Every now and then I tried to force myself to do a bit of homework in updating my spreadsheet for some companies that are in my watchlist.
This article is about consolidating the strength of the company through looking into the lenses of the health of the balance sheet. I am only covering ground on one segment so it cannot be entirely looked into making certain grounds.
Small cap companies have been a favorite for many because of their potential to grow. Unlike matured companies, small cap companies have greater room to grow because they can build on new verticals or improve on their margins by focusing on their specific mix. However, the risk is also greater in the sense they may lack institutional back-ups in the case where liquidity dries, just like what happened during the GFC.
For the purpose of this exercise, I have picked a few small cap stocks which I have added to the list while they remain in my interests. I will be using 4 scenarios: the 2008 GFC, 2011 Euro Crisis, 2015 China scare, and 2017 of today. I specifically picked scenarios where the STI has been much impacted by certain events to see how valuations are.
- Micro-Mechanics
- Tai Sin Electric
- Transit Mixed Concretes
- Riverstone
- Silverlake
- UMS
- Sarine Tech
- Nam Lee Metals
- Second Chance
- Boustead
- Kingsmen
Balance Sheet Strength
The first stress test is to check on the strength of their balance sheet.
On the overall, it looks like most companies have a much stronger balance sheet now as compared to back then in 2008, 2011 and 2015, where companies generally tend to take advantage when interest rates are low. Companies which are visibly in the net cash position for years have grown their cash position to even more in 2017, with Micro-Mechanics, Taisin Electic, Transit Mixed, Riverstone, Silverlake, UMS, Nam Lee, and Boustead leading the pack. Kingsmen reduced their net cash as they had to use the working capital to build on their headquarter.
It is also important to note that while keeping cash increases the strength of the balance sheet in general, hoarding too much cash may not be the best decision as it erodes the long term ROE of the company.
Earnings Valuation
The second stress test is on their respective earnings valuation.
From here, you can easily see that valuations are much more expensive today as compared to back then during 2008, 2011 and 2015. Some industries like the semi-conductor are seeing their cyclical upturn so it is common to see companies get re-rated upon potential stronger growth.
Sometimes, as investors, you’ve got to question yourself if you are rationalizing for enough margin of safety on some of these counters.
Implied Downside
I’ve also included the implied downside scenario and here we are using the 2008 bear market year since it’s a really bad year.
While you might be confident that the companies you are holding are strong enough to withstand the wind, you might need to work out on the potential implied downside psychologically to see that it can happen in a big bear market where liquidity dries and all fundamentals are thrown out.
This is not meant to scare anyone out there but meant to educate and inform that such unimaginable things can happen even to a very strong company. Good companies do rebound when economies recover eventually but you do need a strong steel of balls and mentals to undergo the event.
Thanks for reading.
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I really like this post as it's insightful and kiss.
Seems like kingsmen stands out
Thank you.
Kingsmen indeed has been a very well managed company.
Great post as usual!
Is it possible to share links on how to do stress test or websites that can Co it for you? Sounds like a good portfolio management tool.
Hi INTJ
So far there isn't any management tool I know that could do this automatically, so you have to track this once in a while to see how it is doing.
Hi, What do you think of UMS now?