The Importance of the Cash Flow Statement

The Importance of the Cash Flow Statement

Cash is not everything, but it makes everything different. 

Companies fold not because they are unprofitable, but because they are not able to settle their financial obligations that are due for settlement. 

Most people look at the cash position in the balance sheet, compare it to that of a year ago, and then decide whether the company has improved or not. They wouldn’t be bothered to look at the Cash Flow Statement (CFS). 

Actually the CFS must be studied in detail to gain an insight of what has happened to the cash of the company. Some people like to read it from the bottom to the top, some prefer to read it from the top to the bottom.  It doesn’t matter how you read it as long as you get the facts right.

Cash flow is about cash inflows and cash outflows. It is not about profits. A company may make profits, but its cash may have dwindled. On the contrary, a company’s cash may have improved while the company is showing a loss.

Cash can flow in via the operation of the business, investing activities  financing from banks, right issues, bonds, etc

Cash outflows are operating expenses, interest payment, taxes, company shares buyback, capital expenditure, the purchase of property, etc. 

The CFS will show you all these information. You need to study it carefully before deciding whether a change in the free cash flow is good or bad. 

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Learn more about earnings

In business, the priority is earnings. You need earnings to settle your operating expenses, pay taxes and expand your business. 

No company can survive without earnings. Earnings go by different names. Profit, income, the bottom line and earnings are all the same.

EPS (earnings per share) is the most often used metric to evaluate a company. Many people just look at EPS and then decide whether the company is good or no good. This is a mistake. 

When you look at EPS, you must also look at revenue and the actual amount earned so as to have an idea about its profit margin. A high profit margin is better than a low one.

Often overlooked is the quality of earnings. Earnings can come in many forms. These are: 

01) Profits from normal trading and services provided by the company

02) Sale of a property or some properties that are outside its business model

03) Sale of treasury shares 

04) Sale of some financial instruments, such as equities or bonds

05 A change in depreciation rates

06) Appreciation of foreign money against the local currency

All the above activities can affect earnings. So, the next time you look at EPS, do not forget to read the income statement in the quarterly or annual report to know how the earnings come about. Bear in mind that some earnings are just one-off affairs and are not repeatable in the foreseeable future.

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Know FA to invest well

There are 3 important statements to carefully look into when you analyse a company. They are: the balance sheet (BS), income statement (IS) and the cash flow statement (CF)

The BS shows on a certain date what the company has and what it owes others.

The IS shows the sources the profits come in.

The CF statement shows how cash flow in and out of the company.

When I study the balance, the first thing I look at are the current assets and the current liabilities. From this I work out the current ratio. If the current ratio is below 1, I take this as a red flag, and I shall not bother to dig deeper into the stock. This is my personal style; it is not a standard criteria for you to follow.

Cash is a very important item.The more the better. If a company has plenty of cash, it can do many things. It can expand its business, use it to acquire new businesses, purchase its own shares or distribute some of it to its shareholders.

Debt is the opposite. A high debt, especially one with high interest rate, relative to its paid-up capital is a red flag. Bear in mind that debt has to be serviced. This means interest has to be paid. A company that has a not of cash and much borrowings is not in a strong financial position. 

Personally, I prefer small-cap stocks and mid-cap stocks instead of big-cap stocks. Big-cap stocks are suitable for institutions and fund managers. As a small player, you can’t compete with them. Once institution or fund managers have taken notice of a stock, the stock will no longer be cheap. 

There are many other things to consider when you look at the BS. For example, when you look at the accounts receivable or inventory, you need to concern yourself whether these can be easily turned into cash. 

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ROE Can Be Misleading

A high ROE may not be as good as a low ROE

ROE ( Return On Equity) is a common metric used to gauge the competency of the management. ROE is calculated by dividing the net profit by the shareholders’ equity and expressed as a percentage. Most people think that a higher ROE is better than a lower ROE.  Let see whether this is true.

Shareholders’ equity is the total assets minus the total liabilities.

Consider this scenario: Company ABC has a paid-up capital of 1000, net earnings of 100 and zero debt. Thus its ROE is 10%

(100x100/1000)

Company XYZ also has a paid-up capital of 1000 and earnings of 100, but it has debt of 200. So its ROE is 12.5% (100x100/800)

Assuming that both companies are in the same business. Which is the better company? 

