Recently I have written and published three articles in i3investor using Pintaras Jaya purely as an example, to share the concepts of fundamental value investing. The first one is about how to use a dividend discount model (DDM) to estimate the intrinsic value of a stock, and the second one, upon request of some forumers, to compare with Econpile to discuss which a better company is, and the third, which is a better investment, Pintaras, or Econpile.

http://klse.i3investor.com/blogs/kcchongnz/83959.jsp

http://klse.i3investor.com/blogs/kcchongnz/84114.jsp

http://klse.i3investor.com/blogs/kcchongnz/84172.jsp

I have explained that DDM provides a simple way to value stocks based on the dividends that they pay, and dividends are real cash investors receive. As sustainable dividend pay-out is only possible if the company has a history of making good profits which are translated to free cash flows (FCF) every year. Basing on the history of FCF and dividend pay-out by the company, we can make reasonable good assumption that the future would resemble the past.  

“I know of no way of judging of the future but by the past” Patrick Henry

Below was my opening quote when I discussed the topic on DDM:

“A stock dividend is something tangible-it is not earnings projection; it is something solid, in hand. A stock dividend is a true return on the investment. Everything else is hope and speculation.”           Richard Russell

Earnings is not cash. In construction contracts, many construction companies may report high earnings, but take it with a lump of salt if you can’t see the cash. You may say the client owe you money, in additional works, in additional claims and you book all these in your financial statements. But often, in fact very often, the clients won’t agree with you. Instead, he even make a counter claim on you that you delay his project and slap you with a RM100 claim of loss of profit because you delay his project, of which you claim the additional cost because of additional works, incorrect soil investigation provided in the tender etc. which is the client’s fault. So who is right and who is wrong? The arbitration of Econpile and its client recently will be a long drawn battle, and very often, the one which loses out is usually the contractor.

Even those earnings are true, and you can collect them eventually in cash, but if they aren’t distributed to you and you may not get it if the company eventually squandered it away, or losses it later. Besides, a huge portion of those earnings may have to be reinvested in additional working capitals, in buying more plant and machineries etc.

Just look at V.S Industry which I have written here:

http://klse.i3investor.com/blogs/kcchongnz/83784.jsp

For the last financial year ended July 31 2015, VS collected a net cash of just 11.4m. It has to find another RM53m somewhere (private placement) to purchase property, plant and equipment for its continued operations.  Over a long period of last 7 years, VS earned a total of RM309m in net profit, but “lost” RM4 in cash. So the company got to issues more shares and continues borrowing more money from the banks with total borrowings increased from RM178m in 2009 to RM412m now.

In the above case, yes, VS made a lot of earnings. Earnings grows like mad and the share price has also gone up like mad. But show me the cash! There is no FCF, and it has a net debt of RM168m in its latest balance sheet. So how certain shareholders can be on the sustainability of its dividend, and also its future dividend payments? And how certain can my DDM on VS work?

So how can earnings per share, EPS, be substitute in the DDM to estimate the intrinsic value of a stock?

[Posted by Newbhere > Oct 8, 2015 02:10 PM | Report Abuse

Hi KC, based on the formula and example you quoted above for DDM, am I right to say that if we substitute the Div amount with EPS, this would then equate to a DCF computation? Both DDM and DCF uses mostly the same data.]

Here is an email I received from a reader of one of my articles on V.S yesterday.

“Hi, i just a newbie on share market can u give me some advise i should still keep VS or sell it coa i worry the company not a cash flow company.i buy vs after share split at 1.340 i hold 100lot.Thanks”

Good question, sorry can’t help. I am not the late Paul the Octopus who knows if the share price will go up or down tomorrow or the next few days. But don’t worry, as far as I can remember, every time I write about V.S in this manner, its share price will soar the next day. So tomorrow will be a good day for V.S shareholders like you again.

But I do have an advice. Stop asking and following any advice from the public forums. Often it may not be good for your financial wellbeing. My better advice is, learn about investing, especially the fundamental ways of investing. No one else is in a better position to advise you, then you yourself. Of course provided you have the appropriate knowledge about investing.

