In the Business Times on Thursday:
Backdoor listing is the flavour of the season as companies are taking the reverse takeover (RTO) route to the stock exchange instead of initial public offerings (IPOs).
In the first half of this year, the value of announced reverse takeovers (RTOs) on the Singapore Exchange surged to US$969 million - an all-time high that even exceeded the amount raised through IPOs, year-to-date.
Some US$797 million worth of RTOs were announced for the whole of last year - a record by itself - data from Dealogic shows. The first six months of the year have already surpassed this amount. The RTO trail saves time. In contrast, the IPO process involves roadshows, and lodging a prospectus which is then made publicly available on the Monetary Authority of Singapore website Opera for investors to pore over.
My comments in RED.
I have never been a fan of the RTO process and the new business that comes along with it. In my opinion, the greatest beneficiary of such arrangements are the vendors and owners of the new business. Perhaps for the long suffering shareholders, the only good thing is that they are now able to sell their shares in the open market as a result of an increase in trading volume caused by the buzz surrounding the impending RTO deal. I will dissect the numbers in the RTO recently announced by Showy International to illustrate why it is a lousy deal.
On 7 july:
Showy International Limited is pleased to announce that the Company has entered into a conditional sale and purchase agreement (the “S&P Agreement”) dated 7 July 2008 with Newest Luck Holdings Limited (“Newest Luck”), Leap Forward Holdings Limited(“LFH”), Tan Hoo Lang and Tan Fuh Gih (together with Tan Hoo Lang, referred to as the “TanBrothers”) (collectively referred to as the “Vendors” in this Announcement), for the proposed acquisition by the Company of the entire issued and paid-up capital of Fortune Court, and the allotment and issue of shares in the Company as consideration for such acquisition, resulting in the reverse take-over of the Company.
Fortune Court is engaged in the property development industry in Chongqing. Fortune Court’s subsidiary, Chongqing Yingli Real Estate Development Co., Ltd (“ChongqingYingli”), is a premier property developer in Chongqing with a unique track record of old city reconstruction. It has since developed several major commercial buildings, such as Future International and New York New York. As at 30 June 2008, the total gross floor area (“GFA”) of completed properties held for investment by Chongqing Yingli is approximately 140,621 sq m, comprising commercial area of 78,985 sq m, office area of 22,668 sq m, residential area of 485 sq m and car park space of 38,483 sq m. In addition, the total estimated GFA of Chongqing Yingli’s land bank as at 30 June 2008 is 512,329 sq m. Chongqing Yingli engages third parties to assist in the project management of its properties and to provide project consultancy services.
Showy International shall acquire the entire issued and paid-up capital of Fortune Court for an aggregate consideration of S$545.39 million. The Consideration shall be satisfied by the allotment and issuance of a total of 1.65 billion new ordinary shares in the capital of the Company at the issue price of S$0.33 each. In the end, the total number of shares outstanding will be 1.779 billion.
So the million-dollar question is, is the acquisition amount for Fortune Court cheap or expensive?
Lets take a look at the 2007 financial figures of Fortune Court.
Revenue: S$49.2 million
Profit from operation: S$12.54 million
The fair value gain on investment properties is paper profit and non-recurring in nature. Thus it is not taken into consideration for the calculations.
Book value: S$206 million
Earnings went up by 30% between Y2006 & Y2007. Assuming Fortune Court can eke out the same amount of growth this year (very unconservative assumption considering the China real estate market was red-hot in the past few years), the earnings should reach S$16.3 million in Y2008.
In actual fact, Fortune Court is being valued at a PE of 33.4 (545/16.3). The return on investment is 2.99%! Wait, some may say that the value of Fortune Court lies in the properties and land they are holding. So lets see how much over valuation did Showy agree to pay.
The premium paid by Showy is a whopping S$339 million! (545-206). After this whole acquisition is complete, the forecasted EPS will be S$0.0092 (16.3/1773). If the above figures do not put you off, nothing will. The acquisition price of S$545.39 definitely do not look cheap.
But again, RTO deals are not meant to be cheap. Refer to my title for this posting again. Caveat emptor!!
Saturday, July 12, 2008
Friday, July 4, 2008
Who's the real culprit?
Below are some of the versions we read about recently on the reasons behind the relentless price increase of commodities.
VERSION 1: Speculators
In the current global economic slowdown, it would be fundamentally reasonable to assume that consumption has gone down and prices have weakened. This indeed is the case for lead, zinc and nickel. Copper on the other hand has remained stubbornly resilient and is in striking distance of its previous all-time high despite the increasingly bearish fundamentals. The International Copper Study Group (ICSG) reported a production shortfall for 2007 of about 55,000 tonnes, which is the basis of the widely published conclusion that copper remains "tight". However, the ICSG also states that those numbers make the assumption that all copper imported into China was consumed (Chinese consumption would have had to have been up 37%).
To find out what was actually happening statistically in China, one would look at the National Statistical Bureau (NSB) numbers to see what was produced plus what was imported, and subtract what was consumed. Consumption (3,990,000 tonnes) Production 3,441,000 tonnes Net Imports 1,350,000 tonnes Surplus Balance 801,000 tonnes In 2007 world refined copper production substantially exceeded consumption, by at least 750,000 tonnes. The inventory overhang in China has caused its prices to be at a substantial discount to the rest of the world. In the first quarter of this year, the ICSG has reported that global consumption is down by nearly 1%. First-quarter average mine capacity utilisation was slashed to 82% from 89% in the corresponding period of 2007. This is a fundamental picture of slowing consumption, unreported copper inventories and producers reducing production in face of worsening consumption. In short, it is unrealistic for copper price to be trading at such a high level. Actions of the speculators maybe one of the main contributing factors.
VERSION 2: Demand increase
Unlike in the past, when rallies in commodity prices have tended to be confined to a select few commodities, over 2003‐2007 prices have risen for all raw materials across the board. Links between various commodities through the supply chain (including, for example, transport costs) typically result in positive co‐movements but correlation is at a historical high, pointing to the role of a common demand shock across the raw‐materials sector.
The remarkable rise in oil and metals prices has its origin chiefly in the strength of emerging markets demand this decade. The rally in metals prices has also been driven by the concurrence of strong demand growth from the developing world and weak production capacity. China, which consumed about half of all the increase in copper, steel and aluminium output, and nearly all the increase in lead, zinc and tin during 2002‐2005, has single‐handedly altered the demand side of the equation.
The demand for base metals began to rise at a juncture when supply was ill-positioned to respond, since investment had sunk to a 12‐year low in 2002, due to a steep decline in prices in the 1990s, and a wave of consolidation at the end of that decade caused exploration budgets to shrink.
Comments:
Depending on what you read and who you listen to, the above are 2 of the most popular reasons given for this surge in prices of commodities. In my opinion, both are valid factors behind the price increase. It is clear that as China and India progress, their need for commodities will go up. At the same time, the number of speculators and hedge funds having open interest in various commodities also went up in recent years. However, in the near term, it is unlikely that commodity prices will remain immune to the global economic slowdown that is underway.
A weakening US economy, coupled with the forecast slowdown in Chinese growth, which Fitch estimates will be the slowest in six years, is likely to take a further toll on metals demand.
On the other hand, US House of Representatives recently passed a bill that directs the Commodity Futures Trading Commission to use all its authority to curb speculation in energy futures markets. It seems like the stage is set for a period of stable prices.
VERSION 1: Speculators
In the current global economic slowdown, it would be fundamentally reasonable to assume that consumption has gone down and prices have weakened. This indeed is the case for lead, zinc and nickel. Copper on the other hand has remained stubbornly resilient and is in striking distance of its previous all-time high despite the increasingly bearish fundamentals. The International Copper Study Group (ICSG) reported a production shortfall for 2007 of about 55,000 tonnes, which is the basis of the widely published conclusion that copper remains "tight". However, the ICSG also states that those numbers make the assumption that all copper imported into China was consumed (Chinese consumption would have had to have been up 37%).
To find out what was actually happening statistically in China, one would look at the National Statistical Bureau (NSB) numbers to see what was produced plus what was imported, and subtract what was consumed. Consumption (3,990,000 tonnes) Production 3,441,000 tonnes Net Imports 1,350,000 tonnes Surplus Balance 801,000 tonnes In 2007 world refined copper production substantially exceeded consumption, by at least 750,000 tonnes. The inventory overhang in China has caused its prices to be at a substantial discount to the rest of the world. In the first quarter of this year, the ICSG has reported that global consumption is down by nearly 1%. First-quarter average mine capacity utilisation was slashed to 82% from 89% in the corresponding period of 2007. This is a fundamental picture of slowing consumption, unreported copper inventories and producers reducing production in face of worsening consumption. In short, it is unrealistic for copper price to be trading at such a high level. Actions of the speculators maybe one of the main contributing factors.
VERSION 2: Demand increase
Unlike in the past, when rallies in commodity prices have tended to be confined to a select few commodities, over 2003‐2007 prices have risen for all raw materials across the board. Links between various commodities through the supply chain (including, for example, transport costs) typically result in positive co‐movements but correlation is at a historical high, pointing to the role of a common demand shock across the raw‐materials sector.
The remarkable rise in oil and metals prices has its origin chiefly in the strength of emerging markets demand this decade. The rally in metals prices has also been driven by the concurrence of strong demand growth from the developing world and weak production capacity. China, which consumed about half of all the increase in copper, steel and aluminium output, and nearly all the increase in lead, zinc and tin during 2002‐2005, has single‐handedly altered the demand side of the equation.
The demand for base metals began to rise at a juncture when supply was ill-positioned to respond, since investment had sunk to a 12‐year low in 2002, due to a steep decline in prices in the 1990s, and a wave of consolidation at the end of that decade caused exploration budgets to shrink.
Comments:
Depending on what you read and who you listen to, the above are 2 of the most popular reasons given for this surge in prices of commodities. In my opinion, both are valid factors behind the price increase. It is clear that as China and India progress, their need for commodities will go up. At the same time, the number of speculators and hedge funds having open interest in various commodities also went up in recent years. However, in the near term, it is unlikely that commodity prices will remain immune to the global economic slowdown that is underway.
A weakening US economy, coupled with the forecast slowdown in Chinese growth, which Fitch estimates will be the slowest in six years, is likely to take a further toll on metals demand.
On the other hand, US House of Representatives recently passed a bill that directs the Commodity Futures Trading Commission to use all its authority to curb speculation in energy futures markets. It seems like the stage is set for a period of stable prices.
