Saturday, December 27, 2008

Enterprise Value and Free Cash Flow II

This is a continuation of the last post talking about EV and FCF.

A company generates cashflow based on its day-to-day operations. Eg. SIA selling air tickets with fuel surcharges 2x actual ticket prices. The millions of ticket sales generate cash. Of course SIA needs to pay the pilots, the stewardesses, the fuel, landing charges etc. After netting the expenses, it should still have cash left. Some co.s don't, if you own some of these, good luck! Anyways, this no. is called Cashflow from Operations.

Next, SIA needs to spend some of this cashflow on equipment to maintain its operations. Like buying new planes, pilot training programs, etc. This no. is called Capex which is the short-form for capital expenditure.

When you deduct Capex from Cashflow from Operations, you get a no. called the Free Cash Flow. Basically, that's what's left that can be distributed to shareholders or to pay down debt. If the company has no debt, it's basically money that can be paid to the shareholders.

Over the course of many many years (like 10 yrs or more), a good co. will generate significant Free Cash Flow and has the capacity to even grow this amt over time. Now finally, things are getting interesting right? These are co.s that value investors look out for. Usually, I would look at that past 10-15yrs of FCF and take an average amt to use that to calculate EV/FCF. I am assuming that the company can generate this average FCF in the future for many many years.

Let's look at SIA. Over the past 10 years, SIA has 5 yrs of positive FCF and 5 yrs of negative FCF. Cumulatively, it generated a miserable S$175mn of FCF. Our ministers' salaries over 10 years would have generated as much. This is what the most profitable airline in the world can manage. Moral of the story: Don't ever buy an airline!

Combining the two things, you get EV/FCF which is just a measure of the cheapness of the company. The lower the better, like the PE ratio. If this ratio gives 5x, it means that theoretically, you get back your money in 5 yrs. Usually it doesn't get cheaper than that. EV/FCF ranges from 5-15x usually.

Again, back to SIA, the EV is S$8.8bn based on current stock price of S$11+. Calculating EV/FCF give 8800/175 = 50.3x. If you buy SIA today, the free cashflow generated should be able to cover your purchase in about 50 yrs. That's great isn't it? Maybe just in time to cash out and pay for the funeral expenses!

Sunday, December 21, 2008

Enterprise Value and Free Cash Flow I

Once upon a time, we talked about a radical ratio called EV/EBITDA which was invented and nearly won the Nobel Prize in Most Innovative Financial Ratio ever invented. Well someone topped that and invented EV/FCF which is Enterprise Value over Free Cash Flow.

What's so great about EV and its alphapetical soup of acroynms? Ok, let's define the terms first.

EV = Market cap + Net Interest bearing debt
FCF = Cashflow from Operations - Capex

For the uninitiated, pls follow the hyperlinks and read what is Market Cap, Cashflow from Operations etc. I will explain EV and FCF.

EV stands for Elise Vuitton, cousin of Louis Vuitton who recently came out with her own luxury brand of leather bags to grab share from the legendary LV.

Oops, wrong number. Ok, here's the real deal.

EV is sort of the theoretical takeover price of a company. In the event of a buyout, an acquirer would need to pay the market price (or market cap) to the existing shareholders. However he would also have to take on the company's debt, but pocket its cash (hence looking at NET interest bearing debt is impt). If a company has no debt and some cash, then EV is less than market cap and the acquirer will be getting a bargain!

Actually in today's market, some co.s are trading below net cash! This means that EV is actually negative. You get paid to buyout some co.s listed on SGX! It goes to show how irrational things can get when markets go crazy. However, as quoted by the great Keynes: markets can stay crazy longer than you can stay liquid. Well usually also longer than you can stay patient lah. Nevertheless, having said all that, it goes to show that markets today are really cheap. This is the Great Singapore Clearance Sale value investors have been waiting for! But wait tomorrow things can get cheaper though.

Anyways, that's EV. In the next post, we shall explore Free Cash Flow or FCF.

Saturday, December 13, 2008

Losers' Game

This is the title of an essay and a book by one of the most prominent minds in finance. Just google it to read the original text. I will provide a brief summary here.

In this world, there are two types of games being played. Winners' games and Losers' games. In winner's games, the winner wins through his own actions. In loser's games, the winner wins through his opponents actions. The usual example to illustrate this is tennis. There are actually two type of tennis being played in the world, as observed by some hotshot coach. Amateur tennis and professional tennis.

Professional tennis is a winner's game. Federer wins by delivering the ace that nobody can counter. Or that smash, or whatever. The winner wins through his own actions. In amateur tennis, usually Ah Lian wins by doing nothing. Why? Bcos Ah Beng tries to deliver the ace or that smash to Ah Lian but the ball goes out-of-bounds. Ah Lian wins bcos Ah Beng keeps doing silly things when he is not up to it.

According to the original author: professional golf is also a loser's game. The winner wins by playing it right and let their opponents hit bunker or sand or whatever. But Tiger plays it like a winner's game. Hit bunker but comes back spectacularly and ends with a birdie. That's why everybody loves him!

And finally, the core of this post. What is the biggest losers' game in town? Yes, that's investing. Investing is a loser's game. How do you beat the market?

First, you cannot make silly mistakes. In all loser's games this is the first criteria. You cannot try to be like Federer. Play it safe. do the boring parry. In investing it means don't buy on rumour, don't try to do that punt bcos it dropped 50% in one week, next Monday sure rebound one! Or die die do 2 trades every month to meet that stupid broker quota to save a few dollars on overseas stock deposited at the broker. These are like Ah Beng trying to be Federer. Well unless you ARE like Federer, ie you can trade damn well and earn these quick bucks with 99% success rate, like legendary traders Baruch, Livermore. If so, then ermmm why are you reading this post, you should already be a Big Swinging Dick trading big bucks and writing your own blog! Well, I'm flattered anyways.

Second, you only beat the market when it makes mistakes. Alas, the market don't make mistakes. The market is always right, remember? Well the market is right until the time horizon where all the participants can see what's going on. E.g. the market fell 50% this year as all the participants can only see the severe recession coming in 2009. Nobody knows what's gonna happen after that. If we don't go into the 1930 Great Depression scenario, global economy will bounce back in 2010, 2011, 2012, who knows. But when it does, solid co.s like Coca Cola, Canon, LVMH will continue to grow. So that's one way to beat the market. Sometimes, the market does some obvious mistakes. Like mkt cap of Citigroup going lower than the combined mkt cap of Sg 3 banks. Unless C is going under, this should not happen. And after Lehman went down and create this mess, will the authorities let Citi go down? So in such rare occasion, you can beat the market. But by and large, market don't give you that many chances.

So the conclusion: don't trade, play it safe, and according to the author, who is a strong supporter of indexing, buy indices. Buy the STI ETF, or the S&P500 or the Hang Seng. It's futile to beat the market, so just earn market return.

Saturday, December 06, 2008

Fallacy of scruntinizing ratios for the past few years

Financial statements are very essential in fundamental analysis and value investing. To value investors, it's like soldier's M16, accountant's Excel, taxi driver's taxi, you get the idea. From the statements, we calculate the all important ratios. Basically it's one number divided by another and that's supposed to give you insights into the company's business operations, its edge or whatever. Something like adding apple juice to aloe vera and drinking the new juice will actually make you thin!

Actually around like 2% of the time, looking at ratios actually help a bit. The problem is we always only look at last yr's ratios. Or maybe some diligent analyst will look at ratios for the past 5 yrs. Not bad huh. 5 yrs quite long right? Presidential term only 4yrs. Alas, do they know on average how long is one economic cycle from peak to peak or trough to trough?

Well, its seven years on average. The recent one, 2001 to now and still going. The one before 1997 to 2001. 4 yrs, well sometimes it's shorter than average, obviously. So by looking at 5 yrs of ratios like ROE, operating margin, debt to equity ratio, can you really tell if the co. is really good? Esp if you are looking at 2002-2007 and the ratios just keep improving every yr? Like those we see in annual reports. Sooooo impressive. This co. is really something, we tell ourselves.

Our hero, Warren Buffett some yrs back started to ask co. owners to come forward to him if they intend to sell their stake to Berkshire. One of his criteria: GROWING earnings for the past 15-20 years. So seven years still quite amateur actually. Of course, most Sg co.s were not around 20 years ago. So we just have to make do with seven years lor.

So, that's the moral of the story: a co. with improving ratios for the past few years is not necessary a capable one. Rising tide lifts all boats. Keep the economic cycle in mind when looking at ratios for the past few years.

Sunday, November 30, 2008

So when will the market bottom out?

The bottom will be somewhere in the next 12-24 mths. ie Dec 09 to Dec 10. What? 24 mths? So my portfolio has to suffer another dunno how many % downside? What kind of prediction is that!?? Well, let's start with the disclaimer first, nobody ever predicted nothing. Bell said nobody needs phones, Ford said nobody needs cars, and the most famous one: Bill Gates said nobody needs computers. So that is just my contribution. It won't be right. Maybe we have already seen the bottom. Who knows? Maybe we didnt avoid the Great Depression scenario. We just don't know yet. 

Ok, let's get to the facts. 

