Friday, February 03, 2023

Thoughts #30: Bitcoin and the Metaverse

This post is inspired by Ray Dalio's book, Principles for Dealing with The Changing World Order.

In page 222 of his book, Ray shared the concept of financial wealth which is different from other types of wealth. To the un-initated, this is confusing, wealth is wealth right? What is non-financial wealth anyways? But there are differences. Importantly, Ray implored us to think about financial wealth, real wealth and in the digital world in the future, digital wealth.

Today, we are wealthy mostly just in terms of financial wealth, money in the bank, stocks, bonds, insurance, fixed deposits. This is actually different from real wealth - like owning a house, car, physical gold and silver, watches, jewellery etc. Financial wealth, including cash, are just "promises" created by human beings so that we can transact more efficiently. 

Financial wealth was created around 1350 in Italy (maybe earlier in China) and for most of human civilization, people value real wealth more than financial wealth. Imagine you are a wealthy merchant in the 1500s, if you have the equivalent of a billion dollars back then, did you put in all in the bank and wear T-shirts and jeans? No, you buy a castle, employ a million slaves to serve you, own horses and what not and flaunt. Well, we still flaunt. But real wealth exists in the physical world, they are mostly real assets.  

Financial wealth is not real wealth. When big regime changes (like during wars and/or revolutions), financial wealth may not mean much because it's usually destroyed. According to Ray, over the long history of human civilization, financial wealth is nullified, confiscated and essentially disappears and rich people either become poor after losing everything or are killed.

Well that's story for another day. Today, we also need to talk about digital wealth.  

18-24 months ago, huge bubbles were formed in the Metaverse. Virtual real estate are sold for millions of dollars or more and NFTs can be worth more than auction-able physical art. It all started with Bitcoin. Then came Ethereum, tokens and big companies like Coinbase and Gemini becoming the gatekeepers of digital wealth. While FTX debacle now calls to question is digital wealth real, the alternative is that we might look back and see this as the start of the age of digital wealth. If the era of financial wealth comes to an end, we either go back to real wealth or we might shift to digital wealth. 

Real estate has a mantra: location, location, location. But in the virtual realm, there is no location, no scarcity, so essential virtual land can be created at will. Will virtual Orchard Road, Ginza or Times Square be worth anything? Food for thought. NFT has its own story as well. If you own the original Mona Lisa in the era of real wealth, it is worth something. So how does that translate for Michael Jordan's MVP moment as NFT or the Nyan Cat? 

The Nyan Cat NFT was worth $600k at its peak

I have no answers, but it might be worthwhile to start to think about owning some digital wealth, which is different from financial or real wealth and might be a good diversifier. Albeit 99% may turn out to be worthless, as FTX has shown us. My original short thesis on Bitcoin in the early days was correct, it grew into a big bubble and popped. It sucked in so much financial institutional money because there is some truth in Bitcoin replacing gold. Then, everything crashed in 2022 but it is still $17,000 today! If enough people believe in it in the next 10, 20, 30 years, it will then become the source and the origin of digital wealth. It might just be a good bet to buy a little today.

Friday, January 20, 2023

On Timing, Sizing and Sell Discipline

Today, let’s spend some time to talk about some of the important nitty gritty of investing. This is not the usual fun and games - big ideas, cheap value names or best-in-class companies. Everyone loves ideas, what to buy, deep dives. But what actually brings the dough home is good money and portfolio management. As such, we need to talk about sizing and timing and how we should construct our investment portfolio.

There are three crucial aspects: sizing, timing, capacity and a fourth all-important factor: sell discipline. A lot has been said about how an investment will make money when we buy at the right valuation, but real money only comes into our pockets after we sell. So let’s talk practical about that too. First, it is about sizing the bet.

1. Sizing

Most people do not think too much about sizing and I seldom read literature about sizing which is unclear why given its importance. Perhaps sizing reveals too much financially or maybe we assume everyone knows how to size? But here is what I have figured out over the course of my investment career. Sizing wrongly hurts a lot. It is not easy, it requires practice, everyone has different thresholds and hence we should discuss seriously about sizing.

The first question to ask is how much can you lose and not be affected psychologically? Is it $10k or $100k? Or maybe it is lower or higher. There is no shame about it. If it is $1,000. Then that is your maximum bet size. Don’t mess with your mind. If losing $1,000 makes you unable to sleep, what is the point of playing this game with higher stakes and hurting yourself emotionally and psychologically?

So start with the size that makes you comfortable.

There is a related question which would be if we only bet $1,000, how can we get rich? Well, it will take more than a few ten-baggers and home-runs, but thankfully, low commissions today can make $1,000 bets go far. Back in the days when there is a minimum commission of $20 per trade, it was not feasible to bet $1,000 because you incur 4-6% of transaction cost just by buying and selling. But today, we can do it!

