"When you discover that you are riding a dead horse, the best strategy is to dismount."

Welcome Frank, long time no hear.

Let us discuss what are the few things which we should check if you should sell this particular loser (company name withheld) in your portfolio.

1. Have we made some significant mistakes in the analysis of the stock?
a. For this stock I doubt many people made any analysis at all. If ever there is any analysis, it would have been based on the reports of the company and analysts who have projected ultra rosy prospect for the company years ago in its acquisition trail.
b. Has the prospect projected been realized? Obviously not as its share price has dropped from an adjusted price of more than ten Ringgit per share in 2007 to less than half a Ringgit now.
2. Have the fundamentals changed drastically?
a. Well I haven’t done any fundamental analysis in 2007 and do not know its fundamentals then. However looking at its fundamental now I can say it is horrible.
i. It has persistently making losses for years. Even if there is any profit declared, I have doubt it is real. The cash flow is horrible.
ii. It has high net asset backing (not tangible though as it has very high intangible assets) per share but the quality of the assets is so poor that I doubt there is anything left for common shareholders if liquidated. The only value it has is just a pure option value in its listing status.
iii. There is no visibility in future earnings with my eyes.
iv. I don’t see the management is doing anything to improve the business.
3. Were we wrong about the management or the deterioration of management decisions?
a. This will make a great story about the management, refer to the link below:
http://whereiszemoola.blogspot.co.nz/search?q=knm
b. There is absolutely no credibility on the part of the management.
c. Management is still making “wonderful” decision recently to buy back its own shares with its backside.
4. “If we didn’t own it, would we be buying it today?”
Need I say further?

So the long term investors of this company, are you suffering from this cognitive bias of endowment effect due to your loss aversion and hence causing you this disposition effect?

"Holding a Loser Until it Breaks Even"

The “Endowment Effect” is one of the emotional biases of human being. It is due to the fact that once you own an item, forgoing it feels like a loss, and humans are loss-averse.

Loss aversion is due to the fact that people dislike incurring losses much more than they enjoy making gains. Avoiding regret and seeking pride affects people’s behaviour and in turn causes the disposition effect resulting investors predisposed to holding losers too long (& selling winners too quickly).

This disposition effect can affect the investment return of an investor such as opportunity cost if he continues to hold on to a stock with deteriorating prospect. It can also deprives investors good return from the stock based on the initial thesis, if just because it is a loser and you must sell it.

Hence it is very important to have a good feel of the intrinsic value of the stock and know the relationship between value and price. It can take a lot longer than for value to be realized than we expected, but that it’s taking longer doesn’t mean we’ve made a mistake. If the market hasn’t recognized the value we see and the company is continuing to increase its intrinsic value, why should be a hurry to sell?

A few things need to be checked if one should continue to hold the losers.
1. Have we made some significant mistakes in the analysis of the stock?
2. Have the fundamentals changed drastically?
3. Were we wrong about the management or the deterioration of management decisions?
4. “If we didn’t own it, would we be buying it today?”

Buying something for less than its value. The most dependable way to make money. Buying discount from intrinsic value and having asset price move towards its value doesn’t require serendipity; it just requires that market participants wake up to reality.

If your estimate of intrinsic value is correct, over time an asset’s price should converge with its value.

Trying to buy below value isn’t infallible, but it’s the best chance we have.

Howard marks: the most important thing illuminated.

Katsenelson’s absolute PE for CENBOND (12/1/14)

Instead of using the relative PE valuation method for different industry, Vitaliy created an absolute and more robust method that can be used for any company. The absolute P/E model makes adjustment according to the following:

• An average company that does not grow earnings and pays no dividend, use PE=8
• For every unit of earnings growth from 0-16%, P/E increases 0.65 points, above 16% growth, use 0.5 points. Earnings growth is based on 5 years projection.
• Every percent increase in dividend yield, P/E increase by 1 point
• Adjust P/E according to business , financial risks and earnings visibility

For those who are interested in this method can refer to the following link:

http://klse.i3investor.com/blogs/kianweiaritcles/36512.jsp

Last year, net income of Cenbond grew by 32% from 15.5m to 20.6m. For the last 7 years the compounded annual growth rate has been 12.4%. For adjusting the absolute PE, we take half the rate as a conservative assumption, or a growth of earnings of 6.2%.

Basic PE for CENBOND with a growth of 6.2% and a dividend yield for last year of 2.6% is adjusted by the formula;

Basic PE = 8 + 0.65*6.2 + 2.6 = 12.8

Business risk: CENBOND’s business has high efficiencies with return of assets of 9.7% (>7%) and return of equity of 12.7%. Last year cash return (FCF/IC) is at 37% and average of last 7 years is 16%. Hence an arbitrary 10% discount is applied to its business risk.

Financial risk: CENBOND has a very healthy balance sheet with an excess cash of 64 sen per share. It has very little debt. Current ratio is very high at 4.3. Free cash flow is abundant at 7 times total debt. Hence a discount of 10% is applied to the financial risk.

Earnings visibility: CENBOND has stable and reasonable gross and net profit margin of 20% and 10% respectively. Its cash flow from operations averages about 140% of its net income. It has average free cash flow of about 8% of revenue. No premium or discount is applied to earnings visibility.

Hence the absolute PE for CENBOND is:

Abs PE = 12.8* [1+(1-90%)] *[1+(1-90%)] * [1+(1-100%)] = 15.5

Fair value of CENBOND= 15.5*0.16 = RM2.48

There is hence a 44% upside to its present share price of 1.72 on 12 January 2014.

An investment approach based on solid value is the most dependable.

Posted by houseofordos > Jan 11, 2014 08:01 PM | Report Abuse
KC, I got about same number as you for EPV method. Just wondering how would you adjust the valuation if a company has issued warrants or convertible stock which could dilute shareholder EPV ?

A very good question. Let’s discuss here.

For simplicity, I would think you just consider the enlarged number of shares as if the warrants are converted to the underlying share. Don’t forget to add the amount of cash used for conversion to the balance sheet. This may be quite close if the warrants are deep in-the-money and expiry is not too long in the future.

However, for warrants which are out-of-the-money, we don’t really know if conversion will take place. I would use the Black-Scholes Option Pricing to determine the price of the warrants, then multiply by the number of warrants outstanding to get the amount due to warrant holders. This amount is subtracted from the EPV value of the underlying.

Hope to get input from others.

Jvei,
I have recommended the book in my first post above:

"The Most Important Thing Illuminated" by Howard Marks.

Or if you are interested in learning some financial statement analysis and valuation, it is good to have this book:

"The Five Rules for successful stock investing" by Pat Dorsey

Earnings Power Valuation for Cenbond

Valuation is really a very tough task to carry out. It has to be a forward looking exercise. That means we have to make some forecast of a company’s future cash flows. However forecasting is a very hazardous endeavour and it has been proven again and again that forecasting of future cash flows, especially the optimistic ones often run out by huge errors.

Earnings Power Value (EPV) was postulated by a Columbia University Professor and proven successful investor Bruce Greenwald. It is an estimate of the value of a company from its ongoing operations only.

First we would assume that current revenue is sustainable. We then normalize the earnings to the business cycle. This eliminates the effects on profitability of valuing the firm at different points in the business cycle. This means that we are considering the average % operating profit over 5-8 years. This average would then be applied to current sales. The beauty of EPV, for value investors, is that the numbers used to calculate it are no growth free cash flows. By using no growth free cash flows we eliminate the predictions of future growth and as such arrive at a number which we can be fairly certain of. This isn't to say that some companies can't expect significant growth, but as value investors we refuse to pay for it. The next step is to subtract interest bearing debts and any minority interest and add the cash not required to run the business; and any other investment which has not been consolidated into its results,. The final step in calculating Earnings Power Value is to divide the final cash flow number by the cost of capital. This gives us the present value of a perpetuity without any estimation of growth. That is the Earnings Power Value. Anybody interested in this method can read from the appended link below:

http://www.stockopedia.com/content/how-does-the-earnings-power-valuation-technique-epv-work-60553/

Lets carry out a valuation exercise of Cenbond here using its latest revenue for its ordinary business for year ended March 2013. The average Ebit margin used for the last eight years is 11% as compared to 14% last year. The EPV is shown below:

Revenue for 2013 186841
Ebit (margin at 11%) 25941
less income tax (23%) -6093
EBIT after tax 19848
Add average D&A 2611
Less average capex -5221
Normalized Ebit 17237
Cost of capital, R 10.0%
Capitalized earnings=Nor Ebit/R 172373
Add cash 76865
Other investments 0
Less debts -4599
EPV 244639
Less minority interest (7%) -16719
EPV to common shareholders 227920
Number of shares 120000
EPV/share 1.90

Using the conservative EPV method which can be considered as a bad-case scenario, the intrinsic value of Cenbond is RM1.90. As this is still above its present share price of RM1.72, it appears that Cenbond is a good investment for long term.

