In search of excellent: Are good companies good investments?
Many seasoned investors would have told you to invest in good companies and you will never go wrong. The core of the story is history backs you up; Public Bank, Nestle, GAB, Maybank, BAT etc. Well managed companies are also less risky. But is it really true that good companies are good investments?
First of all how do we define good companies? This is important because many novice investors are confused what are the attributes of a good company; many of them falsely think that a good company is one its stock is going to be manipulated sky high by insiders and that everyone will profit from it.
My criteria of a good company is a well-run company with good corporate governance; no unfair related party transactions, independent board of directors. A more measurable metric for good company is its financial performance; a durable business, constant growth in its business, a return on invested capital higher than the cost of capital, good cash flows and healthy balance sheet. More specifically the company must have sustainable future economic value added in its business.
However, research has shown that investing in good companies is not a winning strategy. This is because the market has built into it these expectations. The biggest danger is that the firm will lose its luster over time and that the premium paid will dissipate. It is only when markets underestimate the value of firm quality that this strategy stands a chance of making excess returns. There is a strong tendency on the part of companies to move toward the average over time, or mean reversion. So what investors can do to profit from investing in good companies by:
1. Buy good companies that are not being recognized by the market as such.
2. Buy good companies when others throw because of overreaction to disappointing news even though the news may not have significant long-term value consequences.
3. Buy when the entire sectors or even markets may be marked down in response to bad news about a few companies in the sector or market.
Screens for buying good companies can be as followed:
1. Return on invested capital (ROIC) > Weighted average cost of capital (WACC)
2. Price/Book < 2.0
3. Price Earnings ratio < 25
This is to avoid under-performance due to the usual high price of the stocks of good companies.
Do you have your attributes of a good company? What are your screens for investing in a good company? What are the stocks from your screens?
Ben, I have a strong opinion that Perak Corp is not a good company. for one I doubt it has good corporate governance being a state-owned company. Its business is not durable because after selling the land, what else? What kind of growth would you expect? Its ROIC is pathetic at only 6%, way below the cost of capital.
However I think it could be a great investment at this price.
Good company? Good governance No Durable business No Growth Neutral ROIC No 6% <WACC Balance sheet Yes
Screens for investing ROIC No P/B Yes 0.4 <2.0 PE ratio Yes 5.2 <20
Is Yee Lee a great company? Is it a good investment?
Yee Lee has a durable business. It is trading at very attractive valuation too as shown below. My main problem is its very low margin and ROIC. So for me I will pass.
Good company? Good governance Yes Durable business Yes Growth No ROIC No 7% >WACC Balance sheet Yes
Screens for investing ROIC No P/B Yes 0.7 <2.0 PE ratio Yes 8.8 <20
When I looked at THPlant's latest financial report ended December 2012, it gave me headache and straightaway I have the impression that this is not a good company. Why?
1) I can't understand its balance sheet, what is the share capital and the number of share outstanding in 2012? 2) 101m of "surplus over fair value of net asset acquired" last year was booked as "other income" which forms part of EBIT! WTF!
To me there are financial shenanigans involved. Get away fast is the best strategy.
However even if I ignored the above and give an assessment as below, it is still not a good investment.
Good company? Good governance No Durable business Neutral Growth ? ROIC No 3% <WACC Balance sheet Neutral
Screens for investing ROIC No P/B Yes 1.4 <2.0 PE ratio No 29.2 >20
saw a picture of the THPLANT board in starbiz. sloppy looking bunch - not buying the stock. funny how we got to same conclusion.
you're right. Yee Lee has super low margins. i'm not sure how vertically integrated, how much upstream it is involved in. its other brands (toothpaste etc) have no recognition. this company has been stagnent for some time, but you know what they say about bull markets....
Posted by Tan KW > May 26, 2013 07:05 PM | Report Abuse @kcchongnz how you get the WACC? need to calculate by yourself?
If a company has 200m equity and 100m debts and the cost of equity you use say 12%, and cost of borrowings at 7%,
WACC=200/300*12%+100/300*7%=10.3%.
I use 12% as my required return for investing in a company with ok but not so good balance sheet and cash flow. If they have healthy balance sheet and excellent cash flow, I may use 10%.
