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.
Monday, March 24, 2008
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.
Tuesday, September 25, 2007
Situations for outperformance
Many variables, including economic cycles and degrees of market saturation, help a company to enter the top stratum and remain there. What follows is a closer look at four ways companies outperformed the market’s returns to investors. Even the most successful large companies aren’t likely to outperform over time if they don’t find themselves in one of these situations.Perfecting the business model
Some companies held onto their top positions for at least a decade by continuing to perfect the business model that made them initially successful—and not going beyond it. This group includes a number of high-tech players, as well as retailers and pharmaceutical companies. For most, the core business was still in its high-growth phase thanks to one or more breakthrough products or services. Obviously, management plays a key role in guiding these businesses to innovate and to capture opportunities. But without the undercurrent of real growth in a segment, it becomes very challenging for even a strong management team to deliver outsized performance. Most companies come upon a big idea only once or twice in their entire existence. A global high-tech company, for example, has generated new ideas as its leading breakthrough products slowed down, but the new ones have had a much smaller impact on the overall business. Consequently, the company’s stock performance has lagged behind the market in the past five years. Very few companies have produced a steady stream of new and substantial growth opportunities by aggressively reshaping the business portfolio.
Extending the business model
A second group of companies (for example J&J, P&G), largely in consumer products and pharmaceuticals, outperformed the market by taking advantage of intangible assets such as brands or patents to increase their profit margins and returns on capital. But though owning strong intangible assets was a necessary condition for their performance, it was insufficient on its own. With that as their base, they differentiated themselves from competitors through strategic clarity and consistently strong execution.
As a result, these companies earned high and increasing returns on invested capital. The accumulation of strong brand capital enabled companies in this group to erect effective barriers to price-based competition—barriers that in turn helped them improve their margins constantly. This group of companies also appears to have grown, after adjusting for inflation, at a rate faster than the growth of GDP, probably by taking more market share from competitors.
Rising commodity prices
Many companies owe their sustained outperformance largely to increases in the price of whatever commodities they produce. The price of commodities, such as oil, steel, and commodity chemicals, in turn reflects a number of complex economic, political, and competitive factors beyond the control of most businesses. From the standpoint of fundamental performance, commodity producers do not necessarily stand out: their returns cover their cost of capital but not much more. Their margins remain steady, and their growth is on par with the expansion of real GDP. At the same time, their TRS performance can be volatile as commodity prices swing. The performance of companies in this group of commodity producers may differ widely as a result of the quality of their assets and, to a much lesser extent, of their operating strategies. Over a 40-year period, a majority of commodity players did not outperform the market.
Turning around large underperformers
A small group of companies managed to outperform the market over a decade by dramatically improving their hitherto poor operations. These companies, from diverse industries, regained their vigor after a prolonged period of suboptimal performance and margin erosion. Against the backdrop of low market expectations, their operating margins and returns on capital improved substantially—often under the leadership of new managers—which led to better-than-market returns. For this group, revenue and profit growth tended to be lackluster.
Sunday, September 23, 2007
Big round china bubble and more
For those contemplating to put in more money or start investing in China funds, please read up on the following link.
http://www.webb-site.com/articles/incredibubble.htm
"This time is different." How many times have you heard that? As an investor, you should be aware that those are the four most dangerous words.
Walk away and ignore it every time you hear this. This time is never different, at least not in the context of economic and stock market cycles.
Asset bubbles and debt crises are as old as international lending. But I don't think we are going to have to wait too long for the next one.
The bull market of the past few years are driven mainly by excess liquidity. Yes, rich-country interest rates are still stunningly low, even allowing for global disinflation. Craving higher returns, global-portfolio funds are increasingly washing up on the shores of distant emerging markets. With growing world demand once again soaking up emerging-market exports, and with low interest rates making debt finance easy, debtor countries have the best of both worlds. But it is not going to last.
Investors ought to realize that last year's 30-40% average return on emerging-market equities was an aberration. Such explosive returns will not be repeated on a yearly basis. As all prices get higher, squeezing out similar returns will only get exponentially tougher.
http://www.webb-site.com/articles/incredibubble.htm
"This time is different." How many times have you heard that? As an investor, you should be aware that those are the four most dangerous words.
Walk away and ignore it every time you hear this. This time is never different, at least not in the context of economic and stock market cycles.
Asset bubbles and debt crises are as old as international lending. But I don't think we are going to have to wait too long for the next one.
The bull market of the past few years are driven mainly by excess liquidity. Yes, rich-country interest rates are still stunningly low, even allowing for global disinflation. Craving higher returns, global-portfolio funds are increasingly washing up on the shores of distant emerging markets. With growing world demand once again soaking up emerging-market exports, and with low interest rates making debt finance easy, debtor countries have the best of both worlds. But it is not going to last.
