kcchongnz blog
Picking Good Companies at Cheap Prices in Bursa Works Best! kcchongnz
In my last article two days ago on “Stock Picking works in Bursa” as appended below, I have shown you a simple value investing just based on low price-to-earnings ratio on a portfolio of 104 stocks provided a total CAR of 17.6%, compared to the 10.8% of the broad market, or an annual alpha of 6.8% a year for 5 years.
http://klse.i3investor.com/blogs/kcchongnz/75946.jsp
That is really not bad at all.
The simplistic PE ratio strategy is vastly improved with the incorporation of “goodness” of the companies such as high return on equity, good cash flow and healthy balance sheet. The portfolio of the ColdEye 5 yardsticks value investing strategy does just that, and it was shown that the improved strategy provided an average total return of 186.4% compared to the 18.5% of the broad market in the last two years from May 2013 to end of April 2015 with a whopping excess return, alpha, of 101%, also shown in the above appended link.
Yesterday, another article of mine, “Picking good companies at reasonable prices (not cheap prices) in Bursa works!” shows that this value investing strategy also worked well with the average return of the 16 stocks at 46.2% in the two years period up to 30th April 2015, compared to the 9.0% of KLCI during the same period. The excess return, alpha, is again a whopping 37.2%. This is really very good too.
I did promise to provide you with a better value investing strategy. This strategy is to buy good companies at cheap prices (not just reasonable prices). This appears to be a similar value investing strategy as that of the ColdEye 5 yardsticks but with some tweaking on some of the financial metrics which require a little more understanding of the financial statements and will be explained below.
What is a good company, what is cheap?
The qualitative criteria of a good company are similar as before; a well-run company with good corporate governance; no unfair related party transactions, independent board of directors, a durable business, constant growth in its business etc.
Quantitatively, the requirement of stable and consistent earnings and cash flow from operations and free cash flow, a healthy balance sheet stay. And the difference is, instead of using return on equity (ROE) as a measure of a good company, I prefer the return on invested capital (ROIC). For cheapness, I use EBIT multiple, instead of the price-to-earnings ratio.
Here are the formulae and explanation of the terms used
- EBIT multiple = Enterprise Value / EBIT
- ROIC = EBIT / Invested Capital
EBIT is earnings before interest and tax, or operating income, or operating profit
Invested capital (IC) = Fixed assets + Net working capital
Fixed assets is generally the property, plant and equipment
Net working capital = Inventories + Receivables – payable
Enterprise value (EV) = Market capitalization + total debts + MI –non-operating assets
MI is minority interest, if any
Non-operating assets include cash and cash equivalent, investments etc
ROIC looks at all the money invested into the company, both by shareholders and lenders, to measure how well management uses all that cash to generate profits. It corrects for a common problem investors hit when they use the more traditional ROE for measuring management performance. Because ROE does not include debt, companies can boost their ROEs as they add debt, even if that debt only drains money for shareholders.
This EV/EBIT ratio allows us to contrast companies with different capital structures on an equal basis by removing the biases of debt and cash. This is better but a little more work is needed to compute as compared to a PE ratio.
This investment strategy is intuitive and plausible. Why wouldn’t a portfolio of stocks basing on the principle of buying good companies cheap work? For those who still doubt why this strategy can work, i.e. why there is a big fat frog jumping around can refer to the inefficiency of Bursa and the concept of Mr. Market in the link below.
http://klse.i3investor.com/blogs/kcchongnz/75910.jsp
Let us examine a real portfolio invested in Bursa using this value investing strategy up to 30th April 2015. I used this portfolio as an example for various reasons. Firstly, it is my portfolio, my own experience investing in Bursa for the last few years. I track my own portfolio, not others. This portfolio of mine is the longest I have with public record in i3investor. The performance of a portfolio is best measured with the longest record available as value investing is a long term endeavour, though I admit that two years plus is not long enough.
Secondly this portfolio was published by a third party, a regular contributor in i3investor named Tan KW when it was formed in 21st January 2013 here. So I play no part in showing off the portfolio or manipulate the stocks in the portfolio.
http://klse.i3investor.com/servlets/pfs/13147.jsp
The portfolio consists of a diversified portfolio of 10 stocks in Consumer Products, Industry Products, Constructions, Property Development, Services, and Technology. The prices are adjusted for all corporate exercises and dividend payments as obtained from Yahoo Finance.
Return of investing in good companies
All 10 stocks in the portfolio except Kimlun, have positive total returns which varies from the lowest of 9.7% for Pantech to 421% for Prestariang for the last two years and three months. The average return is 113% with a median return of 74%, compared to 16.4% of the broad market during the same period. The excess return is a whopping 97%. RM100000 invested in this portfolio on 21st January 2013 becomes RMRM213000 now, compared to RM116000 if invested in the top 30 stocks in Bursa.
