Thursday, 11 April 2019

The nine most important words ever written about investing - "Investing is most intelligent when it is most businesslike."

A person who holds stocks has the choice to become
  • the owner of a business or 
  • the bearer of tradable securities.

Bearer of tradable securities

Owners of common stocks who perceive that they merely own a piece of paper are far removed from the company's financial statements.

  • These owners behave as if the market's ever-changing price is a more accurate reflection of their stock's value than the businesses' balance sheet and income statement.  
  • They draw or discard stocks like playing cards.

Owner of a business

For Buffett, the activities of a common-stock holder and a businessperson are intimately connected.  Both should look at ownership of a business in the same way.

"I am a better investor because I am a businessman, and a better businessman because I am an investor.  (Warren Buffett)

Buffett's investment philosophy is the clear understanding that, by owning shares of stock, he owns businesses, not pieces of paper.  

The idea of buying stock without understanding the company's operating functions is unconscionable, says Buffett.  These include:

  • a company's products and services, 
  • labour relations, 
  • raw material expenses, 
  • plant and equipment, 
  • capital reinvestment requirements, 
  • inventories,
  •  receivables, and 
  • working capital needs.

This mentality is reflected in the attitude of a business owner as opposed to a stock owner.

Types of companies to purchase in the future

Buffett is often asked what types of companies he will purchase in the future.

First, he says, he will avoid commodity businesses and managers in which he has little confidence.

What he will purchase is the type of company that

  • he understands, 
  • one that possesses good economics and 
  • is run by trustworthy managers.

"A good business is not always a good purchase," Buffett says, "although it is a good place to look for one."

Coca Cola's intrinsic value when Buffett first purchased it in 1988.

Buffett first purchased Coca-Cola in 1988.  In 1988:

  • Owner earnings (net cash flow) of Coca-Cola = $828 million.
  • Risk free rate of 30 year US Treasury Bond = 9% yield.

Discounted value of Coca-Cola's current owner earnings.

If Coca-Cola's 1988 owner earnings were discounted by 9% (Buffett does not add an equity risk premium to the discount rate):

  • the value of Coca-Cola would have been $828m/9% = $9.2 billion.

$9.2 billion represents the discounted value of Coca-Cola's current owner earnings.

Was Buffett paying too much for Coca-Cola?

When Buffett purchased Coca-Cola, the market value of the company was $14.8 billion, indicating that Buffett might have overpaid for the company.

Because the market was willing to pay a price for Coca-Cola that was 60% higher than $9.2 billion, it indicated that buyers perceived part of the value of Coca Cola to be its future growth opportunities.

People asked, "Where is the value in Coke?"

The company's price was
- 15x earnings (30% premium to the market average), and,
- 12x cash flow (50% premium to the market average).

Where is the value in Coke? Its net cash flows discounted at an appropriate interest rate.

Buffett first purchased Coca-Cola in 1988.

Buffett paid 5x book value for a company with a 6.6% earning yield.

The company was earning a 31% ROE while employing relatively little in capital investment.

The value of Coca-Cola, like any other company, is determined by the net cash flows expected to occur over the life of the business, discounted at an appropriate interest rate.

When a company is able to grow owner earnings without the need for additional capital, it is appropriate to discount owner earnings by the difference between the risk-free rate of return (k) and the expected growth (g) of owner earnings, that is (k-g).

Using a two-stage discount model

Analyzing Coca-Cola, we find that owner earnings from 1981 through 1988 grew at 17.8% annual rate - faster than the risk-free rate of return.

When this occurs, analysts use a two-stage discount model.  
  • This model is a way of calculating future earnings when a company has extraordinary growth for a limited number of years, and 
  • then a period of constant growth at a slower rate.

We use this two-stage process to calculate the 1988 present value of the company's future cash flows.

In 1988, Coca-Cola's owner earnings were $828 million.

If we assume that Coca-Cola would be able to grow owner earnings at 15% per year for the next 10 years (a reasonable assumption, since that rate is lower than the company's previous seven-year average), by year 10, owner earnings will equal $3.349 billion.

Let us further assume that starting in year 11, growth rate will slow to 5% a year.  Using a discount rate of 9% (the long term bond rate at the time), we can calculate that the intrinsic value of Coca-Cola in 1988 was $48.3777 billion. 

(see Appendix A below for the detailed calculations.)

Using different growth-rate assumptions

We can repeat this exercise using different growth-rate assumptions.

