Value Investing 01 (May 08 - Dec 08)

[la papillion]

Did anyone notice a slew of fabrics companies IPO in singapore market? Wondering if it's overheated..

[fclim]

Hi Blackjack,

Thanks for the sharing... does the company say base on what facts that they conclude the following?

"Forward PE, P/B and momentum are the best ways to generate the highest returns when it comes to value investing."

The danger of relying purely on figures can be very misleading... i remember my "intro to economics" (which I got an embarrassing grade) professor saying... "there are lies, bloody lies and then there is statistics"... numbers can be manipulated easily to show whatever the presenter wants to show?

for e.g. i remember reading somewhere that :
"...it is always possible to beat the S&P yearly without fail. Based on actual historical facts, there is always some funds who did it every year. The only problem is that every year, the funds that beat the S&P are different...."

Textiles industry? Hmmm.... interesting... I thought mr WB failed in his earlier days to turn around a similar business rite? i think he blamed it on the silly nature of the business, where price cutting is a norm, so any productivity increase and costs savings are actually passed to the end-consumers. the so-called ROI never really appears as profits back into the biz... but well, that was a long long time ago... maybe its different now?

have fun,
fc

[HengHeng]

The issue is i think WB highlighted like many others before and after him .... do something within your competence and understanding.

IF you cannot understand what is important in valuating a company then issue is are you able to understand how to value it??

I think Canslim helps to understand some part of value investing in the sense relating to relevance of what is value and different times .

For instance , STEEL and infrastructure , agricultural companies would do well in emerging and developing countries and would do less better in developed ones so how do u value the company? Based on raw material cost ? Potential earnings? etc etc ... factors would be different in two countries and it is impossible to compare apple to apple in exact terms,.

[kennynah]

IF you cannot understand what is important in valuating a company then issue is are you able to understand how to value it??

no words to describe tears in my eyes.... someone shares my view ....

[chaibu]

IF you cannot understand what is important in valuating a company then issue is are you able to understand how to value it??

no words to describe tears in my eyes.... someone shares my view ....

Super duper insight......the mantra of value investing?

[winston]

Very seldom does one has a good knowledge across a few industries.

For the industry that I have been working in, I would not touch those companies at all. However, those stocks flew during the bull run and I missed the entire rally, in the companies I understand the most.

Therefore, I rely a lot on Analyst's report to shortened my learning curve of a certain industry and company. Even then, my info are still inadequate compared to the BBs who have a position in the company..

[helios]

Recently my company invited AllianceBernstein for a talk on their views on equity valuations. Here's the essential points that they covered.
Presenter: Stuart Rae - Chief Investment Officer—Pacific Basin Value Equities

Basically they seem to be fundamentally longists and pride themselves on picking value stocks. On their growth division, I realised that its not all about high growth companies, but rather companies that present a disparity between market view and what has been generated by their house research. I formally thought it only referred to high growth companies (where there might not be a difference in opinion) They also acknowledged their weakness in currency play, which I thought is rather unusual for a company trying to ply business.

Anyway, the gist of their presentation is as such:
1) Forward PE, P/B and momentum are the best ways to generate the highest returns when it comes to value investing. The combination of value and momentum is very powerful.
2) Picks based on plain growth, ROE, ROA, earnings growth usually underperform the former.
3) Most sectors in china stocks are currently trading at levels far below the current world average PE.

Interesting China textiles are chosen as a case study as this is trading at the lowest band of PE.
Main points are:
- Labour costs are not as large an impact as one may expect
- China is encouraging a move by manufacturing industries to move up the value chain (this we can observe currently from some SGX counters as well)
- Expect to see labour-intensive activities increasingly outsourced.
- Value-wise this sector is the most underrated
- Momentum-wise this sector is 'horrible'

Sorrie, BJackie, have to make you write a chunky article, last night.

if possible, can you elaborate on your points 1, 2, and 3.

ie. How would such combo be 'on an Edge' [value]?

[Blackjack]

Did anyone notice a slew of fabrics companies IPO in singapore market? Wondering if it's overheated..

I actually took it as a sign of genuine growth in the industry where multiple players have to gain first mover advantage.
Of course, I am taking it optimistically la. Can also take it that they are desperately trying to stay alive by getting fresh funds to starve off competition.

