KLSE Security Analysis:Owner Earnings

March 30, 2008

After applying criteria for analysis recommended by various books,I have created a checklist before buying any stocks in KLSE.Starting from now,I will elaborate on these criteria under KLSE Security Analysis title in the future.To understand these criteria,you should have medium level of understanding of financial statement.This part has to come from your own initiative.No pain,no gain! 

b_06toyochem.jpgOne of the most important criteria in my analysis is to calculate ‘owner earnings’ from a business.This criteria is recommended by Warren Buffet in his letters to shareholders and has been summarized under a book written by Warren Buffet himself and edited by Lawrence Cunningham entitled ‘Lessons for Corporate America’.Make sure you buy 2007 edition. Owner earnings concept is very useful analysis to gauge what the company has left for its shareholders.Rising share prices does not necessarily means the company has added value for its shareholders.When company earns X from business,it can choose to reward its shareholder by paying a dividend or retaining those earnings and reinvesting them to increase the underlying value of the company. If the company employes this earnings efficiently, over a period of time, the company’s underlying value will go up and cause the stock’s price to increase.

This differs from the view most investment professionals hold. They might have a CFA but they don’t consider earnings theirs until the earnings are paid out via dividends. One good example of owner earnings is the stock of Warren Buffett’s holding company, Berkshire Hathaway, Inc. In the 80s,it traded at US$500 a share. Today, it trades around $76,000, and it still never paid a dividend. The increase in the market price of the stock came from an increase in the underlying value of the company, caused by Buffett’s profitable and efficient reinvestment of Berkshire’s retained earnings.If a company believes it can profitably employ the earnings at a rate of return that is better than the investor could get, the management should keep the cash. But most company keeps on feeding shareholders with ‘sweet’ dividend to attract traders. This act is detrimental for long term shareholders and the business but good for traders.When company suddenly declares juicy dividend,a value investor should look further.

 If you have attended any AGM before, you will be suprised how most shareholders react when the management announces its dividend policy.For me,unapropriate amount of dividend is like a ‘bribe’ to shareholders to blind them from seeing the management incompetencies and failures.Hence,value investors must really make sure the dividend policy is suitable for the business.Rising dividend amount does not always mean good. In addition,dividend is taxed!

In KLSE, it is common for some security analysts to assign a higher target price to companies that pay a high dividend than to those that don’t. This is true even when the company that is retaining all its earnings is an infinitely better enterprise. Maybe the analysts’ brains are controlled by directive from the top. Value investors should check the quality of management by what it does with its earnings. If it retains them, does it profitably employ them, or does it squander them on dreams of grandeur? By analysing the history of the management performance, we can come to a conclusion whether the underlying businesses will create consistent earnings to allow make its shareholders rich.So, how does an investor calculate owner earnings?

1st , check the ‘cash from operations’ under the statement of cash flows. See whether cash from operations has grown steadily throughout the past 6-10 years. If it has steadily growing, then you can go further.

2nd, calculate Owner earnings = net income + amortization and depreciation – normal capital expenditures. If owner earnings over the 6-10years,then it is a good indication. Owner earnings adjusts for accounting entries like amortization and depreciation that do not affect the company’s cash balances. So, owner earnings can be a better measure than reported net income. If you want to be more conservative,you can go on to subtract from reported net income:

• any costs of granting stock options, which divert earnings away from existing shareholders into the hands of new inside owners

• any “unusual,” “nonrecurring,” or “extraordinary” charges

• any “income” from the company’s pension fund.

3rd, calculate the growth of the owner earnings. If the growth of owner earnings is around 7% or more for the past 6-10 years, the company is a stable generator of cash, and its prospects for growth are good.

