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Monday, 30 April 2007

Armarda's AGM on 28th April 2007

I was glad to learn from this AGM that Armarda's joint venture with FESCO group will start contributing profit to Armarda's consolidated profit as early as 2Q 2007, i.e. sometime in August 2007.

More light was also shed regarding the joint venture. FESCO group's HR business involved handling all contract staff for many companies operating in China. i.e. Any company that wished hire general staff, would have to approach FESCO and provide the budget and the number of staff required. FESCO will take care of the hiring, the legal issues and the administrative matters such as pay. FESCO group used to enjoyed a monopoly but not anymore. However, since FESCO group is 100% state owned and had been in the business for almost 20 years, their contacts was extensive. Hence it should be logical to assume its business would not disappear overnight.

Armarda's joint venture with FESCO group involved setting up an IT subsidiary (45% owned by Armarda) just to provide IT services for FESCO, e.g. running of data centre, call centres. This subsidiary should enjoy a recurring income and not a one-off contract. However, FESCO group only gave the subsidiary exclusive right to provide IT service to FESCO group for 5 years. In the worst case scenario, this right might not be renewed. Hence, Armarda, through the subsidiary, should be able to enjoy increased stream of income for at least 5 years, beginning as soon as 2Q 2007.

Thus this cigar butt might had some good puff remaining after all.

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Multi-Chem 1Q results on 27th April 2007

Profit tumbled by nearly 60% due to slow down in PCB drilling & routing demand in Singapore and China. I almost fainted when I see that. But on closer look at the financial statement, I was relieved to learn that its IT distribution grew more than 87.4 % this quarter, 1Q 2007 compared to the same quarter last year 1Q 2006 and 33% compared to 4Q 2006.

Thus, Multi-Chem's IT distribution business was still on track to smoothen out the cyclical earnings of its PCB drilling and routing business. I am still confident that its IT distribution business will continue maintain a strong growth in the next 2 years.

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Tsit Wing's Annual Report, April 2007

Tsit Wing's Q3 2006 and Q4 2006 shows that it was enduring a slow profit margin squeeze (attributable to lost business of high margin tea distribution), I noticed an indication of possible recovery in Tsit Wing dismal performance in the face of intense competition in coffee, tea distribution and catering business.

Comparing segmental results of its 2005 and 2006 Annual Reports, I noticed that its China segment was all along making loses. In year 2004, its China segment suffered a loss of 6.7 million HKD. In year 2005, it the lost was reduced down to 5.2 million HKD. In year 2006, it was further cut down to 1 million HKD. Extrapolating this trend, I expect its China segment to venture into the black, or at least break even this year. This meant that there will be possible stronger showing by Tsit Wing this year, 2007 compared to last. Finger crossed!

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Armarda Special General Meeting on 3rd February 2007

This special meeting was originally called to get shareholders to vote (in favour) of allowing Armarda to form a joint venture with FESCO group in China, a provider of HR services.

The joint venture would see Armarda and FESCO group setting up an subsidiary to provide IT services to FESCO group. Armarda would own 45% of this new subsidiary and the latter would provide a steady stream of income to Armarda in the foreseeable future.

I managed to find out more about Armarda at this meeting than I would from simply googling around and reading Annual Reports. Armarda had about 80 million HKD, translating to about 5 cents (SGD) per share, while Armarda was trading around 4.5 cents then. It was flushing with cash!!! Things were not that simple thougth. The cash was real, no doubt. BUT, 40 million HKD was declared as paid up capital when Armarda ventured into China in 2004 (the year it IPO). This 40 million could not be touched unless the company wind up. 20 milliong HKD was required as working capital to operate the business. Only 20 million was left. Most of this 20 million was generated from business operations in China. Since Armarda was enjoying tax breaks in China (i.e. paid little or no tax), they could not move the cash out unless they pay a heavy charge for the remittance.

