DB Brazil ETF - Part II

The second risk is China's decreasing steel consumption.

The last five years saw China's big ambition to develop its infrastructure and mass market condos for its people and hence steel consumption went through the roof, resulting in the bull market in steel and shipping (of iron ore to make steel). That party is now probably going into its 11th hour and Cinderella is ready to drop her glass shoe.

China needs to shift its economy from manufacturing to services, which would need less steel and hence less iron ore. Not to mention that after getting squeezed by the Australian and Brazilian iron ore producers for so many years, China is also aggressively pursuing new avenues of supply in other regions like Mongolia and Africa. This means new supply, less pricing power. So the iron ore story might not have a happy ending.

The saving grace for the iron ore producers would perhaps be bargaining power. With 3 guys controlling 80% of the market, basically they call the shots. They manage the supply, make sure there is always just enough. They manage the spot market, make sure that it stays elevated, then the contract pricing would have to follow.

In the longer run, it is also worth noting that steel consumption is very much integral to the development of our civilization and it will continue to grow. China may have peaked, but S.E. Asia needs a lot steel in the next few years. Not to mention Latin America would probably step up, which will benefit Vale. After that we have India. So maybe there is still hope.

To sum it up, the Brazil ETF makes a lot of sense, especially for the long run. Pricing wise, it is currently 25% below its all time high. It is likely to surpass that in the next 5 years.

As to downside, well, there is about 70% to its Lehman low, but it's not likely to go there bcos there is some valuation support. I would say it might go to 1.3x PBR or PE of 8x, ie 30% decline from current levels. But if that happens, then it's time to buy more!

Well just to sum up here:

Pros:
Exposure to Energy, Iron Ore and Brazil
Cheap valuation at PER 11x with 3% dividend yield
High single digit long term growth rate
Often at discount to NAV (due to tracking error - see below)

Cons:
Replacement of oil and China's slowdown
Low liquidity (10,000 shares traded per day only)
High tracking error (does not track the index well)
70% from absolute low

DB Brazil ETF - Part I

Last checked, there are now 75 listed ETFs in Singapore. As blogged a couple of times, ETFs present an easy way for lay people to invest into stocks and shares without having to put in too much effort (ie do a lot of study and research). Basically, you just buy into the regional/sector growth of the ETF. To learn more, simply click on the ETF label at the end of this post.

Today's post is about Deutsche Bank's Brazil ETF listed on SGX. It seemed like this might be one of the cheaper ETFs out there amidst global bullishness on Emerging Markets.

Brazil has the 8th largest economy in the world and it is projected to be in the top 5 in the next 20 years. GDP growth should be a high single digit for the foreseeable future, although a tad weaker than China, its cheaper valuation more than make up for it.

The Brazil ETF trades at a PBR of 1.7x, 1 yr forward PER of roughly 11x and gives a dividend of close to 3%. Although not as mouth-watering as in early 2009, I find such valuations quite acceptable, given its growth profile. And definitely cheaper compared to China.

The components of the ETF are basically just 4 items.

1. Petrobras, the oil giant with its mega oil-field currently under-development.
2. Vale, the iron ore major, which depends on China's appetite for steel.
3. The banks, which basically mirror the growth of Brazil.
4. The consumer staples, discretionary and utilities sector in Brazil, ie the Brazilian economy.

These four sectors roughly make up 25% each of the ETF. So basically, for every dollar put in, 50c is betting on Energy and Resource, and the other 50c on Brazil itself.

The first big risk here would the replacement of oil. As we all know, when oil hit $150 per barrel during the heydays, it really gave a wake-up call to the guzzlers of the world (which is pretty much everyone), reminding us that being held hostage by the Arabs is no fun and we better start to reduce our dependency on this energy source derived from the remnants of the dinosaurs.

And so, the techies of the world started their engine and ventured out there looking for new energy sources. We are now going big into nuclear, wind, hydro, oil sands, shale gas, solar and even human dynamo in Africa. Of course, we are also trying to use less at the same time, ie more hybrid cars and EVs. Now this is definitely no good for Petrobras.

Well, fortunately, I think the mitigating factor would be that it takes a long time for these alternatives to actually come to the market and finally free us from the Arabs. So meanwhile, we want to develop other big oil fields to limit their market share of oil. And this is where Petrobras and its mega oilfield comes in. And it is in the interest of the world to develop this and make it work.

Next post, we touch on another risk and round-up this topic!

Habits and Snowballing

The Snowball, the much talked about book on Warren Buffett sits on my shelf waiting to be read. It would probably take me some time to get to it, as my reading list is so damn long, with at least 10 books on it. Not to mention the other big book that also lies in waiting: Poor Charlie's Almanac.

The concept of the title was made known by its author, again both simple and insightful and really apt to describe Warren Buffett. Perhaps you might already have heard of it. Anyways, here is my interpretation of it.

Basically, the idea is that something which starts small can grow very big given enough time, consistency and momentum, just like a snowball. When you first push a small snow ball, it rolls and gathers a bit of snow with every turn but stays small. It takes a while for the consistency to set in, more effort, and finally the momentum kicks in and it can cause an avalanche if you want it to.

It also reminds me of this mass email that basically transpired the same concept. A picture showed a beautiful field of tulips, or was it lavender? But anyways, what was interesting was the signboard next to the field which says:

Who: A woman
How: 1 tulip a day for 60 years
Why: For everyone

Or something like that.

Value philosophy shares the same idea. It is not about quick profits or the next trade of the year. It is consistency, patience, effort and time. One angle of it is about identifying companies that are basically doing that. These are the great consumer staples that basically keep growing their markets by selling the same products with the same strategies. Look at Coke, just do the same thing over and over again in different parts of the world, and the earnings will follow. They were in Asia long before we started talking about it. Now they are in Africa!

One big plus why these companies can do it is because they have planted enough seeds such that their brand is entrenched. Just like the field of tulips that take our breath away when we see it. It is also about mindshare - market share of people's minds. When it's as big as Coke or the tulip field, it's difficult for you and I to start a new drink today to compete. The snowball just keeps rolling until it causes an avalanche.

The other angle is how we as investors exercise and implement this idea thoroughly. That is how we consistently implement the same investment process, find good stocks, at a very cheap price, wait for them to grow and see the return compound to some astronomical number. It is not as easy as it sounds. The big hurdle is, as usual, ourselves. Or more specifically our emotions which inhibit our ability to make rational decisions.

This is the habits part. Good habits adopted at an early stage bring profound results over time. Think about exercising just 15 mins a day, or saving just $20 a day. Bad habits ruin lives: smoking, drinking alcohol. Investing is then also about adopting good processes or good habits.

I would say some important do's would be like reading a couple of newspapers daily, talking to at least a few experts per week. Specifically when looking at stocks, it would involve pouring through at least of couple of years of the firm's financials, trying out the products, talking to other users and finally waiting for the right price.

Don't's would naturally be don't buy on tips/rumours, don't look at the share price daily, don't sell to take 20% profits.

With good habits cultivated, it would then be applying the same processes over and over again when buying each and every stock or investment, for many many years, and hopefully the returns will snowball into something big and meaningful.

Steel Industry

After 186 posts about value investment philosophy, I think it’s about time to write about something else. Well, after all, value philosophy can actually be surmised into just 3 words. So, I am actually quite amazed why I could write so much. So going forward, hopefully I can write about industries and individual stocks. As and when new ideas hit, I will still talk about value philosophy and the big picture. Ultimately, that is what’s most important and what will drive long term return for investors.

In this post, I would like to talk about the steel industry. Steel is a basic commodity used by humans and has been pretty integral throughout the development of our civilization. Sadly as a business, it sucks. The industry as a whole doesn’t really create much value for shareholders although there are periods where it churns out enough cash to whet some appetite.

Today, about 1 billion ton of steel is consumed every year. China accounts for half of the usage. Outside of China, Asia including Japan, accounts for bulk of the rest. Well, this is unsurprising as steel is mostly used in construction and infrastructure which Asia needs, a lot.

The business model is simple enough. Buy raw materials like iron ore and coking coal, throw it into a blast furnace, out comes molten steel, add some other metal to make it better (like nickel for stainless, or zinc coat it for shine) and process it into sheets or beams etc. This in itself is not bad. What is bad is:

1. Both the input and output prices are uncontrollable.
2. Competition is very, very tough
3. It is very capital intensive

Raw material prices are controlled by the ore majors: BHP, Rio Tinto and Vale. Specifically, they dominate the spot market and use the spot prices to determine contract pricing. So the steel makers have no say in pricing. The final product prices are also determined by the spot market. There are international market prices for a variety of steel products including the most famous hot rolled coil (or HRC), for H-beams used in construction, for pipes etc.

The reason why such spot markets developed is probably bcos there are simply so many players in the market that is just have to be done for the benefit of both the steelmakers and their buyers. With such markets, products could be standardized, distributors can handle them easily and lengthy negotiations could be avoided. But that’s bad for profits.

But why are there so many steelmakers globally? Well, in the past, it was a country’s ambition to have its own steel mill. It’s a symbol of strength for the nation. The western countries had it. Japan still has it. Korean has it and now China and India are building theirs. What’s worse is when the various provinces or prefectures also decided that they should have, hence you have all these few hundred steelmakers all over the world, each having less than 1% of the global market.

In the middle of this decade, someone decided to restructure the whole industry. His name was Lakshmi Mittal. So he started buying small steel mills all over the world. But he realized that wasn’t enough. There were just too many. In a move that shocked the industry, he decided to buy over one of the biggest steel players globally. Today, his company is called ArcelorMittal and it has capacity of 100mn tonnes or 10% of the market.

