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Capital Dynamics Sdn Bhd is the first independent investment adviser in Malaysia. It has been described as "one of the country's most iconoclastic and critical research outfits".

In February 2004, Capital Dynamics Sdn Bhd launched icapital education.

Since our inception in 1988, we have remained totally independent and have been providing objective advice on Stockmarkets and Economies through iCapital.

The iCapital newsletter is its flagship product. It has been around since 1989.

In 2002, icapital.biz, the online version of iCapital was launched.


Home > Articles > Value Investing

Value Investing


When investing in the stock market, there are many ways or approaches to go about it. Just as we believe that there are many different roads to heaven, the same applies to investing. First let us recapitulate what we actually wrote about Maica and Worldwide, which should have already sufficiently explained why we rated them as buys.

Maica was featured in the issue dated 6 Sep 2001 at RM0.865 and we said, "It is relatively small with unexciting sales and earnings performance ........ Maica still boasts of a balance sheet that is cash rich with little liabilities". We also said that it has a market capitalisation of less than RM100 mln and does not "appear" to have a single controlling shareholder and concluded that we find Maica an interesting situation (as a matter of regulatory disclosure, the publisher and associates have an interest in Maica).

The last time we featured Worldwide was in the issue dated 26 April 2001 where we rated it a buy at RM1.20 (at the current price of RM1.47, it has gone up 22.5% in less than 1 year - not a bad return). In that analysis, we wrote "it is puzzling that Worldwide is still classified as a Property counter" and explained that investors have misperceived Worldwide as a mere property stock which a breakdown of its earnings - see table below - would confirm.

Worldwide's Earning Breakdown

We also added that the balance sheet of Worldwide has improved significantly. Then, i CapitalŪ added this valuable advice :

"When investing in the stock market, investors should pay attention to this financial parameter (that is, balance sheet strength) and treat it as an important criterion. If not, when a recession strikes, a company with a weak balance sheet facing financial difficulties would have to undergo painful restructuring exercises. Shareholders would then find their 20 or 30 or even 40,000 shares reduced to pittance. When this happens, it is almost impossible for an investor to recoup his sizeable losses. On the other hand, if a company does not have to undergo such nasty capital downsizing, then, when the eventual bull market comes, chances are good that an investor would be able to more than recover his investments."

i CapitalŪ also worked in detail why Worldwide is undervalued. To quote :

"To obtain the total earnings of Genting Sanyen, one just has to multiply the above figures by 5. Not surprisingly, it has consistently recorded pretax earnings above RM200 mln. If we normalise this at a tax rate of 28%, net earnings should be between RM150-175 mln per annum. Based on its paid up capital of 22.5 mln shares, earnings per share are between RM6.67-7.78." A PE multiple of 10, which would be closer to the KLSE's valuation of IPPs, would value Genting Sanyen at RM300-350 mln or around RM2.00 per share. Compare this with Worldwide's present share price of RM1.47.

We added that property development is another major activity of Worldwide and "like any cyclical business, the contribution from this activity follows the ups and downs of the economy". We then concluded that Worldwide is undervalued and rated it as a Buy.

Some people use charts and technical indicators to invest. Some look at macro-economics and pick sectors and then select the stocks. Some only look at the companies and ignore the other factors. Then, many in Malaysia invest based on rumours (and its step-brother, tips), hearsay and inside information. Increasingly, many also invest based on the "usual hype found in the ordinary media".

Like what we said earlier, there are many roads to heaven. But when investing in the stock market, we find that, over the long run, it certainly pays to look closely at the stock you are investing in. Within this approach, there are many ways to analyse and value stocks. One of the most proven approaches is called value investing. Benjamin Graham was supposed to have pioneered value investing in the Thirties. Since then, modifications have been made and value investing nowadays can take many forms. Even Warren Buffett has modified his value investing approach from a strict Graham type to incorporate other features that were mainly passed on to him by Charlie Munger. The primary aim of a value investor is to work out the intrinsic value of a company and then compare this with the price.