JT Yeo,

First of all, if you find any company fitting the Magic formula, i.e. high ROIC and high earnings yield (Ebit/EV), can you please let me know?

30 years ago my boss was at 40 years old and he was still single then. He couldn’t find a life partner because as the first criterion he wanted a wife who would love him very much. Secondly he wanted the wife to be a very 溫柔賢淑, a good wife. Thirdly he wanted her take care of him very well. Fourthly she must be well educated. Fifthly she must young and pretty. And she must not simply spend his money which he had saved up quite a lot because of his stingy behaviour, etc.

Is it easy to find one? I would be happy if the first two criteria; loving me and a good wife were met. Of course if more criteria are met, that would be wonderful. But is this place Heaven?

“If I had to identify a single key to consistently successful investing, I’d say it’s “cheapness.” Buying at low price relative to intrinsic value (rigorously and conservatively derived) holds the key to earning dependably high returns, limiting risk and minimizing losses.” Howard Marks

The above can be achieved buying Cenbond at RM1.54 when I first wrote this article on packaging companies. The earnings yield (Ebit/EV) was at a high of 23%. Even at RM1.72 now, earnings yield is still very high at 19%, much higher than my requirement of 12%.

Some more this Cenbond is also a “good wife” who is 溫柔賢淑. Its ROIC is very high at 22%, much higher than my 12% requirement. What else do you want?

Ok I know you want your wife also takes care of you very well. You want Cenbond to be a growth stock. Cenbond net profit grew at a compounded annual growth rate of 12% for the last 7 years. And as one of the leading paper packaging companies, its future also looks bright. What else you want?

Cenbond also has good cash flows, very healthy balance sheet etc. So this potential wife meets a lot of other criteria too.

For your question of “do you think consistent high ROIC with ultimately have a positive effect on the share price itself?”, I cannot answer you as I don’t have a crystal ball in front of me and I won’t know the behaviour of the investors. But I do believe in what Warren Buffet says:

In the short term, the market acts like a voting machine; but in the long term, it is a weighing machine.

Don’t forget to tell me when you find any stock which meets just the two criteria of the Magic Formula, ok?

Yes, read read and read. If you want to be good at investing, read, read and read. I don't care if you got a Master in finance, PHD in finance, you can't go far in your investing experience, unless you read read and read.

The first book I am introducing here is:

The Most Important Thing Illuminated by Mark Howard.

ctyap, it is a coincidence that the growth assumption is the same as the discount rate at 10%. Hence the present values of discounted cash flows happen to be the same as the growing cash flow.

Calculation is correct.

Posted by digiuser016 > Jan 10, 2014 12:44 AM | Report Abuse

Hi Kcchong, I have a few questions.

1:If using NOPAT/IC where IC = PPE + net working capital
Where net working capital=receivables+ inventories - payable
The "total assets" consist of many other stuff not concerning the "ordinary" business; for example some property investments for some non-property companies; investments in associates and joint venture companies; some "other investments" etc. These stuff are generally not consolidated into the financial statements of the company, and hence by using your formula, you nay have over-estimated the invested capital, and hence resulting in a lower actual ROIC.

Then, do you include Share of profit of associates and Investments in associates when calculating NOPAT/IC for Kfima(sorry for a spam here)?Do you include Non-ordinary(non core) business when calculating NOPAT/IC?


Me: This is my views as a non-accountant and a non-finance professional
1) NOPAT/IC
both the numbers used for the numerator and denominator have to be consistent with each other; NOPAT, or net operating profit after tax takes on the "operating profit" which does not include other profit sources such as from associates, JV, one-time off items etc. Likewise IC excludes investments in associates, jv and other non-ordinary business.


2: what is your view for the below statement. How do you treat deferred tax assets and tax liabilities when calculating IC

Actually, including taxes payable is a judgment call. Many analysts let this item remain as a source of invested capital (as we did here) because most companies never pay these deferred taxes. These taxes are perpetually deferred, and for this reason, some call them "quasi equity". If the company were going to pay these taxes, we would exclude taxes payable from invested capital, but since the company - in practice - is going to hold onto the extra cash, we are going to charge them for the use of it.

Me: Yes, a judgement call remains as a judgement. If you use the formula below without any adjustment, you would have included the deferred tax credits or liabilities in the calculation of IC.

IC= (Total assets - Cash) - (Non-interest bearing liabilities)

If you use the other formula, IC = PPE + net working capital

Then you would have ignored them. My judgement is to ignore them. But seriously generally how much are there deferred tax credits/liabilities for companies which could affect your calculation of ROIC?


If I am not mistaken, Joel encourages the investor to use EBIT when calculating ROIC because different companies have different debt and tax rates, using ebit can avoid the distortions arising from differences in tax rates and debt levels.

Me: When you talked about ROIC, the R or return straightly has to be an after-tax return which is NOPAT, and not Ebit. For the Magic Formula used by Greenblatt, he ranked those stocks with Ebit/EV, and ROIC. There won't be any significant difference if he ranked them by NOPAT/EV, except a little more work in computing NOPAT.

3: what is your valuation method for Tas offshore? its CFFO and FCF has been negative for a few years. but its price is still increasing.

Me: Does the share price increase has anything to do with valuation?

You can't value TAS with free cash flow as there is none. But that doesn't mean TAS is a hopeless company. It just means that for the present moment because of its expansionary business, a lot of cash is tied up in inventories and receivables. It also doesn't mean that the customers don't pay them, or the tugboats, AHTS cannot be sold. It could also mean that too. I don't know unless one knows about its business well.

It doesn't mean without FCF you can't value TAS. There are many other valuation methods, such as using its present or average Ebit instead of FCF.

What are the returns of some stocks in the year 2013?

I have summarized the return the stocks mentioned in this thread up to today as in the appendix below. The “Reference price” was the price at the time when I was asked about that particular stock. What are the characteristics of the return of the stocks?

It can briefly be summarized as below:
1. The average return of the portfolio is minus 8.7% versus the return of the benchmark FTSE Midcap70 of 14.5%. This means the portfolio underperformed the bench mark and alpha is negative at minus 23.2%, a huge underperformance.

2. I would expect a couple of high return stocks because basically these are all the “hot” stocks chased by many people. However, I found there is none. Although there are 4 out of 16 of them have double digit return, what surprised me again is that they are all in the low teens and none of these hot stocks even managed to beat the bench mark of 14.5%.

3. Instead there are 5 of them in double digit losses, all more than 20%. One of them, CSL, had a negative return of 71%, and AsiaMedia at minus 41%. Smartag would have suffered the same faith if not for the stiff rise for the last few days.

4. The above is the total opposite of a value investor’s portfolio which there are many big winners and little or none losers. Even there is one or two losers, the negative alpha is very small.

5. May be one should rethink of their investing strategy by following a proper process of value investing or trading rather than chasing the hot stocks of the day and following rumours.

