Wednesday, September 30, 2009

September 2009 Portfolio Summary and Review

September 2009 can be aptly described as a month in which major economies took even more tentative steps towards recovery from the sharp recession, and the USA is also reporting that the recovery from recession will be slow and very gradual, and that unemployment is likely to exceed 10% before we are through with this “Great Recession”. At the same time, I was highlighted to an article in the Daily Mirror here which highlighted that the recession is far from over as far as the shipping and marine sector was concerned, as many ships are still moored in the waters off Singapore with no cargo to carry and no jobs to service. There is an acute over-supply of vessels in almost all categories (most pronounceably in bulk shipping) and global trade had also dropped off a cliff 6 months ago and is only gradually, albeit slowly, picking up. As economies struggle to shake off the shackles of recession, demand for commodities such as oil and gas will pick up slowly; but it will still take a good 3-4 years before demand for shipping returns to 2007 levels.

Valuations are taking a tentative breather and it is beginning to get difficult to locate genuine bargains in the stock market; this is due in part to gradually improving risk appetites and the entrance of more retail players as they notice the last 6-month recovery in share prices. This has prompted many investors to jump in head first into the pool without testing the temperature of the water, with the unfortunate result of getting burnt for their efforts. Whether the stock market is trading with “blue-sky” scenarios (this term is increasingly beginning to appear in analysts’ reports and irks me to no end), or incorporating extremely pessimistic scenarios; one must always keep in mind that prudence, conservatism and a sense of reality can keep one grounded and enable one to avoid debilitating losses. As some of my previous posts had mentioned, one cannot always only choose to purchase when valuations hit trough levels, as this happens under very rare circumstances (and there is only a short window of opportunity – in this case Oct 2008 through March 2009); one should instead hope to pay a fair price for a well-managed company with solid fundamentals, and let the process of growth in the company’s business and compounding increase the value of your investment over time.

I also managed to spend some time monitoring the mind-boggling property market in Singapore, which has behaved contrary to popular wisdom, which says that property prices should dip in a severe recession rather than rise. As HDB resale prices continued to climb alongside prices of private properties, one eventually has to fork out nearly S$400,000 to S$500,000 for a 5-room HDB flat in a prime location. Assuming a young married couple earning less than S$8,000 buys one of these flats, they would have to take a 30-year loan and be heavily indebted for close to the rest of their lives. Mr. Mah Bow Tan’s has asserted that couples only have to fork out less than 30% of their salary to service their housing loan, which implies it is “affordable”. But affordability has a different definition according to me – it’s how much pain you will have to go through to service a loan assuming you have no other sources of income, and HDB prices are way too high for the average Singaporeans (earning a median salary) to comfortably afford. The recent measures taken by the Government to cool the property market (i.e. scrapping IAS and interest-only loans) may cause some cooling but they probably have to do more in order to deter the speculators.

In terms of the companies I own, there was quite a bit of news which I had summarized in a previous post in order to save space for my portfolio review. Any news between that post and this review is included here. October 2009 will see results releases from Suntec REIT (3Q 2009), FSL Trust (3Q 2009 excluding stub) and Ezra (FY 2009).

There was a new addition to my portfolio during the month of September 2009, and it is a company called MTQ Corporation with two divisions which deal with oilfield engineering and engine systems. Taking into account all of my previous mistakes as detailed on this blog (and in order to avoid repeating them), I chose this company because it has growth prospects in Bahrain (Middle East), Management which is shareholder friendly, a business with barriers to entry, and the Company has consistently positive operating cash flows and a strong balance sheet (it is in a net cash position as at March 31, 2009). Valuations were not excessive at just 5.3x historical PER (at the time of my analysis). Management has also shown itself to be astute, which I will detail in a future post.

I will be providing my reasons and rationale to substantiate the purchase of MTQ Corporation Limited in subsequent posts. I had taken a total of about 2.5 months to fully research on this company and write my report, supported by facts and figures. The reason for the (apparently) long time it took to analyze the company was due to my constant procrastination and also being tied up with work and personal commitments. As a result of the thumb-sucking, I had missed opportunities to acquire at much lower valuations, thus my inaction cost me some measure of margin of safety. I shall endeavour not to repeat this mistake again.

Since trading volume for this company is low, my collection had to be done in stages, and on different days; thus incurring significant brokerage expenses. In total, I had allocated about S$20,000 to this investment for Sep 2009 (as reflected in the increase in my portfolio cost).

As at this point in time, I will also be initiating research on a few other potential companies for value investment. This is in case the market price of MTQ increases to a point where I feel there is lower margin of safety (hence I will stop collecting) and also as alternatives to allocate excess funds which have been accumulated over the months and from the divestment of Swiber and Pacific Andes.

For September 2009, corporate updates and result announcements for my companies are as follow:-

1) Ezra Holdings Limited – No more updates since my last post.

2) Boustead Holdings Limited – No further updates since my last post.