Company ABC has a lower ROE than Company XYZ, but obviously it is the better company.

ROE is a useful metric only when you know how to use it intelligently. 

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The Current Ratio What It Means

The Current Ratio What It Means

One of the metrics I like to look at when I assess the financial health of a company is the current ratio. This ratio is calculated by dividing the current assets by the current liabilities.

The current assets consist of cash, receivables, inventories and financial instruments that can be easily turned into cash.

The current liabilities consist of payables, debts, taxes and dividends that are payable within a year.

The purpose of this ratio is to know how capable the company is in paying its obligations when they fall due.

A ratio of below 1 is not a good sign. This does not mean the company will go bankrupt, but it does mean that it may have difficulty settling payments that are due to be paid. 

A current ratio of between 2 to 3 is preferable. If the ratio is above 3, it may mean that the company is not competent in using its assets to generate returns.

When you compare current ratio it must be done among companies of the same business to be of any use. Simply put, a higher ratio than 1 is better than a ratio of below 1.

To invest intelligently, you never look at 1 metric alone. There are many other things and metrics to look at. The most common ones are: the calibre of the management, business modal, price-earnings ratio, return on equity, market capitalisation, enterprise value, dividend yield, price to sales ratio, price to book value, acid ratio, return on capital employed, net tangible asset, margins, free cash flow, etc.

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Don't Lose Money

What does Warren Buffett mean when he says: Don’t lose money?

For me it means as follows:

01. Don’t speculate or gamble

Gamblers or speculators lose money in the long term although there are occasional gains because of luck. The odds in gambling are always in favour of the House or Banker. That’s why all gamblers, except the professional ones, make money in gambling. Ask yourself. Are you a professional gambler?

02. Don’t listen to insiders

If you think that insiders are keen to make outsiders rich, you are being naive. Insider trading is an offence. Why should an insider take risk of being prosecuted by giving you, an outsider, inside information to make money? Many people are impoverished by what is called an inside tip. Be extra careful especially when the tip is said to come from the horse’s month.

03. Don’t buy what you don’t understand

Many people like to tag along with their friends. They buy I buy. This is not a good idea. Your must know what you are buying. 

04. Don’t play with borrowed money

Play within your comfort zone. Playing with borrowed money will make you edgy. Fear causes irrationality. When you are irrational you are likely to make mistakes that are costly.

05. Avoid rubbish shares.

Shares with high borrowings and little or no earnings and no dividend yields are too risky to get involved. All companies that fold are those with high debits they cannot service. 

06. Insist on value when you buy

Everything has a fair price. To be safe, limit your purchases only to stocks with strong balance sheet, good cash flow, and good growth potential at undervalued prices. Buy dollar notes for 50 sen as advised by Benjamin Graham, the great legendary investor. 

07. Timing is everything

Warren Buffett calls this: The perfect pitch. You will do well to wait for a golden opportunity before you act. Most people do not have the patience to wait. They act in haste and lose money.

08. You can’t win without knowledge and wisdom

“How can the unarmed go into a mortal combat and hope to escape unscathed /James Dine.” The stock market is a battlefield wherein are professionals working full time playing against you.  Are you good enough playing against them? No way, right? Never overestimate your own ability.

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Buy low or Buy High

TA says, buy, when the price is up

FA says, buy, when the price is down

Which advice should you take

Depends on whether gold or silver is what you wish to make

Both can be profitable

If cleverly implemented

Gains could be wondrous

Otherwise, result could be disastrous 

The stock market is full of traps

There are bull traps, bear traps and value traps

Learn what they are

Be knowledgeable to avoid being trapped

You can buy low and sell high

Or buy high and sell higher

which strategy you use is up to you

Just make sure the strategies are not foolishly abused

Tides, Waves and Ripples

Stock prices have three movements. They are known as the tides, waves and ripples. The primary trend is the tide, the secondary trend is the wave and the daily movements are the ripples. 

When you are watching the movements of the sea, it is difficult for you to know whether it is high tide or tide. But if you plant a stick at the shore where the water reaches it, and watch the wares coming in and going out you can easily determine whether it is high tide or low tide. When the waves that come in show higher marks on the stick, you know it is high tide. In a low tide, the marks will be reversed.

