Analytical Review 101 – Part VI

Balance Sheet – Current Assets

What is a Balance Sheet?
The Balance Sheet shows the position of the company as at the end of the financial year (or as at a specific date). The Balance Sheet contains summary information of all assets and liabilities of the company including its' Intangible Assets, Property, Plant and Equipment, Long Term and Current Assets, Long Term and Current Liabilities and the Shareholders’ Equity. This is noteworthy as it gives us an indicator as to the value or worth of a company.

What do Current Assets represent?
The Current Assets are assets which is expected to be sold or otherwise used up in the near future, usually within one year. It usually consists of trade receivables, other receivables, inventories and cash & cash equivalents.

1. Trade Receivables
Trade receivables consist of amounts due from customers. These amounts arise because most business gives credit period and limits to their customers. The average credit period given to customers vary depending on the industry they are in.

Usually, the longer the credit period given to customers, the larger trade receivables amounts recorded in the Balance Sheet. Why then should the company give credit periods to its' customers? Wouldn't it be better to have all sales on Cash On Delivery (COD) terms?

This is not possible for most businesses as it is often necessary to give reasonable credit period to customers for the company to secure sales and maintain customer goodwill.

A sudden increase in the trade receivables of a company compared to previous years is not always favorable. It may indicate that the company is relaxing it's credit period to customers’ to secure additional sales. Another possibility may be the company is facing difficulties in recovering the debts owed by its’ customers. Either way, this may result in the company facing cash flow problems, in the long run.

2. Other Receivables
Other receivables usually consist of:
(i) Other deposits, receivables and prepayments;
(ii) Amount due from related companies and subsidiaries; and
(iii) Loans to employees.

By and large, this figure is stable and does not change over the long run. It is usually not significant in our evaluation of the company's value.

However in Nestlé's case, is noteworthy that Nestlé has a long term loan to its' employees amounting to approximately RM22MIL. Note 9.2 states that “Loans to employees are unsecured, interest free and are not expected to be repayable within the next twelve months.”

Nestlé employees’ must be happy to enjoy such benefits. However, as a prospective investor, we would like to know what criteria is used to give out loans to it’s’ employees and what are the terms of repayment. If the RM22MIL cash was not loaned out to its' employees, and instead was placed in a Fixed Deposit with 4.5% return per annum, the company would earn an additional RM1MIL interest income.

3. Inventories
Inventories usually consists of raw and packaging materials, work-in-progress, finished goods and spare parts. Manufacturing and distribution groups like Nestlé must keep raw and packaging materials to convert them into finished goods such as ice-cream, powdered milk and drinks. Those raw materials that are still being processed into finished goods at the financial year end, will be classified as work-in-progress. Spare parts are consumables held, often for routine maintenance works and repairs of factory equipment.

Although inventories are assets of the company, it is important to examine this figure. When the inventories in the Balance Sheet is too high compared to previous years or to its’ cost of sales, this may indicates that the company is facing fierce competition and is unable to sell its’ inventories fast enough. Such a situation can easily lead to financial troubles. Large inventory balances may lead to additional warehousing rental, insurance premiums and risk of obsolete, damaged or non-saleable stocks. It is critical to ensure the company maintains stringent inventory management before making your investment decision.

4. Cash and cash equivalents
Cash and cash equivalents are cash, either in the bank or placed under fixed deposits with financial institutions. These are highly liquid instruments with minimal capital risk. Cash is critical to the survival of a company, so always keep a close watch on this balance.

Conclusion:
We have appraised and analyzed the major components of the current assets of Nestlé. Some of the important things to watch out for, when reviewing the components in the Current Assets have also been highlighted. My next post will look at the Current Liabilities section.

Romance of the Three Kingdoms – Part III

Interlude

The Battle of Red Cliff 赤壁之戰

Following Wang Yun’s successful 美人計 No Man May Pass the Hall of Beauties strategem, the irresistible synergistic combination of Dong Zhuo and Lu Bu was torn asunder. Dong Zhuo’s death at the hands of Lu Bu and his conspirators, led to a civil war within Dong Zhuo’s faction. The resulting power vacuum within the Han capital was quickly seized by Cao Cao, who took control of the Han Capital and proclaimed himself as Imperial Chancellor of Han, bestowing upon him immeasurable power over the remnants of the Imperial Han Government.

Within a span of less than a decade after taking control of the Han Capital, Cao Cao successfully unified northern China by vanquishing enemies including Lu Bu, Yuan Shao, Yuan Shu and Liu Biao. Cao Cao then turned his ambitions towards Southern China in his attempt to reunite China with infantry numbering approximately 240,000 men.

However, he faced two main nemesis in his attempts to conquer Southern China.

The warlord Sun Quan controlled the river east of the Yangtze river and the southeastern territories abutting it. He assigned his most able commanders including Zhou Yu, Cheng Pu and Lu Su to command 30,000 seasoned marines to meet Cao Cao’s hordes.

Liu Bei, now based Xiakou sealed an alliance with Sun Quan and sent 20,000 marines, led by Zhuge Liang to combine with Sun Quan’s army. The alliance of Sun Quan and Liu Bei had 50,000 men against the 240,000 led by Cao Cao.

So, the stage was set for the Battle of Red Cliff. And what was at stake?

For Cao Cao, success would mean he would be able to reunite the whole of China and eliminate his two main rivals before they became entrenched in their respective positions. If successful, Cao Cao and his descendants would be able to re-establish the Han Dynasty or dethrone the Han Rulers and place himself and his future successors as the emperors of China.

If Sun Quan and Liu Bei were successful, they would maintain control over the Yangtze river. This would provide a natural line of defense that would give them time to consolidate their respective territories. Thus, they would be able to prevent or prolong the period taken by the Wei Kingdom, led by Cao Cao to reunite China.

With a numerical superiority of almost 5:1, seasoned infantry, capable military commanders and fresh from the euphoria of a highly successful northern campaign, Cao Cao possessed immense advantages. Further, he had the moral and legal right to assume control over Southern China as he was the current Imperial Chancellor of Han.

Could the alliance of Sun Quan and Liu Bei resist the overpowering northern army of the Wei Kingdom led by Cao Cao? Or would Cao Cao reign victorious? We shall see how this decisive battle unfolds, in future posts.

Analytical Review 101 – Part V

THE IMPORTANCE OF CASH FLOW STATEMENTS

Today, we will be reviewing one of the most fundamental components of the annual audited financial statements, namely the Cash Flow Statements.

What is Cash Flow Statements (CFS)?
Cash Flow Statements is a summary of the company’s cash inflows (funds coming in) and cash outflows (funds going out) for a period of one year (in the context of the annual audited financial statements). The CFS tracks the movement in the company’s cash and cash equivalents.

What does the Cash Flows from Operating Activities (Operating Cash Flows) tell me?
Simply put, the Operating Cash Flows are cash generated from the company during its’ ordinary course of business such as cash received from its’ customers less all operating cash outflows such as payments to trade creditors, employees, tax and money tied up in working capital (e.g. inventories and trade debtors).

The Operating Cash Flows indicates whether the company’s business is sustainable and is generating sufficient cash flows to fund its’ business. Unless the company is a new start-up or are involved in long term projects (such as construction companies’), operating cash flows should always be positive.

If the company has negative operating cash flows, you need to be very careful if you intend to invest in such companies. Why? Well, if the company cannot generate enough cash to fund its’ operations, how long do you think the company will last? More importantly, is the business sustainable in the long run?

