The End of a Tumultuous Year

The year's been long, with ups and downs, but what a good year it has been. Looking back, I must say that I have learnt a lot about the markets and investing, and how to handle emotions. Let's take a quick flashback on the year that is just about to pass.

2008 ushered in one of the worst performances of the markets to date. The markets were hit by bad news one after another. We started off with Bear Stearns, the quickfire sale to JP Morgan and the U.S government's involvement in it. The 4th largest bank, a century old bank, brought to its knees, once worth $180/share, and the idea of selling it at $2/share was mooted at one point of time.

Now, nobody's gonna forget the mortgage lenders as well, Fannie and Freddie. There used to be an air of invincibility about the 2 lenders, that government support would render them infallible. And then, the markets actually started to doubt the sustainability of the 2 lenders, and the selldown ensued.

Lehmann Brothers was the next victim to have its scalp claimed. Another century old bank, suffering a run, and it went down within a short period. This is bad, the market claimed, and we saw fresh new lows being set and risk aversion at its highest.

Then, around the same period of time, the famous bull of Merrill Lynch, the world's largest brokerage, was sold to Bank of America. Morgan Stanley and Goldman were "converted" to commercial banks for purpose of raising of equity, and this marked the demise of the investment banking business model that had been the success story of the decade where all excesses of the financial world had gathered.

Many high profile corporations were victims of the crisis. Bill Miller, proud record holder of beating the S&P for 15 straight years, has been brought down to his knees, now currently amongst the top 3 for the worst performing fund in 1-yr,3-yr and 5-yr. Washington Mutual, the nice resident bank, with the highly-rated WaMu business model, also went kaput. Many scandals plagued the financial world as well, we had the Madoff scandal, and closer to home, the controversial Lehmann Minibonds saga.

So many incidents, so much turmoil. Consider ourselves lucky to have the chance to look back, years from now, upon this year where presidential elections and terrorist attacks were not the ones that screamed across headlines, but rather, a whole slew of events that threatened to cripple the grand 'ol America.

Even if some of us might emerge from this crisis bruised financially, however, whatever doesn't kill us only makes us stronger. The crisis would almost definitely make us mentally stronger, and emerge as a far better investor by training us to handle our emotions better.

On a personal level, my investing journey has started from the time when the STI was around 3400+ to today's 1700+. That's a close to 50% drop, a very scary period indeed for a novice investor. Nonetheless, coupled with dividends, some nimbleness, a little trading plus lots of luck, I have managed to stay pretty decent. A quick look at my holdings, and the lessons I have learnt from my trading so far.

Let's look back at some lessons that I have learnt.

1) Do nothing when I've nothing to do.

My first foray into the markets was the STI ETF. I lost about $100 on it. The purchase was bought on impulse, I did not think about whether the ETF would be a better alternative to the other companies trading on the SGX at that point of time. I decided to cash out at about the same price that I bought it at, but minus the trading fees.

2) Really understand the businesses that you own, and if u're unsure, stay clear.

I didn't really learn this lesson the hard way, though I looked back and realised that things could have been much grim-mer. I did my research on both companies, but it was very insufficient and I did not have a clear mind as to how the company's operations would be hit and it's competitive strengths. I bought NOL and Sembmar and sold them at around 15% and <10%>

3) Don't take profits for the sake of taking them.

I took profits for NOL and Sembmar because I felt the market's were starting to become a bit optimistic. Pretty silly looking back, because I did not exactly determine, through calculations, why the market was optimistic. It brought me some cash in, and the decision "paid off", but problem is that this is definitely not a method I would be able to employ successfully for my entire investing journey. Pure luck I would say.

I have learnt to not take profits and hold on to them, and even if the profits turn into losses, it's perfectly fine. Do the homework, be sure to handle the price levels and reasons behind them, and we're probably on the way.

4) Build in expectations to ur calculations, and have a handle on why the prices are reflected at this particular level.

I did this for some of the property companies that I held. I incorporated the mark-to-market writedowns into the assets valuations, and found that some of the companies were trading at reasonable levels. It is NOT OUR JOB to predict how much write-downs there will be, but rather, to find out if the market is pricing in earning drops at reasonable levels. If you think so, pick them up. E.g. the markets priced in about 75% write-down in assets, but do note that Kepland's assets are backed by 25% of cash, and you can;t really write down cash can you? Thus I picked them up. Even if prices were to become even more depressed, I am comfortable with a 75% write-down level for Kepland.

5) Do your homework and have confidence in yourself.

I must admit that I have done some homework but still felt a dearth of confidence, which resulted in me previously taking profits. I have since ceased to do so a few months ago. Do your homework, estimate some downside risks. Try not to use relative valuations from previous crises, I believe, because companies that have survived the crises are probably more resilient and valuations will be different. Refer to operational performance instead.

Since then, I have still done a little trading, but very very minimal, and the last done was a few months ago for Parkway where I was "forced" to sell my shares as the markets were being overly optimistic, I figured, pricing in a 10% growth over the next few years when obviously the Group had been hit in the previous few crises( I took a look at the reports during those times). I booked some pretty decent profits of around 40+% before I bought it back at a lower price.

Shall probably talk soon about my individual holdings, the size of my portfolio, and other lessons I have learnt so far, other than the abovementioned 5.

Ciao 2008. Let's usher in the New Year.

A good company = good business?

After looking at Qianhu's financials, I've decided not to become vested. Why so? I've taken away some valuable lessons from this.

1) A good company might not be a good business.

From my business overview so far, seems that Qianhu is a well-run company, led by able management. It might turn out to be a great ornamental fish company, I do not have too much doubts about it. But the problem lies in that a well-run ornamental fish company is at most, a great ornamental fish company. It might not necessarily be a good business. As someone once said, "A horse which can count from one to ten is a remarkable horse, not a remarkable mathematician., or at lest something in the realms of this. There are restrictions in the industry, one the more prominent being the small worldwide industry size of $14 billion (even though it has been growing very impressively).

2) Good management does not necessarily = good outcome

Few will disagree with me on the management capabilities of the Yap family. Rarely do you see someone who has contributed so substantially to not only the company itself, but to the industry as a whole with various product and innovations. Nonetheless, a fantastic manager managing a chicken rice stall can ultimately, only see his chicken rice stall grow larger in size and open a few more stalls, but nothing more than that. Similarly, Mr Yap and family have chosen to continue their family business and venture into the ornamental fish industry. Nonetheless, the industry seems to have relatively muted prospects at this moment. A growing industry, but not huge enough for me to want to own this business for years to come.

However, I might be wrong and rue my missed opportunity for years to come. I shall continue to monitor events within this company though, and hopefully my judgement will be proved wrong in the years to come.

Qian Hu analysis - Business overview

Shall do an analysis on Qian Hu, a company which is not widely covered nor actively traded. My whole analysis shall revolve around one word: sustainability.



What does Qian Hu do? Qian Hu is an ornamental fish service provider, breeding, selling, importing and exporting ornamental fish from around the world. Physical presence in 4 countries, namely Singapore, Malaysia, Thailand and China. Accounts for >10% of Singapore's ornamental fish exports.



Its business generally revolves around 4 areas:



i) export of ornamental fish and accessories

Qian Hu imports, exports, breeds, quarantines, conditions, farms and distributes ornamental fish. When I went down for a visit however, a quick enquiry revealed that Qian Hu acts more of a "holding" area for fishes as opposed to a breeding area, because the costs of breeding are high and not worthwhile. Its ornamental fish are imported from countries in South-East Asia, South America and Africa. It has > 500 species and varieties of ornamental fish, exporting directly to >70 countries and also distributes to local retailers and exporters, including the "Qian Hu" dragon fish(one of which Chow Yun Fatt owns haha)



ii) distribution of ornamental fish and accessories; &

iii) manufacturing of aquarium and pet accessories


The distribution of accessories complements its ornamental fish business, meeting customers' aquarium needs. Qian Hu distributes > 5,000 types of aquarium and pet accessories from more than 20 major manufacturers and principals to local retailers and wholesalers in Asia, including supermarkets operated by NTUC FairPrice, Cold Storage and Carrefour.



Qian Hu has also developed its own brands of aquarium and pet accessories, namely
"Ocean Free", "Delikate", "BARK", "Nature's Gift" and "ARISTO-CATS YI HU", and they are sold through Qian Hu's subsidiaries. Rather silly-sounding names if u ask me.



Qian Hui also manufactures plastic bags(not the NTUC kind, its for packaging fishes) as an ancillary business. Qian Hu manufactures plastic bags for its own use to package ornamental fish for sale in a separate factory located in Woodlands. The plastic bags are also supplied to third parties in the ornamental fish, food and electronics industries. The investment in this area is treated as a sunk cost, and a quick enquiry revealed that the CEO Kenny Yap treats this business as a cash cow for its other segments.



iv) breeding of dragon fish



A licence is required to breed and distribute Dragon Fish, and there are 6 farms in Singapore registered with AVA for the breeding of Dragon Fish. The barriers of entry to the breeding of Dragon Fish are high in view of the knowledge and experience required and the high capital investment involved in the breeding of Dragon Fish, for example, Qianhu has been breeding Dragon Fish (through Wan Hu) since 1995 and capitalised 350 pieces of Brooder Stock amounting to $1.5 million as fixed assets in 1999. This is not exactly something that ordinary fish sellers/farmers would want to go into.



