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Tuesday, 23 October 2018

THE DATASONIC TRADE - WHEN A SCANDAL PAYS OFF

Just like the majority of normal, flawed human beings, we love disasters and scandals. We love reading about them. We gossip about them and waste valuable time and productivity. We read about them in the papers and instantly feel better about ourselves, at least for not paying credit card bills with charity money meant for orphanages.


This time, it wasn't him.


Unlike the majority of normal human beings, we have developed a capacity for trading stocks based on disaster and scandals. This is not necessarily a positive thing as we worship companies with real value first and foremost. But we feel that there is little research currently done in this space.


We know that disasters and scandals create mispricings in stocks. This can create a genuine investment opportunity with massive profit potential. As always, we are obligated to identify and execute such trading opportunities once they arise.


Trading based on pure sentiment requires a more cerebral mind set. We are under pressure to make instantaneous decisions in real time. Not only that, we are also forced to analyse a stock's potential for complete collapse in real time. It is the equivalent of selling life jackets on the Titanic while it's already halfway underwater.


It is also incredibly difficult to buy into a stock which for all intents and purposes has collapsed quickly under the weight of a disaster or scandal. But we managed to do so anyway, and we will show you how we made real, meaningful profits.


But why buy collapsing stocks? It's because we feel that most investors out there put too much weight in a company's value by the price or performance of the company's stock. This is somewhat misguided, even though it's also somewhat accurate; a stock's price is a representation of investors' sentiment of the company's future earnings expectations plus dividend potential. That's pretty much it.


The extremist view would be to see stocks the way someone looks at himself in the mirror. If he feels that he looks good, he feels better about himself. Thus, if investors, analysts, and financial media feel enthusiastic about a stock, the sentiment itself is enough to propel it to new heights, and new lows if they feel otherwise.


Credit : Zunar

You would think that investors would not treat value or defensive stocks in such a way (we get it if this happens with overhyped, capital gains-oriented growth stocks), but this distinction is rarely made. Things such as net asset value are considered irrelevant by most people during the boom times; they arguably become even more irrelevant during a crisis.


Our point: a stock's price does not efficiently reflect a company's value. Sometimes it might, but most times it is distorted by our collective belief and sentiment, whether it's internal (the stock itself) or external (other factors including the current market environment). Because of this, we believe that a stock's price is an absolutely pure representation of investors' hopes and fears. And just like our feelings towards Malaysian politicians, our emotions magnify when a surprisingly unpleasant situation develops.


This is what happened with Datasonic, a firm with a serious dependency towards government contracts. But just like some airline tycoons, we know that a company's best interest is to serve the government of the day; it hardly matters which government it is and who's in charge.


The same case can be made for MYEG, another company hit with scandal but is so entrenched (it helps to have a monopoly in e-payments and an acceptable, profitable product) that it will not evaporate into the night anytime soon. As you may know, both DSONIC and MYEG were hit by scandal and saw a collapse in their stock prices; we only had time to trade the former as its cheaper stock price provided more bang for the buck.


The source of the malaise experienced by long term shareholders of DSONIC and MYEG came from an unexpected source; the former Deputy Prime Minister himself, whom the Malaysian Anti-Corruption Commission is accusing of a long list of utterly dodgy behaviour.


"You have 32 charges? I have 45." Image source.


The news traveled quickly and immediately triggered an epic selldown in their stocks. At midmorning on Friday, 19 October, both DSONIC and MYEG hit their limit down thresholds, or the lowest allowable point for their stocks to trade at on that day.


We are not here to debate the merits of the accusations, or even trade based on the subsequent newsflow. Our foray into DSONIC is purely based on what we consider to be an artificial mispricing in the stock. Bad sentiment is creating a distortion in the stock price. Once panic sets in, we bought into the stock, wagering that a recovery is not to be ruled out. It's peak fear all over again, but there's also more to it.


STOCKS CAN COLLAPSE OVERNIGHT; COMPANIES DON'T


So how do you analyse a collapsing stock in real time? You start by asking many, many questions. The most important one for us is always this : is it an existential crisis for the company? By this we meant : will the company collapse immediately?


In 99% of cases, the answer is no, no matter how bad or scandalous the news might be. But investors do not see it this way. To us, an existential crisis for a company happens due to two things - complete value destruction and an inability to operate as a going concern (think Enron). Quite obviously this was not happening to DSONIC.


Scandals come and go. Companies go through it all the time, and faced with serious allegations, they will refute and fight them to the death. When we first read about the charge involving DSONIC, we were wondering when did the offence allegedly occur and who were the key players? We also considered the possibility of rogue individuals claiming to act on behalf of the company, or even MACC mischaracterising their charges. This is pure conjecture and deserves to remain as gossip fodder, of course; we don't know these things.


