Wednesday, 12 March 2014

Value Investing Check list

Profitability and Accrual
1)      Consistent positive ROE (>10 percent, if long term Government bond is 2.5%, Equity Risk Premium 5.5%)
2)      Consistent positive ROIC (smaller than ROE but the gap is not wide due to non-leverage nature)
3)      Cash Flow from Operation > Net Income

Relative Valuation(Margin of Safety)
1)      Having P/B ratio < 2(adjustable according to ROE, high ROE justified for more P/B)
2)      Current P/E less than ROE
3)      Earning Yield >10%
4)      P/E less than 40% of the highest P/E the stock had over the past 5 years(Graham)
5)      P/FCF less than 15, usually 11-12, if under 10 is the best
6)      FCF is atleast 5% of Sales

Leverage, Liquidity and Source of fund

1)      Lower debt to asset ratio
2)      Improving current ratio history
3)      No new shares issued

Operating Efficiency
1)      Improving Gross Margin for the last 5 years
2)      Higher Asset Turnover Ratio for the last 5 years

Bankruptcy and Manipulation
1)      Check Bankruptcy Risk by Altman Z-score
2)      Check Earning manipulation flag by Baneish M-score

Value creation sub-check list
1)      Improving Cash Flow to the firm by:
a.       Eliminate asset that earn less than cost of capital
b.      Improve operating efficiency
c.       Reduce tax burden
d.      Reduce capital expenditure but balanced against growth
e.       Reduce non-cash working capital
2)      Increase expected growth rate of the earning by:
a.       Increase reinvestment rate provided marginal return > cost of capital
3)      Increase length of high growth period by having economic moat:
a.       High barrier of entry
b.      Strong brand name
c.       Patents
d.      Having high switching cost
e.       Cost advantage of economy of scale
4)      Reduce cost of capital:
a.       Reduce operating risk
b.      Reduce operating leverage by reducing fixed cost
c.       Change financial mix by altering mix of debt and equity used to finance the firm
d.      Matching cash flow on debt and cash flow of asset using derivatives and swap

Know When to Buy/Sell

1)      Buy when volatility index go above 30
2)      Sell when volatility index go below 15(case by case scenario)


Saturday, 11 January 2014

Investment Strategies based on Low P/B with Fundamental Scoring, Earning Manipulator Flag, Bankcruptcy Flag and reasonable ROE and ROIC

Recently working on a project to identify those singapore listed stocks, what are the stocks that are currently selling below P/B value, coupled with good fundamental F-score(Piotroski Scoring) (>=7) on the most recent year, with No Earning Manipulation flag detected using Baneish M-score and using Altman Z-flag, I included ROE and ROIC inside the calculation as well and filter out some SG stocks

The reasoning of the filter is that those low P/B stocks usually are selling below P/B because they are not earning a reasonable ROE that cover the cost of equity, but having a high fundamental score also means that they are fundamentally strong and using Baneish M-score, we will know that whether the company got manipulate the earning and the risk of bankcruptcy is also low through Altman Z-score.

If we are pretty sure the company is safe and yet it generate a reasonable ROE, there is hardly unlikely that the price of the stock will remain below price of book value for a long time period, it might means that it could have margin of safety investing in those companies.

I think Dukang Distillers stands out from the table as it has very 0.5 P/B ratio,with a P/E of 3 and with high ROE and ROIC recent year, definitely worth take a look as a value play, Tat Seng package stands out as well.


Stock NamePrice To Book RatioPrice To Earning RatioF-Score Previous YearF-Score LatestM-ScoreZ-scoreO-scoreROEROIC
FABCHEM CHINA LTD0.32599647214.259111177Not Earning ManipulatorNot likely to bankruptNot likely bankrupt9.41972942411.39632628
CHOSEN HOLDINGS LTD0.52821562924.5833334877Not Earning ManipulatorNot likely to bankruptNot likely bankrupt5.1028536075.802938958
DUKANG DISTILLERS HOLDINGS L0.5650136443.09518666867Not Earning ManipulatorNot likely to bankruptNot likely bankrupt19.7105835816.93335908
TAT SENG PACKAGING GROUP LTD0.5968109475.71725584147Not Earning ManipulatorNot likely to bankruptNot likely bankrupt11.010043598.019543261
JASON MARINE GROUP LTD0.6586151852788Not Earning ManipulatorNot likely to bankruptNot likely bankrupt5.7789519675.909320194
TIONG WOON CORP HLDG LTD0.6614149647.96086482238Not Earning ManipulatorNot likely to bankruptNot likely bankrupt7.7287767515.885250384
NAM LEE PRESSED METAL IND0.6697268758.39776053477Not Earning ManipulatorNot likely to bankruptNot likely bankrupt12.9622071712.29955767
DUTECH HOLDINGS LTD0.8012079534.81519041128Not Earning ManipulatorNot likely to bankruptNot likely bankrupt10.1962505113.773904
NEW TOYO INTERNATIONAL HLDGS0.8215834118.19034890687Not Earning ManipulatorNot likely to bankruptNot likely bankrupt9.9625714518.922675953
CDW HOLDING LTD0.8433358714.75609422478Not Earning ManipulatorNot likely to bankruptNot likely bankrupt14.2347597912.59124281

