Friday, May 20, 2011

The Many Faces of PE - Shiller PE

With the new Cabinet in place and the WP working hard to defend what they have won, it is time to get back to real investment! Today we look at our favourite ratio again!

PE or price earnings ratio has been talked to the death on this blog. This is more to just summarize the various ways to look at this ratio, or rather, how many in the investment community looks at it.

1. Cheap or Expensive

The PE ratio, first and foremost, is the quickest way to determine whether a stock is cheap or not. It is obviously not the best way, as most source will give the PE based on next year's earnings. Now why should it based on 1 yr's earnings is beyond me, given that business and the economy in general tend to go through cycles. In any case, we have discussed this about a million times. Here are a few of the earlier posts:

PE Ratio
Earnings yield

2. Shiller PE

Well it appeared that it wasn't just me who thought that PE should be based on some long term earnings instead of just next yr's. So some professor named Shiller calculated PE based on 10 year's worth of earnings. Before him, of course, the Grandfather of Value Investing: Ben Graham had already advised everyone to use 10 year average in the 1960s. Sadly, nobody bothered. Well at least today Prof Shiller continues to maintain the database of PE based on 10 yr's earnings and below is the chart.

From the chart, you can see why no broker would want define PE using 10 year earnings. Bcos it shows you there is about 3 times in the last 100 yrs where stocks were truly on bargain, 1920, 1931 and 1982.

There is about 10 times where you can buy at 10x PE, which is still quite cheap, over the last 100 years. If you are a true value investor and you know it's risky to buy over 15x, basically, this chart tells you that you shouldn't have bought anything in the last 20 years.

So is it a wonder why nobody showed us this kind of PE calculation?

Ok you might argue that if this Shiller calculation did nothing in the last 20 years, and we missed that bull run in dotcom, and during 2006 and 2007 when China was the bull and the bulls were all in China, then maybe we shouldn't be looking at it at all?

That is true, but I guess the main purpose of using such conservative ratio would be to protect against any risk of losing a lot of money. The Shiller PE would more or less guarantee you that you will not lose money if you bought when it showed 10x. It cannot tell you to buy at 15x hoping it will go to 40x.

Next post we look at the other faces of PE!

Saturday, May 14, 2011

The New Singapore Economy - Part III

This is a continuation of the previous two posts:
The New Singapore Economy - Part II
The New Singapore Economy - Part I

I guess the one major issue with the paper's Rengeration Plan as it was called, was actually the sustainability of the various measures. Just to jot down a partial list of proposals:

1. Doubling the no. of schools and teachers
2. Doubling the no. of hospitals and medical professionals
3. Waiver of Govt fees and taxes such as GST for basic items etc
4. Reducing the cost of raising kids: free education, monthly allowance, more maternity and paternity benefits etc

The problem here is that both schools and hospitals do not make money. Hence the first two proposals increases the burden on the State. At the same time, the last two proposals take money away from the State by reducing its revenue, either with lesser tax and fees or increasing cash outflow such as more allowance, more benefits etc.

While I think we can accept that the first $60bn sunk into building the initial infrastructure can earn zero return (after all it's a Govt, not a profit making entity), it might not be prudent if, on an on-going basis, all the measures simply run losses with no possibility of breaking even on an annual cashflow basis.

Just take an example of a school. The new school has on average say 600 students. Suppose we double the no. of teachers from currently maybe 30 to 60 teachers. In order to attract more people to become teachers, we need to pay them more, say on average $80k per teacher. This means that payroll alone is close to $5mn, including other running costs such utilities, peripheral services like security, maintenance etc, we might be talking about $6-8mn annual cost per school.

With zero revenue since school fees are proposed to be free, and 800 primary schools in Singapore, this alone is $5-6bn. Today, Education consumes just $8-9bn in our Budget including secondary schools and tertiary education. Hence this Regeneration Plan with the doubling of just primary schools and teachers will almost double the burden to the State, with no way of squaring the equation on the revenue side.

Of course the argument is that our Govt always incur surpluses, year in year out, which means that it has too much revenue in the first place. So doubling the burden is just making things right. It is okay to have a $14-15bn Education spending, which by the way will make Education the biggest spending, even bigger than Defense at $10bn.

Nevertheless, it might be prudent for these schools and hospitals to introduce some kind of revenue measures to offset the huge costs. Sustainability has always been a key aspect of our system and I believe our leaders really did get it right for some of the best sustainable systems put in place in the early years.

So how can we make the plan more sustainable?

With schools, we could have a two-pronged approach:
1. Endowment/Foundation for Primary and Secondary Schools
2. Aim to be a Tertiary Education Hub attracting foreign students

The Govt can setup an Endowment Fund for all Singapore primary schools and encourage old boys and girls to donate to their alma mater. Their donations can be tax deductable which would mean those who are successful would be keen to donate more.

