Tuesday, February 24, 2015

CNY Post - Business Moats. Must Read!

Investing is about finding discounts (or margin of safety). The discount is the difference between the intrinsic value of the company, and the current stock price. Intrinsic values of companies do not change daily. Good companies can grow or compound value. Bad firms destroy value. So the trick is to find good companies, and buy them cheap or at a fair price. They only get really cheap during financial crisis. In normal times, like now, we have to look hard. It is not easy but not impossible.

Good companies have what we call business moats or economic moats. They keep building their businesses around certain factors that keep competition at bay. Business moats are not easy to identify to many laypeople. We would usually think that technology is a moat, or innovation or perhaps government support. But these are usually not moats. They can keep competition at bay for a while. But they are not sustainable. Especially government support or policies which can change in a wink.

True business moats that I see time and again are:

1. Brands
2. Scale
3. Eco-system
4. Switching cost
5. Distribution

Technology is usually not a moat because it is usually copied. Some guy invents a new technology, say, the electric vehicle. For 100 years we pump petrol to make cars move. No longer do we need to visit gas stations to fill up our cars for them to run. Then we see 10 other manufacturers making electric cars. Tesla's moat is definitely not that it makes cars that runs on batteries. It's gonna be something else (if they succeed though, they are still burning cash). But that's topic for another day, let's talk about innovation first.

I think innovation comes together with building brands. By itself, innovation is not enough to defend a business. Innovation is also always copied. But if a strong player has a strong brand, by further strengthening it with innovation, then the business moves towards impenetrability. We discussed Colgate and Swatch before. It’s also the same with Kao (in laundry detergent: Attack & Attack Neo), Diageo (Johnnie Walker) and Reckitt (Durex condoms) etc.

Economies of scale is very important, hence investors always look at market share and the industry structure. If the market leader grows to be a certain size, it is very hard for any competitor to replace it. As the largest player, it will also has the lowest cost of production, the biggest spending power, the attraction for talent to join. It is very powerful. When a certain company has over 40-50% market share in certain products, usually its scale is so huge that it's impossible for any competitors to fight them head on.

Eco-system, switching cost and distribution are similar. By building a network that supplement the business, it makes it hard for customers to leave or for competitors to enter. Facebook built an eco-system locking in the world, our friends, families are all on Facebook, we cannot switch easily. Alibaba also has a strong eco-system with its taobao online shopping mall and now all sorts of stuff including a money markets fund and Alipay and taxi apps etc. Honda’s strong distribution and sales network in motorcycles is why it flourishes in the emerging markets. When your bike breaks down, you need the service guy to be round the corner, imagine buying a Korean bike and nobody can service it! Johnnie Walker/Diageo is also sold in over 100 countries, since 100 years ago. We can find those small bottles of Johnnie Walker in a remote village in Vietnam or Africa for that matter. Diageo’s distribution network cannot be easily replicated. In fact Diageo has brand, scale and distribution, which makes its business moat so huge that it's mind boggling!

I do not think the moat list ends here, there will be other moats. It takes time and experience to understand them. Warren Buffett took 50 years. Bros and gals, we are just starting here... As we learn about these business moats, it helps us become better investors and better thinkers. I learnt by reading daily, newspapers, annual reports, books, magazines. This is a hobby that requires you to read a lot. If you like to invest but not reading, something doesn't gel here. Also, screens are killing our eyes, so nowadays actually I would prefer hard copies. Trees or your eyes. Your choice.

But actually, the most important thing in investing is buying with a margin of safety. The 30-40% discount. Even if you have identified the best businesses with the best moats, it will all come to waste if you bought it at a high price. The high price could have factored in years of growth so your return is bound to be miserable. Say a great business can compound at 10% per year. But you bought it at say, 40% over-valuation, it takes 4 years for catch up. So even if you hold it for 5 years, you would only have earned 10% over 5 years. That's 2% per year. That's miserable return, you might as well put in fixed deposit.

To buy at good discounts is not easy. Hence Buffett mentioned that great companies should be bought at fair value. i.e. if the company compounds value at 10%, then just buy at par, no need discount.  Bcos every year it will deliver you 10%. To get it at a good discount, usually it only happens once in a long while, when markets crash big time. Things would look so bad that buying stocks would be the last thing on your mind. At that point, it takes courage to buy when fear grips the whole world, and the stock markets. Hence, "be greedy when others are fearful."

Well it's Chinese New Year or CNY, it's good to be a bit greedy, just a bit and just for these 15 days.  Happy CNY to all! Huat Ah!

Thursday, January 29, 2015

Genting's Management and Financials

Geez 2015 came and the first month is ending! Time and tide really waits for no man. In investing, time helps in compounding, and we just have to keep reminding ourselves that we need to act early and incrementally while we are young. Because, if we don't, before we know it, we are 40, or 50 and the first half is gone and we are into half-time. Need to think quickly how we want to play the second half.