But still, 10% is nothing in a world where the suppliers and customers are much stronger and you still have over a few hundred competitors. ArcelorMittal, amazingly, has been able to generate good cashflow by squeezing cost and investment. Unfortunately, the money has to be used to pay down debt and it will take another 5-6 years to bring debt down to a comfortable level. Not to forget, by that time, it probably needs to resume its capex plans as well.

Which brings us to the 3rd point. Steel is insanely capital intensive. It takes USD 1,000 to bring 1 ton of new capacity on. For ArcelorMittal to increase capacity by 10%, it will cost USD 10bn! That’s one sixth of its equity base today. Most other steelmakers are not even that half its size and a new blast furnace project almost always means new financing.

So in short, the steel business, though integral to the development of our civilization, is bad business. There is usually nothing left for shareholders, after everything is said and done.

Well, that is the big picture. Value investors are also stock pickers and hence the dynamics can change for individual companies.

Buffett had a stake in the Korean steelmaker POSCO for the longest time. The story for POSCO is that the company is the No.1 leader in a country that is perpetually in short of steel despite being one of the biggest exporters of steel intensive products like ships, cars, and consumer electronics. What is more amazing is that POSCO is also one of the world’s lowest cost producers of steel. It can achieve this bcos it has the most integrated high capacity steel mill in the world and it also attracts the best talent in Korea to work for the firm. To that end, it even has its own university!

Hence the firm consistently generated free cashflow and paid dividends while having a clean balance sheet with no debt. Having said that, the wheels of fortune might be turning as Hyundai tries to break its monopoly in the Korean steel market while the company had also tried unsuccessfully to expand into the Indian market. In recent times, the dividend has fallen to 2% while free cashflow yield is also below 5%.

So that’s a short summary of one of the oldest industry on earth. In short, it’s best to avoid, as the industry had not been very profitable for shareholders except for the 5 years starting 2003 when the whole world got into a once in 30 year situation whereby there was a shortage of steel. This happens when a big country industrializes after a long drought and no new investment was made in steelmaking. The last country before China was Japan, which started the steel boom in 1970s.

Next on the list is India, but that might be 2030, if we use the once in 30 year rule.

A Girl in the Convertible

There were some academic studies done on capital structure some years ago by two professors. I only remember the study as the M&M theory. M&M being the initials of the two professors. Both professors subsequently won Nobel Prizes! The same theory also talks about dividends, and I thought that the conclusions are worth sharing here.

According to the study, in a perfect world where there are no taxes, no legal or accounting fees and stocks are infinitely divisible, then it doesn’t matter whether stocks pay dividends or not. Bcos investors can just sell part of their holdings whenever they feel like paying themselves some money.

In the bigger scheme of things, it also doesn’t matter what the capital structure of the company looks like. The firm’s capital can be 100% debt or 100% equity or any other makeup, it doesn’t really matter. What matters is that the firm will only be able to generate enough profits to keep it from going bankrupt, and the market price of the firm is always the right price, ie its intrinsic value. And this is the basis of the Efficient Market Hypothesis.

Luckily the world is not like that and dividend matters. A bird in hand is worth two in the bush. Or as Warren Buffett puts it, a girl in the convertible is worth five in the phonebook. So as investors, we want some dividends to come to us, regardless of what Nobel Prize winners theorize.

Hence, I personally like to find good dividend stocks, and hopefully the firm also enjoys a bit of growth over time. The Dividend Aristocrats of the S&P500 is really a good hunting ground for high quality global names. As for Singapore, I have generated some dividend stock lists in the past couple of years. The most popular one is at the right column of the blog.

Some would question why this huge emphasis on dividends? If a high quality firm can compound its growth much faster, it would be wise to let the firm keep the money and use it to grow. This is the excuse most growth co.s don’t give dividends. Even after they become ex-growth, and they happily squander the cash in stupid ventures or M&As.

Perhaps the best positive example is actually Berkshire Hathaway. Since Buffett can compound growth much better than most people, it doesn’t make sense to pay dividends to his other shareholders. However it is difficult to find managers who can efficiently use capital to compound growth better in the first place. So returning excess cash to shareholders or doing share buyback when the stock is cheap is what a good CEO would do.

Paying an ok dividend also signals that the management have shareholders in mind. (This is also called the signalling theory). Ok being like 2-3% dividend yield, which is whatmost of the Dividend Aristocrat stocks are paying currently. The thinking on this would be something like: Well we don’t need ALL the money to grow, bcos we are in such a fabulous business, we can still grow with limited capex and can generate good cashflow too. And so we would pay our shareholders some dividends, while we continue to grow. Just as we did in the last 25 years.

The long and short of this all is that a stock has a good track record of growing its dividend payment is probably one of the best deals out there (if you can grab it at a reasonable price). Which is probably why Warren Buffett holds quite a number of Dividend Aristocrats like J&J, P&G and Becton Dickinson.

From Free Cash Flow to Willingness to Pay Shareholders

A while back, I wrote this post about stocks that have good record of free cash flow and naturally they also gave a lot of dividends. I thought I would just delve a bit deeper into how free cash flow affects dividend while also looking at 1 or 2 other factors.

Basically, to determine whether a company can consistently pay dividends and grow them, we need to know:

1. The firm's balance sheet, esp the size of its debt
2. The firm’s ability to generate good cashflow or even grow it
3. The top management’s willingness in actually paying dividends
4. If it actually gets paid out, what is the yield?

The first thing I usually look at would be the firm’s long term track record in generating free cash flow, which is operating cashflow minus capex, ie the cashflow that is left after deducting money invested in new equipment, new plants etc. The thinking is that the remaining cashflow can be used to pay down debt or pay out dividend. If the firm has no debt (that’s why Criteria 1 is there), then the money should logically flow into dividends.

On the same post, I only managed to screen out 30-40 companies that have consistently generated positive free cashflow. This is out of 700 listed companies in Singapore. This shows how difficult it is to actually produce enough cash to give out dividends.

However, even if the firm can generate cash, if the management is not willing to pay them out, then there is no point talking about it. To check this, we look at the dividend track record. If the firm consistently paid dividends or even increased dividends, then we are going somewhere.

An interesting case in point would be Yeo Hiap Seng (YHS). The free cash flow track record is stellar but it stopped paying dividends since 2006. It looked like they over-invested in the earlier part of this decade and is now using the free cashflow to pay down debt. But what is the management’s stance on dividends? Will they resume it after the debt issue is resolved? Or are they gonna invest into stupid ventures again?

Let’s look at the previous case study: Starhub. The operating cashflow on average is about S$600mn. The capex is about S$200mn. So FCF is close to S$400mn. The firm has been paying around S$300mn in dividend every year. So that’s very good! There is still S$100mn of buffer for it to grow its dividend.

However there is always the lingering debt issue. Starhub has roughly S$600mn of net debt, and equity in the latest quarter is a miserable S$60mn! This explanation on Drizzt’s blog explains that it’s due to some accounting after they merged SCV. The actual equity is S$1bn. So S$600mn of debt is no big deal. Not to mention, if the S$400mn of FCF is used to pay debt, it will take only 1.5 yrs to clear it.

But still it doesn’t make sense. Why does merging with SCV reduce accounting equity by 90%? Was SCV a negative equity entity? Even if there is no actual impact on every day operations, the book value is something that all investors look at. Can something be done to resolve this?

Well, perhaps it would be resolve in time. Meanwhile Starhub gives close to 8% dividend yield.

Which brings us to the last point: the dividend yield. Is it a reasonable yield? For every dollar buying the stock, are you getting enough back in dividends? But the yield is also a function of future growth expectations. A high yield usually means lower growth expectations.

Starhub’s yield of 8% can mean that there is very limited growth left. Or it can mean that investors expect the yield to fall in the future, ie dividend cut. Or it can really be a steal right now, and over time, the stock rises to $5 and makes the yield more reasonable at 4-5%. Which means you will double your money by buying now.

If you ask me, I think the former reasons look more likely. The market is not stupid, bargains like this don’t last long enough for an amateur blogger like me to blog about it. Not to mention that I am definitely not the first one blogging about it.

The best investment, obviously, is a high yield stock that can sustain or even grow its dividend over time. But high yield with growth is an oxymoron. If the firm can grow, it will keep the cash for growth instead of paying it out to shareholders. High dividend yield and growth cannot go hand-in-hand. But for some value investors, the goal might just be to find 1 or 2 of these high yield growth stocks, buy them and hold forever!

Payout Ratio

Payout ratio is simply Dividend Per Share (DPS) divided by Earnings Per Share (EPS), which tells you how much buffer does the company have for it to increase its dividends. E.g. EPS for Singtel is about 22c and DPS is 11c on average for the last few years, so the payout ratio is 50%.

But what is a good payout ratio?

If the payout ratio is 30-40%, which I would say is probably below the global average, then you know the company has some room to increase dividends.

If the payout ratio is close to 100%, ie the company is paying everything that it earned as dividends, then we cannot expect a lot of growth in dividends unless earnings is going to grow significantly.

In Singapore, sadly, a lot of high dividend stocks also have very high payout ratio, ie no further room for dividend to grow unless earnings can grow. But if earnings can grow, then the firm would want the money to invest in growth and not return them to shareholders. Hence high dividend plus strong growth is an oxymoron. These stocks don’t exist. Or they are very rare.

When dividend and payout ratio both gets too high, dividend cut becomes inevitable.

However, cutting dividend is a big deal for many companies in Singapore, bcos a lot of shareholders buy Sg stocks mainly for their dividend and if it is cut, it means disappointment and selling pressure. Of course it also shows that management is not capable of steering the business well enough to pay their shareholders.

