Balance Sheet and Asset Allocation of a Singaporean Family

Before we go into the asset allocation , let’s take a look at the balance sheet of the Singaporean family. BTW I made all the no.s up and it is not based on any official statistics and no scientific/accounting methodology has been used to come up with the no.s. So please take them with a bucket of salt ok?

Anyways here it is:

Balance sheet of a typical Singaporean family
Assets
Cash & CPF $25,000
Stocks $25,000
Car $45,000
Other assets $5,000
HDB $400,000

Liabilities
Mortgage $350,000
Car Loan $50,000

Shareholders Equity $100,000

Thanks to the real estate recovery in the last 1 year, the typical household now sees some positive equity (as compared to past 10yrs of negative equity for a lot of Singaporean households)

So if we take a look at just the asset part we come to realize that a typical asset allocation/portfolio mix of a Singaporean family is about as interesting as watching a big snake poo-poo. i.e. not interesting at all lah! Anyway, in percentage terms, this would be

5% cash
5% stocks
10% in totally worthless depreciable assets like 1 x Automobile, 2 x Plasma TV and 32,000 credit card points exchangeable for 1 x 60GB white silly looking music player which is also worthless. (btw all these are under Other assets).
and
80% real estate (HDB flat)

If we apply what we have learnt about Modern Portfolio Theory, diversification and Markowitz, the Singaporean household is really quite undiversified and the fortunes of the household is basically determine by how much this little red dot is worth in the eyes of the world.

Fortunately our Government (with a capital G one, don’t pray pray) realizes this (maybe 10 yrs ago) and has planned to make the little red dot the favourite spot for foreigners to come and work and/or invest in our real estate. In concrete terms, 2 important policies made it all successful.
1) The 2 x Integrated Resort (IR) projects
2) The decision to grow our population from 4mn to 6mn pple
And as they say, the rest is history.

So what does it mean for the Singaporean family that is trying to push its asset allocation closer to the efficient frontier? Well if you believe in the almighty of our beloved Government, you can buy more real estate, hopefully somewhere overlooking Marina Bay and Sentosa. If your bet is right, forget about efficient frontier and the rest of the crap, you can start writing your own blog about how you made it and how this blog sucks.

If you believe in Markowitz and diversification, then it’s better to think of how to diversify the portfolio from real estate. Alas, this is not easy bcos RE will probably make up a huge chunk of your asset portfolio and you can only either save a lot more money to invest in stocks or other asset classes, or sell your property and downgrade. I admit both are not very realistic lah. But it’s important to keep this in mind though. And when you have the means to diversify, you should do it.

See also Efficient Market Hypothesis

Asset Allocation

As a seasoned value investor (for those who have been following this blog, hopefully you have become one), asset allocation is a must-know.

Remember we talked about portfolio theory, Markowitz, efficient frontier and the kind of crap. Umm well, actually not that crappy, got win Nobel Prize one, don't pray pray ok. For those blur, read this post. Now in order to earn a return that is on the efficient frontier, meaning the portfolio is so efficient whatever you put in goes straight into your bank account x 10% and then gets immediate giroed to pay your credit card bills.

No, to earn a return on the efficient frontier means that this return can be earned with the least risk possible. Say if you target 10% return, but your portfolio risk is 25% while the risk of a portfolio on the efficient frontier is only 15%, then you loogie big time, bcos your portfolio is not efficient at all and you should really go put some oil on your money to make it run smoothly or something.

So how do we make our portfolio efficient? The answer lies in asset allocation. Asset allocation simply means determining how much to put in different asset classes such that the risk and return will be optimal, i.e. the portfolio is on the efficient frontier.