Today, Let's continue our analysis on Genting. We answered the first few questions: what's the investment thesis, is it a good business, is it cheap etc. Next, we focus on the management. Genting Singapore is essentially being run by two savvy executives and supported by strong managers who know the business well. The chairman is from the founding family and his lieutenant helps him run the day to day operations. Meanwhile the board is also made of more independent directors than insiders which is good for governance. Overall Genting's management has shown to be above board and has generated value for shareholders. The only caveat would be its minimal disclosure and its shareholder return policy while that has also improved with the recent share buyback announcement.

Genting's Board

Next questions: does it have Strong Financials and its Geographical and Industry Exposure? Well, Genting is all Singapore and gambling (just a bit of non-gaming entertainment). For financials, we use the cheatsheet that has appeared various times here (below). Numbers in blue are derived from others on the sheet. The first thing to highlight is that the sheet was updated in Sep 14. Well that's with investing, we are so busy with life, so things like updating spreadsheets shouldn't be top priority. Today let's use this one. Most of the time, things don't change that much in 3 months. Investing is a long marathon. People who wants to play it day by day and week by week are missing the point.

Ok, besides the date, one of the other first things worth highlighting would be its strong free cashflow. Genting is estimated to generate S$800m in free cashflow or FCF in the sheet but it is likely to have the ability to do a billion in the future. Casino is bloody good business once the initial capital outlay is done. Gamblers simply keep coming to drop money, and when times are good, they actually don't mind doing it. Genting is suffering now as per the Macau casinos because of the impact of Xi Jin Ping's anti-corruption campaign. But as the Asia middle income continues to grow, wealthy people will also keep spending and they would want to visit Singapore. Hence it should be a matter of time that free cashflow reaches a billion over time.

Genting's cheatsheet

As the stock nosedive with bad news about delays in Japan, Korea and clampdown in China, we can now get Genting at 5.8% free cash flow yield. If it its a billion in free cashflow, we are talking about 7% and if we consider that the S$2 billion of cash needs to come back to shareholders, then we get close to 10% free cashflow! 10% free cashflow is like a super bargain for a multi-billon dollar firm. It doesn't come often. 

Now, one might question, if Genting is generating so much cash, why doesn't it pay more dividend? Well, that should come in time, but again, things move in years in the world of investing, so shareholders would just have to be patient. Genting didn't start out throwing close to a billion dollar cash. It was listed in the early 1990s but only started to have stable positive free cashflow in the last few years. Before Resort World Singapore was opened, it was committed to build it at the doldrums of the financial crisis, burning S$2 billion in 2009. 

So dividend was never discussed then. Now that things have change, investors hoped for a better shareholder return and Genting responded with a share buyback. Part of the reason was also that the capex needed for Korea and Japan would be delayed, so might as well return cash to shareholders and generate some goodwill. That could be the start of better dividend and shareholder return.

Ok. We discussed all the good news, what about the bad news? 

The key risk is Genting's working capital. In the cheatsheet, it is shown as WC of S$4.7 billion. Somewhere in the right column there is also Accounts Receivables at S$1.5 billion .These are huge no.s considering that Net Profit and free cashflow are still just S$800-900 million. This also relates to Genting's strategy of growing its VIP clientele. 

VIP gamblers don't bring cash to play. They play on credit and Genting has to provide that credit. Some of these clients come from god-knows-where and they disappear after playing. So these are the account receivables on Genting's balance sheet. Some of these monies would likely not come back. So there is this huge risk of impairment in the quantum of S$500-1,000 million! This would be a big hit to its balance sheet with just S$9 billion in equity.

Well the mitigating factor is that Genting has clarified that things are under control and they have provisioned for 1/3 of the amount. Also the market has known this for quite a while so this negative is probably largely factored in.

Genting's franchise

So that's really the short and sweet analysis on Genting, the stock is at a multi-year low, there is the slowdown in gambling and the looming account receivables, but we should continue to see stable growth as the mass affluent from ASEAN and China continue to flock to Sentosa. Not forgetting that Universal Studios still have a lot of room to grow and it is opening its own brand hotel in Jurong later this year which will contribute to near term growth.

As the picture above shows, Genting's transformation to a world class resort would continue. By leverage on the brand name of Universal, Sentosa and Singapore, it would grow and generate even more cash going forward. To be able to get it at 7% free cashflow should look like a bargain years from now. 

This is one stock that probably won't affect our sleep at night.

The first post on Genting.


Saturday, January 03, 2015

Happy New Year! First Post of the 2015: Think Long Term

Happy New Year folks, it's a new year and a new start. This is a short post just to illustrate a simple point: Think Long Term. The effects of good habits and efforts show up over time. This is true for both stocks and our own personal development.

Here's two charts to illustrate this point.

