[Investing] The Time for Value Investing Is Here

The Straits Times Index shed 15% from 3220 a month ago to 2637 today. Many stocks are on discount.

Take for example, DBS was in the $25 range. Now it is $19.35. That is more than 20% discount!

At the current price,

• DBS has a market cap of about $52B (it was $56 when I started monitoring it when the index started to fall). I've learnt its probably more prudent to buy larger cap companies.
• DBS has a P/BV of 1.01 and ROE of 12% and ROA(ssets) of about 1%.
• Its profit margin is 42% (woah!)
•  Dividend yield is 4.2% (5-yr average)

With those stats, I think the current price of DBS is very attractive. I valuated it to be about $22 then. I bought some at $21.60 (including fees).

Has the stock reach the bottom? I do not know. 

But this is not the point of this post. The point of this post is to re-visit the principles of stocks-picking, especially at times like this where prices are low and people are panicking because the prices are low.

Not for a value-investor. This is the time to hunt. The basic principles apply. A good stock has:

• Profitable business
• Good financial strength
• Good cashflow

It boils down to two words: Strong and Efficient. The pre-requisite, however, is consistency.

I aim to find stocks that exhibit characteristics of the basic principles. I cited DBS because I think it fulfill those principles (correct me if I am wrong!).

It is easier to judge whether a stock possesses the basic principles. But is is harder to know at what price should one buy the stock if it has been determined that is a  steal?

I used to think:

• What if the stocks drop further, so I can get a better bargain?
• What if the stocks increase and I missed the chance?

I learnt that I can mitigate this by:

1. Split the investment funds into half. 
2. For the first half buy at the price which I determined to be a good value*.
3. For the second half buy only when the price is substantially lower than the value I determine**.

This way I can lock down my optimal value. If the stock price goes up, at least I have gotten into a position that I think is favorable. If the stock price goes down, I can wait longer and then get into another position again, so than on average the stock price I buy at is lower than the price that I valued. This is my form of managing risk I suppose.

However there are many subjectivity. What is good value? What is substantially lower? This will require some education, experience and emotion-management. 

• On education. Reading helps. I have a curated a reading list in this blog. Read about how stocks are valuated, but do not get sucked into fancy valuation models; simple is great. Learn about risk management. Valuation models that do not address risks should be avoided. Valuation is also subjective; nobody can really pin-point the true value of a stock. And because of this, the value of a stock can also be assessed relative to another stock in terms of efficiency. If stock A is 3% return on Assets and stock B is 5%. Which is more valuable? I prefer to think of it as fair price and efficiency.
• On experience. I watch the stock market perhaps once every quarter? But I do take note of news because I know how the media can affect the markets. I personally buy STI ETF on a RSP basis. Knowing the market helps - how much a stock would max at. Some of my friends use the middle-point of the 52-week range to gauge whether a stock is selling at a discounted price. It is probably a good start. P/BV is probably also another good starting point. DCF too. But that said one should not be sucked into the mania of the media and the markets.

This sale has just started. So it is a good time to do some evaluation and buy stocks when the prices are right.

~ZF

Warren Buffett and Charlie Munger are my heroes.
 

[Investing] Book Review - The Warren Buffett Way (3rd Edition) by Robert G. Hagstrom

As the title suggests, this book is about Warren Buffett and his approach and wisdom on investing. It is well-known that Buffett's investing approach goes something like this.

1. Regard buying a stock as owning part of a business. That is, treat stock investing as you would running a business.
2. Buy stocks of businesses that are easy to understand, within your level of competency, has a competitive edge and run by companies' with competent management.
3. Buy stocks cheap.

The book actually sums up the above 3 points in a form of a framework call the Tenets of the Warren Buffett Way. It has four categories, namely Business Tenets, Management Tenets, Financial Tenets and Market Tenets.

