Monday, July 27, 2009

More Payback in Years

In line with the previous post, here are more scenarios how payback in years can change drastically with the vagaries of modern life

Bought a water stock – 33 yrs
The CEO got married – 99 yrs
To a scientist nominated for the Nobel Prize for water purification – 12 yrs
They divorced – 33 yrs

Bought a condom stock – 35 yrs
Satellite failure stopped the broadcasting of global sports channels for 2 weeks – 16 yrs
False alarm, satellite’s working! – 33 yrs
Korean melodrama satellite fails – 8 yrs
Global power failure caused by Al Qaeda – 2 yrs

Bought a telco stock – 18 yrs
The co. announced that an ex-CEO of a mining co. will take over as CEO – 180 yrs
The new CEO divested poor performing subsidiaries and incurred losses of USD 4bn – 625 yrs
The new CEO got fired – 18 yrs
The subsidiaries recovered – 68 yrs
The telco co. decided to invest in the subsidiaries again – 255 yrs

Here's the bonus for this week!
List of most anticipated IPOs and their relevant payback years

Twitter IPO – 50 seconds
Facebook IPO – 2 hrs
Facebook acquires MySpace – 120 yrs
Twitter acquires Facebook + Myspace – 2,718,28 1,828,4 59,045, 235,360 seconds

Iridium Satellite Phone Returns! IPO – 125 yrs
Lehman Brotherhood Restructured IPO – 214 yrs
Revenge of the Fallen: Mega-Electron General Motors IPO – 369 yrs

Shanghai Stock Exchange US$100bn IPO – 88 yrs
Bird Nest Stadium IPO at $18 – 188 yrs
Jackie Chan Franchise IPO – 288 yrs

Temasek Holdings IPO, CEO Singa the Lion – 440 yrs
Wimbledon Tennis IPO, CEO Aggassi – 1,066 yrs
Tour de France IPO, CEO Lance Armstrong – 1,789 yrs
Terracotta Army Exhibition IPO, CEO Zhang Ziyi – 6,000 yrs

Jurassic Park Ride IPO, CEO T-Rex – 65mn yrs
Google Earth IPO at $3141.59265 – 4.3bn yrs
STAR WARS Franchise IPO, CEO Chewbacca – 13.5bn yrs

Tuesday, July 21, 2009

Price Earnings and Payback in Years

Another way to think about the all powderful Price Earnings Ratio is to think of it as Payback in Years. Ok, here's the expraination:

Price Earnings = Price / Earnings

Say if a stock earns 5c per share and you are paying $1 for it, how many years would it take for you to get back your $1?

Assuming that it will earn 5c every year forever, the answer is 20 years right?

And how did we get 20 yrs? Well $1/5c gives you 20.
Which, in case you fail to notice, is the formula for Price Earnings Ratio.

So lower PE means faster payback in years.

Some people talk about it's alright to buy a stock with PE of 40x bcos it's the dream stock, spectacular growth for the next 20 years!

40x is cheap! Let's put in more no.s to this scenario and see what we get:

EPS for 2007 20c
EPS for 2008 40c
EPS for 2009 60c
EPS for 2010 80c

Price in 2009 $32

This stock is, well... trading at 40x PER for 2010 at $32. In order to get a decent payback in years (roughly 15 yrs), the stock needs an average EPS of $2.4 for the next 15 years.

This means that the EPS needs to triple in the next 3 years, grow a bit more and finally stabilize at $2.6 so that the average can hit $2.4!

Even if it somehow managed to perform this spectacular feat, what you have paid for at $32 merely justifies it. You did not get any upside or discount. There is no margin of safety in this investment. So think really hard when you are asked to buy a stock with 40x PER.

Anyways, in line with the points system found in Men are from Mars, Women are from Venus, here is a list of scenarios and the estimated payback years:

Analysed a blue chip for 3 mths & bought it in a bear market - 12 yrs
Analyzed a blue chip for 3 days & bought it in a bull market - 26 yrs
Bought a blue chip without any analysis whatsoever - 33 yrs
Bought a blue chip, heeding advise from a friend - 52 yrs
Bought a blue chip anticipating a RIGHTS ISSUE - 89 yrs

Bought the highest traded stock on SGX after it dipped 10% - 48 yrs
Bought the highest traded stock on SGX after it rose 15% - 60 yrs
Bought a stock that rallied 30% after some good news - 76 yrs
Bought a stock that rallied 30% after some good news, in a bull market - 182 yrs

