‘Drama Queen’ of Stock Market

A few days ago I had a small incident with my family at home. So my 3-year-old daughter was running around and fell, so her knee scuffed. The next morning, she refused to shower because afraid that her ‘wound’ would be hurt when exposed to water. Her mother repeatedly explained that it was just a little sore so it will not hurt, but she kept shouted 'I said no!' Losing patience, her mom also shouted. As a result, it was an uproar morning at home just because of a small blister on the knee, and the papa (it’s me) should intervene. After taking her to a playground and slowly explaining about her ‘injuries’, she finally willing to shower.

The above case describes how a small and insignificant event could be seem serious, simply because the people involved in the events responded excessively. The mother called her little princess as a 'drama queen', because the baby is too worried about the small cut, whereas it was only a minor abrasion. After consulting Mr. Google, according to www.urbandictionary.com, drama queen is 'someone who turns something unimportant into a major deal'.

The term drama queen usually refers to a woman, whether young children or adults (hence it’s called queen, not king). But in practice, whether male or female, whether a kid, teenager, or adult, whether stock investor or not, sometimes (or even often) they are overreacting in response to a problem.

And in the stock market, one of the problems are related to the company's financial performance. Based on experience, when a company posted financial performance that is a little bad, for example its net profit fell from the previous year, then the investor will often respond excessively, as if the company was totally bad (as the daughter of writer who considers that a small blisters dilututnya severe injury). They will dump their shares, and consequently the market value of the stock can go down deeply, sometimes could drop more than 50% of the highest price. In fact, as long as the company still make a profit, then its net asset value would still growing, would not it? And as long as the company is not exposed to certain force majeure (legal case, etc.), then they will continue to operate normally without any problems, and they would keep making profits from year to year.

But still, because the performance of the companies looks bad, people become unwilling to hold the shares, including those that had intended to buy it is also postpone the buy, and consequently the prices freefall sometimes until it become unbelievably undervalued. For example I recently noticed Erajaya Swasembada (ERAA), Wismilak Inti Makmur (WIIM), and Semen Baturaja (SMBR). Viewed from any side, the three companies are a good company, has a good track record of performance and excellent long-term outlook, small debts, and also managed by a trusted management. But just because their net income fell slightly in the first quarter of 2015, the three stocks continue to record new low when the Jakarta Composite Index (JCI) only fell by about 10 – 12% from its peak.

Logo of PT Erajaya Swasembada, the largest cellphone distributor in Indonesia

At the beginning, I thought that this phenomenon only happens in Indonesia Stock Market, and also confined to small/second tier stocks (bluechip stocks usually will only drop when the stock index fell, even though their performance seemed not too good). But then I found out that it is a common event for any stocks from around the world, including the stock of the famous Berkshire Hathaway. If, in a given year, Berkshire's net earnings fell from the previous year, its shares usually dropped although the net asset value of the company is actually still rising. Here is the data from last ten years (2004 - 2014) of Berkshire Hathaway’s 1. Net earnings (in millions of USD), 2. Percentage of increase/decrease in net asset value of the company, 3. Percentage of increase/decrease in market value (share price) in a year.

Year	Net Earnings	Book Value	Market Value
	(US$ million)	(%)	(%)
2004	7,308	10.5	4.3
2005	8,528	6.4	0.8
2006	11,015	18.4	24.1
2007	13,213	11.0	28.7
2008	4,994	(9.6)	(31.8)
2009	8,055	19.8	2.7
2010	12,967	13.0	21.4
2011	10,254	4.6	(4.7)
2012	14,824	14.4	16.8
2013	19,476	18.2	32.7
2014	19,872	8.3	27.0

By the way, in the company's website (www.berkshirehathaway.com), the data is available from 1964, ie since Berkshire was taken over by Sir Warren. But if we present all the data here, the table would be very long. So I think the above data is good enough for a sample.

Okay, look. Between 2004 and 2007, Berkshire’s net earnings always go up, and so did the net asset value/book value. And as a result its stock price (market value) also continued to rise during the period. But in 2008, the company posted net earnings of only US$ 5.0 billion, or fell significantly over the previous year of US$ 13.2 billion. Because the prices of some Berkshire’s holdings also dropped in 2008, the company's net asset value fell by 9.6%.

And although Warren indeed said that 2008 is a worst year for Berkshire, but investors took the words too much, in which Berkshire shares plummeted by 31.8%, or down deeper than the decline in the real value of the company. In 2009 and 2010, Berkshire’ earnings back to go up, and so did the company’s net assets rose for two consecutive years. But in 2011, Berkshire profit once again fell from US$ 13.0 billion to US$ 10.3 billion. And again investors took it too much, in which Berkshire’s market value was down 4.7% in 2011, whereas the net asset value of the company is still growing by 4.6%.