In stock prices, you look at the highs and lows. A higher high and a higher low means that the market is on an uptrend. A lower high and a lower low indicates a downtrend.

Bear in mind that trends move in trends. This means a trend in motion is likely to continue in the same direction. Thus, you do not buy in a downtrend or sell in an uptrend until the trend is reversed or has shown signals that it is about to reverse. If you do not know TA (Technical Analysis), charts will be of no use to you. 

An investor will not worry about the ripples which are the hardest to forecast. But to a day trader, these movements are the ones that matter most.

A day trader does not carry position overnight. Make or break, he will clear his position at the end of the day. 

Can a day trader make money? A professional one probably can. But for an ordinary one, his chance is close to zero. He may win some and lose some, but on balance over a year, he is likely to lose. High transaction cost which includes stamp duty is high. It eats away your profits, if any. 

The problem with most traders is that they tend to over estimate their skill. They think they are professionals when in actual case, they are not. When they win, they say they are good, but when they lose, they say luck is against them. 

From my experience, I find that when you invest, it is easy to make money, but when you trade, it is difficult unless you are really good.

I have always consider myself an investor. However, there people who consider me as an trader. 

Well, If I am a trader, then, I must be a great one, simple because I have been making lots of money in the last fifty over years. 

Investing Without Tears

Investing is never 100% risk free. No matter how diligent and careful you are, a certain amount of risk is there. But with some knowledge and a good strategy, risk can be mitigated. Here are some guidelines:

1. Be an investor not a trader

Every stock has a company behind it. If you do an in-dept study of the company and you are convinced that the company is fundamentally sound and that your principal is safe in addition to an adequate return before you buy, you are investing. 

2. Don’t buy liabilities

A company with high gearings and no earnings or very little earnings is a problem company. It is a liability. Don’t buy it; don’t buy somebody’s problem. 

3. Follow the trend

Prices move in trends. A trend in motion is likely to move in the same direction. Follow it. When you see higher highs and higher lows in a chart, that’s an uptrend. A down trend is when you have lower lows and lower highs. 

4. Avoid the herd mentality

Just because all your friends are buying a certain stock, and therefore it is safe to follow, is a wrong way of thinking. In the stock market, there is no safety in numbers. You need to think independently as an investor. 

5. Be aware of what is cheap and what is low price

Many people assume that a low-priced stock is cheap. In reality, a higher-priced stock is often cheaper. You must look at the intrinsic value before you decide which is cheaper relative to its price.

6. A stock market is not a casino

The stock market has no mercy for those who treat it as a casino. All amateur gamblers lose money. Trading and speculations are akin to gambling. 

7. Be aware of your own ability

The problem with most people is that they tend to over estimate their own ability. 

Imagine what chance you have if you pit yourself against the professionals who are there ‘playing’ the market full-time.

8. Insist on value when you buy

A stock has three prices. It has a market price, a book value and an intrinsic value.

The market price is easy to understand. It is the last traded price at the end of a trading day. 

The book value is simply the net tangible asset (NTA) as shown in its balance sheet. 

The intrinsic value is the most difficult to calculate. I do not know of any formula for this. At most, it is only an estimation. You have to factor in many metrics such as barrier of entry, calibre of management, earnings potentials (present and future) growth prospects, patents, etc.

So, what should we do? For me, I make it simply. I look at the track record relative to its earnings, earnings growth and dividend yields. The higher these are, the higher the value. 

Buying a stock at high earnings per share (PE) is risky. Unless the forward PE is  expected be much lower, avoid stocks trading with high PE. (A PE of over 16 is too high for me.) 

To value a stock, here are some metrics or key ratios to consider: EPS( earnings per share); D/Y (dividend yield); NTA (net tangible assets); PEG (price to earnings growth); NPM (net profit margin); ROE (return on equity); D/E (debt to equity ratio) C/R (current ratio); PCF (price to cash flow). One other thing to carefully consider is the core business of the company. Here, you need to think about barrier of entry, patents and competition.

9. When is the best time to sell a stock

Close to 100% of all stocks will at one time or another be selling at extremely high valuation that they should be sold. At other times, they will be selling at overly undervalued prices that they should be bought. We want to sell a stock when it is very much overvalued.

