Evaluating companies using ROE and PER

Came accross an article from The Star today: Ways to evaluate a company. Below are some of the excerpts (in green) with my comments (in blue):

Some investors may be wondering, between return on equity (ROE) and price earnings ratio (PER), which method is more suitable to value a company. According to John Neff, ROE is regarded as the best single measure of managerial performance because it shows the management’s ability to generate profit from the capital it employs. It is the ratio of net income to shareholders’ equity.

Warren Buffett said a good business should be able to achieve good ROE without employing high debts. Companies with high gearing are vulnerable to financial risk during the economic downturn and high interest rate environment. Besides, any future investment plans should be funded by internally generated cash flow without having to call on shareholders to contribute. Unless the return generated from the shareholders’ money is greater than ROE, it will show lower shareholders’ returns as a result of the enlarged share capital.

(A brief explanation to those without a financial background: Business can be run with 2 types of funding, Debts and Equity. Debts include loans from banks, leasing and etc and they carry fixed interest charges, regardless if the company is making money. So, in a bad time, when the company is not making much money and with margins squeezed, those with heavy debts are usually those to go down first. The US subprime crisis is an example of how deadly debts can be. Equity are also known as Capital or Shareholders' Fund, include Reserves, Retained Earnings and Paid Up Capital.)

As Buffett is a conservative investor, he prefer companies who are able to generate profits without using much debts and hence, will have higher resilience during bad times. In other words, he think a good company should be able to return good profits to shareholders with minimum capital. However, an aggressive business usually doesn't mind to take on extra debts to fund its expansion, provided the extra returns generated from such expansion is sufficient to cover the interest expense. That's why we have another ratio called "Times Interest covered" which measured how many times the earnings can cover the interest costs. Anyway, ROE is one of my favorite tool in finding "the right company to invest".

PER is defined as the market price of a company divided by its earnings per share (EPS). The principle behind this method is the concept of payback period. This ratio tells us how many times the price is greater than the annual earnings of a share. For example, Company A is currently selling at a PER of 15 times. This means that it takes 15 years for an investor to get back his returns through the company’s annual earnings, assuming that the company will produce the same EPS during that period.

A higher PER implies that it takes more years to get back your returns from the company’s earnings. Based on the academic view, a higher PER is better than a lower one because this implies that investors are willing to pay more than the normal market PER. Nevertheless, in practice, most analysts will say that a lower PER is better because it implies that the company is undervalued and cheap at the current valuation. So which view should we follow?

In an efficient market, companies that are selling at a higher PER are better than companies with a lower PER. This is because when the market is efficient, the current price will reflect past, current and future information.

That is also why high growth companies in highly efficient market like those Google, Yahoo, Alibaba and etc command high PER. People are buying into the idea that they will grow exponentially and bringing down the PER in a few years' time.

In Malaysia however, most academic researchers have concluded that our stock market is not efficient, which implies that the current stock prices do not reflect all information. Hence, there may be some potential past or future information that is not fully reflected in a stock’s current price. Given this, it is quite possible to find some undervalued companies on Bursa Malaysia if we select those with low PERs.
First, we have to understand what causes a company stock to be sold at a low PER, where the market price is lower relative to its earnings. However, not all stocks with low PER imply good value for investing. As mentioned earlier, sometimes the cheap valuation may be a true reflection of certain negative aspects of the company, for example, poor corporate governance, high gearing, uncertainty of future earnings and or it is facing litigation. However, as a result of asymmetric information, not all investors are fully aware of the market’s worries. Hence, analysts with the necessary knowledge, skills and market information play a very critical role in helping investors to analyse companies in detail and identifying those that are truly undervalued based on fundamentals.

One additional point: when we look at past PER, we do not look into any single year or only the latest PER. There might be a year or two when the company is able to earn extra income from some "one-time" gain like selling of properties or revaluation of assets and etc., which might not necessarily reoccurring in the future. Hence, PER is only useful when evaluating a stable company who has been making consistent income over the years.

Also, do not fully trust most PERs published in the newspapers or magazines because they might be using different calculation method. Some of them are even outdated. It is still better to compute your own PER based on the latest company's announced financial reports.

On a side note, low ROE companies (<10%) usually have low PER(<10).

