Fusion Investor Chatbox

This chatbox is for fundamental, technical and related discussions on investing in Bursa Malaysia. Registration is required to join. Please email me at fusion.investor@gmail.com with your preferred name and password and I will inform you when registration is confirmed.

Disclaimer: As usual, you are solely responsible for your trading & investing decisions.

Tuesday, July 31, 2007

RAMUNIA-LA, Asset Allocation, Diversification

From a reader "Lex",

"Hi Seng, I came across Investssmart chatroom and your blog accidentally early this year, ...

I am new in stock market invest and started to trade around end of year 2005. I know nuts about FA and TA. But can understand certain accounting term like NAV or NTA. I invest by buying low and hold (with certain percentage of stop loss) then sell once the price move up around 15% ...

Currently, I holding ... Ramunia LA @ RM1.159 and Ramunia WA @ RM0.855 which I slowly accumulated starting early this month. Of course the reason I start to invest in Ramunia is after go through your blog on Ramunia. I also agree and believe that the future of global oil and gas sector is very promising and got great potential that crude oil price will hit US$100 per barrel.

I still have around xxx capital set aside for share investment, and I plan to use all of it to invest in either Ramunia LA or WA for short term and long term.

Are you able to advise is it wise to do so? As I don't have time to monitor a few counters and so far each time I invest, I bought 1 or the most 2 counters only. Thanks."


Dear Lex,

Thanks for your email. I hope you won't mind me replying here, as it may be useful to the other readers with similar questions as you are. I have taken the liberty to remove any data that might identify you, as well as the more sensitive numbers relating to your actual stock and cash holdings. My thoughts follows. Please treat these as merely second opinion. At the end of the day, I am not a licensed investment advisor, I do not charge any fees, and it is your hard-earned money which is at risk.

Ramunia-LA vs Ramunia-WA

1. At the time of writing, Ramunia closed (prior day) at $1.42, Ramunia-LA $1.10, Ramunia-WA $0.865. At these prices, I still prefer the LA best, and would avoid both the WA and the mother share.

2. The reasons I would avoid the mother share is because come Sep 2007 and 20 Dec 2007, I expect the mother share price to fall as a result of the planned share dilution.

3. The reasons I would avoid the WA is because I expect the WA price to track mother reasonably closely. If the mother price falls, the WA should fall also. Worse, since the WA provides gearing, I expect the WA to fall proportionately larger than the mother. If I'm not buying the mother, I am certainly not buying the WA.

4. It may be counter-intuitive as to why when 20 Dec 2007 comes, both mother and WA falls but LA rises. The reason is simply because the rules of the game says that 1 LA stock gets to convert into 1 mother share, and for all intent and purpose, 1 LA stock is equivalent to 1 mother share comes 20 Dec 2007. As the LA price is significantly below current mother price, I expect the LA price to go up come 20 Dec 2007.

5. I would consider disposing some/all of the WA during strength before the planned September dilution.

6. There may be a smaller outside chance that the mother share might rise after the 20 Dec 07 dilution process completes causing the WA to rise proportionately faster than mother. That I cannot fully discount either as I do not have a reliable crystal ball into the future. Notwitstanding this, I would still prefer the LA, since in my opinion, the potential reward does not appear to fully offset the potential risk.

Asset Allocation

You mentioned you are planning to use all (100%) of your capital to just hold 1 (or 2) stocks. There are 2 separate issues here: 1. Asset Allocation (100%% invested in stocks), and 2. Diversification (1 or 2 stocks).

For the first part, I'm afraid I don't know you well enough to know whether you are still working, whether you expect to be a net saver over the next 6 or 12 months say, your savings rate or access to other sources of savings, your liabilities / planned expenditure, etc.

But assuming you don't plan to increase your capital, then, 100% of capital into stocks is not prudent. Whilst the market is bullish right now, noone really knows when the party will end. Especially if you do not have a history to time the market successfully.

In the Intelligent Investor book, Graham advocates a 50/50 asset allocation. In other words, if you have $100,000 to invest, consider investing $50,000 into stocks and the other half into bonds (or for practical purposes, fixed deposits and cash). Especially since you don't have time to monitor the market.

