There’s A Business Behind Every Stock

If I were to ask you to bet your money on the future success of your investment in a property company, whom would you choose to become the CEO of your company, Dato’ Liew Kee Sin of Eco World Development Berhad or your good friend Datuk Bill Ch'ng Chong Poh of Malaysia Pacific Corporation?

If I can trust your IQ, betting on the most capable person would make greater sense for you than betting on your good friend.

The same philosophy holds true while investing in stocks. You must not put your money on a stock whose name you like the most or whose chairman is your good friend. Instead, you must invest in the stock of a business you believe has the maximum potential.

But this is one reality that most investors forget – that…

“… a stock is not just a piece of paper that has a name, but a share of a business that has real assets and profits.”

While buying a stock, you should take the same approach as you would if you were buying an entire business. The only difference is that instead of buying the whole of the business, or a partnership in the business, you are only buying a tiny share.

“Investing is most intelligent when it is most businesslike,” Ben Graham.

The idea of buying a stock without understanding the company’s operating functions – its products and services, management quality, employee relations, raw material sources and expenses, plant and equipment, capital reinvestment requirements, and needs for working capital – is unacceptable.

This mentality reflects the attitude of a business owner as opposed to a stock owner, and is the only mentality an investor should have. Owners of stocks who perceive that they merely own a piece of paper are far removed from the company’s financial statements.

They behave as if the stock market’s ever-changing price is a more accurate reflection of their stock’s value than the business’s balance sheet, income statement, and cash flows.

For Buffett and all other successful investors , the activities of a stock owner and a business owner are closely connected. Both should look at ownership of a business in the same way.

 “I am a better investor because I am a businessman and a better businessman because I am an investor.” Warren Buffett

As explained in ‘The Warren Buffett Way’ by Robert Hagstrom, these are some of the key questions that you must answer to understand the business of a company.

Questions you must answer to understand a company’s business

Let’s discuss them in some detail here.

Questions on the core business

1. Is the business simple and understandable?

Never invest in a business you do not understand, for you can’t see the future opportunities and challenges before they arise. For example avoid special-purpose acquisition company (SPAC) if you don’t know how shell or blank-check companies that have no operations but just with a famous person can beat all other smart investors and established companies in the world to acquire great businesses and make big fortune for you.

“Acknowledging what you don't know is the dawning of wisdom.” Charlie Munger

2. Does the business have a consistent operating history?
Past performance is no guarantee for future success, but it shows if a business can operate under varying business conditions. Very often, that is the only thing we can rely on. Often naïve investors try invest beaten down stocks of companies with poor and untrustworthy management with the hope of turnaround of the business and hence its share price. Alas with the same management which has shown poor operating and management record, the turnover never does. As Buffet says:

“In the business world, the rear-view mirror is always clearer than the windshield.”

3. Does the business have favourable long term prospects?

‘Sustainable business’ is the key word here. Look for business that would most likely to last for many years to come. Stay away from companies that operate on trends and fads that can go out-dated in the future.  Yes, like APACs.

Questions on management quality

4. Is management rational?

Now this is a very important part of an investor’s business analysis. The rationality of the management and its ability to deploy cash in a profitable manner is what separates a good business from a bad one.

• Stay away from companies with ambition of empire building rather than focus on the efficiency of the core business.
• Do not invest in companies which the CEOs know only how to talk c*** but care nothing about the running of the business.
• Avoid with all cost companies with CEOs who are very good in speculating in shares.

5. Is management candid (frank) with its shareholders?

You don’t want to get into a future Enron, right? Look for managers that admit mistakes and take complete responsibility of their actions, rather than blaming everybody, and macroeconomic and political events and everything else.

6. Does management resist the institutional imperative?

Institutional imperative is the need for managers to act like their peers, no matter how irrational their actions may seem. Avoid managers who have the tendency to give in to peer pressure and do dumb things.

Questions on financial performance

7. What is the return on equity?

As we will understand later, return on equity is one of the most important metric for evaluating the profitability of companies. Earnings can be manipulated, but return on equity will show how worthy a business is.

Intuitively, if you put in RM100,000 capital into a business, are you looking at what earning the business makes, what are the margins, or are you more concern about the return of your capital?

Long term, return on equity will have a more profound effect on the company’s fortune than earnings.

My personal preference is Return of Invested Capitals though, but the principle is the same.

8. What are the profit margins?

A company that can convert its sales into profits is a successful business. The key is to keep costs at the minimum, and go for higher profits instead of higher market share. Avoid companies with low margins relative to its industry.