Tamco announcement

Came across a very interesting article in The Star yesterday: Tamco to announce new core business in six months. Reposting below with comments from Yours Truly:


SUBANG JAYA: Tamco Corporate Holdings Bhd will announce its new core business in six months, group managing director Abdul Latif Mahamud said. “We will make that announcement in six to eight months when we feel the time is right,” he said after the company EGM yesterday.
There are 2 possibilities:
Possibility 1) Assuming they DO have a business plan in mind. From the point of view of an investor of the company, isn't it the obligation of the company to inform every shareholders the future direction of the company? Even if there is a delay, aren't 6 to 8 months a bit too far fetched? Let's look it another way. Let's say you and a partner, let's call him Ah Kiang, is operating a business, Ah Kiang being the managing partner. One fine day, Ah Kiang wake up and suddenly decided to sell off the business. Well, since he is the managing partner, you agree with his move and whatever the price he is selling. So now, the business gone and you two are holding a huge pile of money (to be exact, he is holding, because bank signatories are all under his name). So, you ask Ah Kiang, "what to do now?" And Ah Kiang replied "I cannot tell you now, but I will tell you in 6 to 8 months time, when I feel the time is right." I don't know about you. But I will laugh if I hear him saying this to me.
Possibility 2) They don't have a business plan in mind. The way I look at it, this is a more likely possibility.

Abdul Latif did not disclose the nature of the company’s future core business but said: “We are considering several options. We have plans but we cannot reveal them at this moment.”
However, he confirmed that the company was venturing into “new and different” business streams.
“We are looking at businesses other than what we have now and have identified certain areas,” he added.
Again it's like saying, "We don't know what to do with your money yet, but since you ask, I can only tell you that we are not going back into the old business".

Meanwhile, deputy chairman Datuk Siew Ka Wei said the company was in good hands and had a promising outlook.
“This is the management that brought the company from where it was (when it was listed) to where it is today.
“The management deserves the trust (of its shareholders) to look for a new business that would create value,” Siew added.
Now, Dato Siew is a more reasonable guy. My interpretation is: "Look, we've made you this much money over the years, so you have to give us time to sort this @#% out."
Anyway, I am excited with the phrase "promising outlook" he used.

At the EGM, Tamco shareholders approved the proposed disposal of the company’s core switchgear business to India-based engineering company, Larsen & Toubro Ltd, for RM378mil.
Siew said the bulk of the proceeds would be distributed to shareholders.
Nice proposals. Let's see if it materialise.

Tamco will be disposing of its entire equity interest in four subsidiaries: Tamco Switch-gear (M) Sdn Bhd, Tamco Shanghai Switchgear Co Ltd, Tamco Electrical Industries Australia Pty Ltd and PT Tamco Indonesia.
The disposal is expected to be completed in the first half of this year.
Whatever the case, I think the MD has a trustworthy look. So, the shareholders should have some patience and wait for 6 to 8 months when things become "Promising".

Professionals vs Amateurs

According to definitions from the Wikipedia:
Professional is defined as “a person who earns his living from a give field” or “a person with extensive knowledge or ability in a given subject”;
Amateur is defined as “Someone who pursues something part time, as a hobby or not very seriously”

In sports, under normal circumstances, a professional will beat an amateur by a huge margin. An amateur golfer will never beat Tiger Woods (even if he uses only a 7-iron for the whole course). A casual runner will not run faster than Justin Gatlin or Asafa Powell in a 100m Sprint (either they are on steroids or not). An amateur tennis player who plays only on weekends can only dream of beating Roger Federer or Maria Sharapova (even with them having both hands tied together). Why are these people good at what they are doing? Aren’t they human like us? In my opinion, apart from being born talented, these so-called professionals have put in extra efforts, have been doing what they are doing day in day out, and most importantly, they have the PASSION and determination to do well in their games.

But there is one field where Professionals do not necessarily do better than us amateurs! In some occasions, comparing some of their scores to ours could even put them into abysmal positions. And that’s of course in the world of Investing! This is a playing field where we, amateurs, can beat a 7 figures salaried professional year in year out, if we do the right things! Need proof? Simply look at the Fund Performance table in the newspapers or magazines that track these. I am sure there are many of them who are currently trading below what they were selling 1 to 2 years back. People who have yielded positive returns over the last 2 years are considered to have beaten these professionals! People who have doubled their money or more over the period (I know people who did), can put these professionals in shame!

