January 2011 Portfolio Summary and Review

In case readers have been wondering about the lack of posts for the last 10 days or so, the reasons are purely personal. Upon reflection, I realize my life has been getting busier and more hectic on almost all aspects – tougher work requirements (job), more demanding family commitments (with a 1.5 year-old child) as well as the need to spend more quality time with my loved ones (who, by the way, are not getting any younger). My previous post was on “pace of research”, and it is apt that it comes at a time when I feel I should slow down on active investing and adopt a more passive, but still watchful, role. I guess such a frenetic pace of blogging (one article every 4 to 5 days) cannot be kept up indefinitely, and one does run a little dry of topics and ideas as most have already been mentioned and discussed in the last three years. So to cut a long story short, my frequency of posts will be drastically reduced in light of a more healthy balance of work, time with family and exercise. My portfolio is already generating healthy passive income and though I would, of course, like it to be much more, some things cannot be rushed and it is a good time for me to re-evaluate my priorities in life. The mindless pursuit of money is unhealthy and I need to devote time to being a good son, father and husband too.

And so, I will be cutting down on a lot of content which I feel is quite unnecessary for my month-end portfolio review, and just focus on the companies I own and their businesses.

Below is a snapshot of my portfolio and associated comments for January 2011:-

1) Boustead Holdings Limited – It was a pretty busy and fruitful month for Boustead, as there were three corporate announcements for the month of January 2011. On January 5, 2011, Boustead announced that their energy-related engineering division had been awarded S$16 million in contracts from the oil and gas industries. Then on January 24, 2011, they announced a S$25 million demineralization plant contract secured by both Salcon and Boustead Project, the first time the two companies are working together on the same project. Finally, on January 27, 2011, Boustead Projects was awarded a S$7 million design and build contract for XP Power Manufacturing Facility in Vietnam. From these contracts, it can be seen that the contract size has grown smaller, though the frequency seems to have increased. I shall be anticipating Boustead’s 3Q 2011 results release in mid-February 2011.

2) Suntec REIT – I won’t dwell too much on Suntec REIT as my shareholding is very small as compared to the size of my portfolio. Results were released on January 21, 2011 and a dividend of 0.593 cents/share was declared, and this will be paid out on February 28, 2011. This has been highlighted in my portfolio summary as the XD date has already passed.

3) Tat Hong Holdings Limited – The most major news impacting Tat Hong was the Queensland floods which affected one of Tutt Bryant’s branches. Fortunately, most of the equipment was already shifted to high ground and so damage was minimal. The Company expects some short-term write-offs although they are covered by insurance. Long-term wise, however, the Company did mention that a lot of rebuilding needs to be done in Australia in aftermath of the worst floods in quite a while, and this will bode well for Tat Hong’s business as Tutt Bryant contributes >50% of revenues. I am hoping for a more definite update on the situation when Tat Hong releases its 3Q 2011 results in mid-February 2011.

4) MTQ Corporation Limited – There was no news again from the Company except that the scrip shares have been credited to my CDP account, and will boost the value of my portfolio. Of course, this also means I have odd lots, but since my intention is not to sell the shares but to enjoy the long-term business growth of the company, this does not pose a major problem. If there are more scrip dividends declared in future, I will make use of them as an opportunity to add more shares.

5) GRP Limited – As expected, there was no news from GRP for January 2011. I am expecting 1H FY 2011 results to be released in early February 2011.

6) Kingsmen Creatives Holdings Limited – There was no news of significance for Kingsmen Creatives for January 2011. Full-year results for FY 2010 should be released in late February 2011, and I am expecting a decent final dividend to be declared.

7) SIA Engineering Company Limited – SIAEC released 3Q 2011 results on January 25, 2011. For 3Q 2011, revenue was up 11.6% while net profit was up 7.7%, which was a decent performance considering some of their more recent associated companies and start-ups are still in the gestation phase (and thus will incur start-up losses). For 9M 2011, revenue was up 13.8% while profit was up a more commendable 21.8%. FCF continued to be very strong for 3Q 2011 and the Balance Sheet was also free of debt. In short, I have no complaints.

