Thursday, March 13, 2008

Oh....this and that

I had a few thoughts in my mind today.

It had been raining profusely these couple of days. The rain comes with high intensity and long duration - the type of rain that carrying an umbrella will still get you 30-40% drenched. Since I had to travel on foot often, I thank god for my wonderful high cut boots (had a low cut shoe but haven't dry when I had to 'wade' through the rain on Tues). It is while having dinner in this wet weather that suddenly I thought of straits asia.

I had this company once but had sold it long before it reaches the price that it is trading at now. Today, I was thinking about its business and wondering if it had strong sustainable earnings. Not too long ago, Straits asia was badly hit due to a force majeure on their coal mines in Indonesia, resulting from the extremely heavy rain. Looking at the local weather these few days, it's hard for me not to think of their coal mines back in Indonesia.

I didn't do my due diligence, but I suspected that straits asia are held by forces beyond their control. And they can't do much about it. These are the 2 forces:

1. Bad weather condition affecting coal mining condition. If la nina strikes, the effect of a prolonged wet condition can last 3-5 years, then el nino will strike. Since they mine coal and sell them, their revenue had to be dependent on weather condition, resulting in a cyclical business wholly dependent upon weather conditions. Since no one can predict the weather ever since man start doing it, one can extrapolate this result and say that Straits asia revenue is also unpredictable.

2. Commodity prices will control the price that they can sell their coal. They should fix their selling price in advance, so at least in this aspect, they can control the price of their commodity for a short period of time. However, company's A coal is the same as company's B coal (let's not worry about the different types of coal and which type is more suitable for which purpose), as such straits asia cannot have pricing power over their coal. If they choose to charge a more expensive price, then customers can buy it from others who can do it cheaper.

Of course this is a simplistic situation. Straits asia can acquire a lot of mines so as to monopolise the coal supply at least in their immediate region, forcing customers to buy from them (since logistical support to transport the coal plays a part too) - thus creating an economic moat around them. This moat is obviously short lived since a mine can be productive for a limited number of years - beyond which, it'll be too costly to mine 1 tonne of coal than before. How long can a mine last? I didn't research on that.

To improve their margins, they have to control their costs. I believe mining is a high capital intensive operation with high operational costs too. I wonder how much cost they can cut on these grounds.

Based on my thought experiment, I find that straits asia isn't the kind of business that I would like to own. Care to know my valuation of it? In an idea world, it should be someway around the vicinity of 0.745, not the current 2.930 that it closed today. Based on FY07 earnings, straits asia is now trading at PE multiple of 81 times. This is considered not too bad, cos just a few weeks ago, it is trading at 120 PE. Crazy world huh?

Another thought I had today occurred when I was reading a book in the library. Now, it wasn't the first time I heard of Mr.Market and his maniac depressive mood swings. But when I was reading it again, suddenly the proverbial light bulb in my mind lit up. I started to think about a world where business are valued at their proper prices in the market. Then I started to think about what might happen in such a situation

1. If business are valued properly, it will be an efficient market. In an efficient market, there is no chance to achieve above market returns. In such a situation, one just have to invests in as many stocks available as there is possible, so as to reduce the risks of having any 'dud' stocks that can go busts. The more diversification one has, the less risk. ETF is a good low cost option.

2. The stock quotes will only move significantly every time the company releases results. If the price move before the release of results, there can only be two outcomes. If it moves up, it's good news. Down - it's bad news. No ifs, no buts.

The above is ridiculous isn't it? So much about efficient market hypothesis and the idea of diversification so widely advised by financial planners. The market isn't efficient - at most I'll settle for fairly efficient. To acknowledge that fact is to agree that present economic principles are theories and ideal, and hence are at most a model to appreciate the forces at work here. To treat it seriously as a certainty is a folly.

I've always asked my students this: Newton's 1st law states that a body at rest will remain at rest, and a body moving at constant speed in a straight line will always move in that motion, unless acted upon by a resultant force. How does one know it's true? A body will never be at rest and a body is always acted upon by a resultant force. Just imagine a book resting on a table, it's not moving. Then earth is rotating, so the table found on earth is also rotating, which means the books rotates too. Earth rotates around the sun, the solar system rotates around the centre of the galaxy and so on. Nothing in this universe is truly 'at rest' and they are always acted upon by a resultant force.

Relativity overrides Newton's law. Why call it a law?

My overly active neurons are firing up so much these days :)


fergus said...

Actually, my belief is that stock prices is purely controlled by expectation, rather than facts.

haha I suppose that's why I'm generally more inclined to technical analysis than fundamental analysis.

But even then, for example, fundamentally, US rate cuts have not been done yet, but because it is 'expected' to happen say 50 basis points next week, the market will then start to slowly price it in..

Same for stocks.. The reason why stock price move up, in my opinion, is not because it is a fundamentally strong company or anything, but simply on the basis that earnings is 'expected' to grow..

Sometimes, that can be irrational.. But then, rationality is just a function of expectation.. Just like now, the expectation for anything is irrationally low..

One quote I always liked.. "The market can remain irrational, longer than you can remain solvent."


la papillion said...

Hi fergus,

I've visited your blog, what a handsome cat! (i love cats!)

I've been to both sides of the analysis - TA and FA. So I think I'm in quite a good position to discuss this further :) Did you know that analysing the business also involves looking at its earnings prospects? Hence, one of the reasons why the 'fundamentals' of a company is good is due to sustainable, strong earnings. There are some companies which shows divergence in price and fundamentals, and this is something to watch out for. In my opinion, one should know a little of both so as to understand the viewpoints from both camps.

To clarify, I don't think the price is moved by facts too. It's always the reaction to the facts that matters, not the actual fact itself.


la papillion said...


The cat in your it male or female?

Solomon Grey said...

LP, do you know that if we consider the rotation of earth, then Singaporeans who live on the equator actually move faster than an M16 round, when we are "at rest";

la papillion said...

Hi grey,

Haha, I suppose one can calculate that, though I didn't know it's as fast as a bullet round :)

So much about being 'at rest'.