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Sunday, June 9, 2019

Tong's Value Investing Portfolio as of June 6, 2019

What’s the right and fair pay for CEOs?

The subject of remuneration has always been one of fascination. We are naturally curious about how much our friends, colleagues, boss and competitors are being paid. In the US, mainstream news media such as the Wall Street Journal publishes annually the list of how much CEOs of the biggest listed companies earn, the likes of Bob Iger, Elon Musk, Mark Zuckerberg, Warren Buffett and Larry Page.

This week, The Edge carried a similar article, listing the 40 highest paid CEOs for companies listed on the Bursa Malaysia. (Next week, The Edge will feature a similar listing of the 40 highest paid CEOs for companies listed on the Singapore Exchange) Their compensations, in absolute terms, ranged from RM6.2 million to as high as RM183 million in FY2018 (as disclosed in the latest annual reports).

Table 1: 40 highest paid CEOs
Table 2: Total compensation as a percentage of net profit
Table 3: Compensation as a percentage of market capitalisation
Table 4: CEO compensation compared with total shareholders' returns
Table 5: CEO compensation as a percentage of total staff costs for the company

Remuneration in absolute terms by itself is not very meaningful. Thus, the study goes on to measure their remuneration against several key metrics, including the company’s net profit, total staff costs, market capitalisation as well as total shareholder returns over the same period.

There is no one “best” metric. Often times, that depends on your perspective. As a shareholder, you would be most interested to know how much the CEO of your company takes home, compared with how much profit the company makes and what are your total returns for holding the stock (dividends plus capital gains).

For the 40 companies with the highest paid CEOs, only 16 generated positive returns for shareholders in FY2018.

Shareholders are often told that it is the Board that is fully cognisant of the efforts of management and therefore, they alone should determine how management should be paid. I disagree. It breeds incestuous relationships.

A common approach has been to use consultants as third and independent party. Given that the management and Board appoint these consultants, their independence should be questioned.

Further, it often leads to a wage spiral as consultants tend to use comparable approach. Company A is compared to Company B and Company C. If the CEO of Company A is paid lower than Company B and Company C, it is adjusted upwards, causing the industry average to go up. The subsequent effect is to push up the CEO pay of Company B and Company C … and it goes on and on.

Take Bumi Armada as an example. Total CEO compensation rose by more than 37% y-y to RM10 million in 2018. This includes a bonus of RM4.5 million last year, up from RM3.5 million in 2017. Over the same period, shareholders saw total returns of negative 80% – with the share price falling from RM0.765 to RM0.155 by end-2018. Zero dividend has been paid since 2015. The company turned from net profit of RM352 million in 2017 to net loss totalling RM2.3 billion. It was loss-making in three of the last four years.

Income disparity is a bone of contention the world over. In Malaysia, lagging wage growth relative to the rise in cost of living is one of the biggest grouses for the man in the street. Therefore, as an employee, you would want to know how much of total staff costs are paid to just one person, your CEO.

The three executive directors for KSL Holdings accounted for roughly 38% of total staff expenses (for 621 employees) and nearly 4% of the company’s market capitalisation. Net profit fell marginally in 2018, after having already fallen 29% in 2017. Shareholders returns were negative. No dividend has been declared for the past three years and its share price has fallen by one-third in 2018.

My point of this article is not to criticise any CEO or their pay scale. But I do believe that public listed companies have an obligation to shareholders. The Board should decide on the appropriate compensation. But it must also be transparent and articulate how the salaries are determined, based on clearly defined performance metrics. An excellent CEO should rightly be paid more.

