Post by oldman on Oct 19, 2013 7:07:20 GMT 7
Your First Million, 2nd Edition
Chapter 4 - The Battleplan
I believe that I cannot achieve financial independence by punting the market, as the playing field is not level and the odds are against the investor.
To succeed as an investor, one has to look at stocks on the longer-term horizon and search for multi-baggers (stocks that appreciate in value many folds). However, in searching for these stocks, the investor knows that he will always be near the bottom of the information food chain. Hence, he needs to have an even higher margin of safety. After all, these are the stocks that he will be holding on to. And unlike stocks in the speculation category, if the stocks were to go down, he may want to add to his holdings of such stocks.
This is because, if he truly believes that these stocks are undervalued and the market pushes these stocks further down, these stocks should become even more undervalued and the margin of safety will be even higher by buying these stocks at a much more depressed price.
At this point, it is important to clearly differentiate speculative stocks from fundamental stocks. For all my speculative stocks, I have a cut loss position that is usually around the 5-10% level. For my fundamental stocks, it is not uncommon for me to average down.
For fundamental stocks, to achieve a desired margin of safety, I would only invest in stocks that have a significant discount to NTA (net tangible assets). My definition of NTA is very simple. It is either cash or properties. I discount everything else as I have seen so many ways of creative accounting that I have learnt never to simply trust the stated NTA figure. This means that I don’t take the NTA numbers from the annual report as the whole truth. Instead, I tear these numbers apart, so that I know how much cash the company has, how much the company owes and where their properties are. I then make it a point to visit these properties.
Of course, having a sound NTA is only part of the picture. More importantly, I must like the industry that they operate and I must believe that with the right spark, the business will flourish. This is the toughest part of the call, as there is much less science here compared to simply relying on NTA as confirmation.
Yes, if the share price were to go south, I don’t automatically buy more. But I will take this as a wake-up call to reassess the company. If after this reassessment, I still feel that the company fundamentals have not changed, I will then consider buying more.
The market is the sum total of human emotions which interestingly is manic-depressive. When emotions are good, stock prices zoom like there is no tomorrow. When the feeling is bad, it can hit rock bottom and yet there will be no takers. This is the reality of our markets and to be a fundamental investor, one has to be able to take the rough and tumble of investing and watch one’s fundamental stocks get beaten and bruised. One has to have lots of patience and guts during these depressive states.
When the market is bearish, I keep on accumulating my fundamental stocks. As always, I know that my timing is never good. Hence, I have a habit of collecting stocks slowly and I always make sure that I set aside enough funds to keep collecting over a long period of time. As such, I am seldom fully vested in terms of fundamental stocks.
Renowned investor Warren Buffett always says that there are two key chapters in Benjamin Graham’s The Intelligent Investor and these are Chapter 8 on market fluctuations and Chapter 20 on margin of safety. I have read both of these chapters over 10 times and would still pick up the book every now and then to reread.
It is important to recognise that the market is an uneven playing field. We simply have to accept that there will be the privileged who will get information much earlier than the rest of us. You see, business was not made to serve the stock market. For every deal that is being discussed, there will be lawyers, accountants, brokers, PR consultants, secretaries, management and other people in the know. Hence, the potential sources of leakage of sensitive information are too diverse to plug.
If the market is not a level playing field and one continues to speculate, the odds are, frankly, in favour of those in the know. Hence, I only speculate for the fun of it. I know I am not going to become rich by speculating, as sooner or later, Lady Luck will not smile on me. The later it is, the more likely I would have betted more money and the hit will be bigger. Hence, it maybe a blessing that Lady Luck runs out earlier, rather than later.
Fundamental investing overcomes the issue of timing, as unlike speculation, fundamental investors collect and collect all the time. We do not rush into collecting our fundamental stocks. We take our time to collect.
Fundamental investors do not time the market. When the sensitive information is available is really not that important to fundamental investors. If we are correct in our analysis, we would have got on board much earlier than the release ofthe information. Fundamental investors also know that Rome was not built in one day, one month or even one year. Every business needs to take time to grow and so, true fundamental investors must have a time horizon of a few years to see the companies they invested in begin to grow.
Investing is not like buying a lottery ticket. The results will not be known in days or for that matter, months. It will be years and hence, you must have patience. As for the margin of safety, to put it rather bluntly, one has to buy shares very cheap, just in case one has made a mistake in one’s research. We are all human and to err is human.