Appendix
Return of some stocks
No. Company Ref Price Price 9/1/14 Gain/loss
1 Pmetal 2.520 2.370 -6.0%
2 GCB 1.800 1.410 -21.7%
3 Ivory 0.550 0.630 14.5%
4 PW 0.720 0.810 12.5%
5 Rsawit 0.850 0.785 -7.6%
6 LonBisc 0.680 0.695 2.2%
7 KNM 0.455 0.475 4.4%
8 MPCorp 0.550 0.430 -21.8%
9 MKLand 0.330 0.370 12.1%
10 Careplus 0.315 0.305 -3.2%
11 CSL 0.750 0.215 -71.3%
12 AnComLB 0.185 0.205 10.8%
13 Smartag 0.180 0.135 -25.0%
14 Amedia 0.135 0.080 -40.7%
15 NovaMSC 0.065 0.065 0.0%
16 Hibiscus 1.900 1.920 1.1%

xx Average xxxx xxxx -8.7%
xx FTSE Mid70 12294 14082 14.5%

ctyap,
You have to work out the year-by-year FCF, and discount the yearly cash flow year-by-year with the formula CFn/(1+R)^n and then sum them up (including the terminal CFt). For example, the discounted year 3 cash flow will be 40445/(1+10%)^3 (see below example and my previous post).

https://users.wfu.edu/palmitar/Law&Valuation/chapter%201/1-3-3.htm

Refer to my previous posting

Posted by kcchongnz > Dec 1, 2013 05:59 PM | Report Abuse X
Table 6.2: DCFA
Year 0 1 2 3 4 5 6 7 8 9 10
Free Cash Flow, FCF $ 33426 36768 40445 44490 48939 53832 59216 65137 71651 78816
Terminal FCF, $=CFn(1+g)/(R-g) 1159722
Total FCF, $ 33426 36768 40445 44490 48939 53832 59216 65137 71651 1238538
PV of FCFF of core operations $751,000 $3.41

Posted by JT Yeo > Jan 9, 2014 05:01 PM | Report Abuse
Hi Kcchongnz, just to clarify how did you get the ROIC of 22% for cenbond? Are you using the formula as in NOPAT/(Total assets - Cash) - (Non-interest bearing liabilities) or other formula calculation?

When you use any "formula" to calculate anything, you must understand the rationale of the formula.

ROIC is the return on invested capital, or NOPAT/IC. what is the invested capital in the business, the "ordinary" business? Your formula of (Total assets - Cash) - (Non-interest bearing liabilities) would normally be correct and it is often given by text books too. It is the asset used, less any excess cash and non-interest bearing liabilities. This excess cash by definition is "excess" and is not needed in the ordinary business. Non-interest bearing liabilities is "other people's money", not "invested" by you in the form of equity or debts. Hence it is excluded from "invested capital".

But text book formula is usually simplified. In really life financial statements in Malaysia, the "total assets" consist of many other stuff not concerning the "ordinary" business; for example some property investments for some non-property companies; investments in associates and joint venture companies; some "other investments" etc. These stuff are generally not consolidated into the financial statements of the company, and hence by using your formula, you nay have over-estimated the invested capital, and hence resulting in a lower actual ROIC.

Thus for most people, I would advise them to use invested capital as:

IC = PPE + net working capital
Where net working capital=receivables+ inventories - payable

The two methods generally result in the same invested capital if in your earlier method of estimation you have made the proper adjustments.

Try figuring them out.

This article brings to the attention of two important things about investing:
1. Does bonus issues and share split etc add value to shareholders?
2. Two stocks A & B has different par value, A at 50 sen and B at RM1.00. They earn the same EPS of say 5 sen, and everything else assumed the same. Both the share price are at RM1.00. Does it mean that A is twice more expensive than B?

My response to question 1 is:
Waiter: Do you want to slice your pizza to 5 pieces or 10 pieces?
Me: No, 20 pieces please. I am very hungry.

Everyday formers here argue about how great is the bonus issue and share split and other things like cash payout. AncomLB going to pay a special dividend of how many 4 sen, and another say 8 sen. So 8 sen payout is so much better. Does it really matter that much that for example you have a small business and you find that the till has a lot of money and you make a withdrawal of say RM2000. And now you claim that your business is better than the same business of mine which earn the same profit and cash flow, but you make a withdrawal and I don’t?

My action:
I will make use of the psychology of investing, the cognitive bias of mental accounting of the masses; buy when there is a bonus issue or share split, preferably getting some insider information first, and sell later after the share price has been chased up.

My response to question 2 is there is no difference at all for an investor whether investing in A or B; except some accounting thingy which is not much of a concern. The value of a stock is all depending on its assets per share, earnings per share, cash flow per share, earnings yield (ebit/ev), future prospect etc; but nothing about par value. Par value is immaterial to investors. I think there is why SC is going to do away with the par value thingy as it has no effect except for some corporate exercise thingy.

My action:

Buy the cheaper PE, P/S, EV/Ebit of the two and short sell the expensive one and earn a riskless profit (if I can short sell). Market will eventually adjust the discrepancies and the market will follow the Law of One Price.

OTB,

You may also refer to the following link where I try to explain what is cash flow from operations and free cash flows for a simple business here:

http://klse.i3investor.com/servlets/forum/900214344.jsp

I also remember sense maker has explained how a cash flow from operations statement is prepared starting from operating profit when you asked about it recently.

OTB,
TAS has 26.5 m in “increase in inventories”. This is probably due to cash consumed in some building of AHT, AHTS, or tug boats built and waiting for buyers. They may have some contract works in ship repair of which they claim work has been done but payment not made by customers, and hence the increase consumed cash in “increase in amount due from contract customers” of 16.6m total. They also delayed payment to subcontractor and suppliers of total of 25m which help in their cash flow, otherwise would be worse. These are some of the things which makes “profit” not equivalent to cash received.

Yes, poor in cash flow from operations is not a good thing at all, especially for consecutive years. No free cash flow for a short period may be ok as this may be cash needed for capital expenses for the good of future earnings. No positive CFFO how to have enough money for paying subcontractors and suppliers, and the whole operations and capital expenses? Not to say pay dividend, pay down loan. Pay down loan? Didn’t you see debts has been increasing every year. Worst is short term debt. Because there is not enough hard cash received for the operations.

TAS need cash infusion, more bank loans or right issues, and needs it very soon.

There are a lot of punters in KLSE. I like to punt too, seriously. But I focus on punting on call warrants.

Take for example, the WCT call warrant CM.

CM has an exercise price of 2.55 with an exercise ratio of 2. It expires in 31/7/2014, a long time to go. At the close of 2.14 of WCT yesterday, CM, at 3 sen is trading at a premium of 22%. The premium is a little high but CM has a very good profile for punting. It has a high gamma and hence when the volatility of WCT goes up, delta or the rate of change of the warrant in relation to the underlying goes up very fast. CW has a very high gearing of 35 times too.

At the close today, WCT share price went up to 2.23, for 9 sen gain, or 4%. WCT CM went up to 4 sen, of for a 33% gain. The 4 sen closing price may be illusive as it was most likely pushed up by insider to make it so, but I think CM should be able to sell at 3.5 sen, or a half sen gain. That would be 17% gain too.

Punting call warrant is a probability game. At least for a game of probability, one knows where he stands, rather than just purely based on luck.

Can you appreciate the power of leverage in warrant investing now?

When the above post was written exactly 2 weeks ago, PJ Dev share price was RM1.28 and Wc was 35.5 sen. Now PJ Dev is 1.38, for a rise of 10 sen or 7.8%. PJDev Wc is 43.0 sen now and the increase in price is 7.5 sen. The percentage increase is however about 3 times more at 21.1%.

That is the power of leverage.

Hence if one is very bullish about a stock, investing in its warrants can be a better alternative.

Ayoyo, I have to say that you have done extremely well in your trading adventure last year. But I can't help saying some sincere words here.

The past year is a good market. The broad index KLCI went up 14%, which is much better than a normal year. You would have done much better if you have borrowed money and have heavier bets.

But every once a while, someone makes a risky bet on an improbable or uncertain outcome and ends up looking like a genius. But we should recognize that it happened because of luck and boldness, not necessary skill. In the short run, a great deal of investment success can result from just being in the right place at the right time. The keys to profit are aggressiveness, timing and skill, and someone who has enough aggressiveness at the right time doesn’t need much skill. And that includes many people, and me too.

It is very good that you seem to recognize that too. Many don't. The killer will be if one doesn't appreciate the role of luck.

Posted by houseofordos > Jan 5, 2014 02:14 PM | Report Abuse

KC, all studies have shown that stocks generally go up in the long run. As long as we have cashflow to service the loan, just buying an index fund should give excess returns on the cost of debt in the long run as long as interest rates remain low . However if interest rates were to go up drastically like during the asian financial crisis, leveraging is definitely dangerous..

"all studies have shown that stocks generally go up in the long run", but in the long run, we are all dead.

Ever heard of the lost decade of DJIA? DJIA was above 11,000 in year 2000. 10 years latter, it even went down below 10,000. How many people can afford to have their borrowed fund tied up in the market and continuously paying interest? Yes, you said it right, what if interest rate goes up to above 10%, like what happen during the Asian financial crisis?

What about if in 1990s, you have bought MUI, PMCorp, MPCorp, KNM etc with borrowed fund and keep them until now?

