Sunday, July 23, 2017

2017 First Half Review - Part 1

This year started with a lot of renewed hope after the disastrous 2016 where we saw markets whipsawing investors. Brexit was supposed to crash the market, but it didn't and Trump wasn't supposed to become President and he did! The markets then reacted by going up 15%, when everyone thought it should go down if Trump ever won. In retrospect, the Trump rally continued into 2017 and we saw the S&P500 hitting all time highs and most markets, following US footsteps, are up for the year.

We have passed the first half of 2017 and hence it might be timely to do a quick review for the half year. Looking at various indicators, it could be said that a large part of the positive moves in the stock markets are done. Most markets had seen positive return for consecutive 6 months which happened very rarely in the past 20 years. Our own STI index (chart below) rallied from 2900 to 3200 in the last 6 months with only 3 down counters out of the 30 components. 

STI 1 year price chart


What had caused the general euphoria in the markets?

For one, the US market is very resilient. It's almost a decade since the Lehman crisis in 2008-09 and the system had been pretty much cleaned up. Multiple rounds of quantitative easing (QE) had created enough liquidity (as well as side effects which we shall discuss) to stabilize the economy. Unemployment rate is now quite low, productivity is getting higher with tech innovation and things are looking so good that the Fed is thinking about finally stopping QE. Then they changed their mind and thought maybe the party should go on. So markets rallied even more!

Meanwhile in Europe, things are also bottoming after the Grexit scare two years ago and China seemed to be okay with the big meeting coming up in October and everyone is trying their best to keep the Goldilocks economy going. Things should be not too cold nor too hot, just right for President Xi to announce his dream team during October's plenum session. Hence, other parts of the world are following this Goldilock's story where everything will be just right until they go wrong.

The other big trend that had really taken off in 2017 was the Second Coming of Tech. 17 years ago, we had the dotcom boom and bust when the internet promised the new future but then everything failed to deliver. Back then, we were not ready but we thought we were. There wasn't enough optics fiber to deliver what the internet promised, there wasn't enough profits generated. But today, things have really changed. 

Nasdaq 17 year price chart

Now, we have more than enough optics fiber in the ground and under the sea, we have the top tech companies generate more profits than the GDP of some big countries and we have lots of money created by QE1, 2, 3 and QE Infinity. In a amazing turn of event, the Nasdaq price today exceeded the peak reached during the dotcom bubble of 2000 (chart above). Statistics show that people spend 4-6 hours online everyday, on their phones, using PCs, shopping, playing games, watching videos. We are not doing work, not watching TV, not sleeping, not going out to eat (since we have Deliveroo) and just living our lives online. 

As such, the combined profits of the global tech companies: Apple, Amazon, Facebook, Google, Netflix, Alibaba, Tencent, Baidu and the rest generated c.$40 trillion in revenue and c.$3 trillion in profits. In terms of profits, tech would rank as the 4th largest economy in the world, behind Japan. With such profits in tech, it had generated positive cash overflow into the real economy, creating more high value added jobs, startups and hence reducing unemployment (somewhat). Hence it could be said that there is this symbiosis between QE and tech. QE flooded the world with money which flowed into tech unicorns (tech startups with more than one billion dollars in market cap) and into the other parts of the tech supply chain.

One huge positive side effect was semiconductors. After the bubble burst, the semiconductor industry and its relatives all died as the huge oversupply created in the aftermath caused prices to fall year after year. NAND prices, DRAM prices, chip prices always went down, until now. The tech revival, driven by big data and A.I. today, required more powerful computing and more storage. Much more than most could imagine. All the big tech are investing in server farms and computing prowess to outdo their competitors and this caused a short squeeze in semiconductor chips. Hence these players benefitted big time as well. Samsung, TSMC, Nvidia are at or near all time high!

The other huge market was the advent of tech gaming.

This industry started in Japan when Nintendo created the first console box called Nintendo 64 back in the 1980s. It spawned a huge market that had grown to become a $100 billion industry today. Gaming including mobile gaming, computer games, Playstation and Xbox is bigger than Hollywood and music combined. Then in 2017, we have a game changer: Overwatch.

Overwatch poster

Overwatch was created by a company called Activision Blizzard which also gave us a few of the best games ever created. Most people would have heard of them even if they are not gamers. Games like Call of Duty, Warcraft, Diablo, Starcraft and now, Overwatch. For the uninitiated, Overwatch is a team-based player vs player (PvP) game where gamers band together as different characters to defeat the other teams. It was made possible in today's era again because optic fiber now have ample capacity and chip computing power can handle multiple player gameplay without lags. This was not possible just a few years ago which was why games were always single or double player only.

Overwatch redefined PvP with a few ingenious concepts such as having a "replay" moment (like soccer) where the game automatically replays the significant moments during the match and also introduce a very huge variety of different characters (currently 25) having different strengths and weaknesses so as to keep interest high amongst players as they have to study these strengths and weaknesses well to win. Since Overwatch, this concept had been used in many other gaming platforms including Minecraft (Bedwars) as well as Honour of Kings (Tencent's huge hit in China right now) and Clash Royale (which also belongs to Tencent since they own Supercell).

But what's more significant about Overwatch is the creation of Overwatch League. I believe this marks the turning point of e-sports, a new genre in sports where people go to stadiums to see professionals play computer games. Overwatch will have teams from different countries (or states in the US) fighting one another much like World Cup or Premium League. Teams train together (online) professionally to win and most believe this would be as big as soccer someday where players earn multi-millions with worldwide fan base as well as lucrative sponsorships. So, it may not be bad thing to play games and not study today! Well if your kids are so good at it.

Since the creation of Overwatch League, we have seen e-sports taking off with talks of e-sports being included in 2022 Asian Games or a creation of an Olympic style gaming franchise with the past top games from all genres: Tetris, Street Fighter, Halo, Mario Kart and needless to say Overwatch. E-sports will also spawn other industries such as goods, merchandise and gaming peripherals (mouse/mice, headsets, keyboards) where Singapore's own company is the global leader - Razer!

Okay, so much about tech, in short, QE helped the tech industry to revive and the markets are seeing new trends which got investors excited, but there's are risks that the party might just end soon. Next post we talk more about the outlook for the later half of 2017 and 2018.

Overwatch this space!

