Tuesday, September 30, 2008

Death of equities?

This is the shock I got when I opened up yahoo! finance this morning, like all morning.

I've not seen such a precipitous drop in DJ or SP500 before! STI's fall yesterday seems like child's play when compared to the big brothers over at US. I think STI might fall 6% too, so it will be around 2200. Too bad I've got work, otherwise watch the historic moment unfold.

When I came back home, I was rather shocked to learn that STI did not break 2200. In fact, it's slightly neutral at -0.1%.

What a world of difference a few hours make! Market is hard to predict indeed. STI is surprisingly strong. After going down to 2240, STI rebounded and never looked back. HSI also went from -1k to +135 intraday. Invisible hands at work here?

A little market trivia: The title of this article, "Death of equities", was published by Business Week. Then, DJ was around 800. But by the early 90s, DJ had risen over to over 3k. The rise was started around 3 months after the article was published :)

Sunday, September 28, 2008

Brief overview of local banks

Is it time to buy local banks now? Someone wanted to invest a substantial amount of money into OCBC, so I thought I would do a little research to see whether it makes sense. I do not really know how to valuate banks and will not attempt to do so here. Rather, I'll just dig into the past number and let the reader do the rest of the legwork, if they are interested.

My source for these information comes from Shares Investment book (340 issue) and the respective banks' website.

Here is the brief overview of their segmented business data. It shows the revenue incurred from various segments as a percentage of the FY07's revenue.

We can see that OCBC derived a substantial portion of their revenue from dividend and rental. I suppose that rental means they have, under their holdings, certain properties. DBS has more percentage in terms of interest income and fees/commission. UOB is quite similar to DBS in that aspect, though I'm curious to know what constitutes the 'others'.

Below shows the ratios that I've done for the three local banks from FY03 to FY07. Do pay attention to the * portion below each table, as I noted the assumptions I made when calculating the figures.

Based on annualised 1H08 earnings for the three banks, at current closing of OCBC @ 7.160, DBS @ 16.920 and UOB @ 16.800, the forward PE for FY08 (estimated) and Price/Book are:

OCBC ----------10.7-----------1.6
DBS ------------10.2-----------1.3
UOB ----------- 11.2-----------1.6

I've browsed through the Singapore Country Book prepared by Deutsche Bank around May 2008. They mentioned that OCBC and DBS are well positioned to benefit from double digit loan growth and a rising net interest margin environment. The report seems quite bullish about the loan growth, saying that it is expected to be the second strongest year after Asian crisis. I've nothing much to comment about this, since I'm not in the know. They did cite factors such as strongth growth in business lending (particularly building and construction, property area) and in housing loans (particularly the mass to mid-market private residential, and HDB) as catalyst to push up the loans growth in the local banks.

This is for future reference:




So which provides the most value? Price is often illusory, because the cheapest in price need not be the cheapest in value. Need to do more research.

Friday, September 26, 2008

China milk - tainted milk scandal

I read an interesting company update by DMG and partners regarding China milk. While I can't reproduce the entire report by cutting and pasting, I'll summarise the pertinent points here.

What happened

The whole story begins when recently, it was detected that the milk made in China have traces of melamine. A lot of babies in China, after taking in contaminated milk, had fallen ill and some had even died because of the toxicity. While most cases are contained in China itself, there are reports of one baby who suffered in HK. Despite this, a lot of countries had decided to ban china products outright for fear of further contamination. In Singapore, several products had been taken off the shelves too.

What is melamine

Melamine is a compound that is used in making plastics or fertilizers. It is a non-protein nitrogen containing compound, with about 66% nitrogen by mass and is known by it chemical name as 1,3,5-Triazine-2,4,6-triamine. Due to its high nitrogen content and its cheap cost, it is added to milk by farmer and/or companies to boost the nitrogen content of the raw milk so as to pass the protein test, which is used as an indicator that the raw milk supplied is of high quality.

Melamine can cause bladder and reproductive damages, specifically in the formation of kidney stones. The lethal dose of melamine is more than 3 g per kg of body mass. As such, most if not all the affected victims are babies, as their body mass are much lower than adults and hence the ingested amount, over a prolonged period of time, causes the above mentioned effects.

Possible causes of the addition of melamine to milk

China milk's management mentioned that the main reason why Chinese dairy farmers and companies add melamine is because of the poorer quality of raw milk. As the rising cost of animal feed and fertilizers increases (also linked to the rising price of crude oil) in 2008, the cattles are not fed as well as they should. The consequence of this malnutrition is that the milk produced by these cattles are also of poor quality - that is, of lower nitrogen content. In order for farmers and dairy companies to attain higher profit and margins, they need to send the raw milk supplied for protein test to indicate that it is of superior quality. Hence, the addition of melamine will serve this purpose.

