In recent times, I had purchased a stock called Penguin
International. Then it was 20+ cents and had price earnings and free cash flow ratio in the low single digits. It was a value investor's dream reporting strong growth and was priced attractively at its reported numbers. However, the share price has moved south and is now at 12 cents.
What Changed?
I had overlooked the fact Penguin's earning could be affected by a downturn. Penguin’s customers were companies in the oil & gas industry. Unfortunately, a downturn did happen and now deliveries and orders for its vessels has slowed. As a result, lesser revenue was recognized with increasing
inventories. Penguin’s profitability only decreased one year after the slump of
oil price.
Learning Points
This episode showed how reported numbers are merely the rear view mirror of a car; no matter how good they are, what matters is where the road is heading to. And to learn about the future earnings of a company, it is down to our ability to comprehend the industry's outlook. This is
particularly true for cyclical industries such as: Oil gas, Property/REITS, Commodities and Shipping.
For example, while local properties companies have reported
slightly increased profits, their share prices have stagnated or declined. This
is likely due to their revenue recognition method. Majority of revenue currently recognised are for residential projects which had been sold in 2011/2012. Their
Singapore segment will experience a decline later as residential sales had
slowed since 2013. This too is applicable for Sembmarine and Keppel, where
order books are only starting to decrease only a year after the oil slump.
Hence when investing in cyclical
companies, it is always important to understand where the industry is heading
before investing. While the financial ratios may look good at the current share price, there may be a reason why Mr. Market is still pricing the company at a low figure.
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ReplyDeleteI think to know the future is tough, no one can know that oil will be this low when we were in August last year. So for cyclical stock, we can hardly tell when it peak and bottom. As for me, I feel safer buying several blue chip.
ReplyDeleteAnd who know those who buy now are buying at the bottom. We don't know for sure with so many noises saying oil will be this and that by so call expert we read about them in marketwatch and cnbc.
So are you still holding to your Penguin? I have a friend who bought higher at 26c. Wish you all the best.
victor
Hi Victor,
ReplyDeleteyes, still holding on to Penguin. This is because the price has fallen to rather low levels that a sufficient margin of safety exists in the stock. It will be hard to find companies with that high margin of safety to shift into, the only one i can think of is Silverlake.
The net book value is 21 cents vs current price of 12 cents. Just that Penguin is unlikley to produce free cash flow over the net 2 years.