Long term stock price chart for Jardine C&C

The chart above shows the 14 year price chart for Jardine Cycle and Carriage, one of the the components of our STI index. It's core business is in automobile distribution in Indonesia where its the dominant leader for both two and four wheelers. The chart above shows that it compounds value  tremendously over time. We see again and again that great companies doing great businesses compound their intrinsic values over time. While there would be ups and downs over short periods like 3-6 mths, or sometimes even over 1-2 years, like during the Global Financial Crisis (GFC) in 2009-2010, over the long run, the stock price charts of great companies and great businesses should track an exponential curve.

Long term stock price chart for SIA

Conversely, a mediocre business would follow a different chart like that of SIA's above. Over the last 14 years, one could tell that the intrinsic value of SIA did not grow. This is not to say the SIA's management is crap. SIA is well-known as one of the best run airlines in the world. It was a game-changer when it started some 60 years ago and is still a respected leader in its field today. However airline is a bad business with over 200 competitors and subjected constant external risks such as fuel prices, labour issues, high capex and maintenance costs, SARs and Ebola virus outbreaks and accidents. 2014 was a sad case of seeing our neighbour having three in one year. May the passengers and crew of MH370, MH14 and AirAsia QZ8501 rest in peace.

***

So, that's the short point today. It pays to think long term when it comes to investing. Compound interest takes time to take effect and when we buy and hold on to our winners, time takes it course and our stocks just keeps growing and paying ever bigger dividends!

Again, Happy 2015!

Thursday, December 18, 2014

Herbalife Dying - Part 2

This post continues from Part 1.

So what's so bad about Herbalife? Obviously not every Nutrition Club is gonna make money and not everyone would benefit from nutrition drinks. Isn't it a case of buyers beware? I guess every argument can always be framed on a spectrum. On one hand, Herbalife gives everyone an opportunity to become financially free, and while they are at it, drink lots of overpriced nutritional shakes and sells that to a dozen friends and help them lose weight as well. That's win-win-win for everyone, and that's Herbalife's value proposition.

On the other hand, it's scam that does more harm than good overall as it improvishes a lot more poor people to help a handful of rich people get richer. Yeah, meaning rob the poor and help the rich. But which argument is true?

Every argument always boils down to percentages and probabilities. Type A personalities will have great difficulties understanding this hence they are always arguing over why they are 100% right and others are wrong. We must understand that this world is not digital and the truth always lies in between black and white.

Here's the stats, 99% of all Herbalife members will earn less than the minimum wage (like $3 an hour) Less than 1% will make decent income and about 0.1% of all Herbalife members makes six figure income annually. So what Herbalife promised is technically not impossible. Just seriously difficult. The financial freedom, save your friends, save the world, nutrition for better life blah blah, is a mere 0.1% chance that one could actually make it happen. One in a thousand. It's harder than getting into Harvard University. So to get rich via this scheme? Why not try applying for Harvard instead?

What's more, Herbalife does more damage than just promising an empty dream, it is selling overpriced useless shakes to lots and lots of people. It is estimated that over the next 10 years, consumers will lose $2-4 billion dollars through Herbalife.

These no.s are from http://www.factsaboutherbalife.com/

Needless to say, Herbalife argues that the stats are wrong, they have more members and distributors earning more money. The arguments really get into percentages, probabilities and convoluted counter-arguments. But what stood out was that Herbalife does not like to disclose how much their promoters actually earned. Not the average amount earned, nor median salary, nor any statistics that would show mathematically the probability of making good money. What's also interesting, Herbalife goes out of the way to state their "facts" against misrepresentations:  

Herbalife's version of misrepresentations and facts

Now, the way I understood the word fact was that it should be something quite indisputable, like IBM generated more than 10 billion dollars of free cashflow or IBM's CEO is a lady called Ginni Rometty or IBM has been in existence for more than a hundred years. So let's take a quick look at the 5 facts that Herbalife stated. Well, none of them really stood up to this indisputability test, do they? Is high quality product a fact? Maybe #2 on millions of consumers in and out of network could pass off as one fact. But then again, what's in and out of network?

So here's a firm that couldn't differentiate between what's fact and what's not claiming that it is saving the world by lifting people out of poverty, empowering them to sell great nutritional products and solving the world's obesity issue all at once. That's some firm! Go fly kite IBM.

Alas, we know that's too good to be true. Rather than making nutrition for a better world, there were evidence that Herbalife did real harm. The firm was sued in the past for misrepresentation and also some of products contained hazardous ingredients that have caused people to experience liver failure after consumption. Of course, Herbalife always managed to settle these issues out of court, never admitting to any wrongdoings.