Friday, July 07, 2017

Return on Investment for 38 Oxley Road

With the whole Singapore intrigued with the 38 Oxley Road saga, it is hard to avoid the discussion, be it during lunch, on Facebook and Instagram and worst of all with international friends. This saga could be a watershed moment, marking the downfall of a little red dot, if it is not resolved amicably asap. But since this is an investment knowledge infosite, let's leave the politics to others to comment. Today we shall focus on the investment aspect.

The investment story of 38 Oxley Road is also quite intriguing for those who would be interested in investment returns. In this post, we hope to capture the no.s and paint some scenarios, some very rosy, hopefully to make people forget the disgust and disgrace of the whole situation. Oxley Road was named after a certain Thomas Oxley, a Brit who owned a nutmeg plantation in the 1890s. It was then sold to a Jewish merchant which presumably then rented the house to Mr Lee Kuan Yew's family during WWII. In his memoir, Mr Lee Kuan Yew wrote that he rented the place for $80 a month in c.1944. After the war ended he and his wife went to London to further their studies and got married. They officially moved into the house in 1950. 

38 Oxley Road: front gate and the famous basement

It was not clear when he bought the house but based on circumstantial evidence, one could conclude it could be somewhere between 1945 to 1955. For our calculation purposes later, let's put it down as 1950. The value of the house is much harder to determine. In his memoir, he did mention that back then a decent house could be bought for 12 bottles of Johnnie Walkers towards the end of the war as families ran out of things to sell, like jewellery, the motobike or car, or even family heirlooms, so finally they would sell their houses. This anecdote itself probably deserves another post as it is not with zero probability that we would not revisit those days.

Back then, paper money (which was issued as banana money by the Japanese) was worthless and the economy degenerated and people resorted to barter trade in order to survive. So what became more valuable and could be used as currencies were cigarettes, liquor and usable stuff. Of course gold was on a class of its own. While it cannot be used in daily life, its value had been determined and recognized over the centuries which is why I believe all investors should have some physical gold in their portfolios. It need not be a huge chunk, maybe just 3% but in the improbable event that the modern financial system breaks down, the only asset that will hold its value and sustain daily life is gold.

Ok let's get back 38 Oxley Road. Where were we?

Yes, we were trying to determine its value back in 1950. We have a few numbers to work with. 12 bottles of Johnnie Walkers and $80 of rent per month. Today, 12 bottles of Johnnie Walker would cost between $2,000 to $4,000 depending on which label we are talking about. The Blue Label in some kind of limited edition would cost even more. Anyways, translating these numbers back to the value in 1950, based on an inflation of 3%, we get to $300 to $600. Geez, imagine getting a bungalow at $300! That's probably not too accurate. It could be as low as $1,000 but $300 seemed like too much a stretch. Next let's work with the rent. We know today that rent in emerging markets could be a high single digit or low double digit. A quick check on the rental yield in Africa today points towards that as well.

Courtesy of Global Property Guide

So let's assume that 38 Oxley Road also had a rental yield of c.10% back then. This meant that the value of the house would be $9,600 (8x12x10=9,600). That's probably a more reasonable number to work with. But in order to triangulate better. We can pull in other no.s. Based on what was told about the old days, the first HDB built in the late 1960s cost around $8,000 which meant that extrapolating a hypothetical HDB valuation in the 1950s, we get roughly $5,000. This meant that a house like the one at 38 Oxley probably cost twice or maybe 3x more. So we might get to $15,000, nice. Not forgetting the Johnnie Walker number, perhaps we can put a range on the value of 38 Oxley Road at say between $5,000 to $15,000.

Now that we got the value of the house back then. Let's determine the value of the house today. It was reported in the Straits Times that the valuation of the house is $24m in 2015 but developers, wanting to re-develop the whole area, the house could be bought for much more, like multiples of that number. So what's the right multiple? Again we try to extrapolate/triangulate that number with other numbers.

In a recent transaction, we knew that a Chinese developer bought a piece of land in Stirling Road, paying over a billion dollars for 21,000 sqm of land. That's over $1,000 psf for Stirling Road, near Queenstown MRT. Based on just the psf and land size, we can then know that Oxley should be worth at least $50 million since it's around 1,000 sqm of land. Of course, Oxley is not Queenstown and again the right number should probably be multiples of $50m. If it is 3x, then it's $150m. So there we have it, 38 Oxley Road today could be worth $24-150m. 

So based on these numbers, the return on investment for 38 Oxley Road after compounding for 65 years (1950 to 2015) ranges from 12 to 18%. That's a very decent number. Its at least 50% more for this site namesake! It definitely beats 95% of all professional fund managers out there and almost on par with the world's greatest investor, Warren Buffett's record of 20%.

Ok so here's the kicker.

38 Oxley on Google Map

If you look at the map of Oxley Road above. The plot ratio of the whole area is very low because when one of Asia's most important person was living there, we couldn't risk a sniper in a tall building assassinating him. So it was kept incredibly low at 1.4 whereas the surrounding is at 2.8 to 4.9. So if Oxley's plot ratio is relaxed, we are talking about 2 to 4x increase in plot ratio. This meant that a developer would be happy to fork out even more to acquire the hardest-to-acquire land in that whole area. Audaciously, let's say that 38 Oxley Road could be worth 2x of that $150 million number, at $300 million. Also, since we were never quite sure exactly how much Mr Lee Kuan Yew actually paid for Oxley Road, if we assume it's really closer to 12 bottles of Johnnie Walker, say $1,000 back in 1950, we get a new ROI of 21.4%, beating Warren Buffett's record. Furthermore, it compounded for almost 15 years longer than Buffett's reign hitherto. That's never been done before. 

In conclusion, if that turned out to be the true scenario, Mr Lee Kuan Yew, is Singapore's best investor and our answer to Warren Buffett.

Saturday, June 24, 2017

Lessons from Omaha - Part 3

This is a continuation of Part 1 and Part 2.

In the last post, we discussed that ETFs should be part of every astute investor's portfolio and since tech is becoming so important, maybe tech ETFs might also make sense. Also, if 90% or more of all investors never ever beat the index, then wouldn't be buying the index i.e. buying ETFs (equity index funds) be the best option? So that's coming from the Oracle of Omaha, Warren Buffett himself.