Graham's value investing approach can be split into two types. The first is based on asset or book values. The second is based on a company's earnings. When using these methods, one has to be careful here because adjustments have to be made to the balance sheet and the profit and loss statements. When Peter Lynch says that investors can pick stocks by asking what products his wife loves to buy, he is really oversimplifying the matter.

The flat sales and falling profits described by Dr Leong for Worldwide is not entirely correct. First, as we have explained in the 26 April 2001 issue, in one of the years, its profit was distorted by extraordinary gains. Secondly, for Worldwide, its sales are influenced by its property development and being a cyclical activity, it naturally goes up and down. The earnings that Graham refers to are not a single year or next year's forecast but long-term earnings that are "normalised". What he is looking for is the company's earning power and not just earnings. In the case of Worldwide, we are also using this approach besides looking at its asset or book value. Either way, as we showed in the calculation of Genting Sanyen, we find Worldwide under priced when compared to its intrinsic value, especially when we have not taken into account the other assets Worldwide has.

Whether its sales or profits are rising, flat or falling this year or next year does not really matter. Value investors do not look at earnings or sales momentum. The fact that earnings or sales are growing every year does not mean that a value investor would be interested in that company. Such companies may be already overvalued. The classic example would be the recent experience of the technology companies. For some companies, looking at their sales or earnings would be misleading and investors would miss many opportunities. The classic example is Kuchai. Take a look at its sales and earnings and you would have thought it is crazy for its price to be around RM30.00.

For Maica, it is not purely value investing although there are many elements of it. Although it is reporting losses, these are small and are not expected to adversely impact its balance sheet (subscribers who are alert may noticed that we did not provide the usual prospective PE ratio for Maica. Instead, we gave its book value). In other words, its book value is expected to stay intact. The reason why we find Maica interesting is that the KLSE and Maica's price have dropped very substantially. The usual bull market would return. When it does, all counters would participate, including Maica. Remember that it has a relatively small market capitalisation. As we have said, there "appears" to be no single controlling shareholder. We say "appears" because the various significant shareholders could be related in ways that we do not know of. But we do not want to just rely on the bulls returning. We have to be sure that the company does not go bust in the meantime and for Maica, its cash assets provide this protection. While we do not know what the upside would eventually turn out to be for Maica, we are at least relieved by its limited downside. As our managing director has advised before, once you take care of the downside, the upside will take care of itself.

The only "trouble" with using a value investing approach, whether it is the Graham or Buffett type, is that one needs to be patient. It is certainly not glamorous and many would find it unexciting. Value investors seldom pay attention to share prices except when buying and selling. In value investing, a stock may not move for 3-4 years, in the 5th year shoots up and double its price and with this, a value investor would consider his or her objective as being met.

The reason why value investing works, whether it is the classic Graham or the Buffett or any other version, is because it compares market price with the underlying value. Most investors know everything about price and nothing about value. When the market price eventually turns and tumbles, they are shocked and do not know what to do next. Lipo, a counter that we recently warned our subscribers about and rated as a sell, is a good example. As its share price skyrocketed, many so-called investors must have jumped in, probably mesmerised by the ability of its share price to surge higher and higher. As it climbed, investors forgot to look at the foundation that the climb is built on. When the top is heavy and the foundation is weak in relation to the top, the whole thing will crumble. It is not only Lipo that would experience this. Any counter, including Maica and Worldwide, would face the same fate when the top becomes too heavy. The safety that value investing provides is that it reduces the chance that one would be trapped in the crumbled heap.

Investing in the stock market can sound and look complicated. It need not be. But there are certain basics that an investor must possess, especially if you are doing it on your own. He or she must have the time and discipline to master these basics. The investor must have the minimum skills in accounting and economics. Add in some understanding of human psychology. Then, with i CapitalŪ at your side or in your computer, investing becomes simple and you should be on your way to success.


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