Monday, 2 July 2018

MI EQUIPMENT : HOW WE MADE RM13K IN 4 DAYS BY ANTICIPATING A POST-IPO RALLY


One of our patron saints of investment is George Soros (we like Buffett too, but we're trying to distinguish ourselves from the so-called value investors and mutual fund managers who are currently being condemned to oblivion).


Soros has been called many things; bottom-feeder, destroyer of banks, predator, and moron, among others. But he had innovative ideas and an incredibly agile philosophy towards trading. Being the obsessive nerds that we are, we recommend his biography, which we consider to be one of the best investment books you will ever read. He really did started from the bottom before making his billions.




We have picked out our favorite lessons from George Soros which we kept in mind when we traded Mi Equipment Holdings Bhd, the latest publicly listed company on Bursa Malaysia as of July. These are:


1) Learn From History. Anticipate the Thematics.

2) Invest First, Investigate Later.

3) Ensure That Expectations Are Met.

4) When They Are Met, Pile In, Hard. Utilize Leverage and Ride the Profits.


We applied these lessons to our trade and made reasonable profits, though as always our exit point can be considered conservative. But first, let's go back to the beginning.


Note : We will use a series of tweets to prove that our thinking was made in real time in relation to our trading activity. (Sub-note : please follow us on Twitter)


1) LEARN FROM HISTORY. ANTICIPATE THE THEMATICS

You must have known about the markets in June. For lack of a more appropriate word, it was a truly shit market. Between May 1 and June 29, the FBM KLCI fell by about 200 points, or more than 10%. We can waste time and talk all day long about what caused it, but the following picture practically sums it up.


"I'll put my finger up emerging markets". Source


Anyway, in an environment where on a daily basis you will find 90% of Bursa Malaysia stocks in the red, it helps to start filtering your stock picks. Our fund was in the fortunate position of being 100% in cash as of early June - we had a disastrous May with a series of hilariously wrong market calls, so we took a step back.


But first, a brief on IPOs. In recent years, we have catalogued the characteristics of what makes a successful and unsuccessful public listing for trading purposes. We dislike big money, super-liquid, high volume IPOs due to their low upside potential and oversaturation. The really big ones off the top of our minds include AIRASIA X, ASTRO, and LOTTE CHEMICAL TITAN. They all flopped spectacularly.


We like lower profile listings that are less liquid. For the most part they also possess characteristics of a growth company despite their recent earnings successes. Obviously hype and links to popular political figures clearly boosted previously successful listings - we understood and respected these factors as potential catalysts. Recent successful IPOs that we liked include BERMAZ AUTO, ONLY WORLD GROUP, and SUNWAY CONSTRUCTION (this last one may have been an exception as it was a big-money listing). Again, we say this in terms of trading - it's not a commentary on these companies' fundamentals.


While we do not actively seek out each and every one incoming IPO to trade, we were vaguely aware that MI hits all the right spots in subtle but incredibly important ways. In the interest of brevity we will list them out.


COMPANY

1) A good company with excellent growth potential.

2) A good sector with excellent growth potential.

3) Relative to its peers, the company occupies a not-so-well-understood niche.

4) Its 'friends' (as opposed to peers, but they both are cogs within the semiconductor industry; technically they are not directly comparable) are well-understood businesses and seem to be fairly valued by the market.

5) They talk a good talk. Some lovely promises were made; if anything, the message given by the company is of unbridled confidence. 


STOCK

1) Not too liquid.

2) Good price (a range of between RM1-2). It's fairly affordable.

3) Retail investors will most likely determine the stock's trajectory (it's too small for real institutional focus)

4) Market capitalisation is fairly small. There is room for sentiment to propel it to new heights.

5) At 10.5 times PE, the stock is already at a 17% premium to the IPO price. Wait, did you say only 10.5 times?


MACRO & PSYCHOLOGY

1) Markets are bad. Really, really bad.

2) There is a dearth of opportunities right now.

3) A promising IPO/listing is as good an opportunity as any right now.

4) These kinds of listings are generally market-neutral.

5) It's an exciting semiconductor proxy.

6) By extension, some may consider it a tech proxy.

7) If the stock falls below IPO levels due to a weak market, it's already undervalued for a stupid reason. Thus there is significant upside potential.



