Back to Basics - Stock Investment

The purpose of putting these simple steps is to facilitate my next task – an overview and easy reference for my son to begin his stock investment journey next year. Obviously there are many books, videos, articles, etc on various topics of stock investment from valuations, methodology, behavioural finance to analysis skills, etc. But these simple steps I intend to show him will form a basic overview on the investment process.

1. Searching for investable companies
2. A 1^st and foremost question – only if I can understand the businesses they are in and the business still has potential in the future.
3. Perform quick analysis on key statistic to determine if they are investable
4. If yes, try to perform simple valuation to determine what is the intrinsic value
5. Compare to current price if there is sufficient margin of safety
6. Try to identify if there is potential catalyst to trigger price moving towards intrinsic value
7. Set the amount for this investment
8. Take a quick look at the technical chart. Hold on to buy action if there is unusual price and volume activity observed. Check for possible reasons.
9. Action on the purchase depending on market sentiment – bearish, buy in stages. Bullish – may have to buy at one shot.
10. Read announcement/news on this company or regulations etc that may have effect on the company– sell should be triggered when sell conditions are present

Check list ( No 1 is a must, not tolerable while others are more discretionary as they can be compensated by qualitative factors that may not be quantifiable eg monopoly, special license, patent, etc)

1. Management integrity intact (try to check if there is any integrity issue in the past)
2. Sufficient margin of safety (>25%)
3. Reasonable ROIC (>12%), ROE(>10%) and low PE (<10)
4. Profitable, Not overly geared (<30% gearing level) with healthy free cash flow over the last 1 year
5. Not sun set industry or Industry not in down cycle, preferably in growing industry
6. Preferably with dividend record
   Qualitative factors need to be considered together to determine if the company concerned is indeed an excellent candidate.  

	Check List	Yes/ No
1	Management integrity intact
2	Sufficient MOS
3	Reasonable ROIC, ROE and low PE
4	Profitable, Free Cash Flow & low debt
5	Not sun set industry or in down cycle industry
6	Dividend track record

 

A wolf in sheep's clothing?

I received a message from a cousin this morning and he eagerly shared with me an opportunity to invest in a great company, that will be the Alipay of Malaysia. I had known him well as we grew up together and he has been a very honest person, so I patiently listened to all his voice recording on my whatsapp...wow, the company is going for IPO on AIM, London Stock Exchange (as usual, I am still not excited with all the juicy story). 


I then text him asking for the company website so that I could take a closer look. From the domain name, I can sense something fishy - the website has a totally different name from the company and the webpage looks like a kids' game page. True enough, nothing much can be found on the website - none of these are listed- product/service, management team or corporate news. You need to be a member to login. I worried he got into some funny scam, so I decided to search for more info online.


Yes, there were some video on Youtube on their launch of new corporate name, the CEO spoke about vision and mission and how all members can "see their present from the future". It is getting clearer to me, its MLM related. It claims it is a financial education & learning platform . Then the introduction of crypto-currency and e-payment platform to categorise the company as a fintech company ( I suppose this is the story used for AIM listing) . However, when I get into more details of how members earn their "commission/bonus" or point/etc, it is not so clear. The company has also a share scheme in place with price available to members for buy/sell purpose. What I learnt was that there are lots of restriction and high admin charges when a member wishes to transact/ convert points to cash. I further checked at Bank Negara's website on "blacklisted" companies that may be involved in unauthorised deposit taking/etc, bingo!! the name is there. Is this a wolf in sheep's clothing?  


I have reverted to him on my concern and advise him to get back all the capital first whenever he could. Well, as expected, his response is "an outsider who do not understand the business always wont believe how much money can be made" from this opportunity and show me how many merchants have signed up to accept the crypto currency, how much was credited in his e-account, the IPO. I see he has no intention to bullshit me but I doubt he fully understood how the company can pay them so much when it is such a young company with no real revenue yet.


A scam will only collapse when there is no more fresh "money" flowing in. We knew so many Ponzi schemes/ money game companies every where in the world that can last many years, even in advanced country like US has the largest Ponzi scheme (Madoff case) lasted so many years, with big financial institutions and well educated professionals have fallen victim too. 


I am saddened by the news  that people I know lost their hard earned money to this kind of scam. No doubt greed is the main driver but being ignorant could be the reason for those not so well educated group.


On a separate note, I always remind myself, do not be over confident on my own stock analysis/ pick and take a second level thought when there is contradictory view by others. Try to step back and be a little objective, do I really know something that the market is not aware yet, hence not factored into the price yet? Sometimes we can be blinded by our over-confidence...yes, one needs humility on the investment journey. 

Follow savvy investors - sure win strategy??