The high performers were, Prestariang (421%), Pintaras (203%), SKP Resources (173%), and Jobstreet (121%). There are only two underperformer, Pantech at 9.7%, and Kimlun at -1.2%, and the underperformance of these two stocks were just marginal.
Once again this value investing strategy exhibits the Dhandho Investor characteristics,
“Had I win big, tails I don’t lose much”
Carefully look at the high ROIC accompanied by low EV/EBIT of those multi-baggers return companies listed in Table 1 in the appendix. Look at Pintaras with a high ROIC of 29%, but selling at an enterprise value of just 2.4 times EBIT on 21st January 2013. SKP Resources with ROIC of 33%, but selling at Enterprise value less than 3 times EBIT then. Prestariang was with a ROIC of 150%, but it was selling at an EV of just 5.6 times EBIT. How could you go wrong?
Are the high returns of the portfolio accompanied by higher risk as suggested by the efficient Market Hypothesis? Not that I am aware of as shown in my previous analysis here:
http://klse.i3investor.com/blogs/kcchongnz/44336.jsp
http://klse.i3investor.com/blogs/kcchongnz/44334.jsp
Conclusions
The above value investing strategy of investing in good companies at cheap prices worked well for me in the past in Bursa Malaysia by providing extra-ordinary returns for me. Logically it should as the reasons are highly plausible.
This value investing strategy involves a little more understanding of the business and the computations of the metrics. But like someone said,
“If something is easy to compute and understand, it is extremely unlikely that the market will misinterpret it. Therefore, such information will not, by itself, provide evidence of mispricing.”
So sometimes you may need a little “sophistications” in investing; sometimes, but not necessary always.
Is there some other ways to look at investing besides those which have been mentioned in my last three articles? You bet there are. That will be the next topic of discussions.
Are you keen to learn this financial statement analysis and interpretations, the language of the business, and how to value a business, in order to have a higher probability of success investing in Bursa Malaysia?
Please contact me at the following email address
ckc15training2@gmail.com
K C Chong (4th May 2015)
Appendix
Table 1
|
Date |
|
21/1/2013 |
30/4/2015 |
|
|
|
|
|
|
Stock Name |
Code |
Ref Price |
Adj. Price |
Price now |
Gain |
% gain |
ROIC |
EV/EBIT |
|
Kfima |
6491 |
2.02 |
1.75 |
2.03 |
0.280 |
16.0% |
26% |
3.6 |
|
Pintaras |
9598 |
3.12 |
1.33 |
4.03 |
2.700 |
203% |
29% |
2.4 |
|
ECS |
5162 |
1.06 |
0.92 |
1.63 |
0.710 |
77.2% |
25% |
3.6 |
|
Plenitude |
5075 |
1.85 |
1.71 |
2.33 |
0.620 |
36.3% |
13% |
2.4 |
|
Jobstreest |
*0058 |
2.4 |
1.06 |
2.34 |
1.280 |
121% |
High |
OK |
|
Pantech |
5125 |
0.78 |
0.67 |
0.735 |
0.065 |
9.7% |
9% |
8.3 |
|
SKPRes |
7155 |
0.34 |
0.31 |
0.845 |
0.535 |
172.6% |
33% |
2.9 |
|
NTPM |
5066 |
0.47 |
0.42 |
0.72 |
0.300 |
71.4% |
12% |
10.2 |
|
Kimlun |
5171 |
1.5 |
1.29 |
1.27 |
-0.015 |
-1.2% |
23% |
7.2 |
|
Prestariang |
5204 |
1.21 |
0.48 |
2.50 |
2.020 |
421% |
150% |
5.6 |
|
|
|
|||||||
|
Average |
xxx |
xxx |
xxx |
112.7% |
|
|||
|
Median |
74.3% |
|
||||||
|
FTSE Mid70 |
615 |
12294 |
11679 |
13616 |
1937 |
15.8% |
|
|
|
KLSE |
82 |
1632 |
1550 |
1818 |
268 |
16.4% |
|
|
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Discussions
10 people like this. Showing 30 of 30 comments
Buy and hold strategy is sometimes the best even though I may be speaking based on hind sight. Sometimes moving around too much, keep searching for new opportunity, constantly analyzing, reduces the chances of out-performance. Simply sticking to this portfolio since 2013 would have yielded extraordinary returns (with minimal effort) despite the fact that there were many other candidates that also qualify as cheap and good between then and now.
2015-05-05 17:24
ks55, thanks. I m not bullish on property sector right now. I do own some Plenitude which is a huge paper loss right now. Yes, there are a lot of undervalued property companies now cause market is discounting the future earnings.
2015-05-05 17:51
Base on this blog one should buy Prestariang? No wonder someone trap buying Plenitude.
