Showing posts with label Ang Kok Heng. Show all posts
Showing posts with label Ang Kok Heng. Show all posts

Monday 25 October 2010

Learn from the mistakes of other investors

Learn from the mistakes of other investors
Tags: Ang Kok Heng

Written by Ang Kok Heng
Monday, 25 October 2010 11:43

Serious investors who want to make money from investing in the stock market often pick up some books written by or written about investment experts or gurus such as Warren Buffett and Peter Lynch.

The lessons learnt from investment legends will definitely help one to avoid some of the common investment mistakes. So, learning the right investment tactics and strategies is definitely a shortcut to successful investment.

Other than acquiring the right investment approaches from the masters, one can also study the common mistakes made by other investors, especially retail investors. After learning the types of mistakes commonly made by other investors and why they continue to lose money, we can avoid these mistakes so that we do not fall into the same traps again. Perhaps we can even adopt a completely different strategy in order to make money.

A reluctance to cut losses
The single biggest mistake of local investors is their reluctance to take losses. This is not unique among local investors. In fact, this phenomenon also happens in other countries, including developed market like the US where investors are believed to be more savvy than those in emerging markets.  People have a tendency to feel more pain when taking a loss. Research shows that the quantum of pain from suffering a 30% loss is about 2.5 times more than the joy from making a 30% gain. To avoid the pain, investors tend to keep loss-making stocks year after year. So long as the loss-making stocks are not sold, the pain is not felt.

It is not uncommon to see an investor having a long list of loss-making, poorer quality stocks in his or her Malaysian Central Depository (MCD) statement. The excuse given by investors for not selling these stocks is that they are waiting for the stock to recover. Psychologically, it is believed that so, long as a loss-making stock is not sold, there is still hope that one day the price may recover, but if the stock is sold, the loss is realised.

It is normal to hear that “I am stuck with the stock due to losses”, “how can I sell now, the price is lower than my cost”, “I can’t do anything now as the price has gone down.” As the market does not set traps for punters, it is the punters who voluntarily tie themselves up by refusing to get out of a sticky situation. Stocks do not recognise who gets “stuck” with losses, neither do they feel sympathy for loyal punters who endure financial pain.

For whatever reason, when a loss-making stock is purchased, the only rationale to continue holding on to the stock is hope. Most of the time there is no specific fundamental reason nor news to justify holding the stock. Hope is a bad reason for holding a stock as its fate often purely determined by chance.

Unfortunately, the problem with some of these poor-quality stocks is that if their fundamentals continue to deteriorate, these stocks may fall into PN17 status or be eventually delisted. By then, it will be almost impossible to recover whatever amount invested in the stocks. An 80% deterioration in price can end up as a 100% loss when the final nail is hammered into the coffin.

Quick to take profit
Another reason why a typical investor has a long list of loss-making third liners and little in quality stocks or blue chips in his or her MCD statement is that most of those stocks that made money have been sold. As the probability of making money from investing in quality stocks and blue chips is higher, investors are quick to lock in profit and proclaim a triumphant victory.
Over time, good stocks are sold and poorer-grade stocks are kept in the portfolio. Unknowingly, investors sell the valuables and became collectors of “rubbish”.

It is also common to hear “advice” from fellow investors that one should not be too greedy. If a stock appreciates by 20%, common advice is to lock in the profit before the price comes down. It is not entirely wrong to take profit. But what if the stock price falls by 20%? Should there not be a similar strategy to protect a portfolio when the stock price turns south? Investors make several mistakes by taking early profit:

•    Taking profit early should apply to trading stocks and not on investment-grade stocks;
•    Investors should also set a cut-loss strategy instead of only a profit-taking strategy;
•    Instead of selling quality stocks and keeping speculative stocks, investors should sell speculative stocks acquired based on rumours and keep quality stocks.

Preferring cheap stocks
When it comes to the level of stock price, the common perception is that a RM1 stock is cheaper than a RM10 stock. It may sound logical but it is entirely wrong based on the fundamentals of investment. From an investment approach, a stock is purchased because of its future earnings outlook.  As such, a RM1 stock having negligible earnings is more “expensive” than a RM10 stock yielding RM1 profit per share.

Perhaps a RM1 stock is perceived as easier to be “pushed” by syndicates or easier to move up than a heavyweight. Low-priced stocks are generally considered as retail stocks as they normally lack fundamentals and are not popular among institutional investors. Without the help of so-called syndicates, low-priced stocks are traded among retail investors themselves from the same pool of money.

There is no fresh money to lift the stock price higher. This is unlike investment-grade stocks, where improved fundamentals attract more money including foreign funds, resulting in more demand than supply. Hence, investment-grade stocks benefit from the strong price support, leading to a continuous price appreciation over time.

