Sunday, 22 April 2018

Book Review: 6 reasons for businesses to fail from Scott Fearon's Dead Companies Walking



About the Author:

Scott Fearon is the founder and president of Crown Capital Management, a hedge fund that both longs and shorts stocks. Since its inception in 1991, the hedge fund had only one down year and has averaged an 11.3 percent annual return after all fees, thus outperforming the index.

Interested investors can read more from Scott Fearon on his personal site (here).

About the Book:

This book details 6 key reasons for corporate collapse (apart from fraud) as well as Scott's general investment philosophy. Each reason is illustrated with real-life case studies from Scott's long career as a money manager.

The insights gleaned from this book are useful not only for short sellers but also long-only investors looking for tell tale signs on differences between "turnarounds" and businesses sliding towards bankruptcy. I highly recommend this book to investors who wish to learn tips on spotting companies in permanent decline.

Here are the 6 causes for corporate collapse:

1) The leaders learned from only the recent past

Scott refers to this reason as "historical myopia" where key executives would place excess weight on recent experience and conveniently ignore long-term trends and possibilities. This could result in excessive optimism amongst business leaders, thus leading to poor decision making.

"Historical myopia" is also applicable for investors. While financial statements are important, investors should focus on growth outlook for the companies in order to avoid this trap.

2) Relying too heavily on a formula for success

Scott's recommendation is to use formulas as a guide instead. This is true both for investors and for businesses as qualitative assessment is required as well.

One particularly dangerous formula for businesses is the "hypergrowth" formula - businesses loading up debt to pursue extreme growth targets. Pursuing growth at all costs often results in low-quality growth eventually leading to declines in revenue. Ironically, falling revenue and rising debt form the formula for bankruptcy.

3) Misreading or alienating their customers

Businesses that alienate their core clientele are essentially planning their demise. 

One common scenario would be (new) key executives imposing their own taste and preferences on their businesses' clientele. Scott cites JCPenney as a good example for this scenario. While JCPenney's stores are located in middle and working class location, that did not stop new CEO Johnson's push for luxury retail clients instead of their core customers. Johnson lasted only 18 months on the job.

Another common scenario relates to businesses believing they can create niche demand à la Steve Jobs without consideration of real-world behaviour. In actual fact, few businesses succeed in changing consumer behaviour, and businesses whose product or service do not represent an upgrade on client experience have no chance of doing so.

4) The leaders fell victim to a mania

Much has been discussed by successful money managers about manias or asset bubbles given their repeated occurrences in the economy due to human's herd mentality. 

Scott cautions against investing in businesses built fundamentally on how a new mania or fad would render older ways of living or doing businesses obsolete.

5) Management failed to adapt to tectonic shifts in their industries

Change is the only constant in life and management living in denial of reality often fail to position their businesses for change. This is especially true for businesses that have been hit hard by disruption - if management do not accept that their business model is obsolete, their business will eventually crumble.

6) The leaders are physically or emotionally removed from their companies' operations

Elitist leaders living unnecessarily luxurious lifestyles on company's expense is a sign that they are out of touch especially if the business is undergoing tough times. Management that routinely chooses to blame external environment instead of facing up to root causes is another recipe for disaster.

These leaders are unlikely to take the necessary steps to fix the core problems at their companies.

This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material

Friday, 30 March 2018

FY17 (Apr17 to Mar18) Portfolio Review - A Great Year

Trading in Hong Kong and Singapore are both closed for Good Friday holiday today, meaning that FY17 has officially came to an end. As a result, it is time for my second full year report since I begun investing in April 2016.

Portfolio Results


Time-weighted returns - 118.96% (+63.53% half-on-half, +84.95% year-on-year)
All-time XIRR - 58.93% (+31.55% half-on-half)

Perhaps it is fitting to begin by congratulating myself after such a great year as my portfolio had reaped amazing returns beyond what the index could have provided. Even if I were to take into account the lack of returns from cash held as part of portfolio, the 0% returns attributed to around 20% of my portfolio would still have allowed me to thrash the index thoroughly.

However, I would like to re-emphasize the following: it is pertinent to note that short run out-performance can be influenced to a large extent by luck. Long run performance is the fairest measure of a value investor's success, and that is what I have to continually work towards.

After all, 2017 was a great year for most investors. This is easily observed from our everyday life. For example, there was a marked increase in "experts" offering courses or paid subscriptions towards the end of 2017. It is especially puzzling to me when "experts" who under-perform the market hold courses to teach others on investing. I struggle to wrap my head around how they convince themselves that their advice is worth the money, and why people would bother paying to learn how to under-perform the market. Either way, I see these developments as tell tale signs that the market in 2017 was one that was very kind to investors, myself included.

Open Positions


March was a rather busy month for me as I added both Hop Hing and Riverstone. I also took advantage of the dip in Hock Lian Seng's share price back to $0.46 to add a bit more of Hock Lian Seng into my portfolio.

