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!

Near Monopoly Part 2

To illustrate Pt 4 and 5 of the previous post, we look at a Singapore company: SMRT. As with railroads in other countries, SMRT is a kind of natural monopoly bcos the capital outlay is so intensive, no competitor can come in and build a similar infrastructure just for the sake of competition. Even our beloved Government tried that and failed when they gave the North East line to another operator only to realize it doesn’t work.

So SMRT is in a good position to basically do whatever they want to enjoy supernormal profits.

First, they raise prices like nobody’s business. Well it’s subjected to approval from the LTA but heck, LTA always approves anyways. So the Singaporean passengers comprain and comprain like there’s no tomorrow. Actually in my opinion, it helped bcos SMRT became less aggressive somewhat after seeing the social repercussions. The truth is, Singapore train fares are probably still quite low at 70c for 1 station compared to global average of roughly US$1. So prepare for MORE fare hikes to come.

And after raising fares, the quality of service actually drops. That’s probably the unforgivable action. Trains take more than 10 min to arrive at non-peak hours and they frequently break down with minimal repercussions. Talk about 1st World Service!

Nonetheless, the shareholder benefits. SMRT shareholders have seen net profits grown S$100mn to S$160mn over the past 10 years. Dividends more than doubled from 3c to 7c. If you have bought SMRT at 60c (roughly the IPO price), dividends over the past 10 yrs would have reaped 40c. Not to mention the price today is $1.6.

With increasing population and real estate potential from re-developing its stations, SMRT’s future growth may not slow down unlike some other Singapore monopolies like SPH and Singpost. There is also the wildcard of whether the other future lines (Circle, Downtown etc) will be given to SMRT to manage as well. Again since most of the capex is done by the Government, it's a free lunch for SMRT and its shareholders.

However, it is likely that the company will continue to squeeze the commuters by providing ever declining quality of service and at the same time raising fares whenever the opportunity arises. Hence it is prudent for every commuter to become an SMRT shareholder.

As a shareholder, besides the dividends and capital gain, you can go and eat free food at the AGM and screw the management by asking tough questions. Hopefully they wake up their ideas and start to look at BOTH profits and services.