What does the Cash Flows from Investing Activities (Investing Cash Flows) tell me?
For a company, it is not enough to generate a small positive Operating Cash Flows. It must generate sufficient positive Operating Cash Flows to finance its’ investing activities. In other words, the Company must have enough cash generated to finance enhancements to its' manufacturing capabilities & technologies. It must also have cash to purchase new property, plant and equipment to replace its’ existing factories, equipment and other fixed assets. Interest received from investments and proceeds from disposals of property, plant and equipment will also be classified under this category.

Generally, Operating Cash inflows must be sufficient to finance Investing Cash outflows. If it is insufficient over a period of time, the company must finance its’ investing activities through loans and bank borrowings. When this occurs, you must ask yourself, is the company incurring these loans for expansion purposes or merely replacing its’ current ageing assets.

If it is for the former purpose, the additional future revenues and operating cash flows arising from its' expansion should suffice to repay the loan and interest. However, if it is for the latter purpose, then further analysis is required. If a company cannot generate sufficient Operating Cash inflows to finance replacement of its’ property, plant and equipment, is the business really viable?

What does the Cash Flows from Financing Activities (Financing Cash Flows) tell me?
Financing cash inflows consists mainly of cash received by securing additional loans and bank borrowings. Cash outflows from financing activities usually consists of dividend payments to shareholders, repayment of borrowings &loans and payment of finance lease liabilities.

Commonly, Financing Cash Flows are usually cash outflows except when there are huge loans or bank borrowings secured for a particular year. The Financing Cash Flows indicates how much of cash is being utilised to fund the operations of the company. Over the long term, perhaps for a period of three to five years, the Operating Cash inflows must be large enough to cover both the Investing and Financing cash outflows. This will indicate that the company is a viable one and is in a position to repay its’ loans and borrowings over a period of time.

Overview
The sum of the Operating Cash Flows, Investing Cash Flows and Financing Cash Flows will indicate the increase or decrease in cash and cash equivalents for the year. This indicates how healthy the company is, in terms of cash flows. Healthy cash reserves are crucial for the stability and strength of a company. It would be desirable to review a company's CFS over a period of five years to analyze whether the company's business is viable.

Analytical Review
Please click on the picture above to see the Analytical Review comments.

Conclusion:
A detailed review of the Cash Flow Statements over a five year period is crucial in analyzing the financial health of a company you intend to invest in. Remember, in the long term, the company must have more CASH INFLOWS (cash coming in) than CASH OUTFLOWS (cash going out).

Analytical Review 101 – Part IV

Quality of Earnings Ratio

Let’s start with a quick quiz: What is the lifeblood of any business? [Highlight answer below]

CASH

Of all the figures in the financial statements, cash is the least susceptible to manipulation and creative accounting.

There are numerous techniques used to improve the cash flow position as at year end such as deferring payments to creditors, obtaining down payments from customers or aggressive debtors’ collection strategies. However, there is a limit to these techniques and Cash is still the most reliable gauge of the company’s overall performance.

The Quality of Earnings Ratio attempts to assess the quality of the Profit for the Year earned by the Company. In short, it assesses how much of the Profit for the Year has been successfully converted by the company into cash. Some of you might be scratching your head…

Remember this:
PROFIT FOR THE YEAR DOES NOT EQUATE TO CASH RECEIVED

Remember, in order to convert the profit earned into cash, a company must collect all the debts owed to it by the customers. Some of these debts may not be collectible, hence resulting in bad debts. Inventories held by the company may be subsequently damaged or expire, resulting in additional inventory provisions. There could also be some aggressive earnings management (i.e. creative accounting) by the company to boost profits which is not sustainable. Therefore, it is critical to look at the Quality of Earnings ratio to assess the quality of the profits indicated on its’ financial statements. Let us review the components of this ratio.

Profit for the Year
We have discussed what the Profit for the Year represents earlier. In principal, it represents the gain made by the company for the sales of its’ products less all costs incurred by the company.

Net Cash from Operating Activities
This component represents the cash generated by the company during the year from its’ normal operating activities excluding investing and financing activities. Generally, this amount indicates the cash received from customers, payments to creditors & employees, cash tied up in working capital and income tax payments. A well managed company should have a very strong operating cash flow. Otherwise, the company may run into liquidity problems later on.

Analytical Review
For a company like Nestlé, a strong operating cash flow is expected. Such an established company with excellent brands should get very favorable terms from its’ customers. Most of its’ customers, comprising of established dealers and hypermarkets chains would not have problems paying their debts on time.

A review of Nestlé Quality of Earnings Ratio indicates that this ratio has been hovering, on average, at 100%. This is a strong indication that in terms of cash flows, the company is doing very well in managing its’ working capital and converting profits into cash. Nestlé has been exceptional in the management of its' cash flows.

Conclusion:
Always check and review the quality of profits earned by the companies’ you plan to invest in. A strong Quality of Earnings Ration (close to 100%), indicates that the company is financially sound whereas a weak ratio (anything less than 80%) requires further detailed analysis of the divergence between profits and cash earned.

Analytical Review 101 – Part III

Profit Before Tax and Net Profit, Margins

How is Profit Before Tax arrived at?
If you look at Nestlé’s Income Statement; Profit Before Tax is arrived by using the Gross Profit less the following major items:

(a) Distribution and selling expenses
These expenses are mainly transportation costs incurred in delivering its’ products to its’ distributors & direct customers such as hypermarkets and dealers. Other selling costs consists of salespersons’ salaries, commissions, entertainment and other expenses. Advertising campaigns and product promotions expenses are also classified here.

(b) Administrative expenses
Costs incurred by back office departments such as Finance, Procurement, Credit Collection and Information Technology are usually lumped under these categories. Other fixed overheads (excluding factory overheads) will also be categorized here.

(c) Interest income
Interest income usually consists of interest earned on excess cash placed by the company in fixed deposits, short term money market deposits and other interest earning instruments.

(d) Interest costs
Interest costs consists of financing costs due to loans and borrowings secured by the company to finance its’ operations and capital expenditures.

How is the Tax Expense arrived at?
Tax expense consists of income tax liability payable by the company on its’ profits and deferred taxes. The income tax liability is largely out of the Company’s control, so it is of lesser importance in our analytical review.

How is the Profit After Tax arrived at?
Profit After Tax = Profit Before Tax – Tax Expense

Analytical Review
The Profit Before Tax (PBT) margin gives us an indication of the profit made by the Company from its' sales less ALL costs incurred including COGS and indirect costs such as selling, marketing, administration, financing and other costs.

An overview of the PBT margin of Nestlé from 2003 to 2007 indicates that its' margin has been hovering around 10% to 11% for the past four years. Overall, this figure is reasonably good as it means the company is making a profit of approximately RM0.11 for every Ringgit of sales made.

The Profit After Tax (PAT) margin signals the profit made after deducting the income tax payable to the Malaysian government. Review of the PAT margin for the past five years suggests that PAT margin is improving. However, this is largely due to tax incentives obtained as indicated in note 18 of the annual audited financial statements.

Conclusion:
A profit after tax of approximately 8% per annum is reasonable. However, it is not that impressive considering RISK FREE interest income from fixed deposits are approximately 3.70% whereas returns from EPF are about 5%. Please remember that Profit After Tax DOES NOT EQUAL TO Cash Earned as there is a timing difference in turning profits into cash (as indicated by the Quality of Earnings Ratio).

Further, there is always a moderate risk involved in investing in companies, even in one as established as Nestlé. As indicated earlier, comparison with Nestlé’s competitors’ PBT and PAT margins may give us a more complete picture as to the Nestlé's strength and weaknesses vis-à-vis the industry.

