Wednesday, October 07, 2009

Companies that shouldn't exist

The market is efficient and smart, but only to the point of the average smartness of all its investors. Hence it allows companies that spectacularly generate low or even negative return on capital to exist for very long periods of time.

The No.1 ranking company that achieve this tremendous feat would probably be Chartered Semiconductors, our beloved high tech foundry.

Over the past decade, the company had lost over a billion dollars culmulatively, burnt two billon SGD of cash and generated a spectacular ROE of negative 6%. It has never paid a cash dividend in its entire existence and have asked for money countless times.

Considering that cost of capital is around 6% (see previous post), Chartered failed to even come close. In fact, Chartered helped investors LOSE 6% every year. Yet the market cap of Chartered had been around S$2bn for the good part of the past 10 yrs. (its peak was a whopping S$7bn during the IT bubble and trough a miserable S$300mn during the Lehman shock.) Why would such companies exist in a rational, efficient world?

Well the stock market is just one aspect of the economy I guess. Chartered provides tens of thousands of jobs considering all the peripheral companies that it supports, we cannot just let it go down right? So we did the next best thing, we sold it! And thank goodness, Chartered will be delisted.

Why has a company like Chartered lingered around for so long? Well market participants always had hope and greed and of course Chartered did serve some purpose for punters. Back in the IT bubble, it was so clear that Chartered would be a STAR. It made chips for goodness sake. And chips are what make IT possible. so that was the eternal hope. Even when the company started burning REAL cash for Hungry Ghost festival every year, investors held hope. It's biggest shareholder, Temasek, never gave up. Well until now, that is.

Here lies the new insight I have about efficient markets. Markets are efficient in the short run, ie 1-2 yrs where almost all market participants share similar thought horizon and are able to price stocks very efficiently within this time frame. And markets are efficient in the very long run, ie more than 10 yrs - companies that ultimately shouldn't exist would go, like GM, like some airlines, and perhaps Chartered. And of course, Great companies will rise through the ranks and become behemoths and rule the world, like Walmart, Toyota and Nestle etc.