Lesson from Bohemian Rhapsody - Part 3

This is a continuation of the previous two posts about lessons learnt after watching Bohemian Rhapsody, a movie about the famous rock band Queen and its lead singer Freddie Mercury. Freddie was a free spirited artist who lived recklessly. He brought joy to millions while bringing sorrow to those closest to him. Hence, he have the many life lessons that we can learn here. In this last post, we shall talk about a Chinese idiom - 祸从口出 (huo4 cong2 kou3 chu1).

In Chinese, the famous saying above states that disasters come out from one’s mouth. This is another lesson since time immemorial. Spiteful words are hurtful and could break friendships, bonds and even kinships. Words once spoken cannot be taken back and hence we should always be very mindful of how we speak and choose our words wisely.

Disaster comes from the mouth

It might be worth remembering that we should never say something evil or hurtful even if we meant it. We might mean it at the moment but we are bound to regret it later. Since words once spoken cannot be taken back, the person who hears it remembers it for life. Not for that moment only. So phrases like, “I wished I never had a father like you.” or “You are the most disgraceful child.” Should never, I repeat, never be said.

In one sentence, one’s life could change for the worst. So, never say things with hurtful or bad intent. For Freddie, partly as a result of his free spirited nature, he said things as it comes to his mind and his words pierced like katanas into those closest to him and those who cared about him. He sometimes meant it as joke or he just blurted it out at the spur of the moment. But it was painful to the listener (even for me, as the movie audience). He was mean to everyone, insulting reporters who were just doing their jobs. But for those closest to him, his poison tongue ossified friends, kins, partners. it was a miracle most of them forgave him.

In investing, this is manifested in stock price volatility.

Today, CEOs and leaders do not just say things. They can tweet, they can write and send company emails, they can speak rubbish at quarterly earnings conference calls and all that would be scrutinized by the world. One wrong tweet could bring down billions of dollars in market cap. Surely, Elon Musk comes to mind. His one tweet got him into serious trouble. (The one alluding to the Saudis taking Tesla private.) To upend that, he attended an analyst conference call and addressed it condescendingly which caused his stock to collapse further.

Elon Musk attacks!

Well, if we invest in stocks that had CEOs who are not careful how they speak, or write, then we need to be able to stomach that kind of volatility. Nothing against Elon Musk. He is a genius and a visionary. He just needs to learn the same lesson from Freddie Mercury. Fortunately, most CEOs and Chairmans are polished and learnt not to speak or write like that while climbing the corporate ladder. As investors, we actually have to look out for speakers who are too polished and are hiding things. The good news is: after years of interviewing managers, sometimes we can sense trouble. These skills do come in handy both in investing and in life.

Nectaring our tongues is perhaps more relevant in our family and social lives. We take those closest to us for granted and we simply blurt out hurtful remarks time and again. While some families, close friends and some teams can take lot of hurt and insult, I believe everyone has a limit. Yes, when we are very close, a lot of insults just becomes jokes after time. But I believe this should not be used to gauge that we are close enough. Even as close friends or families, we must remain vigilant. Never say things with evil or hurtful intent.

This is perhaps the most important lesson to me. So, that’s it. To summarise the four lessons from Bohemian Rhapsody:

1. Never betray those closest to you, parents, spouses, cadre friends. Although they will forgive you once or twice, but only so many times. Don’t live like a jerk. In investing, always look out for firms with financial and management integrity. If there is doubt, then move on, there’s not point in further analysing.

2. Never listen to just one advisor, identify the good advisors and listen to them wisely. In investing, beware of CEOs who doesn’t have the right advisors. Lookout for telltale signs like revolving doors of CFO and the other key managers.

3. Four heads are better than one. Teamwork works in creating music, in investing and in life. Don't always think you are right. We all need sparring partners who can make us better.

4. 祸从口出 (huo4 cong2 kou3 chu1)- disasters come from the mouth. Always think carefully before speaking. Words once spoken can never be taken back. Never say things with evil or hurtful intent.

Thanks Freddie Mercury. You are an inspiration but we never want to live like you.

Lessons from Bohemian Rhapsody - Part 1

I have this habit of viewing everything with investors’ lens and again this was what happened when I watched Bohemian Rhapsody recently. This top grossing movie of 2018-19 was about Queen and its lead singer: Freddie Mercury. Friends and acquaintances raved all about it and seeing it as the top movie on the inflight entertainment, I put on my headphones and started watching before the plane left the tarmac.

It was good but not as good as my expectations. Expectations - the markets are also all about expectations. When expectations are too high, then the stock will likely fall. There you go, everything in investor’s lens. Bohemian did tell a good story, but the director Bryan Singer always gave enough clues about what to expect, which makes it too expectable. That’s my complaint. Otherwise, it’s good and deserves its SGD1bn box office worldwide.

Queen, the band behind Bohemian Rhapsody

Nevertheless, watching Freddie’s life story drew so many important lessons that I felt compelled to take notes while I watched in the plane so that I could write this for all the readers here. They are both life lessons and investment lessons, expectedly. Since most things that are important enough are usually universal right? So without further ado, here’s the four lesson from Bohemian Rhapsody:

1. Never betray your cadre
2. Identify bad advisors
3. Four heads are better than one
4. 祸从口出 (disasters come from the mouth)

Ok, before we go into details, I must warn that if you haven’t watched the movie, there are spoilers ahead. I have tried to make it as generic as possible but if you prefer to know nothing about the movie when watching then you should read this after you watched it.

First lesson: never betray your cadre.

This is something we all know but yet forget so often. By cadre, I mean people who we treasure most, be it friends, spouses, parents, teammates, siblings etc. In the story, it showed up again and again that artists are born free and hence they feel that they have to right to live way they wanted it. So Freddie betrayed almost everyone in his life, not just friends, but his parents, his band, his lovers. He did it in all ways imaginable too, like an artist. He spout words that one should never say (we will visit this in a later post). He makes unilateral decisions that were good for himself but bad for his band. In short, he was an asshole.

Unfortunately in life, we are bounded by rules. School rules, company rules and most importantly social rules. For example: we don’t get into a love relationship with more than one person (well at least in current times, in current Singapore and most OECD* countries). In the past, we could, if all parties accepted it. Sorry guys, doesn’t happen today.

By betraying our cadre, we break the primordial social contract that makes us humans. In fact, this is almost biological in mammals. Monkeys who betray the clan are casted out. However the follow-up lesson here is that your best friends and family members would forgive you if you sincerely repent and never do it again. Some squander these second chances. Then, you truly are the asshole and deserve to rot in hell.

What is the relevant investor lesson here?

Integrity before everything else

In investing, this boils down to the integrity of those driving the companies. Would they betray their capital providers? It’s usually too easy to betray shareholders. After all it's more a legal obligation than a social obligation. Sometimes, you can still betray shareholders legally. So what’s there to lose?

Normally, the lack of integrity comes in two forms: financial / accounting integrity and management integrity. Accounting integrity is the pre-requisite of any fundamental analysis. If the accounts are faked, then there’s nothing to analyse right? Most people don’t think to deeply about this because we “assume” the accounting has integrity. After all, it’s all listed companies, vetted by the stock exchange and audited by auditors. Unfortunately, it still happens. It’s illegal but people do it. Look at Midas, Informatics, Enron, Toshiba. So when there is a reasonable doubt that the firm lacks financial or accounting integrity, don’t bother to analyse anymore.