What if you have dabbled in the second board counters in 1996 when most of the stocks are in their tenths and hundredths of dollar a piece?

What if you have borrowed money and invest in the internet companies in 2000 and kept them until now?

Yes, stock prices go up in the long run. Yes all studies show that. But that is history. The future is uncertain. Yes, I agree we should still invest in the long term; but should we leverage, knowing that a black swan can appear any time? Beware of the fat tail.

Even though you invest in good stocks with the borrowed money can be very dangerous when a black swan appears when you are forced to sell off because of banks calling back loan, or margin calls.

Posted by Chrollo > Jan 5, 2014 11:43 AM | Report Abuse

And I would like to ask a question.. I am still learning so what I say may be wrong.. The question is that if we were to go on a value stock.. 1) Will not our funds be held down for the dormant period until it flies? 2)Overdiversifying will also actually bring you lesser return or maybe losses.. What is your opinion? Thank you

Question 1: I will repeat the same response

"The market’s not a very accommodating machine; it won’t provide high returns just because you need them." Peter Bernstein.

"To be a value investor, you have to be willing and able to suffer pain:" The pain of waiting if you may say. Jean Marie Eveillard

But sometimes you may not necessarily have to wait too long, if you are lucky. And luck may not simply come to anybody. Please refer to the return of my two portfolios set up this year, both of them less than a year.

Question 2: Over-diversifying brings lesser return? Sure but have you thought of just having two stocks in your portfolio, or under-diversification, say Kumpulan Fima and SKP resources which fell in price albeit a little, while watching most other stocks went up in price a lot for the last one year?

I advocate diversification, not over-diversification. Please read this:

http://klse.i3investor.com/blogs/kianweiaritcles/43093.jsp

Is there such a thing as "guaranteed" in investing, especially you want to get a return higher than the cost of borrowings?

Posted by houseofordos > Jan 5, 2014 08:39 AM | Report Abuse
This leverage method would work well if you can find an investment that guarantees returns above cost of debt.

Posted by Tan KW > Jan 5, 2014 08:52 AM | Report Abuse
how if borrow $ to invest in good company that sell in great discount price (high MOS) like KFIMA and KUCHAI?
my own opinion, we have to ensure we have enough cash flow to cover the loan repayment but not hoping the equity investment will provide us the cash flow. we only able pick good company with huge MOS but we will not able to determine when the market will give a fair price to the selected stock.
kcchongnz, what is your view?

Tan KW, you have now become a great value investor. Buy them in loads if you find those value stocks as described by you. But with borrowed money for an ordinary investor like you and me, I am not sure. And bear in mind the followings:

The market’s not a very accommodating machine; it won’t provide high returns just because you need them. Peter Bernstein

There is a big difference between probability and outcome. Probable things fail to happen-and improbable things happen-all the time. Beware of fat tails.

Kimlun risk-adjusted return

One of the stocks Kimlun here returned 26% compared with KLSE of 14%. Is that a good risk-adjusted return? We know that 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. How do we evaluate it then?

We have used some academic approaches to evaluate the performance of the stock price of Kimlun for the past one year. One of the methods was the Sharpe ratios to measure its idiosyncratic risk as shown in the link here.

http://klse.i3investor.com/blogs/kcchongnz/44334.jsp

The above link shows that as Kimlun has an annual standard deviation of return of 38%, using a risk-free rate of 3.5%, the sharper ratio is 0.59, way below the Sharpe ratio of KLCI of 1.2 which returned 14% with a volatility of 8.8%. Hence one may say that the risk-adjusted return of Kimlun is below that of the KLCI, or the realized risk-adjusted return of Kimlun is below expectation.

Another academic way of measuring the risk-adjusted return of Kimlun is taking it as a stock in a diversified portfolio, the measure of its systematic risk using the Capital Asset Pricing Model as shown in the link below:

http://klse.i3investor.com/blogs/kcchongnz/44336.jsp

In the above, it was shown that Kimlun’s realized return was as expected with an α closed to zero in accordance to the CAPM.

The above two methods of assessing the risk-adjusted return of Kimlun, however, are just academic. How can we go about assessing the risk-adjusted return of a company based on some common sense, rather than the mumbo jumbo of α and β in academic? Let me venture into something controversial evaluation here.

In evaluating the performance of a diversified portfolio of stocks, I like look at it like the following way:

Risk-adjusted return Ra = α + β * Rm

where α is the excess return, β is a risk measure, 1.0 for the broad market, and Rm is the return of the market. What is this β then? Once we can measure β of the stock, using βm of KLCI as 1.0, we can evaluate if the stock make an excess return as measured by α over the market.

I will try to use the intuition of Katsenelson’s approach when he used some risks adjustments for obtaining his absolute PE in valuing stocks. Note that the method presented below is more of a judgement than hard numbers.

I will adjust the value of β of individual company, add or subtract certain percentage points to β according to its specific risks based on the following five conditions:
1. Earnings growth rate. Subtract when there is good growth rate
2. Dividend yield. Subtract if good and stable dividend
3. Business risk. Subtract if business risks low
4. Financial risk. Subtract if debt is low
5. and earnings visibility. Subtract if good visibility

Value β =1+Eearnings growth + dividend yield + Business risk + Financial risk + earnings visibility

1. Kimlun has a good growth of 16% per year in its earnings. However, for the last two quarters, its earnings has slipped quite badly by more than 40%. I will arbitrary add 15% to “earnings growth” in the formula.
2. Kimlun pays reasonable dividend. However, its cash flow is quite bad and I doubt the good dividend is sustainable. I will be neutral here.
3. Kimlun’s ROE and ROIC of 18% and 23% respectively for the last financial year was good. However, these were achieved with high leverage of 2.6, as its net profit margin is quite low at only 7.6%. Furthermore as discussed, the last two quarters financial performance has deteriorated quite badly. I will add 10% in business risk here.
4. Kimlun has quite a high debt of 161m, or a debt-to-equity ratio of 0.6. And debt has to be increased because of its poor cash flow in the near future. I will add 25% here in the “Financial risk”.
5. Kimlun has been securing some jobs recently and hence earnings visibility is there. However because of the recent drop in earnings, I will maintain neutral here.

Hence β=1.0 + 0.15 + 0 + 1.1 + 0.25 + 0 = 1.6

Hence β x Rm = 1.6 x 14% = 22.4%

AS Kimlun returned 26% last year, 3.6% over what was expected, it can be said that it has earned a higher risk-adjusted return according to this method of evaluation.

Posted by JCool > Dec 29, 2013 12:05 PM | Report Abuse

fyi... whn i talk nonsense... it is whn i wanna talk nonsense... but in mfcb was no nonsense..


MFCB was one of the very first stock I selected for the second half of 2013, just 5 months ago. The price was RM1.70. At the close of today’s trading on 3/1/14 of RM2.28, the total return including dividend is 36%, as compared to the return of the broad market of just 5.3%. Yes in just 5 months. And when I wrote my analysis in the appended link below, I said the below because I expect it will take some time for us to realize its potential,

“擁有一隻股票，期待它下個早晨就上漲是十分愚蠢的 Warren Buffet “

http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/34201.jsp

I review the selection process and I found nothing wrong with it. It was again based on the tested Magic Formula of Greenblatt; buying a good company with a bargain price. In fact a damn good price for MFCB at RM1.70 at that time at earnings yield (Ebit/EV) of more 50%, a good company with ROIC of 18.6%.

Is MFCB a risky company to invest in? You tell me. A company in power generation earning steady revenue and income, with good growth too. Its balance sheet is also squeaky clean. Cash flows are great with free cash flows consistently at mid teens of revenue and invested capital. Tell me which company has this great and consistent free cash flow and I will definitely look deeply into it.

Conservative valuation using the earnings power valuation shows its intrinsic value is RM2.70, way above its price of RM1.70 then.
Will the share price of MFCB continue to go up? I really don’t know. But I know I did not make a wrong pick 5 months ago like what the gentleman above implies, did I?

Buying something for less than its value. The most dependable way to make money. Buying discount from IV and having asset price move towards its value doesn’t require serendipity; it just requires that market participants wake up to reality.

Avocado, I strongly advocate diversification in stock investing. My thought about diversification is here:

http://klse.i3investor.com/blogs/kianweiaritcles/43093.jsp

Not everybody is Warren Buffet who is so good in his investing prowess. Actually many people do not realize Warren Buffet's Berkshire Hathaway actually have many companies and stocks under its portfolio.

