Thursday, 28 April 2016

Stocks I would recommend to friends (Which pictures and stock picks!)

I get this question alot

1. I just started working
2. I have 10-20k
3. Where do I park my money, without caring too much about it?

Of course, the actual answer is to shove it in some savings plan, or cpf 'shudders'. If you are not sure where to get a savings plan, just sit in a square outside raffles mrt and get swamped by insurance agents in seconds.

But if you don't want to take the difficult path of buying stocks yourself, here is my recommendations that I would give to my friends based on investments that

1. Have predictable earnings and dividends
2. Have low downside risk
3. Doesn't do anything.

Recommendation 1: Corporate bonds

I would recommend DBS 4.7% preference shares which gives a nice 3.06% cash yield 
(a simple way to think of cash yield is that if you invest $107.6 now, the dividends and $100 you get back when DBS redeems it at par will give you 3.06%)

This mainly because of its
1)Long call date (4.57 years till you have to decide what else to do with the cash)

2)Too big to fail quality (if DBS can't even pay if preference shares, which it has to pay before its dividends then the whole Singapore is in trouble)

If you want to stretch for more yield Genting 5.125% would be great (5.5% cash yield), just that the company has an option to call it back in 1.5 years. The great thing is that casinos are simply money generators. The simple dumb model of casinos are....

1) You spend alot of cash to build the casino
2) you spend little cash maintain the casino
3) you wait for the cash to roll in, even if the cash doesn't roll in your maintenance is so low, that you have excess cash.

As you can see, it spends loads of cash to prepare for its opening in late 2009, after that the casino just literally spews out cash.

Recommendation 2: Vicom

This stock does nothing. Its a bit on the high side atm with a 3% dividend yield only, but if you want a sleep easy stock, this is it. No one covers it, so no one cares about its earnings, which has not been the most exciting. It business is just slapping 'certified' on cars and collecting a cheque which it then gives to you.

Its free cash flow per share vastly outstrips its dividends per share too, ensuring that your dividends are safe, unlike reits

Look at the growth of the cash pile! This company literally has no idea what to do with it!

Recommendation 3: STI ETF when the index is below 2.8k

Look at the nice line!

Actually, the perfect buying price is when the index is at 2.6k. But if you can't wait 2.8k is fine too

But besides drawing lines, usually when the STI hits 2.8k its price to earnings ratio is at 12x, slightly cheaper than its 5 year average of around ~13x, of course ifs earnings keep falling (like it is now) you may want to stagger your buying (dollar cost average). Also 3% yield

Recommendation 4: Singtel when it hits 5% yield ($3.5)

Despite being the bluest chip of the blue, I actually hesitate recommending Singtel, because Singapore telcos have really been earning above average roe than its peers, and its 4th telco entry may lead to a structural decline. Sure you can say Singtel is diversified, but it still gets 50% of its operating income from Singapore

Of course Singtel is never going to back to the levels of 7% yield anytime soon (that was as the smartphone boom has never taken off yet). But if you take levels from 2013 onwards, then investing at 5% yield seems pretty comfortable.

Disclaimer:  Yes I know that the returns I'm promoting are pretty pathetic, but if you have friends that literally know jack shit, these are my top few picks that are most likely to gain steady returns, without suffering much volatility. 3-4% a year isn't saying much, but hey the STI has returned an amazing -8% if you invested in it 5 years ago (April 11)

Wednesday, 6 April 2016

The dangers of investing in reits (With pictures and stock recommendations!)

Too long didn't read (TLDR) version: I'd advocate buying AAreit, Starhill Global, Frasers commercial trust on their
- Attractive valuation
- Cash flows being able to meet dividend payments
- Lower risk of private placements that dilute your shareholdings
- 6-7% yield
There are plenty of blogs/newspaper articles going about how reits are the best source of stable passive income for shareholders, will settle your retirement plans, a godsend, the 2nd coming and will take care of our nation’s problems.
(Obviously these people have not heard of DBS 4.7% preference shares, or a stock called VICOM)
This then leads to a horde of people dumping cash in reits and uttering the oft-quoted line ‘it generates a steady stream of passive income’ and act all investment-savvyish.
Don’t get me wrong, these people have done extremely well in the initial rush of reits listings (think 2011)
If you invested in the Phillip's real estate income fund since inception, you would have gotten a 4.8% annual return + 5% yearly dividends to boot, resulting in a 10% annual gain that puts fund managers, your cpf, your weight gain to shame
But the problem is that now when reits become extremely commonplace, and that the initial 'pop' of a new category listing is over, buying reits with the thought of 'wow 7-8% yield', 'hurr durr reits are super steady and gib monies' doesn't cut it anymore.
Here are some of the dangers that investors should watch out for before investing.
1. Unrealized losses are STILL losses
Ok I cheated, this really isn't something you look out for but its a mindset you should keep in mind. By just claiming 'never mind lah, will still get dividends' isn't a right mentality, not when your reit dropped 20%,and it only paid out 7% yield (when you bought it). 