The book also discusses the academic forms of finance/investing that gave birth to the modern portfolio theory (the idea of covariance of stock prices as risks, the Captial Asset Pricing Model and the Market Efficient Hypothesis). I found a part pretty meaningful and I shall quote it here:

Today, investors are caught in an intellectual and deeply emotional crossroads. To the left lies the pathway of modern portfolio theory. The theory has a 50-year history full of academic papers, neat formulas, and Nobel Prize winners. It seeks to get investors from Point A to Point B with as little price volatility as possible, thereby minimizing the emotional pain of a bumpy ride. Believing the market is efficient, hence price and intrinsic value are one and the same, adherents to modern portfolio theory focus on price first and asset value later -- or sometimes not at all.

To the right lies the pathway that Warrent Buffett and other successful investos have taken. It has a 50-year history that is full of life experiences, simple arithmetic, and long-term business owners. It seeks to get investors from Point A to Point B not by providing a smooth short-term price ride but by orchestrating an investment approach that seeks to maxmize, on an economic risk-adjusted basis, the intrinsic-value rate of growth. Proponents of the Buffett approach do not believe the market is always efficient. Instead, they focus on asset values first and prices later -- or sometimes not at all

I have read much on value investing (see my reading list!) and I consider myself  a value investor. I think this book is worth a read.

~ZF

[Investment] Stamford Tyres (SGX: S29)

This stock caught my eye and made me went further into research because it is trading at 60% of its book value (BV). The price at the time of writing is S$0.34. BV is S$0.53.

Background : http://www.stamfordtyres.com/

Now for some key statistics

EPS = $0.03

P/E = 9.88

Financial health looks OK but the company has a lot of inventories, although it is appearing to be decreasing. Now, buying the stocks seems to be a good deal in the BV point of view: Buy a piece of the assets at about 40% and the assets have a return of 2.3% (5 year average). The company is constantly buying plants, properties and equipment too, based on the cashflow statement. However remember majority of the assets are actually inventories. A good 80M of it out of 390M of it.

Profitably is actually not so OK. The company is recovering (somewhat) from a massive 80% decrease in 2015. (http://www.straitstimes.com/business/companies-markets/stamford-tyres-full-year-profit-sinks-83) I have not figure out what happened but it was claimed to be some forex and business climate issue. (TBD later)

Cashflow-wise, the company seems to be quite profitable organically. But I notice it has been alternating between long term loans and trust receipts and revolving loans in the years 2014, 2015 and 2016. I wonder why is that. But a huge proportion of the balance cash is actually make up of loans. For example, in 2015, it has about 15.8M of cash. But on the background there was abt 18M of loans going around. In 2014 it is about 14M of loan vs 18.6M of net cash (in all fairness, there was a huge capital layout of 22M to purchase PPE).

Its joint ventures in HK and India seems to been picking up, especially the JV in India has become profitable recently. This could make buying the stock at S$0.34 a sensible, on top of the BV consideration mentioned earlier.

There is a double-edge sword that is worth mentioning. I found that the company receivables are also very high, well around 70M. This is recorded as an asset because it is potential cash. However, the Keppel saga (http://www.businesstimes.com.sg/stocks/hot-stocks-keppel-and-sembcorp-marine-fall-more-than-6), this 70M could be greatly affected if the economy turns sour and companies that owed money start to fold.

There are also numbers that I could not make sense yet. For example for a decrease in inventory from 2015 to 2016, there is no corresponding increase in revenue. Instead the revenue reduced.

There is potential in this company if:

1. Its revenue growth continue to sustain
2. Its cost-control methods continue to be effective
3. It controls its debt well
4. Its JV remains or becomes more profitable

~Huat

[Investing] Netlink NBN Trust Debuts Today - Did You Huat?

So, the very hyped Netlink NBN Trust debuts today. The ticker is CJLU.

"NetLink opened trading at S$0.815 per unit before edging down to S$0.810 on its first day of trade." - From CNA (link above)

All in all, it went up half a cent, or abt 0.6%. By the way, this 0.6% will be wiped out by transaction cost during sell-offs.

Sparked by curiosity, I found out that Shareinvestor has a wealth of information. I found data on the historical IPOs and their performance. There are impressive winners, like those with stock price increase more than 100% (e.g. UnUsUal, Samurai); of course there are impressive losers too. It seems that, by eye-balling (i.e. not validated), there are more losers than winners.

