OUE Ltd

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Over the last few weeks, I have been mulling over OUE Ltd. The company certainly does seem attractive, but it does have its drawbacks as well. Nevertheless, sensing that it was grossly undervalued, I made a purchase at $2.83. The share price eventually went lower to $2.68 a few days later, but has now recovered back to my entry price.

The reasons why I purchased this company were:
1) Having the confidence that the (a) proposed disposal of Mandarin Gallery & Mandarin Orchard into OUE H Trust  & (b) proposed special dividend of up to 50% of remainder fees after allowing for debt repayment of $750 million would go through since majority of the shares were owned by or connected to the Lippo Group
2) Tax savings- By grouping its mainstay properties (Mandarin Gallery & Mandarin Orchard) under a Real Estate Investment Trust, the Group stands to reap tax savings, if it distributes 90% of its income every year
3) Recurring income in the form of the 1) manager’s management fee, 2) trustee’s fee, & the 3) property management fee would provide a steady stream of cash to the Group
4) Reduction of debt- By using the sales proceeds from the two buildings to reduce debt of $750 million, the Group effectively lowers its finance expenses in light of potential rising interest rates. This helps to strengthen the Group’s balance sheet, reducing the net debt to equity ratio from 62.1% to 14.8%
5) Special Dividend after sales of properties- OUE Ltd has announced that it would issue a special dividend up to 50% of remainder fees after allowing for the debt repayment. On a share price of $3, this might work up to a yield of 11%
6) Grossly undervalued business- NTA of OUE Ltd would rise to $4.59/share from $3.44 after the proposed sale. This makes my entry price of $2.83 at a 38% discount to its NTA.

Some of the negative issues were:
1) Reduction of income as OUE Ltd would own only 30% of the proposed trust
2) Earnings from the two properties are less than what the Group is renting the properties for under the new trust

However, after making some calculations, I arrived at a conclusion: OUE Ltd’s earnings will improve after the proposed listing of its properties under a REIT. The sum of its tax savings, interest payment savings, management fees, and earnings from the two properties would outweigh the rental expenses that it would pay to the REIT. As such, foreseeing a better future for OUE Ltd, plus the unlocking of value of its properties, OUE is a buy for me. However, my investment in OUE is more short-term oriented, as I do not think that it is a business with a strong economic moat or strong growth prospects. I believe that the share price would reflect its true value in the coming months due to the issuance of its special dividend, and that might just be the time to sell.

What should I invest in?

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Before stepping out into the investing world, one has to note that there are many different ways that one may go about investing his hard-earned cash.

Some of these include:
1) Stocks
2) Businesses
3) Real Estate
4) Precious metals
5) Commodities
6) Currencies
7) Others

Let’s take some time to go through them one by one:

1) Stocks
These are businesses listed on a public exchange (stock exchange) where you can buy an ownership in the companies that appeal to you. The upside is unlimited as these companies may grow beyond your wildest dreams while the downside is limited to your initial capital. This is only true where you do not use leverage (borrowing of money) to invest.

2) Businesses
Not to be confused with stocks, the difference here would be that businesses tend to be privately owned by a few people, and that it is being run by you or your partners. It generally requires more time and commitment to manage it than investing in stocks. Research has shown that most startups fail in the first year, and most of those that succeed, fail in the years to come. However, if run well, businesses can generally help to turn the fortunes of one more quickly than any other forms of investment.  Many of the richest men in the world were businessmen – Bill Gates, Carlos Slim, Li Ka Shing, Robert Kuok, etc.

3) Real Estate
Real Estate tends to be a longer form of investment for one, as it is more illiquid than stocks. It also requires a higher initial investment than stocks, and one is most likely to tap on his banker to finance the purchase. However, since most people will generally buy a house to live in during their lifetime, it is usually one of their largest investment. Real estate has made countless of people more wealthy, as land prices tend to move up in the long term. The real estate’s value is also never likely to fall to zero, as compared to stocks which might become worthless when the company goes bankrupt.

4) Precious metals
Precious metals include primarily gold and silver. These metals are seen as a hedge against inflation and a form of security when financial markets crumble. The prices of gold and silver tend to rise when the USD falls and vice versa. They tend to underperform when the economy is doing well, as investors are more optimistic than fearful. One can buy the precious metals in physical form through the likes of bullion bars, or through paper holdings like ETFs or future contracts. Since it is a form of protection against inflation, many investors tend to hold gold and silver for the medium to long term.

5) Commodities
Commodities which we can invest in refer to agricultural products, metals and oil like coffee, sugar, corn, wheat, hogs, iron, copper, crude oil, etc. They are bought on a futures exchange, where an investor usually decides on a cash settlement rather than the delivery of the physical good itself. Futures contracts tend to be leveraged as well.

