Wednesday, 31 March 2010

Buffett (1983): Great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets.

While corporate excesses and the concept of economic earnings, different from accounting earnings remained the focal points in the master's 1982 letter to shareholders, let us see what Warren Buffett has to offer in his 1983 letter.

In this another enlightening letter, Warren Buffett, probably for the first time discussed at length the concept of 'goodwill' and believed it to be of great importance in understanding businesses. Further, he blames the discrepancies between the 'actual intrinsic value' and the 'accounting book value' of Berkshire Hathaway to have arisen because of the concept of 'goodwill'. This is what he has to say on the subject.

"You can live a full and rewarding life without ever thinking about goodwill and its amortization. But students of investment and management should understand the nuances of the subject. My own thinking has changed drastically from 35 years ago when I was taught to favor tangible assets and to shun businesses whose value depended largely upon economic goodwill. This bias caused me to make many important business mistakes of omission, although relatively few of commission."

From the above quote, it is clear that the master's investment philosophy had undergone a sea change from when he first started investing. Further, with his company becoming too big, he could no longer afford to churn his portfolio as frequently as before. In other words, he wanted businesses where he could invest for the long haul and what better investments here than companies, where the economic goodwill is huge. The master had been kind enough in explaining this concept at length through an appendix laid out at the end of the letter. Since we feel that we couldn't have explained it better than the master himself, we have reproduced the relevant extracts below verbatim.

"True economic goodwill tends to rise in nominal value proportionally with inflation. To illustrate how this works, let's contrast a See's kind of business with a more mundane business. When we purchased See's in 1972, it will be recalled, it was earning about US$ 2 m on US$ 8 m of net tangible assets (book value). Let us assume that our hypothetical mundane business then had US$ 2 m of earnings also, but needed US$ 18 m in net tangible assets for normal operations. Earning only 11% on required tangible assets, that mundane business would possess little or no economic goodwill.

A business like that, therefore, might well have sold for the value of its net tangible assets, or for US$ 18 m. In contrast, we paid US$ 25 m for See's, even though it had no more in earnings and less than half as much in "honest-to-God" assets. Could less really have been more, as our purchase price implied? The answer is "yes" - even if both businesses were expected to have flat unit volume - as long as you anticipated, as we did in 1972, a world of continuous inflation.

To understand why, imagine the effect that a doubling of the price level would subsequently have on the two businesses. Both would need to double their nominal earnings to $4 million to keep themselves even with inflation. This would seem to be no great trick: just sell the same number of units at double earlier prices and, assuming profit margins remain unchanged, profits also must double.

But, crucially, to bring that about, both businesses probably would have to double their nominal investment in net tangible assets, since that is the kind of economic requirement that inflation usually imposes on businesses, both good and bad. A doubling of dollar sales means correspondingly more dollars must be employed immediately in receivables and inventories. Dollars employed in fixed assets will respond more slowly to inflation, but probably just as surely. And all of this inflation-required investment will produce no improvement in rate of return. The motivation for this investment is the survival of the business, not the prosperity of the owner.

Remember, however, that See's had net tangible assets of only $8 million. So it would only have had to commit an additional $8 million to finance the capital needs imposed by inflation. The mundane business, meanwhile, had a burden over twice as large - a need for $18 million of additional capital.

After the dust had settled, the mundane business, now earning $4 m annually, might still be worth the value of its tangible assets, or US $36 m. That means its owners would have gained only a dollar of nominal value for every new dollar invested. (This is the same dollar-for-dollar result they would have achieved if they had added money to a savings account.)

See's, however, also earning US$ 4 m, might be worth US$ 50 m if valued (as it logically would be) on the same basis as it was at the time of our purchase. So it would have gained US$ 25 m in nominal value while the owners were putting up only US$ 8 m in additional capital - over US$ 3 of nominal value gained for each US $ 1 invested.

Remember, even so, that the owners of the See's kind of business were forced by inflation to ante up US$ 8 m in additional capital just to stay even in real profits. Any unleveraged business that requires some net tangible assets to operate (and almost all do) is hurt by inflation. Businesses needing little in the way of tangible assets simply are hurt the least.

And that fact, of course, has been hard for many people to grasp. For years the traditional wisdom - long on tradition, short on wisdom - held that inflation protection was best provided by businesses laden with natural resources, plants and machinery, or other tangible assets. It doesn't work that way. Asset-heavy businesses generally earn low rates of return - rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

In contrast, a disproportionate number of the great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets. In such cases earnings have bounded upward in nominal dollars, and these dollars have been largely available for the acquisition of additional businesses. This phenomenon has been particularly evident in the communications business. That business has required little in the way of tangible investment - yet its franchises have endured. During inflation, goodwill is the gift that keeps giving.