In this post, we go back to the centuries old business of insurance.

As most students of value investing would know, Berkshire Hathaway grew tremendously after it acquired an insurance business. Insurance is very good for investing because it provides very long term patient capital. One of the greatest obstacles facing asset management is always capital withdrawal or drawdown - one of the most dreadful word in fund management. The thing is, capital or funds (both from retail or institutions) can only be as long term as markets (which is now six months!) Alas, the markets are getting more and more short term. It is now estimated that global exchanges trade all their own outstanding shares every six months. 

By evolution, humans can only think short term. Our primitive minds cannot comprehend long term (like anything longer than a few days in prehistoric times, to a few months a hundred years ago and maybe a few years in modern times). We simply cannot make good decisions when it's too far out even though we know logically it's good. For instance, quit smoking or stop eating junk food. In investing, we just cannot grasp the concept of compound interest. 

Just an example, if you were given a choice of having (A) one cent today which will double every day for the next 30 days or (B) 1 million dollars today, which one would you choose?

A or B?

1 cent today or 1 million dollars today?

Think hard!

Ok, the answer is...

*Drumrolls*

























As you can see, a single cent doubling every day gets to $5,368,709 in 30 days but we would choose a million dollars right? We simply cannot comprehend compounding. For those still lost, the answer is (A)!

That is why despite 100 years of investing in markets, we are still so short term, constantly looking at quarterly numbers, unable to think three to five years ahead. Let alone 10 to 20 years, which is the real operating span for most successful companies and their business strategies and the real power of compounding (sorry it doesn't happen in 30 days, it's more like doubling on every 7-8 years which is 8-10x over 20-25 years). Hence for fund management, we need long term capital, which insurance can provide.

Berkshire Hathaway stumbled upon this when it bought Geico. Insurance provide that long term capital that allows for compounding to happen. Without which it's just meagre returns which is what most hedge funds do today. Essentially, hedge fund managers just suck management fees without adding real value to investors.

This long term capital is called "float". Not the kind below, but close metaphorically.

"Float"


"Float" arising because insurance companies collect premium upfront to insure for some adverse events that people want to avoid, for instance death, illness, flood, or earthquake, or fire, whatever. The insurance companies take the money today but only pay out years later. Meanwhile, they get to invest this money to make more money. This is the beauty of insurance. The ability to hold the "float" is so precious that competitors will charge less and less upfront premium to get "float". In most insurance markets, the amount collected today actually cannot cover the expenses that needed to be paid out because of competition. That's the cost of getting the "float".

But in some cases, it is possible to make a profit as Berkshire found out. Buffett likes to point out that it's because of under-writing discipline, or being able to assess risk properly and hence charge the right premium. If competition becomes irrational, then Berkshire get out and move on. So Berkshire had managed to get the "float" at a profit! When this happens, then the insurer is being paid twice! First of making a profit by under-writing insurance, then again by making money by investing the "float". Buffett says that it's better than free. Something like enjoy a good ONS and then being paid for it? Haha! Okay, that's R21, young investors please just ignore the last sentence.

So, here's my postulation. 

When Berkshire Hathaway started out in 1965, some types of insurance were not well understood, especially auto insurance, which surprisingly only became nationwide in US around the 1960s. Also some types of property and casualty insurance, re-insurance and other specialty insurance only came about later. That is why Berkshire was able to get under-writing profits as a first mover in some of these markets. (Of course, underwriting discipline and good management helped.) Note that it never got into life insurance which is just cut-throat competition, since that's been around for ages. As Berkshire got bigger via M&A, it's easier then to maintain under-writing profits, which helped Berkshire grew its float from $39 million in the 1970s to $91 billion today!

Today, Berkshire makes an underwriting profit of $2 billion, which we can think of it has essentially Berkshire getting paid 2 billion dollars to borrow 91 billion to invest! That means Buffett had been enjoying almost 50 years of negative interest rates! Now, finally the world caught up. 

This is the power of insurance. 

We talked about Markel in the previous posts. This is often touted as the next Berkshire because the firm is essentially operating the same model. But since auto insurance and the other fields that Berkshire dominated are now pretty competitive, Markel ventured into other types of insurance. I had the time to read part of its annual report and was surprised to find all the types of niche insurance. It started as an insurance firm covering bus and truck fleets but had since branched out to shipping, industrial equipment, re-insurance to even insurance for board directors to cover the risk that the companies which they sit on are involved in fraud. 

Markel Insurance

You see, independent board directors are personally liable to be sued if their companies are involved in fraud. But since they are independent directors, they would have no knowledge of the hanky panky that their companies had been doing day-to-day. So why not create insurance for that? Board directors are paid five or six figures and they would be happy to portion out a sum to cover such risks! That's what Markel did. 

So with that model, Markel grew the way Berkshire did. But this is probably it's 17th year or so. If it follows Berkshire's trajectory, we should see Markel go like 20x in 35 years. It's not too late to buy now! Markel is led by a strong team comprising of strong operating people as well as members of its founding family. There is no succession issues since the main guy, Mr Tom Gayner is only in his early 50s. Having said that, Markel is not cheap, is used to trade at teens but had since re-rated to 20x and recently been trading at 30-40x! It just shows how difficult it is to beat the markets! Find a good idea and it gets traded up in no time!

Anyhow, insurance has been one of the most difficult sectors to understand but having gained this perspective, hopefully we can find some ideas closer to home as well!

Here's wishing a very Happy Hari Raya Puasa to all Muslims!

Sunday, June 04, 2017

Lessons from Omaha - Part 2

This is a continuation of the previous post.

Okay, as promised, here's the investing lessons that we can learn from this year's Berkshire Hathaway's AGM (Annual General Meeting for Shareholders). The first lesson came as a big surprise for many. It came about when Warren Buffett was asked why did he advise his heiress (second wife) to buy S&P500 rather than continuing to put her money in Berkshire Hathaway after he is no longer around. He was dumbfounded for about a second which afterwards he recovered and gave a succinct answer:

The S&P500 represents the best of the best 500 companies of corporate America. These company will continue to thrive and it makes perfect sense to buy them. Berkshire will continue to do well. But 30 years from now, or 50 years from now, it will depend on who is running Berkshire at that time. I just thought it would be wise for her to put her money with America's best 500 companies rather than worry and worst listen to unqualified advisors about what to do. (I am para-phrasing him, these are not his exact words)

Meanwhile, Charlie, in his usual style, munching See's Candies, would bet on Berkshire and ask his heir to do the same. I guess both of them are right. Warren is right because the S&P had a century of track record of generating 10% return per annum over time. Berkshire would be dependent on the manager. In some sense, Warren believed that the managers after him would not be able to beat him. Not the current handpicked ones, but the next one and the next one. Who dare says Berkshire would continue to do well indefinitely without Warren and Charlie. 