In other words, Armarda had cash, that it could not use. In order to form the joint venture with FESCO group, Armarda had to enter as a foreign entitiy. This meant that cash from Armarda had to be injected from outside China, and not from the cash it already had in China. Hence when Armarda need the 18 million RMB (about the same as HKD) to enter in the joint venture, Armarda had to raised this amount via placement (instead of using internal funds).

Unless Armarda start paying tax (another blow to its profit attributable to shareholders), the company would have problem taking funds out of its China operation. To simple shareholders, this meant that it would be next to impossible for Armarda to pay dividend in the immediate future. For the business, it would be difficult to invest in business opportunities outside China since its funds outside China was severly limited. Thus Armarda was not so cash rich after all.

Though not cash rich as it seemed from the financial statements, I was still confident of Armarda in the long run. Since I bought Armarda at an average of 5.2 cents per share, this price was not far from the averaged trading price of 4.5 cents in a period where Armarda's profit after tax had more or less bottomed. In this Q3 2006, Armarda's core business was generating about 300 thousand HKD while the 25% of BTL it acquired previously was giving it about 1000 thousand HKD per quarter. Armarda's profit per quarter (when it had been consistently giving profit guidance) before the acquisition was about 1000 thousand HKD. In short, Armarda's profit had bottomed out. Thus, going forward, I would expect Armarda's profit to be much more than just 1000 thousand HKD, due to profit from BTL and the joint venture with FESCO.

Anyway, at current business performance where its core business is almost insignificant, and with my average cost of 5.2 cents or about 50% NAV, Armarda is just another cigar butt in my portfolio.
  1. Surface Mount Technology
  2. United Food Holdings
  3. Armarda

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December 2006, I bought Multi-Chem

The disappointing performance of Surface Mount Technology highlighted the cyclical nature of manufacturing industry, especially for those without clear competitive advantage in a competitive market. Thus I normally do not take interest in companies in the manufacturing sector while shopping for bargains.

However, Multi-Chem caught my attention while I was stock screening based on profit margin and ROE. During stock shopping, I would quantitatively make a first cut selection of stocks, qualitatively assess its business and if these 2 test were passed, I would then make a more thorough quantitative forecast to determine its intrinsic value with my spread sheet program.

Multi-Chem had 3 business segments:
  1. PCB Drilling and routing
  2. Distribution of speciality chemicals and other PCB related products.
  3. Distribution of IT security products
1 and 3 were the its main revenue contributor while 2 was getting less significant with time. I was particularly attracted to its business of distributing IT security products.

Multi-chem conducts distribution of IT security products via an almost entirely owned subsidiary called Their business strategy was to carry only the leading IT security products (e.g. Nokia, Tipping point, Check Point) and regularly conducts courses, seminars with product vendors to raise IT security awareness. The end result was growth in sales quarter after quarter. also formed strategic partnerships with these vendors and Nokia even gave it exclusive distribution rights.

Though PCB drilling and routing was cyclical in nature, IT distribution business enabled it to smoothen out any possible dip in earnings should electronics demand go down in foreseeable future.

I worked in the IT security industry, I knew the recent interest in IT security amongst business would work in favour of M.Tech, (and hence Multi-chem).

However, things were not all rosy. From the segmental information given in the Annual report, I found out that revenue due to IT distribution rose more than 50% year on year, making it comparable to revenue from PCB drilling and routing. Yet, the profit IT distribution brings in accounted for only a quarter of that from PCB drilling and routing. The much lower profit margin from IT distribution business meant that this segment would had to grow to 4 times that of PCB drilling and routing in terms of sales to even out the company earnings. Even if IT distribution business could grow at 40% per year, it would take it at least 4 years to deliver the profits PCB drilling and routing brings in now.

Bearing any down turn in electronics demand and assuming continue good growth in IT security products distribution, I estimated Multi-chem's intrinsic value to be about 52 cents, with cost of capital at 10%.

