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Friday, October 24, 2014

Is The Correction Over?

Question : When the market is in a correction, how do you know when it is time to buy stocks again?

Answer : Wait for a "follow through day"


What Is A Follow Through Day?


A follow through day indicate that a rally attempt have succeeded, and the market direction have changed from a "market in correction" to a "market in uptrend".

Investor’s Business Daily’s "Follow-Through Day Pattern," as described by its former chairman and founder, William O’Neil, in his book, How to Make Money in Stocks, is widely known as a pattern that identifies market bottoms.

Spotting A Follow Through Day


When the market is in correction and move into a new low, look for the first day where the market close up from the previous day. This is day 1 of the rally attempt. As long as the index is above the previous low, the attempted rally is in place.

The Day 1 low becomes the line in the sand; a violation of that low invalidates the pattern. Days 2 and 3 do not have to be positive days, but they cannot be less than the Day 1 low value.

Look for a major move on the 4th day of the pattern, which is call a follow-through day.

Summarizing the rules:

Day 1: Once a low has been established (after a correction), Day 1 occurs if the close is near the high of that day or a higher close occurs on the day after the low.

Day 2: The price must remain above the established low. If the price moves below the Day 1 low, then the pattern has been invalidated.

Day 3: The price must remain above the established low. If the price moves below the Day 1 low, then the pattern has been invalidated.

Days 4 - 7: Follow-through day must occur, with a gain greater than 1.7%, heavier volume than the previous day and heavier volume than average.

Identify Market Bottoms - Fig 1-1
Follow Through Day In Chart 

Let's take a look at our own KLCI chart ..


Based on the KLCI chart, Day 1 rally attempt was on Oct 17th, last Friday (the best time to buy for the very brave!) when the index made a correction low but closed at the high. Day 2 was higher, Day 3 closed lower and Day 4 + Day 5 (today) close higher. 

It seems the market direction has changed from "market in correction" to "market in uptrend". As long as the index does not violate the Day 1 low, the uptrend remains intact ? Let's see the coming days ahead ..

GA


Wednesday, October 22, 2014

How to lead a comfortable retirement life through investing in the stock market? Part 2

Avoiding Lemons

I wrote an article on “How to lead a comfortable retirement life through investing in the stock market?” which described how some well-known super investors in the US and here have accumulate enormous amount of wealth through their long-term investment in the equity markets following the fundamental investing principles.

http://klse.i3investor.com/blogs/kcchongnz/59971.jsp

I also presented my own experience in the last few years and provided facts and figures that value investing is the way to go for long-term wealth building.

I also mentioned about “If one doesn’t invest the right way but by simply listening to rumours and punt on hot stocks, instead of building wealth for retirement, can end up as a pauper.”

I think awareness of avoiding Lemons is a more crucial in long-term wealth building. For me, to choose a good stock to invest and obtaining extra-ordinary return is not easy because there are so many factors, especially regarding the future of the company and its industry is highly unpredictable, whereas avoiding investing in a lemon is much easier; and you can achieve that, half of your battle in investing is won. Hence I feel I should deliberate about it more here.

The Lemons

I first wrote about lemons in an article on the perils of speculating on some hot stocks in Bursa last Christmas in the appended link below:

http://klse.i3investor.com/blogs/kcchongnz/45373.jsp

Those stocks mentioned in the article such as Hibiscus, KNM, Guan Chong, London Biscuits, Smartag, Asia Media, China Stationery, Ivory, MPcorp were darlings of those days and they were some of the most talk-about stocks then, and even now for example for KNM and Hibiscus.

I have given all my reasons form the information obtained from their financial statements that there was no single evidence to show that they were investible, by any measure.

Just a month ago, I have also done some analysis, written a report and published here after the release of their latest quarterly financial results two months ago.

http://klse.i3investor.com/blogs/kcchongnz/59866.jsp

My analysis shows that there was really no compelling reason at all to think that any of the stocks has turnaround, despite the rosy reports written by some investment bankers and others.

Return of the Lemons

It is good to revisit the return of these lemons after a relative serious pullback recently. The broad market in Bursa returned 7.9% two years ago and 1.5% a year ago as on 20/10/2014. What is the return of those Lemons in the list within the last 1-2 years?

Table 1 in the Appendix shows that the average return of the portfolio of nine Lemons was a loss of 27%. The more relevant comparison is the median return, which is much worse at a whopping loss of 40%. Seven out of nine stocks have negative return; the worst is CSL at a loss of 87%, followed by Smartag (-50%), AsiaMedia (-44%), GCB (-42%). The other hot stock Hibiscus also has lost a whopping 40% despite its huge amount of news in securing licenses all over the planet.

There is only one outperforming stock out of the nine stocks, KNM, the “shining star”, which at 74 sen now, has a total return of 63%, not bad at all. That is because it was so happened that when somebody asked me about it, its share price was 45.5 sen, almost at its lowest historically and that price was used as the reference price. Its share price actually shot up to RM1.13 less than three months ago with all the hot news about securing big contracts, privatization of Borsig, getting a big loan (wth?) and all the bullish analyst reports when it is in the mist of going through a rights issues to get more money from shareholders. Since then its share price has fallen by 30%.