Monday, June 30, 2008
Competitive advantage period (CAP) --- Part 3
The CAP for the U.S. stock market, as a whole, is estimated to be between 10 and15 years. However, within that aggregate, individual company CAPs can vary from 0-2 years to over 20 years. As a general rule, companies with low multiples tend to have shorter CAPs. Alternatively, companies with high multiples typically have long CAPs.
For example, companies like Microsoft and Coca-Cola have CAPs well in excess of 20 years, demonstrating their perceived market dominance, the sustainability of high returns, and the market’s willingness to take the long view. If a substantial percentage of the value of acompany can be attributed to cash flows beyond a few years, it is difficult to argue persuasively that the market is short-term-oriented. In turn, it follows that the forecast periods used in most valuation models are not long enough.
It may be more important for the investor to try to quantify CAP than to pass judgment on its correctness. As noted earlier, the components of value are all expectational, and therefore must be considered relative to one another and against the expectations for the business overall. There are a number of ways of estimating CAP, but one of the most useful methods was developed by Al Rappaport. The technique is known as market-implied CAP (MICAP). Determination of the MICAP has a few steps.
First,the analyst needs a proxy for unbiased market expectations as the key input into a discounted cash flow model. Since, by definition, there is no value creation assumed after CAP, the model uses a perpetuity assumption (NOPATCAP/WACC) for the terminal value. Next, the length of the forecast horizon is stretched as many years as necessary to achieve the current stock price. This period is the company’s MICAP. Scrutiny of the MICAP determination process would correctly identify it as a circular exercise. That is, if a stock price increases without changes in cash flow expectations and/or risk, the MICAP will necessarily expand. This in no way weakens CAP’s value as an analytical tool. In fact, this tight link with valuation highlights the power of including CAP as a key tool in the analytic toolbag. For instance, a calculated MICAP can be compared to previous MICAPs for the same company, an average MICAP for the industry (if possible and appropriate), and the company’s historical cash-on-cash return on invested capital.
For example, companies like Microsoft and Coca-Cola have CAPs well in excess of 20 years, demonstrating their perceived market dominance, the sustainability of high returns, and the market’s willingness to take the long view. If a substantial percentage of the value of acompany can be attributed to cash flows beyond a few years, it is difficult to argue persuasively that the market is short-term-oriented. In turn, it follows that the forecast periods used in most valuation models are not long enough.
It may be more important for the investor to try to quantify CAP than to pass judgment on its correctness. As noted earlier, the components of value are all expectational, and therefore must be considered relative to one another and against the expectations for the business overall. There are a number of ways of estimating CAP, but one of the most useful methods was developed by Al Rappaport. The technique is known as market-implied CAP (MICAP). Determination of the MICAP has a few steps.
First,the analyst needs a proxy for unbiased market expectations as the key input into a discounted cash flow model. Since, by definition, there is no value creation assumed after CAP, the model uses a perpetuity assumption (NOPATCAP/WACC) for the terminal value. Next, the length of the forecast horizon is stretched as many years as necessary to achieve the current stock price. This period is the company’s MICAP. Scrutiny of the MICAP determination process would correctly identify it as a circular exercise. That is, if a stock price increases without changes in cash flow expectations and/or risk, the MICAP will necessarily expand. This in no way weakens CAP’s value as an analytical tool. In fact, this tight link with valuation highlights the power of including CAP as a key tool in the analytic toolbag. For instance, a calculated MICAP can be compared to previous MICAPs for the same company, an average MICAP for the industry (if possible and appropriate), and the company’s historical cash-on-cash return on invested capital.
Monday, June 23, 2008
BP world energy review
This posting is contributed with compliments from Julian.... :-)
From the 57th annual BP statistical review of World Energy, here are some summaries:
1. High oil prices are not because of speculation. Speculation might make the price swings more volatile but the push in price is due to economic fundamentals. Global energy growth has been above average for 5 consecutive years but at the same time energy supplies have not been able to catch up. Britain's North Sea oil field recorded world's largest decline in production, ever! Declining by 10% in 2007. Production in Russia is declining. Nationalism is on the rise and this will negatively impact production as some countries like Venezuela are not exactly that good in increasing production output.
2. The world is not running out of hydrocarbon. We currently have 40 yrs of proven oil reserve, 60 yrs of natural gas and 130 yrs of coal. So we still have enough reserve, the problem is more political.
3. Alternative energy comprises of around 2% of total energy consumption. So switching to alternative energy is not as easy as it seems.
4. Conclusion: let the market adjust itself. At these prices, oil consumption would definitely decline as individuals/nations are taking steps in reducing oil consumption. At the same time, at these high prices, nations will try as much as they can to sell more oil to reap the immediate reward. This will help put pressure on demand.
For more, go to BP.com
From the 57th annual BP statistical review of World Energy, here are some summaries:
1. High oil prices are not because of speculation. Speculation might make the price swings more volatile but the push in price is due to economic fundamentals. Global energy growth has been above average for 5 consecutive years but at the same time energy supplies have not been able to catch up. Britain's North Sea oil field recorded world's largest decline in production, ever! Declining by 10% in 2007. Production in Russia is declining. Nationalism is on the rise and this will negatively impact production as some countries like Venezuela are not exactly that good in increasing production output.
2. The world is not running out of hydrocarbon. We currently have 40 yrs of proven oil reserve, 60 yrs of natural gas and 130 yrs of coal. So we still have enough reserve, the problem is more political.
3. Alternative energy comprises of around 2% of total energy consumption. So switching to alternative energy is not as easy as it seems.
4. Conclusion: let the market adjust itself. At these prices, oil consumption would definitely decline as individuals/nations are taking steps in reducing oil consumption. At the same time, at these high prices, nations will try as much as they can to sell more oil to reap the immediate reward. This will help put pressure on demand.
For more, go to BP.com
Wednesday, June 4, 2008
Competitive advantage period (CAP) --- Part 2
Competitive advantage period (CAP) is the time during which a company is expected to generate returns on incremental investment that exceed its cost of capital. Economic theory suggests that competitive forces will drive returns down to the cost of capital over time. If a company earns above market required returns, it will attract competitors that will accept lower returns, eventually driving industry returns lower. The notion of CAP has been around for some time; nonetheless, not much attention has been paid to it in the valuation literature. The equation can be summarized as follows:
Value = (NOPAT/WACC) + [I(R-WACC)CAP]/(WACC)(1+WACC)
where NOPAT = net operating profit after tax
WACC = weighted average cost of capital
I = annualized new investment in working and fixed capital
R = rate of return on invested capital
CAP = competitive advantage period
Rearranged, the formula reads:
CAP = {(Value*WACC-NOPAT)(1+WACC)}/I(R-WACC)
These formulas have some shortcomings that make them limiting in practice, but they demonstrate, with clarity, how CAP can be conceptualized in the valuation process. A company’s CAP is determined by a multitude of factors, both internal and external. On a company-specific basis, considerations such as industry structure, the company’s competitive position within that industry, and management strategies define the length of CAP. The structured competitive analysis framework set out by Michael Porter can be particularly useful in this assessment. Important external factors include government regulations and antitrust policies. CAP can also reflect investor psychology through implied optimism/pessimism regarding a firm’s prospects.
It is believed that the key determinants of CAP can be largely captured by a handful of drivers. The first is a company’s current return on invested capital. Generally speaking, higher ROIC businesses within an industry are the best positioned competitively (reflecting scale economies, entry barriers and management execution). As a result, it is often costlier and more time consuming for competitors to wrest competitive advantage away from high-return companies. Second is the rate of industry change. High returns in a rapidly changing sector (technology) are unlikely to be valued as generously as high returns in a more prosaic industry (beverages). The final driver is barriers to entry. High barriers to entry— or in some businesses, “lock-in” and increasing returns— are central to appreciating the sustainability of high returns on invested capital.
Value = (NOPAT/WACC) + [I(R-WACC)CAP]/(WACC)(1+WACC)
where NOPAT = net operating profit after tax
WACC = weighted average cost of capital
I = annualized new investment in working and fixed capital
R = rate of return on invested capital
CAP = competitive advantage period
Rearranged, the formula reads:
CAP = {(Value*WACC-NOPAT)(1+WACC)}/I(R-WACC)
These formulas have some shortcomings that make them limiting in practice, but they demonstrate, with clarity, how CAP can be conceptualized in the valuation process. A company’s CAP is determined by a multitude of factors, both internal and external. On a company-specific basis, considerations such as industry structure, the company’s competitive position within that industry, and management strategies define the length of CAP. The structured competitive analysis framework set out by Michael Porter can be particularly useful in this assessment. Important external factors include government regulations and antitrust policies. CAP can also reflect investor psychology through implied optimism/pessimism regarding a firm’s prospects.
It is believed that the key determinants of CAP can be largely captured by a handful of drivers. The first is a company’s current return on invested capital. Generally speaking, higher ROIC businesses within an industry are the best positioned competitively (reflecting scale economies, entry barriers and management execution). As a result, it is often costlier and more time consuming for competitors to wrest competitive advantage away from high-return companies. Second is the rate of industry change. High returns in a rapidly changing sector (technology) are unlikely to be valued as generously as high returns in a more prosaic industry (beverages). The final driver is barriers to entry. High barriers to entry— or in some businesses, “lock-in” and increasing returns— are central to appreciating the sustainability of high returns on invested capital.
Monday, May 19, 2008
Competitive advantage period (CAP) --- Part 1
In 1991, Barrie Wigmore, a Goldman Sachs limited partner, released a study that attempted to determine what factors drove the stock market’s above-average returns in the decade of the 1980s. After carefully accounting for earnings growth, interest rate declines, M&A activity and analysts’ rosy forecasts, it appeared a full 38% of the shareholder value created in the 1980s remained unexplained. Dubbed the “X” factor, this mysterious driver of value left Wigmore and the Wall Street Journal, which published a feature article on the study, at a loss. Given overwhelming evidence of well-functioning capital markets, it appears completely unsatisfactory to attribute such a large component of share price performance to some unidentifiable and seemingly inexplicable force.
Fortunately, there is an answer to this problem. However, to understand the solution there must be a recognition that share prices are not set by capitalizing accounting-based earnings, which are at best flawed and at worst substantially misleading. The focus must be on the economic drivers of a business, which can be defined as cash flow (cash-in versus cash-out), risk (and appropriate demanded return) and what is dubbed “competitive advantage period”— CAP— or how long returns above the cost of capital will be earned. CAP is also known as “value growth duration”.