Few trillion dollars have been forked out. Wall Street will be rescued. Global coordinated efforts to help stabilize the whole banking and credit system have done the trick. The life-and-death crisis has been resolved for now. We are out of the ICU, for now. But the stock market keeps tanking! Well, the patient is still very sick. Still on drip and breathing weakly. It takes time to heal. There are still bad stuff in the financial system that needs to be cleared. More disposals and write-off before we are good to go. May go back to ICU again also. But chances not high. Hopefully! We don't want Great Depression II. Check this post

As for the "real" economy, it has started to slow and will continue to slow. Esp US. It is said that we need another few trillion dollar fiscal packages for Main Street. The common folks stuck with paying mortgages that cost more than their homes need money. And those pple using credit card loan lines to buy food and pay bills. So wait for some help to come in the next few weeks. Then we need to wait for China to come back. The credit bubble that fuelled part of China's spectacular growth has burst, so China feels some impact, but it's economy is robust enough to withstand the negative impact. 

Given a few quarters, it will come roaring back. And hopefully, it will lift the rest of the world up. In terms of magnitude, we are probably not far from the bottom. Or may already be at the bottom. But in terms of time, things need time to recover. Positive catalysts on the REAL economy must appear before the market can move up. They won't appear so soon but quite a good likelihood it will come in the next 12 to 24 months. 

So time to open the purse strings, it's the great Singapore sale on SGX coming up!

Tuesday, November 25, 2008

Game Theory - Part 2

This is a continuation of the last post on game theory

Just for argument sake, let's look at the taxi industry in Singapore. There are 6 taxi companies, ie 6 prisoners. The Big Brother is of course Comfort, with 60% market share, having 14,000 taxis out of the total population of 23,000 taxis. Then there is No.2 SMRT with 3,000 taxis or so.

Currently everyone is just following Big Brother moves and nobody is saboing one another. Which is very good for the industry, as profits can improve for everyone. However, passengers suffer lor. We have to accept price hikes no matter what.

Actually, if you think about it, 1 taxi co. can play punk and not follow suit. E.g. SMART taxi sabo the rest by reducing flagdown rate $2, which is significantly lower than its rivals' $3. By doing this it can actually gain market share. Well that's theory lah, in reality, it will not work bcos

1) Passengers currently cannot choose taxis in a taxi queue, so some kind of mentality change needs to take place, maybe like local celebrities leading the movement of choosing taxis in a queue or something

2) Taxi drivers of SMART may not be smart enough (no pun intended :) to realize this can actually boost their revenue and hence protest fervently to the lower flagdown rate

3) The taxi capacity (or supply) in Singapore is actually very tight, demand for taxis at peak hours dramatically exceeds the taxi population capacity, hence there is no need to resort to cutting prices to gain market share to boost revenue at this stage.

Well all this would change as our society matures. Some day in the distant future, taxi usage may decline and taxi population may actually exceed demand and there will be such a need to resort to price wars.

But even so, as one can imagine, after SMART reduces flagdown to $2, Comfort can simply reduce to $1.90 and crush all competition. So nobody will dare to do such things today. So in this set of prisoners, the outcome is usually quite favourable bcos there is a dominant leader that can dictate others' decisions.

However, back to our distant future scenario, taxi usage is in decline and most taxi co.s are struggling, in desperation, SMART, Prime, SMRT and Silvercab merge to form one company which will now have 50% market share. This new entity then reduces flagdown rate to fight Comfort. We may see the worst case scenario in the prisoner dilemma, ie both parties suffer as they reduce prices but yet cannot gain market share. However this will actually be very good for consumers.

Well, that's a sort of real-life game theory analysis of industries. Hope it can give some insights when you think about the companies that you want to invest in.

Wednesday, November 12, 2008

Game Theory - Part 1

Game theory is something that was very popular about 10 years ago I think. It tries to mathematically deduce what is the best course of action given a set of circumstances. The most simplistic example would be the famous Prisoner Dilemma.

For the uninitiated, I will give a Singapore version. Say two opposition party members ganna sued by our beloved Gahmen and are put into difficult situations. The Gahmen needs either one of them to confess in order to sue them till their pants drop, so has resorted to interrogate each of them separately whether they want to confess to their crimes.

Gahmen: Hey loser, if you confess your crime and sabo your friend, we will lighten the sentence for you.

Opposition: I will never befray my comrade, screw you!

Gahmen: You sure? Your friend in the next room is going sabo you, you know?

Opposition: You are lying! He will never betray me, we play Goli together one!

Gahmen: Look we are the most transparent, most efficient, most clean Gahmen in the world basically here are your choices:

1) If you don't confess, and he sabos you, you get sued $1mn, he just pays $1000 for wasting our time and walk away
2) You confess and sabo him, you pay $1000 and walk away
3) If you both sabo each other, you get sued $1mn each
4) If you both don't confess, basically we lock you two up for 3 days, you both pay nothing and then you can walk, bcos we have no other way to get evidence

Transparent enough right? So it depends whether you trust your friend or not, if you really think he will not sabo you, then you should not confess.

Opposition: He will never betray me, we play Goli together one!

Ok, so that's Prisoner Dilemma. How does it apply to investing?

Essentially, a firm in a competitive industry is always in the prisoner's situation.
1) If the firm cut prices and competition doesn't, then it gains market share
2) If competition cut prices and the firm doesn't then it loses market share
3) If both cut prices, then both are in a worse situation than before
4) If both maintain prices, or even better, both raise prices then both parties will improve their situations

Well, value investors look for firms that won't get into this kind of situation. Firms in businesses where there is no competition or somehow the firm has a huge economic moat that shields it from price wars or other threats.

In the next post, we shall discuss a real life competitive industry involving Prisoner's Dilemma

Wednesday, November 05, 2008

How to be a millionaire?

Based on the recent poll, most people actually got the right answer. I guess it's the way the question is structured and the answers are listed out. So congrats to those who chose the last answer (1.134mn answer).

Btw, the question is "If you save $1600 a month and your money earns you 10% return per yr on average, what is your total savings at the end of 20 yrs?"

So that's the answer, just save $1600 a month, let it grow at 10%pa, in 20 yrs you become a millionaire. I guess most readers would say, hey that's not exactly an easy think to do. Some households don't even EARN $1600 a month. And most households in Singapore can barely save a few hundred dollars. And 10%pa is very high target, what's more you need to make 10%pa for 20yrs!

Well, you are right! It is not easy, it's not meant to be easy. If it's that easy why don't we see millionaires everywhere? (Well actually they ARE everywhere, about 70,000 of them in Singapore.)

Nevertheless, I think there are a few takeaways here.

1) If you are really determined about becoming a millionaire, this is one sure way to reach your goal instead of relying on some lucky event to happen in your life. E.g. waiting for your HDB or condo en-bloc, or punting the stock market, or winning 4D etc.

2) Time is an element that you can control. Say if you are not sure you can hit the 10%pa, but we are sure about 5%pa right (bcos CPF pays 5%) then work with 5%. The same amt, $1600 compounded at 5% will reach $1mn in 27 years. So the trick is to start early. If poss. better start to start at age zero. Start for your children! Hehe.

Btw I have to spreadsheet that will calculate this for you. Send me an email at if anyone needs one.

Thursday, October 23, 2008

What could have happened?

The past few weeks actually went passed normally for most people NOT reading this blog. Common folks getting on with their daily lives, occasionally watching the news and see indices around the world fall 25% in one week, goes WOW and moved on. About 10,000 pple were digusted bcos they got conned to buy some Lehman mini-bonds. But actually that's quite far from what could have actually hit them worse. Oblivious to them and partly to me as well is the probability of a financial meltdown that could have happened. We always talked about it. But this has only happened a couple of times in history, usually localized in 1 or 2 countries (this round think Iceland, and maybe Korea) and only once on a global basis: the Great Depression.

When the first bailout plan failed to pass, it was said that we were close to the financial meltdown, systemic breakdown, start of the depression, beginning of the end, whatever you call it. But then global authorities took pain to alter the state of things, and here we are. *Phew* What a relief! And we can continue to just talk about financial meltdown without really going through it.

Well, what could actually happen?

Since I have never lived through one, I can merely speculate. And I assume most readers wouldn't have experienced one as well, so let's just ponder through the following scenarios and try to empathize.

1. Global stock markets collapse 90-95% from its previous high. This means STI will fall to 300. Yes, the no. of Spartans fighting 10,000 mini-bond investors no I believe it's Persians. Dow falls to 2,000 and Hang Seng 2,500. It will take roughly 25 yrs to surpass the previous peaks. As of now, global markets are roughly 50-70% from previous highs, though we averted the Great Depression scenario, we are not quite well off either. It will probably still take 8-10 years to surpass the previous peak made in 2007. But nevertheless, count ourselves lucky.

2. Many banks will fail, and I mean maybe like 40% of all the banks in the world or something. Globally, almost 10,000 banks failed during the Great Depression, bank runs were ubiquitous. Most people basically lost all their deposits bcos if everyone went to their banks to withdraw their savings at the same time, the bank definitely cannot pay up - which constitutes a bank run. This is scary if you think about it. Entire savings gone! The global authorities knew this and have put a stop by guaranteeing all deposits. Singapore did that too recently. In Iceland, they were a bit too late, so what they did was restricting everyone from withdrawing any money from the banks! Even foreigners who deposited in their foreign branches. Imagine your Maybank account getting frozen! But then, that's probably the right thing, bcos bank runs were one of the main reasons that led to the Great Depression. Ultimately the global financial system is built on confidence, without that, banks cannot exist, credit lines cannot exist, business cannot function, global economy cannot grow. We have ensured that credit lines will exist. Bank runs cannot occur. So this is good.