Investors ought to realize that last year's 30-40% average return on emerging-market equities was an aberration. Such explosive returns will not be repeated on a yearly basis. As all prices get higher, squeezing out similar returns will only get exponentially tougher.
Wednesday, September 12, 2007
Why some companies belong to grade AAA.
Fact: Only 9 out of 1,077 (less than 1%) large global companies outperformed their competitors on both revenue growth and profitability over a decade, a McKinsey study finds—confirming that such strong performance is rare.
Characteristics that made the 9 companies outperform:
First, the top nine performers strongly preferred organic growth: they made few acquisitions and divestitures when compared with other companies in their industries. Further, none of the deals these companies made were transformational; that is, no divestiture or acquisition had a value exceeding 30 percent of their market capitalization in the year before the deal.
Second, it was found that all nine companies had higher market-to-book ratios than their competitors did. (The M/B ratio is a measure of corporate performance that compares a company’s market cap with its book value.) In fact, these top performers logged M/B ratios more than two times higher than those of poor and average performers, as well as 25 percent or more higher than those of companies that excelled at either revenue growth or profitability, but not both. These findings indicate that the nine companies rely on intangible assets more than the rest do. Their ability to generate value from knowledge-intensive intangibles (such as copyrights, trade secrets, or strong brands) represents a good starting point for further exploration of their superior performance.
Characteristics that made the 9 companies outperform:
First, the top nine performers strongly preferred organic growth: they made few acquisitions and divestitures when compared with other companies in their industries. Further, none of the deals these companies made were transformational; that is, no divestiture or acquisition had a value exceeding 30 percent of their market capitalization in the year before the deal.
Second, it was found that all nine companies had higher market-to-book ratios than their competitors did. (The M/B ratio is a measure of corporate performance that compares a company’s market cap with its book value.) In fact, these top performers logged M/B ratios more than two times higher than those of poor and average performers, as well as 25 percent or more higher than those of companies that excelled at either revenue growth or profitability, but not both. These findings indicate that the nine companies rely on intangible assets more than the rest do. Their ability to generate value from knowledge-intensive intangibles (such as copyrights, trade secrets, or strong brands) represents a good starting point for further exploration of their superior performance.
Sunday, September 2, 2007
Companies to avoid
People spend a lot of time discussing what companies to buy. But in the spirit of not losing money, it's equally worthwhile to understand the types of businesses that we investors should steer clear. At this moment, there are 5 main categories:
1. Businesses that rely on some fad or sexy growth stories and no cashflow.
Sometimes, share price of a company goes up because the management is touting a new technology or painting a rosy picture over their business prospects. Investors take in the stories and chase up the prices. In all cases, it will be wise for investors to dig for more information before commiting their money. Looking at the cashflow the company can generate is one of the trick. Personally, i will avoid if the company cannot have positive cashflow regardless how glowing the prospects are. These are growth stories without any substance. Also, after promising so much, if the financial results do not improve sufficiently, the share price will be dealt a crippling blow.
2. Businesses dependent on research
It's quite reasonable to believe that research can be a competitive advantage for certain companies. Nevertheless, there is an obvious downside to research. Often, innovative companies are required to do research simply to maintain their competitive position. And if the research dries up, the company suffers.
For instance, consider the plight of Creative. Early on, Creative has had impressive periods of earnings growth because of new breakthrough products and promising future developments. But since the bursting of the internet bubble, it has been on a downward spiral. The company has seen Mp3 player market share eroding in its ever present fight against Apple and earnings have suffered. Creative still produces fine products but the race to keep pace is costing shareholders money.
This is in stark contrast to a company like Diary Farm, which could develop nothing for a decade and still have a healthy business. While I don't think this is sufficient reason to sell off all your tech or biotech stocks, you can understand why certain legendary investors avoid such investments.
3. Debt-burdened companies
In general, one should avoid companies with a lot of debt. This makes sense. During the best of times, large amounts of debt mean that cash that could be put toward growing the business or rewarding shareholders is instead servicing the debt. In a crisis, debt greatly limits a company's options and can sometimes lead to bankruptcy.
A more subtle point is that great businesses throw off piles of cash. Great businesses generally don't need to use huge amounts of debt leverage to achieve an acceptable return for shareholders. So, if a company needs debt to achieve reasonable returns, it's less likely to be a great business.