Finally, remember what Buffett said:

“If a business does well, the stock eventually follows.”

And don’t forget what Peter Lynch said too.

“ Wonderful companies become risky when people overpay for them.”

Hence you must have a good feel of the value of a company in order to avoid overpaying for a business.

By,

K C Chong (15 May 2014)

How To Win At A Winning Game

IN our last article, we showed that the rewards of staying invested in equities for the long term are tremendous. But the fact is a lot of investors in equities ended up losing money.

Consider the track record of Peter Lynch who managed Fidelity’s Magellan Fund from 1977 to 1990. He beat the S&P 500 Index in all but two of those years and averaged returns of 29% a year.

That’s mind-blowing. It means that US$1 grew to more than US$27. Had you invested as little as US$37,000 with him in 1977, you would have been a millionaire in 1990.

You would imagine that most of the investors who put money in the fund had made money. But guess what? Lynch himself once said he believed more than half the unit-holders in his fund had lost money. It depended on when they had bought and sold Magellan.

Morningstar, a mutual fund research organisation, conducted a study to track the cash flows in and out of the United States’ leading growth funds in the 90s.

The contrast between the returns of the funds themselves and the returns of the investors was absolutely breathtaking: The 219 growth funds averaged an annual compounded return of 12.5% for the five years ended June 1994.

But the investors did much worse. They apparently didn’t make any money at all; instead, they lost 2.2% a year with the same group of growth funds.

Both of these findings point to the same conclusion, that is – as a group, investors do a rather poor job of deciding when to buy or sell their investment funds.

Chart 1 shows the movement of the Dow Jones Industrial Index in the US in the last ten years. A typical inexperienced investor will probably behave as below:

July 2005: The market has been quite steady and trending up for the past 2½ years. All the market experts are saying that prices will continue to go up. Ok, I’ll invest US$10,000 to test the water first.

April 2006: The US$10,000 I invested is now worth US$10,682. That’s a return of close to 7% in one year. Not bad. Market looks firm. I think I’ll invest another US$50,000.

May 2007: My capital of US$60,000 invested so far is worth US$72,750. Wow, this definitely beats leaving my cash in the bank. Ok, I’ll transfer US$100,000 more from my fixed deposit and invest in the market.

January 2008: What’s all this news about the sub-prime market? Market is choppy. But it’s ok, these investments are for the long term.

January 2009: Oh no! There doesn’t seem to be a bottom to the market. Now people are talking about the possibility of another Great Depression. During the Great Depression, the Dow Jones fell from a high of 386.17 on Sept 3, 1929 to a low of 40.56 on July 8, 1932. That’s a plunge of some 90%. The market did not recover to the 1929 levels until 1954, some 25 years later! Now my portfolio is down by 37% only. I better take out what I have left.

So the investor exited the market in January 2009, and got back US$101,422 of the original US$160,000 invested. As it turned out, the investor withdrew his or her money near the bottom of the market. Two months later, in March 2009, the market rebounded sharply.

The thing is, if the investor had stayed invested and held on to his or her shares, their US$160,000 would have been worth close to US$200,000 by now (early 2014). All the numbers above exclude transaction costs and dividends.

Because of this emotional tug of war between greed and fear, many investors effectively manage to lose at a winning game.

So how exactly do we ensure that we win at this winning game?

First, understand that when you invest in a diversified basket of stocks, you are investing in a slice of the economy. As long as we need to buy and sell things – there is no question about this here because we can’t possibly produce all the things we need ourselves – then there will always be a value to productive companies.

Second, don’t exit the market when everyone is rushing for the exit at the same time. Then, you will not get a fair value for the businesses that you own.

Third, all the more, you should buy when you see businesses going on sale at a cheap price.

Now let’s see how someone would have done if he or she had kept investing in the stock market through the Great Depression. We know that the Dow did not recover to the levels reached in 1929 until some 25 years later. The Great Depression was the worst period the stock markets had ever gone through – it was way worse than the Asian Financial Crisis and the more recent Global Financial Crisis. So did an investor who put money into the market during the most adverse of market conditions see zero or even negative return?

The chart below shows an investor, let’s call her Mary, who started investing in the US market in early 1926. She put US$100 into the market every year. Her investment did well in the first four years. Then the crash of October 1929 happened, to be followed by the Great Depression. From a high of 381.17 points on Sept 3, 1929, the Dow fell to a low of 40.56 on July 8, 1932. That was a plunge of some 90%! But Mary kept faith. She believed in the continued functioning of the modern economy, that is, as long as companies are allowed to produce what people want and need, they will make money. So she kept investing US$100 into the market every year.