By the same token, when a company announces a share bonus issue or split, which leads to a lower price level, it is welcomed by retail investors.  On the other hand, when a company calls for a share consolidation the stock price will plunge. Stock consolidation can be due to the changing of par value from, say, RM0.20 to RM1 or due to capital reduction.

When our market was less mature, there were many retail investors who invested based on market rumours and speculation. Now, there are fewer retail investors participating in the local market and syndicates are also less visible. The strategy of relying on trading penny stocks has not brought much reward in recent years. Although there may be some penny stocks which turn into a five-bagger or even a 10-bagger, such incidences are few and far between.

Changing the goal posts
Another common mistake is the lack of a clear investment goal and strategy, whereby investment stocks and trading stocks are mixed together. As these stocks have different characteristics, they should be treated separately in terms of investment strategy.

A trading stock is normally purchased on a piece of news or rumour which may or may not happen. An investment-grade stock, on the other hand, is normally purchased based on fundamental reasons such as earnings outlook, business potential, and growth prospects.

As a trading stock is more speculative in nature, it should be monitored based on the reliability of the source of information. Technical charts are more useful in helping one on timing decisions to sell, hold or buy further.

Sometimes, investors know they are speculating on a stock but when the stock is out-of-the-money (in a loss-making position), they tend to keep the stock as if it is an investment-grade stock. A punt on a trading stock for short-term gain with a timeframe of several months may end up as long-term hold for several years. The initial objective to make some quick gains by speculating on a piece of news or rumour may end up in the hope that the stock price will recover to its cost.

On the other hand, some investors buy an investment-grade stock for long-term investment due to its strong fundamentals or dividends. But when the price starts to show gain, some investors are quick to take profit for fear that the price may come down. The irony is that a long-term investment now becomes a short-term trade when early profit is seen.

So long as investors keep changing their goal posts and confuse themselves between trading and investment stocks, between short-term speculation and long-term investment, their equity investments will be in a mess.

Excited by tips
Many retail investors are still fond of relying on tips to make money from the stock market. Many who depend on tips lose so much that they simply leave the market and vow that they will never touch the stock market again. Trading based on tips may be exciting, but experienced investors will confess that it is difficult to make money purely on tips.

What are tips? Tips could be insider news from those who know what is going to happen. Insiders could be company directors and senior management, professionals like corporate lawyers, auditors and bankers who may have some inside information or even reporters, analysts, fund managers and individuals who have access to the senior management of companies.

Tips that something is brewing could be true, some may be pure speculation but there are also some which are fabricated by syndicates as part of their games. Most of the time when a punter obtains a tip, it is not first-hand information. The tip could have been passed down from several people. In such a case, even if there are changes to the information, punters will be the last to find out. After the share price has plunged, will they only then realise that things have gone sour. By then it would be too late to sell and the stock may be added into their long list of “collector’s items”.

Little homework
Most retail investors do little homework before investing. Even if they do, it is normally very superficial. There is also little follow-up on the subsequent changes to the fundamentals. Many retail investors give the excuse that the accounts are too complicated to understand. If someone like an analyst has analysed a stock and recommended a buy, the investors will probably rely on the call to make their bet. Recommendations appearing in newspapers are also one of the main sources of investment ideas.

A lack of patience

Another common weakness of retail investors is their impatience. Most of them want quick gains. After they buy a stock due to a recommendation or a tip, they will monitor the stock movement closely. If the stock price moves up, they will praise the person who recommends the stock. But if the stock does not move after several weeks, they will become impatient and keep asking when the stock will move.

Most retail investors are not too keen to invest in a stock that makes 10% per year. They are excited with highly volatile stocks or high beta stocks that can potentially double in value or gain 20% within a week or two.

Always buy higher, sell higher
Because retail investors have little patience, they are not keen to buy on market weakness and wait for the market to recover. The tendency to chase a stock is common among retail investors. As they want to make quick money, they prefer to buy high and try to sell higher, a strategy more aptly applied in a bull market. This phenomenon clearly explains why more retail investors appear during a bull market but vanish at the bottom of the market when prices are much cheaper.

The strategy of buy-high-sell-higher is definitely riskier than the buy-low-sell-high strategy. The former is not inappropriate, but investors must get out of the market if they are wrong. Unfortunately, cutting losses is too painful for most people and many retail investors eventually get “caught” again.

The lessons
There are many lessons we can learn from the mistakes of retail investors, some of whom could be someone close to you — one of your family members, colleagues, friends or even yourself. To be a successful investor with an aim to increase wealth, we need to overcome some common human weaknesses.

At the top of the list, one has to learn to be impartial and view a stock objectively. If a mistake is made, the best thing to do is to take the losses and cut the stock. And it should be done without hesitation. If necessary, a short time frame should be given to try to sell at a slightly higher price. After the time frame, the loss-making stock must still be axed. If you do not have the discipline to take losses, then trading is not for you.