On the other hand, the response of investors to the financial performance of Berkshire (which is reflected in an increase or decrease in its share price in the market) would also excessively when the company posts a good performance. Look again the table above, in 2006, Berkshire posted US$ 11.0 billion of profit, grew significantly compared to the previous year of only US$ 8.5 billion. And the company's net asset value rose 18.4% in the year, or much better than 2005, which is only 6.4%. And the result, Berkshire stock in 2006 rose 24.1%, or higher than the increase in the real value of the company. In 2013, Berkshire's stock price also rose 32.7%, or higher than the increase in the real value of the company of 18.2%.

And, believe it or not, if we check the longer data, then the story is always the same: The increase or decrease in the market value of Berkshire is always more significant than the increase or decrease in the real value of the company. In 1991, Berkshire’ net asset value rose 7.4%, but the figure is lower than the previous year (1990) where the company’s net asset value rose 44.4%, making it clear that Berkshire posted a decrease in net earnings in in 1991. And as a result, its shares fell 23.1%. Taking one and a half decades back, in 1976, Berkshire’ net asset value rose 59.3%, or much higher than the previous year's increase of only 21.9% (so it was clear that the net earnings of the company in 1976 had been soared compared to the previous year). And as a result, the stock also skyrocketed 129.3% during the year!

Okay Sir, so what's your point?

The above examples prove that one of the basic habits of investors in the stock market is always overreact towards the financial performance of a company, either good or bad. Yep, the stock market is full of drama queens! If a company posts a really good performance, where its profits soared, and its ROE was very large, then people will hunt the shares so that the price could rise significantly, say by more than 100% in a relatively short time. But on the contrary, when a company posts a lil’ decline of profits, then the shares could fall down, especially if the JCI was also go down. In 2011, when the coal sector at its prime, the stock prices of coal mining companies such as Bukit Asam (PTBA), Adaro Energy (ADRO), Indika Energy (INDY), Bumi Resources (BUMI), Resource Alam Indonesia (KKGI), until Garda Tujuh Buana (GTBO), all went up like crazy (rose way higher than the rise in real value of the company) so that their PBVs could reach 7, 8, or even 10 times, aka extremely overvalued.

But in subsequent years, the coal prices dropped, and of course these companies experienced a decline in profits or even losses. So how are the stocks? In 2011, shares of GTBO rose amazingly from Rp109 to 6,000 per share in just one and a half year. But today, the stock is suspended at Rp260 per share, and even the company has stopped its operations.

Well, for commodity sectors such as coal, it is difficult to expect about when the companies in this sector will back to post a positive performance, because we never know when the coal prices will rise.

However, for companies in other sectors that are more sustainable such as consumer goods, cement, trade, banking, or conglomerate (engaged in many areas of business, such as Astra International), then as long as the managements are honest and competent management, usually their overall performance will be good in the long run. But, just as Berkshire Hathaway, in certain years they may have their net profit fell slightly, and consequently the growth of their net assets for the year become slower than before. And that’s when the stock price of these companies will drop mercilessly, perhaps to a level that is unbelievably undervalued.

And maybe, that's our opportunity!

As you know, along with the decrease in Indonesia’s economic growth, in this year there are many companies who posted a not-too-good financial performance, so that their stocks started to falling down. However, if you are able to identify stocks that 1. Although the performance of the company looks bad at this time, but in the end will be good again, and 2. The stock has fallen so badly, so the valuation is actually already very low, then: You can wait until the concerned company released a better performance in the upcoming financial statements. Because when that happens, the shares will most likely to fly. We already mentioned above about ERAA, WIIM, and SMBR (but you can add your own choices). If they return to post a significant increase in net profit, then you know what to do!

So in the stock market, a stock could fly as high as the sky, or conversely fall as low as the bottom of ocean. The majority of investors always take it seriously when a company's performance looks good or bad, because almost everybody is a drama queen in the stock market. However, as a value investor, you only need to use a little logic: ​​When the price of a stock is soooo cheap, while the company is still operating normally and still make a profit, not being caught with any problems or legal cases, and its management is also honest and competent, then what's to worry about? A three-year-old child may have to be told by her mother that small sore on the knee will not hurt when exposed to water. But hey, you’re a grown adult, aren’t you?

Any inquiries about investment in Indonesia Stock Market? Please send an email to teguh@averepartners.com.