Thoughts on Valuation

and the intelligence of the market and why valuation still matters...

In recent years, there is a general disregard for the art/science of valuation.

Everyone is looking for growth/compounders and valuation had became an afterthought.

While I agree that valuation can be an afterthought if there is predictable quality growth which could be forecasted into the next 10 years, valuation become increasingly important when the

  • country does not have a long history of capitalism or public market

  • industry economics is not easily forecastable or industry competition is not benign

  • company business model is not new/innovative but the margin remain indeterminate

I had belatedly got into the Property Management (PM) space in China in May this year despite PM being one of the hottest/highest valued sector in China.

Instead of going for the recognisable names, I had chose to buy the cheapest play in that market which also happens to be one of the smallest company.

The theory is that either this company will trade up (it is valued at 5-7x PE) or the rest of the sector will trade down (from 25 - 30x PE). In the event that M&A starts to happen, I believe that the smallest firm will be taken out first. I believe that the odds are in my favour or at least I did not plan on losing much money.

When PM firms started trading down en masses during the crackdown in gaming in China, I even tweeted out how ludicrous the situation is…

"The supposedly crackdown on property management companies (PMC) in China is the head scratcher here. I could not see what the PMC are doing wrongly. CCP may force property developers to relinquish control which is most likely the precursor for more M&A."

-Ong Wee Hiang on Twitter on 27th July 2021

The market is often smarter than that/me.

The news of the impending collapse of China Evergrande Group came and I think I knew why the PM company rerated down heavily then slowly for the past 2 months.

It is often during such time that I am reminded that when an industry or a company starts selling down without any news on the mainstream media, it is often news that is travelling through the grapevine that is working its effect on the share price.

The market is indefinitely more well inform than an individual working on a laptop on a little island nation.

I am the patsy here…

Going back to the idea of valuation. If I had been betting that the whole sector would continue to rerate higher or stay high, my position would have been seriously hurt.

There is two mitigating factor here.

First, this was taken as a bet (to differentiate what is a bet, trade and investment).

Second, I had bought the cheapest company in the PM space.

Thus, I am spared from a severe absolute decline due to the small position sizing as well as the relative rate of decline (instead of going from PE of 40x to 20x, the stock went from PE of 6x to 5x).

It is during this moment in time that valuation becomes critical.

At 6x PE, a 50% drop would make it a 3x PE. This would make the company a bargain for value investor. A drop of 50% from 40x to 20x may only make a company looks relatively overvalued to a growth investor when the whole industry outlook is dimming.

This is more or less the whole list of PM firms in China. As a sector, they are averaging around 20% - 40% growth per year through organic and M&A efforts. At PE of 10x - 15x, a lot of them would look really attractive (if the growth is real or sustainable).

As a list, majority of them has continue to trade down from a high PE valuation (>20x).

But some had traded up on this day and it all happens to be all the PM firms which are trading on the lower end of the PE range (<10x).

This is the day when the market tells you that the value investors are working their way into the PM sector as there are bargains to be bought…

Yes, I bought one of the company in the green.

And, yes I am a lucky patsy.

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