  • If we assume that Coca-Cola can grow owner earnings at 12% for 10 years followed by 5% growth, the present value of the company discounted at 9% would be $38.163 billion.
  • At 10% growth for 10 years and 5 % thereafter, the value of Coca-Cola would be $32.497 billion.
  • And if we assume only 5% throughout, the company would still be worth at least $20.7 billion [$828 million divided by (9% - 5%)].

Market price has nothing to do with value

The stock market's value of Coca-Cola in 1988 and 1989, during Buffett's purchase period, averaged $15.1 billion.

But by Buffett's estimation, the intrinsic value of Coca-Cola was anywhere from

  • $20.7 billion (assuming 5% growth in owner earnings), 
  • $32.4 billion (assuming 10% growth), 
  • $38.1 billion (assuming 12% growth), 
  • $48.3 billion (assuming 15% growth).

So Buffett's margin of safety - the discount to intrinsic value - could be as low as a conservative 27% or as high as 70%.

"Value" investors using P/E, P/B and P/CF considered Coca-Cola overvalued and missed purchasing it.

"Value" investors observed the same Coca-Cola that Buffett purchased and because its price to earnings, price to book, and price to cash flow were all so high, considered Coca-Cola overvalued.


Appendix A: 

The Coca-Cola Company Discounted Owner Earnings Using a Two-Stage "Dividend" Discount Model (first stage is 10 years)

First stage:
Owner Earnings in 1988  $828 m
Growth rate 15% for next 10 years
Discount factor 9%

Sum of present value of owner earnings   = $11,248 
(Year 1 to 10)

Second stage:
Residual Value or Terminal Value

Owner earnings in year 10  $3,349
Growth rate (g)  5%
Owner earnings in year 11   $3,516
Capitalization rate (k-g)  4%
Value at end of year 10   $87,900
Discount factor at end of year 10  0.4224

Present Value of Residual                           =  $37,129

Intrinsic Value
Intrinsic Value of Company                        =  $48,377

Assumed first-stage growth rate = 15%
Assumed second-stage growth rate = 5%
k = discount rate = 9%
Dollar amounts are in millions.

Descriptive step-by-step approach to the above DCF:

The first stage applies 15% annual growth for 10 years. 

In year one, 1989, owner earnings would equal $952 million; by year ten, they will be $3,349 billion.

Starting with year eleven, growth will slow to 5% per year, the second stage.

In year eleven, owner earnings will equal $3,516 billion ($3,349 billion x 5% + $3,349 billion).

Now we can subtract this 5% growth rate from the risk-free rate of return (9%) and reach a capitalization rate of 4%.

The discounted value of a company with $3,516 billion in owner earnings capitalized at 4% is $87.9 billion.

Since this value, $87.9 billion, is the discounted value of Coca-Cola-s owner earnings in year eleven, we next have to discount this future value by the discount factor at the end of year ten  1/(1 + 0.09)^10 = 0.4224. 

The present value of the residual value of Coca-Cola in year ten is $37.129 billion. 

The value of Coca-Cola then equals its residual value ($37.129 billion) plus the sum of the present value of cash flows during this period ($11.248 billion), for a total of $48.377 billion.

Wednesday, 10 April 2019

What dictates dividend policy?

Management determines if it is going to 

  • distribute earnings in the form of a dividend or 
  • reinvest all earnings to further the business plan of the company. 

The ratio of dividends paid out to investors versus the amount of earnings retained is called the payout ratio.  

The Dividend Decision

Changes in tax law and investor preference can influence decisions in the corporate boardroom regarding how much profit to retain or to pay out to investors in the form of dividends.  

However, dividend increases often lag behind an increase in earnings because management will want to be certain that a new higher dividend payment will be sustainable going forward.

Change in Dividend Yield has a lot to do with change in Share Price

Looking back over market history, we can see that dividend policy and payouts have remained relatively steady and that any change in dividend yield has had a lot more to do with the change in stock prices than with changes to dividend policy made by corporate directors.  (Note:  You can 'price' your stocks by looking at historical dividend yields.)

A cut in dividends is often perceived negatively

Management is usually very reluctant to reduce dividends because a cut is often perceived as a sign of financial weakness.  

Even during the Great Depression, companies were loath to cut dividends.  
  • From 1929 to 1932, dividend yields soared because most companies maintained their dividends as stock prices collapsed in the crash.  
  • But, as stock prices rose from 1933 to 1936, dividend yields fell - even though companies were actually increasing the dividends they paid.