As for management integrity, it is also linked to the first point - how some had ulterior intentions to cook numbers. But it is also about having the “betraying-shareholders” mindset . Management has the onus to work for shareholders and other stakeholders but this doesn’t happen all the time. When the management is working for themselves (without breaking any rules), then shareholders will not see their money. This usually happens when the company culture devolved to be all about management themselves. Old case in point: CK Tang screwed shareholders by taking the firm private below book value. Valuing its Orchard flagship property at c.SGD1,000 psf. Everything was legal. It’s just business, nothing personal. But where’s the integrity?

Privatized below book value at c.SGD1,000 psf

As shareholders, we must always be vigilant. Caveat Emptor.

Next post, we talk about our life cadres and advisors!

*OECD stands for Organization for Economic Cooperation and Development. Today it consist of 34 countries including most European countries, Japan, Korea, Australia, New Zealand, Israel, US, Canada and Mexico.

The Force Awakens: Thoughts and Takeaways

Star Wars: The Force Awakens opened last weekend and smashed all box office records. This episode, #7 in the franchise, will likely make USD 1-2bn in the cinemas alone. When Disney bought Star Wars for USD 4bn in 2012, everyone thought they were stupid. Why pay so much to George Lucas who did a crap job trying to do the prequels (Episode #1-3)? Also how can a 30 year old dated sci-fi saga be worth so much?

Now, Disney is having the last laugh. Episode #7 alone might rack in enough profits to cover the USD 4bn cost and there's five more in the pipeline. Yes, there will be Episode #8, #9 and all the way to Episode #12. The motto is: don't stop if die-hard fans will keep coming back for more. Based on my very crude Google search estimate, there could be close to a million Star Wars fan globally, counting both die-hard and casual fans. Over 60,000 of them gather for a May 4th Star Wars Celebration in the US every year.

Coming back to the math a bit more, here's some interesting revenue and cost breakdown:

In US dollar terms
2 bn Box office 

1 bn Merchandise

1 bn DVDs, streaming, rental and downloads

0.5bn Synergies from rest of Disney (Theme park rides, derivative cartoons, games etc.)

-0.5bn Marketing and cost of production

4bn Profits for Disney from Episode #7 alone

Gosh, George Lucas might be wondering whether he was underpaid. Should he have asked for USD 8bn instead? Well actually that's not entirely fair because he could not have generated USD 4-8bn if he did not have the Disney marketing machine behind it. Lucasfilm Ltd was making a miserable tens of millions from merchandise and mostly from Lego Star Wars.

Why did Star Wars do so well even after so many years? What about Disney, is it then a super investment? What are some takeaways we can learn from this? This post hopes to answer some of these questions and provide the investment thoughts as well. 

New lead characters in The Force Awakens

Ok why did Star Wars do so well? For one, pretty female leads. This instalment we have the 23 year old Daisy Ridley (that's her in the pic above with the cutesy BB8 droid) as the new protagonist, probably the prettiest amongst all the female stars. Well, Carrie Fisher wasn't too bad some 35 years ago although the bikini definitely helped. Natalie Portman was okay but Ridley really gives a fresh look despite her scavenger outfit. Okay, okay, beauty lies in the eyes of the beholder, yes and if beautiful ladies make good movies, then we won't have flops liao, ever. So it's not just about pretty girls.

Star Wars worked because it combined so many qualities of good movie-making: a popular genre (sci-fi) with a vast expanded universe, adrenaline pumping sequences, plot twists, innovative gadgets (lightsabers!) and of course the love story. Romance bring in the ladies, or at least help convince them to watch with their hubbies. Yes, there is still the luck element. The first Star Wars was really a lucky hit. It had huge production hiccups and back then, an untested plot, genre, storyline based on a Japan cult movie: Akira Kurosawa's Hidden Fortress. But when it became a success, it paved the way to build a franchise. 

We just love familiarity which is why franchises work. Today, 60-70% of the top grossing films are franchises: Harry Potter, Jurassic World, Marvel Super Heroes, Lord of the Rings and the list goes on (see chart below). This is very similar to branding, which is why we go back to the same brand of toothpastes, the same food chains, the same cosmetics and the same phones and computers which we have used before and liked it. Nobody likes to learn how to use a new OS.

Once we built a brand, we can have pricing power and pricing power is one of the most important criteria for a good investment. Strong brands can build in pricing power above inflation which is the way to supernormal profits and margins. Star Wars merchandise can be priced ridiculously and fans will just pay up. This is why Disney make billions off merchandise, not just Star Wars, but think Mickey, Disney Princesses, Marvel Heroes and all its other franchises.

Top 20 box office movies of all time

In fact, Disney has 8 out of the top 20 box office movies of all time from Marvel, Frozen, Pirates of the Caribbean, Toy Story and needless to say, Star Wars. So does it make Disney a super investment? Well it's hard to say, because it's not cheap. Disney generates c.USD 7bn in free cash flow annually but trades at a market cap of USD 180bn, that's a 3-4% FCF yield and a big part of the business deals with sports: they own ESPN which has a different business model and analysts argue that costs to acquire content (rights to live telecast sports games) are rising sharply which hurts Disney.

But in the franchise business, Disney is unbeatable. Essentially, it had become a buyer of choice for franchise creators. Pixar, Marvel, Lucasfilm all chose to be bought out by Disney because they knew their life-works would find a better home and soar to greater heights. It has become an aggregator of good quality content, not unlike Berkshire Hathaway as a good aggregator of high quality businesses. With more and more content, Disney is then able to drive more merchandise sales, more synergies between its various businesses (other than sports). 

I guess this is really one of the important lesson learnt in investing: look for good aggregator stocks. Companies that have built that capability to deliver value add by building on its strength of aggregating businesses. They just become a locus of growth and keeps attracting the good stuff to them like a strong magnet. This has been the model of growth for some US companies for some time. Especially in certain sectors like pharmaceutical and medtech.

Even in our daily lives, we can strive to be an aggregator of good quality stuff. We should aspire to aggregate wisdom in some domain and become a master of sorts (yeah like a Jedi Master). We then build a brand for ourselves and people would come to us. There are many niches that one could fulfill. I am sure we know friends who are good at music, or IT, or art, or food, or finance and we seek them out for their expertise sometimes. We should seek to be an aggregator in a field we are interested in and have established some know-how and expertise. 

Strive to be a Jedi Master

The final point I would like to make for Star Wars is the offline and online argument. This came as a revelation in 2015 as online moved to really dominate our lives after 15 years since the dotcom boom and bust saga of 1999-2000. Online and internet came one full circle in the one and half decade fulfilling the prophecies that drove the bubble then. Now we buy groceries online, pay our bills online, chat with friends online, watch movies online, in fact we can pretty much live our lives online. What does this mean for the offline world?

It means that whatever cannot be done online becomes really, really scarce and people seek to do it and cherish these rare offline moments. Every damn thing has become a commodity when it goes online so offline is left for things that are really so bloody important (or simply a hassle sometimes though if the segment hasn't caught up with the online fever, like government related matters or banking) and we will pay any price to do it offline for that experience (obviously not for the hassles though). Again, as online dominates our lives, for the really important offline events, we will pay any prices for the unique experiences in the real world.