I believe some of us like to look out for names of some popular savvy investors on Annual Reports for "hints" if that particular stock is endorsed by successful investors, yes, I do the same too. The fact that they are so successful provide some comfort to us that their stock selection should be better as we believe they have better insights.


There are few investors that I follow did really well basing on the share price performance of those companies they owned. But I did not simply invest in these companies before careful analysis for the following reasons:-


1. They may have entered at a very attractive price, hence, already sitting at handsome unrealised gain when I saw their name on Annual Reports, I will try to do some analysis whether there is anymore margin of safety. Yes, it still warrants careful study before jumping in. 
2.  Is it that they see something that we don't? If I still can't see, I would rather miss than feel sorry later.
3.  They have much much larger capital, hence, that particular stock may just be a tiny fraction of their capital for whatever reasons (diversification or strategic capital allocation for growth stock / dividend stock / aggressive risk taking). I need to study if that stock also fit into my own strategy, otherwise, I may end up with a dividend stock when I need to look for more growth or vice versa. Worst, if that is their high risk bet for high return and they could afford to lose all in this particular stock but I can't afford that.
4. They may have bought it years ago with extremely low entry price, for all you know, they could be in the midst of exiting when we enter.
5. Everyone makes  mistake at times, so are they. Again, when they make mistake, it probably only a ripple to them but for me, it may be a tsunami. Furthermore, they can wait much longer for it to recover but I don't like to get stuck for more than 2 years!!
6. Theirs dividend income is large enough to provide fresh capital for additional investment. I do not have this luxury now, but that's my ultimate goal.


Having said all that, it is still a good source for stock picking as there may still be upside even after their names appear on Annual Reports. Better still if we are in much earlier and ride on the momentum after strong followings from their fans.
The key is - do our homework and think objectively!!

Stock Investment - what is the most important thing?

I have been talking to my son on his course selection lately as he is preparing for his uni next year.
Out of sudden, he said " I want to learn investing and want to achieve financial freedom as soon as possible, can you tell me what is the most important in investing? ".


He really surprised me with his question, though I am happy to hear that but at the same time a little concern as I would very much like him to stay focus on his studies. In addition, that's a tough question! I have read some of the most popular stock investment books and have come to know some of the very successful stock investors and yes, they have some similarity but at the same time vast differences in approach/methodology as well as behaviour/habits, but which is the most important criteria? I have no clear answer for his question, so I have chosen a safer way to answer.


This is a tough question as after 25 years in stock investment, I am still learning and I have also read about successful investors changed their approach from time to time to improve their returns on investment. Hence, I believe the non stop learning attitude is the most important. Though the principle of winning stock investment is very simple - buy low and sell high! Everyone knows it, but to do it well is not  that simple as that will involve lots of hard work from understanding and analysing the financials ( or analysing charts for some), trying to know the business, assess the management integrity, learn to perform simple valuation to compare price vs value, a little behavioural finance, technical analysis, patience, discipline, learn from past mistakes, etc etc. Wow, the list seems long but over time, you will acquire the knowledge and skills and develop good behaviour and habit to win the game.


Yes, continuous learning attitude to me is the most important thing, not only in investment but any thing that we pursue in life.


     

Bottom Fishing when market at peak?

With more than a thousand companies listed on Bursa Malaysia, to look for companies that are deeply undervalued is as hard as searching for a needle in a haystack. Are there more efficient and effective ways to discover or uncover the hidden gems?

Frankly, what I am seeing today is information overflow rather than not having enough information many years ago. One could find lots of stock recommendations or research reports from research house, social media, blogs or subscribed to research reports, whatsapp group, etc, etc. As a result, most of the companies have been "researched" - big companies by research houses and medium to small companies by stocks sifus, bloggers, forums, etc except for some "dead" stocks where not many will notice, either the company is dying or boring. (Please don't get me wrong - no...being contrarian in this scenario may not be the right approach because these companies could continue to remain as such for many many years.)
A recent chat with a friend has alerted me to look closer at his current approach - bottom fishing. The rationale for the change in approach from searching for undervalued stock with growth/high yield to bottom fishing is due to most stocks have gone up quite substantially and the fear of not much upside always linger in our mind. Of course, one must be able to separate wheat from the chaff when bottom fishing as there are reasons why these companies are at their low while market is almost at its peak - resulting in such a big divergence.
Hence, I have set some basic guidelines for bottom fishing when going through companies information and avoid taking unnecessary risks - it must provide some margin of safety at least from asset backing, no excessive gearing and the operating cash flow has to be reasonably healthy.
Some of the other information I look for that may have caused the share price drop :-
1. it becomes unfavourable due to one off event eg write off of assets (eg JTiasa - asset write off from loss making plywood business)
2. is the company in the middle of transformation/major change in business direction/substantial capital spending which has cut its dividend or impact its profit (eg Evergreen - going through what Hevea has gone through 5 years ago??)
3. change of government policy that may impact the business ( is it temporary or has long lasting impact - Tune Protect, Hexza ??)
4. major expansion, acquisition/disposal that have short term -ve impact are not well received by investing community ( APM, SOP, 3A??)
5. merely due to cyclical factors - when the cycle reverse, it will be a totally different scenario eg plantation, glove, cement, shipping?? (Good example will be steel industry- it has seen its up cycle since last year due to combination of factors - government policy change, closed down of country's biggest steel mill and cyclical effect and most of the steel stocks have doubled, tripled or even more - yes, I miss it, I don't have any steel stock at all)
6. the big project is still not completed yet and risks and uncertainty may be high or most investors have no patience to wait till its completion ( WCE??)


