How do normally people talk about stocks in forums? How do people normally “invest” their hard-earned money? Let us go and view a thread in i3investor and see what they say.
“Go..go..go.....tp 20c ...tomolo “
“13cents maybe will consider, 0.155 i don't dare to pick up”
“vsolar broke 0.165 strong support will extended drop to 0.10 “
“0.175 block sudah hilang..but 0.165 still makan tak habis.. “
“0.17 now... unload while u still can before drops to 0.15-0.16 “
“When is a good time to buy? @ 0.2? 0.18? 0.15? “
“Rebound! Rebound! Rebound”
“TA also weekly chart also shooting star and bearish engulfing,,that mean next week will extended drop...”
Did they talk anything about the business? Isn’t investing in a stock investing in part of a business?
Let us look at some research reports from investment banks
Maybank Research on Tan Chong
- 1Q15 earnings above our expectation, below consensus.
- Raise our FY15-17 net profit forecasts by 18% p.a., TP by 1% to MYR3.45 (+1%) on unchanged 0.8x FY15 NTA peg.
On Perisai
- 1Q15 results in line, but 1st rig may succumb to rate cuts, while delivery of 2nd rig is likely to be delayed till end-2015.
- Cut 2015/16/17 net profit forecasts by 50%/36%/17%, largely on lower profits from rigs operation.
- Downgrade to SELL; TP lowered to MYR0.42 (-35%), based on 7x 2016 PER (unchanged).
Valuing Tan Chong based on its net tangible asset (NTA)? Valuing Perisai based on 7x 2016 PER, or price-to-earnings ratio. Why 7, and not 8, 10, 15, or even 30? Why based on 2016?
Has any of these analysts run a business before? Do you agree that investing in a stock, unlike speculating or punting, is about investing in part of a business?
Many may argue with me that they have made a lot of money from the stock market following the above methods or “strategies”, and no necessity to understand a business, but what I know from academic research is to the contrary. And being a person who have done academic research before, I do know academic research is very rigorous, unlike wild claims. The link below shows some research about the outcome of individual investors speculating in the stock market.
And what is wrong in all those analyst reports above?
What is important in a business?
I have worked in the construction industry for many years. The last 12 years I was working in a well-known public listed construction company, mainly doing deep foundation works. Before I was posted to take charge of an overseas wholly subsidiary company, I used to hear good financial performance of this subsidiary company; that they have a lot of huge projects and making a lot of profit, a company with profit growth every year. At that time, I know nothing about accounting and finance. I didn’t know why the financial controller and the finance director in the Headquarter were not happy about the performance of that company, because the head office had to constantly remitting money there. Eventually those key people in-charged were kind of forced to resign.
When I was posted there to take charge of the office, I encountered a lot of problems. Yes, there were a lot of profit in almost every project, but the clients of almost every project seemed to owe us a lot of money. The truth was there were delays in many of those projects for all kinds of reasons. We were claiming for a lot of variation works, unforeseen different ground conditions, delay in issuing of construction drawings, additional costs and loss of profits for delay allegedly due to the client or the consultant’s faults. The other sides were accusing us delaying the work and problems in the work and slapped us with additional works done by third party, and liquidated and ascertained damages (LAD) for delay. Who was right and who was wrong?
So in our book, we have these revenues and profits of additional claims, additional works, but no LAD allowed, of course. We had a lot of profits, profit hidden in uncertain claims, in receivables which were highly arguable. Contractors are always burdened with all these problems, not a nice place to be in.
So we had profits and profit growth, lots of them, but no cash as the clients don’t pay. In fact they asked money from you because you delayed their projects, causing them to lose money for not able to hand over the site to their building contractors and hence delay in the completion of the projects.
So to me in construction, as well as in any other business, cash is king, not profits, nor profit growth, not PE ratio, ROE. The success of a business hinges mainly on its ability to generate cash, and grow internally with the cash generated internally. Even if you talk about profit, it has to eventually shown in real cash. No company can sustain its growth without eventually getting cash from the business.
Look at those high growth companies without generating cash as discussed in this thread here:
How have their share prices performed in the long-term? Need I say more?
Why is cash important?
A business needs to pay all the expenses such as administration, marketing, workers, plant and equipment, materials etc. to produce goods and services. After deducting cash to pay for all these stuff, and sold or executed the services and receive cash, you get some cash left over from the operations, termed cash flows from operations (CFFO). In order to fund growth, the company also needs to spend some cash to buy new equipment, upgrade its fleet of plant, or what we termed capital expenses, capex. What is left then is the free cash flow (FCF) in the year. Without this FCF, there is no money for distributing dividends to shareholders, to invest in other profitable ventures, pay down debts, or buy back shares when they are selling cheap.
