Friday, September 19, 2008

Penny stocks - continued

So, 600+ stocks out of the 700+ listed counters on SGX are penny stocks (trading less than $1). What are the implications? What are some takeaways one can develop?

For me, the few takeaways are as follows:

1. The market is cheap. The stock market can tell you the prices of stocks, but not their true values. When these kind of statistics get on the newspaper, you can tell, yeah things are quite bad, there may be some real bargain going on. But somehow, it feels like it is not the bottom yet. It has to be total despair when prices go way, way, WAY below their intrinsic values. Nevertheless, things do look cheap now. Just that they can get cheaper :)

2. Small frys get killed. Despite its mood swings, the market is not stupid. I am not sure how the same stats look in the best of times (was it maybe 100+ out of 700+ are penny stocks). But this stats did ring a warning in me. Yes not all 600+ counters are really lemons, we can find gems here. But how many? 300? Not likely, 100? Maybe, if we stretch our imagination and start building castles in the air a bit. But my guess is more like 10-20 real good co.s with fundamentals that can bring in cashflow for the next 30 yrs. (I am arbitrarily guessing here, no hard facts to support one...)

Singapore is a young country and has a unique economy that is very Govt driven, a small population educated to be obedient workers, no natural resources and no domestic market. So, how many good co.s can we produce? Sweden, the country with most no. of MNC per capita, has maybe 15-20 MNCs (like Ikea, Volvo, Ericsson etc). I think Singapore can be considered successful if we can produce just one or two.

So, one conclusion that can be made is perhaps as astute investors, we should not bother about investing in these small/mid caps simply bcos the odds of them growing to be great is miniscule. However if there are valid reasons to believe that some of these co.s can produce decent, stable cashflow in the long run and hence a good return on investment, then perhaps there is an investment case. This is similar to investing in See's Candy. It will not grow into giants like Walmart, but by paying at a right price, you can enjoy good cashflow for the next 30 yrs. (again in S'pore context, they must pay you dividends lah, unless you can buy over the whole co. like Buffett)

3. Invest with the leaders. Skip the small frys means the same lesson learnt here would be to invest in some stocks above some kind of cut-off. Most simplistically, stocks trading above $1, which is not very scientific lah. So maybe more tangible measures would be e.g Sales of more than S$1bn, Cashflow of more than S$100mn etc. Or maybe just invest in "global" household names. Not your St James Power Station, but more like Tiger Beer (Asia Pacific Breweries). Actually, really not that many. I cannot come up with another investable name.

4. The Singapore market has too few participants. When 84% of the stocks listed fall below S$1, it does say something about the breadth of investors here. Some bigger developed markets would have so-called "natural buyers" to support the market, eg. pension funds etc. Obviously they are not in Singapore. I am not surprised if it's only a handful of institutions trading in Singapore. Arbitrageurs in bigger markets will also bring prices closer to intrinsic values for listed entities. Again, perhaps our markets lack arbitrageurs.

Limited no. of players also mean the possibility of market manipulation. As a small individuals, go in with your eyes wide shut open, esp into small mid cap stocks which are easily subjected to manipulation. One popular trick would be pressing down the price of a good small cap, then taking it over or taking private, so even if you bought at a reasonable price, it is possible to lose bcos the acquirer will pay you a price even lower than that.

Hence back to the biggest takeaway: stick with the leaders.