Archives for posts with tag: value investing

Some weeks back, my younger brother wanted to learn about investing. I thought about it long and hard for quite a few weeks and eventually, I told him to go and buy this book – The Intelligent Investor by Benjamin Graham, the version with annotations by Jason Zweig.

intelligent-investor-benjamin-graham

Don’t call yourself an investor if you haven’t even read this

Who is Ben Graham?

Benjamin Graham is more famously known as Warren Buffett’s professor and former boss. Graham, together with Dodd, wrote the classic textbook, Security Analysis. Essentially, Graham is the godfather of Value Investing.

Graham biggest contribution was to popularise the idea that buying stocks should be a function of what you get relative to what you pay for. What you pay for is the price but what you get is a share of the profits and assets of the business. In essence, Graham popularised the use of the P/E (price-to-earnings) ratio and, together with Dodd, suggested normalising earnings before comparing with price, which is basically what Shiller’s Cyclically Adjusted Price to Earnings (CAPE) ratio is.

Anyway, I told my brother to buy the book for two reasons and this post is essentially for him.

 

Reason 1: It’s the right way to think about Investing

I don’t mean to offend anyone from what I’ve seen, too many people approach business and investing the wrong way. They learn wrong ideas and end up doing stupid things until they either realise it too late or never at all.

Many people think that investing is all about buying low and selling high and they fail to understand what it really means to buy a stock. From ‘The Intelligent Investor’, there are three important lessons to learn.

#1: Price is what you pay, Value is what you get

Buying a stock means buying a share of the business which is why stocks are also known as ‘equities’ which basically translates into ownership. The essence of Graham, which is at the core of what Buffett and other Value Investors believe, is that an owner of the business cares about the assets of the business and what earnings or cashflows those assets can bring the owner.

Now, the majority of “investors” in Singapore only care about price. They know how much they bought a share of Singtel for. And they know how much they can sell one share of Singtel in the market right now. Why? Because the price is the simplest piece of information to find.

Better investors can cite the earnings, cashflows or dividends that the business can bring in each year. But imagine you’re a business owner. Will those metrics be enough? You’d probably want to know other things: How your competitors are doing? What do customers think of the product? What are the largest components of the cost of production?

The first important lesson from Graham is that being a stockholder means being an owner of the business. If you only buy the stock based on its price and the hope that the price will go higher than the price that you paid for it, that’s speculation. And Graham made it quite clear in the book that therein lies the difference between investing and speculation.

The trick is knowing which activity you’re engaging in.

#2: Price and Value can, and will diverge

The second important idea from Graham is that the stock market is driven by emotion, short-termism, and irrational behaviour. He personified the market as a fellow called Mr. Market who quotes you prices on the stocks each business day.

As Buffett understood, the advantage investors have is that an investor can afford to ignore Mr. Market and take advantage of his over-pessimism or over-optimism. On days where Mr. Market believes that the world is going to end, he ends up quoting prices that are so low that it’s benefit to buy. On days where he thinks markets will keep going up forever, he’ll quote prices that are so high that the business will never be able to provide a decent rate of return for investors*.

#3: Price and Value will converge (eventually)

Of course, for Value Investing to work out, prices and value must converge. In other words, buying at prices that are low relative to value lead to good returns because the market will eventually recognise that the company is worth much more than the current price and therefore bid prices back up to what the company is actually worth.

The problem with this is that this recognition can take time. For example, prices of financial stocks remained fairly depressed following the Global Financial Crisis of ’08-09 and it was only until last year (2017) that bank stocks finally started to gain some favour again.

This is why the great economist, John Maynard Keynes, who was a pretty successful investor as well, said that the markets can remain irrational longer than you can remain solvent. This is why many investors caution against the use of excess leverage. For the majority of retail investors, leverage is something to be VERY careful of. If you choose to proceed, do so with caution.

On the other hand, prices tend to come down fast. So if you’ve bought at a very high price relative to value, don’t expect to hang on to your gains for long. Once again, taking on leverage by shorting the market is also not for the faint-hearted. There are many Value Investors who short Growth and have paid a high price for it. When you short, being early is (almost) the same as being wrong.**

I wanted to do this in one post but it’s gone on for a little too long. In the second part, I’ll show you the parallel between buying “The Intelligent Investor” and investing.

Notes:

*The classic example of knowing how ridiculous the market was when a dot-com CEO told his shareholders that given the company’s share price at the time, he would need to return them 10 years worth of revenues in order for them to just break even. I thought it was Cisco but I can’t seem to find a source for this. Cisco’s price to sales went as high as 37 though.

**For those interested in finance, go watch ‘The Big Short’. It’s accessible and the heroes in the show almost lost everything by being early.

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This is part four of my 10 things every beginning investor should know post.

#4 Turnover is costly

I touched briefly on this in part one so let’s go into more detail here.

Be wary of managers who buy and sell stocks like they would change their underwear. It’s the same thing with dating people who keep having partners, it’s a signal that these people have poor judgement or don’t know what they are doing.