Even if you include dividends, being down 20% should show you that reits aren't just something you chuck in and collect cash. Buy the wrong one and it becomes something like giving your spendthrift friend $100 and being happy to receive $80 back.

Sabana Reit: Down 30%, while paying out 8% yield (if you bought it a year ago)

Keppel Reit: Down 18%, while paying out 6% yield

2. Check the sustainability of dividends
After a reit sinks and yield moves to a tasty 9-10% yield, some investors may think 'how much higher can the yield go?', prices have to rise. t
Problem is that yields can decline by payouts decreasing and not just by increase in prices.

Sabana: on the way down

For me I would like to look at property income & operating cash flow per share to compare against the dividends paid per share. If the company operating cash flow doesn't even cover its dividend payments then its a big red flag for me.
Just remember, reits are supposed to pay dividends out of their earnings. The problem about these 'earnings' along with property companies is that they can come from a variety of sources such as 'revaluation' and 'other property income'.
Companies can't pay you dividends with a newly revalued floor tile of the property they own (although I would love to see that) so its always better to check the operating cash flow on the sustainability of dividends

3. Check its net debt to assets
Ok so as a reit, if you are forced to pay out most of your cash in dividends, you can't really build your property empire unless you raise funds from outside sources such as Mr debt and Mr placement.
The problem is that MAS has recently put a cap of 45% for a reits debt/assets ratio. Unfortunately this means companies hitting that debt limit has to raise cash by Mr placements, which means diluting you, you poor shareholder.
Lets take a look at some examples:
Cache logistics trust
What happened: private placement (Only to accredited investors, not you buddy) of 100m @94 cents, 6% discount to current price, nov 3 2015
Debt to Asset ratio: ~40%
How you lose: Stock fell 3% after announcement, # of units increased by 13% (means you get a smaller slice of the dividend pie)
1 month return after dilution: -9.5%

Frasers commercial
What happened: private placement of 96m shares at a discount, 24 july 2015
Debt to Asset ratio: ~37%
How you lose: Stock fell 3% after announcement, as usual dilution of your dividends yada yada

1 month return after dilution: -18%

Ascendas reit
What happened: private placement of 90m shares 10 Dec 2015
Debt to Asset ratio: ~37%
How you lose: Stock fell 6% after announcement, as usual dilution of your dividends yada yada
1 month return after dilution: -7.5%

In addition, all the stocks that undergo a private placement went thru short term pressure of selling and underperformed. -7.5% does not seem much, but it did occur within a single month.
Also this 'loss' would have exceeded the yearly dividends that areit distributes, by putting of your purchase AFTER a private placement, you could have some a fair amount of cash
Even if the company states its for 'accretive purchases' you can generally avoid these scenarios by searching for companies with a low debt/asset ratio, so they would raise debt first before private placement which sticks the bill to you.

4. Beware the 'new' reits
Similar to what happened in the oil and gas sector in 2013-2014, where you see names such as pacra and posh rush to list before the window closes, the same thing can be said for reits that IPO-ed recently, (4 years ago or less)

There might be quality stuff over there, but for me I'm quite sceptical of things with no track record and claims to pay a high dividend.

Price performances of 'bombers' for new reits (since 2014)
sabana -40%
far east hospitality -24%
oue htrust -17%

5. We have never seen reits in a 'normal' yield environment
Since 2011, we have been stuck in a yield-chasing environment where people will chuck money at lives, breathes and pays 5% yield. Unfortunately this "should" not continue forever and we may see a sudden shock to the sector.