But that statement applies, naturally, only to true economic goodwill. Spurious accounting goodwill - and there is plenty of it around - is another matter. When an overexcited management purchases a business at a silly price, the same accounting niceties described earlier are observed. Because it can't go anywhere else, the silliness ends up in the goodwill account. Considering the lack of managerial discipline that created the account, under such circumstances it might better be labeled 'No-Will'. Whatever the term, the 40-year ritual typically is observed and the adrenalin so capitalized remains on the books as an 'asset' just as if the acquisition had been a sensible one."

Buffett (1982): Always maintain strict price disciple; a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.

While the world of stocks seems to be tearing apart on US subprime woes, what could be better than to indulge in some thought provoking lessons that can help you, as an investor, in staying calm in such situations of panic.  We saw Buffett (the master) talk about his policies for making acquisitions and how managers tend to overestimate themselves. Let us see what the investing genius had to offer in his 1982 letter to shareholders.

In what was probably a bull market, Berkshire Hathaway, the master's investment vehicle faced a peculiar problem. By that time, the company had acquired meaningful stakes in a lot of other companies but not meaningful enough for these companies' earnings to be consolidated with that of Berkshire Hathaway's. This is because accounting conventions then allowed only for dividends to be recorded in the earnings statement of the acquiring company if it acquired a stake of less than 20%. This obviously did not go down well with the master as earnings of Berkshire in the 'accounting sense' depended upon the percentage of earnings that were distributed by these companies as dividends.

"We prefer a concept of 'economic' earnings that includes all undistributed earnings, regardless of ownership percentage. In our view, the value to all owners of the retained earnings of a business enterprise is determined by the effectiveness with which those earnings are used - and not by the size of one's ownership percentage."

As for some examples in the Indian context, companies like M&M and Tata Chemicals, which hold small stakes in many companies should not be valued based on what dividends these companies pay to M&M and Tata Chemicals but instead one should arrive at the fair value of these companies independently and that value should be attributed on a pro-rata basis to all the shareholders, whether minority or majority.

While the master tackled accounting related issues in the first few portions of the 1982 letter, the next few portions were once again devoted to the excesses that take place in the market time and again. This is what he had to say on corporate acquisitions and price discipline.

"As we look at the major acquisitions that others made during 1982, our reaction is not envy, but relief that we were non-participants. For in many of these acquisitions, managerial intellect wilted in competition with managerial adrenaline. The thrill of the chase blinded the pursuers to the consequences of the catch. Pascal's observation seems apt: 'It has struck me that all men's misfortunes spring from the single cause that they are unable to stay quietly in one room.'"

He further goes on to state, "The market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do. For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments."

The above comments once again bring to the fore a strict discipline that the master employs when it comes to paying an appropriate price. In fact, as much as his success is built on finding some very good picks like Coca Cola and Gillette, he has never had to sustain huge losses on any of his investment. The math is simple, if you lose say 50% on an investment, to make good these losses, one will have to unearth a stock that will have to rise at least 100% and that too in quick time. A very difficult task indeed! No wonder the master pays so much attention to maintaining a strict price discipline.

POS Malaysia recommends 12.5c per share dividend

POS Malaysia recommends 12.5c per share dividend
Written by Joseph Chin
Wednesday, 31 March 2010 18:16

KUALA LUMPUR: POS MALAYSIA BHD [] has recommended a first and final dividend of 12.5 sen per ordinary share less tax.

It said on Wednesday, March 31 the dividend was subject to shareholders' approval at its forthcoming AGM.

"The entitlement date and payment date in respect of the proposed first and final dividend will be determined and announced in due course," it said.

Khazanah Nasional Bhd has proposed to divest its 32% stake in POS Malaysia under the New Economic Model.

AmResearch, had in its morning outlook report, said it was maintaining a Hold on Pos Malaysia with an unchanged fair value of RM2.30 a share.

"Khazanah's entry price into Pos Malaysia has been kept sketchy, with bulk of the deals done off-market," it said.

The research house said Pos Malaysia was expecting its new Mail Processing Hub (MPC) to be up in 4Q10. More importantly, it felt the MPC will now allow Pos Malaysia to position itself as a mail outsourcing distribution centre for the Asia-Pacific region.

"Pos Malaysia's well-due tariff review will certainly be hastened in order to tempt takers for Khazanah's shares in the company. A 10 sen (+20%) hike will swell Pos Malaysia 's FY11F's EPS by 61%. Pos Malaysia is currently trading at a slight 2% discount to DCF valuation of RM2.30/share.

"While there is meagre room for upside at this point - possibilities of a more meaningful upside could emerge should its plan to expand its presence regionally, in hand with the tariff hike, materialise," it said.