Some of the most prestigious universities in US have endowment funds that are so big that they need to invest this money professionally for a good return. Our endowment funds should strive to do the same.

For tertiary education, we have already made some inroads in the private sector. Insead and Chicago have their MBA campuses here. The Govt should devise a comprehensive plan to make Singapore an overall education hub in Asia. Revenue made at the tertiary level can be used to subsidize primary and secondary schools.

For hospitals, there is only one option: become a medical hub. ie they would have to attract overseas patients. This means that Singapore has to become a 1st class medical hub that can compete globally with Bumrungrad in Thailand and Mayo Clinic in the US. The potential is definitely there. Our private hospitals such as Mt E Hospital have already made an impression in the region. It shouldn't be too difficult for the Govt to succeed as well.

It will take some time to achieve sustainability so perhaps the most important task for the Govt when it does embark on the Regeneration Plan is to optimize its revenue from taxes such that it can support the system during transformation (as the schools and hospitals try to gain sustainability).

It would probably mean more taxes from the rich and famous, more revenue from property (the playground for the rich and famous) and perhaps some cost savings by de-emphasizing Defence, reducing fat from every civil sector and *drumrolls* reducing Ministers' Pay: the No. 1 item on the voters' wishlist!

Friday, May 06, 2011

The New Singapore Economy - Part II

This is a continuation of the last post.

As with the Govt, various Ministers took pain to tear down the proposals in the paper by biting on points that appeal to peoples' hearts and emotional logic. These are:

1. The $60bn Price Tag
2. Raiding Temasek
3. Loss of Manufacturing Jobs

The first big rebuttal that came about was the big price tag. $60bn is unheard of. Our Govt annual budget is roughly around $30bn. Big no.s floating around are usually terms of millions or single-digit billion like YOG cost overrun ($300mn), Grow and Share Package ($3bn) and Lehman Crisis Emergency Help Everybody Fund ($10bn or so, which drawdown our Reserves for the first time).

However, it was not mentioned that the $60bn would be spent over 5 years. In fact I think it is more likely that it is spent over 10 years. This would be a more reasonable $6-12bn per year. Also it was highlighted that the Govt surpluses over 5 years (over $100bn) would have been more than enough to fund the $60bn.

An additional funding source mentioned was Temasek Holdings. $60bn was roughly just 1/3 of Temasek's portfolio and hence not a major issue. In fact by reducing Temasek's stakes in various listed entities (over a couple years), we could add liquidity to our equity markets and attract more investors to invest in Singapore.

While I do not know if that's entirely workable bcos it would cause major stock price disruption to the various listed entities and change the way investors look at these companies, I think the idea deserves scrutiny rather than the usual simply-brush-it-aside bcos it didn't originate from the Govt.

Perhaps the biggest hoo-ha came from this 3rd point of de-emphasizing manufacturing. 25% of Singapore's economy relies on manufacturing which support hundreds of thousands of jobs. Is this guy crazy to even suggest this?

On closer look, maybe not, you know... Below is a list of countries and the size of their manufacturing sector in % terms relative to the size of their economy.

China 33%
Korea 25%
Singapore 25%
Japan 22%
Germany 22%
Italy 18%
Brazil 15%
US 13%
UK 13%
France 5%

As you can see, most developed countries have a small manufacturing sector (less than 20%) unless they have an edge in manufacturing such as Germany and Japan. Of course in China and Korea, they compete on other factors such as lower cost. But what is the edge that Singapore has against these countries? Why are we pursuing manufacturing? Can we make better cars than Germany? Or better ships than Korea and China? There is no good answer.

The model that we have pursued 50 years ago might no longer be so relevant. Back then Singapore was as cheap as China today, we had a young population and we needed to provide a lot of jobs, fast. Today, we are so different. Things have changed.

On the other hand, the service industry suits our highly educated workforce and is not subjected to the volatility of global consumer demand. Singapore already have some brand with its education, healthcare and creative industries. We can definitely leverage on that and grow them bigger.

Granted, there will be a lot pain during the adjustment but what was proposed does make sense. Again my point is that we shouldn't just brush it off. Someone should be doing more study into whether this actually works.

Of course, the other angle is also that actually our Govt is already doing it. They might have started to shift out of manufacturing years ago. And we did get LucasArts to setup shop here and we got Chicago and Insead to have their MBA campuses here. But still, we shouldn't have built the casinos, right?

Next post, we look at some of the real issues with the paper.

