The steps to calculate stock intrinsic value, also known as fair value, is by summing up 10 years of future net operating incomes that is discounted to present value. I use 10 years assuming that no company will last forever and remember that present value of money is always more valuable than value of money in future of exact amount. In order to calculate present value of money in N year in the future, we simply multiply the amount by 1/1.04N (to the power of N) where N is number of years. To make thing simpler, think of 1/1.04N as factor of money depreciation over a number of years. Then I assume a risk free interest rate of 4% (the current risk free interest rate is ridiculously low which is less than 1%, so I adjusted the percentage to a more realistic depreciation rate of 4%)

But wait. How do I know the company future operating income if it hasn’t come to past? Good question, we seriously won’t know how the company will fare in the future except looking at the historical performance. From historical data, you can get the compound annualized growth rate, and then use the key figure to derive the estimate operating income for the future 10 years.

Recently Genting’s stock has been beaten down a bit from RM7.60 to RM6.50 now. So I took some liberty to find out Genting stock’s fair price. I plugged some of Genting’s financial key figures into my spread sheet. First I extract their past six years of net cash from operating income:

From year 2004 RM 1,685 millions, the operating income has grew up to RM2,551 million in year 2009. The compound annualized growth rate is 7.15%. I then use 7.15% as the average growth rate to estimate Genting’s future operating incomes, I arrive at:

Remember that, money in the future worth less in the present? So we need to multiply each year operating income by the depreciation factor (1/1.04N), then we arrived at:

Notice that estimated operating income in 2019 before and after depreciation factor has a huge different. RM 3,553 vs. 5,259 millions before depreciation. Now sum up the operating incomes from 2010 till 2019, we get RM 30,752 millions, the total operating incomes of the next 10 years.

Now, in order to get one share’s intrinsic value/fair value, we only need to divide RM 30,752 millions by number of share issued in the public, in this case, roughly 3.8 billions shares. The result is RM8.30, versus current market price of RM 6.5.

By looking at the stock intrinsic value vs. market price, there is a margin of safety of RM 1.80 if we purchase the stock at RM6.50. However, to arrive at RM 8.30, we must assume that the earning will be steadily increasing for the next 10 years, a slightly lower earning in one of those years, we will need to readjust the fair value accordingly. On the other hand, if the earning growth rate jumps higher, then the fair value will be higher as well (such as when Genting Singapore starts to fly). Of course there might be some other factors or developments in the company that could largely affect the fair value per share such as change in number of share outstanding or some other factors that you deem might hurt company’s future prospect, you can always discount the fair price accordingly.

As my previous article mentioned, 26% of the total fund (Reported amount RM370 Bil, suspect over RM400 Billions as of this writing) is invested in stock market within Malaysia and some oversea. The recent trend obviously indicates that EPF has been very active in the business arena and stock market, such as recently they extend general offer to buy out MRCB and increasing oversea equity allocation. There are also rumors that the potentially bought out company will be the beneficiary of the mega project EPF join venture with the government in Sungai Buloh that has estimated development value of RM5 Billlions. Though later, EPF cooled down on MRCB deal after many criticism appeared.

With all this moves by EPF, it’s hard not to think that EPF has getting more risk appetite as days go by. Though largely I’m stock investor myself, I’m very much aware of the risk I’m exposed to the market every single day I’m invested. On every investment i make in stock market i will evaluate for several days of weeks plus some observation on the company and movements. How much thought do these fund managers give when investing the EPF money in any assets, especially when the gigantic sum of money is not belong to them, much like any private fund manager such as Public Mutual, they are only investing largely peoples money. How much care they have over peoples money, that is the answer we need to know. Do any of them take accountability and responsibility in person or corporate integrity on the investment decision they make and back it up? If the answer is either vague or unclear, more likely you have no place to cry at when the EPF investment comes back with huge losses, while the so called responsible firm will start to point finger. There are simply no transparency, you might say “Yeah, That’s call Malaysia”. True, but let me put thing into perspective, if you invest in any stock, you as shareholder has voting right in the company’s strategic decisions like appointing new directors. EPF on the other hand, contributors own almost 100% of the fund don’t even get a peek at the company’s balance sheet, and income statement. So, what the hell? In a developing country, this kind of thing which usually deem as outrageous in developed countries is still a norm.

Even EPF loses money in stock market, that’s still not a very serious problem in short term, after all 26% out of 370 Billions is only RM96.2 Billions, besides, EPF has waves of recurring income in hundreds of millions ringgit every month. In the event of EPF making losses, the likely potential problem for EPF to tackle is paying out to the retirees who demands for withdrawal. They can easily solve this by paying these retirees with the recurring incomes, given the total amount of withdrawal does not exceed the total contribution overall for a period of time. For a country with more young working generation this might not be a problem because there are always enough people in the work force contributing to the retirement of some one else. However as the age of the country is catching up, it’s very likely we will see number of retirees increases in ratio to contributors. This has already happen in an ultra modern country like Japan where the age is catching up because many working class chose to be single thus the birth rate is low and the population of young generation simply can’t catch up to the aging old generation. If that’s the case, EPF will have a very hard time catching up to the fund accumulation for any investment returns, the losses in present, even in small percentage will have large crippling effect to future generation in term of ability for EPF to pay back. If that happens, i doubt they will be able to pay even 1 percents of dividend given the money comes in from east and out to west. This is the classic scenario of credit user – use the money now and pay (or suffer) later.