In this context, Mr Wigmore’s “X” factor can be explained by the market’s extension of expectations for above-cost-of-capital returns. As Mr Wigmore’s analysis suggests, the length and relative change of CAP can have a substantial impact on the value of a business and the market overall. For example, the revision in expectations of Corporate America’s ability to generate returns above its cost of capital is a powerful indicator that investors believed that America was more competitive at the end of the 1980s than it was entering the decade. This conclusion was later supported by economic analysis. It should be noted that in a well-functioning capital market all assets, including bonds and real estate, are valued using similar economic parameters. In the case of bonds, for example, the coupon rate (or cash flow) is contractually set, as is the maturity. The bond price is set so that the expected return of the security is commensurate with its perceived risk. Likewise for most commercial real estate transactions. At the end of the day, the process of investing returns to the analysis of cash flow, risk and time horizon. Since these drivers are not contractually set for equity securities, they are by definition expectational and, in most cases, dynamic.
Remarkably, in spite of CAP’s importance in the analytical process it remains one of the most neglected components of valuation. This lack of focus appears attributable to two main factors. First, the vast majority of market participants attempt to understand valuation and subsequent stock price changes using an accounting-based formula, which generally defines value as a price/earnings multiple times earnings. Thus CAP is rarely explicitly addressed, even though most empirical evidence suggests that the stock market deems cash flow to be more important than earnings, holds true to the risk/reward relationship over time, and recognizes cash flows many years into the future.
Second, most companies use a forecast period for strategic planning purposes (usually three to five years) that is substantially different from their CAP. As a result, investor communication is geared more toward internal company-based expectations rather than external market-based expectations. If the determination of stock prices is approached with an economically sound model, the concept of CAP becomes immediately relevant.
Fortunately, there is an answer to this problem. However, to understand the solution there must be a recognition that share prices are not set by capitalizing accounting-based earnings, which are at best flawed and at worst substantially misleading. The focus must be on the economic drivers of a business, which can be defined as cash flow (cash-in versus cash-out), risk (and appropriate demanded return) and what is dubbed “competitive advantage period”— CAP— or how long returns above the cost of capital will be earned. CAP is also known as “value growth duration”.
In this context, Mr Wigmore’s “X” factor can be explained by the market’s extension of expectations for above-cost-of-capital returns. As Mr Wigmore’s analysis suggests, the length and relative change of CAP can have a substantial impact on the value of a business and the market overall. For example, the revision in expectations of Corporate America’s ability to generate returns above its cost of capital is a powerful indicator that investors believed that America was more competitive at the end of the 1980s than it was entering the decade. This conclusion was later supported by economic analysis. It should be noted that in a well-functioning capital market all assets, including bonds and real estate, are valued using similar economic parameters. In the case of bonds, for example, the coupon rate (or cash flow) is contractually set, as is the maturity. The bond price is set so that the expected return of the security is commensurate with its perceived risk. Likewise for most commercial real estate transactions. At the end of the day, the process of investing returns to the analysis of cash flow, risk and time horizon. Since these drivers are not contractually set for equity securities, they are by definition expectational and, in most cases, dynamic.
Remarkably, in spite of CAP’s importance in the analytical process it remains one of the most neglected components of valuation. This lack of focus appears attributable to two main factors. First, the vast majority of market participants attempt to understand valuation and subsequent stock price changes using an accounting-based formula, which generally defines value as a price/earnings multiple times earnings. Thus CAP is rarely explicitly addressed, even though most empirical evidence suggests that the stock market deems cash flow to be more important than earnings, holds true to the risk/reward relationship over time, and recognizes cash flows many years into the future.
Second, most companies use a forecast period for strategic planning purposes (usually three to five years) that is substantially different from their CAP. As a result, investor communication is geared more toward internal company-based expectations rather than external market-based expectations. If the determination of stock prices is approached with an economically sound model, the concept of CAP becomes immediately relevant.
Sunday, May 4, 2008
Appraising San Teh
San Teh’s cement business continues to be its main revenue driver. Riding on to its excellent FY06 results, FY07 has also proven to be a successful year. Since FY04, the cement business has returned to the black after many years of losses. Turnover of the Group rose 26% to $162.7 million and profit after taxation improved 14% to $11.9 million. Sales in cement operation went up by 31% to $128.3 million and the operating profit increased 39% to $21.0 million. The average cement selling price was higher at RMB256 per ton as compared to RMB240 per ton in FY06. In FY08, the average cement selling prices are expected to hover at around RMB250 to 260 per ton on the back of strong fixed-asset investment and GDP growth in China. Profits have continued to be depressed in the plastic division due to the rising PVC resin prices. The low occupancy rate in the newly opened hotel in Suzhou has resulted in a loss for the hotel division in FY07.
Since 2006, the government of China, through The National Development and Reform Commission (NDRC) has started closing down the smaller size cement companies with outdated capacity. Such a drastic step from the government is a very important factor for the China cement industry in the next few years. Although new capacity supply should stay at high levels, the volume of outdated capacity being shuttered should keep net capacity increases low compared with the increase in new demand. Oversupply should gradually ease in the next few years due to the above reason. The main objective for closure of outdated capacity is to reduce discharge and save energy as the remaining players have a more efficient manufacturing process and at the same time weed out all rouge companies operating without permit from the government.
Due to the fact that the existing plant in Fujian Longyan is running at full capacity, the management has decided to build a new cement plant in Dali with an output per year of 1 million tones. It is expected to contribute positively to the bottom line starting from the second half of FY08 onwards and also around 33% of the cement revenue from FY09.
San Teh is in the process of preparing their cement operation for a listing on the Shanghai Stock Exchange by end of this year. Recently, one of the three largest cement groups in China, the Southern Cement Group, together with the other three institutional investors, have invested RMB72.0 million for a 6.67% interest in San Teh’s cement operation. Based on this, the whole cement operation is estimated to be worth a whopping RMB1079 million (S$210 million). Assuming the plastic and hotel business is worthless as they are making losses, San Teh's share price should be at the S$0.72 level.
The current share price is significantly below San Teh’s NTA of S$0.93 as at 31st December 2007. Given the potential events described above taking place in the near future, this huge price discrepancy is unjustifiable. The group’s financial position is healthy and the expansion strategy is right on track to become a mid sized cement manufacturer. This discount gap should narrow considerably once the cement operation has been listed successfully.
Since 2006, the government of China, through The National Development and Reform Commission (NDRC) has started closing down the smaller size cement companies with outdated capacity. Such a drastic step from the government is a very important factor for the China cement industry in the next few years. Although new capacity supply should stay at high levels, the volume of outdated capacity being shuttered should keep net capacity increases low compared with the increase in new demand. Oversupply should gradually ease in the next few years due to the above reason. The main objective for closure of outdated capacity is to reduce discharge and save energy as the remaining players have a more efficient manufacturing process and at the same time weed out all rouge companies operating without permit from the government.
Due to the fact that the existing plant in Fujian Longyan is running at full capacity, the management has decided to build a new cement plant in Dali with an output per year of 1 million tones. It is expected to contribute positively to the bottom line starting from the second half of FY08 onwards and also around 33% of the cement revenue from FY09.
San Teh is in the process of preparing their cement operation for a listing on the Shanghai Stock Exchange by end of this year. Recently, one of the three largest cement groups in China, the Southern Cement Group, together with the other three institutional investors, have invested RMB72.0 million for a 6.67% interest in San Teh’s cement operation. Based on this, the whole cement operation is estimated to be worth a whopping RMB1079 million (S$210 million). Assuming the plastic and hotel business is worthless as they are making losses, San Teh's share price should be at the S$0.72 level.
The current share price is significantly below San Teh’s NTA of S$0.93 as at 31st December 2007. Given the potential events described above taking place in the near future, this huge price discrepancy is unjustifiable. The group’s financial position is healthy and the expansion strategy is right on track to become a mid sized cement manufacturer. This discount gap should narrow considerably once the cement operation has been listed successfully.
Monday, April 21, 2008
Using EVA
Economic Value Added (EVA) is a frequently used ratio by investors from developed market economies. The basic idea of this formula is based on the foundation that the main goal of a company is to maximize profit. However it does not mean book profit (the difference between revenues and costs) but economical profit.
The difference between economical and book profit is that economical profit is the difference between revenues and economical costs, which are book costs and opportunity costs. Opportunity costs are presented by the amount of money lost by not putting available sources (like capital, labor, etc.) to the best alternative use. This relation is possible to describe in following way:
Book profit = Revenues – Costs
Economical profit = Total revenues from capital – Costs of capital
A basic construction of EVA measure is clear from the following formula:
EVAt = NOPATt – Ct x WACCt
where NOPATt is Net Operating Profit After Tax,
Ct is long term capital,
WACC is Weighted Average Cost of Capital
If EVA > 0, then we can say a company is successful. This is the only case when wealth of shareholders increases because they gain more than what they put in originally. In case EVA = 0, a company produced just as much as it was invested and EVA less than 0 leads to destroying of shareholders' wealth.
Book profit = Revenues – Costs
Economical profit = Total revenues from capital – Costs of capital
A basic construction of EVA measure is clear from the following formula:
EVAt = NOPATt – Ct x WACCt
where NOPATt is Net Operating Profit After Tax,
Ct is long term capital,
WACC is Weighted Average Cost of Capital
If EVA > 0, then we can say a company is successful. This is the only case when wealth of shareholders increases because they gain more than what they put in originally. In case EVA = 0, a company produced just as much as it was invested and EVA less than 0 leads to destroying of shareholders' wealth.
Companies which can gain the highest level of profit (NOPAT) while using minimum "cheap” capital will experience positive results. It is possible when investments are consistently driven by criteria of net present value. Therefore EVA represents an interesting measure of judging the performance of companies.
Friday, April 4, 2008
What is Competitive Advantage?
The true definition i got from the internet for competitive advantage is as follows:
An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers than its competition. Competitive advantages give a company an edge over its rivals and an ability to generate greater value for the firm and its shareholders. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage.
There are two main types of competitive advantages: comparative advantage and differential advantage. Comparative advantage, or cost advantage, is a firm's ability to produce a good or service at a lower cost than its competitors, which gives the firm the ability sell its goods or services at a lower price than its competition or to generate a larger margin on sales. A differential advantage is created when a firm's products or services differ from its competitors and are seen as better than a competitor's products by customers.
What are the types of advantages that help protect you from the competition? How do you get to the point where you have a wide economic moat as Buffett calls it? Well, one thing that isnt a source of a moat is technology because that can be duplicated and always will be. Technology is one type of advantage that is short-lived. There are others, such as a good management team or a catchy advertising campaign or a hot fashion trend. These things produce temporary advantages but they change over time, or can be duplicated by competitors.