By the end of 1950, Mary would have put US$2,500 into the market. Her portfolio value as at December 1950 was at US$4,342. This despite the Dow Jones Index still being 38% below its peak in September 1929.

Mary managed to grow her capital by 4% a year by consistently putting money into the stock market even through the worst of times. She managed to beat the inflation rate of 1.3% during that 25-year period. In other words, she generated for herself a real return of 2.7% a year in the most adverse of situations! This excluded the dividends she would have received from her portfolio over the years.

So to recap, the secret to winning in a winning game is:

One, consistently invest in a diversified basket of stocks that represents the real economy over the long term;

Two, don’t bail out at the worst of times. All the more, if you can afford it, put in more money at the most depressed of market conditions.

Keeping to these two golden rules will ensure that your savings will grow faster than inflation, and that you will tremendously increase your odds of meeting your financial goals.

Source: The Star

EPF Declares 6.35% Dividend For 2013

KUALA LUMPUR: The Employees Provident Fund (EPF) today declared a dividend rate of 6.35 per cent for the financial year ending Dec 31 2013, representing the biggest ever dividend payout of RM31.2 billion to its members, up 13.66 per cent over the RM27.45 billion paid in 2012.

In a statement, EPF Chairman Tan Sri Samsudin Osman said thanks to the fund’s robust yet prudent investment strategies, its performance has been consistently stable, especially in the past five years. 

 

“Over the years, we have been diversifying our portfolio, thereby spreading out the scope of our assets to manage market risks and generate consistent returns,” he said.

 

Samsudin said since the global financial crisis in 2008, EPF has declared compounded dividends of more than RM120 billion for its members. 

 

Including the net annual contributions, its investment asset size had recorded a strong rise; from RM342.01 billion in 2008 to RM586.66 billion at the end of 2013.

 

He said the dividend rate was declared on the back of a record gross investment income of RM35 billion, a 12.81 per cent rise from the RM31.02 billion gross investment income recorded in 2012.

 

The 2013 dividend payout was derived after deducting the net impairment allowance on financial assets, investment expenses, operating expenditures, statutory charges as well as dividend on withdrawals.

 

Samsudin noted that as the EPF membership rose to more than 13 million, a total of RM4.91 billion was required to pay every one per cent dividend rate for 2013. 

 

This was 10.06 per cent higher compared with RM4.46 billion paid for every one per cent dividend rate for 2012. 

 

“The amount needed to pay a one per cent dividend would continue to grow between eight and nine per cent annually,” he said.

 

Samsudin said the investment performance has led the EPF to achieve an annual return on investment (ROI) of 6.97 per cent, a rise of 10 basis points from 2012. 

 

“This is a manifestation of our sound investment principles and diversified portfolio across different markets and sectors,” he said.

 

Equities emerged as the largest contributor to the EPF’s gross investment income in 2013, generating RM19.52 billion of income, a significant increase of 40.39 per cent compared with RM13.90 billion recorded in 2012. 

 

EPF’s equities portfolio generated double digit realised returns, exceeding the performance of other similar funds.

 

Loans and Bonds recorded RM7.53 billion of income, a lower amount compared with the previous year, in the absence of significant one-off transactions which had contributed a large portion of returns to the asset class in 2012. 

 

Real Estate and Infrastructure continued to show encouraging performance in 2013, earning RM1.14 billion, a jump of 87.91 per cent over RM606.05 million in 2012. 

 

The year under review also witnessed the investments in Malaysian Government Securities and Equivalents continue to be a key income contributor, achieving an income of RM6.19 billion, while Money Market Instruments recorded RM627.86 million.

 

The 2013 dividend can be viewed on the EPF’s Facebook page at Kumpulan Wang Simpanan Pekerja, Twitter at KWSPBuzz and on YouTube.

 

EPF account statement for the crediting of the 2013 dividend is now available online via i-Akaun at myEPF website (www.kwsp.gov.my). 

 

Alternatively, members can obtain their EPF account statement from EPF Kiosks or any nearest EPF branch, starting tomorrow.

7 Traits of Super Investors by Koon Yew Yin

The last time I published ‘How to become a super investor?’ I received more than 200 commentaries. Of course, most of the commentaries are good, but a few are really bad and insulting. In fact, one doubted my sincerity and accused me of trying to promote Jaya Tiasa. Fortunately or unfortunately, Jaya Tiasa did go up by about 20%, soon after the publication of my article. It went up too fast and not sustainable. As expected, it is making a healthy correction.