But is owner earnings foolproof? It’s not a sole determinant for business of course! For example, when a growth stock is investing heavily in new venture/market, the owner earnings will certainly plunge to negative territory due to losses or charges. If the company has good management and experience, the owner earnings will recover and value investors who hold on through the painful period will be richly rewarded. Investors may also use owner earnings to compare companies in the same industries to gauge their strengths and weaknesses.The value of the business can also be estimated by forecasting future owner earnings and bring them back to present value. This value may be used to check with the calculation of value using Free Cash Flow. More criteria will be introduced under this section. So, stay tune!       

What is Free Cash Flow?

March 22, 2008

Cash flow statement is a more reliable source than balance sheet and P/L. Businesses pay all its bills and expenses using its positive cash flow. Whatever left for growth and value is free cash flow (FCF).

Let’s me explain FCF using an example Company X.

  1. Company X spent RM 100,000 for advertisement for its products.

  2. It received RM 400,000 from revenue because customers paid for the products.

  3. RM 200,000 (50% of revenue) is spent by the company on utilities, salaries.

  4. RM 400,000 – RM 300,000 = RM 100K left in the bank at the end of the year.

How to calculate the final FCF?

  1. RM400,000 of revenue,

  2. RM300,000 of expenses that required cash,

  3. RM 50,000 of depreciation deduction. (No real cash involved but for tax purposes).

  4.  Taxable income is RM 50,000

  5. 20% of corporate tax for RM 50,000 is RM 10,000.

  6. So, Net income is RM 40,000

  7. But, Net Income is not Free Cash Flow

  8. To calculate the actual free cash flow, use revenue and subtract any cash expenditures and add back depreciation. RM 400K – RM 300K – RM 10,000 = RM 90,000

For Company X, free cash flow would be RM 90,000 even though net income reported to shareholders was RM 40,000. The company use RM 90,000 to grow its company further.

Let’s repeat the last operation.

  1. Company X spent RM 100,000 for advertisement for its products. This time, the company needs to borrow RM 30,000 from bank.

  2. It received RM 400,000 from revenue because customers paid for the products.

  3. RM 200,000 (50% of revenue) is spent by the company on utilities, salaries.

  4. Finance cost is RM 3000. (Assumption)

  5. RM 400,000 – RM 300,000 – RM 3,000 = RM 97K left in the bank at the end of the year.

Again, we deduct another RM 50,000 for depreciation; Taxable income RM 47000. Tax is (RM 47000 x 20% = RM 9400). Net income is RM 37600; free cash flow is RM 87,600

Why did the net profit decrease? The company did not generate enough cash to maintain and grow its earnings. Do you check how much FCF your company is making? My point is, without increasing FCF, a business cannot survive for long. It must keep on depending on borrowings to fund growth.

If Company X makes a Revenue of RM 600,000 due to market monopoly and branding, it will not need to borrow to fund its growth anymore. Remember,growth needs money. And Cash is King.

Business Analysis:The Scuttlebutt Approach

March 18, 2008

Scuttle butt approach in investment was popularized by Philip A. Fisher.In his book,’Common Stock,Uncommon profit’,Philip explained that an investor can get better view of a company by interviewing its competitors and vice versa. Information about a company should be obtained at from employees, customers and clients.One should not ask its management because the management will paint the outlook with beautiful colors since it involves conflict of interest. To perform scuttlebutt, one must have a good network with many people in various industry.By socialising with these contacts,one can get a better picture before putting his hard earned money into the business. Sources of information are competitors,vendors,customers,professors and employees. Reading news from research houses and newspaper is not adequate because these sources have filtering system. The research houses and media act like the advertisers of public listed companies rather than helping the investors to understand the business.They are paid to do so.Scuttlebutt approach helps investors to obtain confidential information and ‘insiders’ information’.Of course,the investors must be very good with his communication skills to indirectly dig more information from these sources.Remember,knowledge is power!What are the basic information which an investors should look for? I highlight the questions below.

1. Do these companies have products with market potential to increase sales for at least several years? Your target company may be harvesting profits currently, but it may lack long term potential. This question can help you discern the company’s prospects (and yours).

