[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

[Investing] The Little Book of Common Sense Investing by John C. Bogle

I recently bought copy of The Little Book of Common Sense Investing by John C. Bogle. A 10th anniversary edition, updated and revised, may I add.

At the top of the cover is a review by the Oracle, Warrent Buffett:

"Rather than listen to the siren songs from investment managers, investors - large and small - should instead read Jack Bogle's The Litte Book of Common Sense Investing" 

That is it. Any investment book with the blessings from the Oracle himself must be a good book. You can also check out my reading list for the books I have read or am reading.

John C. Bogle is the founder and former chairman of the Vanguard Group. You may find the group a little familiar because it is indeed the Vanguard Group that manage the Vanguard 500 Index Fund. Warren Buffett had consistently backed investing in a low-cost index funds for everyday investors. This is easily validated by a simple Google search. Also, recently, Warren Buffett won a 10-year wager with a hedge fund manager; more about story here.

Back to the book. It is a little book, but it is also a thick one, a good 270 pages. It contains the rationale of behind investing in a low-cost and diversified index funds, and why it is a common sensical thing to do. The key take-away from the book I have is:

Participating in stocks investing is actually a loser's game. Whether profit or loss, the investment managers or brokers will always get a cut. Investors' earnings are eroding by transaction and management costs, and investing costs are exacerbated by transaction adn management costs. 

Only a low-cost and diversified index funds will allow an investor get his fair share of returns in the stock market, through capital appreication and dividends. 

There is also a chapter on Exchange Traded Fund (ETFs). Bogle warns against buying ETFs that are sector or industry specific and discouraged trading of ETFs.

So the investing principle is rather simple and straight forward (or common sense):

1. Invests in a low-cost and diversified index fund. 
2. ETFs that tracks a broad index (such as the Straits Times Index) is a good proxy. However do not trade the ETF.
3.  Hold for long position. Forever if possible.

If you are starting out in investing, this may be a good book to read. If you are a seasoned investor, maybe this book can give you some ideas too.

To me, index investing is an auto-pilot and simple way of investing. There is no need to pick stocks, read financial statements of the companies that are picked (unless you enjoy doing so, like I do). It is low cost and risks are minimized.

Remember to check out my reading lists. There are some reading recommendations too!

Feel free to air your comments!

~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] Risks and the Value Investor

Warren Buffett says it in it simplest form: Risk is not knowing what you are doing.

Every form of investment involves guessing the future, but nobody is good in that and therefore there is always a certain degree of uncertainty (or risk) in investing.

Value investing minimizes that risks by evaluating a company, as if you have a share of the company (you do when you eventually bought shares of that company).  In general, a company must be  at least financially strong and consistently profitable. Next, the investor has to use his funds efficiently. I will share my thoughts on efficiency in the next post.

Financially Strong

Some of the measures to determine if the company is financially strong are:

Book Value Per Share: Book value is also the net asset value (or equity - see how confusing things can be?) after minusing the liabilities. The per-share value is commonly used by some investor as the proxy for intrinsic value of a company. For example, if a company's book value is $1 per share, and the share price is at $0.90, it is deemed a bargain, because you are paying a discount of $0.10 for some share of the assets which are valued (in the balance sheet) at $1 per share. However, this is assessment is generally not accurate, because there is more to the intrinsic value of a company. How wonder it would if it is so simple? 

Furthermore, future money, such as Receivables and Payables can be so inflated that it can create a false reality of the financial strength of the company, especially the Receivables since they are considered as assets. 

Current Ratio: The current ratio, current assets/current liabilities, measures how much current assets a company has in excess of the current liabilities. This ensures that the company can fulfill its short-term financial obligations. 

Debt/Equity Ratio: Debt and Equity are capital sources of the company. This ratio can be high or low depending on the business operations. Care must be taken if this ratio is exceptionally high, because the company is either servicing a large amount of debt, or it does not need investors (Equity) after all.

Positive Cashflow: The company must generate cash from its operations to pay debts, dividends, etc. This can be determined from the statement of cashflows. Extra care must be taken when a company promises to pay high dividends but generate negative cashflows.

Profitability

Income Statement: In general, if a company is consistently profitable, it will improve the share price in the long run. The profitability of a company can be determined from the income statement. There are a few basic things to note. Firstly, a increasing trend must be observed. Consistency is the key word here.

Secondly, the sources of income must come largely from its organic business. Most businesses have "sideline" investments nowadays, and I wouldn't be surprised if they have more income from their investments than their core business. However, if that's the case I would rather invest in  a holding company.

Thirdly, beware of goodwill. I honestly do not know why it is in the Income Statement. But goodwills are premiums paid when the company acquired another company, and they are not tangible. Be especially careful if the goodwill is reported in very large amount, relative to the company's assets and liabilities.

EPS: EPS is important because it essentially says how much earnings each shares is "making" Compare this relative to the share price, i.e EPS/Price, we get the Earnings Yield, which is the proportion of the price of the share that is attributed to the earnings. The inverse of this ratio gives the P/E ratio, the very popular ratio for investing, but IMO it must be used with other metrics to be useful.

The idea of value investing is to piece all the information that one could get to tell a story of a company. Some metrics are suggested here, but there could be more. However, too much information can be paralysing and therefore use only what is required.

Next up would be something on efficiency!

Stay tune!

~yZhiFa