This inverse relationship between dividend yield and price was really evident during the huge bull market run from 1982 to 1999.  
  • Companies increased dividends steadily over the period, actually increasing dividends paid by almost 400 percent.  
  • Yet the dividend yield collapsed to historic lows because stock prices increased by 1,500 per cent.

Some companies do run into trouble and cut or omit their dividend payments, but this is the exception rather than the rule. 

The typical dividend-paying company

The typical dividend-paying company not only maintains the dividend payout it establishes, but follows a policy of steadily increasing its dividend as earnings increase. 

Some companies increase their dividend payments 
  • (1) every quarter, 
  • (2) some once per year, and 
  • (3) others only as profits allow.

Some companies will even pay extra or special dividends if earnings have been quite good for a number of years.

Dividend policy

Many established public companies pay cash dividends and have a dividend policy that is well known to their investors.  

Some of them have been paying cash dividends for a very long time.

The Investment shown by the DCF calculation to be the cheapest is the one that the investor should purchase.

How does Buffett value his companies?

For Buffett, determining a company's value is easy as long as you plug in the right variables: 

  • the stream of cash and 
  • the proper discount rate.

If he is unable to project with confidence what the future cash flows of a business will be, he will not attempt to value the company  This is the distinction of his approach.

Critics of Buffett's DCF valuation method.

Despite Buffett's claims, critics argue that estimating future cash flow is tricky, and selecting the proper discount rate can leave room for substantial errors in valuation.

Instead these critics have employed various shorthand methods to identify value:

  • low price-to-earnings ratios, 
  • price-to-book values and 
  • high dividend yields.  

Practitioners have vigorously back tested these ratios and concluded that success can be had by isolating and purchasing companies that possess exactly these financial ratios.

Value investors versus Growth investors

People who consistently purchase companies that exhibit low price-to-earnings, low price-to-book, and high dividend yields are customarily called "value investors."

People who claim to have identified value by selecting companies with above-average growth in earnings are called "growth investors."  Typically, growth companies possess high price-to-earnings ratios and low dividend yields.  These financial traits are the exact opposite of what value investors look for in a company.

Growth and Value investing are joined at the hip.

Investors who seek to purchase value often must choose between the value and growth approach to selecting stocks.

Buffett admits that years ago, he participated in this intellectual tug-of-war.  Today he thinks the debate between these two schools of thought is nonsense.  

Growth and value investing are joined at the hip, says Buffett.

Value is the discounted present value of an investment's future cash flow; growth is simply a calculation used to determine value.

Growth can be add to and also can destroy value.

Growth in sales, earnings, and assets can either add or detract from an investment's value.

Growth can add to the value when the return on invested capital is above average, thereby assuring that when a dollar is being invested in the company, at least a dollar of market value is being created.
However, growth for a business earning low returns on capital can be detrimental to shareholders.

For example, the airline business has been a story of incredible growth, but its inability to earn decent returns on capital have left most owners off theses companies in a  poor position.

Which valuation method(s) to use?  Which stock to buy?

All the shorthand methods - high or low price-earnings ratios, price-to-book ratios, and dividend yields, in any number of combinations - fall short, Buffett says, in determining whether "an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value for his investments.............Irrespective of whether a business:

  • grows or doesn't,
  • displays volatility or smoothness in earnings , 
  • or carries a high price or low in relation to its current earnings and book value, 
the investment shown by the discounted -flows-of-cash calculation to be the cheapest is the one that the investor should purchase.

Friday, 5 April 2019

Burned by Dubai, Mobius joins chorus of doom after property bust

Thursday, 4 Apr 2019

Mark Mobius is worried about the frenzy of construction that’s adding to the existing glut in Dubai real estate.

DUBAI: Three years ago, Mark Mobius saw his luxury apartments in Dubai go up in flames. While the suites have by now been restored to their old splendor, the investor has something else to worry about: the frenzy of construction that’s adding to the existing glut in real estate.

The downturn “will get much worse from here,” said Mobius, a pioneer in emerging-market investing, adding he’d hold off on buying more property.

“I would probably want to wait until there’s a real slump when all this new building comes in and people are really hurting to sell.”

Prices and rents have already dropped by as much as a third in the past five years during what S&P Global Ratings has called the property market’s “long decline.”

