Four years ago, when I read the company's financial statements for the
first time, I assumed that the performance of property companies will be much
better than companies in other sectors. Because a property company selling the
houses, offices, apartments etc. that the prices are high, even reaching
billions of Rupiah (about US$ 100K) per unit, so that the company’s revenue was
definitely big. While for companies such as Indofood,
for example, how much the profit from selling Indomie at a price of Rp1,000 per
pack? (in the year 2009, the price of Indomie was still around Rp1,000 per
pack, or about US$ 0.1). From the appearance of the salesmen, we can see that
property agents usually wear suit, aka far more convincing than old woman with
pajamas who selling Indomie in grocery stalls.
But after checking the financial statements, I found out that the net
profit/return on equity (ROE) of Indofood was far greater than the net income
of some leading property companies, such as Bumi Serpong Damai, Lippo Karawaci,
and Summarecon. Okay, in the year 2009 the property sector wasn’t yet booming
as it is now, but even at this moment, when several property companies began to
made its ROE above 20%, but still, their performance in general has never been
better than the companies that selling 'low price products' such as Unilever,
Mayora, Kalbe Farma, and Indofood CBP. You can see for yourself, the most
expensive products that are sold by Unilever is the shampoo with brand TRESemme, at a price of only about Rp16,000
per medium size bottle. While Bumi Serpong Damai? Its ‘cheapest’ products are
small houses with a price of Rp250 - 300 million (about US$ 25 – 30K) per unit,
in the Kota Wisata Bekasi.
But the point is, how can a product that sold at a very low price can be
more profitable than expensive products like properties? And the answer, which
I am sure you already know, is located in the turnover! A property company may not be able to sell apartments
every day, and its market share is also limited to the location of the
apartment itself. While consumer goods company that sells soap, dish soap, and
shampoo, they could sell their products everyday, anywhere, and to anyone,
depending on the ability of its distribution network. When someone uses
the ‘Lifebuoy’ soap (one of Unilever
brands) for example, and he liked it, then in the future he will be back to buy
the soap continuously. So although profits from the sale of a bar of soap is
small, but what about the accumulated profits from the purchase that repeatedly
and continuously by thousands or even millions of customers?
Meanwhile when someone buys a house then feel it comfortable, it does not
mean that tomorrow he will buy another house. Not just a house, when someone
buys a car and was satisfied with the car, it does not mean he will buy another.
The point is, for a company that sells products with a high sale price, then
although the profits generated by a single sale may be quite large, but the
turnover/sales volume is usually much smaller than the sales volume of fast moving consumer goods.
And based on my experience so far, the performance of the companies that
sell low price products almost always better than the companies that sell high
price products. In general, the following are the criteria for companies that
have good and consistent financial performance (thus the shares are worth for
investment), when viewed from the products sold by the company. The following
criteria are sorted by priority.
1. Low/Cheap Price of the Products
We have discussed about this above. Low prices also cause the products to
be affordable to all segment of people,
so its market share is automatically broader than products with higher selling
prices.
But is 'cheap product' always means products of daily needs such as soap
and shampoo? Fortunately not. When you open a savings account at a bank, then
you are only charged an administration fee of US$ 1 per month, so you can say
that the banking services are including low cost products. When you watch
television at home you may gain a lot of shows, movies etc., and instead of
paying, you just have to watch the ads. So the television/media companies are
also selling cheap (or even free) products. And when you pay a fee of US$ 10
per month for your telephone and internet (for school children, there is also
an interenet package of only US$ 2.5 per month), then the telecommunication companies
also includes companies that sell low price products.
Obviously there is an element of subjectivity in describing 'cheap' or
'expensive' here. You probably have no problem to pay US$ 10 per month for the
cost of the internet, but for others it could be a large amount of money.
That's why when a company sells products at a low price, it does not (yet) mean
that the company is offering a good and consistent performance over the long
term, unless the product meets the following requirements:
2. The product is needed continuously by a lot of people
Have you ever bought superglue, for example, to repair your flip-flops? I
have. The price? It was low, less than a Dollar in the grocery shop. But if you
ask how often I buy the glue, then the answer is: In my life, I only bought it
once. Maybe if later my sandal is broken again, then I’ll buy another glue, but
for today I don’t need it anymore.
So, even though the price of the glue is cheap, but the sales turnover is
not as much as soap or instant noodles (which people buy it almost everyday).
Everyone would need a bath, but not all people need to fix something with glue.
And if people need a bath every day, then someone with broken flip-flops did
not have to fix his flops every day.
This point of 'needed continuously by a lot of people' is, in some cases
may be more important in determining the consistency of financial performance
of the company (that produce the products) in the long run, rather than just a
low price of the product. For example, you may know that the investment in the gas station, even though it requires
high investment value and also does not offer the break-even point in a short
time, but it offers a consistent income
as well as low risks. This is
because all the people, either directly or indirectly, require gasoline and
diesel continuously, no matter how much it costs. You can see, although the
price of gasoline is keep rising overtime, but the level of fuel consumption
never fell. If the price of gasoline was raised from Rp4,500 to Rp10,000 per
liter, for example, then the people will still buy it.