Anyone remember the taper tantrum? Prices tanked 17% over a few days and never recovered
By setting up a screen and ranking stocks based on
  1. Debt/asset <38% (I don't want to get dilution, 38% is usually a danger level)
  2. Operating cash flow vs dividends per share (cash in should be more than cash out, to show that mgmt. can afford to pay growing dividends)
  3. Price/Dividends per unit (inverted dividend yield to measure cheapness)
  4. Price/Nav (same valuation method as property stocks)
  5. Positive dividend growth (negative dividend growth comes as a double whammy of both lower prices and yield
  6. Yield: yes I look at it last
Here are my few picks so far

Aims capital reit (buy at 1.3)

  1. Debt/asset = 31%
  2. Operating cash flow vs dividends per share: 7% buffer
  3. Price/Dividends per unit: -1% undervalued vs 5 year historical
  4. Price/Nav: -2% vs historical
  5. Positive dividend growth: yes
  6. Yield: 8.4%
Frasers commercial trust (bought at 1.25)

  1. Debt/asset = 36%
  2. Operating cash flow vs dividends per share: 2% buffer, due to recent placement
  3. Price/Dividends per unit: -16% vs 5 year historical
  4. Price/Nav: 2% overvalued vs historical
  5. Positive dividend growth: flat
  6. Yield: 8%
Starhill global (bought at 0.78)

  1. Debt/asset = 35%
  2. Operating cash flow vs dividends per share: slim -0.83% buffer
  3. Price/Dividends per unit: -10% vs 5 year historical
  4. Price/Nav: 3% overvalued vs historical
  5. Positive dividend growth: flat
  6. Yield: 6.6%
As you can see, the reits above are not really cheap, it was during the great Singapore sale, but I happily missed like the oblivious person I am.

Also some of them don't really have a high buffer for paying out dividend income. (Unlike most mapletree reits, but those are overvalued in my view).

In addition, I have not taken into account industrial factors (like omg there's a huge pile of offices coming on stream in 2016-17). But, if I have to choose 3 reits this would be it.

Monday, 29 February 2016

My simple dumb way of following Warren Buffet method of investing (With pictures!)

There are 3 main points in valuing a stock

1)Value of the company now

2)Fundamentals of the company

3)future earnings

This is literally the basis of the discounted cash flow method where you

- Predict future cash flow(3)
- Compare it against the value of the company(1)
- Take a discount(margin of safety) based on how well you think the company can achieve these future cash flows (2)

1) is easy, load up any bloomberg terminal and you get the answer

When P/E bands are narrowly trading around 18-20x, you know 16 and below is cheap and vice versa

2) is also easy, grab the company's annual report, do the usually check on its cash flow, D/E ratio, margins, ROE/ROA etc and you get quick a good picture of the company

3) Now this is the hard one, and its also the point that essentially dictates whether you are going to make or lose money on the stock.

So how do I do #3? How do I beat all the super smart people that are being paid $10k a month, to not create anything productive but instead to just guess what the company is going to earn next year?

What i do is to....... Not try to predict the company earnings but just find companies with predictable earnings.

I know myself, I'm a lazy investor that cant be bothered to fight with all the smart people head on, I like to answer questions where the answers are also a dead certain

Warren Buffet quote ' I don't cross over 10 feet poles, I look for 1 foot poles to stepover'

Just take a look at the earnings of raffles medical

With my lazy intellect, I can safely assume that this company is going to get me between 0-10% growth a year

Or even Comfortdelgro

I don't need some analyst to tell me that comfort is going to grow 5-6% next year, I can see that for myself

Barring some unforeseen
-terrorist act
-government order
-recession or the end of capitalism as we know it

I can feel safe with these numbers without you know... putting much effort

Of course this largely depends on the industry

Some people look at Sembcorp (like alot of retail investors do)

see it grow about 10% yoy (like alot of retail investors do)

see its high yield (like alot of retail investors do)

assume it will do so in the future (like alot of retail investors do).

Then you forgot about the part where rigs are tied to oil price, and go thru cycles.

Boom -22%!

However, the downside of this method is you dont get those spectacular returns, unlike when you call for the bottom or turnaround in an industry.

Thats because the market rewards people that do hard work and understand cyclical industries, small caps or those that swing from losses to +100% profit next year.

I on the other hand, am slightly allergic to hard work (even though I'm trying to improve), and I don't feel confident on taking all the 'smart people' who are in the serious business of making money head on.

*Insert sun tzi art of war quote here* (know yourself, fight the battles you can win etc etc)

I'm looking for stocks that is at least

-10% undervalued

-grows 5% a year

-pays 2-3% yield.