Under this approach, the defensive (or busy) investor may choose to review his portfolio say on weekends or every fortnight, and updates the % invested in shares.

If after a period of time, the % invested in shares has risen to say $60,000 at the next review date then, the total portfolio is now $110,000 (= $50,000 cash + $60,000 stock). The stock % is now 60/110 = 54.5% which exceeded 50%. The investor could consider rebalancing to 50/50 by selling approximately 4.5% x 110,000 = 4,950 or say $5k the following week. This would then result in stocks of $55k and cash of $55k, or roughly 50/50.

Conversely, if the % invested in shares fell to say $40,000 at the next review date, then, the total portfolio is $90,000 (= $50,000 cash + $40,000 stock). The cash % is now 50/90 = 55.6%. The investor could consider rebalancing to 50/50 by buying approximately 5.6% x 90,000 = $5k the following week. This would then result in stocks of $45k and cash of $45k, or roughly 50/50.

Of course, this is not the most optimal strategy to maximize returns. But Graham is of the view that it forces the investor to buy when prices are depressed, and to sell some when prices goes up, thereby, doing the right thing not to get a poor investment result.

The 50/50 approach may be tailored depending on your risk apetite and individual circumstances and preferences. E.g. if you expect to have say $10,000 worth of future savings coming in over the next 6 months that you plan to commit into stocks, then, you might start to consider this as part of your cash holdings in the above calculations. In other words, effectively, you have tilted towards $55k stock /$45k cash (since actual cash is only $45k and exclude the $10k cash which has not yet come in), or 55% stock, 45% cash allocation.

You may also choose not to act when the stock % is only a small variation from your 50% target, since the amount to rebalance may become too small.

You may also vary the % invested in stocks (from 50%) to another figure such as 55% or 60% especially when market prices has fallen and you are really bullish about the stock market in the future. However, this is potentially riskier since it is inherently difficult to predict future market movement, and more of your wealth is at risk should your assessment turned out to be wrong.


You mentioned you would like to hold just 1 (or 2) stocks.

My general advise is to not to this, even if Warren Buffett himself have personally recommended a stock to me (which he won't).

Why? Because there are no guarantees in the stock market. Despite the best research today, noone can reliably predict the future, and that includes what is going to happen to the company and the stock price during the investment period. Owning a single company is not prudent. One of Buffett's famous quote (and I am paraphrasing him, in a similar context of employing leverage) is that even if there is a 99% chance of enhanced profits, and just a small 1% chance of having a terrible result, he would not take that risk. I think the same principle applies here, when it comes to being 100% invested (instead of 50/50 suggested above).

Perhaps an exception could be considered if the stock is a closed-end fund such as I-Capital, or a carefully selected mutual fund outside the stock market, since the funds in theory holds a diversified group of stocks. For the former, I would consider spreading my buys across lower prices if I am considering entry. For the latter, you need to consult a professional investment adviser.

If you still want to select stocks yourself, consider diversifying into 5-10 stocks at the very least. Apparently, Graham recommends 10 to 30, even though he himself holds nearly 100+ stocks. If you have $100k of capital, and plan to invest $50,000 into stocks, 5 stocks means roughly $10,000 investment each. The actual amount invested can be varied slightly around these rough yardsticks, to make it round lots, or to reflect your varying degree of confidence in the stock.

Other Comments

As this is already a lengthy reply, I think I will leave it at that, even though I have some relatively minor difference in opinion on stop loss when applied to sound, fundamental stocks, or on your sell targets.

Disclaimer: As usual, please treat this as merely second opinions. Always use your own judgement, consult a professional if you are still unclear, and invest (buy, hold, sell) at your own risks since at the end of the day, it is your own money.