In fact, it got so important to the extent that some companies actually issued debt to pay dividends!

The two prominent cases being Singpost and Starhub.

In the early years when Singpost was listed, it was obligated to pay a high dividend yield for some reason that I forgot. So while Singpost’s net profit was just over S$100mn, it has to pay S$300mn in dividends! So bo pian, raise debt to pay dividend. However, that only happened more than 6-7 years ago and the company hasn’t done anything stupid like that ever since.

Ok let’s talk about Starhub.

For the past few years, Starhub generates annual net income of roughly S$300mn and pays roughly $300mn in dividends as well! At the same time, the firm increases its debt holdings almost every alternate year, in 1 year by as much as S$600mn! So people asked questions like why do they raise so much debt when they could have cut the dividends to save money?

Well I guess there are no easy answers. But if we analyse the cashflow statement of Starhub, we can see that perhaps the situation is not as bad. So it might be worthwhile to look at free cash flow vs dividend paid instead. Which is what I would do in the next post!

Singapore's Dividend Aristocrats

The S&P Dividend Aristocrats is a list of stocks in the S&P 500 index that has increased dividends for at least 25 years. As you might guess, this is definitely a very tall order and as of 2010, if I remember correctly, only 10% or 50 stocks made it to the list. It is expected that the list will further dwindle to 40 stocks or so which prompted some to ask whether the criteria is too stringent.

Well, that is the way with our world, I guess, when we don't make the cut, we can always lower the bar ourselves. Haha!

Anyways, some of the names on this prestigious list are very well known, like 3M, Johnson and Johnson, Becton Dickinson, Coca Cola and P&G etc. Thet last four are also famous holdings of our hero.

Intrigued, I went to take a look at which Singapore stocks had a good track record of increasing dividend. Well as our history is not as long, I used a looser criteria of increasing dividend for at least 8 out of the past 10 years.

Here is the list of stocks.

Well, I guess you are as disappointed as I am. Only 8 stocks made the cut. Of which 3 pays a miserable 2% dividend. 2 are in property and construction, a treacherous sector. Another 2 of them belong to the same group entity. And 1 of them is not even a Singapore company.

There are 2 banks, but value investors are very wary of banks bcos there are just too many moving parts to get a good read on these financial beasts. Even Buffett had his fair share of trouble with Salomon Brothers 20 years ago and now Goldman Sachs, which is being criticized for screwing clients left right centre.

Raffles Medical, one of the 2% yield stock, might be interesting but its valuation is way too high at 26x. Might be worth doing some research now and wait for a good entry point.

The truly investable Dividend Aristocrat of Singapore might be SPH but it's main business is in a declining franchise and its high property value is based on frothy valuation in a flood infested shopping district.

In a nutshell, using the dividend arisocrat criteria cannot help us find good stocks in Singapore. We might have some luck elsewhere in Asia.

What constitute an investment?

The way I see it, an investment has to be something that can generate cashflow. Stocks give dividends, bonds give interest and real estate gives rental income. These are real investments.

However in the strange World of Wall Street Craft, anything and everything becomes a feasible investment, an asset class of its own. The recent boom earlier this decade being commodities.

But if you think about it, commodities shouldn't be considered an investment bcos you don't get a cashflow. Holding a ton of copper, or a ton of wheat doesn't give you cashflow. The whole premise is based on prices going up. And when it's based on just prices going up, then it's dangerously close to the idea of the Greater Fool Game. Where you can only make money by selling something that is worth very little, at a higher price, to a greater fool who is willing to buy.

That is why value investors are not interested in price, we are interested in value. Price merely tells us if we can get the asset below its value. If there was no transparent price on the asset, we are happy as long as we have cashflow. But if there is no cashflow, you cannot calculate an intrinsic value of the investment. And in that sense, commodities cannot be classified as an investable asset class. Needless to say, a lot of the newly created asset classes like art, wine, vintage watches and other funny stuff cannot be called investment.

However, if those above mentioned can somehow be construed to generate cashflow, then the story becomes different.

For e.g. if a couple of artworks can be put together at an exhibition hall, and the owner can charge fees for viewers, then we have a cashflow, and the whole business can then be valued. In the same vein, wine is not an investment but the vineyard is. Copper may not be a true investable asset class, but a copper mine or a mining co. is definitely investable.

Similarly, traditional assets that count as investments may not be such if it doesn't generate cashflow. The best examples would be perennial loss making companies. Think Chartered, NOL and the likes.

As the saying goes, cash is king. Well if cash is king, in my opinion, cashflow is then the true master of the universe.

The Story of Bak Kut Teh

Just heads up, this is a post with very little value add. I thought about this while eating Bak Kut Teh. Just for entertainment. :)

For the non-ASEANs reading this, Bak Kut Teh is a Chinese dish that originated in S.E.Asia that is made up of spare pork ribs cooked in traditional Chinese herbs and served in a soup. It is also usually served with rice and soy sauce. You can take a look at my half eaten set below.

There is an interesting urban myth about the origin of the dish. Coolies working in Singapore and Malaysia earlier last century had to do tough work like carrying heavy goods at the ports for the whole day. As they were very poor, eating meat was not an option and eating food lacking nutrition ultimately resulted in poor health, sickness and weak bodies and their ability to work to generate money.

So Bak Kut Teh came to the rescue. The coolies would buy ribs that nobody wanted from the butchers at a cheap price, mixed with simple herbs (also cheap, I think) and then eat with rice and soy sauce. Simple as it is, this dish gives them strength, helps to prevent sickness and allow them to work all year long.

Of course today Bak Kut Teh has evolved into a popular dish that actually costs more than normal hawker food and it is usually served with spare ribs with lots of meat, You Tiao (or fried dough) and other stuff.

So while eating Bak Kut Teh, I thought about investing and realized a few analogies which could be drawn.

1. Value for money

Obviously, value investing is about buying more for less. Buy a good company at a reasonable price. Buy things cheap. Bak Kut Teh stands for this. Well at least during the coolies' times. Cheap but nutritional, helps the coolies stay healthy, get work done, earn more money. Today it is a bit different lah.

2. No Fat

In investing we want to buy companies that are lean and mean with no fat. That's Bak Kut Teh! Companies must understand that they have to stay lean in order to generate good returns. Actually, we ourselves strive to stay healthy and keep those cholesterol away so that we can fend away the harmful effects of metabolic syndrome right?

3. Innovate in changing times

The origin of Bak Kut Teh crystallizes the spirit of innovation. First, the coolies or whoever working with them came up with this spectacular dish that helped improved lives. Then, over the years, the dish itself evolved to fit into society. Even today, it's a highly popular dish. In investing, we must also be on the lookout for companies that can keep re-inventing themselves. As we speak PC and PC related companies are dying, big names like Intel, Dell and Microsoft are going all out to re-invent themselves. Although I must say, it's very hard to predict which companies can successfully evolve.

As with individuals, a lot of people struggle to stay relevant in society bcos things are moving so fast, it just gets harder and harder. Perhaps the story of Bak Kut Teh is really about evolution and how we should always re-invent ourselves to be useful.

High Dividend Stocks

An updated post "High Dividend Stocks 2011" is finally out! Do check it out.

Here is a list of stocks that I generated using the following criteria

1. Market cap more than $50mn
2. Dividend yield more than 4%
3. Past 3 yr average ROE more than 9%
4. Past 3 yr FCF yield more than 7%
5. Past 3 yr EBIT margin more than 4%

Obviously, as with all quant screens, more work needs to be done to refine the results. The first counter definitely look strange. I mean, with dividend of 30%, in 3 yrs you get back your capital. How likely is that?

Chances are something is wrong with the firm or with the data.

The name that I thought might be interesting is Telechoice - which sells prepaid phonecards. With the immigration floodgate opening again, it might see some profit boost in the next few years.

The other safe and well-known dividend names like M1, Starhub, SATS etc, well should always try to buy more of these if you believe in the Singapore story.

Well a small gift to all the teachers reading this blog today!

Valuation Expansion

On Wall Street, a lot of educated monkeys like to talk about valuation expansion. Basically valuation expansion simply means that some stock trading at 15x PE should be trading at 25x PE bcos its industry is sexy, or the company has undergone transformation of its business to become the new growth story or some other cock-and-bull story.

So say the stock price today is $15, and the stock earns an EPS of $1 ie PE is 15x. Valuation expansion simply means that the stock should be $25 bcos PE should be 25x. The basis of this argument is that since the stock is in a growth industry, or has transformed its business, or watever crap reason, the future EPS is not just $1 but much higher. Since we are not sure what that would be, just give it a higher PE to justify this growth.

The ingenuity of this crap theory is that nothing changed, but the "value" of this stock just expanded 60%. This then can be used to justify buying the stock at any price bcos we can always assuming super normal growth and increase the valuation. We can even increase the target multiple further from 25x to 50x. This would expand the original "value" by 333%.

Let's just do a simple experiment the debunk this valuation expansion theory.

Yr 0 EPS $0.5 (Stock price $25, ie PE 50x)
Yr 1 EPS $1 (Stock price $25, ie PE 25x)
Yr 2 EPS $2
Yr 3 EPS $3
Yr 4 EPS $4
Average EPS $2.1
True intrinsic value (using PE 15x) = $2.1 x 15 = $31.5
Upside = $31.5/$25 = 26%
Upside per yr roughly 5%

So assuming today we are at Yr 0 and this company started out with an EPS of 50c but bcos of its super power growth, the stock market has already valued it at 50x PE current yr and 25x next yr. Of course this is assuming it didn't disappoint, its EPS doubled to $1. In fact it didn't disappoint for the next 4 yrs and its EPS grew from the initial 50c to $4. This stellar firm actually grew its earnings 8 folds in 5 yrs!