I believe there are many more reasons/factors and hence, it is worthwhile to start searching and analyse carefully the potential of these out of favour stocks - whether those factors affected its share price are temporary, whether the company has strategy to counter it, whether it is only a matter of time that the new development will bring results, whether the uncertainty will subside over time, etc. Can some of these stocks that are sitting at the bottom of the sea be discovered or brought up to shore by the next tide, only time will tell. Why? Fishing requires lots of patience, more so as this is bottom fishing!!

WCE - an leveraged asset play??

Once a while, I would take a look at WCE’s financial as well as share price performance. The share price has gone up from around Rm0.90 to Rm1.70 and its back to Rm1.28 lately.

Quick overview of WCE Holdings Bhd’s valuable assets:-

 
To make it simpler, let’s just focus on West Coast Expressway and ignore the 30% contribution from JV with IJM as the margin is very thin and keep the 40% profit from Bandar Rimbayu development as bonus. The expressway is still under construction and some sections will be opened for toll collection only by end 2018 and expected to be fully completed by 2019. I have not seen any comprehensive valuation done by analyst as I believe it is not an easy task considering it is going to be a new expressway competing with PLUS for traffics travelling between Perak and Selangor.

What is so exciting about WCE that it gets so much attention every now and then? I do not think there are many long term investors out there (willing to hold at least 5 years), so what are the short term investors/speculators after? I try to figure out the possible reasons.

1. Profit expectation from toll operation? – not likely as I expect loss or low profit in the initial years of operation– the amortisation/depreciation of Construction/Toll Concession cost (say over 50 years will be Rm120 mil a year) and its finance cost (average interest rate worked out to approximately 6.5% will be Rm300 mil a year), that is Rm420 mil before any operating cost. Let’s take a look at a news update on PLUS financials here if that is an good indication.  
2. Dividend play? – only in the very long term. If there is no profit, no dividend from WCE S/B even though cashflow could be very good. WCE Holdings Bhd may be able to give some from Rimbayu project??
3. It is a prime asset that worth a lot more than the construction cost when completed, hence re-rated with much higher valuation. Yes, I would imagine this is the likely reason.

Total cost of construction approximately Rm5.94 bil - Loan is Rm4.74 bil and balance Rm1.2 bil in equity. Frankly, I don’t know how to value it but what I can see is the expected return on equity can be very attractive due to its high leverage (5 x) if market is willing to give a much higher value to a completed infrastructure.
Let’s take a look what are the potential return ( taking a bull view with assumption that it will not be valued below the total construction cost and WCE Holding has 80% stake in WCE S/B)

WCE S/B			RM' billion		WCE Holdings Bhd		RM' billion
		Cost/ Value	Loan	Equity	80% Equity	Current Market Cap	*Expected Rights Issue	Enlarged Market Cap	Potential Return in 2 years
Cost of construction		5.94	4.74	1.2	0.96	1.28	0.256	1.536
On completion, value increase by
20%		7.128	4.74	2.388	1.910				24%
30%		7.722	4.74	2.982	2.386				55%
40%		8.316	4.74	3.576	2.861				86%
50%		8.91	4.74	4.17	3.336				117%
100%		11.88	4.74	7.14	5.712				272%

 *My rights issue assumption is based on the proceeds expected from the planned warrant exercise, which was expired last year and did not manage to raise any fund (thing doesn’t go according to plan sometimes).

However, there may be long gestation period before one can get the return expected. In addition, there is a short term dilemma, if you buy now, you must be prepared to subscribe for its right issues that will come sooner or later as WCE S/B needs to fulfil the debt-equity ratio of not more than 80/20. Hence, WCE Holdings Bhd needs to inject further capital into WCE S/B.
Yes, it’s potentially a very rewarding investment if one believes the Expressway could worth at least 40% more on completion but be prepared for a long winter before spring arrives. As usual, I guess many would rather wait till it gets closer to the completion date only go in for a quick kill.

Some wild thought on the long Merdeka break!