Posted by anbz > Dec 26, 2013 01:34 AM | Report Abuse
bsnpg, tan kw and many more are all his member of gang...jcool call them jcw gang...or is it jwc gang? can't remember
he also recommends fibon before...and they goreng it well..now look at fibon...what has happened???!!!

What is wrong with Fibon?

Fibon was another of my stock picks for the second half of 2013 at 32.5 sen, just 5 months ago. My detail analysis can be read from the link below:

http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/34374.jsp

Its share price is 54 sen now. Hence the return in this 5 months plus dividend is 67%. So what is wrong for a stock pick with a return of 67% in 5 months?

This stock was alerted by a forumer here who practised value investing. I selected it as a stock in my diversified portfolio with the rationales as detailed below.

Fibon has steady revenue and have been making money every year, not a single year of losses since listing a few years ago. It has excellent profit margins; a gross margin of 59% and net profit margin of 29%. It’s has high ROE of 17.1% is achieved with this high net profit margin, with very low leverage. It is a safe company to invest as it has a squeaky clean balance sheet with net cash of 26 sen per share, which amounts to 65% of its net assets, and with zero debt. It has excellent and consistent quality earnings with good cash flow from operations. Its free cash flow is 18% of revenue and 26% of invested capital. It is not easy at all to find a company in Bursa with these type of cash flows.

The best thing is at 32.5 sen then, PE ratio is just 6.6 and enterprise value is just 2 times of its Ebit, or an earnings yield of more than 50%. Where to find this type of company to invest in Bursa.
It share price has since risen to the close of 54 sen yesterday.

So does value investing work? What is wrong with Fibon? Why are you picking on my choice of Fibon?

“If you do a good job valuing a stock, I guarantee that the market will agree with you. It is just a matter of time. But don’t expect immediate success. Oh yes, you have to be right.” Howard Marks

Actually I have no idea why the success is so immediate in less than a few months for Fibon. Well it could be a fluke, but is it a fluke? Frankly, I don’t know too.

So what is wrong with the pick on Kumpulan Fima which lost 2.4% since a year ago? Well there were two or three people in i3 who constantly picked on me for choosing this stock. However they were not able to articulate on why my Kfima pick was such a bad move, except talking nonsense, all of them.

Looking back on the selection process again, I do not see what is wrong. It was selected based on its diversified durable business in security paper printing, palm oil, bulking, food etc. It had high ROIC of 25%, a healthy balance sheet with 255m net cash, or about RM1 per share, excellent quality of earnings with consistent and abundant cash flows from operations and free cash flow. Free cash flow is more than 20% of revenue and invested capital. And most of all, at RM2.06 at that time, the earnings yield (EV/Ebit) was 27%, a great number.

Sure its earnings has dropped by about 10% the last financial year, though its revenue still went up a little. Again which company with plantation as a major earnings didn’t have their earnings reduced last year when palm oil price is depressed? Many even made losses.

Based on Kfima’s last annual financial results, ROIC has dropped to 19%, but this is still a high return of capital. And at RM1.93 now, its earning yields (EV/Ebit) of 26% is still hell of a good bargain. This is a classic case of the Magic Formula Investing Strategy of Joel Greenblatt.

Buying something for less than its value is the most dependable way to make money. Buying discount from IV and having asset price move towards its value doesn’t require serendipity; it just requires that market participants wake up to reality.

Trying to buy below value isn’t infallible, but it’s the best chance we have.

The fact that despite its great fundamentals haven’t changed but its price has gone down a little while the overall market has gone up by 14%, it is even more compelling to keep Kumpulan Fima as a major stock in my portfolio in 2014.

My new portfolio of 11 stocks selected in August 2013 has made an average total return of 44.1% as compared to 5.3% of KLCI in the last five months.

There were two losers, i.e. Kumpulan Fima and Haio which lost an average of 1.5%. Have I done anything wrong when making the selection five months ago? Yes, I think I have made a wrong choice for Haio.
On 4th August 2013 I wrote an article comparing the merits of investing in a few food companies before I made the selection as shown in the link below:

http://klse.i3investor.com/blogs/kianweiaritcles/34314.jsp

I was contemplating whether I should invest in Haio or Zhulian and I have chosen Haio, and that was an error of judgement.

Zhulian has a faster growth in revenue and earnings than Haio. Its ROE and ROIC at 26% and 39% respectively are way above those of Haio at 18% and 29% respectively. I also knew at that time Zhulian’s foray into Indonesia and other Asean countries was very successful at that time.

However I choose Haio over Zhulian because Haio is slightly cheaper at EV/Ebit of 6.9 compared to Zhulain’s 8.5. And also Zhulian’s share price has reached its peak at that time; whereas Haio’s share price was way below its peak of more than 5.00 2-3 years ago. That was an error of judgement.

Since then Zhulian share price has climbed by another 57% from 3.17 to 4.99 now; whereas Haio’s share price has dropped by 5% from 2.70 to 2.57 now, dividends both not included.

The lesson is, it may be better to buy a better company with reasonable higher price than a not-so-good one at cheaper price. And the market has no memory of past stock price. Stock price can go higher if fundamentals improve, and vice versa.

Two companies exactly doing the same business; one has a higher ROE should normally given a higher market valuation; ie EV/Ebit should be higher. This is because it is more efficient utilizing its assets.

Similarly if the same company has improved its ROE next year, then it should be selling at a higher EV/Ebit next year than this year. But there may be other factors, like market sentiment. Even if ROE is lower next year, it may sell at higher EV/Ebit if the market sentiment is so much better than this year, and vice versa. That is the beauty of investing. There are so many uncertainties. The future is unknown.

Be caution about ROE. The E can be deceptive. It can include one-time off non-recurring items and it often does. It can also be amplify by leverage, having more debts, and hence more risky. Hence I advocate the metric of ROIC, a little bit more work to compute.

gark, yeah, Cenbond has a lot of net cash in its balance sheet. Two companies of similar business can have the same EPS, but one with plenty of excess cash, and one without, or even with high debt. Should they be accorded with the same PE ratio? Of course not. First of all the latter one is so much more riskier as an investment. Secondly, the excess cash of the earlier one can be distributed to its shareholders and they will still earn the same EPS. That is why judging the cheapness of companies with PE ratio is not a good assessment.

Hence you notice I emphasize more on enterprise value which both earnings and capitals of the equity and debt providers are considered, rather than just the equity holder in PE ratio assessment. Using the EV/Ebit, or EV/Ebitda will take care of the excess cash discrepancy as this is excluded, and debts included in EV computation.

SKP Resources in this portfolio of mine lost 1.5% for the last one year, as compared with the gain of 14% of the broad market. The alpha is minus 15.5%, not good. Have I done anything wrong investing in this stock at 34 sen a year ago?

Just check my analysis a year ago, SKP Resources meets the Magic Formula of investing with ROIC of 34%, and at 34 sen, EV/Ebit was only 5.8. That is a steal considering its very high operating efficiency. Was it very risky investment at that time. Certainly not.

Investment risk comes with paying too high a price. How can it be high when the PE was 7.5, and earnings yield (EV/Ebit) at 17%? Moreover, SKP Resources had steady and growing revenue and income, at a compounded annual growth rate of 16% for the last 6 years. Its balance sheet is squeaky clean with an excess cash of 10 sen per share, and zero debt, and heaps of cash flows and free cash flows!

The problem is, its earnings has slipped by more than 30% for the last two quarters. Cash flow is also quite poor compared to previous time, but still with positive free cash flow. Yes, there must be some hiccups in its operations. Is it temporary or a long-term problem? I really don’t know. Could anyone foresee the deterioration of its business a year ago? Certainly not me. I read about the positive foray of Dyson into China actually.

Yes, there is a loss in this stock but not much. This was because I have built in a high margin of safety and had considered the risk assessments when buying this stock then,. Was it a wrong decision? I don’t think so.

“The correctness of a decision can’t be judged from the outcome. Nevertheless, that’s how people assess it. A good decision is one that’s optimal at the time it’s made, when the future is by definition unknown. Thus, correct decisions are often unsuccessful, and vice versa.“
Nassim Taleb in “Fool By Randomness”

bluewards,

Everybody read and interpret financial statements differently. For Pintaras, as it is a favorite company of mine, I play with its numbers a lot. Especially for operating income, I tend to omit some items which are one-off, or non operating in nature. This normally I get them from the cash flow statements.