Thought on Artificial Intelligence on Asset Allocation Decision

Recently thought on IBM's deployment on Watson for DBS and the cognitive programming led me lead to a thought that eventually computer will overtaking human being on doing asset allocation. Not sure IBM has already helping Wall Street in doing asset allocation based on real time information feedback

As a comparision, computer vs human in chess playing, as there are discrete steps involving millions of permutation, but in real life investing, there are enormous amount of data being present but human can choose the most important data to analyze and act accordingly, but computer is able to generate trade execution much faster than human being

What i can see from the trend is the profit margin using algo trading will diminished as more computer or algo is trying to grab the profits from the market, while the loser will be those retail player that bet on conventional trading methodology such as cut loss or chart pattern, but Watson coupled with cognitive programming will change this game forever as it is a machine that never tired, and never sleep and trying to find the best opportunities in the market.

But I believe there should be still a few more years to last for value investor, the reasoning is although Watson is intelligence, it won't be able to analyze things that is not presented to it yet, so investing in mid to long term kind of time frame will not be its strategy.

Perhaps the philosophy of value investing which is to invest long term prevent itself from falling into a battleground that it has no competitive advantages.

Saturday, 9 November 2013

Write up on Sarin Technologies


Sarin Technologies (U77.SI)

Recommend to: Hold
Intrinsic value: S$1.82, Previous Closing Price: S$1.90

Main Activities

Sarin Technologies Ltd develops, manufactures, markets and sells precision technology products for the processing of diamonds and gemstones. It provides smart solutions for every stage of the rough diamond manufacturing process, from determining optimal polished gem based on true dollar value, through laser cutting and shaping to inline quality control of faceting. It has operations across India(contributing 76% revenue), Africa(8%), Europe(3%), North America(2%), Israel(5%).

Main revenue contributors are software products that assist in evaluating rough diamonds and also production and planning of unpolished diamonds into polished ones, while the company is also in progress of rolling out Sarin Light and Sarin Loupe which will help to expand the business segment into retail sector by addressing the last of the four C’s - Clarity. Sarin Light is a system that enables the automatic, consistent and quantified measurement of a polished appearance while Sarin Loupe is an imaging system which creates high quality visual imagery to both buyer and seller so that a polished diamond can be inspected virtually from multiple angles without having the polished gem physically in hand.

Key development

High barrier of entry for Planning Software:Galaxy

Sarin has rolled out and refined the planning software for scanning stones down from 2.5 carats and up to 180 carats in weight, which means that the software is able to cover the entire ranges of stone sizes that meet different customer requirement.
Sarin’s Galaxy family system is currently contributing over 25% of revenue of the group in 2012 and recurring revenue grew by approximately 50%. As there is a high barrier of entry and the manufacturer is reluctant to switch to another system once the process has been in place, we view that this is favourable for Sarin to maintain high profit margin going forward.

Penetration into retail segment

Sarine Light is currently being rolled out to enhance the consumer’s buying experience. We view that this is a positive value enhancement to the company to be involved in selling the technology products to retail sector. An initial commercial agreement with significant retail chain of diamond jewellery in Asia was concluded in early 2013 and CIMA, Japan’s leading bridal diamond jewellery chain, has rolled out Sarine Light Performance grading reports on polished diamonds in all its stores throughout Japan in early April 2013. On the other hand, Sarine Loupe is scheduled to be rolled out commercially in late 2013.