They are just so unique! Look at them! 

Warren Buffett and Charlie Munger

Charlie is also right because it's the right thing to say. The next line of managers are in the same stadium and to say that it would be best to investing S&P after both of them are gone is akin to slapping their faces. Or admitting that they would not be as good as their predecessors. Also, Berkshire has built this portfolio of strong solid businesses over these years, surely they would continue to do well for at least a decade or two. No matter who's running the show.

Berkshire Hathaway was founded in 1965, the same year that our beloved country gained independence. The first generation of leaders worked their asses off to make sure that they worked. They have built such strong foundations that we now take for granted. Singapore today enjoys the first world infrastructure, standard of living and status and it is inconceivable that this would crumble in a decade or two. But in 50 years, who knows? No small country ever survived more than 200 years. Even the mighty Sparta. Sparta fell into a long period of slow death decline shortly after they made the legendary last stand against the Persians, depicted in the movie 300 and its sequel.

Parody of a scene from 300, movie about Sparta

Similarly Berkshire had benefitted from Charlie's and Warren's continuously learning for 50 years and become the portfolio of first class companies. It took them a lifetime to amalgamate the these businesses to make Berkshire Hathaway today. In fact, the top few companies, according to Warren, makes up 9.5 Fortune 500 companies. These great firms - Burlington North, Coca Cola, American Express, Geico insurance, Wells Fargo, See's Candies will continue to do well for the next decade or two. But in 50 years, who knows? Very few companies last for such long time span. There are some family owned businesses that lasted centuries, but most companies don't. The only company surviving today in the original 30 Dow Jones started in 1896 is General Electric. 

Original Dow Jones

Hence to think that Berkshire will do even better than the S&P500 over the very long term is wishful thinking. Which brings me to the investing lessons today - maybe astute investors like all the readers here should always consider some ETFs in our portfolios. Long time readers of this site would be familiar with some thoughts on ETFs, which are labelled under ETF. In short, initially I thought that we should have some ETFs, but then realized not all ETFs are created equal so maybe not and now I am gravitating towards having at least 2 or 3 ETFs to be a substantial portion of the portfolio. Needless to say, the basket should include the S&P500. Having said that, I haven't bought any. I have ETFs but mostly legacy ones from the early days which are not doing well.

Anyhow, we should definitely reconsider ETFs!

For the world's greatest investor (and stock picker) to come out to say that he wants his heiress to buy ETFs and to thank John Bogle, the father of ETFs at his AGM, to me, means something. Hence my change of heart with respect to ETFs. Well, I don't think it's good to buy the S&P500 now at all time high, but someday, we should put some money and dollar cost average that over time. However I don't think our own STI falls in the basket of right ETFs to own and I would prefer to pick the few winners in Singapore - Singtel, SIA Engineering, Jardine Cycle and Carriage etc.

The next big lesson was the technological disruption that had dawned upon us. Warren Buffett and Charlie Munger never touched technology because it was too far from their circle of competence. They preferred brick and mortar businesses. They like old economy, solid, tangible businesses. In 2000, they completely missed the tech bubble and they were right then. They were ridiculed then revered bcos as the bubble collapsed, their wealth compounded! Fast forward 17 years, we are seeing the same story. Old economy dying but tech thriving. Today the top 10 largest companies in the world are dominated by tech firms.

World's largest companies

Heck! There only 3 non-tech firms: Berkshire Hathaway, Johnson and Johnson and Exxon Mobil. Talk about deja vu! But there are some differences. Today, unlike the 2000 techies, these firms have earnings. Apple makes US$50-60 bn net profit! Together these companies are generating hundreds of billions in profits. This is bigger than the GDP of some countries. Besides making tonnes of money, these firms have also created huge moats around their businesses. It's their eco-systems. They managed use their eco-system and arm-twist their ways to cannibalize the real economies. Google is eating the old media and advertising companies' lunch, Amazon is eating Walmart's lunch and Uber (still unlisted) is eating Comfort Delgro's lunch. 

In fact, we are so tied to some of these system it's hard to unplugged. Just imagine if we are not allowed to use Google today for some reason, how inconvenient would our lives become? We can't even drive properly since we rely on Google Map so much these days. Or if we can't Grab or Uber. Or if Apple disappears today. A huge part of the world would be dis-advantaged as they find an alternative for their iPhones. That's why Buffett bought Apple!

So I guess the message is that we better have some exposure to these tech names. Again a good way to do that would be to buy some tech ETFs that would have all these names. Preferably it should also be global in nature so as to capture all the non-US names as well. After doing like 15 min of Google search, I believe the few candidates would be:

1. QQQ - Nasdaq ETF
2. EMQQ - Global tech ETF
3. HACK - Cybersecurity ETF

Again, I haven't done the deep dive research on these and I don't own any of these at the moment. The history for EMQQ and HACK is also quite short (only 2 years or so). Hence it would also be homework for me to study further and look at better entry if any. Although given that all of them are near all time high, it would be at the backburner in terms of research priority. In fact, these days, there's more selling than buying.

Ok, so that's the lesson for today. Next post we talk about insurance!

Thursday, May 11, 2017

Lessons from Omaha - Part 1

A trip to Omaha, Nebraska, USA is like a pilgrimage. Muslims hope to visit Mecca once in a lifetime. In the olden days, Christians went to Jerusalem on crusades. As value investors, well, we should pay homage to the world's greatest investor - Warren Buffett aka the Oracle of Omaha, by going to Berkshire Hathaway's Annual General Meeting (AGM) for shareholders, maybe as many times as possible before things change.