3. This time round, if things did go wrong, although we probably won't see 10,000 bank failures, some will still go. More of Northern Rock, IndyMac etc. When banks fail, corporations that rely on banks for credit to do their business cannot survive, there will be worldwide bankruptcies. My guesstimate is 40% of all listed companies going bankrupt. 80% of SMEs will fold. It will be a disaster on Richter Scale 10. Financial tsunami is an understatement. Nothing will be too big to fail. In fact bankruptcies become daily affairs. Workers will be just waiting for their turn, waiting for their co.s to go belly up.

4. With bankruptcies we have unemployment. During the Great Depression, unemployment hits 25% in the US. Today, it will probably hit 20% globally and maybe 33% in Singapore. So 1 in 3 people you know will be unemployed. Most likely you will also be unemployed. Most people will go broke. Their mortgages will be greater than the prices of their homes. And they have no money to pay. Govt may pass laws to stop banks for seizing these pples' properties bcos if they did, then we will see millions of homeless pple.

5. Those lucky ones with a job see salary cuts of 50-70%. Average household income falls drastically, consumption and prices follow. This time round, commodities are falling like autumn leaves already. Ultimately, goods and services prices will also fall 50-70%, but this comes at no relief bcos 30% of households have no income, those with income has only half of what it was. People cannot spend and hence less spending, less production, less jobs and the vicious cycle continues. So the Gahmen is right. Price increase is actually GOOD! ERP up GOOD! MRT fare up GOOD!

6. Global GDP falls 40% to USD 25trn or so and Singapore GDP halves to USD 60bn. Our reserves of USD 100bn come into play to help Singapore, probably to finance some sort of massive fiscal spending like reclaiming land to link all the islands surrounding Singapore, including Tekong, Jurong Island, Sentosa and building 100km bridges to Kusu Island and Bintan. Still it will take 5-10 years for GDPs to return to previous levels.

In short, it's Armageddon. So aren't we glad we averted this outcome and can blog about it?

Thursday, October 16, 2008

Value investing versus technical trading

Some time back there have been some debate on other blogs about whether value investing works better, or technical trading works better or turtle style works better or whatever. It is very logical to think that technicians detest value investors and vice versa. Bcos their investment philosophy is completely different.

One buys stocks that are mundane, cheap, stable earnings based on fundamental analysis. One buys based on short term newsflow, charts, momentum etc. It is very tempting to think that these different investors fight a lot. Like Cats versus Dogs, Chu vs Han kingdom, Man U vs Liverpool etc.

To summarize the styles a bit, they probably look like the following:

Champion style: Buy low sell high - sure win one!
Short selling: Sell high buy low - sure win too!
Value investing: Buy low, sell lower
Technical trading: Buy high target sell higher but usually sell low

Ok, just a joke. This is not your Wikipedia definition of the different styles. And also styles do not dictate whether you can win in this game. No matter which style you use, more than 80% of all investors underperform the markets and most retail investors don't even have positive gain to talk about.

At this point, I would like to draw an analogy to pop music.

There are many styles a pop artist can follow:
A-Mei: strong voice, dance a lot, bold and catchy tunes
Yanzi: R&B music, sweet young thing look
Morning Girls: Act cute, kiddy songs etc

There are basic guidelines to be trained to perform in different styles. Eg. For A-Mei style, vocal singing training, dance training, music and song writing training and probably a lot of real life experience in pub performing etc. For Morning Girls, no need vocals or song writing, just act cute.

Styles do not dictate whether you can sell double platinum albums. Some styles have better chances, some don't. Artists from different styles do not necessary hate one another and fight all the time. They respect one another's talent and attempt to bring better music to their audience, if anything. (Well sometimes they do fight, but not a whole lot :)

Value investing is just a style. One that some people believe and I believe has a better chance to make money. Just a slight advantage. But you can make it big with other styles too. Bernard Baruch is a multi-millionaire trader. Jim Rogers, George Soros bet on global macro trends. Jesse Livermore reads the tape. Peter Lynch, value and growth at reasonable price.

There are a few guidelines/basics on how to do value investing, eg. buy with margin of safety, don't time the market, look for co.s with stable earnings etc. However it doesn't mean that if you know all these, you will make money. In fact if you follow them strictly by the textbook, it is not going to work.

It is the same with technical trading, global macro betting, turtle style, tape reading etc. There are the basics, you learn them. Doesn't mean that you follow them strictly, you will make money. It takes a lot of effort, time, and usually luck as well for all styles.

And it doesn't help anyone to criticize other's style. Some people are good at certain styles. Some are good at others. More than 80% of all investors fail to beat market returns, regardless of which style they use. All styles can make money if you develop the flair, find out what ticks.

Ultimately investing to make money is an art, and in this aspect, investors are also like pop artists, most will falter, some spent their lives singing only in pubs, a small % can make a decent living as an artist and only a handful sells double platinum albums. If we put in decent amount of effort in developing a good investment philosophy and style, I would like to believe that we will be rewarded. May not beat the market, but it should be a positive return and add good incremental cashflow to our household income.

Wednesday, October 08, 2008

Focus on cashflow and not capital gain

When people say they do investing, there is a tendency for most people to focus on the capital gain that each investment will bring in. Eg. Ah Beng buys SGX at $3, today is $6, so his perceived capital gain is 100% and he is happy like a bird. Or Ah Gou buys a property at District 10 for $1mn in 2006 and today it is valued at $2mn, his capital gain is again 100% and he goes and buy a Ferrari. This is very natural and it's got to do with our primitive wiring and we cannot easily re-wire our brains.

However as long as we don't sell and lock in whatever gains, there is no cashflow coming into our pockets. And in most cases, it is actually not to our advantage to lock in the gains. Take the example of Ah Gou's house, if he sells, he gets his $2mn but the a similar house in District 10 will now cost $3mn. So he has to downgrade. And for Ah Beng, he sells and lock in his gain, but now he needs to find something else than to park his money, and in this market, it is difficult to find things that are safe.

Furthermore, price that Mr Market dictates has nothing to do with the true value or the intrinsic value of the asset. ie Mr Market may say that SGX can sell for $6, but it is really worth $6? And so did Ah Beng really double his money? Again the Mr Property Market says Ah Gou's house can sell for $2mn but is it really worth $2mn? If we cannot be sure, then why do we always look at our portfolio value at the end of the month and go smiling when Mr Market says your portfolio is up 10% this mth or down 20% next mth?

So instead of looking at the at the absolute price of the asset as dictated by Mr Market, perhaps the better way to look at investment is the real cashflow that it can generate for us. For stocks, since most people go for capital gain, there may be very little cashflow to talk about. Unless you keep buying and selling stocks and make sure some cash in generated every year or every quarter. However that means you need to be very good at market timing and studies have shown that most people sucked at market timing. So at some point in time, one should think about how to extract stable cashflow out of the portfolio regularly in order to enjoy some of the fruits. I mean no point holding on to stock certificates until you are dead right?

Assuming that your portfolio have grown substantially large over many years, one way would be to slowly sell some shares (assuming that they are infinitely divisible) as one approaches retirement so that cashflow can be generated and support a meaningful lifestyle. Another more realistic way would be to have a good % of dividend stocks that will generate some cashflow even if you don't sell any holdings.

Warren Buffett probably knows this better than anybody and that is probably what he has been doing this for 50 years. I estimated that Berkshire's stable of companies can generate USD 6-8bn of cash every year on an asset size (not original capital amt!) of roughly 220bn, so that's a 4% cash yield, on current asset size. Of course he can buy 100% of the company and demand all cash generated to go to him. That's not quite possible for us lah.

Nevertheless, at some point in time, when we are closing on retirement, we need to focus on how much cash the portfolio can generate every year. And personally I don't think it is wrong to practise that now, even though we may be 20-30 yrs away from retirement. I would be quite happy if my portfolio can have a cash yield of 2-3%pa for a start.

As for property, needless to say, the focus should be on how much rental the property can fetch, instead of thinking whether you can sell this property for $1,100psf after you bought it for $1,000psf. As a rule of thumb, I think we should only buy properties that can generate a sustainable rental yield of 5% over long period of time.

The focus on capital gain also means that we have to constantly buy and sell in order to lock in profits and find new buys. Now value investors do not like to play this game of buying and selling too frequently. It does not fit their investment philosophy and it serves only to make brokers happy. So they focus on cashflow. When thinking about the next investment, ask whether the investment can generate you good cashflow yield over a long time horizon, not whether you can sell at a 10% profit in 1 mth's time.

Monday, September 29, 2008

Are we at the bottom yet?

The short answer is no, but...

1. In terms of magnitude, yes it's pretty scaring, some markets are close to 70% from the previous peak, China is down 50%, India is down 40%. But the US, where everything started, is down only 28%, and Footsie down 27%. Developed Asia-wise, STI is also quite resilient, down about 36%. Hang Seng down 46%, Japan down 37%. So magnitude wise, maybe 60%-70% done. There may be another 10-15% downside, and things should pacify. Timeline-wise, things started to unfold only last June or so. We hit 1 year anniversary not too long ago. Bear markets don't last 1 yr. Usually 2-3 yrs, so chances are, we see some rebound then returning to downward trend until fundamental gets better.

2. Fundamentals. The saying few mths ago was that the sub-prime market was US$1trn, so we have seen write-downs of US$500bn, another 50% more to go. But now, it is not just about sub-prime isn't it. The whole financial industry is in trouble. And if you look at all these bad stuff, ie mortgages, CDS, CDOs, we are talking about US$3-5trn, or even US$10trn according to mega-bears' estimates which would be 70% of US GDP!?!! So how far are we from the bottom? Man, I have no idea, but we are nowhere near the end. But then again, the whole financial industry is built on confidence, if everyone thinks that the bailout will be successful, then it doesn't really matter if we still have US$ X trn of bad stuff. Bcos the market will look past all this and start pricing in a recovery.