Sunday, July 29, 2007

Fundamental Analysis

Recently, there are some interesting discussions on Fundamental Analysis (FA) – e.g. see Moola’s excellent articles below together with the Sahamas discussions:

- http://whereiszemoola.blogspot.com/2007/07/oilcorp-iii.html
- http://whereiszemoola.blogspot.com/2007/07/oilcorp-ii.html
- http://sahamas.net/forum10/3859.html

Definition of FA

If you are a new investor wishing to learn more about FA, I would encourage you to google “Fundamental Analysis” first. It should give you a reasonable idea of what is meant by Fundamental Analysis. The Investopedia can also be recommended (see http://www.investopedia.com/university/fundamentalanalysis/). Some of the main points are:

“Fundamental analysis is the cornerstone of investing (Seng: note: not trading). … some would say that you aren’t really investing if you aren’t performing fundamental analysis.

“The biggest part of fundamental analysis involves delving into the financial statements. Also known as quantitative analysis, this involves looking at revenue, expenses, assets, liabilities and all the other financial aspects of a company. Fundamental analysts look at this information to gain insight on a company's future performance.

“But there is more than just number crunching (Seng: and definitely more than just low P/E ratios) when it comes to analyzing a company. This is where qualitative analysis comes in - the breakdown of all the intangible, difficult-to-measure aspects of a company.

Seng: Note that in both quantitative and qualitative analysis above, there is no mention at all about the stock price nor the volume traded. I have also sometimes called FA as “BA” or Business Analysis, as the focus is mostly on the underlying business which is a different concept from the stock ticker.

Warren Buffet

To me, there is no doubt that the Grand Master of Fundamental Analysis should be Warren Buffett, who started from virtually nothing to become one of the world’s richest man purely through investing over a very long period of time.

Throughout his entire life, he reads a lot and reads extremely widely e.g. he prefers to spend the entire day reading various company Annual Reports than doing other things. Despite his humbleness, he is sharp, intelligent, witty, humorous, with excellent understanding of both the quantitative and qualitative aspects of the business that he follows (which he describes as staying within his own circle of competence). As a result, he knows or is able to calculate very quickly in his own mind the Intrinsic Value of the businesses that he evaluates. This allows him to determine the Margin of Safety quickly. In a typical year, the number of times that he invests is rarely more than a handful (except in the rare years when market crashes when he feels like the only single guy in a harem full of eligible women). But when Mr Market provides him with a very “fat pitch” (large Margin of Safety), he does not hesitate to invest big, especially when others around him are fearful. And after he invests, he would prefer to hold the stock “forever”, unless the business fundamentals deteriorate in future which occasionally happens. In other words, Fundamental Analysis dictates his clear preference for “invest and hold forever” approach.

However, in more recent decades, as Berkshire gets bigger, the size of the investment universe gets smaller. In most years, he and Charlie would sit on large piles of cash, waiting for the big elephants to show themselves up. As cash does not earn a particularly high returns, he and Charlie are compelled to participate in various shorter-term arbitrage / mispricing positions in order not to let the cash drag Berkshire’s overall returns. This has increased his investing activities, although Berkshire turnover is still extremely low relative to the average investor. However, his clear preference is to find a few large “elephants” as opposed to “catching a lot of mice” for Berkshire.

The General FA Strategy

By and large, Fundamental Investors prefer to take their time to identify superior investments. They are generally patient, and can wait for the market to provide a fat pitch (a "low" price, or a large gap between stock price and Intrinsic Value). Once they acquired their position, they don't generally like to let go that position by selling, even when superficially, the price appears to have gone up a lot but still well below Intrinsic Values.

Whilst a lot of work goes into the selection, once the selection is made, it is a generally more laid back approach requiring little activity, and does not usually require constant monitoring of the stock market. Buffett's incredible lifetime results (together with the results of the other students of Graham) speaks a lot about the practicality and viability of this approach.

Some Common FA Myths

It is not uncommon to encounter many myths about FA. For example, some FA practitioners hesitate to invest unless the “stock volume traded” increases. Strictly speaking, the latter is not FA. It should be obvious that OILCORP’s future business earnings will not depend on whether today’s volume traded is 5 million, 10 million, or has been growing from 1 million a week ago. In contrast, OILCORP’s stock price might go up as a result of increasing volume traded, but this is Technical Analysis than Fundamental Analysis.

