Monday, March 07, 2011

Learn about Balance Sheet!

Many people understand what's a Profit & Loss account. It's basically a statement of the sale & profit or loss recorded for the relevant financial period, be it a year or a quarter. Not many people understand what's a Balance Sheet. The Balance Sheet, which will soon be re-named by the accounting profession into something more meaningful Statement of Financial Position, gives a picture of the company's financial position as at a certain point in time. In a Balance Sheet, we can see how the company carries out its business, such as its level of capital or borrowings or working capital requirement. When we compared some of the items in the Balance Sheet with the results of its operation as reflected in the Profit & Loss account- we can assess the efficiency of the company's management.

Recently I told one of my clients that Transmile is in such a deep hole that it's nearly impossible for the management to save the company. As at 31/12/2010, Transmile has a negative NTA per share of RM0.54! She shrugged off the comment & proceed to buy shares of Transmile. When I told another client to sell some of his SAAG shares when it hit the resistance of RM0.15 (after rising from a low of RM0.06 in September 2010), he asked me "What for?". I explained to him that the company's financial position is very bad & it has to raise huge funds via rights issue & debt conversion, he laughed at my concern. I got desperate & tried to explain to him that SAAG is highly leveraged with a debt-to-equity ratio of 1.8 times as at 31/12/2010. While its current ratio appears adequate at 1.3 times, the bulk of its current assets comprised amount due from customers for contract works of RM362 million and trade receivable of RM257 million. When we compared these 2 debtors’ figures to its turnover of RM120 million for FY2010, alarm bells should begin to ring. With debtors’ collection period of more than 2 years (ignoring the amount owing for contract works), the quality of these debtors is highly suspect. The huge amount owing for contract works suggests that the revenue from these contracts has not been booked into the account. Why? Are they collectible? The client nearly lost his temper for my persistent argument and ignored my suggestion*.

Tranmile has been suspended on Mar 3 & it will be de-listed from the exchange unless its appeal is successful. SAAG's share price has since dropped back about RM0.08-0.09. If the market condition continued to deteriorate, the chance of SAAG's completing its fund-raising exercise is pretty slim. Would a white knight ride to its rescue, as the client had speculated? Who knows. As for me, I couldn't help but wonder why, why do traders & punters put their hard-earned moneys on the line so easily. It's almost like taking candy from a baby.

For those who like to look at the Balance Sheet of Transmile & SAAG, you go here & here. For those who like to know how to read a Balance Sheet, do check out this article from Investopedia.

(*Note: The highlighted passage has been amended due to slight error & for further clarity. The earlier passage read as follow: "SAAG's debtors stood at RM362 million as at 31/12/2010, which is equivalent to 3 years of turnover [ SAAG's turnover was RM120 million for FY2010], the client nearly lost his temper".)

6 comments:

Ernest Kat said...

Well there's a new sucker born everyday and of course with a suckers mentality to trading a fool and his money are soon parted

JY said...

Hi Alex

Speaking of Balance Sheet, I have always been wondering about this. What do you think if a stock trades significantly higher than its BV yet it is a strong growing company? High growth, high ROE, low D/E, low dividend.

For instance, Kencana's market price is 2.50 and its net asset per share is 0.49. Its latest quarter eps was 3.16c. It's profit has been growing at CAGR of 33%. It is trading at a P/E of 24x (source: bloomberg).

Many research report still calls for a buy. Is it ok to buy when the P/NTA is so high? What if the projects slowed or stop coming... would the price drop to 1 - 1.5x of its P/NTA?

Appreciate your comment.

Layman said...

Dear Alex,

Any view on hwgb and its wa performance lately? They have been on down trend from 0.8 till now. Any analysis or comment on it. Thanks.

Alex Lu said...

Hi Layman

I am never too comfortable with HWGB. It didn't do too well in its cable manufacturing operation. It also didn't do too well in its casino operation in Cambodia. Now, it is going in tin mining. What's next? Rubber glove? Property development?

Traders & punters would not be discouraged by this inconvenient observations. In my opinion, HWGB is controlled by syndicated pool who will not hesitate to use whatever means to achieve their objective. This would include technical subterfuge, such as "bullish" breakout. Be very careful, as you are swimming with sharks.

Alex Lu said...

Hi JY,

You are taking about valuation- Price to Book (PB). One can justify high PB value for a stock if it is very profitable because you can fall back on its Price to Earning (PE) valuation. Even a high PE value is acceptable if the earning is growing rapidly because you can fall back on Price to Earning Growth (PEG).

Studying Balance Sheet per se will give you a feel about how solid is this company, without comparing it with its share price. If the Balance Sheet shows low current ratio, the company may have liquidity problem six months down the road. If it has high debts to equity, it may have problem settling its debts in 1-3 years time. If it has high receivable or inventory turnover, it is not well-managed and the receivables & stock may not be realizable in full value. The latter would mean that the company will have to make provision for diminution in value & this will hit its reserves.

Sometime we do not (or I did not) bother to look at the Balance Sheet because the target company is assumed to be well-managed. I tend to do that with blue chips or when I make trading calls which are short-term in nature. This is not a good practice I must admit. However, due to time constraint, we skip this process. If you are taking a sizable position then you should do the study on your own. As you can see from my example, it is not difficult.

JY said...

Hi Alex.

Thanks. That is very informative.