Monday, August 11, 2008

Listen to Research Analyst! Or Should You Not?

On 26 February 2008, CIMB Research issued a Trading Buy call with target price of RM10.00. IOI Corporation Berhad ("IOI")'s share was trading at RM8.05. A Trading Buy means the stock's total return is expected to exceed a relevant benchmark's total return by 5% or more over the next 3 months. The target price of RM10.00 is approximately 24% over its current price of RM8.05. In fact, the target price has been upped from RM9.40 to RM10.00 based on a forward price to earnings ratio of 24 times. KLCI was trading at

In the same report, CIMB Research has also raised their international CPO price forecasts by 10% to USD1,045 per tonne for 2008, and by 15% to USD1,060 for 2009. Local Malaysian CPO price is expected to go up by 9% to RM3,150 per tonne for 2008 and RM2,900 per tonne for 2009.

On 11 March 2008 (after the general election's results), IOI dropped to RM6.65. KLCI was trading at 1,206.54 (down by 12% from 1,375.43). Now, wondering what is the target price now? Well, it's RM8.30, down from RM10.00 (down by 17%). Reasons quoted for the lowered target price are (a) downgrade in overall market price to earnings ratio following poor showing by incumbent government during the recent general election (b) a weaker outlook for the property sector as confidence in the sector will be eroded by political uncertainty and weak stock market performances, and (c) risks of additional taxes on the planters if government delays price increases on certain controlled items.

Note that the downgrade in target price was amongst others DUE TO WEAK STOCK MARKET PERFORMANCE. The price to earnings for IOI has been cut from 24 times to 20 times. In other words, at 24 times PE, the target price is RM10.00. At 20 times PE, the target price is RM8.30. What say you if you have heed the call and bought in at RM8.05? And interestingly, the buy call was also supported by CPO price uptrend and potential acquisitions.

On 18 April 2008, KLCI was trading at 1,267.82 (recovered slightly from the 11 March 2008's selldown). IOI has recovered to RM7.30. CIMB Research continued to yell a call with price target of RM8.20. Key supporting for the call are CPO price uptick and potential M&As.

On 29 May 2008, Dato' Yeo How, the group's executive director of finance and corporate affairs resigned. IOI was trading at RM7.10 and the price target is now RM8.40. Key share price triggers including rising CPO price and potential M&As. KLCI was trading at 1,261.82.

On 16 July 2008, the buy call that has been yelled all this while has been toned down to Neutral, meaning the stock's return is expected to be within +/- 5% of a relevant benchmark's total return. IOI is now trading at RM6.50 and the target price has now been revised down to RM7.80. Well, no more mention of rising CPO price... in less than a month's time. KLCI was trading at 1,119.42 (dropped by 11% from 29 May 2008's level)

Best part is on 18 July 2008 when IOI was trading at RM6.10 and KLCI was at 1,105.04 (further drop from 16 July 2008), CIMB has now downgraded the price from RM7.80 to RM6.50! One of the reason is CPO price to peak this year!!!! Key re rating catalysts are softening CPO price, lower crude oil price and higher than expected operating costs.

As you can see in the chart below, the CPO price was trading at above RM3,500 on 29 May 2008 and CIMB Research expects the CPO price to continue to rise. My big question is why is that within two months time, the target price has been cut by a huge RM2! As can be seen in the chart again, not only that the CPO price did not rise significantly but instead has started it's decreasing trend to about RM2,800 plus today.

I have always been a keen reader of CIMB Research's report. However, it just doesn't make any sense when buy and sell calls are made based on KLCI movement. When market is good, PE of 24 times are pegged but when market is trending down, PE was slashed to 20 times. So, what if naive uncle and auntie investors follow your call? Shouldn't your analyst is good enough to predict that CPO price is already peaking at RM3,500? Why is that your analyst still forecasted a rising CPO price when market was doing well but then talked about CPO price peaking when market is on downtrend? Would the price target stays at RM10.00 if market where to trade at above 1,300 level?

In the end, should we listen to you or not? Buy calls when market is good and sell calls when market is down. Any fundamentals? Sounds to me like your rationale was 'created' to justify your buy and sell call, depending on market movements rather than the other way round where you make the call based on fundamentals irregardless of market movements.

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