Well, that’s not funny. I have entrusted my hard-earned money into the hands of these so-called professionals years back and realize now that they are in fact worth way less than what I have paid for 2 years back! My own portfolio has done better! Why have I invested in those funds earlier if I can invest myself? I used to buy into the ideas that these professional stock pickers can invest better than us, with advantages like big research teams, super-skilled professionals (my ass!), superb past performances (this is where past performance doesn’t guarantee future success) and all sorts of crabs. Bottom line is, they want your money! And they want to charge you management fees as a “Professionals”, even if they fail! And they will brag about it like it’s a big deal if they return slightly above the Fixed Deposit rate, when in fact, even the indexes have done much better. In whichever circumstances, they are the winners and we are the suckers. I haven’t even mentioned those funds that got caught in the subprime mortgage crisis, where big chunk of their portfolios got wiped out in days.

Don’t get me wrong, I didn’t say that ALL professional fund managers are bad. There are fund managers that have truly earned my respects. One of them is Mr Tan Teng Boo from I Capital. If I have put all my money into I Capital rather than those X@#$%^* fund, I could be laughing my way to the bank right now!! Besides, there are in fact a couple of funds who did extremely well over the years too. Some top performing funds have even grew the clients' initial investment by a few times. My salute to those! Anyway, my point here is, do not invest blindly into funds. Investing in fund is NOT a fool-proof or sure-win strategy for investment. Things can still go wrong, and on occasions, terribly wrong! If one has the time and resources to do their own asset allocations, one should pick their own stocks rather than entrusted them into unknown hands. Trust me, the chances of success is much higher than beating Tiger Woods!

Reminder: If you don’t have the time to do the stock picking yourself, buy I-Capital (whenever it is selling near its NAV)!

Things I wish will happen in 2008

As this is a brand new year, I would like to make a wish list here and see how many will come true at the end of the year:

1) every family and friends to have a save and healthy year
2) My private fund to return 20% p.a.
3) The global financial market to rebound from the subprime woes
4) KLCI to cross 2000 points
5) I Capital to trade above RM3 (this might sounds greedy, but hey, it's a wish)
6) My daughter knows how to call me "Papa"
7) Malaysia to have a smooth and fair election (no riot, no sudden blackout during counting of votes, no "ghost voters" and etc)
8) The China market did not collapse after Beijing Olympic as predicted by most "experts"
9) some bad and dirty Malaysian politicians are diagnosed with cancers and retired
10) Malaysia Government to manage the tax payer money more efficiently, like clean government, low corruption ("No" corruption is too far-fetched), lower income tax, low crime rate, car AP system to be abolished, Proton to be sold off and etc.
11) Arsenal winning the Premier League
12) Alex Ferguson resigned from Man United and his post is taken over by Bryan Robson (hey, a wish, remember)
13) Hamilton wins the F1 (pity him for losing the title in the final race in year 2007 la)
14) Warren Buffett come to Malaysia for vacation and I meet him on the street and take a photo with him.

I will be a happy person if half of these come true.

Happy New Year 2008

Wishing all my readers a HAPPY NEW YEAR!!
(I really appreciate that you are still visiting this page)

During the past 2 months, 2 GREAT things happened to me. The first, the arrival of my baby girl to the family. She is the greatest gift I have ever received for years and I have been busy picking up new skills on how to take care of her. Now I have finally realised the meaning of "Everyday is a miracle". Believe me, for those who are yet to become a father, this is one exciting experience!

2nd thing, I have FINALLY decided to kick start my personal fund that I have been talking for months since I resigned from my day job. The main reason for me to start this fund is that I have lost patience with the poorly managed funds and unit trusts that are being offered in the market lately. Ok, I admit it, I have such misfortune to have invested in money losing funds, even though I have already held them for 3 years plus. Although I do hear some very good funds that return 10-20% per year, but hell, how much did the market return this year? the KLCI returned around 30% for year 2007, not to mention other big performers like the China Market and Hong Kong ones which have returned 93% and 50% respectively (they have reached much higher levels during the year). So, is it reasonable for us to pay 4~7% management fees for some fund managers that performed even worse than the market? not to mention those that have even yielded negative returns! Oh well, isn't it similar to paying extra high bonuses for company's directors even when they have made losses for the company? What to do? It's an unfair world out there! (sorry, I always got carried away when I start talking about paying people to lose my money!)