"While there is meagre room for upside at this point - possibilities of a more meaningful upside could emerge should its plan to expand its presence regionally, in hand with the tariff hike, materialise," it said.

Berjaya Corp posts net loss of RM155m in 3Q

Berjaya Corp posts net loss of RM155m in 3Q
Written by Joseph Chin
Wednesday, 31 March 2010 18:04

KUALA LUMPUR: Berjaya Corp Bhd posted net loss of RM155.12 million in the third quarter ended Jan 31, 2010 (3QFY10), mainly due to investment related expenses of RM162.05 million and also weaker hotels and resorts business.

It told Bursa Malaysia on Wednesday, March 31 that revenue was RM1.66 billion while pre-tax loss was RM48.75 million. Loss per share was 3.72 sen. The investment related expense surged to RM162.05 million in 3QFY10 from RM21.02 million in 3QFY09.

In the previous corresponding quarter, it made net profit of RM17.94 million on the back of RM1.73 million in revenue. Earnings per share was 0.47 sen.

BCorp said in 3QFY10 the Group recorded a decrease in revenue of 4%. This was unlike 3QFY09 where BCorp enjoyed higher sales due to the Chinese Lunar New Year festivity that fell in January 2009, resulting in high festive sales for the gaming business operated by Sports Toto (Malaysia) Sdn Bhd and the strong sales registered from the Mega 6/52 game.

"In the current financial year, the Chinese Lunar New Year festivity fell in the month of February 2010. Apart from this, the hotels and resorts business was adversely affected by cutbacks in business travels due to the global economic downturn," it said.

For the nine months ended Jan 31, 2010, it posted net loss of RM61.43 million versus net profit of RM61.50 million in the previous corresponding period. Revenue was RM4.89 billion versus RM4.83 billion.

"The increase in the current period's revenue mainly resulted from the higher contributions from the consumer marketing business and higher brokerage income (from stockbroking business), due to the more active stock market. The performance is all the more commendable as the current period did not have the benefit of the
traditional Chinese Lunar New Year festivity which was in February 2010," it said.

BCorp said excluding the non-cash equity dilution effect of RM208.69 million, the group's pre-tax profit would have been RM522.62 million, showing a 57.1% increase over the preceding year corresponding period.

This increase was mainly contributed by Cosway, (benefiting from its revamped business model from retail to free franchise hybrid outlets in Thailand, Korea and Australia, coupled with the introduction of new products and attractive monthly promotions) and the recognition of negative goodwill as well as write-back of impairment in value of investment in associated companies and other investments.

Mary Buffett - Warren Buffett and Long-Term Investing

Value Investing Conference Videos

Buffett (1981): Prefers buying 'easily-identifiable princes at toad-like prices'. These 'princes' are able to preserve margins and generate attractive return on capital year after year.

Warren Buffett wrote in his 1981 letter.

"Our acquisition decisions will be aimed at maximizing real economic benefits, not at maximizing either managerial domain or reported numbers for accounting purposes. (In the long run, managements stressing accounting appearance over economic substance usually achieve little of either.)

Regardless of the impact upon immediately reportable earnings, we would rather buy 10% of Wonderful Business T at X per share than 100% of T at 2X per share. Most corporate managers prefer just the reverse, and have no shortage of stated rationales for their behavior."

By making the above statements, Buffett is trying to highlight the difference between acquisition rationale for Berkshire Hathaway and most of the other corporate managers. While for the latter group of people, the motivation behind high premium acquisitions could range from reasons like penchant for adventure, misplaced compensations and a fair degree of overconfidence in their managerial skills, for Berkshire Hathaway, the maximisation of real economic benefits is the sole aim behind acquisitions.

Infact, the company is even happy to deploy large sums where there is a high probability of long-term economic benefits but an absence of ownership control. In other words, the company is comfortable both with total ownership of businesses and with marketable securities representing small ownership of businesses.

The paragraphs that follow bring to the fore some of the biggest qualities of the man and what makes him an extraordinary investor. Warren Buffett has a knack of knowing his circle of competence better than most and also a rather unmatched ability to learn from past mistakes. These could be gauged from the following comment:

  • "We have tried occasionally to buy toads at bargain prices with results that have been chronicled in past reports. Clearly our kisses fell flat. 
  • We have done well with a couple of princes - but they were princes when purchased. At least our kisses didn't turn them into toads. 
  • And, finally, we have occasionally been quite successful in purchasing fractional interests in easily-identifiable princes at toad-like prices."