The slump will run for another 12 to 18 months because government measures to stimulate the economy -- including granting long-term visas which benefit the affluent and people with specialized expertise -- won’t be enough to revive demand, said Lahlou Meksaoui, a Dubai-based analyst at Moody’s Investors Service.

Mobius recalls how he watched on television from Singapore as revelers in Dubai rang in 2016 with fireworks shooting off the iconic Burj Khalifa.

Just steps away from the world’s tallest building, flames were engulfing Address Downtown and the two luxury apartments he owns in the 63-story tower.

Dubai, one of seven of the United Arab Emirates, lives and dies by real estate. When a property bubble burst a decade ago, it needed a $20 billion rescue from neighboring Abu Dhabi to pull back from the brink of default.

Since prices peaked in 2014, the $108 billion economy had a softer landing as it transitioned from boom to bust.

Early signs of a bottoming out in the property sector even prompted Morgan Stanley to “double-upgrade” U.A.E. stocks in February. An index tracking the city’s real-estate and construction stocks climbed 5.8 percent in the first three months of the year, snapping five quarters of losses.

But Mobius said shares of Dubai’s developers aren’t cheap enough. While the World Expo 2020 fair will reinforce the city’s position on the world map, it won’t be enough to revive the emirate’s property sector unless the government relaxes its immigration policies, he said.

“That’s where you’re going to have real problems,” he said.- Bloomberg


Hyflux scraps restructuring plan after spats with investors

Thursday, 4 Apr 2019

Hyflux’s catastrophic slump has spotlighted the plight of about 34,000 retail investors who were lured by the promise of a 6 percent annual return forever from a company that seemed to have a gold seal of government approval.

SINGAPORE: The embattled Singapore water and power company Hyflux Ltd. has canceled a crucial debt restructuring vote after failing to get a commitment from its would-be savior, throwing one of the country’s highest-profile distressed cases into disarray.

Hyflux’s catastrophic slump has spotlighted the plight of about 34,000 retail investors who were lured by the promise of a 6 percent annual return forever from a company that seemed to have a gold seal of government approval. Their ordeal is now even more uncertain.

The company said in a filing Thursday that it has no confidence that SM Investments Pte, the consortium of Indonesian businessmen that agreed last year to rescue Hyflux in return for a majority stake, is prepared to complete a S$530 million ($392 million) cash infusion plan that forms the core of its survival plan.

Hyflux sought “a final clear and unequivocal written confirmation” from the investor on the proposal that would have enabled voters to make an informed decision, it said.

The investor has declined to provide the company with such written confirmation, and thus repudiated the restructuring agreement, it added.

The breakdown follows public spats over some terms in the Hyflux restructuring plan as the company faces demands from creditors. The case also sparked a rare public protest over the weekend in Singapore.

“The restructuring agreement is therefore terminated and the company intends to take all necessary action in connection with such termination,” Hyflux said.

It now intends to work closely with the key creditor groups and relevant stakeholders to find mutually acceptable bases to pursue alternative opportunities, it said. - Bloomberg


Background story

Once a star company, Singapore’s Hyflux faces major challenges

Hyflux, one of Singapore’s most successful business stories, has applied for court protection to begin a reorganisation of its business and address its growing pool of debt.

SINGAPORE: It had been another record year for Hyflux, as its founder and group CEO Olivia Lum described in its 2010 annual report.

That was the year when the Singapore-based water treatment specialist saw its market capitalisation peak at an eye-popping S$2.1 billion, while raking up another high in revenue and net profit on the back of rapid growth.

But fast forward eight years, and the homegrown firm sent ripples through Singapore for a very different reason.

On Tuesday (May 22), Hyflux said it had applied to the High Court to begin a court-supervised process of debt and business reorganisation – an announcement that some market observers told Channel NewsAsia “has been a long time coming”.

The company blamed “prolonged weakness” in the local power market for its financial woes, which has led to “short-term liquidity constraints in recent weeks”.

In a separate letter to stakeholders, Ms Lum, who also holds the position of executive chairman, said the decision will provide the space and time to focus on ongoing discussions with strategic investors and among other things, optimise operations.


Founded in 1989 with S$20,000, Hyflux has since grown from a fledgling three-person start-up into a leading player in water and fluid treatment with worldwide presence employing more than 2,500 people.

Its rise was synonymous with its founder’s rags-to-riches story.

Much has been said about Ms Lum’s challenging early life. Abandoned at birth and later adopted by a widow whom she called "grandmother", Ms Lum, a Malaysian, started work from a very young age to support the family.

