Featured Articles: About Share Placements

Old articles to share... :)

http://www.oaktree-research.com/index.php?option=news&task=viewarticle&sid=24

Share Placements - Good or Bad?

Roger Tan & Don See, 21 Oct 2003

The number of share placements made by listed companies has grown in recent days. Yes, we are in a bull market and perhaps in the midst of a global economic recovery. With a recovery, there are more opportunities for businesses, deals and contracts. It makes a lot of sense for these companies to tap the equity markets to raise proceeds for further investment at this early stage. However, we believe not all that glitters are gold. We question the intention of some.

We are not planning to give names as we have no facts but a mere conjecture on our part. One of our investee company announced that it would be placing a huge amount of shares through a financial institution to raise funds. This placement will allow them to raise a few million Singapore dollars to expand their operations overseas.

This is bad news to us as it seems the management is hinting to us that their shares are overvalued. However, instead of a drop, the share price rose after the news! Ordinarily, we must be pleased but we do not accept facts as they are. We begin to hypothesis the possibilities. We swam through both conspiracy and financial theories and came to a single deduction.

We threw out conspiracy theory and instead focused on a signaling theory. For the rest of the article, we will explain why the hype over the recent issues can be attributed to signaling theory and the issues are nothing more than an "overvaluation" signal through the "Pecking Order" argument.

Revisiting Capital Structure Irrelevance

Proponents of placement share issues argue that shareholders should be happy that the management has raised new funds to expand and grow businesses. Whether these funds are raised through debts or equity is not the most important concern - the potential returns on these new investments are what matter most.

Miller and Modigliani's Proposition I (MM I) propose that the capital structure of the firm is irrelevant to the value of the firm under the perfect capital market assumptions. Financing methods will not influence firm value. It is the incremental value that these funds can achieve that is critical to the valuation issue. Investors who are buying up shares in these companies attest to this belief.

Altering the Perfect Capital Market Assumption - Information Asymmetry

Roger mentioned in his previous article "Explaining Perfect Capital Market - The Final Frontier" that the perfect capital market assumptions forms a starting point of an analysis. What happens when we change the perfect capital market assumption to that of information symmetry?

It is a reasonable assumption and expectation to say that insiders and managers hold a greater deal of information than non-insiders. They are in the best position to hold proprietary information knows exactly the number of contracts they are chasing or the amount of utility bills they have been paying. If they have such an immense amount of information on hand, we can safely assume that they know if the company shares are overvalued or undervalued. If the managers are rational, their next course of action would be to place out new shares.

What can the shareholders do then? Observe! Though shareholders do not have superior information like managers, shareholders can observe and track the actions of the managers. In the event of a share placement, it would be reasonable to infer that if managers start selling shares (new or old), that the firm must be overvalued.

What about the other side of the coin then? Say the managers do predict a significant upturn in the economy and that today is the most appropriate time to begin investing in new facilities, equipment and machineries, then raising equity is very justified indeed.

Managers do raise funds for good projects but to raise equity would be sending signals that shares are overvalued. To avoid that, managers therefore would try to fund projects with funds that attract the least "attention" - retained earnings. When such funds are insufficient they would then use debts and then finally equity. This order of source of funds is known as the "Pecking Order". Pecking order also explains why companies try to keep high level of "Financial slack".

At this point, we will like to highlight our assumption that the managers are investing in new projects and capital goods that will produce an incremental value. This is basic managerial finance. They will be committing a cardinal sin if they raise equity to invest in projects that are not incremental in value. We certainly hope they are not raising cash for the sake of investment or following the crowd like what many did during the technological hey days.

Coming back, if we base our assumption on information asymmetry and the pecking order theory, placement share issue, as a result, is nothing more than a signal from management that shares are overvalued.

Implications of Discount on Placement Share Issues

What about the discount on the placements shares? We observe that many placements are made at prices lower than the current market price. Herein, we believe management and the placement agent will argue that in order to place out a huge placement successfully, a discount to buyers is required to attract them. However, in our opinion we think shareholders could be short-changed in this instance. The discount is a cost to the company and the shareholders. The discount will effect a wealth transfer from current shareholders to new shareholders and the financial intermediaries .

Indirect wealth transfer happens when new shares are sold at a lower price than its fair value. If prices are a discount of future cash flows, this discount means that the new placement shareholders are receiving higher returns than the current shareholders. When no new investments are made, this higher return of the placement shareholders comes from the current shareholders. When new investments are made, placement shareholders enjoy higher risk premiums then the current shareholders even though both undertake the same risk.

Right Issues For Corporate Governance

Proponents argue that rights issue is less favorable then placement issue because of at least 3 reasons:

1. rights are issued at a higher discount
2. rights may not be fully subscribed
3. rights issue entails higher float cost

These are all true but rights issue will demand stricter monitoring and governing on the corporate managers. How so?

Better managed companies keep a low financial slack because excess cash is a drag on return on asset. Don also wrote about signaling effect of dividends in his last article. He quoted Easterbook who argued that dividends force firms to maintain a regular cash payout and as a result lead them back into the capital markets to raise new cash when they need it for investment in NPV positive projects. He believed that firms that pay high dividend signals the managersEintent to maximize investorsEwealth and to subject him to capital market monitoring and reduces the potential for managerial self dealing and thus reduces agency costs.

Since good companies maintain a low level of financial slack in the company (through dividend and share buyback), they will often have to raise new funds when good investment arises. The high cost involved in issuing rights issue and the risk that shareholders may not fully subscribe to the rights (due to concerns of the investment) will discourage low quality firms from paying out high dividends or buy back their own company share as they rather invest in their own self.

As right issues are also offered at a substantial discount it will increase the cost of equity and capital. However, unlike a share placement, it does not have a wealth transfer amongst shareholders. The company will be extremely cautious on the use of the raised proceeds. They must scrutinize the projects or investments thoroughly before undertaking them.

Don't Give it if you Don't Want To

In conclusion, this article aims to dispel the myths on share placements. Indirectly, through this article, we would like to remind investors and shareholders that your managers have significant discretion powers simply because you have given them the right to do so.

A resolution to allow managers to place certain amount of shares at their discretion must be agreed by the shareholders in a general meeting before such placement can take place. I noticed that many such resolutions are passed (by the majority) but shareholders are unhappy after the placement. Don't Approve Such Resolutions If You are Not Comfortable.

Just another interesting point to note, if you realize that in the last three weeks alone, there are several companies that have placed out shares. However, not all have seen their share price rise after the placement. Some have and some have not. For reasons that are not difficult to see.

Remember all that glitters are not GOLD.

---------------------------------------------------------------
Lost the link and date of the article below... :(
---------------------------------------------------------------


Placements: three things to bear in mind

By R SIVANITHY

THESE days, placements are an increasingly common sight in the local stock market. This is to be expected since companies and vendors quite naturally want to capitalise on buoyant sentiment to raise cash (some observers believe a rising number of placements signals a market top, but we'll leave aside discussion of the market's outlook for now).

But the problem is that placements are often a double-edged sword for shareholders - they can work for you in some instances but against you in others. Worse, as is often the case in the stock market, things may not always be what they seem.

At the simplest level, placements can be viewed as creating an overhang of shares which would impede future progress. Thus, when it was announced last week that investment company Temasek Holdings placed out almost 800 million Singapore Telecom shares at a discount to the prevailing price, the market reacted understandably by selling down SingTel's shares to around the placement price. Several days after the announcement, the counter has still not recovered.

The reaction to the SingTel news was predictable and mirrors how the market generally receives news of more shares entering the market (for example, investors tend to take a dim view of a rights issue for the same overhang reasoning). For now, the basic lesson to be drawn is this: placements move prices.

Not all placements, however, are received negatively. For those who have tracked placements in the second line, it would be clear that sometimes the outcome is a price rise. One example of this is when a small or medium-sized company's main owner privately places out shares to a big-name player that the market perceives to be a sophisticated investor.

If the entrant commands an influential presence in the market, chances are good that the shares would rise after the exercise is completed.

Perhaps more importantly for shareholders, the price paid by the new shareholder forms a base in the market's collective psyche - a floor below which it is unlikely to fall. The reason for this should be obvious: markets always like to know what sophisticated investors have paid for their stakes so that when the price falls close to this level, investors, traders and punters invariably move in to buy, believing that the sophisticated party's entry price approximates true fair value.