2. How effective is R&D in relation to its size in each company? Looking at the financial ratio between total R&D expenditure and total sales is a popular but crude way of thinking about R&D commitment. Such ratios can be misleading. When evaluating a company’s R&D efforts, it is just as valid to inquire about market research as technology research. So, find out how the company investigates (and develops) its market.

3. Can you describe the sales organizations of these companies? Information about the sales operation is seldom discussed in financial reports of public companies. Fortunately, this information is easily obtained using Scuttlebutt. Of all aspects of a company’s activity, the most well-known to sources outside the company will be the sales organization.

4. How would you compare these companies’ profit margins? Sales are of value only when they lead to profits. You want to find out what the target company is doing to maintain or improve profit margin. Scuttlebutt can give you a glimpse into a company’s profit future.

5. How would you describe the way these companies treat employees? Within an industry, it is generally known that there are “decent” companies. It is also generally known that there are companies that “burn up and discard” people. Senior management is often blind to its own reputation, but others will see it clearly.

6. How would you compare depth of management? A small company can do extremely well under an able autocrat. What would happen if that key person were no longer available?

7. How would you compare these companies’ cost analysis and accounting controls? It is not difficult to churn out reams of accounting information. The tough questions are, how valid and useful is this information, and how effectively does management act on it? The Scuttlebutt method is helpful here in revealing significant problems that won’t necessarily appear on the balance sheets.

8. How would you compare the integrity of management? Without breaking laws, there are ways in which senior managers can benefit themselves at the expense of customers, employees, and stockholders. Such managers are generally known within their professional communities. The only real protection against being abused by such managers is to avoid getting involved with them.

It can be very difficult to obtain the information you need about a privately-held company. Scuttlebutt gives you access to the professional assessments and opinions of people who know a company. It’s not perfect information. However, by cross-referencing the answers you get to the questions we have outlined, you can form a picture of your target company. Scuttlebutt helps you combine your judgment with that of industry insiders to draw reasonable conclusions. 

GLC-Should you buy/sell/hold them?

March 10, 2008

images7.jpgInvestors are unloading their shares in GLCs to wait for any policy changes related to these companies.Before you do the same thing and follow the crowd,let’s analyse the situation calmly.

What are GLCs anyway?To answer this question,we should define Khazanah.

Khazanah Nasional is the investment holding arm of the Government of Malaysia and is empowered as the Government’s strategic investor in new industries and markets. As trustees to the nation’s commercial assets, our main objective is to promote economic growth and make strategic investments on behalf of the Government which would contribute towards nation building.

Khazanah is also tasked to nurture the development of selected strategic industries in Malaysia with the aim of pursuing the nation’s long-term economic interests.

Khazanah has investments in over 50 major companies, both in Malaysia and abroad, and our companies are involved in a broad spectrum of industries.

Khazanah is also the key agency mandated to drive shareholder value creation, efficiency gains and enhance corporate governance in companies controlled by the government, commonly known as Government-Linked Companies, or GLCs.

Who are in Khazanah?For this answer,let’s refer to this website.

Will the election results affect GLCs?Of course! In the years ahead,we will see rapid changes and improvement in GLCs.With check and balance from the oppositions,GLCs will have to succeed the transformation which they have promised. Will transformation of GLCs always work.Since the answer is very long,I provide you with this journal for leisure reading. corporate-governance-in-government-linked-companies.pdf

So,should you buy GLCs? Yes,but not now.Maybe when the price is much lower.Should you hold if you have invested in GLCs?Yes,their values will certainly go up when the economy benefited from better administration.