Having gone through the business overview, shall now do an analysis on the sustainability of Qian Hu's business, through a simple SWOT analysis.



Strengths



i) Market leader (shall talk about this slowly in more detail since everyone claims to be a market leader):



a) accounts for >10% of Singapore's fish exports



b) Only fish company in the world to be able to export fish from 4 countries in Asia



ii) competitive positioning

carves a niche by not only rearing Arowana(dragon fish), because most other competitiors like Xian Leng(Malaysia) also do that; Qianhu also sells pet and fish accessories. The reason lies in that the accessories industry is a much larger market than that of the fish itself. Let's do a simple logical explanation: would u keep buying fish or keep buying fish food? That's assuming that you have the skill not to kill your $3000 Arowana once every few weeks. The total customer equity of fish food customers would be the present value of the future consumption(or rather purchases) of fish food. This thus does not come as a surprise that for every $1 spent on fishes, >$2 is spent on accessories($4.5 billion dollar industry for fishes but $10 billion industry for accessories).



The clever part about this is that the accessories industry helps to improve sustainability of Qianhu. Now, let's think again, if Qian Hu sells Arowana solely, will it be sustainable? Perhaps. But think in this way, customers do not keep buying Arowana, this is perhaps a one-off purchase in say, once every few years? It's akin to us not buying wardrobes every few months; similarly, customers do not keep buying Arowana every few months. It does not mean of course that its other competitors do not sell fish accessories, but from management statement(for Xian Leng's, choosing it because it's the largest competitor), there is a noted emphasis on Arowana. However sadly, for some reason, the segment and geographical breakdown is not reported in the financials, so I am unable to conclude whether Xian Leng does in fact emphasise on Arowana and less on accessories. But if Qianhu continues its emphasis on the accessories and Arowana portion, it will bode well for the company, and its actions thus far have proven so.



iii) High barriers to entry



Bredding of Arowana requires R&D(yes, even for fishes). Qian Hu's collaborated with Temasek Life Sciences Laboratory, and the research team has completed the genotyping of all the brooders owned by Qian Hu and has set up an efficient method to identify breeding pairs. For the first time in the history of Arowana breeding, offspring collected from the mouth of
brooders can be assigned to both their parents, opening the way to pedigrees based
on pair-wise breeding. The team is now searching for sex-linked DNA markers that
can be used on juveniles and even larvae.



Qianhu has also invested about S$3m on a new farm in Singapore, next to its current fish farm. This new farm will be 2-3x bigger than the existing one and is under construction(it's the big piece of land beside it which is currently undergoing construction, for those who have gone to the fish farm before.)



Now, how does this help in sustainability? Qianhu's R&D efforts are largely to keep up with competitors(it does not state this in the website of course, you need to look at its competitors'). Its competitor, Xian Leng, is the first Asian company to secure CITES registration, permitting the trading of the Asian Arowana. Although Qianhu has first-mover advantage here in Singapore, however, it has its work cut out to achieve its aim of being one of the top breeders and exporters of Arowana to China(where the market is still damned big despite the one-child policy) and also the top ornamental fish exporter in the world. This expertise has however enabled Qianhu to ensure customers of a loss rate <3%.>60%, which is indeed very high, considering the current gross margins and net margins of 35% and 8% respectively.



v) Vertically integrated



Qian Hu is dependent on the importing of ornamental fish for its supply. However, other than that, everything else can be done in-house because they have the expertise and facilities, i.e. breeding ground, employees, packaging of fishes to be exported(plastic bags). So what does this mean? It means that Qianhu has most production factors are under its control. The control of such factors reduces the lead time required for the entire chain of importing the fish to exporting the fish, or selling it locally, and this high turnover results in a higher potential to convert this into profits.



Now, what's the competitive advantage again? Again, Xian Leng's 4 main subsidiaries revolve around breeding of its Malaysian Golden Arowana; trading of ornamental fish and property holding(#%@!); supplying and trding of aquarium accessories; and trding of aquaculture products. The vertical integration of the supply chain is lacking here where the accessories of Xian Leng in the exporting of fish is actually purchased.



There are other "strengths" which include a management which has been in the business for decades(Kenny Yap and family), employee satisfaction rates of 97.5%(2007), ISO 9001 and 14001 etc, but these are signs and symptoms of strengths rather than actual strenghts itself. Furthermore, there are no significant others to compare with, so I shall not spend more time talking about these little aspects.

vi) Cash convertion

Qianhu's fishes are sold through the conventional pay-at-counter method. There are little problems with receivables as people don't normally pay for fish using cheques, do they? This allows for quick conversion to cash, and Qianhu can now use the cash for investments in breeder stock, instead of having "profits" locked in account receivables. Shall talk about the financial ratios with regards to this in later analyses.

Weaknesses



i) Largely dependent on family management.



Qianhu is largely run by the Yap family, having inherited their pig-rearing business from their fathers 2 decades ago. It is largely controlled by the Yap family, i.e Kenny Yap, Alvin Yap, Andy Yap etc.



Now, why is this a weakness? The Yap family has been running Qianhu's business well for many years, without showing much signs of complacency. However, as it is pretty much a family-run business, it might not augur well for shareholders as the board might not have much say in the running of the business, and the Yap family MIGHT make business decisions which might not be in the best interests of shareholders, although I might be tempted to dismiss this. Kenny Yap has largely been ascribed to the success of the business, and has been largely accountable to shareholders, as shown by its winning of the Most Transparent Company 2 years running(SIAS) and also by Business Times(since 2002). In 1997, Kenny took on a project to automate its fish-packing processes by designing a proprietary auto-packing machine. These are evidences of competent management and help to dispel the abovementioned worries. Furthermore, on a more personal note, Kenny Yap can actually be found chatting online in forums and discussing about fish rearing. This is a clear indication that he is devoted to his job and loves his business, something that long-term investors would like to see. This is a "weakness" that might be seen as a strength too.



ii) Dependent on suppliers for supply of ornamental fish



As mentioned earlier, Qianhu has a integrated supply chain, with the only part of the chain not within control being the supply of the fish itself. When I went down for a visit, the workers revealed that fish breeding(except for Arowana) is generally not practiced in Qianhu(and also other oramental fish companies) because of the large amount of space required and also resources. However, this dependence on suppliers in Malaysia and Indonesia could meet difficulties like export problems( as they are obtained from overseas). This is one major factor that Qianhu cannot control, and I do not foresee that happening in the short run due to their recent $3 million investment in the new Arowana farm. Even if there's capability to purchase a new farm for breeding of ornamental fish, this would not make business sense as it is akin to "inventory pile-up".



iii) Dependence on Asian markets

The revenue contribution from Asian markets is 70% as opposed to European markets which makes up the remaining 30%. This is a modest 2% increase from its previous 28%. Nonetheless, the point here is that the Asian markets are more receptive towards the Arowana (dragon fish), especially so for the Chinese which believe in the superstitions related to the Arowana. This trend is not likely to change in the near future because this is a cultural habit, and consumption patterns take very long to change. Nonetheless, the Chinese market is still large enough for Qianhu at the moment, and geographical diversification is not an absolute necessity.

Opportunities:

1) Growing market

As aforementioned, the ornamental fish industry is currently about $14 billion, not big as compared to other industries, but what is most important is the sustainability. This has been proven so far, with the market growing at a CAGR of 15% p.a since 1985, very impressive indeed. To appreciate this figure, try imagining if your current equity holdings right now are being compounded at 15% p.a. for 23 years ala Buffett-style.

Nonetheless, what does it bode for Qianhu? A growing industry is likely to bring in new competitors. But bring in the point about the industry having high barriers to entry. This likely means that the current leaders in the industry will enjoy the bulk of the growth. Furthermore, Singapore has the nickname "ornamental fish capital of the world", having been the top exporter in the world in 2005 with a current global market share of approximately 20%, and is already the world's largest farm breeder of ornamental fish. Qianhu, being the biggest player here, seems poised to capture a large market share.

Now, why is this important for Qianhu still? Do take note that, as earlier mentioned, ornamental fishes are not bought at the frequency you buy toothbrushes or chocolate bars, perhaps only fish accessories. People are likely to buy 1-2 Arowanas or slightly more, but probably not much more than this figure, nor will they repeatedly buy ornamental fishes. Thus, it is increasingly important for Qianhu to outsource and increase its customer base instead of solely focusing on customer retention, at least more important than other companies not in this industry. The increasing market share will increase the amount of fish sold to new customers, and since this is a somewhat personalised service, customer retention will take care of itself through post-purchase service and fish accessories.

ii) Arowana popularity in China

Like earlier mentioned, the dragon fish has a position in the hearts of the wealthy Chinese due to their aesthetic beauty and its purported luck, something that us Chinese can personally relate to.

iii) Accessories business

Some of these are repeated points. As earlier mentioned, there is a potentially much larger market for accessories rather than fishes. The financials indicate $2 spent for every $1 spent on fishes, but an enquiry with Kenny Yap revealed that the figure is around $5 for every $1. Agreed, this might be a lower margin business. But using logic again, does Qianhu need to actively market its accessories? The customer base comes from the people who buy fishes, and people will purchase accessories after purchasing their fishes, thus it is a complementary business, and there is no need for Qianhu to spend more resources in marketing this segment of the business. In fact, it doesn't make sense at all for Qianhu to market its accessories solely. Thus, this means that not much extra effort is needed to sell the accessories, and this can be seen as a potential cash cow for Qianhu, or rather a cash multiplier. There's no such term, but I feel that it suits the nature of this business because it reaps in more revenue for Qianhu than without this segment.