An economic moat is a structural thing. If your competitors know your secret and yet still cant copy it, thats a structural advantage. Thats a moat. Frankly, there are really only four sources of economic moats that are hard to duplicate, and thus, long-lasting. One source would be economies of scale and scope. Wal-Mart is an example of this, as is Cintas in the uniform rental business or Procter & Gamble or Home Depot and Lowes. Another source is the network affect, like eBay or Mastercard or Visa or American Express. A third would be intellectual property rights, such as patents, trademarks, regulatory approvals, or customer goodwill. Disney, Nike, or Genentech would be good examples here. A fourth and final type of moat would be high customer switching costs. Paychex and Microsoft are great examples of companies that benefit from high customer switching costs. These are the only four types of competitive advantages that are durable, because they are very difficult for competitors to duplicate.
Normally in the IPO prospectus of companies, we see the following mentioned as competitive strengths/advantages:
1) We are a leading manufacturer of XXXXXXXX.
From 2002 to 2004, we have been ranked first in terms of sales.
2) We have an established brand name.
We have built up an established brand name within the industry.
3) We are amongst the most technologically advanced manufacturers.
Our strength also lies in the technology we employ in our operations.
4) We are a manufacturer of quality products.
Several of our products have won awards for excellence and quality.
5) Our commitment and ongoing efforts to R&D.
Our management places a strong emphasis on R&D and our R&D initiatives are focused on
developing and introducing new products to cater to our customers’ needs.
6) We have an experienced and capable management team.
Our Executive Directors have approximately a total of 40 years’ experience.
Can you see the difference?
An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers than its competition. Competitive advantages give a company an edge over its rivals and an ability to generate greater value for the firm and its shareholders. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage.
There are two main types of competitive advantages: comparative advantage and differential advantage. Comparative advantage, or cost advantage, is a firm's ability to produce a good or service at a lower cost than its competitors, which gives the firm the ability sell its goods or services at a lower price than its competition or to generate a larger margin on sales. A differential advantage is created when a firm's products or services differ from its competitors and are seen as better than a competitor's products by customers.
What are the types of advantages that help protect you from the competition? How do you get to the point where you have a wide economic moat as Buffett calls it? Well, one thing that isnt a source of a moat is technology because that can be duplicated and always will be. Technology is one type of advantage that is short-lived. There are others, such as a good management team or a catchy advertising campaign or a hot fashion trend. These things produce temporary advantages but they change over time, or can be duplicated by competitors.
An economic moat is a structural thing. If your competitors know your secret and yet still cant copy it, thats a structural advantage. Thats a moat. Frankly, there are really only four sources of economic moats that are hard to duplicate, and thus, long-lasting. One source would be economies of scale and scope. Wal-Mart is an example of this, as is Cintas in the uniform rental business or Procter & Gamble or Home Depot and Lowes. Another source is the network affect, like eBay or Mastercard or Visa or American Express. A third would be intellectual property rights, such as patents, trademarks, regulatory approvals, or customer goodwill. Disney, Nike, or Genentech would be good examples here. A fourth and final type of moat would be high customer switching costs. Paychex and Microsoft are great examples of companies that benefit from high customer switching costs. These are the only four types of competitive advantages that are durable, because they are very difficult for competitors to duplicate.
Normally in the IPO prospectus of companies, we see the following mentioned as competitive strengths/advantages:
1) We are a leading manufacturer of XXXXXXXX.
From 2002 to 2004, we have been ranked first in terms of sales.
2) We have an established brand name.
We have built up an established brand name within the industry.
3) We are amongst the most technologically advanced manufacturers.
Our strength also lies in the technology we employ in our operations.
4) We are a manufacturer of quality products.
Several of our products have won awards for excellence and quality.
5) Our commitment and ongoing efforts to R&D.
Our management places a strong emphasis on R&D and our R&D initiatives are focused on
developing and introducing new products to cater to our customers’ needs.
6) We have an experienced and capable management team.
Our Executive Directors have approximately a total of 40 years’ experience.
Can you see the difference?
Monday, March 24, 2008
Acquiring a business - How not to do it (China Powerplus case)
Investors need to evaluate motives for a merger in order to asses whether the newly formed entity is likely to create long-term value or not. There are numerous questions concerning motives for any merger that need to be asked and answered when evaluating the new company. Among others, investors need to know if a merger makes sense and what are the chances of the new company making it in the tough world of capital markets.
On 15 January 2008, it was announced that JGL shall sell and Powerplus shall buy 50% of the fully paid ordinary shares of China Steel Australia held by JGL. Powerplus is currently in the process of acquiring 142,450,000 China Steel Australia shares from JGL, representing a 46.25% stake in China Steel Australia at the Consideration (RMB 155,302,000).
The payment can potentially increase another RMB 11,419,000 if the audited FY2008 consolidated net profit after tax of China Steel Singapore Pte Ltd is greater or equal to
RMB 48,000,000. Currently, China Steel is listed on the Australia Stock Exchange.
In my point of view, this is a lousy acquisition. Below are the reasons:
1) The net profit for FY2008 will surely exceed RMB48 million due to the non-recurring and non-cash financial income of the convertible loan it is holding on its accounting books. For FY2008, this will amount to RMB41.7 million. For evidence, please read up the prospectus of China Steel.
2) Powerplus have grossly overpaid for the acquisition. Please refer to my earlier posting on “What is synergy?”. I will demonstrate with some calculations why this is so.
Powerplus has paid RMB155.3 million for a 46.25% stake. This means the valuation of China Steel is RMB335.78 million. This figure excludes the “extras” that they will pay if the profit exceed RMB48 million. Let’s look at what is the amount of premium they have paid in this deal. After the listing in Australia, the total book value of China steel is expected to be AUD$7.813 million (RMB50.39 million). Powerplus has paid an astonishing high 6.6 times book value for a 46.25% stake. Whatever synergy and cost benefits that one can reap from such an acquisition disappears with such a high purchase price.
3) Chances are that in total, Powerplus will pay RMB166.7 million. Assume that the true earnings (without exceptional items) for FY2008 is RMB38 million. For that, Powerplus is able to claim RMB17.6 million by virtual of its shareholdings. This translates to a return of 10.5%. This kind of investment hardly inspires any confidence considering the ROE of Powerplus for FY2007 is 15.5%. If we take out the cash component, the adjusted ROE is an excellent 35.5%.
4) Shares in JGL is owned by Dr Lim Seck Yeow’s wife and son (Mdm Tan Geok Bee & Mr Hung Lim). Conflict of interest is present. Enough said.
5) Potential dilution of Powerplus’s stake as China Steel seek to raise funds for the new plant in year 2009.
6) Convertible loan agreement with an individual called Zhang Guangxia. He may get in the region of 130 million shares. Potential stake dilution.
The whole deal smacks of bootstrapping. When a company’s earnings increase as a result of the merger transaction and not due to the allegedly created economic benefit from the merger, this is called the bootstrapping effect or bootstrapping earnings.
Below are some of the factors that will impact the earnings of China Steel in the near future:
A) Barriers of entry not exactly high. China Steel has developed its own internal know-how which has contributed to the success of that company. This know-how is not protected by patent or similar rights. There is a risk that competitors may copy this know-how or develop similar or better know-how and produce better or less extensive product that currently produced by China Steel. There is also a risk of employees leaving the China Steel and disclosing know-how to competitors.
B) Reliance on a single key customer and supplier and contract with Huaguang expires on 8 October 2010.
C) High raw material prices. Coke is one of the main raw materials used by China Steel in the production of Nickel Pig Iron. The ever rising coke prices have caused China Steel to get customers to supply their own coke. There is no guarantee that this arrangement will work out.
D) Taxes will be incurred from 2009 onwards.
On 15 January 2008, it was announced that JGL shall sell and Powerplus shall buy 50% of the fully paid ordinary shares of China Steel Australia held by JGL. Powerplus is currently in the process of acquiring 142,450,000 China Steel Australia shares from JGL, representing a 46.25% stake in China Steel Australia at the Consideration (RMB 155,302,000).
The payment can potentially increase another RMB 11,419,000 if the audited FY2008 consolidated net profit after tax of China Steel Singapore Pte Ltd is greater or equal to
RMB 48,000,000. Currently, China Steel is listed on the Australia Stock Exchange.
In my point of view, this is a lousy acquisition. Below are the reasons:
1) The net profit for FY2008 will surely exceed RMB48 million due to the non-recurring and non-cash financial income of the convertible loan it is holding on its accounting books. For FY2008, this will amount to RMB41.7 million. For evidence, please read up the prospectus of China Steel.
2) Powerplus have grossly overpaid for the acquisition. Please refer to my earlier posting on “What is synergy?”. I will demonstrate with some calculations why this is so.
Powerplus has paid RMB155.3 million for a 46.25% stake. This means the valuation of China Steel is RMB335.78 million. This figure excludes the “extras” that they will pay if the profit exceed RMB48 million. Let’s look at what is the amount of premium they have paid in this deal. After the listing in Australia, the total book value of China steel is expected to be AUD$7.813 million (RMB50.39 million). Powerplus has paid an astonishing high 6.6 times book value for a 46.25% stake. Whatever synergy and cost benefits that one can reap from such an acquisition disappears with such a high purchase price.
3) Chances are that in total, Powerplus will pay RMB166.7 million. Assume that the true earnings (without exceptional items) for FY2008 is RMB38 million. For that, Powerplus is able to claim RMB17.6 million by virtual of its shareholdings. This translates to a return of 10.5%. This kind of investment hardly inspires any confidence considering the ROE of Powerplus for FY2007 is 15.5%. If we take out the cash component, the adjusted ROE is an excellent 35.5%.
4) Shares in JGL is owned by Dr Lim Seck Yeow’s wife and son (Mdm Tan Geok Bee & Mr Hung Lim). Conflict of interest is present. Enough said.
5) Potential dilution of Powerplus’s stake as China Steel seek to raise funds for the new plant in year 2009.
6) Convertible loan agreement with an individual called Zhang Guangxia. He may get in the region of 130 million shares. Potential stake dilution.
The whole deal smacks of bootstrapping. When a company’s earnings increase as a result of the merger transaction and not due to the allegedly created economic benefit from the merger, this is called the bootstrapping effect or bootstrapping earnings.
