Monopolies

Anyone who played a game of Monopoly will realise that the eventual goal is to establish as many monopolies of districts which share the same colour. After doing so, they can move on and build their houses and hotels, then charge a daylight robbery rate for stepping on it. By charging high rates, they are able to drive the competition bankrupt and become the last man standing.

In reality, thats also how monopolies work. Being the only(or for some industries, largest) producer, they are able to capitalise on the large market share and manipulate the market. It is also interesting to note that because of their monopoly status, they are able to charge a higher prices compared to if they were not monopolies.

Purchasing a monopoly is always a safe bet. Since the monopoly is the only producer, there is little worry that the company would be knocked out by the competition. For this reason, it is interesting to note that the stock price of monopolies are often over-valued, by the standards of valuation ratios.

When it comes to investing, I am often very concern about valuation ratios. This is because I find the idea very intuitive. PE and PB are my favourite ratios. In particular, I like using Price to Book ratio(PB) because it indicates how much of a discount is the company selling at. I find it rather intuitive because if I want to buy a company, I wouldn't want to pay too much for it since I know most likely no one would do so as well, which makes me a sucker.

However, using PB is extremely ineffective when the discussion of a monopoly is concerned. This is not some thing surprising if you think about it. Think about it, monopolies are stable businesses, especially in a highly globalised country like Singapore. Competition does not just come from within, it also comes from abroad. A monopoly would protect the company from competition.

Below is a list of monopolies and their PBs

Singpost

PB: 6.93

SMRT

PB: 3.97

SPH

PB: 2.62

Singtel

PB: 2.42

Some figure are from October. Somehow SGX is down.

This lead to 2 reasons why monopolies in Singapore are overvalued by the standards of valuation ratios. The first reason is as described above, investors want to own monopolies so as to leverage on its stability. This gives the investor the opportunity to adopt a passive attitude towards the stock and focus his attention elsewhere. The second reason is the government. In order to protect the interest of the state or the ruling party, it is in the government's interest to own a large portion of the company so as to ensure no external party can buy over the company to distrupt national interest. This is seen in companies such as SPH and Singtel, which the government own a substantial portion of.

So when evalutating monopolies, my suggestion is to...

• Monitor the history of the company. It is important that there is steady growth in EPS, sales and cashflow. It is also important to note that there is no overstocking of inventories and no problems in collection of payment(account receivables). This is should usually be no problem as monopolies tend to be able to grow fine, especially with the absence of competition.
• Evaluate the profit margin to ensure that the business and the industry is a profitable one. Its not good if the monopoly is not profitable because the pay out will usually not be good.
• We need to note how much debt the company is borrowing. Debt ratios are crucial because it is never wise to borrow too much.

This list is not exhausive, there are many other things to look at and evaluate. I'm kind of tired so I ended at the third point. Other indicators can be found on the web or investment books.

It is interesting to note that some of these monopolies share some common characteristics.

• Defensive counters

Their stock prices do not fluctuate alot, making them very good defensive counters. This is for people who are interested in capital preservation.

• Good dividends

SPH and Singpost are known to be stocks which give decent dividends. This is especially seen in SPH which has a tack record of giving 7% dividends annually, making it the highest % of dividend payout in the STI index.

• The company business goes beyond the industry which it is a monopoly

SPH and SMRT have some dealings in the property industry. SPH owns Paragon, an upmarket shopping mall. Singpost beside doing mail, also deal with payment to government organisations such as CPF and they collect a small fee for it.