Analytical Review 101 – Part II

Gross Profit%
What does the Gross Profit % represent? To understand this, we need to understand two components, Revenue and Cost of Goods Sold.

Revenue

Revenue, turnover and sales all mean the same thing. It represents sales to customers for goods sold or services rendered. For a company like Nestlé, its’ revenues, inter-alia, are derived from the marketing and the sale, both locally and for export, of ice-cream, powdered milk and drinks, liquid milk and juices, instant coffee and other beverages, chocolate confectionery products, instant noodles, culinary products, cereals, yogurt and related products.

Cost of Goods Sold (COGS)
Cost of goods sold, COGS, or "cost of sales", comprises of all direct costs attributable to the production of the goods sold by a company.

This amount includes the materials cost used in creating the goods along with the direct labor costs used to produce the good, meaning only costs that are directly tied to the production of the products are classified under COGS.

For Nestlé, its’ COGS would include costs of raw materials purchased including transport costs to bring these materials to its’ factories. The factory workers’ wages and overheads to convert the raw material foodstuffs into saleable products’ would also form part of its’ COGS.

Gross Profit

Gross Profit = Revenue - COGS. Therefore, gross profit % represents the overall gain realized from the sale of its’ products. A gross profit % of 32.94% means that for each Ringgit of sales made, Nestlé earns RM0.32 sen. This means it only costs Nestlé RM0.68 to produce the product.

However, take note that the Company must cover its’ other costs not included in the COGS. These include indirect costs such as distribution & selling expenses, administrative expenses, other expenses, interest costs and tax expense.

Analytical Review

So what does else does the Gross Profit % tells us? Not much really. That is why we need to compare over a period of time. By constructing the financial dashboard, we can see the trend of the Gross Profit % over a period of five years, from 2003 to 2007.

Overall, we can see that Nestlé has been successful in maintaining its’ Gross Profit. This means that despite the increase in raw materials such as basic foodstuffs, the Company has managed to pass on these additional costs to its’ customers by raising its’ prices. It may also indicate that the factories of Nestlé are continuously improving its’ efficiency and processes and keeping operating costs down.

An even better comparison would be to compare Nestlé Gross Profit % with its’ competitors such as DUTCH LADY MILK INDUSTRIES BHD. We shall do this at a later date.

Conclusion:
By performing some basic computations, we know now that Nestlé appears to profitable as it is making approximately RM0.32 for every RM1 of sales. These profits appear sustainable as the Company has managed to maintain its’ Gross Profit % despite the rising costs of raw materials foodstuff.

Analytical Review 101 – Part I

Before we start, I would like to quote Steven Covey, from his book “The Seven Habits of Highly Effective People”:

BEGIN WITH THE END IN MIND!

So, you should ask yourself: What is the end product of my efforts to calculate these financial ratios and performing analytical reviews?

Well, it should look similar to the financial dashboard above!

In order to analyze and assess companies' quantitatively; we need to construct financial dashboards to make sense of all the information contained in the annual audited financial statements. We will be attempting to construct the above dashboard to help us assess whether the company is worth investing based on its’ current market share price.

The information contained in the financial dashboard above is based on the Annual Audited Financial Statements of Nestlé’ (Malaysia) Berhad, downloaded from the Bursa Malaysia website.

For those of you interested in learning about the construction of the financial dashboards and performing analytical reviews, kindly download the Annual Report for Nestlé’ (Malaysia) Berhad for the financial year ended 31 December 2003 to 2007. All the analytical reviews and financial ratios calculated will be based on Nestlé’s audited financial statements. The link to the Bursa Malaysia is available on my Investment Resources Link section.

Please go through the financial dashboard above carefully. I will be reviewing each financial ratios in detail, in my subsequent posts so that we can make sense of the information in the financial dashboard.

Basics of Investing – Part VII

RECAPITULATION (SUMMARY)

Fundamental Lessons:
1. There’s no such thing as a free lunch: You won’t get something by doing nothing.

2. The irony of money:

The more you have, the more you’ll get and the less you’ll need;
The less you have, the more you’ll spend and the less you’ll get.

3. A fool and his money are soon parted: Don’t be foolish – THINK BEFORE YOU LEAP!

4. Caveat Investire: Don’t leave your money to the EXPERTS! Take charge of your own investments!

5. Beware of the Black Swans: Impact of Highly Improbable Events.

6. Always Cash Out and Recoup Your Capital.

7. Consider the Fundamentals: Risk, Return and Liquidity.

Basic Lessons:
1. Follow the investment philosophy used by richest person in the world: Warren Buffett. His Investment Philosophy? Value Investing!

2. Ascertain companies qualitatively:
· Characteristics of Top Management;
· Substantive Competitive Advantage; and
· Corporate Social Responsibility

3. Ascertaining companies quantitatively by analyzing the financial statements and using Analytical Review techniques. Keep a look out for my Analytical Review 101 posts.

4. The Legal Aspects: Understand the legal repercussions of investment in shares. The Limited Liability concept and Separation of Ownership and Management.

5. The Financial Aspects: Understand the significance of Annual Reports and Quarterly Reports.

6. Audited Financial Statements: The Income Statement, Balance Sheet, Statement of Changes in Equity, Cash Flow Statements, Auditors’ Report and Notes to the Financial Statements and their significance.

7. Recapitulation: Summary of Investment Lessons learn so far.

Conclusion:
We have covered the fundamental and basic lessons of investment in shares. The next step will be evaluation of the companies' quantitatively using the Analytical Review techniques.

Basics of Investing – Part VI

AUDITED FINANCIAL STATEMENTS!

Earlier on we discussed about Annual Audited Financial Statements. Aside from the Management Accounts (available to Management only), the most reliable information available to small time investors like us would be the Annual Audited Financial Statements. Let's have an overview of what audited financial statements are.

Audited
So what does audited mean? This merely means that there has been an independent examination of the underlying records that is used to compile the information in the financial statements. The auditors have performed some reasonableness test and checking to ensure the figures are reliable.

Are the figures 100% correct?
NO! Although an independent review has been carried out, this only gives us reasonable assurance. The more prestigious the audit firm, usually one of Big Four audit firms, the more reliable the figures. The Big Four audit firms are currently, PricewaterhouseCoopers, Ernst & Young, KPMG and Deloitte Touche Tohmatsu.

Are the figures materially correct?
YES, most of the time. Unfortunately there are exceptions, the most notable one being Enron that led to the collapse of one of the most prestigious global auditing firm – Arthur Andersen.

What about UNAUDITED quarterly and annual reports?
These means the financial statements have not been audited. Consequently, the profit announced in the quarterly reports could be different, sometimes materially different from the audited financial statements.

Income Statement
The Income Statement is also more commonly referred to as the Profit & Loss Account. This section tracks the results achieved by the company for the financial year (or quarter). It shows the Sales, Gross Profit and Profit before Taxation, Taxation Expense and Profit After Taxation, of the Company. Generally, it provides information on the financial results of the company’s efforts for the year. We can use this assess the past performance of the company and as a guide for future performance.

Balance Sheet
The Balance Sheet shows the position of the company as at the end of the financial year (or as at end of the financial quarter). The Balance Sheet contains full details of the all assets and liabilities of the company including its' Intangible Assets, Property, Plant and Equipment, Long Term and Current Assets, Long Term and Current Liabilities and the Shareholders’ Equity. This is noteworthy as it gives us an indicator as to the value or worth of a company.

Statement of Changes in Equity
As a shareholder, you should be concerned with your equity or your stake in the company. The value of your stake in the company will consist of the share capital, retained earnings and other reserves. This statement will show the movement in your equity for the financial year.