I regard IPOs as a form of speculation. Firstly, there are market participants with the aim to flip some profits from that fact that IPOs generally will gain a decent amount during the first week of opening. This usually works if one has a lot of capital. It does not make sense for small timers like me. For example, if I could only afford $1,000. A 45% increase would just be $450. On the other hand, it would be $45,000 for a person with $100,000. Sometimes absolute numbers are important.

Secondly prospectus are always very optimistic, but always remember that prospectus are a way to gather capital. They are no different from a sales brochure. There will be much ha-has about how their business is going to do well, how good their leadership is, and so on. Fortunately, the only good thing that come out from the prospectus is the numbers. Numbers do not lie. Analyse the numbers carefully to see if the investment is worthy.

Finally, there is no certainty that the IPO will flip say 20% or 40% or even -10% when it opens. We can hope. But there is no certainty. I wonder how it will do for the next few days, especially there could be a massive sell-offs by opportunists who hope to profit from a spike from an IPO during opening day.

Since we are talking about certainty. In the link from CNA, there is a line I quote:

"As a business trust, the future cashflow is predictable, so there is a lack of imagination on this kind of IPO,"

Just to note: As an long term value investor, I appreciate certainty and predictabiluty; I do not need/want to be imaginative. I look for stocks that is profitable, financially strong and sustainable with a healthy cashflow.

For CJLU, my view still holds: I am not going to consider it for sometime, even it means a missed opportunity. You can read about my opinion in the previous blog.

~Huat

[Investing] IPO Review - Netlink NBN Trust

There is much hype about this IPO because firstly, it is going to raise $2.3 billion, the biggest since Hutchingson Port Holdings (IPO in 2011: US$1 , current price as of writing: $0.45), and is dubbed as one of the 'blockbuster' IPOs in 2017.

Netlink is not a stranger to household. They were formerly known as OpenNet. Our broadband is set up by them. They (probably) own the optic fibre network here.

A good resource of the 'boring' points are can be found here.

The salient points are:

• Each unit is going for S$0.82
• About 2.9 billion shares is going to be issued
• Total Market Capitalisation is about S$3B
• Average EPS is 1.5 cents
• Cash is S$92M, Debt is at S$1.6B
• Dividend Yield is about 5%
• Use of proceeds - 1) purchase Singtel's assets and 2) repayment of S$1.1B loan to Singtel

Normally, my analysis will cover FInancial Strength, Profitability and Sustainability. But I have many questions, and hence red flags, just by listing the points above, even if I have not read the prospectus.

A Very High P/E

Just from the points above, the P/E of the trust is going to be at 54x. One conventional way to look at P/E is that it is the number of years for our investment to break-even. In this case it will take 54years. I look at it's recipocal which is E/P, the earnings yield, it's going about 1.8%. That is, for every dollar invested in this trust, it accounts for 1.8% of the earnings.

The high P/E could also mean much hype or expectations for the trust.

To me anything that is greater than 30 is too high, although there's really no hard and fast rule for P/E.

Too Little Cash, Too Much Debt

As stated, there is only $92M of cash but $1.6B, or $1600M of debt that's almost 20x. Even if the proceeds from the IPO is used to pay $1.1B of it, there remains $0.5B, or $500M. It is still 5x of cash! 

From the EPS, I infer that there will be challenges repaying that debt just by the business operations, unless they grow there business, which is my next point.

Lack of Growth Plans

It seems that there are no growth plans (or maybe there is). It is stated that the 'fixed residential wired broadband household penetration stood at 88% as of Dec 2016'. I suppose there is still 12% potential. I did not see any other plans like R&D, or expansion overseas. 

Sustainability of Dividend 

I highly doubt the sustainabilty of the dividends at 5%. A 5% dividends  at S$0.80 translate to about $0.04. Recall that EPS is about 1.5 cents, thats S$0.015. I do not know where the trust is going to top up the money.

A Cash Bump for Singtel

It seems that most, if not all, of the proceeds are going to Singtel. Not only does Singtel receive money for the loan to the Netlink, but it is also able to 'dispose' of some of its assets for cash. If you ask me, Singtel seems to be a big winner here.