For more practical numbers, let’s use something with some macro-economic basis. I would start with $50,000. That is my maximum bet (not to be confused with initial bet) and a certain delta around that number might work better for you. Why $50,000? Well, it was slightly higher than my first annual paycheck and it is also in the same ballpark as the GDP per capita of OECD countries, which is $42,000 according to the link below.

But let’s talk about first paychecks. That’s more interesting. When I started work about two decades ago and took my first paycheck home. I was so happy, I gave money to my parents. I have enough money for the first time to afford stuff. It feels good. Everyone remembers their first paycheck.

So when I lost on an investment that was bigger than this first annual paycheck. Imagine the pain. Imagine I had to tell my better half I lost that much money. I couldn’t sleep just thinking about it. So that was how I figured out, my maximum loss is $50,000. It doesn’t matter if you think you have done your homework. You know the stock or investment and you are sure it will not drop beyond 50% or 80% therefore using this way to think about a maximum bet size is wrong. No it is not because if you have invested enough, one of those wrong bets will go to zero.

So when you have determined that number. Make sure you don’t ever buy more than that in one investment. Next, we need to build that up over tranches. You don’t put all $50,000 on Day 1 because you will never know if the stock will go down more and you lose the chance to buy at a lower price.

My rule of thumb is to think in baseball batting terms. You have three swings. After that, you are strikeout. Each swing you place 1/3 of the position. Some people like to do more, some less. It depends on how well you can do this, it is a subtle art.

Some people say it means a lack of conviction. If you are sure, just go all in. They have never invested. You go all in, you can get strikeout after the first swing. How does that feel? If you are really confident, maybe you can go 1/2 instead of 1/3 with your first swing. Going all in doesn’t end well most of the time. Trust me, been there, done that. Nope. Didn’t go well.

So if the first swing turns out well, the stock runs, then unfortunately, you cannot deploy the full amount. At least we have benefited. But if it didn’t, this is when the second and third swings will count. Here we will need time diversification.

2. Timing

Timing is about time diversification. You would have done a lot of homework before the first swing. So by and large, there will be enough upside. You know the margin of safety. But to make this work better, say the first swing didn’t go as planned and the stock corrected 10%. Then it pays to wait one month and take advantage of market movements later for the second swing. Of course, you also want to pay attention to the price. If it drops between 10-15% lower, then it is good to get in by averaging down.

There is another reason to think monthly or even longer. We are all busy with our lives, if this is not your day job, maybe spending a few hours once a month to focus and think and then execute is the best option. Don’t go buying today, buy more tomorrow if it drops or sell next week after you made 5%. It takes up too much energy. So set aside a time every month to think and trade. Then move on, come back and monitor monthly.

There are exceptional times when you need to do a lot in a few days. Think March 2020. Pandemonium struck but it was also the best time to buy. It takes guts. You have be able to recognize such times and deploy money well. Most investors will not be able to do so. They have either lost too much to think straight or just scared cold and unable to move. I would say you need to think in terms of your portfolio, not individual bets. Ideally, if you can deploy 50% of your portfolio in Mar 2020, you would have created a huge positive impact. There is no second chance next month. The window will be just days. But it is so scary that it is hard to move a lot. You are figuratively catching a falling knife with your bare hands, maybe even your kids’ hands. So try your best. Test your capacity.

3. Capacity

Besides the capacity of your gut i.e. ability to take losses, capacity is also about the number of bets, stocks, investments, ideas that you want to have. Most laypeople think that a portfolio, especially an individual or retail portfolio should have just a handful of bets. Depending on the individual it could be 10 or 15 bets at the maximum. For some people, it could be just 5 or 6 concentrated bets.

But it comes back to sizing. Unless you can stomach big losses, having say 5 bets, each bigger than GDP per capita of OCED countries is not something everyone can do. Hence a lot more bets at your maximum bet size makes sense. The upper bound could be your capacity to monitor. If you don’t want to monitor more than 10 bets. Then it is 10.

However to enjoy the benefits of diversification, one of the few free lunches in investing, maybe the number of bets should be big. The CFA textbook says it should be 30. But most people may think that is too much diversification. They cannot remember yesterday’s lunch, or 3 things the last writer asked them to remember, let alone 30.

In statistics, recall that we learnt about the Law of Large Numbers. So what is the smallest number that we can to be considered a Large Number? Remember N? Our teacher Mrs Shirley would say N >= 30. So maybe it should still be closer to 30.

Some astute investors don’t subscribe to this. Except for Peter Lynch, who managed Fidelity’s Magellan Fund, became one of the most celebrated successful portfolio manager and he held over 1,000 names. Today, most good investors think that an ideal portfolio should have 10 to 15 names. Warren Buffett said it was 20 for him. So, the idea is to pick your 10-20 best ideas and rake it in. You cannot have 30 best ideas, surely some of them are not best by the time you get #29 on that list.

