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Tuesday, June 28, 2016

(Icon) My Observation & Assessment of KC Chong's Investment Philosophy

(Icon) My Observation & Assessment of KC Chong's Investment Philosophy
Author: Icon8888 | Publish date: Mon, 27 Jun 2016, 10:12 PM

1. Introduction

KC Chong has published many articles in i3. However, in my opinion, many people don't understand his investment philosophy, including myself. I guess the main reason is because his articles covered a wide range of topics : ROIC, Earnings Yield, Enterprise Value, Free Cash Flow, Moat, Mean Reversion, Margin of Safety, etc. Many people are not sure what exactly is the key message and how the various components fit together.

To try to figure out how KC invests, I undertook a study of his various articles. The following are some of my observations and assessments. I am quite sure KC will read this article. I look forward to his comments on whether I have got him right and whether he agrees with the way I look at various issues.

2. The KC Chong Template ?

Step I - Identify The Stock

My study of KC's articles led me to conclusion that KC are attracted to stocks that did well in recent one to two quarters (very similar to my practice). The conclusion was arrived at after comparing the timing of his Buy calls with the timing of quarterly results. There is a strong correlation between Buy calls and strong quarterly results for Tasco, Scientex, Magni-Tech, Jobstreet, Prestariang, Pintaras Jaya (non exhaustive). I believe this is sufficient as proof.

Step II - Evaluate The Stock

After identifying the stocks, KC will conduct financial analysis on the stocks. His favorite tools are ROIC and Earnings Yield. He will only buy a stock if its ROIC and EY is high enough. High ROIC is an indication of durability while high Earning Yield shows that the stock is attractively priced.

Step III - Calculate Intrinsic Value

KC will come up with a long term free cash flow projection and then perform a discounted cash flow analysis. The Net Present Value he gets will become the stock's intrinsic value. Based on that Intrinsic Value and existing market price, he will be able to determine the Margin of Safety. That will allow him to determine whether the stock is a good buy.

Step IV - Buy and Hold

My survey of the various articles showed that KC very seldom sells his holdings. Come to think about it, it is not surprising at all :

(a) KC bought a stock with the Intrinsic Value in mind. As long as it is still trading below Intrinsic Value, there is still potential upside. If that is the case, logically, he should hold on.

(b) KC is a big fan of Warren Buffett. Buffett holds really long term.

(c) Mean Reversion is something KC talked about very often. This concept is particularly relevant when the investee company's profitability has declined due to unfavorable operating environment. For Traders like Icon8888, when a company's profitability declined, it is time to flee. But for somebody who has Mean Reversion in mind, he doesn't mind holding on as given some time, profit will eventually revert to the norm - there is no need to cut loss.

3. Portfolio Performance

KC's portfolio did very well in 2013. Prestariang, Jobstreet and Pintaras shines, delivering more than 100% return. The interesting thing is that all these three superstars' profit did not grow much after he bought into them. The re-rating was caused by Valuation Multiples Expansion (for example, Jobstreet's PE Multiple was 10 times when he bought the stock, but it expanded to 30 times within two years). I am still scratching my head why there is such coincidence (three stocks) ? Was his ROIC and EY concept so powerful that it can allow him to predict those stocks are cheap and will experience second stage re-rating through Multiples expansion ? I wonder whether KC has the answer ?

It is impossible to tell how Jobstreet will perform over the long run as it subsequently sold its business. But Prestariang and Pintaras' profitability declined substantially in the subsequent years. Is this proof that high ROIC is not good predictor of a company's durability (Moat) ? Or is it proof that KC is right that there is no point analyzing a business in detailed as it is impossible to predict future earnings ? I will leave it to you to ponder.

Anyway, I do not want to leave you with the impression that KC only pick stocks with no growth. His picks such as Homeritz, Scientex, Magni-Tech, etc all turned out well, growing their profit by leaps and bounds over the years.

4. Concluding Remarks

I studied KC's investment philosophy not for the purpose of criticising or attacking him. What do I gain from doing that ? I have better things to do in life.

I undertook the study to find out whether his method is different from mine, and if different, in what way. I want to find out whether there is anything I can borrow or adopt, if not the entire package, at least some useful parts that can augment my own strategy.

The study revealed one similarity - very often it is a stock's strong recent performance (profitability) that attracts us to look at the stock.

The study revealed certain differences :-

(a) Financial ratios such as ROIC and EY play an almost "predictive role" for KC (indication of moat, and hence ability to grow earnings over long run). For me, those ratios play an "analysis role". I use them mostly to identify lemons such as London Biscuits and Engtex;

(b) Intrinsic Value is an important component of KC's stock picking decision. I very seldom bother about Intrinsic Value. Instead I prefer to play by ears - buying when stock is trading at low PER and sell when stock has achieved my targeted return; and

(c) KC holds real long term while I don't. I hate to go through down cycles (for a particular industry, not market. I very seldom time market). I try to ride upcycle and quit when there is risk that down cycle is approaching (whether can get it right is a different thing).

Come to think about it, I am not surprised that there are all these differences between KC and me. KC is a long term investor. I am more of a trader (Value Trader, I have discussed this before in my previous articles). There is no need to debate whose method is more superior. I guess as long as you buy and sell based on FA, you should be ok.

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