It is in my character to hunt for bargains when I go shopping, and buying shares is no different. There are those who would feel shy to search through the bargain bins at a sale, but in my case, this is where you will find me. I use much the same principle when buying stocks. I like to buy stocks very cheaply.
If one invests in stocks when they are near their highs, with a market downturn it can be very nerve wrecking. Hence, my policy has always been to collect stocks when they are unloved. This will provide a wide margin of safety. Rarely do I need to average up my fundamental stocks, as I would have collected enough over the past few months when they are unloved.
However, if the price falls below my average buying price, I am more likely to average down. This is why I always feel that fundamental investors have to take more risk than punters, as the latter never average down – they sell and make a trading loss and move on. For fundamental investors, if we believe in our selection of fundamental stocks, we are likely to see more value in the stocks when they go down further.The market is always manic-depressive – it goes through a cycle of over pessimism followed by over-optimism. Herd mentality dictates that it will exaggerate the ups and downs, so that when the market drops, nerves are unsettled and the selling becomes far overdone. Then optimism re appears and it becomes the turn of buying to be overdone.
Fundamental investors should not over-react to such manic-depressive characteristics of the market. If we still feel bullish about our economy, we should stick to our belief in the stocks that we have selected. However, if we think that the bear is around the corner, we should re-look at all ourinvestments.
I have been reading the works of investment guru Benjamin Graham for well over 10 years and it is only recently that I started to understand the true wisdom of his words. Many stocks have multi-bagger (stocks that appreciate in value many folds) potential but only a few have a high margin of safety. Like it or not, most stocks have potential. But with potential comes risk. What Mr Graham enunciated is that the stock market is about ups and downs, with stocks sometimes being undervalued and sometimes overvalued.
When a stock is undervalued, especially when it is well supported by assets, it would offer a higher margin of safety. Here is where most investors are inclined to bend the truth, as what constitutes a high margin of safety is open to argument.
I have seen some folks do discounted cashflow (DCF) projections, as if this were a science. But really, most CEOs I know tell me that business is so fluid nowadays that no one can forecast more than a year in advance. For investors to try to forecast 10 years in advance, they must know a lot that even the CEOs don’t. It may be possible to do DCFs 10 or 20 years ago, as businesses then were more stable. But today’s real business world is very dynamic and I cannot understand how DCFs can be used to justify whether a company is undervalued or not.
Then, there are some who confuse margin of safety with potential. If a stock can go up 10 times, then the logic is that it is undervalued. I don’t think this is the context in which Mr Graham instituted his margin of safety.
Margin of safety, to me, is determined by the existing asset backing of the company. Those who know me well know that I drill deeper into the assets, so as to consider only cash and properties as true assets. The reason for this margin of safety is that it gives a higher level of comfort in the event that the shares fall further.
When the share price falls, I usually reassess the existing business to gain confidence that the actual business is not loss making to such an extent that the assets are being eaten into. Yes, there are some turnaround situations in which I have invested, but these require an even higher margin of safety than the usual fundamental shares that I pick up.
I don’t think long-term investors suffer that badly in a market downturn, if they select their stocks well and have enough funds set aside to collect more in a downturn.The key to successful fundamental investing is the margin of safety – and your own definition of what constitutes the margin of safety is equally important.
For me, I am super kiasu (afraid of losing out) and kiasi (afraid of dying), and hence, my margin of safety is cash and properties at a discount to existing share price, with the company’s core business thrown in for free.
As investor extraordinaire Warren Buffett so aptly put it, “Rule 1: Never lose money. Rule 2: Never forget Rule 1.”
To reduce one’s likelihood of losing money, one must practise a very strict margin of safety. If this margin is eroded, I will sell the stock. Let me illustrate with the example of why I sold my holdings in luxury brand retailer F J Benjamin. When I was buying F J Benjamin and its warrants, the mother share was around 20 cents and the warrant was 1 cent each. Its assets of cash and properties then were close to its share price and moreover, I felt that its buildings were undervalued.
So, I was not only getting the business for free but was riding on the revaluation of its buildings. When the mother share reached 65 cents (warrants were then over 25 cents) and the warrants were about to expire, I knew that the exercising of these warrants would result in twice as many shares. This means the company would have to double its profits just to keep its earnings per share. Sure, I still like the shares but I did not like the eroding margin of safety and hence, I exited both the mother shares and the warrants.
When shares run up, their margin of safety is likely to decline. There will come a time when the margin of safety is no longer that safe. It is then time to sell the shares. Yes, timing of any sale is an art. One is most unlikely to sell at the highest price. The key is to be willing to sell when there is still a lot of hype and liquidity in the company and its shares.