Another common myth is for “FA practitioners” to buy because the stock will soon split. Strictly speaking, this is also not FA. It should be obvious that splitting a stock does not necessarily increase the Intrinsic Value of the underlying business. Yet, stock splits can result in the stock “appearing cheaper” to retail punters, and the stock price can and usually (but not always) goes up after the split. So, a stock split is not FA, but is more “perception” investing, as it is based on appearance of a cheaper price than true business substance.

Another common myth is that FA is focused on low P/E only. There are many variants to this myth. Some would not buy if the P/E is say double-digit, and would only focus on single digit P/Es. Some would not buy if the P/E is higher than the average company in that sector, or higher than the average stock market P/E. Others would simply look at P/E only, and ignores cashflows (the latter happens more frequently than you might think). In my personal opinion, rigid adherence to these absolutes are examples of "incomplete FA", as FA is more than just P/E, even though P/E is important. To the best of my knowledge, Buffett would never condone purchasing such stocks for Berkshire on such a simplistic basis.

There are of course other myths about FA, but that would be outside the scope of this article. It should also be noted that some FA practitioner in practice employs a variety of methods to arrive at they buy/sell decisions. For example, you will sometimes come across the term "Rational Investor" for someone who employs both FA and TA in their investment approach. (My blog name "Fusion Investor" is another similar term).

Does it matter?

At the end of the day, one might ask - does it matter to adopt a “rational/fusion approach” (which combines elements of incomplete FA, TA, psychological investing and other methods) as label it as “FA”, as long as the stock price goes up?

Besides the obvious mislabelling, there are other potential dangers to be aware of.

First, I believe that mislabelling is potentially misleading, and in my personal experience, tend to impede rather than promote learning. If the overriding goal of any new investor is to achieve a superior investment result over his / her own lifetime, then, this will not help. Since habits once formed are harder to change, it can lead the new investor away from the teachings of Graham and Buffett permanently.

Second, an incomplete FA method can give good (or bad) results initially, but over the long-term, may be less than optimal if there is no change. If one's objective is to achieve superior investment performance over a lifetime, then, this will make it harder.

Third, a poorly communicated basics or incomplete approach can promote unnecessarily longer dependency on the guru. To me, the best teachers are those that teach their students to become independent, if not to become better than them. Yet the market place has many gurus and followers with little hope of becoming better than their "guru". In this regard, Graham could not have been prouder of Buffett.

Some final words

My personal belief is that if someone truly wants to have a superior investment result for the rest of his life, he will not have a bad result by studying Graham and Buffett. The web and good bookstores are full of such resources on both Masters. Personally, I’ve read many written by and about both of these Masters and haven't yet encountered a really bad book on both of them. New investors can start with Janet Lowe’s introductory book "Value Investing Made Easy". More experienced investors may wish to consider Buffett’s biographies, other books written about Buffett and Graham, as well as Buffett's own writings in his annual Berkshire Chairman’s Letter.

Disclaimer: The above merely represents my own personal view on the subject matter. As usual, always use your own judgement and invest (buy, hold, sell) at your own risks.

Friday, July 13, 2007

EUROSP - Business P/E

From "starter" ...

"Seng, how you can get a PE of 3.5 for EUROSP? Correct me if I'm wrong but I think the PE should be around 8 base on the current price."

Dear starter,

Here are some simple facts about EUROSP:

1. Last night, EUROSP closed at $1.16. At this price, the stock is capitalized at $46.4M.

2. The TTM (Trailing Twelve Month) net earnings (PAT) is $7.2M, or 18.1 sen per share.

3. At the last Balance Sheet date (28 Feb 2007), the stock has a Net Cash of $22.2M, or 56 sen per share and nil borrowings.

4. This implies that EUROSP's underlying business is available for sale for only $46.4M - $22.2M = $24.2M

5. So, the Business P/E is 24.2M / 7.2M = 3.4, which I've simply rounded up to 3.5. Compared to its listed competitors, I believe EUROSP is trading at a very undemanding multiple.

6. Superficially, if one doesn't put any value on its $22.2M cash hoard, then, you could say the P/E is 46.4 / 7.2 = 6.4 times.