I do not know which school is right? I do like to stick to the textbooks, maybe it is good to try to get 30. What worked for me is to have 8-10 top ideas and another 8-10 potential top ideas and the last few tail ideas that you want to have it in case they become so big for whatever reasons. This will be the goal for this newsletter. We will aim to get to 30 ideas!

4. Sell Discipline

When we have our best ideas, we were taught to buy and hold forever. “Our holding period is forever.” so says the Oracle of Omaha. No value investors talked about sell discipline. Naturally, I was brought up to think buy and hold.

It didn’t work for me.

Selling is so important. To sell well is perhaps the hardest part of the art. Well, to be fair, Warren Buffett did say never sell the best names and if you must, only sell when:

1. you have a better opportunity

2. you need the money for more urgent matters

3. when the investment thesis has gone wrong or has changed

I am not about to refute the Oracle so the above reasons are definitely the best reasons to sell. But as alluded throughout the article, investment is about timing, sizing and the many nitty gritty important details. So, the big idea is that we don’t have to sell everything all at once. We only sell 1/3 or 2/3 and we can hold the remaining 2/3 or 1/3 forever. We can use time diversification to sell over time when the right reasons present themselves to sell. With this in mind, I have added three more reasons when we should sell.

1. We should sell when valuation is rich → sell 1/3 or 1/2 depending on how expensive the stock has become. We can then recycle that capital to better names, which is #2 below.

2. We should sell to rebalance the portfolio (for me this means keeping bets at $50k if they have grown to $100k, ie lucky me! But we need to bring the notional sum down because losing all that gains back is very bad psychologically.

3. Lastly, we should sell when markets are overall expensive (e.g. Dec 2021). Although it is difficult to do so because at that point in time, we won’t know whether it is at the peak. As such, we diversify the selling, ie selling 1/3 or 1/4 or in different proportions. It is also good to accumulate dry powder during such periods so that we can deploy back when markets turn cheap.

It is important to understand your own style as well. If you tend to be too early when buying, then buy slower with the first bets being smaller accordingly. If you tend to overstay, then start doing bigger first sells. Understand your maximum loss and size according to your most comfortable level, diversify both the number of names and buys / sells over time, figure out your best ideas and structure the portfolio accordingly. When it is time to sell, look closely at valuations and the overall markets and document everything. With these steps hopefully we can get the portfolio to grow well. Target just 2-3% of value up every month, over time it will compound crazily.

Huat Ah!

Thursday, January 05, 2023

Books #18: Security Analysis - Part 3

In this last post on Security Analysis, we would discuss some of the difficulties analyst faced when analysing stock then and now. The authors have put some thoughts out elegantly which is worth studying here. Here are a few lines from the book, including one of the most famous line in full and in bold:

The market and the future present the same kind of difficulties. Neither can be predicted or controlled by the analyst, yet his success is largely dependent upon them both. The major activities of the investment analyst may be thought to have little or no concern with market prices.

The market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.

Alongside the famous line on the marketing being a voting machine, the authors also lay out this chart above to try to decipher what goes into determining market price. In short, there are so many things that make prices unpredictable in the short-term but yet it is the stock analyst's job to understand everything because in the long term, analysis of the business and its earnings power makes the difference.

Short term prices are also inexplicable but Wall Street wants actions and will explain for it, regardless whether the explanations are justified. This remains one of the hardest job of the day even for seasoned investors - to explain price action fo the day. Sometimes, stocks jump 5% for no reason and we only figure it out over the next few days.

Again, here are lines from the authors themselves:

The exaggerated response made by the stock market to developments that seem relatively unimportant in themselves is readily explained in terms of the psychology of the speculator. He wants action, first of all; and he is willing to contribute to this action if he can be given any pretext for bullish excitement (whether through hypocrisy or self-deception, brokerage-house customers generally refuse to admit they are merely gambling with ticker quotations and insist upon some ostensible reason for their purchases.) 

Stock dividends and other favorable developments of this character supply the desired pretexts, and they have been exploited by the professional market operators, sometimes with the connivance of the corporate officials. The whole thing would be childish if it were not so vicious. The securities analyst should understand how these absurdities of Wall Street come into being, but he would do well to avoid any form of contact with them.

As such, in order to profit from stock investment, we come back to valuation. We cannot win trying to profit from short term market movement. The only logical way to win is to determine the intrinsic value of the stock and buy with sufficient margin of safety. The following paragraph, the authors cautioned that general market conditions ie beta sometimes overwhelm everything so we need to be careful.