Now how spectacular can a normal company get? I would think this type of growth puts the world's best growth firm to shame. Look at APPL, the darling-est growth stock in our lives. Currently it's the 2nd biggest company in the world by market cap. Its net profit was $1.3bn 5 yrs ago. Last year, it was $8.3bn. The 5 yr growth alas is 6.4x, still a tad less than our hypothetical co. at 8x.

So 8 fold increase in EPS is really as good as it gets. But, if you have bought it for 25x or more, the return in stock price is likely to be single digit return. As I calculated, the intrinsic value is $31.5 vs today's price at $25. Of course, the stock might bounce up a lot, to say $50 then collapse, or it's price might continue to stay very much higher than its true value of $31.5, but we are value investors remember? We don't follow prices. We follow value.

What I am trying to say is this: when you buy a valuation expansion story, your rate of return is destined to be meager even if the story comes true. In our hypothetical case, the stock return over 5 yrs is about 5% per yr. How fantastic!

To me, valuation expansion is then just another variation of the Greater Fool Game. Valuation expansion means the earnings of the company is not great now, BUT bcos there are a lot of people willing to pay 25x now, therefore the stock price should rise by a huge magnitude.

I would think that a better way to make money would be the always buy below PE of 17-18x. Value investors would certainly do that. With valuation expansion, there is no margin of safety at all. What if the growth didnt come true? What if the genius CEO died?

So when you hear valuation expansion next time, pls beware!

PS: APPL did trade at 25x PE 5 yrs ago and you would have made a lot of money buying it at 25x 1 yr fwd and held it until today. But the better chance to buy was during the Lehman Crisis when the PE fell to 15x 1 yr fwd and you could have more than doubled your money in 2 yrs!

Did Buffett underpay Mrs B?

I did a post some time back highlighting that perhaps the acme of investing might actually be not to short-change anyone in any transaction. ie to buy a stock at its intrinsic value while waiting for the intrinsic value to grow. This is a very sensitive point when we are dealing with day-to-day business owners rather than the stock market.

Obviously buying at intrinsic value is also different from buying a company at a huge discount and then waiting for it to revert back to its intrinsic value, which is the original thesis of value investing.

I thought that Buffett might have just pulled this off, and that is why he is the greatest investor on Earth.

Recently I did some study on the exact transaction that he did: buying over Nebraska Furniture Mart from its long-time founder and operator Mrs B.

The story goes something like this. In 1983, Buffett on his birthday, simply went in to the Mart and asked Mrs B. if she would like to sell, and at what price?

Here are some no.s at the time the transaction was done.

NFM
Sales 100mn (reported)
NP 5-10mn (estimate by 8%pa)

GPM of NFM 60% (reported)
Furnture mkt OPM 10% (industry average)

$55mn of 80% stake (reported)
$69mn for 100% stake (reported)

Buffett paid 7-14x PE

Based on my estimate, Buffett probably paid 7-14x PE for NFM. Now this is a huge range. If he paid 7x, he would have obviously underpaid Mrs B. If he paid 14x, then it's probably fair. So did he underpay Mrs B?

Well, sadly we will never know for sure, but chances are Buffett probably did underpay somewhat, judging by his track record and considering how the firm grew over the past 30 years. However we must also note that Mrs B was a willing seller at $69mn. She quoted Buffett that price.

Also, Mrs B probably would not have gotten much more if she were to list her company in the stock market. The brokers will take a cut. She has to pay for some auditors. Perhaps hire a few more staff to handle Wall Street people etc. With Buffett, she got her $55mn check on that day. And the best part, she continues to do what she does bcos Buffett wanted her to continue to run the business. No Wall Street analysts on her back every quarter!

I guess the conclusion here is that Buffett might not have been as noble as I thought. He did underpay his acquaintance somewhat but judging from the circumstances, Mrs B didn't mind that she got a couple of millions less (that is assuming she actually bothered to go and do a thorough valuation of her own co.) and she gets to do her job exactly the same way she liked it.

In fact, a couple of years later, Mrs B sold another business to Buffett. If she felt cheated, would she had gone back to Buffett?

The real lesson learnt for me here would actually be thinking about the best solution for both parties in every transaction. This means disclosing all the pros and cons to each party about the transaction, not witholding any information at all and working out the seek the win-win situation. I think this is very possible if both parties are rational, honest and committed to a long term relationship.

Portfolio Management for Retail Investors

Ok so much so for institutional portfolio managers. On average, they are crap. Once in a while, you find stars like Peter Lynch, Seth Klarman and Warren Buffett. But these exceptional people are far and few in between.

The interesting story about Seth Klarman is always about this book that he had written like ages ago, called “Margin of Safety”. It talks about value investing and it didn’t sell well at all. So it went out of print. But recently, some Wall Street people started to bid for it on Ebay and it was sold for US$1,000!

Well, I got a free internet copy and am reading it. Cost me like S$10 to get it printed and binded.

Anyways, today we talk a little about portfolio management for the retail investors. How can a retail guy like you and me try to do some portfolio management?

Well, first, we must have like a couple of tens of thousands to start with. If you only have $10k. Then you can basically only buy 1 or 2 stocks. There is not much portfolio management to talk about. Just buy the blue chips or maybe buy an ETF and wait for it to grow to like $50k.

The reason why $10k can only buy 1-2 stock is bcos if you divide $10k up buy 10 stocks, you will be paying $40-60 of transaction cost for each stock, which makes the cost 4-6% for each stock and this will eat too much into your return per stock (which is like 8-10%pa).

So for those who do have $50-100k, then you might want to think a bit about which 5-10 stocks you want to buy. Here are some guidelines... Well actually it’s the same guideline, which is to diversify across everything. You definitely don’t want 5 stocks all in airlines or airline related industries.

1. Diversify across industries

So first we think across industries. If you are a conservative guy like me, you may want to allocate like 50% or more of your money to defensive industries like staples, food, utilities, telcos etc. Of course there are some megatrends happening in our lifetime, so maybe put some into resources, China related, or even tech. But you must definitely understand the risks here.

2. Dividends

This is one big criteria for me. I would want to put 70-80% of the stocks into good dividend stocks. Stocks with rising dividend over time, these are the best. Actually, these stocks will usually come from staples or food. So there is no contradiction bet 1 and 2.

3. Geographical exposure

China and Asia are the darlings of the stock market for the next 10-20 yrs. It makes sense to put money with exposure to these regions. This also means that you should look for Singapore co.s with such exposure. I would put maybe 30-50% in Asia, but also provided I can find cheap and good stocks. This might be the hardest thing to do today.

4. Asset Classes

For those who need more security, you can definitely consider 10-20% of the portfolio into bonds. However, since bonds usually pay 4-5% interest only, which you can get with some stocks in Singapore. It really doesn’t make too much sense to buy them, unless you can buy them like 80c to the dollar or something.

5. Structure

So just to round things up, if you can have a 10-12 stock/bond portfolio, it may look like this:

5-6 stocks in staples/food/telco, which includes 3-4 dividend stocks
2 Asia stocks/ETFs
2 Resource/Energy stock
1-2 bonds

One last note, unless you are really good at market timing, it pays to avoid value destroying industries like most of the tech industry, airlines, container shipping, oil refining etc and industries in secular decline like newsprint, general textile etc.

Hope this helps!

How to Fail in Portfolio Management

Portfolio managers as a group has not contributed anything to the society at large. I mean a barber helps to cut people's hair, a doctor saves lives and a teacher educates our children. Lawyers, politicians, portfolio managers, as a whole, subtracted value from the society, if you ask me.

The famous stats is this, and I must state again: more than 80% of all fund managers fail to beat market indices over long periods of time. Some of them do beat the index for like 1 or 2 yrs, only to falter in the 3rd or 4th.

The market is really terribly efficient. The S&P500 has returned 10%pa on average over the last 80 years. Most other indices don't go that far back but academic studies have shown that stocks or equities, returned high single digit to low double digit per annum, on average.

Hence it is not easy to beat the market over the long run. Yes you may have a lucky trade, like buying BP at 250p and now it's close to 400p, a 60% return in 2 mths. But to replicate this for 10 years is another story.

Value investors don't fare too much better. Some studies showed that 20-40% of value funds outperform market indices. That still means that majority of so-called value investors still fail to beat their benchmark! Although they are about twice as good as the average fund manager.

I think there are several factors that explain why portfolio managers fail so spectacularly and it serves to remind us that if we can just adopt the right philosophy, we can avoid most of their mistakes.

1. Herd Mentality

Just a simple analogy. In a shopping mall, when we see crowd gathering near certain stores, bcos there is some event, we gravitate towards the crowd. If we see everyone running for the exit, bcos there is a bomb threat, we run! The market is a transparent place. Prices move every day as investors buy and sell stocks. Portfolio managers eat, breath and think prices daily. Hence when prices move up, they want to follow, and when prices move down, they avoid. Most retail investors also do the same. Maybe some kind of wiring in our heads tries to follow this flawed logic with prices but I think the analogy with the crowd sort of makes sense.

2. Short Investment Horizon

This is a very amazing trend. In the 1980s, the average holding period for a stock on NYSE was 5 yrs, as derived from the turnover volume. ie annual turnover was 20% of NYSE total stock volume or something. Today, the turnover is 200%! The average holding period is then 6 mths! As we know, institutions make up the bulk of trading volume. Hence portfolio managers are the main culprits here. Every one of them is just looking for the next BP trade. Long term investing is for the dinosaurs. But true value cannot be realized in 6 mths. Franchises take time to build. Firms take years to grow. Sadly, nobody is interested. Buy-and-hold value investors are a dying breed on Wall Street.