Some might ask, if Herbalife was really such a scam, how did it earn over a few billion dollars in revenue annually with significant net profit over all these years. Its products are also sold globally and a lot of people have heard about it, or even consumed some of these products and found them beneficial. Well, I would say that scam could go on for a long, long time before it gets unravelled. Madoff was at it for 30 years, Enron also cooked its books for decades. Sometimes, some of these would never be uncovered. Sadly only in Disney movies would the bad guys ever get punished and the hero and his princess live happily ever after.

Having said all that, nothing is ever 100%, it is always between 1-99%. We cannot know for sure that Herbalife is 100% fraud and another Enron in the making. Everything lies on a spectrum and we can only say that maybe Herbalife is closer to the dark side ie it subtracted rather than add value to our world. One of the real time vindication would also be the stock price. The chart below showed how it roller-coastered over the past 2 years, rising up and down from $20 to $80 and now crashing its way to its multi-year lows.

Herbalife's 2 year stock price

Sad to say, the crash was actually brought about by slowdown in its emerging market sales leading to profit warnings and not because its scams were uncovered in a big way despite the SEC investigating it. In many parts of the world, it's business as usual. Herbalife stuffing its inventories into poor families and gullible people. They in turn living an empty dream that they would be financially free selling nutritional products to others.

Ironically, Herbalife dying and disappearing from existence would save some of these families. In other words, it would be Herbalife's death that is really nutrition for a better world. ;)

Part 1

Friday, November 21, 2014

Herbalife Dying - Part 1

We have to digress from Genting a bit given that this story is probably worth telling. We shall get back to Genting soon, hopefully the stock stays low! 

Ok, Herbalife, as most people would know, is an MLM scheme. MLM stand for multi-level marketing which is a legalized form of pyramid or ponzi scheme. We shall get into this in more detail later. Back to Herbalife. Herbalife sells some nutrition stuff by recruiting people to sell to their friends and their friends hopefully sell to even more friends. Herbalife claims that its products are healthy, very good for the body and apparently also help with weight management! What's more, the seller can make impressive passive income by become a distributor selling Herbalife products to others. It has operations all over the world, including Singapore and it has made huge monies. In recent years, revenue is close to USD 5 billion and net profit of USD 500 million. So this is no small fry!

Herbalife logo

Now MLM while disgusting, is quite legal. Many companies use MLM rather than traditional distribution (like via NTUC or internet) to sell stuff. In a ponzi scheme, which is illegal, there is no product involved. A person pays say $100 to join the ponzi scheme and benefits when he can recruit more downline (say 5 friends each pay $100 to their original upline friend). He takes a cut from his friends and if his friends recruit more people then he earns more. This obviously is unsustainable and hence outlawed in many countries when it became well known how the trickery works some 80 years ago.

However, MLM introduces a product (usually something qualitative with intangible benefits like health products, cosmetics etc) and if the value of the product exceeds 50% of the transaction, then it becomes legal! Now this makes things quite tricky because numbers can always be played around. Of course not all MLM are bad. Insurance works on the MLM concept and Tupperware was originally sold via MLM. But I would say that majority of MLM out there are dodgy and it is best to avoid them wholesale.

Ok, back to Herbalife.

The story begins when a famous hedge fund manager Bill Ackman uncovered the atrocities that Herbalife committed. Herbalife years ago started out selling to rich overweight people who can afford their overpriced health drinks but as it would, growth ran out. In order to continue growing, Herbalife in recent years started targeting low income and less educated sellers to help generate more earnings for their upline. The master salespeople dangled carrots of nutrition, weight loss, huge passive income and managed to con tons of these people. 

Here's how things work. A successful upline guy would usually invite a friend or two to one of Herbalife's health supplement party where they get to sample herbalife products. There will be lots of people at these parties but mostly already Herbalife people and everyone appears happy and chatty and it's easy to get sucked in and buy some of these overpriced stuff. Maybe like $200 for a week's worth. I believe in the a very short term, the product could have some visible health benefits, so people get hooked.

As time goes by, these people get persuaded to setup their own party or as Herbalife calls it: Nutrition Club to get more downline, sell more Herbalife products to their friends and earn passive income! Alas, most people cannot fork out $200 every week so 90% of these Nutrition Club owners see their life savings get sucked into buying inventories and inventories of Herbalife products. Some of these clubs become the neighbourhood childcare centre as the other low income mums and dads put their kids there while they go to work. There were sob stories of how families were ruined as they got conned into a promise of strong passive income for life but ended up broke with truckloads of unsold Herbalife inventories.

Due to some legalities around MLM, Herbalife cannot put up its logo and sell its products outright so Nutrition Clubs are not discernible from the outside. Usually, the interior is also pretty badly done up since most of these owners would not have money to invest in capex. The nice parties that they went to were akin to "mock" setups that doesn't represent most real nutrition clubs.