What we do know is that despite the charges, DSONIC is not a fraudulent company. It will continue to operate in the coming years, with real products and real cash flow. But processing the news did lead us to the next important questions - how bad will the stock be impacted? Will it hit limit down?


We began observing the stock almost as soon as the news hit. At the time, DSONIC, which closed at 69.5 sen the previous day, had already begun losing value, easily breaking the 60 sen mark in midmorning on Friday. MYEG was already in free fall as it slipped from RM1.50 to RM1.30 in under 20 minutes; we thought this was going to be equally painful for DSONIC.


In about 75 minutes, DSONIC hit its limit down point of 39.5 sen at around 12:05PM. MYEG hit its own limit down of RM1.05 at around the same time. There was a cascade of panic stricken investors selling their shares at virtually any price; they did not wish to become trapped at limit down, where trading would virtually cease due to the massive sell orders and no buyers.


This brings us to the most crucial question of all - is this the time to go in and trade this thing?


THE LIMIT DOWN TRADE


Limit down, bad news, and panic selling; we have read these headlines before. We have written extensively about them for our readers' benefit. Read about our entries on Sapura Energy and KRETAM, for starters. Then read about our little adventure in TOPGLOV, and how possible fraud could not hold down a good company for long.


Here we write about it again, just to demonstrate that trading this angle requires a clear-cut plan and a decision making process that is formed by experience, not pure gambling. We'd also like to emphasise that this angle is not only tradeable and repeatable, but also leads to outsized profits.


For DSONIC, we only look for one thing at that limit down point; an immediate buying support and a small but significant recovery. This basically means that we are planning for the possibility of a strong rebound, right there and then. It's a calculation that the extreme price point ('peak fear') marks the end of the trend, and that those who were desperately dumping shares have already done so.
 

DSONIC price chart, 5-minute intervals, 19 October, 2018


We expected to find out within minutes whether the stock is tradeable or otherwise. Given that investors have priced in the accusations as reported in the papers, the possibility of a rebound is apparent (to us). We got our first signal by 12:10PM, as the stock made a marginal recovery and moved away from 39.5 sen. It went to 41.5 sen; not much, but it's a start.


In chart form, you may not be able to appreciate how volatile the situation was. We saw thousands of lots change hands in seconds. There was some selling desperation, but there was also a willingness by some opportunistic investors to snap the shares at its depressed level; we wanted to be part of that. So the first signal was met easily - no sustained pressure at the limit down point, followed by a marginal recovery. 


Things were quite risky at this point; there was a real possibility that a new wave of selling would engulf the stock, sending it back to 39.5 sen. But this did not happen over the next 20 minutes, giving us our second signal; the sustained buying just above the limit down point suggests that there is real buying interest. We made a decisive move and bought a large number of shares at 42 sen.




During a selldown, the selling pressure overwhelms the buy orders. But as a stock recovers, this imbalance starts to reverse. By 12:25PM, there were larger buy orders for DSONIC but much lower selling orders. This could lead to a buying frenzy as the stock was illiquid at upper price points (43, 43.5 sen, and beyond). We were willing to wait and ride this thematic; our price target at this time was 46 sen and above, or about 10% in return on investment. We'd be happy with those numbers.


Just before the market closes at 12:30PM, we noticed another crucial development; MYEG's stock also rebounded strongly from its limit down point of RM1.05. We literally saw five million shares change hands in mere seconds; given that the stock is far more liquid and pricier than DSONIC, we deduced that the buying interest is real. As both stocks were reacting to the same newsflow - they hit limit up at almost exactly the same time - it probable that both stocks could stage strong recoveries simultaneously too. (Editor's Note : this trend exists but only for very limited durations)


MYEG hit a peak of RM1.18 just before closing at RM1.13, while DSONIC closed at 44 sen.


AND THEN....


The situation develops. The companies, most definitely unnerved by the their stock price collapses, decide to go on the offensive. MYEG decided to halt trading on its stock for the afternoon session. DSONIC went one step further to publicly rebuke the MACC's assertion in a stock exchange filing.


We were asked this question - did we know about this?


Another answer : we considered the possibility of the company denying the accusations seriously, although we had no clue when this might happen or in what form. As always, we were trading based on the price and volume activity, not the anticipation of a favourable development.


DSONIC's stern reply supercharged buying interest in the stock. We believe that the public's logical reaction is this - if the accusations are untrue, why shouldn't the stock recover to it pre-crash level completely? Why shouldn't it go back all the way to 70 sen?


We don't necessarily agree with this point of view, but we understood its appeal. At any rate, this would be favourable to our holdings. And so, as the market opened at 2:30PM, DSONIC shot up to a peak of 55.5 sen, or an immediate 30% gain from our entry price point. 


The result:


That had been a very eventful five hours. Now we're back to hibernation as we await Budget 2019 and an increasingly likely stock market collapse worldwide...











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