Posts Tagged ‘Eureka Report’

Answer to reader quiz: likelihood of takeover

Tuesday, August 18th, 2009

In our previous article, we gave our readers a short quiz to assess the likelihood of a takeover. The purpose of this quiz was not to be a lesson on takeover analysis- the takeover discussion was a red herring to distract you from the core of the issue. As Pete, one of our readers said,

Whilst looking at these takeover targets from a “what has happened in the past” perspective seems intelligent, takeovers rely on much more than is mentioned in those points.

Instead, the purpose of this quiz is to show you a very common mental pitfall that will deceive the minds of many unsuspecting investors.

Now, let’s take a look at this paragraph in the quoted Eureka Report article:

Of the six [takeover likelihood criteria], I find that the presence of strategic shareholdings is the strongest predictor of corporate activity; in fact, since 2000 about 60% of listed Australian companies receiving takeover bids had such strategic shareholders already on their register, even though only about 20% of total companies in the ASX 300 index fulfil this condition.

Upon reading that paragraph, it is easy to conclude that if a company fulfils all the six criteria, then its likelihood of takeover (based on statistical probability and assuming that all takeover bids are successful) is at least 60%.

Unfortunately, even if you believe that statistical probability is an accurate gauge of takeover probability (those who believe in that must read Failure to understand Black Swan leads to fallacious thinking), that number is wrong. The reason why 60% is the wrong number is because it is skewed by survivorship bias.

As we quoted an article in Mental pitfall: Survivorship Bias, the

… tendency for failed companies to be excluded from performance studies because they no longer exist. It often causes the results of studies to skew higher because only companies which were successful enough to survive until the end of the period are included.

That 60% is based on companies who were taken over. It does not include companies who fulfil those criteria and were not taken over. If we take the entire sample of all companies that fulfil those criteria, the proportion of those who was taken over could well be far below 60%.

Today’s lesson on survivorship bias is very instructive on how statistics can be misused to lie and deceive.

Reader quiz: likelihood of takeover

Monday, August 17th, 2009

Today, we will give our readers a simple quiz.

Last month, Eureka Report released an article titled “Top Ten Takeover Target.” The article goes like this:

PORTFOLIO POINT: What are the most likely takeover targets for the year ahead? Here?s my list.

Will BHP come back for Rio? Will Kerry Stokes go the whole way and make an audacious bid for the
Packer family’s Consolidated Media.

It’s never easy picking takeover targets in advance, but neither it is impossible. Over the years I have devised certain criteria that I hope you’ll find useful. There are some obvious factors, such as a wave of pending consolidation; and others that might not be too obvious to the untrained eye, such as ?lazy? balance sheets.

The six main criteria I use to select takeover targets are:

  • The presence of a strategic shareholding on its register.
  • Industry consolidation taking place.
  • Substantial changes to the legislative or regulatory environment.
  • The occurrence of a previous (and unsuccessful) bid for the company in question.
  • Monopolistic and/or duopolistic industry structures.
  • Underutilised balance sheets and strong cash flows.

Of the six, I find that the presence of strategic shareholdings is the strongest predictor of corporate activity; in fact, since 2000 about 60% of listed Australian companies receiving takeover bids had such strategic shareholders already on their register, even though only about 20% of total companies in the ASX 300 index fulfil this condition.

So putting these criteria together and overlaying them on Australian stockmarket, what do you get?

Here then are my top 10 takeover targets (in no particular order) for the year ahead:

Let’s say you searched high and low for a company in the stock market. Finally, you found company XYZ that fulfils each one of the six criteria.

Our question to you is: how likely (expressed as a percentage) is company XYZ going to be taken over?

Stock tip-sheets?influential or manipulative?

Friday, February 23rd, 2007

How useful and helpful are some of the stock tip sheets? No doubt, some of them are very influential. However, we cannot but feel that their influences border on manipulation. Today, we will give you a couple of examples and let you be the judge.

Today, Eureka Report sent an email to their free subscribers (subscribers who chose not to enrol on their paid subscription) saying,

We don’t want to carp…but you missed it! On Wednesday [21 February 2007] Eureka Report subscribers were alerted to Oncard Ltd, a terrific Chinese loyalty card company backed by Australia’s richest investors. On Thursday the stock rose by 45%. We don’t highlight small stocks too often but when we do, we mean business. Our On Card story is this week’s Eureka Express feature.

In that email, they include a link to their ?free? report which was published on the 21 February 2007: Investment aces back Oncard. In that report, Alan Kohler said,

I plan to buy Oncard shares for my family?s super fund, but not ahead of you. In line with Eureka Report?s policy of always putting subscribers first, I?ll be waiting at least 24 hours. The shares last sold at 21.5¢.