In the above paragraph, the master uses a childhood analogy and likens managers to princesses who kiss toads (ordinary businesses) to convert them into princes (attractive businesses). Put differently, there are certain managers who believe that their managerial kiss will do wonders for the profitability of a company and convert them from toads to princes. While the master has gone on to add that there are indeed certain managers that can achieve this feat, his own track record is nothing to write home about and hence, he would rather prefer buying 'easily-identifiable princes at toad-like prices'.

Although the opportunities for finding these types of companies are very rare, the master is willing to commit a large sum once such opportunities surface. According to him, such businesses must have two favored characteristics:

  1. An ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilised) without fear of significant loss of either market share or unit volume, and

  2. An ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.
Indeed, an ability to preserve margins and generate attractive return on capital year after year are the qualities that one should seek in a firm that one wants to invest in.

Buffett (1980): The true value is determined by the intrinsic value of the company and not the dividends.

Warren Buffett in his 1980 letter to the shareholders of Berkshire Hathaway:

"The value to Berkshire Hathaway of retained earnings is not determined by whether we own 100%, 50%, 20% or 1% of the businesses in which they reside. Rather, the value of those retained earnings is determined by the use to which they are put and the subsequent level of earnings produced by that usage."

The maestro made the above statements because in those days he felt that the prevailing accounting convention/standards were not in sync with a value based investment approach (Infact, they still aren't). In the paragraphs preceding the one mentioned above, he painstakingly explains that while accounting convention requires that a partial ownership (ownership of say 20%) in a business be reflected on the owner's books by way of dividend payments, in reality, they are worth much more to the owner and their true value is determined by the 20% of the intrinsic value of the company and not by 20% of the dividends that are reflected on its books. In the Indian context, imagine someone valuing a company like say M&M -if it had say a 20% stake in Tech Mahindra- based on the 20% of dividends that the latter pays out to M&M. This will be a rather incorrect way of valuing M&M, which in effect should be valued taking into account 20% of the intrinsic value of Tech Mahindra and not the dividends.

"The competitive nature of corporate acquisition activity almost guarantees the payment of a full - frequently more than full price when a company buys the entire ownership of another enterprise. But the auction nature of security markets often allows finely run companies the opportunity to purchase portions of their own businesses at a price under 50% of that needed to acquire the same earning power through the negotiated acquisition of another enterprise."

Buffett, as most of us might know, is a strong advocate of buyback, especially at a time when the stock is trading significantly lower than its intrinsic value and the above paragraph is just a testimony to this principle of his. Indeed, when stock prices are low, what better way to utilize capital than to enhance ownership in the company by way of buy back. The master further goes on to add that one can buy a portion of a business at a much lower price, provided there is auction happening. In other words, when there is a panic in the market and everyone is offloading shares, the chances of getting an attractive price is much higher. On the other hand, when there is a competition between two or more companies for buying another enterprise, the competitive forces will more likely than not keep the acquisition price higher, in most cases, higher than even the intrinsic value of the company.

Buffett (1978):"Turnarounds" seldom turn. Be in a good business purchased at a fair price than in a poor business purchased at a bargain price.

Warren Buffett in his 1978 letter to his shareholders places a great deal of importance on the quality of business and also the fact that he had to let go of many attractive investment opportunities just because the price was not right. In the following write up, let us see what the master has to offer in terms of investment wisdom in his 1979 letter:

"The inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business (i.e., ordinary income tax on dividends and capital gains tax on retained earnings) - can be thought of as an "investor's misery index". When this index exceeds the rate of return earned on equity by the business, the investor's purchasing power (real capital) shrinks even though he consumes nothing at all. We have no corporate solution to this problem; high inflation rates will not help us earn higher rates of return on equity."

The above paragraph clearly demonstrates that in order to improve one's purchasing power, one will have to earn after tax returns that are higher than the inflation rate at all times. Imagine a scenario where the inflation rate touches 9%, which means that a commodity that you purchased at Rs 100 per unit last year will now cost you Rs 109. Further, assume that you put Rs 100 last year in a business that earns 10% return on equity and the tax rate that currently prevails is 20%.

Thus, while you earned Rs 10 by virtue of the 10% return on equity, the tax rate ensured that only Rs 8 has flown to your pocket. Not a good situation since your purchasing power has diminished as while your returns were only 8% post tax, you will have to shell out Re 1 extra for buying the commodity as inflation has remained higher than the after tax returns that you have earned. Further, high inflation does not help the business too unless it has some inherent competitive advantages, which enables it to pass on the hike in inflation to the end consumers. Little wonder, investors lay such high emphasis on businesses that earn returns way above inflation so that the purchasing power is enhanced rather than diminished.

"Both our operating and investment experience cause us to conclude that "turnarounds" seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price."