Understanding the value of a stock is crucial in this respect, and with the help of technical analysis, you have the advantage of the competitive edge.  

10. Control your emotion

Taking action for action sake is a weakness that many people fail to control. Some people need to move in and out of the market often enough to overcome boredom. 

They forget that transaction costs eat into their earnings. 

Buy and sell with good reasons and not simply with intuition and the need for action.

Following the guidelines mention above will go a long way to help you to invest intelligently. 

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An above average-company at below-average prices

In early 2014, PRK was the subject of a capital restructuring and repayment exercise. The investment arm of the Perak State Government (PSG) and some other parties had proposed to privatise the company at RM3.90 per share. Sime Darby considered the price too low, and as a result the proposal did not materialise.  Indeed the price was too low considering that the NTA value of PRK was at that time more than RM5 plus per share. 

PRK had a 15.74% stake in Integrax. Recently it sold this block of shares to TNB at RM3.25 per share. This will add in some RM153 million to the coffers of PRK with a gain of about RM50 million or 50 sen a share. 

Before this transaction, PRK was already cash-rich with RM100 million in cash although it had about an even amount in debt. 

PRK is building a township in Perak and in a joint venture with the Sanderson Group to develop a theme park in the vicinity of its township. The Sanderson Group is a specialist in operating theme parks. Hence, the success of this theme park is likely to be odds in favour.

The media has reported that the theme park would be ready for operation by early 2016. There is bound to be some furore when the theme park is launched. This will have a positive impact on the price of the stock. At the last traded price of RM2.96, this is a buy. 

The PSG has failed to privatise the company in its first attempt. I don’t think it will stop at one. I strongly believe that it will make another attempt in the not too distant future, probably within the next 12 to 18 months. It could even be within the next 6 months. The offer if it does come could be as high as RM4.50 per share. This is not a wild guess but a logical conjecture. 

I am long on the stock. I intend to accumulate more before it shoots above the RM3.30 level. This is an above-average opportunity to make a good profit. 

Whatever action you take as a result of this article, you do so at your full responsibility. In other words, you buy, sell or hold the stock at your own risk absolutely. 

MMSV My Stock for 2015

I highlighted MMSV on Dec 08, 2014 as a good buy at 53.5 sen. 

At 11.50 am today, the share price has gone up to 62.5 sen. This is an increase of 9 sen. Together with the interim dividend of 1 sen, the gain is 10 sen or 18.69% over a period of 3 months and 18 days. While this is not something to shout about, nevertheless, the gain can be considered as commendable. 

What is the status quo of MMSV now? Let us take at look as its latest balance sheet. As at 31 Dec 2014, the key statistics are as follows:

Share Issued: 163 ml shares

Par Value: 10 sen

Revenue for the year: RM39.691 ml

Net Profit: 10.645 ml

Net Profit Margin: 26.343%

EPS: 6.41 sen

Total dividend for the year: 2 interim dividend of 1 sen each

Total non-current assets: RM9.922 ml

Total current assets: RM30.468 ml of which RM15.715 is in cash and cash equivalent

Total equity: RM31.402 ml

Total non-current liabilities: RM503,000 

Current liabilities: RM8.486 ml

Current ratio: 3.59

Quick ratio or acid-test ratio: 2.72

Return on equity: 33.90

Debt to equity ratio: Not applicable, as the company has zero borrowings

Some of the things I like about this stock are as follows:

Current ratio of 3.59 means that the company is solvent and solid.

Its cash position is high. Thus, the company does not have any cash problem.

The Return-on-equity ratio of 33.9 shows that the management is competent.

As for growth, the company’s profit has surged 109% in 2014 when compared to the profit of the preceding year.

Inter alia its filings with Bursa are the following statements:

Financial period-to-date against preceding year corresponding financial period 

The Group’s total revenue of RM39.691 million for the year ended 31 December 2014 marked a hefty increase of 49% (RM13.017 million) as compared to RM26.675 million reported in the previous financial year. The higher revenue was contributed by the higher volume of machines delivered to meet the surge in the market demand of smart phones/devices together with the LED related products. This higher revenue was attributed to the Group’s ability to penetrate into the niche market of smart phones/devices. 

