One Minute of Fame, Years of Devotion.

In the short run, the stock market is a voting machine. In the long run, it is a weighing machine.
Benjamin Graham

Very often, we look at our investments in the form of their share prices, for that is what we will sell them for, and if the market is transacting the businesses at this price, surely they must be valued at this price now – yes?

Well, it turns out this is half-truth.

For businesses that do not carry their weight in gold, this statement is true – in the sense that their value may be deprecated suddenly when their business activities slow down significantly. For instance, the Bloomberg article at the end shares how some companies are collectively issuing warnings on their earnings and how this malaise seems to be widespread as regional consumption slows.

What used to be a sexy growth story suddenly transformed into a risk nightmare. These companies are suddenly “appropriately appraised” in their valuations when their earnings decrease. The high-flying valuations abruptly gets grounded. Whatever expectations that was paid for vaporised.

If an investor happens to have invested in said group of companies at such astounding valuations, surely she must be concerned about what is the share price of her investments now, for there is a chance that these investments may take very long to recover the original value, or never, for that matter.

Weighing machine; tests for body fat composition too.

Meanwhile, there is another group of businesses that reported growth despite generally slowing consumption throughout the region. In fact, their business seems to get better with every crisis. These businesses do not seem to care about the market volatilities. The management team seems to be so boringly interested only in their business – they do not need to overhype about their achievements nor their market standing, they just continue to add value to their loyal consumers and let their results do the talking.

For instance, while analysts were predicting and reporting a not-so-beautiful earnings reporting season, Company Free recently reported a 15% increase in sales for the October-December quarter, as well as a 30% increase in operating income. They raised their dividend payout by sixty percent. These are part of the ongoing improvement it has underwent for the past 6 years.

They finally broke free from yesteryear’s restrictions to grow into their golden period, while ironically some countries are increasing trade restrictions and causing hordes of companies to fall in operations.

Like what we shared in the Outlier article, investors might be tempted to point at this occurrence and say “oh, this is a one-in-a-million lucky result” or “it is just different”. But we go about it more methodically – what were the various factors leading up to this operations improvement? Was it a lucky break or is it a structural change that the management team prepared for, from the ground up?

What we saw in Company Free was more than 30 years of hard work ploughed into the creation of their unique products and services, and it seemed that the time for them to be appropriately paid for their hard work has finally arrived. The increment in their results is not one-off nor financially engineered, it was prepared for and meant to happen – it was just a matter of time as they reach more customers.

In fact, Company Free has been sustainably increasing dividends for the past ten years, and by most conservative measures, investors may still end up accusing them of being cash hoarders – they generated so much free cash flow that their net cash position currently accounts for 50% of their net tangible assets (NTA) or 20% of their market cap.

Q1) Since you have a choice, which group of businesses would you rather own?

Q2) How do you weigh your investments?

Excerpts from the Bloomberg article:

[…The number of Chinese companies warning on earnings is turning into a flood, with no industry spared from worsening demand.

Some 440 firms disclosed on Wednesday — the day before a deadline to do so — that their 2018 financial results deteriorated.

“We’re only just seeing the beginning of deterioration in corporate earnings as the economy slows further,” said a fund manager at… “Things will continue to go downhill for firms seeing business slowing and even as the macro-economy recovers, these individual firms will never be what they were.” …]