3. Information overload

Portfolio managers are bombarded by useless information daily. In today's world, we are talking about probably 300-500 emails from brokers, analysts, colleagues etc. Most of these are daily reports of newsflow happening in the world, analysts' upgrades or downgrades and other non-relevant stuff. But PMs, being paid to do some job, are basically salaried workers and couldn't just delete all these emails right? So they spend significant amt of time reading junk emails when they should be reading the real good stuff like articles on this blog. And seriously, when you hear a hundred opinions about a stock, you lose track and get confused.

4. Misaligned incentive

PMs are being judge by their annual performance and not long term performance. If they make money this year, they get the fat bonus. If they lose money, they eat grass. So this scheme basically drive their behaviour to find a 6 mth trade that works. Value stocks that will make you money in 3-5 yrs? Sorry, talk to my hand. Hence it's not a big surpise why the average holding period is 6 mths.

So I guess these are the major reasons why portfolio managers cannot beat their benchmark over the long run. Bcos of the strange nature of their job, some inherent human biases and perhaps most importantly, misaligned incentives that shaped their behaviour. The rest of us, we should do exactly the opposite and generate good long term return!

Portfolio Management: The Job

So basically portfolio management boils down to over or underweighting some benchmark stocks. Now that doesn't sound too difficult, why should the portfolio managers or PM be paid exorbitant salaries? And despite getting paid so much, they FAIL to deliver the results?

Well first we talk about the skills needed. The portfolio manager needs to know a lot to do his job. And I really do mean A LOT. If you think in terms of those 300 page university textbooks, it's probably 30-40 of them (CFA has 18 for 3 levels). Plus, 10-20 years worth of global news material, that is maybe volume to fill another 5-10 textbooks.

On academic subjects, first, he needs to know about security analysis, that is the basic bread and butter. Then the financial statements, ie accounting. Of course there are the relevant subjects like economics, finance, business, statistics etc. Well most these are covered in CFA, but CFA just gives a basic flavour. To be well-versed takes years more and there are also subjects outside CFA, like psychology etc.

Then on the non-academic side, there are the 6 major industry groups: Financials, Resources, Industrials, Staples, IT and Utilities. The portfolio manager needs know the dynamics/drivers/issues of all of them. Not to mention there are perhaps close to 100 different sub-industries and businesses in all. On top of that, he needs to be in tune with global current affairs.

Of course, you don't really need to learn and know everything to be a good portfolio manager or PM. Warren Buffett knows nothing about tech and the 21st century new glamour industries right? Though he reads a lot.

Well, you can get away with that when you are your own fund manager and people beg you to manage money FOR them. Alas most portfolio managers are salaried employees and they need to show senior management that they have the knowledge and experience before they get the job. But they certainly are not required put 50% of their net worth in the fund that they manages for others.

That perhaps also partly explain why they are so good at failing to meet their KPI!

Anyways, PMs need to know a lot and be capable of continuous learning in order to make better investment decisions. In most global fund management houses, their jobs go beyond just portfolio management. They need to do marketing, recruitment of analysts, monitor trades and settlements, prepare reports etc. All these perhaps partly explains their high pay. If you ask me, maybe it justifies like 20% of the total package!

Yeah, no matter what, we can never forgive them for not delivering the most basic result right?

But let's go back to over or underweighting stocks. So all the knowledge is just the preparation for the most important part of their jobs: to decide which stocks to over or underweight. This is what determines the portfolio return over the long run.

The irony of this all is that PMs don't think or act accordingly to deliver this result. Partly bcos of the institutional imperative that Buffett talks about. Partly bcos PMs are also humans, subjected to peer pressure and emotions.

Let's just have an example: Say we have PM Ah Gou managing the Singapore portfolio with STI as his benchmark. Naturally, NOL our beloved container shipping company, is in the benchmark.

Now the container shipping industry is very similar to the airline industry. Over the past 20 years, if you add up the culmulative profits of the whole industry, it is a negative number. The whole container industry has never made money for two decades, or perhaps even longer. However, in the boom years from 2005-2007, huge profits were made, NOL became a darling of the stock market. But all the profits were wiped out in just 18 mths. And NOL went from darling to dog. Yeah, the biggest underdog. The co. bled money through its hull and finally came hand in hat to investors, multiple times!

If you are even half a value investor, you would have avoided NOL at all cost. Even traders with sense know NOL is a risky trade, you could lose everything with this one. After all, Singapore is moving to value added services. We are talking about bio-tech, financial hub, education centre, casinos and more high end stuff, more service oriented industries. It was mentioned that SIA can be allowed to fail. Even Chartered got sold finally. How many times can Temasek bail out this loser in a losing industry like container shipping?

But if you are a PM Ah Gou managing singapore stocks, the story is different. After NOL lost a billion dollars and then got funding from its rights issue, analysts are shouting BUY bcos the industry has bottomed. Global trade is picking up, freight rate negotiations ended with huge price increase for the shippers. Indeed NOL rallied 80% or more from the bottom. If you did not overweight NOL, how are you going explain yourself?

So that's the dilemma for PMs, in the next post, we explore in depth about why they never beat the benchmark.

Portfolio Management

To be a portfolio manager is a much coveted goal for a lot of people struggling in the financial industry. This position is deemed as being at the top of the food chain. Everyone feeds information to the portfolio manager so that he can make the best investment decisions. The portfolio manager is THE Top Dog.

However, the way that the industry had evolved makes the top dog's job rather stupid. In fact the whole fund management industry doesn't really make a lot of sense.

Just look at the whole management fee issue. For most funds that it out there, 1% is taken out of the asset base to be paid out as management fee. Basically for every $100 of unit trust that you buy, $1 is paid to the fund manager which consist of the portfolio manager, the team of analysts and the support staff that manages the fund for you.

Now 1% may not sound big, but since average investment return is usually less than 10% per year, it means that you are paying out 10% or more to these fund managers every year.

Well, we can talk about this atrocity some other day. Let's look at the portfolio manager's job. His job is to manage the fund such that he beats some benchmark. This benchmark is usually some stock index. Say the S&500, the Hang Seng Index or the STI index etc.

Well, statistically they sucked. Less than 20% of all portfolio managers that ever existed beat their indices over a long period of time, like say 10 yrs or more.

Why is portfolio management such a difficult thing? Well to answer that might take a few more posts. But first we can talk about how the top dog goes about doing his job.

We talked about the benchmark. Basically the portfolio manager's job is to beat the benchmark. ie if the benchmark return is 10%, the PM should be delivering 11% return or more.

The most logical way to do this, according to the fund management industry, is to over or underweight stocks in the benchmark. Now what does this mean?

You see the benchmark is basically made up of stocks with different weightage. For e.g. the STI index has 30 stocks. Singtel has a weight of 8%, UOB 5%, SIA 4% etc (btw all weights are arbitrary, I dunno the real weights and they change all the time). So a portfolio manager who needs to beat the STI would consult his analysts and all other information sources and decide ultimately, what stocks to over or underweight.

Eg. after all his research, he decides that Singtel has better prospects, so he overweights Singtel, ie instead of putting 8% in Singtel, he puts 10%. And similarly he has to underweight some other stock, eg SIA, so instead of putting 4% in SIA, he puts just 2%.

If over time, Singtel does better than SIA, like say over 3 years, Singtel delivered 30% return but SIA only 20%, then he made the right decision. And since the portfolio manager has to do perhaps a couple of hundred or more of these decisions over say a 10 year time frame, he earns his existence if the net result is that his portfolio delivers a return that is higher than the benchmark.

This is, in a nutshell, the job of the portfolio manager. In the next issue, we discuss some issues with his job.

The Vilification of Leisure: Death of the TV

There are a few major consequences with the vilification of home leisure activities

1. Growth of share of mind-time for new activities

We all have only 24 hours a day, and this is the amount of time that things can occupy our minds. In the past where there are only TVs, radios and print, we spend our mind-time on these things. In fact the world probably spends 80% of home leisure time watching TV during the 2nd half of the 20th century. However as we move to the 21st century, we are spending our mind-time differently.

Internet, Facebook, iPhone, iPad, Youtube, Gaming (Xbox, Wii, PS3, DS, PSP), Blogging, Twittering etc. Some youngster completely stopped watching TV since they can watch it on the internet. No doubt TV is still big. It is still the major portion of global advertising revenue and is likely to be so for some time. But the winds of change are blowing. TV as a % of our mind-time is dropping and will continue to do so until it is just another form of media in a whole spectrum of others.

2. Ad spending to traditional media to fall

The revenue sources for most media comes from advertising, sale of content and subscription, with advertising usually making the bulk of the money. As mentioned, TV has dominated that total media ad spending for the 2nd half of the 20th century as it has the widest reach as compared to print, radio, outdoor or other forms of advertising. This makes the absolute dollar amount huge, like $100,000 to $300,000 for a 30 sec TV commercial in the US, and in tune of millions for high-profile programs like Superbowl, but the cost per 1,000 impression (CPM) is actually comparable to other forms of advertising at $10-30 CPM. This means that even though a company spends $300,000 on a TV commercial, it reaches 15mn viewers in that 30 sec, while other forms of media probably reach only 1/10 or even 1/100 of that no. of viewers.

Now the total ad spending over the long run can only grow with the global economy or perhaps slightly faster. With more and more people spending time on Facebook and other internet sites, traditional media CPM has to come down. Maybe from $10-30 to $6-20 or something. This means that ad spending on TV and other traditional media will be a smaller % of the global ad pie. While blogs, Youtube, Facebook and iTunes grow to take their places.