That's watching Star Wars in the theatres. The internet has taken over the world and we can pretty much watch any movie online, paid or pirated. But if there is one movie in 2015 that you would want to watch it live in the cinemas, just like the good old days, there would only be a handful. And Star Wars would rank pretty near the top. In fact for Star Wars fans, it would be at the top. Now these fans would drag their loved ones to go with them. Or better, they would first watch it once themselves on the first day, then drag their loved ones to go with them for a second round. This explains the huge box office sales.

That's what is really happening in the real world. Since everything has gone online, what is left offline has to be really important. People will cherish the remaining offline experiences and will be willing to pay huge premiums to get these experiences. Yes, it's pricing power all over again. Think of live concerts, Michelin star restaurant meals, theme parks, birthday parties, invitation-only events and even shopping. People want to be awed when they do things offline. Hence they are no longer shopping at some local malls. They want to visit flagship stores to discover new things. They want unforgettable experiences. It's not shopping to buy stuff. We can do that on Amazon, it's about creating awesome experiences. They go to the flagship Disney store to see the Princesses or meet Darth Vader. That's shopping in 2015.

Disney understood this and embarked on an ambitious marketing campaign globally with Star Wars. We have the Changi Airport campaign in Singapore which is becoming a huge success and we see families flocked to the airport for the experiences: a photo on a life-size X-wing and another one battling the Dark Side with lightsabers. Then flooding Facebook with Star Wars photos, intriguing more people to go Changi and then go watch the movies. This offline and online loop is really the force awakening the new paradigm shift as we move forward. The winners would be companies that could find the balance well between both offline and online, the light and dark side of consumerism.

May the Force be with you! Merry Christmas and Happy Holidays!

Invert, always invert

This is a quote originally from Carl Jacobi, a German mathematician but has now been attributed to Charlie Munger, Vice-Chairman at Berkshire Hathaway, investing partner alongside Warren Buffett. Munger used this phrase so many times in so many of his books that value investing students would have to come across it sooner or later. 

Inversion is a technique used widely in math to solve problems by reversing the thinking to come to some kind of solution. In investing, Charlie encourages us to also always invert to see through issues that are not easy to do so conventionally. Today, we would like to discuss three topics about inversion and hopefully gain some insights about using this technique in the future.

Satoru Iwata, the late President of Nintendo was perhaps one of the most brilliant executor of inversion. Sadly he passed away this year before being able to steer Nintendo to greater heights after its successful launch of Wii some ten years ago. Not sure if most readers would remember, during 2004-2006 the gaming market was an epic battle of specs between Playstation and Xbox. Back then there was no mobile gaming, PC gaming was very niche and game consoles were the main devices that people played games with. Sega was dead after it lost out to Playstation and everyone thought that Nintendo would follow Sega.

Sony and Microsoft were well funded to develop game consoles that were going for higher quality graphics, faster controllers, more storage, customized computer chips to run these machines. Nintendo had neither the cash nor the resources to compete. Hence Mr Iwata decided to invert the problem. The problem was not about what core gamer wants, which was thought to be all of the above: graphics, speed, specs and all. The problem was how to get the non-gamers to play games.

Nintendo and all its cute characters!

The answer was the Wii. It had none of the graphics, nor speed, nor specs. It was cutesy Nintendo characters and the innovative wand controllers. It was about making game play much more accessible to non-gamers and it worked! Wii sold more than 100m units and Nintendo at its peak became the 3rd most valuable company in Japan. However the Wii also opened the market for casual mobile gaming as people caught on to how games should be made simple, addictive, fun and on the mobile phone which was in everyone's pocket all the time. Nintendo did not catch this mobile gaming trend fast enough and went into losses. But Iwata-san was quick to react and switched the firm to join the mobile bandwagon last year. Again by inverting the logic that Mario games should only be played on Nintendo devices.

Iwata-san did not live to see the fruits of his legacy as he succumbed to cancer that plagued him for two years. He worked till the final days of his life, giving all he had for the firm, for the shareholders and for Nintendo fans. Iwata-san has my full respect as an innovator who dared to invert mainstream logic and brought the firm to a soaring success never reached before and will likely be renewed with the direction that he set by moving into mobile gaming. Rest in peace, Iwata-san!

The second and third topic would be around TED videos that I watched recently that really opened my mind to issues that are really important. Do read on carefully! Before watching, I was pretty much thinking the same way as most people would, but the videos showed that by inverting, we get to enlightening solutions. The first one is on charity and the second one on happiness and work.

On charity, the consensus thinking, which was also my thinking is that charitable organizations should never aspire to pay its staff market compensation. They should also work with a low cost to donation ratio (like 10-20%) and spend very little on growth. But the speaker argued that all these were wrong and if we continue to think the way we did, we would never solve any of the world's biggest issues like poverty, cure for diseases or helping the disabled and the less advantaged.

The speaker gave powerful examples to illustrate these points. Most memorable being that a CEO of a charitable organization could only be expected to receive $80,000 a year while a CEO of say even a small SME would be paid $200,000 and an MBA graduate would be paid much more than that as they reach the peak of their careers. So these folks could donate half their income, seat on boards of charitable organizations to supervise the poor CEO and be recognized for doing good charity, enjoying fame, status on top of being rich. So who in the right mind, with the capabilities of a SME CEO or earning an MBA would want to be that CEO of a charitable organization and really do all that heavy duty stuff and yet get supervised by MBA grads?

Well, for those really interested, I strongly encourage you to watch the video:

https://www.ted.com/talks/dan_pallotta_the_way_we_think_about_charity_is_dead_wrong

The solution was really to invert and think big. For charity to really become a force to reckon with and solve the world's biggest problems, they have to be for profit corporations, not non-profit charitable organizations. This is inversion at its best!

The last issue that was interesting was related to happiness. The conventional thinking was that we think of happiness as a goal, as something to be achieved, as boxes that needed to be ticked. If we do this, we will be happy. If we go for that holiday, we would be happy. If we achieve that sales target, we would be happy. But the speaker opined that the inverse was what actually made much better sense. If we were happy, we would do this, and do it better. If we were happy, we can plan and enjoy that holiday much, much more. If we were happy, we would over-exceed the sales target by manifolds. Invert, always invert!

The key to happiness is not about goals and ticking boxes. It's to train our brains with the few simple things below:

1. Write down notes of gratitude for one thing and one person daily

2. Share a moment with our loved ones

3. Perform a random act of kindness

4. Exercise or engage in some physical activity: gardening or photography

5. Meditate or contemplate our day and update them in a journal

The talk below:

https://www.ted.com/talks/shawn_achor_the_happy_secret_to_better_work

Time to invert and transform our lives!

Look for Free Options

Those who have knowledge, don't predict. Those who predict, don't have knowledge - Lao Tzu

Investing is not about predicting the future. Predictions are usually not accurate. We heard the famous ones: Bill Gates predicting nobody needed no more than 640KB of memory, Dow Jones 36,000, who needs cars when we have horses blah blah.

Yeah, how right. So what do we do if we do not want to predict?

We want to be prepared. This post serves to illustrate how.

First we must accept that the future is unknown. It is a set of probabilities. We want to make sure that whichever future pans out, we will be okay. In mathematical terms, it means that the expected return is positive. In investing, we want to look for free options, or near-free options. In layman terms, it just means be prepared, don't anyhow bet.

