Sorry fundamentals not my style haha. I'm more of a trader, using technicals and behavioural finance. I made 700% last year.]
In the stock market, we always hear about success stories like the above. They are glorifying and morale boasting. Seldom do we hear people telling us they have lost money investing/speculating in the market. It is demoralizing and not good for the self-esteem. People would look down on you and say that you have no standard, a loser etc. However, the fact remains that most people lost money in the stock market. In the above case, the same speculator actually lost two thirds of his bet since then until now with that particular stock. But he never mentioned it in anywhere now.
Let us assume we have a portfolio of two stocks equally weighted, one good stock and one bad stock. Over a period of say 5 years we made a profit of 200% for the good stock but we lose 100% on the bad stock. Our portfolio return would be 50% (50%*200% - 50%*100%). However, if we have two good stocks, one makes 150% and the other 50%. Our portfolio return would be 100%, twice better than the first one. That is because although the positive return is lower for each stock, we have no loser.
My basic principle in investing is always to be prudent;
“Focus on the downside and the upside will take care of itself.” Mark Seller.
If you can avoid losing money in any stock you buy which is not possible, but at least minimize the chance of losing money, half of your battle in investing is won.
What are some of the things to look for to guard against risks and minimize or avoid the downside?
Let us look at some of the hot Bursa stocks which some people in i3 forums asked me about three years ago when I posted a few threads on value investing.
I started to write about them as “A Christmas reflection of the pitfalls in investing in Bursa in 2013” on Christmas day 2013. I have updated them on the Christmas day in 2014 as “2014 Christmas Reflection of Pitfalls Investing in the Stock Market kcchongnz”. Subsequently I have written about them in a number of occasions in my blog,
Many i3investor forumers said these are boring and repetitive stuff. For me, they are interesting and there are numerous investing lessons we can learn from them. I believe a newbie in the stock market can learn much more from the pitfalls of investing and learn how to avoid and guard against them, for the reasons I have mentioned above, rather than listening to how much whom and whom have made in the stock market.
Return of portfolio and individual stocks
The portfolio has lost a total of 43% since about three years ago since I first wrote about them, while the broad market has gone up by about 10%, a negative alpha of a whopping 53%! Almost all the stocks incurred heavy losses up to more than 80%, with the heaviest losses in Hibiscus, one of the biggest hypes two years ago. There are only two “winners”; London Biscuits and KNM, up by 22% and 12% respectively since three years ago.
The three-year “winner” of KNM has actually lost a whopping 95% of its value at its peak about 10 years ago, while the other -68%.
Compared to their peak prices, half of the 9 stocks have lost over 90%, with the Median loss of the portfolio at 80%! Gosh, we are not even near any bear market yet.
What are the characteristics of these stocks which grossly under-performed and have fallen so much in prices from their peaks? How should we guide against these risks?
Characteristics of lemons
Characteristic 1 Hypes, rumours, fads and hopes
They are hypes, rumours and fades, and investing in them is based on hope.
Investing in Hibiscus is based on hope; hope of the opportunity to strike oil big while other bigger international companies are denied of that opportunity. Hibiscus share price was chased up by 80% from RM1.50 to RM2.70 in just four months from August to December 2013 just because of rumours that when or when the drilling machine would reach the destination, and when it started drilling, as if oil would definitely ooze out as soon as the drill rig is lowered. Its share price just jumped because they were given some licenses to explore oil in some countries, presumably they are more deserving than many other bigger and more established international oil exploration companies. Well, we are still in the dark when it will strike oil, but already many retail punters were spilling blood everywhere as its share price has dropped by 32% to RM1.84 in just three days just before the Christmas of 2013. It closed at 23 sen the last day of 2015. Those who have bought it at the peak of RM2.70 would have lost a fortune of a whopping 90% in just two years while the market is falt. Not a single drop of oil has been extracted yet.
Investing in Smartrack and Asia Media Group are also based on hope, hypes, rumours and distorted positive feelings; Smartag has been hoping that with their political connection, the Royal Customs Department would give them the ultra-lucrative contracts of RFID tracking the containers which eventually fell through. Asia Media has been hyping that its advertising in trains, LRT and buses would earn them extra-ordinary profits, which eventually did not materialize.