Conclusion

I believe the red flags I have listed are enough to deter me from participating from this IPO. I could still participate in this IPO, and make whatever earnings after it is launched, but I will not hold it for too long - not with a P/E that high and not when I cannot figure out how it is going to sustain the dividends. I am saying - there are other opportunities around. Remember that after 6 years, Hutchinson Port Holdings is now at 45% of its IPO value.

Other Reference:

1. http://www.theedgemarkets.com/article/blockbuster-listings-pipeline-singapore-2h17-deloitte
2. http://www.straitstimes.com/business/netlink-nbn-trust-set-to-be-biggest-ipo-in-singapore-in-six-years-with-pricing-at-81-cents
3. https://www.shareinvestor.com/fundamental/factsheet.html?counter=NS8U.SI

~Huat

[Investing] Stocks List as of June 2017

So here are the 30 stocks that are selected based on my hybridized formula investing approach. Check out the link for more on the investing approach I written in another blog. More info can also be found in the Wikipedia page.

I'll be tracking these stocks for over a year to measure its performance. Right now the total value is $27.24.

~ZF

[Investing] Can This Method Beat An Index Fund?

A repost from my investment blog.

So, it is well known that Warren Buffett, my idol, has won a bet with some hedge fund bet. He even commented that money spent on plumbing is better than on a hedge fund.

Anyway, from my previous posts, I have been sharing alot on the Formula Investing. Can this approach beat the Index Fund approach?

Just a short recap, since May last year, I picked some 20 stocks using a hybrid of my methodology and Formula Investing. The constituent stocks have equal weight in the portfolio.

Since now it has been over a year, I shall assess the portfolio's profitability.

Here's the results:

Since monitoring* the stocks in May 2016, Sim Lian Group has been privatised. From the results, the total portfolio worth is $11.6, up 19% from $10.05. If the price at which Sim Lian Group was "sold" is included, which is $0.94, the percentage goes up to 28.3%!

*There wasn't much effort to monitor actually. I just picked and recorded the price into a spreadsheet, and waited.

Seems promising eh?

However, do take note that these figures are purely capital gains - they do not include the trading costs, or any dividends. If the costs and dividends are included, that percentage would be well about 12%.

How would the STI index and gold fare, for the sake of comparison?

Let's look at how the STI performed in the similar period:

May 2016: 2791
May 2017: 3231

Figures approximated from Yahoo! Finance. It is a 15.8% gain. Generally an index fund would perform slightly worse, and this is excluding any costs and dividends paid.

Let's now look at how Gold performed in the similar period:

May 2016: 1215
May 2017: 1253

Figures (in per oz) approximated from goldprice.org. It is a 3.1% gain. Just look at the chart, gold seems to have gone through a roller coaster ride though. But that is none of my business because I'm only interested in stocks.

It does seem that there's some promise my hybrid approach. This is expected because 1) the Formula Investing approach picks up a portfolio of stocks that are already efficient (per stock dollar value) to begin with, and 2) my methodology adds a more stringent criterion to the selection process mete out by the Formula Investing approach.

In retrospect and theory, I should be able to pick out the stocks such that it optimises my returns, right? By this, I mean I could apply the principles of Modern Portfolio Theory to maximise my returns.

In my opinion, the approach is allready satisfactory without using the MPT. Could I do better? I may get a friend who is interested in MPT to help me find out, but personally I do not like complicating simple things.

The Formula Investing method looks promising now, but it does not guarantee returns every time. In fact, it is meant to be iterative process over a long period of time (say 20 years or more).

I will continue to assess this portfolio. I hope to come out a 2017 portfolio soon, so stay tuned! Meantime, I will still blog about the usual stuffs - value investing, accounting, determining stock value, etc.

Oh, and please read the Disclaimer.

~ZF

[Investing] Value Investing in 3 Equations

Value Investing is an investing idea pioneered by Benjamin Graham, the mentor of Warren Buffett. The latter used the principles and added his own to become a hybrid or sorts.