It's easier to use an example, so we go back to Singapore's property market, my favourite topic. As of now (mid 2014), we can probably trace 3 paths that our beloved property market would follow in the next few years:

1. It will crash and burn, ie prices collapse, falling 30-40%, most speculators fall into deep shit and every Tom, Dick, Harry and his wife and his dog totally shun this market. That's when value investors come in.

2. It will continue to cruise along, doing nothing much at 2% rental yield or an average of $1,500 psf ie 90% of Singaporeans would not be able to afford anything any time soon and foreigners continue to nibble on some of our high-end stuff.

3. It will rise and rise as Singapore becomes the Monaco of Asia. Prices rise to $2,500 to $3,000 psf or higher and stay there forever. 99% of all Singaporeans and their children and their children's children will never be able to afford anything and have to resort to living in Iskandar.

Iskandar. Not too bad. Who wants to retire there?

I have posted in the past about why I think Singapore's property market should not continue to rally. But it's not supposed to be a prediction. It's merely a view I hold which I would attribute say a 70% probability that this future is likely to come true.

As for the other possible futures: 2 and 3 above, I would attribute say a 20% probability that our property market would do nothing and a 10% probability that we would become the Monaco of Asia and we will all have to move to Iskandar some day.

So the way to invest here is to make sure that no matter which future pans out, you would be ok. And if one of them happens to be right, you make a lot of money.

Now obviously if you have bought 5 properties on leverage and is paying interest instalments out of your salary, you are betting on Future 3. But if you believe my probabilities, then if Future 1 pans out. Good luck! See you in Iskandar, sorry I mean your makeshift cardboard at the void deck this weekend while I bring my kids to Legoland! That's way too much prediction and too little preparation.

On the other extreme, if you have sold your home and your mum's and in-laws ones as well and on top of that you go short $500k of Singapore property stocks, then you are heavily betting Future 1. But if Future 3 pans out, then jialat liao (ie in deep shit!). Not only you have no place to live, your short would probably be losing close to a million dollars. Makeshift cardboard at the void deck all over again. Again, that's not rational investing.

In investing, most of the time, it's very difficult to make free money or in investing lingo - to find arbitrage opportunities. You have to take some risk to make some good return. But that's just not very efficient. So the lesson here is really to just keep finding those arbitrage opportunities or what I would call "free options".

A free option or a near free option is a bet that would give a good payout if a stipulated event happens in the future but the cost is either free or almost zero. It could be said that one of the goals of investing would be building a portfolio of free options or near free options.

I must stressed that this is not going to be anything easy. The market is efficient and arbitrages are easily profited away by the professionals. Arbitrages are like dollar notes that fell out of people's pocket accidentally on Orchard Road. It would be picked up in a blink. So it's really not like money would fall from the sky. In investing, some of these free options are hard to come by.

But there are times when "free options" come about. We just have to be savvy enough to spot them. In the Singapore market, ironically, one example would be the property play Ho Bee. In early 2012, Ho Bee's share price fell to $1 as it was becoming clear that Sentosa's luxury properties might struggle to find buyers and Ho Bee was the Sentosa developer. It was clear that Ho Bee could have some serious issues as lower sales meant its cashflow would get tight but it had to finance its huge capex for its residential projects and its crown jewel commercial building: the Metropolis.

The Metropolis is a mega-deal for Ho Bee, at 1 million square feet of rental space right outside Bueno Vista MRT, this property alone is worth more than $2 when converted to Ho Bee's share price and even after netting all its debt, there is still $1.5 left. So when Ho Bee traded at $1, the market was saying Ho Bee's entire Sentosa plus other projects are worth nothing and its prime Metropolis could either be marked down drastically because Ho Bee might have to do a fire sale of this prized asset to survive.

Now I am doing this analysis with the full benefit of hindsight. I didn't invest in Ho Bee then and I am drawing conclusions now just for the purpose of illlustrating what's a free option.

The market is not stupid. Remember markets are usually efficient and I believed that there was a likelihood that Ho Bee needed to sell a part of Metropolis cheap to keep itself going in 2012, hence the market priced it below Metropolis valuation. But at $1, the market priced in the worst possible scenario. If it had gotten any lower, someone would have taken Ho Bee private. In fact, the management could just bite the bullet, partner with some private equity and took itself private at say 80c since the company and its management owns 70% of itself already.

So there was a free option on the table when Ho Bee was at $1. I would attribute say 20% probability that it could still fall another 20% which if it did the prudent decision would be to buy even more Ho Bee. But in another scenario, there is an 80% probability that it could rise 50% back to Metropolis minus debt at $1.5.

As things turned out, the upside was 100% and more. Today Ho Bee trades at $2.20. 

So ironically, despite my negative view on the Singapore property market, a prominent property play called Ho Bee was a free option regardless how the whole Singapore property market performed.

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!

Patience

"Patience is a Virtue."

I was googling around for this topic and as usual, Wikipedia came to the rescue. Sadly, it's still loss-making because donation somehow doesn't work on the internet. Google should just buy them out.

So what did Wiki says about Patience? It's actually part of the seven heavenly virtues which are counterparts of the more famous seven deadly sins, protrayed in the cult movie starring Brad Pitt and promoted Kevin Spacy and Gwyneth Paltrow to stardom. Patience is described in more context than our current world usage: usually like waiting patiently for someone or for the MRT to actually move smoothly. Accordingly, it is about endurance, moderation, grace and forgiveness. The counterpart in the sins is wrath.

In investing, the masters have talked about this over and over. And this is the Nth time I am re-learning this lesson as well. Baseball is the favourite analogy. It is known that the best baseball players do not anyhow swing. They wait for the perfect pitch. When the pitcher screws up and throws a slow ball, in the right zone, they swing the bat and hit that sayonara home run. In buying stocks, it's the same. You don't just buy when Singtel drops 10%. You wait for something to happen or some crisis for the stock to fall really, really cheap. Actually it's sort of happening now with some of our Indonesia exposed names like Jardine Cycle and Carriage.

And you swing when the slow fat pitch comes. Like when Jardine drops to $30, when it's PE hits 8x and its dividend yield goes up to like 6%. Imagine! 8x and 6% for the No.1 auto and motorcycle distributor in Indonesia where both auto and motorcycle market would likely be in the Top 5 globally in the next few years. 

These opportunities do not come often. Usually once every few years. The last time Jardine was this cheap was 2011 when the Greek tragedy hit. As for Singtel, the No.1 stock in market cap in Singapore, the last time it was cheap enough was Lehman, that's half a decade ago. So as patient value investors, most of the time we should really just do nothing. It's called "sit-on-your-ass investing" according to Buffett. To deploy capital over mediocre opportunities simply just doesn't cut it, especially if we are trying to hit 8%pa kind of return.

Ok, that's patience in investing, but what about patience in life?

I think this could be the more important lesson. Patience in life could work in various circumstances:

1. When we are preparing to do something bigger. Hence needing the patience to remain in the current situation for longer, allowing more time for training and mastery.

2. In facing our adversaries, one of the best weapon is patience. Wait for them to commit mistakes. But we need to do our part in maintaining our best. The wait would usually take months if not years. Although sometimes we ought to leave the mud-house especially when the bosses are not on the right side. Choose not to wrestle pigs, if possible.

