Re-Looking Value Investing

I have been reading Howard Mark’s earlier book ” The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor” and his latest book “Mastering the Market Cycle: Getting the Odds on Your Side” lately.  First off, I would strongly recommend that all investors read both books.  It is the culmination of Mark’s 40 years of investment experience.  I find the first book especially relevant as it encapsulates higher level investment thinking perfectly in its manifold complexity and subtlety.  It is certainly thought provoking to read it now again as we enter into another period of turbulence and possible major correction in the markets.  It definitely helped me put all the current stock market volatility in context.  Incidentally, I had also been re-reading Benjamin Graham’s classic “The Intelligent Investor”.  Maybe because I’m getting on in age but now reading this classic again, I find the many examples given by Graham to be so relevant today even though he was talking about stocks in the 1960s and 70s and those decades before that.

In the same spirit, I have taken a re-look at Asian stocks.  I must say that to my surprise and bafflement, some of the stocks that I had previously not looked at or even considered, seem to offer quite a bit of “value”.  Here are some stocks to ponder about:

  1. China Machinery Engineering (1829 HK)China Machinery Eng FA

This stock is one of the greatest investment conundrum in my investing career so far.  Can a stock really be traded so cheap consistently?  As of 30 Jun 2018, according to Bloomberg’s data, the stock has cash worth USD4.2bn on balance sheet and debt (and related) of USD193m and a market cap of only USD1.9bn currently?!  This gives the stock a negative Enterprise Value (EV) of ~USD2bn!!  Ok I admit, this is the first time I have seen an example of a stock that is traded at a negative EV.  The most puzzling thing is this: that the stock has consistently traded below its net cash per share since 2014.  Indeed, it’s value had not prevented it from being further derated by the markets this year as its negative EV swelled from USD780m last year to USD 2bn currently.  What could have caused this to happen?  Isn’t it cheap enough for a stock to be traded below its net cash per share?  Isn’t that a big enough margin of safety?  Any investor thinking so would have lost money in the stock since 2014!  This is a sobering thought for many value investors and one for me to remind myself of.

This reminds me of another stock that I have looked at a long time ago called Hankuk Electric Glass listed in Korea but was subsequently privatised by its majority shareholder Asahi Glass in 2011.  It was the first time I had encountered a stock that was traded so close to cash per share.  The market cap at the tender offer price priced the company at ~KRW477m at that time, hence it was just a mid cap company back then.  Of course it was in a pretty unattractive industry at that time, producing glass tubes for CRT TV at that time.  Lousy sunset industry but generating good enough cash.  Enough at least for Asahi Glass to take it private at a EV/EBITDA valuation back then of 4x.  In this case, the case for value investing was upheld as stock was taken over at a premium of ~35% of last traded stock before the announcement.

2. Weiqiao Textile (2698 HK)

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Weiqiao Industry is the other stock that I noticed that trades at a negative EV.  Cash on balance sheet of USD13 bn and debt of USD7bn which means a net cash of USD6bn.  The stock is now trading at a market cap of USD2.7bn??  Note that this is not a small/mid cap either.   If you look at the Historical Price to Book ratio of this company, it is absolutely baffling.  The stock spends most of its time below 0.4x PBR.  Indeed, it is currently trading at 0.15x!  This is not too far away from its GFC low of 0.12x.  Sure, the textile industry is not a very sexy industry but to trade at these valuations??

weiqiao-pbr.gif

 

3. Tencent & MGM China

These 2 are not exactly value stocks but I happened to look at their PBRs this week and lo and behold, they are now trading below their GFC lows!  So is the current situation as bad as it was in 2008?  Maybe I’m really wrong but it certainly doesn’t feel this way to me!

tencent-pbr.gifmgm-china-pbr.gif

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During the current market correction in Asia, it certainly feels that the crisis hasn’t shown any signs of slowing down.  In fact, if anything, investors are just seeing companies reporting their first set of quarterly results since the Sino-US Trade war.  It seems increasingly likely that the Trump might continue to escalate it further.  The US market is also starting to break below their 200 day ma this last week.  If this is the beginning of a long overdue market correction in the US, it is unlikely that emerging markets will escape unscathed.  So are we headed for a crisis worse than the GFC in 2008?  I am not sure but certain stocks are already priced at those levels with quite a few stocks already trading at below net cash levels.  Let’s see how future events unfurl.

 

This time is different

OK, today is like a bonanza day.  I’m posting 2 entries a day to make up for what I missed the last week.  I have been contemplating a very fundamental problem in investing: should we be buying when things are down thinking that they should recover after a while (as they always have) OR do we really think that this time is different and that we are in a very unique world right now and what we are seeing here is unprecedented and we will not be going back to the old norms.  Believe it or not, despite having gone through this torture for more than 20 years, I still find myself having to go through this agony of self doubt every time this happens.

