Tuesday, July 10, 2012

Why I appreciate better businesses than cheap stocks

There is this quote from Warren Buffett, 'It is better to buy a great company at a fair price than a fair company at a great price.’

If you follow my blog, I am in awe for great businesses rather than cheaper undervalued stocks. As an example, I did say I see greater heights in Nestle, while I have some reservations over RCE Capital despite its valuation is way undervalued and attractive (PE) due to some structural problems. Well, these are my opinion. Nestle's PE is about 29x while RCE's PE is around 5x. Some readers, I noticed prefer value buy - nothing wrong with that.

Now, let me tell you again why I am into great companies. Great companies are built by great business people - at least during the process of building the business, there is at least one individual why has created the DNA of a great company. See Wal-Mart (Sam Walton), Apple (Steve Jobs, of course), Genting (Lim Goh Tong) and even Coca-cola was helmed by several great individuals. Great companies can attract more investors.

Now, think of stocks as a business investment and we as investors put the trust of our decision into the hands of these businessmen. Along the way in the process of building the business, for sure they would have their hands in acquisitions, expansion, divestiture etc. A great leader may have put their skills into test by making decisions that benefit the business in doing that acquisition or divestment. Even in divestment, they would probably know when to divest a business or what their foresight would be like in business decisions that they make. The CEOs literally invest for us besides just managing the company. His / her future action is what you pay for now. Question is, are you willing to pay a premium for a great manager or are you willing to pay below average for an average manager?

Just as an example, Genting Malaysia's foray into Australia, Miami and New York's gaming business. If you are an investor of Genting, your investment is dependent on their decision making on these investments. You are investing into the management as well, not just the company and the brand. In a great company, you are investing into a company which other people are looking to invest as well. Great companies attract more attention. Additionally, owners of great businesses tend not to sell (at fair price) - especially after all the hard work of building it. On the other hand, if the business is just average, the tendency to sell would probably be higher.

Undervalued?

Now, turn it around and let's see a company which is grossly undervalued - Insas. It is now trading at RM0.41. Its book value is RM1.40, hence trading at 70% below book value. If you have invested into the company, you probably have not seen much gain. I have noticed this company for years but to be frank I am probably lucky I did not put my money into it as I was doing a sum-of-parts analysis, and it is attractive now and before. I was really attracted to the idea of buying some stocks - 7 years ago and if I had bought and held it until now, I would probably see no gain.


Let me ask you, are you going to put your money into this company now that you know it is undervalued? Bear in mind, it could have called for a delisting exercise at a slight premium to its price today. You as a minority investor would probably have no say. Again, I probably would not know what is in store for the future but if I have made my decision 7 years ago, I would not have liked it.

On the other hand, if you found a great company with undervalued prices, then you have hit a jackpot!

12 comments:

Anonymous said...

Thx for d sharing. Do u think tradewind is undervalue? This company with low p/e but with stable consumer business.

Felicity Cheah said...

I believe you are talking about Tradewinds (M) Bhd. It is a Syed Mokhtar's company - would be tough to have a view, honestly.

Anonymous said...

Mind to explain? Thx ya.

felicity said...

Syed Mokhtar has good businesses. However, most of them are acquired. With his political connections, he is able to get good businesses - but is it that simple as in just by looking at financial numbers and valuation we can come out with a conclusion?
I am apprehensive. Can we be sure there are no political figure involved? Something, at my level I am not able to analyze. Hence might as well stay away - not because of they are not attractive but this is something which I am not able to value.

khengsiong said...

Peter Lynch also says:
A company with 20% earning growth selling at PE 20 is better than one with 10% earning growth selling at PE 10.

Anonymous said...

I think investor dun like shrinking business especially no political connection. Insas do not do well in this year. Not every stock will become jackpot and sifu not gonna hit jackpot.

Sunny said...
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Sunny said...
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Sunny said...

If you're raising cows, find the best stallion if you can, even though it is more expensive. Why? Because of the multiplication (at good value) effect outweigh the costs by far.

E said...

Hi Felicity,

RCECAP announced a while back that they are acquiring a company for RM18million. But it does not state the basis of the price and rationale.

Are companies not required to disclose these info for any acquisition?

felicity said...

Hi E

This is a cash purchase and below certain threshold of its shareholders funds. No they do not need to reveal those.
SOmetimes the SC may do the questioning, but it seems it did not ask RCE in this case.
Not a good thing considering that RCE is owned by a senior person in the market.