In the above paragraph, the master once again extols the virtues of a good quality business and says that he would rather pay a reasonable price for a good quality business than pay a bargain price for a poor business. It would be worthwhile to add that in the early part of his investing career, the master himself was a stock picker who used to rely only on quantitative cheapness rather than qualitative cheapness. However, somewhere down the line, he started gravitating towards good quality businesses and out of this thinking came such quality investments as 'Coca Cola' and 'American Express'. These were the companies that 
  • had virtually indestructible brands (a very good competitive advantage to have), 
  • generated superior returns on their capital and 
  • had ability to grow well into the future.

We prod you to find similar businesses in the Indian context, pick them up at a reasonable price and hold them for as long as you can. For if the master has made millions out of it, we don't see any reason as to why you can't.

Buffett (1978): Commodity type businesses must earn inadequate returns except under conditions of tight supply or real shortage

In this write up, let us see what Warren Buffett has to say to his shareholders in the 1978 letter:

"The textile industry illustrates in textbook style how producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage. (Comment: Note Glove companies!)  As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed. Such a supply-excess condition appears likely to prevail most of the time in the textile industry, and our expectations are for profits of relatively modest amounts in relation to capital. We hope we don't get into too many more businesses with such tough economic characteristics."

The above paragraph once again highlights the fact that no matter how good the management, if the economic characteristic of the business is tough, then the business will continue to earn inadequate returns on capital. This can be further gauged from the fact that despite all the capital allocation skills at his disposal, the master was not able to turnaround the ailing textile business that he had acquired in the early years of his investing career. He further adds that such businesses have little product differentiation and in cases where the supply exceeds production, producers are content recovering their operating costs rather than capital employed.

While the comment is reserved for the textile industry, we believe it can be extended to all commodities like cement, steel and sugar. Infact, the current downturn the sugar industry is facing has a lot to do with supply far exceeding demand and this in turn is having a great impact on returns on capital employed by these businesses. The only hope for them is a scenario where demand will exceed supply.

"We get excited enough to commit a big percentage of insurance company net worth to equities only when we find 
  • (1) businesses we can understand, 
  • (2) with favorable long-term prospects, 
  • (3) operated by honest and competent people, and 
  • (4) priced very attractively. 
We usually can identify a small number of potential investments meeting requirements (1), (2) and (3), but (4) often prevents action. For example, in 1971 our total common stock position at Berkshire's insurance subsidiaries amounted to only US$ 10.7 m at cost and US$ 11.7 m at market. There were equities of identifiably excellent companies available - but very few at interesting prices."

Those of you, who are regular readers of content on our website, the above paragraph must have rang a bell or two. Indeed, time and again, in countless articles, we have been highlighting the importance of investing in good quality businesses run by honest and ethical management. That the master himself has been looking at similar qualities does go a long way in further reinforcing our beliefs. Buffett then goes on to make a very important comment on valuations and says that no matter how good the businesses are, there is a price to pay for it and he in his investing career has let many investing opportunities pass by because the valuations were just not right enough.

Comparison can be drawn to the tech mania in India in the late nineties when good companies with excellent management like Infosys and Wipro were available at astronomical valuations. While these companies had excellent growth prospects, investors had become far too optimistic and had bid them too high. Thus, investors who would have bought into these stocks at those levels would have had to wait for five long years just to break even! Hence, no matter how good the stock is, please ensure that you do not pay too high a price for it.

Buffett (1977): ROE is a more appropriate measure of managerial economic performance

Over the past many years Warren Buffett has been dishing it out in the form of letters that he religiously writes to the shareholders of Berkshire Hathaway year after year. Many people reckon that careful analyses of these letters itself can make people a lot better investors and are believed to be one of the best sources of investment wisdom.

Laid out below are few points from the master's 1977 letter to shareholders:

"Most companies define "record" earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. (Comment:  This leads to a drop in ROE).   After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding. Except for special cases (for example, companies with unusual debt-equity ratios or those with important assets carried at unrealistic balance sheet values), we believe a more appropriate measure of managerial economic performance to be return on equity capital."

What Buffett intends to say here is the fact that while investors are enamored with a company that is growing its earnings at a robust pace, he is not a big fan of the management if the growth in earnings is a result of even faster growth in capital that the business has employed. In other words, the management is not doing a good job or the fundamentals of the business are not good enough if there is an improving earnings profile but a deteriorating ROE. This could happen due to 
  • rising competition eroding the margins of the company or 
  • could also be a result of some technology that is getting obsolete so fast that the management is forced to replace fixed assets, which needless to say, requires capital investments.

"It is comforting to be in a business where some mistakes can be made and yet a quite satisfactory overall performance can be achieved. In a sense, this is the opposite case from our textile business where even very good management probably can average only modest results. One of the lessons your management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds."