3) Suntec REIT – Suntec’s next distribution will be announced in Oct 2009, and in the meantime in Sep 2009 they issued S$25 million of fixed-rate notes to finance the purchase of the Suntec City Convention Centre.

4) China Fishery Group Limited – Golden Target and Pacific Andes have been actively buying shares in China Fishery over the last few weeks, with several tens of lots being transacted every single day. I do not take this as any indication of merit or that a possible takeover is on the cards, though there of course have been rumours that this is so. With the change in financial year to September 28, 2009, it means that China Fishery will report full-year 2009 results (9M 2009) before November 30, 2009.

5) First Ship Lease Trust – There was no news further news from FSL Trust. October 2009 will be the time the Trust releases its 3Q 2009 results and DPU (apart from the stub distribution). I will also receive the distribution of USD 1.27 per unit on October 30, 2009.

6) Tat Hong Holdings Limited – There were no subsequent updates from Tat Hong, and I have to wait for the results of the EGM on October 6, 2009 to know if shareholders approve the AIF Capital investment in RCPS.

7) MTQ Corporation Limited – There was no news from the Company for September 2009.

Portfolio Comments – September 2009

Once again, a direct comparison cannot be made between August 2009’s portfolio and this month’s portfolio as there had been an addition of a new company into my portfolio. For the record anyway, my portfolio is up +28.6% thus far, and with realized gains of S$9.4K, the total portfolio gain is +36.7%.

I recall mentioning that it was stressful to decide how to best allocate funds in a very low interest rate environment, as cash lying idle in bank accounts pays a very scanty return of less than 1% per annum. That prompted me to start my search for a suitable company to invest in during June-July 2009, which led to my eventual purchase of MTQ Corporation. This is an investment which I believe should give a constant decent dividend yield and which will bear fruit in 2-3 years time. I would be expecting their 1H FY 2010 results (the company has a March 31 year-end) in early November 2009, and due to the weakening in the oil and gas sector and a drop in enquiries, MTQ’s business is expected to suffer in the short-term, though I would still expect cash flows to be positive and an interim dividend to be declared.

My next portfolio review will be on Saturday, October 31, 2009.

Sunday, September 27, 2009

Behavioural Finance Part 5 - Gambler’s Fallacy

After a long hiatus, it’s time to get back to discussing the interesting and volatile aspects of human behaviour, and how this influences our decision-making processes concerning our investments and money. Behavioural Finance is a growing field and incorporates principles of human psychology to see how it influences the way we perceive and handle money. Interestingly, I had always noticed that one of the more intriguing aspects of human behaviour concerns gambling, as noted by occasional news reports of casino or lottery winners; and also of gamblers having to pawn and sell all their belongings just to avoid bankruptcy. This is in addition to the almost total collapse of the “victim’s” family and social support, as his gambling addiction totally destroys all aspects of his life.

From an investing perspective, I would like to introduce what is called the “Gambler’s Fallacy”. Essentially, by definition this refers to a person’s view that since a random event has occurred with a certain regularity or in a certain perceived pattern, this would immediately indicate that this pattern or trend is unlikely to continue in the future. This is incorrect because random events are considered independent events in probability theory and have no correlation or causative effects on another random event. Yet, people tend to associate both events together and make deductions or conclusions based on the frequency or probability of occurrence of the second event. This works both ways in investing to the investor’s disadvantage – when the price of a stock (note: NOT its value) is going up in consecutive sessions, an investor has the urge and tendency to sell because he believes the trend will not continue. Conversely, if the stock price has gone down a few consecutive trading days, an investor may also tend to hold on longer than he should as he believes the trend will “break”. This is akin to flipping a coin 20 times and getting “heads” every single time, thus you expect that on the 21st flip, it would have to come out “tails” because it was heads for 20 times already! Of course, one can clearly see the flaw in logic in this example as each coin toss result is independent of all other coin tosses.

When a person observes the price of a counter and does not focus on the value of a company, he will be subject to Gambler’s Fallacy all the time. By studiously going through a company’s newsflow, fundamentals and financials, one can make a more informed decision of the actions he should take with regards to an investment which are not prejudicial to his own interests. Instead of relying on price actions to guide his decisions, one can make more astute decisions by treating stocks as part ownership of businesses and making a business decision instead. One will then cease to be classified as a “gambler” (i.e. speculator) and become an investor.

Interestingly, I had noted the gamblers’ mentality when I recently assisted a friend to purchase some 4-D and Toto tickets (the Singapore version of lottery tickets). Most of them consist of blue collar workers and retirees who stake anything from a few dollars to a few hundred dollars buying numbers in a certain sequence and hope for a windfall gain. Others (usually strapping young men) also engage in legal soccer betting through Singapore Pools by studying the odds on a big LCD monitor and then placing their bets at the counter. Most of these folk, I am sure, are totally clueless about the exact probability of winning the top prize (or any prize, for that matter!). It has been said that a reward quantum should be based on magnitude of reward, as well as probability of achieving that reward. To give an example, if the probability that I will win $100 in 50%, that means the reward quantum is $50 (50% of $100). In a lottery, the probability can go down to as low as one in ten million (yes, it’s 10,000,000 with eight zeroes!), and the top prize is probably about $1,000,000. So this means the reward quantum is about $0.10 (1 million divided by 10 million) – not a very attractive proposition and certainly nothing to salivate at! But the problem here is people’s expectation of that great big reward which keeps them punting and returning to try their luck, irregardless of how many times they fail to hit the jackpot.

