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Saturday, October 29, 2016

In Search of excellence in Bursa kcchongnz


Author: kcchongnz | Publish date: Sat, 29 Oct 2016, 05:06 PM



Buy companies with good products, services, and good management and the investment returns will come. This is a story that you have heard over and over from the most impeccable sources. As with other investment stories, this one resonates because it is both intuitive and reasonable.

What is a good company?

It is difficult to get consensus on what makes for a good company since there are so many dimensions on which you can measure excellence. There are some who believe that good companies have managers who can fry (manipulate) the share price of the company for the shareholders to make money numerous times in a year. They think the CEO must be a high profile and a talking head in the press.

Many people think that good companies must often carry out corporate exercises such as bonus issues, share split and free warrant to “reward” their shareholders like those companies mentioned here:

http://klse.i3investor.com/blogs/kcchongnz/106438.jsp

Why not? This is what your shareholders want; if the management “fries” the share and always give freebies like those in the link above, the share price will always go up, and they as shareholders will make tons of money, so it seems. Really? From where?

Of course, you can’t forget that there are many investors who think that a good company must have higher profit this quarter than the next, and the next better than the next, etc. One quarter of reduced profit will be disqualified as a good company and the share must be sold.

If one reads i3investor, we can’t ignore that there are also many who think that a good company must be owned by fund managers, EPF, analyzed and written by investment bankers and professional analysts, owned and constantly promoted by big and high profile super investors etc.

Uh, there are also some who believe that a good company must have huge amount of debts as cost of borrowings is cheap. They think that the management is doing a horrible job if there is huge amount of cash in its balance sheet.

There are also investors, me included, who think that a company which gives good and rising dividends are good companies.

http://klse.i3investor.com/blogs/kcchongnz/103906.jsp

Generally, many believe the management of a good company frequently listen and respond to their shareholders’ best interests. Finally, there are still others who believe that good companies respond not just to shareholders but also to other stakeholders including their customers, employees and society. For those who are trained as accountants, remember the “Balance Scorecard”?

What are my criteria of a good company? Has investing in good companies in Bursa provided exceptional return? what are the evidence if it has?



In Search of Excellence

My criteria of a good company are a well-run company with credible management and good corporate governance; no unfair related party transactions, independent board of directors. A more measurable metric for good company is its financial performance; a durable business, better if it is a business with wide moat, quality growth in its business in the long term, a return on invested capital (>10%) higher than the cost of capital, good cash flows which on average, close to net profit, and positive free cash flow, and a healthy balance sheet. Good and increasing dividend of course is also one of my criteria.

However, research has shown that investing in good companies is not necessary a winning strategy. This is because the market has built into it these expectations. The biggest danger is that the firm will lose its lustre over time and that the premium paid will dissipate. It is only when markets underestimate the value of firm quality that this strategy stands a chance of making excess returns. There is a strong tendency on the part of companies to move toward the average over time, or mean reversion. So even though a company may be a good company, we try not be pay lofty prices with PE ratio not more than 25, and Price-to-book less than 2.5.

I wrote an article in i3investors on 25th May 2013, before I started my blog within i3investor, giving my thoughts on searching good companies to invest in with reasonable prices.

http://klse.i3investor.com/servlets/forum/900255072.jsp

Many forumers posted me questions on their stocks in the above link whether they are good companies to invest in. Here is one of those questions.

[Posted by joe2703 > May 27, 2013 06:11 PM | Report Abuse

@kcchong, I'm your fan and I learn a lot of things from you, you have given a lot of useful information and advice. Thanks.
What do you think about TA Global ? Need your advice.]

Another regular contributor, Tan Kian Wei, summarized what my thoughts were and tabulated those stocks which I had expressed my opinions answering questions about if they were good companies selling at good prices.

http://klse.i3investor.com/servlets/pfs/19821.jsp

A total of 16 stocks were commented by me as good companies selling at reasonable prices and hence were considered as good investments as shown in Table 1 summarized by Tan KW in the Appendix.

How has the performance of those stocks been?



Return of investing in good companies

Three and a half years has passed since then. Table 1 in the appendix shows the up to date total return as on 28thOctober 2016 of the 16 stocks chosen from 25th May 2013. The portfolio comprises of companies from various industries, but unfortunately a little concentrated in plantation. The prices were adjusted for all corporate exercises and dividend distributions and as provided by Bloomberg.

Almost 90%, or 12 out of 16 stocks outperformed the broad KLCI index. The average total return of the 16 stocks was a whopping 225%, with a median return of 72.2% in the three and a half years’ period, compared to the negative return of -1.5% of KLCI. The excess return, alpha, is a whopping 226.5%. RM100000 invested in May 2013 becomes RM325000 three and a half years later, compared to a small loss if invested in the broad market index.

Ignoring the extremely return of the outlier of Technic which returned 1900% after its corporate exercise, the average return of the remaining 15 stocks is still way above 100%.

There were only two losers in SOP (-32.2%) and TDM (-10.5%) with relatively small loss. This was unfortunately due to the low palm oil prices for the last 3 years as almost all palm oil stocks have suffered losses during this period. Surprisingly, there are two other palm oil related counters in the list of stocks; Kim Loong, still with high gain of 81%, and MBL at a small gain of 9.2%. That is the power of choosing good companies even during the down cycle of the industry.

There were only two other stocks with single digit return; P&O at 9.2%, and Perak Corp at 8.6%. But they are still producing relatively good results compared to the drop of the market during the same period.

The rest of eleven winners are all double-digit and triple-digit winners, with six of them in the triple digits; Technic (+1900%), Eforce (+470%), Gadang (+301%), Magni (+278%), and Thong Guan (+185%).



Conclusions

The above value investing strategy of investing in good companies at reasonable prices worked well for the mid and long term in the past in Bursa Malaysia by providing extra-ordinary returns for investors. Just like other fundamental value investing I have been discussing, this strategy also produces high extra-ordinary return for a substantial number of stocks, but minimal number of underperformer and negative return, and when negative return, the quantum is small.

The interesting phenomenon of this value investing is the repetition of the Dhandho Investor;

"Heads, I win (big)! Tails, I don't lose that much!"

The beauty is, this value investing strategy is not difficult. One just needs to spend a little time to learn, and check qualitatively and quantitatively if those companies are indeed good companies, and that they are selling at reasonable prices. The metrics can be easily extracted and computed from the three important financial statements; income statement, balance sheet and the cash flow statement. It is just a matter of whether you are willing to spend some time and effort to learn and do some homework before investing?



In your quest of building long term wealth, haven’t you got tired of losing money all this while listening to rumours and hot tips in the stock market? Or you still believe there is tooth fairy in the stock market?

If you think you have been in the “wrong path” in your investing journey, and wish to do something positive about the future of your financial wellbeing, you may contact me at

ckc14training@gmail.com

K C Chong (28th October 2016)



Appendix



Table 1: Return of investing in good companies from May 2013 to end of October 2016


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