So in front of us is the opportunity to buy many stocks cheap, especially in China. However, many smart institutional investors that I speak to have warned me about investing in China, maybe ever.  I was told that the closer the investor is to China, the more pessimistic their views.  Investors based in China are very bearish about the future of China whilst investors in the US are most optimistic (because many of them have only seen Bull market corrections in their own markets in the last 20 years … every dip is a buying opportunity!).  My Chinese friends have pointed out to me that many of the smartest and most politically connected people in the country have been trying their hardest to move their assets out of the country despite the very tight controls that have been in place for very many years now.  Many prominent businessmen have moved to Singapore, I have been told.  In fact the families of many Chinese government officials have also emigrated to Singapore.  One would have thought that these are the guys most sensitive to what is happening on the ground and are the most astute analysts of China.  Who would you trust on their analysis of China, these guys or some analyst/fund manager based in the US?  My friends have pointed to deep seated NPL problems within the banking sector and the structural problems of the economy.  Where would the growth come from, they asked?  The factors that have contributed to the past success of the country is now gone: export growth fuelled by cheap Chinese labour and open international markets, government infrastructure spending that ensures that growth targets each year are met.  Now with a hostile US, suspicions on China and their intentions everywhere around the world and lack of further room for significant infrastructure build up compared to the past, where indeed is the growth going to come from?  The US-China trade war might have started a irreversible process of manufacturing moving out of China into other emerging markets (and even maybe back to the US).  So definitely one less source of FDI.

Speaking to another of my friend this week working in a senior role in a sovereign wealth fund, I was told that the fund is starting to contemplate the unthinkable: what if China were to take over Taiwan forcefully?  If the recent sanctions on ZTE showed the world anything, it was the fact that when it comes to technology, China was still at the mercy of US and its tech companies.  More specifically, China is seriously lagging behind in the semiconductor industry.  Indeed, most of its imports was in semiconductor related products.  And of course the easiest and fastest way to overcome that is to take over control of Taiwanese companies which are at the frontline of many technologies.  Anyway, I leave you to ponder the severity of what might follow if this scenario plays out.

So is this time really different?

Investor depressed 05102018

Relief rally?

Markets rebounded today.  I suspect this was due to the strengthening of the RMB.  One could say that this was caused by interventions by the Chinese government or because of market causes.  The rise in the RMB does seem too much too fast and technical selling has come in.  Whatever the reason you pick, the weakness of the RMB which had caused the earlier weakness and crisis of confidence in the markets has reversed today.

RMB Strengthening Against the USD – Too Much Too Fast?

CNH 27082018

HSCEI

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So is the HK/China market finally turning the corner or is it just another dead cat bounce?  I think the honest answer is no one really knows.  But if you look at the HSCEI chart objectively, the downward trend has not reversed itself.  My yardstick to measure trend change, as I have mentioned before in my last post, is that the 100 day moving average line must cut the 200 day moving average line with both trend lines turning up.  As you can see in the chart above, if anything, the 100 day ma has just cut the 200 day ma downwards not too long ago in July!  I think there is no need to anticipate the markets.  Just let them prove themselves.  If the trend is strong, it is never too late to jump in.

 

Drawdowns in Markets

Investors are obviously worried about the outcome of the Trump Trade War. Asian markets have entered into a technical bear market but the US markets have hit an all time high. Just last week, the US markets officially recorded the longest bull market in its history.

Usually markets have cycles. Some say there is a 7 year Joseph cycle in Asia. 7 fat years followed by 7 lean years. An entire book has been written about it and I shall not repeat its observations here. So why hasn’t it applied to the US markets today? I believe one of the reasons might be this unusual period of market interventions called the QE since 2008. Excessive liquidity pumped into the markets has certainly made its way into equity markets and real estate in general, and even the bond markets. The markets have been pumped up when on its own natural rhythm should have have started gong down from 2015. (7 years from 2009). In fact, the decline has been observed in Asian markets, especially in HK/China which saw a low in many stocks. Consequently by that same theory, we should have seen 7 years of up markets from then up to 2022.

So the current correction is probably just a typical market correction in a bull market. The underlying fundamentals of the companies seem to confirm that view. In China for instance, unlike in 2015, many companies are reporting strong results and not declining profits as was the case in 2015. Just looking at the China auto sector where representative stocks such as Brilliance China and BAIC Auto (Mercedes Benz) JV, stock prices have halved from their recent peaks less than 6 months ago, when the companies are reporting profit growth of 30% or more. The outlook also remains bright as their foreign JV partners such as BMW are expected to introduce more models into China. The structural trends are still intact, as Chinese consumers are still enamored with these foreign luxury brands. The decline in share prices is caused by the recent news that the auto sector would be slowly liberalized and foreigners are allowed to own majority stakes in foreign JVs. Some worry that this means that foreign brands no longer need to work with Chinese companies and can sell cars on their own. However, the current JV agreements are still in place at least until 2023. There is still plenty of time to negotiate the new arrangements. But markets of course hate uncertainty. But to half the share price because of that?