Investors should be clear about the investment plan when investing. Buy-and-hold investment stocks should be segregated from buy-and-sell trading stocks. As the two types of stocks have different characteristics, they should be treated separately with different strategies. The worst mistake is to buy a short-term trading stock and eventually keep it as long-term investment stock. In general, investors should learn to cut their losses and let the profits on investment-grade stocks run instead of selling all the good stocks and accumulateing speculative trading stocks in their portfolio.

Investors who like to dabble on tips should always remember that speculative stocks are trading stocks and certain time frames should be given for the “tips” to work, otherwise the stocks should be discarded, even at a loss. This is the nature of the game. The bet is either you win or you lose.


Ang Kok Heng has 20 years of experience in research and investment. He is currently the chief  investment officer of Phillip Capital Management Sdn Bhd.

This article appeared in The Edge Financial Daily, October 25, 2010.

Wednesday 23 June 2010

Investment is like a bet

Investment is like a bet
Tags: Ang Kok Heng | Berjaya Group | Elliott Wave | Forecasted profit | Hedge fund | HF Managers | Investment | Iskandar Development Region | MACD | management | risk management | Stochastic

Written by Commentary by Ang Kok Heng
Monday, 21 June 2010 11:23

There are risks in every investment which will result either in a profit or a loss. In a way, investment is like a bet — heads you win, tails you lose. If we hit it right we make a gain, but if we are wrong we will most likely end up with some losses.

Although investment is different from speculation, which depends more on luck rather than judgement, there is still uncertainty in every investment no matter how careful we are. Everyone will definitely want a good bet which has a higher potential for profit than loss. The job of an investor is to avoid a bad bet.

Before deciding on an investment, most people will consider various aspects of risk so as to avoid choosing a bad bet.


Investors bet on management
Management is one of the most crucial factor investors will look at, especially in emerging markets. Most Malaysian listed companies are run by the owners themselves who set up the business. The fate of the company will depend on the few key persons.

Before the company grows big, this is the way to go. This is unlike multi-national corporations which run on an established system — standard procedures, a clear work flow, internal control, risk management system, clear accountability, etc.

Serious investors who buy based on management is also betting on the management’s ability to continue to deliver what they have in the past. Management is the most crucial attribute of a good stock. Good management will be able to predict potential problems, overcome troubles, identify business opportunities, implement expansion plans, reduce costs, optimise efficiency, etc. Investing in such a company is like having a reliable member of staff who can handle most of the boss’s workload.

There are also other management risks, and we can hope that the strong track record of the past will continue into the future. Hopefully, there will be no change in the senior management, staff will remain highly motivated, there will be no internal squabbling and no resignations en bloc. One of the main challenges of the present management is to groom up the second echelon to take over the baton in order to maintain the growth of the company. Only with an equally capable manager can it be ensured that the growth of the company will not be disrupted.

Another danger of betting on management is the fall in vigour of the key drivers. When the owners become richer, they may not be as “hungry” as before. There are also other factors which may change the drive of the owners, such as health factors, family problems and less eagerness to take risks as age catches up.


Bet on business growth
Investing in a company is betting on the future earnings growth. Certain industries have stable growth — for example, power, telco, utilities, toll concessionaires, gaming and consumer-related businesses.



But there are also many industries which are very cyclical, such as plantation, property, construction and technology. It is the cyclical businesses that require more attention.

When a major up cycle comes, it will benefit all the companies in the sector. However, at a certain point in time, the cycle will turn downwards and earnings will also plunge. Attempting to catch the ups and downs of these cycles is similar to the endeavour of predicting the top and bottom of the market.

The earnings of companies are affected by many factors. Some may be related to raw material prices, foreign exchange rate, changes in government regulations, adoption of new technology, emergence of a major competitor, changes in consumer trend, etc. Whenever such events occur, the company’s profit will surge or plunge, depending whether it benefits or suffers from such changes. Such a swing in earnings can only last for a few quarters before profit stabilises at the so-called “economic profit” again, after the industry players adjust their production capacities.

Some analysts and fund managers are good at sensing such opportunities before they come. Hedge fund managers are also good at predicting business cycles by studying demographic and economic data. For long term investors, they may position themselves in a certain sector way ahead of time. For shorter-term investors, timing is crucial, as they do not want to squat on a stock for more than two quarters. In the case of punters, their time frame could even be shorter, perhaps over a month or two.


Bet on forecasted profit
Most fundamental investors rely on the earnings of a listed company to determine its value. A company that makes more profit will attract more investors.

The profit is derived based on orders received, expected revenue, cost of production, operating capacity, bad debts provision, margin, etc. Some profit forecasts are rather simple, but there are also many companies which have diversified into many lines of businesses, where their profit forecasts are more complex.