MP Corp is another company which investors live with hope; hope that the management sells their land, which they valued the same high value as the neighbouring one which was transacted, and distribute the cash to them.
Characteristic 2: High growth, even extremely high growth
Many of those lemons listed above were and still are growth stocks.
KNM’s growth for the last ten years outpaced Microsoft, an international conglomerate. KNM’s was the darling of the market during the mid-1990s. It had big plans; foraying and making its foot prints all over the world with big acquisitions (and lose big money). Its revenue grew by 30 folds from less than RM65m in 2003 to a RM2 billion revenue company now. The CAGR is a whopping 41%.
LonBis’s growth is also very high. Its revenue grew by 5 times since 10 years ago from RM82m to RM403m as at 30thJune 2015. It’s earnings, as that of KNM, has not been very exciting, but it also has never lost any money since listing.
Guan Chong Berhad, GCB’s revenue grew by fourfold from about 464m 7 years ago to 1.82b for financial year ended 31st December 2015, or a CAGR of 22%. This is also a very high growth rate and another billion-dollar club member.
Others were not with high growth but the “hope for high growth”
Characteristic 3 Low return on capital
Alas, the growth of these companies above were such a poor quality growth with the return on capital way below their costs, and in a clear deteriorating manner.
The return on equity, ROE, for London Biscuits was in an as-clear-as-crystal unabated downward trend from 12.8% ten years ago to just 3.7% last financial year ended June 30 2015.
It is the same trend for KNM.
GCB had very good ROE from 2010 to 2012 when ROE was from 35% to 54%! However, those high ROE remain as illusion as there is never ever any free cash flows except in 2014 when they made losses.
CSL of course was having high ROE but that is another story. The rest ae loss making and of course no ROE to talk about.
Characteristic 4 Poor cash flows
Besides GCB which has negative FCF every year since 8 years ago, London Biscuits and KNM behave exactly the same, all with poor cash flows from operations (CFFO) as well as free cash flows (FCF).
Huge amount of inventories and receivables build up way above the increase in revenue were common phenomena of these companies.
These companies also spent huge amount of money in purchasing property, plant and equipment, without yielding any positive results, no increase in profit or cash flow, and yet deteriorating ROE, a value destroying act.
Characteristic 5 Poor quality balance sheet
It is clear that the balance sheet has to be deteriorating with persistent negative free cash flows.
- Where can they get money to pay down debt without FCF?
- Where to get money to pay dividend without?
- How to keep its doors open for business without FCF?
- Where to find money to do investing without FCF?
You can see their debts keep on increasing unabated to the extent of the high risk of bankruptcy with high debt-to-equity ratio, below unity current and quick ratio, and negative cash flow coverage. This is despite that they have been putting out their hands to ask shareholders to give more and more money in rights issues and “free” warrant issues until the share capital increases in huge amount.
Yeah, making money (for own self) is so great from other people’s money. Borrow more baby and issue more rights issues and give more “free” warrants!
These companies may have low price-to-book value of below 0.5. However, the quality of the assets, mostly in receivables, property, plant and equipment, tax assets, and intangible assets which when liquidated, are worth little or even nothing at all.
Characteristic 6 The red chip
The Chinese listed companies are notorious for their questionable financial account. Chines Stationery Limited, CSL’s annual report shows they are making tons of money with plenty of cash flows and cash in bank, a few times higher than its market capitalization. And yet the major shareholders dumped the shares, millions of them at a fraction of the cash per share in hand.
Its share price was RM1.66 three years ago. The loss is a whopping 83% in three years when the broad market has gone up by about 10% during the same period.
Another Chinese listed company XingQuan not covered here, also has hundreds of millions of cash in hand. However, it never, or just pay a pittance in dividend, and yet putting out its hands recently to ask money from shareholders for rights issues and “free” warrants, for some dubious capital expenses. What a joke!
This red chip phenomenon happens all over the world, the US, Singapore, and Malaysia. There is hardly any exception.