Below are some of the factors that will impact the earnings of China Steel in the near future:
A) Barriers of entry not exactly high. China Steel has developed its own internal know-how which has contributed to the success of that company. This know-how is not protected by patent or similar rights. There is a risk that competitors may copy this know-how or develop similar or better know-how and produce better or less extensive product that currently produced by China Steel. There is also a risk of employees leaving the China Steel and disclosing know-how to competitors.
B) Reliance on a single key customer and supplier and contract with Huaguang expires on 8 October 2010.
C) High raw material prices. Coke is one of the main raw materials used by China Steel in the production of Nickel Pig Iron. The ever rising coke prices have caused China Steel to get customers to supply their own coke. There is no guarantee that this arrangement will work out.
D) Taxes will be incurred from 2009 onwards.
Friday, March 7, 2008
Structured warrants - Love or hate them?
A few days ago, the local newspaper reported that despite the current bearish sentiments in the Singapore stock market, financial institutions are still continuing to issue structured warrants on the exchange. The reasons these institutions give to encourage investors to buy them include leverage, hedging of risk...... blah, blah.
Make no mistake, the issuing of these structured warrants are cash minting machines for these financial institutions. For those that are unconvinced, pls talk to friends or relatives working in the structured warrants department of these institutions. I believe it will be interesting to find out if the top management of these companies make use of such warrants in their own investment plans. But that is another story for another day.
There are a few reasons why these structured warrants generate income. Firstly, they are being issued at a premium. Generally, one could use the black-scholes formula to calculate the warrant's fair price. So strictly speaking, if one buy the warrants on its listing day, one is overpaying for it. Would you pay $1.3 for a dollar note?
Secondly, the financial institution's risk are fully hedged using the dynamic delta hedging process. Of course there are variations of how this can be carried out. In short, the institution will go out on the open market to buy and sell the underlying share in order to maintain a delta neutral position. It doesn't matter whether the price of the underlying share goes up or down. Under ideal conditions, the income earned will be equal to the premiums charged. However, in reality, this amount can fluctuate too. But not to worry, at the end of the day, the institutions will still collect their cheque.
To sum up, issuing of structured warrants, which picked up over the past few years, are new methods of generating income for these institutions. Please open your big eyes to understand the big picture before putting in your hard-earned money.
Make no mistake, the issuing of these structured warrants are cash minting machines for these financial institutions. For those that are unconvinced, pls talk to friends or relatives working in the structured warrants department of these institutions. I believe it will be interesting to find out if the top management of these companies make use of such warrants in their own investment plans. But that is another story for another day.
There are a few reasons why these structured warrants generate income. Firstly, they are being issued at a premium. Generally, one could use the black-scholes formula to calculate the warrant's fair price. So strictly speaking, if one buy the warrants on its listing day, one is overpaying for it. Would you pay $1.3 for a dollar note?
Secondly, the financial institution's risk are fully hedged using the dynamic delta hedging process. Of course there are variations of how this can be carried out. In short, the institution will go out on the open market to buy and sell the underlying share in order to maintain a delta neutral position. It doesn't matter whether the price of the underlying share goes up or down. Under ideal conditions, the income earned will be equal to the premiums charged. However, in reality, this amount can fluctuate too. But not to worry, at the end of the day, the institutions will still collect their cheque.
To sum up, issuing of structured warrants, which picked up over the past few years, are new methods of generating income for these institutions. Please open your big eyes to understand the big picture before putting in your hard-earned money.
Tuesday, March 4, 2008
Intelligence is over-rated, really!
A short quiz:
What is the difference between investing, speculating and gambling?
Ans:
In investing, the probability of winning is >90%
In speculating, the probability of winning is 50%. You lose when brokerage fees are factored in.
In gambling, losing probability is >95%
Definition of investing:
An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.
As in most countries, those people who call themselves “investors” are not investors at all. They are speculators. In the short run, particularly while capital markets are rapidly developing, speculators may be able to earn high returns by rapidly trading stocks without doing thorough analysis. But in the long run, you cannot earn sustainably high returns from mere “gut feelings.”
People like to speculate because they become addicted to their own belief that they are about to make money. And when they do make some money, they turn greedy as their actions have been justified by a positive result. In terms of brain chemistry, the anticipation of profits activates the dopamine system in the brain, flooding our neurons with a signal of excitement.
Greed is generated in the same regions of the brain that produce pleasure when we find food or shelter or love. These basic reward circuits are among the oldest systems in the human brain.
Geniuses have them, too. Brilliant people are better at generating great ideas than the rest, but they are no better at controlling their own emotions than you or I.
Luck has a great deal to do with it. Whenever a stock trades, the buyer thinks the seller is making a mistake. The seller thinks the buyer is mistaken. Only one of them can be right. After they both pay their dealing costs and any taxes on the transaction, neither may show any net profit for his pains. In the short run, almost anyone can be right a few times in a row, by luck alone. Even in the long run, luck can rule the day. It can take years, even decades, to determine whether an investor has genuine and repeatable skill or is just lucky. The danger comes when you believe you are skillful and, in fact, you turn out to be merely lucky.
If one do not put policies and procedures in place, in advance, to control one's emotions, one will never be able to resist the siren song of the markets when the markets go mad. Common sense and good judgment are vastly more valuable than intelligence.
What is the difference between investing, speculating and gambling?
Ans:
In investing, the probability of winning is >90%
In speculating, the probability of winning is 50%. You lose when brokerage fees are factored in.
In gambling, losing probability is >95%
Definition of investing:
An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.
As in most countries, those people who call themselves “investors” are not investors at all. They are speculators. In the short run, particularly while capital markets are rapidly developing, speculators may be able to earn high returns by rapidly trading stocks without doing thorough analysis. But in the long run, you cannot earn sustainably high returns from mere “gut feelings.”
People like to speculate because they become addicted to their own belief that they are about to make money. And when they do make some money, they turn greedy as their actions have been justified by a positive result. In terms of brain chemistry, the anticipation of profits activates the dopamine system in the brain, flooding our neurons with a signal of excitement.
Greed is generated in the same regions of the brain that produce pleasure when we find food or shelter or love. These basic reward circuits are among the oldest systems in the human brain.
Geniuses have them, too. Brilliant people are better at generating great ideas than the rest, but they are no better at controlling their own emotions than you or I.
Luck has a great deal to do with it. Whenever a stock trades, the buyer thinks the seller is making a mistake. The seller thinks the buyer is mistaken. Only one of them can be right. After they both pay their dealing costs and any taxes on the transaction, neither may show any net profit for his pains. In the short run, almost anyone can be right a few times in a row, by luck alone. Even in the long run, luck can rule the day. It can take years, even decades, to determine whether an investor has genuine and repeatable skill or is just lucky. The danger comes when you believe you are skillful and, in fact, you turn out to be merely lucky.
If one do not put policies and procedures in place, in advance, to control one's emotions, one will never be able to resist the siren song of the markets when the markets go mad. Common sense and good judgment are vastly more valuable than intelligence.
Thursday, February 28, 2008
No coffee for 3.5hrs
Yesterday, Starbucks closed all its 7100 company-operated outlets across the US for 3.5hrs to retrain its 135K employees on the proper method of handling breverage tasks. A business analysts said it made sense to address training issues in one mass session because its shares are 50% lower since late 2006.
WHAT CRAP!!
Firstly, employees come and go. Training should be a continuous process. All employees should take the training seriously.
Secondly, just because the share price fell by 50% so we should have a mass training to clear all errors and discrepancy is similar to saying that we should cut cost and improve business efficiency after the share price performed poorly.
Personally, i will look at companies differently if they can
--- train its employees properly
--- cut cost when it should
--- look for ways to improve business efficiency
on a daily basis!!!!
Quote of the day:
Whenever you find yourself on the side of the majority, its time to pause and reflect (M-Twain)
WHAT CRAP!!
Firstly, employees come and go. Training should be a continuous process. All employees should take the training seriously.
Secondly, just because the share price fell by 50% so we should have a mass training to clear all errors and discrepancy is similar to saying that we should cut cost and improve business efficiency after the share price performed poorly.
Personally, i will look at companies differently if they can
--- train its employees properly
--- cut cost when it should
--- look for ways to improve business efficiency
on a daily basis!!!!
Quote of the day:
Whenever you find yourself on the side of the majority, its time to pause and reflect (M-Twain)
Tuesday, February 12, 2008
Realization-of-value problem
What kind of business do you want to own? Investors out there know that identifying what to invest in is a mind-challenging event. There is no better reward than seeing our money appreciate based on our own decisions and conviction. We are taught by the grandmasters (Buffett, Fisher) that one should only invest in businesses that have superior economics and selling for the right price. But what is a desirable purchase?
There is no business that is perpetually bad. Stock prices do not go down forever. With that in mind, most businesses were possible candidates for investment as long as they are selling at a bargain price. Through calculations, one could find out the intrinsic value of any business and if their stock price falls below that value, we should buy it to add into our portfolio. In this way, we wouldn’t be too concerned with the nature of the business we are buying. Simple isn’t it. A portfolio of such stocks can be built up based on the belief that someday the price will rise to or above the stock’s intrinsic value.
However, investors with this investment strategy will face the realization-of-value problem. In short, what do you do if the stocks you bought continue to sell below their intrinsic value for many years? The magnitude of returns depends on time. If the realization of value doesn’t occur, every year that one waits, the projected annual compounding rate of return diminishes. And if it takes longer than a few years, one could even end up with an annual compounding rate that may be less than what one could get from bonds or other financial instruments.
In reality, many companies were incapable of being analysed and their intrinsic value could not be determined. Quantitative reasoning, though reflective of the quantitative side of a business, does not fully articulate what is happening in the business. Stable earnings may allow one to place an intrinsic value on a business, but they will not always indicate the nature of the business’s underlying economics.
One solution to this problem would be to identify a near term catalyst which will move the stock price up north, and to insist on a bigger margin of safety before the purchase.
There is no business that is perpetually bad. Stock prices do not go down forever. With that in mind, most businesses were possible candidates for investment as long as they are selling at a bargain price. Through calculations, one could find out the intrinsic value of any business and if their stock price falls below that value, we should buy it to add into our portfolio. In this way, we wouldn’t be too concerned with the nature of the business we are buying. Simple isn’t it. A portfolio of such stocks can be built up based on the belief that someday the price will rise to or above the stock’s intrinsic value.
However, investors with this investment strategy will face the realization-of-value problem. In short, what do you do if the stocks you bought continue to sell below their intrinsic value for many years? The magnitude of returns depends on time. If the realization of value doesn’t occur, every year that one waits, the projected annual compounding rate of return diminishes. And if it takes longer than a few years, one could even end up with an annual compounding rate that may be less than what one could get from bonds or other financial instruments.