Investment based purely on forecasted earnings is like a bet placed on the reliability of the profit. It is not uncommon to see listed companies providing earnings guidance to analysts for the coming quarters.

But that is as far as it will go. Analysts who track the quarterly earnings may not be able to predict what will happen in two to three years time. As fundamental investment is a long-term commitment, earnings over the medium to longer term is more important than the quarterly profit. Many a time, analysts make a 180° turn in recommendation after realising that quarterly earnings are off track. By then, the stock price could have fallen substantially.

As such, there is no assurance that investment based purely on forecasted profit will definitely be a successful one.


Bet on a theme play
Some fund managers like to bet on a particular theme. The theme can be in terms of a business sector such as tech, auto, plantation, property, construction, power, water, banks, telco, oil and gas, etc.

The idea behind sectoral theme play is to ride the cyclical upturn in the earnings of these sectors. An improved outlook could be due to a change in business environment, favourable government policies, increased demand, surge in selling price, fall in cost of production, etc.

As cycles come and go, theme play has a finite life. Prices of stocks that were chased up will eventually come down. The bet on theme play relies on the ability to determine how long the cycle will last. The risk of riding a theme play is being caught in the middle of the cycle when prices suddenly fizzle off.

Theme play can also relate to other ideas. Some of which are related to location (for example, a Sarawak play or a play on the Iskandar Development Region), business group (for example, Berjaya Group), business activity (for example, export-oriented or domestic-oriented industry), size of company (for example, big-cap or small-cap stocks), etc. Other themes popular among fund managers include dividend play, defensive play, growth theme, etc.


Bet on specific economic/political event
It is also common for investors to be confronted with economic or political troubles from time to time. There is no single year in which the market does not encounter uncertainties. As uncertainty is part and parcel of the stock market, all of these events require certain forms of judgement as to what to do: sell, buy or hold.

How an economic or a political problem will eventually play out is not an easy guess. Not only are we limited by the required information we need, an understanding the mechanics of the problem is also very challenging. Every problem could be different, and the past pattern may not necessarily be relevant, though it is not uncommon to find analysts and economists using historical experience as a guide.

As the outcome of an economic or a political predicament will depend very much on the interference of the authorities and how the public will respond to those actions, it is very difficult to provide a good prediction. Investors who make a decisive call to buy or to sell are taking a bet on the outcome.

Take, for example, what the outcome of the Greece debt crisis will be. Will it lead to a domino effect causing other southern European economies to collapse? Will it result in eventual disintegration of the European Union? Will it cause further deterioration of Eurodollar? Those who believe the rescue package is sufficient to prevent the contagious debt crisis in Europe will take the recent market selldown to buy. Investors fearing further deterioration of the debt crisis will sell on panic. Only time will tell who is right and who is wrong. Optimists who load fully on stocks now and pessimists who cut all their holdings are taking extreme risks.


Bet on situational play
From time to time, there are some situational themes which will last for a short period. Year end window dressing is an annual affair keeping investors guessing which stocks will be pushed up for the sake of “dressing” so as to provide a better valuation. On the other hand, October always reminds investors of the many mishaps that had happened in the month.The listing of a large initial public offering (IPO) will also attract the attention of investors on similar stocks in the same industry. Some investors may try to bet on the spillover effects from the large IPO.

Following the government’s intention to pare down its investment in quoted GLCs and subsequent proposed privatisation of Pos Malaysia, investors are betting on which is the next to be disposed off.


Bet on chart reading
For technical chartists — using tools like MACD, Stochastic, Elliott Wave, etc — technical readings provide the timing to buy or sell, to enter or exit a position. Technical indicators provide guides as to what to do. Some of them may also indicate the potential profit from a buy signal and at what level to get out.

Even though technical pointers act like the eyes to traders, they cannot guarantee profit for every trade. As such, traders can only bet that what happens in the past will be repeated.

Choosing reliable indicators are crucial for a successful trader. If the trader sincerely believes the technical indicators he is using and the bet is right, profit will be made. If the bet is wrong, then he will have to admit it and get out with some losses. Traders know that every trade is a bet, a calculated bet at least.


Risk and return trade off
Every trade, be it based on technical readings or fundamental reasoning, has a risk. But every trade has its corresponding potential return too. Traders and investors will have to weigh each trade by looking at the risk and return trade off. They have to determine what is the upside potential from a particular purchase and what happens if they are wrong, resulting in possible losses.

In analysing the risk and return trade off, liquidity is important — especially for institutional investors whose positions could be big, as the stocks must be liquid for them to exit if necessary. Fundamental investors have more considerations than stock traders do. Fundamentalists — basically longer-term investors — incorporate risks such as management trustworthiness, corporate governance, business predictability, pricing power, business volatility, business scalability, cashflow sustainability, fluctuation in interest rate, changes in political outlook, shift in government policies, etc.