Back in the good old days when we have only 3 asset classes, the classic answer is 50% stocks, 40% bonds and 10% cash or some similar variation, say 60% stocks, 30% bonds and 10% cash etc. But today, we have 10,000 asset classes, so things are not so simple anymore. An efficient portfolio probably looks like this

40% stocks
10% bonds
10% hedge funds
10% real estate
5% private equity/venture capital
5% commodities
5% gold
5% cash

For a more scientific asset allocation, go google for Havard Endowment’s asset allocation, and you can see how the pros do it. If you want to be better then on top of the above mentioned asset classes, maybe you should consider adding

1% art and antique
1% wine and coke bottles
1% watches and diamond rings
1% krisflyer miles
1% adopted chinese brilliant kids
1% securitized future cashflow from this blog

Ok that’s just for fun hor, don’t follow blindly. The point that is being illustrated here is that current wisdom advocates finding more asset classes that are uncorrelated and then putting some portion of your portfolio in them. (This post has more info). The truth is for the retail investor, finding exposure to asset classes other than equities, bonds and real estate is actually not that easy. Most hedge funds and private equity funds will not accept retail money. But I always believe that when there is a will, there is a way. If you think you really want a well diversified portfolio then you will find ways to do it. Next post of a typical asset allocation for a Singaporean household, watch this space!

See also Efficient Market Hypothesis

Forward PER

PER may be a simple concept but its application can actually be quite complicated. For those who need some refresher course on the PER, it is the Price Earnings Ratio of a stock. It tries to determine the cheapness of the stock by dividing the stock price by its earnings per share (or EPS). For more info, read this post.

Now the issue here, which have never really been discussed in detail in this blog all thanks to this blogger who conveniently left it out, is which EPS should we use to calculate PER? Is it the latest historical EPS announced by the co.? Or what?

The answer is the expected EPS in 1 yr's time (not announced by the co. yet, i.e. it is not in the annual report). The resultant PER is also called the forward PER. The reason is very simple. The stock market always look forward, not backward. It is the culmulation of the expectations of all the players in the market. Hence when using the expected EPS of the stock in 1 yr's time to calculated PER, we roughly get a good sense of the market's expectation of the value of the stock.

BTW, this expected EPS (also called the consensus EPS) is usually the average of all the sell-side analysts EPS estimates for the next year and this no. can be easily pulled off bloomberg or other financial information providers. Now of course you may argue, sell-side is good-for-nothing and their estimates are usually wrong. Then naturally you can do your own homework and come out with your own expected EPS in 1 yr's time and use that to calculate the stock's forward PER. Well that won't be too hard right?

Also, you may ask why 1 yr? Why not 2 yr or 10 yr? Well actually you can use any year you want, if you can forecast correctly the EPS of the stock in 10 yr's time. You should use that. For some business, you can, and you should. But when you are looking at a stock for the first time, it would be easier to get the consensus EPS estimate and get a rough sense of the stock's forward PER. As a rough gauge, I would consider anything less than PER 18x as cheap and I would not buy any stocks that is trading at more than PER 18x.

See also Price to book ratio

The truth about being rich

Most of us dream about becoming rich. We want to be able to afford every desire we have. i.e. wine and dine at fancy restaurants, buy that Prada bag, that pair of Ferragamo shoes and that dream house and that dream car.

But not many people get there. Somehow we are always just one step behind the Joneses (or the Queks, or the Khoos for that matter). Somehow, the next pay rise didn’t really improve our quality of life as we expected it to. Why is that so?

The truth is being rich is a relative game. You are only rich when those around you are poorer than you are.

To illustrate, 10 yrs ago if you drove a nice Civic or Sunny, you would be considered rich and successful. You are on your way to attain the 5Cs. Good job, keep it up. But today, Ah Beng drives a Civic too and you suddenly realize you are driving an Ah Beng car. And so, you must upgrade to get back into the inner circle of the rich and successful.

This is means that the standard to become rich has gone up.

In other words to reach the status of being rich is a moving target. You need to run faster, work harder, work smarter than everyone else, so that you can earn more money and join the premier league. To become rich is a rat-race and it only gets harder.

10yrs ago, if you earned $4000 a mth you will be in the top decile of Singaporean earners. Today you need to earn $7000. Even if we consider inflation is 5% per year (which is a lot, long-term average is only 3%), $4000 10yrs ago should be equivalent to only $6000 today. But if you earned $4000 in 1997 and your earnings power improved by 50% to $6000 today, you would have become poorer because you have been relegated to the 2nd decile. (You would have beaten inflation but bcos you didn’t beat the other Singaporeans who are now earning $7000, you actually become poorer.)