2015-05-06 04:51
Posted by truthseeker1 > May 6, 2015 04:51 AM | Report Abuse
Base on this blog one should buy Prestariang? No wonder someone trap buying Plenitude.
Yeah, shouldn't you buy when the portfolio was put up on 21st January 2013 when its adjusted price was 48 sen? You would have made 421% in just two years like I did.
As whether you should buy now, may be you can advise the people here, why buy, and why not. After all you are a truthseeker, and someone seeking the truth and nothing but the truth all the time, aren't you. no.1 truthseeker some more. No, your advice is not for me.
As for Plenitude. Not bad return what. The return was 36.3% in two years, as compared to the 16.4% of the broad market. What is the problem? Can tell us your reasoning ah?
2015-05-06 05:52
DJ seem no direction up or down. Maybe waiting clue of interst rate hike.beurope down. China bull market over? Malaysia politic problem? Will there market crash soon? All this factor also will the determine entry time n price beside company performance n foundation.
2015-05-06 09:49
follow kcchong strategy to invest, high roic, low evm and q ratio >1, is safe and simple. how much is your return is not you decide but god decide.
with this tool you can't win, then you are not deserved for big wealth, but you still can tumpang on other people's luck to make small money
2015-05-06 10:29
thank you mr kcchong,
I follow your strategy, I make money
but
I know luck is still an important ingredient in all investment
so
be generous to share your profit and you will get more in return
that's why you can see most of the Muslim countries are wealthy with oil and other natural resources because they pay zakat
2015-05-06 10:37
Posted by Ny036 > May 6, 2015 09:49 AM | Report Abuse
DJ seem no direction up or down. Maybe waiting clue of interst rate hike.beurope down. China bull market over? Malaysia politic problem? Will there market crash soon? All this factor also will the determine entry time n price beside company performance n foundation.
“As an investor you want to spend very little time on forecasting the weather (that is, what the Fed will do with interest rates next month or the rate of growth of the economy),” Katsenelson
2015-05-06 15:59
we just do our job, invest in the best way we can, if it wants to rain, let it rains lah...
2015-05-06 17:50
RIGHT I win big , WRONG I won't die
good day makan nasi, bad day makan ubi
I tell you frankly, if it wants to rain, no one can stop, no one can escape.
but if we put our money in a right place, after the rain, it is still there.
2015-05-06 18:03
Another good article explaining what value investing is, and why it should work in the link below.
http://klse.i3investor.com/blogs/kianweiaritcles/76070.jsp
2015-05-06 20:00
Hi KC ,
as you said "Quantitatively, the requirement of stable and consistent earnings and cash flow from operations and free cash flow, a healthy balance sheet stay. And the difference is, instead of using return on equity (ROE) as a measure of a good company, I prefer the return on invested capital (ROIC). For cheapness, I use EBIT multiple, instead of the price-to-earnings ratio. "
But how about if a company with high debt ? does the ROIC alone still apply to such high debt company ? or you still need to add in (EBIT multiple = Enterprise Value / EBIT) to make it work better ?
2015-10-03 10:45
Posted by citychew_1886 > Oct 3, 2015 10:45 AM | Report Abuse
Hi KC ,
as you said "Quantitatively, the requirement of stable and consistent earnings and cash flow from operations and free cash flow, a healthy balance sheet stay. And the difference is, instead of using return on equity (ROE) as a measure of a good company, I prefer the return on invested capital (ROIC). For cheapness, I use EBIT multiple, instead of the price-to-earnings ratio. "
But how about if a company with high debt ? does the ROIC alone still apply to such high debt company ? or you still need to add in (EBIT multiple = Enterprise Value / EBIT) to make it work better ?
ROIC, or return on invested capital measures the "goodness" of a company, the whole firm, unlike ROE which is just for the equity shareholders. Invested capital includes all capitals put in by the shareholders as well as debt holders and lenders. Hence ROIC has taken care of all capitals, whether it is high debt or low debt.
The above only measure "goodness". A good company is not necessary a good investment. Hence we have to look at if it is cheap enough to invest, even it is good. EV measures all market values including equity shareholders, debt holders, minority interest, but less of non-operating assets. So it is the price of all the stakeholders. Same thing for EBIT. it is the earnings of the whole firm. Hence all these numbers are in consistent with each other. Yes, you should also consider the price in term of EV/Ebit, similar to P/E, but for the whole firm.
2015-10-03 13:21
Hi KC ,
thanks for the reply.
let me give an example here .
let say company A have total invested capital of rm1000 ,and the EBIT is rm200 ,so the ROIC is 20% . ( EBIT/total invested capital) and company A is zero debt . but company B have the same ROIC as company A but company B have rm500 debt in the balance sheet.so are they still have the same "goodness" ?
2015-10-03 15:57
Simply sibuk a bit... :)
I think they have the same 'goodness'.