3. The real economy only just started to slow. US GDP dropped two quarters ago but it is still positive. China GDP growth is still 8%, may need it to go to 6% or something. Usually it takes at least 4-6 quarters before GDP growth recovers. The stock market would be 1 or 2 quarters ahead of that bcos it always looks forward. So based on this measure, recovery is at least a few quarters away.

4. We are only at the bottom when nobody is asking whether we are at the bottom. Everybody stops talking about markets. Maybe this blog gets updated once a year. And this blogger writes about restaurants or cars or girls or something totally not related to investment. And none of our friends are in finance bcos those those that wanted to join freaked out, and those that were in finance got fired or their co. blew up. Think Lehman, Washington Mutual, AIG, Northern Rock!

Conclusion: it is not clear yet if this is the bottom, a lot of conflicting info pointing to different outcomes, my guess is that we are not quite there yet. One thing sure is that this uncertainty will continue. So brace yourselves for more volatility in the markets!

Friday, September 19, 2008

Penny stocks - continued

So, 600+ stocks out of the 700+ listed counters on SGX are penny stocks (trading less than $1). What are the implications? What are some takeaways one can develop?

For me, the few takeaways are as follows:

1. The market is cheap. The stock market can tell you the prices of stocks, but not their true values. When these kind of statistics get on the newspaper, you can tell, yeah things are quite bad, there may be some real bargain going on. But somehow, it feels like it is not the bottom yet. It has to be total despair when prices go way, way, WAY below their intrinsic values. Nevertheless, things do look cheap now. Just that they can get cheaper :)

2. Small frys get killed. Despite its mood swings, the market is not stupid. I am not sure how the same stats look in the best of times (was it maybe 100+ out of 700+ are penny stocks). But this stats did ring a warning in me. Yes not all 600+ counters are really lemons, we can find gems here. But how many? 300? Not likely, 100? Maybe, if we stretch our imagination and start building castles in the air a bit. But my guess is more like 10-20 real good co.s with fundamentals that can bring in cashflow for the next 30 yrs. (I am arbitrarily guessing here, no hard facts to support one...)

Singapore is a young country and has a unique economy that is very Govt driven, a small population educated to be obedient workers, no natural resources and no domestic market. So, how many good co.s can we produce? Sweden, the country with most no. of MNC per capita, has maybe 15-20 MNCs (like Ikea, Volvo, Ericsson etc). I think Singapore can be considered successful if we can produce just one or two.

So, one conclusion that can be made is perhaps as astute investors, we should not bother about investing in these small/mid caps simply bcos the odds of them growing to be great is miniscule. However if there are valid reasons to believe that some of these co.s can produce decent, stable cashflow in the long run and hence a good return on investment, then perhaps there is an investment case. This is similar to investing in See's Candy. It will not grow into giants like Walmart, but by paying at a right price, you can enjoy good cashflow for the next 30 yrs. (again in S'pore context, they must pay you dividends lah, unless you can buy over the whole co. like Buffett)

3. Invest with the leaders. Skip the small frys means the same lesson learnt here would be to invest in some stocks above some kind of cut-off. Most simplistically, stocks trading above $1, which is not very scientific lah. So maybe more tangible measures would be e.g Sales of more than S$1bn, Cashflow of more than S$100mn etc. Or maybe just invest in "global" household names. Not your St James Power Station, but more like Tiger Beer (Asia Pacific Breweries). Actually, really not that many. I cannot come up with another investable name.

4. The Singapore market has too few participants. When 84% of the stocks listed fall below S$1, it does say something about the breadth of investors here. Some bigger developed markets would have so-called "natural buyers" to support the market, eg. pension funds etc. Obviously they are not in Singapore. I am not surprised if it's only a handful of institutions trading in Singapore. Arbitrageurs in bigger markets will also bring prices closer to intrinsic values for listed entities. Again, perhaps our markets lack arbitrageurs.

Limited no. of players also mean the possibility of market manipulation. As a small individuals, go in with your eyes wide shut open, esp into small mid cap stocks which are easily subjected to manipulation. One popular trick would be pressing down the price of a good small cap, then taking it over or taking private, so even if you bought at a reasonable price, it is possible to lose bcos the acquirer will pay you a price even lower than that.

Hence back to the biggest takeaway: stick with the leaders.

Sunday, September 14, 2008

Advertisement for my other blog and penny stocks on SGX

After 3 years and 120 posts I think I have covered more or less 80% of value investing, and 50-60% of investment and finance in general. I reckon there are about about 50-60 core concepts in value investing and I have more or less touched on all of them: margin of safety, circle of competence, value trap, economic moat/barrier to entry, stock markets' mechanism etc.

There may be a few more stuff to expand on Financial Statement Analysis. But it's very dry and I don't really enjoy writing about Financial Ratio and Cashflow. I am sure most people read those posts only when they want to get some sleep.

In the past 2 yrs, new posts have been slow at about 2 weeks per post bcos I can only write when new ideas, key concepts enter my knowledge base and well, new ideas and key concepts don't really come by the minute, hour or even days or weeks.

Meanwhile I have been working on another blog which I have simply named "Industry Knowledge and Other Information" which contains snippets of useful stuff (I think!)

The link is here

It's in a very informal style and lots of no.s and statistics are included. More useful for myself than for pple who don't really want to think about what the statistics mean. Yes, the messages in the posts are not so clear cut. And sometimes, no message at all! :)

Well the latest post is about an interesting statistic: 84% of the stocks, or a whopping 600+ stocks listed on SGX are penny stocks (ie trading below $1). Of course, we are in a bear market, so what do you expect right? But let me share another statistic: less than 10 stocks trade more than $10 and less than 20 stocks trade more than $5. And in my short investment career, actually I can't really think of that many stocks trading at a high dollar amount. (Yes I know dollar amt doesn't mean anything, market cap is much more impt, but I am arguing from a simplistic angle).

I think all these statistics reflect a point: finding a real ten-bagger on SGX is 1 in a 100 or even less probable. Why? Bcos if the SGX has been around for more than 20 yrs and you see less than 20 counters trading at $5 or more. Assuming no stock split, and stocks IPO at $0.50 or so, it means you must be really good or damn lucky to identify that handful of $5-10 stocks.

Yes there are stocks that IPO at 20c, rally to $2 which would make it a ten-bagger. But they subsequently falter and return to their IPO price of 20c or even lower. Hence in my definition, they cannot really be considered "real" ten-bagger, right? So what does this all mean? Food for thought huh? I guess I will share my conclusions in another post. :)

Tuesday, September 09, 2008

Hopes and Dreams

Flipping through the newspaper everyday, I see so many dreams asking us to fork out top dollars to make them come true. Proprietary trading systems to help you trade and earn big money, ways to become millionaires, weight loss to a perfect figure, teaching methods to make your kid a genius, and many more others. Most of the time, they don't work, bcos if they did, they won't need these advertisements, people will just flock to their shops by the truckloads.

But the sad truth is, people still pay top dollars to go through these useless programs bcos they are buying a hope, hoping that somehow these programs will make their dreams come true. Humans are given the gift of hope such that in the most desperate of times, we can mentally survive bcos we know things could be better. In prehistoric times, cavemen needed hope to tide through winter, our grandparents needed hope to survive the wars. Today, this has become a marketing tool to entice people to buy hope that their dreams will come true.

Alas, you reap what you sow. How can you expect to lose weight by just paying money while you continue your 3,000 calories diet every day? How is it possible that your investment will make you money if you don't devote time to study what kind of investment you bought? We live in a world of cause and effect. One has to put in the right effort in order to get the desired results. So even if someone told you that the programs did work, it is more bcos they themselves put in the effort to cause the change. Or they may be just lucky.

To make money from investment is just about that: putting in the effort to learn, to think and then execute, ie buy the right securities. Most of it is free. The learning can be found all over the internet and needless to say, on this blog! The thinking is up to you, whether you like mental workout or just let your brain rot. Like most of us let our bodies rot by slouching in front of the TV after a hard day's work. The execution, well, competition among the brokers have brought commission down. So it's not expensive anymore. Unless of course you get some relationship managers or private bankers to service you and you actually get enticed to buy their high cost, high commission investment products. Then sorry lah, you might be paying 5% or even more of your capital for buying stocks or other securities.

The bottom line is this: don't pay top dollars for investment seminars, brokerage services, private banking services, don't pay top dollar for trading systems, learning to invest or any other programs for that matter. The great lessons in life are usually free.

Sunday, August 31, 2008

Ping Pong, Patience, Psychology

After 48 years, the Singapore women table tennis team finally got through the nerve-wrecking semi-finals to end the medal drought. It was the most fascinating experience watching the semi-final game live. And hence the inspiration to draw parallels between table tennis and investing.

For those who missed the game (btw it was office hours, so most diligent, career-focused Singaporeans were actually working hard), let me just briefly summarized what happened. Feng Tianwei won the first match easily and it looked like the rest of the game should be a breeze for Singapore. But Li Jiawei lost the 2nd match after 5 tough games. Singapore came back to win the doubles, then Wang Yuegu lost the 4th despite putting up a very strong fight and it has to come to the 5th match. Of course our heroine Feng battled all out in the last match and finally broke the Koreans.

The Koreans are very defensive players, they sliced the balls all the time and simply waited for the Singaporeans to make mistakes. That was how Li Jiawei lost. She was not on form and her successful smash rate was definitely below par. But needless to say, when she succeeds, the smash was a sure killer. Feng, on the other hand, smashes with higher accuracy but seldom kills the opponent, ie they managed to defend. Feng is also definitely more patient, only smashing when she gets a good angle.