Portfolio Review – January 2011
Realized gains stayed stagnant at S$49.1K as the Suntec dividend was a little too small to make a meaningful impact on realized gains.

For the month of January 2011, the portfolio has fallen -1.0% against a -0.4% fall in the STI. Cost of investment continues to remain at S$202.4K, and unrealized gains stand at +18.9% (portfolio market value of S$240.7K).

February 2011 is the month to look out for, as four of my companies will be releasing results. They are Boustead, Tat Hong, GRP and Kingsmen Creatives. I expect dividends from GRP and Kingsmen, while the other two companies will provide updates on their businesses and a commentary on business prospects as well.

My next portfolio review will be on February 28, 2011 (Monday).

Pace of Research

As I sit here facing the new year with a mixture of delight and trepidation, I begin to muse over the financial resolutions I had made at the close of the previous year, 2010. One of them was to engage in research and reading in order to unearth more companies to invest in, and I had mentioned that I would devote more time to this pursuit. However, a friend of mine told me the other day about the importance of family time and values; and to be honest, my wife has been complaining incessantly about my time spent at the computer doing research and reading of annual reports. This made me think about what was truly important in my life – making money and financial freedom, or previous time with my loved ones including my daughter. I guess it’s no point being financially free if your family is fragmenting before your very eyes!

Which brings me to the point of this post – that research into potential companies to invest in need not be undertaken in a hasty, rushed manner. My previous detailed research into SIA Engineering company was done in a mere two weeks, and involved a lot of late nights poring over annual reports, compiling numbers and reading and crunching facts and figures. One of the main reasons for the rush job was because I was hasty to deploy some capital, which resulted in some fatigue and perhaps some biasness towards accepting the data and information gathered (commonly known as selective retention in marketing literature). Part of me was also afraid that valuations would continue to climb higher, thereby making a purchase difficult due to the decreased margin of safety. As it was, valuations were already not exactly cheap for SIAEC as it was a blue chip, but further dragging of feet could have resulted in valuations which were even more demanding. Hence, there was a concerted effort undertaken by myself to hurry up on my research to produce a credible report on which I could base my investment decision on.

I now realize that this logic is rather flawed, because if valuations are demanding then the purchase decision should be postponed, and the company can be placed under a “tracking” or “watch” list, to be purchased only when there is a market crash or if valuations become depressed for some reason. The idea of being an investor is being able to wait for the big fat pitch, and then swing when it comes along. To this end, patience should be an enduring virtue possessed by the successful investor; and I realize I may have lacked this when I did my SIAEC research. The pace of research should be slow and relaxed, as one needs time to absorb, digest and analyze disparate pieces of information gathered from various sources, in order to collate them into a coherent investment thesis. The investor’s job is to make sure the business he is researching is understandable and simple enough to digest, and he should ensure he gives himself enough time to read and understand the business model. By giving yourself enough time and space to understand and appreciate the inner workings of the business, as well as possibly arranging for a meeting with the Management and Directors to further delve into the corporate aspects, one can have a more holistic view of whether or not to invest your money in that company for the medium-term.

Now when I think deeper on this issue, I realize that many companies can sit on the backburner for at least a couple of years while one monitors and tracks the business growth of the Company. This is especially so for the newcomers (i.e. IPOs) which may not have much of a track record. The idea of investing is to ensure you are sufficiently comfortable with the track record of a company and the consistency of revenues and earnings in order to be able to place some money on it. With more time on your hands, you can safely assess companies to see if they conform to your investing criteria in terms of growth, ROE and other metrics; and whether Management has delivered on their promises over the years. Therefore, it is absolutely all right to slow down your pace of research and identify good companies, yet not invest in them immediately. Right now, I am in the process of compiling a list of very good companies which have decent prospects, are able to weather a significant downturn, have strong Balance Sheets and good cash flow generation. Obviously, some of these companies will not be trading at attractive valuations as the economic recovery had already taken place, pushing valuations up higher as compared to during the Great Recession. The idea, then, is to build up a decent laundry list of companies with which you will swoop down on and scoop up significant amounts of shares when their share prices are forced down in a market crash or economic downturn. Of course, the usual requirements of controlling your fear and greed are always applicable, as it takes a strong stomach to purchase shares during a market crash. However, it does get easier over time as you adjust yourself to a value mindset and adopt the mentality of a business owner. If one thinks this one, one will be immune to the daily fluctuations caused by Mr. Market and able to act quickly and decisively to purchase shares.

