Monday, December 23, 2013

Investing is about Swaping Cashflows

If we strip down to the bare basics of investing, it is swapping today's money for tomorrow's cashflows (or future cashflows). So, you buy a stock at $100 today. What you actually want is that the stock can generate more than $100 in terms of future cashflows into perpetuity. The goal of value investing is then to determine how much all these future cashflows is worth today, and pay a lower price (at least 30% lower). So in theory, if you can accurately calculate that the value of all the future cashflows is worth $200 today and you buy the stock for $100. Then you have made a lot of money. Of course that's the hardest part - estimating all the future cashflows.

So, how do we calculate all the future cashflow? The simplest methodology is to apply a multiple. If the co. earns $10 today, give it a reasonable multiple, say 15x - there, you have it. The value of all its future cashflow is $150. Now that's crude right? But essentially that's what the whole finance industry does and that's also what the world's greatest investor, Warren Buffett does. Of course Warren Buffett perfected this art, by buying businesses that have predictable cashflow into perpetuity. Well it's still an art, so by default, it is hard to get it right most of the time. I have also discussed this in detail in the 5 Things You Need to Know about Investing.

Buffett also thinks hard about how to discount future cashflows correctly. Discounting is essentially saying that a dollar in the future should be worth less today as a result of compounding. The methodology is discussed in detail in this post: Faces of PE - DCF. But at the crux of it, the ways and means to value a stock is not different. For those readers yearning for a short cut. the easy way out is to determine a long term average earnings per share (EPS) of a company with a solid business (like Colgate or Swatch or Coke) and then multiple it by 12-18x. For a great business, you can pay up to 18x. For a so-so business, better just pay 12x or less.

That's Warren Buffett, world's greatest investor.

Many things affect whether a stock should be 12x or 15x or 18x. You can find some discussion in the Valuation label. Now once you have determined the right valuation, the right EPS and have gotten the intrinsic value of the stock, you compare it with today's stock price. If the stock price is significantly lower than its intrinsic value (like 30% or lower), then you have got a strong case to buy. That's really putting it in very elementary terms and no guarantee for you to make money. To learn more, do read the rest of the 250+ posts on this blog and you can start with this 1,500 word introduction on Value Investing :) Cheers! 

 Ok, next we talk about something more mind-boggling. If we think in terms of swapping cashflows, then we must also realize that this is a totally different ball game vs buying a stock at $100 and hoping that the price goes up and we sell and make a profit at $120 to a Greater Fool. The mind-boggling way to think about this is that there is no stock market and no daily price after you bought the stock. You are buying an asset at $100. The only return you are assured of is how much this asset will generate down the road ie how much cash will this investment eventually churn out over time, into perpetuity. There is no other buyer who will come quote you a price every day. And you cannot hope to sell at a higher price to a Greater Fool who is willing to pay for it at the higher price. 

That is the way we should invest. Warren Buffett ever so often says that the market can shutdown for 10 years, he doesn't really care. Because essentially he is buying future cashflows. And he doesn't give a damn if nobody is willing to buy his business or give him a quote tomorrow, or one year out, or 10 years out. When he paid $100 for the business he wants, he is already sure he would make money. Because the future cashflows from the business is very likely to be more than the $100 he paid today. So essentially, money is already made when we buy, not when we sell.

 I believe that's the way to invest.

Thursday, December 12, 2013

Swatch’s Everything (including Serina Wee)

The first Swatch post started in Sep 2012. After 15 months and 8 posts, I am still not done! It’s a marathon competition against the City Harvest trial to see who can last longer. But City Harvest would win the popular vote I guess, with Serina Wee, Singapore's prettiest accused criminal. All Singapore straight guys are just jumping around and can’t wait to see her strut down Supreme Court again in January. But, this blogger would not go down without a fight to win the popularity contest.

Here’s a pic of Serina Wee.

Ah! My eyes… No… Sorry, paisei, sala pic. You can see Serina at the end of the post :)

Anyways, 15 months! That’s too long a time to do a trial, sorry I meant an analysis. So, this is the post that shall end it all. It must be stressed that a good analysis need not take 15 months. Warren Buffett does his in two days. For the rest of us mere mortals, I would say we might be able to do it in a week or two if we put our minds to it? Anyways, sometimes you don’t really need to know 100% or even 90% of the company. Just know the few key drivers.

For Swatch it would be their retail expansion/distribution strategy, the reform of Harry Winston and in the longer run, succession planning. I have discussed these in the previous Swatch posts and Harry Winston would be discussed below.

Do take a look at my work on 3M and Colgate as well to get a feel.