Posted by necro > May 26, 2013 08:08 PM | Report Abuse I will recheck of what your opinion bout THPLANT bro kcchong... Hurmm... Hurmmm..in Plantation company what company that u like?
Necro, these two are the plantation companies I like most. One is a high growth company SOP, the other is value company TDM. But TDM will embark on a high growth path in the near future. Below is my assessments:
SOP Good company? Good governance Yes Durable business Yes Growth Yes 32% CAGR for last 7 years ROIC Yes 18% >WACC Average Balance sheet Yes
Screens for investing ROIC Yes P/B Yes 1.8 <2.0 PE ratio Yes 15.5 <20
TDM Good company? Good governance Yes Durable business Yes Growth Yes 12% CAGR for last 7 years ROIC Yes 15% >WACC Average Balance sheet Yes
Screens for investing ROIC Yes P/B Yes 1.0 <2.0 PE ratio Yes 12.1 <20
arv18, yeah i notice we have some common investment philosophies. This is hard to find in the finance blogger-sphere.
The low margin of Yee Lee is not a concern for me as many excellent distribution companies like Harrison, DKSH etc, supermarket chain (like Walmart) etc have low margins too. That is the nature of the business. Important companies should have high ROE. Low margin companies can achieve this with high asset turnover, meaning have high turnover, or clearer use of leverage. Companies must produce return on capital higher than the cost of capital. If not what is the purpose of using good money to chase for poor return? Yee Lee's ROE and ROIC of 7-8% is hardly encouraging.
Regarding THPlant, I highly doubt the integrity of the board and management by reading through its latest annual financial report as I have mentioned in my previous post. This is a killer in investment.
Is Gadang an excellent company? Is it a good investment?
necro, I have no idea about Gadang before you mentioned to me. You know lah I am just a small time retail investor, not a big timer. Neither am I a fund manager. But Gadang does seem to stir up some interest of its stock movement recently, doesn't it?
I just peeped through Gadang's past performance. It's performance has not been good until the last few quarters when trailing twelve month ROE just managed to skipped through 10%. So without knowing the company management, its future, I am not able to rate it as a good company.
But is it a good investment? Maybe. As again I don't have any insider information about it. It may well be looking at the interest it seems to have created, or is it? But this strategy is about finding a good company, then only decide if want to invest. So I won't invest in it. Below is my assessment.
Gadang a Good company? Good governance ? Durable business Neutral Growth Neutral ROTC Yes 11% >WACC Balance sheet Yes
Screens for investing ROTC Yes P/B Yes 0.7 <2.0 PE ratio Yes 6.8 <20
bro kcchong, how about taking a look at Gkent ? Profitable every year,pays a dividend ,healthy balance sheet. Do you think its a good company to invest in?
Is FAVCO a great company? Is it a good investment?
FAVCO, a crane fabricator has a good business spread all over the world. Its earnings has been growing at a fantastic CAGR of 36% over the last 6 years. ROIC is high at 17%. Yes, it is definitely a great company. But is it a good investment at the present price of RM2.64 after going up 30 sen today? I think so. Below is my assessment.
FAVCO Good company?
Good governance ? Durable business Yes Growth Yes 36% Net profit 6 yr CAGR ROIC Yes 17% >WACC Balance sheet Yes 0.23 <1.0 D/E ratio
Screens for investing RM2.64 28/05/2013 ROIC Yes P/B Yes 1.6 <2.0 PE ratio Yes 9.1 <20
hi @kcchongnz, i really like your analysis with figure and i am a fan of value investing as well.. About PE ratio <20, I know this is used as a rough guide on whether a stock is overprice.. but isn't small and mid cap company average PE ratio don't get that high? during bull sure all inflated.. but wat PE do you reckon is realistic for small cap, mid cap, growth company? thanks..
plutus, this thread is about investing in a great company, not a undervalued stock. The strategy is first to find the great company; good governance, social responsible company, high return of investors capitals, durable business with lasting moat, good cash flows etc. Normally a great company's stock is sold at high valuation. Hence before investing in a great company you have found, you need to check if the valuation is reasonable. For a great company, even a PE ratio of 20 may not be high. don't you agree?