The above quote is a consequence of repeated failures by Buffett to try and successfully turnaround an ailing business of textiles called the Berkshire Hathaway, which eventually went on to become the holding company and has now acquired a great reputation. Indeed, no matter how good the management, if the fundamentals of the business are not good enough or in other words headwinds are blowing in the industry, then the business eventually fails or turns out to be a moderate performer. On the other hand, even a mediocre management can shepherd a business to high levels of profitability if the tailwinds are blowing in its favour.

If one were to apply the above principles in the Indian context, then the two contrasting industries that immediately come to mind are cement and the IT and the pharma sector. Despite being stalwarts in the industry, companies like ACC and Grasim, failed to grow at an extremely robust pace during the downturn that the industry faced between FY01 and FY05. But now, almost the same management are laughing all the way to the banks, thanks to a much improved pricing scenario. Infact, even small companies in the sector have become extremely profitable. On the other hand, such was the demand for low cost skilled labor, that many success stories have been spawned in the IT and the pharma sector, despite the fact that a lot of companies had management with little experience to run the business.

It is thus amazing, that although the letter has been written way back in 1977, the principles have stood the test of times and are still applicable in today's environment. We will come out with more investing wisdom in the forthcoming weeks.

Buffett (1994): Don't get bogged down by near term outlook and strong earnings growth; look for the best risk adjusted returns on a long-term basis

Warren Buffett highlighted, in his 1994 letter to shareholders, the futility in trying to make economic prediction while investing. Let us go further down the same letter and see what other investment wisdom the master has to offer.

One of the biggest qualities that separate the master from the rest of the investors is his knack of identifying on a consistent basis, investments that have the ability to provide the best risk adjusted returns on a long-term basis. In other words, the master does a very good job of arriving at an intrinsic value of a company based on which he takes his investment decisions. Indeed, if the key to successful long-term investing is not consistently identifying opportunities with the best risk adjusted returns than what it is.

However, not all investors and even the managers of companies are able to fully grasp this concept and get bogged down by near term outlook and strong earnings growth. This is nowhere more true than in the field of M&A where acquisitions are justified to the acquiring company's shareholders by stating that these are anti-dilutive to earnings and hence, are good for the company's long-term interest. The master feels that this is not the correct way of looking at things and this is what he has to say on the issue.

"In corporate transactions, it's equally silly for the would-be purchaser to focus on current earnings when the prospective acquiree has either different prospects, different amounts of non-operating assets, or a different capital structure. At Berkshire, we have rejected many merger and purchase opportunities that would have boosted current and near-term earnings but that would have reduced per-share intrinsic value. Our approach, rather, has been to follow Wayne Gretzky's advice: "Go to where the puck is going to be, not to where it is." As a result, our shareholders are now many billions of dollars richer than they would have been if we had used the standard catechism."

He goes on to say, "The sad fact is that most major acquisitions display an egregious imbalance:

  • They are a bonanza for the shareholders of the acquiree; 
  • they increase the income and status of the acquirer's management; and 
  • they are a honey pot for the investment bankers and other professionals on both sides. 
  • But, alas, they usually reduce the wealth of the acquirer's shareholders, often to a substantial extent. That happens because the acquirer typically gives up more intrinsic value than it receives."

Indeed, rather than giving in to their adventurous instincts, managers could do a world of good to their shareholders if they allocate their capital wisely and look for the best risk adjusted return from the excess cash they generate from their operations. If such opportunities turn out to be sparse, then they are better off returning the excess cash to shareholders by way of dividends or buybacks. However, unfortunately not all managers adhere to this routine and indulge in squandering shareholder wealth by making costly acquisitions where they end up giving more intrinsic value than they receive.

To read our previous discussion on Warren Buffett's letter to shareholders, please click here - Lessons from the master

Tuesday, 30 March 2010

A quick look at Xingquan

Xingquan International Sports Holdings Limited Company

Business Description:
Xingquan International Sports Holdings Limited. The Group's principal acitivities are manufacturing shoe soles and shoes and selling shoe soles, shoes, apparels and accessories. Other activities include investment holding, provision of management services and lease of factory and land.
Wright Quality Rating: LANN Rating Explanations

Stock Performance Chart for Xingquan International Sports Holdings Limited

Yr. End
QtrPeriod EndRevenue
RM '000

Date Announced: 25.2.2010
Xingquan-Q2 '10 Results.pdf

A quick look at XINGQUAN


This is yet another recent IPO.  I am wondering why 'anonymous' likes IPOs.

Given its short history, one will not be able to assess with confidence the quality of this company.  Moreover, the integrity of the management is unknown and yet to be proven.  In the absence of a track-record, those wishing to buy into this stock should treat this more a speculation rather than an investment as defined by Benjamin Graham.

