Engineering Breakpoint

How the usage of checklist helped me...

May 13, 2021

Previously, we talk about selling when you simply do not know. This is a part of the risk management that we had put in place.

I am not too sure how many of you remembered names like Ng Teck Lee (Citiraya), Ming De Quan (Celestial Nutrifood) and Chen Jiulin (China Aviation Oil). They had all been infamous due to some level of fraud committed at their public company.

Sometimes, the smallest detail can allow you to glean additional information on the company and as investors we usually need to take heed of these signals.

Since 2010, I had not been close to any fraud. I am unsure why but maybe the act of instituting a long checklist to act as my engineering breakpoint helps.

Engineering Breakpoint in complex engineering system is an intentional small pause performed for safety, reflection and debugging.

Recently, I am looking at an interesting pet food company operating in Europe. It is a business which I could understand. Who wants to purchase pet food at retail and then lug a huge bag of pet food home? The logical choice is to buy it online. I stopped once I spotted the change from EBIT to EBITDA (without explanation) as the time passes. The EBIDTA may become normalised EBIDTA soon. The ability to shift their goalpost on their public document makes me wonder what other goalpost they are shifting privately…

“The first principle is that you must not fool yourself, and you are the easiest person to fool.”
-Richard Feynman

The trigger of writing this article is also due to the initial elation and the subsequent amusement on a discovery of a technology company which is growing at 40% a year but is selling at a single digit PE. The company has SUBSTANTIAL non-current trade receivables. The need to have any non-current receivable is already a red-flag. Substantial non-current trade receivables is like a nightmare… In addition, the main risk highlighted in the auditor report is revenue recognition due to the eagerness to please shareholders and analysts? That is something that I had never read before or maybe I had not been reading enough dubious annual reports….

Coupled with a website that seems to have been build by a novice and the lack of details on any of their product… This is a screaming _ _ _ _ _ .

When you try to swing for the fences in investing you are bound to experience some near misses.

To build the concept of of risk management further, let me share some stories of how serendipity helped me to side step some of the biggest fraud on SGX during my 1st decade of investing (2000-2010) and helped me build a checklist which had helped me avoided fraud for my second decade.

It is the early 2000. Right after the tech bubble and the hottest company is no longer a technology company.

I had just gotten out of National Service (NS) and was just getting enrolled into the university. Since I had the time, I started to read up on the hottest company on the SGX - A recycling company known as Citiraya Industries (Citiraya). The growth, the balance sheet all look really good. When I found out that my good friend is dating an accountant working in Citiraya, I know it is time for a double date.

After a couple of hours into the double date, I finally manage to get the accountant to talk about Citiraya. Most of the things she shared are things which I could glean from the annual report. Instead, the most unusual thing was a story that had circulated within the Citiraya office. It seems that a number of the initial founders left prior to the IPO.

That sounds strangely odd to me. Why would anyone exit an investment right before payday?

Subsequently, Citiraya was found to be involved in a fraud and the boss had been on the run since.

I did not to invest and that double date saved my NS savings from being wasted on Citiraya.

{story remained unverified}

Mid 2000s. I am doing my internship at wallstraits.com - this is the Singapore version of the Motley Fools in the 2000s.

Life is really good. I am interviewing management, writing investment articles and living the ideal life. Being part of the investment community also meant that we got invited to meals sponsored by the listed company which is a big thing for poor and young analyst like me.

During one of the water cooler break, a colleague talked excitedly about the lunch he had just attended at Raffles City which was hosted by China Aviation Oil (CAO) for the investment community. It is a luxurious lunch coupled with an expensive free gift courtesy of CAO or more appropriately CAO’s shareholders.

Disgusted with the information, I promptly sold the shares. That disgust saved my internship pay.

CAO subsequently need to be bail out due to some hedging losses and Chen Jiulin admitted to fraud.

This happen in the late 2000s. I am attending an investor conference organised by SGX.

Ming Dequan, the CEO of Celestial Nutrifood (Celestial) got on stage and pronounced in mandarin, we are going to build the world largest unsinkable aircraft carrier.

I am sure that largest and unsinkable do not go together for a floating structure on the sea is definitely sinkable.

From the annual reports, it shows that Celestial is definitely not an aircraft carrier for they are in a commodity business! I sold out of my position by the time the conference ended.

Celestial subsequently collapsed and the directors of the company were sued for fraud.

If you like us to continue this series on how we structured our engineering breakpoint or what is in our checklist, do drop us a note in the comment section.

Weighted Capital

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