"If I were a robot, I'd swipe right on all of these". Source



A disclaimer : we did not prep for this trade. We are vaguely aware of the key details (and always attuned to the current macro/market environment, of course). We made the decision to enter this trade on the second day of MI's listing, and this was after a cursory examination of the price and volume activity.


These detailed rationalisations are mostly after-the-fact, which brings us to our next point.




2) INVEST FIRST, INVESTIGATE LATER

In the rarefied world of old-world value-based investing, such a statement would send mustaches twirling and teacups shattering. But in trading, there may be times when there is no time for an in-depth analysis. By anticipating the thematics, we were actively testing the waters in the expectation that MI would turn out to be a successful listing.




Pay close attention to the time and date stamps in our tweets. 



On June 21, 2018, the second day of MI's listing, we took the plunge after we noticed that the stock immediately rebounded from a brief spell below its RM1.42 IPO price. At the time, this was all the information we needed to trade. We most likely entered the trade late - our first position was at RM1.59, a premium of 12% over the IPO price.


For the chartists : on June 21, the stock hit a high of RM1.61 and a low of RM1.53.




You may ask : isn't it bafflingly stupid to enter a trade at what was then the intraday high? Aren't you guys aware of the huge resistance point at RM1.60 (huge selling volume there)? If some research house says the fair price is RM1.66, aren't you guys irresponsibly entering a trade with a low upside (RM1.66 target price) and a huge downside (RM1.42, the IPO price) ??


We have counterarguments for all of this.


First, we are fully aware of technical charting and research house reports. But unlike most of the general population of retail investors (in our biased opinion), we do not consider these as dealbreakers (in fact, we do not use any technical indicator, other than the price and volume activity).


We entered the trade as the stock activity already points to a real buying demand - a 17 sen rise above IPO is a big move. We knew that this has nothing to do with the broader market; in fact it was a particularly painful day for Bursa Malaysia. We also knew that in the case of BERMAZ and ONLY WORLD, their stock price appreciation potential was essentially limitless; both stocks rose by more than 50% in their first two weeks. MI could potentially be part of this club.


'Could' is the key word here. This is why we tested the waters first. Our initial position was small enough that any significant move downside (even a decline of 17 sen per share) wouldn't hurt us. We have an understanding of how volatile new listings can get. In other words, we will only build a meaningful position once our expectations are met.


3) ENSURE THAT EXPECTATIONS ARE MET


If we were to give one clichéd trading advice for beginners it would be this : dictate your own terms while trading. Never let your emotions or the market dictate them for you. Setting your own rules and parameters are important to ensure that any trading decisions made are not based by emotions or cognitive biases. We do not claim to be geniuses, but we do slavishly follow the rules. 


So, the first rule : set a target.

*stock

Bear in mind that on June 21 the highest MI's stock price ever got to was RM1.61, and we bought in between RM1.57 and RM1.59. We are patient realists; we know there will likely be some short term downside volatility. On this day our position was a smallish (in our view) 50,000 shares.


We are also used to downsides, especially during trades that have failed in the past. We have reduced our hesitance in dumping unprofitable positions. The second target was setting a downside limit; we would've sold the entire position if it falls to RM1.51. In stark terms, we were willing to accept a RM4,000 maximum loss on this trade. 


Obviously, the trade must show an improvement before we can consider boosting our position in it.


 This was another of our expectations.


On June 22, the stock performed a bit worse. After closing at RM1.56 the day before, it hit a high of RM1.57 before closing at RM1.55. Our position was suffering not-so-insignificant paper losses. 



4) WHEN EXPECTATIONS ARE MET, PILE IN, AND HARD 


On June 25 (the next Monday), the stock fell to a low of RM1.52. This triggered a few warnings for us, and we sold 30,000 shares at RM1.53 - if anything, we were being conservative due to the continuing broader market turmoil.



However, within a span of 20 minutes, MI's stock rocketed back to RM1.59. This was when we really started paying attention. Not only did we replenish the previously sold position by buying back 30,000 shares, we further accumulated another 30,000 shares. This brings us to 80,000 shares owned worth about RM127,000.


For our fund, it was a disproportionately large one position. We were also able to utilize leverage to achieve this - thanks to our track record, our broker gave us generous terms. We were also 100% in cash prior to entering this trade. For all intents and purposes, we piled in, and hard. (editor's note : leverage is having the means to buy a position that is worth more than the actual cash at hand).