Tuesday, May 03, 2011

The New Singapore Economy - Part I

One of the Powerhouse Opposition candidate Mr Tan Jee Say wrote a comprehensive paper to revamp Singapore's economy recently. I had the opportunity to read it in full and I must admit it's IMPRESSIVE. You have to give it to him (and the Govt training that he went through). After all that's the quality we would expect from a former high ranking civil servant and PPS (Principal Private Secretary) for the top officials.

Here is my unabashed point form summary that really doesn't do justice to the 45 page report. I urge readers who are free to read it in full. It's available on the onlinecitizen website. Here are the points:

1. Mr Tan Jee Say thinks that Singapore's economy should move away from manufacturing as this industry takes up too much land, labour and resources and Singapore is in short of all three elements. Manufacturing also adds volatility to our business cycle as it relies on global exports which is dependent on fast-changing consumer demand. In today's knowledge based economy, Singapore's reliance on manufacturing does not make sense.

2. Partly due to our big manufacturing industry (and also other reasons), the Singapore Govt had to rely too much on cheap foreign labour to generate GDP growth. This resulted in economic benefits trickling down to foreigners rather than the bottom 20%-30% of the population, causing their income to stagnate or even fall.

3. Singapore's future lies in the service industry but the Govt went into the wrong kind of services by building casinos. The emphasis should be on education, healthcare and creative industries.

4. Cost inflation in Singapore is largely driven by the rise of non-tradable goods and services (55%). While import prices accounted for the rest (45%). This means that costs like labour, fees and perhaps most importantly rental accounted for a significant portion of cost inflation in Singapore.

5. He proposed a $60bn package to address various needs including a restructuring of the manufacturing industry, promoting education, healthcare and creative industries, improving neighbourhoods and quality of life and a reduction in various fees that has added to cost inflation.

The paper also highlighted economic irregularities amongst various issues that really challenges some of our basic assumptions in Singapore. At least to me, it was a totally worthwhile read that was not only informative but also highly educational on economics, policies and moral issues.

Just as an example: he mentioned that the Sg Govt usually resort to price-mechanism to control demand such as in the case of ERP for driving and Foreign Work Levy in the case of importing foreign labour. However there are flaws with price-mechanism bcos the crux of the issue sometimes lies in supply or demand dislocations and using price does not solve the issue but simply add money to Govt coffers.

Take the case of ERP. The real problem has to do with too many cars and not enough roads. In 10 years the car population increased by 20-30% while the length of roads stayed the same. So is it a surprise that raising ERP doesn't work but just add money to the Govt coffers?

In the case of Foreign Work Levy, raising the levy benefits neither the employer nor the employee. Instead it benefits the Govt. So obviously, the Govt would use it in the first instance to restrict employers from recruiting too many foreigners. However this does not solve the fundamental problem: manufacturing and some industries like construction, low-end services are not suitable for Singapore's knowledge based economy. Hence we need to import foreigners to fill the gap.

On moral grounds, the paper also highlighted that is was not just economic no.s that matter, Govt should implement measures that are also morally right.

So, casinos was a major setback. While the Govt tried to promote a different image via the concept of Integrated Resorts, the truth of the matter is casinos come with social costs/issues that are very difficult to avoid.

Minimum wage, besides having a strong economic argument, is also morally right. If we ask for the service and effort of others, we should pay them what is an acceptable minimum amount in our society. When foreigners come, this concept is totally lost and the lower income households bear the full brunt.

Next post, we look at some Govt rebuttals!

Sunday, May 01, 2011

Solutions to the HDB conundrum

This is a continuation of the last 2 posts:
Are HDB prices really expensive?
What's wrong with HDB prices?

What is the solution to this huge conundrum of HDB prices being much higher vs its history and vs some Singaporean household income (esp lower income groups) yet lower in terms of rental yield and absolute prices vs other Asian cities?

The Opposition had come up with the cost plus solution. ie if the cost of building a HDB flat is $150,000, then the Govt should just put a tag of say $200,000 and sell it to Singaporeans. While this solution is pleasant to most would-be buyers, it creates huge problems for the system.

First by making new HDB prices widely different from current market prices, you run the risk of enticing speculators to join in the fun. Already, there are young couples who had tried to game the system just to get a good flat at a good location, balloting 10x in the span of a few months. It might become a major issue. Maybe people might just pretend to get married just to get a HDB flat then sell it after 5 yrs, divorce and split the profits. Things can really get out of hand. Hence cost plus model might not be ideal.

It is also imperative to bring prices down slowly over time rather than crashing it, a pointed highlighted by various ministers as it affects the valuation of 1mn homes. If prices crash, a lot of people might not be able to pay their mortgages, go bankrupt and create more problems.

Having said that, there are other possible solutions, which admittedly, the Govt is already implementing. Well, what do you expect, it's our First World Govt after all. They would have thought about it.