How China milk can benefit from this

Management mentioned that earnings will be expected to remain stable because the core business of the company is not in selling milk but in selling bull semen, despite the name of the company. They mentioned the price of each straw of semen (specifically the pedigree Canadian bull semen in which they have a monopoly on) - RMB 70 per straw - and typically two straws are needed to impregnate a cow.

Since Canadian bull semen will produce cows which yield the best quality and volume of raw milk, the management believes that this will be an effective step in rebuilding China's reputation in the milk industry worldwide. China milk will stand to benefit from this process of rebuilding China's reputation. It will take 3 years from conception before a calf can be milked, so the healing process will not be short.

Furthermore, China milk grows 75% of their own feed and produces their own fertilizers, so they have the ability to control quality at each step of their value chain. Since feeds takes about 50%++ of their operating cost, they will stand to gain from their independence off the rising feed/fertilizer price.


While china milk mentioned in a separate announcement that they are not involved in the scandal, and none of their customers are listed in the affected companies mentioned in mass media, the industry wide scandal affects each and every player in it. It will take years before confidence will be regained.

It is important to note how the demand for china milk will be affected. If less domestic milk is consumed, then farmers will be less inclined to have more cows to produce milk, and the subsequent drop in demands for cow embryos and sperms will also be reduced.

JP Morgan listed china milk under high cash high debts - meaning a possibility of management's poor financial discipline.

How to benefit from this

PE of China milk is around 3x. I think one needs to do a projection of the earnings at much lower percentage than one based upon historical rates. Even if using a earnings growth of 5%, we have a PEG of 0.6. My views is that not much can go wrong, though I said it with a biased views of an investor with vested interest in it.

Addition announcement dated 26th Sept 2008

China milk posted another announcement on SGX. Here's a summary of the new announcement:

a. Management believes that the sales of raw milk are not expected to be materially affected as there is still demand from milk processor and milk product manufacturer

b. As the Group believes in the quality of its raw milk (which contain no additives) and because the shortage of good quality dairy cows in China still persists, the Group is cautiously optimistic that it will be able to continue securing orders to supply raw milk to its current customers (none of which are manufacturers of the affected milk powder brands in China).

c. In addition, the Group believes that there will not be any material adverse effect (financial or otherwise) on its other business relating to the sales of bull semen and cow embryos. Although the Group expects that there may eventually be some consolidation and/or adjustments in the milk production industry in China, the Group believes that there is still sufficient underlying consumer demand for dairy products in China. On the other hand, demand for its bull semen and cow embryos (both for breeding of dairy cattle as well as for fertilisation of dairy cows for the purposes of raw milk production) is expected to remain relatively consistent given the shortage of good quality dairy cows in China as a whole and the fact that dairy cows need to be fertilised every year in order to produce milk.

(I've seriously not thought about that before. I've always thought that the main economic moat of China milk is that it holds a substantial herd of Canadian Holstein, known for its high quality and high volume milk production, before China banned the import due to outbreak of mad cow disease. Now that they said it, it does make sense that the continued demand for sperm is due to the fact that diary farmers need to fertilize their cows every year to produce milk!)

d. The Group further believes that the demand for its bull semen and cow embryos will remain good as the Group only produces bull semen and cow embryos of Canadian pedigree.

e. Purely as a precautionary measure, the Group has sent samples of its raw milk to an independent laboratory for the relevant testing and will follow up with an announcement on the results of the tests after receipt of the same.

(I should wait for their report of the lab test. I like China milk's way of handling the crisis. How a company manages a crisis and offer words of confidence is as important as how they capitalise on the opportunity posed by the crisis.)

Thursday, September 25, 2008

The sleeping dragon (and China map)

Below is the map of China. As my portfolio had quite a bit of exposure to China, I think I should put in a map of the different provinces of China for future references.

These days, there are many reports by brokerage firms on S-shares. S-shares are Singapore listed China companies. As always, they have plenty of things to say about s-shares. With s-shares having superbly low PE below 10 (3 even!), there are reports saying some are value buys and some are never buys. When the bull is charging, reports of QDII funds coming delights these analyst, so target prices keeps shifting northwards. When the bear is charging, reports of possible frauds, unsustainable growth, poor governance (among other stuff) are cited to keep pushing the target prices downwards.