Whether or not this is really the case is debatable and we'll discuss this point shortly. For now, we reach a second conclusion about placements: they serve as a signalling mechanism because when a big name moves in, the placement price signals a floor of sorts.

Things get a bit tricky from here on. If placements move prices and if they also serve as a signalling mechanism in certain circumstances, might it not be possible that sometimes, a false signal could be sent?

Put differently, might it not be in the interests of vendors, shareholders and big-name new entrants if the actual price paid for a placement is lower than that which is disclosed? It certainly bears thinking about - telling everyone that a sophisticated player has bought into a company at a higher price than that which was actually paid would clearly be beneficial all round.

Major shareholders or vendors gain because of the subtle signal of where the floor price lies; the new entrant benefits because it enjoys a large price cushion and is therefore in-the-money right from the start; and shareholders benefit because the signal ensures plenty of price support.

The only parties at a disadvantage in such situations would be the investing public at large, which leads us nicely to a third and final conclusion about placements: all of them should be viewed with scepticism.

Whether or not vendors deliberately send a false signal like the one just described is a matter of conjecture but it does bear thinking about - especially the next time a parcel crosses, the price starts to move and you're tempted to jump on board.

Looking Back At Hai-O Then And Now.

Someone asked me why I do less full review of stocks lately.

Well two reasons. The main one is that I am rather lazy. ( LOL! Totally lame! :P )

Secondly I lack motivation. (Haha! What an even more lame excuse! :P )

Well in my flawed ways, when one writes a review of a stock, one should present it in the best fullest possible way giving full consideration to the possible pros and cons on the stock. One should attempt to give both side of the story highlighting the possible positives and possible negatives about the company. To insist only the positive while brushing aside all posble weakness is way too shallow. That's my flawed personal opinion. :)

And this is where it gets tricky and tacky.

And as mentioned many times before, I always believe that any stock can go up or down on any given day. That's just how complicated and complex the market.

And no, I am not even suggesting that fundamental reasoning does not matter. I certainly dare not.

And to complicated matters, time frames complicates matters. It does.

And more so share price movement ( and yeah, it's even more complicated when different time frames are used) is used to judge one's reasoning instead of the justification of one's reasoning.

One of the most interesting example is of course, Hai-O's example, a posting which I had posted yesterday. ( Update On Hai-O ).

Now this one is certainly an interesting case since I had blogged on Hai-O back in 2008.

This was my FULL Review Of Hai-O on April 2008.

I am re-posting it in full here.

-------------------------------------------------------

Dedicated to Unker TK.

All data is compiled by myself from Bursa Malaysia website. ( I am liable to make an error and if I do make an error on any numbers, do let me know)

Background.

HaiO sells herbs, health suppliments, health tonics and tea. Here is the company website: http://hai-o.com.my/

Hai-O yearly earnings track record.

Numbers are always extremely interesting and can always be interpretated in many, many ways.

For example, using the bigger picture perspective, one can see from the above table that, HaiO's performance from 1999-2006 was poor. FY 2006 showed HaiO earnings 10.1 million which is a fantastic improvement from its fiscal year 2005's earnings of 5.5 million. However, I would base it on the bigger picture and would consider the fact that for its fy 1999, HaiO was already earning some 11 million. Hence the huge jump in earnings in 2006 should rather be discounted and that HaiO's earnings only turned around in 2007.

So from a bigger picture perspective, one can argue that so far, HaiO has only fantastic year which is fy 2007 and also judging from its ttm (trailing twelve months) earnings, HaiO should have another grand earnings for its current fy 2008.

Now here's another way to look at it where I can make HaiO look like one incredible growth stock!

Let me take out the FY 1999 to FY 2003 earnings. And let's look at the earnings below.

This is now looking like one incredible growth stock eh?

Firstly, here's a site for you to calculate your CAGR (Compounded Annual Growth Rate): http://www.moneychimp.com/calculator/discount_rate_calculator.htm

Let us see if we calculate the CAGR from 2003, we would get the following:

Which looks simply superb! A company growing at an annual compounded growth rate of 57% for its most recent 5 years!

And it's so good that the company has this chart on their website. (see http://en.hai-o.com.my/new/investor_financial_highlights_profit.asp )

However, if the time frame is switch to focus on HaiO's performance from 1999 to 2003, see the results below.
And the CAGR would show a terrible result.


Point is one should understand that numbers can tell different stories depending on how and where you want to look at it from.

For me, I would merely note that HaiO had a fantastic fy 2007 and this year, it should have another fantastic fiscal year.

Would I boldly declare HaiO as a fantastic growth stock? Would you?

Some would simply argue that two great years do not make a growth stock.

Some would simply argue that in HaiO's case, one should look at the bigger picture. From 1999 to current, one has a 10 year time frame, and out of this decade, HaiO has probably performed terribly for 7 years! Although the current 2 years, HaiO is performance is fantastic.

Hey, don't stare at me. I already said that it's so subjective on how one looks at a set of numbers, didn't I?

Hai-O's Current Quarterly Earnings

If you look at the table above, basically HaiO's change of fortune happened since its FY 2007 Q3 earnings.

Balance Sheet

Balance sheet is looking great lately. However, from the quarterly earnings table do note that SI denotes Short Term Investment.

And I never do like to see stuff like this in our local stocks. For me, a listed company should just concentrate and maintain their focus on the company's core business ( Did HaiO failed in this area before?) and not dabble into short term investments. Any excess cash should be simply returned to their shareholders.

From HaiO's website, from their 2007 Annual Report (634 KB) (see page 115) it states that this short term investments is in Unit Trusts!

As of the recent quarterly earnings reported last month, short term investments stood at 22.850 million. Now isn't that an awful lot of money to put into Unit Trust?

Broker Coverage

Affin, OSK and RHB Research covers the stock. So does I-Capital.

RHB in its latest report:

• Corresponding to the change in our FY04/08-10 earnings projection, indicative fair value is upgraded to RM4.64 from rm4.04 based on unchanged target PE of 19x CY08 EPS, which is at 40% discount to our CY08 target PE of 16x for the consumer sector, to reflect the smaller earnings base and market capitalisation. Maintain Outperform.

Note: I see CY08 earnings net profit forecasted by RHB is at 38.1 million. (ttm earnings indicates a net earnings of 37.6 million)

OSK in its latest report:

• Maintain BUY. Having taken into account on the current stock market condition and our downgrading in the GDP projection from 6.2% to 5.8%, we are now more conservative thus assuming the lower band of the PE and P/BV of the retail sector. Notwithstanding, our target price revised higher following the earnings revision; and rolling our numbers to FY09. We peg a target price of RM5.00 (previously RM4.60) by applying the composite of 10x (previously 12x) over FY09 EPS of 50.6 sen and P/BV of 2.6x (previously 3x). We reiterate our BUY recommendation on Hai-O.

Note: I see OSK is basing HaiO value on its estimation of HaiO's FY09 earnings, which is estimated at 42 million.

The reports can be be downloaded here: Hai-O Robust earnings driven by MLM division, Hai-O 3QFY04/08 Results Boosted by MLM and Hai-O Amazing Performance

Pros

1. Earnings have been absolutely fantastic the past 2 years or so.

2. Balance Sheet is looking fantastic. Its cash flow is simply awesome!

Concerns

1. Is this a flash in a pan?

What's driving this success for HaiO? Last June, the following article was published on Star Business: MLM and pu-er tea to drive Hai-O sales. The following section is worth noting:

• The sterling performance was due to the MLM division, more intensive sales promotions by the retail division for its royalty customer programme and additional sale of pu-er tea.
  
  Revenue contribution from the MLM division grew 84% while the wholesale segment jumped 119% in FY07.
  
  In addition, the company’s profit margins had improved, thanks to the ringgit appreciation, which lessened import costs and it saved RM1.5mil from a waiver of rental costs and reimbursement on certain expenses for leasing of a shopping complex.
  
  Higher investment income also added to the profitability, Hai-O said.
  
  In keeping to its promise to pay 50% of after-tax profit to shareholders, Hai-O has declared a final dividend of 13 sen per share, bringing the total dividend for FY07 to 18 sen a share.
  
  “We’re proud to be able to sustain our growth since we’ve been around for 32 years now,” Tan said, adding that by carrying only premium products, it was able to fetch better margins.
  
  The MLM model was also seen as sustainable as Hai-O had an average of 1,000 new recruits every month, he noted.
  
