Wednesday, April 16, 2014

Three Key Points for Newbie Investors

This is really more of a post for me to jot down what to say in the elevator or in a casual setting where I only have a few minutes to talk to someone and I would like to give the biggest impact and let him or her take away as much as possible with regard to the world of investing.

Now, I am assuming someone with very little investing background and who may or may not know who is Warren Buffett. If he wants more info, I can always refer him to this blog. But in that span of a few minutes, I must basically let him know the most important things about investing. 

So what should I say?

Here's what I thought could be well covered in a few minutes, and understandable to the layperson.

#1. Investing is about owning the very best businesses.
#2. Identify the blue chips (in Singapore) that satisfies #1.
#3. Buy only those in #2 with a strong dividend track record and a high yield.

Owning the very best businesses

For the readers here, you would know all about good businesses. These are firms with strong economic moats such as excellent business models (eg razor and blade), oligopolistic industry structure, recurring demand, brands, high market share, strong distribution, mind share, cost leader, pricing power etc. Great businesses are just a combination of these that allows them to generate very high returns on capital invested.

One Singapore stock that is becoming very interesting is SMRT. Disregarding all its trials and tribulations over the years, passenger rail is a simple business to understand. The demand is recurring - we go to work daily. It is a monopoly - unless we take buses or drive and clog up the roads further. There is always huge opportunities in retail and property development around the stations. It is one of the best businesses around. Buffett bought one for 26 billion dollars.

Obviously, in Singapore, the risks manifested themselves too well. Regulations - prohibiting SMRT from raising fares. The firm's own mistake in investing too little in operations and maintenance, causing major breakdowns. All these, together with the popping of the property bubble caused the stock to crashed to $1. A level not seen in since 2006! But as it falls, a lot of these risks are factored in the price. I would argue that we could have seen the worst. Time to think about buying SMRT.

Passengers walking along the track when the train broke down

Buy only blue chips

Well, there are blue chips and there are blue chips. Some companies and their businesses are just not as good. They have no economic moat - bad business models, poor industry structure etc. Chartered Semiconductor was a blue chip. But it was a crazy business. Players invest in billion dollar fabs that got obsolete in 3 years. It was a race that only 1 player could survive. The biggest global player - TSMC. Airline is another treacherous business. There are over 200 airlines globally and they compete away all the economic earnings. SIA is still profitable mainly because of its subsidiaries.

A lot of blue chips in Singapore actually do not satisfy the good business criteria. I would say majority of what makes up the STI would not make the cut. Temasek just bought one out. Olamak!

Dividends

The final test of whether a company is just good or truly great is, in the end, the dividend track record. Great businesses will continuously churn out cash and these companies will have no problem paying out dividends. Some can even increase its dividends year after year. In US, the small group of companies called Dividend Aristocrats have been increasing their dividends for the past 25 years. 

Twenty five freaking years!

Well, in Singapore, our history is too short and even amongst the blue chips, there is only a handful that have a solid dividend track record. The handful that qualifies as true blue chips with strong dividend payout, in my opinion, would be Singtel, Jardine Cycle and Carriage, SIA Engineering, SATS and Keppel Corp. As of now (mid 2014), none of them look really cheap. I would think twice about buying now.

This actually brings me to the most important thing about investment: how much will you pay for it? Hence in my last statement #3 above, it has to be a high dividend yield. Like a 4-5% yield. A high yield would ensure that you bought it cheap and your capital should be well protected. In fact, today (mid 2014) it is very difficult to find true blue chips with 4-5% yield.

Ultimately, investment is an art and there are really no rules that can work at all times. As of now, these five names look like the right candidates and the only thing now is to wait for them to correct to buy them. But we also know that SMRT used to be one that looked right and crashed. Now could be the time to relook at it, but it would take some time for it to be established as a true blue chip again.

So these would be the three points that I would say, next time, in an elevator, or in a casual setting. Own good businesses. Identify the right blue chips, and only buy the Dividend Aristocrats cheaply! Huat Ah!

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