Supposedly a Herbalife Nutrition Club

In short, Herbalife was a con job, according to Bill Ackman, who uncovered most of these stuff in a 300+ page presentation a few months back. In fact he started shorting Herbalife about 2 years ago and repeatedly reported that it was a mega ponzi scheme waiting to blow up. However, given Herbalife's strong earnings growth, nobody believed him. Most unfortunate for Bill, another richer and more well known hedge fund manager Icahn bought Herbalife and squeezed up the stock price. Herbalife went from $40 to $80 and Bill Ackman lost a billion dollars at its peak. They went on TV and got into a vicious "gladiator fight show" with the media. It was bloody. 

Meanwhile Herbalife itself was feeling some heat from Bill and decided to launch its own fightback. It retorted some of Ackman's claim point by point in its investors' day presentation. Reading some of the slides reminded me of this famous Chinese story about a guy who duck a hole and buried some gold, but he was afraid that somebody might take it and hence he wrote,"there is no gold underneath this soil" and stuck it exactly where he buried the gold. Now if Herbalife is doing a legit business and making honest money, why does it need to make a big fuss over some hedge fund manager's claim?

Was it more than meets the eye? Stay tuned for Part 2!


Saturday, November 01, 2014

Genting Singapore

The author owns Genting and dollars in this post refers to SGD.

Genting Singapore has recently dropped to multi-year lows and the stock at this level looks increasingly interesting. The stock has fallen from its high of $2.30 in 2011 to a dismal $1.04 as investors lamented about the lack of growth and the looming accounts receivables on its balance sheet. 

Genting, needs no introduction. It started the first casino in Malaysia some 40 years ago and was awarded the licence to run the Resorts World casino in Sentosa, Singapore in 2006. Its transformation from a local casino operator in Malaysia to an entertainment conglomerate today is nothing less than spectacular. Today, the Singapore business alone makes close to 3 billion in revenue and it has a market cap of more than 12 billion dollars. 

In this and the next few posts, we would do some analysis on this name to determine its intrinsic value and try to understand its business moats. As with the past analyses, we would be asking the few questions on the Stocks page.



1. What is the Investment Thesis?

Genting is one of the only two casino operators in Singapore earning over 3 billion dollars in gross gaming revenue or 45% market share on the island. While Singapore's gaming market has not grown much in recent years, growth should track the regional GDP over the medium term at 5% YoY. It has also sought to differentiate itself by providing family entertainment and a different experience for tourists. It owns Universal Studio Singapore as well as other strong entertainment franchises that would continue to grow alongside its casino business.

Genting has also eyed opportunities overseas and it announced an investment in Korea and would likely be a key player in Japan when its gaming market opens up. These overseas business remain free options of $0.20 to $0.40 per share today as most investors and analysts do not factor any value into its share price given the time horizon is still a good 5 to 7 years away.

2. Is it Cheap?

With the 60% decline in stock price, Genting is becoming quite palatable. Genting trades at 17x forward PE and 9x EV/EBITDA which are at the lower ends of its historical ranges. Its PE is still pretty high if we just think about PE as we discussed before ie 17x means it would take 17 years to recoup our capital. But we have to understand that this is fundamentally a great business and the 17x PE is based on next year's earnings which would not necessarily do justice. Looking over the past few years, it managed to achieve a record of over 1 billion dollars in net profits and if we use that number, then PE goes down to 15x.

Based on free cashflow (FCF), the preferred way to look at valuation, Genting could generate around 600 million dollars to 1 billion dollars of FCF annually. If we use a conservative 600 million, we are talking about a 5% FCF yield which is quite high by any standards. This would also reflect that the stock has really corrected to such a level which makes it attractive enough for value investors.

Unfortunately, Genting does not pay a lot of dividend, so despite having a 5% FCF yield, its dividend is only 1%. But as the stock price correct further, its management might think about strategies to boost it, including raising dividends or perhaps a symbolic share buyback to signal that the stock is too cheap.

Genting's stock chart since IPO, at $1.04, it's back to 2009 levels

3. Is it a Good Business?

Well, gambling is great business. Not just good, but great, especially for the casino operator though not necessarily for the gamblers and their families. It is said that all vices make great businesses: smoking, drinking, gambling which is why they are also heavily regulated. Such businesses are driven by the idiosyncrasies of the human behaviour namely habit and addiction which makes consumption very sticky and allows the operators to have pricing power. Hence gambling is a good business, sorry great business.

Gambling habits have been well studied globally and statistic showed that around 1% of the population would suffer from gambling issues. The 1% of compulsive gamblers would also contribute to a significant 30-40% of the casino's revenue. In Singapore's case however, with the various restrictions and the focus on attracting VIP gamblers, the revenue contribution from Singaporeans and residents had declined from a high of 60% to 30% today. For Genting, it also has a significantly high VIP revenue of over 50% driven by Chinese and South East Asian tourists.

