InvestorsFriend Inc. Newsletter June 12, 2011
Sino-Forest
Sino-Forest Corporation has been very much in the news in recent days. Its stock price plummeted about 75% from about $18 down to about $4.50 after a report was released that accuses it of being a fraudulent operation with a true value of under $1.00 per share.
Sino-Forest has been listed on the Toronto Stock Exchange for since the early or mid 90’s. But all of its operations are in China.
The report by “Muddy Waters Research” is available here:
http://www.muddywatersresearch.com/wp-content/uploads/2011/06/MW_TRE_060211.pdf
The company is defending itself and denying the allegations. It remains to be seen whether there is any truth to the allegations.
I am particularly intrigued and interested in the whole situation because I once had over 4% of my portfolio invested in this stock. I was a big fan. I held it for about 5 years and I read it’s annual reports and studied its financials for over five years. However, by late 2005 I was growing wary because it seemed to have changed its business model. Trees that I understood it had planted throughout the 1990’s and which it said would mature in 5 to 7 years did not seem to have been sold by 2005. When I called the company to inquire I recall I was told they had only started planting trees around I believe they said 1999. That did not accord with what I thought I had read in their annual reports.
In fact the 1996 annual report states
At December 31, 1996, Sino-Forest has phased in a total of approximately 37,600 hectares of plantation lands, or 6% of the plantation lands currently under contract.
Now maybe 37,600 hectares of planted trees is not much but that did not explain why approximately none of these trees, some of which were said to mature in just five years, were apparently not sold by late 2005. And it contradicted the information I received when I called the company and was told that the reason the trees were not sold yet is that planting had only started in, I believe they told me 1999 or it may have been even later. The point is based on that conversation and the other risks I perceived I decided I could not trust the company.
I have now re-posted my old 2005 report on Sino-Forest and highlighted the concerns I had at the time.
http://www.investorsfriend.com/2005%20Sino-Forest%20InvestorsFriend%20report.htm
Now, it is not clear even today whether my lack of trust was justified. I just want to point out at this time that I in fact lost trust in the company in 2005 and let my customers know that.
UNDERSTANDING STOCK MARKET RISK
One of the hardest concepts to understand when it comes to stock investing is; What exactly is risk? How should risk be measured? How much risk should we take? How risk can we afford to take financially? How much risk are we prepared to take emotionally?
The investment industry is leery to be responsible for deciding how much risk any of us should take. It’s too tough a question fro them to ask and they face risks if they get it wrong. So, quite naturally, they leave the decision on how much risk to take to the client. The industry pretends that clients can decide this by checking off a box on a know-your-client form. The reality is that most of us have little basis to decide how much risk we should take. It’s really a question that is impossible to answer “accurately”.
The academics of the investment industry like to pretend that risk can be measured rather precisely using statistical measures like standard deviation and “betas” and various formulas. They are wrong, risk by its very definition can never be measured precisely. And anyhow once disaster strikes, the fact that statistically it was a very low risk is cold comfort. What comfort is it to the people in Japan that the risk of an earthquake and Tsumani causing a Nuclear disaster was (or was thought to be) so small as to be insignificant. It’s cold comfort indeed.
In 1985 when I was taking a Finance course at St. Mary’s University I was taught that risk in the stock market was unmeasured by the standard deviation in the movements of as tock price. In other words to him, as an academic, stock risk was measured by these usually small squiggles up and down in a stock’s price. I recall I challenged the professor at the time since to me, the real risk was not that my stock would move down by 3% or something. The real risk to me was that for some reason it would plunge suddenly and unexpectedly towards zero and stay there and essentially never recover. That to me was the real risk, and I failed to see how that risk could be measured by squiggles in the stock price.
Sino-Forest is a perfect example. Nothing in its stock price pattern was ever going to predict that one day a report would come out and suddenly send the stock price down 75%.
In fact the academics seem to contradict themselves. They will tell you that technical analysis if absolutely useless. That it is bunkum. They will tell you that under the efficient market hypothesis, every stock is priced correctly based on the available information. They say the past price pattern is of zero predictive value. But then they turn around and use the past volatility of the price to measure risk. And they use the past correlation of the stock price to the overall market to measure risk. In fact what they are attempting to do is to measure what is ultimately to some degree random and not measurable.
By nature the academic measures of risk tend to be useful for measuring smaller risks but tend to fail completely when it comes to rare catastrophic risks. The “Black Swan” events.
I have written before on the nature of risk in the stock market and the many fallacies about risk that are believed.
See:
Risk and Return Fallacies
and
Practical Lessons From Modern Portfolio Theory
The full Phalanx of my articles on risk are available here
Is Now a Good Time to Invest in Stocks?
This is always the question. We can never be sure it is a good time to invest in stocks, especially for shorter time periods.
Here are some reasons why it might not be a good time to invest in stocks:
Economic growth in North America and Europe is fairly slow and seems to have little prospect of a sharp turn-around.
Oil prices remain high at near $100 which is a drag on the economy.
Housing prices in the U.S. have continued to fall which hurts the economy.
Greece and some other countries in Europe are at some risk of defaulting on bonds in some fashion or other. Such a default would cause interest rates to rise and stock prices to fall. In the United States itself there is some talk of a refusal to increase the ceiling on the national debt and apparently that could cause a shut-down of all non-essential government services and could even cause some kind of technical default on government debt even if only for a few days. These things could cause another credit crisis. Credit is truly the grease of the economy. Not much trade can happen without credit. A credit crisis would definitely send stock prices down.
Some would argue that the valuation of the market in terms of its dividend yield or its P/E ratio is higher than historic averages, or high in terms of the growth outlook and that this is a negative indicator for stock prices.
There are ALWAYS reasons that can be listed out that indicate that investing in stocks is risky. They could fall in price.
However, here are some factors that argue in support of investing in stocks:
To invest in stocks is to own a share of “corporate America” or of the corporations of the world. Few would argue that large corporations are going to stop making money. As an owner stock investors tend to make a good return over the years.
The P/E ratio of the market (for example the Dow Jones Industrial Average) was 14.0 at the end of May based on earnings reported in the previous 12 months. The long-term average P/E on the Dow is 17.8 and when some high outlier years are excluded (years when the Dow P/E was very high due to abnormally low earnings) the historical average is 15.5. So today the price you pay for each dollar of earnings is a little lower than the historic average. And consider that interest rates are at historic lows. When interest rates are very low it justifies paying more for each dollar of corporate earnings (a higher P/E). Basically if you can’t get much interest on your money then stocks which an earnings yield of a 1/14 or 7.1% look like a good investment. When you could get 10% on your money in the bank a 7% earnings yield on stocks would not look attractive. But 7% compared to close to nothing at the bank seems okay. Of course you are not guaranteed this 7% if you invest in stocks.
Stocks in the past have always done well over longer periods of time like 25 years.
Predictions of gloom about the economy are probably ill-founded. North America and the world continue to benefit from technological innovation. Trade is growing. Populations are growing. There is little reason to think that major corporations will not continue to grow over the years. The question is will you own your share(s) of this?
Canadian Exchange Traded Funds
Exchange Traded funds are often recommended as an alternative to mutual funds. However, in order to invest in exchange traded funds one needs to know the trading symbols of some funds. It would also be nice to know of the P/E ratios n and other fundamentals of the funds.
To my knowledge, our reference article is the only source that has compiled this for a group of Canadian Exchange Traded funds. We have the data for quite a few funds but not all of them.
Click to see this reference article which was recently completely updated.
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Shawn Allen, President
InvestorsFriend Inc.
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