She was determined to do well in school and later moved to Singapore, where she graduated from the National University of Singapore and found a job as a chemist at Glaxo Pharmaceuticals.

However, she soon decided to strike it out on her own and founded Hydrochem with “a big dream and youthful idealism” to solve the world’s water problems.

The initial years of entrepreneurship weren’t easy. In various interviews done over the years, Ms Lum shared how she worked 14 hours a day to sell water treatment products and systems by knocking on the doors of factories in Singapore and Malaysia.

The company got its first break in 1992 when it obtained the exclusive rights from a supplier to distribute membranes and membrane filtration plants to industrial customers. This later paved the way for a research and development team in 1999, which aimed to make its own membranes that would set it apart from competitors.

Then came 2001 – the “defining year” when Hyflux, with Hydrochem as its wholly-owned subsidiary, made a splash by becoming the first water treatment company to be listed in Singapore. It also secured its first municipal water treatment project in Singapore to supply and install the process equipment for the country’s first Newater plant in Bedok.

Other key projects that followed included Singapore’s third Newater plant in Seletar and the SingSpring Desalination Plant, the country’s first seawater reverse osmosis desalination plant.

It also began reaching out further beyond the shores of Singapore, with projects in China, India and the Middle East North Africa (MENA) region, which included Oman and Algeria.

In 2011, Ms Lum became the first Singaporean and the first woman to be crowned the Ernst & Young (EY) World Entrepreneur of the Year award.

That year, it also clinched Singapore’s second and largest seawater desalination project, and proposed incorporating an on-site 411 megawatt combined cycle power plant to produce electricity for the desalination plant and power grid.


But that marked the start of the company’s woes, analysts said.

Touted to be the first in Singapore and Asia, the Tuaspring Integrated Water and Power Project was expected to raise efficiency levels and reduce the cost of desalination. The power plant, which began operations in 2016, also marked Hyflux’s foray into the energy business.

It has, however, been a drag on earnings.

For the full year ended Dec 31, 2017, the integrated water and power plant registered a net loss of S$81.9 million, with wholesale electricity prices clearing at levels that are below fuel costs.

This contributed in a big way to the company’s first annual loss since listing – a loss of S$116.4 million, compared to a restated profit of S$3.8 million for FY2016.

The losing streak continued in the three months to March 31 as Hyflux logged losses of S$22.2 million, widening considerably from a restated loss of S$64,000 a year before. To turn a profit in 2018, a stronger rebound in wholesale electricity prices at a sustained pace will be needed, the company had said.

This strain in the balance sheet and financial covenants coming up may have proven too much.

The water treatment firm has a coupon payment due May 28 on its S$500 million of 6 per cent perpetual securities, which it has said it will not make. It also has S$100 million of 4.25 per cent bonds that will mature in September.

“Hyflux seems to have borrowed too much and the debt is a millstone around your neck when the environment becomes adverse,” said Associate Professor Nitin Pangarkar from the National University of Singapore (NUS) Business School.

While companies with strong balance sheets can survive these downturns, “too much debt can bring down a company”, he warned.

In the case of Hyflux, there was “too much risk” that included the oversupply and deregulation of the local electricity market. “These different sources of risk will tend to multiply.”

Agreeing, CMC Markets sales trader Oriano Lizza said Hyflux has incurred a mounting debt burden from “over-expansion into additional sectors that (the company) may not be so specialized in”.

In addition, market conditions like the massive overcapacity depressing prices and an influx of natural gas as an alternative energy source certainly did not help Hyflux to sizzle in its energy venture.

With the company having “overcapitalised too rapidly and spread itself too thin in terms of asset allocation”, Mr Lizza said Tuesday’s announcement "has been a long time coming".

For iFast’s senior fixed income analyst Ang Chung Yuh, “the speed at which things went downhill” exceeded his forecasts. He had expected Hyflux to be able to meet its obligations for the next 12 to 18 months.

Mr Ang added that he is also unsure as to why Hyflux opted for a court-driven reorganisation process, instead of first approaching creditors, including bondholders, with a proposal.

“But in any case, if management has crunched the numbers and found that it is impossible for them to come up with the money needed one or two years down the road, we think it is a good thing that management has chosen to bite the bullet now rather than later,” he added.


Analysts agreed that the 30-day moratorium, which kicked in automatically from the date of Hyflux’s application to court, will buy the company some much-needed time.