It is arguable if investment income is operating income or not, as investment is a big part of their income because they have a lot of cash, and investment in equity market. I view it as non-operating, and so I deduct that away from operating income. Even for net income, sometimes I just deduct off some amount which is one-off, such as gain in revaluation of property. So even my net income may differ a bit from what others see.

As I have said many times before, investing is an art, and the process and methods of doing it is also an art. There is no right or wrong, unlike science.

What is the intrinsic value of Cenbond?

Posted by yfchong > Dec 31, 2013 09:41 PM | Report Abuse
Dear bro KC, I would like to Know wat is the intrinsic value of cenbond thks.


Say if a big packaging company, like Oji Paper wants to buy over Cenbond, how would they negotiate on how much to pay?

What they can do is to refer to a past transaction of similar nature, for example how much HPI was sold at what metric. Or another way is they refer to the average EV/Ebit of the seven companies on the list, and then pay the price of the average EV/Ebit. Or they may refer to four of them, or whatever, all depending on negotiations.

The average EV/Ebit of these companies is 8.09, and Cenbond’s Ebit for the last financial year is RM24,951,000. So the fair price would be an enterprise value of 8.09*24,951,000=RM210 million. This is translated to a market capitalization of RM280m, or RM2.34 per share. Whatever excess cash the buyer pocket, and whatever debts they pay.

They can also use EV/Ebitda, or even EV/Sales, especially when there is no profit yet, or whatever. Of course they can also use Price-to-book value and other metrics also.

But I think Ev/Ebit, or EV/Ebitda is very commonly used in private market transactions.

Company Cenbond Tomypak Daibochi BoxPak PPHB Muda Orna Average
Price 1.54 1.41 4.12 2.25 0.650 0.920 0.790 xxxx
EV/Ebit 4.56 6.73 13.59 6.30 3.43 13.21 8.83 8.09
EV/Ebitda 3.80 5.58 10.32 5.57 2.71 6.77 5.13 5.70

Posted by Ooi Teik Bee > Jan 1, 2014 01:53 AM | Report Abuse
Dear Kcchongnz,
What is the standard for EV/Ebit ?
Please advise.
Thank you.

This depends on the individual expectation as well as the particular industry. But when we compare valuations of companies of the same industry what what we do now for the packaging industry, then obviously we would prefer a lower EV/Ebit one. But in absolute term, I think the following discussions before are interesting:


Posted by kcchongnz > Dec 11, 2013 02:02 PM | Report Abuse X

Posted by houseofordos > Dec 11, 2013 01:03 PM | Report Abuse
I was just wondering what would the basic EV/EBIT be for the calculations if we were to use EV/EBIT rather than PE for valuation method in this thread.

This sounds like an interesting statement to me. First of all, all these thing is arbitrary. For example why use the base PE of 8? Why not 10, 5, 15? But if you flip the PE ratio over, the earnings yield (E/P) is about 12%. That may be is the yield the original author of this absolute PE valuation method wants. What about EV/Ebit, what should be the base then?
All I can say is if you replace P/E with EV/Ebit, you should demand a EV/Ebit of lower than 8 above. This is because:
1) The cost of debt is lower than the cost of equity, and hence valuation using EV must be lower when compared with market capitalization.
2) The denominator Ebit has not taken tax into consideration. Hence EV/Ebit must be lower than PE.
But how much lower we must demand EV/Ebit than PE ratio? Again it is arbitrary. What about an earnings yield of 20%, or EV/Ebit of 5? Or should earnings yield be 15%, or EV/Ebit of 6.7?
It also depends on what kind of industry it is.

Posted by houseofordos > Dec 11, 2013 02:20 PM | Report Abuse
Tax rate of about 25%, cost of equity (the returns required to own the stock) of about 10%
So lets say the base EV/EBIT = Basic P/E (8) x 0.75 x 0.9 = 5.4x which is close to what you calculated
Your last statement "It also depends on what kind of industry it is." is more like relative P/E approach. In this case I would just compare the EV/EBIT for companies in the same business and put a target EV/EBIT based on the average EV/EBIT of all the companies whereas the absolute EV/EBIT method would assess the business and financial risks to come up with the target EV/EBIT. I suppose the more practical way should be the former as any take over would be justified based on relative valuations rather than absolute.


Posted by houseofordos > Dec 11, 2013 02:25 PM | Report Abuse
Mistake... actually
Basic EV/EBIT = Basic P/E (8) x (1-0.25) x (1-0.04) = 5.7x (around 6x)
Where 25% is the tax rate
and 4% is the difference between cost of equity and cost of debt (could be subjective.. assuming 6% cost of debt)

miketyu, this was my previous comments on FLB.

Posted by kcchongnz > Oct 31, 2013 06:49 PM | Report Abuse X

Is Focus Lumber a good company? Is it worth investing?

I have not studied those stocks before you mentioned here. But since you ask, I will try to look into one of them. I will give my opinion if this is a good company worthy of investing.

Focus Lumber Berhad is engaged in the manufacturing and sale of plywood, veneer and laminated veneer lumber (LVL), and investment holding. The Company mainly produce thin panel plywood, of which the thickness is below six millimeter (mm) and are capable of further processing by laminate factories. It also produce thick panel plywood ranging from 6 mm to 18 mm.

The business is cyclic in nature and it appears to be good this couple of years although there is sign that it is slowing down.

It's business has a high net profit margin of about 10% and provides a return of 14% (>12%) of invested capital. The quality of its earnings is good. Free cash flow is abundant at more than 10% of revenue (>>5%). It has plenty of cash, amounting to 57 sen per share with zero debt and hence a very safe company to invest in. The only shortcoming is its business is quite stagnant with not much growth.

At 81.5, its PE ratio is 7.3 (<10), EV/Ebit=3.0 (<8) and price-to-book of 0.7 (<1). So it is not expensive and hence may offer investors a good investment.

Posted by yfchong > Dec 31, 2013 09:41 PM | Report Abuse
Dear bro KC, I would like to Know wat is the intrinsic value of cenbond thks.

Posted by jennylee1382 > Dec 31, 2013 11:16 PM | Report Abuse
Kcchongnz can buy at what px

I am using the same valuation method as the gentleman below with some slight different assumptions. However, our valuation do not differ by more than 10%. that is pretty close.


Posted by houseofordos > Dec 23, 2013 12:12 AM | Report Abuse
4. Valuation
a. DCF valuation
As CENBOND's earnings are consistent and it generates free cashflow, a discounted cash flow valuation was used. Since CENBOND's latest cashflow was exceptionally high, I decided to use the 6 years average FCF as a starting point in the analysis to avoid over-optimistic valuation results. With the assumption of a 5% growth for the next 10 years and 3% perpetuity growth, the FCF/share came up to RM2.14 which represents a 25% margin of safety.

Current stock price $1.58
Share outstanding (Mil) 120000
This year FCF $13,871
Next year's FCF (mil) $14,564
Growth for the next 5 and 10 years 5.0%
Teminal growth rate, g 3.00%
Discount rate, R 10.0%

PV of FCFF of core operations $203,000
Non-operating cash $76,865
Investment properties $0
Interest in associates $0
Debts ($4,599)
PV of FCFE $275,266
Less minority interest ($18,813) 6.8%
FCFE $256,453
Number of shares 120000
FCF per share $2.14 34% higher than = $1.58
MOS 25%

Using a reverse DCF calculation shows that at the current price, the market is expecting almost no growth in CENBOND's free cashflow at all for the rest of its life which is highly unlikely.

Tan KW, you have not included the dividends received in that period. It is ok. I have done that in my review of the return of this portfolio in the other thread.

Happy new year

It is end of the year and exactly five months have passed since I first started this portfolio on 1/8/2013. It is time to review the performance of this portfolios now before moving to the 2014 new portfolio. As a note, this portfolio only has two stocks in common with the earlier one set up by me in January 2013.

In this five months, KLCI has risen from 1773 to 1867, or 5.3%. But how has my portfolio performed?

My portfolio of 11 stocks has made a total return of 44.1% in the last five months as shown in the link below.

http://klse.i3investor.com/servlets/pfs/21089.jsp

The total return has taken into account all dividends paid in this period plus the corporate exercise of one for one bonus for Pintaras and 1 for 5 share split for Datasonic. That means the portfolio has an excess return, or an alpha of 38.8% using the KLCI as a benchmark.