Chapter 4 - The Battleplan
I believe that I cannot achieve financial independence by punting the market, as the playing field is not level and the odds are against the investor.
To succeed as an investor, one has to look at stocks on the longer-term horizon and search for multi-baggers (stocks that appreciate in value many folds). However, in searching for these stocks, the investor knows that he will always be near the bottom of the information food chain. Hence, he needs to have an even higher margin of safety. After all, these are the stocks that he will be holding on to. And unlike stocks in the speculation category, if the stocks were to go down, he may want to add to his holdings of such stocks.
This is because, if he truly believes that these stocks are undervalued and the market pushes these stocks further down, these stocks should become even more undervalued and the margin of safety will be even higher by buying these stocks at a much more depressed price.
At this point, it is important to clearly differentiate speculative stocks from fundamental stocks. For all my speculative stocks, I have a cut loss position that is usually around the 5-10% level. For my fundamental stocks, it is not uncommon for me to average down.
For fundamental stocks, to achieve a desired margin of safety, I would only invest in stocks that have a significant discount to NTA (net tangible assets). My definition of NTA is very simple. It is either cash or properties. I discount everything else as I have seen so many ways of creative accounting that I have learnt never to simply trust the stated NTA figure. This means that I don’t take the NTA numbers from the annual report as the whole truth. Instead, I tear these numbers apart, so that I know how much cash the company has, how much the company owes and where their properties are. I then make it a point to visit these properties.
Of course, having a sound NTA is only part of the picture. More importantly, I must like the industry that they operate and I must believe that with the right spark, the business will flourish. This is the toughest part of the call, as there is much less science here compared to simply relying on NTA as confirmation.
Yes, if the share price were to go south, I don’t automatically buy more. But I will take this as a wake-up call to reassess the company. If after this reassessment, I still feel that the company fundamentals have not changed, I will then consider buying more.
The market is the sum total of human emotions which interestingly is manic-depressive. When emotions are good, stock prices zoom like there is no tomorrow. When the feeling is bad, it can hit rock bottom and yet there will be no takers. This is the reality of our markets and to be a fundamental investor, one has to be able to take the rough and tumble of investing and watch one’s fundamental stocks get beaten and bruised. One has to have lots of patience and guts during these depressive states.
When the market is bearish, I keep on accumulating my fundamental stocks. As always, I know that my timing is never good. Hence, I have a habit of collecting stocks slowly and I always make sure that I set aside enough funds to keep collecting over a long period of time. As such, I am seldom fully vested in terms of fundamental stocks.
Renowned investor Warren Buffett always says that there are two key chapters in Benjamin Graham’s The Intelligent Investor and these are Chapter 8 on market fluctuations and Chapter 20 on margin of safety. I have read both of these chapters over 10 times and would still pick up the book every now and then to reread.
It is important to recognise that the market is an uneven playing field. We simply have to accept that there will be the privileged who will get information much earlier than the rest of us. You see, business was not made to serve the stock market. For every deal that is being discussed, there will be lawyers, accountants, brokers, PR consultants, secretaries, management and other people in the know. Hence, the potential sources of leakage of sensitive information are too diverse to plug.
If the market is not a level playing field and one continues to speculate, the odds are, frankly, in favour of those in the know. Hence, I only speculate for the fun of it. I know I am not going to become rich by speculating, as sooner or later, Lady Luck will not smile on me. The later it is, the more likely I would have betted more money and the hit will be bigger. Hence, it maybe a blessing that Lady Luck runs out earlier, rather than later.
Fundamental investing overcomes the issue of timing, as unlike speculation, fundamental investors collect and collect all the time. We do not rush into collecting our fundamental stocks. We take our time to collect.
Fundamental investors do not time the market. When the sensitive information is available is really not that important to fundamental investors. If we are correct in our analysis, we would have got on board much earlier than the release ofthe information. Fundamental investors also know that Rome was not built in one day, one month or even one year. Every business needs to take time to grow and so, true fundamental investors must have a time horizon of a few years to see the companies they invested in begin to grow.
Investing is not like buying a lottery ticket. The results will not be known in days or for that matter, months. It will be years and hence, you must have patience. As for the margin of safety, to put it rather bluntly, one has to buy shares very cheap, just in case one has made a mistake in one’s research. We are all human and to err is human.
It is in my character to hunt for bargains when I go shopping, and buying shares is no different. There are those who would feel shy to search through the bargain bins at a sale, but in my case, this is where you will find me. I use much the same principle when buying stocks. I like to buy stocks very cheaply.