Before we go into that, what exactly is turnover?

In general, turnover refers to transacting. Therefore, a turnover can be thought of as each buy and sell transaction. In evaluating a portfolio, investors can see how often a manager turns over the holdings in the portfolio but looking at something called the ‘turnover ratio’. Investopedia defines this as such:

The turnover ratio is the percentage of a mutual fund or other investment’s holdings that have been replaced in a given year…

There are a few reasons why turnover is costly. Firstly, transaction fees have to be paid each transaction. This means that for each buy and sell transaction, fees are twice.

Secondly, turning over means that investors incur taxes on short-term gains which are usually higher than taxes on long-term gains. While that may not apply here in Singapore since there is no taxes on capital gains, there is no reason to believe that Singaporeans only invest in funds that invest in SGX-listed companies.

Thirdly, even if the manager matches the returns on the market. With the additional fees paid when turning over a stock, it means that returns are compounded over a smaller base.

Fourth, turning over means that the manager must consistently find winners. It’s just pure odds. Let’s be generous and say that the odds of picking a winner are 50%. Having the manager pick just once means that the manager’s odds of picking a winner are 50-50. However, the more times a manager has to pick, the lower the odds (as a total) are because to pick two winners in a row would mean that the odds are 1/2 multiplied by 1/2 which now gives us odds of 1-in-4. Even if the manager has a secret sauce which increases his or her odds of picking winners, the odds that winners are picked must necessarily fall over time due to mathematical laws and as other market participants start to follow the same kinds of strategy.

To sum up, in the words of legendary economist Paul Samuelson:

“Investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or grass grow. If you want excitement, take $800 and go to Las Vegas…”

 

This morning I was having the usual coffee sessions with a few of my colleagues when the topic got around to investing. These colleagues don’t know the exact nature of my portfolio and investing style so I basically got to hide under the radar and listen to the more experienced folks share their war stories. This leads to pretty interesting and thought-provoking ones.

Tale of the day came from a more senior colleague (let’s call him Uncle P) who swears by investing in S-reits. Said reason for investing in reits is because of a talk given by another colleague on the topic sometime in late 2007. After which, he plonked money into the markets when they came crashing down with the collapse of Bear Sterns and Lehman Brothers. His timing couldn’t have been better and he bought into reits at yields that investors would die for. For example, he bought into the same reit that I have. Only thing is, my yield in Aug 2007 when I first bought into the position was some 7%. Uncle P’s? A whopping 30% based on the DPU then.

Uncle P then talked about accumulation and being unperturbed by market gyrations. A fall in price invites an opportunity for more. That’s what he said.

The second half got more interesting when Uncle P revealed that he actually sold the counter for three times his cost as the market ran off. That wasn’t the only counter. He sold off other holdings bought at dirt-cheap basement bargain prices as they ran up, only to see those run up even more.

Then, it struck me.

It takes someone really extraordinary to hold onto his holdings for the long-term. Talk is cheap. After all, why give up an annual yield of 30% for 300% capital gains when more than likely, the switch will be into other counters where prices have run up and returns are likely more muted.

Also, Uncle P took a nibble approach even though prices were terribly, terribly cheap. (I know, I know, hindsight is 20-20. More on overcoming that another time). My view is the nibble approach won’t help if you’re a young person with an average salary, frugal lifestyle and yet looking to make the leap into an elevated income class.

If counters are at bargain prices, it makes more sense to bet the farm (and some more) because these crises (on the scale of the GFC) don’t come around that often. When it comes, we gotta make it count. That’s my view of why Uncle P is probably still a colleague of mine today.

An acquaintance of mine posted this (along with a picture of the book ‘Reminiscence of a stock operator’*) on his facebook wall the other day:

“Retail investors quote Warren Buffett. Fund managers quote Jesse Livermore.
Who would you rather trust?”

I’m not sure why these two financial market personalities were even mentioned in the same breath but given this particular acquaintance’s recently found interest in trading I think the point he was trying to make is that if you want to make serious money, go down the path of the fund manager and not the retail investor.

There are a couple of ideas implied in that sentence that I find terribly misinformed.

First off, not all fund managers are going to have short holding periods (and therefore, should be classified as ‘traders’). Most do but that doesn’t change the fact that different fund managers have different styles and mandates.

Second, studies (championed by financial market luminaries such as Jack Bogle) have shown that fund turnover correlates strongly with worse returns.

Next, I like to present to you Jack Macdonald.

Jack who? Well, Jack MacDonald was a retired attorney from a Washington State who left close to US$200 million in his trust to three charities. That’s right. You didn’t read that wrongly, he left almost US$200 million. How did Jack do it? He didn’t do it by running an extremely profitable legal practice. Nor did he trade his way to those riches. He just stuck to good old fashioned investing and playing really strong (financial) defence. So strong, in fact, that no one in his retirement community even figured he was a millionaire, much less a hectomillionaire. The beauty of what he’s left behind is that his trust will probably be able to generate millions of dollars to disburse year after year to his charities in perpetuity. This is the kind of legacy you can build through proper investing. (you can read more about him here. h/tip: Joshua Kennon)

Trading might be a way to get you to riches but ultimately, to leave behind a legacy that lasts, one will have to adopt proper investing.