When looking at the global VIP gambling dynamics, one would then have to consider where Genting stands in the regional high class luxury entertainment and how this would evolve in the next 5 to 10 years. With half a dozen countries talking about integrated resorts, competition would undoubtedly intensify in the next few years. Genting's focus on entertainment and gambling could be its value proposition against the other competitors in Macau and some of the other ASEAN countries coming up with their own integrated resorts. It is also developing its brand name alongside megabrands like Universal Studios and Hard Rock Cafe.

In the last few years, the VIP gambling market suffered quite a bit as the Chinese economy slowed and the government clamped down on corruption/extravagance of its officials and this had a huge snowball effect on the whole global luxury market. However while this trend would continue, the rise of the global middle class and high income earners would in time offset this weakness.

Genting is well positioned to attract these high rollers both from the ASEAN region and from China and we would further examine its financials and risk in another post.

Friday, October 10, 2014

What is Your Legacy?

"Seize the day. Gather ye rosebuds while ye may, because... we are food for worms."  - Robin Williams  as John Keating from Dead Poets Society.


We are all food for worms. From the moment we were born, the clock started ticking. We will spend no longer than a dozen decades in this universe. For most of us, it's about 7-8 decades. The first 2 decades we spent learning just to get by. The next two we enjoyed a bit, but then we needed to raise the next generation. Then we realized almost half the time is gone. At some point, our time ends, and we become food for worms, or organic fuel for the cremation ceremony. That is the destiny that awaits all men.

There are so many questions! Why are we born so as to die? What is our purpose in life? What legacy do we want to leave behind? Big questions. Since the human race evolved to possess thinking minds, we have not stop asking. But there are also no good answers. Some believe science cannot provide the answers. But perhaps religion can. Not everyone can accept that because religion introduces the concept of an Almighty, which could be a case of Occam's Razor - it calls for the ultimate additional assumption, ie the Almighty. For some of us with our stubborn engineering trained minds, this just doesn't gel. 

I recently attended a seminar called Life Academy. It was started by some Taiwanese which had gotten quite popular over the years with more than 100,000 attendees globally. It was a seminar that would provoke some thinking about the answers to life's biggest questions. I must say it's pretty profound. Of course, not all the answers would be satisfactory but I believe everyone who attended would have at least one or two takeaways.

For me, it gave a glimpse of how to view our existence in this world, this reality and this one time that we will live and experience all there is. Here's how I would frame it. Imagine that we are going to attend a party. It's an 8 hour party. Every hour for a decade roughly. Well for some lucky folks, it could stretch to 12 hours but for most of us, probably 8 hours. So how should we spend our time?

First, we must make sure we last 8 hours right? Don't get knock out at the fourth or fifth hour. That's health. Eat right, drink right and walk around or dance! (ie exercise). Just keep our bodies and minds strong. Then we must decide, what we really want. Most people realized this party won't last forever only at the fourth or fifth hour or even later. Well, it's never too late, but wouldn't it better to know what to focus earlier on? For readers in their first or second hour, good luck! Do focus and keep walking!

So what is it that we should want out of this party? I would say I would want the following:

1. Experience
2. Love
3. Legacy

Well first, I guess it's about experiencing the party. Try to experience all there is. Well don't do the bad stuff that affects health or the other two on the list: love and legacy, like smoking, or betraying trust, or spread hatred. But for the rest of the experience, by all means, try all the fun!

In a party it would mean talking to a lot more people, do stuff like taking a dip in the pool, playing all the games, exploring the venue in and out. On Earth, I guess it means expanding along the same thought horizon, meet people (of all races and places), do stuff (rafting, backpacking, skiing) and see our world (a lot to see: Machu Pichu, Niagara Falls, Great Wall, Aurora, Great Barrier Reef, Angkor Wat, African Safari, Easter Island etc). Well this in itself would probably take a lifetime. But we must not forget the other stuff. The next on the list being love, which could be the most important.

Humans are social animals. We don't live alone and we yearn to be accepted. Sometimes in bizarre ways. Like buying a flashy car, a mechanical watch or a Berkin bag, just to show people we are "somebody". It's a bit like a young pugilist in those swordfighting novels who had not mastered any skills but needed to hold a jade sword just to impress others. Yeah, like Zhang Ziyi in Crouching Tiger. Ironically, there will be those that we hold dearly in our hearts, with no need for any of the gimmicks above. Our significant other, our kids, our family, our friends. We love them just the way they are. And they, vice versa.

The simple thing about love is to simply just to give it out, and it comes back multiple folds. So give love to our family, friends, colleagues, mates and if we are ready, to strangers too. All too often, we simply give almost everything to our work, to make more money, thinking it's more important. But the clock is ticking, our kids will turn to teenagers then adults in a flash. Our parents will leave this party earlier. Some of our friends too. Is it really about work and money? Do you go to the party to do work and make money in the prime 3rd, 4th and 5th hour? Tick tock tick tock, remember this party only lasts 8 hours.