One final point to note is that one should also continue to research and read up on companies already existing in one’s portfolio, as these will also be prime candidates for further investment should their share prices drop like a rock during the next downturn. Since you purchased them in the first place, it is assumed that they had already passed the initial intensive screening and will remain as good investment candidates unless something drastic occurs to upset their status as being worthy investments. It is of paramount importance that one assess the investment worthiness of the companies you already own from an objective perspective (though in essence this is nearly impossible as you are already vested), in order to assure yourself that they remain investment worthy.

Personal Finance Part 21 – Checklist for the Financially Sound

This post started out as sort of a reminder to myself on the attributes a financially sound person (and family) should have, and went on to become a detailed checklist of what I think a married couple and investor should take note of in order to be classified as “financially sound”. Please note, however, that I am not licensed or registered to give financial advice – this is merely a list of what I feel a person should either practise or possess in order to hasten his journey to financial freedom and to avoid being shackled by debt and high expenses. If there are any points which any reader would like to comment on, add on or disagree upon, please feel free to do so (but keep it constructive, please!).

1) Knowing how to budget – I think that first and foremost, it is very important for any individual to understand the basics of budgeting. When you step into the working world, it is basically a balancing act of making sure you have enough cash to last the entire month (assuming you are a salaried employee), and how not to over-spend at any one point within the month so that you have negative cash flows. While this may sound simple, remember that all of us have multiple commitments as we age and therefore the list of expenses grows steadily longer. Not only do we have household expenses, we may also have phone bills, utility bills, conservancy charges and credit card bills; and GIRO deductions on top of those for donations and insurance. Hence, it makes sense to build up a simple budget using pen/paper or an Excel spreadsheet and to key in all future-dated expenses so as to ensure there is enough cash inflow (and at the right timing) to cover all these. I have my own personal spreadsheet which is updated daily to ensure the cash flows smoothly.

2) Understanding the importance of “paying yourself first” – This has probably been discussed to death on many personal finance websites and blogs, but it still bears repeating. One should always allocate a proportion of your salary or allowance to a separate bank account and NOT touch the money within that account. This should be done immediately once you receive your pay check, and before you even entertain thoughts of spending it. The standard is 10% of your take-home pay (after CPF), but my personal goal is about 50% to 55% (currently, I am at about 45%). Having the discipline to do so is not as common as you might think, and I do not have that many friends actually practising this as I may like to believe.

3) Appreciate the value of investing – The best way to grow one’s money is not just through fervent savings (though it will grow, albeit slowly), but to also invest the money to make the money work harder for you. Everyone has heard of the axiom – Do not work hard for your money, make your money work hard for you! This is precisely why I advocate investing as a means to not just supplement your income (through dividends), but to also allow you a chance at long-term wealth accumulation through ownership of excellent businesses. Of course, one has to be properly equipped with the essential background and knowledge on how to invest properly and prudently without taking undue high risks, otherwise instead of growing your money you will very well see it shrink faster than you can say “Hey!”. For those who feel that they are ill-equipped to handle the emotional roller-coaster which the stock markets provide, they can always choose to invest in an index fund (i.e. ETF).

