Are There Any Good "Bad Companies"?

Many fundamental investors prefer to buy shares in companies which meet certain criteria such as consistent EPS growth, high ROE, high DY, low gearing, low PE etc.

I follow most of these criteria for the past 2-3 years and it works quite well.

So, basically I won't touch any company which is making loss in recent years, or producing excessively fluctuating results, or struggling to grow its topline, or facing declining profit over the years, or having high debts with low quick ratio, or merely thriving on thin profit margin.

However, after accumulating few years of experience, now I think I should not totally ignore those companies with "bad" results or financial ratios.

While avoiding such "ugly" companies makes our investment safer, we might miss a few golden opportunities to make really good profit.

If you follow this blog, you may notice that most of the stocks I bought recently are not "fundamentally-strong".

Johotin's profit fell a lot last year. Geshen struggled to grow its business. HHGroup is new and unproven.

All have low ROE, low or no dividend and no EPS growth whatsoever.

Two years ago, I won't touch this kind of stocks. Now, there seems to be an unconscious change in my investment style to more like an opportunist.

I don't know whether this is a good change or not. It is still too early to tell.

If you invest in a fundamentally strong company with consistent EPS growth, most probably the company will continue to grow and its share price will follow.

If the company grow fast, its share price will go up faster. If the growth is slow, then share price will crawl up slowly.

If you invest in a company with ugly financial results which not many people want, and that company suddenly turns profitable in style, then the return can be enormous.

It's true that higher risk, higher return.

Of course not every company with ugly results is good. Most are really bad and "uncurable" because of lousy management, lack of competitive edge or being in a sunset industry. So it is for us investors to find out which is the good "bad company".

My sister once worked for a listed company and she told me that almost all the top management team are only interested in their salaries. There is no plan to grow the company and it is also full of office politics.

When I checked the financial result of this company, true enough, it has been making loss for the past 16 years with a few years of small profit here and there.

Am I going to put my money in this company? No way unless the whole management team is changed.

Most good companies become "bad" because of the cyclical nature of global economy.

Generally when world economy suffers, demand for most products and services will drop and so do the related companies' financial results.

When US economy is bad, those companies who export most of their products to US will suffer. This is the same with other parts of the world such as Europe, China, Japan etc.

A country's economy cannot be bad forever. When it recovers, those companies' results will also improve, as long as they can survive the difficult time.

Besides this, commodity price also plays an important role in making a company's result bad.

We have seen recently how low crude palm oil price has affected the financial results of plantation stocks negatively. Soon this might also occur to O&G related stocks.

However, if the commodity serves as the main raw material or major cost for a company's product or service, this company will benefit from low commodity price such as crude oil in aviation & resin related industry, corn/soybean in poultry industry etc.

Commodity price as well as global economy will go up and down in cyclical manner. Investors who are sharp enough to see the reversal trend early will make the most money or lose the least money.

Sometimes a company's bottomline looks bad because of certain non-cash items such as high depreciation charge, forex loss, non-recurrent loss from impairment or something written off.

These paper loss may not affect its cash flow severely and this type of company have a chance to survive and then rebound when their time finally arrive.

An ailing company can also turnaround when luck is on their side. They may suddenly get a big customer or contract, or strike a good deal of merger & acquisition, or successfully venture into new business.

Anyway, for all these to happen, it is not solely due to luck. The company's management team has to be decent at least.

I expect my investment style to change with time. So don't be surprise if you see me investing in companies with single digit ROE or even in companies that are making loss.

If this doesn't work, then probably I will revert to less adventurous investment style.