Nine out of eleven stocks made positive returns with all of them in double digit percentage. The two losers, i.e. Kumpulan Fima and Haio only lost an average of 1.5% as shown in the appended Table 1.

The outlier is the rule breaker Datasonic with a return of 229%, something which I have never expected to be truthful. Even if we ignore this outlier, the total return is still well above 25% in this five months period.

KC Chong (12.10 am on new year day 2014 in Auckland)

xxxx Ref date Now xxxx xxxx xxxx
New 1/08/2013 31/12/2013 Dividend xxxx xxxx
Pintaras 2.495 2.860 0.075 0.440 17.6%
Kfima 2.060 1.930 0.080 -0.050 -2.4%
MFCB 1.700 2.180 0.030 0.510 30.0%
Haio 2.670 2.570 0.080 -0.020 -0.7%
Fibon 0.330 0.560 0.013 0.243 73.5%
CBIP 2.830 3.210 0.000 0.380 13.4%
Tien Wah 2.510 2.680 0.080 0.250 10.0%
Homeritz 0.430 0.675 0.010 0.255 59.3%
Willow 0.530 0.680 0.000 0.150 28.3%
Daiman 2.530 3.090 0.120 0.680 26.9%
Datasonic 0.670 2.190 0.015 1.535 229.1%

Average xxxx xxxx xxxx xxxx 44.1%
Median xxxx xxxx xxxx xxxx 26.9%
KLSE 1773 1867 xxxx 94.0 5.3%
Alpha xxxx xxxx xxxx xxxx 38.8%

When one invests his hard earned money, it pays to be skeptical, agree? Here are my skepticism about the bullish write-up oft Hibiscus here:

1st) The SC had tighthen the rules of the new SPACs listings.

LET’S SEE WHAT THE “TIGHTENING” IS.

2nd) The Hibiscus which is formerly a SPAC had failed to get oil for the 1st drill in OMAN. This is the Black Swan that I meant.

DO YOU UNDERSTAND WHAT A “BLACK SWAN” IS? I DOUBT SO.

This is because the tighthening of the rules can make sure the investors are well protected.

REALLY?

1st The management team is not allowed to touch the money from the trust for their salary. Isn't this obvious enough to protect the investors? This will ensure the management really work on the deal and not slacking in order to get QA ASAP!

WHAT ABOUT THIS. WHOSE INTEREST DO YOU THINK THE MANAGEMNT IS CONCERN OF, YOURS OR THEIRS? YES, MANAGEMENT WILL DEFINITELY TRIES TO GET A QA ASAP, NO DOUBT ABOUT IT. BUT IS THATYOU’RE YOUR INTEREST, OR THEIRS? ANSWER THESE QUESTIONS YOURSELVES:

1) WHO STARTS TO GET PAID?
2) WHO GETS FEES AFTER GETTING THE QA?
3) WOULD YOU GET A GOOD ASSET WHEN MANAGEMENT WANTS TO GET A QA ASAP TO GET PAID, TO GET FEES, TO BE ABLE TO SELL THEIR LOW-COSTS SHARES AT HIGH COST JUST BECAUSE GETTING A QA?
4) WHY OTHERS WANT TO SELL THE MANAGEMENT A GOOD QA AT A GOOD PRICE? AREN’T THEY MANY OTHER BIG AND ESTABLISHED INTERNATIONAL COMPANIES WHICH WOULD PAY HIGHER PRICE?
5) WHY WOULDN’T THEY REAP THE EXTRA-ORDINARY PROFIT THEMSELVES, IF THERE IS ANY, INSTEAD OF SELLING TO YOU OR SHARING IT WITH YOU?
6) ETC ETC ETC.

2nd The discount of the initial investors should not be lower than 40% of the IPO price. This is also good for those late investors like you and me! At least we are making sure that they don't get crazy profit for doing nothing! Anyway, it will be even better if they could even lower down the discount.

40% DISCOUNT LOW? WOUNDN’T YOU SELL YOUR SHAREHODLER AT 40% PROFIT ASAP WHEN LISTED, RATHER THAN WAIT FOR THE HOPE TO GET A FANTASTIC QA FROM SOME DAMN KIND PEOPLE AND THEN MAKE HUGE PROFIT, OR HOPE FOR THE HIGH PROFIT?

Or are you talking about ROE, the return of equity?

Why minimum ROE of 10%?

The E in ROE is the equity of the shareholders, the net asset left for equity holder after all liabilities are settled. You can view it as the money left over for you after all dues are paid. So if this money doesn't earn you 10% return, would you still want to leave it there for the management to manage for you?

For me, if they cannot get 10% return, I prefer you to give back to me and I can find other investment providing me much more than 10%.

And if so many other companies can return 15%, 20% from the equity, why should I invest that money in your company?

All those earnings-based companies I have invested and posted in i3 have ROE>10%. Many have ROE >15%. Some even 20% like Pintaras. But because many of them are cash rich and debt free, more useful return metric is return of invested capital. Many have ROIC of >30%.

OTB, What is your ROR? Is it the rate of return of your investment in a stock?

If you are interested in the academic aspect of required rate of return in investment, have fun reading the appended link:

http://www.investopedia.com/articles/fundamental-analysis/11/calculating-required-rate-of-return.asp

For me for simplicity, I require a minimum of 10% for a low risk company with steady profit and cash flow, good operating numbers and a healthy balance sheet. Otherwise I may require a ROR of 15%-20%, depending on the risks I evaluate and judgement made for that particular company.

I used this ROR to discount the future cash flow to present to obtain the present value, or intrinsic value of the stock, and most of them still come with a margin of safety of more than 30%. This means if my judgement of the future cash flows are good, my return of investment would be way above the discount rate I used.

The return of my portfolio of 10 stocks I selected a year ago return 52%. The highest is 146% (Prestariang), and the lowest is minus 3% (SKPRes). It is the same for the portfolio of yours a year ago.

So it is not difficult. But of course the past one year is generally a bull market and we can get such a good return. However over a long term, to invest in the equity market, I still want a minimum of 10%.

This relates to the risks you take as equity market return is very volatile. A risky asset demands a risk premium over a bench mark such as fixed deposit.

I am in the process of writing an article of how to determine the rsik premium. It is a very subjective matter.

OTB
I have just looked at LBAluminium's audited accounts for 2013.

Cash flow from operations (CFFO)for 2013 is 33831 thousand for 2013, as per your CFO. I don't know what is your CFFO stands for. CFFO and FCF is generally not consistent each year, so you have to look at a number of years and make a judgement if they are good.

For looking at the bankruptcy and solvency risks of company, I don't look at the ratio of cash/Debts. I look at D/E ratio (<1, or 0.5 depending), current ratio (>1.5), times interest earned, or times cash flow cover (>5). LBALum is generally alright in these aspects.

CFFO should be more than Net income, especially for high asset based business like LBAlum as there is high depreciation cost. LBAlum is ok also in this aspect as CFFO=200% of net income. Free cash flow I prefer average over a number of years to be above 5% of revenue. FCF=CFFO-capex. the FCF I obtained for these two years are 24.6m and 1m respectively. I don't know how you get yours and they are different from mine.

ROE last year of 7.1%, twice better than previous year is still not good for me. Why? As a equity holder, I won't invest if the return is less than 10%. Hence you can say my minimum ROE is 10%. Worse still, ROIC for LBAlum is only 6.3%, though it is also twice better than the previous year of 3.3%. This is way below the weighted average costs of capital, roughly about 8%-10%.

The only thing which may entice me to invest in it is if it is very cheap, since its operating numbers are not good. However, at a PE of 8.5, and especially a EV/Ebit of 10, it is not cheap at all for this type of performance.

Oh yeah I think I told you before, in valuation you have to have a good and reasonable estimate of future growth and required return. And these have to be consistent in all your valuation methods. You should not fudge the numbers just to get the similar end results you want.

My opinion of you using a growth rate of 15% for the Graham growth formula is ultra liberal. The method is also more suitable to check if other liberal valuation method is too liberal, rather than to get the intrinsic value. Using the ROE method is suitable for financial institutions which the assets are generally marked-to-market is the appropriate one, but not for others, especially for LBAlum which the assets quality is low of which most of the assets is in PPE. Similarly for the Graham number.