4) Be aware of the importance of insurance and protection – Much as we like to believe that nothing untoward or bad will befall us, the truth is that at any given point in time, we are exposed to danger coming from a variety of sources. Even crossing a busy road using a signalized junction can be hazardous if you happen to encounter a drunk driver. My point being that we never know if disaster will befall us, just like the recent news of once in a century floods occurring in the state of Brisbane, Australia. I would bet my last dollar that those people who were affected and inundated did not have a clue that things would get so bad, and quite a few lost almost all their belongings in the deluge except for some personal items and the clothes on their backs. Therefore, I will always emphasize on the importance of being properly insured, not just on your life but also for stuff like hospitalization, critical illness and total permanent disability. Recently, I added another category to that which is disability income insurance, meaning the policy pays out a sum of money to you for the rest of your life if you cannot work in your chosen profession. All these insurance may be costly, but they provide protection for you in case of any unforeseen circumstance; and most importantly, provide you with peace of mind and a good night’s sleep.

5) Being knowledgeable about different kinds of debt – The world we live in is awash in different kinds of debt, and loans make the world go round. That’s why banks are able to exist – they serve a purpose by providing funding for start-up companies, new ventures and mega-projects which are undertaken by established companies. Hence, it is in our best interests to find out about how loans work, how interest rates work and to use this information to our advantage. Besides the normal secured loans out there, there are also other types of debt such as car loans, mortgage loans, credit card debt and bank overdrafts (i.e. line of credit). These carry different interest rates and have different conditions attached, and the individual will be much wiser if he understood how the system works so that he can exploit it to the fullest (or at the very least, avoid being exploited by the slick and glossy marketing). Too many people end up in debt for the wrong reasons, and it becomes a burden to them as it drains precious cash flows. If one is aware of how to harness leverage wisely, then one can make use of debt to their fullest advantage and become much wealthier in the process.

6) Differentiating between wants and needs – I think I had mentioned this before in one of my posts, so I shall not elaborate. I have included this because of the importance of stressing this once more, as I feel the line is becoming increasingly blurred in our society where materialism and consumerism is so prevalent.

7) Setting financial targets – Last but not least, setting financial targets is important because it helps us to work towards a goal to be attained, and to ensure we stay on track to meet these goals. In order not to waver, these targets should be explicit and deliberately difficult, such that they are achievable but much effort needs to be put in in order to achieve them. An example would be to save $X a year or to reduce your mortgage loan by $Y. If one fails at attaining the target, then one should do a thorough review on what caused the failure, and ensure that the same mistakes are not repeated.

The above are just some of the factors which I believe make one financially sound. There are probably many others which I had left out as these seven were sort of off the cuff thoughts I had which I could immediately pen down and write something about. Readers may wish to use the comments box to articulate some other ideas they may have on this topic, or to opine on what I had written.

Can Value Investing be considered a Gamble?

Interestingly, the above question was posed recently on the Value Buddies forum, and attracted considerable interest and wide-ranging views from a variety of participants. The question above was posed from the standpoint that value investing (or any kind of investing, for that matter) can be considered a gamble as it may take a long time for the market price of a security to rise to its intrinsic value. Thus, there is an element of chance and perhaps even luck and is no different from blackjack or slot machines at the casino.

I found this to be a somewhat interesting topic as the subject matter raised was one which many investors would have asked themselves countless times when their investments are stagnant and not doing well. Value investing, by its very nature, requires an investor to purchase part-ownership of a company and hold its shares for more than a few years, in order for business growth to make the company more valuable. If he chose the right company, there would also be a return on his investment in the form of dividends, which come from the cash flows generated by the Company. But to classify an investment as a gamble is somewhat wrong, as I feel that any event which has a probabilistic outcome amid uncertainty qualifies as a “gamble”. However, it must be stressed that value investors will “gamble” with the factors in their favour, in order to increase the odds of success, and reduce the chances of failure.