The fundamental risk of investment encompasses a wide range of uncertainties, some foreseeable but many of which are unexpected. Despite all the various hindrances, investors will still have to bet on each stock based on the best judgement at the point of purchase.


Incorporating probability
Since investment is a game of uncertainty, it is best to incorporate probability in each and every risk-and-reward bet. What we should look for are trades which provide high profit if our forecast comes true. We will never venture into an investment which only yields low return even if we are right.


HF managers
The technique of incorporating probability in every trade is widely used by hedge fund (HF) managers, who are usually misconstrued to be high risk operators. Many HF managers are cautious traders. Each and every position they take is well calculated based on the risk involved and potential profit. To HF managers, every move is a bet. Taking a position in a stock is a risk. Holding longer than the required time frame is a risk.

HF managers screen through much data, and come up with various possible scenarios. Although not all scenarios can be converted into profitable trades, they do provide various trading ideas.

Looking for trading ideas are the challenges facing HF managers. As HF managers are not emotional, they treat each investment as a trade or a bet with the intention of making money. When a trade has served its purpose, it will be closed, regardless of whether it provides a profit or a loss. A bet is initiated when it is deemed profitable, and it is liquidated when it is deemed to be unfavourable.


Risk management
As there are risks in every position taken, risk management is crucial in investment. Good traders know that risk management is very crucial in trading. The survival of traders depends on risk management to protect their capital. They can only survive and remain in the market if their capitals are not entirely wiped off.

In this way, a single-stock portfolio has higher risk than multiple stocks portfolio. A portfolio which diversifies into several stocks is deemed to be prudent. The diversification is not about getting higher returns but about managing the risk.

Position sizing
Diversification requires investors to place a weight on each stock. The weight is the percentage of the portfolio in a single bet. Obviously, higher weightings will be placed on the more attractive bets, and a smaller proportion of the investment will be placed on trades that are less promising.

Some traders initiate each trade with 2% of the portfolio money. If a trade becomes more attractive from the risk-reward perspective, more money will be placed on the bet. Controlling the size of each trade is important and also requires lots of discipline.

Placing a certain amount of portfolio money in a single trade is known as position sizing. It is a good risk management control. Regardless of investment or trading, investors and traders should use the concept of position trading to manage risk.


Ang has 20 years’ experience in research and investment. He is currently the chief investment officer of Phillip Capital Management Sdn Bhd.


This article appeared in The Edge Financial Daily, June 21, 2010.

Tuesday 25 May 2010

Investment myths


Investment myths

Tags: Ang Kok Heng | Buy low | Buy the best | Complicated | dividend | gambling | Long-term | market direction | October | Only for the rich | Risk of losing money | sell high | Sell in May | Short memories

Written by Ang Kok Heng
Monday, 24 May 2010 10:37


There are several investment myths that are uttered among the investing public. Some of them are true, while others may only apply in certain circumstances. Some investors or punters who have experienced similar situations believe that this is the investment maxim. There are so many versions of good investment practice, so much so that investors may just get more confused after hearing all these investment myths. Further explanations could help to clear some of these myths.


Buy low, sell high
Buy low and sell high is a common advice to investors. Many know this, but few actually know how to do it or do it well. When market is falling, it is always surrounded by various negative news and investors are fearful that the worst is not over and market can fall further. As such, it is difficult to “buy low”. As long as the market did not hit the bottom, there is always a chance that it may go down further after a purchase. Similarly, selling high is also difficult to practise. In a bull market when prices keep going up, chances are stock prices will continue to go up after the disposal.

Investors must remember “buy low, sell high” is not the same as “buy lowest, sell highest”. Low is relative. It means that prices are relatively low, though not the lowest. As long as prices have fallen substantially, it poses an opportunity for the buyer. Staggered purchase is recommended in a falling market, instead of a bullet investment. If the market has fallen by a substantial amount say 20%, it poses an opportunity to invest and investors can put in some money. If the market falls further and becomes even cheaper, investors can then buy more.

The “buy low, sell high” strategy must only be used when the overall fundamentals have not deteriorated substantially. In a crisis, this strategy must be used with care. If the market descends because of changes in sentiment, then this strategy will work well.


Buy the best, and ignore the rest
For savvy investors, buying a few good stocks and ignoring the rest of the noise is a good strategy. Different investors have different criteria as to what constitutes a “best” stock. Some will focus on pure fundamentals, which may also vary from person to person. Some of the fundamentals required by investors include prudent management, business model, business prospects, cash flow, dividend yield and valuation.

The problem with this method is that some stocks with strong fundamentals may not be the favourites among fund managers; thus, these stocks remain undervalued for years. Investors buying into these types of stocks must have lots of patience for the stocks to realise their true values.


