Finding the “right” company

There are certain companies I seek out for:

1) Companies in a boring industry selling low-cost disposable items that people need. Repetitive simple products that do not require much innovation or invite competition. Think Gillette, Riverstone (Gloves), and Super Group (3 in 1 coffee).

2) The “secondary” or sister companies providing services to companies in a competitive industry. Well, companies in a competitive industry are often willing to spend money to differentiate themselves from their competitors (not that they end up with high-profit margin). The companies in competitive industry get all the limelight but it is the “secondary” or sister companies that get the high earnings (or to put in simply the iron-smith who forge the swords for the Knights. Let the knights have the glory and slaughter each other, the iron-smith will still be there forging the swords). Think Corning Glass vs companies in the cut-throat LCD, tablets and smartphones industry (Samsung / LG / Sharp); SIA Engineering & SATS vs SIA; Vicom vs Comfortdelgro; and even NeraTel vs Sheng Siong & Dairy Farm.

3) The defensible companies with a strong moat (in start up cost / high entry barrier) in a boring and sometimes disagreeable industry. In bad times or good times, people would need their products or services. Think Colex, 800 Super, ISOTeam, NeraTel.

4) The fallen star – once a stable or growth company that has fallen on bad times due to some blunders or external factors that do not affect the company fundamentally. For example, Sung Hung Kai & the biggest corruption case in Hong Kong’s history; Super Group and external factors causing a loss in profits (Thai political situations, currency exchange rate, Malaysian GST etc). However, I find it difficult to add to my positions subsequently, after I’ve first purchased the stocks (the window of opportunities does not come often). Also, I do not consider mediocre companies with bad fundamentals (eg. Olam, Noble) or companies which I am dubious figures or products as fallen stars (eg. Sino Grandness).

Of course, there are other factors which I would have to first consider. Most of it is rudimentary figures (because at the end of the day, figures can’t lie):

• Low or zero debt, high current ratio;
• Low Price to Book Ratio;
• Current stock price lower than intrinsic value;
• Low PEG (less than 1);
• Low EV/EBITDA (below 10);
• High earnings or profits growth (min 20%);
• Low institutional ownership & Managements that own a lot of stock;
• Increasing operational cash flow.

Or simply companies that have a good track record of improving earnings built up over many years. A few bad quarters or years should be reviewed against their past records (eg. min 5 yrs – best would be 10 yrs as practiced by Warren Buffett) and not taken singularly, or by its sudden drop in share prices.

“I’m not very good at judging people. So I found that it was much better to look at the figures rather than people. I didn’t go to many meetings unless they were relatively nearby.” Walter Schloss

There are also certain companies that I avoid:

1) Cyclical companies. I am a bit skeptical about these companies as I have yet to successfully made money from their stocks. It is always difficult to time the entry (Property counters, Commodity counters or Oil counters can be considered). Examples of these are the (recent & not so recent) drop in prices of Indo Agri, Golden Agri, First Resource, Keppel Corps, Sembcorp, Ezion, Nam Cheong and even Luk Fook Holdings (Intl) Ltd. The length of time from declines to recovery could take many years and the major economic or political factors are just hard to comprehend. I could have passed out many opportunities by just holding on to these stocks (at depressed prices). In addition, there is really very little to grasp onto (inconsistent earnings & cash flow), or a compass to point the right direction when you are in the dark. You can’t fall back on fundamentals or major economy factors.

2) IT or Tech related companies or just companies in highly competitive industries. Eg. Chartered Semiconductor, Venture, Creative, SIA (realized it was a mistake after I bought it). However, recently several of these companies have caught my attention, just based on their earning growth eg Tencent Holdings Ltd, NeraTel, Airbnb (not listed). However, being the low-tech guy that I am, I have my reservations. I always remember what Alibaba chief said when he compare Alibaba to the traditional brick and mortar companies – something like for the traditional company, expanding to meet an increase no. of customers, they need to add so many buildings and infrastructure, but for him, it just takes 2 servers. But at the back of my mind, I was wondering, won’t that also apply to his competitors? If there is no high entry barrier – it is easy for others to overtake him.

3) Fashion or retail related companies, toy companies, companies selling papers or books. With the rise of the online shopping & online media and the constant need to innovate or redesign, it is not difficult to see why many companies are not able to make huge profits. Eg. FJ Benjamin Holdings, Dream International Ltd, Popular, SPH and Sears. Nevertheless, a few companies caught my attention just purely based on their earning growth, eg. Hosa International Ltd.

4) Big complex companies. After buying CapitaLand stocks and reading its annual reports, I must say I could only grasp a small portion of what is in it. Same for Golden Agri. I do not like the use of complex terms like fair value gains, currency risks, foreign tax, property valuation (how I know if these are accurate?), or the presence of too many unrelated subsidiaries. I did not study economics or have a finance degree.

I like what the current CEO of CapitaLand is advocating – to streamline the operations of the company and to cut down on duplication. With regards to Boustead, it would be good to have a more focused company (eg. spinning off its real estate division). But of course, others might want a diversified Boustead as the different divisions can help cushion the shortcomings of each other. For me, I like a simple spreadsheet, easy to understand Annual Report or Quarterly earnings report. I don’t really care if the turnover is a few million or a few billions, as long as there is a good improvement and no hidden or difficult to understand segments.

If there is a lemonade stand that is simple and making good money, I would rather put my money there (Revenue – expenditure = profit; it’s that simple).

However, there is always a counter argument that says that it is not easy for big companies to fail or go bust. Well, it may be so – but I have witnessed how slow and painful decline can happen to these so called infallible companies. Won’t die – just slow and consistent bad earnings.

5) To a lesser extent, I do not like companies that have high CAPEX, or which are labor intensive. However, I do make exceptions. There are companies that thrive despite these challenges. Eg. Japan Food and Colex. Where others have tripped eg. Breadtalk, Tiong Seng, Lian Beng etc.

6) Companies that I do understand or have products that I am not aware of. The recent sell-down of Sino Grandness Food Industry Good Ltd in Oct 2014 would have been a good opportunity to buy except for the fact: (1) I am not familiar with its loquat drink (Garden Fresh)   (2) It is an S-chip with seemingly ‘too good to be truth’ financials eg. gross margin of 40%. I have read too many S-chip counters with fake reports.

It could be a case of misunderstanding. However, I have to, first of all, convince myself of the fundamentals of the company (to have confidence in the company) before investing regardless of whether there is future potentials or immediate profits to be made. If I have not even seen Garden Fresh before, how can I be confident of the company?

At the end of the day, there is no Perfect Company. Some have more things which I favor while others have less.