The idea is simple - buy stocks that are undervalued, because value can and will only be realised overtime. Or the popular saying "Buy a dollar for eighty cents".

However, the execution value investing varies. So the valuation techniques and the corresponding valuations are and will be different.

For me, I summarise it into 3 equations.

The Compounding Equation

Pr * (1 + R)^N

Compounding is a very important concept in investing because it accelerates wealth with time. Here, Pr represents the amount of money invested (the Principle), R is the Rate of Return, and N is the number of years invested.

The equation assumes that the returns generated from R is reinvested. For a principle of $100 (Pr = 100), compound at a rate of 10% per year (R = 0.1) for 10 years (N = 10) we would get about $259. The absolute value does not look impressive, but the principle has grown over 2.5x (or 250%), averaging out about 25% a year. And we started out with only 10% in this example.

These are the three variables that make the magic work. There is a choice for each Pr and N, that is, we can choose how much we wish to invest and for how long we wish to stay invested. It is the R that is the challenging part because it really depends on the quality of the business, and I think this is the essence of value investing.

My blog is about finding this R reliably.

The Accounting Equation

A = L + E

This simple equation that quietly resembles a beverage is the next important equation. A stands for Assets, L Liabilities and E Equities. These three entities form the basis of a Balance Sheet. The equation basically means that the assets that a company owns must be supported by some form of liability (debts and loans, for example) or from investors' money (equities).

From this equation, we can also interpret that Creditors (from the L part) and Investors (from the E part) have rights to claim assets. To put it into the investors (that's us) perspective, we can arrange the equation and it will be clear.

A - L = E

That's right. Investors can claim whatever that is left after deducting liabilities - debts and taxes have to be paid first, unfortunately. Hence as an investor, we would want to consider a company with maximal assets and minimal liabilities. In another words, we are looking for financially strong companies.

Assets are generally regarded as necessities to conduct business, which general revenue, and thus profits. Hence assets has to be studied for their quality and also effectiveness, because more assets may not directly equate to better prospects. The next equation is linked to the effectiveness of the deployment of assets.

The Income Equation

P = R - Ex

Here, Profit (P) is Revenue (R) less Expenses (Ex). To be profitable, R must be maximised, and Ex minimised. A company's profitably by and large depends on how they generate revenue through deployment of assets and minimise expenses through efficient business conduct. So it goes back to the efficiency of assets deployment.

The simplest way to assess the efficiency is using the ratio P/A or the return on assets.


These three equations look simple, but they have profoun impact on how we look at companies financials and our decision on whether a company's stock is investment-worthy. And I shall attempt to discuss them in depth in my future entries.

Such is value investing.

~ZF

[Investing] My Thoughts on the Delisting of SMRT

SMRT was considered a good piece of blue-chip stock. Its rail business is profitable, and its media and real estate are doing pretty decently too. It is no surprise why so many are upset when it was announced to be privatised (reference). Then a friend did ask me "Isn't SMRT already private?"

I did not buy the stock despite its assumingly delicious and stable dividends payout for two reasons.

Firstly, its book value is only about $0.60. The stock price when I last checked was about $1.80-$1.90. SMRT EPS stands at abt $0.07 a share. Operating profit is about 10%. It made no sense to me paying a 300% premium for something like that.

Secondly, I roughly understand how this kind of things work. Being public-listed means it had to be profit driven. I believe that public transport should do public good. Being profit-driven normally means that this basic function is compromised, whether privatising will really make it efficient or not. It will be nice to have the best of both worlds though.

Since fares are regulated, SMRT cannot raise fares prices as much as they wish, which is the easiest way to be profitable. So they have to be lean, and most corporations approach that by coming out with cost-cutting measurement.

Cost-cutting is good, except when times when essential functions are cut because they are not generating profits. Nobody would actually see the downstream problems, while the "hero" who recommended the cost-cutting measure was exalted for his/her "forward-looking" and "outstanding" leadership. Then we know what happened later.

Of course there are many other issues that I do not understand, such as the rail infrastructure being publicly funded but the profits are disbursed back to the public (and reliability suffered).