6) Currencies
Currencies are usually known as FOREX. The FOREX market is the largest market in the world, and one which never sleeps. In simple terms, the investor gains when the currency he buys appreciates against the currency he sells and vice versa. Trading FOREX is also on leverage, and it tends to be short term in nature. However, one can still take a long term view to FOREX by investing in ETFs that track a country’s currency, or in the different products that banks offer.

7) Others
Other forms of investment include paintings, luxury watches, rare stamps, wines etc. These are generally termed exotic investments, which are not practised by many people. However, if done right, one stands to profit greatly as well.

In conclusion, that there are many forms of investment which we can use to build our wealth. I strongly believe that all investments can prove to be profitable if we are willing to spend time to learn, and to acquire knowledge about that particular field. A strong understanding of the different risks that each investment holds is also important. For me, I am more comfortable with the first three forms of investment: 1) stocks, 2) businesses, &  3) real estate as a means of building my wealth as I do not currently possess the knowledge to invest in the rest.

Warren Buffet and the Interpretation of Financial Statements

Warren Buffet and the Interpretation of Financial Statements
The first book I will recommend for newbie investors would be Warren Buffet and the Interpretation of Financial Statements. Warren Buffet has always been one of the world’s richest men during his lifetime, and unlike many other tycoon entrepreneurs, he made much of his wealth through the power of value investing in other’s businesses. Thus, it would be wise to start learning from the very best.

The essence of this book would be identifying a company which has a durable competitive advantage through the analysis of its financial statements. Buffet believes in buying companies with a durable competitive advantage as they have great wealth-creating economics. To him, it is  “far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”

The author, who was once the daughter-in-law of Warren Buffet, goes into how Warren Buffet looks at the 3 financial statements: Balance SheetIncome Statement, & the Cashflow Statement. It is an easy read for the beginner investor, who has no idea about accounting or financial statements. The main crux of the book is focused on breaking down the different line items on each financial statement, and how each line item gives us a glimpse of how the company is doing. It also includes a few chapters on how Warren Buffet values a company, which is quite different from the way his mentor, Benjamin Graham, carried out his.

Overall, this book is a great introduction into the study of value investing and how Warren Buffet thinks when it comes to his investments.

Book Reviews

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Books are rich resources where one can learn more about the world of investing. Compared to investment workshops which can be very pricey, a much more affordable way to go would be to head down to a local bookstore and checking out the personal finance section. However, the vast resources at the bookstore may also confuse a newbie investor like me. Thus, I have started a new series of reviews on books which I have found helpful in my investing journey.

As German philosopher Friedrich Nietzsche once said, “He who would learn to fly one day must first learn to stand and walk and run and climb and dance; one cannot fly into flying.” 

So, take a step forward and start learning!

Sowing the first seed

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Today, after much research and contemplation, I sowed my first seed- China Minzhong at a price of $0.94 before commission. 2 questions that I foresee regarding this purchase would be: 1) Why China Minzhong? & 2) Why now?

Let’s tackle the first question first. China Minzhong is a vertically integrated vegetables producer to various markets in the world. Having all of their cultivation and processing facilities in China, the company basically produces two types of vegetables- fresh and processed. Most of the fresh vegetables are supplied domestically while most of the processed vegetables are exported to  countries in Europe and Asia. So what makes this vegetables company so interesting?

Some of the many positives are:
1) Revenues and profits have been increasing over the last 3 years, and this has resulted in increasing EPS for the last 3 years
2) Gross and net margins are consistently high
3) The company has low debt – ST debt worth around 1 year’s earnings, and little LT debt
4) Consistent ROE at 17-18%
5) Counts large funds and companies as its shareholders
6) Growth prospects- synergy with Indofood (its largest shareholder), and a growing market for vegetables consumption. Has presence in many countries all over the world.
7) Business model is less capital intensive and more efficient than traditional farming- less manpower & land needed; higher yield, ability to adjust capacity and to continue operations during bad weather conditions. The company’s strategy is also in line with that of the government’s- to support modern agriculture. CMZ has also been increasing its branding domestically, which I believe will aid its products.
8) Company is currently trading at 3.4 times PE, 0.64 PB, and 0.2 PEG, which is way undervalued for a stock with the above characteristics

However, there are some red flags that I encountered:
1) Cashflow from operations have been decreasing over the last 3 years; however it has increased largely in the year-to-date
2) Large amount of trade receivables

Being an S-chip, the company would definitely warrant a greater risk. As such, I gave it a higher margin-of-safety. Assuming a 20% growth rate (down from the current earnings growth rate of 34%), I arrived at an intrinsic value of $1.35. This is assuming a historical yearly PE low of 4.45. To me, China Minzhong would be classified more as a growth stock. Thus, I foresee the market pricing in higher valuations for this stock in the near future.