Anyway, it's great to start writing again! My apologies for being away for so long and many thanks to those people who have pushed me to start writing this blog again. Let's hope that this is going to be one good NEW Year for all!

Growth Investing - part 1

Read an interesting article by David Gardner from The Motley Fools: "The Highest Possible Returns. Period." He is one of those investors that like to go after high growth companies. For those who like young and exciting companies, he is one to refer to. Below are an excerpt from the article about his experience of coming across the then so-called-overvalued AOL (America Online):
"In 1992, I was 26 and already spending my fair share of time online. For several years, I'd been a satisfied customer of America Online. Although I liked the service, I decided not to buy shares of the company at the initial public offering that year. I thought I'd wait a while. Idiot.
I kicked myself for two years while the stock quadrupled (means, up by 4 times). In the spring of '94, I followed my instincts and became an AOL shareholder -- in spite of an article in a major financial publication that declared AOL grossly overvalued and predicted that the stock would decline by 35%. (these sort of pessimism sound familiar?)
The following year, the stock dropped 25% or more three times. (oh wow!! it did fall!!) And then in 1996, shares absorbed a drop of 65%! (oh my God! jump ship! jump ship! cut lose! cut lose!) Despite these setbacks, the company went on to wreak havoc on the business and journalistic establishments en route to putting up some of the best returns available during a decade of great investment returns. Even with all of the temporary downturns, and even though the stock is today down from its all-time high, my initial investment has still increased about 37 times overall -- $10,000 in stock at that time would now be worth $372,156, which amounts to an annualized return of 31%." (er...)

Seriously, we might have heard of these kind of stories many times. Some examples from our own soil include Public Bank, IOI Corp, Genting and etc, have all gone through those kind of growth phase and returned as much. Congratulations to those who have hold on to them for such long time! I personally knew a few who does. Who said investing for long term is boring? I have some painful experiences myself (I kicked myself too hard!). Some close friends of mine can proved that I am not lying. One example is when Parkson was listed in China 2 years back. I remember the IPO price was around HK9 something, when I-Capital started to recommend this stock. Although actual feedbacks from friends in China are that the Parkson Stores there are doing very well, I hesitated because I thought the price is slightly high. So I bought the holding company Lion Diversified instead (Thank you, I-Captial!) Well then, fast forward to today, how much do you think Parkson Retail is selling? Reminder, HK9 just 2 years ago. As at last friday, it hit an intraday high of HK85! (Although the mother did almost as well, I swear I have sold all my holdings earlier. So, I haven't made all the gains myself. Told you who did. I-Capital! They are still holding big chunks of its shares.)

Anyway, back to the article, David Gardner did point out 6 signs of identifying these sort of Rule Breakers (as he called these high growth market leaders):

1) Top dog and first mover in an important, emerging industry.
2) Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors.
3) Strong past price appreciation.
4) Good management and smart backing.
5) Strong consumer appeal.
6) You must find documented proof that it is overvalued according to the financial media.

More details discussion on these 6 signs later.

The Black Monday Deja Vu

The Dow Jones stumbled by 366 points or around 2.6% on last Friday, 19th October. People tried to find the causes and among them: concerns on crude oil prices at all time high, which in turn will eat into corporate profits for the months to come; concerns on the aftermath of the Sub-prime melt-down and its impact that can pull down earnings of big financial institutions; super high inflation and etc. (Remember when I said human fear of the unknown? People have to find excuses to get rid of that fear). But what I find most interesting is the saying that it was the effect of the 20th Anniversary of the Black Monday that happened on the 19th October 1987. Some history: on that day, the Dow Jones was down by 22.61% in a single day, wiping USD 500 Billion off the market back then. How big is 500 Billion? To give a simple comparison, as at last count on end June 07, the Bursa Malaysia has a total market capitalisation of USD387 billion (should be higher by now), that means, the USD500 Billion lost during that Black Monday alone could have bought up ALL the listed company on Bursa Malaysia today, with a fat 20+% premium. Mind you, that was way back when the Dow Jones was still at 1739 points (compared to around 14,000 points today), which means those super huge corporations like Exxon Mobil, Citibank, McDonalds and etc were still at their teenage years. Today, Exxon Mobil alone have a market capitalization of over USD 500 Billion. Sorry, got swayed off topic. This post isn't suppose to whine about how tiny our market is. Anyway, that Black Monday was the single largest decline in the history of the American stock market in percentage term.