I once asked this friend of mine why he spent so much (tens of dollars at a time, twice a week) on punting. He said he was “investing” in lottery and he wanted to make a windfall gain. My natural reaction that was to ask if he had kept track of every single transaction in an Excel spreadsheet and tracked his “ROI”. He looked blank for a while but then confidently asserted that he must have “made money” over the long-haul, because he remembers hitting the top 3 prizes (for 4-D) a few times, so he should have recouped all his capital and more. The problem with this line of thinking is that your “winners” will pervade your thoughts more than the countless number of times you had “lost” money (i.e. not won the lottery). This is also why traders and investors tend to remember their winners rather than their losers, and so kid themselves into thinking they made a pile of money while not accounting for their realized (and unrealised) losses! The right way to go about this is to document every single trade (yes, including fees) over time and to compile it over an extended period (3-5 years minimum) to see if one consistently can generate a decent return on investment. I am currently doing so myself to remain objective and to remind myself that I have “losers” as well as “winners”.

The same thing happens at casinos, which I feel compelled to comment on now that the IR in Singapore is almost close to completion. Casinos play on many behavioural aspects of human beings and thus act as a “trap”; in fact there is little entertainment value (go play a computer game) and is hardly suitable for money-making (try investing in an ETF instead), yet there are hardcore casino players (called “high-rollers”) who spend millions and burn their money away till some are bankrupt. Take the most notorious case of a certain Chia Teck Leng, a former APB Finance Manager who swindled about S$117 million (over 4 years) from several banks – the money was not for altruistic reasons like helping African children to buy more food, in fact it was to feed his insatiable addiction to casino gambling!

So to end off, one should always be wary of gambler’s fallacy, as well as the dangers of problem gambling. A little punting here and there on soccer betting is probably harmless, but if one gets obsessed with winning and starts to stake higher and higher amounts then it will spiral into a huge problem, and will end up a disaster in the making.

Monday, September 21, 2009

Corporate Updates

This post is mainly to update on the corporate developments for the companies I own thus far for September 2009, as I would not like my month-end portfolio review to get too cluttered with words. I shall ease off some of the news flow in my month-end report and just briefly go through some salient points there, while highlighting other issues of interest in both the broad economy as well as Singapore-related news. In addition to posting the news and updates, I will also provide a small commentary on my views on the news and how I feel about the prospects of each Company.

Ezra Holdings Limited – On September 11, 2009, Ezra announced that they had clinched new and renewal charters for three of their AHTS vessels in the range of US$152 million. These contracts are for 5.5 to 6 years and they will make positive contributions through FY 2010 (beginning September 1, 2009 as Ezra has an August 31, 2009 year-end). Then, on September 16, 2009, Ezra announced that they had contracted for 5 ROV (Remote-Operated Vehicles) with Triton Group for US$23 million to boost their subsea division. These ROV will be deployed along with three incoming subsea-capable vessels to provide a more complete range of services for their clients. Triton will provide Ezra with ship interface engineering and installation services from its support in Singapore from September 2009 till delivery in 2Q 2010.

Comment: It is heartening to know that Ezra can still manage to clinch contracts of long duration even as the financial crisis eases and the recession shows signs of ending. The long-term nature of their contracts gives revenue visibility and allows steady cash inflows over the specified period of time, so this is good news. EOC does have vessels which have charters ending soon, so hopefully there is good news on renewing the use of those vessels (heavy lift accommodation work barge) soon. The ROV contract was a surprise as it allows Ezra to further enhance and “beef up” its planned subsea division and goes along with their July 16, 2009 news release on their “Next Lap Growth Strategy”. The complete range of service offerings which Ezra is targeting to provide means that they are better able to secure higher-value contracts with better margins as they are able to package their services into a one-stop solution for clients. Management had actually been planning this for 2 years and the execution has proceeded smoothly thus far. Of course, I would expect some hiccups along the way but Lionel Lee seems to have planned for this way in advance and has already allocated resources for these corporate moves. That said, I believe there is unlikely to be a final dividend declared when Ezra announces its results in mid-October 2009 due to the capex required for their shipyard, new vessels and now the ROV. I am also awaiting news on a possible financing structure for the Chim Sao (Vietnam) FPSO Project, in which EOC was named as a front-runner for some time back; as well as news on their gas FPSO Lewek Arunothai which has started producing gas after protracted delays.