For the uninitiated - Berkshire Hathaway is Warren Buffett's investment vehicle which was a textile company that he bought 52 years ago. It went bankrupt but he used it to invest in other companies which then became the world's largest conglomerate (4th largest company by market cap). Some people ask is it worth making the 30-hour flight just to see him? What's the value add of doing that? What would he say that would be different from what he had said all these years? Isn't the whole AGM already broadcasted live on the Internet? 

Well, we can always listen to Coldplay on YouTube right? Why do we go to Coldplay's concerts? Why do some die-hard fans fly all over the world to every concert venue to listen to them sing the same songs? It is for the experience. To share the atmosphere with like-minded fans. In a way, the trip to Omaha is like going to a live concert. Actually it's more a pilgrimage. It is very difficult for non-investors to understand despite our best effort to explain. But having really made the trip, I have this to say: the trip is worth every effort and I urge every serious investor reading this to try to go while both of them are still alive. Warren Buffett is 86 and Charlie Munger, his Number Two, is 93.

What's there to do in Omaha besides attending the AGM? Before the trip, I was also quite dumbfounded, would it be just attending the AGM and visit Buffett’s house? I was so wrong. There's so much to do! I would say that it might be worthwhile to stay in Omaha for 5 days or so to fully enjoy the experience. The usual affairs would be just 3 days from Friday to Sunday but in order to fully cover everything, we certainly need more days!

Here's a list of Must-Dos:

1. Shareholders' Shopping Day before Berkshire's AGM
2. Eat at Gorat's Steakhouse (Buffett's favourite restaurant)

Gorat's Steakhouse

3. Visit Nebraska Furniture Mart and Borsheim's (both Berkshire companies)
4. Visit Warren Buffett's house and office
5. Go to Markel's AGM (usually the day after Berkshire's AGM)
6. Visiting Nebraska Crossing Outlets (factory outlet with Coach, Kate Spade, Adidas, Nike, Under Armour, North Face etc)
7. Eat at the various other restaurants (Sullivan's, Red Lobster, Five Guys Burger, 11-Worth Cafe, Orsi's Italian Bakery and Pizzeria etc)
8. Shop at the key US retail shops (Walmart, Target, Best Buy etc)
9. Attend other events surrounding the AGM (there are many, some with high entry fees - the key one being the Value Investing Conference which is a few hundred dollars for a dinner but there are also others which are quite affordable)
10. Last but not least, do the 5km Berkshire Run!

Invest in Yourself!

Ok so what are the lessons we can learn from such a pilgrimage? I would put the investing lessons in the next posts, which are some of their thoughts on technology disruptions, good businesses, the state of the economy etc. In this post, I would like to share some life lessons that he and the other speakers talked about. My favourite quote of the week was actually from Charlie Munger. Charlie is pretty much the all-important Number Two without which Berkshire would never achieve what it had achieved. Much like the trusted advisor and architect like Zhuge Liang of the Three Kingdom, Goh Keng Swee of Singapore and Steve Wozniak of Apple. 

When asked what he admired about Warren Buffett most, he said this (I'm paraphrasing him): "Buffett is very much capable of continuous life long learning. He is a learning machine. Years ago he would never have bought Apple. Yet after learning about its products from his grandchildren, he bought it!” You see, in the past, Warren Buffett never invested in tech stocks because he believed he couldn't read them well enough but he had since bought IBM (and sold some stocks after it languished) and Apple. This proved that Buffett is capable of learning new things and changing his mind and admitting mistakes, learn from them and be a better investor, despite being 86 years old. Now he is saying he regretted never buying Amazon. Maybe he might just buy in 2017?

Anyways, after talking about this point, Charlie added the most wonderful quote in the week, 

"I think that a life properly lived is just learn, learn and learn all the time. And I think Berkshire has gained enormously from these investment decisions by learning through a long, long period. That's continuous learning. If we had not kept learning, you wouldn't even be here. You'd be alive probably, but not here (in Omaha, at this AGM)."

At 86 and 93, these guys are still learning. Here's them telling us, never stop learning, certainly not at our age. The joy of learning is the impetus to wake up every morning, to read more and gain new knowledge. Then eat steak and continue to enjoy life! It reminds me how important it is to be able to enjoy learning, all the way, throughout our lives. Is the Singapore education system inculcating the joy of learning in our kids? That's a big question mark.

Never stop learning!

Anyways, that's Buffett's standing poster at Gorat's. The pins represent people coming from all over the world to eat and learn from him! Unfortunately, he wasn't at the restaurant when we were there and we missed him at the newspaper toss the day before! Hopefully that's a good enough reason to go again, provided the exit permit from OC of the house gets approved. Haha!

So that's the first message. Keep learning all the way! The second message came from the Markel AGM. Markel has been touted as the next Berkshire. It started as an insurance company for buses and trucking industries by the Markel family. It then branched out to other specialty insurance and as it grew, it used its "float" - or excess insurance premium earned by underwriting lots of insurance, to invest. This was pretty much how Berkshire grew in the early days. It had since invested outside of insurance and grew its investment portfolio substantially. Its current CEO, Thomas Gayner, is a remarkable guy and pretty much being compared to Warren Buffett. I attended his 2 hour AGM and learnt so much.

The next takeaway was from him. It was a simple message that came about as he addressed the audience. He speaks fast and most of it quickly lost amongst his words but this phrase was so strong and it just stuck. Again I am para-phrasing him:

"The folks at Berkshire had pretty much said the same things all their lives. That's consistency. I think that's what make them unique. Keep saying the same things because that's really the essence of good communication. There is no ambiguity. It's all about consistency, keep saying the same things, keep the communication simple and most importantly, really do what you say."

In short, be consistent - say what you do and do what you say.

It's easy to just state but how many people can actually do it? And do it for over 50 years? In our current culture of ADHD (attention deficit hyperactivity disorder) demanding instant gratification, we are drawn to our phones every other minute when we get bored. We soon then get tired of the phone itself, and change them every year. In fact, we are changing everything every other year. Most people are changing jobs every three years, changing cars every five years, some are changing houses and even life partners sooner than ever! We are always searching for that something new, but never quite get it right. We want to choose to change but yet cannot accept change if it was pushed onto us. How ironic?

We cannot say what we do and do what we say because we lost the ability to focus, to really grit our teeth and do that hard things to get it right. To sweat it out, push and persevere. It's just too difficult and we are giving up too easily. What I realized is that such a kind of trip is good because it reminds us that it can be done. It is possible to keep saying the same things and to keep doing the same things and live in the same house for 50 years. That's how long term effort can be exhibited with the power of compounding and snowballing.

