Category: Company Analysis

The commotion surrounding Muddy Waters and Olam has been the latest talk of the town. Muddy Waters said that Olam has accounting discrepancies and it has since released a 133-page report on why it feels as such. Olam retorted and defended itself in a 45-page report. Muddy Waters has said in its report that Olam is a “black box” just like Enron, which collapsed in 2001. The purpose of this post is not to dissect the reports, as many other capable accountants and analysts have already done that, but rather to educate readers on how to avoid investing in such companies.

I’m not surprised that Olam has attracted the attention of Muddy Waters. The debt levels of Olam are astronomical and cash flow from operations and free cash flow has been negative for a long period. Only in two of the past 11 periods has free cash flow been positive. The table below shows some of the figures for six periods from 2007 – 2012:

Olam’s CEO, Sunny Verghese, has told The Edge recently that Olam attracts many traders who short the stock due to their financial numbers. How can an investor protect himself and invest in a company that does not attract the attention of Muddy Waters and the likes?

One way is to invest in a company with a clean balance sheet. This means investing in companies with zero or negligible debt. Having lots of debt presents problems. Take the “Total debt” and divide it by “Net Income”. Ensure that it this value is below three (zero would be the best). This ensures that the company is not over-leveraged. Companies with lots of debt will face re-financing problems when a recession strikes. In the worst case scenario, the company might go into bankruptcy.

The company must also have positive Cash Flow from Operations. Preferably, the numbers should be increasing yearly. Furthermore, the company must have Cash Flow from Operations higher than Net Income. Cash is king in any company and scrutinizing the Cash Flow Statements is more prudent than scrutinizing the Profit & Loss Statements. Net Income does not provide an accurate picture as some revenues are booked even though the cash has not been received physically by the company yet.

The above are some of the matrices one has to look into before investing in a business. Avoid investing in companies with lots of debt and negative free cash flow for long periods of time. It is better to stay away from such businesses entirely than be sorry later!

Tiger Airways has been banned from flying until next Saturday in Australia, following a serious safety breach on Thursday. The Australian Transport Safety Bureau confirmed it was investigating the latest incident at Avalon Airport, near Geelong, on Thursday night in which a plane is understood to have dropped 900ft below the 2500ft safe minimum height.

Tiger has also been given the Civil Aviation Safety Authority (CASA) show-cause notice to improve the proficiency of Tiger’s pilots, improvements to pilot training and checking processes, changes to fatigue management as well as improvements to maintenance control and ongoing airworthiness systems.

Today, on the first day of trading after the ban, Tiger Airway’s stock price plunged 15.97% to close at $1. Is this just a small blip for Tiger or is this the start of more woes? Only time will tell.

Many who have been following the stock market closely since May would know about Artivision. They released a news on 15th May saying the company has made a Facebook application called Advision which is a revenue-sharing application that displays advertisement on videos and still photographs uploaded by users of Facebook. The share price has been volatile for some time and rose by a whooping 69.2% to close at 22 cents yesterday!

However, if we were to look at the fundamentals of the company, it’s nowhere near a company that value investors will invest in. Take a close look at the following:

From the above, it can be seen that Artivision had net losses, dwindling shareholders’ equity, negative cashflow, dwindling cash balances, negative margins, negative ROE and ROA for the past three years. The share price has been going up like crazy based on pure speculation and not due to the fundamentals of the company.

We should all remember that behind every stock price, there’s an underlying business. If the underlying business is not sound, one should stay away from the business. Buying such businesses will only cause an emotional roller-coaster (based on fear and greed). Unless you have lots of money to spare and can stomach huge risks, you should stick to investing in fundamentally strong companies with good free cash flow. Such prudent investing will ensure that you can have a good night’s sleep and can also pave way for a worry-free retirement.

I recently looked into a local listed company involved in the aerospace industry. It is NOT a business that suits the value investing tenants. It is actually a company that has been having net losses for the past 3 financial years (FY2009 to FY2006). I analysed this company to learn from the mistakes of this company and to not have these negatives in the company that I invest in.

Looking at the FY2009 annual report, the CEO’s message didn’t touch on the losses and what the company did wrong. I was looking if there were reasons given by the CEO for the dismal results for the past few years but it was nowhere to be found in the CEO message. This is very atypical of a good CEO. A responsible and honest CEO would talk about the losses and share with the shareholders what went wrong frankly and not sweep them under the carpet.

In the 2007 annual report, the CEO mentioned,  “We believe we can overcome challenging times”. In 2008, the CEO cited, “We will overcome the challenging times ahead s we overcome the previous ones, emerging even stronger”. However, all these are not evident in the financial statements which can’t really lie unless one cooks the books.

Under the operations review section, the losses were solely blamed on the financial crisis even though the company has been having losses consistently and not only for that particular year.

Looking at the balance sheet, the company has huge trade receivables almost year-on-year and this is affecting the cash flow of the company.

Thus, when investing in a company, do look out for an honest CEO message and strong financials. You are putting money in a company so you would surely want the company to be run by truthful, dependable and competent people who can grow your funds.