Companies that pay regular dividends are safer investments
A bird in hand is better than two in the bushes. Companies that do well must also reward investors. Dividend is a proof of cash flow and the ability of the management to manage the company’s finances. An investor who invests in a stock is seeking a return which comes in two forms — dividend and capital gain. If the expected return is 10% and dividend yield is 4%, then the expected capital gain of 6% will depend on the market. This is better than hoping purely for capital gains of a non-dividend paying stock.


Don’t believe everything you hear
In a market full of various news and hearsay, it is difficult to differentiate between facts and rumours. There are many instances where owners and syndicates who want to see higher stock prices purposely fabricate various news on potential contracts, corporate exercise, etc to analysts and reporters with the intention to mislead investors. Every piece of news must be scrutinised to determine the authenticity and its impact on the earnings. Although this could be difficult in many cases, effort is still needed to avoid falling prey to unwarranted predators.

One advice for investors is to only believe events which are more likely to happen, and only on those stocks where the management can be trusted.


Don’t try to catch a falling knife
This is a different strategy from “buy low, sell high” which postulates buying on the way downwards. In a bear market, there are also many cases where the market continues to fall like a knife. A fundamentally-cheap buy can still go cheaper due to deteriorating market sentiment. Technical chartists will advise against buying downwards, as they will prefer to see the market hitting a bottom and start to show some confidence from buyers. Each method has its merits and demerits. “Buy low, sell high” is suitable for fundamental investors aiming for long term investment, whereas the “Don’t try to catch a falling knife” strategy is normally used by shorter term traders who do not want to tie up their money in the market.



Investors have very short memories

Some believe that investors are now smarter and they have learnt their lessons, but others think that investors have very short memories and they will continue to repeat the same mistakes again and again. The fear of losing money in a bear market and greed of making quick money in a bull market come and go when market progresses from boom to bust cycle. Investors, being human, are subjected to the psychological hurdle every time the market moves into the bear or bull phase. So long as investors cannot overcome the temptation of their peers to make a killing in the market, they could fall into the same trap again. When the market plunges the unwillingness to cut and take losses will get them “stuck” with some stocks.


Investing in stocks is like gambling
Certain people believe that the stock market is like a casino. Punters will buy a four-digit stock hoping for the share price to appreciate. Some will chase after hot news and look for stocks which are actively traded recently. Fundamentals are less important. What is more crucial is that the price must go up. A good stock is defined as one where the price will soar regardless of the fundamentals. The priority of a punter is to find the next winning horse and avoid the limping horse. This strategy was popular in the past. Some may make money from good tips, but many had experienced huge losses gambling this way, and they are still licking their wounds as many of these stocks have not seem to recover at all even though the market has recovered by 50% over the past one year.


Investing is complicated
Other than relying on tips to pick the favourite stock, some investors do not have a clue as to how to select the right stock. Although experts have advised them to do their homework, study annual reports, read research reports produced by analysts, buy on fundamentals, go for prudent management, etc, they find the process too tedious. Not only do they see contradictory recommendations from different research houses, they also do not know how to decide which stock is still undervalued. Some analysts say a stock is cheap but not exciting as the growth is low. Other analysts will recommend a stock based on the net present value of its discounted future cash flow. Some use price/book ratio, price-earnings ratio, price over enterprise value, PE over growth ratio, etc. As there is no single method to judge which is a best stock to buy, investors get more confused when they start to do some research. They realised even the so-called “gurus” could be wrong too.

No doubt, investment is not easy. If it is so easy, everyone will be rich and nobody will need to work. Doing some homework may not guarantee profit but it can only help to avoid some of the investment pitfalls. Knowing what you are investing in is better than investing blindly. The additional knowledge accumulated over the years will help to reduce the risk of investment and hopefully it will lead to a wiser choice of selection.


Investing is too risky
Besides the hard work needed to commence investing, the risk of losing money may deter would-be investors. Seeing how some of their friends lose large sums of money dabbling in the stock market may imply that investing in the stock market is risky. The only safe way is to avoid this type of investment. Some have resorted to investing in unit trusts to grow their money. However, investing in unit trusts still requires certain forms of investment knowledge such as the timing of investment, type of funds and manager’s investment styles.

There is no doubt that investing in the stock market has risks. Those who do not know how to invest and do not have the discipline to follow an investment policy will continue to fail. There are also many who have invested successfully for years. Investors should follow the footsteps of successful investors who are able to grow their wealth via investment rather than be deterred by the unsuccessful dabblers who rely on luck instead to make money.


October is a bad stock month
Although Halloween falls in October, it is not a curse for the stock market. However, for whatever reason, many investment mishaps so happened occurred in September/October — the Wall Street Crash of 1929, Black Monday in 1987, 1997’s South American market crash, the Sept 11 (2001) terrorist attack, subprime crisis in US causing a black week where the US market fell by 18% in September 2008, etc. Historically, October is a bad month in terms of stock performance and it also denotes the bottom of the market for investors looking to buy for the medium term of 3-5 months.