Lastly, I thought I’d mention that Jesse Livermore died penniless and of a self inflicted gun wound while Warren Buffett looks likely to eventually pass on a wealthy and happy man.

I think I’ll continue to listen to the retail investor in me.

*This book, of course, is the biography of Jesse Livermore.

I am by no means an adventurer.

In Value Investing there is a common adage to look for value where few dare to go. This makes complete sense as the place(s) that few dare to go are usually the ones that have seen the most carnage and destruction of value. It is also usually when prices are most beaten down that one can find the best bargains. This train of thought should be, and most of the time it is, evident to all investors but one (especially those inexperienced) can never escape this sense of fear that causes an investor to sink his roots in the ground and embrace the warmth of inertia.

This is why I propose another strategy- go where few are able to go.

Recently, I bought some lots of Transit-Mixed Concrete (SGX: 570) for two of my portfolios because I believe that the recent announcement of the URA masterplan means that the number (and value) of construction projects in Singapore over the next two decades are going to be huge*. Of course, TMC is not a huge player in the market- their revenues as a percentage of the value of construction projects in Singapore in any given year is small but my expectation is that the value of construction projects will mean that TMC will also be kept busy (and profitable).

That’s from the revenue point of view. Operationally, TMC has used very little debt and has high returns on capital (approx. 15%). One of the reasons for that is that TMC returns a fair bit of its free cash flow as dividends to investors and this is precisely the reason I’m taking a position in TMC. I’m essentially taking the view that TMC can maintain its costs while seeing an increase in revenues which in turn will allow a higher operational cash flow and eventually lead to higher dividends (more than the current 2 cents per share).

What’s the downside? TMC is a very illiquid stock- management (CEO Chua Eng Him and Founding Member and Director Yap Boh Lim) and the Wee family (through Kheng Leong Company Pte Ltd) collectively own some 70% of the company. This makes for low trading volumes and wide bid-ask spreads which are basically no-nos for anyone managing serious money and traders who scalp for a living.

However, that’s not a bad thing for the retail investor who’s patient enough. Forget the easy capital gains! Forget the quick buck! Sit back and enjoy the 5+% dividend with a chance of upward appreciation. This is what Warren Buffett meant when to think of stocks as equity bonds** and while concrete pumping (TMC’s core profit driver) may be a cyclical business, I believe the future macro environment will be in its favour for some time to come.

Let’s see what happens.

*HDB has released a record number of flats (more than 25,000) this year too.
**Of course Warren Buffett was referring to equities that have such strong moats that their revenues and earnings are more predictable than companies that operate in a cyclical environment.

From the recently published pages of Warren Buffett’s letter to Katherine Graham, whose family is in the news recently for selling the Washington Post to Jeff Bezos, some 38 years ago:

I am virtually certain that above-average performance cannot be maintained with large sums of managed money. It is nice to think that $20 billion managed under one roof will produce financial resources which can hire some of the world’s most effective investment talent.

Why the lack of optimism regarding such huge sums of money? Buffett offers this logic:

Down the street there is another $20 billion getting the same input. Each such organization has its own group of bridge experts cooperating on identical hands and they all have read the same book and consulted the same computers. Furthermore, you just don’t move $20 billion or any significant fraction around easily or inexpensively—particularly not when all eyes tend to be focused on the same current investment problems and opportunities. An increase in funds managed dramatically reduces the number of investment opportunities, since only companies of very large size can be of any real use in filling portfolios. More money means fewer choices—and the restriction of those choices to exactly the same bill of fare offered to others with ravenous financial appetites.

Buffett was advising Katherine Graham on the Washington Post’s pension fund and this letter was what saved it. Of course, the same case could be made for sovereign wealth funds of which, ahem, we have two.

PS: Actually, the headline is a little misleading. GIC’s 20 year real annual return is only 4% which seems to give truth to Buffet’s theory.

Source QuartzWarren Buffett, age 44, explains the futility of playing the market. (h/t: The Big Picture)

Singapore’s foremost investing forum, Valuebuddies.com is back after a downtime for some days.

Yay!

It’s a pity that Musicwhiz has decided to stop blogging.

Although too wordy sometimes, his was one of the best blogs on value investing and fundamental analysis in the Singapore context. I’ve met the guy once and he’s a great guy too- very intelligent and detailed but I suppose if you’ve been reading his blog, you’ll realise that from his posts.

Thankfully, MW is keeping the blog alive so that  one may trawl through the invaluable gems that’s he’s written over the years. It’s an amazing blog because of how he documents his investment thought processes, mistakes made and lessons learnt along the way. For those that will miss MW’s contributions, he’ll still be contributing (albeit in a less detail. Hopefully not less frequently though) over at ValueBuddies, possibly the best forum for investors in Singapore.