Brilliance China

brilliance china 27082018

[Ed (27 Aug 18):  Brilliance China incidentally announced interim profit growth up 54% and the stock popped 14.7% today.]

BAIC 

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I have observed that share price decline fall into several categories. Declines of up to 20% should not be treated with concern. This is still within the normal deviation of stock prices in general. In more volatile markets or stocks, fluctuations in stock prices up to 30% can happen as a normal course of action without any news or change in fundamentals. I have learnt that this can be heart wrenching if we look at our P&Ls on a daily basis. However the best thing to do in this case would be to do nothing or we risk being shaken out by short term market fluctuations. The only exception to this rule is if the stock price were to break its 200 day ma. We should then sell the stock immediately as this usually isn’t a good sign. It shows that investor sentiments have changed and we do not know how much further it would go. The caveat to this rule of course is if you are a truly long term holder in the stock like Warren Buffett and you need to have unshakable conviction in your investment and analysis. Make sure you are also sufficiently diversified. In life many things can go wrong even when you have done all you can to consider all things in your analysis.

The second type of correction is the 40% correction from the last peak. A stock that recently fits this criteria is HM Sampoerna in Indonesia, majority own by British American Tobacco. The stock has compounded total returns of more than 25% in USD since its listing. A very impressive achievement in Indonesian markets given its volatile history and unpredictable FX movements. (A feat achieved by the equally impressive Unilever Indonesia, it has it be mentioned.) Tobacco stocks, it has to be said, normally do very well over the long term. Once I did a study and dug out the share price performance of the longest listed tobacco stock I could find – BAT London and was amazed to find that the stock has also compounded close to 20% p.a. since the 1960s which was as far back as my data source went. If anyone out there has a longer listed history of a tobacco stock, I would be interested to know the compounded annual TR of the stock. This proves to me that certain consumer companies like tobacco companies are much suited to weather through all sorts of economic conditions. Well back to HMSP. It is indeed unusual to find these stable stocks correct so much in such a short period of time. To be sure, the decline from recent peak has been about 44% in USD terms and have rebounded recently. In local currency terms the correction had been less. Investors are worried that the company has been losing market share and have not taken recent excise duties very well. But if we understand the long term characteristics of the tobacco business, I would say this should at best be a temporary issue. Indeed BAT Malaysia has also more than halved from recent peaks but for a different set of reasons. It is my contention that these stocks therefore are probably pretty close to being ripe for long term investors. If only I could get it at a lower price… Haha… Patience…

HM Sampoerna

HMSP 27082018

HMSP 1991 to 2018 Returns

HM Sampoerna compounded at a compounded return of 25.44% since it was listed in 1991.  That is a total return of 43,528% over the last 27 years! And this is in USD terms (hence taking care of the weakness of the Rupiah over this period.)  Notice that the total return is a lot higher than the price return.  Which means that about 60% of the total returns are made in dividends!

BAT Malaysia

ROTH MK 27082018

The final and most severe correction are those that typically go down. 60%-90%. These normally signal a severe crisis of confidence such as the Asia Financial Crisis on 1997 or the Global Financial Crisis in 2007, or if there are some structural reasons in the stock or the industry that the stock is in. Stocks are sold because of fear and not because of the fundamentals. Indeed, fundamentals and valuations are no longer meaningful. The only question then is when the we buy the stock., This would have been more an art than science. This is where I believe that technical analysis would be useful. It would be advisable to wait until the long-term trend is confirmed to be changed. In other words, we wait for the markets to signal that the trend is changing. Currently, my preferred indicator would be to wait until the 100 day moving average line cuts across the 200-day moving average line. This will ensure that we will not be tricked by the many false starts that are typical of a downward moving bear market. The dumps out this approach of course is that we normally would not be able to pick the bottom of the market. In fact, from my own observations, we would typically miss about 20 to 30% of the price from the low. This would of course be a small price to pay in order to avoid catching a falling knife. And you would also help reduce too many sleepless nights while we all want to stop to find it only to go down further if we went in too early. Here, I’m of course speaking from my very own painful experience. This is just a guideline for myself and of course if you readers have any other alternative way of timing the bottom I will be interested to find out as well and to refine my own approach.

This has been a very long discourse but I thought this would be a good time to summarize my own views on what to do when markets are down. Of course, to minimize our risk and to maximize our outside, it would be advisable to enter a stock only when it has declined more than 40%, I find that this would be much safer in the long term. This would also mean that we might miss a lot of opportunities along the way. But I would very much prefer to keep my bullets for those few real opportunities for the stock has declined 50% or more and has a chance within the next two to three years to double in price. The compounded annual return for some of these stocks will then be more than 20% which I think is a very reasonable goal and a very lucrative one for many investors.