28 October 2013

Shares Investment Ideas - What Happen if ROE Fluctuate?

Since my first shares investment since Asia Financial Crisis 15 years ago, I always look for reasons how shares price can move up or down. Apart from Macro Economy perspective, the 1st reason why a company can have its share price move up in long run is due to its strong performance in its business development over a long time frame.

My thought is that, to earn money from stock market over a long run, we should first focus on the fundamental of a company, before move on to find out the entry and exit point of each investment. To do so, we can always figure out financial ratio of a company and 1 of the most important ratio is ROE (Return of Equity). It is one of the indicators to access how strong the earning power the company could have and the competitive edge against its peers. 

Most of the time, I would look for consistent and high ROE company before move on to search for volatile ROE companies. So I would like to find out the reasons why ROE fluctuate in this post. 

First of all, it would mean that the company is a cyclical company. The performance can be better during economic boom and worst during recession. So, we have to look at longer term, say 10 years performance of a company to determine what the long term sustainable growth rate the company would have.

Secondly, the company could have a different product mix during different financial years. This is quite common when the company is having wide range of products. The reasons why they try to diversify the product range instead of concentrate on single sectors could be due to the risk management or having better bargaining power against customers. 

Thirdly, the company cannot increase / control the sale price while inventory cost surges up. It may happen to commodities companies where they cannot easily pass the inflation costs to customers when the sales price is fixed.

Fourthly, Huge CAPEX (Fixed Cost) expenses per yaer - Companies must maintain certain amount of CAPEX (be it replacement cost or increase of fixed asset purchase) so that to have the economic of scales in long run. In theory, a company with high Capex is not a good choice during recession. 

Fifthly, The company had exceptional earnings / losses during financial years. It could be fair price gain/loss from investment (be it securities / properties / other investment tools) or disposal gain from PPE (e.g. real estates etc) or even a provision for future losses. We may need to do some adjustments to bring this back to normalized rate (e.g. you may need to focus on core earnings stream before looking at the other operating income / expenses. )

Sixthly, Income & Expenses not arrive at the same time. For example, a company may need to take in huge borrowing and thus incur interest expenses before the project completes and bring in better income stream later. 

1 comment:

  1. We must assess every situation to make sure that our real estate business is well managed. Always think of a better situation for our business and we must place our mind with it. Changes doesn't need as long as we ensure our business to be running well.

    Property Investment Portfolio


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