So that’s why we cannot stop running on that treadmill and the worse thing is, the speed keeps increasing as you run!

Now let’s suppose that we actually made it. We have managed to earn truckloads of money and kept our status in the premier league, year in year out. No sweat. In the statistics our income grew from $7000 to $20000 per mth. Woopee!

But if you think about it, we have just raised the bar for everyone else. So now Ah Beng who was earning $7000 and has only managed to up his income to $10000 has been relegated to 2nd decile. He can afford the Prada bag and the Ferragamo shoes. But now the new standard is Jimmy Choo. So too bad for Ah Beng.

This means that by becoming rich, you have just made a lot of people poorer. And that's why a lot of rich pple give back to the society (at least those who have a conscience.) Bcos they inadvertently contribute to more poor pple in the society.

Is there a solution to this rat-race? I am afraid the answer lies in the realm of enlightenment, inner peace, knowing what is enough for yourself and that kind of philosophical stuff. Not something for the aspiring rich and famous reading this blog perhaps.

See also Compound interest

Diversification or diworsification?

According to Markowitz (he is a Nobel Prize Winner on Portfolio Theory), diversification is the only way to achieve a higher return at the same level of risk. This actually makes more mathematical sense than common sense, and most value investors do not subscribe to this thinking. Let's try to examine whether diversification is actually diworsification.

To paraphrase the essence of Markowitz's theory, basically it means that if you are only willing to accept the risk that you will lose, say 10% of your principal, and a portfolio of stocks and bonds can give you 8% return, the only way that you can earn more than 8% is to invest in other asset classes like commodities, real estate, bonds, private equity, integrated resorts, submarine fiber optic cables and credit card points. (Ok the last 4 are not socially accepted asset classes btw)

In order to achieve the maximum positive effect of diversification, the asset classes should also move in different directions, i.e. when one goes up the other should go down. This way, say if equity markets crack, hopefully bonds or commodities will still help to offset some losses. Ok we all know that's bullshit right?

Buffett and Peter Lynch (he is a star fund manager at Fidelity some time back, quite famous too) thinks diversification is bullshit too. Lynch calls it diworsification. This is bcos all of us have limited time and resources, and it does not make sense to try to invest in as many field as possible since we can only be an expert in only a handful of them. You should bet your entire net worth only when you find a potential ten bagger (a stock that will rise 10 fold) and only if you are damn sure. This way you maximize your effort in research, make money, feel happy and can go buy that Prada bag for your wife and that Ferrari for yourself.

I kinda think that the truth is again, somewhere in between. Diversification helps to a certain extent, but not as good as what is promised by textbook, but if you don't diversify, chances are that one basket that you put all your eggs will break. (Trust me, Murphy's Law works.)

As individual investors, diversification options are actually quite limited, we do not have access to some non-conventional asset classes like commodities and private equity. Most people will have to stick with bonds, equities and cash. Even so I think there are some benefits that could be reaped. E.g. by investing in stocks in the different sectors or different countries. You don't need a 100 stock portfolio to enjoy the benefits of diversification, the textbook says 30, personally I think anything more than 5 stocks should be good enough.

Of course, when the markets correct, like last week, correlation of all kinds of asset classes that you can think of goes to 1. i.e. everything will crack together, commodities, bonds, stocks, real estate, private equity, Toto, CoE, salaries etc. And diversification fails. But by and large, diversification should help to generate a better return for the same level of risk.

See also Efficient Market Hypothesis
and What is the Stock Market

CFD Diversity

Add diversity to your stock portfolio by trading CFDs. CFDs are margined products so a trader only has to put up a fraction of the cost of the stock. A trader can profit from both rising and falling prices in value if the right choices are made. A properly placed stop loss can help to manage any risk.

What is the "sexy story" about this stock?

In the world of Wall StreetCraft, people like to talk about stories. What is the sexy story for this stock? They would ask, or has this industry got an interesting story?

Translated into English, it basically means this: Tell me why you are buying this stock and make sure it's a fairy tale that everybody likes.