3. Consumer leisure dollar gets vilified

Another form of impact of the Vilification of Leisure affects the consumer leisure dollar. Before the explosion of these 21st century leisure activities (ie Facebook, apps, Youtube etc), the consumer leisure dollar for the masses is actually pretty limited. There is Hollywood, ie going to the movies. Buying CDs and DVDs, buying games for Wii, Xbox. Pay TV or cable and maybe some magazine or radio subscription. And that's about it! Well we are not going to explore leisure dollar into hobbies like photography, collecting comics, going for concerts etc though.

So with the Vilification of Leisure, the leisure dollar now gets spread over thinly to buying apps, buying items for your avatar in some online game, downloading songs, buying e-books not to mention buying newer and newer devices like iPad, Kindle, netbooks, PSP, the new DS, iPhone 4 etc.

Now the total leisure dollar that can be spent has a limit. Just a wild guess, it's perhaps $200-300 per month per person in developed countries. It is not going to double unless global GDP doubles. So this means that what was used to pay Hollywood, cable TV, games etc now needs to spread to all these new gimmicks. Of course, these new gimmicks enjoy spectacular growth since they start from zero. Like apps, it was nothing 2 years ago. Now it's a billion dollar industry. But it would be wrong to assume that it can be a $10bn industry in 3 years bcos the leisure dollar can only stretch so far. This goes for social online games, songs, online subscription whatever.

-----

So there you have it, Vilification of Leisure will hit us strong and we should be aware of its various impact. In short, a slow death for TV and a quick growth and plateauing for a lot of these new entrants.

Facebook and the Vilification of Leisure

Ok time for a confession: I don't have a Facebook account.

Geez what kind of dinosaur doesn't have a Facebook account these days? Even my grandma has a Facebook account. Well the rationale was that I do not need to have a Facebook account bcos I meet my friends LIVE and those that I have lost touch, I am happy that the relationship stays that way.

Well the same argument can be used for cellphones. Who needs cellphones anyways? We have letters, land lines and if we wanted to link up with an old friend, we would just call them up for dinner using fixed line phones. When we want to meet outside, we determine the exact time and place to meet, before meeting up. If they are late, we would just wait until they show up! And we write letters to our penpals, who needs phones?

Well, I am just saying it. (Borrowed from RWJ, one of the funniest on Youtube, go Google "RWJ =3")

I guess Technology cannot help you manage your life if you don't want it to. Grandma just wouldn't use Skype even if she could use it to see her adorable grand-son playing happily on the other side of the globe, every day. Dad refuses to use the cellphone with a GPS even if it means that he never needs to read the map again, Evar (yep fr RWJ too!).

Does anything change? Well actually it doesn't. Grandma and Dad are still very happy, oblivious to what they are missing out. It's ok, life goes on. What's wrong with just seeing cute little Toby once a year? Or with reading maps anyways? Technology is not everything. Yes that is true. It is also true that we had horses, hence we didn't need cars and we had letters, hence we didn't need phones. In fact, if we had continue to use horses today, maybe the big environmental issue might be avoided! And the mailmen wouldn't have lost their jobs and contributed to the 10% unemployment.

Well, I am just saying it.

Okay, in the bigger scheme of things, technology ultimately leads to better productivity. However technology does not increase productivity overnight. It needs enough time and people to embrace it before the curve takes off. Not all technology becomes truly beneficial, like Segway or even Gaming. Technology also comes with side-effects: like carbon emission. But on the whole and over the long run, it has allowed humans to progress faster than otherwise.

Back of Facebook, how does it help improve our lives? Now that we are at it, how do we define Facebook anyways?

Well, according to most, Facebook is a social networking platform where you can link up with friends, share photos or music or interesting weblinks, or you can use it to chat with friends, play games or just surf around for interesting stuff. In one sentence: it is a leisure, edu-infotainment and networking hub. There are now close to 400mn users on Facebook, (ie about the whole of US plus 20 Singapores) which also makes it a super powerful marketing machine. Facebook has recently turned profitable, I expect it to make a few billions in revenue in a few years and profits might reach a couple hundreds of millions. However, if it ever gets listed, the PE would be like 80x ie there wont be a chance to buy it at a reasonable price.

So how does one's productivity increase with Facebook? Well the most compelling argument would be Photos. The age of digital cameras means that people no longer print out as many photos as in the past. Most photos are stored in hard drives and the only time we get to see friends photos now is, well, through Facebook! Unless you are talking about wedding glamour shots or specifically going to some friends' house and ask them to show their Hawaii photos (which would be in their PCs btw and the reason you would ask is bcos they don't have a Facebook account where they could upload it).

Other than that, Facebook just becomes this viral photosharing-networking-eduinfotainment hub that sucks away time from the TV, the phone, the radio and other forms of leisure. There might be some productivity increase bcos instead of passively receiving entertainment/leisure/knowledge you actively search for it. Well the argument works both for Facebook and for the internet.

But what is happening with Facebook is actually much bigger than Facebook or Internet or Dinosaurs with no Facebook account. I call it the Vilification of Leisure.

In the past, like say 30 years ago there are only about 3 forms of home leisure activity.

1. TV
2. Radio
3. Books/Newspaper

Well there is a fourth one involving kids: either playing with them or making them, but let's just leave this one aside for now.

Then. gaming consoles came along, followed by the internet, then American Idol (needing both TV and cellphone), then Youtube, iPod, Facebook, iPhones, Wii, Skype, World of Warcraft, iPad, Natal, Twitter, PPS etc etc. The whole home leisure scene just exploded. But sadly we still only have 24 hours per day. Even sadder, we probably spend only 2-3 hours of our day doing these things. So 30 yrs ago, we spend 2-3 hours every night in front of the TV. Now it's gonna be spread over this huge maelstrom of activities. (Of course it would be more like maybe Family A goes Facebook, Family B still watches TV, Family C goes Wii or Brother of D goes Warcraft, Sister of D goes iPad etc).

In any case, the home leisure which used to be dominated by just TV now becomes a million things. This is the Vilification of Leisure.

In the next post, we discuss its impact.

PS: Well I lied, I have a Facebook account since 2008.

Economics of YouTube Musicians

I have been spending some time watching Youtube recently and was amazed by the talents of all these YouTube Musicians all over the world.

Check out Sungha Jung
http://www.youtube.com/user/jwcfree#p/u/16/JykAgIVT6-s

And Singapore's own YouTube Sensation
http://www.youtube.com/user/ling86#p/u/8/bUY8iT525yQ

The analyst in me started wondering about the business economics of these musicians. So here I will simply share some random thoughts on how things can work.

First, as pointed out by Mary Meeker and her famous Price to Eyeballs, the no. of hits should have some value. Btw this is a crazy idea in finance and still draws laughter to this day. I guess Meeker's greatest mistake is to attribute the price of a stock directly to eyeballs, which grossly overstates the true profits that millions of hits actually generates.

It is surely quite a tough job to determine the true profits from millions of hits.  But it's been 10 years now and we have a history of stuff to help us. Also, I will stop short at revenue and not profits, which  requires another few levels of analysis. For a start, let's look at some online businesses out there:

Online social games: Zygna, revenue paying users: 5-10%
2nd Life: Revenue paying users 5% or less
Facebook: Revenue paying users probably 2% or less
Blog clicks: 8percentpa, monetize clicks 1% of all page views
Less than successful targeting online: e.g. selling Amazon books on personal websites, less than 1% of all page views

So with these historical no.s, we can roughly say that maybe 1% of the eyeballs, or hits can be converted to money. Obviously the kick comes from the per user revenue, or just to throw in a technical term: the ARPU or average revenue per unit/user. The ARPU varies widely depending on the nature of the online business. For Zygna, this is pretty high, at $4-5 or even more . For Blog clicks, unfortunately, it's more like 10c or less.

Back to YouTube Musicians, so a million hits converts to perhaps 10,000 potential revenue paying users and then if we put ARPU at $1, that's $10,000. That's the theoretical value of a Youtube Channel with a million hits.

In reality, we need some form of infrastructure to realize this $10,000. Specifically for YouTube Musicians would be distribution: like iTunes to sell the music via downloads, or record labels to sign them up, make albums and sell CDs through music stores like HMV, sponsors, experienced artists to help them (like with joint live performances), capable producers, good agents etc. And depending on many other factors, the realized value can be much greater (or smaller) than the theoretical value.

Now you might be thinking, this isn't all that attractive right? Even if we scale up the value by 10x, a million hit channel can only generate $100,000. That cannot even buy the cheapest HDB flat. I guess there are two points pertaining to this.

1. In the world of internet, the scale needs to be in 10-100 million or more

Sungha Jung has over 130mn hits for all his performances, going by my simple calculations above, his channel's theoretical value is $1.3mn, and in reality he has probably monetized even more. He succeeded with help for famous guitarists all over the world, supportive parents, perhaps generous sponsors and producers etc.

When we look at some old world artists with just one hit song, like Lisa Loeb with "Stay" or Berlin with "Take My Breath Away", CD sales are formidable at just a few millions, that is bcos the no.s left out people who listen half-heartedly and decided not to buy. Whereas the internet captures all these no.s as hits. To put it another way, if "Stay" started out as an internet song, it could have generated 100mn hits.

2. Longevity issue

A channel that can generate $10,000 in revenue one off might not be any good. But a channel that can generate $10,000 annually for say 10 years is something. Singapore's GDP per capita is $40,000. One channel that can year in year out gives $10,000 is worth a lot. But needless to stay, that can only be achieved with constant maintenance and updates. This in itself is a lot of hardwork.