In investing, this concept is actually pretty important. Buffett used to remind us, "Imagine you only have 15 bullets in your life, do you shoot everything that pops out, or do you go for the big turkey?" Li Jiawei goes for the kill at the slimmest chance, she misses a lot but when she hits, its a grand slam. Yes, the opponent get killed spectacularly, but it's still just one point.

In investing, Jiawei's strategy can work if that grand slam is a 10 bagger, and you recover all your losses from the other 9 losing bets. This is how Venture Capital (VC) works. But my guess is you will have better luck with Feng's strategy. And this ties in with patience. Don't simply buy stuff on a spur. Cosco has dropped 50%, it is definitely a buy now! SPC dividend yield is 10%, buy! There are reasons why they dropped so much in the first place. Exercise patience, strike when your chances of success are very high, not just when it is hot.

Back to the matches, it occured to me that it should be quite unlikely whereby someone is down by 2 games and then comes back to win the next 3 games and win the match. Similarly, if you are lagging by even just 2 or 3 points and your opponent is at game/match point, it is quite difficult to win. Psychology is at work here. In order to counter this, a lot of mind training is needed. In this aspect, I would say the Singapore team was quite good, but the Koreans were better. Of course, world No.1 Zhang Yining, is probably the best at this.

In investing, your opponent is the market. Most of the time, you are down by 2 to 3 points bcos it is very hard to beat the market. 90% of all professional fund managers underperform the market. So you need to train your mind and be calm. Otherwise, emotions cloud everything and you make stupid mistakes. Trading rules some times help. E.g. stop loss levels, profit taking levels. Needless to say, right-sizing the bets is equally important. If your investment is too big and you are losing sleep, you need to scale it down.

Of course, most true blue value investors don't believe in trading rules and sizing of bets. They believe that if the stock is down, you should buy even more since it's cheaper now. And you should bet your house and car on it bcos that's how you maximize returns.

Thursday, August 21, 2008

The Singapore Property Market: Personal Take II

This is a continuation of the last post.

Ok, so the bulls will say expats can pay. Now I do not know what is the average expat pay, but let's just assume the average expat gets the same salary of the top 10% of our population ie $12k per mth. If you are an expat earning $12k per mth, will you fork out 33% of your salary for rent? For me, if I were an expat, I know I am not going to be in Singapore forever, I would rather stay somewhere cheap, save the extra $1-2k on rental and spend it on touring Angkok Wat or something right? Of course that just me lah.

Btw the rule of thumb is roughly 20% of your salary on rental/mortgage. So going by this rule only expats earning $20k or above can afford this place. How many expats in Singapore earn $20k per mth, ie $240k per yr? Given that only 2,000 people earns more than $1mn in Singapore, my guess is roughly 7,000-8,000 people (including expats and Singaporeans).

How many rentalable condos in Singapore? About 300,000. So, sorry, charging $4,000 per mth for rental, it's a once in a lifetime chance, it won't last. Yes some hot locations can command this kind of rental today, but you cannot expect to charge this kind of rental for the next 20 yrs. At least not until Singapore GDP per capita further improves from here.

The other argument is that the company pays for the rent, not the expat himself. Now if you are the HR and you have your budget to work with, essentially the rental of $50k restrict your capacity to hire pple bcos you can only pay someone $50k less than what he should get. ie this expat suppose to get total package of $300k you can only give $250k bcos the other $50k goes to his rental. So this means less expats will choose to come to Singapore over time.

So the bottom line is this, $50k annual rental (which works out to be rental of $4 psf per mth) is not sustainable in Singapore today. It may be sustainable 10 yrs from now when our GDP per capita increases and our expat population increases tremendously. But not now. Our salary levels are too low compared to property prices today. Note that expat salary is also a function of our GDP per capita and our salaries, so as of now, $4 psf per mth is too expensive. That's my personal view.

So this translates to the fact that a $1000 psf for property price is to expensive. We are not even talking about those $3k psf yet... Ppty prices have to come down. FYI Singapore is now more expensive than Tokyo, New York and maybe Shanghai. We are only behind Hong Kong, London and a few whacky cities where psf is like 5 digits and above (in USD) like Moscow and Mumbai.

The time to look at property will be the time when prices are falling to $600-700psf in prime areas. ie pple who bought at $2,000-3,000 psf lose more than 70% of their property value and the whole world gets totally digusted with Singapore ppty as with in 1998. It may take some time, but now is the time for us to prepare and have to guts to buy when the time comes.

Tuesday, August 12, 2008

The Singapore Property Market: Personal Take I

In this post, I am going to give my two cents on the Singapore property market. As with people giving their two cents, usually it is worth about one cent, esp when people try to give their two cents in some arena where another 10,000 people already gave their answers to 6 million dollar questions. So always do your own analysis and learn to be an independent thinker. I think that should be everybody's goal and that means also you shouldn't be reading the rest of this post. Hehe.

But read lah, just for entertainment lor.

So back to the Singapore property market, I belong to the bearish camp, and the following would be my rationale:

Lets start with today's $1,000 psf, a sort of low benchmark for ppty in some prime locations. But we have to start somewhere, so let's just use $1,000 psf. This means a 1,000 sqf condo will cost $1mn. In order to justify $1mn on the property, I would say that the rental yield needs to be 5%.

Actually in the industry pple use 4% and they call this the cap rate, but I try to be conservative here. You can also think of this as assuming that the PER for the property is 20x, which will give an earnings yield of 5%.

As you can see, PER of 20x is not cheap at all, but if we use a lower PER or higher yield, in will only further prove my point: the property market has gotten too expensive. So let's just stick to this 5% yield.

With the yield at 5% it means that the property priced at $1mn should fetch you $50k rental per yr if you rent it out. This works out to be $4,000 plus per mth. The 90th percentile household salary in Singapore is $12,000, so basically only 10% of Singaporean household can afford to rent this place, assuming that they are willing to fork out 33% their household salary on rental.

Ok most pple won't, or rather couldn't, bcos they spend like 90% of their salary. Esp for Singaporeans, we hate to fork out cash for mortgage. And it is impossible to use just CPF to pay for a $1mn mortgage. Well the point here is that this property cannot be rented out easily to Singaporean households or foreign workers earning less than $12,000 per mth.

Link to Singaporean household income

Stay tuned for Part 2!

Thursday, July 31, 2008

The end of Alpha

A few hundred years ago, humans were not capable of calculating the speed and acceleration of apples falling from trees, the movement of heavenly bodies and predicting simple things like whether a 2kg ball and 1kg ball will roll down a slope faster. Btw the answer is both balls will roll down the slope at the same speed.

Then came along a guy called Newton who sat down in a park some day and an apple fell on his head. (I'm guessing this guy is a nerd and has no dates!) And as they say the rest is history. Well no offense, Newton was a great guy and I admire him as much as the next value investor reading this blog.

Anyways, the analogy here is that would there be a day when humans can fully predict the prices of stocks and all other investments? And all securities would be priced fairly all the time and there would be no room for speculation and the market becomes truly, madly, deeply EFFICIENT.

Of course, even a genius like Newton failed at winning the stock market (he speculated in the stock market in England during the South Sea Bubble and lost a lot of money) so it may really take a long long time for some achievements on this front. And some may argue that this would not happen bcos stocks move on emotions and no one can predict human emotions. Esp the emotions of the woman whom you decided to spend the rest of your life with.

Well... that's true... but we have also achieved a lot of impossible feats, like going to the moon, heart transplant, calculating a 2 to power of 10mn digit prime no. etc. So let's just for argument sake postulate that some day, all securities are priced efficiently all the time.

What's gonna happen is that capital would be allocated efficiently all the time, all investors will earn the same rate of return and there will be no Greater Fool Games, no bubbles and no crashes.

The stock prices of companies will be step functions corresponding to the growth of the companies. There would be no technical analysis since it's all straight lines now. Any new developments will be instantly reflected in the stock price so you see the prices move vertically up or down. Hence the step functions.

There would be an army of arbitrageurs who would bring the stock price back to its intrinsic value if any punter tries to even move the stock price by 1/256 from its intrinsic value. Btw this value will be calculated accurately to the 10th decimal place all the time and changes accurately to a new value with new pieces of information.

Brokers would still be around but their sole purpose would be to faciliate any trades. They will earn their fair share of commission, probably at 0.0001% of the trade or whatever. There would be no need for analysts or economists babbling nonsense since everyone can simply use bloomberg to find out the intrinsic value of any securities.

Fund managers exist solely to mix and match different securities to create suitable portofolios for their clients who are too lazy to do it themselves. No investor will ever lose unnecessary money except for the case of company bankruptcies. But even so, his portfolio will be protected by insurance. How perfect!

Well, that's a dream. It may happen someday, but most probably not in my lifetime.

Wednesday, July 23, 2008

Mind Share

This concept should be familiar to followers of the guru and value investing as well. Essentially, we should invest in companies that have a market share of our minds. The bigger the better.

Well, basically, we are talking about branding, but Mind Share sounds so cool right! So let's just use this term indiscriminately in this post.

For the uninitiated, let's try to define what's Mind Share.

In today's world, most of us suffer from information overload, everywhere we go, we get bombarded by sexy ads, bright slogans, spam emails, fancy taglines, funny ringtones etc. We used to just ride a bus. Now we flag down buses with huge ads, watch TV on buses while surfing the net with our PDAs, talking to our gfs/bfs on our mobile and listening to Ipod at the same time!