In reality, many companies were incapable of being analysed and their intrinsic value could not be determined. Quantitative reasoning, though reflective of the quantitative side of a business, does not fully articulate what is happening in the business. Stable earnings may allow one to place an intrinsic value on a business, but they will not always indicate the nature of the business’s underlying economics.
One solution to this problem would be to identify a near term catalyst which will move the stock price up north, and to insist on a bigger margin of safety before the purchase.
Wednesday, February 6, 2008
Wednesday, January 16, 2008
Myth on decoupling
Recently there is much discussion on the decoupling theory between Asia and US markets. Unfortunately, it may all be a delusion. In fact, the powerful forces of globalisation make decoupling virtually impossible.
For an economy to technically decouple, it must satisfy three criteria. Firstly, it must have robust self-sustaining domestic demand - especially private consumption. Secondly, there has to be diversification in export goods and trade partners. Thirdly and more importantly, it must have policy autonomy - the ability to establish independent monetary, fiscal and currency policies.
Be aware that the slowing that has occurred in the US to date has really been in homebuilding, financial and automobile sector. These 3 sectors can be considered the main pillars of the US economy. The impending slowdown in the next three to six months will manifest in the consumer demand sector (evident from a miniscule private consumption 4Q07 forecast growth of 1%), which is America’s most global sector.
China is at the top of the external vulnerability chain. Its export sector, which rose to nearly 38% of GDP in 2006, surged at a 41% year-on-year rate in 1Q07.
A more critical point in the decoupling debate: the United States is China’s largest export market, accounting for 21% of exports. As the US economy slows, the biggest piece of China’s export dynamic is at risk.
The day will come when the rest of the world can escape the pull of the US$13.3 trillion US economy, especially when the BRIC nations mature. Until then, it is too soon to count the Americans out and the theory of decoupling will remain a case of hope over reality.
For an economy to technically decouple, it must satisfy three criteria. Firstly, it must have robust self-sustaining domestic demand - especially private consumption. Secondly, there has to be diversification in export goods and trade partners. Thirdly and more importantly, it must have policy autonomy - the ability to establish independent monetary, fiscal and currency policies.
Be aware that the slowing that has occurred in the US to date has really been in homebuilding, financial and automobile sector. These 3 sectors can be considered the main pillars of the US economy. The impending slowdown in the next three to six months will manifest in the consumer demand sector (evident from a miniscule private consumption 4Q07 forecast growth of 1%), which is America’s most global sector.
China is at the top of the external vulnerability chain. Its export sector, which rose to nearly 38% of GDP in 2006, surged at a 41% year-on-year rate in 1Q07.
A more critical point in the decoupling debate: the United States is China’s largest export market, accounting for 21% of exports. As the US economy slows, the biggest piece of China’s export dynamic is at risk.
The day will come when the rest of the world can escape the pull of the US$13.3 trillion US economy, especially when the BRIC nations mature. Until then, it is too soon to count the Americans out and the theory of decoupling will remain a case of hope over reality.
Forward looking in Y2008
Everyone seems to be talking about recession these days. But as far as investing is concerned, the 'R' word just doesn't matter. Why? Let me explain. By definition, a recession can only be confirmed after 2 consecutive quarters in which "real" GDP (adjusted for inflation) declines. So normally, the public will only know that they are in a recession 6 months after it started. At that time, it will be too late to pull out your money from equities.
Basically, successful investing is about having foresight. Search for business that have a high probability of continuing their growth and cash flow regardless of economic conditions. If you are not convinced, look at the price chart (attached picture) of the company called Whole Food. Besides that, one should also be on the lookout for corporate actions that are potential catalysts which will propel the stock price higher. To achieve excellent returns in Y2008, strong stock-picking acumen is needed. You can no longer rely on a rising tide to lift all boats.
Basically, successful investing is about having foresight. Search for business that have a high probability of continuing their growth and cash flow regardless of economic conditions. If you are not convinced, look at the price chart (attached picture) of the company called Whole Food. Besides that, one should also be on the lookout for corporate actions that are potential catalysts which will propel the stock price higher. To achieve excellent returns in Y2008, strong stock-picking acumen is needed. You can no longer rely on a rising tide to lift all boats.
Sunday, December 30, 2007
Saying no to SUNEAST
A few months ago, i found some "advertisements" on the listed company SUNEAST on various online forums and decided to take a closer look on the company's financial reports and news announcements. In early november, I sent out an email to their CFO, with the aim of clearing some of my doubts after doing my own analysis. But unfortunately, till now, no reply has been forthcoming. So much for transparency and investor relations. Below is the entire content of my email.
Hi Ms Jennifer Shum,
As a retail investor, I am currently doing some analysis on Suneast before taking any investment position. While going through the company's financial reports and news announcements, I have the following questions. As such, I hope that you are able to address my doubts.
Q1) The 51% acquisition of NuXD was completed on Feb 2007 for HK$60 million. According to the 2 nd quarter financial results, the group has cash holding of HK$105 million as at 31st Dec 2006. Can you explain why Suneast choose not to use its cash holding for the acquisition but instead opt to undertake a fund raising exercise through the issuance of US$15 million worth of secured floating rate notes to Deutsche Bank and thus incurring an effective interest rate of 13.5% at inception?
Q2) In the 2007 annual report, I have extracted the following statement from the chairman's message from page 4: "The results of its efforts have been very encouraging. Cruiser is today one of the leading ready-to-drink brand in Taiwan. Similarly, since NuXD took over the sales and marketing of Coors Light in 2006, it has become one of the best selling beers in Taiwan's entertainment outlets." Can you provide the evidence from an independent market research firm to back up the above statement?
Q3) Can you justify the need to have a pre-payment of HK$179 million for advertising and promotion activities?
Q4) On page 72 of the annual report, the fair value of the exclusive distribution rights in NuXD is stated to be HK$120 million. Can you explain how Suneast arrived at this figure? Any independent valuation done?
Q5) Suneast obtained an unsecured bank loan of HK$35 million for FY07. As I see it, there is ample cash holding on the balance sheet. Can you justify the need for this bank loan?
Regards
With the above questions in mind, i would not recommend SUNEAST even though the share price is low. One big negative point on the company is that the management has decided to change its business focus just one year into its IPO. I welcome those vested to provide answers to the above questions and convince me why the shares are worth buying.
Hi Ms Jennifer Shum,
As a retail investor, I am currently doing some analysis on Suneast before taking any investment position. While going through the company's financial reports and news announcements, I have the following questions. As such, I hope that you are able to address my doubts.
Q1) The 51% acquisition of NuXD was completed on Feb 2007 for HK$60 million. According to the 2 nd quarter financial results, the group has cash holding of HK$105 million as at 31st Dec 2006. Can you explain why Suneast choose not to use its cash holding for the acquisition but instead opt to undertake a fund raising exercise through the issuance of US$15 million worth of secured floating rate notes to Deutsche Bank and thus incurring an effective interest rate of 13.5% at inception?
Q2) In the 2007 annual report, I have extracted the following statement from the chairman's message from page 4: "The results of its efforts have been very encouraging. Cruiser is today one of the leading ready-to-drink brand in Taiwan. Similarly, since NuXD took over the sales and marketing of Coors Light in 2006, it has become one of the best selling beers in Taiwan's entertainment outlets." Can you provide the evidence from an independent market research firm to back up the above statement?
Q3) Can you justify the need to have a pre-payment of HK$179 million for advertising and promotion activities?
Q4) On page 72 of the annual report, the fair value of the exclusive distribution rights in NuXD is stated to be HK$120 million. Can you explain how Suneast arrived at this figure? Any independent valuation done?
Q5) Suneast obtained an unsecured bank loan of HK$35 million for FY07. As I see it, there is ample cash holding on the balance sheet. Can you justify the need for this bank loan?
Regards
With the above questions in mind, i would not recommend SUNEAST even though the share price is low. One big negative point on the company is that the management has decided to change its business focus just one year into its IPO. I welcome those vested to provide answers to the above questions and convince me why the shares are worth buying.
Tuesday, December 18, 2007
A proposal to Hotung
I have been a shareholder of hotung for slightly more than a year. But for the past few years, the share price was consistently trading at huge discount to its net asset value. I believe the time is ripe for the management to address this problem. As such, i have sent out an email to Hotung last week outlining my proposal. Below is the entire content of the email.
Dear Management Team of Hotung Investment Holdings Limited,
As a current shareholder of Hotung which is listed in Singapore, I fully appreciate the efforts put in by the management team in the past few years to turn the company around to profitability. For many years the share price of Hotung has not reflected its true value and since fiscal year 2007 is drawing to a close, I would like to take this opportunity to recommend a proposal which the management can consider.
Proposal: To change the trading currency of Hotung shares from USD (United States Dollar) to SGD (Singapore Dollar).
Below are my reasons for the proposal:
1) The USD (United States Dollar) will be on a general downtrend in the foreseeable future due to the various economic problems and interest rate cuts.
2) The change in trading currency will enhance liquidity of the counter as it removes the necessity and cost of foreign exchange conversion. With easier settlement of trades, retail investors, in particular, will find it more convenient to trade in Hotung shares.
3) By denominating the shares in SGD (Singapore Dollar), the potential pool of institutional investors may expand as several funds and insurance companies in Singapore, which are permitted to invest only in SGD-denominated stocks, can now consider Hotung as an investment option.
In reality, there are many factors that caused Hotung's share price to stay low which we may not know of. However, for a start, the management can take a pro-active step to improve the conditions and reduce the uncertain variables on which the shares are traded. In my humble opinion, a change of trading currency is the way forward at this moment.
Yours sincerely
Dear Management Team of Hotung Investment Holdings Limited,
As a current shareholder of Hotung which is listed in Singapore, I fully appreciate the efforts put in by the management team in the past few years to turn the company around to profitability. For many years the share price of Hotung has not reflected its true value and since fiscal year 2007 is drawing to a close, I would like to take this opportunity to recommend a proposal which the management can consider.
Proposal: To change the trading currency of Hotung shares from USD (United States Dollar) to SGD (Singapore Dollar).
Below are my reasons for the proposal:
1) The USD (United States Dollar) will be on a general downtrend in the foreseeable future due to the various economic problems and interest rate cuts.
2) The change in trading currency will enhance liquidity of the counter as it removes the necessity and cost of foreign exchange conversion. With easier settlement of trades, retail investors, in particular, will find it more convenient to trade in Hotung shares.