My open positions are currently anchored by 3 stocks - AEM, Hock Lian Seng, and Riverstone, whose prospects I am all confident about. SUTL Enterprise is a potential multi-bagger over the long run which I am prepared to keep for some time. My Hong Kong bets are small positions for me to start learning more about the Hong Kong stock market.

All in all, I am very comfortable with my Open Positions set up. With 5/7 of my counters trading Cum Dividends, I am also happily awaiting the upcoming dividends.

Closed Positions


I had closed a total of 7 positions over the past year. Most of the decisions to exit turned out to be pretty good as the counters' share prices have not progressed since my divestment. 

In terms of bad decisions, Sapphire stands out as the only loss. I made a mistake with my investment thesis, so I guess there can really be no complaints.

Going Forward

After the transactions made in February/March, and with the addition of my entire bonus into the portfolio, I am now sitting at 30% cash. In the short run, I am constantly on the look out for the right opportunity to deploy this capital.

In the long run, there is still plenty to learn about value investing. I hope to have a better grasp of the Hong Kong stock market over the next year, and to learn more about valuing tech companies. In terms of formal learning, I hope to complete my CFA, and to read more books on value investing.

Appreciations

This blog was originally started as a personal journal to capture the crux of my investment theses so I can hold myself accountable to them. The fact that I have these many readers is an unintended positive consequence of this personal journey for which I am rather thankful about. Today, I count some professional investors as readers of my blog, and am particularly glad to have met those that bothered reaching out. 

Over the course of the past year, I have also been thinking about how to set up this site to self-select audience who might be more serious about investing. Given the thought, I have also stopped publicizing my writings on mediums where readers might not have the same appreciation for validated opinions that differ from theirs. After all, my primary purpose of writing is neither to make money off it, nor to convince others to buy or sell.

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This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.

Wednesday, 14 March 2018

New Counter: Riverstone Holdings

Equity: Riverstone Holdings (SGX: AP4)

Business: Glove manufacturer
Markets exposed: Global
Stock exchange: SGX
Purchase price: 1.03 (including transaction costs)
Purchase month: March

10% per annum thesis: 

Riverstone Holdings is a solid fast grower with moat particularly in gloves used in cleanroom environment which commands higher margins.

Introduction:

Riverstone Holdings is primarily a nitrile glove manufacturer that sells its gloves around the world. Gloves sold cater to 2 main segments - cleanroom environment and healthcare.


Considerations:

1) Governance and Management

Founder, CEO, and Executive Chairman Wong Teek Son also doubles up as the largest shareholder with 50.75% of total shareholdings. Co-founder and COO Lee Wai Keong is another who eats his own cooking, holding 11.66% ownership. Given that the lion's share of ownership is in the hands of management, we have definite management-shareholder alignment.

It is also worth highlighting that Riverstone's board consist of 3/6 of the directors as independent directors, and comes in at a very respectable 56th place on 2017's SGTI rankings (here).

2) Fast Grower

Riverstone is a company with a fantastic track record for organic growth.

Source: Compiled by Author

The company produced 7.6 billion gloves in 2017 and plans to produce 10.4 billion gloves by end of FY2019. Given their impressive track record, it appears that the company is well set on executing its grand plan to increase capacity. The fact that the company is growing without leverage also lowers the investment risk of the growth thesis.

From an industry point of view, it is worth noting that listed rivals Top Glove, Hartalega, and Kossan Rubber Industries have all been growing their nitrile glove segment steadily. This is a sign of strong and growing industrial demand likely driven by increased usage of nitrile glove in advanced manufacturing and also in healthcare. Riverstone's optimism that their increased capacity would be absorbed by the market therefore appears to be well-placed.

3) Valuations

Riverstone is undervalued relative to its listed peers.

Source: Compiled by Author

One possible explanation is the size of the company - Riverstone is the smallest amongst the 4 companies. However, Riverstone is not inferior to the other companies in terms of any financial metrics from margins to returns. In fact, the company can also boast of having the highest return on equity amongst its peer group.

Source: Compiled by Author

Given the above, my personal opinion is that Riverstone is relatively undervalued to peers. 

At my buy-in price of $1.03, Riverstone trades at a trailing Price/Earnings of around 18. While not exactly cheap, my personal opinion is that this is a valuation that is more than fair considering that the company has been growing net profit at a CAGR that exceeds its Price/Earnings ratio.

Risks:

A) Increasing price of Butadiene, which will raise production costs.

B) Weakening of USD/MYR, thus leading to FX losses.

C) Weakening of demand for both cleanroom and healthcare gloves.

Conclusion

I have taken advantage of weak Q4 results by Riverstone to establish a position in this counter which I had been monitoring for the longest time. I am pleased to announce my first SGX purchase since November last year and have established Riverstone as one of my core portfolio positions.

I remain on a lookout for undervalued counters to add to my portfolio so please feel free to throw up a couple of names!

This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.