An additional note on valuing this stock.  When the price of a stock is low, all the valuations matrix look very 'beautiful'.  This is something one should beware and take note of.

Always invest into quality company and a good management.  In the absence of these, move on to another stock; don't even bother to value the stock.

Investing Money in Plain English (Video)

Shouldn't retail investors be wary of IPOs?

Legendary investor Warren Buffett is wary of IPOs. Shouldn’t retail investors walk his path? 

It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller to a less-knowledgeable buyer,” Buffett reportedly said on IPOs. 


But why did majority of the IPOs fail to deliver? The usual answer from the companies and bankers will be “that’s the way market is”.Although there’s no single reason, a dominant one is the pricing as sellers try to get the maximum, which, at times may be even higher than their traded peers by sugar-coating prospects. Broadly speaking, the companies that debuted with high valuations compared to their listed peers failed miserably. 


Most of the IPOs failed to deliver simply because they were priced too aggressively.  Besides the company specific reasons, the common factor among them was their high price to earnings (P/E) multiple that they were asking. 

Why I usually avoid IPOs

Monday, 29 March 2010

A quick look at Kelington Group Berhad KGB (ACE)

Kelington Group Berhad Company

Business Description:
Kelington Group Berhad. The Group's principal activities are providing engineering services and general trading. It provides UHP gas and chemical delivery systems solutions that comprise of products and services, such as system design and installation, gas and chemical industry equipment, control and instrumentation, QA and QC, as well as maintenance and servicing to various foundries and clients who require UHP gas or chemical delivery systems in Malaysia, the People's Republic of China, Taiwan and Singapore.

Stock Performance Chart for Kelington Group Berhad

Current Price (3/26/2010): .74
(Figures in Malaysian Ringgits)

Wright Quality Rating: LBNN

The ratings consist of three letters and a number. Each letter reflects a composite qualitative measurement of numerous individual standards which may be summarized as follows:
A = Outstanding; B = Excellent; C = Good; D = Fair; L = Limited; N = Not Rated.

This is a recent IPO (November 2009).  
Probably better to avoid IPO in general.
Its longer term profitability and growth have yet to be established.  
Can relook after a few years when its business track record can be better assessed.

A quick look at KGB.
Once again, it is not easy to assess a newbie company.

Investors to be all ears at PM's address

Published: 2010/03/29

The two-day Invest Malaysia conference, beginning tomorrow, will most likely hog the spotlight of market-moving news flow this week.

It has traditionally been the stage where investor-friendly policies are announced by the government, while corporate chieftains strive to sell their story to fund managers attending the event.

Prime Minister Datuk Seri Najib Razak's keynote address will be the highlight, and he is expected to unveil the first stage of a new economic model.

Investors are also looking forward to more information on the next privatisation wave, in which the government is said to have identified companies that it may sell its stakes in later this year.

The anticipated details on this front will likely generate more excitement in the immediate term.

But how the government plans to reform Malaysia's economic structure is crucial to win over investors, especially after the disappointing twists in some previously announced policies.

"While the Najib administration undoubtedly exceeded our expectations in 2009 by announcing various reforms that required strong political will, of late, the pace of reform seems to have slackened," OSK Investment Research noted.

The stockbroker pointed out the scrapping of the proposed tiered fuel subsidy and the delay in a decision on the power tariff increase as well as the second reading of the Goods and Services Tax (GST) Bill in Parliament.

"We believe these developments may give rise to concern among foreign investors that there might be a potential slowdown in economic reform, thus making Malaysia less of an attractive investment destination," OSK said.

Last week, water-related stocks were in the spotlight after Gamuda's 40 per cent-owned subsidiary, Syarikat Pengeluar Air Sungai Selangor (Splash), made a RM10.8 billion offer to take over the Selangor state government's water-related assets and operations.

Bank Negara Malaysia's raised projection of economic growth this year of between 4.5 and 5.5 per cent provided some cheer.

The local stock market will likely face some volatile times ahead, OSK said. While corporate earnings reports in the fourth quarter of last year proved surprisingly strong and spurred a rally early this month, fears of a contagion effect from Greece's budget deficit problems, concern over interest rate movements in China and perceived risks of a possible slowing of reforms back home saw the benchmark FBM Kuala Lumpur Composite Index first rally some 58 points by March 10, only to give back more than half of it over the following weeks.

In view of the volatility, OSK said, investors should be cautious on cyclical blue chips. It advised investors to shift some of their portfolios to more-defensive big-caps, such as higher-yielding utility and gaming stocks like Tanjong, PLUS, Petronas Gas and Berjaya Sports Toto.