3. To garner support for change, sometimes it take years for things to move. Like the changes in our education system. Together with others (more prominent opinion leaders and education specialists), I have discussed about revamping PSLE a few years ago in a few series of posts on Education. Finally, something would be done. Well, at least, PM Lee promised.

Being patient in situations is not about admitting defeat. It is taking a step back to leap forward. It is taking time to strategize, recognizing that the time to act is not now. Recall the old battle scenes before machine guns were invented. The army needs time to reload their guns. So you cannot fire when the enemy is coming until they get near enough. Patience makes the difference.

Of course, there is a spectrum to everything. Pulling patience past its limit is cowardice. Unwilling to act after waiting and the opportune moment passed. That would also be a grave mistake. How do we know when is the right moment then?

Oh, we know. We ALL know. When the stock hits 6% dividend but we fail to act even though we already decided we must buy when it hits that price. We didn't because our balls shrunk and we say let's wait. It's the same feeling as seeing the girl leaving and our balls shrunk and we say, "next time I'll ask for her number."

To sum up, we need a suitable amount of patience to succeed in investing and in life. Train up and be prepared. Focus and wait for the opportune moment. Then seize the day! George Savile, an English statesman who lived 400 years ago also summed it up pretty nicely, "A man who is a Master of Patience, is a Master of Everything Else."

Choose Stocks Like You Would Choose Friends

I attended a wonderful class gathering a few weeks ago. It was our 20th year since graduation. Gosh, time flies (and I am revealing too much about my age here :). We were teenagers then and now mums and dads. In a few years, our kids would be teenagers themselves. How would we advise them how to choose their friends? How did we ourselves end up with good friends?

Well, a lot was actually just fate. We were classmates. We didn't really get to choose. Even if we could, we were young and innocent teenagers then. We wouldn't really pull out a checklist and choose whom we should or should not be friends. We just clicked and here we are, after 20 years, sharing life moments and having fun. But it is also true that we gravitate towards people that we like and enjoy their company. Some of us are closer to secondary school friends, others in JC and some others have good friends from the army or university days. So we somehow, unknowing, do "choose" our friends.

Life, in my opinion, provides a lot of lessons for investing and our attitude towards investing is also a reflection of our way of life. So how should we choose our stocks? Can we learn from how we choose friends? If I think about a quick template for "choosing" friends it would be as follows:

1. Character
2. Trust
3. Long Term

Character: Birds of a feather flock together. We hang around with people that are not very different from ourselves. So non-smokers usually have few friends who smoke. People who value similar qualities will find people who think like them. Of course, it doesn't have to be a 100% match. We can be different enough yet we find it enjoyable to hang out together. Someone who values integrity, humility, tenacity (I really like all these "ty"s) will seek friends with similar values and character.

In investing, I believe similar principles hold. You want to find stocks that fit your temperament. If you like excitement, maybe Tesla, Facebook or Hyflux are stocks that appeal to you. You can still apply value philosophy, buy them at the right price (ie when price is way below intrinsic value) and make money. For me, I would prefer the Colgates and Heinekens of the world. Slow and steady winners with strong branding. Value investing can work for different stocks. But you have to find the right stocks for yourself.

Trust: Of course, friendship is also about mutual trust, respect and helping one another. Some of these once broken can never be repaired. Investing is a bit like that sometimes. There are times when you actually disappoint a stock by selling too early, or by not buying and you never get a chance to own it again, Ever! I speak from experience and this can really be painful. Especially seeing these stocks go from strength to strength after you sold, way too early! Or get taken out at 50% premium like F&N, after you missed buying it bcos it rallied 20% and you refused to pay up and buy. Ouch! Then, there are times the stock disappoints and you sell it the first chance you get. But good friends like good stocks can be life long relationships. It's a commitment.

Long Term: Some people might prefer hi-bye friends all their lives. But for most of us, I would believe we want to stick around our friends. Investment is the same. Invest with a long term mindset. A good stock is really like your best buddy or your sworn sister. Of course this analogy has its limit. You can't really be there or be a shoulder to cry on for a stock. But like a good friend who will help you whenever you need help, a good stock just will pay you dividends whenever the payable date comes. It will also grow as you grow. And when you have time to learn more about it (ie the company and its business, as owning a stock is simply owning a small part of the company), you also learn more about yourself.

Investing is a process of discovering: who you are, what you’re interested in, what you’re good at, what you love to do, then magnifying that until you gain a sizable edge over all the other people. I really like this quote. This quote comes from Li Lu, a famed value investor who introduced Chinese companies to Warren Buffett. I would add that good stocks, like good friends, help you tremendously in that process of self discovery.

Start With Why

Just saw a great video on TED. The speaker was Simon Sinek and he was sharing how leaders inspire by appealing to peoples' hearts and emotions. The way they do that is to "Start with Why". The leaders share with the people why they do the things they do. When people see and believe their causes, the inspiration follows.

He asked a question: "If you ask someone what his company does, he would have no trouble answering that, but few people would be able to answer WHY the company is doing what it is doing". The reason that a great company is able to keep growing sales and profits while their competition "cui" (ie falter) in the wind is because the company has a belief and that belief is what defines them and inspires people to believe in what they believe in.

He used Apple as an example as it is easy to understand. There are a dozen or more computer makers in the world but they all cui while Apple rules the globe. Why? Apple has a mission. The firm believes its mission is to create technological products that are easy to use, fun to use and help us connect better with technology and also with other human beings. The firm believes its mission is to think different and bring the best of technology to enrich peoples' lives. Apple happens to just make computers and mobile phones. And we buy their products by the truckloads. It is not WHAT you do (or make), but WHY you do it.

Take Colgate as another example. A stock which I have talked about and own. (Yes pls read the disclaimers carefully :). Colgate does not just sell toothpaste and dental stuff. The firm believes it is their fundamental mission to help everyone have better dental health. They started campaigns to teach school children to brush their teeth when they were young. Those Singaporean readers old enough would know this! They continue to innovate and create better toothpaste (try Colgate Total for its new sensation) and toothbrushes (those that massage your gum while you brush). Colgate's competition is how to give ever better dental care, not P&G. That is why it keeps growing market share. It is the firm's belief that defines it and help grow sales.

He gave an interesting quote on employing staff: "If you hire people just because they can do a job, they’ll work for your money. But if you hire people who believe what you believe, they’ll work for you with blood and sweat and tears."

So when people believe what you stand for, not just will they buy your product, they will want to work for you. And you don't need to pay them! They will also help you spread your belief. Bcos that's what they believe in as well. Humans have an innate capability to empathize and that is why we follow those who believe in their cause.

Whether they're individuals or organizations, we follow those who lead, not because we have to, but because we want to. We follow those who lead, not for them, but for ourselves. And it's those who start with "why" that have the ability to inspire those around them or find others who inspire them. Quote from Simon Sinek.

So here is what I believe.

I believe that I can help everyone identify bargains. Not in the bargains in real life during the Great Singapore Sale, whereby it's almost effortless and everyone knows that three for $10 is a good buy. And obviously, nobody needs my help there.

I believe I can help everyone make good investments and avoid bad ones. I live in the financial world and see fortunes made and lost. Sometimes unduly lost. I brushed up my expertise in identifying bargain investments such as stocks, bonds and properties and I want to help everyone understand when we should be buying; ie when things are cheap like some global stocks now. Not when the market is hot and your grandma opens a brokerage account so that she can buy Creative in 1999. Hence I also believe that I should help people avoid expensive stuff. Like Sky Habitat at $1700 psf. Or Facebook at 50x PE.

