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Sendai: Lesson 4, Cold Eye 5 Yardsticks kcchongnz

kcchongnz
Publish date: Sun, 24 Nov 2019, 04:51 PM
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In my last article on the use of the Cold Eye 5 yardsticks investing strategy on Magni, I have shown how the strategy could yield extra-ordinary return over the long-term.

https://klse.i3investor.com/blogs/kcchongnz/238267.jsp

There were six criteria used in the Cold Eye 5 (6?) yardsticks investing; ROE, Cash flows, Growth, P/E, P/B and Dividend yield. Cold Eye replaced P/B to Growth. It is very difficult to get all the criteria meeting the 5 yardsticks, but if a stock does, it is highly likely that the stock will provide extra-ordinary return over the long term.

Take for example Magni-tech. I started investing in Magni since at least 6-7 years ago. My first article on Magni appeared in i3investor here on 3rd May 2014 in the link below when it was trading at an adjusted price of about 80 sen as shown in the share price movement of Magni-Tech in Figure 1 below.

https://klse.i3investor.com/blogs/kcchongnz/51356.jsp

After that, I had also shared many articles on Magni in i3investor on various subjects. The adjusted share price of Magni has more than tripled since then in the last 5 years as shown in Figure 1 below.

The secrete was that Magni-Tech has met all the criteria of the Cold Eye 5 (6) Yardsticks throughout the last 5 years.

Figure 1: Adjusted share price movement of Magni-Tech

What if you invest in a stock that fails in most of the criteria of the Cold Eye 5 Yardsticks?

I have so far written three lessons on the stock Eversendai. Let us continue with the fourth lesson; the lesson on investing in Sendai using the 5 yardsticks of Cold Eye.

 

Sendai: the fourth lesson on Cold eye 5 Yardsticks

On 25th May 2017, Sendai announced its 1st quarter result with an earnings per share, EPS of 1.97 sen, a turnaround from its loss of 25 sen the preceding quarter. It was trading at about 90 sen then. Its quarterly performance continued to improve to EPS of 2.66 sen in the second quarter, 2.69 sen the third quarter, and finally 3.84 sen as shown in Table 2 in the Appendix. The total EPS for the year 2017 is 11.16 sen.

Assuming that was the expectation on 25th May 2017, the prospective PE ratio then was,

P/E = 0.90 / 11.16 = 8.1 < 10

Sendai’s net tangible asset was about 1.12,

P/B = 0.90 / 1.12 = 0.8 < 1.0

The above most commonly used metrics of P/E and P/B of Sendai met two criteria of the Cold Eye 5 Yardsticks. The other criterion, Growth, appeared to be met too as there was an expectation of good growth due to the various projects it had secured then. That made it to three qualifying criteria investing in Sendai using the Cold Eye 5 Yardsticks.

There were numerous clarion calls to sailing and margin on Sendai then. Sure enough, the share price of Sendai shot up to RM1.40 at the end of June 2017 as shown in the share price movement of Sendai in Figure 2 below.

Figure 2: Share price movement of Sendai

No dividend had been paid for a couple of years. The fourth criterion of dividend yield failed.

For the fifth criterion on ROE of Sendai, it was as computed below,

ROE = expected EPS / Book value = 0.1116/1.12 = 10% < 15%

ROE of 10% for Sendai, a company with huge amount of debt at a gearing of 1.3, which was more than 1.0, is unsatisfactory. I would require a ROE of at least of 15% for the high risk involved.

The worst was its cash flows which requires some illustration as below.

 

Cash Flows of Sendai

Table 1 below shows that Sendai has been making profit for the last 5 years, except for the year 2016 when they incurred a huge loss of RM274m, worsen by an impairment loss of RM102m from an investment. However, its net cash flows from operations (NCFFO) were far from satisfactory. For example, in 2018, net profit was RM74.7m, but there was a deficiency in NCFFO of RM92.5m, even after adding back the non-cash depreciation of PPE of RM58m. The worst was in 2015 when Sendai purportedly made a net profit of RM61.5m, it had to fork out cash of RM250m in the year.

Table 1: Cash flows from operating activities and free cash flows of Sendai

Year

2018

2017

2016

2015

2014

Total

Net Profit

74727

87066

-274089

61549

36315

-14432

NCFFO

-92548

71590

-87040

-249533

52063

-305468

Purchase PPE

-61815

-85073

-61883

-166458

-100209

-475438

Sales of PPE

1079

832

781

378

925

3995

Free Cash Flows

-153284

-12651

-148142

-415613

-47221

-776911

 

The poor cash flows of Sendai raised an important red flag; were the earnings real?

That would throw everything haywire. Is the low P/E dependable if earnings, E is in doubt?

What about ROE?

If ROE is below the cost of capital, the Growth becomes a shareholder value destroyer.

If assets are all specialized plant and equipment and long aged receivables and other IOUs, net tangible asset may not worth much and hence plausibility of P/NTA. Just look at our famous London Biscuits. NTA of London Biscuits is RM1.28. It is trading at just 8.5 sen now under Liquidation process.

Share price of Sendai did move up when investors saw the prospective rise in profit in May 2017. The share price of Sendai rose up in fast and fury from 70 sen to RM1.40, or 100% gain within 4 months from March to July 2017. Retail investors were chasing the shares with the touting by interested parties in the internet. However, over time, the market is efficient somehow. Smart money won’t touch it or will abandon it. You could see that with the share price of Sendai dropping as fast and furious from RM1.40 to 40 sen from slightly more than two years.

However, if an investor could use the Cole Eye 5 Yardsticks to evaluate whether Sendai is a good candidate to invest in amid all the touting three years ago, he would have never invested in this stock, and as result, saved plenty.

 

Summary

The Cold Eye 5 (6) Yardsticks is a plausible, powerful and proven successful investing strategy. When a stock meets all or most of the criteria, it is likely it will earn extra-ordinary return over the long-term. On the other hand, if the stock fails most of the criteria, especially in a couple of important ones such as cash flows and ROE, it is better to avoid investing in the stock. Sendai was a good example.

I have written an eBook which includes a number of investing strategies besides the Cold Eye 5 yardsticks. If anyone interested, you may contact me at

ckc13invest@gmail.com

This eBook is given out free.

For those who are interested in doing some hard work learning the nitty gritty of fundamental investing to obtain extra-ordinary return paying up (not overpaying) for investing in good companies, or just avoiding losing big in bad companies which is equally important for your personal financial well-being, I have also written a comprehensive hard cover book on it. You may also contact me for this if you are interested.

Happy investing,

KC Chong

Appendix

Table 2: Quarterly earnings of Sendai

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