In view of this situation, I am obliged to write this article and also I genuinely wish to share my knowledge with people who are interested in share investment.   

For a long time, I have been trying to teach my wife, close relatives and friends to follow what I did but all of them could not emulate my performance or achievement. I think the reason is that to be a super investor your brain has to be wired differently when you are young. It is a nature built into your brain which cannot be nurtured. By the time you are an adult, either you have it or you don’t have it.

For a start, let me define what is a super investor? To qualify as a super investor, you must have a long term track record of making more than 20% per year. Warren Buffet has been able to achieve about 22% per year over the last 20 or more years. Using the empirical formula of 72; when 72 is divided by the rate of return the answer is the number of years for you to double your capital. In Warren’s case, he can double his capital in 72 divided by 22 = 3.3 years. That means $1 will become $2 in 3.3 years and $2 will become $4 in 6.6 years and $4 will become $8 in 9.9 years. At 22% return pa, Warren can turn $1 to $8 in about 10 years.

How many of us can achieve more than 20% return per year in the last 10 or more years?      

To test the putting is in the eating. In retrospective, did you make a huge amount during the Y2K computer crisis when MPI and Unisem went above Rm 40 per share? Globtronics went up from about Rm 2.00 to above Rm 20.00 in about 18 months.

Did you make much money when CPO went above Rm 4,000 per ton a few years ago?

Did you make a killing when all the rubber glove shares shot through the roof due to the HINI fear about 3 or 4 years ago? Supermax went up from Rm 1.00 to Rm 6.50 in 18 months.

Did you buy SOP when it was selling about Rm 2.50 about 3 years ago? SOP went above Rm 6.50 per share recently.

If you did not make much money when the above mentioned opportunities came, you can only be a mediocre investor and you have no hope to be a super investor.

Looking forward, do you dare to buy Jaya Tiasa when it is not showing much profit currently and the share price has been depressed for quite a long time? Most fund managers are not interested to own Jaya Tiasa. Can you see that it is really undervalued and it has tremendous profit growth prospect?

About 3 years ago, Sarawak Oil Palm (SOP) was selling about Rm 2.50 per share because most of their oil palms were young. As a result, the company was not showing much profit. For the same reason, Jaya Tiasa is now showing poor profit. Most of the Fund Managers do not want to own it. But, do you have the patience to own it and wait for a few years to maximize your profit? I am obliged to tell you that Jaya Tiasa is my major investment holdings.    

I can tell you that very few of you can achieve above 20% return per year over a long period of time and if you spend enough time studying investors like Charlie Munger, Warren Buffett and other famous investors, you will understand what I mean.  

I know that everyone reading this article is exceedingly intelligent and you have all worked hard to get where you are. You are smart and experienced. And yet, there is little likelihood of anyone here becoming a great investor. You all have a lot of advantages over normal ordinary investors, and yet you have almost no chance of standing out from the crowd over a long period of time. 

The reason is that it does not much matter what your IQ is, or how many books or magazines or newspapers you have read, or how much experience you have, or will have later in your career. These are things that many people have and yet very few can end up compounding at 20% or more  over their careers. 

I know this is a controversial thing to say and I do not want to offend anyone. On the bright side, although most of you will not be able to compound money at 20% for your entire career, a lot of you will turn out to be good, above average investors because you can learn to be an above-average investor. You can learn to do well enough, if you are smart and hard working. You can make millions without being a great investor. You can learn to outperform the averages by a couple points a year through hard work and an above- average IQ and a lot of study. So there is no reason to be discouraged by what I am saying today. You can have a really successful, lucrative career even if you are not the next Warren Buffett.

Going to the best business schools and reading every book or article ever written on investing would not make you a super investor. Neither will years of experience. If book knowledge and long experience will make you a multi- millionaire, then all the Professors in finance, all the old fund managers and old people who have been investing for decades, would be multi-millionaires.

So what are the sources of competitive advantage for an investor?  They have to do with psychology, and psychology is hard wired into your brain. It is a part of you. You cannot do much to change it even if you read a lot of books on the subject.  

After having said all these discouraging words, I think some of you who can master the following traits or qualities will have a better chance to become a successful investor. 

Trait 1. The ability to buy stocks while others are panicking and sell stocks while others are euphoric. In 1983 when China wanted to take back Hong Kong, the stock market crashed. Did you dare to buy Hong Kong shares knowing the risk when the communists took over the control Hong Kong?  

