Disclaimer: This article is written for the purpose of discussing my thought on a buy or sell process basing on a fundamental approach. It is not a recommendation to buy or sell any particular stock. Like other posts I wrote recently, I have put this up in my private learning blogs first prior to publishing here.
“Whether socks or stocks, I like buying quality merchandise when it is marked down.” Warren Buffet
In MyThirdPortfolio, I have three stocks not meeting the principle of the Magic Formula investing strategy as shown in the appended link below. They did not performed well too especially for Plenitude (-25.4%) and Perak Corp (-36.3%).
http://klse.i3investor.com/blogs/kcchongnz/68248.jsp
However as mentioned in the article, I have decided to keep them in my portfolio going forward in 2015. Why didn’t I cut loss? What is so great about these losing stocks? Nothing actually, but just to share some thoughts about deep value investing.
Value investors do not just cut loss because the stock price has gone down, unless they have determined that the value of the company, and hence its stock has lost its value. What value are we talking about since they do not meet the requirements of the Magic Formula?
All these stocks, including another one of Daiman Development in MySecondPortfolio as summarized in Table 1 in the Appendix, were purchased based on the proven balance sheet investing strategy, in particular, the Graham net net working capital value, or NNWCV.
NNWCV = Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) – total liabilities
It's the lowest form of valuation you could possibly do because it ignores everything about the business and just focuses on tangible assets, and even discount them. The formula states that;
For more information of this investment strategy, please refer to the appended link below:
http://klse.i3investor.com/blogs/kcchongnz/45296.jsp
Here we will take Plenitude as an example to compute its NNWCV
Graham Net Net Working Capital Valuation for Plenitude
Plenitude is an established property development and investment company in Malaysia. Its latest balance sheet as at 30 September 2014 was used to compute its net tangible asset and NNWCV. Besides cash, the net net values of land, development costs and investment properties owned are also taken as 100% of the book value. This is a fair assessment as it is believed that these assets are likely to worth more than their book value than otherwise. Note that tax assets, property, plant and equipment, Goodwill and “other assets” are taken as worth nothing.
Table 2 in the appendix shows the detail computation of NNWCV of Plentitude. At the close of RM2.29 for Plenitude as the end of year 2014, it is trading at a discount of 38% and 31% to its net tangible asset backing per share of RM3.71 and NNWCV of RM3.31 per share respectively. These discounts are wide.
The other three stocks are also trading at a wide margin of safety to their NNWCV as shown in Table 1 in the Appendix; Daiman at 25%, Perak Corporation at 30%, and Kuchai at a whopping 61%. In fact Kuchai is one of the very rare negative enterprise value stocks in Bursa.
What is negative enterprise value stock?
Kuchai, negative enterprise value, and arbitrage opportunity
One way to look at it is considering the enterprise value (EV) of a stock is as below:
[Think of enterprise value as the theoretical takeover price. In the event of a buyout, an acquirer would have to take on the company's debt, but would pocket its cash. EV differs significantly from simple market capitalization in several ways, and many consider it to be a more accurate representation of a firm's value. The value of a firm's debt, for example, would need to be paid by the buyer when taking over a company, thus EV provides a much more accurate takeover valuation because it includes debt in its value calculation.] Investopedia
EV = Market Capitalization + Debt + Minority Interest - Cash – associates – equity investment
http://klse.i3investor.com/blogs/kcchongnz/49016.jsp
Base on the latest balance sheet of Kuchai at 30th September 2014, the enterprise value of Kuchai is:
EV = 1.26 * 123.8 + 0 + 0 – 38.4 – 134.9 – 201.2 = -218.5 m.
This negative enterprise value of 219m provides us with an arbitrage opportunity as below:
Borrow money and buy all Kuchai shares, m |
156 |
Liquidate all equities except Sg Bagan |
201 |
Cash in balance sheet |
38 |
Total cash available |
240 |
|
|
Pay loan |
-156 |
Pay 6 month interest at 8% rate |
-6 |
Pay all other liabilities |
-3 |
Total liabilities paid |
-165 |
|
|
Balance cash to pocket, m |
75 |
We can withdraw and pocket the balance cash of 75 million Ringgit after paying all my personal loans and liabilities of the company. Besides I still own an shop house in Singapore worth 23m which I can collect a rental income of RM780,000 a year. I will also own 26% stake in Sg Bagan worth RM48 million at the market price of RM3.03 now.