In 5 years that results in 10% + 5(3%+5%) = at least a 50% gain which is about 10% a year.

Now, even though it pains me to say this: markets are surprisingly quite efficient (most of the time)

and that its quite hard to find these stocks at even a 10% undervaluation.

But certain events such as

1) General market weakness

2) Slight miss in quarterly earnings

3) 1 time solvable problems

Can give you that window to invest

1) General market weakness

Comfort tanked about 13% due to the so-called China 'meltdown'
I'm sure that would hurt Comfort when it has a great...... 5% revenue exposure in China

2) Slight miss in Quarterly earnings

I don't have an example here, since most of my stocks have a bad, or should I say good track of beating earnings. But the point is, unless there's a huge shock or change in the direction of the company, there is no cause of concern.

If you expect the company to make 5-7% a year and it actually made.... 4%. I mean I'm disappointed but it shouldn't cause panic which is what Mr Market sometimes do

3) 1 time solvable problems

Visa tanked 13% in less than a month when Russia wanted to ban it (Russia contributes to a stunning.... 1% of Visa's revenue). It didn't get banned anyway.

The huge risk

However there is a huge risk in this seemingly safe method which is the structural shift of the company or industry.

This method heavily hinges on the company being in a position/industry so impenetrable (think coke) that it can be counted on to deliver steady earnings and is awarded with a generally high PE level.

But when the company loses it, everything gets thrown out of the window.

Lets start with Warren Buffet stocks (since he is a big user of this strategy)

1. Walmart/Tesco (Position decimated by amazon)

2. American Express (Decimated by supreme court ruling and losing its brand to Visa/MA)

3. IBM (Destroyed by cloud computing giants, though it may be too early to write them of as ibm has continuously reinvented itself)

I'd like to add on another i fell for

4. Sands China (Anti- Corruption Drive)

The good thing is these problems even though well-documented, takes AGES for the market to realize it.

Visa and Amazon didn't come out of nowhere, and neither did cloud computing giants. Xi started his anti-corruption drive back in 2014. So there should be ample time for you to get out when you see the signs

The bad news is that it hurts a lot, you suffer the horrible word called 'de-rating' where instead of having a nice 20x you get sent down to 12-13x, funnily enough same pe as industrials

The other bad news is that theres alot of false challenges. Loads of people tried to displace coke over the years and yet no one is calling for its demise, apple pay is trying to supplement visa (maybe in 10 years), but failing horribly etc etc.


Its not totally a buy-and-hold strategy, you still have to sell out when there is large structural changes, or when the stock gets too pricey (I mean if the stock goes up 20-30% while earnings grow 5%, there is a bit of a problem) its good to take money off the table.

But if you do want a sleep-easy portfolio, something that you won't feel worried about when the markets are tanking, then this may be a good method to start your investing journey

P.S I started investing 4 years ago, and I'm still refining this method instead of trying new ones

P.P.S Look at the performance of the companies I mentioned during this downturn (aka. coke, comfortdelgro, raffles medical, visa), in this period of horrible times they are all trading..... near record highs

P.P.P.S That makes me quite mad because they aren't cheap. I'm in this situation where the markets are tanking and I can't seem to add positions.

Monday, 8 February 2016

Markets aren't really crashing, they are normalizing

As much as I think its an extremely bad habit to make predictions on the global outlook/sentiments because

1. you are most likely to be wrong
2. unless you fancy yourself as a global macro trader, there are too many links before your call can affect your stock price (global outlook -> industry outlook -> country outlook -> stock earnings outlook -> stock price)

But, it is fun because for a brief moment I can sound like an 'expert' as the guy who is in the serious business of making money with little or no effort (and also with little or no substance)

1. The problems aren't new, just sentiment has changed
The 3 reasons that have been quoted endlessly on why the market is falling have been
1. China slowdown
2. Falling oil prices
3. US interest hikes

The problem is that all of above were already present in..... 2nd half of 2014. China didn't 'suddenly' slowdown, neither did oil prices 'suddenly fall', and there has been so many articles  analyzing the fed's move and Janet Yellen's words, that these people seriously need to get a life.

No, the big problem is that people are slowly waking up to the thought 'wait why am I paying premium valuation for stocks when the outlook is so gloomy?'

2. About that 'bear market' in the U.S
We are getting closer in technical terms (-20%), the S&P and NASDAQ is already down mid-teens from its all time high. Let me repeat, all time high. Even with the market bloodbath the past month, its still trading AT its 5-year P/E average.