  Hai-O has started opening retail outlets in high-traffic shopping malls, such as 1 Utama, Queensbay Mall (Penang) and Pearl Point (Old Klang Road), he said, adding that previously it was focused on shoplots.
  
  Next year, another outlet is targeted to open in Mid Valley Megamall.

From a PURE investing perspective, serious consideration has to be made on the sustainability of HaiO's impressive earnings. In short, is it a flash in a pan.

As stated, pu-er tea and aggressive MLM is driving in the earnings.

Is there a sustainable long term competitive advantage in these two factors?

For example, pu-er tea. How many people you know really drinks this tea? Is it a fad? Is there a substitute equivalent? How much do you really know about this tea?

And then you have the MLM issue, all which is so highly debatble of course. Some believe strongly in such marketing strategy, while some don't because they believe that MLM simply don't last! ( The following recent article is interesting too: Top Hai-O agents earn RM1mil a year - wow, so lucrative?)

How? Would you rate this as a concern at all?

2. Is there a risk to HaiO strong cash balances?

I like to look at the past. It gives an idea what the company has done before and I used it as a rough indicator. For example, in the case of HaiO's strong cash balances, the main concern is what if the company squanders the cash by spending in an extravagant manner? Would this not be a legimate concern? After all, we are talking about investing (buy-and-hold long term) in this stock?

Back in 2003, there was an interesting article on HaiO.

(The above screenshot of the article is clickable for a larger and clearer image or u can see the same article here: http://www.hai-o.com.my/cms/layout/Printer.asp?ProductID=62 )

The following section of the article was very interesting for me:

• On why Hai-O was venturing into the IT sector, he said: “We are debt free and cash rich as we have RM8mil in fixed deposits, RM4mil in our current account, and RM20mil in overdraft facilities. Therefore, we will venture into any business if it can bring us some benefit.”

I didn't like how and what's been said. Rather arrogant in my opinion.

Firstly, HaiO then was a simple Chinese herbs player. That it wanted to venture into IT was a shocker! A shocking diversification if you asked me. And the manner it talked about its cash balances to the media was rather so arrogant!

And what's more shocking is the following table below.

As one can see from the above table, for its fy 2003. HaiO had a total cash of 13 mil. And note that the above table indicated a huge jump in the number of shares in HaiO.

And when I dig deeper, I noted that HaiO had a Rights Issue in 2003.

Now how? This gives a whole meaning of being cash rich company, yes? See, their debt free and cash rich was not via the company's hard work but this net cash resulted from a rights issue!

And what happened next was interesting.

Now if one look at its 07 Q4 quarterly earnings (Quarterly rpt on consolidated results for the financial period ended 30/4/2007), one would note..

• On 18 April 2007, the Company disposed of the entire 100% equity interest in Hai-O Informtech Sdn Bhd , comprising of 2,000,000 ordinary shares of RM 1.00 each for a total cash consideration of RM 280,000.

Invested 2 million.. sold for 280,000. What about the extras spend during this period? Remember the inital plan was to spend as much as 10 million!

And if one refer back that April 18th announcement: DISPOSAL OF SHARES IN HAI-O INFORMTECH SDN BHD (533171-D)

• 3. EFFECTS OF THE DISPOSAL The Disposal is not expected to have any material impact on the issued and paid-up share capital and shareholding of the major shareholders of Hai-O. The Disposal is also not expected to have any material impact on the net assets and earnings of Hai-O Group for the current financial year.

No material impact?

Take 2007 numbers. It said that it earned a net earnings of 22.114 million. Take this investment of 2 million. Sold at 280k. This is a loss of 1.716million. Yes it's small. BUT do compare 1.716 million to its net earnings of 22.114mil. Well that's about 7.7%.

And strangely, I do not see where and how HaiO accounts for this loss.

Anyway would you call that as an example of past extravagent spending?

Fast forward to present day.

Hai-O buying land in Klang for new facilities (See also: New warehouse to contribute positively to Hai-O in 2009 )

• Hai-O buying land in Klang for new facilities
  21 Dec, 2007
  Source: New Straits Times
  
  HAI-O Enterprise Bhd, a wholesaler and retailer of Chinese herbs and medicine, is spending RM50 million to buy a plot of land and build new facilities in Kapar, Selangor.
  
  The company will pay RM45 million to Bata (Malaysia) Sdn Bhd for a 11.2ha site, and spend another RM5 million to set up a new factory and a warehouse there, senior officials said.
  
  It has yet to finalise the building plan and manufacturing output, they added.
  
  Managing director and chief executive officer Tan Kai Hee said the company would use its reserves to pay for the land and build new buildings to expand its manufacturing output. It may also consider a private placement to raise the fund.
  
  "We are cash-rich, generating RM10 million to RM15 million annually to our reserves," Tan told reporters at the signing of a sale and purchase agreement on the Kapar land in Kuala Lumpur yesterday.
  
  Financial controller Hew Von Kin said Hai-O would use about 6.8ha of the land to build new facilities, while the balance of 4.4ha would be leased back to Bata for handsome fees.

Oh oh.

Where did I read this statement, "We are cash-rich, generating RM10 million to RM15 million annually to our reserves" before?

Dejavu again?

Some view an investment into a stock as being a business partner of the company. Now as a business partner of this business, how do you feel if your partner keeps telling the whole world that they are cash-rich?

And what about this 50 million land purchase again?

Tell me, am I biased or is the sum of this purchase simply way too extravagant? Isn't it simply excessive?

Isn't it like back in 2003. Company had no expertise in IT but yet it went in big time. And now spending 50 million to buy land.

Instead of trying to justify this so-called investment, let's focus on the size instead.

50 million is a lot of money!

Why can't this company spend 10 million instead?

Seriously, can the company not buy land and built a factory with 10 million? No other land in Malaysia?

Ok, if 10 million is not enough, how about 20 million?

Surely 20 million is enough, right?

So why 50 million?

( Note: Hai-O secured RM20m loan to finance property buy )

How? Does one see concern and risk to HaiO's strong cash balances?

And do note, HaiO has been actively buying back the company shares in the open market. And that HaiO's management has promised to return back 50% of its earnings back to the shareholders as dividends and not forgetting that it's rather active with their unit trusts investments. So much plans, eh?

And it all seems to hinges on this pur-tea and MLM earnings.

How would you evaluate your risk in such an investment?

Would you invest in this company?

--------------------------------

This was followed by another posting: More On HaiO

TK said:

• I was initially interested in Hai-O. However, I do not like the 50 Mil investment in property.
  
  Pu-er tea, Moo Moo, this tea, as far as I know, once being 'goreng' & some cost few thousands ringgit a kati hoo.... dun play play... There are people who buy this tea to keep (investors?), the value will goes up according to its age if it is properly kept.
  
  Re the herbs, Hai-O looks like improving in its marketing (outlet design, product packaging). I think its competitors will be 'Yu Yan Sang' I was shocked when I see the price of 'Tong Chong Chow' RM400-RM800 per pack.& I beiieve that chinese herbs business is a fat profit margin business.One of my classlmate drove Merz after joining their MLM while I was still in college. But thats before Hai-O listed... How?

Many thanks Unker TK for sharing what you know.

BullBear posted on FusionInvestor chat:

• HaiO is selling at a low PE (based on ttm-eps). It earns >25% on equity and its net profit margin >10% of its revenue. The arguments centred on its management and its business franchise. IF HaiO continues to perform, those who invested into it would have a return of x% (?5%, 10%, 30%, 50%, 100%), if it unperforms, one might lose y% (?5%, 10%, 30%, 50%, 100%), . Works out the odds (x/y), and see if you like the odds.
  
  Peter Lynch: "The very best way to make money in a market is in a small growth company that has been profitable for a couple of years and simply goes on growing." The key objective of the investor should be to avoid a major loss, the occasional huge winner will offset a number of small losses." "When the news seem terrible, that's when you make the big money in the market."

My dearest BullBear,

A low PE stock means only one thing and that is the stock is trading on a lower valuation compared to what it is currently earning.

Some simply consider that what is happening is the stock is being ignored in the market despite its impressive earnings.

Why?

The market could be wrong and that perhaps this is a stock that's an ignored gem. Yeah, the classical hidden gem and if this is the case, investors who invests in the stock could be rewarded for their stock selection.

However, on the other hand, sometimes the market could be right and that they do sense something is not right within the stock.