However, things are not that simple as the shareholding of these three companies, Kuchai, Sg Bagan and Kluang Rubber are intertwined. And 60% of Kuchai’s outstanding shares are held by related parties. Nobody would be able to make a hostile takeover without the consent of the Lee brothers. Otherwise, Kuchai would have long been taken over by some rich value investor/arbitrageurs.
Does NNWCV works in Bursa?
Graham reported that the average return, over a 30-year period, on diversified portfolios of net current asset stocks was about 20%. An outside study showed that from 1970 to 1983, an investor could have earned an average return of 29.4% by purchasing stocks that fulfilled Graham’s requirement and holding them for one year. http://capitaldiscussions.com/benjamin-grahams-net-current-asset-value-approach-to-stock-selection Another study shows from 2000 to 2012, NCAV stock investing strategy earned an annualized return of 18.28% vs 1.57% for the S&P500 and 5.31% for the Russell2000 (Jae Jun). It certainly had worked in the 1920's during Graham’s time and also in modern times in the US market. But does it work in Bursa? |
It would be great if someone can provide a research on this in Bursa. I have about a couple of years of experience on a portfolio of 10 NNWCV stocks as shown in the link below:
http://klse.i3investor.com/blogs/kcchongnz/56472.jsp
Table 3 in the Appendix shows the latest return of the stocks Vs the broad market. The portfolio of 10 NNWCV stocks returned an average of 32.6% , or for a two and a half times more compared to the return of 13.3% of the KLCI in about a two-year period. Seven out of the ten stocks out-performed the broad index with KSL gaining 110%, and PMCorp 97%. There are only two losers. FACB and Perak Corp with an average loss of just 4.3%. Outsized gains and minor losses seems to be the characteristics of all value investing. This also shows Graham NNWCV strategy also worked in Bursa for short term too.
Conclusions
The balance sheet investing strategy of Graham net net working capital value has shown extra-ordinary return for a long period of time in the US market. This strategy also worked for me for a shorter period of two years in Bursa. As the NNWCV of the four stocks mentioned in this article are still way above their stock prices, and hence a wide margin of safety, that is the reason why I still keep them in my portfolio, patiently waiting for the unlocking of their values, like what happened to KSL and PMCorp. Most of all, this is a safe investing strategy meeting the Dhandho Principle:
“Heads I win; Tail I don’t lose much” Mohnish Pabrai
What about the two company warrants in MyThirdPortfolio, BIMB Wa and MRCB Wa? They are down by huge 36.4% already? Cut loss? No. They were purchased with financial risk management in mind. Just what is this financial risk management? We will talk about it next.
Are you keen to learn this proven safe investment strategy for building your long term wealth for a small fee? Please contact me as the next course will start soon.
