Lessons Learnt from China Minzhong

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The recent China Minzhong scare has caused me to rethink my investment principles and strategy over the past week. There are a few key lessons which I have learnt from this saga:

1. Invest within my circle of competence  I realized that I did not have the necessary knowledge and expertise in the agricultural industry to ascertain whether CMZ had a solid business model, even though its prospects looked bright. The fact that its operations were centered in China, and that I had never seen its products or plants made my investment one based merely on the company’s reports and updates. The “red flags” raised by Glaucus Research highlighted some issues pertaining to company filings, which the public would not have access to. As such, investing in a foreign-based company whose resources and products are not readily available to me, was risky despite its low valuations.

2. Diversification is important – Sensing that CMZ was deeply undervalued, I continued to invest heavily in the stock, making it my largest purchase. At the point of accusations by Glaucus Research, my portfolio was heavily weighted towards it, such that a rise/fall in its valuation would have a significant impact on my portfolio. Although Warren Buffet advocates focused investing, where an investor invests only in a small number of stocks which he understands deeply; my lack of understanding of CMZ coupled with my large investment in it made my decision an even riskier one. Thus, ample but not over-diversification is crucial in one’s portfolio management.

3. Only invest in competent managers with integrity – During the saga, the integrity of CMZ’s management was questioned. Questions like, “Were sales fabricated?” were shot at its management. As I was unable to ascertain the quality of its management prior to investing, the presence of institutional investors, like GIC, Templeton, and Indofood eased my concerns. However, I learnt from this episode that the presence of institutional investors should not stop me from analysing the management of the company, and that institutional investors might be wrong in their judgement as well. Warren Buffet always views management as the primary key to a wonderful business, and that should be one of our vital checks as investors as well.

4. Take analyst reports with a pinch of salt – The job of an analyst is to perform checks on a company and present his findings along with his opinions to investors. However, the responsibility of investing one’s hard-earned money lies with the investor himself, not the analyst. As such, we should always perform our own due diligence on the company, and not allow analysts’ opinions to cloud our thinking. In analysing a company, there will always be assumptions and estimates being made, and these could be very different for both the analyst and the investor. In the recent case, CIMB had an “Outperform” rating on CMZ before Glaucus’s attack, but immediately ceased coverage of the stock after the report came out. As such, retail investors who relied on CIMB’s research would have been left fending for themselves, or in the worst case, incurring significant losses as the share price plummeted.

5. Invest in businesses which give you a peaceful sleep at night – If an investment is keeping me awake at night, it probably isn’t a suitable investment for me. CMZ’s turbulent share price movements kept me worrying about my investment, and since I was unable to check the operations of the business, I had no clue whether the business itself was real. This incident made me understand through first-hand experience, the phrase ” conservative investors sleep well” by the late Philip Fisher.

6. Let go, pick yourself up, and move on – If there is a mistake I made, I ought to admit it, and cut my losses before the mistake worsens. In this case, the main mistakes I made were not understanding the business and its management deeply enough. The act of cutting one’s losses is indeed painful, but crucial if one wants to become a better investor. I hope that I will not repeat the mistakes I made here again. In times like this, one has to always remember that there is more to life than just the stock market, and that there are many things that we ought to be grateful for. So learn from our mistakes, but take heed not to beat ourselves down too much.

I count myself fortunate to have been able to exit from this investment, not to mention making gains from it. However, I could have easily lost my whole investment should the company be found to be fraudalent in its practices. There have been cases where S-chips have been halted from trading for years, leaving investors in limbo. Indeed, I am grateful to have been able to learn from this incident, and for it to have moulded my investment principles and strategy at no cost. Moving on, I will have to work on my due diligence when it comes to investing.

Portfolio Update

As of 2 September 2013, I have sold off all my holdings in my portfolio for various reasons. The table below shows my returns from the sale.

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Was my decision to sell all my holdings a hasty one? I certainly hope not. After the CMZ saga, I relooked my portfolio, and questioned the reasons behind all my investments.

1) OUE Ltd: In my earlier post, I felt that OUE was significantly undervalued in terms of its NAV. However, I realised that I made the mistake of investing in it just because there was a mismatch between its intrinsic value and its current price. The company was not a business which I wanted to hold on for a long time due to it not exhibiting the characteristics of a “wonderful business”. Moreover, it was trading at 29 times PE due to increased expenses in its past earnings. The impact of a rise in interest rates would undoubtedly affect OUE Ltd as well, and this might result in a downward pressure on earnings. As such, I sold off my stake in OUE Ltd.

2) Tiong Seng Holdings: I still see Tiong Seng as a fundamentally strong stock, with lots of growth potential. However, as I became more conservative after the CMZ saga, I started to feel uncomfortable with Tiong Seng’s high debt in lieu of rising interest rates. The more indebted a company is, the more precarious its position is in rainy days. Moreover, the CMZ saga has shown me how little I actually know about my investments. As such, I felt that I did not understand the property and construction sector enough to wisely invest in it. Thus, I exited my investment at a loss.

3) China MinzhongThe recent incident involving China Minzhong and Glaucus Research has been a tumultuous ride. From a share price of $1.02, it crashed all the way to $0.53, before rising all the way up to $1.13. The report and accusations of fraud by Glaucus Research had caused shareholders and shortists to sell the stock down to $0.53, before China Minzhong’s strong defense sent its share price back up. The final move up was secured by the offer to purchase the company by Indofood, CMZ’s largest shareholder. As mentioned in an earlier post, the reason I was intending to sell CMZ was because I realized that I did not understand the business fully. Thus, when the opportunity arose after trading was resumed, I sold off my stake at $1.13. As my portfolio was highly weighted towards CMZ, the gains helped cover my losses in both Tiong Seng and OUE Ltd.

Due to the liquidation of my investments, I am now sitting on purely cash. I will be sharing more about the lessons learnt in the recent China Minzhong scare in a future post.