And because of this reasoning, I have always realised that a low PE stock does not make a stock a QUALITY stock.

It just means the stock is trading 'cheaply'.

It could be a bargain but it could also be a trap.

In this instance, HaiO is obviously trading cheaply compared to its current earnings.

Now, yes I've raised the concerns on the management and business model.

In every investment reasoning I always evaluate my pros and cons in any investment opportunity.

Yes, HaiO is making tons of money but what's the concerns? What's yours? Well mine are the two simple issue, management and business model.

Main issue here is, are the concerns that I raised legitimate?

Are you comfortable with a MLM business model? Would you invest and buy-and-hold for the long term in such a business?

The issues I raised about the management. Well, did it not happened? Was it not legitimate?

------------------------------------------

:)

Ah.. I never got the answers for the questions I raised in the posting More On HaiO

But that's not important.

LOL!

Hai-O soared. Did you make money?

And here's the chart since 2008. Note where I had drawn the line when I made that posting. (I believe the chart had adjusted and priced in the 'bonus and stock split' exercise in 2010)

Nope, this is not ego booster posting and not certainly not a I told you so posting.

Let's look at the Pro and Cons.

The pro.

• 1. Earnings have been absolutely fantastic the past 2 years or so.
  2. Balance Sheet is looking fantastic. Its cash flow is simply awesome!

The earnings continued to soar and I have to add that Hai-O was rather generous with their dividends too.

Needles to say, the stock soared. CHECK!

Now the cons.

• 1. Is this a flash in a pan?
• 2. Is there a risk to HaiO strong cash balances?

And the questions I had raised on the other posting.

• Yes, HaiO is making tons of money but what's the concerns? What's yours? Well mine are the two simple issue, management and business model.
  
  Main issue here is, are the concerns that I raised legitimate?
  
  Are you comfortable with a MLM business model? Would you invest and buy-and-hold for the long term in such a business?
  
  The issues I raised about the management. Well, did it not happened? Was it not legitimate?

Well, as we all now today, that flash in the pan lasted much longer. The boom in Hai-O's earnings caused by the incredible growth in Hai-O's MLM's business model, lasted much longer.

And the stock went up, up and awaayyyyyyy!

Buyers and investors of the stock was well rewarded for taking the investing risk in the company.

But as stated as one of the cons of the business is the MLM business model itself. As many would know, the MLM business model simply isn't sustainable for the long term.

If had one bought the stock in 2008, would one be holding it and loving it forever and ever and watch the stock price sink lower and lower the past year?

Or should one recognise that business model had taken the turn for the worst and recognise that the earnings had been slowing down badly ( do see yesterday Update On Hai-O ) and perhaps the best option is to exit the investment?

Or should one still consider to HOLD because they simply believe in the buy and hold investment theory?

Ah... don't ask me. I have no answers for I am not the friendly investment advisor.

LOL!

Yup, exactly!!!

My talk or writing is simply way too cheap. :=)

But isn't this simply too interesting?

Buyers who understood the pro of the stock would have been rewarded handsomely and if the buyer understood clearly that MLM business growth cannot last forever, certainly they would have understood that there's a time frame involved with such an investment.

ps: How about Hai-O today?

Simple question I would ask ... 'Is Hai-O today the same as Hai-O back in 2008'?

What's the difference then and now?

Featured Posting: GMO's James Montier: Seven Immutable Laws of Investing

From John Mauldin's Outside the box article (You can subscribe to the article here: http://www.johnmauldin.com/outsidethebox/the-seven-immutable-laws-of-investing - Free lah) feature's GMO's James Montier piece this week.

• The Seven Immutable Laws of Investing
  
  James Montier
  
  In my previous missive I concluded that investors should stay true to the principles that have always guided (and should always guide) sensible investment, but I left readers hanging as to what I believe those principles might actually be. So, now, for the moment of truth, I present a set of principles that together form what I call The Seven Immutable Laws of Investing.
  
  They are as follows:
  
  1. Always insist on a margin of safety
  2. This time is never different
  3. Be patient and wait for the fat pitch
  4. Be contrarian
  5. Risk is the permanent loss of capital, never a number
  6. Be leery of leverage
  7. Never invest in something you don’t understand

I like 3,5,6,7

LOL! I know.. how can I leave out MoS? Well I find the Margin Of Safety so badly abused nowadays but that's my flawed opinion. Don't get misunderstood. It's not that I think MoS is flawed, in fact I agree with it but like I said, it's so badly abused by investors who tweaks the MoS to their own requirement.

Anyway, here's James Montier No.3, 5, 6 and 7.

3. Be Patient and Wait for the Fat Pitch

Patience is integral to any value-based approach on many levels. As Ben Graham wrote, “Undervaluations caused by neglect or prejudice may persist for an inconveniently long time, and the same applies to inflated prices caused by over-enthusiasm or artificial stimulants.” (And there can be little doubt that Mr. Market’s love affair with equities is based on anything other than artificial stimulants!)

However, patience is in rare supply. As Keynes noted long ago, “Compared with their predecessors, modern investors concentrate too much on annual, quarterly, or even monthly valuations of what they hold, and on capital appreciation… and too little on immediate yield … and intrinsic worth.” If we replace Keynes’s “quarterly” and “monthly” with “daily” and “minute-by-minute,” then we have today’s world.

Patience is also required when investors are faced with an unappealing opportunity set. Many investors seem to suffer from an “action bias” – a desire to do something. However, when there is nothing to do, the best plan is usually to do nothing. Stand at the plate and wait for the fat pitch.

5. Risk Is the Permanent Loss of Capital, Never a Number

I have written on this subject many times. In essence, and regrettably, the obsession with the quantification of risk (beta, standard deviation, VaR) has replaced a more fundamental, intuitive, and important approach to the subject. Risk clearly isn’t a number. It is a multifaceted concept, and it is foolhardy to try to reduce it to a single figure.

To my mind, the permanent impairment of capital can arise from three sources: 1) valuation risk – you pay too much for an asset; 2) fundamental risk – there are underlying problems with the asset that you are buying (aka value traps); and 3) financing risk – leverage.

By concentrating on these aspects of risk, I suspect that investors would be considerably better served in avoiding the permanent impairment of their capital.

6. Be Leery of Leverage

Leverage is a dangerous beast. It can’t ever turn a bad investment good, but it can turn a good investment bad. Simply piling leverage onto an investment with a small return doesn’t transform it into a good idea. Leverage has a darker side from a value perspective as well: it has the potential to turn a good investment into a bad one! Leverage can limit your staying power and transform a temporary impairment (i.e., price volatility) into a permanent impairment of capital.

While on the subject of leverage, I should note the way in which so-called financial innovation is more often than not just thinly veiled leverage. As J.K. Galbraith put it, “The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.” Anyone with familiarity of the junk bond debacle of the late 80s/early 90s couldn’t have helped but see the striking parallels with the mortgage alchemy of recent years! Whenever you see a financial product or strategy with its foundations in leverage, your first reaction should be skepticism, not delight.

7. Never Invest in Something You Don’t Understand

This seems to be just good old, plain common sense. If something seems too good to be true, it probably is. The financial industry has perfected the art of turning the simple into the complex, and in doing so managed to extract fees for itself! If you can’t see through the investment concept and get to the heart of the process, then you probably shouldn’t be investing in it.

Equity Mutual Funds: Invest And Lose

Highlighted by BB, an editorial on UK Telegraph blog: Warren Buffett 'fund' illustrates rip off management charges

That article link of course is interesting. For example take the following 2 paragraphs.

• .. If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.8m.
  
  “However, if instead of running Berkshire Hathaway as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2 per cent of the value of the funds as an annual fee plus 20 per cent of any gains, of that $4.8m, $4.4m would belong to him as manager and only $400,000 would belong to you, the investor. And this is the result you would get if your hedge fund manager had equalled Warren Buffett’s performance. Believe me, he or she won’t.

Yes.. in a more simplified manner.

An investment in Berkshire without fees.

• A $1000 investment would turn into $4.8 million after 45 years. ( Annualised return of 20.73%)

An investment in Berkshire with fees ( assume simple 2 and 20 fees is charged.)

• A $1000 investment would turn into $400,000 after 45 years! ( Annualised return of 14.24%)

And needless to say, it's so glaring! If fees were charged, the fund investor would have lost a whopping $4.4 million to fees!

The calculations is simple.

Berkshire Hathaway grew at a compounded rate of 20.73%.