Can you give me a list of GLCs?Sure,why not? 31jan2008_investstruc.pdf

Organizational Culture

March 10, 2008


images4.jpgimages3.jpgWe have to agree that the Malaysian companies have different working culture than our Western counterparts.But if we look at giant successful companies,which most of them are from the developed countries,we should start to look at good culture which should be practised in this era of globalisation. 

images2.jpgimages21.jpgIn today’s globalised world,the competition is fierce,hence Malaysian companies must be able to change their ways of doing things.What are the good points which drive companies like Maxis,Digi,Dutch Lady,BAT,Nestle to perform extremely well for the past decade? 

images5.jpgimages6.jpgIs it the people in the company?According Philip A. Fisher,it is essentially the people who will drive growth in a company.What we can notice from the people in these companies are their diverse nationalities.As the people comes from different background and countries,they contribute more creative ideas and processes to overcome problems.If a company consists of all Malaysians only,the people tend to have groupthink-a phenomena where all the people in the companies agree to one another for the sake of avoiding confrontation.We are more conservative due to our culture and background.It’s good to form harmony but in a business settings, people needs to challenge each other positively and to come out with better ideas.In long term,the diversity in the ethnicity and nationality will benefit the company and gives value to the shareholders. 

Multi national companies (MNC) also have better ‘check and balance’ corporate structure in place. If you analyse their corporate governance by looking at the board of directors,you will notice a diverse background and nationalities of the directors.This is a positive sign because it is harder for ALL directors to act against the interest of shareholders.

MNC also has a few major shareholders.Usually the ownerships are divided into 40% to 50% by the founder,30% to 40% by institutions/funds,10% to 30% by retail investors (public).The founder and institutions will watch over the board of directors and management.Independent directors can report straight to the founder without being restricted by the board.

Let’s look at an example of a well managed company (DIGI) for better clarity of my explanation. stv002.jpg

DIGI has 3 major shareholders in early 2007 (Telenor Asia 61% , Goldman Sachs 4.79%,Smallcap World Fund 2.9%).Telenor Asia has been requested by SC to reduce their shareholdings by end of 2007 but this is beyond our scope of discussion today.Let’s look at the figure above showing the people in the board.We have a combination of foreigners and Malaysians in the board.This is a good indication because directors who have broad explosure and global experience can bring in new exciting ideas into the company.When brilliant idea is put into implementation,rapid value growth will occur in DIGI.

I’m not encouraging investors to buy DIGI but these are the few qualities which value investors should look at besides price and safety margin.If the P/E of these companies is attractive,I will put vast net worth into these companies.Although the price of these companies will be volatile in short term,the value is intact and will march upward in the future.By then,the financial community will revise their valuation upward.   

Astro’s New COO

March 6, 2008

According to PRWEEK,Astro is going to get Henry Tan from GroupM as COO. The news is attached below.So,who is Henry Tan?Let’s read about him in the news attached below.  


Tan departs GroupM for Astro

KUALA LUMPUR – Henry Tan (pictured), the chief executive of GroupM Malaysia and Singapore, is leaving to join Astro as the Malaysian media company’s chief operating officer.

Tan confirmed the move, but would not comment further on the news.

The highly regarded executive has spent 17 months running GroupM Malaysia as well as Singapore, an additional role he was handed following the departure of former GroupM South and Southeast Asia CEO Andre Nair.

Mark Patterson, GroupM’s Asia Pacific COO, said the search was underway for a successor, and would be interviewing internal and external candidates.

“Henry is an outstanding individual,” said Patterson. “He has been one of our most accomplished leaders. He was there at the formation of MindShare and has served the network brilliantly for 10 years. He will be a hard act to follow.”

Astro is one of Southeast Asia’s largest commercial radio, satellite television and magazine publishers, with operations in Malaysia, Brunei and Indonesia.


The following news is from Adoimagazine.


I have had a fixation about the likeness of Henry Tan, CEO of GroupM Malaysia, and my favourite martial arts genius Bruce Lee ever since the first time I met Henry. Maybe that’s why I already admire him, even before knowing more about him. In fact, Henry Tan is like an open book, a refreshing change from most of the media pundits you see around town. In a sentence: he has nothing to hide. And that’s how our conversation began….