Boustead Singapore Limited – Mr. FF Wong of Boustead had been interviewed by Reuters on September 7, 2009 and Business Times then proceeded to write an article on the interview. Unfortunately, the article was factually wrong at some parts and omitted key details which would have given the report more clarity. Boustead then proceeded, on September 9, 2009, to clarify certain aspects of the interview. The key points to note are that FF Wong mentioned a rise in revenues of about 10%, but still maintains that net profit will NOT exceed that achieved for FY 2009. Also, enquiries made of Boustead’s oil and gas division amount to S$500 million, but how much of this translates into Boustead’s order book is unknown. A potential US$5 million acquisition by Salcon was still in negotiation and due diligence stage, and not “about to be finalized” as stated in the report. On September 14, 2009, Boustead announced that they were one of only 5 Singapore companies to be included under Forbes’ “Best Under A Billion” companies (of which Ezra was also 1 of the 5). An awards ceremony will be held by Singapore Business Federation in November 2009 to honour these 5 companies. The Company also made a minor announcement of the incorporation of a 100% subsidiary in the UK called Boustead International Steam Generators Limited with an issued capital of £5,000.

Comment: From the Reuters interview, a few issues were discussed and became clearer. The Group still expects to enjoy revenue growth for FY 2010 despite the severe financial crisis, which means all divisions are still doing relatively well and holding up. Of course, profits will dip as a result of the lack of any property disposals (which had been occurring at least once for the last five financial years); but core net profit from their divisions should be either stable or will dip just slightly, unless COGS rises much faster than revenues (this is possible as there was evidence of this from FY 2009’s and 1Q 2010 financial statements). But proper cost control should mitigate the risk of this dragging down the Group’s profits by too much, and if their operational cash inflows are healthy the Group should still be able to declare a decent interim dividend in November 2009. Enquiries made of their oil and gas division amount to about S$500 million, a surprising number given the slump in oil and gas activities since oil peaked in July 2008, and I would expect some contracts to materialize in the short-term as Boustead has a solid reputation for providing services to the oil and gas industry. The most interesting news by far is Salcon’s potential acquisition of a US$5 million company dealing with waste gas treatment. Even though the company clarified that this deal was still preliminary, at least it shows that Management is actively looking out for good M&A targets which are potentially earnings accretive and can exhibit synergies with their existing businesses. Salcon also needs a boost in the arm after suffering from losses for the past few financial years; and for FY 2010 it has a chance to turn around with the award of several large projects. Knowing FF Wong’s conservative stance and that he will not waver on his criteria for acquisition, I can rest assure that Management will thoroughly review this US-based company before making any moves.

First Ship Lease Trust – OK, there’s quite a handful of news for FSLT, so I will try to summarize them here. On September 2, 2009 FSLT announced waivers on their LTV (Loan to Value) Covenants, which means the banks (their lenders) are less likely to require forced sale of vessels to meet their debt obligations. The downside is that FSLT has to pay a slightly higher interest rate on their debt and they intend to prepay more of their debt; though they claim it will not affect DPU. The next day, FSLT announced in detail the set of requirements which the banks had imposed on them in order not to breach any of the covenants. Then, the following day, FSLT dropped a bombshell by announcing a placement of up to 100 million new shares, at an issue price of 10% discount to S$0.59. Eventually, only 80 million units were placed at an issue price of S$0.525, raising gross proceeds of S$42 million. Net proceeds amount to S$40.9 million after deducting expenses and fees. The funds raised are not for prepayment of debt, but was stated as being for potential acquisition of vessels or companies holding vessels. This move increases the number of issued shares to 598,665,077, which dilutes ALL shareholders. Because of this new issue, Management declared a “stub” dividend of 1.27 US cents to be paid on October 30, 2009 to separate the existing shareholders from the entitlements of the new shareholders. The new units will start trading on September 18, 2009.

Comment: While it is definitely good news to know of the LTV covenant waivers, it was not such good news to know that interest expenses had increased. But since FSLT Management had buffered for this by reducing payout to USD 1.5 cents per quarter, this move had no further impact on projected 3Q 2009 DPU. Even with the issue of the new units, Management is confident of sticking to its USD 1.5 cents DPU for 3Q 2009. The good thing about FSLT is their diversified fleet type and customer base and that they have no capital commitments for new vessels, unlike the case of Rickmers Maritime which has to raise funds in double quick time as they had committed to buying vessels. Even though the new units issued would be dilutive to DPU, the funds raised right now could still be used to purchased distressed vessels which are DPU-accretive as there is currently still a major over-supply of vessels which will not clear for the next 2-3 years (according to reports I’ve read). Thus, the proceeds from this fund raising could potentially be used for accretive purchases in order to enhance long-term DPU and ensure stability of DPU going forward. I am optimistic that the Management team know what they are doing (having spoken to several key executives before) and that they will be able to pull a rabbit from their hat. I had mentioned before that my investment in FSLT turned out to be a mistake as I had not anticipated the sharp downturn in the shipping sector; but then no one (even the industry veterans) could have foreseen the magnitude of the crisis and the collapse in vessel values. For this, maybe I can forgive myself slightly in not adhering to my often preached mantra of “capital preservation”. I am, after all, still a novice and learning more every day about investing and analysing.