Hi Blackjack,
Thanks for the sharing... does the company say base on what facts that they conclude the following?
fc

I think such are at best deductions from past experience/ empirical data/ trading strategies/ hocus pocus and can never be based on hard facts. Same as how there are so many methods of valuation and even investing styles which there is just no right or wrong, but lucky or unlucky right? In any case Allianz did provide certain historical data on percentage of world GDP, asian share of world imports/exports over the years, destination of exports, etc. Again you might argue the analysis may be skewed but that's the way it is. We listen to many views and formulate our own rite?

Hi Blackjack,
Textiles industry? Hmmm.... interesting... I thought mr WB failed in his earlier days to turn around a similar business rite? i think he blamed it on the silly nature of the business, where price cutting is a norm, so any productivity increase and costs savings are actually passed to the end-consumers. the so-called ROI never really appears as profits back into the biz... but well, that was a long long time ago... maybe its different now?
fc

Yes I always thought this example should remain quite edged in investors' minds, coming from a guru. Same for tech stocks somehow people usually have a natural tendency to stay out of.

Sorrie, BJackie, have to make you write a chunky article, last night.

if possible, can you elaborate on your points 1, 2, and 3.

ie. How would such combo be 'on an Edge' [value]?

No prob. But I think basically what they did was they tabulated compound annual real GDP growth over a period of 30 yrs and tried to relate this to annualised market return, long/short investment strategies, price momentum and forward PE for a few Asian countries. Just some simple surface comparisons to illustrate their style, nothing too scientific.

[helios]

I think basically what they did was they tabulated compound annual real GDP growth over a period of 30 yrs and tried to relate this to annualised market return, long/short investment strategies, price momentum and forward PE for a few Asian countries. Just some simple surface comparisons to illustrate their style, nothing too scientific.

are you refering to the price momentum model? momentum reversals?

[la papillion]

For avid readers of my blog, you might have realised that I am undergoing a deconstruction process of my valuation techniques. Just yesterday, I was debunking my own way of using a bastardized version of DCF to calculate the intrinsic value. Mr.Investor could very well describe me.

It's important to read about investing and it's also very important to practice it by valuating listed companies. Only then will the things read be transferred from the RAM of your brains to the more permanent hardisk. For now, I'll be deconstructing my PE ratio analysis.

We can use the PE ratio to derive the future price of a company, if we also know about the earnings in the future. To go about doing that, we just need to follow the steps below:

1. Assume an earnings growth rate. Project future earnings by applying the earnings growth rate to current earnings.

2. Assume a PE ratio. Then multiply the projected future earnings with this PE ratio, and we'll get the future price.



For example, company A has earnings growth rate of 21.1% (CAGR over 4 years). For simplicity, we assume a earnings growth of 20%. FY07's EPS is 5.6 cts per share. Thus, projected FY08's EPS is 6.7 cts per share (5.6 x 1.2 = 6.7).

Here's the historical PE ratio:



* EPS in FY07 is actually 0.278 RMB, not 0.278 SGD. There is a mistake in the headings.

The lowest PE ratio is 5.5x and the highest is 26.3x. To be conservative, we assume a PE ratio of 5.5x to multiply the FY08's earnings of 6.7cts per share, giving us a future price of $0.365.



Easy right? But there is actually a lot of things hidden beneath the simplicity of the maths. Besides the difficulty of assuming the earning growth rate, there is also the problem of using historical low PE ratio to justify the multiples. Actually these two are inherently the same problem - that of projecting the past into the future.

To illustrate, imagine this. A 90 years old man, having lived to such a ripe old age, had never died before (obviously!) in this entire lifetime. Based on historical data, this old man will continue to grow at the CAGR (based on the past 90 yrs) of 1 year per annum. In fact, he will continue growing for the next 90 years, based again on past data. If we can extend this further, he will probably never die because past data had no records of him dying before. What do you think of this?



To assume that the price of the company will not fall below the historical low is a myth, and is best dismissed with facts. In 2003, if we are to compile the historical PE data of company A, the lowest PE is 8.5x. If the investor bought in at 8.5x, thinking that the price will be supported at that PE level, he will be sorely disappointed. In 2004, lowest PE becomes 7.1 x. In 2005 and 2006, lowest PE becomes 5.5x. The lowest historical PE just keeps getting lower and lower.

Based on 1H08, EPS for Company A is 3.126 cts per share. Current price now is 24.5 cts. If we annualised 1H08 by multiplying by 2 (assuming constant earnings for 2H08, haha, the irony of it), we end up with a FY08 EPS of 6.252 cts per share. So guess what's the PE? It's 3.9x.

PE can get lower than what past historical data showed. To project the past into the future, is akin to a 90 year old man projecting his future life span forever because he had never died before. Amusing but ultimately ridiculous.