4. Companies with questionable management
Management has incredible power as they often hold more than 50% of the stakes. If executives want to enrich themselves at the expense of shareholders, either directly or by misrepresenting the company's prospects, individual shareholders have almost no hope of stopping them. One should avoid companies where there's even a hint that management lacks integrity. Some clues to look for here include excessively optimistic press releases, overly generous compensation or options grants, and frequently blaming external circumstances for operational shortcomings.
5. Companies that require continued capital investment
Over the long term, shareholders make spectacular returns by buying businesses that are able to achieve extraordinary returns on capital. This leads to excess capital that the company can use to repurchase shares, pay a dividend to shareholders, or reinvest in further growth. Companies that constantly need to make additional capital investment to keep the business going are the antithesis of this ideal and the main beneficiaries will not be the shareholders.
1. Businesses that rely on some fad or sexy growth stories and no cashflow.
Sometimes, share price of a company goes up because the management is touting a new technology or painting a rosy picture over their business prospects. Investors take in the stories and chase up the prices. In all cases, it will be wise for investors to dig for more information before commiting their money. Looking at the cashflow the company can generate is one of the trick. Personally, i will avoid if the company cannot have positive cashflow regardless how glowing the prospects are. These are growth stories without any substance. Also, after promising so much, if the financial results do not improve sufficiently, the share price will be dealt a crippling blow.
2. Businesses dependent on research
It's quite reasonable to believe that research can be a competitive advantage for certain companies. Nevertheless, there is an obvious downside to research. Often, innovative companies are required to do research simply to maintain their competitive position. And if the research dries up, the company suffers.
For instance, consider the plight of Creative. Early on, Creative has had impressive periods of earnings growth because of new breakthrough products and promising future developments. But since the bursting of the internet bubble, it has been on a downward spiral. The company has seen Mp3 player market share eroding in its ever present fight against Apple and earnings have suffered. Creative still produces fine products but the race to keep pace is costing shareholders money.
This is in stark contrast to a company like Diary Farm, which could develop nothing for a decade and still have a healthy business. While I don't think this is sufficient reason to sell off all your tech or biotech stocks, you can understand why certain legendary investors avoid such investments.
3. Debt-burdened companies
In general, one should avoid companies with a lot of debt. This makes sense. During the best of times, large amounts of debt mean that cash that could be put toward growing the business or rewarding shareholders is instead servicing the debt. In a crisis, debt greatly limits a company's options and can sometimes lead to bankruptcy.
A more subtle point is that great businesses throw off piles of cash. Great businesses generally don't need to use huge amounts of debt leverage to achieve an acceptable return for shareholders. So, if a company needs debt to achieve reasonable returns, it's less likely to be a great business.
4. Companies with questionable management
Management has incredible power as they often hold more than 50% of the stakes. If executives want to enrich themselves at the expense of shareholders, either directly or by misrepresenting the company's prospects, individual shareholders have almost no hope of stopping them. One should avoid companies where there's even a hint that management lacks integrity. Some clues to look for here include excessively optimistic press releases, overly generous compensation or options grants, and frequently blaming external circumstances for operational shortcomings.
5. Companies that require continued capital investment
Over the long term, shareholders make spectacular returns by buying businesses that are able to achieve extraordinary returns on capital. This leads to excess capital that the company can use to repurchase shares, pay a dividend to shareholders, or reinvest in further growth. Companies that constantly need to make additional capital investment to keep the business going are the antithesis of this ideal and the main beneficiaries will not be the shareholders.
Thursday, August 16, 2007
On free lunch & active management
Inherent in asset allocation theory is that the best performing asset classes varies from year to year and it is not easily predictable. Therefore having a mixture of asset classes is likely to meet your goals. A more fundamental justification for asset allocation is the notion that different asset classes offer non-correlated returns. As such, this diversification reduces the overall risk in terms of the variability of returns for a given level of expected return. This is as close to a free lunch as you will get in the world of investing.
Some people think that active money management is a hoax or lure to quick riches, like gambling. IFA Harold Evensky sums it up pretty much when he says "to match the performance of a buy-and-hold (passive) portfolio, the active manager would have to be correct 70% of the time".
In short, he is saying that it's close to impossible for an active portfolio to beat a passive one. There are, however, some, exceptions. Consider Legg Mason's Bill Miller who beat the S&P Index for the last 15 years by posting a 16.2% return from 1990 to 2005. According to Bloomberg Magazine, this record puts Miller in the same league as Warren Buffett. The odds of finding this expert to manage your money are 1 in 2.5 million!
Some people think that active money management is a hoax or lure to quick riches, like gambling. IFA Harold Evensky sums it up pretty much when he says "to match the performance of a buy-and-hold (passive) portfolio, the active manager would have to be correct 70% of the time".
