Posted by: donmihaihai | January 27, 2011

1st post of 2011

“I would buy Genting when it dropped to $2.” You said.

Great and that is less than 10% below current share price. What a decision and waste of effort. But I did not say it out because it will make me a strange guy or alien. But that is just how many “investors” work. Set a target buy and sell price. A strange one where a 10% movement in share price will make lot of different. The different between $2 and $2.20 is return. But that is just a 10% return where I can get it simply by buying another stock at $0.20 and sell at $0.22 ignoring transaction cost. Actually while you are happy to sell at $2.20, you might even just as happy to hold on and let it run to say $2.50 or $3.00. If it ever happened, you will be so proud of yourself about making a $1.00 gain but will you feel the same about buying a stock at $0.20 and sell at $0.30?

Return from a stock investment is the spread between buy and sell price plus dividends collected but the measurement should be in percentage, not in dollar value. And it does not say anything about investment or speculation. Or perhaps it is investment when successful and speculating when not. Whatever it is, this is not how I think or how I approach it.

After few year of trying, I realized that a 15% annualized return is pretty good and that is where I set my target at my buy price. The 15% mark is a rough estimate since I am not using spreadsheet or calculator. How to get that 15%? I used a simple approach what is a) what is the underlying stock is yielding, and b) how much I am paying for it. Someone can just say — earning yield.

Someone might say, good management, low leverage, paying good dividend, etc etc. After going round and round, the only thing matter is ROE. It will usually reflect lot of businesses and when it does not, I can simply switch to changes in equity over the years.

Accounting is the language of business. It may not be the best language but it is a damn good one. The best thing that I can think of is there is a set of rule to follow. Knowing these rule allow me to look into businesses. Anything other than that is rubbish. One of the worse things is the rule keep changing to satisfy those who do not know the rule and it is becoming kind of crap.

Let try a lazy example. Qian Hu announced FY2010 results recently with net earnings of 4,517K and it was 7,645K in FY2009, average up will be 6,081K and with average equity at 71,125, it average ROE is 8.5%. If this is the average long term ROE of Qian Hu and if Qian Hu can still be a going concern(long term) with this kind of ROE then the only way I can get a 15% annualized return is to buy at a maximum price of 0.6 X NBV. And that is $0.08 per share, about 40% below current share price.

Let try a high profile company – EZRA and treat it as another normal company(I would never treat it as a normal example in real life). Average net earnings of 72,972K for FY2009 and FY2010. Average equity of 563,773K makes average ROE of 13%. Looking at an annualized return of 15%, I need to buy at maximum of 0.9X NBV. Using 1Q2011 number, and exchange rate of 1.27987, buying at 0.9X NBV mean buy at $1.06 which is 37% below current price.

I heard someone say, there is no mention of growth, moat, dividend or good management. No, everything is already inside.

What about changes in valuation? Changes in valuation can be good or bad depending on valuation going upward or downward but it will never mix to get that 15%.

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Responses

  1. There is a flaw with using just ROE as a metric. You didnt take into account capital structure of the company. 2 companies in the same industry having the same number of high ROE ie 30%. are they efficient? one probably has no debt while the other has earnings boasted by high debt.

    and if you just go by ROE, why not buy starhub? it has exceptionally high ROE. ie >>>100%. Does it mean you can expect a return of 100%?

  2. When I am talking about ROE, I am talking about this

    (Net profit/ sales) X (Sales/ Total Assets) X (Total Assets/ Shareholder equity).

    After cancelling each other out, what left is what we commonly see. Net profit/ shareholder equity.

    Well, leverage is in the equation!!!

    Talking about Starhub. While I don’t know anything much about StarHub, let just take the latest results.

    FY2010 NPAT = 263.2M
    Shareholder equity = 54M
    ROE = 487%
    No. of share at 31 Dec 10 = 1,715,967,205.
    Share price at 15 Feb 11 = $2.62
    Market Capitalisation = 4,495.8M
    price to NBV = 83.3X
    Buy at 83.3X NBV = 5.8%

    Buying StarHub at current price get 5.8%. The only way to get 487% is to buy at $0.03.

    Make sense? I think so and simple enough.


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