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2nd Cigar Butt, Surface Mount Technology's 2Q Results in November 2006

I bought Surface Mount Technology at about 15% below NAV. Its ROE used to be above 15. 2Q earnings nearly tumbled 40%. What went wrong?

Apparently, Surface Mount Technology, operating in fiercely competitive EMS market, was facing a profit margin squeeze too (a keen to United Food) . On one hand, its facing escalating prices and shortage of raw production material. The shortage arose because suppliers do not hold much materials in stock due to highly volatile prices.

On the other hand, Surface Mount Technology was facing pricing pressure to maintain market share. The end result was profit margin squeeze and hence tumbling profits.

Without a clear and viable strategy to compete with its rivals, it would be difficult for Surface Mount Technology to reverse the trend of dwindling profits.

Share price of Surface Mount Technology subsequently tumbled to slightly over 30 cents, or nearly 50% NAV, earning it a seat in the cigar butt category too.

This brings my cigar butt count in my portfolio to 2:
  1. Surface Mount Technology
  2. United Food Holdings


The ugly cigar butt raised his head, United Food's 3Q results in October 2006

Citing rising raw material prices and operating expenses, coupled with pricing pressure to maintain market share, United Food Holdings saw a nearly 50% drop in net earnings.

Such margin squeeze was common with firms who operate in competitive environment without a clear strategy to compete. Thus, I would expected to see a decline in profits in coming quarters.

The fact that it traded substantially below NAV and without impressive performance earn it a place in the category of stocks called Cigar Butts. The latter term was first coined by Benjamin Graham to mean heavily beaten down stocks that might still have a good puff or two, i.e. such beaten down stocks should be so low that the only is up for them should circumstances change for the better.

It might make sense to invest in Cigar Butts with tremendous diversification because a few runaway Cigar Butts that do turn around would be enough to raise the entire portfolio above water. However, I subsequently realised such approach was similar to betting that the stocks would turn around, a risky gamble in essence.

I realised it make more sense to buy good companies at reasonable price (normally the price of good companies stay reasonable only if they were not noticed by general public or fund managers) than buy cigar butts and hope they turn around. The risk for cigar butts to turn around was much higher, though the returns would be proportionately higher too.

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First purchase after refined understanding, Tsit Wing in October 2006 and Food Empire in November 2006

With refined understanding about investing, most importantly in how to understand and value a business, I made new purchases, two stocks trading above NAV this time.

In October 2006, I bought Tsit Wing (coffee and tea distributor) at 30 cents. I estimated its intrinsic value to be about 60 cents, cost of capital at 10%. Tsit Wing was able to conquer a substantial market share of Hong Kong and was venturing into China. I thought then that if Tsit Wing could survive so well in Hong Kong, there must be something it did right to maintain its market share, something considered as competitive advantage? I would realise later there wasn't much competitive advanage about Tsit Wing.

In November 2006, I bought Food Empire (coffee distributor) at 53 cents. I estimate its intrinsic value to be about 75 cents, cost of capital at 10%. This business was brought to my attention by a fellow value investor. By then it was trading at 53 cents, its nearly 1.7 times NAV. However, the fact that it operated in emerging market in Russia, Ukraine, Eastern Europe (not popular China, India) fascinated me. There were so many brands in these countries, yet the coffee provider, Food Empire (foreign to the market it operate in) could conquer a substantial market share showed that it should possess some competitive advantage over rivals, at least in term of branding.

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Sunday, 29 April 2007

I nearly completed the book, Financial Statement Analysis and Security Valuation by Stephen Penman in October 2006

By October 2006, I completed 3 out of 5 parts of the book, namely, Financial Statements and Valuation; The Analysis of Financial Statements; Forecasting and Valuation Analysis.