Investment in bargain issues needs to be carried out with some regard to general market conditions at the time. Strangely enough, this is a type of operation that fares best, relatively speaking, when price levels are neither extremely high nor extremely low. The purchase of "cheap stocks" when the market as a whole seems much higher than it should be will not work out well, because the ensuing decline is likely to bear almost as severely on these neglected or unappreciated issues as on the general list. 

On the other land, when all stocks are very cheap, there would seem to be fully as much reason to buy undervalued leading issues as to pick out less popular stocks, even though these may be selling at even lower prices by comparison.

On valuations, it was refreshing to see that the authors did lay out something concrete and also attributed the development to a certain Roger Babson (pic above), whom I didn't know who he was but apparently someone famous back then. The following is his rule of thumb:

The multipler might be equivalent to capitalizing the earnings at twice the current interest rate on the highest grade industrial bonds. The period for averaging earnings would ordinarily be seven to ten years.

In short, if the bond yields are at 3-4%, then earnings yield should be double of that at 6-8% and we should use the averaging earnings over 7-10 years. So we come back to why we should always buy stocks trading at teens price earnings, which can be difficult in today's context, so I would carefully stretch that to low twenties. 

Last but not least, here's their words on wisdom on trading. In trading, there is no margin of safety, you are either right or wrong and if you are wrong you lose money.

The cardinal rule of the trader that losses should be cut short and profit safeguarded (by selling when a decline commences) leads in the direction of active trading. This means in turn that the cost of buying and selling becomes a heavily adverse factor in aggregate results. 

Friday, December 30, 2022

Introducing Substack

I was introduced to Substack, a platform for writing and found it very complementary to the current blogspot space. Substack also has an app and allows for podcasts, chats and can help foster the discussion better. As such I have created which will have posts from the current blogspot space (free) and also discuss investment ideas and strategies (paid subscription). Please sign up for the free subscription to give it a try!

Going forward, the blog will continue to discuss investment thoughts, charts, books, financial basics while the Substack will focus on value added posts. We will also track and publish the track record of the ideas, discuss lessons learnt and invite readers to contribute as well. This is the power of Substack, which allows for deeper interactions and collaborations.

I believe that a simple successful investment process depends on:

1. Good insights and initial due diligence

2. Discussing the idea with other like minded investors to uncover plotholes in the investment thesis.

3. Buying at the right valuation

4. Monitor and sell when valuation is rich

This blog and Substack will help with all the steps but step #2 is where everyone can chime in to discuss and help refine investment ideas which will create investment returns for everyone. We hope you can continue to support us in this effort and huat together!

Here's wishing all readers happy holidays and a good 2023 ahead!

Friday, December 16, 2022

Taking Stock of the Stock Market and the World

Time files. We are coming to the end of 2022 and it is always good to take stock at such timing. How was the year? Did we have anything to celebrate? What are the lessons learnt? As of this writing, there is nothing much to celebrate. We are still not out of the COVID-19 pandemic. We have a war in Ukraine and the global stock market has corrected on average 17% since the start of the year. Nasdaq is down almost 30%. 

NASDAQ -28% 
HKSE -25% 
DAX -21% 
SPX -17% 
Nikkei -10% 
STI -1%
Source: Tigerbrokers

Surprisingly, STI is flat while most markets are down double digits.

Valuations remain high despite interest rates going up. More importantly – the risk-free rates are going up! As you may recall from those textbook studying days, risk free rate forms the basis of all valuation. If I can earn 4% risk free, which is what the Singapore government Treasury bills give today, very broadly speaking, there is no reason to buy any stock with PER > 25x i.e. earnings yield < 4%. Why should I take risk to earn 4% or less when I can buy T-bills which are risk free and giving me 4%? 

But global stock markets have not caught up with this logic. The following are the PER and EV/EBITDA ratios for the same markets:

NASDAQ PE 26x EV 15x (vs low at PE 21 EV 10x in 2012) 
SPX PE 18x EV 12x (vs low at PE 13x EV 8x in 2011) 
Nikkei PE 15x EV 9x (vs low at PE 14x in 2018 and EV 7x in 2011) 
HKSE PE 11x EV 9x (vs low at PE 9x EV 7x in 2011) 
DAX PE 11x EV 7x (vs low at PE 11x EV 5x in 2011) -> DAX looks cheap! 
STI PE 11x EV 12x (vs low at PE 9x and EV 10x in 2011) 
Source: Bloomberg

Long term investors who had looked at a few cycles may recall that T-bills was not 4% when these valuations hit their lows in 2011-12. Japan has a different story back then and today and at PER 15x, it is not screamingly cheap, even though the yen is and everyone and his dog is in Tokyo buying luxury products. Germany, Hong Kong and Singapore look like of cheap, but clearly the US markets look expensive when compared against the current interest rate environment and with other markets. It is also expensive when compared against its own history. The SPX needs to be closer to Mar 2020 bottom of 2500 for valuation to make sense, assuming earnings hold up.