Highlight from Financial Statement 2012

Revenue increased by 10.3% to a record US$63.8m despite a significant decline in industry activity during the months of June through September. Increased in revenue mainly contributed by high rate of penetration and usage of Galaxy-related product(25% of revenue) .

Gross margin improved to 68%(up 2% YtoY) due to increased sales volume and recurring revenue contribution of Galaxy business model. Operating profit also increased to record US$24.5m representing high profit margin of 38.4%. Net profit is a record of US$20.8m(up 19.5% YtoY) while the net profit margin increased to 32.6% from 30.0%.

Cash level is healthy as seen from operating cash flow greater than net income which stands at US$23.2 mil. ROE and ROA stands out at 36.9% & 30.6% respectively. Dividend payout ratio also increased to 74.2% representing a dividend yield of 5%

Risk

1)      Drop of price of the rough diamond in 2012 but remain stable in 2013, though this will contribute positive sentiment in diamond industry, but is a key risk factor to watch out for if there is any slowdown in economy.
2)      High geographical exposure to India which is currently battered down by high inflation and current account deficit which will hinder the growth of the business if the manufacturer decided to scale down the business.
3)      Location of the company is in Israel, which remains as another geographical risk factor if there is any political instability in Middle East countries.

Valuation

Using FCFF valuation of maintaining current revenue growth rate of 11.2 % (5 years average) and a pre-tax operating margin of 72.61%(5 years average) deriving an intrinsic value of S$1.82. Remain hold.






Write up on Maxi-Cash

Maxi-Cash Financial Services Corp Ltd (5UF.SI)

Recommend to: Reduce Exposure
Intrinsic value: S$0.31, Previous Closing Price: S$0.40

Main Activities

Maxi-Cash offers financial services in the form of pawn-broking which acts like collateralised micro-loan to customers on short term time frame with redemption period up to 6 months. It also engages in retail and trading of pre-owned jewellery and watches through retail outlet.

Incorporated in 2008 and wholly owned by Aspial(a listed company in SGX retailing under the brand of Aspial and Lee-Wah), it now has pawnshops and retail outlets at 28 locations, most of them are in strategic locations(near to bus interchanges and MRT station) across the island. Its market share in pawn-broking business is approximately 13% in terms of number of licensed pawnbrokers incorporated in Singapore. The company successfully raised an IPO in June 2012 which raised about S$16m in cash proceeds. This will serve as a capital to expand the business operations by increasing the number of pawnshops and through strategic acquisition, joint ventures or strategic alliances.

Key development

Overcrowded for Pawn-brokering Business

According to Singapore Registry of Pawnbrokers, the number of pawnshop outlets increased to 200 in 2013 from 127 in 2009(Up 57.5%), this is partly due to the opening of the 2 integrated resorts and people seeking more short term financing to deal with the liquidity issues. However judging from the increased in IPO activities for pawn brokering busineses(ValueMax has just been listed in SGX), means that there will be a fierce competition among the 3 dominant players(ValueMax, MoneyMax and Maxi-Cash) to grab the market shares. Given the low interest rate in the market and Pawnbrokers Act that the business cannot charge more than 1.5% a month, we view that there is a limited upside to the interest income that the company can earn going forward.

Lower gold price contributing to lower gross margin

The recent slump in gold price(from average price USD1800 per ounce in 2012 to current price of USD1300 per ounce) also drives down the gross margin for the company. This is due to the fact that the pawn-brokering business have distributed a higher loan amount to the customer when the gold price was higher than the current price. Current potential customers might also not willing to trade giving the low sentiments of the gold price, therefore there is a possibility that revenue might not grow from here if the gold price remain side way for the near term.

New proposed regulation might reduce ROC

Currently the government is looking to make several amendments to the Pawnbrokers Act to tighten regulations and further professionalise the industry. One of the changes being proposed is an increase in the security deposit for each pawnbroking outlet to S$100K from S$20K currently. We foresee this will increase the capital required to setup new outlet and further reduce the return on capital if the amendment pass through.

Highlight from Financial Statement 2012

Revenue increased by 14.6% to a record $100.5m from $87.7m. Increased in revenue mainly contributed by higher interest income from providing collateral loan services(up 84.5% YtoY). Revenue from retail and trading of pre-owned jewellery increased 6.5% to S$78.2m from S$73.4m

Pretax profit for pawnbrokering business increased more than 300% from S$1.5m to S$6.2m due to operating cost not increasing within the segment despite of higher net interest income. However for retail and trading of jewellery business, there is a pre tax loss of S$0.1m due to lower gross margin and higher operation expenses.