3. About STI's world beating performance
Yes the STI is at 5-year lows, but as stated in the previous post
thats due to the heavy sector weightage towards, Offshore marine, banks and telcos, which each have their individual problems.

4. This unfortunately means stocks are not cheap enough.
When I mean cheap, I mean recession fear levels where every stock gets beaten down due to sentiment even though its unrelated to the global economy. The problem is that it hasn't happened yet to Singapore OR the US

Comfortdelgro (still trading above its 5-year average P/E, -5% this year, hardly a move)
Raffles Med (down 20% in 6 months, and its still trading at......35x P/E)
Sheng Siong (has not budged from 85 cents for almost a year)

If you bought into 'momentum' stocks, then I can't help you there. On the blue-chips front, even though stocks like JNJ, Coke, Disney, 3M, PG, Visa have fallen in-line with the market (Well, I mean thats almost half of the Dow) its still trading wayy above its historical averages.

5. Going forward
Any fun market outlook post, isn't going to be complete without fun predictions, here's some of mine

Buy Oil at $30 Sell at $35 or whatever 10-15% gains you are happy with.   
You can do this by buying U.S oil etf's (USO US) or heck even keppel corp or those smaller O&M names. My simple dumb reasoning is

1. Oil is finally forming another support (not bottom, but support). The same thing happened when it was finding its support on $40 and bumped back up to $45 (on middle east troubles, less inventory than expected etc etc)

2. We are finally starting to see mega-mergers in the oil arena, horrible profits and shutdown on rigs.

3. Simple dumb math, if you think oil has a higher chance to go to $40 ($10 gain) than $20 ($10 loss) go ahead

Sell when you see an STI pop
The markets aren't really volatile actually. They're only volatile when you compared to the previous abnormal 2 years (when the banks were easing the market). This current volatility is quite normal-ish which is good news to sell out of some of your STI ETF holdings. 

The banks and keppel corp are going to take a looong time to recover from China slowdown and Oil(which isnt going back up to $60 anytime soon). Get rid of them when there's a pop, put your money elsewhere, or.... you can do the normal retail investor thinking of ('keppel and dbs won't die what, just hold until price recover and collect the dividends lor). Whatever works.
Cheap hiding places
Singtel and keppel DC reit, Genting 5.125% perps are the only 3 cheap hiding places i can identify, if you cant stomach the volatility, these counters would fit perfectly due to

Singtel  (Diversified portfolio + 5% yield)
Keppel DC reit  (Data centers, stable compared to office, hospitalility and logistics +6.8% yield)
Genting perps (almost trading AT par. Casino's also have strong cash flows, I mean all they do is to build a casino and sit back and collect cash, no inventory, no R&D, and even with the china tourists slowing down, its still has a pretty big war chest of cash)

Friday, 5 February 2016

Things I do not invest in.

Its always important to define your 'circle of competence', in addition to that, its even better to understand your limitations.

Look, I'm a 24 year old guy, been investing for 4 years have some experience looking at stocks and listening to analyst calls. But thats about it. Making huge calls on where the economy is going and predicting earnings on complicated companies are wayyyy out of my depth.

Of course that means passing up some (alot) of opportunities here and there but its fine. I'm perfectly happy to sit still and do nothing, then assuming that i know everything.

So here's a list of industries that I don't invest in.

Besides the line 'the P/B ratio of Sg banks are now < 1, the first time in 5 years or whatever' I have no other good reason to invest in them.
Do I have a clue where NIM's are going?
Do i know how the china slowdown is gg to affect NPL?
Or the weakening business climate and slowing property market affecting loan growth?

Not a clue

Do I want to find out? Ain't nobody got time for that!

Even more complicated than banks, and sticking to my true form of failing to not recognize my limitations, i invested in AIA, will be looking to see when can i exit this dumb mistake.

Industrials (O & G)
Making a long term investment in industrials is all about catching economic cycles, oil price cycles (for O & G companies), as usual I can't even predict my lunch for tmr, I'm not expecting to predict when the next cycle is going to happen. Although I do have a hunch (we all do), I don't feel comfortable putting $5000 in it

Look if i want to gamble (a.k.a buy noble stock) I might as well wait for CNY blackjack, its much more fun.

Same as banks, Besides the line 'the P/NAV ratio of property companies are now < 1' I don't have much insights on who is selling what, whether the government is relaxing its 12 cooling measures, so on and so forth.