Cheers by Mayday, echoing the views in this post

Make time for those who meant the most to us, who had helped us, and those who had walked this unique journey with us. Share the love, the friendship. Cherish those moments together.   

And finally, what is your legacy?

Most people never got this far. The toils really got to them. They were working and making money all the way to to 6th, 7th and 8th hour. They would ask how do you spell legacy? To them, life was about making ends meet. It wasn't a party. It was about food, shelter, security. For those of us in a better position, sometimes we think like that too, we need to buy that condo, that lifestyle when there is no need to. We should be helping others instead. Bill Gates and Warren Buffett, the world's richest two men pledged to distribute their wealth for this purpose. Noble souls.

For most of the readers here, we are the fortunate ones who have the luxury to think about our legacy. What do we want to leave behind? Maslov had pretty much summed this up. This is self-actualization. Our calling. Well, it's not easy to figure out. But do think hard. The clock is ticking, the party will end.

For Steve Jobs, it was putting a dink in the universe with an aluminium case that is now in the hands of hundreds of millions of people. For Jack Ma, it was creating an internet firm to help millions of small business owners sell their wares. For most parents, it's about raising our kids. For most others, it's art forms: poetry, photos, music, paintings, movies or creating something, like building a company, a charity foundation or simply becoming an entrepreneur. It is not about whether it was the first of its kind, or whether people liked it. How many units sold or whether it was a success. It is about whether we actually took the step to do it. To execute. Please, do it. Just do it. You don't want to leave the party knowing you did not try.

For me, one of the legacies to leave behind would be a stock portfolio. Amongst other legacies that I thought about: taking beautiful photos, creating a music platform, having a real farm growing my own food, start my own fund and needless to say, raise my kids well. I hope to achieve all of them, although the odds are definitely against me. Well since this is an investment website, let's just focus on the portfolio. 

The goal is to create one portfolio that can hopefully generate good returns for a few decades. It would consist of 50 or so stocks. The best of the best globally. Strong global businesses with huge economic moats. Companies that would continue to pay dividend for years to come and the dividend cheque will get bigger and bigger over time. Companies like Diageo, Disney, Singtel, Jardine Cycle and Carriage, Swatch, Adidas. Companies that produced products that I adored. Johnnie Walker, Omega, Star Wars merchandise. Companies that had made Singapore proud. You get the idea. This portfolio would also provide for my family. The goal is to make the dividends bigger than my annual expenses. It would fund my kids education and my retirement in time. 

It would also represent the fruits of my lifetime of picking stocks. I hope to discuss the stocks with my kids when they grow up. Let them understand why each stock is there and how collectively they contributed to our well beings. Part of this website and investment eco-system contributes to this as well. I hope it would be an interesting legacy. One with meaning, love, abundance and admiration for the people who made great products and businesses.

At the crux of it all, it's always about people. We want to be touched and we want to touch other people's lives. Be it through a product, an art form or simply, acts of love. Experience, love and legacy also revolve around people. Experience is about the people we met, love is about giving it to our friends and family and legacy is about providing for our future generations. By putting others before self is one of the ways to live a meaningful life, perhaps the way. Because, at the end, we are not going to take anything away. Not the flashy car, nor the mechanical watch, and definitely not the Berkin bag. We are here to make a difference to others. It's time to seize the day before we become food for worms. 

Start doing what is really important. Start your legacy, today

Wednesday, October 01, 2014

The Efficient Market Hypothesis

Investing, as with life, is a paradox. We have to learn to live with it and hopefully, sometimes, we find the way out. It is not rocket science. It's just about understanding the world and human behaviour. The world is ever changing yet human behaviour rarely changes. That is why it is so difficult for smokers to quit smoking even when we know that smoking is no longer as cool as when they shot Breakfast at Tiffany's. Yes, paradox. And it is equally difficult for diets to succeed and for value investors to dominate the investing world and for any investor to beat the market. Although that doesn't mean we shouldn't try :)

While this whole website and eco-system is built around value investing and trying to educate investors to understand value philosophy and to beat the market, we must be cognizant that the market is efficient. It is very hard to actually beat the market over the long run. Just as it is very hard for smokers to quit smoking or to successfully lose weight. Statistics showed that less than 10% of smokers can actually quit smoking without the help of medication and 95% of all fat people gained back their weight after some diet regime. In investing, about 10-20% of all investors will actually beat market return ie earn more than 8-10%pa over time.

In an era when smoking was still cool, Audrey would be asking, 
"Are you the 10% or are you just like Cat, a no name slob?"

The Efficient Market Hypothesis or EMH came about in the 1950s and 1960s when a bunch of professors in the University of Chicago and MIT did detailed research on the markets and came to the conclusion that most investors had never beaten the market ie the returns they generated were less than the average market returns of 8-10%. Over the years, the EMH has been debated to the death. Behavioural  finance "sort of" proved that humans are not rational when it comes to investing and hence EMH couldn't hold since one of EMH's core assumptions was that investors are always rational.