The old story goes as such, if US is not cheap and US falls, then the other markets will not be spared. Remember the old adage - when US market sneezes, the world catches a cold. Hence a lot of investors are bearish. Some are saying there will be a big, big crash e.g. GMO.

According to GMO, the markets should have collapsed pre-pandemic. We glimpsed that in Mar 2020 but then the huge rescue package from the various governments drove markets to new highs! At the end of 2021, the S&P hit its all-time high at c.4800 (see chart below).

Source: Google

This marked the backdrop of this crazy year. Since then, we had a war, inflation going through the roof, the shortest tenure UK prime minister and the meltdown of the GBP, the UK bond and stock markets, the assassination of a former Japanese prime minister and Donald Trump having a second go to be the world’s most powerful man after he messed it up big time last time!

Just when we think the world cannot be crazier, Koreans squeezed into a small alley to watch K-pop stars and got stuck, resulting in a stampede that killed more than 100 girls, an unthinkable accident in a developed country (my heart goes out to the families, pls pray for them). At the same time, we also realized China has become a prison and is forcing their rich and powerful (with the ways and means) to flee the country, pushing up home prices and rentals in Singapore!

So, how do you feel about 2023?

I would say this. We are not at the bottom. The war in Ukraine is escalating and inflation is here to stay. This means that global interest rates will stay high and the stock markets need to correct to lower valuations before we can say we are near the bottom.

Inflation will be a big topic in 2023. The following chart shows Singapore’s inflation for the past 25 years and we are at historical high. While the chart may seem to have peak out, anecdotal evidence tells us this is not the case. Rental cost in Singapore continues to rise, we are still seeing restaurant raising prices and importantly, as long as global issues causing inflation are not tamed, we will continue to import it due to the nature of our open economy.


This brings us back to the STI. Recall that it corrected 1% while the rest of world has corrected double digits. Yes, we trade at lower PER (11x) but that is because of the constituents are mostly in the financial sectors which command lower multiples. Moreover, against our own history, we are not super cheap.

The only cheap market seems to be the DAX, but with the Russia-Ukraine war still looming large and the energy crisis unfolding, it is hard to bet on Europe. There might be individual stocks that might be interesting. Screening tools could come in handy. For the courageous, there is the option to buy some short ETFs but we need to be careful about the decay which can be 6-10% per year. Caveat: this is definitely not value investing and only seasoned investors should try this!

In conclusion, 2023 might be the year to just hold on tight. We shall wait for interesting names getting to interesting valuations as alluded in our first ever real investment idea on But mostly, stay vigilant and stay liquid.

Huat ah!

Thursday, December 01, 2022

Value Investing Algorithm: Can We Put Warren Buffett in a Box?

I talked to a friend some time back and he asked an interesting question - can Value Investing be automated? What is the Value Investing algorithm? I thought long and hard about this. It should be possible. In fact, everything can be automated. It is just a matter of inputs, processes and output. Some processes have a lot of complexity but in theory, it is always possible. As complex as life can be, our DNA is an algorithm, determining how we eat, love, sleep, reproduce, fall sick and die. So, the answer is yes, value investing can be automated. The question is how. How can we put Warren and Charlie's wisdom into a box?

World's greatest living investors: Warren Buffett, 91 and Charlie Munger, 97

Before we answer that though, let's think about why it hasn't been done yet. Well, maybe it is too hard. There are too many inputs. Market share, number of competitors, profit per employee (including part-timers), culture, CEO's ambition, regulator's scrutiny, branding, strength of eco-system etc. For most of these inputs, you cannot put them into numbers, like how do you transform Coca Cola's brand value into a quantifiable number? Or how can we quantify Costco's business model of using peoples' homes as inventory storage thereby reducing its own cost of business? So if there are ways to quantify these attributes and put them into an algorithm, then perhaps the true essence of Value Investing can someday be digital. We can then figuratively put the world's greatest living investors into an ultimate money-making box that anyone can use to make tonnes of money.

Until we can do that, human value investors will still have the advantage.

The other problem with the markets and not just value investing is that everything affects everything else. The algorithm is not run independently and is affected by "other inputs" which we have no control over. This could be interest rates, wars, pandemics, politicians, terrorist attacks, new discoveries, blockbuster games or movies that no one expected etc. How will our algorithm be affected by these and how can we model them in? It is not easy. To add to that complexity, stock prices and stock markets are also affected by what other people do. It is a psychological game.