Although if you closed your eyes, bought Facebook stock when it IPO-ed without reading a single shit or with the logic 'because Facebook is everywhere' you would have more than doubled your money, I never seem to be able to do that.

Things I do invest in

Yes, with the 'forever new entry of the 4th telco', this industry isn't as steady as it used to be, but your dividends, earnings, valuation can still be easily predicted.

Consumer staples
Mostly for large branded companies like (Dollar General, Coke, Sherwin Williams in U.S) you can't really go that far wrong in predicting what earnings growth next year will be when it has been growing 5ish% for the past 5 years (hint: its going to be around 5%)

Same, especially if you are the middleman (hospital or pharmacist). Steady growth, easy to understand business.

Ok this one doesn't quite fit because it is tied to the property market and general economy, but with a payout that doesn't fluctuate much and easy to understand earnings (I mean they already own the buildings not sell new ones) valuation is easy. 

Waste management services, exchanges, payment services are all tollbooths.
You have to use them, so the volume they get doesn't really fluctate
The charge per transaction is mostly fixed
The cost are fixed too, they already built the booth

So this is shown in most of my holdings (past/present) which shows you how I invest or screw up.

Past holdings
Visa (tollbooth)
SGX  (tollbooth)
Raffles Med (healthcare)
Shengsiong  (Consumer)
Coke (Consumer)
Aims Capital  (Reit)

Current Holdings
Keppel reit (reit)
cache logistics (reit)
oue h-trust (reit)
AIA (screw up)
Dollar General (consumer)
Sherwin Williams (consumer)
Fedex (consumer)
Stericycle (healthcare)
CVS (healthcare)

Thursday, 4 February 2016

Having the right mindset for new investors

There's loads of starry-eyed people that like to start investing and drop hints to their friends like

'I'm in the markets'
'I monitor the markets'
'I read the companies fundamentals and judge its future earnings prospects' etc etc

The problem about this, it usually causes people to have the wrong mindset, that they are the smart ones in this 'serious business of making money' and then emotions start to come into play when they need to explain to their friend about how they go about the 'serious business of making money', which causes them to make the wrong choices.

There's plenty of blogs/strategy's out there that tells you how to 'look' at stocks, but not much about the proper mindset they should have, so here's a short list of stuff that I hope will help people alter people's mindset

Rule #1: Don't lose money
Pretty obvious but most people forget the fact that the majority of retail investors lose money, don't feel the pressure to 'beat the market', you are just a retail investor with a fresh annual report and a stock screener, relax, adjust your expectations

Rule #2: Don't forget rule #1
Another note: Even Warren Buffet places these 2 rules at the top of the list, drill it in your head.

Rule #3: There is no rush to invest
If you got into the markets 'early', bought the STI Index 5 years ago, you would have lost -20%, sticking it into a structured deposit or even your current account that gives you a 0.05% interest, would have allowed you to outperform other people that are in the  'serious business of making money' by 20.05%

Rule #4: Inflation burns you ALL THE TIME
There is the usual argument that if you don't invest, inflation will burn your returns. True, but that is not the main reason you should invest. Inflation doesn't disappear when you invest, its always there. Don't feel pressured to invest because of inflation.

Rule #5: Opportunities appear/disappear everyday
Unless capitalism is going to end tmr, opportunities are going to appear/disappear on a daily basis.  
 'You will regret the chances you don't take' But that's an obvious statement to make, there's an infinite number of chances, opportunities, but the # of chances you can take is a finite option.

Same as Rule 3-4, don't rush, there will be other chances. 

Rule #6: you are not smart
Before buying a stock, take a step back and think. 'Wait why did i just put $5,000 in a stock?' Am i really going to spend 5k based on this simple logic like

'p/b below 1 so i buy?'
'i like the fundamemtals'
'my friends all use the product'

Controversial point here, especially for people that think they are in the I mean the 'serious business of making money' .

You have to think of yourself as just a small little investor, no knowledge and just calculate a few numbers. By investing in a stock, you are making the claim that the market is wrong, the stock price is wrong,everyone is wrong, because I'm in the 'serious business of making money'

Once you have that in your mind, then check your logic for buying the stock. How are you different from the other people?

Don't get me wrong, investors can get lucky sometimes and small investors can beat large investors but usually not with '3 lines of logic'

I drill this in my head everyday 'whats a shmuck like me with an excel sheet buying stocks?' Helps to keep your head sane.