Threats

i) Disease outbreaks

Qianhu lost its entire brood of 4000 loach fins about a decade ago, and this had threatened to send the family into bankruptcy. Not to say that such events will not happen, as there is still a likelihood that disease outbreaks or other unforseen scenarios can wipe out portions of Qianhu's breeder stock. However, this is likely to have a smaller material impact as Qianhu's farms are now geographically diversified, and the experience gathered these years in rearing fish would minimise the impact of disease outbreaks. Furthermore, do again take note that these fishes are not totally in-bred as mentioned earlier due to space constraints, and the majority of the fishes are imported, then immediately exported within a short period of time.

ii) Forex risks

Qianhu has exposure to certain currencies like the baht, USD, yen and ringgit. This is likely to have an impact on earnings, with forex losses at around 7.7% at present. There are currently no measures to hedge against these positions, and might have a more significant impact on Qianhu during times of crises. However, I believe that holding such forex swap contracts or their equivalents will chalk up increases in expenses that are totally not related to the business, and this amount of money may actually be better off invested in breeder stock. Thus, I do not see this as a problem for now. Even if forex risks are to increase substantially in the short run, I do not see this causing a huge problem for Qianhu's sustainability, as it is highly unlikely that forex risks will cripple Qianhu's earnings at the current level.

iii) Government legislation or regulation

This is the biggest weakness of Qianhu in my opinion, as this is something that will materially impact Qianhu's business and at the same time, not something that Qianhu's management can control as this is the nature of the business. There are certain species of fishes that are restricted due to them being endangered. In fact, the Arowana is an endangered species, and under CITES, the fishes actually have to be tagged and the sales monitored to ensure that wild stocks are not being traded.

One important weakness of a business is its restricted markets, and this is one good example. This indicates that the business might not have the potential to continue to grow at the rate it has seen previously due to restrictions not within its control.

Is the ornamental fish industry any different? Somewhat. Firstly, Qianhu has already obtained its licence to breed Arowana. 2ndly, the beauty of ornamental fish is that fishes are not all identical, as in-breeding can occur. This means that the supply of ornamental fish can be said to be unrestricted save for the ones that are endangered. This again, bodes well for the sustainability of Qianhu.

That was one long analysis. Shall talk about the financial portion in my next analysis.

Blue Chips or not?

For some investors, blue chips are the only companies which are worth picking up. They have had proven cash-generating ability, sustainable dividend yields, and also gone through some crises, and are a must in some portfolios. Whilst these may be true, however, the markets are largely efficient to the extent whereby blue chips are mostly fairly valued. There are hundreds of brokerages out there covering blue chips, and a million other investors out there which have their eyes on the companies, waiting to swoop in once some idea of inefficiency rears its head. As such, blue chips are likely to "market perform".

With these being largely true, value investors will tend to stray away from them. However, with the recent turmoil in the markets, some value seems to be emerging amidst the sell-down. Now, why should value investors stay away from them if their valuations have been beaten down? Only because of the notion that there are many other brokerage firms which are covering them, and thus a low likelihood that one would catch it when it is undervalued? I believe 2 main points actually disprove this idea for now.

1) fund redemption

There had been an increase in capital outflow from Singapore from mutual funds. This has led to a massive sell-down in equities. One can argue that the mutual funds are selling to the extent whereby the prices reflect the current financial turmoil, and that prices are reflecting the newsflows.

However, over 90% of trades a day are accountable by mutual funds (quoted from Pulses), so it is likely that massive sell-downs can be attributed to the large funds. So, if all the funds start to sell collectively, will there be any fund manager which would want to pick up stocks even though they are aware that value is compelling? It is highly unlikely that a fund manager would want to be caught catching a falling knife, especially so since their performances are tracked on a quarterly basis. Now, if all fund managers were to hold on to their holdings, would the markets be faring as badly? Probably not. But this is only likely to happen in an utopian world. This can be likened to the prisoner's dilemma, where few fund managers would want to dip their toes into the markets knowing well that other fund managers are still selling.

2) Other unforseen circumstances

One such example is margin calls. Let's all recall the performance of Keppel T&T over the past few months. It dropped from $4++ to <$1 at penny stock status in a matter of a few weeks, dropping 30+% compounded for 2 straight days. Reason? Fundamental change? Not really. A large shareholder (though not substantial enough to hit the 5% mark) was caught in a margin call and was forced to sell his holdings, resulting in the dramatic drop. It is currently trading at around 73 cents. Now, what on earth could have made a company lose 60% of its value over 2 days? Was the market valuing Keppel too highly before the drop? Or is the market valuing it too lowly after the drop? Mind you, Keppel T&T isn't exactly the kind of obscure stock where market inefficiencies might lie. It was a spin off from the Keppel conglomerate years back. Even though it has a low float, however, this is no reason for a huge discrepancy in the valuation in the space of 2 days. However, I have not seen its financials to be able to make a more informed stance on whether it is undervalued or not. Nonetheless, this is another prime example of how companies, even the better-known ones, can suffer from certain market inefficiencies.

Now, how can we know if a blue chip has been priced out of its fundamentals or not? One essential way is to look at how much of a fall that the markets have priced in. E.g. for property companies, this means taking a look at how much the markets are pricing in for a devaluation in the revalued net asset value. Now, if the markets have priced in too large of a fall (in your opinion), you might consider picking up the stock.

More importantly, blue chips are largely proven to have been consistent earners, and there is a high chance that earnings will go back on track after some hiccups here and there. Back to the definition of an undervalued stock again, which is to purchase stocks of a company when they are trading way below its intrinsic value. This intrinsic value is derived from its ability to generate earnings beyond the current 1-2 years, quite possibly even 5-10 years down the road. Now, blue chips have seldom fallen into this undervalued category, at least in my opinion. Was trying to bargain hunt for some blue chips but realised that the majority of them had been priced expensively, only until recently did it change. It does not mean that the small-to-mid cap stocks are the ones which are more likely to be priced inefficiently; the same can also happen to blue chip stocks, but only rarely, and possibly in bear markets like these.

The bottom line? No matter blue chip nor S-chip nor red chips, do your homework. True, blue chips can be covered by hundreds of brokerage firms around. But due to several reasons where value is emerging but nobody dares to purchase (factors as mentioned earlier), blue chips can still be hunting ground for value investors. Although the markets are efficient, there can still be opportunities abound. Information takes seconds to disseminate, but insight takes much longer.

Short-term view coupled with Long-term view

Got me thinking in this bear market about a short-term and long-term view. Value investors have the mantra: take a long-term view and purchase the stock when it is trading at a significant discount to the intrinsic value.

Not that there are any flaws with regards to this idea. But problem lies in that, for e.g., u apply a 10-yr DCF for a certain company and u arrive at say, $5. So, if you apply a significant MOS, say 50%, you should purchase it at $2.50. But as everyone might have been aware, this might have left you smarting with some losses at this moment of time. Simply because the markets are viewing it more bearishly say at $1.50, largely because of the fall in their short-term earnings.

The natural response might be to average down your cost, some might say. If the MOS was applied, the losses might not have been huge at this moment of time, and all you need to do is to dollar-cost average your way down. But, let's be a little realistic here. We're retail investors. How deep are your pockets? you've got $200,000 more? $1 million more? There's going to be an extent to which you can average your way down.

How now? Do we still stick to this principle? Of course! But, we need to understand that the fundamentals do change with the macroenvironment. Do we apply a larger MOS? You could. But what I think could work better is to find out how much of earnings downgrade the market is factoring in. The ways to do this will not be covered for now, but a simply suggestion(but highly inaccurate) could be to predict the earnings next year and apply a suitable PER. Most importantly, the concept lies in that one should know what this short-term price, that the market values the security currently, means. This will help to limit your downside, probably, and after you've factored in some earnings downgrades, back to the principle, do apply a MOS as well.

Now, the difficulty in this lies in that earnings cannot be predicted so easily. If it could, we would have all been rich. There are probably 2 ways to do so:

1) refer to analyst estimates and consensus estimates

2) look at how the company has been performing previously in crises, and predict the earnings from there.

I try not to use 1), not because of overconfidence that I'll predict better than the analysts, but only because they tend to try to be accurate, but value investing is all about being roughly accurate, because it is indeed very tough to be highly accurate. When you try to do that, chances are that you might make mistakes somewhere by failing to account for itsy-bitsy pieces of information. For now, I've been trying to apply the 2nd methodology. Of course, companies change with time. The $5 stock I mentioned could be much more robust now than in previous crises, possibly because of a regional franchise, or larger sources of revenue. But the macroenvironment could be different based on the previous crises (i.e. Sars and Asian Financial Crises). That's where the MOS comes in handy.

Now, how much of earnings downgrade to factor in will alter your pick-up price. Then, the question comes. What if you've factored in too much an earnings downgrade, or too high a MOS? You could miss picking up the stock because of that. I can't answer this question, but for myself, what I do is to make a reasonable earnings downgrade, and apply a smaller than usual MOS only because you have subconsciously applied an MOS when you did your earnings downgrade. Will this method work? I'm not sure. Try calling me in a few years time to see if I've moved to a larger bungalow or mansion. But worth trying? Maybe.