Leverage is a thorny issue for some - think of it as a double edged sword that can just as easily destroy you. But in the context of this trade, it helped us derive larger profits than we would've achieved had it been made purely in cash-on-hand terms. Being leveraged allows us to focus on an absolute return target as opposed to a percentage return one. This meant that we no longer aim for 15-30% returns; when leverage is in play, a 5-7% return is worth just as much.


A brief detour : here's one of our favorite Soros anecdotes. In one of his most celebrated trades, the Plaza Accord coup, Soros was making huge profits in his long yen position after anticipating this thematic (basically, the 1985 accord was a multilateral agreement to devalue the US dollar to address an ongoing trade imbalance. Anyone who sells short the dollar and goes long the yen or deutsche mark stood to make huge profits). 



Hey kids: learning about old guys in suits can pay off. Source


His traders were more than happy to lock in their yen gains right after the accord was announced - the yen and the mark both appreciated sharply, as was the intention. But Soros was furious. In his mind, this was just the beginning. Why shouldn't he buy a lot more yen and capitalize on a long term trend? He berated his traders and said that he will assume their yen positions if they're going to sell. As one author puts it: "this was the real genius of Soros. He saw that his expectations were already validated, and it was time to leverage to the hilt".


As Soros himself puts it in his book, "we have assumed maximum market exposure in all directions". His ultimate positions were worth USD1.46 billion, or twice the cash value of his fund at the time. His flagship fund, Quantum, eventually made a profit of nearly USD1 billion from this trade. The dollar ultimately fell by 51% against the yen, an unprecedented move in the history of global currencies at the time.


OK, back to MI. Now it's time to recognise a bit of market psychology.


The T4 phenomenon.

'T4' (also known as 'T+4' is typically the time period allowed for retail traders to keep a position without actually buying them. The date of purchase is known as 'T-day', followed by a three-day period (also known as the contra period). 


On T3, the broker will ask the trader/investor whether he/she wants to keep the position. This means actually acquiring bought shares with cash in the trading account. (note: T4 is the ultimate deadline for selling the shares. There are also extended periods such as T8 being offered by some brokers).


The aim for most retail traders is to make money within the contra period. If the position proves to be a profitable one, the trader effectively puts no money down at all; he enjoys all the profits after commissions with his capital untouched. But if he is losing, he can opt to sell the entire thing (absorb the loss) or acquire it with cash. 


This is a very dry explanation, but bear with us. The reason this is important is in the above tweet; those who were caught out by the volatility may be facing a loss; for those who bought on June 20, the first day of listing, their T4 is on June 26 (four trading days later). This is not an absolute rule, but T4 days typically involve forced selling. This means that even for stocks with positive momentum, their price may be somewhat stagnant on these days as the market absorbs this force selling activity. 


We will never know for sure, but in MI's case, the T4 day looks like this:



Notice the weakness.

We had no advance knowledge of this weakness, but we did anticipate the possibility of this happening. Again, the tweet: since this was actually happening, it was time to add to the position at a good price. It was already clear on Monday that the breakout has occurred; we were expecting the rally to continue further (remember our target of RM1.85, as seen on the June 21 tweet). In fact, we bought some 20,000 shares at between RM1.63 and RM1.64, bringing our exposure to 100,000 shares.

At this point our position was already profitable. We initiated our trade on June 21, hence it was only T3 for us. At the June 26 close of RM1.67, we were strongly in the green. 


On June 27, we actually sold our entire position at around RM1.80-1.81. Again, this was a conservative move due to the rapid appreciation in the stock price (MI rose by 28 sen within three days; it can easily fall as fast, or quicker). Hours after we disposed of the entire position, MI hit our RM1.85 target.


As soon as we are out of a trade, we no longer hold any opinions on the stock's future direction. But the trajectory of MI's stock remains positively solid as of June 29 - indeed, it continued rising to RM1.93.

  Awesome. 


To sum it up: we had a plan. We considered the downsides. We rode the profits. We benefited from having leverage. And we did a contra trade : our gains were pure profits with no impact on our capital position. Note that the entire duration of our trade was during the T4 period (June 21-27).


Our absolute returns? A not-so-insignificant sum.

























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