Wednesday, 2 December 2015

Investment philosophy: Don't predict earnings, find companies with predictable earnings

Investment philosophy

The price of stocks are a sum of three parts

1) Quality of the company
2) Future earnings of the company
3) Value of the stock

1) Quality of the company

- Quality of the company consists of 2 components
- The current industry the stock is in
- The historical/current financial health of the company

The current industry the stock is in involves checklists such as
- Stability of the industry
- Monopolistic/Oligopolistic nature of the company
- Company's branding

The historical/current financial health of the company
- Earnings track record (net margins, volatility in earnings, historical growth etc)
- Debt (interest coverage, D/E etc)
- Productivity (ROE, ROA)
- Cash flow (FCF, growth of OCF, expenditure on capex)

Summary: The quality of the company is used as a screen to find out which companies to look at. As a retail investor/long term holder we do not try to predict the future earnings. Thus investing in companies that have great positioning in the market + financial health gives us confidence that the company can deliver on its predicted earnings

2) Future earnings of the company

This literally decides the value of the stock, however its where people have the biggest folly. Sticking to Warren Buffet's principle, we do not try to predict the future, especially for companies that are in cyclical industries or have lumpy earnings.

Thus we rely heavily on the quality of the company, the rationale being: If a company (think JNJ) has a dominant position in the market, good financial health, and has been growing at a rate of 5% a year, there's a high chance its going to grow at 5% a year in the future

3) Value

The problem about identifying good companies with steady growth is 1) There isn't too many of them 2) They are usually properly valued. Even though they would tend to grow in the future (Stock gets cheaper as earnings increase), we would like to purchase a 'wonderful company at a fair price'.

This involves not comparing it with its peers (which are not accurate, probably not in the same position as the firm) but against history, where by logic, if the firm grows constantly, its P/E should be fairly constant. The P/E, forward P/E bands of these stocks rarely fluctuate.

Thus, our job is easy
1) Find stocks that fit our criteria
2) Use consensus estimates/ check its not too far off from historical growth
3) Buy it when its cheap.

You would realize my method is the same as bonds. Or 'equity bonds' as warren buffet likes to call it. As bonds have a universal method of valuation, my job is to find companies that act like bonds and buy it on the cheap.

Selling criteria

Generally, selling criteria is harder than buying. Here's an example, when you see a stock like comfortdelgro trade at lets say 12x (way below its historical average), because of a crisis or whatever, you buy the stock. But when to sell it, 14x, 18x, 22x? That's a harder one to answer

2 criteria
1) When stocks go above a certain value
2) When the fundamentals of the company change

1) When stocks go above a certain value
This is an easy one, usually the stocks i look at usually revert to the mean, when a stock goes 20%+ its historical p/e level its usually time to sell. Give or take. Here's an easy way to think of it:

- stock's earnings is expected to growth 5% yearly
- stock is trading 20% above average p/e
- assume stock will revert back to average

This means that the earnings has to grow 5% for 4 years for the stock to do.... nothing.

2) When the fundamentals of the company change

This is infinitely harder to do, but totally crucial. You would realize the quality of the company is the main/sole reason I like the stock (future earnings + value just tell us when to buy the stock).

Once the quality of the company or the industry changes, you should get out of the stock. This is fairly hard to do, quarterly earnings fluctuate, perceived threats may occur, but identifying a structural shift and a potential de-rating is what thats important.

Warren buffet follows this extremely strictly, he did not sell coke, amex, p&g (aka his untouchables) even though they have constantly exceeded point 1. But he dumps stocks without mercy once he sees 2). Tesco & Walmart got dumped the second he realized there's a structural shift to online retailing.
He dumped airlines the second he realized that discounters are destroying the entire model.

There is no fixed method of doing this, but if your company has constantly missed earnings (2 Quarters is a good gauge) on losing market share, change in regulation, mgmt. doing stupid things, then its time to worry.

Summary: Don't anyhow.

Its the same thing as sticking to your circle of competence. I don't know how to predict earnings, so instead of doing so, I find companies that have predictable earnings and a good track record. I don't try to make 20-30% returns, or pick 'multibaggers', I instead try not to lose money and sleep easy at night.

TLDR version: (step 2 is actually the hardest)
1) Pick good quality companies with predictable earnings
2) wait for the price to fall
3) Buy it when its cheap.