Let me use the compensation framework for Avarga (listed on the Singapore Exchange) as outlined in the latest 2018 annual report as an example. We have a clear approved framework from the beginning of each year, stating the targets, the formula to calculate pay and bonuses, and how these financial variables are determined. And taking into account the agreed risk parameters, what is the required profit and cash flow return objectives. Broadly, the framework goes like this:

A risk assessment matrix is undertaken at the start of the year. Each operating business entity is assigned a risk score out of 20 based on outlook for earnings sustainability, performance risks, country risk and currency risk. The scoring is also relative to the past.
An agreed required rate of return for each risk profile, established objectively and approved by the Board of Directors.
Multiplying this required rate of return with the percentages of total capital employed for each of the business entities would yield the overall weighted required rate of return for the company.
To this is added the prevailing risk-free rate of the market, which is what could be earned if the entire capital is invested in risk-free assets such as government securities.
Finally, the required rate of return is topped up with a gearing multiplier, since a higher gearing will raise overall risk profile. This encourages management to use debt prudently.
For 2019, management compensation is based on exceeding a hurdle rate of 8.52% of total capital employed. Note that this rate is in fact higher than the weighted average cost of capital of 5.8% that is derived by Bloomberg.

The framework and parameters I have outlined for Avarga may not necessarily be right or right for all companies, but they are intended to be comprehensive, transparent and quantifiable.

What is the recourse for minority shareholders when confronted with outsized compensation to the CEO who is also the controlling shareholder? What happens when the company decides to pay no dividend but streams out cash flows as compensations?

One might argue that minority shareholders can sell their shares. But why should fiduciary responsibilities be set aside where there might be clear conflict of interests? Is there a need for regulatory oversight?

My Global Portfolio rose 1.6% this week, slightly better than the MSCI World Net Return Index’s 1.5% gain. This raised total returns to 4.3% since inception. Nevertheless, the portfolio is still out-performing the benchmark index, which is up 2.7%, over the same period.

Trading volume on the Bursa Malaysia was thin ahead of the Hari Raya celebrations. Traders are likely wary of holding positions over the holidays given the myriad uncertainties and resulting volatility in global markets.

My Malaysian Portfolio closed flattish for the holiday-shortened trading week. Total portfolio returns now stand at 46.7% since inception. This portfolio continues to outperform the benchmark index, FBM KLCI, which is down 10.1% over the same period, by a long way.

Performance Comparison Since Inception (%)
  • Tong's Value Investing Portfolio
SCGM BHD11,0661.72919,190.70.8709,627.4(9,563.3)(49.8%)
AJINOMOTO (M) BHD1,50011.81317,720.017.40026,100.08,380.047.3%
Y.S.P.SOUTHEAST ASIA HOLDING10,5002.41325,340.02.46025,830.0490.01.9%
FORMOSA PROSONIC INDUSTRIES18,0001.44025,920.01.70030,600.04,680.018.1%
POH HUAT RESOURCES HOLDINGS13,0001.47019,110.01.51019,630.0520.02.7%
SUPERLON HOLDINGS BHD15,0001.28919,327.50.95514,325.0(5,002.5)(25.9%)
CIMB GROUP HOLDINGS BERHAD6,0005.14030,840.05.32031,920.01,080.03.5%
Total  157,448.2 158,032.4584.20.4%
Shares bought       
No transaction.       
Total shares held  157,448.2 158,032.4584.20.4%
Shares sold       
No transaction.       
Cash Balance    135,453.4  
Realised Profits / (Losses)    92,901.6  
Change since last update May 30, 2019       
Portfolio      (0.0%)
FBMKLCI      0.5%
Portfolio Returns Since Inception  200,000.00 293,485.893,485.846.7%
Portfolio Returns (Annualised)      10.0%
Portfolio Beta      0.903
Risk Adjusted Returns Since Inception      51.8%
Performance ComparisonAt Portfolio StartCurrentChangeRelative Portfolio Outperformance
FBM KLCI1,829.71,644.1(10.1%)56.9%
FBM Emas12,700.411,538.6(9.1%)55.9%
*Current price is as at June 6, 2019. 
*Portfolio started on Oct 10, 2014 with MYR200,000. 
*This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks.