Cash Flow Statements
What is the life blood of a business? Cash! The Cash Flow Statement shows the movement in cash flows from the beginning of the year to end of the year. This is crucial in the evaluation of how well a company is doing. Even if the company is making fantastic profits, if its’ operating cash flow position is negative; this is an indication that something is not quite right with the company!

Auditors Report
Auditors will usually give an unqualified opinion, which means that in their opinion, the audited financial statements are reasonable. If they give anything other than unqualified opinion, it means something is not right with the audited financial statements. You will need to be circumspect when relying on audited statements, if the auditors’ in their audited report gives anything, other than a qualified opinion.

Notes to the Financial Statements
This contains inter-alia, the Accounting Policies of the Company, additional details of the figures stated in the Income Statement and Balance Sheet, and non-financial information including Contingent Liabilities and Segmental Information. This allows you to gain further insight into the Company.

Conclusion:
To truly evaluate the value or worth of shares in a company, it must be based on fundamentals. You must analyze the audited financial statements to assess the overall worth of a company. I suggest you download the audited financial statements of companies such as Nestle from the Bursa Malaysia and read it to get a feel of how they look like.

Romance of the Three Kingdoms - Part II

Interlude

美人計 No Man May Pass the Hall of Beauties

In Ancient China, the seeds of the destruction of the Han Empire were sown due to the neglect and ineptitude of the latter Han Rulers. During the chaotic times, the warlord Dong Zhuo managed to seize control of the Han Capital, Luo Yang and install Emperor Xian as his puppet figurehead.

Dong Zhuo was a tyrannical megalomaniac and put many loyal and noble officials to their deaths. Although several warlords throughout the country formed an alliance led by Yuan Shao to defeat him, their attempts ultimately failed.

The reason was exceedingly simple. Dong Zhuo had an adopted son, the famed Lu Bu, widely regarded as the fiercest and skilled warrior of his times. Lu Bu was a master in horseback riding, archery, and was thus known as the Flying General. He was a handsome and mighty warrior wielding a ji known as the "Sky Piercer" on top of his steed, Red Hare.

So long as the combination of father and son (adopted) stood firm, the tyrant Dong Zhuo could not be overthrown. Thus, the 美人計 Mei Ren Ji strategem was hatched by the Imperial Minister of the Interior, Wang Yun.

Wang Yun had a beautiful song girl named Diao Chan in his household that he treated like his own daughter and used her as a tool to plant the seeds of strife between Dong Zhuo and Lu Bu. He invited Lu Bu to his house one night to present him a gift. Lu Bu was enamored with Diao Chan’s beauty as she served wine during the banquet. Wang Yun, taking advantage of this, promised to marry her to Lu Bu.

Wang Yun subsequently held another feast for Dong Zhuo with Diao Chan displaying her skills in singing and dancing. On that very night, Dong Zhuo brought back Diao Chan back to his household and made her his concubine.

When Lu Bu heard of this event, he was seized with an uncontrollable rage. Whenever she was alone with Lu Bu, Diao Chan pretended that she was taken by force by Dong Zhuo and acted as though she really loved Lu Bu. At the same time, she constantly complained to Dong Zhuo that Lu Bu had evil intentions on her although she was already Dong Zhuo’s concubine.

Through her constant manipulations of father and son, their relationship soon soured. In the end, Lu Bu and several conspirators successfully hatched a plan and assassinated Dong Zhuo, ending the tyrant’s life. Alas, the death of Dong Zhuo merely hastened the rise of another warlord, Cao Cao.

And what happened to our bold warrior, Lu Bu? He survived as a minor warlord for some time. Unfortunately, he also met his bitter end at the hands of Diao Chan. Though he was killed by Cao Cao, he was ultimately defeated as he was too enamored with Diao Chan’s beauty that he neglected his duties and allowed his vigilance to wane.

Conclusion:

Take note that this strategem refers to the Hall of Beauties. As Beauties is a generic term, it can refer to anything desirable, be it sex, drugs, gambling, cash, riches, even sympathy and flattery, so do be careful to avoid falling for this strategem employed by your adversaries.

Further, no matter how beautiful a woman may look on the outside; a wise man should always consider her morality, character and wisdom. Do not be led astray by a moment’s desire only to suffer for an eternity.

A woman’s external beauty
Is like a flower in full bloom
Exciting, enchanting and enticing
Ephemeral, a mirage

A woman’s inner beauty
Is like a candle shining brightly
Patient, persistent and protective
Banishing an eternity of darkness and ignorance

Financial Intelligence - Part V

Dilemma:
钱不够用 Money No Enough!
(A Singapore movie by Jack Neo)

Answer:
知己知彼 Know Thyself, Know Thy Enemy
百战百胜 A Hundred Battles, A Hundred Victories
(In the book “The Art of War” by Sun Tzu)

It’s a jungle out there, someone remarked to me once. As I reflect on this, I realize that true enough; it really is a concrete jungle out there!

Just like the jungle world, we have the human equivalents of jackals, hyenas, tigers, panthers, cougars, falcons, eagles, piranhas, sharks and all other manners of fierce and ferocious beasts ready to pounce at our every mistake. One wrong (financial) step could be your last!

And what do I mean when I by the above? Simple, whereas in the past: past predators were after your flesh (i.e. food), nowadays you have HUMAN PREDATORS (AND CORPORATE SHARKS) that are after one thing: YOUR MONEY!

If there is one phrase that most adequately describes the financial status of most of the working people like you and me, it would be the phrase below:
钱不够用 Money No Enough!

Are you:
• Finding it difficult to make ends meet?
• Not saving enough for your retirement fund?
• Not saving enough for your children’s education?
• Not having enough money to pay your bank/car/house/[insert item here] loans?
• Being chased by your banks (aka your friendly corporate money lenders) to pay just the interest on your credit card loans?
• Being chased by Ah Longs (aka your friendly neighborhood money lenders) to pay up your debts?

No? Phew! Lucky you! Ok, scram and get out of here! You probably have enough money, so you don’t meet the criteria: Money No Enough! :)

Yes! How did I get myself into this mess, you ask? Then read on:

Example: Credit Card Loans
So, just how did you get yourself into this mess? If you are just like the average Ah Beng, remember the time…

You were in college minding your own business when suddenly… two very pretty girls approached you…

“Sir, sir,…are you interested in credit card? Right now, carry cash very inconvenient. Pre-approved already, you only need your parents as a guarantor. Can go out on a date with girlfriend, no worries!”

Cannot lose face in front of pretty girls-mah, right? So, you went to your Old Man (aka Dad) and ask him to sign but that he refuse. Luckily, Ah Mah (aka Mother) agree to be your guarantor after you beg her…. Free credit up to RM10K from SHARKS BANK BERHAD. Every month you spend over the limit and use your allowance to pay off interest.

I am sure your Old Man is so proud of you. Before you even graduate you already so lucky, you got confirmed job offer already. You have maxed out your credit card and have a RM10K loan owing to the bank. Although you have yet to earn your first dollar, you devil you: already spend RM10K first using the banks’ money.

Yay, you are now officially an employee of SHARKS BANK BERHAD even before graduation. Every month you have to pay loan interest of RM1,800 a year (RM10K * 18% interest) to SHARKS BANK BERHAD. Hmmm…not bad (for the BANK), that’s about a months’ salary.

Later, you come and tell me: 钱不够用 Money No Enough!

My answer: [Highlight the area below]
Ar but den?
[Translation: Well, if you have a credit card loan even before you started working, what do you expect? Of course, you won’t have enough money to spend if you have to spend all your SALARY just to service the debt. What about the Principal? Of course you won’t have enough money, you silly boy!]

