The trade conflict between the US and China has been escalating in the last few months. This also affected the equity investment in the perceived riskier emerging markets including Malaysia which rely more on global trades. Most of shares in Bursa suffered big losses due to heavy selling by foreigners for fear of a full-blown trade war which could adversely impacting on their exports.
The KLSE index retreated from a high of 1900 points three months ago to 1663 points three weeks ago, below the psychological level of 1700 points before recovering and closed at 1769 last Friday on 27th July 2018. Foreign funds continued selling relentlessly in Bursa. Since the last 11 weeks, starting from just before the elections, well over Rm10 billions have been pulled out from the Malaysian equity markets by foreign investors. This outflow of funds was a little scary.
Adding to this downbeat sentiment in global markets, demand and margin weakness were evident for nearly all Malaysian companies, especially those exporting companies. Few escaped unscathed, as underscored by disappointing earnings results, due mostly to lower demand, rising material, fuel and labour costs, and stronger Ringgit. The uncertainties of a new government and cancellation of some mega projects added salt to the wound, although these could be good in the long-term for the equity market.
The share prices of many companies, good ones included suffered double-digit loss since the last few months, including some of my own.
Jaks Resources’ share price is no exception. It has dropped by 40% from its peak of RM1.83 to close at RM1.10 on 28th July 2018, for a loss of 40% in about 6 months.
Having the price of the shares one holds diminishes by 40% in a few months is not that abnormal. Those who had gone through the periods of the Second Board Saga in 1996, the Asian Financial crisis 1998, the Dotcom Bubble in 2001, the US Subprime Housing Crisis in 2007 would understand what I mean. That is the nature of investing in the stock market.
But the problem is what if one engages in margin finance?
The Peril of Margin Finance
Just not long ago, I read three books in Chinese written by a real super investor in Malaysia who has built substantial wealth in the stock market. As I remember in his books, he keeps on discouraging the use of margin finance for the public, but following the “right path” in investing, in particular value investing, to build long-term wealth in investing in part of a business, i.e. investing in good stocks of public listed companies. He had sent the right and proper message to the public, despite he had also sometimes made exaggerated return of investment by using leverage. This is a great advice from him.
Those who have been reading my articles would have noticed I have been a little “loso” 囉嗦, or repetitive in this topic of margin finance. I always like to present an alternative view, for newbies and youngsters. I have written a number of articles on this as published in i3investors. For those who are interested to know more about my opinion on margin finance and its peril to your financial well-being, just goggle with key words “kcchongnz margin finance, leverage”. I feel that with the continuous touting of the investment bankers and individuals in the public forums enticing individuals to borrow and punt in the stock market, I would not have done my social service in this respect.
Recently, I have written two articles on margin finance with examples as below,
- Margin Finance, Ever-Sendai: A real time case study
- Musing on the hottest stock
In the first article above, Ever-Sendai dropped from RM1.37 to 80 sen, for a loss of 42% in just three months a year ago. Punters with RM1m own capital and used 50% margin finance would have lost 86.8% (with other fee and borrowing costs), in just three months. RM1m invested in Sendai would have left with RM132k. The share price of Sendai continued to slide to 70 sen after that, before reversing and closing at 90 sen on 27th July 2018. Assuming the investment banks were kind enough not to force sell the shares, which may cause total loss, punters were still in the red of RM723k, or a loss of 72.3% now.
In the second article above, Heng Yuan was the hottest stock then. The share price of HY rose steadily from RM2.00 in less than one year ago to its intraday peak of more than RM19 at the beginning of January 2018, for a gain of 850% in a year! Those who bought HY with margin then would have made a fortune. However, those who punt it at its peak with margin finance would suffer heavily.
Heng Yuan’s share price plunged from its peak of RM19 to RM12, for a loss of 37%, and plunged again from RM15 to RM8.20, for a loss of 45%, both within a few days. Those who doubled up their bets when the share price dropped faced a big surprise. It went down below RM6.00 a couple of months later and closed at RM6.80, a further drop of 17% from the day the article was written.
Imagine if one was using margin finance to try to get rich quick with this hot stock and seemingly a good investment then. That is the peril of leverage, margin finance, and the use of other people’s money, OPM.
Now, the hottest stock, and also with a margin financing theme falls on Jaks, as you can see the number of articles and comments in i3investor now. As usual, I would also like to join in the fun.
Jaks and margin finance
Figure 1 below shows the share price movement of Jaks Resources from a year ago. As mentioned above, the share price of Jaks lost 40% from its peak of RM1.83 to close at RM1.10 on 28th July 2018, in about 6 months. What has been the detrimental effect of using say 50% margin finance to hope to make it big investing in Jaks?
Figure 1: Share price movement of Jaks
Assuming again one uses RM1m of his own money and borrows another RM1m from bank. The leverage ratio would be 2 to 1.
