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Monday, August 22, 2016

The Art of Successful Investing in the Stock Market kcchongnz

The Art of Successful Investing in the Stock Market kcchongnz
Author: kcchongnz | Publish date: Sun, 21 Aug 2016, 02:20 AM

I read a good article when the author describes on hindsight in the link below that investors could have avoided losing big money in Globetronics if they were aware of the cognitive behaviour of confirmation bias and have done some detail business analysis.

http://klse.i3investor.com/blogs/JTYeo/102530.jsp

Frankly, readers would benefit much more by reading this type of sharing, rather than those boasting how much they have made in the share market, and encouraging you to take excessive risk such following the greater fool theory and using margin finance to boast your return and to become multi-millionaire overnight.

Here, I would like to share what I had seen for the same stock, Globetronics, how investors could have avoided some heavy losses, and for a couple more stocks, Focus Lumber and Latitude Tree, if they know and care to carry out some quantitative analysis and valuations.

Globetronics Technology Bhd

Globetronics, a great company which I will describe later, had its share price plunged by 55% in less than 8 months from RM6.50 at end of year 2015 to RM2.90 at the close on 20th August 2016 as shown in Figure 1 of its share price movement below.

Anyone who has bet big on it with margin finance would have lost everything in just than 8 months. Why not bet on it? There are numerous reasons why an investor would “sailing”, or bet all on it.

Figure 1:



When Globetronics announced its fantastic result for year ending 31st December 2015 on 23rd February 2016, I did take a good look at Globetronics with the intention to invest in it.

Earnings per share improved (again) by about 15% to 25.3 sen per share from the previous year. Return on capitals were again great at more than 20%, more than twice its costs of capitals. Cash flows were great too. There had been profit growth every year since many years ago. This is what I would classify as a great company.

However, bear in mind a great company is not necessary a good investment, provided that it is selling at a reasonable price. So was Globetronics selling at a reasonable price at RM5.95 at that time?

PE ratio was at 22.3, not really expensive as the company has excellent growth in the past and beautiful operating numbers. However, Enterprise value was 17 times earnings before interest and tax (Ebit). This is definitely on the high side for me as it is two and half times more than what I would pay for an ordinary company. Oh yeah, I like growth, but I am cheap skate as I won’t pay much for it.

I did a discount cash flow analysis from the fundamental aspect assuming growth is internally generated through return on capitals, assuming a bold 15% growth for the next 5 years and 5% subsequently. I was only able to get an intrinsic value of RM4.15, way below its price of RM5.95 at that time.

With that market price, investors were expecting Globetronics would continue to growth at very high rate of more than 20% as before, and with margin expansion and higher return on capitals, and hence willing to pay a high price.

I gave up the idea of investing in it as I think it was overvalued at that price.

Shortly after that, the growth expectation did not materialize, and profit plummeted the last two quarters. With the high price paid by many investors, it was a double whammy, and the rest is history.

“Wonderful companies become risky when people overpay for them.” Peter Lynch

Focus Lumber

I have written about Focus Lumber before in the link below:

http://klse.i3investor.com/blogs/kcchongnz/97079.jsp

Focus Lumber is another great company. Just before it announced its third quarter results for period ended 30thSeptember 2015 somewhere on 17th November 2015, its share price jumped by 70% within 3 months from RM1.84 to a high of RM3.09 on January 12 2016 as shown in Figure 2 below.

The results show the vast improvement for the third quarter 2015 with net profit increased by more than 200% from RM3.3m to RM9.6m for the corresponding period in 2014. EPS, as a result, also increased by more than 200% from a EPS of 3.2 sen to 9.4 sen for the quarter.

Figure 2



Some investors who purely base on a single metric of “Profit growth”, without considering where this “growth” comes from, saw a great opportunity and annualized the EPS by multiplying by 4 to the single quarter exceptional result and obtained an expected EPS of 37.6 sen for the next 12 months, and chased the share price up to more than RM3.00 in early January 2016.

However, many do not care about its financial statements and failed to see that the greatly improved result for the third quarter of 2015 was in a major part, due to the gain in foreign currency as a result of rising USD against Ringgit from the beginning to the end of the period, a one-off item.

When the next quarter showed a reduced profit from the preceding quarter due to some recovery of Ringgit against USD, investors dumped its share, resulting its share price dropped more than 30% to less than RM2.00, in less than two months. It closed at RM1.72 on 19th August 2016. They would have lost a total of 44% in less than 8 months.

Again paying too much to chase the illusive growth story, without understand where the “growth” comes from, is hazardous to one’s financial health.

At RM1.72 now, I think Focus Lumber is a great value stock to invest for long term. But why is there no interest in this stock? Once bitten twice shy?

Latitude Tree

Latitude Tree was and still is a great company in my opinion with high return on capitals, excellent cash flows and a good growth story. I personally have written a number of articles discussing about it, including a number of other furniture companies.

Latitude Tree was heavily promoted in i3investor when it was about RM6.00 sometime in November 2015. I was a contrarian then and I have written my last article on it discussing about the cyclical and the power of mean reversion in investing in the link below, and hence put forth my opinion that at RM6.00, it wasn’t cheap any more.

http://klse.i3investor.com/blogs/kcchongnz/80034.jsp

Latitude Tree’s share price continued to climb to above RM8.00, pushing its PE ratio, based on the latest and historical highest earnings per share, to about 12, way above its historical PE of single digit number.

I did hear some investors making hundreds of million investing in this share when its share price climbed from RM6.00 to above RM8.00. But how many retail investors lost big when they bought at about RM8.00 and now the share price is lingering at RM5.15?

At this price, PE ratio is only 6.4, considerably below its historical PE ratio, but nobody talks about it at all.

Figure 3:



Conclusion

Most investors chase the growth story, buying stock without having an idea the value of a stock. They usually follow some rumours and hypes, taking the road where the greater fools go. They buy stocks when they are selling at high prices, hoping someone else will buy from them at even higher prices. They paid too high a price for some growth expectation, expecting trees to grow to sky. The end result is, most of them lost money when there is a double whammy; that they pay too high a price for something which eventually did not materialized.

The only way to have a higher probability of success for retail investors in the jungle out there is to have some knowledge of the business, and know the language of the business, that is the ability to read and interpret financial statements, and have a feel of the value of a business, i.e. to know how to carry out at least some simple valuations.

If you know how to do the above, you would be able to buy some great companies selling cheap.

Sure, everyone makes mistakes in his judgment. I have my share of those too. Investors must realize that the stock market is unknowable and unpredictable. One must know what he may not know, especially about the future. Even Charles Munger said this,

"IInvesting is not easy; anyone thinks it is easy is stupid".

Know and understand the relationship between price and value. Understand risk, recognize it and control it.

And that is what I try to teach you. And if you are interested to learn about them for a small fee, because you want to have a higher chance of getting satisfactory return of your investment in the long run, please contact me at

ckc15training2@gmail.com

KC Chong

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