Warren Buffett's house since 1957

Next post, we will discuss the investing lessons. Stay tuned and wishing all Buddhists a very Happy Vesak Day!

Part 2 is out!

Tuesday, May 02, 2017

More on Sustainability

This is a continuation of the last post.

In the last post, we discussed how we should focus on the big picture and pull the big levers to move things. In diet, it's about cutting meals and cutting meat and putting in the hours in the gym or hit the road running 20 km per week. In investing it's about understanding business models and putting in the hours reading annual reports. Needless to say, investing is also about margin of safety - the biggest lever, the most important concept.

We are really fortunately to be living in the 21st century in the developed world as food is never a problem. We can pretty much eat whatever we want, wherever we want. Our issue is having too many meals. The breakthrough concept should be this: we have 21 meals per week, how many meals should be a treat? Seven? One per day or maybe, for some, every meal? The idea is to know that we will always have enough opportunities to eat whatever we want, wherever we want. Hence, in my opinion, a treat should be once a week or even less. If possible we should eat very little for every dinner because our bodies are winding down for the day and not ready to do heavy duty digestion.

Kay Lee Roast Meat


During the recent long weekend, I had to attend various parties and ate more than my fair share of food as these were "occasions". We just had to eat, because food is love. The next moment, I saw my weight jump and my body spent all its energy digesting Kay Lee Roast Duck (now owned by SGX listed Aztech), BBQ chicken wings, Indian curry and Ba Kut Teh amongst various food. They were all good! But it really took out my sustainable routine of managing my weight. 

Sustainability is truly under-rated. It is way more difficult than most would like to think. My sustainable regime was supposedly light dinner at least 5 times per week, exercise at least 2 times per week. This was thrown out over the long weekend and it took weeks to get back. A famous musician once said, "if I didn't practise for a day, I know it. For two days, my wife knows it and for three days, the whole world knows it." It takes great effort to sustain simple things. But once achieved, then anything is possible. Like waking up 5am every morning for ten years to swim bags an Olympic Gold. 

In investing, sustainability manifest itself in a similar fashion. I would like to illustrate this with companies' return on investing capital or ROIC in short. We all love hyped up stories of high ROICs bcos these justify super high PEs and super high stock prices. But the real question is, are they sustainable? Let's look at the famous tech stocks of recent days past, Linked In, Twitter, Fitbit, Alibaba and Facebook. All of them started with high ROICs in the days of their listing. Alibaba had 200% ROIC but had since collapse to 18% (still not bad). Meanwhile Linked In, Twitter and Fitbit all saw their high ROICs turned negative in a span of a few quarters. Only Facebook had managed to maintain a very high ROIC over 30% (peak was 80% though) although we could say it's history is still short compared to brick-and-mortar firms with truly sustainable high ROICs. 

Unsustainable 35% ROIC vs Sustainable 15% ROIC

Let's delve deeper in this. The chart above shows two hypothetical companies. The one on the left has a high ROIC of 35% to begin with but subsequently falters off to 5% (still positive) by Year 4 while the one of the right simply managed a sustainable 15% ROIC (which is what great co.s like Colgate or Diageo can do) forever. At the end of 15 years, which is the investment horizon that most should think about (not 15 months), we can see how the accumulated returns compare. The one that started with 35% only earned $3,841 with a starting equity of $100 while the other had $5,572 which is c.50% higher.

35% ROIC taken over by the 9th year

In fact, the sustainable ROIC firm would generate more returns after the 9th year. Yes it will still take 9 years but this is how investors should be thinking. We cannot be chasing unsustainably high ROICs every year and hoping to run out in time and catch the next one. It's too tiring. Chances are, we won't run fast enough. How many investors in Fitbit, Linked In and Twitter would have managed to get out in time before these stocks collapse 30-50%?

Unsustainable 50% ROIC vs Sustainable 15% ROIC

Next we look at another example. This time we have a 50% ROIC vs again a 15% sustainable ROIC. This one would look more like our Twitters and Fitbits. But as high as a 50% or 100% ROIC, we should imagine that the collapse would also be fast and furious. In the example, we would model its ROIC to fall to 10% in Year 2 and then 5% in Year 3. To give the hypothetical firm the benefit of the doubt, let's assume that it doesn't turn negative (which is not true in reality given that Linked In, Twitter, Fitbit all turned negative). At the end of 15 years, we see a similar pattern. The sustainable company would have accumulated c.50% more equity vs the once 50% ROIC firm.

50% ROIC 50% taken over by the 7th year

Again if we look at the time frame when the sustainable firm earns more, it's even shorter than the previous example. By the 7th year, the 15% sustainable ROIC firm would have made more returns. Of course, all these are just hypothetical. In reality, these numbers are generated by hundreds and thousands of workers doing their jobs well. As such, it is already a feat to sustain 15% ROIC. Most firms would only be able to manage a mid to high single ROIC. That's because basic economic theory tells us that competition competes away excess returns as soon as possible. Just imagine, if we know some business can make 15% easily, wouldn't we all be in it? Hence 5% ROIC should be the norm. People who argue that 50% or 35% ROIC is sustainable likely don't know what they are talking about. Yes, there might be a handful of maverick firms globally that might do 35% sustainable ROIC, but we cannot assume the one we invested in would be the one.

Likewise, 15% ROIC for 15 years would be feats only achievable by moat companies. Moat companies have unique characteristics that help keep competition at bay, like brand, scale, eco-system, businesses with recurring revenue etc. Hence they are capable of generating and sustaining high returns. These are your P&G, Unilever, Colgate amongst others. In Singapore, sadly, it's even more rare. SIA Engineering managed to do 16% years ago but its ROIC had since dropped to 7% partly as a result of its large cash holdings. Singtel had managed a 12% ROIC for the last five years.

It is the constant and continuous effort that makes the difference. Just as I found out how difficult it was to keep a simple cut dinner and exercise regime, just as the new buyers of Kay Lee roast joint found it hard to sustain and even expand a 70 year old household brand to a regional franchise, the sustainably high ROICs of some of the best global businesses should be revered. Thinking big and sustaining the effort to make it happen, that's the secret to success in investing and perhaps everything else in life.