Peter Lynch, the star fund manager for Fidelity some years back, gave this one piece of advice that has got stuck inside my head ever since I read it. If you cannot explain the why you bought this stock into three sentences, then probably you should not buy it in the first place.

For those who have never heard of Peter Lynch, well I suggest you go look him up at Wikipedia. And don't forget to come back here and click on that Amazon link to buy his book!

So the moral of the story is this: Know why you are buying the stock. The reasons should be simple and easy to understand.

In other words, when you buy a stock, make sure that you know its "story". It should be sexy, it should make people say "wow" and make monkeys drool, as if they see truckloads of bananas. But it should also be realistic and the earnings are real.

Over the years, sell-side clerics in the World of Wall StreetCraft have mastered the art of story-telling. They can really spin an infinite amount of fairy-tales and all of them promise a happy ending.

Things like replacing all wires and connectors in the world with Photonics Technology (i.e. light or photon beams), Satellite Mobile Phones (guess most pple remember this one, and the co called Iridium went bust) and my favorite: 3D Holographic Video Phonecalls: some real life technology akin to Princess Leia sending the distress message through R2D2, which was later picked up by Luke Skywalker in the original Star Wars. Too sexy for for your money huh?

But, ultimately, I personally think there are only 3 kinds of stories around. Those that are real and can make you money and then you REALLY live happily ever after one.

1) Growth story: Simple and straight forward, the company has got growth and it is sustainable, valuation is also still reasonable (not PER of 50 or 80x, but say around 15x). Note: the stories listed above (e.g. 3D Holographic Video) sound like growth, but there is a different name for them. They are called concept stocks. There is only a concept, no earnings or sales to justify the story yet.

2) Restructuring story: Company has a good business but somehow cannot generate profits. i.e. very strong sales but no earnings. But one fine day, new management steps in and decide to do something about it. OP margin doubles. i.e. earnings also double and stock price quadruple. Shiok right?

3) Value story: This story can manifest itself in various ways but the basic idea is that you are buying something worth $100 for $40 or less. The difference between this story and the growth story is that the company usually has little visible growth but still the business is very solid and generates good cashflow.

See also Brokers cannot be trusted
and What drives stock prices?

Labels: How this blog is organized

This will be a post on how this blog is organized. Thanks to the improvement in blog technology, we now have something called Labels which comes in quite handy. Labels are like different categories which can be used to organize all the different posts on this blog. Some posts are included in more than 1 Label, and the organization may baffle some readers. Pls feedback if you can. Currently I have 11 Labels: 5 Easy Labels and 6 Super Chim Labels.

General (14 posts): Well nothing more to describe, in this label I talk about general stuff related to investment and how I think is a good way to manage our own personal finances.

Value investing (12 posts): This is the crux of this blog, value investing talks about one style of investing that has been proven to be successful and made some individuals very rich, like our hero Warren Buffett.

Investment philosophy (7 posts): This is the guiding principle of one's investment career. I discuss about how it should be developed and followed. You can subscribe to the value investment philosophy, in which case this blog will serve you best. But if you believe in a different investment philosophy, personally I think it's also ok.

Stock market basics (6 posts): Very related to the General label, a few key points on how we should view the stock market. Is it a voting or a weighing mechanism? And what are the idiosyncrasies of the market? Quite a good label to start with if you are first time here.

Bubbles and Crashes (5 posts): This label deals with bubbles, Greater Fool Theory, MLMs and other crazy stuff in investment and in life. Not so techical as well.

So that's all for the fun labels, below are the highly technical labels where most people will fall asleep reading and usually I fall asleep writing them.

Financial Statement Analysis (17 posts): It's never easy to make money, if you want to gamble, buy Toto or 4D or bet soccer matches. Investment is about hardwork and analysis. This is for those who want to make real money. If you like to punt stocks, err, well you can still read, it helps you fall asleep. Ok, enough. This label is the nitty gritty on how to read annual reports and analysis if a company is good or crappy. It will probably take a lot of time to digest them. Can email me if you need help.