The table above shows some of the s-shares with warning signs. It's taken from a report from JP morgan. Surprisingly, out of so many s-shares, none of them mentioned my beloved Hongguo. Hongguo must be a pretty uninteresting company to these analyst, since not one of these big names mentioned them. I was a little perturbed when China milk had the privilege of being listed as the company with high cash, high debt. This 'indicates poor financial discipline', according to the report. 'Balance sheet management around book closure date, or in the worst case scenario, a possibility of fraud or embezzlement of cash' might be the possible reasons.

Well, it seems like chinamilk had the dubious honour of having total debt/market cap>30% and total cash/market cap>30%, hence it was identifed as having high cash, high debt. I wish to defend it, but was flabbergasted and not sure what to say. Why was I unable to defend? My confessions:

1. I did not read up much on china milk before buying.

2. I did not know the business as much as I would love to.

Forgive me, I bought one tranche in Dec 2007 and another batch in March 2008. Well, to atone myself from the sins of value investing, I promise to write a detailed report on the valuation and business of china milk, with as much detail as my Hongguo writeup. This will not only give me the confidence to hold on, but the confidence to add on when the opportunity so arises.

Monday, September 22, 2008

Book review - A Random Walk Down Wall Street

A Random Walk Down Wall Street, a book by Burton G.Malkiel, is one of those must-read books on investment/finance. I think there are 9 different editions of it and the first edition was out in 1973. I must say this book is really a good read as the author talks about a variety of topics. The author is bent towards indexing for the majority of people who do not like the hard work of picking stocks. It comes as a surprise for me too when I realized that this book is not really about the efficient market hypothesis (EMH). I feel that the stance is almost similar to Benjamin Graham in The Intelligent Investor, where he proposed about the passive and enterprising investor.

The author’s main idea in this book is that everyone should have a core portfolio of index funds. If one likes the challenge of individual stock picking, then apportion a part of the investing capital to it, but still keeping the core of index funds.

The reason I like this book is that it gives such a wide variety of investment/finance linked topics. It ranges from the stock market crashes in the past, the different types of valuation in different eras, the pros and cons of TA, FA and EMH, brief understanding of modern portfolio theory (MPT) and the related Capital asset pricing model (CAPM). As if it’s not enough, there are chapters on behavioral finance, personal finance and how guide for ‘random walkers’ in the stock market.

I admit that I am biased towards EMH, CAPM and MPT (though I said that, I actually read through William Bernstein’s classic The Four Pillars of Investing, albeit partially). This book, however, gave me another view point – a somewhat more moderate stand. The author is not an ‘extremist’ in EMH, and he mentioned that himself in the book.

One of the best parts of the book, in my opinion, comes from a story. J.P.Morgan had a friend who was so worried about his stock holdings that he could not sleep at night. So the friend asked what he should do about his stock holdings. Morgan replied, “Sell down to the sleeping point.” Much wisdom is contained in that simple reply. Yours truly had dabbled in high risk warrants (HSI warrants, not STI, mind you) with huge position in the past, and so I can truly understand what is meant by holding on to sleeping point.

Personally, I have investments in a few types of assets:

1. Bank savings account – this is certainly the safest of the lot, and certainly the most boring. Guaranteed to a super deep comatose kind of sleep (For Singapore, insured up to 20k only, aggregate)

2. MMF – this is the next safest, after bank savings. The one that I had, Phillips Money market fund, had 55.78% of their asset allocation in money market securities, 42.36% in term deposits and the remaining in cash and other accruals. Their top 5 holdings in Aug 2008 include capitaland commercial, CDL bonds and SG bonds. This should be giving investors a long afternoon naps and a good night’s sound sleep. However, recently, I had a few dreams that rouse me at night, especially after learning that such funds in US had fallen from the financial woes there.

3. Stocks – this must be like sleeping beside 100 crying babies, on a bed full of spikes, with spotlights on your face and with neighbors blasting heavy metal music all night long. However, I’ve been sleeping rather well, having accustomed to the fluctuations of the market. There is such a thing as being numb to the market.

There are many others who have CPF. These are also super safe instruments, guaranteeing a good night sleep. In fact, it's so guaranteed to provide a good sleep that you have to hold until the withdrawal age, which is increasing all the time. Rip van winkle would have approved of it :)

What's your sleeping point?

Sunday, September 21, 2008

It shall soon pass

It's been a while since I blogged because I am too busy with work to do anything. There's so much happening in the world today that I had barely enough time to catch up on the major developments unfolding right now. There is no shred of doubt that we're all sitting right in the middle of this action and we all have the honour to bear witness to this historical event happening right before our eyes. When all these are over, and when necessary heads are rolled and the dust settled, we will all look back and say that hey, we've survived this "once-in-a-century" event!