Having said all this, I’m not opposing to any investment moves EPF has done. So far they have done an amazing job (at least it appears to be, in general reporting) with return of 5.65% in dividend for such a clumsy fund size. However, given the non transparent nature of the investment strategy, EPF should always be reminded that the fund need to be taken care of with extreme due diligent – Do not forget that the money is peoples’ hard earned money of their entire life and some people will die losing it. Of course it will be better if the EPF can provide some form of reporting resembling listed corporate annual report including the essential financial statements so contributors can have some understanding of EPF fund’s health as a whole instead of remain ignorant.

Note: I will start referring call warrant as warrant in subsequent text.

Have you ever thought the stock you’re planning to invest is way too expensive that you can’t afford to purchase enough? How good is it if the stock price will come down during the right time when you have the money? Consider the odd timing of stock market and you being a busy person yourself, such chance are quite rare. But you don’t need to wait. With warrant at hand, you are owning the right to buy the share at a fixed lower price. However, even though the exercise price is much lower than the stock price during exercise, that does not mean you can profit from it, simply because the warrant price is not zero as well. In order to buy certain amount of underlying shares in exercise price, you also need to own up to certain amount of warrant units depending on the conversion rate. To understand more about warrant, i will illustrate through a few examples.

We will use Supermax warrant SUPERMAX-CW as our example, following are some fact:

Warrant Type: European Style
Exercise Ratio/Conversion rate : 8 SUPERMAX CW : 1 SUPERMAX Share
Exercise Price : RM 5.60
Issue Price : RM 0.175
Listing Date : 9 March 2010
Expiry Date : 10 March 2011

Warrant Type – There are mainly two types of warrants available in the market; American style and European style. With American style, you can exercise your right at any time up to the expiry date. While you could only exercise your right on expiry date for European style warrant.

Exercise Ratio – 8:1 means for every 8 units of warrant you own for SUPERMAX-CW, you have the right to buy 1 SUPERMAX share at RM5.60 each on expiry date.

Exercise Price: At the time of writing on this article, SUPERMAX is floating around RM7.0 – 7.1. So assuming that the share price never go lower than RM5.6 till 10 March 2011, you can exercise the right to buy SUPERMAX share at RM5.60 per unit. Of course, you still can buy the share if the share price go lower than RM5.60, but that doesn’t make sense right?

Issue Price – This is the warrant unit price. This price will usually go up in tandem with the underlying share, vice versa. In the event that the underlying share price goes lower than the exercise price, warrant will become no longer attractive thus the warrant price will be much beaten as well.

Listing Date – the date the warrant is issued and listed in stock exchange.

Expiry Date – Any warrant not exercise beyond this date is worthless and can’t be exercised anymore. Thus warrant also depreciate when the expiry date is approaching, unless the underlying share increases in value which could possibly off set the depreciation because of demand.

So how do we make sense out of this?

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First of all, let’s set a target quantity you would like to purchase on exercise date (expiry date). Say 2000 units at price RM5.60.

Price you pay for buying 2000 unit of SUPERMAX share at exercise price : RM 5.60 x 2000 = RM11,200

In order to buy 2000 units of SUPERMAX share, you need to have 16,000 units of SUPERMX-CW, because 8:1 = 16,000: 2,000.
Cost to buy 16,000 unit of SUPERMX-CW : RM 0.175 x 16,000 = RM2,800

So the total cost of Supermax stock investment plus owning the warrant is RM11,200 + RM2,800 = RM 14,000

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Now here is the fun part, how do you know if you are buying it cheap? A bare eye will probably think exercise price of RM5.60 and market price of RM7.00 is cheap.

Scenario (A) – Assuming on date of exercise, the underlying share price is still RM7.00, this is the outcome:

RM7.00 x 2000 = RM 14,000

If you sell the stock right away at RM7.00 per share, you are even (market price: 14,000 – cost price: 14,000 ). Minus out brokerage fees, you are in losing ground. You see, even at the discounted price of RM5.60, you are only even after including the warrant purchase cost or RM2,800.

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Scenario (B) – However, if the share price is RM10.00 on exercise date then it would be a different story.

RM10.00 x 2000 = RM 20,000

If you sell the stock right away at RM10.00 per share, you will be earning a cool RM6,000 (Market price: 20,000 – cost price: 14,000).

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Scenario (C) – Now, let revisit scenario (A) and see if we can turn the situation around by tweaking the quantity. I will increase the warrant quantity up to 32,000 units, so we have the right to buy 4,000 underlying SUPERMX share.

The cost of investment up till exercise date : RM5.60 x 4,000 + 32,000 x 0.175 = RM 28,000

While the market price up till exercise date, RM7.00 : RM7.00 x 4,000 = RM 28,000

If you sell the 4,000 unit of share right away at RM7.00, you still don’t earn anything even though you increase the warrant quantity.

You see, by increasing the number of share you buy on warrant exercise, you still can’t turn a profit given the warrant price and underlying share price remain fixed. In contrast, as the warrant unit price increases so does the cost of investment, therefore the break-even point gets higher as well. Of course, the main thing to bet on when using warrant as tool in investing is the underlying stock price movement, the higher the stock price goes, if you have acquired the warrant in low price (usually during early life span of the warrant), the break even point would be low as well. At the writing of this article, SUPERMX-CW has appreciated to RM0.30 because of appreciating underlying share, thus if investor starts subscribing the warrant now will require a much higher underlying stock price to break even. As a conclusion, before investing using warrant, be warned. Take note of the exercise date. Do have a strategy. Make detailed calculation of all the figures before jumping in. Warrant can be so sweet in bare eyes as it offers the stock at large discounted price but it could also cause loss at a blink of an eyes.

Readers take note: I wasn’t recommending SUPERMAX share in KLCI, it was just an example to illustrate use of warrant.