3) By denominating the shares in SGD (Singapore Dollar), the potential pool of institutional investors may expand as several funds and insurance companies in Singapore, which are permitted to invest only in SGD-denominated stocks, can now consider Hotung as an investment option.
In reality, there are many factors that caused Hotung's share price to stay low which we may not know of. However, for a start, the management can take a pro-active step to improve the conditions and reduce the uncertain variables on which the shares are traded. In my humble opinion, a change of trading currency is the way forward at this moment.
Yours sincerely
Wednesday, December 12, 2007
TAX CUTS EXPLAINED (Just for laughs)
Let's put tax cuts in terms everyone can understand. Suppose that every day, ten men go out for beer and the bill for all ten comes to $100.
If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that's what they decided to do.
The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Because you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80. The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?' They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer.
So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
"I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man," but he got $10!"
"Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"
"That's true!!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!"
"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
For those who understand, no explanation is needed.
For those who do not understand, no explanation is possible.
If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that's what they decided to do.
The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Because you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80. The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?' They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer.
So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
"I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man," but he got $10!"
"Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"
"That's true!!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!"
"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!
And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
For those who understand, no explanation is needed.
For those who do not understand, no explanation is possible.
Tuesday, December 4, 2007
Share buybacks
The following are some of the benefits of share buybacks.
1) They will allow Singapore companies to compete on more equal terms in international financial markets with foreign companies which are able to repurchase their shares.
2) Companies with excess cash can quickly and efficiently solve the problem by returning the excess funds to the shareholders.
3) A share repurchase by a listed company may have the effect of increasing the market price of the company's shares.
4) A share repurchase may promote a competitive price environment which will help to reduce uneconomic takeover activity by allowing a potential target company to quickly adjust to its debt equity ratio.
5) A share repurchase may allow a listed company to acquire small shareholdings, such as 'odd-lots', thus reducing the company's administrative overheads and allowing the relevant shareholders to sell without incurring material transaction costs.
6) A share repurchase may be useful in allowing companies to resolve disputes with dissenting members.
7) A share repurchase gives the company flexibility in setting or fine-tuning its capital structure.
Under Singapore law, no treasury stocks are allowed. Shares purchased or acquired are deemed cancelled and the rights and privileges attached to those cancelled shares expire.
Lastly, if the company is doing a share buyback, you can be sure that the company won’t go bankrupt in the next 6 months or so. It is against the law for an insolvent company to do a share buyback!
1) They will allow Singapore companies to compete on more equal terms in international financial markets with foreign companies which are able to repurchase their shares.
2) Companies with excess cash can quickly and efficiently solve the problem by returning the excess funds to the shareholders.
3) A share repurchase by a listed company may have the effect of increasing the market price of the company's shares.
4) A share repurchase may promote a competitive price environment which will help to reduce uneconomic takeover activity by allowing a potential target company to quickly adjust to its debt equity ratio.
5) A share repurchase may allow a listed company to acquire small shareholdings, such as 'odd-lots', thus reducing the company's administrative overheads and allowing the relevant shareholders to sell without incurring material transaction costs.
6) A share repurchase may be useful in allowing companies to resolve disputes with dissenting members.
7) A share repurchase gives the company flexibility in setting or fine-tuning its capital structure.
Under Singapore law, no treasury stocks are allowed. Shares purchased or acquired are deemed cancelled and the rights and privileges attached to those cancelled shares expire.
Lastly, if the company is doing a share buyback, you can be sure that the company won’t go bankrupt in the next 6 months or so. It is against the law for an insolvent company to do a share buyback!
Monday, November 26, 2007
The Minsky Moment
Hyman Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.
Today, with the markets in turmoil, his views are reverberating round the globe as economists and traders try to understand what's really happening. Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.
At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they've taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. This is likely to lead to a collapse of asset values. When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.
Little wonder why many analysts have agreed that we are in the midst of a Minsky moment, bordering on a Minsky meltdown. With more writedowns at the end of the year, be prepared for a nasty 2008.
Today, with the markets in turmoil, his views are reverberating round the globe as economists and traders try to understand what's really happening. Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.
At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they've taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. This is likely to lead to a collapse of asset values. When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.
Little wonder why many analysts have agreed that we are in the midst of a Minsky moment, bordering on a Minsky meltdown. With more writedowns at the end of the year, be prepared for a nasty 2008.
Tuesday, November 20, 2007
Stocks & Discount rate
Many people dismissed the Fed Reserve cut on discount rate lending to banks in the middle of August as a "last ditch symbolic gesture". At the end of that day, many stocks markets around the world went up. New research by US academics shows that the rise could have been predicted. Even though the study was done in the US markets, there is plently one can learn from.
This report, available from the CFA institute shows that the discount rate is a good indicator of the direction of monetary policy. When it changes direction, it signals a shift between the expansionary and restrictive monetary policy.
A strategy would then be to buy defensive stocks when the discount rate goes up. These are sectors (resources, utilities and consumer staples) not highly sensitive to the overall economy.
When there is a rate cut, the strategy would then be to buy cyclical stocks (financials, technology).
From 1973 to 2005, this crude strategy would have beaten the market by 3.78% a year. As such, the discount rate seems to be a powerful signal tool.
This report, available from the CFA institute shows that the discount rate is a good indicator of the direction of monetary policy. When it changes direction, it signals a shift between the expansionary and restrictive monetary policy.
A strategy would then be to buy defensive stocks when the discount rate goes up. These are sectors (resources, utilities and consumer staples) not highly sensitive to the overall economy.
When there is a rate cut, the strategy would then be to buy cyclical stocks (financials, technology).
From 1973 to 2005, this crude strategy would have beaten the market by 3.78% a year. As such, the discount rate seems to be a powerful signal tool.
Sunday, November 18, 2007
Agape love
Probably the biggest reason the dog has become man's best friend is because we know that when it comes to love, a dog can always outdo us. The highest form of love, agape love, which is completely unconditional, is something that people often have to work at or grow into. Agape love seems to come naturally between parent and child, but it's more difficult between husband and wife, and harder still between friends. To love someone regardless of what wrongs they have done you is very difficult for humans.
A dog, however, is born with an endless capacity for agape love, and doesn't even have to work at it. You can be a complete grouch, ignore your dog, and refuse him your love. When you decide you're ready to be sociable again, your dog doesn't pay you back by ignoring you too. He's just happy you're there. More amazing still, is that the love that dogs and owners feel for each other lasts a lifetime. This is the ideal love humans strive for, but often fail at.
Learning to know somebody intimately is often the beginnings of dislike, sometimes even of contempt. However, dogs never lie about love. Among humans, love often does not survive a growing acquaintance, but in a dog, love seems to grow with acquaintance, to get stronger, deeper. Even when fully acquainted with all our weaknesses, our treachery, our unkindness, the dog seems to love strongly and this love is returned by most dog-loving humans. We, too, seem to love our dogs the more we get to know them. The bond grows between us and our dogs.
This is why we need dogs. They do something for us that rarely a human companion can do. No matter how much you mess up your life, or how much wrong you do, no matter how many mistakes you make or how often you make them, regardless of your looks, income or social standing, your dog never judges you. He always thinks you are wonderful and loves you with all his heart.
A dog, however, is born with an endless capacity for agape love, and doesn't even have to work at it. You can be a complete grouch, ignore your dog, and refuse him your love. When you decide you're ready to be sociable again, your dog doesn't pay you back by ignoring you too. He's just happy you're there. More amazing still, is that the love that dogs and owners feel for each other lasts a lifetime. This is the ideal love humans strive for, but often fail at.
Learning to know somebody intimately is often the beginnings of dislike, sometimes even of contempt. However, dogs never lie about love. Among humans, love often does not survive a growing acquaintance, but in a dog, love seems to grow with acquaintance, to get stronger, deeper. Even when fully acquainted with all our weaknesses, our treachery, our unkindness, the dog seems to love strongly and this love is returned by most dog-loving humans. We, too, seem to love our dogs the more we get to know them. The bond grows between us and our dogs.
This is why we need dogs. They do something for us that rarely a human companion can do. No matter how much you mess up your life, or how much wrong you do, no matter how many mistakes you make or how often you make them, regardless of your looks, income or social standing, your dog never judges you. He always thinks you are wonderful and loves you with all his heart.
Thursday, November 8, 2007
LMA - Caution needed
The price of LMA went to a low of $0.35 recently after the profit guidance announcement. For those who bought at $0.35, well done. I suppose there will be a rebound after the initial shock. However, i would urge caution for investors who feel that it is a good buy at current price due to low P/E or low price to cash flow or other financial ratios.
The point i want to make is on the qualitative aspect of the company.
1) For those who bother to read up on the IPO prospectus again, you will find that the IPO is actually an exit strategy for many of its pre-IPO investors. Nearly 90% of the shares offered are from the selling vendors. Ask yourself why the pre-IPO investors want to cash out from a company holding patents of a widely used product?
2) Potential Conflicts of Interest.
The relationship between Venner, Mr. Gaines-Cooper and Mrs. Gaines-Cooper are described in "Management—Arrangements or Understandings.” In addition, a number of our Directors are directors of companies which supply or manufacture our Products. Mr. Gaines-Cooper, Mrs. Gaines-Cooper and Mr. Curtis-Bennett are directors of Venner Trading and FMT. Mr. Gaines-Cooper is a director of Venner Singapore. The info above is taken from the IPO prospectus but they still exist till today.
3) Low sustainable competitive advantage in LMA's patent.
The original master patent relating to the basic design of the LMA-Classic™ airway device and the later single-use version of it, the LMA-Unique™ airway device, expired in December 2002. However, LMA hold or have applied for patents for features in their products.They include the aperture bars in use on the LMA-Classic™, LMAProSeal™ and LMA-Flexible™ devices and the LMA-Fastrach™ handle. Our aperture bar patent protection does not extend to the United States. In my opinion, the patents are not valuable as the competitors can always substitute the features will something else. In short, expiration of patents + low technology product will cause an influx of competitors. Sad to say, the airway product is no longer exclusive. It is becoming a commodity and thus, usually the company with the lowest cost will survive.
4) Over the years, LMA has spent a sizeable amount of cash to buy innovative products, intellectual property rights and distribution companies in its bid to boost the earnings. Please look at my earlier posting to understand why we should generally avoid companies with continued capital investments.
Cheers!
The point i want to make is on the qualitative aspect of the company.