So, what caused the Black Monday back then? There were a few potential causes, among them: overvaluation, illiquidity and market psychology. Sounds familiar? Yup, we tend to hear these terms almost every other day for the last few months now. Anything new? well, the credits should go to the market commentators and economy experts for their creativity. They start to think of something new like the oil crisis, carry trade, trade deficits, external debts, weakening of the Dollars and etc as excuses. These have already been there for like many months now, what happened since then? The market continues to rise into unseen territory. And today, you see the Black Monday thingy. *applause*

Anyway, I didn't say that the market will not Correct or the year-long Bull-Market-party won't end. It will, sooner or later. It's the economical cycle we all have to go through every few years. So? do we go out and sell everything we have? Before that, please have a look at the following graph:

This is a 100 years record of the Dow Jones Industrial Average. Where the arrows are pointing are some major events in the history of the US stock market. The first one to the left, around year 1914, it was when the First World War broke out and the market have to be closed for four months. The second one at around 1929, was the beginning of the Great Depression, where the American stock market went into a slump that it never recovered until almost 20+ years later, this was also regarded as the longest bear market in known history. The third one around year 1987 was the Black Monday mentioned above. And the last one, which only happened not too long ago, was the burst of the IT bubble, which brought the whole market down. Have you noticed the panics that happened after the September 11 terrorist attack? The Iraq war? The murder of JFK? You might need a microscope to find those.

So, what's the implication of all these histories? Would you noticed all those major events or market crashes (except for the last one) if I didn't point them out? I doubt so. Why? because they are so insignificant. When we look back into history, these setbacks are like nothing. The market will continue to grow, people will learn new ways to do business more efficiently and more profitably (like using computer and internet), and find new ways to solve problems (like using Biodiesel to substitute oil) and etc. Most importantly, good companies will continue to grow and bring more profits to shareholders, in turn, increasing their market value. Remember when I mentioned above that the total market value lost during the biggest one day stock market crash in history is only equivalent to the market value of one Exxon Mobil today? That's the nature of human beings. We grow. We evolve.

So, does it matters if we see another Black Monday or Bloody Red Tuesday next week? Yes, of course. You might want to see if there are bargain discounts. By the way, I haven't mentioned that the largest one day percentage gain of the Dow Jones, actually happened just 2 days after the Black Monday, have I? Don't worry about the market crash. We can't predict them anyway.

Conclusions. I know I have mentioned this far too many times, oh well, no harm mentioning it again then. There are only 2 important things that matters when it comes to long term value investing: THE RIGHT COMPANY TO BUY and THE RIGHT PRICE TO PAY.

You've got to find what you love - Steve Jobs

Below is a link to the commencement speech given by Steve Jobs 2 years back in Stanford. Steve Jobs is the CEO of Apple Computer, founder of Pixar Animation Studio and is currently on the Board of a few big listed companies in the US. He is worth around USD5.5 billion as of this writing. Many of you might have heard it or even read it, but I am posting here again for those who haven't and for my future reference. It is a wonderful piece of speech and should be read by those who are hesitating with what to do with their life now. Really, it will be a 10 minutes very well spent:

http://news-service.stanford.edu/news/2005/june15/jobs-061505.html

Mistake 3 - The most unlucky stock picker

Ever had any of the following experiences?

Found a stock that meet all the criterias you were looking for, nice valuation, good business prospects and etc.. but, you were not sure when to call your broker to make the Buy order... you waited and waited for the "feeling" to call on you as you watched the stock kept its upward push, slow and steady.. and one fine morning, you suddenly saw one hell of a good news about this particular stock in the newspaper and the projections is that its profit is going to double (for whatever reasons..) in the next financial year (or whatever good news you can imagine).. "oh my god.. this thing is gonna shoot up today.. I am gonna miss the boat!!" you told yourself.. as the market opened, the stock suddenly gaped up for like 5% and it never look back since then.. you can wait no more and you know that you just NEED to call the broker RIGHT AWAY!! ...