In short, he is saying that it's close to impossible for an active portfolio to beat a passive one. There are, however, some, exceptions. Consider Legg Mason's Bill Miller who beat the S&P Index for the last 15 years by posting a 16.2% return from 1990 to 2005. According to Bloomberg Magazine, this record puts Miller in the same league as Warren Buffett. The odds of finding this expert to manage your money are 1 in 2.5 million!
Wednesday, July 25, 2007
Level13 investor creed
Do not believe in anything simply because you have heard it. Do not believe in anything simply because it is spoken and rumored by many. Do not believe in anything merely on the authority of people who are above you. Do not believe in anything simply because it is found written in books. But after observation & analysis, when you find that anything agrees with reason and is conducive to the good and benefit of one and all, then accept it.
Wednesday, July 18, 2007
Just for laughs
Classic Definitions & Cool Meanings:
1. Conference : The confusion of one man multiplied by the number present.
2. Compromise : The art of dividing a cake in such a way that everybody believes he got the biggest piece.
3. Conference Room : A place where everybody talks, nobody listens & everybody disagrees later on.
4. Classic : A book which people praise, but do not read.
5. Office : A place where you can relax after your strenuous home life.
6. Etc. : A sign to make others believe that you know more than you actually do.
7. Committee: Individuals who can do nothing individually and sit to decide that nothing can be done together.
8. Experience : The name men give to their mistakes.
9. Philosopher : A fool who torments himself during life, to be spoken of when dead.
10. Diplomat : A person who tells you to go to hell in such a way that you actually look forward to the trip.
11. Miser : A person who lives poor so that he can die rich.
12. Father : A banker provided by nature.
13. Criminal : A guy no different from the rest... except that he got caught.
14. Boss : Someone who is early when you are late and late when you are early.
15. Politician : One who shakes your hand before elections and your Confidence after.
1. Conference : The confusion of one man multiplied by the number present.
2. Compromise : The art of dividing a cake in such a way that everybody believes he got the biggest piece.
3. Conference Room : A place where everybody talks, nobody listens & everybody disagrees later on.
4. Classic : A book which people praise, but do not read.
5. Office : A place where you can relax after your strenuous home life.
6. Etc. : A sign to make others believe that you know more than you actually do.
7. Committee: Individuals who can do nothing individually and sit to decide that nothing can be done together.
8. Experience : The name men give to their mistakes.
9. Philosopher : A fool who torments himself during life, to be spoken of when dead.
10. Diplomat : A person who tells you to go to hell in such a way that you actually look forward to the trip.
11. Miser : A person who lives poor so that he can die rich.
12. Father : A banker provided by nature.
13. Criminal : A guy no different from the rest... except that he got caught.
14. Boss : Someone who is early when you are late and late when you are early.
15. Politician : One who shakes your hand before elections and your Confidence after.
Monday, July 16, 2007
Raising capital at Contel
Contel Corporation Limited, a company listed in singapore. It is a ODM/OEM maker of digital media products, is driving its margin-focused business strategy on four fronts – revenue stream, product range, clientele, and geographical market reach.
Recently there are people who recommend me the stock due to its low P/E and high growth story.
However, I would urge caution at putting money into the company contel.
Below is the reason using the FY2006 annual report as reference.
It seems like contel is in urgent need of capital As shown in the annual report, it has US$6 million at the end of last year. To solve their problem, contel has issued convertible notes to Advance Opportunities Fund and collected S$26.5 million in the process. At first glance, it seems gd as contel does not need to pay interest on the notes. But it is clear that in the past months, Advance Opportunities Fund have converted all the notes into shares. So in short, they are actually raising funds through the issue of more new shares. Basically, the cost of capital is the highest for equities as compared to bank loans or bonds. An investor will expect 8-10% return in the long run for the shares.
My question is, why cant contel borrow S$26.5 million from the banks and pay the normal interest rate? With the conversion, there are now 417 million shares outstanding and the minority shareholders’ stakes are diluted.
However, the worst part is this:
Suppose Advance Opportunities Fund did not sell any of the shares after the conversion, it should be holding 167 million shares. With this amount of shares, it should be a substantial shareholder. However, I have yet to see any announcement of this nature!! This has led me to conclude that Advance Opportunities Fund has been selling away the shares that it converted in the open market so that it will always hold less than 5% stake at any one time. Seems that Advance Opportunities Fund is not too eager to hold on to the shares.
The historical P/E for the company at the current price of $0.24 is about 4. This value is quite low and i believe that is the part attractive to investors.
But one have to understand that for this low P/E story to hold, contel have to grow its bottomline by 20% or more. Below is a simple example why this is so.
In the FY2006 annual report, its revenues are US$178.9 million.