The Solution:
知己知彼 Know Thyself, Know Thy Enemy
百战百胜 A Hundred Battles, A Hundred Victories

If you find yourself having insufficient money, then it’s time for you to track your monthly income and expenses. You need the discipline to do this for at least three months.

Just like the proverb above, you need to obtain sufficient information about your income and spending habits. This information will give you sufficient knowledge about your strengths and weaknesses when it comes to earning and spending money. Only then, can you start to formulate a plan to reduce your expenses and start saving more for your future.

Conclusion:
Do you feel like the guinea pig in the cage? You keep running on the exercise wheel but end up nowhere, financially? Then it’s time for you to keep a detailed record of your financial income and expenses. As to the income, I’m sure you have no problems.

For your expenses, I don’t care how you do it. Jot it down in your 888 notepad, your PDA, your mobile or your BlackBerry. JUST DO IT for three months and you are already on the road to Financial Freedom.

Basics of Investing - Part V

The Financial Aspects

I would like to reiterate that one of the important consequences of a formation of a limited liability company, listed on a Stock Exchange (such as Bursa Malaysia) is that ownership and management are often segregated. That means professional management is hired to run the company and the owners are not involved in the day to day running of the business.

This presents a dilemma for the owners. After all, if you are a part owner of the business, wouldn’t you like to know how the company is doing? If the company has not been performing up to your expectations, you would like to reprimand top management. Conversely, if the company is performing exceptionally well, maybe its’ time to give your management a bonus to retain them.

Over the years, a framework has been set up to allow the shareholders (i.e. owners) or prospective investors to assess the performance of companies listed on the stock exchange. The reason why the information has been standardized and regulated is simple. A single public listed company could have thousands of owners, depending on its’ float. Therefore, there must be a standard mechanism to provide the information to all these investors in a fair and uniform manner.

If each and every one of these part owners started requesting information from the listed company at their whim and fancy, the Finance Department of this Company would collapse!

Today, we will be looking at the critical information provided by public listed companies on the Bursa Malaysia, which is vital to us assess their performance.

(a) Annual Reports
Annual Reports are a report which reviews the company’s overall performance for the year. The Annual Reports made available to the shareholders, within four months after the financial year end. Although Annual Reports vary from company to company, there are typically three segments that you should focus on:

(i) Operating and Financial Review (OFR)
The OFR typically comprises of the letter from the Chairman, Managing Director’s review, Management Review and other non financial information. The information contained inside should give you an insight into the competitive advantages held by the company, the challenges it faces and its’ future visions and plans.

(ii) Corporate Social Responsibility (CSR) Initiatives
The presence or lack of CSR initiatives in the Annual Report should be apparent once you review the Annual Reports. Be sure to go through this section carefully to see that the company actually cares about its’ CSR, rather than this just being a Public Relations (PR) exercise.

(iii) Annual Audited Financial Statements
Last but not least, this is the where the REAL MEAT lies, if you truly wish to assess the companies’ financial performance. Typically, it will consist of several sections, the Income Statement, Balance Sheet, Statement of Changes in Equity, Cash Flow Statements, Auditors’ Report and Notes to the Financial Statements.


(b) Quarterly Reports
For investors like you or me, the information contained in the Annual Reports is extremely useful. However, there is one problem! You only get the reports annually. If you have to wait for a period of once a year to assess the company performance, this is not timely at all.

Example:
You bought shares in ABC Berhad for RM10 per share based on the Annual Report for the year ended 31 December 2006 made publicly available on Bursa Malaysia on 30 April 2007. ABC’s Berhad’s financial year end is 31 December.

Unfortunately ABC Berhad has continuously made losses from 1Jan 2007 to 31 December 2007. However, you have no way of knowing this since the information is not made publicly available. Even though you are part owner in ABC Berhad, you are NOT entitled to the management accounts.

On 30 April 2008, you receive the Annual Report of ABC Berhad for the year ended 31 December 2007. The company has suffered huge losses during the year. The share price drops to RM6 per share. You almost get a heart attack and start raving:

What the [insert expletive here]! If only there have provided information on a timelier basis! I would have sold my shares a long time ago.

Fret not! In order to avoid these problems, companies listed on Bursa Malaysia are required to provide quarterly reports, two months after the quarter end. However, these quarterly reports are highly summarized information and they are usually unaudited. This means that the information contained within are usually less reliable than the audited financial statements issued together with the Annual Reports.

Conclusion:

Annual and Quarterly Reports of Public Listed Companies are made freely available on Bursa Malaysia. It is important that you familiarize yourself with these reports as they will be foundation for you to base your investment decisions.

I will cover each section in the Audited Financial Statements in detail in my subsequent posts. This will enable us to understand how to assess the performance of the company for the financial year and more importantly, its' financial prospects in the future.

Basics of Investing – Part IV

The Legal Aspects

Before investing, I believe it is important to have a good grounding of the legal aspects on investing in companies. Most of the time, people gloss over the fundamentals and assume they know the full legal repercussions of investing in companies.

When you assume – you are making an ASS out of yoU and ME, so don’t do it. Find out, by reading the facts below. By the way, I have a law degree, so you can have a measure of confidence in the matters below. However, if in doubt, you can always check with your lawyers.

What is a Company?
A Company can be described as an artificial person recognized by law as having legal rights and liabilities, (i.e. a company is a separate legal entity). In the case of Salamon v Salamon & Co, Lord Macnaghten judgment in the House of Lords decided that:

“The company is at a law a different person altogether from the subscribers…; and though it may be that after the incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law, the agent of the subscribers or trustee for them. Nor are the subscribers, as members, liable in shape of form except to the extent and in the manner provided by the [Companies] Act”

What are the consequences?
The major consequences of a company being recognized as a separate legal entity, for you as an investor are as follows:

(a) Limited Liability
As a company is a separate legal personality, any and all debts assumed by the company will be borne by the company itself. Its' shareholders will be completely free of any personal liability.

In Malaysia, all incorporated companies will either have the word “Sdn Bhd” or “Bhd” after their names. The acronym “Bhd” stands for “Berhad”, i.e. Limited. What this means is that the company is a separate legal entity. The shareholders liability is limited to the extent of the share capital contributed to the Company. As an investor, this is a very important concept to grasp. This means, if the company you invested in fails, your loss is limited to the amount that you bought the shares for.

Compare this to a situation where you are invited and become a partner in an trading firm. This trading firm is not incorporated as a company but is a partnership. Currently under Malaysian Laws, all partners are jointly and severally liable for any and all liabilities of the partnership. In other words, if the partnership fails and still owes money to the banks and creditors, you as a partner will be PERSONALLY liable to pay for this liability. The separate legal entity concept DOES NOT apply to partnerships.

Example:
Assuming your trading firm suffered huge losses and you have decided to end the partnership. You have a 10% voting right and your other partner has a 90% voting right in the partnership. Currently, your partner has been declared a bankrupt by the Courts. The total amount to settle the liabilities of the partnership is RM100K. How much do you have to fork out of your PERSONAL assets to settle the debt?

Some of you may think, 10% * RM100K = RM10K :)

Well, generally that may be true. However, since there are only two partners and your other partner is bankrupt, you are SEVERALLY liable. What does this mean?