"At the same time, we do not advise total avoidance of small-caps. Indeed, the volatile market could provide ample opportunities to trade small-caps. We continue to advise trading in small-caps in the construction (particularly with exposure to Sarawak), steel, rubber glove and healthcare sectors. We believe the market may swing between the 1,250 (15 times price-earnings multiple) and 1,400 (16.5 times price-earnings multiple) levels for the next four to five months," the broker said in a market strategy report last week.

PM's Hong Kong visit eye-opener for investors

CREDIT Suisse group is forecasting a more bullish outlook for Malaysia with a gross domestic product of 6 per cent this year compared with Bank Negara Malaysia's (BNM) estimate of 5.5 per cent.

It also expects more senior investors to come to Malaysia for in-depth research on local listed companies following Prime Minister Datuk Seri Najib Razak's address at the Asian Investment Conference in Hong Kong last week.

"They now better appreciate that he is a prime minister who means business, but also respects the fact that he faces a herculean task in reforming Malaysia," said Stephen Hagger, country manager & head of equities for Credit Suisse in Malaysia.

He said that a key takeaway was that the prime minister understood what the market wanted, but has to balance that with socio-political considerations and getting elected.

"PM Najib's visit to Hong Kong served as a timely reminder to many investors not to forget about Malaysia," he said in response to questions sent via e-mail.

Credit Suisse is the number one institutional investor research company globally.

In Hong Kong, Hagger said he met several senior investors keen to come to Malaysia to "kick the tyres" or go the extra mile in doing company research after hearing the prime minister and realising that Malaysia was becoming "under-researched".

Najib last week met top-notch fund managers besides delivering a keynote address on Malaysia's attributes as an investment destination for equity and capital market investments and its ground-breaking economic reforms.

He also met Credit Suisse special adviser, Sir John Major, who moderated the luncheon address where Najib discussed Malaysia's economic transformation efforts to emerge as a high-income economy by 2020 and the soon-to-be unveiled new economic model.

Hagger said those who met the prime minister were surprised on the upside, particularly with regard to his openness and frank answers to questions.

Asked about concerns about investing in Malaysia, he said there were only a few well-capitalised stocks on Bursa Malaysia, while fund managers needed large and liquid stocks, so that they could buy or sell a position in one day.

"Malaysia has few such stocks and is competing for capital and 'air time' with the larger more liquid North Asian markets," he said.

Fund managers are also looking for well-managed companies, he said. 

However, he said the government has achieved considerable success with the government-linked companies' reform programme in scaling down equity in listed entities, particularly at Khazanah Nasional Bhd, the government's investment arm.

This has been followed up by the beginnings of a "selldown" by Khazanah, which should improve the liquidity of those stocks.

He cited how there was clearly a potential conflict of interest in the government owning controlling stakes in both Malaysia Airlines and Malaysia Airports Holdings, when there was no regulator to ensure "fair play" with other airline operators.

Hagger said Malaysia was struggling to stay relevant as an investment destination for global fund managers primarily due to size and liquidity, but also of course, valuation.

"We notice that the foreign ownership of the Malaysian market has fallen significantly and the number of visits by foreign fund managers has dwindled."

He said the annual Credit Suisse Asian Investment Conference was a great forum for companies, governments and investors to meet, whereby there were about 270 companies from around Asia, including 16 companies from Malaysia, meeting some 2,000 fund managers from around the world, including several from Malaysia.

In addition, working with CIMB, "we are proud to have "showcased" the prime minister and several Malaysian companies in New York last year."

"We have also assisted the three regulators - Securities Commission, Bursa Malaysia and BNM - to meet fund managers overseas.

"Unfortunately, some company chief executive officers take investor relations more seriously than others," said Hagger.

Hagger said Malaysia's problems looked very easy to fix "when you are sitting behind a desk in Boston".

The reform of the "30 per cent Bumi listing rule" would have been perceived as a "no brainer" by many foreign fund managers, who probably failed to appreciate that it was an incredibly brave step by the prime minister, he said.

"I believe that is why Prime Minister Najib took such pains to explain that ... he understands what the market wants, but he has to balance that with getting his party re-elected," he said. - Bernama

Undervalued good quality stocks in KLSE

Is KLSE over-valued?  What is KLSE market PE?

The historical market PE is around 10 to 20, averaging 15 over the long term.   With the KLSE index at 1312.48 recently, the  market PE was 19.23  (Source: iCap website).   This market PE was at the upper end of the normal market PE range.  The index-linked counters are probably trading at fair or high value. 

However, if one were to browse through the stock section of our local papers, there are still many stocks trading below ttm-PE of 10.  Many stocks maybe priced such due to lack of 'popular support' or 'neglect'.  They maybe 'fallen' stocks.  Amongst these, there are good quality stocks that are undervalued even in the present market.

If you discover any gem(s), please share here.  

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