Say I invested in 1965 an investment of $1000 into Berkshire. By end of the first year my investment would have grown into $1207.30. (1000 x 20.73%)

The fund charges 20% for any gains. This means the investor gets to keep only 80% of the return. So 80% of the gain of $207.30 = $165.84. (0.8 x 207.3)

Now 2% annual fee is charged based on the value of the fund.

The value of the fund less the initial 20% charged for any gain = $1000 + $165.84 = $1165.84. Less 2% = $1142.52.

Which means the fund 'ate' 1207.3 - 1142.52 = $64.78 of your profit or a return of 14.52%.

So a 20.73% return would turn into a return of just 14.52% only.

And if you compound it 45 years, an investment of 1000 would turn into 446.334 after 45 years!

Yeah.. the 4.4 million... it went into the fund management heaven! LOL!

The article then continues..

• “Two and twenty does not work. That does not mean that 1.5 per cent and 15 per cent is OK, or even 1 per cent and 10 per cent. Performance fees do not work. They extract too much of the return and encourage risky behaviour.”

Let's see the impact of a 1% and 10% fee charges based on Berkshire example.

A $1000 investment would have turned into 1207.30 in the very first year.

10% is charged on the gains. So the investor gets to keep 90% of the gain or 0.9 x 207.3 = 186.57.

And so the value of the fund after the first year = 1186,57.

1% annual fee based on the value of the fund = 0.99 x 1186.57 = 1174.70.

Which means a return of 17.47%.

Compound that 45 years, would see the value of the fund becomes 1.4 million.

Remember, without fees, the fund would have returned 4.8 million. Which means the fund 'ate' 4.8-1.4 = $3.4 million!

Yes! I fully agree that "Performance fees do not work. They extract too much of the return and encourage risky behaviour.”

How?

Interested in investing in a equity fund? I suggest you to read the load charges and understand the implications of the charges and fees imposed by the fund management.

Investing In Turnarounds

The following was taken from a stock forum and if not mistaken it was from 'shareinvestor' forum. Many apologies because I have lost the link, so I cannot give the due credit.

--------------------------------------------

yes, let's not discriminate because the posting is made by one who is a hybird investor (ie one who based their strategy on TA and FA). Just give the following posting a read...

--------------

How many times have you seen it...?

An otherwise great company admits it has a serious problem. Could be accounting. Or a boneheaded expansion program that’s gone awry. Or perhaps the problem is merely an aggressive acquisition that takes more than one quarter to “swallow.”

Often you’ll see stocks fall 80%-90%, even when the problems in the company have nothing to do with its core business or its most valuable assets. People simply panic. Not the insiders. They are ready to pounce, and will buy millions when no one wants the stock...and sell millions when they do!

The opportunity in these kinds of situations is enormous. Remember: when a stock falls by 90%, its shares have go up by 900% just to return to their original price. Take a $5.00 stock that’s fallen to 50c – down by 90%. If management can turn things around and the stock rebounds to a new high – say $5.50 – investors who bought at $5.00 will have made 11 times their money (or 1000%). And situations like this develop all the time, every year.

You just have to look for them.

But...how can you tell the difference between a company that’s going out of business...and a company that will soon “rebound,” making new investors, who bought near the bottom, a fortune?

Actually, it’s easy. In fact, it’s so easy, once you know how to do it, you’ll wonder why you don’t buy more rebound stocks.

This kind of investing is especially appropriate considering the current market conditions. The stock market as a whole is unlikely to go much of anywhere for the next several years as rising interest rates makes it next to impossible for the broad market to move higher. But, “rebound stocks” are not correlated to the market. They trade higher (or lower) according to their own internal restructuring plans. Find the right company, after its bottomed out and you can make better than the best bull market gains, no matter what happens in the stock market as a whole.

THREE STEPS TO IDENTIFYING SUCCESSFUL TURNAROUNDS

The most important thing to figure out before you invest in a turnaround situation is whether or not the company can afford to fix itself. Basically you have to answer one question: Are there enough assets on the balance sheet to finance a turnaround?

Fortunately, figuring this out is not hard to do. You just need to make some critical calculation. It’s really very simple. What you have to do is check the company’s latest balance sheet.

Step One: How to Determine If A Company Can Afford to Restructure

Check to see if its an asset rich company, despite its debt. Does it have some valuable operating businesses as a backbone? Are there properties it could sell, if absolutely necessary, to finance its turnaround? Can non-core assets be sold to pay off debts, leaving the company’s best assets, which, managed correctly, to produce positive results?

So, while the whiners and the wailers will be crying, you are developing a plan of action, backed by facts and figures. Other investors, after seeing the stock drop +90%, will be too scared to make a rational evaluation. They'd probably have sold in a panic, right at the bottom.

Step Two: Make Sure Excellent Management Is in Place

There’s more to life than money. And there’s also more to a successful turnaround than solid financing. The key is excellent management, ones who weren’t used to losing. A turnaround business needs new officers who are fresh, aggressive and who believe they can win.

You can’t fight a winning battle with leaders who are used to losing. Thus, the second most important key to rebound success is a winning management team. Make sure new, winning management has been recruited and is in place before you buy a rebound stock. Even better, to prove their commitment, this same management buys lots of company stock, at market prices (not just options).

Step Three: Make Sure the Business Model is Sound and the Product is Good

After money and leadership, you’ve got to have a business worth saving. The key questions investors must ask is: does this potential rebound stock have a valid business model, good assets, and does it have great products?

Make sure the business you’re trying to save has solid future prospects. Don’t invest in a troubled business that only has a mediocre future.

I’m sure you’ve noticed that the analysis required to evaluate a solid rebound stock isn’t that difficult. Yes, it does take time, but these things are not hard to do: you check the company’s finances, thoroughly. You take a detailed and in-depth look at management. And you make sure the business model is proven and sound. It’s not that hard, but it can be incredibly lucrative.

Most people don’t look this closely at stocks that have fallen by 80% or 90%. Most people simply panic when they see a stock fall that much. They don’t carefully evaluate a firm’s financial position. They don’t wait and see if new management can be successfully recruited. And they don’t consider the intrinsic value of the company’s ongoing business.

If you can learn to do these things, buying rebound stocks can be the most lucrative investing you’ve ever done.

--------------------------------

And the following is taken from Fools.com. Again I lost the link. :(


Here is an old Fools article..

Investing in Turnarounds

Whitney Tilson uses BJ's Wholesale Club and Office Depot as case studies to explain how he invests in companies that may be poised for a turnaround. Although both stocks are currently cheap, you would do well to look closer at the issues confronting the two companies and whether their strategies to overcome them are working.

By
March 28, 2003

Even with the severe decline in the stock market over the past three years, I find it difficult to find significantly undervalued stocks among companies that are performing well. Instead, I am typically buying stocks of businesses that have issues -- generally ones in which earnings have fallen (or, at the very least, growth rates have slowed), either due to external factors such as the weak economy or a company's own missteps. I call the latter category "turnaround situations," which means that the company needs to fix certain internal problems in order to turn itself around.

Today, I'd like to share some thoughts what I look for when investing in turnaround situations. As case studies, I'm going to use BJ's Wholesale Club (NYSE: BJ) as of today and compare it to Office Depot (NYSE: ODP) in January 2001 (a stock I bought then at $8, sold a year later at $17, and which I have recently repurchased).

When I've done well investing in turnarounds, most of the following characteristics have been true:


* A strong balance sheet
* Robust free cash flows
* Share buybacks
* Great management
* A strong competitive position
* The right strategy
* A really cheap stock

Let's take a closer look at each of these metrics and apply them to BJ's and Office Depot.

A strong balance sheet and robust free cash flows
The first question to ask in any turnaround situation is: Does the company have the financial strength to survive until it can turn itself around? Even the most brilliant turnaround plan is worthless if the company goes bankrupt before it can be implemented. So, look for a strong balance sheet or robust free cash flows -- preferably both.

At first glance, BJ's appears to score well in this area, but the picture isn't quite so rosy. While the company has $33 million of cash and no debt, it has leased most of its stores (rather than buying the land and building as, for example, Costco (Nasdaq: COST) typically does). So, BJ's is on the hook over many years for more than $1.6 billion of operating leases, contingent lease obligations, and closed club lease obligations (as of its Q3 10-Q) -- a material amount for a company whose shareholders' equity and market cap are both under $800 million.