If I want to embark on a strategy to buy value stock, I will first go find a company trading at low PE ratio, say 10 (of course this ratio will depend on the sector, size and the prevailing market ratio etc), then I will check if there is other criteria which are too much compromised. For example, my value stock must have a growth of at least 5%, not so much debt say Debt-to-capital ratio <60%, that the quality of earnings is good (meaning good CFFO too) so that I am not cheated with managed earnings, etc.
Yup this 1 I'm totally agree,2 years is too long...else if cold eye buy in at open market & become JCY & Unisem director then possibly we will consider him as M'sia Warrant Buffet :)
Posted by jtpc2006 > May 28, 2013 08:22 PM | Report Abuse Hi KcChong, any possibility you can comment on Mercury? thanks very much.
Wah there are really a lot of stocks in bursa which I don't know. Take for example, Mercury. I got no idea about this company at all previously. How can I comment.
Just looked at it. Mercury is a smallish industrial product supplier. Small revenue of about 50m and profit 6-7 m. No growth last year and in fact profit dropped. And as mentioned I don't know about the company at all; its corporate governance, management credibility etc. So how can I place it as a great company?
Its ROE and ROIC appears to be good though at above 15%. However, that is because of the seemingly low equity it has but with a huge accumulated loss in its balance sheet which tips its amount of equity and hence raises its ROIC. Adjusting for this accumulated loss, ROE and ROIC will be only about 7%, way below the cost of capital. Hence though it is selling cheap, but I won't be interested in it. Below is my assessment.
Mercury a Good company? at 1.33 Good governance ? Durable business Neutral Growth No ROTC Yes 16% >WACC Balance sheet Yes
Screens for investing ROTC 6.8% <WACC P/B Yes 1.0 <2.0 PE ratio Yes 8.5 <20
Posted by faberlicious > May 28, 2013 11:13 AM | Report Abuse bro kcchong, how about taking a look at Gkent ? Profitable every year,pays a dividend ,healthy balance sheet. Do you think its a good company to invest in?
The topic discussed in the investment strategy in this thread is about a good company. So is George Kent a good company?
George Kent involves in the water industry in Malaysia for a long time principally in manufacturing and marketing of water meters, fittings, fiberglass panel tanks and a variety of hot-stamped brass products and components. It certainly has its niche in the market. If i remember correctly, it even got a package of LRT construction recently based on its political connections though they have no experience at all in that field. Umm it relies on political connection to get big jobs like that and of course they would sublet out the work to some Chinaman companies to execute the work. Not really my kind of contractor. I prefer contractor who has its own expertise to secure jobs, good margin jobs and execute the work and have control over everything. The company which straight come into my mind is of course Pintaras Jaya.
Nevertheless, below is my assessment of GK. Not too sure if it is a good company although it meets the ROIC and cash flows requirement, but certainly it is not expensive to buy this stock. However the strategy here is to invest in good company and check to ensure the price is too high to invest. Hence for me, I will let this go.
George Kent a Good company? Good governance No Durable business Neutral Growth Neutral ROTC Yes 13% >WACC Balance sheet Yes Cash flow Yes
Screens for investing ROTC Yes 13% >WACC P/B Yes 1.0 <2.0 PE ratio Yes 8.6 <20
bro kcchongnz,thanks for your comments. Actually I bought some at 86 sens bcoz it is iexpensive and there's a final 4.5 sen to look out for. Not a great company but ok for short term holding.
bro Kcchongnz, thank you very much on the Mercury update. Properties now heating up, and lighted on Ivory. What do you think of this counter? thanks for your feedback.
jtpc2006, I thought I have already rested my case about Ivory. Since you asked, I just want to reiterate that Ivory is a lemon. True true true, its share price has risen since the last time I said it is a lemon, but now I still say it is a lemon. So if it is a rotten lemon, I don't bother to look at if it is a cheap buy. A rotten lemon can't be eaten even if you get it free (just exaggerate a bit). Please read my comment below if you are interested.
Posted by kcchongnz > Mar 5, 2013 07:52 AM | Report Abuse X
Ivory has released its annual financial results ending 31/12/2012. Revenue and earnings have increased by big margins from 132m and 24.4m to 212m and 32.5m respectively. From the income statement, the revenue and profit appear to be from its ordinary business of property development and hospitality business, as there is no gain/loss of any “extra-ordinary items”. Very good so far. a huge annual growth, or is it? Earnings per share is 8.8 sen. With the present price of Ivory at 49 sen now, the PE ratio is only at 5.5. Isn’t it damn cheap? A value stock? Hold on until you look carefully into the details of financial statements.