Mr Lizza thinks the immediate remedies for Hyflux include turning to its investors and shareholders for additional capital injection or speed up the sale of its existing loss-making assets.

“If they are able to shift these assets for cash in the short term, it will give them continued breathing space until they can balance their books.”

Hyflux said in February last year that it is exploring a partial divestment of Tuaspring, and has also been looking at a potential divestment of its Tianjin Dagang desalination plant. Alongside the release of its first-quarter financial report earlier this month, it said that divestment discussions for these two projects are in progress with interested parties.

But now that things have changed, Hyflux will have to play its cards carefully.

“The problem is that investors will be circling these assets in hope of a bargain because they know the situation that Hyflux is in,” said Mr Lizza. “If they sell too little, it won’t get them out of the current situation but if they are unwilling to budge on current prices, they won’t (get) any interest.”

“They are really in a sticky situation,” he added.

Mr Ang reckons a debt restructuring could be a “virtual certainty”.

“In our opinion, to have some chance of restoring Hyflux’s financial health for the long run, the exercise needs to involve a debt-to-equity conversion of a substantial part of the perpetual securities,” he said, adding that the firm had about S$2.4 billion of debt outstanding at end-March if the perpetual securities are taken into account.

“Short of a Government bailout, it is difficult for us to conceive a scenario where a capital injection by external investors could achieve a sustainable capital structure for Hyflux.”

Hyflux on Wednesday morning called for a suspension of trading in all its shares and related securities, which had been halted since Monday and analysts do not rule out the prospect of heavy selling when it resumes trading.

The route ahead for Hyflux will not be an easy one, experts added.

Describing the trading halt and seeking of court protection as “a broad, open admission of its festering business problems”, NUS Assoc Prof Lawrence Loh said: “Hyflux’s ongoing reorganisation move is necessary to ensure that any asset divestments will get the best value for its stakeholders, particularly creditors and shareholders.”

“While there were already market expectations for the troubles at Hyflux, the issue has probably brewed for a time much longer than necessary. Hyflux has probably seen this coming and could have been more expeditious and decisive in its restructuring efforts along the way,” he added.

As Ms Lum had forewarned in the company’s latest annual report, 2018 was going to “be another challenging year”. But with “boldness, entrepreneurial spirit, customer satisfaction focus, and teamwork”, she said she was confident of overcoming the obstacles ahead.

During a 2016 interview with Channel NewsAsia, the award-winning entrepreneur described herself as a “more optimistic person”, and that challenges and uncertainties are the norm for any business.

“I still have the hunger in me,” she said. “Every day, I still look forward to more and more exciting business opportunities and persevere to manage the challenges.”

And with that, all eyes will likely be now on the businesswoman to see if her unique brand of tenacity can reverse the fate of one of Singapore Inc’s most-visible success stories.

Source: CNA/sk

OCK's tower leasing to drive earnings in FY19, says RHB

Friday, 5 Apr 2019

KUALA LUMPUR: OCK Group's tower leasing business will drive long-term recurring earnings for the group, says RHB research.

In a note, the research house said it expects the tower leasing business to remain the group's key growth driver, underpinned by strong orderbook for built-to-suit sites and inorganic expansion in Myanmar and Vietnam, domestic build and lease contract for U-Mobile and rising tower co-locations.

"We see a recovery in domestic contracting revenues in FY19 after the 15% YoY decline in FY18.

"We project tower leasing revenue contribution to reach 34% and >40% in FY19 and FY20 (FY18: 28%)," said RHB.

The research house also sees OCK as a key beneficiary of 5G spending on higher demand for sites and network densificaiton by the operations.

It expects the group to be well placed in securing potential fiberisation jobs falling within the scope of the National Fiberisation and Connectivity Plan given its good deployment track record.

In the meantime, OCK is planning a joint bid for a RM2bil solar farm project under the large-scale solar scheme in mid-August.

"A successful bid would bolster recurring revenues although the solar project contribution is likely to only account for less than 5% of group revenue," said RHB.

The research house maintained its buy call with a lower target price of 82 sen from 89 sen previously after incorporating the higher cost of debt at its Vietnam operations.

FY19F-20F core earnings were raised by 3-6% to build in higher lease revenue assumptions for Vietnam and Myanmar as well as the recovery in domestic contracting revenue.