The way to achieve my goals are already spelled out nicely in value investing and what the masters have been saying. I believe that it is the purpose of this blog to apply the principles in value investing to help identify bargain investments. It will take some effort for the un-initiated to be familiarized with some concepts such as margin of safety and valuation. But I believe that is not at all difficult if you are willing to put your mind to it.

I believe that the world will be a much better place if more people understand value. We will not see Sky Habitat at $1700 psf, or COE at $90,000 bcos people understand that it simply doesn't pay. Let alone makes sense.

Well, that is my belief.

2nd Level Thinking in Real Life

2nd Level Thinking works in real life as well. We should not be thinking superficially and derive simplistic answers to some of the problems we face. Again in most cases, consensus would be right, and it's tempting to just follow the crowd. Sometimes, maybe average is good enough. But in other important issues, we might need to strive to be one level up.

Take my favourite topic: our kids' education. All the parents in Singapore are stuck in this crazy competition of getting into branded schools, tuition marathons and fighting to be one up against the rest. But the since every parent is doing that, no child stands out. To make things worse, parents waste money on tuition, waste time at volunteer work and every child actually has less free time, are more stressed and become less proficient in other non-academic areas: such as learning to iron, cook or fix a light bulb.

One solution to this issue is for authorities to step in as mentioned in previous posts. The nature of the game has evolved such that it is impossible for the participants (ie parents) to resolve the issue, even though everyone is just simply working in their own best interest. This is akin to asking all women to stop wearing high heels. (See this post if you don't get this.)

Well that's topic for another day.

The idea here today is to apply Second Level Thinking. Different but better. Needless to say, it cannot be just different. Some might say don't go for tuition lah, don't succumb to doing parent volunteer and support this elitist system. But then the kid loses out. So it has to be more innovative than that.

Again we ask questions such as:

1. What are the viable alternatives?
2. How can we invert and think out of the box?
3. Where are the kids today lacking?
4. What are other parents not doing enough?
5. Does my kid have a talent?

When we think through some of these answers we are effectively applying Second Level Thinking and some solutions might well be different and better.

Take question 3, what are kids today lacking? There are plenty! As alluded to above, they cannot do simple chores (Blame the Maids!). They speak less mother tongue (60% of homes are English speaking). They are exam smart not street smart. They don't see as well (a lot of kids are short-sighted).

A lot of the issues have no relevance in academics but still something to think about. The one key here: kids today speak much more English and are bad at their mother tongue.

20 years ago, English was a problem, bcos 60% of Chinese homes speak Mandarin at home. Today it is the opposite. Our Chinese kids are becoming bananas fast. Yellow on the outside, all white inside. Their command of the Chinese language is poor, and they and their parents either have no intention to do anything about it or are incapable of doing anything bcos the parents themselves don't speak good Mandarin. In fact, MOE wanted to lower the bar to satisfy some parents, only to get lambasted by the Chinese elites.

So the 2nd Level Thinking here would be to let our kids become proficient in at least 2 languages. In fact, we should let them be exposed to more if possible. Research have shown that kids can learn languages better than adults. So while we are at it, we can definitely throw in important languages like Malay, Japanese or even Spanish.

Of course language needs the environment, so if the parents cannot speak Spanish, it is hard for the child to pick it up out of the blue. But for some parents who are bilingual and speak dialects, or Malay or other 3rd languages, it might be useful to impart these to your kids.

Alas, as in stock market, people catch up to 2nd Level Thinking fast. What worked yesterday might not work today. Some parents prepared their children for Primary 1 when the kids were in K1, K2 many many years ago and those kids gained the one up against their peers during that time. But today, all parents do this and the bar is raised, to the detriment of those who cannot keep up.

Similarly, I won't be surprised that a lot of parents are making sure their kids are effectively trilingual and in the near future, we need to apply 3rd Level Thinking to gain that one up again.

Second Level Thinking

This is a phrase coined by Howard Marks in his book, "The Most Important Thing". This book is truly a rarity for investors, with both new and old concepts well thought out and written clearly. The best part: the concepts are even valid for institutional fund managers. Very rarely we find something useful both for professional and retail value investors.

So one of the most intriguing concept is this Second Level Thinking. What is this all about? Well to answer that, we first need to know what is first level thinking.

According to Howard Marks, most investors possess only first level thinking. First level thinking is obvious, superficial and consensus. Examples of first level thinking would be:

"Apple is launching iPad 3 in 2 weeks, let's buy."
"Oil just went up another 5%, airlines will be hit, sell SIA."
"WD is being hit by the Thai flood, buy Seagate."
"Toyota recalls 100,000 cars! Sell sell sell!"

Almost everyone can be a first level thinker. Just read the headlines and draw the obvious conclusion. Well, this doesn't mean that first level thinking investors doesn't make money. I can hear you shouting, "If this dumb blogger have bought Apple 2 years ago when the stock price was at $300, he would be so rich that he wouldn't be blogging now."

That is obviously true. Being consensus can still help you make money, but it may not help a lot over the long run. You might make money from Apple but you might jolly well be sucked into buying Yahoo! in 1999, or Li Ning at it's finest moment, holding the Olympic torch in 2008 or Singapore's Oceanus, the abalone story that went on fire a couple of years back. Btw all 3 examples would have burnt big holes in the investors' pockets.

First level thinking won't get you very far because everyone is doing it. It derives easy and average answers. That cannot help you generate good long term return. It is even less likely that you can beat the market.

2nd Level Thinking is complex and tedious. It is about mental aerobics, in-depth research and perhaps even long, difficult discussions with like-minded thinkers. The 2nd Level Thinker asks questions such as:

1) Does the market already know this?
2) What are all the scenarios?
3) How can one invert and think otherwise?
4) Are there comparison with other situations?
5) What is the probability that I am right and the market is wrong?

2nd Level Thinking is not just about non-consensus. It has to be non-consensus and yet correct. Different and better. It has to be two steps ahead.

A good illustration of 2nd Level Thinking would be about BP and its accident in the Gulf of Mexico. For the un-initiated, BP's off-shore oil rig exploded 2 years ago and caused the world's largest oil spill that impacted millions of humans, plants and animals in the vicinity.

For those who remember the drama, it was pretty excruciating. First we see footage of the explosion, then the spills, the poor ducks, the fishermen being interviewed and for days on end, they couldn't cap the well. Oil kept gushing out. Experts opinionated everything. How BP cut corners, how the ecosystem will be irreversibly damaged, the penalties and costs will run into billions. Meanwhile the CEO went sailing with his son and got lambasted further. Major media circus.

So the first level thinkers were like, BP is going bankrupt. Let's sell BP. Or even better, short the stock dead. Meanwhile BP's market cap halved. In absolute dollar terms, it fell roughly USD 100bn. A few years ago, that is the GDP of Singapore. Even today more than 100 countries still have GDPs lesser than USD 100bn.

So the 2nd Level thinkers would be going, "Wait a minute, 100 billion? Is that right?" When was the last big oil spill? What was the final tally for costs and penalties? Did the affected co. go bankrupt? What is the Gulf of Mexico's contribution to BP? Can BP simply ring-fence its US operations? Is bankrupting BP better or would the US Govt prefers BP to continue generating cashflow to pay the costs?