The case studies that come to mind are Netflix and Peleton. Peleton is Netflix combining a gym class while cycling at home. It became the ultimate pandemic start-up play. But its share price is affected by how people buy it up and down depending on the mood of the day. I couldn't say it has a solid business model but the market believed it did one day, then not so the next day. So the stock did just that. However, Netflix does have a solid business, it has hundreds of millions of subscribers paying $10-20 a month. Most readers on this blog cannot cancel Netflix even if we want to because our kids will scream at us. I am sure some hard-core value investors out there have figured out the intrinsic value of Netflix and will be looking to buy at a certain price. But can we create an algorithm so strong that we can also churn out the right intrinsic value, for Netflix, Peleton and all the 10,000 listed companies in the world?

Courtesy of Google images: Netflix's CEO Reed Hastings and Netflix's recent sub numbers

Ultimately, it comes back to valuations. If we buy something expensive, then it is inevitable that when the market mood swings towards negativity, the stock trades below our buying price, which hopefully is below its intrinsic value. Then there is still hope it will go back up someday. Recall that intrinsic value is always a range, it is not an exact number. As such, investing is not a science, which implies that creating an algorithm is inherently difficult.

In its most basic form, the intrinsic value depends on the company's earnings or income and a multiplier. The multiplier is based on the industry dynamics, the companies' earnings power which is exemplified as margins and ROEs, interest rates and investors' sentiment, amongst other things. The right multiplier gets redefined depending on the times. When I started this blog around 15 years ago, something trading above 25x price earnings is considered so expensive that I would not touch with a ten foot pole. Then I found that there is nothing to buy. I started buying stocks above 25x price earnings. Now, it looks like my original rule based on prudence may come back in vogue again.

However it is possible to use screens and quant trading based on valuations to make money. There are many quant shops that have done it. They made good money. Renaissance Technologies have gone a few steps further to perfect the quant-based money making machine. It delivered annualized c.40% returns over 40 years! Even putting Warren Buffett in a box could not have generated those kinds of returns.

What's most important for me though is that Value Investing is a journey. As we read about interesting companies and learn about their businesses, we understand the world that we live in. I become a better person as I become a better investor. If I created an algorithm just to find value stocks and buy blindly, then where is the fun in all this? 

That said, investing is not for everyone. If you do not have the time, passion and gut to stomach painful losses, it is best just to buy the index. That is the next best thing to putting Buffett in a box.

Huat Ah!

Saturday, November 19, 2022

Thoughts #29: Little Men Doing Big Things

Warning: this post contains spoilers for "The Crown", please do not read on if you are keen to watch without knowing story plots.

In Season Three of "The Crown", one of the episodes featured one of humankind's greatest achievement - the moon landing and how Prince Philip asked for a session with the astronauts. He wanted to know how they felt achieving what they had achieved only to find out that the astronauts just did what they were told, ticking off checklists, following procedures and just mundanely went and came back. He was very disappointed and then decided to renew his faith in religion.

But I think this episode taught us more about life than Prince Philip's read. The great achievements are sometimes, simply doing mundane things. The success of the moon landing mission was about:

1. Following procedures and checklists

2. Teamwork

3. Safety and contingencies on top of contingencies

4. Keep practicing until everything is prefect and there is no room for mistakes

In many ways, it is very similar to investing. Warren Buffett did all the mundane things for 30 years until people found out how tough it actually was. Then lo-and-behold, he achieved 20% return over that time frame and he just kept going and is still doing it today. That's the path to greatness.

"One small step for a man, but giant leap for mankind."

To me, greatness is about taking the small step every day, being disciplined, being consistent and being kind. In investing, it is about:

1. Reading

2. Debating with friends

3. Being patient and demanding the all-important margin of safety

4. Repeat the steps above

Once in a while, you will get the homerun stock and that's the alpha. Of course, sometimes, we can innovate our way to greatness (like Renaissance Technologies) and then we have to incorporate ways to put innovation into our processes.

Keep walking!

Friday, November 04, 2022

Lessons Learnt from 4 Biggest Losses - Part 2

This is a continuation of the previous post lessons learnt from my 4 Biggest Losses. To recap they are: 

1. Overseas Education, negative c.30%, operator of one of the largest international schools in Singapore. Student enrollment and revenue fell continuously for almost 10 years. It was exacerbated by the pandemic but even if the world normalizes, it is unclear if the stock will rebound. Management are owners and exemplified small cap risks.

2. SIA Engineering, negative c.20%, aircraft maintenance arm of our national carrier. I overpaid for this and am now suffering. It is unclear if I can breakeven. Oversizing the position also caused outsized absolute losses. This is the ultimate reminder for me not to overpay and to size my bets well.

3. Under Armor, negative c.70%, this was a stock that got into the portfolio because of a structured product went wrong. I sold puts and it got exercised. After holding the stock, it continued to drop and was hit by the pandemic. While there is a chance it can go up 100% or more from here (the 40x gap between Under Armor's and Nike's market cap seemed too big), I am not betting on it. This is another lesson about valuation - never overpay!