Also if the markets were truly efficient, how do we explain bubbles and how Warren Buffett and his group of Superinvestors beat the market for years and years? So is the EMH a fluke or is the market really efficient? Again, paradox.

I believe, as with all things in life, things are never binary. Everything must be explained in percentages (ie analogue basis, not digital). Type A people will never understand this. Let's hope more readers here are Type B.

The market is largely efficient. Maybe 95% of the time efficient. Bubbles and Warren Buffetts exist, but they do not refute the EMH. As investors, we must learn to respect that markets are, by and large, very efficient. To be better than the market, we must think better and see further and that ain't easy.

Why is the market necessarily efficient? 

As a simple analogy to illustrate this point, imagine that we stuff the National Library with $100 bills and get 10,000 people to go look for them. How long would it take before 95% the bills are taken? Not too long perhaps? A day or two? Yes, after that, there could be a few that are stuffed in between books like Security Analysis or War and Peace that might take some time for people to find them - that's where value investors look at.

The stock market is, by and large, like that. It is not easy to make money because everyone is looking for those dollar bills. Here's another paradox, the market did not start being efficient from Day 1. It became efficient as each and every investor took pain to extract the inefficiencies one by one.

The National Library analogy has its limits, so we need another one to better explain the structure of the stock market. The way that most investors (or shall we say speculators) play the stock market is hope to buy something and flip it fast, ie sell it to another buyer at a higher price. Now playing the market this way might make you money. But it is very tiring and you are far more unlikely to make it big. If the success rate for an average investor to beat the market is just 10-20%. Then playing this buy-and-sell-it-to-another-greater-fool game would likely have a lower success rate. Friend, don't make the game harder, already very pai(2) tan(3) liao(3), ho(2) sei(3) boh(2) ie already not easy to make money, pls wake up your idea.

So how?

Let's imagine now that there is a comic book store selling all sorts of comics from Marvel and DC Comics to Japanese manga to Hong Kong's Wind & Cloud or Lao(3) Fu(1) Zi(3). For a moment, also imagine that there is only one store in town and one copy for each comic. Some others might still be playing the previous game here, buy some comic in hope to sell to a Greater Fool. But a better way to play this is to: 

1) Buy a comic that is not expensive to start with
2) But also a comic that is interesting which you can rent out to others
3) Finally it is also evergreen such that the comic's rent price will actually rise over time

There are a few prices here. One is the price of the comic (ie the stock price) and there is the rent price (ie the dividend). The intrinsic value of the comic is determined by how much rent price it can fetch over its lifetime. The future price is determined by whoever willing to pay the highest. If you buy the issue #1 for Superman for $5 and you can rent it out for 5c every month, essentially you earn back the $5 in 100 months or 9 years (a bargain!) and you can sell that #1 of Superman for a higher price, provided the rent has then also increased to 10c per month. (Also imagine that both pirated paper and internet copies do not exist :)


#1 Issue of Superman in 1938

So you see, if you get the right comic, it will provide you an income and one that would rise over time. However you also want to buy them at the right price, because if you overpay, then it takes too long for you the reap the benefits. Say if you buy that same copy of Superman for $20, then it will take you 400 months or 35 years to earn back your cost, and you may not get to sell it at a higher price. That's poor investing.

The market is efficient here because there will be all these other comic buyers snooping for the good comics. Similarly there will be all these investors scouring the stock market for all the good stocks. Usually the buying price is at 12-18 earnings multiple ie it would take 12 to 18 years to earn back your cost. As you can imagine, it would not be easy to spot the great comics selling at a discount. You would have to be at the store every day, reading through all these comics and finding the real good ones which are undiscovered (think: reading a lot of annual reports and analysing a lot of stocks). And/or to wait patiently for some bargain sale some day and amazingly nobody is around.

Once in a while, the buyers disappear as they somehow collectively decided that nobody will read comics no more and you get the bargains. At other times, one or two comic become so superhot as to fetch prices that will take 100 years to earn back the cost (think Facebook, Alibaba). It's better to avoid the temptation to buy these hoping that you can flip and sell to a Greater Fool. Often, people find that they themselves are the Greatest Fools.

Most of the time though, the market is bloody efficient and very few outsized returns could be made. The Efficient Market Hypothesis works. While that is true, it doesn't mean that aspiring investors should just sit back and do nothing. For some, well, scouring for stocks year in year out really isn't their calling, then perhaps it would be better to buy the market (ie buy ETFs). And do other worthwhile things with our lives before we become food for worms.

For the rest of us, yes, we are here to figure out the paradox. Why are we born so that we become food for worms some day? Why try to beat the unbeatable efficient market? 

Because, we are here to seize the day and find as many gems while we can!