Most musicians, if you ask me, don't really survive 10 to 20 years. Think of all the hits in the 80s and 90s, and where are the singers? Tiffany, Debbie Gibson, NKOTB, Jewel, Boyz To Men, Michael Learns to Rock, Cranberries etc. Well one might argue they made enough, called it a day. Or they might have drifted into oblivion against their will. Actually the pace of human civilization is so fast that most careers don't last that long as well. Guess that's why a lot of people in their 40s and 50s struggle with jobs and competition from the younger generations.

Back to YouTube Musicians, longevity is an issue, there is no two way about it. It would be quite a feat to last even just 10 years.

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To sum it all up, let's try to think about how to then maximize the full value of a popular channel.

I guess one logical answer would be tremendous hardwork and then promotional work in the first two years. This would include quick updates of new videos, selling via iTunes, finding sponsors and producers etc. This would then be accompanied by live performances, appearances in media, shows etc. Hopefully, with these, the revenue scaling really does go from $10k to $100k for a million hit channel. Of course, the better leverage factor would be generating more hits ie from million channel become 5 mn channel. This would in turn translate into more revenue down the road.

As the years progress, things will definitely slow down, so the focus might be on recycling the songs for other uses: awareness videos, commercials etc. And perhaps selling distribution rights but retaining a very small revenue share.

Thus the maximum absolute dollar value extracted could probably be somewhere between $300-400k. Well good enough to get a 3-4 room HDB in the suburbs, I guess.

Farewell Dr Goh

Friday was a sad day for me.

One of the greatest minds in Singapore history passed on. The Chief Architect of Singapore, Dr Goh Keng Swee. To quote Mr Lee Kuan Yew, generations of Singaporeans benefited and will continue to benefit bcos he laid the foundations of modern Singapore. EDB, SAF, JTC, CPF, MOE, MAS, GIC, Temasek, you name it. Down to the SSO, Zoo, Bird Park, Sentosa and even the Chinese and Japanese Gardens. He started everything! And the best part, he was selfless, he was humble and he cared for the people. He put his best 25 years into making Singapore a better place.

Dr Goh was a thinker way ahead of his time. He knew that Singapore has limited chances of surviving without a hinterland after the separation with Malaysia. So he came up with an original plan with Dr Winsemius, Singapore's economic adviser from the UN during the early days, to invite foreign MNCs to setup factories in Singapore, enticing them with tax breaks and cheap labour from Singaporeans. The site would be in Jurong, which was a swamp at that time. It was his most major gamble and he said himself it could be his greatest folly. But it worked. Singaporeans were just happy they had jobs, MNCs got their competitiveness and Singapore prospered. Years later, other countries including China followed his strategy.

He started our sovereign wealth funds, Temasek and GIC, in the 70s and 80s. The term "sovereign wealth fund" did not exist until a quarter century later. He did that because he saw the need to manage such large pools of money with dedicated teams of professionals to ensure decent returns (at least market returns) on our monies. The combined size of our sovereign wealth funds exceeds our GDP multiple folds today.

Dr Goh is truly one of Singapore's finest leaders. All Singapore flags should fly half mast for a week, in my opinion. All our dollar bills should have his face on it. May 14 should become a public holiday. The parliament house should have a statue of him. And yes, Jurong Industrial Estate should be renamed Goh Keng Swee Industrial Estate.

I wish I have the dollar bill with his signature. I would frame it and put it beside my Buffett and Munger dollar bill.

Someone is doing major update on Dr Goh's wikipedia page. Information has improved tremendously over the past few days.
http://en.wikipedia.org/wiki/Goh_Keng_Swee

I guess the sad revelation that I learned from reading his life story over the past few days was that he sacrificed his personal life and his health for the sake of Singapore. Or maybe he just wasn't as lucky as MM. After 25 years of intense innovation, adding immeasurably huge contributions to our society, he was diagnosed with bladder cancer. The fortunate part was that he still lived over 20 years after with his current wife, children, grandchildren and great-grandchildren.

So, live life to the fullest, but also in moderation and take good care of our health.

Just to put down here one of Dr Goh's best quote:

"The only way not to fail, is by not doing anything at all. And that, in the final analysis, will be the ultimate failure."

This quote was passed down to me across generations, from people who worked directly with him. and now it is with me. Thus his legacy lives on in all of us, Singaporeans. And it is up to us to let our children and our children's children understand his greatness and continue to learn from him. Like how schoolchildren today in the US still adore Benjamin Franklin and Abraham Lincoln, benefit from their foresight, worship them and still learn from them. Our children and their children will also continue to benefit from Dr Goh's far-sightedness. This is the least that we should do: pass on the legacy of one of our greatest Titans.

Thank you Dr Goh, thank you for all that you have done for Singapore.

On Wikipedia and Markets

I was reading this book "The World Is Flat" and this small little story on Wikipedia caught my attention. Btw this is quite an old book and one can so obviously deduce I am so behind in my reading... I think the author has written like three updates and published at least a sequel. There wasn't much of truly good insights but lots of small interesting stories which makes it an entertaining read and perhaps that's why it's selling million copies.

Anyways the story on Wikipedia was that even though it was a free encyclopedia,  contrary to popular belief that Wikipedia has a lot of crap, things posted can actually be quite accurate. The rationale was that for every topic, there will always be those that are Pro and Against. So the Pros will write their story, but whatever is overboard gets deleted by the Against. This goes on until what is written on it presents the most valid view and nobody edits the page any further.

Of course this only works when there are many people editing the pages. At the end of the section, the author did state an example where a senator was accused of involved in killing JFK on Wikipedia, and since a lot of sites simply take what is on wiki, he was shocked to find newspapers calling him asking  whether he killed JFK. Similarly you can go and write a wiki page full of rubbish to spite your idol's rival and if not enough fans edit the pages, you achieve your aim.

Now the link here is that markets work in the same way too. Someone who thinks the stock is too cheap buys it, someone who thinks otherwise sells it. Until equilibrium is reached. Now this equilibrium is based on every market participants judgement on the stock at that point in time. So the current stock price should reflect the most efficient price to most of the participants at that time. This is the basis for the efficient market hypothesis.

Needless to say, if the stock is very thinly traded, ie not too many people have an opinion on it, the stock can be mispriced and stay mispriced for a long time. Value investors buy stocks that are  mispriced by being very cheap and wait for the market to find its true value. Or in the Singapore context, these stocks get taken out private at a cheap price. Of course, the way the human mind works, a lot of people actually don't mind overpaying for garbage, like companies with no earnings, LV bags and Mickey mouse apartments at $1000psf. So stocks can stay mispriced on the upside for a couple of years too.

Now you might be asking if the market is efficient, how does value investing fit in? If the stock is always at the right price, there is no gap between price and intrinsic value, how can value investors benefit then?

The answer is Patience. Most of the time, price trade very close to value. There won't be 50% upside. But there will always be times when things go out of whack. In the big way, it would be like 2007 financial turmoil, where great companies get whack down to very cheap levels even though nothing much has changed in their businesses. Think Coke or P&G, do people stop drinking and stop shampooing in a financial crisis? In the minor ways, some stocks trade down on temporary, one-off issues. Most market players then get emotional and judge the stock only in one direction (ie down) in the span of that few days or weeks.

E.g. bcos of bad weather, less people go out shopping, fashion clothing stocks get sold down. We all know that girls need to change their wardrobe every month, so when chances like these come by, just go buy Gap or Victoria's Secrets or Zara. (disclaimer: I have never researched these co.s, just arbitrary naming fashion stocks) Sooner or later, they go back up to their true value.

In a sense, this is how value investors can beat the market. But this is still easier said than done. Well at least now we know Wikipedia may be more accurate than your beloved local press reporting, so for those who thinks Wikipedia is unreliable, give it more credit!

The Acme of Value Investing

I have been thinking about this for a while. Some time back, Warren Buffett started buying over mum-and-pop businesses that have grown tremendously over a long span of time from its original owners. These owners have painstakingly built their empires over the years, they are now old, they want to cash out some of the future earnings of their business, so they go to Buffett. But how do they determine price? Buffett being Buffett, is not going to undercut them by paying them just 10x earnings. But he definitely will not overpay as well.

In the stock market, Mr Market determines the price, which some times go crazy and the owners of businesses (ie shareholders) have no choice but to sell at basement prices. Buffett takes this opportunity to buy from these willing sellers. Well, in the first place, some of these market participants never regarded themselves as the owners of the firms which they hold stocks. They are in for the quick gamble. So Buffett gladly profits from their fear.

However, in private transactions, Buffett knows these sellers. Some of them are his friends in Omaha. He is not going to shortchange them. So the logical conclusion is that Buffett pays a reasonable price for these businesses he buys, Maybe 18x earnings. We can think of it as the sellers get 18 years of future cashflow from their business. Thereafter, the profits will be what Berkshire shareholders stand to gain from. There is bread from everybody. Nobody gets shortchanged.

To put it graphically, value investing is often viewed as buying an asset below its intrinsic value with a margin of safety (ie buy when purple line is below green line). Since Mr Market eventually prices asset correctly (albeit after a long time and only for a short while), money is to be made when value investors buy stocks way below intrinsic value and wait for it to rise back to intrinsic value.

However what Buffett does with buying good franchises would be buying an asset at its intrinsic value, at that point in time. And since it is a good franchise, its intrinsic value rises over time and way out into the future, Berkshire shareholders benefit from the exponential growth in intrinsic value. This is perhaps why he keeps talking about buying a strong franchise at a reasonable price, rather than buying a mediocre firm at bargain prices.

In every transaction, we are taught that usually there is a buyer and a seller, and there is a winner and a loser. Yet in Buffett's position, it is possible to have a transaction and yet benefits both the buyer and the seller. In my opinion, this would qualify as the acme of value investing.