Everyone thinks they can do this, but then when the market crashed on October 19, 1987, almost no one had the stomach to buy. When the year 1999 came around and the market was going up almost every day, you could not bring yourself to sell because if you did, you might fall behind your peers.

Trait 2. A great investor is one who is obsessive about playing the game and wanting to win. These people do not just enjoy investing; they live it. They wake up in the morning and the first thing they think about, while they are still half asleep, is a stock they have been researching, or one of the stocks they are thinking about selling, or what the greatest risk to their portfolio is and how they are going to neutralize that risk.

Trait 3. A good investor is the willingness to learn from past mistakes or to admit that he or she has bought the wrong share. It is so hard for people to recognize their own mistakes and sell the bad share which they bought at a higher price. Most people would much rather just move on and ignore the dumb things they have done in the past. But if you ignore mistakes without fully analyzing them, you will undoubtedly make a similar mistake later in your career. In fact, even if you do analyze them it is not easy to avoid repeating the same mistakes. 

Trait 4. A fourth trait is an inherent sense of risk based on common sense. You must have the common sense to realize the risk of buying any share which has gone up a lot and when all the analysts are recommending buy. No share can go up indefinitely for whatever reason. Quite often you might be tempted to fall in love with your purchase because it has been going up and up. You are so proud of your pick and refuse to sell it. Remember your ego can skew your judgment.  

Trait 5: Great investors have confidence in their own convictions and stick with them, even when facing criticism. Buffett never get into the dot-com mania and he was being criticized publicly for ignoring technology stocks. Eventually he was proven right. Unlike Buffet, we small investors can get in and out quickly and make some profit.

Besides confidence, you must have patience to wait to buy when it is has established a base and not buy when it has shot up due to some exciting hot news.  

Trait 6. It is the ability to think clearly. There are a lot of people who have genius IQs who cannot think clearly, though they can figure out bond or option pricing in their heads. I have met a lot of smart people in my life time but very few of them can come up with an inventive way of looking at a problem.

As you know, there are so many criteria to consider in share selection and invariably all the professionals will consider the current profit is most important. They do not look at the future profit growth prospect of the share. They do not look at the company and the industry like a business man or an entrepreneur.

Again I have to use Jaya Tiasa as an example to explain this important point of making super return. You only have to have the elementary knowledge of arithmetic to calculate that JT will almost double its fresh fruits bunches (FFB) production in 3 years. Even if the CPO price remains unchanged, its profit from its oil palm plantation will surely double.

Moreover, JT has about 2,500 sq km of forest to supply all the raw material for its plywood and timber business. Surely any one with eyes should be able to see the huge forest ( 50 km X 50 km approximately) which is the competitive advantage it has over all the manufacturers in China, Taiwan, Japan, India and in any other countries. Yet all the professional fund managers cannot see the forest as the competitive advantage JT has over other competitors.  

As Warren Buffet often say that in the competitive world of doing business, all your competitors are constantly trying to attack you and you must build a moat around you to protect yourself. Unfortunately, in the Malaysian stock market, we do not have stocks like Coco Cola, Gillett Razors or Mac Donald which have the market competitive advantage.

Trait 7. Finally the most important, and rarest, trait of all is the ability to live through volatility without changing your investment thought process. This is almost impossible for most people to do; when the chips are down they have a terrible time not getting themselves to average down or to put any money into stocks at all when the market is going down. People do not like short- term pain even if it would result in better long-term results. Very few investors can handle the volatility required for high portfolio returns. They equate short-term volatility with risk. This is irrational; risk means that if you are wrong about a bet you make, you lose money. A swing up or down over a relatively short time period is not a loss and therefore not risk, unless you are prone to panicking at the bottom and locking in the loss. But most people just cannot see it that way; their brains would not let them. Their panic instinct steps in and shuts down the normal brain function.

Conclusion: I must realize the risk I am taking in writing this article. People will judge me and they will laugh at me if I am wrong in betting Jaya Tiasa so heavily. I still have some SOP which I have bought when it was cheaper and I sold a large portion to buy JT.  I also have Mudajaya,  Kulim,  and smaller amount of Symphony Life, Success Transformer.

Only time will tell whether I am right or wrong. Nevertheless, my intention is honorable and altruistic. I also believe I have some special knowledge which will help you make more money from the stock market.   

Note:

Koon Yew Yin (born 1933, c. age 80) is a prominent philanthropist, as well as the founder of 3 leading Malaysian construction and development companies:

1. IJM Corporation Berhad;
2. Gamuda Berhad; and
3. Mudajaya Group Berhad.