Investors should not rush to buy the company shares as soon as they see the company’s announcement that it has acquired a new large piece of land for property development or the company has secured a new construction contract.
Property Development Business:
Acquisition of a new piece of land does not necessarily mean that the company will surely make additional profit, especially when there is currently an oversupply of properties in every town and city in Malaysia.
Even if the land is cheap, it takes about 1 year to get planning approval, another 1 year to draw all the architectural plans, another 1 or 2 years to get approval. Calling tender and selection of contractors will take at least another 1 year. Construction will take at least another 2 years. Assuming all the projects can be sold with profit, investors can only hope to see announcement of profit after 8 years.
If investors rush to buy the share as soon as they see the announcement of land acquisition, they have to wait 8 years before they can see that the company has profit growth which is the most important catalyst to move share prices.
Construction contracting business:
Securing a new contract does not necessarily mean the company will surely make additional profit.
Studies have shown that there are more failures and bankruptcies in the contracting business than in any other business, and also almost all construction projects are not completed within the original scheduled time.
The delay in completion will cost the contractor more and that is why you can often see abandoned projects which have been undertaken by inefficient contractors. There are many reasons for this peculiar phenomenon.
Open tender system
Although this system is the best way to ensure completion of any project/contract at the lowest price, it is the most difficult obstacle all contractors have to overcome in the real competitive world. They must know their business very well and be efficient to face the open competition all the time. Like a good athlete, they have to keep fit and constantly be aware of the market conditions and their competitors.
There is a classic saying, ‘a cheap thing is not good and a good thing is not cheap’. But contractors always have to produce good work at the cheapest prices.
In order to submit the cheapest tender, the contractor must be very optimistic in all his assumptions to get the cheapest rates. He must assume that he will not encounter any cash flow difficulties and that he will always get his progress payments on time to pay his creditors.
He must also assume that he will not encounter any difficulty in getting all the required materials on time to avoid any delay and also that there are ample workers for him to pick and choose from.
Furthermore, he must also assume that the heavens will be kind to him and he will not meet any inclement weather during construction. Invariably, many of these assumptions are proven wrong and thus completion delayed, and his contracted price is not sufficient to complete the contract. As a result, he loses money.
My advice to contractors:
My advice to all contractors is to diversify into other businesses such as manufacturing of goods for sale, develop properties for sale or do other businesses.
If you look at IJM and Gamuda, you will see that they are the 2 largest construction companies in Malaysia. They started as construction contractors and they gradually diversify to develop properties for sale and do many other kind of businesses. They are successful because they did not solely depend on construction contracts to make profit.
My advice to investors:
Investors must consider company announcements carefully before they buy any company shares. Investors must remember profit growth is the most powerful catalyst to move share prices. If the company shows reduced profit, the share price will drop.