Cash

Recently, found myself looking for companies where valuations were distressed enough for me to take a second look. However, in the midst of looking at them, I realised that I might have been straying away from good businesses and looking at valuations only. However compelling, one should always make it a point to buy only when the companies are looking at, and selling for a song. Shall treat this as a reminder, keeping true to my resolve.

Thinking about the nature of some businesses recently since the start of the week, and how they can bring in the cash for the company. Realised that it might be wise to steer clear of companies which generally depend on contracts for their businesses. Firstly, contract bidding is something which might result in inconsistent margins. Secondly, and probably the most important point, is that cash doesn't come in until after stages. Talked about KingsmenC some time back, but realised that they lie in this 2nd category. After awarding of contracts, they start their work. But payment is received only after certain stages of the project are completed. Now, this only means that the cash has to be invested first, i.e. u can be working for the entire year and only see ur money coming in at the end of the year. How's that for cash? High profits with low cash received, mostly in accounts receivables, Enron-style. During times when contracts keep coming in, the cash might keep coming in too. But when contracts dry up, u're faced with a dearth of cash. Profitable? Might be, but this lack of cash visibility might keep some investors like myself away. It's unlike the kind of business where you immediately see your cash coming in(e.g. I don't think you buy your shirts on contract, but that's just only one example). So, these companies might have high leverage so as to continue on their projects first. When contracts dry up, debts still have to be repaid.

Let's take this simple analogy. Today, I just made some "money" on the markets, because the prices have risen(akin to winning of contracts). Now, if one does not sell away the shares, the "money" is still in the markets(akin to profits in accounts receivables), although the reason and whether you should sell or not is another issue for another day. So, if you "earn profits" in the markets in this way, your profits are techinically not yours, you can't take the money out to invest in other shares to earn more money(akin to lack of cash visibility to reinvest), or repay your housing loan(akin to the business not having the profits in cash to repay debt). What's more, your profits might not remain profits anymore as the price might drop below cost anytime(akin to customers defaulting on payment). Hope this helps.

Now then, what's the way to avoid this happening? Sadly, most of the time, that happens to be the nature of the business, there isn't much that you can do about it. If you can understand and handle it, stay vested. If not, you might want to steer clear.

Anyhow, shall only update more frequently and writing up more in one week's time after everything at hand now is over. Shall look at some property companies if possible and talk about them. Seems like property companies do fall in the abovementioned category, but there are some exceptions. Would really love to hear comments regarding this;)

2nd Chance Properties on Business Times

Didn't catch this article on the day itself. Shall post it here for all to read. The exact link is here: http://www.propertyguru.com.sg/news/2008/11/1457/second-chance-an-undiscovered-property-play


Nov 14, 2008 - The Business Times
R Sivanithy

ONE of the more interesting corporate developments over the past few weeks may have gone unnoticed by most investors - an offer to listed retail-cum-property group Second Chance Properties (SCP) to buy the company's entire property portfolio.

While some companies might have jumped at the chance of a large cash windfall (something all shareholders would surely welcome because it would mean a big payout), what's interesting about it is that SCP on Wednesday announced that it had decided to reject the offer. The reason? It doesn't need the money!

'We have been accumulating properties since 1999 at attractive prices and have managed to build up a sizeable portfolio,' said SCP's chief executive Mohamed Salleh in an interview with BT. 'All our core businesses are doing well, our gearing is low and the offer, which was unsolicited in the first place, was not attractive so I didn't want to waste the company's time pursuing it.'
SCP on Oct 20 disclosed that it had been approached by an international property consulting firm on behalf of an unnamed client who was interested in buying SCP's entire property portfolio for an undisclosed sum.

As at June 30, SCP owned 42 properties valued at $118 million, of which 39 are spread throughout Singapore and three are in Kuala Lumpur.
The Singapore portfolio comprises mainly shop units in shopping malls in the Orchard Road area and in HDB hubs. Net rental per year is about $7.5 million.

'We have very low gearing and all our properties are tenanted with leases of 2-3 years that provide a steady rental stream,' said Mr Mohamed Salleh.
'Even with the downturn, we've found that demand for retail premises is high so there's no problem finding tenants. Of course if things get much worse, we may have to accept lower rentals, maybe 10 per cent. But for now, there is still plenty of demand.'

SCP this week reported a 22.4 per cent increase in its first quarter revenues to $19.2 million. Net profit was down 2.8 per cent to $5.4 million. The company has proposed an interim cash dividend of 2.5 cents per share and is also proposing a share buyback scheme.
'We want to do a buyback because our shares have fallen to a large discount to our NTA (net tangible assets) of 30.4 cents,' said Mr Mohamed Salleh. SCP's shares yesterday traded at 20 cents, a 34 per cent discount to NTA and indicating a dividend yield of 12 per cent.

If SCP presents an attractive investment story, why has its shares languished from lack of attention? One reason is a misplaced perception - despite the company's name - that it is mainly a retail company specialising in female Islamic apparel.

This, in turn, has led to an absence of adequate research coverage by broking houses which tend to view the firm as a retail play - with all the associated slow-growth connotations that accompany the sector.

Truth is, although SCP counts the retail sector as one of its core businesses, it should also be viewed as offering decent property exposure. In fact, it may be one of the local market's undiscovered - and possibly undervalued - property plays.

Red Flag alert?

2nd Chance posted its 1Q FY2009 results quite recently. Revenue and profits up by double-digit figures despite Hari Raya being in 1Q FY2008, which seems hearty considering the current climate. All 3 segments of business posted increases in profits, with the securities segment paper loss of $10 million charged to equity after 2nd Chance declared the near-term intention not to sell or purchase equities, thus classifying it under financial assets for sale.

Management kept to their promise, declaring an interim dividend of 2.5 cents, which at the price I bought, equates to about a 15% interim dividend yield, sticking to the declared dividend payments at which I could look forward to a total 20% yield. Sounds good, the market says, with the counter trading volume going up and trading price rising 7-8% compounded during Thur and Fri trading, bucking the overall downtrend. This came rather surprising to me as companies normally run up some time before the declaration of the dividends, so the markets must take the results and the sustained dividend yield as a positive for the share price to run up so sharply.

Time to rejoice? Not yet. Let's take a quick look at the financials.

1) There has been an increase of appoximately $16 million in short-term borrowings that are due in less than a year, which are backed by mortgages and assigment of rental proceeds. Assuming that of course the borrowings will not be repayed through the mortgages, how much of the rental proceeds can cover the short-term borrowings of $43 million? Rental proceeds at this moment are still little less than $1 million. Seems that the cash from operations is still healthy at around $4 million, but this amount is insufficient to cover the short-term loans, even if this $4 million is a quarterly figure and that retail businesses tend to pick up towards the start and end of the calendar year due to seasonal effects.

2) The dividend declared for this FY was 3.5 cents. At the current float, this amounts to around $10 million attributable to shareholders. However, the net cash at bank of around $1.6 million is largely financed by the additional $16 million short-term borrowings. Is it possible to sustain this high dividend distributions to shareholders without constant loans?


Agreed, one might argue that hey, 2nd Chance's gearing is at ~0.5X right now. This is relatively low compared to its peers. But it sure tweaks a few eyebrows to know that the current dividends are being sustained by borrowings from banks, even if the likelihood of securing loans is very high due to its low gearing.

3) medium term outlook has detoriated due to the political instability in Malaysia. Management has candidly revealed that the plans to expand to 100 stores in the next 5 years will have to slow down. Nonetheless, market share might improve as 2nd Chance has the financial resources to weather this slowdown more than the smaller fragmented retailers who do not have differentiated positioning. Furthermore, the business cycles of 2nd Chance tend to overlap i.e. gold prices are might continue going up as it is viewed as a safe store of value in tough times, so its gold business might see improved profits, although revenue might be another issue.


Nonetheless, 2nd Chance's boss, Mr Salleh, has proved to be relatively astute in investing in downturns, and has a large percentage holding of 2nd Chance shares. Looking on the bright side too, 2nd Chance recently requested for the mandate of shareholders to approve share buybacks. At this time, seems that the management might be finding shares at current valuations very attractive. Maybe the management knows something that we don't. Still, would seek clarifications before deciding on my next course of action.

Pays to look at your company's statements from time to time, to keep track of the latest ongoings and whether certain red flags are appearing or not. Shall wait and see.

Will try to look at Olam's very soon and post some comments regarding their recent set of statements. Traded slightly down due to management's warning for tough times ahead, despite posting a relatively good set of results. Will try to see how much the market is pricing in for a drop in commodities prices and post my verdict from there.

Ho Bee update

Still busy, but took some time to briefly look at Ho Bee's financial statements for the 3rd quarter.

Revenue down 59%. Profits after taxation down 50.1%. Profits from operations down 47%. Cash flow from operating activities down 99%. Pretty dismal showing here.

Now the markets have already punished Ho Bee relatively badly here. It's currently about 80% down from its peak, trading at around 38.5 cents now. Let's take a look at how the markets have factored in the pricing for Ho Bee. Will not take a look at other parts of the financial statements for now.

Development projects up in FY2009 are The Coast, Paradise Island, Orange Grove Residences, Vertis and Quinterra. The accummulative book values( NOT revalued ) are at $1,259,427,000. Its investment properties stand at $303,432,000,along with its short-term receivables of $15,715,000 and cash in the bank of $94,523,000.