Financial Ratios (7 posts): The sequel to the label above, more analysis and more math. Not for punters and people thinking of buying stocks to make a quick buck.

Company Analysis (3 posts): After knowing the very basics, we move on to more qualitative ways to analyse companies, this would still be technical but less so than those 2 nightmare labels above. Actually apart from the 2 nightmare labels, the rest should be quite readable for the layperson.

Industry Analysis (3 posts): Companies make up industries and this label talks about how to analyse industries. This will help investors to learn about new fields and discover new investment ideas.

Quantitative Analysis (2 posts): Talks about how to use technology to screen for stocks, DCF and scenario analysis. The more technical/math part of investment.

Portfolio Theory (2 posts): Looks at some academic work on portfolio management, efficient markets and how to apply them in real life. Will be adding more to this section.

So basically that's currently what's on this blog. I would say that's the rough 40% of the knowledge you need to start off. The world and the markets are constantly evolving and as investors, you have to keep up with the changes to earn your worth. It's never easy and it should not be. This blog will continue to be updated as and when I have new ideas (and time to write).

Scenario Analysis or Sensitivity Analysis

This is another no-brainer concept that is given a cool and sophisticated name so that financial advisers and analysts can brag about their knowledge in investment.

For those first-timer to this blog, pls read the relevant posts that are linked here in order to understand what I am trying to say. Most likely this post will overwhelm you if you read it without the background knowledge.

Essentially what you do in scenario or sensitivity analysis is that you try to stress-test your assumptions and see if they work when the state of the world has change.

I guess the easy example here is SIA. In a previous post, I mentioned that SIA earned $1 EPS in 2005 and given that it is trading at $17, this means that its PER is 17x, or an earnings yield of 6% (i.e. you expect SIA to earn you 6% for every dollar you invest.)

Now we need to test how robust is the EPS of $1 (or the earnings yield of 6%), i.e. we want to know if SIA can actually deliver an EPS of $1 when the world has changed. Usually we will set up 3 scenarios.

1) The base case is where the state of the world is as today, goldilocks, not too hot not too cold. In this case, we assume that SIA will continue to deliver the EPS of $1. Hence its PER is 17x and its earnings yield is 6%.

2) Then we have the nightmare scenario where the world goes into recession, i.e. Sept 11 again or some war breaks out. Obviously we have to assume EPS drops to some very low level, maybe $0.10.

3) And finally we have the blue sky scenario where the world prosper and SIA lives happily ever after and EPS becomes an astronomical no, like $10.

After that, if you like doing math, you can acsribe probabilities to each of the state and calculated the expected EPS of SIA. For me, I am just interested in the nightmare scenario. I want to know if it happens, is SIA still cheap. Obviously, if the nightmare scenario comes true, SIA can only earn me 10c for every $17 of the stock, I might as well buy Singapore T-bills. Hence I will not buy SIA.

The fun part here is how to ascribe an EPS to the nightmare and blue sky scenario. What is the appropriate no.? Is 10c low enough for the nightmare scenario? In which case PER goes to 170x and earnings yield become 0.6%? Or is it 1c, then PER goes to 1700x. Woah, that’s better than Google at its peak (PER 400x or so I think).

I would say the success rate of this kind of analysis only gets better with experience. It also depends on your view of the world and your emotional state and personality. A conservative investor will think that EPS goes to zero and hence will not buy SIA, bcos he thinks SIA will simply drop like a rock if another catastrophe strikes. A greedy and bullish investor who have only seen bright and sunny days will think that SIA will fly no matter what happens. And he will say SIA is still very cheap at PER of 17x.

See also SWOT analysis
and Investment philosophy and process

The power of compound interest

When asked what is mankind's most wonderful invention, Einstein's answer was "compound interest". Guess most people wouldn't want to argue with Einstein, unless you think you can win a Nobel Prize too. But what's so good about compound interest?

For those lao jiao value investors, sorry for writing this simple post which you all would already know and swear by it.

Ok, for those value investors wannabies, this post is gonna change your life. So get ready.

