Don’t Judge A Company By Looking Simply at Its History

Date: October 3, 2011

by Roger Tan, SIAS Research @ October 3rd, 2011

Here is a quiz: Two men started an army to take control of a state. The first man came from a family of renowned generals. He is well educated and is also well trained in martial arts. More importantly, he is well versed in military strategy and had won numerous battles. He is awed by many great men in the nation. This man has over 100,000 soldiers under his command.

The second man was born in a peasant family. He has been more of a loafer for most part of his life and dislikes reading. He also dislikes farming and seldom helps his father in the field. He does not know any military strategies and has never fought a battle. Before starting the revolution, he was just a patrol officer in a small county and it was rumored that he bought his post by bribing the magistrate. This man has about 3,000 men under his command.

Based on the above information, which of the two men do you think will win the war and become King?

I posted this question on SIAS Research’s facebook recently and many immediately identified the quiz as the war between Xiang Yu (the first gentleman) and Liu Bang (the second gentleman) during the Chu-Han era. As such, many were able to identify Liu Bang as the ultimate victor and the first emperor of the Han Dynasty. However, when I did a street survey (I asked a few friends) of people who were not aware of the history, many chose the first gentlemen as the probable victor. There were a few smart aleck who suspected the second gentleman.

What point was I getting at? We cannot simply look at a person’s past and foretell his future achievements and success. Ability and aspiration to me are more important factors to know and track to estimate a person’s success probabilities. This may also hold true when looking at companies.

In a recent article “Will LionGold be a glittering investment?” on Business Times (dated 30 Sep 11), Felda Chay warned investors who wished to gamble on the counter (LionGold) to be aware that the company’s market capitalization has increased by S$224.1m since it went into gold in Dec 2010. The article highlighted that all the company has “from its new business is a string of artisanal mines and mining licenses that remain untested, and that ONE gold bar it produced”.

The article also quoted unnamed traders from CIMB securities explaining why CIMB (and UOB Kay Hian) curbed the availability of margins on this counter. It also quoted an unnamed CEO of one mining company saying that the mining business is all about luck – 90% luck and 10% skill to be exact.

If what the mining company CEO said is true, then the success of the big mining and even the big oil and gas companies is due nothing more than to luck. And if that is true than all of such companies are overvalued since their value would roughly be zero over a long period of time. LUCK IS A “FINITE COMMODITY” AFTER ALL. I guess the CEO wished to remain unnamed to prevent his investors from dumping his shares or worse get him fired.

But back to my point, it is true that this is LionGold’s first foray into the gold mining business and it is also true that the last business – the environmental business – did not perform as well as expected. It is easy to point the finger and “snuggle” in a judgment based on the past. But frankly, this is business. Not every business venture will be successful, not every successful business will stay successful forever, and more importantly no past success can guarantee future performance. We can easily name a few old darlings who have failed but we will leave it here.

Likewise, it is also possible that a company with a weak history can perform well in the future. What it needs are opportunity, a good strategic plan, and a lot of perseverance to make it happen. It took LionGold about three months to produce its first gold bar in Ghana using newer extraction technology. Building a traditional gold extraction facility would have easily taken them a year. As such, this gold bar – to me as an observer – has a lot of significance and is not just another gold bar.

Of course, LionGold’s share price has risen by 52.6% since Dec 2010 but gold prices have risen by over 30% and gold has been the most popular commodity in 2011. The exuberance on the stock can therefore be explained by past gold price movement and expectations on future price trend.

Can investors make money investing in LionGold? It all really depends on them achieving their production targets over time.

Is there risk in investing in this stock? Of course! Risk has always been a feature in investing – never a bug.