ANSWER [highlight this line]:

YOU PAY RM100K!!! [you are liable for the entire debt]

If you and your partner set up a company instead of a partnership, what would the answer? [Highlight the area below]:

YOU WOULD NOT NEED TO PAY ANYTHING! THE COMPANY IS LIABLE FOR THE WHOLE OF THE RM100K AND YOU ONLY LOSE THE AMOUNT YOU INVESTED AS SHARE CAPITAL IN THE COMPANY :)

(b) Separation of Ownership and Management
In large companies such as those listed on the Main Board in the Bursa Malaysia, ownership and management are usually separated. This merely means that the people running the companies’ [management] are paid salaries and are not owners of the company. The owners of these companies are the people who hold shares in the companies, called shareholders.

This is an important fact as it means that you must have the utmost confidence in the management of the companies (usually Chief Executive Officer and his management team) you invest in. At times, top management may have ulterior motives and act in their own interest instead of the interest of the shareholders.

In companies such as Enron, it is clear the management acted in their own interests and profited at the expense of the shareholders. Shares of Enron were trading at a high of USD80 per share in Jan 2001 but were worthless one year later. The faith of investors in the top management including Kenneth Lay and Jeffrey Skilling were clearly misplaced and many investors suffered huge losses. However, these top management would not have suffered any major financial losses are they are NOT owners of the companies [and probably would have sold their shares in Enron earlier on].

Conversely, companies that are well managed such as Berkshire Hathaway means that by investing in their companies, you will profit from their sound management and astute decisions. Consider the fact that USD10K invested in Berkshire Hathaway in 1965 would be worth USD51 million in December 31, 1998, compared to USD132,990 for the S&P (analyst report by Paine Webber).

Conclusion:
A sound understanding of the Malaysian Law is fundamental before you begin to decide in any investment vehicle. We have covered two important concepts today. For those of you that are interested in furthering your understanding of company law, I suggest that you visit Lawyerment.

Basics of Investing - Part III

Ascertaining the Value of Companies of Quantitatively

Despite the inherent ambiguities in assessing companies qualitatively, you should do this instead of relying wholly on quantitative factors. Most of you may not be aware of this but some companies resort to “window-dressing” their financial statements every year end to reflect better results. Financial statement fraud cases such as Enron and Worldcom are more common than you think!

How do I assess the companies quantitatively?
Now, this is tricky question. As an Accountant by profession, I can tell you truthfully that Financial Statements are not easy to understand. Assessing companies by looking at their Financial Statements is an art. The best method would be to take up a professional accounting qualification such as ACCA but that may be too arduous for some.

So, are you going to help me?
Yes, instead of boring you to death with the theory and nitty-gritty details, I will teach you the mystic arts of “Analytical Review”. So what is Analytical Review? Well, it’s a series of techniques of extracting information from the financial statements so that you have a general idea of how the company is doing.

Huh! What the [insert expletive here] !!!

I can see some of you are scratching your heads :)

Imagine this; you are sitting beside your wife who is driving her car. Now, imagine I am asking you the following:

· How fast is she going?
· How far has she travelled today?
· How much petrol has she got left on her car?

How are you going to tell me this?
· Are you going to set up sophisticated speed measuring equipment along the highway to measure the speed of the car?
· Are you going to rely on your note book to jot down the distance in kilometers travelled since this morning?
· Are you going to use a dipstick on the petrol tank to measure the gallons of petrol still left?

I imagine most of you will tell me: look at the dashboard, you silly boy!

Exactly! Same thing with financial statements, we will try to construct a dashboard with the important indicators. These will tell us the financial status of the Company we intend to invest in.

The mystical arts
The process of reviewing financial statements (i.e. constructing the dashboard) is called Analytical Review. Please look out for my future Analytical Review 101 posts. In that series of posts, I shall explain the process of evaluating companies quantitatively via Analytical Reviews.

However, I have to warn you that reviewing companies quantitatively is an art and there are no hard and fast rules. Even with certain guidelines, you still must exercise your own judgment as to the worth of a company.

Conclusion:
Assess companies qualitatively first. Then, use Analytical Review techniques to assess companies quantitatively. The combination of your analysis will reveal to you whether the company is worth investing based on its’ current market price.

Romance of the Three Kingdoms - Part I

Interlude

Romance of the Three Kingdoms

All work and no play makes Jack a dull boy. So, today’s post will be slightly more whimsical in nature. Most of you personally know me, so it will be no surprise to you that the good looking chap on the left hand side doesn’t resemble me even vaguely [sigh!].

So, who is he? Well, he’s one of the smartest blokes during a very chaotic time in China in the Romance of the Three Kingdoms. He’s known as the Sleeping Dragon or Zhuge Liang, the famed strategist to the Warlord Liu Bei of the Shu Kingdom. Even though I don’t even have 1% of his intellect, it does no harm to strive to try to emulate some of his strategies and wisdom in life.

The Romance of the Three Kingdoms is an interesting book set during a turbulent time in China which begins with the fall of the Han Dynasty. The part fiction, part historical novel describes the intrigue, wars, generals and strategists vying for power and covers a span of almost fifty years. During this time, the Han Dynasty disintegrated and China was split into many warring factions.

In the end, three major factions rose to power:

(a) Wei Kingdom led by Cao Cao
Cao Cao was a kickass charismatic bad dude that steamrolled over everybody. Fortunately, this dude was smart enough to recruit enough really muscular muscle man and braniacs to help him take over half the kingdom. He was on the verge of reuniting China but suffered a huge setback at the Battle of Red Cliff. The golden opportunity for him to reunite was lost. Cao Cao also recruited this really smart and savvy dude by the name of Sima Yi which gave his descendants a lot of grief in the end.

(b) Shu Kindom led by Liu Bei
Liu Bei was the charismatic sissy, who was lucky enough to be surrounded by brawny dudes such as Guan Yu and Zhang Fei. Over the years during his nomad journey, he managed to convince handsome chaps like Ma Chao & Zhao Yun and an old kickass dude like Huang Zhong to join him. He managed to also con master strategists to join him including Zhuge Liang and Pang Tong. Unfortunately, it was all for naught and his bumbling escapades allowed him to repeatedly snatch defeat from the jaws of victory.

(c) Wu Kingdom led by Sun Jian and Sun Quan
Sun Jian and Sun Quan were capable leaders that strengthened their hold over Southern China. As their territories were separated by a huge river, they manage to repel Cao Cao due to their superior naval armies and capable leaders. However, their succession policy sucked big time and their last Ruler capitulated to Wei without a fight after the fall of the Shu Kingdom.

To cut a long story short, in the end, all three of them got sh*ft*d by Sima Yi and his descendants. Sima Yi and company overthrew Cao Cao’s descendants and took over the Wei Kingdom. They, then subjugated the Shu Kingdom and Wu Kingdom in short succession and formed the Jin Dynasty.

In my next interlude, I’ll be looking at the stratagems used by the different factions during their struggle for power. The first stratagem is my favourite:

美人計 No Man May Pass the Hall of Beauties

By the way, I apologize if anyone of you tried to visit my blog during the weekends. It seems the kind people of Google thought my blog was a spam blog (aka splog) and deactivated my blog. Right now, it’s been activated again. Hopefully it stays this way and the problem doesn’t recur again!

Basics of Investing – Part II

Ascertaining the Value of Companies Qualitatively!

In order to assess the true value of companies that you plan to invest in, there are two dimensions you need to assess, namely Qualitative and Quantitative factors. Today, we shall discuss on Qualitative Factors.

Qualitative Factors
Qualitative factors are those intangible factors that cannot be qualified precisely in monetary terms. In other words, it’s something that has the accountants stumped, since they can’t put it in their Balance Sheet.