Turning to cash flows, BJ's was free cash flow positive last year, with operating cash flow of $151 million and capital expenditures (capex) of $135 million. But it is planning a big increase in capex this year, to $215 million-$225 million, versus expected operating cash flow of $170 million-$190 million, such that the company will be free cash flow negative and end the year with $40 million-$50 million of debt. This is not an alarming amount, but the trend is worrisome and adding debt on top of the lease leverage is risky.

In January 2001, Office Depot didn't have a great balance sheet, with $378 million of net debt and even greater lease obligations. However, the company did have very healthy cash flows: in the first three quarters of FY 2000, its operating cash flow was $435 million vs. capex of only $181 million.

Share buybacks
If the company is financially healthy, yet the stock is trading well below intrinsic value, then buying back stock can create tremendous shareholder value. It's critical, however, for management to be savvy in buying back stock only when it's at low levels.

BJ's management has failed miserably in this area. Last year, the wholesaler repurchased approximately 2.6 million shares of stock at an average cost of $31.51, and since 1998, when it began repurchase activities, has repurchased approximately 9.8 million shares at an average cost of $31.69 per share.

It's bad enough that it spent $310 million buying back stock at what turned out to be very high levels, but even worse is that, with the stock down by nearly two-thirds from the price at which it was aggressively buying back stock, it has essentially suspended its repurchase program.

Office Depot, in contrast, had repurchased $781 million of its stock in the previous four quarters (from Q4 '99 to Q3 '00), at an average cost of less than $10, reducing the share count by a whopping 27%.

Great management
Great management is critical for the long-term success of any company, but it's especially important in turnaround situations, in which there is often little margin for error. My rating of BJ's management is mixed at best. I think they are good operators but, as I discuss elsewhere in this column, poor capital allocators and strategists. In January 2001, Office Depot's CEO, Bruce Nelson, had been on the job less than a year, but had an excellent track record at Viking Office Products (which had been acquired by Office Depot) and had the right strategy for turning the company around (which I discussed in The Importance of Strategy).

Strong competitive position
Companies with strong -- ideally market-leading -- competitive positions generally have the best chances of successfully turning their businesses around. BJ's is much smaller than Costco and Sam's Club (a division of Wal-Mart (NYSE: WMT), which means that it does not have comparable economies of scale, purchasing power, etc. Being a distant third in a three-horse race is not a good position. Office Depot, in contrast, is the world's largest seller of office products.

The right strategy
I have written three columns on the importance of strategy, so I won't repeat myself here. It is in this area that I have the greatest concerns for BJ's. I believe it is fundamentally competitively disadvantaged relative to the larger warehouse clubs (Costco and Sam's Club), but fundamentally competitively advantaged versus supermarkets. (BJ's prices are 40% lower than supermarkets', according to one survey BJ's cited on its recent conference call.) Therefore, I agree entirely with its management's strategy outlined in the most recent earnings release and conference call: Focus on taking share from supermarkets and differentiate BJ's from Costco and Sam's Club to avoid their competitive onslaught.

But the actions BJ's recently announced are not consistent with this strategy. For example, if it is already 40% cheaper than supermarkets, the primary competitors they've identified, then why slash prices and kill margins and cash flow? And given the harsh competitive and economic environment, why is it ramping up capex by more than 60% this year? I think it may be making the classic mistake retailers often make: worrying more about the altar at which Wall Street worships, same-store sales, rather than far more important margins, profits and cash flows.

In contrast to BJ's' imprudent actions, Bruce Nelson had exactly the right strategy to turn around Office Depot in early 2001. Rather than investing in the low-margin North American retail store base, the company closed underperforming stores and improved operations, which generated cash that was then reinvested into the higher-margin, faster-growing catalog, contract, Internet, and international businesses, where it has real competitive advantages.


A really cheap stock
My general rule of thumb is that turnarounds, even if they work, take twice as long and cost twice as much as even the most conservative estimate. So, it's especially important that the stock's valuation reflects a huge margin of safety.

BJ's stock certainly appears cheap, trading at only 8.6 times this year's consensus EPS estimates of $1.28 per share, and at $8 in January 2001, Office Depot was trading at a similarly cheap 9.4 times trailing EPS.

Conclusion
Of the seven metrics I've laid out, Office Depot in early 2001 scored very highly in nearly every area, so it's not surprising that the stock did exceptionally well (it was among the three best-performing stocks in the S&P 500 in 2001). In contrast, my analysis of BJ's reveals major issues, which is why I don't recommend it despite its seemingly cheap price.

Did Kenmark Case Proved That Buy And Hold Investing Strategy Does Not Work?

I was listening to some coffee table chat on Kenmark. And naturally since Kenmark shares had collapsed from 90 sen, one aunty was quick to blast the investing strategy. Because of the collapse of the share and the incredible losses announced by the company, she was quick to stress that buy and hold does not work in Malaysia, not when companies like Kenmark are listed.

Is this really the case?

I have compiled a set of data. Now do verify the data because I made the compilation myself and obviously, I could screw up with the data. Hey, I am not perfect. Not at all.

Now assuming one had 'invested' in Kenmark after Kenmark's fiscal 2005 numbers. Now Kenmark reported 2005 Q4 earnings can be found here: Quarterly rpt on consolidated results for the financial period ended 31/12/2005. That earnings was made in Feb 2006.

The next year, Kenmark changed its fiscal year. Hence 2007*** represented a 15 month fiscal year. Yeah kind of complicated.

That earnings was reported on May 2007. Consolidated results for the financial period ended 31/3/2007

If you click on that earnings link above, Kenmark lost 6.618 million for the quarter.

Which means, Kenmark's net profit for 15 months is only a mere 4.545 million or a razor thin 1.25% only. Cash balances only 18 million and loans over 137 million.

The massive drop in profitability was a big, big warning yes?

Now if one had purchased Kenmark, should one continue to HOLD the stock given such a circumstances?

Does one want to hold and hope that the business could recover? What was Kenmark's core business?



And amazingly, the stock was very kind. Look at the chart above. If one purchased the stock as suggested in Feb 2006, at around maybe 1.08 or so, one could have easily exited the stock with minimal losses.

Now one assume ignored this warning and continued holding to the stock.

The next fiscal year 2008, earnings did improve.

Perhaps HOLDING looked like a smart move.

Come May 2009, all the warning signs flashed like mad. ( see the compiled table)

Earnings dropped back to 4 million. Net margins slumped to 1.6%. Cash slumped to an incredible low 0f 2.222 million. Loans were 144 million and receivables were over 160 million!

Given such razor thins profit margins, were there any logical reasoning that Kenmark was running receivables over 160 million???

Seriously that is sounding like an extremely poor company with very weak fundamentals, yes?

That warning was on May 2009!

And again the stock was very nice to investors seeking to exit for it held strong.


The above chart showed Kenmark's trading range between June to Dec 2009.

Still HOLD on to the stock despite the clear deterioration in the company's fundamentals?

(the following notes taken from what I had posted in the posting A Deeper Look At Kenmark Losses )

Aug 2009: Quarterly rpt on consolidated results for the financial period ended 30/6/2009
2009 Q1
Sales 57.686 million Net Profit 1.013 million Receivables 207.584 Million Cash 2.202 million Total borrowings 144.463 million.

Any improvement? Or did the spike in receivables raised the warning signal up another notch?

Is this not yet another reason to leave the stock?

Nov 2009: Quarterly rpt on consolidated results for the financial period ended 30/9/2009
2009 Q2
Sales 35.334 million Net Profit 3.718 million Receivables 225.317 Million Cash 2.298 million Total borrowings 143.354 million.

By Nov 2009, earnings did improve but receivables have now gone up another notch. It's pure insanity now that receivables are now at 225.317 million. And despite the improve in profits, Kenmark's cash level is still extremely low at 2.298 million!

Seriously... does it make any sense to hold the stock?

Isn't it so clear that Kenmark did not even look like an investment grade stock at all?

And isn't it so clear that EVEN if one had make an investment mistake by purchasing Kenmark stocks, one could easily exited the stock with minimal losses if one had acknowledged the fact that perhaps they had err-ed by investing in Kenmark.

Now Kenmark has collapsed... totally.

Should one fault the investing strategy 'Buy and Hold'?

No I would not.

Kenmark business fundamentals had been poor for so long already. There was no reason to buy the stock, let alone hold the stock!

Sorry but this is my flawed conclusion.