Lehman brothers, who had been around for 158 years, declared bankrupt as the debts piled up and they could not find any white knight to save them. AIG, major insurance player in US, almost fell when they too needed a lifeline to save them from bankruptcy. It's a great irony to see that management of AIG, being involved in insurance whose role is to spread risk, did not practice what they preached. As the Queen song goes, 'Another bites the dust'.

Locally, we're not spared from the financial nuclear bomb that erupted over at US. Many policyholders of AIA, a subsidiary of AIG, had terminated their plans, fearing the worst had yet to come. Despite the calming pleas from AIA (they had taken the trouble to print a whole page in Straits Times newspaper about the situation of AIA), holders of their plans did not believe them. This is a classic case of the extreme pessimism and fear that spreads over the minds of people these days.

I see with my very eyes that LEH dropped 99.1% to reach the status of a penny. What force could have crippled a company with such a long history? Yes, it is the same enemy that causes the fall of kingdom and the corruption of man - greed. This shall serve as a very good lesson for us all - that history does not extrapolate itself to the future. An old man who had not experienced death in his whole life might think that he will live forever, but when the sudden and unpredictable event with catastrophic consequences strike, all his future will become history.

I remembered clearly that long before subprime pervades the mass media, there are a series of fashionable themes, arranged chronologically:

1. China might becomes the next superpower, over-riding US

2. China overextended itself and fear of its economy overheating

3. Subprime problem began

4. Subprime contained in US only, does not affect the world. Major financial institution have negligible exposure

5. FED going to cut interest rate

6. Commodity and oil prices going to rocket upward on surging demands. Analyst said that oil will reach USD 200 per barrel.

7. Commodity and oil prices going to be depressed due to economic recession. Analyst said that oil will be depressed around USD 100 per barrel.

8. China milk causing fear in milk products

The above is based on sheer memory, so if I didn't get it correct, do forgive me. I've been only in the market for 2 years and I think I've seen enough to recognise that optimism and pessimism switches periodically like the oscillation of a pendulum. The market prices stocks at PE above 50 when everything is happening smoothly and the bull is deemed to last forever. When catastrophe strikes (did you notice catastrophe seldom strike alone? Bad news comes in triplets, as the chinese saying goes), PE of stock goes to sub-10 and it's all gloom and doom.

Such is the vicissitudes of the market and we can all take advantage of the excellent value that the market is throwing at us in fear. When all around is panicking and running away from the market, do your due diligence, research and strike hard! In time to come, this could very well be one of those period in which future generations will remember as the best time to invest! To invest in stocks is to believe in the ingenuity and optimism of the human race, in whatever odds that seemed impossible to overcome when it happens. I feel that we're sitting right at the crux of this historical moment, do you hesitate? Will you act?

Work out your own salvation with fear and trembling. Be brave and say to yourself, it shall soon pass.

Thursday, September 18, 2008

AIG portfolio

AIG's portfolio are listed below. Take note of MMP and FSL. Concerned investors might want to check what percentage of these holdings are to the total outstanding shares.

Stocks-----------------------------------Shares (m)
FIRST SHIP LEASE TRUST----------40.422
STX PAN OCEAN----------------------37.241
HO BEE INVESTMENT----------------0.72
HOTEL PROPERTIES-----------------0.4238
FIBRECHEM TECH-------------------2.062
FERROCHINA LTD-------------------1.055
RAFFLES MEDICAL-----------------1.002
RAFFLES EDUCATION---------------1.812
SWIBER HOLDINGS-----------------0.733
SYNEAR FOOD HLDG----------------1.385

Source: Bloomberg

Thursday, September 11, 2008

Perils of PE

For avid readers of my blog, you might have realised that I am undergoing a deconstruction process of my valuation techniques. Just yesterday, I was debunking my own way of using a bastardized version of DCF to calculate the intrinsic value. Mr.Investor could very well describe me.

It's important to read about investing and it's also very important to practice it by valuating listed companies. Only then will the things read be transferred from the RAM of your brains to the more permanent hardisk. For now, I'll be deconstructing my PE ratio analysis.

We can use the PE ratio to derive the future price of a company, if we also know about the earnings in the future. To go about doing that, we just need to follow the steps below:

1. Assume an earnings growth rate. Project future earnings by applying the earnings growth rate to current earnings.

2. Assume a PE ratio. Then multiply the projected future earnings with this PE ratio, and we'll get the future price.

For example, company A has earnings growth rate of 21.1% (CAGR over 4 years). For simplicity, we assume a earnings growth of 20%. FY07's EPS is 5.6 cts per share. Thus, projected FY08's EPS is 6.7 cts per share (5.6 x 1.2 = 6.7).