Characteristic 7 A lot of corporate exercises
KNM has made numerous corporate exercises; right issues, “free” warrants, share split, share consolidation after split, share value reduction etc. Its major shareholder even talked numerous times about taking it private because of its grossly “undervaluation”.
London Biscuits follows suit. It has numerous rights issues, private placements, and “free” warrants too. It never loses out in this respect.
It was the same for Asia Media; bonus, rights, share split and consolidation. What a wonderful corporate world!
Characteristic 8 Favorites of analysts’ coverage
Recently, I have received a recommendation from a fund manager and professional analyst to buy KNM at 57 sen on August 3 2015 as below. Oh my God, haven’t we gone through that before many times in the 1990s?
“Dear Investor
With legacy issues resolved, KNM is now on a stronger footing to bid for bigger projects. We are sanguine on KNM's plan to go big into renewable energy where the recurring earnings have better visibility. KNM is currently trading at FY16 PER of 7.7x, at 41% discount to average Malaysia O&G PER of 13x. KNM share price has retraced to a bargain hunting level. Hence, we have a Trading Buy call.”
Yeah man, anything related to O&G is great. Also a low “Per”. More on this below.
I also read and commented on this “Irresistible bite” here regarding a rosy report from an investment bank on London Biscuits:
These are some catchy headlines from the investment bank.
“LonBis has registered 12 consecutive years of profitability”
What use is this “profitability” when the company eats cash like nobody’s business resulting increasing share capital and ballooning debts?
“Historically, LONBISC earnings decline from FY10 to FY12 is caused by its high investment to upgrade its capacity and expansion to modernise its equipment and machinery. However, the period of high capex should be coming to an end”
After the writing by the investment bank, its capital expenses almost doubled again from RM22m to RM41.4m. Heck, its net profit only amounted to RM17.3m that year!
“its cashflow has improved and is now being used to pare down debt to a healthier level.”
Really ah? The FCF has actually worsen to its historical worst at RM49.3m in the latest financial year as I can see!
There were also many favorite reports on GCB previously and recently when its earnings spiked. However, if you look at its negative cash flows from operations, you would get very scared.
Asia Media also had many favourable analysts’ reports some years ago when it was carrying some corporate exercises. Investors lost their pants following those buy recommendations.
Characteristic 9 Low price-to-earnings ratio, and price-to-book
London Biscuits, KNM, GCB, KNM and Ivory Properties have always been traded with low single-digit PE ratio. The PE ratio of CSL was even more ridiculous at 2 or 3.
The rest of the stocks return “NA” when you check their PE ratios, as they have negative earnings most of the time.
This low P/E or P/B ratios only can deceive naïve investors, or those who don’t even bother to examine the financial statements, thinking that they are cheap. Smart investors and institutional investors will know the poor quality of the earnings and the poor quality of assets and avoid them.
Characteristic 10 High volatility
Many of those hot stocks are volatile in their share prices as insiders, syndicates treat those individual investors as easy meat, frying the share price up and down, resulting many individual investors losing their hard earned money.
Check the share price movement of KNM, London Biscuits, GCB, Hibiscus etc. and you will know what I mean.
Do you think the individual investors can beat these insiders, manipulators and syndicates in this zero-sum game of speculating and gambling?
Conclusion
It is always not easy to predict if a company would do well in the future and that its share price would rise. If someone is so confident to tell you that his recommended stock is a sure and can’t miss thing, think twice, or even 10 times.
However, it is much easy to see if a company is likely not to do well. The evidences are all over the walls. I seldom get wrong in this respect, may not be in the short-term, but often in the long-term.
For individual investors, it is best to take care of the downside first and let the upside takes care of itself. Guard yourself against risks. This should be the golden rule in investing.
The interesting thing is you can do it by yourself you are willing to spend time and effort to learn about it. And I am very sure you will be able to avoid falling into the pitfalls in investing, and will have better chance of getting extra-ordinary return from investing in the stock market.
“You don’t have to pee on an electric fence to learn not to do it.” - Charlie Munger
If you are interested to make a decent return on your investment in the stock market and guard against risks, please contact me for a flexible online investment course for a small fee at
KC Chong
Appendix
Table 1: Return of Lemon as at 31st December 2015
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