Picking Stocks in Bursa, Margin of Safety Investing works safely kcchongnz

“There are many areas in valuation where there is room for disagreement, including how to estimate true value and how long it will take for prices to adjust to true value. But there is one point on which there can be no disagreement. Asset prices cannot be justified merely by using the argument that there will be other investors around willing to pay a higher price in the future.”      Prof. Aswath Damodaran,

In the last consecutive three days, I have been burning midnight oil to write three articles on value investing strategies in Bursa. The first one shows that simply buying cheap stocks with low price-to-earnings ratio worked well with an annual excess return of 6.8% over the broad market for 5 years.
http://klse.i3investor.com/blogs/kcchongnz/75946.jsp
By incorporation of some “goodness” of the companies such as high return on equity, good cash flow, good dividend yield and healthy balance sheet, or using the ColeEye 5 yardsticks, the return was greatly amplified with an excess return of 101% over the last two years.
My second article on value investing in Bursa shows that just buying the stocks of good companies at not-too-expensive-prices also worked well with an excess return of 37.2% over the same two years period.
http://klse.i3investor.com/blogs/kcchongnz/75962.jsp
Then the last article posted yesterday shows that by considering the “cheapness” in terms of Enterprise value / Earnings before interest and tax multiple of the stocks to the “goodness” of the companies in term of ROIC, or return on invested capital, the return is greatly amplified with an excess return of 97% in the two year period from May 2013 to end of April 2015.
http://klse.i3investor.com/blogs/kcchongnz/75985.jsp
More importantly, the second and third strategy described above show that there were very few losers, and the loss of the losers were minimal, generally in single digit, whereas most winners are in tenths and many were multi-baggers. Hence they can be considered as low risk investing strategies.

Valuation Matters
The above analysis tell us that in order to have a better chance of earning good return from the market, we first need to identify if a company is a good company before we even consider if we should invest in it. A good company as we have learned has a business of high margins related to its peers and the industry, a healthy balance sheet so that there is little risk of bankruptcy in economic downturn, and plenty of cash flow and free cash flow. A good company should have high return on capitals and higher than its costs. A good company should have a healthy and sustainable growth etc.
However, a good company doesn’t mean it is a good investment. This is because you could purchase the best stock in the world, but if you buy it at a lofty premium, it is a bad investment. Vice versa, the stock could be the worst company in the world, but if bought it cheap enough, it could work out to be an excellent and profitable investment. The question is how would you determine if the stock is cheap?
Seth A. Klarman in his book “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor” stated that, “To be a value investor, you must buy at a discount from underlying value. …. While a great many methods of business valuation exist, there are only three that I find useful.” (Margin of Safety, pg. 121).
The three methods Klarman was talking about for estimating the value of the stock are:

1. Net Present Value Analysis
2. Liquidation value
3. Stock Market Value

Let us examine the return of a real portfolio invested in Bursa using this value investing strategy; i.e. buying stocks at a margin of safety from its intrinsic value, up to 30^th April 2015. Again, I used this portfolio as an example for various reasons. Firstly, it is my portfolio, my own experience investing in Bursa for the last two years with a public record in i3investor. I track my own portfolio, not others. Secondly this portfolio was published by a third party, a regular contributor in i3investor named Tan KW when it was formed on 1^st August 2013, purportedly as a stock pick challenge for the second half of 2013.
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/blidx.jsp
There were only two portfolios then in the “challenge”, the other one was put up by another regular contributor here, Mr. Ooi Teik Bee, unlike scores of them in the latest “challenge” organized by Tan KW. The competition has really become very keen now as there are more savvy investors now, making very high return in just 4 months. It is a good sign.

My portfolio of Margin of Safety Investing
The portfolio consists of a diversified portfolio of 11 stocks in Consumer Products, Industry Products, Constructions, Property Development, Trading & Services, and Technology as shown in Table 1 below. The prices are adjusted for all corporate exercises and dividend payments as obtained from Yahoo Finance website.
All my stock picks came with detail reports and analysis on growth, margins, returns on capitals, cash flow, balance sheet, etc. In valuations, the Stock Market Valuations (item 3 above) such as PE ratio, P/B, P/Cash flow were used for almost all the stocks picked. Discount cash flow or net present value analysis (item 1 above) was also extensively used with the margin of safety calculated as shown in Table 1. Liquidation value was used for Daiman Development Berhad, or more specifically the modified method of Graham net current asset value. All analysis and reports can be viewed from the following the link below.
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/blidx.jsp

Return of Portfolio of Stocks with Estimations of Intrinsic Values
The table below shows the average return of the 11 stocks is 76% with a median return of 45%, compared to the total return of 7.7% of KLCI from August 2013 to end of April 2015, or a period of one year and nine months. The return of the portfolio is 10 times that of KLCI of 7.7% during the same period. The excess return is a 69%. RM100000 invested in this portfolio on 1^st August 2013 becomes RMRM176000 now, compared to RM107700 if invested in the top 30 stocks in Bursa.
Table 1: Return of Margin of Safety Investing

This time, there are four underperformers as shown in the Table 1 above; Tien Wah -15%, Haio -4.1%, Daiman -3.2%, and Kumpulan Fima 6.3% compared to the 7.7% of KLCI. The seven winners all outperformed KLCI by very wide margin. Datasonic and Homeritz provided outsized return of 342% and 221% respectively, and both of their share price has exceeded their intrinsic value computed at that time. The other stock which exceeded the original intrinsic value is Willoglen as shown with a total return of 73%. The share prices of the other stocks are still far from their intrinsic value estimation then.
Once again the return of the portfolio exhibits the Dhandho Investor characteristics,
“Had I win big, tails I don’t lose much”

Valuation is an Art

Valuation is more of an art than a science. All valuation methods involve choices of data and assumptions. Each valuation method may only be suitable for certain type of companies, with its individual strengths and weaknesses. None of the valuation methods is infallible. However, they are the best of what we got. Frequently investors will want to use several methods to value a single business in order to obtain a range of values. In this case investors should err on the side of conservatism.
Without knowing the estimated value of a company or stock, I just find it extremely difficult to make the decision of whether to invest (read not punt) in that stock or not, even though it is a great company. Hence I strongly believe that knowing some valuation methods is essential to improve the investing experience of an investor.
Are you keen to learn some valuation techniques in order to have a higher probability of success investing in Bursa Malaysia?
Please contact me at the following email address
ckc15training2@gmail.com

K C Chong (5th May 2015)