1) For those who bother to read up on the IPO prospectus again, you will find that the IPO is actually an exit strategy for many of its pre-IPO investors. Nearly 90% of the shares offered are from the selling vendors. Ask yourself why the pre-IPO investors want to cash out from a company holding patents of a widely used product?
2) Potential Conflicts of Interest.
The relationship between Venner, Mr. Gaines-Cooper and Mrs. Gaines-Cooper are described in "Management—Arrangements or Understandings.” In addition, a number of our Directors are directors of companies which supply or manufacture our Products. Mr. Gaines-Cooper, Mrs. Gaines-Cooper and Mr. Curtis-Bennett are directors of Venner Trading and FMT. Mr. Gaines-Cooper is a director of Venner Singapore. The info above is taken from the IPO prospectus but they still exist till today.
3) Low sustainable competitive advantage in LMA's patent.
The original master patent relating to the basic design of the LMA-Classic™ airway device and the later single-use version of it, the LMA-Unique™ airway device, expired in December 2002. However, LMA hold or have applied for patents for features in their products.They include the aperture bars in use on the LMA-Classic™, LMAProSeal™ and LMA-Flexible™ devices and the LMA-Fastrach™ handle. Our aperture bar patent protection does not extend to the United States. In my opinion, the patents are not valuable as the competitors can always substitute the features will something else. In short, expiration of patents + low technology product will cause an influx of competitors. Sad to say, the airway product is no longer exclusive. It is becoming a commodity and thus, usually the company with the lowest cost will survive.
4) Over the years, LMA has spent a sizeable amount of cash to buy innovative products, intellectual property rights and distribution companies in its bid to boost the earnings. Please look at my earlier posting to understand why we should generally avoid companies with continued capital investments.
Cheers!
Monday, November 5, 2007
Quotes on statistics
Information is just signs and numbers, while knowledge involves their meaning. What we want is knowledge, but what we get is information. (Heinz R. Pagels)
There are two kinds of statistics, the kind you look up and the kind you make up. (Rex Todhunter Stout)
He uses statistics as a drunken man uses lampposts - for support rather than for illumination. (Andrew Lang)
Statistics, like veal pies, are good if you know the person that made them, and are sure of the ingredients. (Harvard President Lawrence Lowell)
There are two kinds of statistics, the kind you look up and the kind you make up. (Rex Todhunter Stout)
He uses statistics as a drunken man uses lampposts - for support rather than for illumination. (Andrew Lang)
Statistics, like veal pies, are good if you know the person that made them, and are sure of the ingredients. (Harvard President Lawrence Lowell)
Saturday, October 27, 2007
Why you should not trade unit trust.
The following conclusion was reached according to the Dalbar Study, which originated in 1995 in the United States, to determine the profitability of trading for the small investor of mutual funds (unit trusts).
An investor who bought an S&P 500 index fund would have earned 11.9% annually for the twenty years from 1986 through 2005. The average equity investor, however, earned a 3.9% annual return. Investors who hold their investments have the potential for greater success than those who try to “time” the market.
The Buy & Holders will love the results as it "proves" that buying and holding is better than trying to switch to so-called "hot" funds. However, one should not just buy and hold mindlessly.
There are a few reasons for the underperformance of the average equity investor:
1) Investors poured money into recent "hot" funds after hearing and seeing huge gains.
2) The fund managers are then unable to successfully invest the large cash inflows.
3) Investors selling away the funds after a few quarters of tepid performance.
To improve one's chances of coming out on top, my recommendation is to buy a low cost passive fund. Not to mention returns, a high cost fund will immediately burn a hole in your pocket.
An investor who bought an S&P 500 index fund would have earned 11.9% annually for the twenty years from 1986 through 2005. The average equity investor, however, earned a 3.9% annual return. Investors who hold their investments have the potential for greater success than those who try to “time” the market.
The Buy & Holders will love the results as it "proves" that buying and holding is better than trying to switch to so-called "hot" funds. However, one should not just buy and hold mindlessly.
There are a few reasons for the underperformance of the average equity investor:
1) Investors poured money into recent "hot" funds after hearing and seeing huge gains.
2) The fund managers are then unable to successfully invest the large cash inflows.
3) Investors selling away the funds after a few quarters of tepid performance.
To improve one's chances of coming out on top, my recommendation is to buy a low cost passive fund. Not to mention returns, a high cost fund will immediately burn a hole in your pocket.
Sunday, October 21, 2007
What is synergy?
Mergers and acquisitions are arguably the most popular and influential form of discretionary business investment. Synergy is a word often found in the press release of the reasons given by the acquirer when they bought over another company. Like a major R&D project or plant expansion, acquisitions are a capital budgeting decision. Stripped to the essentials, an acquisition is a purchase of assets and technologies. But usually, the acquirer often pay a premium over the stand alone market value of these assets and technologies. They pay for something called synergy.
The common definition of synergy is 2 + 2 = 5. However, the accurate definition should be increases in competitiveness and resulting cashflow beyond what the 2 companies are expected to accomplish independently. It can simply be modeled as:
NPV = synergy - premium
From the above formula, one can understand why the share price of the acquirer usually drops after the announcement. If a high premium was paid, the net present value of the assets and technologies gained will be negative if the expected synergy did not occur. According to a McKinsey study, more than 60% of the the acquisition programs were failures because the acquisition strategies did not earn a sufficient return on the funds invested. Companies that do not understand this fundamental fact risk falling into the synergy trap.
Quote of the day
The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do. A too high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favourable business developments.
------- Warren Buffett (1982 annual report)
The common definition of synergy is 2 + 2 = 5. However, the accurate definition should be increases in competitiveness and resulting cashflow beyond what the 2 companies are expected to accomplish independently. It can simply be modeled as:
NPV = synergy - premium
From the above formula, one can understand why the share price of the acquirer usually drops after the announcement. If a high premium was paid, the net present value of the assets and technologies gained will be negative if the expected synergy did not occur. According to a McKinsey study, more than 60% of the the acquisition programs were failures because the acquisition strategies did not earn a sufficient return on the funds invested. Companies that do not understand this fundamental fact risk falling into the synergy trap.
Quote of the day
The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do. A too high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favourable business developments.
------- Warren Buffett (1982 annual report)
Sunday, October 7, 2007
What drives the stock market?(2)
Behavioral-finance theory holds that markets might fail to reflect economic fundamentals under three conditions. When all three apply, the theory predicts that pricing biases in financial markets can be both significant and persistent.
Irrational behavior.
Investors behave irrationally when they don't correctly process all the available information while forming their expectations of a company's future performance. Studies have shown that investors often put too much weightage and focus on recent events and results, regardless of the level of significance. This is an error that leads them to overprice companies with strong recent performance. Others are excessively conservative and underprice stocks of companies that have released positive news. Similarly, stock prices of companies tend to get oversold after 1 or 2 quarters of weak financial earnings.
Systematic patterns of behavior.
Even if individual investors decided to buy or sell without consulting economic fundamentals, the impact on share prices would still be limited. Only when their irrational behavior is also systematic (that is, when large groups of investors share particular patterns of behavior) should persistent price deviations occur. Hence behavioral-finance theory argues that patterns of overconfidence, overreaction, and overrepresentation are common to many investors and that such groups can be large enough to prevent a company's share price from reflecting underlying economic fundamentals—at least for some stocks, some of the time.
Limits to arbitrage in financial markets.
When investors assume that a company's recent strong performance alone is an indication of future performance, they may start bidding for shares and drive up the price. Some investors might expect a company that surprises the market in one quarter to go on exceeding expectations. As long as enough other investors notice this myopic overpricing and respond by taking short positions, the share price will fall in line with its underlying indicators.
However, this sort of arbitrage doesn't always occur. In practice, the costs, complexity, and risks involved in setting up a short position can be too high for individual investors, especially in singapore market, where the terms and conditions do not favour the short-sellers.
Irrational behavior.
Investors behave irrationally when they don't correctly process all the available information while forming their expectations of a company's future performance. Studies have shown that investors often put too much weightage and focus on recent events and results, regardless of the level of significance. This is an error that leads them to overprice companies with strong recent performance. Others are excessively conservative and underprice stocks of companies that have released positive news. Similarly, stock prices of companies tend to get oversold after 1 or 2 quarters of weak financial earnings.
Systematic patterns of behavior.
Even if individual investors decided to buy or sell without consulting economic fundamentals, the impact on share prices would still be limited. Only when their irrational behavior is also systematic (that is, when large groups of investors share particular patterns of behavior) should persistent price deviations occur. Hence behavioral-finance theory argues that patterns of overconfidence, overreaction, and overrepresentation are common to many investors and that such groups can be large enough to prevent a company's share price from reflecting underlying economic fundamentals—at least for some stocks, some of the time.
Limits to arbitrage in financial markets.
When investors assume that a company's recent strong performance alone is an indication of future performance, they may start bidding for shares and drive up the price. Some investors might expect a company that surprises the market in one quarter to go on exceeding expectations. As long as enough other investors notice this myopic overpricing and respond by taking short positions, the share price will fall in line with its underlying indicators.
However, this sort of arbitrage doesn't always occur. In practice, the costs, complexity, and risks involved in setting up a short position can be too high for individual investors, especially in singapore market, where the terms and conditions do not favour the short-sellers.
Monday, October 1, 2007
What drives the stock market?(1)
As stock markets around the world are into the bull mode, investors have been asking the themselves the above question. During the past few decades, the academic theory brought forward was that financial markets accurately reflect a stock's underlying value. But lately, the view that investors can fundamentally change a market's course through irrational decisions has been moving into the mainstream.
With the exuberance of the high-tech stock bubble and the crash of the late 1990s still fresh in investors' memories, adherents of the behaviorist school are finding it easier than ever to spread the belief that markets can be something less than efficient in immediately distilling new information and that investors, driven by emotion and greed, can indeed lead markets awry. Some behaviorists would even assert that stock markets lead lives of their own, detached from economic growth and business profitability. A number of finance scholars and practitioners have argued that stock markets are not efficient—that is, that they don't necessarily reflect economic fundamentals. According to this point of view, significant and lasting deviations from the intrinsic value of a company's share price occur in market valuations.
Most agreed that behavioral finance offers some valuable insights—chief among them the idea that markets are not always right, since rational investors can't always correct for mispricing by irrational ones. In fact, significant deviations from intrinsic value are rare, and markets usually revert rapidly to share prices commensurate with economic fundamentals. Therefore, investors and managers should continue to use the tried-and-true analysis of a company's discounted cash flow to make their valuation decisions.
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