Ho Bee is a relatively highly geared firm, especially compared alongside the other developers, with debt-equity of around 1.45. Total liabilities, short-term and long-term, stand at $1,301,427,000.

The net position is as follows:

(Bk Value of invest prop + devt projs + short-term receivables + cash) -

(short-term and long-term liabilities + payables) =

( $303,432,000 + $1, 259,427,000 + $15,715,000 + $94,523,000 ) -

($1,301,427,000) =

$371,670,000.

The current no. of shares that Ho Bee has as issued share capital is 737,338,000, no Treasury Shares. Therefore, the current net of surpluses is:

$371,670,000 / 737,338,000 = $0.5041 / share.

The markets are now exchanging Ho Bee's shares at $0.385. The implied valuation net of surpluses is thus 737,338,000 * $0.385 = $283,875,130.

The markets are factoring in a write down of approximately ($0.5041-$0.385)/$0.5041 = 23.6% write-down in Ho Bee's assets.

Now, let's take a look at Ho Bee's current 8 residential projects. Out of these 8, 3 are yet to be sold out. Paradise Island's % sold-to-date is 96%, Turquoise 48% and Orange Grove Residences 92%, with the majority, save for Coral Island, yet to be recognised in the quarter.

Now, let's take a quick look at the quality of the portfolio. Out of the 8, 4 are Sentosa Cove, one Mount Sinai, Amber Gardens, Holland Road and Orange Grove Road. All high-end.

Now, with the current prices factoring in about 1/4 of Ho Bee's assets to be written off, it's unclear whether the stock is trading attractively or not. Downside COULD be limited to around 50%, i.e. $0.25/share. But the quality of the portfolio could limit this downside. Attractive? Anybody's guess.

Anyhow, but still, there's a likelihood that the markets will punish Ho Bee tomorrow for this dismal showing. But then again, which company hasn't been hit badly in terms of profits?

Great Singapore Sale

I must say, since my last update, the markets have gone on a wild ride. Valuations have become so depressed, that I could only stand at the sides and dip a bit of my toes in, only because I haven't had the capital to purchase much more than I would have wanted to.

This entry is only going to be a generic one, I've been so busy will only start updating regularly in a few week's time. Nonetheless, I managed to take out some time to analyse a few companies and pick up some shares, including Kepland at 1.45, Tat Hong at 0.385, Olam at 0.89, 2nd chc at 0.17. Those who have waited to "time" the market might have missed it's bottom at around 1,500 (might, because no one knows whether it has bottomed or not, and I am not interested in attempting to call for one). The point is that, do pick up any counters with significant margins of safety and do not hesitate when you see them.

Anyhow, would like to talk about a discussion I had one day with a friend. Were talking about some counters I had in mind but do not intend to purchase at the moment. One of these companies is C&G Industrials. It released its financial results quite recently, and on this grounds, I think it is trading at too ridiculous valuations. With about 560 million RMB in cash(about 100million SGD) at hand(in the bank), the cash per share is about 25cents. Now? it's changing hands at 6 cents. The maintenance capital expenditure is estimated at around 120 million RMB(based on past year experiences). So, if the company continues to expand at the rate it has been doing so far, and earns zero profits, we can safely assume that the company can stay solvent for 4 years plus. The management has released statements on scaling back of capital expenditure in the coming year and has just pulled out of one project. This can probably result in a cutback in cash burn rate. Attractive? maybe. I've not taken a look at the business of C&G, so I may not be in a position to make comments.

For 2nd Chance, a company that has posted 6 straight years of record profits, its profits had taken a turn for the worst recently due to its securities portfolio. As I had previously mentioned, one of my concerns was its increasing share in the portfolio. Sadly, the words have come back to haunt me, as they have to book a loss in the coming quarter due to its unrealised losses in securities. The market immediately punished 2nd Chance, dropping about 20% in one day of trading. Rational? I don't think so. It is an unrealised loss, and not loss in cash or its core businesses. The management have already provided guidance, that the securities portfolio will be limited and not added upon. The loss is only an accounting procedure for booking it into the P & L statement, and its profits will still provide the cash for its dividend payout. Thus the decision to pick up more at 0.17.

Some of the property stocks out there are trading at relatively ridiculous valuations of around 0.3X book, and around 0.5X RNAV. The market seems to be pricing in for a prolonged downturn in the property market. However, for those with a long-term point of view again, might want to look at some companies who have vested interests in other countries like Vietnam (where the PDI is rising at CAGR of around >10% and mean age around 40 years) and China. The long-term fundamentals are still intact, unless a war erupts.

Most importantly, we should look at companies where the earnings visibility can be projected far ahead. By this definition, I might be tempted to exclude the O & M sector (darlings of yesteryear) and the technology sector to a certain extent, but property companies might still tend to trend upwards due to demand for their assets in the long run. Cash is also important at this moment, so companies which are sitting on hoards of cash right now might survive, increase market share and thrive. An e.g. could be the change in the automotive industry landscape, with Toyota poised to overtake General Motors as the market leader, as the latter might face insolvency from high cash burning. Might be time to take a look at some market challengers, and if they are holding onto large amounts of cash compared to leaders who have been less prudent, keep a watchful eye.

Have a great day shopping on the Singapore Exchange. But compare the prices and do your homework before you open your wallet.

Kingsmen Creatives

One of those companies that I have been following, but not exactly sure that the valuations were attractive, until the recent selldown. Kingsmen Creatives is a regional player which designs events, museums and trade shows. The aim of the company is to provide "one stop shop solutions" for design, and has served some big names, including Burberry Asia, Dickson Group and FJ Benjamin. Some of the projects clinched by Kingsmen so far include fabricate seating and corporate suites for the F1 Grand Prix recently, Singapore Airshow, BMW event launches, "roll-out programmes for Apple, Burberry and Chanel, 2 Integrated Resorts, ION Orchard, Beijing Olympics blah blah blah...haha i think u should get my point here.



It's been increasing its presence in the region, and its pricing power has been characterised by its increasing profit margins not totally attributable to its drop in expenses. It's been in the business since the 1970s, and this gives it an early entrant advantage. By stamping its brand on most major projects happening in the region, this in itself has created a form of advertising. Notwithstanding the fact that Kingsmen has a diversified customer base and also sector exposure(financials, retail, etc) and this would help to ensure that the company does not struggle to keep afloat during trying economic times.

Roller coaster ride

Lehman. Merrill Lynch. AIG. Washington Mutual. These were some of the big names whose scalps were claimed quite recently in the financial turmoil which unfolded in the past week or so. However, as some of the investors stayed at the sidelines, others who had bought on the recent weakness saw some rewards after plans were unveiled to save AIG and the Fed announced a huge bailout plan for banks. Questions abound in the markets on whether this was a time to stay vested to ride the eventual rebound from current levels. Before retail investors like us start to get carried away and put our entire house mortgages in the markets, it is better for us to think of the signs and symptoms that this might still be a bear market rally.

1) The bailout plan is still a plan after all, not a consequence. It is still debatable as to whether the Fed should, and can, rescue the banks that have fallen. It is arguably a distortion of the markets for the Fed to continually rescue the banks, and might merely delay the eventual selldown of the markets. The markets might be reacting to the prospects of a renewed banking sector, taking note that the stock markets are generally leading indicators rather than accurate indications.

2) The bottom of markets might probably only be found when the selling reaches a climax, i.e. prices stop going any lower despite bad news unfolding. I personally believe that perhaps good news of this magnitude might not be an accurate barometer of the reversal of the markets.

3) Notice the selldown recently before the news was unveiled. This might have been the work of short sellers taking to profit from the weakness. Similarly, the sharp rally might have been short-covering by this group of traders. Just simply what I thought of, sadly there's nothing to back me up on this claim;)

I wrote this post not for the purpose of making a market call, that the bear market is not over yet, but to remind investors like myself not to be complacent and over reliant on the Fed to clear up the mess. The mess might need to culminate in a selldown of extraordinary proportions before we can say a market bottom might have reached. Thus, it is essential again for all of us to invest in the markets only when valuations are truly attractive. No point looking to vest in counters which might still be at premiums despite the quite recent selldowns in the hope that they will fetch higher ratings in future.

Just some reality check there.

The Value Trap

Just a very short entry. Buying for value investors has frequently been a roller coaster ride. Buying when the stock is going down is a big faux pax for technical investors, but might be exactly what value investors are doing. Just a few points on what I think can be done to minimise being caught in a classical 'value trap' when prices that r cheap keep going down.

1) Stick to a big margin of safety before purchasing

Especially so in a bear market. Go for the big fat pitch, as Buffett says, rather than go for the small ones. If the stock does not fall within ur radar on valuation grounds, no matter how good it might be, do avoid it unless u have really sufficient reason to do so. Especially so since retail investors like us need to be more careful due to limited capital.

2) Yes, average ur way down, but don't put all in at one go

Do go for the big fat pitch. But prob is, if a stock goes down, it is likely to go down further for various reasons. So, hold ur cash first, don't put in a big portion at one go. The institutional investors with much deeper pockets can do that, but not the retail ones. Agreed, u might say that it's all about long-term investing, an it doesn't matter too much. BUT honestly speaking, who doesn't want to purchase at a lower price?

3) Only put in more if there's a substantial drop

I think that one shouldn't keep buying at approximately the same prices. It pays to be patient. Even averaging down is a skill; it doesn't mean simply buying when the prices come down further. If the stock only goes down say, 5%, do not think of purchasing more. If it goes much further down, put in more; if it goes up from here, be thankful u invested already and do not attempt to put in more when it goes up, because it will lower ur margin of safety.