Now, let us take a look at Oncard Ltd?s price-volume history here. As you can see, on and before 21 February 2007 (the day the report by Alan Kohler was released), Oncard?s has been trading up to $0.21 with average trading volume (the number of stocks turned over) of around a couple of hundred thousands per day. On 22 February 2007, its trading volume skyrocketed to 9.5 million and its stock price surged to a closing price of $0.37. Today (23 February), its stock price rose to $0.41 with a trading volume of 5.8 million. There were no price-sensitive announcements by Oncard leading up to 21 February?the only announcement on that day was the release of a corporate presentation that was made before sometime in February.

Let us give you another example. Take a look at Bolnisi?s stock price history here. From 1 February 2007 till yesterday, Bolnisi?s share price had been stuck in a range between $2.80 and $3.00. At the beginning of today?s trading, it looked as if Bolnisi?s price will remain within that range. Then at some time today, its share price suddenly surged to a high of $3.16 and closed at a price that is 6.8% higher than yesterday?s closing price. Its trading volume surged to an above average high of 3.9 million. Interestingly, there were no price-sensitive company announcements to explain this curious behaviour.

Guess what happened? Today, a stock tip sheet sent a note to their subscribers, telling them that Bolnisi?s share price had breached a technical resistance level, which is a buy signal for technical traders.

We try not to be cynical, but from these two examples, we cannot help but smell a rat. We suspect those are just the tip of the iceberg.

See like an entrepreneur… how will Telstra be like in 2010?

Wednesday, February 14th, 2007

Today, we heard an interview on Sol Trujillo, the Managing Director of Telstra, on the Eureka Report podcast. In the interview, Sol was asked what will be the main drivers of revenue for Telstra in 2010.

Sol replied, ?By 2010, Telstra wouldn?t any longer be called just a telecom business. It?s going to be a media-comms business, which means our revenue profile [will] change.? He then went on to explain that revenue streams from Telstra’s traditional telephone services (PSTN) will decline, while other revenue streams will gain in prominence. Growth areas include wireless Internet broadband (NextG), mobile phone services, media content (Foxtel) and online and print directory services (Sensis). Furthermore, Telstra is expanding overseas, buying an online real estate business in China, which Sol affirmed that it was ?growing at triple digits? as the Chinese real-estate market is rising exponentially.

This is what we expect to hear. Back in November last year, we said in Is the Telstra T3 offering worth a buy?:

Will Telstra remain just a telecommunication company in the future? This is a very interesting question. If the answer is ?yes?, we would not be keen in investing in Telstra because there are much more lucrative opportunities elsewhere. We suspect the answer will be ?no? because if we were Sol Trujillo, we would have taken the strategic path to transform Telstra to one that is more than a telecommunication company. We believe this strategy is the key to Telstra?s future.

One of the pre-requisite skills of an atypically excellent investor is the possession of entrepreneurial foresight. Entrepreneurs see the future creatively and understand the big picture. If you can see the future through the eyes of an entrepreneur, it will lead you to today?s small businesses that may be on the way to become big businesses of the future. If you invest in such small businesses today, your returns can multiply in terms of hundreds and thousands of percent. Of course, such investments are not without risks. What separates the best investors and the mediocre ones are how they deal with risks. For the excellent investors, they mitigate risks with knowledge, understanding and skill. For the average investors, they mitigate risks with wholesale diversification.

Stock analysts, by definition, are usually not entrepreneurs. The dichotomy between their analysis and entrepreneurs? foresight is illustrated by Sol?s comment in this article, Hurdles, but Trujillo’s Telstra a winner:

Trujillo opened up on the sort of long-term group returns he is aiming at when I pointed out that most of the analysts say that Telstra will generate big future cash flows but not substantial profit rises. “Yeah, well, the analysts here in Australia that have written about Telstra have been absolutely wrong almost across the board,” he says. “Look back at what they said in November 2005 and what has happened since then. So that’s why some people are analysts and why some people are managers and leaders.

We guess many stock analysts will be insulted by Sol?s comments. By insults aside, let us see why analysts are often ?wrong.?

We believe the reason is in the difference between the thinking of analysts and entrepreneurs. Analysts, by definition of their job description, look at businesses through the eyes of the status quo. Yes, they may engage in the forecast of future earnings of a business, but their forecasts are usually made by extrapolating from the status quo or some other derivations from it. Entrepreneurs, on the other hand, look at businesses from the eyes of what can possibly be in the future. As such, what others see as ?impossible? is an opportunity for entrepreneurs to force the camel through the eye of the needle.

Thus, we would not go as far as to say that analysts are ?wrong? as Sol had done. The job of analysts is to base their analysis on what is already solid and ?proven,? which is usually what the eye can see as the current state of affairs. But the job of entrepreneurs is to take risks and turn the current order of things upside down and sweep the status quo aside. With luck, determination and skill, entrepreneurs may succeed. Or they may fail.

As investors, we rather go along with the entrepreneurs and try to understand the risks they take instead of shying away from them by diversifying and diluting our investments.