The proper definition of a gamble is – “any matter or thing involving risk or hazardous uncertainty” (from dictionary.com). While it is generally acknowledged that investment carries risks and uncertainties, value investing, by its very nature, seeks to adequately address the uncertainties while at the same time, mitigating the risks. Uncertainties can be smoothed out through an understanding of the industry in which a company is operating in, and also by studying its long-term track record using ten-year financial analyses (plot this using MS Excel and you can see the trend of revenues, profits and dividends). Though one can argue that uncertainties in terms of economies and industry cycles can never be completely understood or predicted, one can use history as a somewhat reliable guide and factor in a suitable discount to computed intrinsic value as a margin of safety. In terms of risks, these are mitigated when an investor gains a thorough understanding of the business, including what drives it, its business model, prospects, plans and Management quality. Of course, this entails a lot of reading, research, fact-finding and some even go to the extent of visiting the premises and plants/factories to gain a better appreciation of how the business is run from an operational and tactical standpoint. To further mitigate and control risk, an investor can “go the distance” and use Phil Fisher’s “Scuttlebutt” technique of visiting Management and conducting interviews with them on various aspects of the business. Usually, however, being a minority shareholder means that the Management will not allocate time to entertain you, as they have more pressing matters at hand (like running the business day-to-day!). However, some companies have excellent IR personnel who will respond to queries and provide appropriate updates, news and facts when requested to do so.

So back to the question of whether value investing is considered a gamble. Yes it is if you go by the strict definition given by the dictionary; but then again everything in life can then be termed a gamble, from what you choose to study in University, who you marry, which job you take up and which friends you decide to associate with. After all, all these events involve uncertainty and some of them carry a fair amount of risk as well; but we still have to move on and make decisions which seem best under the circumstances. So my assertion is that we all take daily “gambles”, it’s simply the impact which differs for each of these actions that’s all.

From my limited and short experience (less than 4 years) as a value investor, I did note that valuations will normally revert back to the long-term mean, and that if an investor purchased shares in a company whose valuation is trading at a discount to the mean, and the Company is doing well in terms of business growth and cash flows, then one can reasonably expect a reversion to intrinsic value as time goes by. But after going through one complete bull/bear cycle, I have to categorically state that it is by no means easy to spot whether valuations are “cheap” or “expensive” as these terms can be relative, depending on the state of earnings and economic growth in general. One must learn to be flexible and adaptive in assessing valuations and to keep an open mind.

Ultimately, as investors we have to make an intelligent gamble, with the odds tilting in our favour. That’s basically what investing is about, and when the odds are strongly in our favour, then learn to bet larger amounts. If there are too many uncertainties and risks, then an investor should be prudent and only commit a small amount of capital. In other words, we should do position sizing based on our comfort level with a certain company, and this is something which I believe all investors practise. After all, when it comes to the crunch, I dare say a value investor will still do much better than a gambler at a casino playing cards because in the former case, we are talking about business growth and the management of uncertainty; whereas in the latter case, there is the “house advantage” which is an artificially created additional layer of mathematical uncertainty out to sabotage the gambler!

The Art of Deal Making

With this first post in the New Year, I thought I would touch on a topic which has been revolving in my mind for quite a while, and which has been incubating since Boustead announced their Bio-Treat and Big Box deals. I would readily admit that the main content for this post comes from observations and analytical thoughts stemming from the failed investment in Big Box, as well as the investment decision for Bio-Treat. These two events, coupled with my own personal experiences in negotiating and observing how deals are made, compelled me to write something on this in order to start a fruitful and engaging discussion.

Deal-making is the process by which top management such as CEOs and Managing Directors engage in (sometimes) long, protracted discussions and negotiations with third-parties on potential M&A deals. As readers would already know, some of the really large mega-deals involving mergers (such as the SGX-ASX “merger”) and acquisitions (of which there were a few reverse take-overs announced in 2010) were a result of long and intensive negotiations and a lot of give-and-take on both sides. Though some may wonder if the deals actually did turn out to be earnings and yield accretive to shareholders, one should not question the amount of effort and hard work put in by the Management Team to secure these deals.

Deal-making normally starts with casual introductions through a network of business associates, probably over a meal or drinks. These introductions are made usually with a mutual business associate introducing both parties, whereby he acts as a catalyst to facilitate the initial exchange. Subsequent business discussions will be left to the individuals to arrange and the role of the introducer is simply to introduce and provide a summary of what each party is doing (e.g. engaging in what business, looking for what kinds of opportunities etc.). This emphasizes the importance of having good business networks in order to snare potentially juicy deals, and it also helps if you are someone who is well-liked by the business community and is viewed as a successful and down to earth entrepreneur. Going back to FF Wong’s case, he is indeed someone who is affable and will attract others who may wish to conduct deals with him; which also opens him up to a lot more opportunities as compared to those who have to go out and actively seek partners.