In short I just find it "unethical" (unethical is a strong word, but my vocabulary is lacking) to buy stocks like this. I was called "silly" but I am glad I stood firm to my beliefs.

It's silly I know. There are many who would grab money at any opportunity. I am just happy being the "silly" few.

~yZhiFa

This post is also in my investing blog! Thanks for your support!

[Investing] Efficiency Measures in Investing

Just a quick question:

If you have a dollar, would you buy something that is worth 1) $0.90 or 2) $1.10?

My answer is "depends". It depends if I am in a desperate need of that something. It is a question on the word worth, which is also an important element in investing. But if that something happens to be a share, I will definitely choose 2). That way my $1 is well spent! In fact I managed to increase its value by 10%. 

That is a crude way to introduce efficiency. Efficiency is getting the maximum output give fixed resources. In the previous example, my "output", or reward, would be -10% if I choose to buy 1) and +10% if i chose 2).

As you can see, efficiency is a relative measure. It is important as it affects operation costs and also infers the management's capability. In general, if a company is not efficient, it will incur high costs to produce its products or services, which will then be translated to the customers. Unless the company is the price setter, which is not usually the case, customers will stop doing business with them and find alternatives that are cheaper (customers ARE efficient). The company may increase its margin to compensate for the sales lost instead of being efficient, and thereby increase the cost, and continue to lose customers. This cycle will continue until the company realises the need to be efficient, or go bankrupt.

As investors, we want to make sure that our money is used efficiently to benefit the company (to make the company profitable in general) so it will in turn benefit us. I opine that efficiency is the most important factor to assess if a company is worthy investment.

How to assess efficiency then?

Efficiency is a relative measure, hence a single metrics by itself is not meaningful - something has to be measured against another. There are several metrics that can be useful in helping us make investing decisions.

Earnings Per Share (EPS)

While this may not be considered an efficiency measure, EPS is important. The shares do not make the earnings per se, but the EPS infers the earning power, or profitability, of the company. But as with all ratios, it is dependent on the numerator and the numerator. If the number of shares (denominator) is massive, it dilutes the earnings. Imagine having a piece of 16" pizza to go around 10 people. How about 20? 100? 1000? EPS gives us a quick glimpse of how much of that "pizza" are we going to be entitled to. The next question is, how much should we pay for it?

Earnings Yield

This is the proportion of the price paid that can be accounted by the earnings. (Although there is another interpretation, that is, how much earnings is there for every dollar of the shares paid. I find this interpretation a little warpy). This is a measure of how efficient our (the investor) capital can be used. Suppose a stock with EPS $0.20 that is going for $1. The earnings yield is 20%. Obviously, the higher the number, the better.

"Return in" Ratios

There are a number of return ratios, and the Return on Assets (or Capital) are particularly useful. It compares the earnings over the assets of the company. It shows how efficient the company is at deploying its asset in generating earnings.

Turnover Ratios

These are generally used to measure the company's management efficiency. The inventory and receivable turnover ratios are particularly useful if we want to assess if the company is good at managing its inventory and collecting outstanding payments respectively.

~yZhiFa

[Investing] Compounding - How Wealth and Debt Build Up

There was a time, quite recent actually, where I received a shock from a credit card bill (from a boat-brand bank) - I forgot to pay my credit card balance of $2,389.29 (yes, I have to be this precise). I was topped up with a Late Charge of $60 and an Interest Charge of $145.30, a total of $205.30, not forgetting calls from the company "reminding" me to pay the bill and that they cannot waive the interest charge because of my forgetfulness (this is the first time I forget to pay the credit card bill by the way). I quickly paid the bill, and then closed the account. Well, this account has nice perks, like earning up to 3.5% interest, if you meet some prerequisites, like spending a minimum amount, cashing in your salary, etc. But the interest charge is too much for me. I do not have much money inside that account (heh~).

Not including the Late Payment Fee (as if the interest is not enough), the interest is already at about 6% (145.30/2389.29). Or ~8.6% if I include the Late Charge. This is a 1 month late debt. If I translate it to a per annum value, if I may, it is a 72% interest. To the bank!