THONG GUAN INDUSTRIES BHD12-Dec-1608-Dec-175,0004.24321,215.04.10020,500.0(715.0)(3.4%)
KERJAYA PROSPEK GROUP BERHAD12-Jan-1715-Mar-1811,0001.02511,280.01.54016,940.05,660.050.2%
KERJAYA PROSPEK GROUP BERHAD - WARRANTS B 2018/202308-Mar-1815-Mar-183,0000.0000.00.330990.0990.0-
LUXCHEM CORPORATION BHD30-Aug-1715-Mar-1816,5000.73212,072.50.72011,880.0(192.5)(1.6%)
WILLOWGLEN MSC BHD14-Dec-1722-Mar-1820,0001.01020,200.01.26025,200.05,000.024.8%
MUAR BAN LEE GROUP BERHAD26-Oct-1722-Mar-1813,5001.24016,740.01.17015,795.0(945.0)(5.6%)
CHOO BEE METAL INDUSTRIES BHD07-Sep-1716-May-188,0002.19017,520.02.44019,520.02,000.011.4%
CHOO BEE METAL INDUSTRIES BHD07-Sep-1721-May-188,0002.19017,520.02.30018,400.0880.05.0%
SUPERLON HOLDINGS BHD01-Dec-1721-May-186,0001.1757,050.01.5509,300.02,250.031.9%
OKA CORPORATION BHD14-Dec-1728-Jun-1812,0001.54118,488.01.27015,240.0(3,248.0)(17.6%)
SUPERLON HOLDINGS BHD01-Dec-1728-Jun-186,0001.1757,050.01.2107,260.0210.03.0%
WILLOWGLEN MSC BHD14-Dec-1728-Jun-181000.50050.00.54054.04.08.0%
PANTECH GROUP HOLDINGS BHD17-May-1802-Aug-1843,0000.58024,940.00.56024,080.0(860.0)(3.4%)
KERJAYA PROSPEK GROUP BERHAD10-Jan-1706-Sep-1811,0001.02011,225.01.40015,400.04,175.037.2%
LUXCHEM CORPORATION BHD25-Aug-1706-Sep-1816,5000.71711,825.00.65510,807.5(1,017.5)(8.6%)
HOCK SENG LEE BHD19-Apr-1806-Sep-1814,5001.52022,033.01.37019,865.0(2,168.0)(9.8%)
GENTING MALAYSIA BERHAD06-Sep-1828-Nov-183,8005.07019,266.03.06011,628.0(7,638.0)(39.6%)
TOP GLOVE CORPORATION BHD06-Sep-1806-Dec-183,6005.50019,800.06.03021,708.01,908.09.6%
MAH SING GROUP BHD28-Jun-1814-Jan-1919,0001.00519,095.00.93017,670.0(1,425.0)(7.5%)
WILLOWGLEN MSC BHD14-Dec-1714-Feb-1919,9000.5009,900.00.4649,236.0(714.0)(7.2%)
SAM ENGINEERING & EQUIPMENT14-Jan-1914-Mar-193,0007.38022,140.07.90023,700.01,560.07.0%
PANASONIC MANUFACTURING MSIA16-May-1818-Apr-1960026.15717,182.037.87022,722.05,540.032.2%
HONG LEONG INDUSTRIES BHD14-Dec-1718-Apr-192,0009.12618,251.010.64021,280.03,029.016.6%
MALAYAN BANKING BHD16-May-1818-Apr-193,00010.25030,750.09.13027,390.0(3,360.0)(10.9%)
ECO WORLD DEVELOPMENT GROUP BERHAD28-Jun-1818-Apr-1915,2001.23518,772.00.92013,984.0(4,788.0)(25.5%)
DIALOG GROUP BHD06-Sep-1818-Apr-195,7003.45219,676.43.11017,727.0(1,949.4)(9.9%)
HARTALEGA HOLDINGS BHD28-Mar-1818-Apr-1911,0004.61050,710.04.75052,250.01,540.03.0%
A Note to Readers

It is my pleasure to share with you my Value Investing Portfolio. However, I must emphasize that it is by no means a recommendation or a solicitation or expression of views to influence you to buy or sell any stocks. I am just sharing openly on what I am doing with my stock portfolio.

Further, I like to remind all investors that investing is not just about the profits or returns. You will inevitably suffer stock losses too. You need to understand your own investment objective, risk appetite and the amount of loss you can afford to bear. So, while many investors talk only about absolute returns, I am also sharing the computed risk-weighted returns of my portfolio.

Tong Kooi Ong

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