Of course a company can resort to issue new shares, borrow more money from banks to fund all these stuff. Many of those high growth companies in the link above did just that. However, issuing more shares dilute your interest in the company. Borrowing more needs to pay more interest. Worse it becomes more risky in time of economic downturn when banks may show no mercy in recalling back their loans in the worst timing. Has any analyst tell you about these?
Let us look at two construction companies listed in Bursa which I happen to be more familiar with, Pintaras Jaya Berhad and Kimlun Corporation Berhad.
Cash flow of Kimlun
Table 1 shows that Kimlun has consistent profit for the last 5 years. It has a good profit growth of about 8% a year for the last 4 years too.
Table 1: Cash flow for Kimlun
| Year |
2014
|
2013
|
2012
|
2011
|
2010
|
Av 5-yr
|
| Net profit |
49182
|
35476
|
49222
|
42676
|
36559
|
42623
|
| CFFO |
82714
|
-17671
|
-60228
|
-38536
|
37012
|
658
|
| Capex |
-18088
|
-37172
|
-75589
|
-12080
|
-20792
|
-32744
|
| FCF |
64626
|
-54843
|
-135817
|
-50616
|
16220
|
-32086
|
The problem is, especially for the three years from 2011 t0 2013, there were negative CFFO, meaning that the company has to fork out money from somewhere to fund its operations, or not enough cash collection to pay for administration expenses and working capital requirements. FCF during those three years was at a total negative of 240m, meaning that the company had to find 240m somewhere else in those three years, just to keep its doors opened. In the last 5 years, cash received just barely enough for its operations. But what about cash needed for capital expenses, paying dividends etc.?
A look a t its balance sheet tells the story as shown in Table 2 below.
Table 2: Balance sheet of Kimlun
| Year |
2014
|
2013
|
2012
|
2011
|
2010
|
2009
|
| Share capital |
150281
|
120225
|
120225
|
114500
|
114500
|
82500
|
| Total debts |
179080
|
235126
|
161439
|
65025
|
31109
|
45878
|
| Cash |
86103
|
32128
|
36334
|
81653
|
111217
|
68013
|
| Net cash |
-92977
|
-202998
|
-125105
|
16628
|
80108
|
22135
|
Kimlun has to do just that; issuing more shares and borrowing more money each year. The share capital, or the number of shares, has almost doubled from 82.5m to 150m in the last 5 years from rights issues and private placements, diluting the earnings per share. Total borrowings from banks has increased by 4 times from 46m to 179m. It is all the bad news. The good news is it has improved considerably in the recent year in 2014. This is due to none other than improved cash flow. The question is will this sustain the next year. It has to if it wants to survive. That is how I see it.
Cash flow of Pintaras
Table 3 below shows the profit and cash flow of Pintaras Jaya for the last 5 years. You can see a total different picture.
Pintaras net profit grows by 27% a year from 2010 to 2014. Its CFFO grows in tandem, the same can be said about its FCF, despite its heavy capital expenses for growth.
Table 3: Cash flow of Pintaras Jaya
| Year |
2014
|
2013
|
2012
|
2011
|
2010
|
Av 5-yr
|
| Net profit |
54238
|
52317
|
42149
|
25682
|
20737
|
39025
|
| CFFO |
63300
|
49090
|
54592
|
24353
|
12848
|
40837
|
| Capex |
-33874
|
-8233
|
-20230
|
-30291
|
-10056
|
-20537
|
| FCF |
29426
|
40857
|
34362
|
-5938
|
2792
|
20300
|
How does this good cash flow impact on its balance sheet?
Table 4: Balance sheet of Pintaras
| Year |
2014
|
2013
|
2012
|
2011
|
2010
|
2009
|
| Share capital |
160128
|
160128
|
160128
|
160128
|
160128
|
160128
|
| Total debts |
0
|
0
|
0
|
0
|
0
|
0
|
| Cash |
168721
|
155459
|
122429
|
101741
|
97331
|
94892
|
| Net cash |
168721
|
155459
|
122429
|
101741
|
97331
|
94892
|
The share capital doubled from 80m to 160m from a one-for-one bonus issue capitalized from its retained earnings, not as a rights issues and hence did not dilute the interest of the shareholders. It needs not borrow any money from the banks as the cash it receives each year, after spending to buy more machineries for growth, still left a lot in its balance sheet, after paying increased dividend each year with a dividend yield of about 5% each year. Need I say more about this?
Figure 1 in the Appendix shows the relative share price performance of Pintaras and Kimlun for the last 5 years. A picture paints a thousand words.
Conclusions
It is entirely possible for a company to generate “profits” while operating at a cash loss. But take heed. Businesses don’t grow because of profits. Vendors don’t take “profits” in lieu of cash payments. Owners don’t make money with “profits”.
Success in a business, growth, stability in business all come down to one simple thing: Cash.
Why your advisers or the analysts aren’t tell you all these? Why don’t you take heed on that?
K C Chong at ckc15training2@gmail.com
Appendix
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