4) Buy in smaller volumes at one go

Do determine how much u want to invest in a company, based on model's like Kelly Optimisation or anything that u find suitable. For example, if u think u want to invest $5,000, do not put in $5,000 in this company at one go. U might want to put in $1,000 first, and wait to see if it drops more, and put in another $2,000, before putting the remaining $2,000 if the stock still continues to drop. For myself, I try to invest 3 times and average down, if the stock does not go further down, I leave the remainder for another more attractive company. Well, I'm obviously not a guru, but just want to share some techniques that I use with others and invite comments.

5) However, do take note of transaction costs

Some might want to take note that u tend to incur transaction costs when u average down. Do calculate them and subsequently only average down if ur total value after transaction costs will bring down the average cost significantly.

Styles

Went for a technical analysis workshop yesterday, not because of interest or curiosity but because of an obligation. Shall not elaborate on that. The speaker was a very engaging one, he claims to have found a trading strategy that nobody else has found, and demonstrated his technique through demonstrations by looking through previous charts. Seemed to be a wonderful strategy, did a live demonstration but wasn't as convincing due to the fact that he said certain blue chips were controlled by the big boys and wasn't so accurate, sounding doubtful in tt statement. Shall give him credit for the fact that some of his charts do look convincing on this technique, and according to his claims, this technique probably works well for him(he mentions earning a 24% p.a compounded interest on his portfolio for the last decade), and he claims that he is teaching and not trading because his passion lies in teaching people(MOE?) and not trading and earning money. He charges $3,000++ for his course and has a few months of mentorship for members. For those interested to know more, you can contact me. Shall charge him a commission for advertising his technique here, and tell him that my passion lies in advertising, and not in earning money.



The intention of this post is to bring out the point that well, the stock markets aren't something u can predict accurately in the next few days or so. He demonstrated this when like earlier mentioned, a person from the crowd picked out UOB as one of the stock picks to demonstrate his technique and he failed to find a discerning pattern. Well, when you can't beat them, join them as they say. Which probably explains why indexing is a great place to park ur funds right now.



The only fund that tracks the Straits Times Index is the streetTRACKS STI ETF. What the ETF does is to aim to track the movement of the underlying index, which in this case is the STI. The ETF is traded live on the Singapore Exchange in the secondary market, and is managed by fund managers who merely attempt to track the index, which is also called passive investing as there is no attempt to outperform the index. Units will be bought from Participating Dealers who create and redeem shares(because the STI ETF is open-ended), and this allows the fund price to be close to the Net Asset Value of the fund(which obviously changes everyday).

Since the ETF holds the same underlying stocks as the index it is attempting to track, the performance of the fund moves in tandem with the markets. There are several advantages of this:

1) There is a great amount of diversification. For e.g. the STI comprises of 30 of the largest companies according to market capitalisation, and by owing the STI ETF, the investor immediately diversifies his holdings according to the index, which is also relatively fairly represented in various sectors.

2) Low costs. Instead of attempting to time the market and trading very frequently which results in high transaction costs incurred, owning the ETF is much less costly. The charges will comprise of the brokerage fees (which depends on which brokerage you signed up for) and the management fees (which is kept minimal , <1%, because the fund is passively managed, as previously mentioned). Compare this to another mutual fund which attempts to outperform the index (and frequently fails to) and charges much higher transaction fees(~5% inital and 1-3% for management).

3) Easier transactions. An ETF can be sold intra-day like a stock, i.e. during trading hours from
9 - 1230 p.m and 2 - 5 p.m. Compared to unit trusts, the latter cannot be traded intra-day and will only be processed the next day when the order is received before 3p.m.(check your individual prospectuses for this one).

4) Cheaper alternative to real indexing. Indexing, not through a fund, will require a huge amount of money. To do so, the investor will need to buy the components of the stock at its individual allocated weights, and this will incur a transaction cost larger than that of the STI ETF(some stocks trade below the minimum level, so the minimum brokerage fee of $25 will be charged, and this $25 will be a larger percentage than the usual 0.25% for other stocks). The STI ETF will not require such a large amount to invest in, with the minimum trading board lot costing around $3,000 or so.


Every good thing has a bad side to it.

1) Illiquidity. The ETF is not currently a very liquid stock, with trading volumes varying around a few hundred lots per day, to a drab 48 lots exchanged for today.

2) Tracking error. The ETF also employs derivatives and options to attempt to track the index. There are times when the ETF has a tracking error, i.e. the ETF cannot replicate the performance of the STI. Don't forget the fact that there is a small management fee charged annually, just like any other mutual fund.

3) Health of the general Singapore economy. The economy's well being is essential to the STI ETF doing well, as the STI is a general indicator(albeit leading) of the economy's prospects. In the event that the STI does underperform, the ETF is expected to follow suit, and also vice-versa.

For the 1st point, although the STI ETF is relatively illiquid, it should not matter to investors who wish to invest for a longer time horizon. As for the 2nd, the ETF's tracking error is not expected to be large, although there are times when the price does lag the general market(possibly due to pricing in). The 3rd point is something that the investor cannot do anything about though, sad to speak.

In essence, the ETF is definitely suitable for investors who wish to compound their earnings in a more passive manner. Although it is tempting to attempt to pick up stocks that will outperform the market, however, those with little resources and energy, and also expertise, should try to stick to the ETF to maximise their returns. Active investing might add a few years to your retirement instead of shaving them off. Alright, that's a might, and there are probably other reasons you want to pick individual companies in the first place(e.g. for the experience of investing) The returns of individual companies might be tempting, but it is equally likely for the investor to falter when it comes to stock picking.

Back to the beginning, the investor who wishes to adopt a less active approach by minimising transaction costs will be better off doing fundamental approaches rather than technical approaches. Without going into a lengthy debate as to which camp will be better at maximising wealth, I would simply like to point out the main difference, which is seldom mentioned, between these 2 camps: that the technical trader will probably be more cash rich(provided he is a competent trader) whilst the fundamental investor will probably be more asset rich(provided he is a competent investor, which in this case his assets are in stocks). The trader is more likely to see more cash end up in his pockets whilst the investor who buys on fundamentals is likely to see his cash compounded in the markets in the long run. So, for those investors who wish to see more cash in the pockets, but are also fascinated by the riches and wealth of successful value investors like Warren Buffett and the like, do take heed. The idea of having lots of cash in hand, and also compounding earnings like other successful investors like Peter Lynch does, might not reconcile at all. Think twice before u set your mind on which style of investing is suitable for u. For those enticed by the potential riches, do note that fundamental investing might result in extended periods of time where cash flow is insufficient(on this note, please do not invest any money that u require for emergencies in the markets. That might create an emergency in itself!)And yes, do not for one actually think that u can compound ur earnings at the rates that the legends have done. Stay practical and be on ur feet.

Hang on. This is one hell of a ride.

2nd Chance Properties

This company is not a very widely followed company, and is not covered by analysts. Its market capitalisation as of 29 Aug 2008 was approximately $111 million, and thus can be categorised as a small-cap company. Shall talk a bit more about its business since not many people may have prior knowledge of this company, although most would have seen and recognised the brand.

2nd Chance Properties Ltd is a company which sells Muslim apparel under the "First Lady" name, as well as gold jewellery under the "Golden Chance" brand. It is also a small property player in Singapore, owning retail property in places like City Plaza, Toa Payoh and other places. It has rather ambitious aims to be the largest Malaysian retailer and wholesaler of modern Islamic apparel in the region, hoping to expand to 100 stores in Malaysia in the next few years from 30(although it recently mentioned that it will slow down expansion in Malaysia less aggressively due to the deepening political crisis).

The CEO of 2nd Chance, Mr Mohd Salleh, has been adopting the strategy of investing the cash flow from its retail and gold businesses in selective retail property, acquiring about $85 million worth of property in total, with an eye on the future growing demand for City Plaza. It then paid of its debt relatively, bringing its debt-equity down from 1.26 in 2003 to 0.40 in 2008(full year FY2008 unauditied statements).

A quick look at its 2008 profit/loss statement saw a 10.39% rise in revenue, with a jump in its net profit for the period by 31%, recording its 6th consecutive year of record profits. Its competitive position has been highlighted by its margins, with its profit margin increasing from 38.1% in 2007 to 45.4% in 2008. Its cost of sales had impressively dropped by 6.90%. Do take note of the fact that gold has been rising at astronomical rates following the weakness in the equity markets. Operating cash flow jumped 47.3% for the same period. After revaluation of its property value by Jones Lang LaSalle, it showed a $15.1 million increase with total value now standing at $118.4 million. Its book value sood at 34.27cents, which translated to a price-to-book value of 1.00 as of today.

Taking a look at cash flow, free cash flow for the firm dropped though, by a drastic 68.2%. A quick look at it revealed that there was a 6-fold jump in the investments in property, as well as securities held for trading. The recent weakness in the property markets have brought down property prices to more realistic valuations, and the large increase in acquisition activities does not come as a surprise. However, its increase in securities trading, where the firm actually bought REITs, although the board had previously mentioned would be cutting down, could be a cause of concern. Although the selloff in equity markets might have brought prices down, however, as an investor, it would probably be a little more re-assuring if the company places its emphasis on its core businesses. A little more reassuring could be the fact that it had a net outflow in securities due to disposal.