There are 4 key guiding principles that I learnt:
  1. Price is what you pay, but value is what you get.
  2. One does not buy a stock, one buys a business.
  3. If you are going to buy a business, know the business.
  4. Stick to your beliefs and be patient, prices gravitate to fundamentals but can take some time.
I already understood the importance of intrinsic value and margin of safety after reading The intelligent investor by Benjamin Graham. Thus the main concept I learnt from the book was how to determine the intrinsic value. In investing, investments add value only if they earn above their required rate of return. An equity should sell at a premium if its ROE is forecasted to exceed the cost of capital (required rate of return). Likewise, it should sell at a discount if its ROE is to be less than the cost of capital. Thus, the intrinsic value of an equity was a function of its NAV and ROE.

In order to determine the intrinsic value the business, I need to uncover the drivers of its ROE, growth and their sustainability. One way was to reformulate the various financial statements. Reformulation is the lens that helps to bring the business activities into sharper focus and help me discover the drivers of ROE, growth and ultimately arrive at the intrinsic value of the company. My investment decisions will then be based upon whether I can purchase the equity at a discount to the intrinsic value, essentially the margin of safety I require.

Thus, my investment philosophy was refined to seek and purchase good business at a reasonable price. In order to do that, I go through at least 5 years of company financial reports and reformulate the various financial statements in a way helpful for equity analysis.


Reinvest profit from Golden Agri-Resouces in Full Apex and Surface Mount Tech in September 2006

On one hand, I continue to read up financial textbooks and other investment books, as if I'm preparing for CFA. On the other hand, with fresh funds after disposing Golden Agri-Resources, I started to look for new opportunities. I just couldn't let my cash idle away in the bank.

By September 2006, I started to accept that good business (displaying high ROE, e.g >15 ) might justify share price above NAV while under performing ones (displaying low ROE, e.g <10)>15), it is also trading below NAV by about 15%. Next I bought Full Apex at 29.5 cents. Full Apex manufactured PET bottles and had prominent customers like Pepsi-Cola as its clients. But it was trading slightly above NAV for ROE greater than 15 too.

Originally, I was quite confident about Full Apex. Though it faced rising price of raw materials due to high crude oil prices, it decided to build its factory to produce plastic resin, an intermediate raw material for making PET bottles, to deflect some of the rise in raw material cost. I thought such vertical integration in business operation was good until a fellow value investor pointed out that not all companies benefit from vertical integration, else why would many out-source some operations. Anyway, I didn't hung on to Full Apex before selling it off because I was still not comfortable with above NAV counters. I subsequently sold off Full Apex at 31.5 cents in the same month when I thought the general market had appreciated too much and was due for another correction. I thought then that I could wait out for another under NAV gem.


Sold off my Golden Agri-Resources in August 2006

By August 2006, the interest in Palm Oil as an viable ingredient for bio-diesel was starting to heat up. Palm oil price started to rise and the profit of Golden Agri-Resources was expected to improve dramatically. Hence it share price started to aim for the moon. From around 40 cents, its share price rose to 90++ cents in over several weeks before easing to 88 cents. Since my shares for this counter already double, I decided to cash in. (looking at Golden Agri-Resouces last done price now, $2.46 at 27th May 2007, my heart still ache everyday I see its price rise...)


May 2006 Singapore Sale

I wanted to get more serious with investing. I began to pour over books, either introduced by fellow value investors or search results from google on the subject matter.

But I couldn't complete much (I was busy, yes, excuses) before great Singapore sale arrived. When STI corrected about 10% over a few weeks, almost everything was going for discounts. Sale! Sale! Sale! That's what I heard then and I got in again to grab some bargains.

My financial knowledge was still quite shallow. However, I just learnt a new ratio, Return on Equity (ROE). I knew (but still couldn't understand why) that good ROE means good performance.

Hence by May 2006, I was screening stocks based on:

1. price to NAV
2. ROE

(ROE greater than 20 was impressive, 10 to 20 was good, less than 10 was mediocre)

As far as buying shares was concerned, my strategy was to allocate the same amount of cash to each counter. Even if I'm very sure of one counter, I won't buy more. My aim was not to maximise profit if I'm right. I'm more afraid of aggravating any loses if I'm wrong. This was still the strategy I adopted today.