If you buy $10,000 of Singapore govt T-bills (i.e. govt bonds or Treasury bills) today, it earns you 3% interest, bcos of compound interest, it will become roughly $24,000 in 30yrs. Without compound interest, it's just $19,000. That's 55% difference (14 divided 9). If you put it in the bank, it earns 0.025% and becomes $10,700 in 30yrs. You might have as well put it under your pillow.

Now imagine if you can save $10,000 every year to buy T-bills for the next 30 yrs, and they give 3% interest. Do you know how much it will become?

It will be close to $500,000.

If you save $20,000 every year and buy T-bills for the next 30 yrs, you get close to $1,000,000. If you invest and get 5% instead of 3%, you get close to 1.5mn, if you invest as well as an average investor on Earth, i.e. you earn 8%pa, you get $2.5mn. If you invest as well as our hero, Warren Buffett, you get 24%pa and you get *drumrolls* $65mn. That puts you in the top 30 richest Singaporean list.

This is the power of compound interest.

You don't have to do a lot, save enough, earn a good rate of return, and just wait. You will be a millionaire in 30 yrs. Now that seems quite easy right?

So why we don't see millionaires all over Singapore? Well actually they ARE all over Singapore but too bad we are not one of them. There are a few reasons:

1) Discipline: Most pple, after working long and hard for one month will grab their paycheck and spend it on some gadget or some luxury bag worth $7 selling for $700 to reward themselves, including this blogger here. Who has time to think about saving for 30 yrs?

2) Diligence: Putting the money you saved in fixed deposit is not enough. Only when there is some campaign, you get 3% but usually it's only 0-1%. So you have to put them in T-bills and rollover every few months. That's difficult. Imagine spending your precious weekends in banks to rollover these stuff. Now we have POEMs, so pls go open an account today. But still, it's a hassle.

3) Time: Now compound interest works best when the time period is long enough. Warren Buffett took 50 yrs, for the illustration above, you need 30 yrs. Most pple can only have some savings after major cash outflows like wedding, buying a house, having kids etc. So even if you start at 25, you will only become a millionaire at 55.

So that's why it seems easy but it's not. But there people who does this and got there. Their parents started for them when they were like 10 yrs old, and when they are 40, they become millionaires. Well, don't blame your parents, just make sure you try your best to help your children! Hehe.

Marketable and Investment Securities

Marketable and Investment Securities is probably one of the most neglected rows in the balance sheet after the "others" column. I mean most people look at cash, shareholder's equity, assets. If they have any more free time, they look at debt, accounts payables and receivables and inventory. Who has got time to figure out marketable and investment securities?

Well in most cases, even if you don't figure them out, it doesn't really matter. That's why most people don't look at them. They only matter when the daughter (or son) becomes more important than the parent. Now what the hell does that mean?

Marketable and Investment Securities refer to stock holdings of the company. Marketable simply means the company has no intention in holding them for the long-term and would sell them when it's appropriate. Investment securities are usually holdings of subsidiaries or affiliate co.s and the parent company has no intention of selling them.

Now bcos of accounting rules, these holdings may be accounted for at cost (i.e. at prices when the parent acquired them) or at market value 1 yr ago (i.e. when the book closed last yr). In some cases, the market value of these holdings may have grwon to be quite significant, e.g. 50% of the parent's market cap or more. Such cases would arise when the stock market enters a rally trend, or circumstances like acquisition offer or simply bcos the subsidiary grew so much faster than the parent.

So essentially when you buy the stock, you get a lot of "freebies" that comes along in its balance sheet. And investors love this kind of stuff. One good example would be Yamaha Corp, the musical instruments maker.

Yamaha Corp owns 20% of Yamaha Motors, the motorcycle maker. And Yamaha Motors market cap is now a few times more than that of Yamaha Corp, its parent co. bcos of its cheap and quality motorcycles are selling like hotcakes all over the world. So when you buy Yamaha Corp, you are actually buying its musical instrument business, plus a huge freebie: shares in Yamaha Motors.

However, this value may or may not be unlocked bcos Yamaha Corp may want to hold on to its shares of Yamaha Motors, instead of selling it and returning the cash back to shareholders. In that case, you can only suck thumb.

See also Cash and Debt