Here's the historical PE ratio:

* EPS in FY07 is actually 0.278 RMB, not 0.278 SGD. There is a mistake in the headings.

The lowest PE ratio is 5.5x and the highest is 26.3x. To be conservative, we assume a PE ratio of 5.5x to multiply the FY08's earnings of 6.7cts per share, giving us a future price of $0.365.

Easy right? But there is actually a lot of things hidden beneath the simplicity of the maths. Besides the difficulty of assuming the earning growth rate, there is also the problem of using historical low PE ratio to justify the multiples. Actually these two are inherently the same problem - that of projecting the past into the future.

To illustrate, imagine this. A 90 years old man, having lived to such a ripe old age, had never died before (obviously!) in this entire lifetime. Based on historical data, this old man will continue to grow at the CAGR (based on the past 90 yrs) of 1 year per annum. In fact, he will continue growing for the next 90 years, based again on past data. If we can extend this further, he will probably never die because past data had no records of him dying before. What do you think of this?

To assume that the price of the company will not fall below the historical low is a myth, and is best dismissed with facts. In 2003, if we are to compile the historical PE data of company A, the lowest PE is 8.5x. If the investor bought in at 8.5x, thinking that the price will be supported at that PE level, he will be sorely disappointed. In 2004, lowest PE becomes 7.1 x. In 2005 and 2006, lowest PE becomes 5.5x. The lowest historical PE just keeps getting lower and lower.

Based on 1H08, EPS for Company A is 3.126 cts per share. Current price now is 24.5 cts. If we annualised 1H08 by multiplying by 2 (assuming constant earnings for 2H08, haha, the irony of it), we end up with a FY08 EPS of 6.252 cts per share. So guess what's the PE? It's 3.9x.

PE can get lower than what past historical data showed. To project the past into the future, is akin to a 90 year old man projecting his future life span forever because he had never died before. Amusing but ultimately ridiculous.

Wednesday, September 10, 2008

The false security of 'intrinsic' value

I thought after playing with numbers for more than 9 months, I've got a little experience, however small, to talk about the perils of the calculation of intrinsic value. There are so many ways that we can evaluate the intrinsic value. In our need to place a certain number to our uncertain analysis, there could be a risk where the investor places too much confidence on what I call GIGO - Garbage In Garbage Out. However, armed with this magic number generated from fundamental data (that is, from the financial statements), the investor feels more confident than is justified and thus begins his (possible) sorrowful journey with the company.

I used to believe greatly on the certainty of the numbers, believing it will give me the ultimate decision to decide if a company's price is worthy of its value. It couldn't be further from the truth when the real test of investor - bear market - begins to maul down all the calculations made.

Here's an example of how an investor could 'justify' his purchase.

Company A had the following data:

Impressive! Pretty good ROE of around 17.5% averaged over 4 years, high gross margins of around 24%, PATMI margins of 20% and had very low debts ratio of 20 to 30% compared to equity. Closing at $1.750 today, the investor almost jumps out of joy when he realised that the company also gave dividend, amounting to a dividend yield of 8.5% (inclusive of specials and based on FY07)!

Mr. Investor immediately logged in to his online brokerage account and started keying in his order when he suddenly remembered that as an investor, he ought to at least do out a DCF or other forms of valuation so that he can find out the price to value discrepancy. Didn't Benjamin Graham and Warrent Buffett keep harping about margin of safety? How could he, a practioner of safe and long term investing, forgot to do that? Tsk tsk.

So on he went, opening his excel and begin putting in the numbers. Since long term is 5 years to him, he started putting in the DCF with EPS for the next 5 years, projected at an EPS growth rate of 20% and discount rate of 4%. Mr.Investor used an EPS growth rate of 20% because from historical data, the PATMI per share is growing at a CAGR of 19.5% over 4 years, so it's reasonable to project this for another 5 years. 4% discount rate is because the long term SG treasury bonds is around 4%. Since Mr. Investor did not do out terminal value, which accounts for a huge bulk of the value, he thinks that it's very conservative already.

Here's what Mr.Investor did:

The current closing price is $1.75 but the intrinsic value is $1.25. Company A is actually overvalued! Mr.Investor tried checking the inputs for any mistakes but couldn't find any. As such, he reasoned that there is no reason why the earnings will stop after 5 years, so he could be too conservative. He decided to extend his timeframe to 10 years.