I acquired Radiance at 12.5 cents, 2nd Chance at 21 cents and United Food at 25 cents. Radiance, an EMS solution provider, was about 40% below NAV, yet its ROE was greater than 15. 2nd Chance, involved in retailing, was trading 20% below NAV but with a ROE greater than 15 too. Unifood was trading at 35% below NAV, ROE slightly below 10 but was cash rich (though not as rich per share as Armarda). Somehow, I love counters with lots of cash. Then, I was thinking that shares were trading at a discount if they were neglected or simply because they were doing well. If its the latter, then chances for turn around are higher with cash rich companies compared to those in debt right? It was much later,that I found out things were not so simple after all.

However, when I did a more thorough research (due to my limited financial knowledge, I could only read up on the companies, their business etc) on these 3 companies, I decided to dump Radiance (at 13 cents) and 2nd Chance (at 22 cents). This was a mistake that I vowed never to make again (so far I haven't), i.e. to research a company before buying, not after!

However, when I did a more thorough research (due to my limited financial knowledge, I could only read up on the companies, their business etc) on these 3 companies, I decided to dump Radiance (at 13 cents) and 2nd Chance (at 22 cents) after their price recovered in July 2006 (By then, STI had also recovered). This was a mistake that I vowed never to make again (so far I haven't), i.e. to research a company before buying, not after!

Radiance was more than 80% owned by Goldtron. The latter was heavily in debt. I was afraid Goldtron would force Radiance to pay out all its earnings as dividend in order to repay its debt. I think I was right. Radiance subsequently paid out 0.026 cents of dividend against 0.019 cents of earning per share, i.e. give more than it earns???!!!

2nd chance had 3 business segments. One dealt with apparel, one in gold & diamond jewellery. The last in rentals from properties it owned. The reason I sold off 2nd chance was when I discovered it took a hefty bank loan to acquire REITs because it couldn't find properties to acquire at reasonable price! Why park my cash with 2nd chance if I could buy REITs myself! On hindsight, I think I was wrong then, somehow, 2nd chance could ensure its dividend from REITs more than offset the interest from the bank loan to make it a worth while venture.

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I started in August 2005 with Armarda & Golden Agri-Resouces

I started investing in August 2005. I purchased two counters, Armarda and Golden Agri-Resouces. I was pretty green then. After reading the book, The intelligent investor by Benjamin Graham. My mind was set on value investing.

I was a trained engineer. I knew practically nothing about finance or investment technicalities then. The only accounting module I did in university didn't help much. The intelligent investor merely paced the way and set the mindset straight on investing (as against speculation). But it is not the purpose for the book to deal with technical details on investment or finance.

However, I'm too eager to dive into the stock market. I couldn't wait to pick up more adequate financial background by reading up books on, say financial statement analysis etc.

Thus my stock screening criteria was very simple, price to NAV (Net asset value). So long as a stock is going for less than its book, is still profitable, it got into my watchlist.

I bought Armarda (an IT service provider focusing on banking services) at 5.5 cents and subsequently bought more at 5 cents because by then, it is trading at nearly 50% NAV and its cash holdings per share was 5 cents! Imagine paying 50 cents for a dollar bill, what a discount! It was only much later that I found I was naive then, to think this way.

I then bought Golden Agri-Resources (Indonesian Palm Oil Plantation Company) at 41 cents. It is also trading at nearly 50% NAV. The reason I bought this was different from Armarda. I liked its business. Back in August 2005, I saw the potential for palm oil to be used as an alternative ingredient for bio-diesel. I was sure then that it'll become gold grown on trees in 10 years down the road. I was subsequently proven right, but fortunately, I didn't have to wait for 10 years.

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