Everything is trying to get even the slightest attention of our hearts and minds, every minute of the day. In fact, all of us are now superstars, and all the products in our lives are fans demanding attention. So if some products can just get a tiny slice of our thoughts, wouldn't that be very significant? And the fact is, some brands in some products simply dominate people's brains.

Think soft drink -> Coca Cola
Think shaver -> Gilette
Think portable music player -> Ipod
Think search engine -> Google
Think luxury handbag -> Louis Vuitton
Think fuel efficient car -> Prius (or Toyota)
Think diapers -> Pampers
Think cheese -> Kraft
You get the idea, I hope...

One important tenet of value investing is that the business must have very high barrier to entry such that profits will not get eroded by competition. And branding is one such high barrier. Once a brand becomes synonymous with its product, it will take years or even generations to change that. The same goes for bad products. There is even a Chinese proverb: bad name smells for 10,000 years, right?

When a product has significant Mind Share, or branding power, it can command any prices and people will still pay for it. Even if competitors comes up with a better product, Mind Share is so powerful that it negates the positives of the newer product and urge the consumer to stick with the old one. Remember the Pepsi Challenge? People actually like drinking Pepsi more than Coke when subjected to blind tasting, but still, they will buy Coke over Pepsi anytime.

So does it make sense that Buffett owns some of the most distinguished brand names like Coca Cola, Gilette, Kraft? Why doesn't he owns Apple or LVMH or Toyota or Google? That's gotta do with Circle of Competence, which most people don't really practise even if they understand what it's about. That's topic for another day.

Back to Mind Share. If you come across a new product that has a piece of your mind and also a share of the minds of people you talked to, then chances are it has got a significant Mind Share (and most probably market share as well) and it makes sense to think that the business should be worth investing.

Of course, do more homework and research first. The amount of research done is inversely correlated with the probability of losing money!

One final caveat:
Think Efficient Government -> Singapore!

The future is bright for this Little Red Dot. Whether the heartlanders benefit is another question though.

Thursday, July 10, 2008

Choosing Numbers, Beauty Contests and Stock Markets

I once attended a class where the professor asked us to play a game. It was a pretty simple game on the surface. Everyone was asked to choose a number from 1 to 100. The person who chose a number that is closest to 2/3 of the average number that everybody chose will win the game.

Now how should one choose such that it would maximize one's chances of winning?

Well, first you must determine what is the average of everyone's number choices. There were about 100 students in the class, so assuming everyone randomly chooses a number, probably the average will be close to 50. So 2/3 of 50 will be 33.

But wait a minute. If everyone thinks similarly and chooses 33 then the average will be 33 and 2/3 of the average then becomes 22.

Hey wait a second, if everyone then chooses 22, the 2/3 of the average will then become 2/3 of 22 which will be 15. And so the reasoning goes.

So in the end, I chose 1, based on the above logic. Of course, I did not win the game. The real winning number, was somewhere between 22 and 33 (I forgot the actual no.). So what went wrong? And what the hell has it got to do with Beauty Contests and the Stock Markets?

Let's talk about the Beauty Contest first. The great economist John Maynard Keynes came up with this concept to explain the stock market. So this Beauty Contest is also sometimes known as the Keynesian Beauty Contest.

Btw Keynes is a big name in economics, if you don't know him, shame on you and pls go check him up on Wikipedia.

Anyways during Keynes time, some newspaper in London publishes 100 pretty faces and asks its readers to choose which face would likely be the pretty face that most readers choose.

So there are people who would simply choose who they think are the prettiest. However that's quite unlikely to win bcos we all have different tastes right? Xiang Yun may be your favourite but I like Fann Wong. Ah Beng may like Auntie Zoe and Ah Seng likes Wong Li Lin. (Ok as you can see, I belong to a dinosaur generation and has no clue who are the new stars.)

So some smarter readers will naturally try to guess who they think the general public will choose as the prettiest face. And just like our number game, even more sophisticated readers can even go further, and choose the face that other readers will choose as who they think the general public will choose as the prettiest face. And one can further increase the order of the guessing game.

Ok if you have been reading intently this far, you would have guessed that the stock market works in a similar fashion. Well that is if you want to pick a winning stock tomorrow, or next week or even in the next 6 or 12 mths.

Basically you can throw fundamentals out the window. Technicals may help a bit but what's gonna make you big bucks is to guess what everyone else is thinking and be a step ahead. The winning stock will be one which the market participants think will have the rosiest earnings growth in the near future. It does not necessarily mean that the stock will actually deliver the rosiest earnings. Just what everybody thinks is what it counts.

Actually the market mostly likely works in the 3rd order: ie the winning stock will be one which most market participants expects most other market participants to like a lot. This is chim, right?

Today, these are your alternative energy, oil exploration, frontier stocks etc.

It does not make sense to go too high into the order bcos the market cannot be too sophisticated as there will always be some uncles, aunties and amateurs choosing their own favourite pretty face (or their own favourite stock). That's why choosing 1 in the number game will not win.

In the stock market, it means that you shouldn't be buying stocks of a company that provides the core component for a high-end analytical equipment used to detect uranium in some desert. And as you know, uranium is used for nuclear power generation - the hot, sexy story in today's environment. The market is not sophisticated enough to think so far ahead. Even though you may be right and the company may have a genuine investment thesis.

This means that you shouldn't be thinking too far ahead of the market. You should be 1 step ahead but not 5 steps ahead. Well, that is if you want to pick winners in a short time frame: ie from 1 day to 6 to 12 mths.

In summary, the stock market works like the beauty contest in the short term. It's the ultimate guessing game and chances of you getting it right is not high unless you have that flair or talent. But over the long run (ie 5 yrs and above lah), stock prices have to reflect fundamentals: earnings growth, shareholders' return and companies' true intrinsic values. And value investing ensures that you have better chances getting that part right.

Zoe, Fann, Li Lin can be Queens of Caldecott Hill but Mother Theresa, Florence Nightingale, Helen Keller are the real winners in life's beauty contest.

Tuesday, June 24, 2008

Don't get caught in a bubble - Part 3

The 3rd bubble that we will talk about would be Singapore's own property bubble in 1996-1997. This is the most interesting example bcos it is the only 1 in my 3 examples whereby prices have surpassed the previous peak.

However that doesn't mean that investors who invested at the peak did ok. In fact most people will still be under water. But at least, they have much better chance to recover their capital even though their compounded return will still be quite miserable.

The Singapore property bubble actually started in 93-94 when Asia experienced tremendous boom. In fact, four economies were given a very special name - Asian Tigers (or was it Dragons?) due to their spectacular double digit growth. They are of course, our beloved motherland, Korea, Hong Kong and Taiwan. Even so the rest of the region enjoyed high growth. Singapore properties were snapped up by Malaysians, Indonesians, Taiwanese and closer to 1997, of course, the Hong Kongers, who feared major upheavals following Hong Kong's return to China.

Well that's of course just part of the story. Many many factors came into play and even today we cannot say for sure what caused the spectacular rise and fall of the Little Red Dot's real estate prices.

Besides that foreign demand story, the other factor would of course be the lack of supply of property at that time. Back in the early 90s, HDB was lagging behind the curve (as usual) and cut down on building new flats even though demand for flats remained high as the economy grew. So, young couples were made to wait 4-5 yrs for their flats after they get married. And meanwhile the Govt expects more babies when young couples have to dunno-live-where for 4-5 yrs after getting married.

Also back then, private condos project developments were not built by the truckloads (probably approval wasn't that easily given that HDB's thinking was always about 3 yrs behind). So there was a general lack of supply and huge demand from both foreigners and young married couples. And as they say, the rest is history.

Property prices went through the roof. The highest end luxury stuff was like S$2,000 psf and even prices in undesirable locations like Boon Lay, Hill View also hit S$800-900psf, HDB in Bishan sold for a record $800k or so. There was no general price index that I could find but some charts indicated that if we use 1993 prices as 100, prices in 1997 were 120% or so higher.

After that, again a confluence of factors push prices down by roughly 50% (like HDB building 150,000 new flats in Seng Kang and Punggol when they realized they were wrong to stop building flats 5 yrs ago), only to rebound significantly in 1999 and 2000 and then went into a gradual decline until it bottomed at 2005. Prices at 2005 were 30% below its peak in 1997. Of course, things turned around in 2006 and 2007 with en-bloc, Integrated Resorts, Middle East investors, F1 and the other usual Ra-Ra stuff.

See Chart 1 for the whole history of our roller coaster ride!

And so today average prices finally exceeded the peak made in 1997 after 11 years, Well that's kinda good news when comparing to other bubbles, where usually, the previous peak was never surpassed. Nevertheless, if you have bought some of those luxury high end stuff at $2,000 psf, today you might be able to sell at $2,500 psf (that's a big assumption since your property will be 11-yr-old while some other cool stuff are just next door and brand new). So your return will be 25% after 11 yrs which is about 2%pa. Abt the same as fixed deposit today.

Well that's great right considering most other bubbles you usually don't see your capital.

So, moral of the story: Don't ever ever get caught in a bubble!

Tuesday, June 03, 2008

Don't get caught in a bubble - Part 2

The 2nd bubble that we will talk about is the one that is most familiar to many of us. This bubble goes by many names, the dot com bubble, tech bubble, IT bubble etc but I shall call it the TMT bubble (as some in the financial industry calls it). TMT stands for Tech, Media and Telco (I think), and it is named as such bcos these are the sectors that rallied the most during those days in 1999 and 2000.