Here's what Mr. Investor did after extending to 10 years:

Now, the intrinsic value changes to $3.82. With current closing price of $1.75, that represents a margin of safety of 54.2%! Being a skeptic, Mr. Investor started thinking. If it is grossely undervalued, why is everyone not buying it? He started to feel insecure about his figures. Perhaps the EPS growth rate of 20% is too high. Over 10 years, it's highly unlikely that earnings will continue to grow at such a high rate, he reasoned. As such, he decides to do another valuation. This time, the EPS growth rate is changed to 10% (though the historical CAGR over 4 years is 19.5%) - conservative estimate!

Here goes:

Ahh..this sounds more reasonable, at $2.21. The current price gives a margin of safety of nearly 20%. For such a high quality company with low debts, strong margins and good yields, it's worth it! Besides, Mr. Investor already had 3 layers of safety margin:

a. The valuation assumes that the company folds over in 10 years. Since it is unlikely, the intrinsic value is supposedly higher than the calculated one. There is no perpetual or terminal value, which forms the bulk of the DCF value. As such, the value erred on the conservative side.

b. EPS growth rate of 10% is so much lower than historical growth rate of 19.5%. Conservative again.

c. Mr. Investor bought at a 20% discount to intrinsic value. As such, he had a 20% buffer against unforeseeable adverse circumstances.

Mr. Investor happily bought it, satisfied of having done a thorough analysis to Company A before buying. He can sleep soundly everyday knowing that he had done his valuation and bought with several layers of margin. So what's wrong with this?

With the right combination of earnings growth rate, discount rates and period of investment, DCF can make any purchase at any price justified, even with a margin of safety built into it.

Tuesday, September 09, 2008

Kingsmen Creatives

I promised Cheng I'll do a valuation of Kingsmen, so that he can compare with his method of using FCF as a basis for the numerical intrinsic value. I did not undertake a check on the figures he passed on the the spreadsheet, so all the figures are taken from it.

A few things to point out:

1. I do not know the business of Kingsmen Creatives as intimately as him, as such, I'm approaching it with the curiosity of a quant. I'm just interested to see how the figures tally. Since I'm did not do a comprehensive research on Kingsmen, the figures I put into my calculation might be a case of GIGO - garbage in garbage out. DO NOT use the figures as an anchor for the intrinsic value, without doing more extensive research yourself.

2. All my calculations are based on the following assumptions:

a. I assume that the diluted EPS for FY08 is 7 cts. While 1H08 EPS is 2.85 cts, it possible to reach this full year EPS of 7 cts because Cheng mentioned that the second half is the stronger half of the financial year.

b. I assume that the EPS will grow at various rate, namely 10%, 15% and 20%. The CAGR of EPS is 45% from 2003 to 2007. The most recent EPS growth (from 2006 to 2007) is 61.3%. I do not expect Kingsmen to keep growing at the phenomenal rate of anyway near 40% or 60%, hence I’m more comfortable to use an EPS growth of at most 15%. When unsure, it’s best to not to be too optimistic.

c. My investment horizon is 10 years, hence I will discount the earnings up to 10 years. I assume that the company will fold over then, hence it will have no terminal or perpetuity value. This serves as an underestimate of the worth, as a great bulk of the intrinsic value comes from the terminal value (assuming that the company continues growing in perpetuity).

d. Interest rate is taken as 4%. I prefer using a range from 4% to 8% with the lower limit as the long term (10yrs) SGD Treasury bond rate and the 8% as the long term index market return. The figures are just ball park estimate, so any more accurate values will not add any more certainty to the inherent uncertainty of the calculation. So, why so serious?

Here's what I get:

I'm comfortable with the intrinsic value from 0.80 to 1.00. That's the target for 10 yrs. Current price is now at 0.435. Thus, the CAGR returns will be between 6.3% to 8.7%. If we take the maximum value of 1.39 (20% EPS growth rate, 4% discount rate), the CAGR returns will be 12.3%.

How about we do it the reverse way? I want to get 15% per annum over 10 years, so what price will I have to buy in now so as the get that kind of returns? Assuming an intrinsic value from 0.80 to 1.39, we'll need to buy in from 0.20 to 0.34.

PE based on FY07 earnings is now at 5.53 x. Historical lowest PE is around 4.9, so maybe we can expect to see it drop to 0.385 (representing 4.9x FY07 earnings) before it's safer?