Well as it turns out, penalties and costs today cannot even hit USD 50bn. Even the amount that BP already paid out: 37bn or so, might not be fully utilized. A 2nd Level thinker at that time would also have found out that the whole US operations contributes only a third to BP and ring-fencing the whole US would have made sense if penalties and costs exceed a certain amount. Certainly BP would be worth much more alive than dead, why would the US Govt bankrupt BP?

So, when the market cap fell by USD 100bn, the market went crazy thinking BP would go bankrupt. It factored in more than the worst scenario that BP will lose its entire US operations. So it was time to buy BP back then, not sell.

Today BP's market cap is USD 150bn. So a 2nd Level thinking investor made 50% or more. Perhaps with more to come.

The Story of Bak Kut Teh

Just heads up, this is a post with very little value add. I thought about this while eating Bak Kut Teh. Just for entertainment. :)

For the non-ASEANs reading this, Bak Kut Teh is a Chinese dish that originated in S.E.Asia that is made up of spare pork ribs cooked in traditional Chinese herbs and served in a soup. It is also usually served with rice and soy sauce. You can take a look at my half eaten set below.

There is an interesting urban myth about the origin of the dish. Coolies working in Singapore and Malaysia earlier last century had to do tough work like carrying heavy goods at the ports for the whole day. As they were very poor, eating meat was not an option and eating food lacking nutrition ultimately resulted in poor health, sickness and weak bodies and their ability to work to generate money.

So Bak Kut Teh came to the rescue. The coolies would buy ribs that nobody wanted from the butchers at a cheap price, mixed with simple herbs (also cheap, I think) and then eat with rice and soy sauce. Simple as it is, this dish gives them strength, helps to prevent sickness and allow them to work all year long.

Of course today Bak Kut Teh has evolved into a popular dish that actually costs more than normal hawker food and it is usually served with spare ribs with lots of meat, You Tiao (or fried dough) and other stuff.

So while eating Bak Kut Teh, I thought about investing and realized a few analogies which could be drawn.

1. Value for money

Obviously, value investing is about buying more for less. Buy a good company at a reasonable price. Buy things cheap. Bak Kut Teh stands for this. Well at least during the coolies' times. Cheap but nutritional, helps the coolies stay healthy, get work done, earn more money. Today it is a bit different lah.

2. No Fat

In investing we want to buy companies that are lean and mean with no fat. That's Bak Kut Teh! Companies must understand that they have to stay lean in order to generate good returns. Actually, we ourselves strive to stay healthy and keep those cholesterol away so that we can fend away the harmful effects of metabolic syndrome right?

3. Innovate in changing times

The origin of Bak Kut Teh crystallizes the spirit of innovation. First, the coolies or whoever working with them came up with this spectacular dish that helped improved lives. Then, over the years, the dish itself evolved to fit into society. Even today, it's a highly popular dish. In investing, we must also be on the lookout for companies that can keep re-inventing themselves. As we speak PC and PC related companies are dying, big names like Intel, Dell and Microsoft are going all out to re-invent themselves. Although I must say, it's very hard to predict which companies can successfully evolve.

As with individuals, a lot of people struggle to stay relevant in society bcos things are moving so fast, it just gets harder and harder. Perhaps the story of Bak Kut Teh is really about evolution and how we should always re-invent ourselves to be useful.

The Truth Shall Prevail

Value investing is based on an inherent fundamental assumption: that someday, an asset's true value (or intrinsic value) would be realized. Hence buying a stock when it is trading significantly below intrinsic value would yield good return bcos they eventually trade back to its intrinsic value (albeit after a long time and only for a short while). But what happens if the stock never reverts to its intrinsic value? Is that likely? Well I don't have a good answer to that, but let's explore this topic a bit more broadly first.

Analogous to this the concept that a stock eventually reverts to its intrinsic value are similar logics like: the truth shall prevail, good will triumph over evil, hardwork eventually gets rewarded etc. I would think that these tenets should hold most of the time, if not all the time. The issue in the real world is that it can take generations for them to come true. Think Khmer Rogue, North Korea. Think about why some incompetent managers can stay in the firm for years. Or why some evil deeds never get punished (50% of murder cases are unsolved). Well the stock market is efficient, but the reality may not be as efficient.

Khmer Rogue did get its retribution after killing 6 million Cambodians 30 years later, and one or two ex generals are getting trial. One may say that this is too little too late. But Cambodia is finally thriving now with its Angkor Wat and a few hundred other Tomb Raider ruins. But our beloved tyrant in Pyonyang is still enjoying his tyranny. It's been about 20 years of hardship perhaps for the North Koreans? Well I hope I can see some resolution in my lifetime.

Of course, bad managers, they manage to stay afloat for some time but eventually they are either being force to retire or they themselves choose to retire after creating maybe 20 years of negative goodwill amongst colleagues. Yes the damage is done. But what I think could happen is that these people accumulate so much negative goodwill during their lifetime, even though they can be rich and living a luxurious life after retirement or termination, they are not happy. And they die not happy.

As for murder cases, again we can only hope that goodness finally prevail whenever the murderer reflects that he lived a meaningless life, caused only harm and pain to the world and dies a lonely death with nobody to mourn for him, eventually.

The fortunate thing about markets would be that many many participants are judging the stocks, everyday. Hence prices revert to value relatively quicker (but still a good 3-5 years). However there are cases that prices never revert back to value, then shit happens, like the company got taken private at a cheap price (very likely in Singapore). But overall, I would say maybe 70-80% of the time, prices will revert back to intrinsic value over a period of 3-5 years or sometimes a bit longer.

In the case of bad tyrants and bad managers, I guess the problem lies with too few judges. For bad tyrants, virtually nobody can judge them until things get so bad that the people revolt (usually 50 years or more? If we look at the history of China). Or in today's context, global leaders may force a regime change. For bad managers, well perhaps a few bosses on top judging them but not a whole lot efficient. Hence, in my opinion, universal truths can take a long time to prevail. In the worst case, a hundred years.

What is the solution to this?

In the stock market, it would be some diversification, buying enough value stocks so that even if one or two stocks never returns to its intrinsic value, the portfolio should be ok. And that is perhaps why good value fund managers tend to be able to beat the market more often than other managers.

In reality, my current thinking would call for dis-association. Or simply escape from such situations, bcos we cannot live a hundred years to wait for things to revert. I always wondered why North Koreans can endure such shit for 20 years. Shouldn't 90% of the population be gone by now? Indeed I estimated that 0.5% of the population escapes the country every year. But the conclusion I arrived at is that people weigh the risk of dying while escaping vs risk of dying in North Korea and choose the latter. Aside from the great famine in 1993-95, most people have enough food to eat so as they won't die, they have a shelter over their heads, medical is taken care of somewhat. And they adapt. However population growth for the country is near zero or may even be negative. Needless to say, economic growth is also near zero. Well that's North Korea.

As for situations closer to our reality, like in the cases of your bosses happening to be real jerks, pls quit your jobs asap. That is the first step, the 2nd step would be to help the world by revealing their evil deeds such that justice can prevail faster.

The 7 Levels of Market Participants

This was inspired by the 7 Levels of Photographers by Ken Rockwell, which was perhaps inspired by religion. Well, in any case, here are 7 Levels of market participants, with One being the lowest and Seven being divine. Enjoy!

