Portfolio Commentary: September

There were much transactions made on my little portfolio this month due to the extreme volatility in the Hong Kong market. For 10 days, the Hang Seng Index fell from a high of 28416 to 26345, a 7.8% decline. With the increased volatility, I increased capital injection. Some of the transactions include:

a) Divested Playmate Holdings after ex-dividend. Realized my mistake in valuation and move on until there is a larger, significant discount (40-50%). This means a price of $0.70 or so.

b) Divested Hop Fung Group on government regulation worries. The following screenshots off the quarterly report explains:

This brought about a 65% decline in net income, and the balance sheet was substantially weakened. Cash fell from 335 to 222m, and debt increased from 17m to 51m. The market subsequently sold the stock down 44% in a matter of three days.

This isn't a pretty picture and I disposed Tat Seng as well.

Cash from the divestment above, and additional capital, were deployed into the following
a) Increased TTJ after a 8-10% discount from my first purchase price

b) Initiated purchase of Thai Beverage; I do believe that the company will be able to turn the company around from its troubles, given the 10-year records. Meanwhile, I am expected to receive about a 4% dividend.

c) Increased position in Xinghua Port Holdings after the volatility provided the liquidity for this little-traded counter. After a few days, I received news that the Stop-Work Order on Xinghua Port's CCIP is lifted.

d) Initiated position in Qingling Motors, a net-nets stock with a pretty good dividend yield. It has fallen well over 20% in recent months.

e) Increased position in a slow-grower which identity I would keep mum since I am still in accumulation stage.

Most of my companies have some sort of problem weighing on them but I think they are temporary. I am a strong believer that markets are usually efficient and the ability to wait out problems is a major advantage of a retail investor. How long can problems last?

As the Hong Kong market recovered in the last two days, my little portfolio's year-to-date returns stands at +16%, leading the STI by 20% and HKEX by 27%. I am counting my blessings...

Speculative Profits: What is Investing?

If you invest in stocks with the mindset that cash is king, here is a company that has generated next to no cash, but yet brought unbelievable amount of profits to shareholders as its stock price climbs on stairs made of purely hopes. This company is mm2Asia ("mm2").

Shareholders who bought right on day 1 have little to complain about. It closed at $0.25 a share and gone through two, 1-to-2 splits in 2016. Today the share price is $0.37, which is $1.48 a share. That is a 592% increase.

On paper (accounting profits), the business generate salivating numbers:

The company has the right to boast, on its annual report in 2018, that its CAGR for revenue grow 85.8%, and net profit 77.0%. It has acquired and spun off companies, and including a large, well-known cinema operator in Cathay. Yet it has paid no dividends to its shareholder, who probably won't complain on the account of its stock price (and free entertainment tickets via balloting).

To me, if you were to insist on paper profits, the right metric is not net profit but returns on invested capital. A revenue growth and a net income that grew side by side is common. But if the growth in paper profits is slower than the growth needed for capital, it is actually detrimental.

The simplest way to measure ROIC is to take net income and divide it by the total of shareholder equity (without accounting for minority interest), and debt. ROIC calculation can be extremely subjective since the proper way to do it is to take cash generating assets minus interest-paying liabilities. What I am doing here is the blunt and lazy way.

Shareholder equity does not include minority shareholder's capital.

All debts include non-current and current debt.

From 2015 (first year since IPO)  to 2018, the share capital injected into the company is about 100m more. Returns on capital has been great in 2015, 26.09%. Today, the figure is a lot more modest at 10.81%. 

What about the cash?

 

If one were to take into account Operating Cash Flow (OCF) before working capital changes, this company is actually pretty good. But its net operating cash flow has been next to nothing. It is no surprise that the company is in a hurry to spun off subsidiaries in public listings (which will generate the highest pay off), paid zero dividends in the last 4 years, and had to acquire a large sum of debt to acquire Cathay.

I note that they have a severe increase in payables, from 46m to 274m this year. It is a sign of potential cash flow issues.

Investors in mm2 are still paying about 16 price to earnings, based on trailing twelve months basis.
The price is far from being depressed, despite a significant decline of 47% from this year's high.

But who cares right? 592% in paper profits for investors!

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Just to illustrate how little do investors consider stocks as a form of business ownership, consider the story of TheHourGlass. It is far from being the most neglected company in SGX, listed for more than 20 years. Neither is this company the most profitable...

Based on figures since 2008, the company has never had a negative cash flow. It has an average of about 29m in free cash flow yearly, since 2008-2018. By the wisdom of the market, the whole company is worth 472m. This represent a cash yield of 6.1% as a business owner. As a minority shareholder, dividends were paid for the last 10 years, with a yield of about 3% currently.

For ten years, next to no additional share capital was injected in its books. This means there were no significant shareholder dilution.

Yet the price of this company move between $0.56 to $0.67 a share for the last 5 years.

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So what is investing? It might be old fashion to think that stocks represents business ownership, as the market constantly ignore the essence of capitalism which is to generate cash profits, but chose to focus on potential instead.

I guess the market loves risk takers.

Is it easier, as an investor, to bet on the future of a company that has presently no cash generating abilities, or to bet on a consistent cash-generating company that is in some kind of temporary trouble?

I am a sucker for the latter.