7. Superficially, if you prefer to use outdated 2006 Financial Year earnings, then, the P/E is 46.4 / 5.8 = 8 times. But to me, this is not the right way to value a business - and is potentially dangerous when applied to other stocks - since it gives no credit to recent earnings growth (EUROSP Financial Year ends 31 May), as well as not giving credit to EUROSP's strong cashflow and its large cash hoard.

8. If you think such a business, in the current environment, deserves a P/E multiple of 7, then, the Target Price could be 18.1 sen x 7 + 56 sen = $1.83, say between $1.50 to $2. Whether EUROSP actually reaches this price or not will depend to a large extent on the market.

For more details, you may refer to my previous writing on EUROSP here - http://fusioninvestor.blogspot.com/2007/04/eurosp-business-proposition.html


Disclaimer: As usual, use your own judgement and invest (buy, hold, sell) at your own risks.

Thursday, July 5, 2007

RAMUNIA Shares and Analyst Recommendations

Further to my article on RAMUNIA-LA, more than one reader mentioned the concern on the potential dilution of shares for RAMUNIA. Also, readers have requested for more analyst information. I will attempt to cover both topics below:

Potential Share Dilution

I have summarized the potential dilution with time frame and other information for easy reference.

A few points worth noting:

1. The above prices are at lunch time today (5 Jul 2007). Prices will vary over time.

2. The first line - mother share of 285m - includes the 45.5m private placement shares recently completed.

3. There are a couple of new share issues this month and in Sep 2007 as noted above (Line 2 & 3). Whilst Ramunia cash coffers are going to be increased by approximately $48m and $68m respectively after the placement of these new shares, there will be some dilution effects since the prices are done at below market price. The new theoretical price (assuming all things equal) should come out at around $1.43, or say 3 sen below current market price as a rough yardstick.

4. The next dilution will occur 20 Dec 2007 from the LA stock. It is important to note that this is not a new issue, but conversion of existing LA stock into mother shares. As such, it is not a true "new information", but something that has already known to the market for a long time (even though it may appear new to some of us). The LA stock also has a certain price and a certain market capitalization. To assume extreme dilution (with nil LA stock value) would be equivalent to "magic", that come 20 Dec 2007, total market capitalization can suddenly dissappear into thin air. To me, that is not rational. So, the theoretical diluted price, assuming lunch time prices is $1.31, or say 15 sen below current market price. This still represents a safety margin of 1.31/1.19 - 1 = 10% approximately gross of brokerage expenses, based on lunch time prices. Note the safety margin has decreased since my last article, since I didn't know about point 3 above at the time. Still, the safety margin does its function, which is to act as a buffer in case I was wrong ... :-)

5. The next 2 dilution will occur on 20 Dec 2009 and 2014, both events are relatively far away.

Approaching 20 Dec 2007

It is worthwhile to ponder a little what will happen to both share prices as we approach closer to 20 Dec 2007. 20 Dec is a Thursday, for some people, around the start of Christmas holidays. Some of you may be wondering what sort of prices should the LA and the mother stock trades on the day before (Wed), or even a few days before then ...

1. Assuming everything equal (and real life is never equal), then, prior to conversion, presumably some mother shareholders would be nervous that prices would fall, and start selling out. Maybe mother price falls a little from $1.46 to $1.45, 1.44, 1.43, etc. It might not happen yet, but as the conversion date gets closer and closer (say end of this year, in addition to this month and Sep dilution), then, we may start to see the effects.

2. Around the same time in 1. above or earlier, the large gap between LA and mother share price induce more and more buyers to buy more LA, driving the LA share price up, from $1.19 to $1.20, 1.21, 1.22 ... reducing the gap... Again, this might not happen much yet, and I suspect we'll see more activity happening as we get closer to the conversion date.

3. Come the day before conversion, I guess there should still be a gap, but smaller than what we see today ($1.46-$1.19 = 27 sen). It's hard to put a precise figure. Immediately after conversion, my expectation is that the reference price for mother share gaps down, and LA cease trading. Holders of LA can either sell out earlier when LA prices rise in early Dec, or wait for conversion to complete, and then sell. I suspect there may be advantages to wait after conversion, since the next conversion is a long time away - 2 years - and the best of Ramunia's future earnings are still to come. I.e. I expect after 20 Dec, the market will be relieved that the conversion is over, and then bid the prices up back to old levels to offset the earlier effects stated in 1. above.