4. Cinema related small cap name, negative c.80%, this is a Chinese cinema technology provider that was badly hit by the pandemic. It is also another small cap name which comes with it small cap risks, like Overseas Education. The lesson is therefore not to invest in too many small caps and/or if we must, demand a much higher valuation discount.

In a nutshell, the lessons learnt here are: sizing, small cap risk, understanding unknown risks and over-valuation. I have discussed about sizing and hence we shall touch upon the rest today.

Small cap: I would refer to stocks trading at lower than USD2bn market cap and this was the case with #1 and #4 above. Small caps are usually run by owners, less experienced management teams and the business revenue also tend to be more volatile and as such deserves lower valuations. But we tend to forget that and ascribe just a 10-20% valuation discount to a similar business which is much bigger. 

Courtesy of CME Group

Looking at the four names, we can also argue whether Under Armor (market cap USD3.9bn) truly has an investment case. It is small cap looking through the eyes of Nike (market cap USD147bn) and Adidas (market cap USD28bn). One is much better off buying Nike or Adidas. Why bother with the third smallish player? The chart above says it all - it shows returns between large cap and small cap are not really different yet small cap investors take on a lot more risks. As such, the lesson here is that perhaps we should just avoid small caps. 

Understanding the risks: This brings us to the second lesson. We think we have uncovered everything. We have done our homework well. But it is actually very difficult, especially with small caps and inherently volatile industries. I think there are no good advice (to myself and readers) here, it takes years of experience to understand some of these industries and I urge everyone to always have robust discussions with other smart thinkers. 

The case-in-point here is the cinema technology provider that I bought which has gone down 80%. We all go to cinemas and we think we know the industry well. But with Netflix and streaming disrupting the industry, let alone all the faster changes in China, the writings were on the wall that risks are mounting. When the pandemic hits such small cap names, it was game over. 

It was a similar story with SIA Engineering. I thought I got the investment thesis right. There will be a lot more middle income tourists in the world, Changi will build T4 and T5 and SIA Engineering will benefit. I discussed with smart friends and even though they said it is not water-tight, I refused to listen. Lo-and-behold the pandemic came and turned everything upside down. Looking back, the airline industry is just inherently volatile and it doesn't pay to put too much money into one name and let alone related names (yes, I have other related names!).

Over-paying: There are multiple mistakes with SIA Engineering. Not only did I read the industry wrongly, I overpaid for it at more than 20x PER at the time of buying. I did the same with the cinema name (25-30x PER), believing in the growth story. I also overpaid for Under Armor at more than 30x PER. So much so for proclaiming to be a value investor. But this is also portfolio-manager-wanting-action error. 

Swing you bum! - Courtesy of MyTrade PH

Sometimes, we are compelled do to things even when there is nothing that we should do. From 2016-2020, the market was overvalued and as such most stocks are over-valued. I thought I was getting bargains for getting these high growth names at 25-30x PER. After all, Amazon and Tesla did so well trading at even higher valuations right? Well, unfortunately, I didn't have those but had these! The related lesson is that not all sexy stocks are the same. So perhaps it was best to avoid high valuations, esp after triangulation, they are still high. Again it's easier said than done. The inner voice is constantly shouting "Swing you bum!"

To sum up this last lesson:

1. When everything is expensive, it pays to do nothing.

2. Don't think your growth stock is Tesla.

3. Do not overpay. 

Huat ah!

Friday, October 21, 2022

Books #18: Security Analysis - Part 2

This is one of those long awaited sequel post as we took time to discuss T bills and dividend stocks given the interesting market movements in the recent months. As mentioned in the past post, Security Analysis is this seminal book which provides good lessons for any investors but it's a bit difficult to read. But we can still learn a few lessons from it.

As promised, let's discuss the financial shenanigans and bad management which happened then (i.e. c.1920s) and will still happen as long as humans are greedy. As the gurus put in, the financial statements that will uncover financial shenanigans are usually the balance sheet and the cashflow. The P&L statement is the most straightforward and since most laymen can read it, shrewd management will not screw that up. 

The balance sheet and the cashflow statements require more financial knowledge and it is the balance sheet that is used to hide the bad stuff. As such, the authors of Security Analysis warned against bloated balance sheets. By bloated, we are referring to account receivables, other assets, other liabilities and lines in the balance sheet that is used to hide the bad stuff. 

Most of the time, it is not easy to uncover because bad management has gone all out to hide stuff. I managed to find Enron's balance sheet in year 2000 online. Without hindsight, it is not easy to say things are wrong. The lines - "asset from price risk management activities" were where most of the bad was parked under, USD21bn worth of it, but management made so much effort to explain it so well that it's difficult to fault analysts for not being able to figure things out. 