Sometimes Eternity Does Not Work In Investing

I hear many local investors preached about Unker Buffy and used him as the role model for the buy and hold investing strategy.

Remember in an investment, one buys the stock which represents a company with the wonderful business and the idea of course is to hold on to the investment forever.

However, there are two important exceptions to this simple investing idea.

1. The stock must remain a good company. That is the wonderful business must remain intact.

Many fails to understand this simple point. Companies do go bad. For example, the fundamental economic of the business do changes and sometimes these changes are permanent, which ultimately could render a good business poor. Owners do change. Yes what should we do when owners change and the new owners are simply lacking? Why should we continue to be an investor? Shouldn't one sell when such events occur?

2. Market do really go out of whack.

Yes, they do. And this is why investors can go bargain or value happening and if they don't go out of whack, good old Unker Buffy can just retire. Needless to say, market goes out of whack, both ways. Yes they do. Stocks can be insanely cheap but they can also be insanely overpriced. Well, what do you want to do when it's insanely overpriced? Yes, sometimes selling makes logical sense.

Anyway, here's an article on CNBC showing Berkshire disposal of shares. Warren Buffett's Berkshire Hathaway Sells Lots of Kraft (And Other Stocks) in First Quarter

Well what's my point?

Warren Buffet and Berkshire do SELL their shares.

Do not misunderstand this posting. This is not a posting urging you to simply sell but rather to remind you that sometimes it does make logical sense to sell. Yes, sometimes the justification to sell the shares are real. So do not get hung up on what some bad investment advice suggesting that you should hold your shares forever, for decades.

Remember nothing last forever. Stock markets can crash, good stocks can turn bad, good stocks can be insanely overpriced. So what do you wanna do about it?

Hold it forever and ever, for eternity?

And are you even sure you that the stock you are holding, should be considered a good stock? That is, is it really a stock which has a wonderful business? What if it's a average stock? Or what if it's really below average stock? Would holding it for eternity sake help you make money from a poor investment?

And sometimes we can overpay for our investment for the so-called good stock and holding it for decades would not help and erase the fact that we did make the mistake of overpaying for our investment!

Just because some local investing sifu says so?

Remember sometimes eternity does not work in investing. Yes, sometimes.

Would You Buy This Hidden Gem?

Have you ever come across the hidden gem articles suggesting to you that you should invest in a stock?

I have. :)

I have always asked myself that if ever there's this hidden gem in the market or if ever there's this EXTREMELY undervalue stock in the market, why is the person sharing such an info PUBLICLY to everyone. For the minute, they advertise the stock, surely the stock would go up and the hidden gem won't be hidden no more and the EXTREMELY undervalued stock would most likely not stay undervalued any more.

This morning I would like to examine on what happens if one buys a so-called hidden gem and I do actually have one real live example.

What do I mean by real live? Well back in Jan 2008 I made a posting highlighting a news article publishing a hidden gem.

The stock was trading at 8.30. It went up a cool 50 sen after the article was published. LOL!

See how profitable it is to share and publish your hidden gems to others! Let them chase the stock!

Let me call the stock xyz and let me reproduce the chart of the stock when I highlighted the hidden gem stock back in Jan 2008.

What was incredible was the news article called the stock a laggard in its sector but based on the chart above, I was so dumbfounded to read that the stock was branded as a laggard.

Let's fast forward to November 2008.

Could you guess what happens next if a reader decides to take a plunge in this hidden gem?

LOL!

Yeah, me bad. Bad me. Yeah, it does not take much a genius to guess that what comes out of me isn't really a tip and most probably this stock probably tanked since Jan 2008. LOL! Guilty as charged! :P

Some would highlight the recent crash as a reason for the stock dismal performance.

Spot on. :D

By Nov 2008, the stock traded as low as 4.45.

How?

If one had purchased the stock at 8.30 in January 2008, as suggested by the news article, one was at staring at 4.45 for their hidden gem!

How?

Buy more?

Would you buy more?

Yeah, some say that as long as one's reasoning is correct, one should not be afraid to hold for the long term.

That's so true.

But what if one's reasoning is flawed?

Not possible?

Not remotely possible?

And of course the cynic would be extremely quick to point out the bare fact that by using 'hold for the longer term' strategy back in November 2008, one is merely finding an excuse to justify their wrong reason to purchase. Hey, didn't one NOT buy the stock, just because it was tauted a hidden gem? Not true? And didn't one buy the stock despite the fact the stock was already soaring sky high? (I believe some call this as chasing the stock!)

How?

It's now December 2009.

How do you think the stock perform since then?

The stock closed yesterday at 7.40.

Yes, like most stocks, this stock has recovered since its plunge last year.

But it's still below where the stock was taunted as a hidden gem.

Oh.. silly me. I have forgotten to mention the stock name. LOL!

Here's the screenshot of the news article.


And this was my posting dated January 2008: Hidden Gem In The Plantation Sector. ( Link to Star Business article: Chin Teck a hidden gem among plantation stocks)

The following point stood out rather sorely.

• A brokerage in a report said Chin Teck’s operating efficiency was on par with some of its larger peers and it enjoyed one of the highest profit margins in the sector.

As mentioned in the posting, I said back in Jan 2008. "I wonder... who is the brokerage? And when was the report dated? ( Sometimes, I seriously wonder why our business articles cannot quote or name their sources directly. Why?)"

So who was this brokerage that recommended the stock back then?

Seriously hor.

Think about it for a moment.

If this brokerage is of some 'quality' and if this brokerage had decent reputation, surely the brokerage would have absolutely no problems to state their claim on such a recommendation!

Yeah, if they dared to taunt the stock as such a 'hidden gem', why the need for them to remain hidden also.

Clearly, Chin Teck, the stock had flew sky high, back in January 2008 but yet this unknown brokerage called Chin Teck a hidden gem.

Look at the consequences of such a recommendation.

How?

Now... I seriously wonder... who is the brokerage? And when was the report dated?

So the next hidden gem article that you read, would you just buy because they said it was a 'hidden gem'?

Or would you do your own research and see if the recommendation is justifiable or not?

--------------

ps: do understand that this is not a tipsy! I have no idea if Chin Teck is a gem. So it's best that you stop assuming that this is a stock tipsy from me to you. But if insist to ass-u-me, it's your ass not mine. (LOL! Yeah, I do know that such a disclaimer does not sound too nice. :p3 )

Mohnish Pabrai: There's Only One Warren Buffett

Here's a wonderful interview on Mohnish Pabrai. Enjoy!

• Mohnish Pabrai currently manages Pabrai Investment Funds, which he founded in 1999. The fund has around half a billion dollars in assets under management. Pabrai went to the US in 1982 to do his undergrad in computer engineering. After that, he worked with Tellabs in Chicago. In 1990, he started his own company TransTech, an IT services/system integration business and ran that for around ten years, before starting Pabrai Investment Funds. He has written a book on investing, The Dhandho Investor: The Low-Risk Value Method to High Returns. Excerpts from an interview:
  
  How did you get into investing business from information technology?
  Around 1994 I heard about Warren Buffett for the first time accidentally. The first couple of biographies about him had just been published a year or two before that. I read those books and I was quite blown away by some data points that were coming out about him and the industry and so on. I didn’t have any experience or even education in the investment business. But I was very intrigued by it.
  
  I started to invest in the public equity markets using Buffett’s model in 1994 and basically did extremely well, north of 70% a year, till about 1999. I was getting more and more interested in investment research and securities analysis and made a decision to leave my company. I brought in an outside CEO and decided that I would spend more time on investing and at the same time some friends of mine wanted me to manage their money for them. It started as a hobby in 1999 with about a million dollars from eight people. About a year later the business (TransTech) actually got sold, I wasn’t running it anyway, but I was completely cashed out. And then I thought that let’s make my hobby a real business, try to scale it up and get investors. We now manage about $500 million — ten years later.
  
  How did you narrow down on Warren Bufett and value investing?
  Basically in 1994, when I read about Buffett, there were two things that stood out. One was that he had compounded money at a very high rate. If you are compounding at a high rate, even if you have a small amount of money — let’s say a million dollars — in thirty years you could have a billion dollars. So the idea of compounding at a rate above the market rate is an extremely fine notion because it can lead to enormous wealth creation. That was the first thing.
  
  The second thing was that the way Buffett was compounding money at a rate higher than the market was based on a core wisdom which he stood for. If you are physicist, whether you believe in gravity or not, it will always impact you. Just like there are laws of physics, laws of gravity, there are laws of investing.
  