The Man Who Has Nothing To HideContent is not necessarily king, distribution is king and engagement is the ultimateBy THE HAMMER

Henry Tan’s easy-going demeanour makes it very difficult for one to grasp the fact you are talking to someone who has made a legendary mark on not only the Malaysian media scene but also across the region and the world. Awarded National Agency Head of the Year at the MEDIA AsiaPacific Agency of the Year Awards was only the beginning for Henry as head of MindShare Malaysia. The mind-blowing part is this sifu of ours also beat the rest of the world to wrest the MindShare Worldwide Global Agency of the Year in the MindShare network at a worldwide summit recently! To understand this phenomenon one has to see Henry as a Malaysian first, and a world-beater second.

He speaks animatedly about his challenges and sings glowing praises of his team members like a boy in a candy store. As I sat back to listen to his tales at the Starbucks outlet on the Ground floor of his offices in Menara Millennium, Henry wanted no time regaling me about the achievements of his colleagues. And the time when he was confronted by a brand agency working on the same client he was handling, on why they were doing the creative assignment; a mainstay of the brand agency’s offering. Rather than get into a debate about who’s crossing the line, he let the work speak for itself. And the campaign has been running for the fifth year now – entirely conceived and executed by MindShare for a multi-national advertiser!

“Sadly, innovators are penalized rather than rewarded. Many in the industry are defending their turf rather than aiming to excel. They would rather hijack good ideas to prevent them from blossoming rather than be challenged by them.”

Serious words from the man who is more than qualified to say so.Besides running Malaysia’s hottest media specialist group comprising MindShare, Mediaedge.cia, MediaCompete, Motivator and Maximize, with total media billings in excess of 30% of Malaysia’s adex, Henry has steered MindShare to post double-digit revenue growth, winning all major business pitches and achieving a 100% client retention rate for 2005.MindShare Malaysia alone accounts for over 15% of Malaysia’s adex!

There was talk about creative and media going head-on in the battle for revenues and lines of control, what’s your take on this?There is no confusion. Both are important. Creativity or content is the product and media is the distribution. I am not ashamed to say that. And the channels of distribution for messages have become increasingly important with media proliferation. Content is becoming more of a commodity and is only the beginning of something far more important: an engaging conversation that lives on (ideally) or dies (quickly) if it doesn’t engage audiences.

Content is not necessarily king, distribution is king and engagement is the ultimate.

Where’s the excitement in the media space now?Everywhere! The television remote control is the most powerful device in the hands of consumers, and now the mobile phone. Look at media phenomena like Akademi Fantasia and Malaysia Idol and you’ll sense the power of mobile phones .

Blogs are another area where consumer-generated content (CGC) or user-generated content (UGC) is driving the way forward. Look at what happened to poor Neil French, death by blog. Even our ex Prime Minister agreed to be interviewed by MalaysiaKini, an online news portal.

Everyone is recognizing the power of the internet.While TV talks to you in a uniformed message for the masses, the internet has a different feel to its experience. It seems to talk to you one-to-one, but in actual fact it is also talking to millions. One has to get a handle on how the media works these days. If nobody criticises you, it doesn’t mean you are right. In fact, dialogue is good. Any feedback is good. That’s how consumers get closer to you. That is the new language of interaction.

Conversation is the ultimate form of engagement.Henry, many media owners especially the smaller ones and those in the ambient space say they do not have a chance in hell to air their media options to advertisers because media specialists get in the way and screen them first…

May the best proposal or idea win, irregardless of where it came from.I have nothing against media owners talking to advertisers, we can’t possibly talk to clients all the time about all the media available in the country. These are the rules of engagement the new media democracy that is already upon us. At the end of the day we, as media specialists, are custodians of the clients’ interest and as long as the client understands there is no fear in the relationship being short-changed by a media owner offering a direct deal to an advertiser, it should be ok I tell my clients they can talk to anyone.

I’m not afraid of losing clients, I’m afraid of not doing good work!

You mentioned about media owners consolidating…It is happening already. Look at Media Prima – they virtually own free-to-air. AMP Radio Networks have the radio territory covered and ASTRO is dominant in pay TV. The Star is an institution in its own right for print. We increasingly a seller’s market and this trend can be worrying. In the media buying arena, size matters more and more.