Ckc13invest@gmail.com
K C Chong ( 16/01/2015)
Appendix
Table 1: Graham net net working capital value stock
Graham net net |
Company |
31/12/2014 |
Total return |
NAB |
NNWCV |
MOS |
1 |
Plenitude |
2.29 |
-25.4% |
3.71 |
3.31 |
31% |
2 |
Daiman |
2.65 |
9.5% |
5.02 |
3.51 |
25% |
3 |
Kuchai |
1.26 |
5.0% |
3.21 |
3.20 |
61% |
4 |
Perak corp |
2.35 |
-36.3% |
5.54 |
3.37 |
30% |
Table 2: NNWCV computation for Plenitude
Balance sheet item |
Amount |
Wt |
Amount |
Proportion |
Per share |
Excess cash |
421712 |
100% |
421712 |
37% |
1.56 |
Property development projects |
306758 |
100% |
306758 |
27% |
1.14 |
Land held for development |
194189 |
100% |
194189 |
17% |
0.72 |
Investment Properties |
46568 |
100% |
46568 |
4% |
0.17 |
Receivables |
60604 |
75% |
45453 |
5% |
0.17 |
Inventories |
37880 |
50% |
18940 |
3% |
0.07 |
Other assets |
73884 |
0% |
0 |
6% |
0.00 |
Total tangible asses |
1141595 |
xxx |
1033620 |
100% |
xxx |
Total liabilities |
-139317 |
100% |
-139317 |
xxx |
-0.516 |
Sum |
1002278 |
xxx |
894303 |
xxx |
|
NTA |
3.71 |
xxx |
3.31 |
xxx |
3.31 |
|
|
|
|
|
|
Price |
2.29 |
xxx |
2.29 |
xxxx |
|
MOS |
38% |
xxx |
31% |
xxxx |
|
|
|
|
|
|
|
Table 3: Return of NNWCV stocks
Graham net net return |
|
|
|
|
||
No. |
15/01/2015 |
Ref price |
Now |
Dividend |
Gain/loss |
return |
1 |
Daiman |
2.630 |
2.570 |
0.120 |
0.06 |
2.3% |
2 |
KSL |
1.010 |
2.070 |
0.050 |
1.11 |
109.9% |
3 |
Plenitude |
2.100 |
2.270 |
0.120 |
0.29 |
13.8% |
4 |
Insas |
0.630 |
0.910 |
0.020 |
0.30 |
47.6% |
5 |
PMCorp |
0.150 |
0.295 |
0.000 |
0.15 |
96.7% |
6 |
Hexza |
0.635 |
0.720 |
0.090 |
0.18 |
27.6% |
7 |
Prkcorp |
2.820 |
2.790 |
0.000 |
-0.03 |
-1.1% |
8 |
Kuchai |
1.200 |
1.350 |
0.020 |
0.17 |
14.2% |
9 |
KESM* |
2.040 |
2.400 |
0.060 |
0.42 |
20.6% |
10 |
FACB |
1.260 |
1.120 |
0.068 |
-0.07 |
-5.7% |
|
|
|||||
|
Average |
1.45 |
1.65 |
0.05 |
0.26 |
32.6% |
|
KLSE |
1627 |
1745 |
98 |
216 |
13.3% |
*A course participant has rightly pointed out that KESM is not a NNWCV stocks.
Created by kcchongnz | Jan 22, 2024
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Posted by paperplane > Jan 16, 2015 06:54 PM | Report Abuse
With so many shr holding in lee family. You think they will shr with you? Kuchai some ppl hold 10yrs still like this. Like facbind.
You got a valid point. Buy why do you think they are so cheap at huge negative enterprise value? Surely there must be reasons. Don't you think so?
But do you think the long term return of Kuchai is so bad? There is one way we can make an inference if it is so, ie to compare the return of the broad market during the same period. If you look at the comparison of the return of Kuchai and KLCI from the year 2000, or 15 years ago, the longest you can get from Yahoo finance, you will find that Kuchai did quite well despite the stinginess of the major shareholder. Look at the graph in the appended link below:
https://sg.finance.yahoo.com/echarts?s=^KLSE#symbol=^klse;range=5y;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefined;
The graph show that since 15 years ago, the return of Kuchai is always above that of KLCI. Yes, all the time. And sometimes it is significantly higher.
Don't trust my words. Look at it yourself.
FACB unfortunately shows a complete different story.
https://sg.finance.yahoo.com/echarts?s=^KLSE#symbol=^klse;range=5y;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefined;
That is why any value investing strategy, one must have a diversified portfolio, 10-20 stocks. You made from say 65%, but small loss for 35% of them, then you will do very well. Haven't I shown you the performance of many value investors in US?
The other difference between Kuchai and FACB is I think it is the business. FACB's business didn't do well. Kuchai? Kuchai has not much business except investment in equity and property, and the steady palm oil industry. That is why the value of Kuchai won't deteriorate much. In fact, it rides along with the slowly up trending market.
That is why I think Kuchai is very safe to invest, at this low price Vs value.
"Heads I win, Tails I don't lose much"
2015-01-17 09:29
Oop the comparison chart doesn't come up. But you can use that KLCI chart and then type in 2186.kl for Kuchai in the "Compare" slot, then you see those two price movement curves. Use the "Max" period.