Tis goeth down to a fundamental aspect that “An investment in knowledge pays the best interest”        - Benjamin Franklin

Here is another comment in one of the thread above regarding FCF:

[Posted by TylerDurden > Oct 8, 2015 09:50 PM | Report Abuse

KC,
Would you mind to share your views regarding the outlook/future profitability of Pintaras Jaya?
Do you think that Pintaras is able to maintain its FCF of RM 40+ million a year in the next few years?
If Pintaras FCF is halved to RM 20 million, should we put a new valuation on it?]

Below was my response to the question above:

[Posted by kcchongnz > Oct 9, 2015 05:11 AM | Report Abuse X
Nobody can tell you that, not even Dr Chiew of Pintaras Jaya. Revenue will likely to drop the coming year but construction industry seems still to be okay, but not forever.
I am a small retail investor, and I have no resources to predict the future, or make a comprehensive study of the company, its risks which also concern the industry risks. That will answer your next question. Tons of research has shown that even analysts are very poor in predicting the future. They often even got the direction wrong. Hence I don't place emphasis on anyone who says he is good in predicting the future.]

Here is what I got from his reply below:

[Posted by TylerDurden > Oct 9, 2015 07:53 PM | Report Abuse

KC,
I must admit your answer on Pintaras' business outlook is underwhelming. It seems to me that you lack understanding of Pintaras business fundamentals. You dont even understand the overall industry. Anyway, one man's meat is another man's poison. I say good luck with your fundamental value investing.]

As I have mentioned before that

“I am a small retail investor, and I have no resources to predict the future, or make a comprehensive study of the company, its risks which also concern the industry risks.”

So thanks for reminding me that. However, in my third article above, and the links below here, I have shown in statistical significant way that fundamental investing I am following has worked in US, and it has also worked in Bursa, and it works on its very own.

http://klse.i3investor.com/blogs/kcchongnz/50988.jsp

http://klse.i3investor.com/blogs/kcchongnz/78049.jsp

Hence I do have some published results in i3investor to show and do not need any blessing from this guy above. Nevertheless, I would like to hear his analysis on the industry outlook of the construction industry, Pintaras business fundamentals, and his predictions of Pintaras future cash flows etc. Please share.

I did share my view when another former asked me this question below:

[Posted by james_owk > Oct 10, 2015 10:48 PM | Report Abuse

Hi KC, thanks for the sharing, its very informative! btw wondering what is your view on their low order book as most of their projects are at tail end?]

[Posted by kcchongnz > Oct 11, 2015 07:23 AM | Report Abuse X

It isn't about how much is the order book for the coming year, or the next couple of years. Definitely the sum of discounted future dividends which gives its intrinsic value is not about its predicted profit for the next quarter, or next year, or the next two years. Anyway, I don't have to predictive power, although i acknowledge that the order book for this year will probably will be less, and so is its profit and cash flows and free cash flows.
But study carefully the dividend discount model, are the earnings for the next year, or next couple years an input in the model? To put it more specifically, are the dividends for next year, or next couple of year have a significant effect on its intrinsic value?
Not unless if you are speculating, not investing, for its profit growth for the next quarter, the two quarters after that, or one or two years.
Well, I never say one can’t make big money speculating.]

Most of us receive tons of market outlooks and other macro thingy, and target share prices for scores of stocks from investment bankers every day. We are in the age of information overloading. So seldom I read those reports and I tend to stay within the few companies I know best, however little it is. One doesn’t have to swing at every pitch.

From the companies you know, buy the better one with the better ROE and cash flows as shown in the comparison here:

http://klse.i3investor.com/blogs/kcchongnz/84114.jsp

And most of all, buy when it is selling cheap.

http://klse.i3investor.com/blogs/kcchongnz/84172.jsp

And buy with a high margin of safety, with less uncertainties.

http://klse.i3investor.com/blogs/kcchongnz/83959.jsp

It is just that simple. What else need to say?