EU’s palm oil ban dampening industry’s near-term prospects

EU’s palm oil ban dampening industry’s near-term prospects — Analysts

Looking ahead, the research team expect the upcoming results season in May to see a sequential recovery in most planters’ earnings as improvements in CPO prices likely outweighed a seasonal drop in FFB output in 1QCY19.

KUCHING: The European Union’s (EU) ban on palm oil will dampen near-term prospects of planters despite some positive factors developing domestically in the plantation sector.

The research team at Kenanga Investment Bank Bhd (Kenanga Research) said while some positive factors are developing in the plantation sector, negative news flows have diffused negative sentiments and weighed on CPO prices, dampening near-term prospects of planters under its coverage.

“In addition, stockpiles have not eased as quickly as we had hoped in the January to February 2019 period, no thanks to shorter working month during Chinese New Year,” it said in its sector report outlook yesterday.

However, it pointed out that as the negative news flows subside in coming months, it believed crude palm oil (CPO) price will return to the recovery trajectory.

“Over the next three months, key positive factors that we are monitoring closely are as follows easing stockpiles in both Malaysia and Indonesia, higher exports to China given its pledge to buy 50 per cent more palm oil from Malaysia, and further clarity on new biodiesel initiatives (B30 in Indonesia and B20 in Malaysia).

“Nevertheless, we believe these positive factors have been largely priced in with the KLPLN index staging a handsome 11 per cent recovery from the low in December 2018,” it added.

Currently, it noted that planters under its coverage are on average trading at minus one standard deviation (range: minus two to 0.5 SD) from their respective mean PER, which is consistent with the uncertain environment but lacks comfortable margin of error to turn positive on the sector at this juncture.

“However, should the biodiesel initiatives and palm oil offtake from the Chinese pan out better than expected, we would relook our valuation basis with an upward bias. On the other hand, if the EU and the Philippines’ palm oil biodiesel ban escalates further, we are likely to downgrade our CPO price assumption,” Kenanga Research said.

Looking ahead, the research team expect the upcoming results season in May to see a sequential recovery in most planters’ earnings as improvements in CPO prices likely outweighed a seasonal drop in FFB output in 1QCY19.

“This has also been verified by several planters under our coverage. Furthermore, from our observation of the movement of daily futures curves in the past two quarters, we believe the average CPO price realised by planters could have improved by five to six per cent or more in 1Q19,” it added.

Despite expected improvements in CPO prices, Kenanga Research maintained its ‘neutral’ outlook on the plantation sector as it believed the positive developments have been largely priced in with the KLPLN index staging a handsome 11 per cent recovery from the low in December 2018.

“However, should the biodiesel initiatives and palm oil offtake from the Chinese pan out better than expected, we would relook our valuation basis with an upward bias. On the other hand, if the EU and the Philippines’ palm oil biodiesel ban escalates further, we are likely to downgrade our CPO price assumption,” it added.

Wednesday, 3 April 2019

No One is Immune from The Party Effect or Recency Bias

What is the Recency Bias?

When describing the stock market each participant sees their portfolio’s performance 
  • from their perspective only and 
  • thus they are always “right”.
This leads to what I call The Party Effect or what Financial Behaviorist call the Recency Bias.

An illustration

Historical average rate of return is 12%.  What does this imply? Would everyone have the same rate of return?

Imagine that you attended a party hosted by your investment advisor and that in addition to you, also in attendance were several other clients. As you go around the room and meet people you learn that everyone at the party owns the exact same S&P 500 index mutual fund. I use the S&P 500 for this tale because by many measures it has historically produce an average rate of return of about 12% and as many people know, and now you know as well, it represents what many investors call “the stock market.” 

The question then is would everyone have the same rate of return at this party? 
  • Of course the answer is, no they would not. 
  • If they started at the same time they would but since people invest or come into the life of the investment advisor at different times, the answer is no.

A party with only 30 guests, specially selected for illustration.

Let’s tighten up the party attendee list and invite only 30 guests. For simplicity, let’s assume that Guest 1 purchased the fund 30 months ago, that Guest 2 purchased it 29 months ago, that Guest 3 purchased it 28 months ago, etc. 

What would the guests discuss? What would be their perspectives of the stock market?  In order to determine what the guests would discuss and how they would evaluate their performance we need to have some data in the form of monthly rates of return. So we need to develop a monthly rate of return for 30 months to see what they see. 

A 30-month cycle: 18 months bull market phase and 12 months bear market phase 

Again, for simplicity, assume that for the first 18 months the fund goes up 3% per month and for the next 12 months it goes down 2% per month. 