Today we shall cover the rest of the stuff with Swatch. The key remaining components are: Industry and Geography Exposure, Harry Winston (a new topic), Risk and Mitigators and the final questions.

First stop: Industry and Geography. These are no.s that an investor would like to look at. For Swatch I have decorated them into the nice pie charts below. Take that! Serina!

On the left chart, you can see that China and Asia are the key sources of earnings for Swatch. It is worth pointing out that a big part of the sales in Europe is also driven by Chinese and Asian tourists. On the right chart, needless to say, watches and jewellery would be the main contribution. But what is more useful could be the further splits into watches vs jewellery and the split between manufacturing vs retail.

Another important split is by its brands. It should be highlighted that Omega is by far the most important brand for Swatch generating 35% of sales and 40% of EBIT. EBIT is short form for Earnings Before Interest and Tax, also known as Operating Profit. It is the most important line in the P&L statement.

Some of these no.s would not be easy to come by. It would take a lot of reading (of annual reports and analyst reports) to figure them out. Sometimes it’s best to be able to ask someone, like an analyst or the investor relations of the company. But that is not usually an option for retail investors. So for really serious investors, we might want to think about setting up a company if only to gain access to more information.

Next topic: Harry Winston.

Swatch bought over Harry Winston in 2013 with USD 1bn to further its reach. As luxury watches are a very men thing, Swatch is deemed as not capturing the women’s market. With Harry Winston, a niche jewellery brand, Swatch can further increase its expertise both in retail and in nurturing the women’s segment and can also perhaps carve out some synergies with its existing businesses in the future. Harry Winston made sales of US 400m or so with 5% operating margin before its integration with Swatch. Compared to Swatch’s own margin at 20%, there is some room for Harry Winston to improve. Nayla Hayek, the Chairwoman for Swatch will become the CEO of Harry Winston. Hopefully she can put some of her magic to transform and synergize Harry Winston.

Every investment has its risk and we need to be able to identify the 1 or 2 key risk factors and hope to be able to mitigate them. For Swatch, the biggest risk is the anti-corruption clamp down in China. This risk turned out to be a far greater threat than was previously thought as 2013 panned out. It impacted everything from flowers to hard liquor to even mooncakes! And right in the middle of it was luxury spending on watches. You see in order to do business in China, a lot of time and effort is spent taking officials and important counterparties to places, buying gifts and stuff for them. When Xi Jin Ping took over, he wanted to clean up this corruption issue in a big way. So a lot of these gifting was stopped, elaborated parties were cut down. Fresh flowers were not needed at banquets anymore. Mooncakes as gifts for officials were banned too. Swiss luxury watches bore the brunt of the blow. In the past, gifting someone a Swiss watch was one of the best ways to open doors. But now that it was banned, sales plummeted.

The Omega Speedmaster, also known as the Moon Watch.
It was first worn on the moon by Buzz Aldrin on the Apollo 11 mission.

Well, actually, this risk is now almost behind us. What was the mitigating factor? It's the rising middle income class. Swiss watches are part of the aspiration package as the number of middle income families increases globally. The family needs a nice car, which over time gets upgraded to a luxury German one. The mother starts buying high end fashion and jewellery. The father buys a luxury watch and in time buys more for his kids or passes down the old ones and buy new ones. It is a rite of passage for many modern countries, including Singapore. Well for some, it goes further, like launching a music career for the wife while siphoning money from a church, in the meantime engaging a beautiful accountant to do the dirty work. (yes yes piccoming... at the end of the post.)

So, since we will see the rise of the middle income not just in China but globally in the next few decades, the story for Swatch should remain intact after the Chinese government harvested all the bad seeds from this anti-corruption saga. (No City Harvest pun intended :)

The final questions refer to the last few that was listed on the Stocks Page ie "Is there a Second Level Thinking angle here?" or "Can I sleep well at night?" These are part of a sanity check that investors should always bear in mind. Usually there won't be easy answers. Esp for Second Level Thinking. Swatch is a luxury brand and will continue to be one. The angle could well be what's been described above: instead of worrying about anti-corruption, we should be seeing the rise of the middle income class.

As for sleeping well at night. I would say that if you bought the stock and it's been too volatile and you are not sleeping well because of that, then please sell it. Life is too short to brood over a stock. But if you are not sleeping well because you are too excited that you can see Serina in a few weeks on Straits Times, sorry I have no advice for you. Maybe go join City Harvest? Haha... just joking.

As promised, we have come to the end of our analysis of Swatch, so here's her "melancholy look" pic snapped from Google. Stop drooling please.

Do also take a look at my first post on Swatch.