I have provided ample evidences that value investing has worked in the most matured market in the world, the US market, in the past, and it continues to work, as shown in the link below.
More importantly, does value investing work in our Bursa Malaysia? What are the evidences?
Value investing in Bursa
Unlike the US market, there is little research done on the return of stock investing in Bursa using value investing strategies which we can rely on to provide evidences of any extra-ordinary return using these strategies. We do know there are some super investors in Malaysia such as Dr Neoh Soon Kean and Mr Fong Si Ling (Cold Eye 冷眼).
Dr Neoh, an academician, worked as a lecturer in University Sains Malaysia. He was an investment adviser for firms and individuals. He is an established but remains as a low profile value investor, emphasizes more on earnings and dividend yield.
Mr Fong was a reporter for 30 years, and he acquired his value investment skills through self-learning and experience, reading every annual report of companies he invests or intend to invest in. He emphasizes on investing in stocks as investing in businesses and the need of established earnings and cash flows for companies he invests in. Basing on his proven value investing strategy, he has built up a sizable wealth, all from the stock market. He has shared his valuable investment methods and philosophy with the investment community, but like Dr Neoh, he prefers to be in low profile and avoiding the limelight.
As it is difficult to find evidence of the success of value investors in Bursa, I will use some data myself from my experience to try to provide evidence on the success of value investing in Bursa. I will start off with the 5 yardsticks of investing from Mr Fong, or ColdEye.
The Five Principles of ColdEye
In one of his presentations given to the public on 16th March 2013, Mr Fong listed his 5 principles in investing. Rather he emphasized that investors should look out for this 5 things before he invest in that stock:
1. Return on equity, ROE,
2. Cash flows
3. PE ratio
4. Dividend yield and
5. Net tangible asset backing per share, NTA
Explanations of the 5 yardsticks of Cold Eye
Based on that talk, I wrote an article in i3investors giving my thoughts on what the above mean in the link below, and provided some of my own yardsticks for measuring them as shown in the link below.
- Return on Equity (ROE)
If you invest RM100000 in a business, you would want to have a reasonable return from your capital, or equity you put in. A business is risky and probably you may want a minimum return of say 25%. For investing in the share market, you may want a minimum return say 10%, 6% above the return you get from bank deposit. If the business only returns you 4%, why would you want to invest in it when you can get that rate from bank fixed deposit without having any worry at all?
ROE is one of the most important profitability metrics. ROE reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet. If you think back to lesson on the balance sheet, you will remember that shareholder equity is equal to total assets minus total liabilities.
Mr Fong mentioned that companies customary retains a portion of their earnings and the equity base grows with it. The test of efficiency of the managers in managing the business is whether they can return a high ROE from the money retained in the business, not if the earnings grow or not. He mentioned that this metric has become his most important yardstick in determining if a stock is good to invest in and he will not invest in a company with low ROE.
2.Cash Flows
Mr Fong mentioned that cash flow is the next important metric in his investment. In your business, you would expect that all your debtors pay you promptly and that you don’t have to stock up a lot of inventories which will tied up your capital. Otherwise you would have to put in more capital, or borrow more money each year even though you appear to make money. I would expect the hard cash I can received must be about the earnings I make each year or even more as the expense item on depreciation in the income statement is not a cash outflow and hence are added back to net profit to get cash flows from operations.
My business would also require capital expenses each year to keep it going, better growing bigger so that I would earn more in the future. This I would need to buy more and replenish the equipment, buy or open more shops etc. It would be ideal if these expenses can be met with the cash I receive each year and not having to come up with more of my own money or borrow from bank. After that, I would be happy if there is still money left for me to draw out (as dividend), or the company can have extra money to invest in other lucrative business. This money available after all the Capital expenses is termed as free cash flow, or FCF. It is this FCF from which dividends are paid out by companies.
As FCF is hard cash left after all expenses including capital expenses, I would be happy if the FCF is more than 5% of the revenue I am doing. FCF of more than 10% would be fantastic.
3. PE Ratio
A good business as shown by high ROE and good cash flows may not be a good investment. It all depends on if the price is right. If the above business make a lot of money, say 30000 a year, or 30% (30000/100000), would you buy it if the asking price is 1 million, or a PE of 33 (1000000/300000)? This will give you an earnings yield (1/PE ratio) of only 3%. This yield is lower than bank fixed deposit, and why would I want to invest in a risky business with that meagre return, unless it has huge earnings growth in the future? Hence a good business does not mean it is a good investment if the price, as measured by PE ratio, is too high.
As an investor, I am willing to pay a price of no more than 15 times earnings for a normal growth company, and may be up to a PE ratio of maximum 20 for a light asset and high growth company.
4. Dividend Yield
“A stock dividend is something tangible-it is not earnings projection; it is something solid, in hand. A stock dividend is a true return on the investment. Everything else is hope and speculation.”