Table 1 in the Appendix shows the returns of your investment with different scenarios of total returns with a leverage ratio of 2 to 1. The interest rate is assumed to be 4.85%. The setup facility fee is assumed to be 1% and the two-way transaction cost of 0.8%. Note margin account incurs much higher transaction cost than normal account.
Referring to Table 1, if one was unlucky and had bought Jaks at its peak of RM1.83 six months ago, one would have lost a whopping 40% now! The person who uses RM1m his own capital, and another RM1.m OPM would have lost RM834k, or 83.4% in just 6 months. coincidentally, the chart above shows heavy volume at that time. It was no big surprise as most punters are followers of the Greater Fool’s Theory and many would have bought the share at higher price, enticed by the numerous promotions in the public forums, only when the share price has gone up. Being human, they are greedy and wish to mimic the success of super investor of obtaining exaggerated return from OPM.
What if the share price of Jaks drop just another 15%, or 16 sen to 94 sen as shown in column 7 of Table 1 in the Appendix? The RM1m capital would be completely wiped out and become zero!
What if the share price of Jaks drop to 70 sen? Not possible? In this case, not only the punter lost all his RM1.0m, he still has to find more money to pay the bank RM269k as shown in column 8 of Table 1 in the Apendix! It is no joke.
Even if one was lucky enough to not buy Jaks at its peak price of RM1.83, but at the time when its share price stayed steady at about RM1.45 for two months from April to June 2018, one will still lose a whopping 52% with that kind of margin finance. It is really scary.
Imagine, how could one get back to his feet after losing 83.4%, or even 52% in 6 months? How long would it take to recoup those if the market returns to normal with a long-term CAGR of 10%?
The above examples are simplistic, as things like margin calls will come in and loss would be realized earlier, but it does show the peril or horror of using OPM.
Some may argue that it is perfect time to invest in Jaks now as the share price has “unreasonably” beaten down by 40% in such a short time as shown in one of the recent articles in i3investor here,
The article above mentioned about the good value of its Vietnam power plant. He may be right as this is what normally value investors do; buy low and sell high.
How about using margin investing in Jaks now since it is “cheap”, say use own capital of RM1m, and margin finance of another RM1m?
Imagine if Jaks share price goes back to RM1.83, say within six months, the person above would have made 66.4%, or 128% with 50% margin as shown in Table 1 in the Appendix. How wonderful!
However, personally I beg to differ.
I have offered my personal opinion of the power plant before here,
Basically, it is a matter of risks and return, the long gestation period, the cash flows, etc. I doubt Jaks, and also its shareholders will receive a single sen in the next few years, even after the completion of the power plant. Instead, there will be more cash calls to come, for more equity in the joint venture, for fixing its problems in property development and construction. Forget about “profit” during construction stage. It is just from left pocket to right pocket, and back to the left. Whereas when I invest in a company, I wish to receive dividends, and not continuously forking out money, which I am not sure if I would be rewarded in the future.
Investing in a company is not only a segment of its business. It is investing in the whole company; its various businesses, construction, property development, power plant in Vietnam, and their durability, and more importantly, the capability and credibility of its management and its staff etc.
Think about it. Without no experience in power plant development, how did Jaks got this project from a foreign country? What it has to do such that the project will be smoothly carried out? Without any experience in power plant EPC contracts, how is it going to carry out the project?
Of course we know it is the Chinese company doing the whole project, and yes, it will be completed. But Jaks is just an Alibaba. With Chinese calling all the shots, and all the uncertainties in the future, will Jaks get what he may be deserved of? I don't know, but just posed these questions.
I could very well be wrong in my assessment about Jaks and its share price movement in the short-term, and often in the first few days after I wrote my article. Please do not follow me.
Whatever it is, I will still won’t use any margin finance, in any of my investment, more so for a company like Jaks. Yes, I always admit I am a kiasu investor.
Jaks is another good example to illustrate the peril of using OPM. I have used a number of examples in i3investor.
It’s great to borrow a cow and selling the milk, but not until the cow runs off. Now you’re stuck. You owe a cow and don’t have one to return, and no milk. The risk of leverage is investing that debt and losing what you borrowed, which can wipe out any profits, or even your entire capital, and maybe more.
I would also like to reiterate that I have nothing against people making so much money using OPM. It is the prerogative of individuals. But I always like to spread some right message and offer some good advice and maxim to the public.
““Borrowing money is a way of trying to get rich a little faster, but there are plenty of good ways to get rich slowly,” Buffett said. “And – you can – you can have a lot of fun while you’re getting rich as well. My partner, Charlie, says that there’s only three ways that a smart person can go broke. He says, ‘liquor, ladies, and leverage.” Warren Buffett
This article is more about the peril of margin finance than the company, Jaks.
Table 1: Returns with leverage, Jaks