Tat Hong Holdings Limited – Tat Hong received in-principle approval for the issuance of the RCPS and on September 14, 2009 despatched a circular to shareholders with details on this RCPS and also to convene an EGM (on October 6, 2009 at Fullerton, 11:30 a.m.) to approve this move and to amend the Company’s M&A of Association. I am still in the process of perusing through this circular as most of the details within are rather technical and require a lot of reading and re-reading to fully comprehend. On September 17, 2009, the Company also announced the disposal of mining equipment belonging to PT Tat Hong Energy Indonesia. While the good news is that cash of US$19.1 million will be coming back to the Group, it also means recognizing a loss on disposal of about US$1.1 million, which will hit the Income Statement for FY 2010.

Comment: The RCPS is old news by now, and after looking through the terms and conditions for conversion, I should think that the Management must be sufficiently confident of Tat Hong’s long-term prospects and their expansion in China to be able to agree to this deal. AIF Capital is also viewed as a strategic partner with contacts and network in China, and a non-executive non-independent director Mr. Andy Tse will be appointed onto the Board of Directors of Tat Hong. He is a managing director of AIF Capital with 14 years of experience in handling private equity deals in South-East Asia, so his experience and contacts should benefit Tat Hong over the long-term. The announcement of disposal of equipment is because Management did not want to expend further cash and resources to overhaul the machinery in order to enjoy a higher rental rate; thus the decision to divest and free up the cash for other uses. I see this as a good move as Management do not drag their feet when it comes to making painful decisions to recognize a loss, as the retention of old equipment will not benefit the Group in the long-term and their cash will be “trapped” inside these assets.

Overall, corporate developments have been numerous; and this is just to provide an update and some views on the latest. Results will be released in Nov 2009 (except for Ezra's results in Oct 2009) so it will be interesting to note if business conditions have turned up since the recession has technically ended.

Wednesday, September 16, 2009

The Importance of Monitoring

I guess I cannot emphasize this more - but monitoring is one of the aspects of investing which an astute and dedicated investor CANNOT miss out on (the caps are intentional to highlight the significance of this activity). By "monitoring", I mean not just monitoring business news about the health of the economy and the latest industry trends and news, but also to monitor, on an almost microscopic level, the corporate announcements and strategic moves made by the companies you own (as well as do not own). I will elaborate below......

The lack of monitoring is actually the leading cause of failure to obtain a decent and sustainable return in the stock market. After all, doing the research is only the first part in an investment decision - we must still stick around to ensure things are going smoothly, and beat a hasty retreat when things are not going as planned or if we discover we had made a flawed judgement call. I've actually met many friends who express surprise when their investment falls in value sharply, as in the case of Jurong Technologies where a few of my friends expressed surprise and amazement that it was suspended. A simple cursory glance at the financials would have told something, and the frequent announcements made on SGXNet would have alerted one to its potential troubles and its eventual suspension due to inability to service their debts. I am really surprised when friends approach me for simple, basic information about the companies they own as this information is readily available on SGXNet or the Company's website. This seems to imply that most people are just lazy - they do not bother about where their money goes and do not seem to care what happens to the company in which they are part-owners of. This heck-care attitude can only lead to financial disaster because if you do not put in effort and time into growing your wealth, then it's like a plant which has not been watered and given sunlight!

After scanning through the book "Your Money and Your Brain" by Jason Zweig for a third time, I came across a section which mentions what we should monitor, and how it will help us in our investing journey and also to hone and sharpen our investing acumen. Apparently, monitoring just the companies you own is insufficient as it only allows you to learn about what you are vested in. In fact, the book mentions that in addition to that, we also have to monitor companies which we had sold as well as companies we thought of buying but eventually did not. For companies which one has sold, we should continue to monitor it to see if we had made the right decision then to divest; or if the decision was based on incomplete information or flawed logic. For example, though I had divested Swiber some time back, I still keep up with corporate news surrounding Swiber. In a way, I would think that we can learn and see if our original views for divesting (or investing) were right and this can help us to test our principles and philosophy and assist us in refining it further. Selling an investment which subsequently does very well would also allow one to classify it as a mistake in selling too soon (mistake of commission) which one will do well to learn from.

As for monitoring of companies which we planned to buy but did not, the aim is to assess if this turns out to be a mistake of omission! A good example I can quote is Rotary Engineering, which appeared on my radar around Feb or Mar 2009. I did some reading up and due diligence on the company but decided against investing it in due to comments made by the Chairman Mr. Chia Kim Piow about the long-term prospects of the industry (i.e. oil storage tanks). I was also not too comfortable about their net margins and was unsure of their competitive strengths in terms of being able to clinch mega-deals. It turned out that I was very wrong as Rotary had announced a SGD billion dollar deal a few months back and the share price has rocketed from a mere 20 cents (yes, with cum dividend of 2 cents to boot) to the current S$1.20, a 6-bagger. Such "sins of omission" should be monitored closely for it helps us to crystallize our thoughts on why we avoided it in the first place and why we should have chosen it. Of course, the key here is to stay focused and rational and not to "jump on the bandwagon" just to prove yourself right and in the process, throwing caution to the wind and ignoring proper margin of safety.