Think about it for a moment. How do you quantify something like the “X-Factor” that Richard Branson brings to Virgin Group or Steve Jobs brings to Apple Incorporated? Yet, most the mystique and value of these companies are dependent largely to the charisma and leadership qualities that their CEO brings. That’s why most CEOs are paid obscene amounts of money.

However, it is difficult to quantify these qualitative factors about companies. Fortunately, we can rely on Warren Buffett to provide the answer. In his interviews, he did mention two books that guided him in his investments. I have talked about the first one, The Intelligent Investor by Benjamin Graham.

The other is Common Stocks, Uncommon Profits by Phillip A. Fisher. So what’s so great about this book? Well, it provides a framework on how to analyze the qualitative factors of a company. And, currently the RICHEST PERSON IN THE WORLD relied on this book to make his billions!

In brief, Fisher suggests that you use 15 questions to evaluate a company. I am summarizing his 15 questions into THREE MAIN QUALITATIVE FACTORS to consider, which I will believe will serve you just as well. The other questions are mainly due to with Quantitative Factors, which I shall cover later.

1. Characteristics of Top Management
Integrity, Wisdom and Charisma! These are the qualities that Top Management should exhibit. In the end, Companies are made up of people. Most of the time, it is the Top Management that will set the tone for the rest of the employees to follow. A company whose Board of Directors exercise due diligence when making their decisions will act in the best interest of their shareholders (meaning YOU, if you invest in the shares of the companies).

These are people who will be frank in good times and bad. If they have made an error of judgment, they will openly admit it and move on. Charisma is also an important factor as most institutional investors base their decisions on the reputations and charisma of the CEOs. A more charismatic CEO may be able to convince analysts and investors to invest and support the Companies they lead.

2. Substantive Competitive Advantages (i.e. Moat)
What differentiates a Company from its’ competitors? Each Company must have its’ own unique offerings to the customer to enable them to maintain customer loyalty.

For instance, in the car industry, the Ferrari brand evokes an image of luxury, quality and success. The association of prestige to the Ferrari brand, is one of its’ main competitive advantages which allows Ferrari to charge premium prices for it’s’ brand.

If a Company is not careful, it may find that its’ competitive advantage being eroded by its’ competitors. Once its’ competitive advantages are eroded, a Company may find its sales dropping, cash reserves dwindling and brand name diminishing. If it does not do something soon enough, these events will turn into a death spiral leading to the Company being bankrupt or being taken over. That is why you must always ask yourself, how is the Company going to sustain its’ competitive advantages in the future.

3. Corporate Social Responsibility (CSR)
Most companies only talk about CSR but rarely practice what they preach. For them, CSR is a good Public Relations (PR) exercise but nothing more. That is why you should be wary of this. By CSR, I mean does the Company have a holistic view about its’ raison d’être (its’ purpose in life).

If the Company’s purpose is purely about increasing profits for the shareholders at the expense of the stakeholders, I suggest you do not invest in such Companies. These companies will meet a sorry end, sooner or later. Prime examples of such companies include Enron and WorldCom.

When a Company (and its’ employees) truly believes in the benefits that their products bring to the consumers, then the Company will naturally flourish. By ensuring that they are fair to all stakeholders, be it customers, suppliers, the government and employees – it’s a WIN WIN situation for everybody. These are Companies that have the potential to grow and to be around for a very, very long time. Genuine companies that grow together with their stakeholders will remain in business for a very long time. These are companies that you should invest in.

Conclusion:
We have talked about qualitative factors of the Companies that you should be looking at. Obviously, its’ easier said than done, since you may not have all the information available to assess these Companies qualitatively. I shall be doing my own personal research on suitable companies to invest in July 2008 and assess them qualitatively, to see whether they are good investments.

My next topic will be on assessing the Quantitative Factors of a Company, so stay tuned.

Basics of Investing - Part I

VALUE INVESTING

Value investing is an investment strategy derived from the ideas on investment by Ben Graham & David Dodd. Graham’s book, The Intelligent Investor explains his concept in detail to average people like you and me.

Why should I bother about what Graham talks about? Well, there is one very good reason!

WARREN BUFFETT

Who is Warren Buffett?
Warren Edward Buffett is regarded as one of the world's greatest stock market investors, and is the largest shareholder and CEO of Berkshire Hathaway With an estimated net worth of around USD62 billion, he was ranked by Forbes as the richest person in the world as of February 11, 2008.

[Extracted from Wikipedia @ 9 May 2008]

Warren Buffett is the most notable proponent of value investing. And if you wish to invest in shares and want to be successful doing it, why not learn from the very best?

What is Value Investing?
In simple words, value investing is about the WORTH of a company. Instead of thinking of a company as an inanimate object, why NOT consider a company as a real living sentient being?

Let’s consider the value of a person. As a baby, when he comes into this world, he may have great potential. However, before this person becomes a person of value and contribute to the world, it will take time.

He will need to go to school to be educated. After facing the trials of examinations in primary, secondary and tertiary education, he has to embark on his working or entrepreneurial life. He will face all manners of challenges, trials and tribulations. If he rises up to the challenges in life, he will grow in value as a person. Soon, he will be a person of value and be able to contribute to his family and society in general.

The same applies to a company. Before you invest in any company, you must first understand the value proposition a company brings. Just like a person, to truly value and comprehend the company: you must first know:

(a) it’s origin, the past challenges and tribulations endured by the company (PAST);

(b) who is its' current leaders, the current company corporate culture and its' competitive advantages (PRESENT); and

(c) its' future vision, hope and aspirations (FUTURE).

Only by performing extensive research and analysis on your own, can you thoroughly appreciate the value of a company.

Why is this relevant?
If you truly recognize the TRUE (or INTRINSIC) VALUE of a company’s share price: you can compare it to the stock market’s share price. If your assessment of the value of Company A share price is RM10 and the stock market share price is only RM6, then it’s time for you to buy the shares of Company A. Sooner or later, other people are going to realize the same thing as you, and you can make a handsome gain of RM4 per share (40% capital gain), probably within one to two years.

Conclusion:
You need to truly comprehend the value or worth the company you are planning to invest it. Compare the real worth of Company's A shares to the its' current stock market price. If the market price of Company A drops below its' intrinsic value, then it’s time to buy the shares in Company A.

So, how do we assess the real value of a Company? This will be covered in my future posts.

Fundamentals of Investing - Part VII

RISK, RETURN AND LIQUIDITY

There are numerous investment vehicles [i.e. things!] that you can use your money to invest in. However, there are three important dimensions when considering what to invest in:

1. Risk
There are two dimensions of risk:

(a) Capital Preservation: What is the volatility of your investment vehicle maintaining the Ringgit value spent buying it?
The less volatile the investment vehicle, the less risky it is and vice versa. In other words, if you bought shares in Bear Stearns at USD100 per share a year ago, how likely is it that it will depreciate in value? Recent events have resulted in shares in Bear Stearns worth only USD10 per share, so investing in shares is a risky investment.

(b) Certainty in Rate of Return: What is the level of comfort that you will obtain the expected return on your investments?
The more certain the rate of return from your investment, the less risky the investment and vice versa. For example, if you invested RM10K in a fixed deposit with a local bank @ 3.70% per annum, it's virtually certain that you will obtain an interest of RM370 per annum. So there is a very high level of comfort on the rate of return.

2. Returns
Return is the combination of:

(a) Capital Appreciation
This means the increase in value of the investment class (excluding the recurring income generated). For example, if you bought a house for RM200K and rented it out, you would obtain rental income. However, you may find buyers approaching you to buy the house from you at RM250K. Therefore, your capital gain [IF YOU SOLD YOUR HOUSE!], would be RM50K.