Assuming there is a revenue growth of 30% to US$232.57 million in FY2007 and the net profit margin remain unchanged, the estimated net profit will be US$13 million. With the current outstanding shares of 417 million, the estimated EPS is US$0.031 (S$0.0465) and the forward P/E is 5.16 at the current px of S$0.24. So I will say that the current price is a bargin ONLY IF it can achieve a net profit growth of 20% or more.
Besides, there is no free cash flow to speak about for the past 2 years and the profit margin is low.
Recently there are people who recommend me the stock due to its low P/E and high growth story.
However, I would urge caution at putting money into the company contel.
Below is the reason using the FY2006 annual report as reference.
It seems like contel is in urgent need of capital As shown in the annual report, it has US$6 million at the end of last year. To solve their problem, contel has issued convertible notes to Advance Opportunities Fund and collected S$26.5 million in the process. At first glance, it seems gd as contel does not need to pay interest on the notes. But it is clear that in the past months, Advance Opportunities Fund have converted all the notes into shares. So in short, they are actually raising funds through the issue of more new shares. Basically, the cost of capital is the highest for equities as compared to bank loans or bonds. An investor will expect 8-10% return in the long run for the shares.
My question is, why cant contel borrow S$26.5 million from the banks and pay the normal interest rate? With the conversion, there are now 417 million shares outstanding and the minority shareholders’ stakes are diluted.
However, the worst part is this:
Suppose Advance Opportunities Fund did not sell any of the shares after the conversion, it should be holding 167 million shares. With this amount of shares, it should be a substantial shareholder. However, I have yet to see any announcement of this nature!! This has led me to conclude that Advance Opportunities Fund has been selling away the shares that it converted in the open market so that it will always hold less than 5% stake at any one time. Seems that Advance Opportunities Fund is not too eager to hold on to the shares.
The historical P/E for the company at the current price of $0.24 is about 4. This value is quite low and i believe that is the part attractive to investors.
But one have to understand that for this low P/E story to hold, contel have to grow its bottomline by 20% or more. Below is a simple example why this is so.
In the FY2006 annual report, its revenues are US$178.9 million.
Assuming there is a revenue growth of 30% to US$232.57 million in FY2007 and the net profit margin remain unchanged, the estimated net profit will be US$13 million. With the current outstanding shares of 417 million, the estimated EPS is US$0.031 (S$0.0465) and the forward P/E is 5.16 at the current px of S$0.24. So I will say that the current price is a bargin ONLY IF it can achieve a net profit growth of 20% or more.
Besides, there is no free cash flow to speak about for the past 2 years and the profit margin is low.
Thursday, June 28, 2007
Choosing funds
Each day, we come across numerous fund/unit trust advertisements in the various print medium. It can get quite intimidating. What to look out for? Fortunately, there are a few pointers serious investors should take note of when searching for the next high performing fund.
1) Look for funds in operation for more than 5 years.
A fund should have been around long enough to invest in both good and bad markets. The longer the track record the better.
2) A long management tenure.
The manager should have a long track record at the same fund so that we are able to gauge his performance over time.
3) Low management fees (<1.5%).
Avoid funds with front- or back-end loads -- additional fees charged every time you buy or sell a share. Also we do not want to pay more for mediocre returns.
4) Relatively low fund turnover.
We want the manager to be investing, not trading. But remember, small-cap funds typically have higher turnover than large-cap funds.
5) Is the fund following its investment objective?
Check out the fund's top holdings. Are they consistent with its stated objective?
6) Check the fund's ability to beat the benchmark.
Again, that's the main reason why we put money in funds. Isnt it?
So as to achieve a better than average return.
7) Ideally the manager should also have a stake in the fund.
You would like them to eat their own cooking too, dont you?
1) Look for funds in operation for more than 5 years.
A fund should have been around long enough to invest in both good and bad markets. The longer the track record the better.
2) A long management tenure.
The manager should have a long track record at the same fund so that we are able to gauge his performance over time.
3) Low management fees (<1.5%).
Avoid funds with front- or back-end loads -- additional fees charged every time you buy or sell a share. Also we do not want to pay more for mediocre returns.
4) Relatively low fund turnover.
We want the manager to be investing, not trading. But remember, small-cap funds typically have higher turnover than large-cap funds.
5) Is the fund following its investment objective?
Check out the fund's top holdings. Are they consistent with its stated objective?
6) Check the fund's ability to beat the benchmark.
Again, that's the main reason why we put money in funds. Isnt it?
So as to achieve a better than average return.
7) Ideally the manager should also have a stake in the fund.
You would like them to eat their own cooking too, dont you?
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