Wishing all readers a very Happy Labour Day!

Tuesday, April 11, 2017

Think Big and Think Sustainability

There are a few tough things in life, one of which is losing weight. It is said that 95% of diets ultimately fail and losing weight successfully is one of the hardest things to do, along with quitting tobacco, kicking off addictions and investing successfully. As such, having some mild success with both (diet and investing), I would like to share lessons which we could draw from one to the other.

I think there are two big concepts:

1. Think Big: Don't sweat the small stuff, pull the big levers!
2. Think Sustainable: If it cannot be sustained, then it won't work. Make sustainable changes!

We all know the different diets. There are now 1,001 diets out there and over the years, like many of us, I have tried my fair share. Counting calories, Atkins diet which emphasizes low carbs, intermittent fasting, less oil, less sugar and dunno what else. It didn't work! All the talk about such and such amazing diets in the end never lived up to expectations. Then I came to the realization that I have been sweating all the small stuff. I did not pull the big levers, or rather, there was not enough pain at all.

Just to go into counting calories, this is the funny one. You see, diet is about losing weight, or rather losing mass right? Calories is a unit of energy, not mass. In secondary school, we already learnt the law of conservation of mass which means that mass cannot be created or lost. So by counting and cutting calories, which is energy, how can we expect to lose mass or lose weight? Energy has nothing to do with mass except in Einstein's theory. E=mc2. Diet is not nuclear physics. It's about reducing mass (ie the food we eat), not energy. Well, counting calories did work for some people but ultimately it's bcos they have also reduced mass intake by a lot!

Now, low carbs, the most popular diet in the last 15 to 20 years, popularized by a certain Dr Atkins. Why was it so popular? That's because it didn't involve hard work. Oh, just cut carbs, eat more meat, that's very doable. We didn't like potatoes, plain rice etc anyways. But unfortunately, it won't work. Dr Atkins himself died of heart attack as he loaded up too much on meat, causing other problems.

And so it dawned upon me that all these diets were not focusing on the big picture. It was like trying to just solve part of the problem. They were futile attempts to reduce complex problems into one dimension to solve, like counting calories. Or focusing just on one food type, carbs. It was trying to fix one side of the Rubik's cube only without thinking far enough about how to solve for all sides!

Our bodies are machines that have evolved over millions of years and hence it would not yield to half-fuck diet solutions. In fact our bodies are so complex, we probably only know really little how nutrition and our digestive systems work. The Chinese in the past believed that eating tiger's penises could boost male vitality. Obviously, things didn't work that way. But hey, modern nutrition now also realized that eating high cholesterol stuff might not be the reason for accumulation of bad cholesterol which cause heart diseases, or eating good fats didn't cause obesity (it was the bad fats or trans fats, or so the experts currently think). 

Tigers being farmed for their penises

The body is so complex that what we know is really just a fraction of how it really works. Think about it, a piece of fatty meat that we eat doesn't just stick to part of the belly as we might be tempted to think. It is digested, broken down into molecules then reconstructed all over again. Similarly, it is ultimately lots and lots and lots of exercise to burn off that belly that has been there after years of eating badly. Eating less alone would not cut our waistline by 1cm. 

So when it comes to a good diet, I decided to stick to broad principles which are basically just common sense: eat natural food (ie less processed food including bread, sugar, rice, noodles etc) as much as possible, eat a huge variety of food in equal proportions and drink a lot of water (less coffee, tea, soft drinks etc). As to losing weight, it has to be big levers that could effect change. I would surmise a few key levers as follows:

1. Cut meat and cut dinner - ie eat a lot less
2. Exercise a hell lot more
3. Change enough of the bad habits!

Just a quick run through of these points. Meat besides having more mass vs plants, is the most complex of all food types (proteins and fats are long molecule chains). Hence, in my experience, eating less meat, rather than carbs, would be much more effective in losing weight. I am sure in some cases, less carbs might work, but for me, it was cutting down meat. An ideal diet, in my opinion should be like say 20% vegetables (green leaves) 20% tubers (carrots, radish), 20% fruits, 20% grains or carbs 10% nuts and other plants products and finally 10% meat and animal based products (milk and eggs).

On top of that, we have to exercise, although it is true that diet will do 80% of the work. We need the 20% exercise to complete the circle. You cannot solve just 5 sides of the Rubik's cube and leave one side out. Follow through with the tough stuff, we definitely see the waistline getting smaller. Ultimately, it is also making enough changes, like stop all snacking, drink everything sugarless, exercise three times a week. Change enough bad habits to good ones, the results will follow.

In investing, it's more or less the same philosophy at work, we need to think holistically and always look at the big picture. Some time back, I notice a criticism on one of the the stock analysis I had done. The critic was saying how my models were not accurate enough (or rather bear case scenario not drastic enough), how that's poor Excel work, that I don't understand the business etc. I didn't bother to reply. I have noticed that young and/or inexperienced investors always like to tinkle with Excel a lot. They believe that by making the Excel model perfect, they can predict the company's future, make the right bet and make a million bucks. If the stock prices or calculation of intrinsic values correlate with changes in what we do with the Excel spreadsheet, why isn't every investor rich?

It is always more important in investing to focus on the big picture. There are usually a few key factors for the company and it's important to get those right. The modelling is a small part of trying to paint part of the picture. It is about understanding the business model, the industry dynamics and getting the valuation right. The stock in question was SIA Engineering. It does aircraft maintenance and this is a recurring business. Every airplane that's flown in the air has to be maintained. Sometimes, they beat up passengers to get things done.

United passenger being "escorted" off the plane 

Just kidding, but you get the idea, airplanes need maintenance. Needless to say, the big trend of more air travel will not reverse. Even with the risk of getting beaten up by security guards on airplanes, we have no choice but to fly more. There will more planes in the air, more LCCs or low cost carriers and Singapore as a hub will grow with T4 and T5. The down cycle with new planes needing less maintenance will pass and meanwhile, we're paid to wait with an annual 4% dividend. This is the big picture for SIA Engineering.