(b) Recurring Income
Recurring income are the returns generated by the investment class on its' own.
Example: Interest Income from Fixed Deposits, Dividend Income from Shares.

3. Liquidity
Liquidity merely means how fast you can convert your investment into COLD HARD CASH. For example: Your house is a relatively illiquid asset as you need time to sell it. Conversely, investment in shares are highly liquid as you can easily sell your shares on the Bursa Malaysia.

So, what is the best investment vehicles to invest in?

Let me ask you, who is one of the three richest person in the world today, excluding Bill Gates?
WARREN BUFFETT!

Let me ask you another question: What investment vehicles does Warren Buffett usually invest in?
SHARES IN PUBLIC AND PRIVATE LISTED COMPANIES

Now, why do you think one of the world's richest person prefers to invest in shares?

Well, let's consider three different Investment Vehicles:
_________1. Fixed Deposits_______2. House________3. Shares in Public Listed Companies
Risk:_______Minimal_____________Medium_____________High [Medium risk with skill & experience]
Return: ____Minimal_____________Medium______________High
Liquidity:___High________________Low_________________High

Between the three investment vehicles:

(a) Fixed Deposit is the safest but with the lowest rate of return. The current FD rate might not be sufficient to offset the inflation rate now!

(b) Investing in a house is less risky but requires a huge capital outlay [i.e. a lot of money]. Sometimes, you might make a bad decision and it might be your last. Take for example, if you bought a house in Rawang in 1997 in the expectation that area will be developed extensively [rumours of Putrajaya and Proton City being located there]. Currently, there is a lack of development and you might make a loss on your house if you sold it now. You can't even rent it out for a good price to cover your loan interest. So, there is a moderate risk in investing in houses.

(c) Shares
You could make handsome gains in a year without doing anything. There's a good chance of capital appreciation [increase in share price] whilst you get dividend income from your shares. It's highly liquid and you can cash out anytime. The income is also TAX FREE. What more could you want?

Unfortunately, it's RISKY! Yes. You need to put in the effort to analyze and research into the Companies before buying them. Otherwise, like one of my readers mentioned, you could be fooled by the RED HERRINGS [aka shitty companies in the stock market].

Imagine a USD100 stock dropping to USD10 in less than a week. Now imagine your retirement fund of USD1MIL dropping to USD100K in a week. Scary? Darn right, it's scary. That's why you need to be very careful when investing in shares.

How to tell the SHITTY companies from the GOOD ones? Well, that's the topic my future post: An introduction to Value Investing.

Financial Intelligence – Part V

BUY ASSETS! NOT LIABILITIES!

Today’s lesson on Financial Intelligence is darn simple! And like all simple lessons, we tend to IGNORE IT! I just want you to focus on the definitions of the two items above:

ASSETS: ____SOMETHING THAT PUTS MONEY INTO YOUR POCKET
LIABILITIES: SOMETHING THAT TAKES MONEY OUT OF YOUR POCKET

Got it! Yes, you say! Nothing could be simpler…
Yeah right, you only THINK you got it.

Let’s have a quick quiz and see how much do you really understand.

QUIZ:
1. Which of the following is an Asset?
(a) Your car
(b) Your house
(c) Your collection of books / antiques / gadgets
(d) Your money in the Current Account

2. Which of the following is a Liability?
(a) Your car loan
(b) Your housing loan
(c) Your credit card loan
(d) Your loan to your brother-in-law

3. When is an Asset a Liability? [Fake Assets]

4. When is a Liability an Asset? [Fake Liabilities]

Answers:
Make sure you have answered all the questions in the quiz first! Remember the definition of ASSETS AND LIABILITIES? Yes? All right, ready? Please highlight the text below and here we go:

1. NONE OF THEM
· Your car takes you to work so you don’t have to waste time waiting for the bus. However, does it put money into your pocket? No! It’s not an ASSET, period.

· By staying in your house, you save on your rental expense. But does it put money into your pocket? No!

· Sure, you might think your collections are priceless. However, your wife might think they are a pile of junk. Besides, is it really putting money into your pocket? If might give you loads of happiness, but NOT MONEY!

· Oooh…money in the Current Account! Surely that’s an asset right? WRONG! Your money in the Current Account doesn’t earn you a single SEN! It’s not an asset! It’s actually a liability because the banks are going to charge you banking charges to maintain your Current Account facility.

2. ALL OF THEM EXCEPT FOR (D)
· Sure, interest rates on car loans are cheap. For those of you who can afford posh cars, interest rates are approximately on 3% per annum or less. Hey, that’s cheap right. It’s lower than the Fixed Deposit rates of 3.70% per annum the bank are giving. Hmmm… let’s think about it again. By taking out a loan of say RM100K, you are paying the bank RM3,000 per annum. Wait a minute. Does the car loan fulfill the definition of a liability to you? Is it taking money out of your pocket? Yes! Then it’s a liability. Who cares what interest rates of Fixed Deposits are? What you should be concerned is how much you are donating to the bank from your monthly salary!

· Ooohhh, you are buying a house. So what, if you are taking out a HUMUNGOUS LOAN to buy the house, you say! It’s an asset right, so the HOUSING LOAN IS NOT A LIABILITY. Really? Let’s see, you took out a loan worth RM300K at an interest rate of 8% per annum to purchase that house. You are currently paying interest of RM24K per annum (or RM2K per month). Well, you rented out the house to your tenants for RM2K per month. That's before deducting the insurance, quit rent, legal fees, maintenance and repairs on your house. So, is the housing loan a liability? Why YES! It’s taking money out of your pocket isn’t it? Even though you can finance the housing loan with your rental income, what about the other expenses? You might argue: What about the CAPITAL GAINS on your house? Are you sure you will make a capital gain by selling the house? Just ignore that since you haven’t sold your house…like they say – don’t count your chickens until they are hatched.

· Your credit card loan! Ooohh, I just LOVE the banks motto! SPEND MORE, SAVE MORE! Now, that’s an OXYMORONIC statement that sounds so good! How can you save more by spending more? Here’s the bank’s logic: Spend RM5,000 a month and I’ll give you 500 points. You can cash the 500 points for a gift worth RM50. In the meantime, since you overspent your budget, you can't afford to pay your credit card on time. Pay interest on the credit card debt amounting to RM75 (RM5,000 * 18% * 1/12). Fantastic! Thank you for donating to our local banks and stimulating our economy. So, is your credit card loan taking money out your pocket? Yes? Well, it’s a liability then!

· Assuming your brother-in-law will eventually pay back the loan with INTEREST, is it an asset? Yes, it is! Is it a good asset? That depends on how much interest your brother-in-law is paying you. If he’s paying you less than the Fixed Deposit rate of 3.70%, then forget it! The banks will pay you automatically and it’s virtually risk free. Your brother-in-law may need numerous reminders and nudges before he finally pays up.

3. An Asset may become a liability once it STOPS putting money in your pocket. For instance, your loan to your brother-in-law may stop becoming an ASSET if he decides to stop paying back to you, your principal and interest. ALL ASSETS can become LIABILITIES, so you need to monitor your assets carefully, especially investments in shares.

4. A Liability may become an Asset once it stops taking money OUT of your pocket and puts money INTO your pocket. Example, if you move your money out of your Current Account into a Fixed Deposit, you start earning FD interest on it. Another example might be if you have an interested buyer in your antique collection and can sell to the buyer at a higher price than you bought it for.

CONCLUSION:
Before you buy or spending unnecessarily, remember: BUY ASSETS! NOT LIABILITIES!