At some point in our investing lives, we will face a time when the share price of companies we have bought underperforms the Straits Times Index (SGX”^STI) or even worse, drops below the buy price. When this happens, the conundrum comes when we have to decide whether or not the share price drop is justified. To do this, we have to decide whether the drops are driven by general share market volatility, or face up to the fact that our companies has suffered permanent loss. But what is permanent loss? A step that might help In Step 12 of the…
At some point in our investing lives, we will face a time when the share price of companies we have bought underperforms the Straits Times Index (SGX”^STI) or even worse, drops below the buy price. When this happens, the conundrum comes when we have to decide whether or not the share price drop is justified.
To do this, we have to decide whether the drops are driven by general share market volatility, or face up to the fact that our companies has suffered permanent loss.
But what is permanent loss?
A step that might help
In Step 12 of the Motley Fool’s 13 Steps to Financial Freedom, we shared some of the reasons to consider selling shares that we own. One of the reasons for selling is when a company’s underlying business changes for the worst. In other words, this is when the underlying business may have suffered a permenant loss of value. Below are some thoughts which decribes how a company might have undergone a permenant loss:
There’s no way around it: Businesses change — sometimes significantly. We could be talking about a major acquisition, a change in management, or a shift in the competitive landscape. When this occurs, we incorporate the new information and re-evaluate to see if the reasons we bought the company in the first place still hold true. We will consider selling if:
- The company’s ability to crank out profits is crippled or clearly fading.
- Management undergoes significant changes or makes questionable decisions.
- A new competitive threat emerges or competitors perform better than expected
Let’s look at a local example
To do this, we can look at Fung Choi Media Group Limited (SGX:F11). For the financial year ended 30 June 2010 (FY 2010), the media and marketing company had four divisions for its revenue. By the financial year ended 30 June 2014 (FY 2014), it had five divisions for its revenue. However, the composition of the revenue was quite different for the two particular years, and breakdown by percentage is shown below.
Sources: Company earnings report
For FY 2010, majority of its revenue came from the printing and the commercial display division. Its printing division, which consists of printing of periodicals and yellow pages, commanded 31.6% of its total revenue. On the other hand, the commercial display division made up 35.6% of total sales. This division counts large scale commercial signage, and point of sales displays as part of its revenue. The most profitable division (by margin) in FY 2010 was the advertising division.
The rise of online advertising alternatives has taken a massive toll on this company. Revenue for its advertising division fell more than 74% from HK$186,212,000 in FY 2010 to HK$48,238,000 in FY 2014. As a result, Fung Choi media has moved into a new supply chain management segment last year. However, the profit from this new division was insufficient to arrest the fall in profits from the other divisions. In line with this, the net income fell by more than 50% during this five financial years.
Source: Company earnings report
In The Straits Times report on 18 September 2014, the newspaper reported that Fung Choi Media has allegedly missed a bond interest payment to its lender, BCA Best Business Service. As a result of this, the company has requested for a voluntary suspension while it sought legal advice for this dispute.
If investors bought shares in Fung Choi Media in FY 2010 with the thesis of continued strength in the advertising business, they might have to reevaluate their thesis at the face of its performance over the last five financial years. Questions for investor to answer might be: is there a reasonable cause to believe that the company would be able to reverse this 74% fall in revenue? If not, then is the supply chain management division what investors want as part of their thesis going forward?
With it, investor might be able to decide on their own whether or not this performance accounts to a permanent loss of underlying value.
Foolish Take away
To sum this all up, a quote from Warren Buffett comes to mind. Mr. Buffett once quipped:
“Price is what you pay, value is what you get”
It follows that if “the value that you get” has diminished over time, then it may be time to come to terms that the share price drop may well be justified. Instead of waiting for a reversal of fortunes in the share price, that time is perhaps better spent looking under the covers of the company to access if there is permanent loss of value. With it, the Foolish investor may find the answer to “who moved my share price”.
Click here now for your FREE subscription to Take Stock Singapore, The Motley Fool's free investing newsletter. Written by David Kuo, Take Stock Singapore tells you exactly what's happening in today's markets, and shows how you can GROW your wealth in the years ahead.
The Motley Fool's purpose is to help the world invest, better. Like us on Facebook to keep up-to-date with our latest news and articles.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.