Approach Investing Like Buying Durians

Foreword from ShareInvestor

This article “Approach Investing Like Buying Durians” by Arthur Lee was first published in The Business Times on 12 Mar 2016 and is reproduced in this blog in its entirety.

Understand just what you’re getting into and examine the ‘fruit’ closely before parting with your money

My newsroom colleague Anita recently wrote “An IPO elsewhere is not always a big loss for SGX”.

A successful SME owner gave me sound advice on this subject some years ago. It was during a period when IPOs were hitting the market every few weeks. I asked if he would consider an IPO.

He said: “There are three reasons why a company decides to do an initial public offering: one, the owner needs funds to grow his business; two, he wants to cash out; three, he wants to enhance his company’s market visibility.”

Since he was doing well and didn’t need funding, he said that he had no plans for an IPO.

An IPO is an opportunity for the public to participate in a company’s growth. It is also a very liquid form of investment with good returns if the company does well.

Some have indeed done very well. Perhaps the most recognisable success story is Google.

It went public in August 2004 at US$85 a share. There were some detractors then about the viability of its business model and revenue streams. Our publication’s own former IT editor regretted that he had not bought it.

Today, Google is trading at over US$700 a share despite a stock split in 2014. It has done so well that, on a split-adjusted basis, it is up about 1,500 per cent from its IPO!

Working in The Business Times has given me the opportunity to attend numerous IPO announcements and I have gone for many over the past 20 years.

Looking back, I see not all the companies delivered on their promises. There were some success stories while others were suspended, went into voluntary dissolution or are underwater.

At the launch, there is usually a nice PowerPoint presentation extolling the company’s growth in the past and the promising future it has.

During the period when S-chips (China stocks) were market favourites, some of the companies went out of their way to garner investor support.

Beauty China had a catwalk show with pretty bikini-clad models strutting their stuff for guests at its evening reception in Suntec City. It was so hot that if you applied for 100 lots, you got just a few.

China Milk in 2006 had a very promising business model – or so it seemed. It was in the business of milk production and pedigree breeding of cattle. Everybody drinks milk and many eat beef, so its prospects appeared good. At its peak, it reputedly had a market cap of about S$1 billion.

Today, if you scroll through the Singapore Exchange (SGX) listing of companies, the name is still there – suspended!

I too lost money buying into a supposedly promising IT company listed on Nasdaq. One year later, all I got for my money was a note from the broker stating that it had gone into Chapter 11 bankruptcy.

A well-packaged presentation with a promising business model is no guarantee of success. Unsuccessful companies are very common – much more common than interested parties such as securities exchanges, underwriters (banks) and PR consultants doing the marketing would like us to know.

After all, they can take refuge, having complied with the rules and regulations and having issued a thick prospectus with the all-important caveat emptor.

So should the common man invest in IPOs or other financial instruments? Equity markets are often momentum-driven by a confluence of economic data and business sentiment. A good ship will make slow progress when the winds are absent. But with favourable winds, even average boats can go far. This is an important rule when trading the markets.

With stocks and other financial investments, we are exchanging cash for “scrip”. In the process, it’s good to remember the old adage: “In God we trust. All others pay cash.”

Two important points to consider when buying a company’s shares are its business model and corporate governance. Why would you buy into something when you do not (or cannot) know if the business is genuine? The recent scam that involved selling aquilaria trees is a clear example.

Are there also adequate good- quality audit checks in place to ensure that company finances are managed properly? And are the projections reasonable and fair? Creative accounting is more common than we think.

A bank relationship manager once offered me a financial product. After reading the brochure several times, I still couldn’t understand its intricacies – a clear warning sign to be extra careful. But what I did understand was its bias in favour of the issuer. It was structured in such a way that I was responsible for all losses but my profits were capped at a specific level!

Three wise men have been my good friends when parting with hard-earned cash: they are why, where, and how.

A loss means you have to work extra hard to recover the loss before you can make any money.

So the first rule in making money is to avoid losing any. It’s true that returns are proportional to risk but we need to differentiate between a visible risk and one that cannot be estimated.

Why are the owners going for a listing or selling the product? After all, if it’s so profitable, why are they willing to share the profits with me? A good rule of thumb is to be very wary whenever something looks too good to be true.

Where is the business situated? The simplest analogy is perhaps in the field of medical treatment. The standards are different in each country, and it follows that business practices differ too. Low standards can result in poor rates of “cure”.

How will the business grow and progress? Durian trees are a good analogy. It can take anywhere from five to 10 years before they bear fruit. There is also no guarantee that a tree will bear high-quality fruit. But with good grafting techniques, time and care, the odds are good.

Financial investing is a bit like buying durians or durian trees; pick the right ones, and you can be well rewarded.

Durian lovers know only too well the tricks of the fruit sellers. They cut open one corner and let you “test”. But when you get home looking forward to a feast, you sometimes discover that you’ve been had: other parts of the fruit turn out bad.

Unlike buying durians, it’s not possible when investing to split the “fruit” right open and transfer the good seeds into a styrofoam box. The market is strewn with poor-quality fruit with low- grade and sometimes worm-ridden flesh. But the “king of fruits” still carries the promise of a feast that many look forward to. Just be extra careful when handling and choosing what to buy – as sharp thorns can hurt.