Most participants in Bursa only care about how much they can make from investing in a particular share, without taking into consideration of the risks involved. There is no such thing as “risk” in their dictionary.
In parties, gathering, the public forum and internet, you hear and read a lot of people bragging about how much they have made speculating in certain stocks in the short term. But really, return alone, and especially return over short periods of time says very little about the quality of investment decisions. Return has to be evaluated relative to risk taken to achieve it.
I often read about how some people made millions, or even tens of millions by using the Golden Rule; this quarter’s profit must be higher than the previous, the subsequent quarter must be higher than this quarter, and the PE ratio must be less than 10. The only thing matters is the earnings, and nothing else.
I even heard about interview in radio proclaiming that one has consistently making money, a lot of money without even having to know how to read the balance sheet.
That is interesting, as for me, the balance sheet is one of the important parts of the language of business, telling me how safe is it investing in the company, for I don’t want to lose all my money just because the company I am invested in can’t pull itself through during an economic or a financial crisis.
Let us refer to this company Eversendai to illustrate my point of view. Incidentally I have just written an article about the cash flows of the company in the link below,
Again, I must clarify here that I have no idea what the share price of Sendai will be in the next few days, the next few weeks, next few months or the next few years. I have no intention to promote (for it seems every time I write about Sendai, its share price jumps up), nor I have any intention to bash it (the share price never comes down whenever I write something not good about it). I totally have no position in it, nor am I intending to buy it cheap, or to short it. This article is purely for sharing my view, and I hope, sincerely, you learn something.
Eversendai Corporation Berhad, Sendai, provides specialist engineering and construction services, specializes in structural steel design and construction. It operates in Asia, India, and the Middle East.
In the last 5 years from 2014 to 2018, Sendai’s revenue grows by 70%, from RM1 billion to RM1.71 billion for a compounded annual growth rate (CAGR) of 14.2%. Net profit grows at a higher CAGR rate of 20% from RM36.4 million to RM74.7 million, or 9.2 sen per share. In 2016, it made a huge loss of RM274m. Sendai can be considered as a high growth company.
In analyzing the balance sheet, we look at one of the most important things of the growth in equity, plus the dividends which will determine if the company has increased shareholder value throughout the years. The equity has grown by just RM45m from RM910m to RM970m, or just a CAGR of 1.2%. That was due to the huge loss in 2016. In the last 4 years, only a total of 2 sen dividend distributed in 2015 and 2016.
The glaring thing in the balance sheet is the growth of 140% in its inventories from 2014 to 2019, or a CAGR of 25%, almost double the growth in revenue. Trade account and other receivable and amount due from customers also grows at an alarming CAGR of 20%, way above the growth in revenue. To put that into perspective, it takes the company more than 400 days to collect its outstanding debts.
The jump in Inventories and Receivables was particularly alarming from 2016 to 2018. This seriously and adversely affecting the cash flows of the company, with huge amount of cash tied up as working capitals for the operation. Being a construction company, it also casts some doubts on whether some of these Receivables are subject to disputes and if they are collectable.
No wonder the company has to continue to borrow money from the bank in order to stay afloat. Its total short and long-term interest-bearing debts has increased by 132% from RM537m in 2014 to RM1248m in 2018, in just 4 years. Yes, RM1.25 billion, a huge number. The increased in the short-term debt of about 300% is particularly a red flag to watch.
Trade and other Receivables and amount due from customers made up 60% of its total assets as shown in Figure 2 below.
The next big asset item is property, plant and equipment, which we are doubtful about their actual realizable value. Only 0.6% is in cash. We can say the asset quality for Sendai is low.
Hence although Sendai’s net asset value is RM954m, or RM1.22 per share, it is doubtful it is worth a small fraction of it on liquidation.
Table 1 below tabulates the liquidity ratios and long-term financial strength of Sendai.
Table 1 shows that Sendai financial position is precarious with current ratio less than the required norm of 1.5, and negative cash flows from operations. It may not be able to fulfill its short-term financial obligations when due. Its long-term financial strength is also poor with excessive debts and high operating leverage. There are plenty of red flags around. It is particularly vulnerable in times of financial and economic crisis.
A company, even a specialist with jobs all over the world with amounting to billions a year for a company doesn’t signify its stock is a fantastic investment. Some industries, one such as the construction industry, is a challenging one, more so in the international arena. Earnings which is not translated to hard cash is not a good sign and it signifies a big red flag. Management efficiency in cash management is vital for the success, otherwise it will lead to a precarious balance sheet filled with the risk of bankruptcy.
It is no wonder at the price of 50 sen at the time of writing, with its low-quality assets and low-quality earnings, Sendai is trading at a very low price-to-book ratio of just 0.4 and price-to-earnings of just 5.2 times. Yet I am not willing to risk my money investing in it.
Understand the risks of investing through reading the balance sheet is very important to see if there is cockroach around the closet, for you don’t want to lose everything investing in it.
I have written and compiled a eBook on personal finance and what you should look out for in investing. Those interested in my eBook giving out free may contact me at my email below,
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