So the task of monitoring rests squarely on the shoulders of investors, and those who are corpulent and tardy in getting information risk losing most or all of their capital. The act of monitoring cannot be emphasized more and I spend most days checking for any corporate updates and reading up more on the companies I own (as well as those I wish to own!). Investing is a continuous learning process and we can never claim to be good enough at it. We should, as investors, constantly cast a critical eye on our own portfolios and try to re-balance them now and then to maximize returns. On the flip side, I should also caution against buying and selling frequently just for the sake of re-balancing. What I mean is that if an investment fails to meet our original stringent criteria, it should be divested and the proceeds allocated to a more promising company.

Thursday, September 10, 2009

Valuations are Normalizing

OK, I admit the title looks deceptively simple but I am not going to go into a discourse on valuations because it is a dry and boring topic and one is probably better off reading “Security Analysis” by Benjamin Graham and David Dodd. This post serves as a sort of warning and wake-up call that valuations, in time, will always revert to the mean and that “cheap” valuations will not stay for the long-term. Just as irrational exuberance was expounded as a leading cause of high and unsustainable valuations, irrational pessimism is the exact opposite and leads to the converse.

Of course, one may argue that just 9 months ago, economists and many educated individuals were pronouncing that global growth would be negative and that the stock market may stay at depressed valuations for 10 years at least. The doomsayers and prophets foretold of a dark period where wages struggled to remain at current levels and economic growth was all but non-existent. On hindsight, everyone (including myself) believed them because the situation back then seemed so bleak, so hopeless, that one could not have imagined otherwise. There is a certain limit to human imagination and certain events are of such a huge magnitude that it literally blows one’s mind away, leaving it to struggle to absorb new realities among the vestiges of the broken financial system. Such an event occurred one year ago in September 2008 with the collapse of Lehman Brothers; which propelled the world on the brink of financial disaster akin to the effects of an atomic bomb spreading out like a mushroom cloud across the world. That single event was cataclysmic in its effects and a huge destructive ripple spread across all financial institutions, threatening to shut down the global finance system and wreck chaos. In disaster movie jargon, we would have called it “Financial Armageddon”, or so it seemed.

If we fast-forward to the present moment, governments all over the world have pledged to boost their respective economies with massive fiscal spending, of which the USA is a frontrunner under President Obama. This concerted effort has created “green shoots” since May 2009 when previously all one could see was dead soil and brown weeds. Therefore, valuations were rightly beaten down when prospects of corporate revenues and profit growth were muted; and many companies traded then at trough valuations as yet unseen, which create another wave of shock across the globe as stock markets plunged to levels not seen for the last 10-15 years, effectively wiping out the economic growth for the last 10 years. The discerning investor should then sift through the rubble and debris to look for shining gems in the stock market, which at the time resembled a blasted wasteland full of writhing corpses. Those who had the fortitude and foresight to pick stocks at trough valuations, and who believed in the long-term prospects of economic growth and the eventual easing of the recession, were in turn handsomely rewarded when news of these green shoots was announced. To buy on uncertainty is no doubt difficult, for it resembles the intrepid adventurer heading down a dark, unknown tunnel (fear of the unknown); yet this is when the investor gets valuations which are so attractive that they remain a talking point for years to come, as well as dividend yields so high that they exceed inflation over an extended period of time. This is in essence the embodiment of the slogan “you pay a high price for a cheery consensus”, uttered by Mr. Warren Buffett.

Once news broke on the possible early recovery of the financial system and that global growth would be restored by 2010, coupled with record low interest rates to boost liquidity; people then began to view companies in a whole different light. Companies are the backbone of a society and their products and services are the ones which support and move the economy along, like oil on cogs turning the huge machines of industries. So the process began to look for quality companies which could continue to survive and grow amidst the carnage, and valuations have thus risen in tandem to this expectation. Even analysts are now keenly using the average PER valuation for the last 5-years as a gauge of the “cheapness” of a company, when previously all the reports only featured trough valuations and price-to-book ratios (it was assumed earnings were non-existent).

As a result of these factors, we have seen stocks becoming less than cheap, and definitely less attractive as the huge margin of safety present during the period of October 2008 through to March 2009 has all but disappeared into the ether. Even with our Finance Minister Mr. Shanmugaratnam warning of a possible double-dip recession, it is unlikely that valuations will scrape trough levels as expectations of growth are already being priced in, and people are now willing to pay more to own the same companies. The process of methodically selecting good companies must now be applied once again.

In other words, the days of “easy money” are probably gone, swept away very suddenly in the first 2 weeks of May 2009 as valuations increased sharply. Only on hindsight could we have seen that the “smart money” was actually quietly but actively buying up shares of solid companies; without much fanfare and in a creepily discreet manner. This is what we, as astute investors, should have been doing as well – staking our future on the innovativeness and creativity of the human race to overcome adversity and adapt to changes; instead of blindly believing the false prophets singing their hymns of doom and proclaiming, with almost divine fervour, that they indeed know more than us. In reality, no one knows the future, but we must still strive to invest; for only through proper investing can we achieve the eventual goal of a comfortable retirement and a steady increase in the value of our wealth.