2015-01-17 11:02
well lets be fair in comparisons. FACB only became negative enterprise stock after disposing its steel business in 2013, to make comparisons prior to that may not be relevant. for past 2 yrs it slightly underperform klci while past 5 yrs it still outperform klci based on the yahoo charts. From a NNWC valuation standpoint , Kuchai does have more margin of safety, but if you look at historical p/b, FACB is trading at a steeper discount to its historical p/b, hence may offer higher upside should there be a mean reversion...
2015-01-17 22:20
Hi kcchongnz, may i ask some help from you ? recently, i performed a valuation on Gadang using net net assets valuation method (ben graham) to determine the downside risk. It seems Gadang is a good buy as long as it is between RM1.30 to RM1.40. Is it ok if i email you my thinking process ? It will be great if you can access the reasonableness of my thinking...
2015-01-18 14:22
Posted by kancs3118 > Jan 18, 2015 02:22 PM | Report Abuse
Hi kcchongnz, may i ask some help from you ? recently, i performed a valuation on Gadang using net net assets valuation method (ben graham) to determine the downside risk. It seems Gadang is a good buy as long as it is between RM1.30 to RM1.40. Is it ok if i email you my thinking process ? It will be great if you can access the reasonableness of my thinking...
Gadang is not a Graham net net stock. It appears to be inexpensive earnings wise at the price you mentioned.
2015-01-18 17:52
Thanks Mr Kcchongnz for your valuable info always.
Like to learn from your discussion. Mostly are eye opening points.
Thanks thanks nothing else...
2015-01-18 17:55
My point is not using nnwc alone. My first priority is always look at holders, who are controlling behind, their mgt, also the percentage of top 30%.
2015-01-18 21:35
Posted by paperplane > Jan 18, 2015 09:35 PM | Report Abuse
My point is not using nnwc alone. My first priority is always look at holders, who are controlling behind, their mgt, also the percentage of top 30%.
Sure sure, everyone has his own investing strategy. NNWC is just one of the proven successful investing strategies to utilize in a diversified portfolio of stocks which I have provided evidence.
I also know about other proven investing strategies such as Greenblatt's Magic formula, low PE, low P/B, Low market cap, Jockey Stocks, Follow the leaders, etc but I have never heard of any proven successful strategy by looking at the controlling shareholder, management and the top 30 shareholders.
I only mentioned and provided facts that Kuchai is a dirt cheap negative enterprise value stock. Hope you understand what I mean. And may be it is worthwhile to be patient investing in it. I never said its controlling shareholder/management is good in taking care of minority shareholder.
2015-01-19 05:24
With these type of stocks, it is better to diversify across at least 10 to 20 of them to increase the chances of success. I hv no confidence on my ability to judge management or their intentions.
2015-01-19 09:03
Hi KCChongnz,
What is the meaning of
"Gadang is not a Graham net net stock. It appears to be inexpensive earnings wise at the price you mentioned."
Care to elaborate? Also, how do we value the earnings?
As usual, thanks for your input.
2015-01-19 10:38
Posted by kancs3118 > Jan 19, 2015 10:38 AM | Report Abuse
Hi KCChongnz,
What is the meaning of
"Gadang is not a Graham net net stock. It appears to be inexpensive earnings wise at the price you mentioned."
Care to elaborate? Also, how do we value the earnings?
Read the article here again and understand what Graham net net is.
There are numerous ways of estimating the intrinsic value of a stock. Some of them are listed here:
http://klse.i3investor.com/blogs/kcchongnz/68009.jsp
This talks about ROIC and EY
http://klse.i3investor.com/blogs/kcchongnz/67260.jsp
This talks about some simple ratios but very useful and back of the hand.
http://klse.i3investor.com/blogs/kcchongnz/56316.jsp
This uses discount cash flow analysis
2015-01-19 10:55
Posted by paperplane > Jan 18, 2015 09:35 PM | Report Abuse
My point is not using nnwc alone. My first priority is always look at holders, who are controlling behind, their mgt, also the percentage of top 30%.
http://klse.i3investor.com/blogs/kianweiaritcles/68676.jsp
2015-01-19 11:49
paperplane
With so many shr holding in lee family. You think they will shr with you? Kuchai some ppl hold 10yrs still like this. Like facbind.
2015-01-16 18:54