If one invests in stocks when they are near their highs, with a market downturn it can be very nerve wrecking. Hence, my policy has always been to collect stocks when they are unloved. This will provide a wide margin of safety. Rarely do I need to average up my fundamental stocks, as I would have collected enough over the past few months when they are unloved.
However, if the price falls below my average buying price, I am more likely to average down. This is why I always feel that fundamental investors have to take more risk than punters, as the latter never average down – they sell and make a trading loss and move on. For fundamental investors, if we believe in our selection of fundamental stocks, we are likely to see more value in the stocks when they go down further.The market is always manic-depressive – it goes through a cycle of over pessimism followed by over-optimism. Herd mentality dictates that it will exaggerate the ups and downs, so that when the market drops, nerves are unsettled and the selling becomes far overdone. Then optimism re appears and it becomes the turn of buying to be overdone.
Fundamental investors should not over-react to such manic-depressive characteristics of the market. If we still feel bullish about our economy, we should stick to our belief in the stocks that we have selected. However, if we think that the bear is around the corner, we should re-look at all ourinvestments.
I have been reading the works of investment guru Benjamin Graham for well over 10 years and it is only recently that I started to understand the true wisdom of his words. Many stocks have multi-bagger (stocks that appreciate in value many folds) potential but only a few have a high margin of safety. Like it or not, most stocks have potential. But with potential comes risk. What Mr Graham enunciated is that the stock market is about ups and downs, with stocks sometimes being undervalued and sometimes overvalued.
When a stock is undervalued, especially when it is well supported by assets, it would offer a higher margin of safety. Here is where most investors are inclined to bend the truth, as what constitutes a high margin of safety is open to argument.
I have seen some folks do discounted cashflow (DCF) projections, as if this were a science. But really, most CEOs I know tell me that business is so fluid nowadays that no one can forecast more than a year in advance. For investors to try to forecast 10 years in advance, they must know a lot that even the CEOs don’t. It may be possible to do DCFs 10 or 20 years ago, as businesses then were more stable. But today’s real business world is very dynamic and I cannot understand how DCFs can be used to justify whether a company is undervalued or not.
Then, there are some who confuse margin of safety with potential. If a stock can go up 10 times, then the logic is that it is undervalued. I don’t think this is the context in which Mr Graham instituted his margin of safety.
Margin of safety, to me, is determined by the existing asset backing of the company. Those who know me well know that I drill deeper into the assets, so as to consider only cash and properties as true assets. The reason for this margin of safety is that it gives a higher level of comfort in the event that the shares fall further.
When the share price falls, I usually reassess the existing business to gain confidence that the actual business is not loss making to such an extent that the assets are being eaten into. Yes, there are some turnaround situations in which I have invested, but these require an even higher margin of safety than the usual fundamental shares that I pick up.
I don’t think long-term investors suffer that badly in a market downturn, if they select their stocks well and have enough funds set aside to collect more in a downturn.The key to successful fundamental investing is the margin of safety – and your own definition of what constitutes the margin of safety is equally important.
For me, I am super kiasu (afraid of losing out) and kiasi (afraid of dying), and hence, my margin of safety is cash and properties at a discount to existing share price, with the company’s core business thrown in for free.
As investor extraordinaire Warren Buffett so aptly put it, “Rule 1: Never lose money. Rule 2: Never forget Rule 1.”
To reduce one’s likelihood of losing money, one must practise a very strict margin of safety. If this margin is eroded, I will sell the stock. Let me illustrate with the example of why I sold my holdings in luxury brand retailer F J Benjamin. When I was buying F J Benjamin and its warrants, the mother share was around 20 cents and the warrant was 1 cent each. Its assets of cash and properties then were close to its share price and moreover, I felt that its buildings were undervalued.
So, I was not only getting the business for free but was riding on the revaluation of its buildings. When the mother share reached 65 cents (warrants were then over 25 cents) and the warrants were about to expire, I knew that the exercising of these warrants would result in twice as many shares. This means the company would have to double its profits just to keep its earnings per share. Sure, I still like the shares but I did not like the eroding margin of safety and hence, I exited both the mother shares and the warrants.
When shares run up, their margin of safety is likely to decline. There will come a time when the margin of safety is no longer that safe. It is then time to sell the shares. Yes, timing of any sale is an art. One is most unlikely to sell at the highest price. The key is to be willing to sell when there is still a lot of hype and liquidity in the company and its shares.