Saturday, September 05, 2009

Can we afford to make mistakes in investing?

Mistakes in life are one aspect of life which no one likes to talk about, and perhaps the one thing you don’t know well about your friends (and even your loved one) as most people are embarrassed to admit their faults. But it’s a fact of life that as human beings, we are fallible and less than perfect. We frequently make mistakes and it is a natural process of evolution that mankind learns from mistakes and avoid repeating them, or else repeats them to his own detriment. There is of course a saying that “History always repeats itself”, but in the world of investing, if history repeats itself too often with respect to mistakes, then one will end up a lot poorer.

The big question I have posed is: can we afford to make mistakes and yet come out better from the experience? How many mistakes are investors “allowed” to make before one is made significantly poorer, or significantly wiser? I think the answer to this depends on the nature and severity of the mistake made, and how much of one’s capital was staked on that particular investment in question. Giving a recent example of mine: my investment in Swiber turned out to be a mistake due to the way the Company was managing its cash flows and also to the fact that its debt levels were too high – but fortunately due to sufficient margin of safety I avoided losses and even managed to book a small gain when I divested my shares. So the idea here is to keep your losses small and manageable by adopting proper techniques to determine margin of safety, and never over-paying for any investment.

Making mistakes in investing is unavoidable, but it is the lessons we learn which are the most valuable. I personally feel that making a small number of minor mistakes is actually good for an investor as it tempers his ego, allows him to learn more about investing (as well as himself) and makes one more determined not to repeat the mistake. Of course, this is based on the assumption that one can be totally honest with oneself and admit that “it was my fault”, and not blame it on everything else like your broker, your friend who gave you the tip, the weather, Ben Bernanke and a host of other unrelated events. It is pretty easy to shift blame but ultimately one has to answer for one’s own actions as it is your money and no one else’s at stake here.

Another seldom mentioned aspect of making mistakes is the length of time required to recognize a mistake. For my Swiber investment, it took 2.5 years for me to fully appreciate the gravity of the situation and make a swift exit, but there is an opportunity cost attached to the time involved and one can argue that the money could have been deployed elsewhere to generate higher returns (on hindsight, of course). The fact that growth companies like Swiber do not give out dividends further compounds the problem of opportunity cost as there is nil return at all during the period of being a shareholder. Even if an investment were to pay say 3% dividend yield but turn out to be a mistake, one can argue that one can easily achieve a 5% or more yield investing in a variety of blue chips which offer more safety and stability. But all this is paper talk until executed; so as an investor we must learn to balance such viewpoints against the practicality of getting such returns over an extended period of time, which brings me to my next point.

An investor cannot afford to make too many mistakes of a much longer duration, as arguably there are not many chances for him to be vested for 10-15 years and observe many business cycles before realizing he has made a mistake. One’s life span is finite and full business cycles can last for 10-20 years; so one should avoid mistakes which only crystallize after a long period of time, during which the hapless investor either earns a paltry return or a very sub-par one (as compared to returns generated from an index fund, for example). So, in such cases, I would advise that investors avoid making such mistakes but instead read more books and learn from Other People’s Mistakes instead ! By distilling their experience and knowledge, one can learn from them without committing the same cardinals sins and at the same time, saving oneself 10-15 years of anguish and mental stress due to an under-performing investment.

So the answer to the topic will be: yes we can afford to make small mistakes, which is good for our ego and temperament as it keeps us grounded and rooted in reality instead of getting carried away by exuberance; but when it comes to major mistakes or those which take a long time to manifest, it is much better to learn from others’ instead of committing them yourself.

Tuesday, September 01, 2009

August 2009 Portfolio Summary and Review

August 2009 was the month in which many countries reported that they were out of the long recession caused by the sub-prime fallout in 2007. Among the countries to emerge from recession were Japan, Hong Kong, Germany and Singapore. This still qualifies, however, as one of the longest recessions since the post World War II era, and is also one of the deepest in terms of the magnitude of GDP decline. Economists are now saying that recovery will be very weak and tentative and is likely to take up to 5 years or more for global trade to resume its 2007 level. It is also one of the rare instances where global growth was negative, dragged down by the developed economies of USA and UK.

Valuations have continued to normalize in the stock market, as can be seen by the gradual increase in market price of blue chips across the Board. Although the sentiment on the ground is still wary and fragile, the stock market had managed to make a remarkable recovery from its March 2009 low of 1,456 points; and the surprising thing that the property market in Singapore had taken a surprising twist and headed up to new record highs, defying expectations and stunning the “experts”. As we see mid-level and mass market condominiums hitting new highs (in psf basis), including those selling beyond the city fringes, one wonders if Singapore may be subject to the same kind of sub-prime type crisis which hit USA (the USA housing market had been booming since 2002 as a result of cheap credit which the Federal Reserve had initiated to recover from the crash). In Singapore, banks are all too ready to lend and interest rates are at record lows; plus schemes such as interest-absorption has made it very attractive for people who are not willing to stump up money and yet be able to secure a unit. Whether prices can continue to scale the stratosphere is another question though – this sounds uncannily like the Greater Fool Theory in play, but in the property market this time instead of the Stock Market.