"I have nothing else to add" is the normal reply when Warren buffet asks Charles Munger if he has anything else to say after replying to shareholder query, implying Warren Buffet has looked into all angles.

You sometimes talked nonsense, but in here you talked sense.

Posted by JCool > Dec 28, 2013 07:11 PM | Report Abuse
Kcchongnz....
d risk taken by u when u invest in a co... is d sum total of all d risks taken by d company tat co itself..... such as... credit risk... interest rate risk... marketing risk... cashflow risk... liquidity risk... political risk... reliance on keymen risk...etc etc... whc r quite readily shown in d financial statements of cos nowadays....

Excellent comments. "I have nothing else to add"

Posted by Ooi Teik Bee > Dec 27, 2013 11:20 PM | Report Abuse
Dear Kcchongnz,
I need a favour from you, I like to learn about Operating cash flow (OCF).

Who else if not sense maker who is an accountant by profession and working in the industry who is qualified to explain that? Thanks sense maker and hope more input from you on my postings.

The easiest way to know what is the cash flow of operating activities is just look at the CFO statement. Years ago (before Enron?), companies were not required to provide the cash flow statements. One who is interested had to work out this CF statement like what sense maker has done, ie starting from the operating cash flow. Some may start from net profit like what I would do, some from profit before tax. But eventually the CFFO would be the same if you follow the principles of what constitute cash flow of the operating business.

CFO is the actual hard cash you receive from the ordinary business. Net profit is just an accounting number, based on accrual accounting. Ulicorp made a net profit of 17m doesn't mean they receive 17m cash in the year. They only receive a net cash of 6.5m. Why? sense maker had explained that clearly.

Company may report 20m profit by including some non-operating income, such as a gain from selling some plant and equipment, a hedging gain, a revaluation of properties etc. But these stuff are non-operating. They are one-time off items, non-recurring or not dependable on recurring.

Beware of construction companies which appear to make profit but bleeding cash. They can book in doubtful claims and variation orders into the receivables which are not even approved by the consultants nor agreed by the clients that these claims are valid yet. It is likely that the claims can become liabilities as the consultant decides that instead of it as a claim of loss of profit or additional works cause by the fault of the clients or consultants, is actually the faults of the contractor who have delayed the work and cause damages to the clients.

forex, good that you are interested in these thingies as ROE and ROIC and would like to know about them. However, these stuff is all over the net and in i3, also put up by the same gentleman, Tan KW.

It will be a much better learning experience for you if you could goggle them. There are many good articles bout them, heaps. Only if you can't understand then may be then you ask. There are many others who may help you too in i3.

Risk-adjusted return

My portfolio of 10 stocks posted in i3 in January 2013 returned 52% for the year. Is that good? I will talk about it when KLSE closes for the year 2013.

In actual fact, 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. How do we evaluate it then?

First we have to compare the return of a benchmark, and let say we just take KLSE as one. KLSE’s total return including dividend is about 16% for 2013 with a standard deviation, sigma, of 10% say. One may jump into conclusion that a stock in the portfolio, Kimlun with a total return of 26% is better. But let say the sigma of Kimlun is 20%, does Kimlun make a better risk-adjusted return?

A simplistic way to look at it is Kimlun returns 1.3 (26%/20%) per unit risk compared to 1.6 of the KLSE. Hence Kimlun does not do better than the market in a risk-adjusted basis.

The other way to look at idiosyncratic risk is the use of a more acceptable ratio, the Sharpe ratio;

Sharpe Ratio, SR=(Rs-Rf)/Sigma.

Where Rs is the return of stock, Rf the risk free rate, say 3.5%.
In this case, Kimlun’s risk-adjusted return of 1.13 is still inferior to the 1.25 of the market.

In evaluating the performance of a diversified portfolio of stocks, I like the following way:

Risk-adjusted return y = alpha + Beta * x,

where alpha is the excess return, Beta is a risk measure, 1.0 for the broad market, and x is the return of the market. In theory, Beta of s stock is the slope of the regression of the return of the portfolio against the return of the market, and Beta of the portfolio is the weighted average of Betas of individual stocks.

If you have a portfolio of concentrated (of the same industry) and volatile stocks, Beta can be very high, say at 2.5. So if the return of your portfolio is 35%, and the return of the market is 16%, your excess return, alpha, is minus 5% (35%-2.5*16%). You do no better than the market.

However, if you have a diversified portfolio of stocks with low correlations, and stable and less volatile companies, say with a Beta of 0.8, meaning less volatile than the market, and a return of 13%, your alpha is positive at 0.2% (13%-0.8*16%). You outperform the market even though the return is not as good as the market.

You may carry out regression to get the Beta value of a portfolio. But I still don’t buy the notion that a portfolio which moves more than the market is a risky portfolio. However in practice, it is more of a judgement. Judgement of Beta is a skill of an experienced investor, not anybody.

KC Chong (28/12/13)

No, I am not encouraging anyone, including myself to take risk to invest in the stock market when it is very high. I will just sell of my stocks and do nothing. I am "kia si" like hell too in investing like you. I also do not have the skill to control the risks in such a lofty market, not at all. Even if the market go higher later and I miss the opportunity to make more money, "it is ok for me when others make a lot of money, and I don't".

There are many times the market became risky like that. some of the time i can think of off hand are the Nifty Fifty in the early 1970 when the good dividend stocks (mind you good stocks) were selling at PE of high tens, or even hundred; the internet bubble in late 1990s when technology stocks were chased up when they earn nothing yet; the second board euphoria in the mid 1990s at home,etc. If you have invested at these times for long term, you most likely have lost money. Yes buying stocks at high price is risky, very risky.

But is KLSE that high now? I remember 20 years ago in 1993, KLSE was at about 1300, and it is now 1861. that translate to a compounded annual rate of growth of less than 2%. Add on another 3% dividend yield, the CAGR is only about 5%.

What is the broad market PE now? 15%? And what is the interest rate now? 3.5%. So the risk premium is about 3.5%. Yeah a bit low, but that is the broad market. Aren't there value stocks around?

Is buying a stock at a margin of safety of 30% risky? Yeah, it has become increasingly difficult to find such gems now. But still holding stocks with 20% of margin of safety risky? Not so to me.

What is risk?

“ I am a risk taker, no risk no gain.” This is what most people say most of the time when punting stocks. Risk taking seems to be a heroic thingy, something macho. But my question is do you understand what is risk when you punt a stock? Because if you don’t, and if all the time you are only talking about how high return you would get, you may make spectacular return once in a while, but most of the time, I am very sure, the outcome would not be favourable to you.

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.

What exactly is risk in investing? In academic, one of the measures they talk about is a Greek word called sigma, the volatility or annual standard deviation of the return of a stock. The more volatile, or more and big up and down swing of the stock prices, the higher the volatility, and the higher is the risk. As most investors are risk averse, or they shun risk, high sigma is not good, or isn’t it?
But is sigma a good measure of risk? Datasonic share price rose from about 1.30 a year ago to above RM10.00 now. Its volatility as measured by sigma must be hell of high, more than 100%, 200%? By the way, the sigma of the broad market is around 25% a year. So is Datasonic a risky investment a year ago as sigma is so high, and hence risky? I cannot figure out that way, and so I don’t think Datasonic is risky in that sense, do you?

Another measure of risk in academic is beta for a diversified portfolio of stock. Beta is also very interesting mathematically. It is the slope of the straight line when you regress the return of the stock against the return of the broad market. The higher the beta, the higher the risk of that stock in the portfolio, so it says. Surely when you regress the return of Datasonic against the return of the market, you would get a very steep upward line. So does this imply Datasonic is risky? To me it is not with the same logic as above.

No, in my book, risk is none of these stuff. To me riskier investments are those for which the outcome is less certain. The probability distribution is wider. They come with:
1. Higher expected return
2. The possibility of lower return, and
3. In some cases the possibility of losses

In practice, risk is the danger of loss of capital, or an unacceptable low return

Is Datasonic a risky stock with its present price now using the context of risk as just defined?

Yes, it is in my opinion. Its share price has risen too high and a lot of future rosy expectations have been incorporated inside. The high growth expectation is extrapolated in a straight line into the future. To me, there is probability of lower return, or possible loss, not because of the poor quality of its business, but the high price you are paying. Yes, paying a high price for a stock is the most risky thing in investing.

What is your context of risk in investment?