As to the question of “why now?”, my view is that the fundamentals of the global economy are slowly recovering, and that the “noise” in the market is currently causing fear and pandemonium in the market. For example,  rumours of the Fed tapering its bond purchases should be a sign that the economy is recovering and not a sign of weakness. The recent market reaction is akin to a sick man who is slowly recovering and doesn’t require too much medication anymore, but suggestions to reduce his medication are being violently rejected by his family members. In the long run, the “overdosage”  of the medicine might just make his condition worse. Well, as for me, I will just take advantage of this buying opportunity to accumulate more “high quality seeds”.

As the wise sage Warren Buffet once said, “Be fearful when others are greedy, and greedy when others are fearful.”

*P.S. By the way, its a coincidence that my first seed was literally, a “farm”.

Fundamental or Technical Analysis?

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Fundamental analysis is in essence, the study of the financials of the company, its business model, and the industry in which it operates in. The end goal is to identify whether the company is a strong company, and whether it exhibits characteristics of a durable competitive advantage. To me, it involves a comprehensive understanding of the business of the company, its risks, and its future potential. Value investing is a form of fundamental analysis, in which a value investor identifies a strong company that is trading below its intrinsic value, ie. selling at a bargain. In value investing, the crucial point to note is that one has to treat each stock as a business, and approach it from a business mindset. Like what Benjamin Graham once said, “Investing is most prudent when it is most business-like.”

Technical analysis, on the other hand, is the study of price patterns, charts, and trends to time entry into and exit out of positions in stock. Momentum trading is a form of technical analysis, where one trades based solely on identifying short term trends and timing entry and exit based on the trend’s strength or weakness.

In both analyses, different risks are taken on. In FA, the main risk is company risk- the risk that the company you invested in encountering obstacles and problems in its business. In TA, the main risk would be leverage risk as traders tend to use leverage more often than investors do to amplify their gains. In addition, FA practitioners tend to have a longer term view while TA practitioners tend to be more focused on the short term.

So, which is better and what does the restfulfarmer use? Honestly speaking, one’s man poison is another man’s meat. I feel it all depends on the mindset and character of the person. Value investors tend to take a patient approach, and it can get boring at times, while traders tend to prefer the excitement of being in and out of the market. Personally, I believe value investing is more suited for me, as I do not enjoy tracking stock prices everyday. However, I believe that using TA to time my entry into the market for a value stock could help to improve my returns as well. As the Chinese would say, “FA and TA will help you to 发达!“. At the moment though, my knowledge on TA is lacking, and it will definitely be useful to learn more about it.

Why invest?

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The question I get from many well-meaning friends is, “Why invest?”. Many of them are often divided into two schools- one which says “it’s just too hard” and another which reasons that “it’s just too risky”. I tend to agree with both of them on these two aspects.

Investing can be a mouthful to the newbie investor, like me. One has to understand accounting terms, which Warren Buffet describes as “the language of business”. Furthermore, one has to pour time and effort into researching about a company’s business model, the economics of the industry it is in, and its past financials before even proceeding to identifying or calculating an entry price. However, my opinion has always been that nothing in this world comes free. If we do want to make a significant improvement in our finances, we would have to start on the journey of learning more about investing. And that, surely is a reason good enough for many of us to embark on this path.

As for investing being too risky, we all need to admit that every single investment carries risk. To me, I see keeping our hard-earned money in savings deposits as an investment decision as well. The question to ask now, would then be “What are the risks of keeping my money in the bank, and earning interest every single year?” The answer to that is simply, losing the value of our money due to the ugly green monster known as inflation. Current yearly interest rates on savings accounts at our local banks are in the ballpark of 0.05%-0.1%, while fixed deposits pay interest of around 0.2%-0.85% per annum; which is a tad higher, but still ridiculously low. For illustration purposes, $1000 put into a savings account in a local bank at a rate of 0.05% interest p.a would give us an interest payment of $0.50 in that year, while a fixed deposit on a 0.85% interest p.a. would give us $8.50 (based on simple interest calculations). Inflation estimates for the current year are in the range of 3-4%. Although one can argue that a large part of inflation is due to escalating housing and car prices, we all know that things weren’t as cheap as it used to be. At an inflation rate of 3% each year, $1000 would have been eroded to a purchasing power of $970 next year, and around $750 in ten years. This brings us to the area of negative real interest rates, which is the rate of interest we expect to receive after accounting for inflation. As such, that is the risk of keeping our money in saving deposits in our local banks.

I choose to invest amidst its risks, as I believe that investing can help to preserve my purchasing power, as well as to accumulate wealth over the long term. However, the main motivation why I choose to invest is because by securing a brighter financial future, it gives me the time to pursue my interests in life. And that, is why I invest.