But, the interesting question would be how Price you should pay for
each shares considering its Book Value per share.
i.e, how to justify P/B for A given a value of P/B of B given by market?
(As you know the Book Value of A is double than B for above scenario).
2015-10-03 16:06
Posted by citychew_1886 > Oct 3, 2015 03:57 PM | Report Abuse
Hi KC ,
thanks for the reply.
let me give an example here .
let say company A have total invested capital of rm1000 ,and the EBIT is rm200 ,so the ROIC is 20% . ( EBIT/total invested capital) and company A is zero debt . but company B have the same ROIC as company A but company B have rm500 debt in the balance sheet.so are they still have the same "goodness" ?
Thanks Probability for the clarification.
Same "goodness" but is the "cheapness" the same? Remember, good company doesn't mean good investment and vice versa.
So to determine which is cheaper, you should read this article.
http://klse.i3investor.com/blogs/kcchongnz/49016.jsp
This article is one of the least popular article of mine in i3investor, but one of the most important, in my opinion. So many people talk about the simplistic PE ratio. You hardly even read anything from professional analysts talk about enterprise value.
2015-10-03 17:02
Hi KC Chong,
Good Evening !
I would like to ask for your valuable advice regarding 9822 SAM
All their contracts to manufacture plane parts is in USD
What if our ringgit stabilize on next year will it make the company profit drop or turn into losses ?
Thank You
2015-10-07 14:14
Posted by slater > Oct 7, 2015 02:14 PM | Report Abuse
Hi KC Chong,
Good Evening !
I would like to ask for your valuable advice regarding 9822 SAM
All their contracts to manufacture plane parts is in USD
What if our ringgit stabilize on next year will it make the company profit drop or turn into losses ?
Thank You
Slater, maybe you can tell me if Ringgit is going to go up, down or remain the same, when will it happen, and how much does it affect SAM's bottom line, if it goes up, down, or stabilized.
2015-10-07 15:54
Dear KC,
Good Evening !
Would like to ask for your latest advice what is your latest review on latitude
Any possible positive catalyst once they release their annual report on next month ?
Their previous quarter results net profit 79 million plus already surpass last year profit 60 million plus
7006 LATITUDE TREE HOLDINGS BERHAD
Thank You
2015-10-20 14:26
anyone can calculate latest return to date? To see if this method works even during down time now.
2015-10-20 14:57
Posted by slater > Oct 20, 2015 02:26 PM | Report Abuse
Dear KC,
Good Evening !
Would like to ask for your latest advice what is your latest review on latitude
Any possible positive catalyst once they release their annual report on next month ?
Their previous quarter results net profit 79 million plus already surpass last year profit 60 million plus
7006 LATITUDE TREE HOLDINGS BERHAD
Thank You
Slater,
I did write a number of articles about Latitude to share my view, that it is a good company, and was at good price to buy. However, I am no analyst, and I have no insider information of how much they are going to earn, what the share price will be, and yes no ability to forecast its future earnings and cash flows etc.
But I can give my opinion here. A good company may be good to still hold it but may not be a good buy if the price has risen too much. Trees don't go to sky.
Whether it is still a good price to buy you have to look at its price relative to its earnings, compare to its historical PE ratio, etc.
My latest article in i3investor can be found here.
http://klse.i3investor.com/blogs/kcchongnz/80034.jsp
2015-10-20 16:07
Dear KC,
Good Evening !
Companies that do share buy back has confidence in their own business
Will the share buy back increase the EPS & NTA ?
What is the good and bad thing about share buy back ?
2015-10-29 17:52
Paperlane,
Sound easy !!
But what is low ?
What is high ?
That is a question mark ?
Need to assess this carefully bcos this is where success and failure is determine loh....!!
2015-10-29 18:24
Posted by slater > Oct 29, 2015 05:52 PM | Report Abuse
Dear KC,
Good Evening !
Companies that do share buy back has confidence in their own business
Will the share buy back increase the EPS & NTA ?
What is the good and bad thing about share buy back ?
Generally yes, but not all the time. I have seen company buying back shares but the major shareholders sell. Something is not right.
If company buy back shares when they are very cheap is good, otherwise no. Sometimes because the management may have a lot of shares from ESOS, they want to jack up the share price to sell. It is very common, I think.
Share buyback will increase EPS, and NTA of outstanding shares in the market. if the bought back shares are redistributed as ESOS, or sold to the market, then there is no effect.
2015-10-29 18:25
I always dislike to first look into book!
First thing to look at always is the mgt and directors!
Look who are them, how they practice their biz and how they mgt it.
2015-10-29 18:31
Kc chong and others what do you all think about latitude share buy back proposal ?
2015-10-29 20:58
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KC， thanks for your sharing~ When I see the title of your article, I will click the link and read, its helpful for a newbie like me to learn and study
Nice sharing, keep it up :)
2015-05-04 20:19