For investing, the analogy to exercising a hell lot more and changing enough bad habits would be all the hardwork we discussed in previous posts. Investing is about doing enough major mental workouts. It's a lot of reading followed by analysing and discussion. An average investment professional (or any high level executive) needs to read 120-180 mins a day. That translates to 60 to 120 pages of reading (news, annual reports, articles, books and business magazines) per day depending on one's reading speed. Its then about changing habits to read better, analyze better. It means giving up chasing serials, sacrificing family and friend time. It is always the pain we take to be better. There is no two way about it.

To sum it up, I would say the three key levers for good stock investing would be

1. Seeing the big picture: understanding the business model, the positives and the risks
2. Doing the homework: reading, analysis, discussion, lots of it!
3. Paying less for more: only buy when there's good margin of safety

Next post, we talk about sustainability!

Monday, March 27, 2017

Buying Singapore Savings Bonds

Investing is a fascinating game in a sense that no formula ever works all the time. There is no "Bao Jia" or sure wins. There are no programmable solutions, no absolutes and we must always break the rules to win. There is also no such thing as never. Warren Buffett himself broke his own rules so many times, in order to win. He said he would never buy tech stocks, yet he bought IBM and Apple.  He concluded airlines won't make their cost of capital, yet he bought airlines! 

Airlines, the one industry that was guaranteed to lose money! How to be a millionaire? First, make a billion dollars and then buy an airline! That's the infamous running joke in investment circles for decades. To ward off that taboo, Vietnam's most famous LCC (low cost carrier) airline deployed the auspicious red color and bikini girls to market itself. So far, it had a successful IPO, but we shall see!

VietJet and its bikini girls

Singapore Savings Bonds or SSB is also an idea that is somewhat against the rules in value investing practice. Value investing targets high single digit return, not 1-2% return over 10 years. So why are we discussing SSBs here? Shouldn't we talk about Colgate and Unilever and Moutai?

Ok first let's look at what's SSB all about? 

SSB was launched in 2015 with underwhelming response but had since grown to be slightly more popular. According to a recent ST report, 32,000 people had invested S$810 million in SSBs. This is 16x more popular than the conventional government bonds which require investors to hold to maturity i.e. 30 years for the longest issues. With SSB, we can sell and get back capital plus interest any time. However, the total investment so far is way below the S$4 billion target. 

As another gauge of its popularity or rather un-popularity, we have hundreds of thousands of retail investors in the stock market (triangulated from 1.6m SGX CDP accounts with some that are likely dormant), the mere 32,000 in SSBs again pales in comparison despite the product being investable at just S$500! The lowest denomination for stocks would usually be four digits.

Why the un-popularity one might ask. I guess it's really about the lack of marketing and distribution. This is a product directly launched by MAS (Monetary Authority of Singapore) which obviously had no marketing track record and the banks, even though they are distributing the product, had no incentive to sell SSB since it sucks deposits out of their balance sheet and they don't earn anything by selling more (only S$2 per transaction!). Also, the interest rates are really not palatable to investors. The table below shows how it works.

SGS interest rates

SSB works differently from a conventional government bond as you can redeem it anytime. But because it provides this optionality, the interest rate is also slightly lower. Hence depending on how long you put in, the interest rate you get is different. Reading from the table, it says that if an investor put the money in for 1 year, he stands to earn 1.02% interest. This is similar with some of the fixed deposit schemes out there but as you can see, the interest rate creeps up the longer one holds. At 4 years, we get to 1.5% and at 10 years, we get to 2.27% (look at the average return per year not the interest in the middle row). This is actually close to where the conventional 10 year bonds are trading at.

The chart below shows that 10 year Singapore Government Bonds are trading at 2.24 to 2.32% yield. So, it's really not too different from SSB yield at 10 years. The trouble with bonds is that the global low and negative interest rate environment had really caused yield to collapse. Reading from the same table below, we see that 30 year bonds are trading at only slightly higher 2.5% yield. Holding this for 30 years gets you just 2.5% per year! Singtel gives you c.4% dividend with growth potential in India, Thailand and Indonesia! 

SGS prices

Ok, so bonds are really too boring for value investors. We are talking about 1-2.5% return over decades. So why bring it up here? The argument here is that this instrument should really be competing with cash, not compounders or value stocks. This was the original intent by MAS, and if we think about it, it's really thoroughly thought through and quite beneficial to small retail investors. We all have dormant cash lying all over the place. This cash earns 0%. What we should do is to put some of our dormant cash into this (lowest denomination starts at $500!). If and when we need the cash, we can just take it out (but we do stand to lose the additional interest for the subsequent years). Everything can be done online. It's that easy.

Ok but what about fixed deposit schemes offered by the bank that are better? Well, they are usually for only 3-6 months and we have to keep rolling to enjoy the good rates. It's really a bit too much hassle for most working people and only retired aunties and uncles can afford to do that - queuing at the different banks to roll fixed deposits and get free Fitbit or porcelain sets. The irony here is that most aunties and uncles usually roll the same pot of money just to get that additional 20-30bps, but if they had put into SSB, they stand to earn up to 2.27% over time, more than 100bps incrementally. 

As astute investors, we should also deploy some capital here bcos it's better than cash. Most investors usually have some cash, say 5-15% to have the optionality to buy great stocks if and when the opportunity comes. This cash earns nothing but if it is deployed into SSB, it stands to earn at least 1%. If it so happens that the cash is subsequently needed in a few months, we still get the accrued interest. So, it's essentially cash but earning interest.

SSB details

There is one last point to make which is listed in the details above. There is actually a cap on how much SSB one can hold. It's $50k per issue and $100k across all issues. That's like not enough to pay the ABSD for some who are thinking of buying their second properties. This is likely a precaution given that our Government is super cautious. We don't want some shady billionaire putting in one billion and then earning $20m per year out of this. Another caveat is that CPF and SRS funds cannot be used, unfortunately.

So, that's in short the idea that's against the rules. Investing and portfolio management is also about relative benefit more so often than absolute benefit. This is a lesson that some may never learn because we have been thought to think in binary terms - something is either good or bad, right or wrong. A portfolio is never like that. If this is better than cash, we should buy this over cash. We judge a stock by its relative upside vs other stocks in the portfolio. Never only looking on its own merit. By always thinking in relative terms, we can then upgrade our portfolio part by part and hopefully some day achieve optimization.

That's practical investing!

Disclaimer: this author bought the SBAPR17 GX17040N SSB tranche.