Economics will tell us supply and demand determines price. So we should aim for tools that can help us control these, as well as measures that can deter punters. Anyways, here are the some widely discussed must-implement measures:

1. Smoothen supply and leave some slack

If you look at HDB supply of flats over very long periods like 5-10 yrs or more, you see huge ups and downs, some years 20,000 new flats, recently has been 8,000 and lowest was at 5000. They should have learnt long ago not to time such cycles. Knowing that Singapore has 20,000-26,000 marriages every yr, just build say 15,000 flats every year (since not every new couple will get a HDB). Then review the system every 2-3 years.

In fact it might be prudent for HDB to always have some slack. Ensure there are always 5,000 flats available. In times like this, release them and make people happy. After all, if it's the Govt, isn't it ok to have stockpile of flats, when govts around the world stockpile stuff of national interest like oil, rice, or even gold.

2. Increase grants or other benefits to needy

While we cannot go for a cost plus model, we can always increase grants to people who need them. Current grants are like $30-40k when HDB prices can go to $700k. This is a miserable 4-6% of HDB prices. This should be increased to 10-15% to make it relevant.

As for lower income households, HDB can also help by reducing the interest rate for mortgage. Currently it's still 2.6% while commercial banks are giving 0.8%. Perhaps for the needy, HDB can match the commercial rate.

3. Variable LTV

For most speculators, LTV is an important ratio. LTV stands for Loan-To-Valuation and it basically determines how much money a buyer can borrow from the bank to finance the mortgage. For HDB, it's 80-90%, ie one can borrow up to 80-90% of the house price. In other words, punters can simply put up 10-20% in cash and punt the property.

The LTV can be made variable to deter punters and help the poor. Total asset size and household income might be a good place to start. A household with $50k in assets and $50k annual income probably isn't looking to punt HDB. But a retiree with zero income on paper but $50k from overseas stock dividends and $5mn in asset after his condo en-bloc sale might be.

There are other probable solutions to help cool the general property market (not just HDB) and also protect the rights of home owners. Maybe someone should write a 46 page report to address these points.

1. Improve lending rules to deter punters

Albeit this is already being implemented esp on the LTV front. Perhaps more can be done at the int rate level. Implement measures such that commercial banks cannot provide lending at ultra low interest rates as it encourages punting. This might include charging a higher spread over SIBOR or SOR, or maybe even a complete revamp of the system: ie not using SIBOR/SOR but a flat rate of say 2.x%, like HDB. The other solution would be for MAS to raise short term interest rates. However this have far wider economic implications.

2. Tax developers more

Property developers enjoy supernormal profits. If a developer just sell 60% of a condo development and can breakeven, something is not right somewhere. The other fact is somehow any Ah Beng, Ah Seng also can be developers. Look at Popular bookstore, SPH or some of the smaller construction firms. I am not sure about the specifics, but I think there is some loophole somewhere. Increase their taxes.

3. Change en-bloc rules

If 80% of the people say you should let them sleep with your wife, does that make it ok to really let pple sleep with your wife? The en-bloc rule is terrible for someone with no intention to sell their house. Protect their rights - naturally this will disrupt the supernormal profits of developers as well.

4. Land sales

This is coming. Marlboro Tan was pressured to do something to cool the property market. Maybe land supply should also follow the same logic with HDB, ensure some supply in place and use it as a tool to control prices. Also, make it difficult for developers to get land cheaply.

5. Tighten psf criteria

As you should know, they change the ruling some time in the 90s to allow like balcony, aircon area, wall area to count towards floor area of house. Hence old flats are much bigger even with same paper floor area. Change this. Or maybe make sure it doesn't get worse and owners doesn't get shortchanged.

6. Talk down markets

Talk is cheap. Just give some conservative statements. Like "although property prices will rise in the long run given Singapore's progress, the current situation calls for prudence. We urge new buyers to consider their financials when shopping for new homes." Don't just talk Ra-Ra all the time.

7. Restrict foreigners

Make it more difficult for foreigners to buy. After all they are mostly punters anyways if they don't stay here, or have any connections with Singapore. How do they contribute to the well-being of Singapore? Make sure they need to park like a godzillion dollars here before they can buy anything. Oh and their LTV should be like 20% or something. And tax them jialat jialat!

Well these are some measures that can be put in place, albeit some already are. The implications are that property prices will fall, a lot of punters will go bankrupt and the banks with the most mortgages might suffer a little. But it might be a good thing for the future. Take out the froth, endure some pain. At least our kids would be able to afford HDB again and maybe even pursue the 5C dream of owning a Car, a Condo, a Country club membership and have some Comfort in having their own Children some day.