Humpty Dumpty sat on the wall
Humpty Dumpty had a great fall
All the king's horses and all the king's men
Had scrambled eggs for weeks and for weeks

Monday, September 08, 2008

How to make investment enjoyable

Durio asked me to write an article on how to make investing enjoyable. I thought that was a very good topic to explore, and what better time then to do it in a bear market like this? Have fun while working and you’ll never find yourself working again.

My definition of investing in this article refers to a very general kind – any activities related to the stock market, which includes trading for short term. Why not try some of the activities suggested while waiting for the Return of the Bull? I divided the activities into two parts, one for the technically inclined and the other for the fundamentally inclined.

For the fundamentally inclined:

For those who are classified as ‘long term investor’ type, you can play a stock market trivia. There are so many companies listed in SGX, each with their own peculiarities and oddities that you’ll never run out of pure fun! You can do a search of the ‘most’ list, like:

1. Which company has the lowest PE?
2. Which company has the highest dividend yield?
3. Which company has the highest net margins?
4. Which has the greatest discount to NAV?

Actually the harder questions are those that relate to the business, not the numerical figures as the latter can be easily found using any competent stock screeners. For more advanced level, try these:

5. Name a listed company that deals with printing of annual reports, IPO prospectuses, and shareholders’ circulars in Singapore?
6. Is there a listed company here that do funeral and crematorium business?
7. Is there a listed company here that manufactures and sells batteries?
8. Is Sakae Sushi listed?
9. Is POEMS listed?

Suggested answers:

Do note that the thing is based on Shares Investment book, number 338 edition, which is from 18th Aug to 31st Aug 2008. As such, new market information thereafter might change the answers.

1. Ossia International, PE of 0.7
2. Transpac Industrial, having a yield of 47.3%
3. Rowsley, having net profit of $5,607,000 net profit on a sales revenue of $6,000 in FY08, resulting in a net profit margin of 93,450%
4. Enporis Greenz (formely Seksun) having a NAV of $0.441 and current price of $0.05, resulting in a discount to NAV of 88.7%.

5. I know Xpress is one.
6. Asia-Pacific strategic investments (what a misnomer!)
7. GP batteries
8. Sakae Sushi itself is not listed, but its owned by a Apex-Pal International which is listed. Apex-Pal also owns Hei sushi, Crepes & Cream, Uma Uma Men and Sho-U
9. I do not think so. It’s a private company.

For more fun, try walking around and finding brands, then check to see if those brands are listed, either here or other countries. Do check their margins and profitability; you’ll be surprised on what you’ll find! For example:

a. Durex – listed in UK (I think), under SSL international, which also owns Scholl. Contrary to my feelings that I’ll be a good profitable company, they registered a net loss in the recent financial year. Operating margin is around 12+%. It’s interesting to note that they are building their manufacturing facilities in China.

b. Wiley, publisher of many journals and books, is listed in US. They have an EPS CAGR of 18% since 1998, with an ROE of 22% with net margins of around 7.7%. Quite respectable.

c. Coach, famous for its brand of bags, is listed in US. They have a net profit margin of 24.3%, gross margin of 77.4% and ROE of 33%. That’s what I call branding power!

d. Adidas, listed on Deutsche Börse stock exchange in Frankfurt, had a gross margin of 47%, net margin of 5.4%, 18.2% ROE. EPS CAGR of 17% from 2003 to 2007. Net margins of 5.4% is quite on the low side, my opinions of course.

For the technically inclined:

You can start looking out for obscure yet potentially potent chart formations. Here's a few of them:

Vampire duck formation

Chart shows a vampire duck formation. It's a very bearish sign, with the bearishness in sync with the length of the 2 vampire tooth (specifically, the top vampire tooth). As the formation builds up, we have to look at the legs of the duck. As can be seen in the chart, there is a well formed legs which forms the fulcrum that leverages the duck forward, creating a short term price vacuum that is proportional to the spike of the volume generated at the legs. Potential downside is usually twice the distance from the tip of the front tooth to the legs, as the fulcrum of the legs dip the duck forward.

Downside is 129 - (139 - 129) = 119

Dragon drinking water formation

Here's a rare glimpse of the dragon drinking water formation. The formation is characterized by the downward sloping dragon approaching the water body of MACD. Formation is usually bullish in nature, especially when the spacing of the two legs are in 23.6% and 61.8% of the whole length of the dragon, coinciding with the Fibonacci retracement zone period. Money Flow Index (MFI) shows a reversal in the making as the dragon prepares for the upward flight after touching the water base. Price target is unclear yet as there is also an equally likely possibility of the dragon drowning in the water body, especially when the price goes below 0.20, which is the water base level. If the head of the dragon goes below the water base at 0.20, institutional support is deemed to have left and the dragon will drown, possibly towards 2/3 of the water base, at 0.134.