Out of the 32.6 m profit, “other operating income” which forms part of the EBIT is RM51.3m, just what is this “other operating income”? A look at their cash flows statement may provide some clues. Cash flow from their ordinary business is negative at RM38.3m. Where is the hard cash when they declared that they made 32.5m? Digging deeper into the CFFO shows that they have booked in 36.6m in “Bargain purchase gain on acquisition of subsidiaries” as part of the EBIT, which should rightfully be an extra-ordinary gain at the bottom of the income statement. Isn’t there a conflict of the statement of income and the cash flow statement? Is it financial misstatement or financial shenanigan? Neither is credible for Ivory. I was curious about who the external auditor is. OMG, it is KPMG. This cannot be. I must have made a wrong inference.
That means for the last two years, though Ivory announced that they have made more than 10 sen per share each year, none of the year has yield any real cash from operations. In actual fact, more cash has to be found to carry out its business. Last year, a right issues was called to get 102m and borrowed another 214m from bank to carry on its business as well as paying back 220m debt. Some 26m worth of land was also sold to help in its cash flow. Ivory’s latest total debt is RM287m, or 64 sen per share. Total receivables of 177m is 0.83 times revenue, or it will take more than 8 months to collect. How much are these receivables collectible?
Posted by joe2703 > May 27, 2013 06:11 PM | Report Abuse @kcchong, I'm your fan and I learn a lot of things from you, you have given a lot of useful information and advice. Thanks. What do you think about TA Global ? Need your advice.
TA Global, property development and investment all over the world! Wow!! Don't really know much about this company but I doubt it is really that lucrative to invest all over the world where many places you are not familiar with.
Just by looking at its latest financial statement ended 31/1/2013, I don't see it meet my view of a good company. Huge outlay of total capital of 3.6 billion with debts closed to equity. Net income is just a pittance of 92m, for a ROTC of just 4%, a huge destroyer of economic value. This is one type of company I would like to avoid. Below is my assessment.
TA Global a Good company? 0.315 Good governance ? Durable business No Growth No ROTC No 4% <<WACC Balance sheet Neutral Cash flow Yes
Screens for investing ROTC No 4% <<WACC P/B Yes 0.7 <2.0 PE ratio Yes 18.2 <20
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Posted by kcchongnz > 2013-05-25 12:03 | Report Abuse
In search of excellent: Are good companies good investments? Many seasoned investors would have told you to invest in good companies and you will never go wrong. The core of the story is history backs you up; Public Bank, Nestle, GAB, Maybank, BAT etc. Well managed companies are also less risky. But is it really true that good companies are good investments? First of all how do we define good companies? This is important because many novice investors are confused what are the attributes of a good company; many of them falsely think that a good company is one its stock is going to be manipulated sky high by insiders and that everyone will profit from it. My criteria of a good company is a well-run company with good corporate governance; no unfair related party transactions, independent board of directors. A more measurable metric for good company is its financial performance; a durable business, constant growth in its business, a return on invested capital higher than the cost of capital, good cash flows and healthy balance sheet. More specifically the company must have sustainable future economic value added in its business. However, research has shown that investing in good companies is not a winning strategy. This is because the market has built into it these expectations. The biggest danger is that the firm will lose its luster over time and that the premium paid will dissipate. It is only when markets underestimate the value of firm quality that this strategy stands a chance of making excess returns. There is a strong tendency on the part of companies to move toward the average over time, or mean reversion. So what investors can do to profit from investing in good companies by: 1. Buy good companies that are not being recognized by the market as such. 2. Buy good companies when others throw because of overreaction to disappointing news even though the news may not have significant long-term value consequences. 3. Buy when the entire sectors or even markets may be marked down in response to bad news about a few companies in the sector or market. Screens for buying good companies can be as followed: 1. Return on invested capital (ROIC) > Weighted average cost of capital (WACC) 2. Price/Book < 2.0 3. Price Earnings ratio < 25 This is to avoid under-performance due to the usual high price of the stocks of good companies. Do you have your attributes of a good company? What are your screens for investing in a good company? What are the stocks from your screens?