This month saw many interesting corporate events, as well as my divestment of Swiber Holdings Limited, an investment which I had held for 2.5 years. There were results releases by Swiber, Tat Hong, Boustead and China Fishery and I had provided an analysis of both Swiber and China Fishery in previous posts. I also received dividends from Tat Hong, Boustead, FSL Trust and Suntec REIT.

September 2009 is likely to be a very quiet month as no corporate results are expected for the companies I own, until mid-October 2009 when Ezra releases its FY 2009 results. In the meantime, I shall hunt for suitable investment opportunities using the proceeds from recently divested Pacific Andes as well as Swiber.

For August 2009, corporate updates and result announcements for my companies are as follow:-

1) Ezra Holdings Limited – Ezra announced on August 28, 2009 that it had entered into a “landmark deal” to provide fleet management services to a specialist offshore fund, in return for a 50% profit sharing arrangement (after deducting operating expenses). Ezra has signed a Vessel Operating Agreement (VOA) which will allow it to provide its services without major capital outlay, and should be viewed as a positive move in extracting more value from its assets and expertise without incurring significant capex. Probably, more detail needs to emerge before one can conclude if this latest deal is positive in the long-term.

2) Boustead Holdings Limited – Boustead released their 1Q 2010 financial statements on August 13, 2009. It was a credible showing with revenue rising 49.4% to S$118.9 million and net profit rising 68.3% to S$9.5 million. However, the company cautions not to use quarterly results for comparison as its projects are lumpy and revenue are recognized on a piecemeal basis. Cash balance stood at S$173.1 million as at June 30, 2009, and Boustead is still expecting more cash to flow in from the completion of the sale of property by GBI Realty. In addition, on August 5, 2009, Boustead Projects announced a S$15 million contract to design and build a new HQ for Charles and Keith. Today, on August 31, 2009, Boustead re-started their share buy-back program and re-purchased 307,000 shares at S$0.742, spending a total of S$227,781.63. Just to re-cap, the last re-purchase occurred on 1 April 2009 when Boustead bought back 8 million shares at 40 cents each in a married deal. To date, a total of 9.807 million shares have been bought back at an average price of S$0.4527.

3) Suntec REIT – There was no news from Suntec REIT for August 2009.

4) China Fishery Group Limited – China Fishery announced their 1H 2009 financial results on August 14, 2009 and I did a post some time back reviewing and analysing their performance. In addition, on August 26, 2009, the Company announced that it had changed its year-end from December 31 to September 28 in order for ease of preparation of financials and less “clashing” with other listed companies. The entire Pacific Andes Group has changed its year-end to September 28, and CFG will report its full-year (FY) 2009 results by November 29, 2009.

5) First Ship Lease Trust – There was no news from FSL Trust during August 2009.

6) Tat Hong Holdings Limited – On August 3, 2009, Tat Hong announced that AIF Capital will be injecting S$65 million into Tat Hong, in exchange for the issuance of 65 million RCPS (Redeemable Convertible Preference Shares). Immediately the day after, Tat Hong announced the formation of an EJVC with Mr. Yuan Zheng to take a 53.8% stake in a Tower Crane company. These 2 events have been mentioned during my Tat Hong AGM review (in my post dated August 6, 2009). Subsequently, on August 14, 2009, Tat Hong released their 1Q 2010 results which showed sharply lower revenues (down by 37%) and drastically reduced net profit (down 64% to S$10.6 million). Though the results looked bleak at first glance, I was mollified by the fact that rental revenues remained relatively resilient, and that their China operations showed good potential for growth in the years ahead.

Portfolio Comments – August 2009

No direct comparison can be made between July 2009’s portfolio and August 2009 as there had been a divestment in shares of Swiber Holdings Limited, but in general price levels for all my companies had risen, with the exception of FSL Trust and Tat Hong. For the record, my portfolio has registered an unrealized gain of +26.1% (S$25,000) and a realized gain of S$9,000. The total dollar value gain (realized + unrealized) is S$35,000 or +35.5% of my reduced cost of S$95,700.

I must admit it can get rather stressful when one has too much funds staying idle, waiting to be deployed and allocated to suitable investment opportunities. Of course, this is a much happier “problem” than having insufficient cash when the right opportunities strike. My job now is to actively do my homework and seek out suitable companies for long-term investment, based on value principles. I must also avoid making the myriad mistakes which I had documented under “Investing Mistakes” since 2005, in order for me to grow and mature as a more seasoned value investor. To be honest, right now I still feel like a greenhorn and very wet around the ears….

My next portfolio review will be on Wednesday, September 30, 2009.