Richard Russell
How nice it would be if the business earns enough for me to draw down 10,000 a year consistently. For my dividend yield would be 10% (10000/100000), or 2.5 times that of FD rate of 4%. Besides, my business may still be growing and would provide me with higher dividends in the future. Hence many investors looking for regular income emphasize on dividend yield. In actual fact, dividends are the “real” return provided to investors as they are given out as cash, in oppose to the illusive earnings, or net profit. A dividend yield comparable to fixed deposit rate will be good.
5. Net tangible asset
“A healthy Balance Sheet is akin to a healthy lifestyle, it gives the best chance of avoiding a damaging illness, namely a financial crisis.”
Well if at the end if I want to exit from the business, if the net tangible asset of my assets worth more than what I put in, or more, I can recoup my initial investment. These assets must of course the more valuable the better, for example hard cash, property and land etc., rather than some money which I have been arguing with the debtors whether they are going to pay me or not, or some inventories which are outdated, or a worthless “Goodwill”.
“Take care of the downside, and let the upside takes care of itself”
Hence NTA is important too and I generally won’t pay a price more than one and a half times its NTA. In some businesses, example the service industry, technology companies and other light assets industries, there are valuable intangible assets such as their people, technology or brand names which are not reflected in the NTA.
The 5 yardsticks of Coldeye investing strategy is a very intuitive and powerful strategy. It invests in good companies, companies with high ROE and good cash flows when they are selling cheap at low PE ratio, low Price-to-NTA, and high dividend yield.
Return of stocks using the ColdEye 5 yardsticks
After my above post was published in i3investors, it received good response and constructive comments from many forumers. Many of them asked me about if their stocks meet the Cold Eye 5 yardsticks. These are all well documented in this thread in i3investor here:
Table 1 in the Appendix shows 9 stocks met the criteria above and were chosen as good investing candidates at about the time on 17thMarch 2013 basing on the ColdEye’s 5 yardsticks. The return of these stocks were compared to the broad KLCI after two years and seven months as shown in Appendix.
As on 30th October 2015, the average total return of the portfolio of 9 stocks chosen is 270% in about two and a half years, with the median return of 58%. This return way out-performed the total return of 8.6% of KLCI over the same period.
There are only two stocks, APM, and MBL, making relatively small single digit negative return and they are the only stocks which underperformed the market. A number of stocks over-performed the market by wide margins. Latitude returned 804%, Prolexus 776%, Liihen 640%, Willow 120% and ECS ICT 58%, during the same period.
The characteristics of the return of this portfolio basing on the ColdEye 5 yardsticks strategy are summarized as below:
- Most stocks, seven out of nine, or about 70% outperformed the broad index.
- The underperformers underperformed marginally against the market; a negative return of just 7% for both under-performers, indicating it is a safe investing strategy.
- The average total return of the portfolio outperformed the broad KLCI index by very wide margin; 270% versus 8.6% during the same period. Similarly, the Median return of the portfolio of 58% also way above the return of the broad market.
- This show the Coldeye 5 yardsticks, though a safe investing strategy, can sometimes provide outsized return.
- There isn’t a criterion on the requirement of growth on revenue or profit for the 5 yardsticks, though some of the stocks “accidently” become growth stocks. That means you don’t pay for growth, or rather growth comes free of charge.
Can we make use of this strategy to see if Perstima, a stock which I have written in the link below fits the criteria of the Coldeye 5 yardsticks investing strategy?
Perstima and the Coldeye 5 yardsticks
I have written an article articulating the use of dividend yield investing strategy propagated by Dr Neoh Soon Kean. I have also used a dividend discount model to estimate the intrinsic value of Perstima and found that there is a wide margin of safety investing in its stock at the present price of RM5.04 in the link above.
Here we will use the Coldeye 5 yardsticks for the assessment of the financials of Perstima to see if it meets the criteria as an investment candidate as shown in Table 1 below
Table 1: Coldeye 5 yardsticks for Perstima
It is shown in the Table above that Perstima meets all the criteria of the Coldeye 5 yardsticks as a good investment candidate. The metrics obtained for cash flows and dividend yields in fact way excel the given criteria with abundant cash flows and free cash flows, and very high dividend yield of twice the criterion.
Conclusions
The ColdEye 5 yardsticks appears to be an attractive investing strategy in Bursa which can provide potential high return with limited downside. The metrics are easy to use and can be quite easily extracted from the three basic financial statements.
Perstima meets all the criteria stated and hence appears to be a good investment candidate based on the Coldeye 5 yardsticks investment strategy.
Please contact me for any suggestion or query at
K C Chong (1st November 2015)
Appendix
Table 1: Stock return from the Cold Eye 5 yardsticks at on 30th September 2015
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