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Saturday, 3 November 2007

Stocks -- fooled by randomness?

I chanced upon an interesting idea/concept while reading a book on risk, titled "Against the gods, the remarkable story on risk", by Peter L. Bernstein.

If the results of an activity is truly random, taking statistical measurements of repeated trials should resemble a normal distribution, i.e. a bell curve. The sum total of two dice repeated sufficient number of times will result in a bell curve with more counts centered about 7 and 8, tapered towards the extreme of 2 and 12.

Does that occur to stocks? With the help of my friend, I got hold of the daily closing value of STI from April 1985 to Oct 2007. I plotted the total counts of daily changes in percentage against the changes and got the following graph.

On first look, the graph fit a bell curve quite nicely. But on closer look, other than the change from 0 to 0.5%, there are more counts for almost all corresponding percentage changes in the positive category compared to the negative ones. e.g. there are more counts of 0.5 to 1% compared to -0.5 to -1% etc.

Daily changes of STI index can be said to be nearly random but skewed towards more positive changes. Hence, over time, STI should appreciate. A check on STI index from 1985 to 2007 verifies this.

In other words, if a typical investor blindly dollar averages STI index (e.g. via index ETF) from 1985 to present, he would have reaped sizable returns while being saved from daily emotional stress, swinging between extremes of anguish and euphoria.

One reason why STI index (or any broad based index of any country with open economy) demonstrates daily randomness is because world events, be it fundamental or sentimental, occurs in random and unpredictable manner. STI is thus affected unpredictably, resulting in short term random behavior. But as the economy of any country with open economy increases over time, so does the index which reflects its economic growth.


Multi-Chem 3Q results on 30th October 2007 - Mixed results

Heartening results
Overall profit finally improved 37% quarter on quarter even though overall profit for first 9 months still lagged last year by 19%, due to poor Q1 and Q2 results.

Drilling Business
The better results was contributed mainly by its stunning growth in drilling services in PRC while Singapore posted only marginal growth.

3Q 2006 - 3Q 2007
12.6m - 16.9m --- 34.2%

2Q 2007 - 3Q 2007
11.4m - 16.9m --- 48.5%

IT distribution
After several quarters of record growth in revenue, 3Q 2007 shows signs of slowing down.

3Q 2006 - 3Q 2007
11.9m - 20.5m --- 72.2%

2Q 2007 - 3Q 2007
21.8m - 20.5m --- (5.8%)

Referring to my earlier post on 2Q 2007 results, the unexpected slow down in IT segment might derail the target of 42.9m revenue required to match the earnings contributed from the drilling segment within 2 quarters, i.e. 1Q 2008. Bearing further slow down in this segment, I'm cautiously optimistic that revenue could only hit 42.9m by end of 2008.

Multi-chem's has tremendous resources tied up in the capital intensive drilling business segments. Its high operating leverage nature works to its favour when all the machines are ultilised, resulting in better profit margin from increasing economy of scale.

However, due to cyclical nature of drilling business, it is inevitable to encounter down cycles. When that happens, machine utilisation rate may fall so low that this segment starts to incur losses due to the high fix cost.

Thus I can only hope its IT segment can grow quickly to match the earnings from the drilling segment in order to stablise future earnings.

Going forward
Bearing unforeseen slow down in both major business segments, drilling and IT distribution, I am hopeful that 2008 will be a good year for multi-chem.

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I bought IPCO on 23rd October 2007

Business Overview

IPCO is basically a holding company with 4 major investments in vastly different industries.

  1. Excellent Empire Ltd (88.89%): Its subsidiaries hold exclusive 30 year natural gas supply concessions for 3 cities in Hubei province, PRC.
  2. Asia Plan Ltd (70%): Its wholly owned subsidiary, Capri Investment L.L.C, is engaged in residential real estate developement near Seattle in the state of Washington, USA.
  3. ESA Electronics Pte Ltd (62.5%): It acts as manufacturer, agent and distributor of semi-conductor back-end equipment, such as burn-in systems, vision inspection systems and test systems.
  4. C.N.A. Venture Sdn. Bhd (40%): CNA is primarily engaged in the manufacture of polymer and passenger seats for the automotive industry in Malaysia.

Reasons for purchase

Ever since IPCO undertook restructuring in 2003 to consolidate its various business segments, its financial performance in terms of EPS had steadily bottomed out in 2004/2005. However, its share price had been fluctuating around 8 cents (which already was more than a hefty 50% discount from NAV of 18 cents*). Going foward, business performance in various segments should improve further and and lift up overall group earnings.


With IPCO trading at severe discount* to NAV and having a meagre ROE of less than 3 (a great improvement of below ONE a few years ago), I classify it as a Cigar Butt. Bearing unforeseen changes to business developments, I will be glad to dispose it around NAV, achieveing more than 100% returns.


*On the surface, IPCO at 8 cents, is trading at a severe discount* to NAV of 18 cents. However, looking deeper, this actually comes at no surprise.

Firstly, with ROE below 3, it is well below any moderate cost of capital of 10% to cover the risk in equity investment. A discount to NAV is definitely justifiable.

Secondly, IPCO being a holding company, had acquired many business above their book value. This results in tremendous goodwill on the balance sheet. Together with distribution and licensing rights, IPCO actually carries about 139K of intangible assets.

The management carries out annual test on the various business units to determine whether there is a need (due to revision of recoverable amount of the business, essentially the income) to write down the goodwill. The distribution and licensing rights also need to be amortized.

Taken together, this means that under the worse case scenario where all intangibles are wept off the balance sheet, the NTA of IPCO is merely 5.8 cents.

NTA (without intangibles): 5.8 cents
NAV (with intangibles): 18 cents

Hence its either I'm buying IPCO at a great bargain or buying it at a premium.

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