"Hey, Tom, buy me 5 lots of SOB Holding Limited, whatever price it is selling, quick quick, don't let it runs away.." (you might even called the wrong name, whatever, who cares!!) all you know is that you need to buy that SOB or else you will be kicking yourself if it hits limit up.. as you waited for ages to get the order confirmation from your broker, your mind were thinking, "what the hell!! does he even know how to use a computer? My grandma could have keyed in the order faster than he does! if he don't get it done in the next minute, I swear I am going to change a remisier"... "bloody hell, is he done yet?"... "ok, Done!!" as Tom (or Harry, whatever) confirmed the execution of the order, you heaved s sigh of relief *phew*, "oh yeah! I am on the boat now.. c'mon, let's ride, show papa what you can do"..

eh? suddenly, you saw the buying discontinued, and all the sell orders started to pile up.. 1 cents lower, 2 cents lower.. 5 cents lower.. and as the buy orders disappeared, the fall started to gather momentum.. 10 cents lower, 15 cents, and in just a few minutes, 20 cents off the peak which you've just bought.. "what the hell?".. and without long, it was back to where it closed yesterday, and stayed there for the whole day.. you were shocked, you were disappointed.. but yet, things didn't improve over the next few days.. 1 cent up, 2 cents down, 3 cents up, 4 cents down.. as it went side-ways for the next few weeks, you suddenly let your anger took control of you and you've decided to cut loses and sold it off at whatever price it was.. you thought that's the end of the story eh? heh.. the nice part had just begun.. the stock started to climb... (I leave the rest for your imagination..)

Does this all or any part of it sounds familiar? And you thought that you are the most unlucky stock picker in the world? and you are born to be a loser?

Don't be. Honestly, I have been through that too.. made some hasty decision when my emotions took control of me. I've learnt some painful lessons, luckily I didn't have much capital to invest in back then, or else I would have hurt myself even worse. And, I realised there are many others who have had the similar experiences.

What triggered me to write out this blog? I read something interesting from a book called "Hedgehogging", written by Barton Biggs (finally, something else away from Warren Buffett eh?). The book is about his life being a fund manager, worth your time if you are thinking of becoming one.. Anyway, since you've been reading until here, I don't mind to share with you here.. below is an ad, printed in the "Bawl Street Journal" in 1980 which Biggs had shared in the book, and it goes like this:

PROFIT FROM OUR MISTAKES!!
Investing money is a zero sum game. For every winner, there is a loser. We've been losers! If you had sold what we bought, and if you had bought what we sold, you would be rich!

In 1968, we went heavily into stocks and by 1974, we're down almost 50%! In 1973-1975, we invested over $150 million in real estate, and not just any real estate -- we concentrated in Atlanta; We lost our ass! In 1978, we hired a bright theoretical consultant from Harvard who had a "yield tilt" model which told us that energy stocks were overpriced and auto stocks cheap. This seemed to make sense, so we sold Texas Oil and Gas at $8 and bought General Motors at $60. We lost 33% of our money. If you had gone the other way, you'd be up 430%!
All investors make some bad decisions. But we make a lot -- and with consistency. Now for the first time, you can profit from our mistakes. For $10,000 a year, you can receive copies of the minutes of our quarterly Finance Committee meetings in which we establish our investment philosophy. For an additional $25,000 a year, we will give you a monthly update over the telephone of our current market outlook. And for only $100,000 a year you will receive copies of our trade confirmations so you will know on a daily basis what not to do. It's part of our Contrarian Theory.
This may seem like a very unusual offer, but look at it this way: we can't seem to get on the right side of markets, so if we let you pay to profit from our mistakes, we will have finally found a way to profit from our mistakes as well.
Subscribe now. Time is limited. We are about to undertake a major restructuring of the portfolio, and we'd hate to see you get caught going the SAME way.