Taking a look at the breakdown in contributions, revenue from Malaysian operations increased by 26.3%, in-line with management's ambitions of expanding in Malaysia. There were 10 new stores opened in the financial year. Rental from investment in properties increased by 13.0%, as most of the shops fetched higher rental rates for the company. The revenue from the gold business however dropped by 9.7% due to the decrease in demand for gold in times of rising gold prices. The Malaysian business saw a 36.4% increase in gross profit due to the expanding business, and although gold revenue dropped, the profit rose by 5.4% due to lower average cost of gold in stock.

Going on to debt, although there was a decrease in debt-equity, however, the current ratio rose to 1.44 from 0.9, the reason being the management's change in focus by switching its fund from long-term funds, which were carrying higher interest rates, to short-term loan facilities. Debt-equity was not totally reflective of the debt level of the firm, which rose as a whole, because the shareholder's equity rose more than the debt, from $96.7 million to $113.6 million. This is however not a cause of concern for the firm's current liabilities can be covered by its current assets despite a drop in working capital. The firm has been adequately backed by strong cash flow from operations as well. Also, looking at the brighter side, the firm can finance its operations through borrowing relatively easily because of its low gearing.

Inventory turnover dropped from 2.2 to 1.9. However, as the breakdown of inventory(which consists of gold and apparel) was not shown in the reports, it is hard for me to ascertain which particular item led to this drop. A guess on my part though, could be that the drop in demand for gold could have resulted in higher inventory levels, thus affecting the inventory turnover, especially so since gold would have been a large portion of its inventory.

Looking forward, the company faces times where its profits from First Lady Malaysia could be affected due to inflation and the political crisis, as earlier mentioned. As for gold prices, the volatility could result in either higher profits(if it rises) or lower profits(if it drops). The retail segment looks more promising however, due to the rise in rentals and a strong SGD which could keep the SIBOR and other interest rates down. The management has declared a dividend for next year and 2 years later at 3.5cents and 3.8cents respectively, which at current prices translates to a dividend yield of slightly more than 10%.

I believe that 2nd Chance now stands in a unique position whereby property rental income might now be the cash cow for the firm. Due to its previous efforts of 'biting the bullet' and paying off its debt for the retail property, the rental is now bringing in the cash for the firm. This could bode well for its gold and retail arm, which had previously supported the property business of the company.

Going on, its new concept of the Muslim Mart seems to be kicking off, but however, the full impact and revenue contribution from this concept will only be seen in the next FY. The concept revolves around providing a one-stop destination for Muslims to purchase their clothings, books, toiletries and other items together. I paid a visit to its Mart and found that this concept had brought about a big difference as compared to the fragmented retailers which were situated nearby. Although I agree that the retail industry is a relatively low barriers-to-entry industry with many fragmented players, however, I believe that the niche lies in its appeal to the mass market and the branding of First Lady. It is distinctively the most recognisable brand, alongside other brands in the area, and apparel are going at low prices(so the high margins are due to its gold and jewellery business). It also aims to gain the heart share of the market through its regular Lucky Draw promotions, although I believe this would have a limited impact on the business of the company. Its easily recognisable brand however plays a huge part in the capturing of the heart share, as Nike, Addidas and other big companies have shown in decades.

After applying a conservative 5% increment and 9% discount rate to my DCF method, i arrived at a implied value of around 41cents, not including its dividend yield of around 10%. The market seems to be projecting a modest growth of the firm, without being influenced by the board's ambitions and the CEO's views that 15% CAGR is attainable for the firm. Now then, you would probably want to ask, with the stock trading at relatively comparable prices to its implied value,and thus a smaller margin of safety, why would I want to single out 2nd Chance as a candidate for someone's portfolio?

To answer this, we shall look at several factors. This stock was not spared in the equity market weakness, dropping around 32% as compared to the STI's drop of approximately 29%, underperforming the index slightly. Weak sentiment in the property market could have led to the company trading at current valuations. However, it has not fallen as much as the rest of the property players, possibly due to its high dividend yield and also because it is not a pure property play. It is my belief however, that this stock is still trading at a discount to its intrinsic value, due to the following reasons. Its ROE has been relatively 'low' at 21%. This is probably due to the fact that it owns the property that it rents out, as compared to other property players which might lease the property and thus rake in much higher profits. This would mean that the ROE would only increase in future, as can be seen from the latest financials when its ROE increased despite increase in shareholder's equity. Also, I would like to think that because of this factor, 2nd Chance is currently situated in a position whereby it can either increase its income by raising rental rates or expand by pumping in money from its rental income into its retail businesses, both being win-win situations. The recent weakness in the property market might entice the astute CEO, who has won the Malaysia Businessman Award, to go hunting for more property. The current retail stores in City Plaza and Paya Lebar area have en-bloc potential with Paya Lebar being earmarked as a sub-regional centre. This could easily fetch high prices on sale, and result in special dividends or capital gains, either way which could bode well for investors. With the CEO's good track record of investing smartly in property, I wouldn't bet on him not repeating his actions again.

There are of course downsides to the stock. One big problem I would like to point out is that the stock is largely illiquid, with days where not a single trade had been completed. This is largely due to the low amount of free float, with the CEO himself owning around 50% of the stock(which might make u think if the CEO has another motive in being so dividend happy, but which of course is another story altogether).

Now, for those who have had the patience to read up till here, I would like to emphasise that this company is not the sort of deep-value plays that have been characteristic of value investors. It is essential however, to keep in mind the main advantage of the company: providing stable, free cash flow and at the same time providing growth potential. Its retail segment is a stable source of regenerating income and the retail segment, especially with the new Muslim Mart concept, could be an opportunity for 2nd Chance to improve on its market share(by its own estimates, 40% of the market share in Malaysia and Singapore). A pseudo-REIT, with the potential for more growth as compared to the average REIT. It probably deserves at least a 2nd look.

Also, pardon me for not being so specific in my financial analysis, the reason being that I don't want to make this post too long. For people who might be interested to know more, do feel free to make a comment or drop me a mail.

Test of resolve

The blue-chip index, the Straits Times Index, ended the week at2,723.30, capping its losses with a small 9.83 point increase. With many companies having their market capitalisation wiped off, surely one may ask, the downside is now very much limited and it is probably time to bottom-fish.

However, many who have started to invest during the recent bear-trap where the index rallied to around 3,200 points on renewed hopes that the sub-prime crisis was nearing an end only found themselves surprised by the magnitude and velocity the index came tumbling down, the exact way it went up. Its recent lows were levels last reached 2 years back in 2006.

Now has come the time for investors to truly test their resolve and their belief in the investing methods that they have espoused. Value investors, most of whom pride on their belief in investing based on a "margin of safety", have found themselves falling into a value trap. This occurs when a stock price falls, and falls, and falls.(quoted from the Business Times, 20 Aug 2008). The margin of safety rule has not been that safe after all. Now, the 'value investors' who have gone through the market in the previous years and found themselves sitting on handsome profits might have seen most of them wiped out. The question now is, of course, that whether value investing still works for them or not, or rather, if it even works for them in the first place. Most types of investing would have worked anyway in the bull markets which ended not too long ago. But for now, the volatile swings in the markets have most investors embracing the motto for now, "buy into weakness and sell into strength". This tactic seems to have done well for most investors at this moment of time, and could probably entice a few into adopting similar strategies.

But for those who have kept faith with value investing, this appears to be tough times indeed. To see the other investors pulling ahead and earning profits may not be the best kind of medicine to swallow at this point of time. But before one decides to adopt a change of strategy, please do consider the following: in the past 15 years, large-cap value funds have had an annualised return of 8.66% whilst for the same period of time, large-cap growth funds have progressed 8.03%(Morningstar). Note that this period of time includes the '87 stock market crash and the bursting of the Internet bubble.

Now, some may question, but the '87 crash was a steep one, and the Internet bubble was not exactly the best times for growth stocks. The sub-prime crisis has seemingly been a never-ending one, and the ones who have stuck their heads out to proclaim the crisis near to an end have had eggs in their faces. Detoxifying in itself is a long and ardous journey, and value investors could have underestimated the length of the unfolding of this crisis.

For now, those of us who have managed to escape relatively unscathed either through skill or luck, should take the time off to decide if each investing style previously adopted is suited for you. For now, I stick with my faith. Let's take all in good stride and that if Mr Market decides to go berserk any further, do take this chance to capitulate on more opportunities. And pray.

I shall try my best to look at individual companies very soon.

Turnaround Companies

One particular type of investing style that I had always wanted to try but did not have the courage to do so revolved around looking for companies that had fallen out of favour with investors due to declining profits and weak fuure prospects. The exact opposite of growth stocks, they suffer from PE re-rating every now and then when they publish their quarterly reports showing declining figures in every single aspect of their business. This approach however, involves looking for exactly such companies. The bleaker the prospects, the more suitable it is as a candidate for investing.

Now, why would an investor want to look at a company which is losing money? The reason is that this particular style of investing banks on the hope that the management will keep the company afloat for as long as they can, and hopefully, be able to survive for long enough until the company turns profitable again. They reason, that these businesses will naturally find a way back into profitability as management would try means and ways to keep the company afloat, although I believe that this proposition itself is up for contention. Nonetheless, the trick is in finding such companies who have enough stockpiles of cash to tide them through these trying periods, so that in the event they turn profitable again, the company will be back in favour with investors.