The Truth Shall Prevail

Value investing is based on an inherent fundamental assumption: that someday, an asset's true value (or intrinsic value) would be realized. Hence buying a stock when it is trading significantly below intrinsic value would yield good return bcos they eventually trade back to its intrinsic value (albeit after a long time and only for a short while). But what happens if the stock never reverts to its intrinsic value? Is that likely? Well I don't have a good answer to that, but let's explore this topic a bit more broadly first.

Analogous to this the concept that a stock eventually reverts to its intrinsic value are similar logics like: the truth shall prevail, good will triumph over evil, hardwork eventually gets rewarded etc. I would think that these tenets should hold most of the time, if not all the time. The issue in the real world is that it can take generations for them to come true. Think Khmer Rogue, North Korea. Think about why some incompetent managers can stay in the firm for years. Or why some evil deeds never get punished (50% of murder cases are unsolved). Well the stock market is efficient, but the reality may not be as efficient.

Khmer Rogue did get its retribution after killing 6 million Cambodians 30 years later, and one or two ex generals are getting trial. One may say that this is too little too late. But Cambodia is finally thriving now with its Angkor Wat and a few hundred other Tomb Raider ruins. But our beloved tyrant in Pyonyang is still enjoying his tyranny. It's been about 20 years of hardship perhaps for the North Koreans? Well I hope I can see some resolution in my lifetime.

Of course, bad managers, they manage to stay afloat for some time but eventually they are either being force to retire or they themselves choose to retire after creating maybe 20 years of negative goodwill amongst colleagues. Yes the damage is done. But what I think could happen is that these people accumulate so much negative goodwill during their lifetime, even though they can be rich and living a luxurious life after retirement or termination, they are not happy. And they die not happy.

As for murder cases, again we can only hope that goodness finally prevail whenever the murderer reflects that he lived a meaningless life, caused only harm and pain to the world and dies a lonely death with nobody to mourn for him, eventually.

The fortunate thing about markets would be that many many participants are judging the stocks, everyday. Hence prices revert to value relatively quicker (but still a good 3-5 years). However there are cases that prices never revert back to value, then shit happens, like the company got taken private at a cheap price (very likely in Singapore). But overall, I would say maybe 70-80% of the time, prices will revert back to intrinsic value over a period of 3-5 years or sometimes a bit longer.

In the case of bad tyrants and bad managers, I guess the problem lies with too few judges. For bad tyrants, virtually nobody can judge them until things get so bad that the people revolt (usually 50 years or more? If we look at the history of China). Or in today's context, global leaders may force a regime change. For bad managers, well perhaps a few bosses on top judging them but not a whole lot efficient. Hence, in my opinion, universal truths can take a long time to prevail. In the worst case, a hundred years.

What is the solution to this?

In the stock market, it would be some diversification, buying enough value stocks so that even if one or two stocks never returns to its intrinsic value, the portfolio should be ok. And that is perhaps why good value fund managers tend to be able to beat the market more often than other managers.

In reality, my current thinking would call for dis-association. Or simply escape from such situations, bcos we cannot live a hundred years to wait for things to revert. I always wondered why North Koreans can endure such shit for 20 years. Shouldn't 90% of the population be gone by now? Indeed I estimated that 0.5% of the population escapes the country every year. But the conclusion I arrived at is that people weigh the risk of dying while escaping vs risk of dying in North Korea and choose the latter. Aside from the great famine in 1993-95, most people have enough food to eat so as they won't die, they have a shelter over their heads, medical is taken care of somewhat. And they adapt. However population growth for the country is near zero or may even be negative. Needless to say, economic growth is also near zero. Well that's North Korea.

As for situations closer to our reality, like in the cases of your bosses happening to be real jerks, pls quit your jobs asap. That is the first step, the 2nd step would be to help the world by revealing their evil deeds such that justice can prevail faster.

How To Live Longer

This would probably be my first non-investment related post. Well, it’s sort of related bcos in order to reap the full benefits of value investing, time is a terribly important component. So by living longer, your investments can compound for an extended period of time and you get richer! Remember Warren Buffett only got famous around 1980s when he was already 60 plus. Then finally attend icon status after the dot com bubble burst, when he was closer to 80 years old!

Btw, much of what’s below is lifted out from some CLSA report. Much as I dislike having non-original content, this list is too good not to be shared around.

Anyways, here is real deal:

A researcher called Dan Buettner spent a lifetime studying people living in what he called Blue Zones where the population life expectancies are much higher than average. Here are the things that he found out:

1. Exposure to sunlight: his studies showed that people living in places with a lot of sun tend to live longer, like Hawaii, Okinawa, Mauritius whereas people in Norway, Siberia are not so lucky.

2. A little alcohol every day. But not too much. I think this is quite well-known.

3. Big breakfast. Not too sure why is it so impt, but I guess all those diet programs emphasizing less food during dinner do ring a bell here.

4. Eat more vegetables. Not exactly zero meat, but more vege definitely do our bodies more good than bad.

5. Eat a lot of tofu. This is the only food that can slow aging somewhat. There are 99 processes that age human beings and no one pill, food or treatment can reverse all of these processes. Tofu comes up top though.

6. Have a social circle. With a group of close friends or relatives looking for one another definitely helps to improve life expectancy I guess. And this is not about your 501 Facebook friends, but real buddies and kakis that you really like to hang out with forever.

7. Choose your friends well too. No point if your best friends are thugs or serial-killers I guess. Even obese friends are not so good.

8. Get married. Married people significantly outlive singles. But not sure about those who are married multiple times though.

9. Sleep 7 hours a night. Not too much though. 10 hours apparently doesn’t help. But 4 hours is the other extreme. Napoleon died at 52.

10. Have a purpose in life. Retiring is not a good idea, statistically the year you retire is one out of the two years in life that people are most likely to die. The other being the year you are born!

11. Be optimistic.

What not to do:

1. Exercise too vigorously – like going for marathon every week. Moving naturally is good enough.

2. Smoking – Takes 8-10 years of life away.

3. Diet programs – doesn’t work. What is needed are long term changes to eating habits, eat more veges and less in total.

I always believed in the Grand Theory of Balance. Basically, do everything in moderation. For each of these points, you cannot overdo or underdo. Like alcohol, sleep etc. So to live longer is then really about living life in moderation.

Wealth, innovation, hardwork and others

This post serves as clarifying some economics concepts for myself also. It has to do with wealth and how it links to being rich and famous and getting adored by the masses.

Imagine that the world has only 2 pple: 1 farmer and 1 fisherman. The farmer harvests some rice every day and the fisherman catches some fishes. The farmer will sell some rice to the fisherman and vice versa. So the money supply in this world has maybe like $4, $2 with the farmer which he gets from selling 2 kg of rice and $2 for the fisherman who sells 2 kg of fish.

So the question is how can either of them get richer?

This is quite easy to answer, say the farmer is the aspire-to-be-rich kind, so he contemplates to be richer than his other companion on this lonely Earth. Well, what can he do? He can raise prices.

Say previously he sold 1kg of his rice for $1 to the fisherman. Now he can sell $2 for 1kg. Then he will be earning twice as much! How wonderful. But then since there is only one other person on this lonely planet, i.e. the fisherman, he will raise prices too unless he is stupid or something.

Then we get into a situation called inflation. Nothing really changed just that things got more expensive. It doesn't mean that if you have more dollar notes, you are richer.

So how does the farmer REALLY gets richer than his companion?

1) He can work harder than his companion, he harvests more rice and sell more to his companion. But since his companion may not be as hardworking, i.e. the fisherman only catches the same amt as previously, he will not be able to sell more fish to get more money to buy more rice.

The farmer's wealth in this world is restricted by the total money supply of $4 so the farmer get "richer" by way of having more free time since he can store up his harvest and wait for the fisherman to have more money to buy from him.

Or he can sell more rice on credit to the fisherman and now he gets more dollars in his safe deposit box while the fisherman has some debt.

2) He can cross pollinate the rice grains and sell a new grain of rice which is more delicious and charge his companion more for each kg. The fisherman "naturally" has to understand the quality difference and is willing to pay more for delicious rice. But again bcos the fisherman may not fish better quality fishes, he is again limited in his capacity to spend and the farmer gains by having more free time or getting money on credit again.

So in other words, the farmer get richer than the fisherman either by working harder, by thinking harder (innovate a new grain of rice) or by luck. Well, the farmer can get lucky and somehow the rice mutate by themselves into a better grain and he then sells it more expensive to the fisherman.

Well there is a fourth way, but it delves into immorality like by cheating the fisherman, telling him the rice is a kind of new grain but in fact it is not. Sadly, a significant proportion of rich people actually amass wealth through this fourth method.

So how can both of them get rich?

It can only be through improvement in efficiency (or technology advancement) for both of them. Say both the farmer and fisherman somehow managed to harvest and fish much more in the same time versus previously, they can then sell to each other in higher volume and get more dollars from each other (i.e. an overall increase in wealth).

If you think of these issues in our world today. Usually most people get rich by through their own hardwork or innovation or luck (or some through deceit), and they managed to amass wealth ahead of the population. But bcos the population is not as advanced as these rich people are, the poor simply gets left behind, becoming poorer in a relative sense. In our 2 pple world, the money supply is restricted bcos there is only 2 pple so the rich farmer can only get more free time or earn money on credit. But in the real world, the rich amass fortunes from 6bn other poor pple. So they get a lot of dollar bills - which are credit to buy services from the society.

The true accomplishment would be the raise the bar for all pple so that everyone gets richer. But this is a feat that is difficult to achieve. Why would the rich raise the bar for everyone so that they become poorer in the relative sense? But for those that do that, we gotta take our hats off to them.