The difficult part of deal-making is then the stage of negotiations, for it often involves a huge amount of paperwork, spreadsheets, forecasts and face-to-face interactions. This is the part where each party summons its troops to prepare detailed analyses on the feasibility of partaking in the deal, and each side will also conduct its respective due diligence. Normally, this will involve aspects such as obtaining the Company’s instant info (from ACRA), checking the shareholders and directors (to determine that it is not a fly-by-night company), procuring financial statements and MD&A (if any) and making notes on the potential deal and the rates of return and payback periods.

Due diligence also has several aspects to it – financial, legal and physical. Using the Boustead/Bio-Treat example, physical due diligence will refer to the actual sighting of the asset(s) in question, to make sure they are in existence. In Boustead’s case it was to send down some staff to China to ensure the water treatment plants as stated are actually there. For REIT acquisitions, this involves actual sighting of the buildings to be acquired to ensure they are physically standing and in good condition. Legal due diligence consists of engaging lawyers to review the agreements and contracts relating to the deal to ensure there are no loopholes and points which can be exploited by the other party; and also to draft suitable correspondences to ensure there is no undue liability for each party. Legal due diligence also involves getting the lawyers to inspect all relevant certificates, licenses, patents and other legal documents to determine their authenticity. If the acquisition is foreign (e.g. for Bio-Treat’s case, it is in China), then Chinese lawyers will probably have to be engaged as they are familiar with Chinese laws and regulations governing asset acquisition, and also the paperwork required to effect the deal. Up to this stage, the costs are also quite significant as it involves flying people to China and engaging lawyers in both countries to deal with all the outstanding issues.

Financial due diligence is probably the most important aspect of the deal, and can actually make or break it. This process can be long and protracted as revisions may need to be made on assumptions, and terms and conditions may also change in light of new news or as a result of negotiations. Generally, the financial aspects which are considered important will include ROE, payback period and IRR (Internal Rate of Return). There will be detailed spreadsheets done to simulate the operational aspects of the acquired company or assets and this will be used as the basis for decision-making. Note that all these may require specialized personnel who are knowledgeable about the industry or assets in order to come up with a realistic projection. Hence, more money needs to be spent to hire such professionals to provide an opinion. At this stage, the Company may have its in-house team to do the projections or it may engage consultants to evaluate the deal. Needless to say, consultants are always more expensive than having an in-house team, though sometimes the results are often rather similar!

In light of the above, it is not difficult to see why companies can spend close to S$1 million just conducting the due diligence itself, as Boustead did mention during one of its audiocasts for a failed acquisition target. The problem is that even after incurring all these costs, the deal may not materialize due to problems discovered. Some companies may not even admit to these and still bash ahead as they felt that they have sunk so much into the due diligence that it does not make sense to abandon the project now. A more realistic and wise move would be to exit while the deal has not been hammered out yet, as Boustead had done, rather than take on a bad deal just because of emotional reasons.

So, as can be observed from the above, deal-making is not an easy process and can consume copious amounts of time, manpower and resources. I blogged about this to allow readers to better appreciate what goes on in the “back office” of such deals, rather than just focusing on the glossy news releases which companies put out on SGXNet. The PR companies and spin doctors will do their job of promoting the deal and making it sound attractive, but as investors, I believe we have to assess such deals with a pinch of salt and an objective mind. There have been cases where the institutional imperative has kicked in and a lousy M&A deal was “packaged” to look attractive. So I guess, ultimately, it boils down to “Caveat Emptor” for investors who decide to purchase shares of a Company which is either undergoing an M&A, or is contemplating a major one.

Interestingly, just as I am writing this, GLP (Global Logistics Properties) just announced the purchase of a 53% stake in China’s Airport City Development Co Ltd, paying S$485 million in a 30% cash, 70% shares ratio.