In this case, the subjectivity on whether the price of gasoline is
considered expensive or cheap, it's not important anymore. Because if you
consider that the price of gasoline is expensive, you'll still buy it anyway, as
your car/motorcycle might not filled with water.
3. Could be mass produced at low costs
When the price of a product/service is affordable to all people, and it
takes a lot of people continuously, then the product only needs one more
condition to be able to generate large sales turnover for the company in
question, namely: Can be produced in mass quantities. I mean, how could your
company sells one million bars of soap per year if the production capacity is
less than that?
But fortunately for companies that produce the goods such as natural
resources, pharmaceuticals, cigarettes, cement, etc., the production volume is
usually large. If the products are services, such as banking, insurance, media,
the quantity of production could be even larger. To provide banking services in
a district, for example, then a banking corporation could simply open a branch office
there, so the marketing team could offer savings and loan services to the
surrounding communities.
But when a product can be mass produced, so that the sales turnover became
large, then it does not mean that the company in question would make huge
profits, unless the company could suppress the production costs so its net profit margin become huge.
Therefore, the final condition of an ideal product is can be produced at low costs. If you look at the Indonesia Stock
Exchange, there are several sectors which have low production costs (could be
seen from their net profit margin that is large). They are the consumer goods,
banking, financing, insurance, cement, animal feed, coal mines, oil palm
plantations, and automotive and components.
While other sectors have lower profit margins on average, including
property and construction sectors. For some sectors such as basic industry and
manufactures, the margins are relatively small because they have to import
their raw materials at a price that is quite expensive, because the domestic
industry has not been able to supply.
On the other hand for some specific sectors, their large margins can be
lower at any time when their revenue drops because of the falling price of the
products. For example, the coal sector, where the price of coal in the last two
years continued to fall to a level where the cost of production was almost bigger
than the value of coal itself. That’s why Warren Buffett does not like
commodity stocks, because its profit margin is not stable in the long term.
Okay, I think that's all. Thus when you want to buy a stock for long term
investment, then try to learn the type of products of the company. Is it cheap?
Is it affordable to all segments of customers? Is it takes a lot of people
continuously? And can be mass produced at low costs? You may check the company
that their products/services meet the above criteria, usually their fundamentals
are excellent.
Then about the example of companies with ‘perfect products’, you must be
already know. But here I will give one example of a company that is not listing
here, but in the Nasdaq Stock Market in the United States, namely Google, Inc. Well, check this out:
- The price of products/services: Not only
cheap, it’s even free! More than 90% of Google's products can be obtained/used
by people all over the world for free. And even for the pay products, the
price is never too high, but only in the range of US$ 5 - 25 per item (on
average).
- It takes a lot of people constantly: When someone
starts using the internet, he will surely uses the services provided by
Google continuously, ranging from search engines, email, Youtube, Google
Map, Google Earth, etc.. Even the website you are now reading is using one
of Google's services, namely Blogger. And yes, I use it every day without
rest at all.
- Can be mass produced at low costs: If
Indofood may be dizzy when the price of wheat rise, then Google did not have
to worry about the cost of 'raw material' in the making of their services,
because their various kinds of services can be obtained/used by all people
throughout the world. Google's biggest costs are only for the research and development of the
products. But once the product is finished and functioning, then the
company would gain the income almost without the cost of production at all.
Because their products are perfectly meet the three criteria above, then it
would not be a surprise if Google become one of the most 'magic companies' in
United States and even in the world, because on the other side the company is
managed by brilliant owners. In 2009, its stock price was US$ 400 per share.
But now? Already more than US$ 1,000! If you like to invest in overseas, then
Google is one blue chip stock that you may consider.
Unfortunately, when a company’s products meet the above criteria, then the
share price is usually too expensive, because the company generally has
excellent fundamentals. Google itself, at the share price of US$ 1,011, its PER
reached 27.5 times. And of course,
it is hard to say that Google is a value stock.
 |
A collection 'cheap products' produced by 'expensive company'. You do not
need to guess, what company it is.
|
That's why I’m not too hard when implement the above three criteria in
selecting stocks, but gave some tolerance.
For example, for a phone credit retailer company like Erajaya Swasembada and TiPhone
Mobile Indonesia, as we’ve discussed in last week's article, the price of the
products is cheap and it takes a lot of people continuously. On the other hand
the cost of production is very expensive because the companies buy the phone
credit/vouchers from other companies, not produce it themselves.
But because the share prices are make sense, then the shares are still
worth to invest. Even in the case when the valuation of a stock is really undervalue,
we do not longer need to pay attention to whether the products of the company meet
the three criteria above or not, as long as the profitability and other
indicators are good. On the other hand if you find a stock with low numbers of
PER, PBV, and dividend yield, while the products sold by the company meet the
three criteria above and the company itself have fairly good fundamentals, then
what are you waiting for?
Original article written at October 21, 2013
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