Out of the 10 biggest one-day falls in the US, seven falls were in October. This could be a coincidence. There is no assurance that the next crash will be in October, but when it does come, it also poses an opportunity for those who believe in long term investment.


‘Predicting’ the stock market is impossible
Nobody can predict the market direction — how high it can go and how low it can fall. The general trend of the stock market is upward bias due to corporate earnings growth. Market moves in a cycle similar to the economic cycle. But it is also very much influenced by market sentiment and the flow of global funds seeking maximum returns. From time to time, it follows market fundamentals on PE valuation and earnings growth. There are also times when the market is driven by fear of changes in policies.


Sell in May, go away
This is a seasonal indicator for investors who think that summer holidays are bad for the market. If buying fund managers were on leave during this period, the market may come down. On the other hand, if selling fund managers were on summer holidays, then it may not be a bad news.

“Sell in May, go away” also denotes the six-month period from May to October where the market generally performs poorer than the other six-month period from November to April. Between May and October, the worst months were September and October. The month of May appears to be a reasonable month as far as stock performance is concerned.


Stock markets are only for the rich
Some investors believe the rich have the upper hand when it comes to investments as they have deep pockets to average down in a falling market. The rich definitely have that advantage. The limited resources of the “poor” suggest that they adopt a bullet investment style by putting all their investments in a single stock in a single day. In this way, there is no time diversification for the “poor” who have limited resources to invest. The bullet investment style is definitely riskier. For those who can afford, time diversification is preferred. One does not need to be a multi-millionaire to dabble in the stock market. In fact, small investors also have an advantage over large institutional investors who may have several hundreds of millions to invest. For one, small investors can invest in a wider range of stock without fear of liquidity constraint when it comes to selling.


The long-term always pays off
This statement seems to suggest long-term (LT) investors perform better than short-term (ST) investors. Other than the duration of investment, the strategies of LT and ST investment, may not be the same. LT investors tend to invest in low beta, fundamentally-sound investment grade stocks, whereas ST investors tend to look for higher beta, volatile and high-liquidity situational stocks. In a bullish market, ST investors could make more provided appropriate cut loss strategies are put in place. There are also many LT investors who kept a portfolio of non-performing stocks where prices continue to decline due to deteriorating earnings.

What is required is the right strategy regardless of short-term or long-term investment.


What goes up must come down
Like Newton’s Law of Gravity, “what goes up must come down”, this investment myth describes the volatile pattern of stock prices. While the price of a trading stock may fluctuate within a certain range from the mean, the price of a growth stock will continue to go up in the long run. Even if the price of a growth stock goes down, it is only temporary. Having said this, in the


This article appeared in The Edge Financial Daily, May 24, 2010.

http://www.theedgemalaysia.com/in-the-financial-daily/166634-investment-myths.html

Tuesday 3 November 2009

Investors suffer from recency bias

Investors suffer from recency bias
Written by Ang Kok Heng
Monday, 02 November 2009 10:36

Human beings suffer from various forms of psychological biases (see Table 1). One of them is recency bias. Recency bias is a kind of mental myopia where investors focus on the more recent events, that is giving more weight to the recent happenings. Like many other diseases where there is no known cure, there is also no known financial doctor who can heal this mental myopia as it is hereditary.

Everyone, irrespective of race or level of education achieved, suffers from this problem, the only difference is the degree. In the absence of a cure, the only advice is for one to understand the cause of the disease, and learn how to control it so that we can reduce incidents of bad decision, while at the same time make more sensible investment decisions.


Short memory
As humans tend to have short memories, events that happened months or years ago tend to be neglected. Instead, recent incidents that are of lesser importance are still fresh in the memory. These incidents have a strong impact on our day-to-day judgement as they interfere in the decision-making process and influence our decision on a particular assessment.

Unlike the memory of a computer where every file is kept according to the names, the human mind arranges the “files” according to time and relative importance. Recent affairs are fresh in the memory. Some of the more important events are also kept at the top of our mind, but trivial events are suppressed to the bottom so as to release more room for the brain to remember relatively more important happenings (see Chart 1).

Some of the very important occurrences that happened recently will always be at the top of our mind. As a result, our brain will always remind us of other recent events, especially those which are more important. From time to time, our brain will also recall some of the more important happenings that occurred many years ago. There is also a tendency for old information to be out-weighed by new information, even though both are of equal importance.

All these “reminders” that pop up during our decision-making process influence our judgement sub-consciously.