Bloated baby syndrome:

This particularly dangerous chart formation is a mutated head and shoulders, a very bearish sign too. This chart formation is characterized by the small head, bloated belly and the upright legs. There must be a volume spike at the baby's belly for the chart to be valid, followed by a gradual decline in the volume. This twisted pattern will usually end with the baby breaking wind, forming a downward pressure to the price, with a target objective of at least twice the distance from the tip of the belly to the end of the leg, measured downwards. Hence we can expect a downtrend pressure of the price towards $0.08. Terrible.

Who says investment is not enjoyable?!

Friday, September 05, 2008

HSBC weekly chart

Weekly chart for hsbc:

Price is hovering around 118, which is at the bottom supporting trendline of the symmetrical triangle. Being a symmetrical triangle, I've no idea which side it will more likely tend towards, so no comments on that. I'm looking closely at the price breaking 118 level, which might bring the level down to support at 112. That is so close to my ideal price at 100 - 110 :)

I'll wait patiently.

Thursday, September 04, 2008

Book review - Benjamin Graham on Value Investing by Janet Lowe

It's been quite a while since I did a book review. Having finished a big portion of what I wanted to read as I began my journey in fundamental analysis, I found that there are less and less things worthy of writing down. Most are pretty much the same, perhaps only the tone and the examples used are different. Once a while, I'll come across a gem worth blogging about and it is this book - Benjamin Graham on Value Investing - by Janet Lowe that I am pleased to review here.

My gf told me a very interesting insight. I asked her if she had heard of Warren Buffett, which she replied yes. Then she told me that she will be more interested in reading how his family raised him as a child to make him who he is today, rather than read about all his techniques or methods of investing (all written by others, by the way - he had yet to write a book on investment himself, save his annual berkshire hathaway reports and shareholders's letters). I think the same can be applied here on this book about the Dean of wallstreet - Benjamin Graham.

This book chronicles the life of Ben, including his encounters and various relationships with women. I find his life extremely interesting - though a bit unlucky and unfortunate. While I will not elaborate parts of his life in this review, suffice to say, Ben is a very smart and practical investor, who also had the clarity of thought and eloquence to write in the most convincing and simple way. He is also very generous, to the point of being easily taken advantage of (though he do not seem to mind). This book came with some pictures of the "superinvestors of grahamsville and doddsville", referring to the class that Warren Buffett is part of, in which Ben taught in Columbia Business school.

Having read his autobiography in this book, I was tempted to re-read The Intelligent Investor the second time, and Security Analysis the first time. I'll do Security Analysis (1951 edition) first, of course. I find that I can relate to Ben better, having understood why he did certain things. Musicwhiz is right. He mentioned, having read my analysis, that I am more graham and less buffett. Now, I agree totally with him. Perhaps my inherently shy nature makes it hard for me to ask anything during AGM (I confess I still haven't attended one!). It helps that I'm very comfortable with numbers too.

Perhaps in such a market time, we all need to remind ourselves of the teachings of Ben. Below are but 10 simple steps to select undervalued stocks:

1. A earnings yield (reverse of PE) that is double the triple A bond yield - if the triple A bond yield is 6%, then the earnings yield will have to be 12% (giving a PE of 8.3x too)

2. A PE ratio that is four-tenths of the highest PE achieved by the stock in the most recent five years - PE is defined as average stock price for a given year divided by earnings for that year

3. A dividend yield of two-thirds the triple A bond yield - stocks that do not pay dividend or with no current profits to pay dividends are excluded

4. A stock price of two-thirds the tangible book value per share - TBV is defined as all assets excluding intangibles like goodwill, patents etc, subtracting all liabilites and debts, then divided by total number of shares

5. A stock price that is two-thirds of the net current asset value or the net quick liquidation value - the net quick liquidation value is current assets less total debts then divided by total number of shares

6. Total debt is less than tangible book value

7. Current ratio of 2 or more - current ratio is current assets over current liabilites. This is an indicatioin of the company's liquidity, or its ability to pay its debt from its income

8. Total debt at or less than the net quick liquidation value

9. Earnings that have doubled in the most recent ten years

10. No more than two declines in earnings of 5% or more in the past ten years

Criteria 1 - 5 measures risk; 6 and 7 define financial soundness; 8 - 10 show a history of stable earnings. Not all companies will have all 10 criteria. I found that this is a good guide to screen stocks, though take note that the usual graham holdings is no less than 10 stocks and is widely diversified (30 or more stocks in portfolio is ok).