I always wonder, how one could resist from “investing” in a shining star KNM if you refer to all the bullish analysts’ reports here. Let us just take this investment banker’s report and try to dissect KNM and see how we can study analyst report with scepticisms.

http://klse.i3investor.com/ptservlet.jsp?sa=pts&q=knm

The only shining star, KNM

Three investment banks, Maybank, HLG and MIDF gave an average target price for KNM at RM1.33 on 8th August 2014 when KNM was at RM1.03. Today KNM is trading at 74 sen for a whopping loss of about 30% in less than 3 months. On 20/10/14, the bankers still affirmed their target price. Let us see the report written by HLG titled “KNM - Too Cheap to Ignore!”

My comments are in italic.

HLG “KNM - Too Cheap to Ignore!”

[At current share price of RM0.745, KNM is only trading at 8.8x FY15 P/E despite strong earnings growth prospect (CAGR of 55% from FY14-FY16). In our opinion, without any change on the fundamentals, we believe the sell down is overdone and this provides bargain hunting opportunity for investors. Its owner Ir Lee Swee Eng also shows his confident on the company by progressively increased its share stake in open market with price ranging from RM0.69 - RM0.815.]

Strong earnings growth prospect? CAGR of earnings growth of 55% from FY14-FY16 blah blah blah. What did HLG based on? Ir Lee Swee Eng told them so? Based on KNM’s “great” past performance and great delivery of their projects? HLG has done a profit analysis of KNM’s future prospects and came up with those great forecasts? Or HLG has a crystal ball of KNM’s future (a big deviation from its past) in front of them? One really has to know how to read and interpret financial statements in order to judge what HLG said if it has any truth in it. To me with the data at hand, they all totally bullshit.

Ir LeeSwee Eng also shows his confidence buying KNM’s share? Of course. To me General Lee is the most confident man in KNM. I remembered him telling the whole world a few years ago he was going to privatize KNM numerous time because according to him, KNM is way undervalued, even when KNM was trading at a few Ringgit at those times. Not only that, didn’t EPF also confident in buying KNM share recently?

Just bear in mind that the world may not be as simple as what HLG professes to be.

[Despite dry newflows for upstream sector in next few months, we expect more EPCC contracts from RAPID. We understand KNM has been actively negotiating for few subcontractor jobs from the refinery packages and bidding EPCC contract for tank farms and other associated facilities. We expect continue contract newsflow for KNM until 1Q15.]

Oh, newsflows is also so good for KNM’s share price. No wonder so much news about KNM nowadays. Actively negotiating for subcontract job is good enough for KNM’s future? Have they secured them? Let me tell you this, even KNM gets a few more packages, I believe the chance of losing money is higher than making a tiny profit. Well I am just basing on the past performance when it was not short of multi-million or even billion contracts at all. History may not repeat itself, but it rhymes. By the way, do you know what the gross and operating margins of KNM’s jobs are, HLG?

[Catalysts]

i) Announcement of more RAPID contract win(s);

ii) Financial closing of EnergyPark Peterborough;

iii) Strong quarterly earnings due to lower finance cost.]

More contracts mean more profit? Isn’t that too simplistic? Financial closing of its subsidiary also a catalyst, what the hell? I couldn’t even see how the performance of its overseas subsidiaries and associates in its quarterly report. Strong earnings, where from? Can substantiate ah, HLG?

[Valuation]

We maintained our BUY call with unchanged target price of RM1.35 based on 16x FY15 P/E. Our TP have not factored in value from EnergyPark Peterborough yet.

Despite weakness in oil price, we advise investors to stay invested and subscribe to the rights. KNM is one of the alpha stocks that will benefit from the mega RAPID project for the next few years with commencement of UK Peterborough project to provide long term recurring income.]

Source: Hong Leong Investment Bank Research - 20 Oct 2014

Wow, use PE ratio of 16 times FY15 earnings, fantastic! Why 16, why not 5? Looking at its precarious balance sheet, poor earnings, little CFFO, no free cash flows for years, dismal ROE, ROIC blah blah blah, I think a PE ratio of 5 is also too high already. What say you? And what about earnings? How much and how do you substantiate earnings in 2015? I guess must be from General Lee again.

Alpha stocks? Wth? Talk until using Greek already. Really dangerous!

I don’t know about you, I have no faith, none at all with HLG’s report, do you? This is especially when the right issues of KNM is on the way. You must know whose interest the investment bankers care about. Certainly it is not yours, believe me.

Yes, you need a strong foundation in fundamental investing in order understand what are the messages the financial statements convey to you in order to have a better chance to survive and thrive in the market, rather than reading and believing in investment bankers reports.

This was the question I asked in my previous article above less than three months ago,

“So how long more this share price of 95 sen of KNM can be sustained?”

Conclusions

Know how to avoid the Lemons in the market is as important as trying to make extra-ordinary return from the stock market, if not more important, especially in this volatile market. It is utmost necessary for the wellbeing of your personal finance and for retirement planning and wealth building for the long term. There is a jungle out there. Are you equip with the necessary skills? If not, are you prepared to join me in my new online finance and investment course to be held soon?

K C Chong (22nd October 2014)

Appendix
Table 1: Return on Lemons past 1-2 year
No.
Company
Ref Price
22/10/2014
Gain
1
GCB
1.800
1.040
-42%
2
Ivory
0.550
0.510
-7%
3
LonBisc
0.680
0.690
1%
4
KNM
0.455
0.740
63%
5
MPCorp
0.550
0.375
-32%
6
CSL
0.750
0.095
-87%
7
Smartag
0.180
0.090
-50%
8
Amedia
0.135
0.075
-44%
9
Hibiscus
1.900
1.140
-40%



Mean
-27%

Median
-40%
KLCI
1685
1796
6.6%

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