This week marks the beginning of my Value Investing portfolio. As the name denotes, the portfolio will buy stocks that appear underpriced relative to some intrinsic value or fundamental analysis.
It is not just about buying stocks at bargain prices. More importantly, we aim to discover companies with sustainable business models, improving productivity, unique products or services, innovative ideas or disruptive technologies, low stock valuations, good growth and strong balance sheets.
It is unlikely we will find a company with all the above characteristics. But we hope to find companies with some of the above characteristics, sufficient for us to be confident that they can be good long-term investments.
On October 10, we bought 50,000 shares in the first of these companies, OceanCash Pacific Bhd. It manufactures and exports resonated and thermoplastic felts that function as heat and sound insulators. The products are used in automobiles, air conditioners, and as insulation for buildings.
The company’s sales have grown consistently, with EBITDA margins rising from 14% to 18% in the last 4 years. With no additional investments into assets, ROE has climbed from 5% to 14% the last 3 years, generating huge productivity gains. Inventories and trade debtors are flat and well managed, despite rising sales revenue. Its gearing ratio is 3.7% and an interest cover of 23 times.
The stock has a beta of only 0.2, ideal when the overall market is volatile and uncertain. Edge Research gives this company a fundamental score of 2.1 out of 3.0 and a valuation score of 1.80 out of 3.0. A score of 3.0 is the best to have.
The stock’s trailing 12-months P/E is 9.6 times and the price to book ratio is 1.5 times with a dividend yield of 1.2%. Market capitalization is small at RM65 million. We believe it has strong growth potential in both existing and new markets. With an excellent balance sheet and with rising productivity and margins, OceanCash fits our criteria of Value Investing.
Some will say it is too small to invest. Well, wait till the price is much higher and the market capitalization is big enough for you then. In any case, our next stock pick will be about 10 times larger.
For those of you who are keen to be updated faster than reading this column only on Saturday each week, there are a number of options. Firstly, we will only buy the stocks in this portfolio after it has been highlighted in the daily Stock Pick of the Day by Insider Asia. This stock pick will be featured in The Edge Financial Daily and in www.theedgemarkets.com.
Secondly, all the analysis that I have presented above for OceanCash and more, including news and comparative analytics with other companies, are available for free at www.theedgemarkets.com. In fact, the same data and analysis are available for all companies listed on Bursa Malaysia and Singapore SGX. In other words, by using www.theedgemarkets.com, you can discover you own value stocks to invest in. You do not have to wait for us.
Why am I starting this portfolio now?
Partly, it is to promote The Edge and in particular, www.theedgemarkets.com.
It is also a challenge to discover undervalued companies in the face of an overvalued overall equity market, precariously supported by excessive liquidity and by local funds. Besides high valuations, we are also concerned with the prevailing negative real interest rates scenario, likely capital outflows and a lower Ringgit, falling corporate ROE and productivity, regional geopolitics and heightened racial and religious polarization.
But we understand that despite the above, many investors will continue to invest. Cash in hand and deposits in bank will only lose real value over time. And the property market will continue to consolidate in 2015.
Value investing for the longer term worked in the past and will continue to create value in the future for investors. Finding these stocks is difficult especially in an overvalued market. I believe using www.theedgemarkets.com can help you make better decisions.
Chart 1 shows the KLCI Index performance and the corresponding Normal P/E and the Schiller P/E Ratios. While the market is not excessively expensive, trading at just above the historical average P/E, it is also clear there are not going to be many bargains around.
In Chart 2, we show the drivers of the FBM KLCI performance. The overall market was driven to an overvaluation in 2013, but for 2014, the market has flattened out and corporate earnings have caught up a bit.
Chart 3 shows foreigners were net buyers up to the middle of 2013 and have since turned net sellers. Local institutional funds are supporting the stockmarket. While it reduces the downside, markets that have little volatility lose investors over time.
The real drivers going forward relates to the macro environment. In terms of valuations, are companies investing for growth, is labour productivity rising, will private investments grow, are margins and sales rising?
On the economic front, how far will interest rates rise in the face of rising domestic inflation and higher US interest rates? What will be the extent of capital outflows, and will crude oil and palm oil prices head further south?
While foreign ownership of domestic stocks is relatively low, foreigners currently own more than 40% of the Malaysian Government Securities. Should they exit, local institutions will need to fill the void and they will have to sell other assets to raise this capital. Of course for the short term, Bank Negara can also step in to buy these securities.
The point is this. There is no reason why the overall market should have a higher valuation than it is now. The balance sheet of the government and households are already extended. Corporate earnings growth is unlikely to surprise on the upside. Momentum for growth is slowing. There is no sign of overall productivity gains and in fact, total factor productivity trends for Malaysia fare badly. Heightened domestic political, racial and religious polarization is not a recipe to be positive.
At the same time, the market is not excessively overpriced. Much depend on what policies the government adopts and executes in the near term. Much will also depend on how the people come to a social consensus.
With this as the background, a possible strategy for the average investor would be to buy undervalued companies for the longer term. Enjoy reading and I hope you will have as much fun as I will.