Do you have any No-Brainer Investment?
“The price you pay determines your rate of return” Benjamin Graham
The problem with a No-Brainer Investment (NBI) is that most people won’t agree with you. That is also the reason why it is a No-Brainer in the first place. You must be comfortable and confident about it.
When Insas Preference Share PA, face value RM1.00 with coupon, or interest rate of 4%, was first listed a couple of months ago, its price went down to below 80 sen. At 80 sen, the cash yield (interest/price) was 5%. That fixed cash yield is more than 25% of what you can get from fixed deposit from banks. Insas PA can also be used as a RM1 cash for conversion of Insas warrant to Insas mother share, at your option within the next 5 years. Moreover, Insas share itself is already way undervalued. Please read all the analysis on Insas, its warrant and preference share in the link below:
For me, buying Insas PA at 80 sen at a cash yield of 5%, or a potential cash return of 30% with little risk if it is viable for you to use PA as RM1 cash to convert the warrant to Insas share, say within a year, is a NBI. There is plenty of margin of safety. A NBI just jumps out at you. You don’t need to do much math. This is just an example and that is already history. We must look forward; how we can make good return with little risk in the future when investing.
Move over Earnings, make way for Cash
Most investors use, if they ever use at all, the price-to-earnings ratio (P/E) to measure the value of a company. Even almost all investment bankers and analysts do the same. By dividing the market price by earnings, you can get an easy-to-understand measure of a firm's value and a simple way to compare different companies to each other. Flip the ratio over, you get E/P, or what is termed earnings yield. This you can use to compare with the return of alternative investments such as bank interest rate.
But there are hell lots of problems with the “E”, the accounting earnings. As you all know, accountants are some of the most creative people on earth. This “E” can mean anything. The link below explains some of the problems with this “E”, and the associated P/E ratio.
In the example above on Insas PA, what you will receive is hard cash, not the obscure earnings. Similarly for investing in a company, we want to see cash as businessmen do, specifically free cash flow as explained in the link below:
A NBI is one which provides you with a cash yield of double, triple, or more the cash you can get from a bank fixed deposit interest, in a consistent manner.
What is Free Cash Flow Yield or Cash Yield?
Like interest rate, cash yield (CY) for investing in a stock is simply
CY = Free cash flow (FCF) / Price,
Price is the market capitalization (MC) of a company, P = share price * no. of shares outstanding
What is free cash flow then?
Cash flow from operations and free cash flow
In my last article, almost all comments given talked about “Cash” as cash in the balance sheet, despite my lengthy article explaining about cash flow; cash flow from operations and free cash flow. Well can’t blame them as their remisiers, investment bankers and professional analysts don’t tell them what those stuff are. In actual fact, this stuff is not difficult at all if you pay some serious attentions to it.
Cash flow from operations (CFFO) is the money, hard cash, a company brings in from ongoing, regular business activities, such as manufacturing, construction and selling goods or providing a service in a particular period. It is calculated from the difference of cash received from customers and cash paid to suppliers, and then deducting tax to the government. It doesn’t include the cash received from interest income, dividend or any cash received from other investments. Net CFFO is obtained after paying interest to lenders, and this is the net CFFO attributed to the shareholders of the company.
Free cash flow (FCF) is what is left from CFFO after spending capital expenses (Capex) for maintaining the ongoing business, or expenses for growth of the ordinary business such as building new or upgrading the production lines, open up more similar shops for business etc.
FCF = CFFO – Net Capex
It is this FCF that company uses to distribute dividends to shareholders, to invest in other profitable ventures and produces more cash for the company, pay down debts and hence save money from paying loan interest, or buy back shares when they are selling cheap and increase the cash attributed to shareholders with less shares outstanding, without resorting to borrow more money from banks and as a result making the company risky in times of economic downturns, or issuing more shares and hence diluting the value per share of the company. Profit, profit growth do none of these things without receiving the hard cash.
The FCF year-to-year is normally lumpy for most companies except for those stable and matured businesses because things like working capital requirement and capital expenses are not consistent and they vary a lot year to year. So use the average of a few years’ FCF as the numerator to be more representative. We generally prefer to see the trend of FCF to be growing in the long-term.
“Don’t worry about precision math; focus on precision strategy”
So now CY (FCF/MC) is comparable to the earnings yield (Profit/MC) above, except that it is a much better ratio as it focus on hard cash, not the obscure accounting earnings. Companies that have a wide moat and trade at a CY higher than fixed income return are generally good potential as investments.
Investing in stocks with high cash yield in Bursa
Invest in companies when they are selling cheap is actually intuitive, especially when you measure it in hard cash term, i.e. the cash yield. I actually have not specifically used this strategy in Bursa although I discussed about it often. However, we can just do an academic exercise and see if this could be a viable investment strategy using my longest portfolio of stocks set up more than 2 years ago.
“Posted by truthseeker1 > May 14, 2015 08:45 PM | Report Abuse
As usual bias is prevalent in his blogs. Why only his counters got cash?”
This type of comment above will surface again. But this is my portfolio I know of well, and there are public record in i3investor. I can extract data easier from my spreadsheets. Otherwise which portfolio of stocks to use? Who is going to obtain the data for it? Let us just be patient and use my portfolio of stocks as a learning exercise. Ok?
Portfolio set up on 21st January 2013
Table 1 in the appendix shows the portfolio of 10 stocks set up on 21st January 2013 and their returns as on 30th April 2015. It was published by another forum member, Tan KW in i3investor. The prices are adjusted for all corporate exercises and dividend payments as obtained from Yahoo Finance website.
All 10 stocks in the portfolio except Kimlun (-1.2%), have positive total returns which vary from the lowest of 9.7% for Pantech to 421% for Prestariang for the last two years and three months. The average return is 113% with a median return of 74%, compared to 16.4% of the broad market during the same period. The excess return is a whopping 97%. RM100k invested in this portfolio on 21st January 2013 becomes RMRM213k now, compared to RM116k if invested in the top 30 stocks in Bursa.
7 out of the 10 stocks which outperformed the market were with cash yield varying from 4.5% for NTPM to 17.8% for ECS ICT. These CY were computed using average FCF over a 2 to 5 years period, depending on the data available. They are much higher than the bank interest rate of about 3% then. There are only 2 underperformer, Pantech at 9.7%, and Kimlun at -1.2%, and the underperformance of these 2 stocks were just marginal. Coincidently both the stocks were with negative FCF, and CY were negative then as shown in Table 1 in the Appendix. Pantech and Kimlun were traded at low PE ratio of 10 and 8 respectively. The only stock, Kfima with a very high CY of 14% didn’t outperform as expected.
Based on CY, we could generally conclude that high CY companies, i.e. buying companies cheap in term of cash return, is a No-Brain Investment (NBI).
No, a NBI is definitely not what they do here:
Conclusions
"Investment is most intelligent when it is most business-like". Said Warren Buffet
Business owners don’t make money with “profits”. Business can’t grow with obscure “profit” without FCF. Success in a business, growth, stability in business all come down to one simple thing: Cash.
This portfolio of stocks described in this article clearly shows that cash, or FCF, and not earnings, is king. Note this opportunity has past. We should focus in the future.
You know in the past those who shared and discussed their investing ideas with in i3investor in productive ways had produced some fantastic results as shown in the appended links here:
I got many excellent investment ideas from the above. So this time do you have any No-Brainer Investment to share here? Or you can email me for opinion, preferably with calculations on CY at
ckc14invest@gmail.com
K C Chong (17/5/15)
Appendix
Table 1: My Portfolio set up on 21st January 2013
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