Of course, this assumes everything else is equal, and real life is almost guaranteed to be unequal. So, take the above with a big pinch of salt.

Analyst Recommendations

First of all, thanks to everyone who wrote in and provided me with analyst reports. I have done a compilation of 5 analyst reports below.

A few notes:

1. Interestingly, the analysts actually have differing views on what should be the appropriate number of shares outstanding to use to calculate P/E! Target Prices are usually 12 months, but the number of shares outstanding seem to reflect different time-frames!

2. The latest report is by S&P, with a TP of $1.6. S&P actually assumes 662m shares i.e. exclude the WA due in 2014, as it is a long time away. But that would include the PA, which is due in 2009, which is different from other analysts. I suspect the difference is time-frames. But if one has a 12 month time frame, then, it is borderline ...

3. Aseambankers report is 28 June, which is still fairly recent. The TP is $1.80. Aseambankers assume 807m shares outstanding, which exclude PA, but include WA. This approach treats the PA holders under "minority interest", and takes a fully diluted shares at 807m. I can understand this approach too as preference shareholders are assumed to be paid first, and whatever profits left belong to ordinary shareholders. The time frame is definitely after 2014.

4. AmResearch report is dated 5 June, slightly dated. The TP is $1.95. AmResearch assumes nearly 1 billion shares outstanding, i.e. the time frame is after 2014.

5. ZJ Advisory report is dated, on 18 Apr. The TP is $1.41. ZJA does not include ICULS, i.e. only 556m shares. This is probably a weak assumption.

6. OSK report is the oldest, dated 18 Oct. The TP is $1.51, but because it is a very old report, one should not put much weight on it. In fact, RAMUNIA year end is 31 Oct, and so, its estimate of 2006 PAT of $22.8m is actually over-stated. Actual is $16.8m based on Bursa announcement dated 8 Jan 2007, but unaudited. We can expect slightly different results after audit. In fact, even the 2006 PAT differ slightly between the analysts - I suspect the analysts were given different figures after auditing and after company visits. S&P 2006 PAT include minority interest.

So, 5 different reports, with 5 different Target Prices. How do we make sense of this? To me, a few principles:

1. Superficially, all gives target prices which are higher than current LA stock price of $1.19. Superficially, there is comfort in this sense.

2. All 5 analyst predicts much higher PAT for 2007 vs 2006, as well as 2008 vs 2007. What is happening here that is causing all 5 analyst to be so bullish about Ramunia's future prospects? To use the word of one reader, do all 5 analysts believe in "magic"?

3. Point 2 highlights the fact that RAMUNIA is widely regarded as a growth stock by the market. The market is willing to pay a very high trailing P/E. Based on my standardized number of shares outstanding for all 5 analyst of 556m shares (i.e. using a time-frame up to 6 months), the trailing P/E ranges from 37 to 66!

4. One key principle in investing in growth stocks is to be certain of its future growth! This is because if the company fails to deliver the higher earnings, then, the market will not be kind to the stock, and the stock can expect a large price fall. This is definitely a high risk/high return play.

5. The O&G sectors is currently a market darling sector. Make no mistake about it. Even fellow bloggers and investment community are generally bullish about O&G at this point in time. Could they be wrong? Your guess is as good as mine.

6. But if the company delivers the earnings growth, then, the 2007 P/E falls to 14 to 22 range, and the 2008 P/E falls further to 8 to 14 range.

7. So, it all boils down to how reliable are the analyst projections for 2007 and 2008 earnings for Ramunia specifically. In other words, why are the analysts so bullish about Ramunia's future prospects? For this, stay tuned to a future article, if I have the time ... :-)

Disclaimer: The purpose of this article is not to promote RAMUNIA. Please read an earlier article on RAMUNIA-LA for context. I own RAMUNIA-LA, and so, my views may be biased. Always use your own judgement, and invests (buy, hold, sell) at your own risks.