KCCHONG Focus lumber oh KCCHONG Focus lumber

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Focus Lumber: the wind of change of foreign exchange kcchongnz

Author: kcchongnz   |   Publish date: Tue, 24 May 2016, 05:31 PM 

Just before Focus Lumber (Flbhd) announced its third quarter results for period ended 30th September 2015 somewhere on 17th November 2015, its share price jumped by 70% within 3 months from RM1.84 on October 12 2015 to a high of RM3.09 on January 12 2016 as shown in Figure 1 below.

Figure 1: Past one year share price movement of Focus Lumber

The results show the vast improvement for the third quarter 2015 with net profit increased by more than 200% from RM3.3m to RM9.6m for the corresponding period in 2014. EPS, as a result, also increased by more than 200% from a EPS of 3.2 sen to 9.4 sen for the quarter.

Some investors who purely base on a single metric of “Profit growth”, without considering where this “growth” comes from, saw a great opportunity and annualized the EPS by multiplying by 4 to the single quarter exceptional result and obtained an expected EPS of 37.6 sen for the next 12 months, and chased the share price up to more than RM3.00 in early January 2016.

Focus Lumber only has a total number of 103.2m shares outstanding with a total market capitalization of RM258m at that price of say RM2.50. The free float is even less. With just a capital of RM18m, you can buy and own 7% of its total market capitalization. If one uses 50% margin finance, he just needs RM9m in capital outlay. There are some players in the market who have that amount of money, and much more. Hence it is very easy to jack up the price, isn’t it?

Why not? Trees can grow up to the sky. With net profit tripled in that quarter and quarterly result annualized, the profit growth was more than 200%. With that growth compounded for the next 5 years, even at half that rate, Flbhd EPS will balloon to RM12 per share. With a PE ratio of 10 then, it should worth RM120 a share! Who doesn’t want to be a billionaire?

However, many failed to see that the greatly improved result for the third quarter of 2015 was in a major part, due to the gain in foreign currency adjustment of about RM4.7m, or about 4.5 sen a share, a result of rising USD against Ringgit from the beginning to the end of the period as shown in Figure 2 below.
Figure 2

Without that gain, the EPS for the quarter is only about 5 sen. The EPS for the quarter was boasted by this foreign exchange gain of a whopping 47%! Will USD continue to strengthen at such a high and steady rate against the Ringgit in the next 5 years?

How could a one-time-off foreign exchange translation gain to be used to extrapolate the expected profit in the future when the foreign exchange rate can go up and down, and according to academic research, nobody can predict correctly and consistently the direction of the change in the future?

There came the power of mean reversion in investing. Here are some examples of the power of mean reversion in investing, a very powerful phenomenon in investing indeed.

http://klse.i3investor.com/blogs/kcchongnz/95848.jsp

Subsequently, Flbhd’s share price drops from the high of RM3.09 to less than RM2.00 in just less than two months, or a third of its value when the power of mean reversion took place when Ringgit strengthened against USD. Investors who blindly follow this fuzzy profit growth investing strategy, without understanding where this “growth” came about, lost a bundle when they panic and sold their shares at less than RM2.00, or had no choice but forced sold by their investment banks because of margin calls.

Wonderful companies become risky when people overpay for them.” Peter Lynch

The moral of the story is; Trees can’t grow to sky, and in investing, be conservative and invest with a high margin of safety, and for long term. Most importantly, do not be greedy by using margin finance as constantly propagated by investment bankers and individuals alike. If you do not make double or triple return without the margin finance, it is okay, because you may lose everything you have if the event turns against you, and it happens often in investing, especially in the short term.

Focus on the downside and the upside will take care of itself.”

The latest quarterly results ending 31st March 2016
Focus Lumber announced its first quarter 2016 results ending 31st March 2016 on 20th May 2016. Its revenue jumped by 77% to RM53.3m and gross profit doubled to RM14.9m as compared to the corresponding period in 2015. However, its net profit remains flat at RM3.3m compared to the corresponding period the previous year.  When compared to the preceding quarter, net profit sinks by 69% from an EPS of 10.4 sen to just 3.2 sen.

As expected, the share price of focus Lumber sank by 33 sen, or 14% at the opening bell on 23rd May 2016. It closed at RM2.07 at the end of the day, for a loss of 11%, in just one day.

Is Focus Lumber worth investing with the steep correction of its price now?

Questions to ask
One of the cardinal rules in investing is that we should never invest in a share without thorough analysis because someone asks us to, especially he owns a lot of it.  It also doesn’t mean that we should scorn the share just because of that. We should do our own homework, analyze the business to see if it is a good and sustainable business in the long run, and more importantly, if the price is reasonable, or even better, if it is cheap.
Some other questions you should ask and seek answers before investing in it are but not limited to the followings.

  1. Are you a short-term trader looking for quick gains (and also quick loss), or a long-term investor aiming to build long-term wealth in a sustainable way?
  2. How has been the financial performance of the core business of the company in the past, and what probably will happen in the future, after stripping off the one-time-off gain or loss such as that of foreign exchange, sales of assets, revaluation of asset etc.
  3. How has been its return on capitals? How that return comes about, from high profit margin, asset turnover, or leverage?
  4. How is its dividend history? How is it compared to alternate investment such bank deposit?
  5. How is its balance sheet? Bear in mind this is important to assess the risk in investing, and the sustainability of dividend also depends on how much cash per share in its balance sheet.
  6. How has been its cash flows, especially free cash flows? This is also hugely important for the sustainability of its dividend payment.
  7. More importantly, is it selling a good price now in term of PE ratio, P/B, P/Cash flows, earnings before interest and tax versus its enterprise value etc.?
  8. What about its cash yield?
  9. What is its intrinsic value, and hence what is the margin of safety investing in it at this price now?
  10. Etc.

An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operation not meeting these requirements are speculative
Benjamin Graham

The well written article below by Harry appeared in i3investor yesterday may give you some good clues.

http://klse.i3investor.com/blogs/kianweiaritcles/96910.jsp

Yes, to invest safely and have higher probability of success, one does need to do some homework as above. Forget about what others say you only need intuition, guts feelings, and no need to look at the company’s financial performance and position, ROE, cash flows etc. as they are history and hence not important. Those talks are bullshit.

I always say I do not have the ability to give you stock tips to help you to make money in the stock market. I also believe no one else will and can do that consistently, and most of all, sincerely. This is because the stock market is unknowable and unpredictable. You may have heard numerous times how others had made millions in the stock market, and how they have amplified their wealth by using other people’s money. But no one will tell you they have lost their fortune, or almost of all what they have. That is just human nature.

However, if you wish to learn about how you can answer some of the questions above, I may able to help.

 “Tis goeth down to a fundamental aspect that “An investment in knowledge pays the best interest”- Benjamin Franklin

Please contact me with the email address below if you are interested to learn about fundamental investing for a small fee in order to make good and safe investment decision yourself.

ckc15training2@gmail.com

Believe me, in the long run, it is much better for your future financial wellbeing than following the stock tips from anybody in the stock market.


K C Chong