- THE FORD FOUNDATION

Feel better? See, I am (or, we are) not alone. Even the professionals and experts did have their bad times. So? should we blame it on luck? or should we just give up investing totally? Well, I have chosen my path long ago. I have chosen to stick to Value Investing. If there are already so many successful investors out there, there must be a way that works! Learn from them! Learn from Mistakes! Have a little Faith and move on!

Mistake 2: The Wrong Management Team

(With addendum in red)

One of the costly mistakes I have made during my not-so-long investing career is to entrust my hard earned money onto companies with not-so-good management team.

There are numerous examples that happened on our own soil here in Malaysia recently that proved that I am not the only one that have to learn from this mistake. Transmile, Megan Media, Wimems, F-Tec.. just to name a few, have seen their share prices hammered badly due to questionings by SC on suspicions of wrong-doings within the companies. I am pretty sure there are still many similar cases out there, and it's going to be up to us as an investor, to be extra cautious when picking stocks.

But the questions is, how do we know if the company is managed by trustworthy people? Here are some of my humble thoughts:

a) Most importantly, refer to the financial statements and compare them across a few years. Good management should exhibit capability to grow revenue while cutting down costs, widening the profit margin, continually generating high returns on capitals over the years and etc. All in all, making more money for the shareholders. For the sake of this topic, let's just keep to these simple stuff.

b) Another more entertaining way compared to reading those boring numbers is to read the Chairman and MD's statements in the annual reports. Trust me, these statements tell alot about the person in charge. Ever read/heard about the world famous "Letter to Shareholders" written by Warren Buffett himself in the annual report of Berkshire Hathaway? In these letters, Buffett explains the performance of the company for the year, and some major decisions made by himself and some of his thoughts that he wanted to share with his shareholders (or usually referred to as Partners). These letters are treated like Bible by the investment community and there are people who try really hard to study the philosophies and principles of the legendary investor, as well as to find clues about his next move from these letters.

Besides, I especially like to read those statements by Chairman where the companies are in the red. It is usually interesting to see how they tried to cover the holes and give unreasonable excuses to us shareholders (when he thinks that we are suckers). These are usually followed by some very optimistic projections about the future and promising ways to improve the condition. Hmm.. if they already know what need to be done, why haven't they start doing them? Worse, sometimes I feel like they didn't even write those statements themselves..

c) Take a look at the Directors' Salaries and Remuneration package. I prefer those below 5% relative to the Net Profit. You can have your own threshold, depends on your generosity.

d) Read the newspaper and Internet. They might give some clues on what the person in charge is working on at the moment, and sometimes, their characters. I've heard jokes (or real cases, I don't know) where some "people" fly first class to meet their girl friends in London, bought a penthouse for them as "investment in strategic properties" with the companies' fund, buy a multi million dollars paintings as "furniture and fittings" for the office and etc, all in the company's expenses. I didn't say these are all wrong, my point is: Rich people have different hobbies from us ordinary people... Well, some of them might be really beneficial to the shareholders, hell knows. Why bother with these stuff? Mr Buffett once said something like: if the CEO of the company is someone you are comfortable to marry your daughter to, then it is the right business to invest in (well, of course with the assumption you don't hate your daughter). So, don't you want to know a little more about your potential son-in-law?

e) Lastly, this might need you to put in some effort to master the skill. Ever heard of a type of Asian fortune telling skill called "Face reading"? This is defined in Wikipedia as ".. the interpretation of facial features of the nose, eyes, mouth and other criteria within one's face and the conversion of those criteria into predictions for the future... usually covers one phase of the client's life, and reveals the type of luck associated with a certain age range". Once you master the skill, go look at all the pictures/portraits of the directors in the annual reports. Believe it or not, it might even be more accurate and effective than all those other methods mentioned above.

(Seriously, ignore the last one, I am merely writing to make up the numbers)

Addendum on 10/10/07: One big mistake I have made was that I overlooked the impact of management can have on a business/stock. I used to pick "undervalued" stocks by looking only at the numbers in the financial statements and totally ignored the intergrity of the management at the helm. From my experience, there are more homework need to be done. No matter how good the business prospect is; or how dominating it is in its market; or how "cheaply valued" the stock is, as long as you have someone stupid/dishonest/incapable/selfish/greedy (or whatever bad characteristics you can think of) up there, you won't see the stock performing well in long term. Period.