The index representative of this bubble is, of course, the NASDAQ, where most of the tech stocks are listed. Names like Microsoft, Cisco, Oracle, Amazon, Yahoo! etc. At the peak, NASDAQ was roughly at 5,000+. Again today it trades more than 50% discount of its peak at 2,200+ (though it is a good 100% up from its bottom at 1,100) So again even if you had bought 30% below its peak, you would still be under water today.

It remains to be seen whether the tech stocks will suffer the same fate as Japan, ie never surpassing the previous high. It is now 8 yrs after the bubble bursted, and the NASDAQ has since risen 90% from its low. If it takes another 8 yrs to rise another 90%, this will bring NASDAQ close to 4,200. So perhaps those who bought at 5,000 can actually breakeven after 16 yrs.

Then again, the annual compounded rate of return will be quite bad right? In fact it will be 0% IF it breaks even at 5,000 after 16 long years. If you hold out longer, maybe the return can creep up to 2-3%pa. So in order to reach an average return of 8%pa, perhaps you will have to hold 100 yrs or so.

Moral of the story: don't get caught in a bubble!

Thursday, May 15, 2008

Don't get caught in a bubble - Part 1

Investing in stocks or real estate or any other asset class is a good thing most of the time. Over time, most "well-known" investable asset classes give a good real rate of return (ie a return that can beat inflation lah). Ok the other caveat here is "well-known" asset classes, ie dont go and invest in wine or art, jewellery etc, chances are you are likely not to see your money again.

Just some ballpark no.s to play with, historically these asset classes have been able to generate these returns (nominal not real and they also include dividend or other forms of yield, real return will be these no.s - inflation rate)

Stocks 10%pa
Real Estate 12%pa
Private Equity 15%pa
Bonds 5%pa
Commodities 8%pa

However, as we all know, these are historical AVERAGE returns, There is no guarantee that the future will be like the past. It may not be possible for us to enjoy these returns going into the future. In fact if you had invested at the wrong time, there is a chance that you will never get close to these rate of returns.

Of course the wrong time willl be ********drumrolls******** investing at the peak of some bubble. I shall highlight three real life examples on how investing at the peak of some bubble will make sure that you will earn a meagre return over a long period of time.

The first bubble that we are going to introduce here is probably the biggest bubble in recent history (yes even bigger than the dot com bubble) in terms of magnitude. There are two asset classes involved: real estate and stock market (as usual btw) and sadly these asset classes never ever recover close to its peak even after 19 long years.

Yes this is the Japanese bubble which ended in 1990 when everything collapsed. At the peak of the bubble, the Nikkei was close to 40,000 and real estate prices in Tokyo reached close to USD 140,000 psf. (Okay so Singapore is not so bad lah, only SGD 3,000+ psf this time round, we are about 2 more digits away).

Today the Nikkei stock index hovers around 13,000 levels and Tokyo real estate prices are on par with Singapore's SGD 3,000+ psf. A lot of Japanese that invested in real estate near the peak had to finance their mortgage with maturities stretching 2 lifetimes ie the sons have to continue to pay the father's mortgage.

Imagine if you have bought stocks or real estate even at 30% below its peak level, you will still not see your capital today, and the sad truth is, perhaps you will never ever see your capital again.

As for the stock market, the Nikkei declined steadily over the next 13 yrs after it cracked in 1990 and eventually reached a bottom at around 8,000 in 2003. So even if you DCA all the way down, you may not have broken even today. Subsequently, it rebounded to 18,000 before declining back to 13,000 today.

Moral of the story: Don't get caught in a bubble, but easier said than done right?

To be continued...

Sunday, May 04, 2008

DCA: When the market down, BUY MORE!

Value investors rejoice when the markets go into correction mode. Bcos that means they can pick up good businesses at bargain prices. Logically and intuitively, this makes perfect sense, but somehow our ape-evolved brains are not wired to think that way.

When the markets have rallied for some time and it goes down, we panic. When they subsequently rebound, we curse and swear that why didn't we buy more during the correction. And when the markets go into correction mode for 3 years, we get totally not interested in the markets. Many don't ever return to invest, even though it's the best chance they got against inflation.

So some have come up with a method to counter this flaw and help us invest wiser. It's called Dollar Cost Averaging or DCA for short. It simply means that you put the same amt of money to buy stocks/UT/index funds etc at fixed time periods.

The logic is that although you lose money when the markets go down, bcos you put the same amt again after it has declined, you buy more of the stock/UT/index fund, and over time, since all markets will rise, you will earn the market average return of 8-10%.

However, one must be wary that it's also detrimental if you cut it too thinly ie if you DCA every mth, you end up paying a lot of commission bcos sometimes for UT there is a sales charge for every transaction, and for stocks the bid-ask or the $20 transaction cost kills you. This is what brokers will recommend bcos it generates more commission dollars, so beware!

I have 2 recommendation to improve on DCA that I hope will help most pple.

1) This is just reiteration. Don't cut it too thinly, ie maybe at least once a year and buy more at one go, like maybe roughly $10k at one go. Imagine if you DCA every mth at $1k. You pay 2% sales charge, or you pay $20 on transaction at the brokerage, which is also 2%, you are giving the return away, investment earn only 8%pa on average. So it has to be a huge amt to offset these costs. At $10k, the $20 becomes 0.2% + some bid-ask which ends up maybe like 0.8% or something. Alas, for UT or funds that charge 2%, too bad, $10k you still pay 2%. So avoid funds with huge sales charge.

2) Buy more when the markets are down. Instead of DCA-ing the same amt. You can buy more when markets are down ie. in 2000 you really DCA a minimum amt, 2001 you increase your DCA to 120%, 2002 to 140% of original, 2003 another increment etc. Of course, on hindsight, that's easy. We knew what happened already. How about now? Do you increase your DCA amt next year if the markets are down? Chances are if it goes down in 2008 it's gonna go down in 2009 as well right? But I guess one simply has to strengthen the will to increase DCA when the markets are down and lighten up when the markets are rally. That way, it will enhance return and help you hit 8-10%pa over the long run.

Sunday, April 27, 2008

More on inflation

In the last post, we talked about how inflation will hurt us badly. Today we shall discuss some countermeasures.

So inflation is a major issue if you think hard about it. All your savings goes down the drain and you are back to square one. You think you save S$1mn for your retirement and that should be enough. But hey 30 yrs from now, S$1mn cannot even buy HDB, Bcos the value of S$1mn in 2038 is worth only S$300,000 in 2008 and basically you might even have lost money even though you saved like mad for the past 30 yrs. What the heck! What should we do?

Actually there is nothing much we can do, except to invest in stocks and real estate properties. Historically these are the only two asset classes that can keep up with inflation. With stocks, you are buying pieces of companies and good companies will create value for their shareholders, inflation or not. The same goes for real estate.

There are some other unconventional methods to beat inflation completely original from this blogger so just read for fun and implement at your own risk!

1) You can increase your debt! Inflation helps debtors bcos the money they owe also decline in value, so if you borrow tons of money before inflation kicks in, next time you only need to pay back less than what you borrowed in real terms. But you must not put them in your bank and earn fixed D bcos then your fixed D also decline in value and you suck thumb. So you must borrow money and spend them asap, like buying Prada bags and Ferragamo shoes and satisfy your immediate desires! So maybe not much help to build your retirement nest.

2) Buy stuff that will retain its value over time, this means buying things like limited edition Rolex watches, silver, gold, white gold, platinum jewellery or other maybe pure gold bars. (Not diamonds btw, if the real supply of diamonds are released into the global markets, 1 carat diamond is worth as much as 1g of sand, the perceived high value of diamonds can be regarded as the biggest marketing gimmick in our times. Sorry girls, diamonds are worthless, contrary to what you think).

So back to the original solution: nothing beats buying stocks and properties to combat inflation, so keep your savings in these asset classes. The rest of the asset classes like cash, bonds, other currencies sadly will not help much.

Monday, April 14, 2008

The return of inflation

Most of us never really lived through periods of high inflation, thanks to very effective central banks throughout the 80s until today. But with recent rise in commodity prices translating to higher food prices, higher raw material prices, higher property prices, higher taxi fare, higher this, that and everything else, inflation may be coming back to haunt us. And believe me it's gonna be scary.

It is generally accepted that mild inflation is actually good for the economy bcos it helps increase wages, improve productivity, encourage employment and keeps the economy churning along and all is well. But usually this means inflation of 2-3% per yr or something. And if wages increase by 5% per yr then it is a real increase over inflation and everybody is happy!

However, this time round, the world, and hence Singapore (or maybe more Singapore) may be going into a period of not-so-mild inflation. This means inflation of maybe 5-10% per yr. Although not as bad as hyperinfation, this has very drastic consequences for value investors, or rather, everybody.

A bit of digression here. Hyperinflation refers to inflation getting totally out of whack and hence the value of the currency of the sovereign entity goes down the drain. This means that in people's eyes, the currency has no value and becomes as good as banana money (read further down to know more abt this) or simply worthless paper. The worst case of hyperinflation is of course Germany in the 1920s when the inflation rate was 10^27 times.

For those who fail to comprehend the significance of this, it means that $1 today get reduced to 1/1,000,000,000,000,000, 000,000,000,000 of its value. To put it in another way, even if you are a gozillionaire in Deutsche Mark, ie you have 1 million billion trillion Mark, all you have becomes $1 at the end of the day.

Basically your money is worth even less that the paper used to manufacture the note.