  • Please note that I didn’t pick this sequence of numbers randomly. I have a purpose to this. 
  • This particular sequence approximates how the stock market moves in terms of bull and bear market duration and after 30 months returns approximately 12%; 12.28% to be exact. 
  • This sequence of numbers is a good sequence to illustrate The Party Effect or Recency Bias. 
  • We can characterize the first 18 months as the bull market phase of the 30-month cycle and the last 12 months as the bear market phase of the 30-month cycle.

Focus on 4 guests (1, 10, 19 and 25) to illustrate the Party Effect

To illustrate The Party Effect lets focus on 4 guests and see how they describe the stock market. Let’s look at guests 1, 10, 19 and 25. I picked these 4 because readers of this tale can relate in some form or another to one of these 4.

  • Guest 1 started 30 months ago, at the beginning of the bull market phase, and his rate of return is 12.28% for the entire 30-month cycle. He enjoyed the ride up for 18 months and now the ride down for the last 12.
  • Guest 10 started 21 months ago, halfway through the bull market phase, and his rate of return is 1.36%  for the 21-month period he has been invested.
  • Guest 19 started 12 months ago, at the beginning of the bear market phase, and his rate of return is  -21.53% for the 12-month period he has been invested.
  • Finally, Guest 25 started 6 months ago, halfway through the bear market phase, and his rate of return is  –11.42 for the 6-month period he has been invested.
These 4 guests experienced entirely different rate of return outcomes and view their portfolios and thus the stock market completely different. 
  • All 4 are correct. 
  • All 4 are right and yet they couldn’t possibly have more divergent outcomes. 
  • If they don’t have a complete picture of the stock market, they can get themselves in trouble. 
  • The difference between the best performing portfolio that is up 12.28% and the worst performing portfolio that is down 21.53% is an astounding 33.81%. 

Stock market investing will always produce different outcomes

Is this too obvious? You may say, of course they have different outcomes, they started at different times but that is not the point.  The point is that stock market investing will always produce different outcomes. 

  • One guest started at the worst time possible. 
  • Another guest started at the best possible time. 
  • How they look at the past determines how they see the present. 
  • Most importantly, it will determine how they will act going forward.

Pitfalls and dangers of the Party Effect or Recency Bias

The Party Effect simply states that stock market participants evaluate their portfolio performance based on their perspective and their perspective only. 

They do not see the market as it is but as they are. 

Without an expert understanding of how the stock market works, this leads to incorrect conclusions that ultimately lead to incorrect decisions. 

The field of Behavioral Finance (BF) has shown time and time again that people have variable risk profiles. BF demonstrates that fear is a stronger emotion than greed. 
  • This means that in our simple 4 guest example, Guests 3 and 4 are more likely to exit the stock market at just the wrong time since their recent, thus Recency Bias, experience is one of losing money. 
  • It means that Guest 1 and 2 are more likely to stay invested, thus catching the next wave up that is likely to follow. 

No one is immune to the Party Effect or Recency Bias

All 4 have intellectual access to the events of the last 30 months.  All 4 can educate themselves on the stock market. 
  • However, their particular situation is so biased by recent events that the facts are unimportant. They behave irrationally. 
  • I have witnessed this irrational behavior throughout my career. 
  • No one is immune, even advisors.

To overcome:  be an expert on the stock market yourself.

There are ways to combat The Party Effect trap but it is the deadliest of all the stock market traps that I know. Few can overcome it.  

The only sure way to overcome it is to
  • become an expert on the stock market yourself, 
  • learn to manage your emotions, and 
  • then either manage your own money or hire competent managers that you recognize are expert in their chosen investment discipline. 

However, if you hire an expert on the stock market you have not solved the problem if you do not have expertise. Let me repeat this sentence and highlight it. If you hire an expert on the stock market you have not solved The Party Effect trap if you do not have expertise yourself. 

When you hire an expert on the stock market without being an expert yourself all you have done is added complexity to a complex problem. 
  • You have inserted another variable between you and the stock market. 
  • You now have three variables to worry about, the stock market, your advisor and yourself. 
Without expertise you have no way of knowing if your advisor is an expert. You are in an endless loop. 
  • You are in a recursive situation. Just like we ask, what came first the chicken or the egg? 
  • The Party Effect asks, how do I hire an expert without being an expert myself?

If you are unwilling to become an expert on the stock market you must find a way to solve The Party Effect trap?