Bought a stock not covered by any analysts - 27 yrs
Bought a stock rated SELL by an analyst from a broker house - 42 yrs
Bought a stock rated BUY by an analyst from a broker house - 84 yrs
Bought a stock rated Strong Conviction BUY by an analyst from a broker house - 205 yrs

Bought an S-chip at IPO - 51 yrs
Bought an S-chip at IPO, heeding advise from a friend - 90 yrs
Bought an S-chip at IPO, heeding advice from a taxi driver - 122 yrs

Bought a stock Warren Buffett bought, at a lower price - 14 yrs
Bought a stock recommended on this blog - 21 yrs
Bought a stock recommended by a value manager on CNBC - 29 yrs
Bought a stock recommended by a magazine - 48 yrs
Bought a stock recommended by a broker - 128 yrs
Bought a stock recommended by two different brokers - 199 yrs
Bought a stock recommended by a self-professed stock guru, advertising "How To Make 1 Million in 2 week" on Straits Times - 256 yrs


Friday, July 10, 2009

Traders and Investors

Just like to share my own definition of traders and investors that I thought about recently...

First let's start with Ben Graham's definition of investors and speculators.

Graham first stated that an investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return and operations not meeting these requirements are speculative.

So an investor focuses on analysis to look for capital safety and adequate return. This is usually interpreted as fundamental analysis of the company, its business model, its competitive advantage, margins, sales growth and of course, the financials: cash on hand, debt, bankruptcy risk, capex needs etc.

Anything less of such analysis means speculation. A speculator is simply one that doesn't do that kind of rigorous analysis.

Simple right?

For me I think it's about different focuses.

An investor focuses on value.
A trader focuses on price.

An investor is interested in the value of a stock (or any other thing he wants to buy), and he spends an awful lot of time and effort to figure out this value (or intrinsic value). This is analogous to Graham's analysis. Or more accurately rigorous fundamental analysis of business operations and financials. Price serves only to tell him how much he actually has to pay if he were to buy the stock. Needless to say, the lesser the better. Graham and most value investors advocate buying 30-40% (margin of safety) below the stock's intrinsic value.

To an investor, profit is made when the stock price subsequently rises to its value which usually take years.

A trader is interested in the price of a stock and he spends an awful lot of time and effort following how the price has moved. Actual value of a stock basically serves no purpose for the trader.

To a trader, profit is made when the stock rises above his buying price and he sells it to another person willing to buy at a higher price. Usually also known as the Greater Fool.

So, that's that! Just two different philosophies here to make money.

Friday, July 03, 2009

Balance and Reversion

Taoism talks about being in tune with the Universe and consequences of allowing a strong force to overwhelm others. Yes we are talking about the Yin and the Yang. Both forces should balance each other to achieve Balance. A stronger Yin over Yang or vice versa leads to unrest, discomfort and ultimately it calls for a reversion to the mean.

In Graham-speak, this becomes Bond versus Stock. Back in his days where there were only 2 asset classes: Bonds and Stocks, his strategy was to always maintain a portfolio with at least 25% in one asset class and a maximum of 75% in the other. And this is when one asset class in grossly overvalued versus the other. In most cases, it should be a 50:50 split between bonds and stocks.

So as with Taoism, the ideal situation is always an equal split between the bonds and stocks. Both asset classes will be in balance. Bonds give income, stocks give capital appreciation. Bonds counter deflation, stocks counter inflation. Bonds, downside protection, stocks provide upside. Totally in sync with the Universe!

However there are times when a stronger force overwhelms the other. With investment, well usually a stock bubble brings valuation so out of whack that it makes sense to disrupt the balance. In this case, overweight bonds and underweight equity. Ultimately, the Universe must return to its status quo, ie stocks will correct to its appropriate valuations and the investor benefits.

Value investing focuses a lot on the process up till buying the stock. But very little is said about selling. Buffett, the Oracle of Omaha, is famous for saying you never sell a good stock except when you want the money to buy a better one. Graham never specifically said anything about selling as well.

But I guess, by reading between the lines and drawing lessons from Taoism, we should sell when things are out of balance. In the case of stocks, when it’s grossly overvalued. The sad mistake we all make is to rationalize the overvalue-ness to justify why we still hold on to the stock. Like the company has this new product that will be a hit, or the company is going to do M&A, or the company is going to increase dividends etc.

So the next time we want to hold on to a stock that had gotten too expensive, think about the balance of the Universe and why reversion will always occur and it’s time to allow that to happen. Sell the damn stock.