Benjamin Graham popularised the term 'Net net current asset value", which is the current assets net of total liabilities. He set a criteria of buying into a company if the market capitalisation was at 2/3 the value of its NNCAV. For a compay to be priced at this level, the markets would probably be so pessimistic about the prospects of this stock that they are unwilling to pay even the NNCAV of the company. Now, there probably aren't that many companies out there trading at such levels, so you could tweak the criteria a little, according to your own comfort level. Then, the next step is to evaluate the balance sheet strength of such a company. Determine the cash burn rate of the company, i.e. the rate at which the company is using up its cash. For e.g., if the cash holdings of the company is $8 this quarter, and $6 the next, then the company is probably using up cash at approximately $2 per quarter. So, making an intelligent guess, you might figure out that the company might be able to hang around for probably 2-3 more quarters. Now, depending on your comfort level, you might want to look for a company which can hang around for at least a year or two.

What then about the business model? Is there a need to look into the sustainability of the business model? Well, the reason why I quoted the "cigarette butt" investing phrase is because the company that you are looking at is probably gonna be around for only a short period of time before it finally folds. Good for just one more puff, but nothing more. The very fact that the company is in dire straits at this moment of time bears testimony to the inferior business model of the company, unless of course there are other reasons that you believe resulted in the company's current situation. But do of course be cautious in your stock picking. Other than the cash burn rate, the liquidity value of the company could be another part that you want to consider. NNCAV is simply just a measure of how the company's working capital can cover its long-term liabilities, but this assumes that in the event that the company really does wind up, inventory and other receivables may not be totally redeemable at the price indicated on the balance sheet. If the company you are looking at it is in a sunset industry, you might want the company to be trading at a huge discount to its NNCAV before you even consider buying up its stock. There are also many other factors that you want to consider, things like its operating cash flow(profits dropping but operating cash flow increasing would be a good sign). In essence, do your homework with regards to its financial strength, but you could be forgiven for not wanting to take a second look at its business model.

Complacency

Most investors, especially young and brash investors like myself, tend to be overexcited by initial success on the stock market. Many investors are besotted with short-term gains and believe that they have the bragging rights after a short period of outperformance of the stock market. Many of us can probably recall how often they have found a stock which has outperformed the market by a huge percentage and feel exceptionally proud of themselves.

However, without sounding too morbid, things in life always do happen for a reason. But whether u know the reason or not is another matter altogether. A stock might rise for numerous reasons, for e.g. M&A prospects, quarterly earnings surprise on the upside, and other short-term catalysts. For value investors, they ignore short-term catalysts, believing instead that the current market price tends to underprice the intrinsic value of the stock because it tends to lag the fundamentals. As such, value investors can be termed "long-term arbitrageurs" who tap on this window of deviation between fundamental value and current market price, and hopefully when the market realises the potential of the stock, the stock price will correct itself to its intrinsic value. However, what investors should ask themselves is, why should a stock be priced below your calculated intrinsic value? Is the market really being too short-term orientated, or is it panic selling that has led to a recent weakness in prices? Or are there other reasons behind it?

Papers have been published on the EMT and random walk theory to propose the idea that individuals will not be able to beat the market consistently, and if one does that, it is purely by coincidence or chance rather than skill. Proponents feel that a fund manager is no better at picking stocks than a monkey who chooses by throwing darts.

To a big extent, I agree. Look no further than our surroundings: can you name me an instance whereby u think that u have discovered something that someone else hasn't? simple things like the quiet corner to study in school which nobody knows of, or even a stall where you can buy the cheapest chicken rice in Singapore but without a compromise in the quantity? Now, like I'm going to emphasise again, things do happen for a reason. The reason why nobody wants to study at that secluded corner could be because the place is the furthest from the lecture theatre, or the cheapest chicken rice stall could be selling at such prices only because their rental rates are one of the cheapest in Singapore.

Now, try to apply this to the stock markets. A particular counter that you think has the best prospects e.g. high ROA and ROE, fat margins, rising profits and revenue, consistently generating high cash flow, may trading at very low PERs compared to their peers, or could be at a discount to book. Now, before you throw your hard-earned savings into this wonder counter, take a step back and try to understand this very simple concept: everybody wants to make money on the stock markets. And, if everybody has this mentality, why are they shunning away from this particular stock? In other words, does the market know something that you do not already know? Even in bear markets, where the general mentality of "long-term investors" is that the prices of securities in bear markets will only go north from here and not south, and that holding your stocks for the "long-term" would mean that your stock price will eventually go above your purchase price, the likelihood is that you might be in for a surprise.Or rather, shock.

Whenever I do a qualitative analysis of a counter, I include a particular point that I feel that: 1) either the market has viewed a particular aspect of the company too bearishly, or 2) the market has probably discounted this aspect altogether. The likelihood of (2) happening is rare, but if you think you have found a company which fits the bill, bet heavily. 3 possibilities I can think of: 1) you are already rich. 2) you are going to be very rich. 3) your last name is Buffett. Either way, please do leave a comment behind. And your contact no. as well. Please.

I'm not trying to drive across the point that it is impossible to discover such a company. But, it is better to be less complacent and figure out why the company is "depressed" according to your valuations. I came across a company recently which is in the property sector. Its ROE is nothing in the league of the big boys, nor are its profits and revenue, although both have been rising steadily. What I noticed though was that this company actually owned the property they were renting/leasing out, unlike the other developers which rented out property that they themselves had leased on a long-term basis. Now, the reason why the company is changing hands at a lower value is probably because of its less-stellar results. But, could the markets have overlooked the fact that this company actually owns the property that they rent out? Naturally, a company which owns their own property will have a lower ROE, coupled with the fact that it has been slowly scaling down on its gearing which results in an even lower ROE. It will only be a matter of time before the company's performance starts to accelerate north. This is just an example of what I think the markets could have overlooked in a company, but then again I could be wrong and have egg in my face. But at least I would have the contact no of the rich guy who leaves the comments on my blog to fall back upon. Margin of safety.

All investors in the market are generally smart. Even value investors who claim that market inefficiency is the reason why they are able to earn money actually pray for the market to be efficient. For, if not, there would never be a convergence between current market prices and their calculated intrinsic value, and Buffett would probably have to continue his newspaper selling business instead of compounding his savings at such astronomical rates. Benjamin Graham may have made famous his ficitious personna, Mr Market, who has the erratic behaviour of quoting prices which fluctuate daily. But, Mr Market wants to make money as well. And the fact is, he is not stupid.

Conglomerates

F & N, who has recently hogged the spotlight for its search on a more effective management structure of its different divisions, recently posted a set of results for the 3QFY08, with revenue dropping 7.5% year-on-year to S$1.2billion, and net profit rising 13.6% to $110.3million. The F&B and property arm of the conglomerate posted revenue growth, whilst the Printing & Publishing division(P&P) posted a slight decline. Without going through the financial statements again, I would like to express my views on the recent shake-up developing within F&N.

F&N has profitted from the recent property boom, which has boosted its bottom-line, whilst the F&B and P&P segments have dragged the performance of the business down, or so as analysts would have you believe.

However, with the recent downturn in the property market, the property division of F&N will probably fail to repeat their sterling performance in recent years, or worse, bring down the performance of the company. So the question that shareholders should be asking is: is this the right time to spin off the P&P and F&B divisions?

Look no further than Sembcorp Industries and Keppel Corp for a clue to answering this question. Keppel Corp's results were dragged down by Keppel Land's delay in launches, but their results were propped up by the Offshore & Marine (O&M) segment. As for SCI, its entire business ex marine(including Utilities, Parks, Environmental Engineering etc.) was a disappointment, but the reason why it managed to eke out a marginal 1H08 net profit growth of 1% was because of the stellar O&M division on the back of a $9.4 billion order book. Now, if both Keppel and SCI had seen their other underperforming divisions as a drag to earnings, would spinning off be better? But, would they have anticipated the lacklustre performance even before it had started?

The reason why this conglos have their heads above their waters is because of the diversified nature of their business. While the property arm of Keppel Corp did badly, the O&M segment shone. While the utilities and other divisions of SCI did badly, their O&M division shone. The nature of Keppel's business is that both the property and O&M segments are cyclical in nature, but it just so happens that these cycles overlap each other to a certain extent, so when one is on the downtrend, the other just so happens to be on the uptrend. So, who is to say that the property arm of Keppel is dragging down its earnings? In a few years to come, the exact opposite might happen. But well, I shall not touch on the topic of diversification for now.

Now, let's go back to F&N's business. The P&P and F&B divisions are not exactly the most cyclical divisions. People don't drink more F&N Grape because the weather is hot in January, nor do they start to print more brochures in June because it's the school holidays and there are people out in the streets to take notice of the flyers. They are stable, cash generating businesses which unfortunately, do not grow as much as their shareholders would like them to. As for the property arm, it is famously cyclical, although I wouldn't comment on whether the property market is starting a downtrend or not. However, what you will have to agree with me is that there is a pronounced slowdown at this moment of time. Now, wouldn't this be a really bad time for F&N to spin off its business? It's easy to denounce the P&P and F&B divisions during times of good growth for the property arm, but their importance is only emphasised more during trying periods like this. You don't miss your Printing & Publishing and Food & Beverage divisions until your coffers run dry.

Just some food for thought.