Bad management will never admit that they are bad so sometimes, in the end, it really boils down to gut feel. I have written about this on various posts in the past: Billon Dollar Whale Fraud Detection Lessons and Theranos, the fraudulent startup. To jot down a few tell-tale signs:

1. Bloated balance sheet, what we have we talking about so far

2. Keep talking about importance of secrecy, trade secret and know-how, trademark protection to mask the lack of disclosure

3. Lack of governance

4. Past issues with the law, including ongoing litigation.

As a side note, companies with litigation risks should also be avoided because the cost is simply to hard to measure. We discussed BP and Bayer in the past on this infosite. Both names did not recover past their previous peaks after the litigation mess broke out. BP was the infamous Deepwater Horizon accident and Bayer was ensued in the supposedly cancer causing Roundup fertilizer class action lawsuits.

In the next and final post, we discus other lessons learnt from Security Analysis.

Huat Ah!

Friday, October 07, 2022

Lessons Learnt from 4 Biggest Losses - Part I

Most people brag about their investment wins. It is just human nature. We need to show we are better, so we get status, pride and get to lead and enjoy the benefits that get accrued to leadership in tribes. In prehistoric times, alpha males who can hunt, have muscles, can fight well tend to get the best food, the best shelter and the women and produce more offsprings and win the natural selection competition. 

As such, bragging is biological.

Alpha male primate can even get cookies!

Today, it is about money. You can be bald and fat but if you are a billionaire, then prestige and goodies and some women will come your way. So we brag about investment wins to showcase that. We buy cars, watches, houses and NFTs to display wealth. It is imperative, biologically and socially.  But what is truly and fundamentally beneficial is to learn from our losses. That is how we get better as investors. That is what this post and the next is about. 

As I look at my portfolio, there are now four big loss-making positions which I felt compelled to write about. The losses amount almost to six digits and you can imagine how it pains to write about them. But I believe there are many lessons learnt and I hope readers can really takeaway some of these so as not to repeat them. But trust me, it will be easier said than done! Here are the losers in no particular order:

1. Overseas Education, negative c.30%, I have blogged about this stock.

2. SIA Engineering, negative c.20%, pandemic victim, I have also briefly blogged about this.

3. Under Armor, negative c.70%, hit by overvaluation and the pandemic.

4. Cinema related small cap name, negative c.80%, looks like I will never recover my capital.

As I looked at the four painful names, I see similar mistakes and recurring lessons. While all four names were somewhat impacted by Covid-19, it was not just the pandemic. It was overpaying i.e. valuations, it was ignoring small cap risks and not understanding all the issues and most importantly, it was not getting the sizing right. Actually, sizing is so crucial so let's talk about that in more detail. 

What I got from Google wrt to sizing

For me, the sizing mistake relates to all four names but it had the biggest absolute damage in the first two. As such, despite the percentage loss was only 20-30%, the outsized impact on the absolute damage was big and this is the nutshell lesson about sizing:

We must size the bet such that we can still sleep if we lose 80% of the amount invested. We must also think in terms of percentage of the portfolio. In most professionally run portfolios, there are hard limits like 10% for one position but for personal accounts, we may want to size it lower depending on our own psychological construct and the amount of absolute loss we can bear.

Let's use so numbers to illustrate the above. First we must determine how much we can afford to lose in one position. I will arbitrary put that as S$40,000 which is close to half of Singapore's median household income. (Imagine when you need to tell your better half that you lost half a year's income on one stock. This should be good pyschological threshold ;) Looking at my actual losses, since a position can go down 80%, that means the maximum bet on one stock should be c.S$50,000. Of course that also depends on your portfolio. If this is more than 10% of your portfolio, then perhaps it should be smaller. 

There is also a minimum size for a position which relates to transaction costs. When I first started, round trip (buying and selling) transaction cost can cost minimally $100 which means that any position should be c.S$10,000 otherwise it doesn't make sense as it costs 1-2% every time you do some buying and selling. Well, the world has changed and transaction costs can go to zero with some brokers, but still, sometimes it's not and it pays to know what is the optimal minimal size for you.

Going back to my mistakes, if I sized the bets correctly, I could have reduce my absolute losses by half and the pain will also be halved and I would not have to endure the wrath of my better half! When you can size correctly, losses cannot hurt your portfolio and your family peace and you can sleep better at night. There is a lot more to talk about sizing which perhaps deserve its own post but let's stop here for today and we shall discuss in the next post:

1. Valuations 

2. Small cap issues

3. Unknown risks

There are two rules in investing. First rule: don't lose money. Second rule: don't forget the first rule.

Huat Ah!