What would happen if I continue not paying?

How Debt Accumulates

So I will owe the bank $2,594.59 on the Month 1. If I do not pay I incur yet another $60 and 6%, which becomes $2,810.27 ($2,594.59 *1.06 + $60). This is $420.90, or ~18%,  increase from the original sum owed. What was ~8.6% becomes ~18% in 2 months.

If I continue it for 12 months (assuming I do not get a lawyer's letter from the bank after 3 months), I will have to pay a whopping $5,819.92, 144% increase from the original debt. See the picture below.

The effect of compounding is clearly shown here. Interest is applied on what was owed. And interest charges pile up (or compound) quickly. At 6% interest rate each month (the compounding period) it takes about 12 months to double the amount owed (this is the Rule of 72). 

So the lesson learn is: Do not owe the bank money.

But you might think - but it is not fair, The bank pays us next to nothing (about 0.024%) for the deposits we make and they charge us so much when we owe them money? Well this emphasize the need for investing the savings, to make your savings work harder, and the good news is that we can make use compounding to our advantage too!

How Wealth Accumulates

Now suppose the above example, you are the one receiving the 6% per compounding period. With $2,400 in an investment that gives 6% per month, you will get about $4,800 in 12 months! 

But how does one really make compounding work? Many books I have read do not explicitly say, but I can think of some:

Reinvesting Dividends

This approach consistently buys a share that pays good dividends, and the dividends are used to buy in more shares. By good dividends I mean at least 4%, which is the rate where most blue chip stocks in Singapore are paying.

For example, for an investment of $1,000 in a stock that costs $1/share (hence I would have 1000 shares) and pays 10% dividends, I will receive $100 every year as dividends, which I will use to buy an additional 100 shares. The following year, I will receive $110 which I will buy 110 shares. At the end of the second year, I would have 1210 shares. This means I will have $121 dividends in the third year, and so on.

This is the idea, but in practise it is not that easy to execute namely because:

1. The number of stocks that can be bought is likely to be constrained by the minimum lot size. In Singapore the minimum lot size is 100 shares. If the dividends paid out can buy 1 lot of shares, no problem. The problems lies when we cannot buy 1 lot of shares with the dividends we received - likely due to too little holdings or the dividend yield is too low. The work around could be topping up the difference to buy 1 lot of shares.
2. 1 year is actually a pretty long time frame, relatively speaking. Discipline is required to be consistent. Suppose we are unable to buy 1 lot of shares with the dividends and we opt to wait for the next dividends period (which may be the following year, or may not depending if the company could pay dividends), we might actually forget about this little agreement we made to ourselves. Add in uncertainty, and the dividend next year may not be enough to even supply the balance funds to buy 1 lot of shares, which means waiting another year?  

Reinvesting Capital Gains

This approach is similar to dividend counterpart, but this time the stocks are actually sold, at a profit, and the money is used to buy the same stock or the different stock of the similar yield. Not only this approach has the challenges mentioned in the dividends approach, we have to be an expert in picking stocks that are cheap and we know that it is going to appreciate in the stock price. Definitely a no-no.

Regular Savings Plan (RSP)

RSP are plans that lets you put in say $100 every month to buy a stock or a fund (a unit trusts, ETF, etc). It makes use of dollar-cost-averaging, which the dividends and capital gains approach make use of. You buy more when the price is low, and less when the price is high, but all the value is the same. Except that RSP are generally on autopilot because chances are the funds are managed by professionals. Of course we can set up our own funds (or portfolio) to invest in, we can adopt the Dividends Reinvesting (it is also called Drip Investing) approach to do it. But RSP works only if the time horizon is very long, I would say at least 3 years.

Compounding is a double-edge sword. But understanding it is much more beneficial because it will help us avoid debts and make better investment choices. I have already discussed how a debts can accumulate into a nightmare because of compounding. The contrary is also true, that compounding can help accelerate returns for our investments.

Compounding is dubbed the eighth wonder of the world.

The only outstanding task to do is the execution of the plan, which will be in my future post.

Stay tuned!

~ZF