  I noticed in 1994 that the mutual fund business had two things: one, they did not follow the laws of investing, and two, their results were affected by the fact that they did not follow the laws of investing.
  
  For example, a basic law of investing is that you make very few bets, you don’t buy a hundred companies because you are not going to have an understanding of business. But if you look at mutual funds, that is not the way they operate.
  
  So essentially, what you are saying is that investors should make fewer bets?
  So you make few bets, you make big bets, infrequent bets and you only make bets when the odds are heavily in your favour. What I found very funny was that here is a guy (Buffett) who is telling you very much the approach to investing he follows, and this is like Newton telling you the laws of physics. The second thing is that the investment industry does not care about these laws, and their results reflect it.
  
  The third conclusion I came to is, I said, OK, if what I am saying is right, what it means is that a person like myself, who has no experience in this industry, could come in and apply Buffett’s rules and do better than all these managers running all these funds. So I said, well, that hypothesis means nothing until you test it out. I had an asset sale take place of a part of my business in 1994, and I had about million dollars in cash, sitting with me for which I did not have any need for.
  
  I decided I am going to take this million and put this on a twenty or thirty-year compounding engine. I was about 30 years old, I wanted to see if by the age of sixty I had my billion dollars. I started playing this thirty-year game in 1994, and basically I found that first of all, it was very enjoyable and second, that it’s been fifteen years now and the original hypothesis I had is absolutely correct — which is that the industry doesn’t get it, they still haven’t changed their ways, and there results reflect that.
  
  What are the factors you look at before deciding to invest in a company? Can you give us an example?
  The first thing you got to look at is, “I am not buying a stock, but I am buying a business.” And you only buy the business if you were willing to buy the entire business if you had money for it. So, for example, if Reliance Industries has a market cap of $100 billion and you had a $300 billion, the question you would ask yourself is, would I buy the entire business for a $100 billion?
  
  The first thing is that you are not buying pieces of paper, but you are buying an entire business. The second is that you ask yourself, do I understand the business? Do I truly understand how it will work, how it makes money, how will it do in the future?
  Then the third thing is, if Reliance produces $3 billion a year cash flow and it trades for $100 billion, I have no intention of buying it at 33 times cash flow. It is like I have no interest in putting money in an account that pays 3% interest.
  
  So I love Reliance, maybe, if the fair value of business is 15 times cash flow, which is $45 billion. And since I am cheapskate, I don’t want to buy it for more than half its fair value, so I just say to myself, that if it goes below $20 billion in value — or one-fifth the current price — then I will look at it again. In fact, that is the way to look at the Indian Sensex. You take all the Reliances, the Wipros and Infosyses of the world, chop their price by four, and that’s your entry price.
  
  What has been your most successful stockpick till date?
  You know that’s a very funny question. The most successful company I ever invested in is Satyam. I invested in 1995, and I was completely out by 2000. When I invested the stock was at Rs 40, and Satyam’s earnings at that time were about at Rs 12 a share, so you were buying a business for three-and-a-half times earnings. And the more interesting thing for me was that property the company had in Hyderabad exceeded the market capitalisation as it was carried at a value that was bought a long time ago.
  
  The only reason I knew about Satyam was because I was in the IT services space. These guys had actually visited us to see if they could do business together. And I had been pretty impressed by the way the business operated and the people I had met.
  
  I looked at it from my investment point of view after was amazed that such a business could trade at such a price. So I invested in Satyam. In 2000, it was trading at Rs 7,000, that is about a 150 times the price I bought it at. This was in the days before demat, and actually when I bought the stock with an account through Kotak that I had in Mumbai, I was given physical delivery of these shares that looked like tattered pieces of paper that were falling apart.
  
  Satyam from less than a PE of 3 to more than PE of 100. I just said I am out of it because now I owned a bubble stock even though I did not buy it at bubble price. I sold my entire position within 5% of the peak. Within six months it had dropped from Rs 7,000 to Rs 1,000, and continued on the sidelines for a while. That was the best deal that I ever made.
  
  I also happened to read somewhere that you wear shorts to work and do not as a matter of habit short stocks?
  Well, I am wearing shorts right now … the math for for shorting is really bad. When you are long on a stock, as it goes down in price, the position is going against you and it becomes a smaller portion of your portfolio. In shorting, it is the other way around: if the short goes against you, it is going to become a larger position of your portfolio. When you short a stock, your loss potential is infinite; the maximum you can gain is double your value. So why will you take a bet where the maximum upside is a double and the maximum downside bankruptcy?
  
  Also, any time you short a stock, you are hooked to a (stock price) quote machine for life support because you have to watch what is happening all the time. Many a times, when I am travelling in India, it could be several days when I don’t have a quote for any positions that I hold. So I don’t want to be a in a situation where I have an umbilical cord linked to some quote machine … and blood pressure going up and down.
  
  Do you have investments in emerging markets like India and China or do you stick to the stocks in the US market?
  I would say that most times a very large portion of our portfolio has a lot of exposure to the global market. I have (shares in) several companies in Canada. I own (shares in) one Chinese company and an Egyptian company, I don’t own any Indian companies right now, but I use to own Satyam. Also Pabrai Funds use to own Dr Reddy’s.
  
  You have said in the past that investment ideas come to you by reading a lot…
  An investor should think of himself as a gentleman of leisure. Don’t think that you are in some profession. You just think that you are a person who is focused on enjoying and living life well. If you focus on yourself as a gentleman of leisure what is going to happen is that you do not feel any compelling reason to act. It has been several months since I have bought any new stock. And that is not a problem because we went through a period in December when we bought ten stocks. The first thing is that we are in a profession were you don’t pay for activity, you get paid for being right. So there should be no compelling reason to act. Basically, the thing you do is you take out the reason to act.
  The second thing you do is you focus on acquiring worldly wisdom. I read an enormous amount of stuff and relate to what different investment managers who I respect are saying. So, at times, things become no-brainers.
  
  In the fourth quarter of last year, when everything was going to hell, one part of the market that went to extreme hell was commodity-related stocks. Commodity-related stocks absolutely got crushed. 95% down. 90% down. And if you simply keep in mind that you look at the growth rates of India and China, you can get an insight.
  
  Through our foundation Dakshina I spend a good amount of time in rural India. I can see nuances about India, that most people would not see. You can see that the pressure on the few commodities in the earth’s crust is tremendous.
  
  China has severe problems with fresh water and you really have big problems with agriculture with those type of water issues. When you have growth rates of 7-8%, people will want to eat the best. Generally it is proven that protein consumption climbs very high when economies do well. It is absolutely a given that 10 years from now the amount of agriculture and protein needed will be much higher from today. And getting there will not be easy.
  
  So the thing is there are certain businesses that serve as toll bridges in that space. For example, one toll bridge is if you look at Latin America. It has a lot of land and it is flooded with fresh water rivers. South America can basically take that land and convert it into producing corn and soybean or whatever and export the hell out of it to China. And that is exactly what will end up happening. Latin American agricultural companies with large land holdings today are not excessively priced, they are very cheap. But there is absolutely no way for India and China to satisfy the consumption demand that is coming without going to Latin America. So we will just own the toll bridges and wait.
  
  How much of Warren Buffett’s success can be attributed to his investment prowess and how much to the fact that he is Warren Bufett?
  Well the thing is you could have invested even after Buffett had invested and you could have made six times the money out of it.
  
  In fact there are a couple of professors in Ohio, who studied any stock that Warren Buffett bought, if you bought on the last day of the month, when it was public that he owned that stock, and you sold it after it was public that he had started selling it, you would have generated north of 20% annual rate of return.
  
  I would say that we will never see another Warren Buffett. Just like we will never see any Albert Einstein or another Mahatma Gandhi. Buffett is a very unique individual. His skillsets outside of investment are phenomenal but they get dwarfed by his investing skills. The main thing that makes Warren Buffett Warren Buffett is that he is a learning machine who has worked really hard for, let’s us say seventy years, and is continuously learning every day.
  
  So the thing is if you want to be like Buffett, there is no short cut. First of all, you have to be deeply interested in investing and you have to be very willing spending tens of hours, hundreds of hours, reading the minutiae. There is a very famous value investor called Seth Klarman. He is into horse racing. And his famous horse is called Read the Footnotes.

Source: here