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