In Singapore, of course, we have our infamous case of the banana money issued by the Japanese military during WWII. Luckily or unluckily $1 of banana money becomes only 1/1,000 of its value by the end of Japanese occupation.

Well all these seems a bit far-fetched and probably we will not see such dramatic times again. So back to the real story, if inflation hits us at 5-10% per yr what happens? Well let's work with 8%pa (I like my blog name you see). This means that your money loses 8% of its value every year. Basically in 6 yrs, every dollar you save becomes 50c. Even if you invest wisely and earn 8%pa return, it only means that your $1 stays at its original purchasing power.

In reality $1 you invest becomes $1.08 after 1 yr but your Kopi-O also jump from $1 to $1.08 so effectively your investment did not help you build up your wealth.

Monday, March 31, 2008

Lemmings falling off the Cliff!

Lemmings are small rodents usually found in the Arctic. They breed very quickly and when their population reaches a certain critical mass, they are known to commit mass suicide by leaping off the cliff. (Although according to Wikipedia, it is proven that this was not the usual behaviour of lemmings but rather something propaganded by media to create sensational news.)

Anyways this strange behaviour of Lemmings excited many social scientists bcos they have found similar behaviour in people living on a small island south of Malaysia. But since there are no cliffs around, these people employ foreign maids and constantly abuse them for pleasure. Some experts believe that overcrowding and the pursue of status and material wealth leads to such inexplicable symptoms.

Ok let's move on to something related to stocks.

As you would have guess, in financial markets, participants exhibit Lemmings' strange behaviour as well by mindlessly following others' irrational actions. In most aspects of normal life, most people behave rationally when looking to buy a car, a fridge, whatever. They collect information, talk to others, get viewpoints but ultimately come up with a decision that is usually rational.

However when it comes to stocks, somehow, independent analysis becomes a taboo. People like to follow what others are doing. When the market is shouting buy, buy, BUY into the peak, they simply react like Lemmings, rushing ahead regardless and then when they see the Cliff, they happily jump over it, just like all the other Lemmings ahead of them who jumped. (Of course participants won't literally see a Cliff until they fell off it as the market tanked.)

Strange huh?

I think this has got to do with greed (and not overcrowding or pursue of status though). For the general public, they seldom come in contact with stocks, investments in their daily lives but in times of bubbles, unscrupulous bankers, brokers, agents will start calling them up and sell them dumb products at the peak of markets. And they get sucked in bcos of the dumb freebies and all. I guess it's also human nature to get easily persuaded by friends (selling insurance policies) or sweet young bankers (selling some dumb structured pdts). So it's difficult to really fault the general public.

Well I guess the lesson learnt from the Lemmings is this: always think on your feet and dont blindly follow the front Lemming (or the sweet young banker leading you) down the cliff. (Which makes me think about the condo called The Cliff, so those staying there are Lemmings of the property market?)

Sunday, March 23, 2008

Defensive stocks

In different markets, different sexy terms come into play. I guess the latest infatuation on Wall Street in recent months has been "defensive stocks". Defensive stocks usually refer to stocks that will see stable profits even during times of trouble, ie like the past few months lah. These would be stocks in industry sectors like: consumer staples ie your food, beverage, razor blades etc. The thinking is that people need to eat, drink and shave no matter what right? Stock market down means everybody goes without food? Unlikely, so these are defensive stocks.

The other sectors are like pharma (your diabetic patient needs his pills regardless of stock market woes), utilities (eh, obvious I hope, we need electricity even during bear markets) etc. So you get the idea, things that we can't do without even during an economic downturn.

So what are things that we do without during the downturn? Well it actually differs for different entities on this planets. For example, Ah Beng who made money punting property and bought himself two Ferraris will still drive his Ferraris and buy Prada bags for his Ah Lians even though his latest punt has gone wrong and he has a $4mn mortgage but his condo at Sentosa is worth probably <$1mn and his monthly salary is $5k. So to him, Ferraris and Prada bags are still things that HE cannot do without even during a slowdown. But for most people and for the stock market, consumer non-staples (like car, furniture, luxury products, massage chairs, high tech goods etc) usually see profit decline.

Also most of the darling sectors that rallied during 2003-07 bull market ie oil exploration, shipping, property etc. One reason would be bcos credit is drying up and most of these sectors require a lot of credit financing to grow their profits. Of course, some experts may beg to differ, these sectors are in a secular boom and some silly sub-prime trouble is not going to derail their "sexy" story. Well... this blog is big enough for differing biews, so share your thoughts if you have some. The other type of defensive names would be stocks that pay high dividend, has huge amts of cash on their balance sheet, or stocks that generate huge cashflow regardless of business cycles

Friday, March 07, 2008

Hurray! Buffett is World Richest!

This is a time for the world's value investors to rejoice. Our hero, Warren Buffett has become the world's richest man, overtaking Bill Gates, Founder of Unpopular Vista and Insecure Windows and Carlos Slim, Monopoly Tyrant oops Tycoon of Mexico. Of course, Lady Luck has got a lot to do with this, here are a few facts to support the thesis:

1) Microsoft has eaten full full and got nothing better to do, so decided to launch a bid for Yahoo! which aggrevated a lot of investors bcos it's quite a stupid move given that Yahoo! is like yesterday's darling (ie like Demi Moore or Alicia Silverstone, does anybody remember them anyways?). Hence Bill Gates lost like 20% of his net worth in a couple of days and got relegated to No.2. Or was it No.3?

2) Thanks to the sub-prime crisis, investors are desperately looking for safe haven to park their money to hide away from the storm, and where's a better to place than to hide with the Guru? So Berkshire stock rallied like nobody's business and our hero became No.1.

So that's that, fellow value investors buck up and follow your idol and the road to riches will be short ride.

Er, wait a minute, although this blogger believes that value investing is a good way to help you grow your wealth, there are a few things that Buffett can do while most of us cannot. So the road ahead is always not that short I'm afraid. The philosophy is important, but it may not reach the same destination depending on the execution. Here's a few tricks that Buffett can use but we cannot:

1) Buffett can buy over whole co.s and ask mgmt to pay out excess cash to Berkshire. This is a very powerful tool as we all know that mgmt simply cannot be trusted to handle shareholders' money. We have seen so many examples of good co.s generating good cashflow only to see it squandered away on useless ventures. I think the most aped example would be Microsoft. Bill Gates must be cursing Steve Ballmer to death now for doing the Yahoo? deal. Shareholders are so much better off if Microsoft just generate cash and return them to shareholders.

Well this trick is something that you and I cannot do. But it is a good philosophy to bear in mind and remember to apply this, if it is ever applicable in our lives. I guess one example would be property. If you are holding a property that can generate rental yield of 15%. I guess you should never sell this property unless it's like a super real estate bubble in which your property will fetch as much price as the whole of Bintan or something. Except for that scenario, you should never sell something that gives you 15% yield bcos in 6 yrs you get back your principal and the ppty will continue to generate 15% per yr for as long as you own the property!

2) Buffett's investment actions follow the self-fulfilling prophecy. There are websites, blogs, analysts, TV programs, cell groups following Buffett's every investment moves and hence whenever Berkshire makes a move, a lot of people will simply charge and buy with the Sage of Omaha. So is it a wonder why whatever Berkshire buys always goes up? Of course, this is also due to Berkshire's brand name. ie whenever Berkshire buys something, it is a stamp of recognition that the stock or investment is undervalued and money is to be made.

In other words, at a certain stage when a famous investor or fund manager becomes so successful, his success will simply feed onto itself bcos a lot mindless followers will simply support him and validate his investment decisions. Again this is something that we cannot do, yet. You see, this blog will become a sensation in time and start recommending stocks which will then send its own army of mindless followers to buy and the early birds here will reap the rewards. Haha fat dream right?

Well hope is a good thing, and all good things never die. (taken fr Shawshank Redemption by Stephen King) So keep hoping!

Friday, February 29, 2008

Shareholders' Equity

The balance sheet is basically an elaborated display of a simple equation.

Assets - Liabiilities = Shareholders' Equity or simply Equity

What this means is that whatever assets that a company owns, subtracting whatever the company owes, gives you what's left for shareholders. This is also known as the book value of the company.

Shareholders' Equity is usually at the bottom right of the balance sheet (Assets on the left side, Liabilities on the top right) and is usually broken down into the following sub components:

Common stock
Paid in capital
Retained Earnings
Preferred stock
Treasury stock
Others: there are actually a lot more complicated stuff but I will just lump it under others and we will talk about that on another day.

Common stock and paid in capital are usually thought of as the original capital of the company. Common stock is the no. of outstanding shares multiplied by its par value which is usually some arbitrary no. like $1 and paid in capital is usually the proceeds received during IPO or subsequent secondary equity financing.

Retained earnings would be the impt sub-segment to know. Needless to say, retained earnings comes from net profit (from the P&L statement). So what this means is that retained earnings should be as big as possible. If you see a company that has an original capital of say $1mn but retained earnings is like $80mn or some big no. then you know this co. has created tons of value for shareholders. And conversely, if paid in capital is bigger than retained earnings, either this firm is still very young, or it has continously raised new money from shareholders ie old shareholders keep getting their stake diluted and the business model's sustainability is questionable

Preferred stock is basically a stock pays dividend forever and is usually not a big sub-segment. Thus it pays to find out why a co. might have a huge preferred stock capital.

Treasury stock is a negative entry (ie the $ amt here is negative not positive) in shareholders' equity and it arises only when a company does share buybacks. This is a good sign bcos it signifies that the company has its shareholders in mind and is using share buyback as a way to return capital to its shareholders.