Where’s the potential for growth?The middle-income level Malay consumer is the single largest and fastest-growing segment in our marketplace. We need to arm ourselves with the depth of understanding and grasp the softer issues of this audience to tap into their psyche and potential. This is easier said than done, especially when you look at our industry which is mostly Chinese professionals. Clients question me too; about my feel for this target audience. My answer is simple: look at my team, we have some of the best brains in the market and they are of the same race and have a thorough understanding of the target audience. There’s no escaping the fact that this is where the potential is.

What’s the biggest fear you see in our industry?The fear of unlearning. Too many of us fear the process of unlearning old things and having to change to new ways of doing things.

MINDSHARE WINS AGENCY OF THE YEAR!MindShare pipped Universal McCann to emerge Agency of the Year champions at the recent Malaysian Media Specialists Awards show on June 9 in a glittering ceremony at the Grand Ballroom of the Mandarin Oriental. Carat won third placing.

HENRY HUMBLED26 hours after he first stepped out of his home in Petaling Jaya, Henry Tan had arrived in the hushed ambience of the Ritz Carlton in Los Angeles. He was in no mood for another marathon session, be it a meeting or even a long-drawn drink by the bar. As he greeted his MindShare colleagues from all around the world, the senior management of over 90 offices across 65 countries, the weariness gave way to quiet anticipation.

It was the stage for the inaugural MindShare Worldwide Global Agency of the Year Awards. MindShare Malaysia had just won the best for the AsiaPacific region, which was a big surprise to Henry who always held his India agency in great awe.

But the moment of truth had come and the night went to Mindshare Malaysia as it clinched the highest accolade in the MindShare world! Henry was stumped, the rest of the world were more stumped to see an Asian office dominate the world. Henry tells ADOI, “I was humbled.” And ADOI replied, “It looks like Malaysia humbled the world!”



All about Satellite Television Companies

March 4, 2008

To get to know what is the prospects in Astro,let’s look at one of the satellite tv company in New York: Dish Network

DISH Network Corporation provides satellite delivered digital television services in the United States. It offers direct broadcast satellite subscription television services, as well as provides video, audio and data channels, interactive television channels, digital video recording, high definition (HD) television, international programming, and professional installation services. The company designs and develops DBS receivers, antennae, and other digital equipment. It also designs, develops, and distributes equipment for international satellite service providers, as well as offers receiver systems and HD receivers. As of December 31, 2007, the company had 11 owned or leased in-orbit satellites; and offered 2,700 video and audio channels to consumers. DISH Network Corporation offers its products and services through satellite retailers, direct marketing groups, consumer electronics stores, nationwide retailers, and telecommunications providers. The company was founded in 1980. It was formerly known as EchoStar Communications Corporation and changed its name to DISH Network Corporation in January 2008. DISH Network Corporation is headquartered in Englewood, Colorado.

P/E ratio

Broadcast technology

While for years DISH Network has used standard MPEG-2 for broadcasting, the addition of bandwidth-intensive HDTV in a limited-bandwidth world has called for a change to an H.264/MPEG4 AVC system. DISH Network announced as of 1 February 2006, that all new HDTV channels would be available in H.264 format only, while maintaining the current lineup as MPEG-2. DISH Network intends to eventually convert the entire platform to H.264 in order to provide more channels to subscribers. Both a standard receiver and a receiver with built-in DVR (Digital Video Recorder) are available to subscribers. The Dish Network ViP622 HD DVR has received good reviews[4] from CNET and others. Both a standard receiver and a DVR (Digital Video Recorder) are available to subscribers for an upgrade fee. Currently Dish Network charges $5.98 per DVR as DVR service fee, which covers cost of licensing EEPG(Extended Electronic Program Guide) from TV Guide.

From Dish Network,we can see that Astro may implement these technologies in Malaysia,Indonesia,India,Brunei and China in the future.