SINGAPORE (June 24): It was another good week for US stocks. President Donald Trump tweeted that he would meet with Chinese President Xi Jinping in Japan this week to revive stalled trade talks, giving investors one more reason to push stock prices higher. Earlier this month, stocks rallied on expectations that the US Federal Reserve would cut interest rates in the near future. Both the Dow Jones Industrial Average and Standard & Poor’s 500 index are within a stone’s throw from their all-time record highs.
Stock markets around the world too gained on the improved sentiment. Relevant bellwether indices in the region including Singapore, Thailand, Indonesia, Hong Kong, China and Japan are all sitting on gains for the year-to-date. The one standout is Bursa Malaysia’s FBM KLCI, which is down 0.9% so far this year.
This lacklustre performance for Bursa has triggered some politically motivated rhetoric in recent days. But the fact is that stocks have fared poorly for far longer — well before the change in government. Case in point: The FBM KLCI has fallen in four of the last five years. So, if not politically related, why has the Malaysian stock market done so badly?
One of the biggest reasons has to be underlying earnings, which are the main driver for stock prices over the longer term.
We tabulated the net profit for all companies listed on the Bursa throughout the past five years, from 2014 to 2018. We categorised the 855 companies into their respective sectors to determine the profit trend and compound annual growth rates (CAGRs) for each sector (see Table 1).
Table 2 shows the annual year-on-year net profit growth/decline for each sector over the same five-year period; Table 3 shows the sector net margin for each year.
Tables 1 to 3 show that total net profit for all companies fell in 2015, 2016 and 2018 — the CAGR of the decline was -6.8%. Net profit margin too has contracted sharply over the past five years, from an average of 11.3% in 2014 to 7.7% in 2018.
Not surprisingly, the years in which total profits fell were also the years in which the FBM KLCI and broader-based FBM Emas Index ended in the red (see Table 4).
Notably, even though share prices have been declining, the size of the drop is lower than that of earnings. There may be a few reasons for the limited share price volatility on both the upside and downside. Surely one of them has to be the huge impact of local funds such as the Employees’ Provident Fund and Permodalan Nasional Bhd. While there may be benefits, there are also long-term consequences to the integrity of the Malaysian capital market.
Regardless, the result is that price-to-earnings valuations are higher now than they were in 2014. And this is why the stock market is underperforming — valuations are not attractive even though share prices are lower. It also means a turnaround is unlikely until there is broad-based earnings recovery.
Not surprisingly, the energy (oil & gas) sector fared the worst in terms of profits, given the sharp fall in crude oil prices and resulting collapse in global exploration and production activities. Brent crude fell from well over US$110 a barrel at its 2014 peak to below US$30 during the lows in 2016. Oil prices are now hovering around US$60 a barrel.
Profits for plantation companies too were affected by commodity prices, falling 15.6% annually, on average, since 2014. In this case, crude palm oil fell from an average price of RM2,400 a tonne in 2014 to RM2,170 a tonne in 2015. CPO prices recovered to RM2,630 and RM2,800 in 2016 and 2017 respectively, before dropping back to RM2,240 a tonne last year.
Construction, consumer products and services, properties, transport and logistics, utilities, telecommunications and media and even real estate investment trusts reported negative profit growth between 2014 and 2018.
Healthcare, the best-performing sector with a CAGR of 5.7%, has only 15 companies. Financial services, with 34 companies, grew at a CAGR of 4.3%; and technology, with 81 companies, expanded just 2%.
Profits for the biggest sector by number of companies, industrial product and services (239 companies), were up only 0.4% a year, whereas consumer products and services (183 companies) fell 2.3% annually on average. Net profits for property companies declined at an average clip of 3.1% annually for the past four years.
Suffice it to say that, even setting aside the energy and plantation sectors, which are heavily influenced by external factors, the average Malaysian company has not fared well at all. Net profit margin for all sectors declined through the five-year period.
In other words, the causes have been years in the making and are structural in nature.
Increasingly market-dominating government-linked companies and government-linked investment companies — with explicit and/or implicit unfair advantages — led to the crowding-out of the private sector. The lower number of banks — after rounds of consolidation — resulted in less diversity in terms of lending strategies, practices and appetite for risks.
Together with falling corporate profits, they translated into chronic underinvestment in productive assets, technology, R&D and innovation. The quality of the local education system has been in a long-term decline.
Companies that relied heavily on cheap, low-skill foreign labour and failed to move up the value chain were, increasingly, faced with pricing pressure from digitalisation and technology disruption.
Those that have, in the past, flourished under government subsidies were, by and large, unable to fully pass on rising costs, leading to a narrowing of margins. Unfortunately, many Malaysian companies remain simply rent seekers.
The issue of corporate governance may be another reason. As I wrote recently, if controlling shareholders can pay themselves half of the company’s profits as annual compensation, which represents 4% to 5% of the market capitalisation, with no dividend paid to shareholders, surely it must be clear that this amounts to a blatant transfer of wealth of a public company to its controlling shareholders.
The above are some of the more obvious reasons for the chronic underperformance, in terms of corporate earnings and the stock market. They must be addressed urgently and within a holistic framework if we want to see a sustainable turnaround.
But despite all the gloom, investors can still profit by investing wisely and rationally. I will discuss this next week.
My Global Portfolio continued to fare well in the week ended June 20, gaining 1.7% and lifting total portfolio returns to 7.1% since inception. The portfolio is outperforming the MSCI World Net Return Index, which is up 5.9% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports
This story first appeared in The Edge Singapore (Issue 887, week of June 24) which is on sale now. To subscribe, click here