High P/E > 30 also seemed to be on the high side of the valuation. Currently the company is not generating a positive cash flow from operation due to cash being used for working capital such as loan issued to customers

ROE and ROA stands at 6.53% and 2.12% respectively, which indicates that there is a rivalry between the competitors and thus not able to earn a higher return of equity. We foresee the ROE will remain flat at this level.

Valuation

Using a single stage residual income model and the current ROE of 6.6%, we drive the intrinsic value of SGD0.31 which is lower than the current price of SGD0.40. Reduce exposure for this counter






Saturday, 19 October 2013

Parodox of wealth and the effect on expected return

William J Bernstein's article on "paradox of wealth" http://www.cfainstitute.org/learning/products/publications/faj/Pages/faj.v69.n5.1.aspx highlights an important investment rule implying that the expected return is inversely related to the wealth level created. Key points to taken from this article:

Rapid technology development is a destroyer of return(decreased return) by

1) Increasing societal wealth but decreasing cost of capital since there is an abundance of capital if the society get richer
2) Encouraging enthusiasm from gullible investors, meaning they are more willing to invest more capital therefore reducing cost of capital
3) Diluting shares as increase in share issuance required to capitalize new forms of technology and rapidly growing economies

So what's the implication for investor in the future? I think it is prudent not to assume a high return on equity in the future. This has also implied that the aggregate P/E of the companies in the future will be higher than the present level due to technological advancement and wealth creation effect. 

This can also shown from the generic valuation formula that as the denominator required to discount the future cash flow into present value decreases, then the valuation will become more expensive in the future.

Friday, 18 October 2013

Recommended Investment Books

Throughout the investment journey, I have read lots of investment books, below highlight some of the books which I found very useful for learning investment concept:

1) Berkshire Hathaway - Letters to Shareholders 1965-2012 - Warren Buffett
http://www.amazon.com/Berkshire-Hathaway-Letters-Shareholders-Buffett/dp/1595910778

It can be downloaded from http://www.berkshirehathaway.com/letters/letters.html as well, but I always think that reading from paper is much more effective from e-book. The book categorize the topics into different financial topics such as Investing, Value, Moats and Return on Capital, Accounting and also topics on industries such as Insurance which you can go to specific pages to look at the topics that you are interested at.

However, this is not for beginner as you do need to have a strong financial or accounting knowledge to fully grasp what he means for eg topic like goodwill amortization. For me I definitely looking forward to re-read this book many times to revise and implement value investing concept from the greatest investor of all time.

2) Investment Valuation - Aswath Damodaran
http://www.amazon.com/Investment-Valuation-Techniques-Determining-Finance/dp/111801152X

Damodaran is considered one of the top valuation guru in the field, there are different topics on how to value a company using Discounted Free Cash Flow, Discounted Dividend and Relative Valuation and other valuation methodology. I was hoping to study in much detail on the methodology that he proposed, but you can also read his blog on how to value a hyped company such as Twitter, Facebook etc(http://aswathdamodaran.blogspot.sg). I believed for someone to master the art of investing, valuation is a must-to-master subject.

3)The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New - Jeremy Siegel
http://www.amazon.com/The-Future-Investors-Tried-Triumph/dp/140008198X

If you are new investor and planning to do some asset allocation on your current wealth, you can start off by just reading this book. This book provides a great detail on how to do asset allocation (on the last chapter) for a long run. The rest of the chapters also highlight the reasons why you shouldn't buy IPO or buy stocks that are over-hyped. To me, I felt that he is the one of the few professors(including Damodaran) that research investing topics that really put theory into practical perspective.

4) The Winning Investment Habits of Warren Buffett & George Soros - Mark Tier
http://www.amazon.com/Winning-Investment-Habits-Warren-Buffett/dp/0312358784

Though George Soros is a Macro-economic investor and Warren Buffett is a Micro-economic investor, they shared the same 23 investing habits. As your habit highly correlated with your your investment result, therefore it is crucial to understand what the common habits that they shared.

I particularly like the investment habits of

Habit 1: Always protect the capital
Habit 4: Has already developed the investment system(selection, buy and sell)
Habit 22: 24x7 working for investment.
Habit 23: Put his words into action, eat what he cook.