Level One: The Tippee

The Tippee is someone who receives a tip or some advice and wants to make a quick buck out of greed. This level of market participants usually never had a brokerage account and decided that they should make a some money from the stock market bcos everybody else is doing it. They are inevitably tipped to enter the market by friends who give bad advice at the peak of the bull market and are inevitably burnt and vow never to return. Only to do so during the next bullish peak, again tipped by another friend. In normal times, they live their quiet lives in reality, having full-time jobs and enjoying themselves like other normal folks. This level includes grandmas opening a brokerage account for the first time in their lives, taxi drivers, housewives, first time unit trust buyers, retirees and primary school kids.

Level Two: The Amateur

The amateur is a market participant who decided that he/she should dabble in the markets and learn about the intricacies of the world of investing. They are usually bold, eager to learn but lacking in knowledge and information. The amateur spends time after school or work to read up and learn more. The amateur has the potential to reach the higher levels of market participant if he/she has the determination to pursue their goals to the fullest, devoting time to learn the tricks of the trade. This level usually includes high school students or undergrads, young working professionals, semi-retired, rational investors.

Level Three: The Tradee

The Tradee is a term that I invented meaning someone who gets traded by the market, ie being played by the market. Most tradees aspire to be hotshot traders earning $10k per month but lack the knowledge or the will to pursue their goal to the fullest. Most of them never attain the status of a trader (next level). Well if they did some rational thinking, they would realize even the hottest shottest traders don't earn $10k per month unless their capital base is like close to $1mn. And if you already have $1mn, why bother trading? Tradees also don't have a robust trading system and the emotional stronghold to withstand the markets. Amateur can become tradees quite easily hence this level also includes a lot of young working professionals, semi-retirees, undergrads, housewives etc.

Level Four: The Trader

Okay a small no. of tradees do evolve into traders. These guys make the cut by adhering to their robust trading systems and rules. They definitely have their emotions under control as well. Usually they have put in a lot of effort as tradees, learnt their lessons and have proven themselves. They quit their full-time jobs to trade, making good money (unlikely to be $10k per month maybe $4-5k). They do not blog, they don't argue in forums as to whether traders are better or value investors are better. They spend their time analyzing and thinking. This level usually includes mid career professionals, ex-army officers, ex-investment bankers, PhD students and civil servants.

Level Five: The Manipulator

Now we get to the interesting stuff. Manipulators are the big boys. Much like Gordon Gekko. Their investment philosophy is buy high, sell higher. They keep asking, where's my edge over the market. Things they do are in grey zones like buying ahead of earnings downgrade by analyst. They had lunch with the analyst and he hinted. They also engage in activist moves. Like accumulating a lot of Company ABC stock, then announcing some plan to restructure the company, to be led by a restructuring guru, who is their buddy. Technically, it is all still legal, but grey. These people would include big names like ex-remisiers, high net worth stock operators, hedge fund managers, ex-prop traders etc

Level Six: The Value Investor

Ok this is the level we are familiar with. We buy value. Stocks that trade at a margin of safety below their intrinsic value. Usually mundane companies with a history of stable earnings. We spend a lot of time reading annual reports, looking at financials and if possible talking to industry people, analysts, company management etc. These level can include a whole spectrum of people including working professionals, undergrads, old-timers, fund managers, retirees and bloggers.

Level Seven: The Legend

This is the pinnacle. This are people who have seen it all, been there and done that in the world of investing. Usually they have a knack for finding value but they also have a nose for a good trade, has good macro economics background and are very smart and very diligent. They would buy value stocks only when they see a catalyst for the value to unlock. This is unlike dumb value investors who would just wait and wait. They would also go for high probability trades - like shorting Korean Won or Thai Baht after analyzing and knowing that their central banks cannot defend the currencies. They have surpassed all levels and reached the pinnacle whereby their investment philosophy is no philosophy. Using the formless to combat form. Legends are investors with names that people from all walks of life would know of, like movie stars, famous scientists and world leaders.

What's Right with Buy-and-Hold?

So Buy-and-Hold has its flaws, but the alternative, which is trading is not much better. Empirically, trading has not help generated wealth. But before we come to some conclusion, let's look at the usual Pros with regard to Buy-and-Hold.

Pros

1. Missing out the 10 biggest days in positive movement

Studies have shown that if you subtract the returns of the 10 biggest positive gain days in the past 20 yrs, your long term average annual return drops something like from 8%pa to 4%pa. This is major bcos suddenly you might as well go and buy 30 Yr Singapore Govt bonds and that could have given you close to 4%pa, without all the risks associated with stock market. Since we cannot predict which days will be the biggest positive gain days in advance, value investors argue that we should always buy and hold to reap the full benefits.

2. Transaction cost

This has come down over the years but still constitute 0.5% or more to most retail investors. Considering in Singapore where the minimal brokerage cost is S$20 per trade, you need to do a S$8,000 trade so that you can get the buy and sell costs to be 0.5% of your trade. Sadly it can only go as low as 0.25% bcos after that, the brokers charge based on the size of your trade. So let's work with 0.5%. Most retail investors would probably do more than 1 buy-sell trade per year, let's say they do 2. We know that average annual market return is 8% and two trade incur transaction costs of 1%. Congrats, you just gave your brokers a 12% commission. Every year. So Buy-and-Hold pls, save the transaction cost.

3. Dividends

Globally dividend yield usually ranges from 2-4% and in extreme times, you see dividend yield of a market going to 6-7%, like the STI in 2008. Albeit it's a lagging yield bcos the data is always late to factor in a drop in dividend going forward. Anyhow, the point is, dividend is a huge part of return. Since we all know that average market return for investment is only 8%, dividends can constitute 25-50% of this market return. It does make sense to focus a lot on dividend stocks. And needless to say, to get dividends, you can't just trade, you need to buy-and-hold.

4. Missing out the full growth

This will be the most compelling argument. Trust me.

If you have bought a Great Company, not just Good but Great with a capital G, then there is never a right time to sell bcos the company simply grows exponentially and overwhelms everything! Some of Berkshire's companies would illustrate this very well. I will just highlight See's Candy and Coke. Buffett bought over the whole of See's Candy for USD 25mn in 1972. Today See's generate pre-tax earnings of over USD 1bn, if See's is a listed co. the market cap would be close to USD 20bn. So that's close to a 1,000 fold return. Mind you, that's 100,000% return. If you sold for 100% profit in 1973, you just made the biggest mistake of your life.

Coke tells the same story. Berkshire bought 8% of Coke for USD 1bn in 1988, today the same stake is worth USD 10bn and Coke's pre-tax earnings is USD 7bn, of which Berkshire is entitled USD 600mn (on paper). In another 10 yrs, the profits entitled to Berkshire would be more than what Berkshire paid for and this current ten bagger will become a 20 bagger or even more. So is there ever a right time to sell Coke?

Sadly, most retail investors never get to enjoy this kind of thrill bcos a 20% profit in 2 weeks is already better than sex.

Conclusion

Again in investing, there are no hard and fast rules, most of the time buy-and-hold makes sense, but there are times that they do not, some times you can take some profit here and there during those periods. However, to trade in and out every few weeks or days and try to beat buy-and-hold is a tall order. Much taller than most people would like to think so. Not to mention the effort needed to do those weekly trades! So run through the pros and cons again, when you are tempted to trade!