Profit before tax surged by a significant 109% (RM5.479 million) to RM10.510 million from RM5.031 million in the preceding year, mainly attributable to the increase in revenue coupled with the favourable forex gain during the financial period under review. 

• Prospects
  The Board of Directors foresees that the current positive market momentum will enable the Group to continue delivering another good set of results for the quarters to come. The Board is confident of reaping benefits arising from the continued growth of both the LED and smart devices industry. Besides, our huge cash resources will come in handy for use of the Group in any future prospective business opportunities that may arise.
  The Board is also pleased to announce that the Group has obtained approval in principle from Malaysian Investment Development Authority (MIDA), a 10-year 100% tax exemption under Pioneer Status for one of its subsidiaries. This is a very promising development which bodes well for the Group’s future.
• Conclusion
• My view is that this stock will have a good run in 2015 and beyond. The present price is a good entry point. 
• As usual, you buy at your own risk. 

Stock Investing & Some Predictions for 2015

When it comes to investing in the stock market, you need to be extremely choosy in selecting stocks to buy if you want to survive in the survival of the fittest.  You can’t simply buy a stock, sit on it and hope to be profitable. 

Without an in-dept study of a stock before buying it, your chance of being profitable is less than that of the player in a poker game who plays without looking at his cards. 

My first priority in stock investing is safety of principle. For this reason, I always insist on value when I buy. 

Every stock has a company behind it. You need to check up the company and find out what it is all about. Some of the things, you must look into are: the balance sheet, the cash flow statement, the income statement and the Chairmen/CEO’s statement. This will tell you a lot about the company and how it is likely to fare going forward. 

In our computer world, this is not too difficult a task. Nowadays, every listed stock has a website where you can look into at your own convenience. 

I like to combine Fundamental Analysis (FA) and Technical Analysis (TA) when I buy. This is to ensure that what I buy are fundamentally sound and at the right time. 

Knowing FA & TA alone is not enough to guarantee success. You have got overcome one big obstacle….. Yourself. 

The stock market is controlled by Greed, Hope and Fear. Greed causes you to hold on to an overvalued stock. Hope causes you to hold on to a losing position which may cause irrecoverable damages to your portfolio if you average down indiscriminately. And Fear causes you to sell in a panic sale when you should be buying. 

To overcome these potent forces, you must have knowledge, wisdom, discipline and patience. Lacking in any one of them is most undesirable.

When you are in the stock market, you are competing with some of the best money makers in the world. Fortunately, the market is also full of  simpletons, the naive and the inexperienced. 

Stock investing or stock trading is a zero-sum game. 

You can’t expect to make money from someone who is as good or better than you. Thus, if you want to succeed, you have to keep upgrading yourself all the time. 

The stock market is never efficient. The price does not always reflect the value of a stock. Very often stocks become overvalued because of over-optimism; they can become undervalued because of over-pessimism as well. Those who know can exploit this inefficiency to invest profitably. 

In concluding this article, here are my parting words:

Never buy a stock without doing an in-depth study of it.

Never overpay for a stock even though it is a great one.

Never buy a stock without having a good look at its chart.

Never be impatient. (Many mistakes are made because of hastiness.)

Never go against your charts.

Never buy in a downtrend, especially when the downtrend is at the start after a prolong uptrend.

Never fail to use a stop-loss and a trailing stop-loss if you trade.

Never fail to change with the circumstance. (It is not the most intelligent who can survive in a crisis but those who have the ability to adapt well.)

My predictions for 2015 are as follows: 

Crude oil prices will remain low unless productions at some producing countries are disrupted by one thing or another. By low, I mean below US$75 per barrel.

Malaysian Ringgit will remain subdued against the US$.

GST will impact our stock market negatively.

The FBM KLCI high of 1892 will not be surpassed in 2015.

Equities listed in the US will do well.

Equities listed in Bursa will not do well except for a few export-oriented stocks.

Europe will recover slowly.

WLC.TO., a stock listed at the Toronto SX will have a great run this year and the next. (The stock is lasted traded at C$0.57.)

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The New Year 2015 has just commenced. May all my readers be blessed with good luck and have a fruitful year.