, to learn the fundamental analysis, thank you KC, merry Christmas and happy new year
bluefun, you make my day. Not many like my articles as you can see.
2015-12-27 18:07
Kcchongz sifu, frankly, your article very boring...u may consider put some cartoon to make it interesting
2015-12-27 18:09
Because all your article same pattern and same format..and the font all same size...hopes you dont mind i gv you some feedback ya
2015-12-27 18:10
Like u go to a concert and the singer sing with same tone for all the songs...very boring...hopes u understand what am i talking
2015-12-27 18:11
koonbee9,
Thanks for your feedback.i will consider your suggestions, definitely.
2015-12-27 18:17
Hi KC, I am glad that I can make your day, thanks for always share v us your fundamental article, opinion and overview.
Through your article, I have learn what is CY, what is EBIT multiple.
And I realize that FCF is very important for a company to run a business and maintain their operation.
I always use it as my valuation and calculation before I invest into one stock
Although I am seldom comment to your article, but most of your article I got read and I am appreciated your effort to share v us.
You are great, my sifu, KC Chong
:)
2015-12-27 18:19
Thanks for the education.
This web site is incomplete without you.
But I must say every ratio starts from the audited accounts....and you already know what they can do to audited accounts.
Other gurus put emphasis on other non quantifiable things such as.....business model, management, ....shareholder strengths, relationships, concept stocks. Etc etc....and this year earnings, latest q earnings. PE ratio.
2015-12-27 18:47
At the end of the day, big money is made by buying small cap stocks with low PE and gets re rated because of increasing quarterly profits.
Ratios hardly help in this respect.....but insider information and deep understanding of the company and its environment will do the trick.
Even simple rations have too many factors behind it to use to predict the future.
2015-12-27 19:10
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Dear kcchongnz,
Thank you very much for sharing. Novice like me benefit a lot from your fundamental discussion.
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2015-01-05 17:28