Narrow framing
Another problem of recency bias is short-term bias. Many people are focused on the immediate future and are not too interested in the broader perspective. This phenomenon is sometimes called “narrow framing”, as it distorts our perception to the point that we do not think rationally. It changes the way we think, the way we analyse an issue. This framing bias gives a selective simplistic picture of reality.

Narrow framing is seen in emphasis by analysts to focus on quarterly results. A company which performs poorly in the latest quarter tends to be downgraded by analysts as if the poor showing is sure to be continued over the next few quarters. A more detailed analysis is needed to determine whether a particular below-average result is due to a luck factor, events beyond the control of the management, cyclical nature, change in circumstances, etc.

Unfortunately, most analysts and fund managers place undue emphasis on the belief that what has just happened to a company will continue to happen. As analysing quarterly results is the job of analysts, they tend to be over-excited by short-term changes of earnings, and they have the tendency to exaggerate transient changes.

There is no denying that the poor results of some companies signal the beginning of their downturn. Unless there is clear evidence to show that a drastic fundamental change has occurred, it would be too simplistic to assume that every company having a weaker quarterly profit will continue to go down.


Emphasis on recent trends
A study by Kahneman and Tversky in 1973 found that people usually assume there is a strong correlation between the recent past and future outcomes.

Investors believe recent trends can predict future market directions. Assume the market goes up five times and down five times. The different orders of the up-market (U) and down-market (D) will influence investors’ perception differently. If the market is directionless (as in Chart 2a), investors will not be able to decide where the market is heading. But if the market forms an obvious downtrend recently (Chart 2b), fear of a further downturn will make investors bearish for the immediate outlook. However, if the market has been trending upwards recently (Chart 2c), there is a tendency that investors will believe the market will continue to go up.

In all three examples, the market comes back to the original level. Investor (a) is at a loss. Investor (b) feels like selling to preserve the capital after the initial market run-up. Investor (c) is hopeful that the market is recovering again after the initial losses.

This type of psychology is also seen in punters who play roulette in a casino on the belief that recent results will form a pattern. In fact, each outcome is independent of previous outcomes. Similarly, a series of heads from tossing a coin will not show nor give you the ability to predict the exact outcome of the next toss, whether it is a head or a tail.

In predicting the outcome of market direction the next day, the past few days’ performance will not be sufficient to predict the market direction correctly. If there is any correlation, the degree of accuracy using the past few days’ performance to predict the next few days’ direction is only marginally relevant.


More weight on recent events
Given a list of items, most people tend to recall the items at the end of a list rather than items in the middle. This type of human weakness in recency bias is exploited in many instances.

For example, lawyers schedule the more “influential” witness at the end of the witness appearance in court to influence the judge or jury; event managers schedule a list of speakers to achieve the desired results at the beginning or end of an event; personnel managers emphasise the recent conduct of an employee to judge the performance of the employee, etc.

There is a tendency for an investor to focus on “what happened lately” while making a decision. This recency bias puts more weight on recent events rather than looking at the longer period of evaluation. An investment for a longer period of three to five years should not be evaluated based solely on the past six months’ events and ignore the happenings of the past few years.


Reinforced by frequency
Recent happenings can also be reinforced by the frequency of news heard or read. Investors are biased by the frequency of news received. A piece of news repeated many times is lodged more deeply in the mind than one that is broadcast only once. The more times an investor hears or reads about a particular piece of news, the more likely he or she will react to the outcome of the news. This is because repetition distorts our belief that a particular event is more important.

Unfortunately, the media likes to repeat and sensationalise a particular type of news, especially negative ones. This type of biased reporting will only mislead investors into making prejudiced decisions. In the recent crisis, the negative comments and fear of recurrence of a 1930s-style depression were repeatedly broadcast by both the electronic and print media, and it swayed many into believing that another depression was imminent.

Other than distortion by frequency of news, breaking news that highlights a particular incident — usually negative — will also increase the bearish opinion of investors as if such a mishap would happen again soon. Getting influenced by such reporting does not help investors in rational thinking.


Recency leads to overconfidence
A series of recent successes may also lead to overconfidence in investors, as if nothing could possibly go wrong. The years upon years of success of LTCM (Long Term Capital Management) in managing a client’s money misled fund managers into believing that their strategies were perfect. In order to make more money, they increased their leverage and bet heavily on Russian bonds. The unexpected collapse of the Russian economy resulted in huge losses that led to the subsequent downfall of the invincible LTCM in 1998.

The Internet stock rally of the early 2000s is also a good example of how the daily gains in the “new economy” dot.com stocks misled investors into believing that the momentum would continue, and that these hot stocks will just keep rallying.

We all fall prey to recency bias, whether you are a professional fund manager or an individual retail investor. There is a strong tendency to believe in our hearts that whatever happens recently is going to continue. As such, a bull market enhances market confidence, and a bear market depresses the mood of investors. Unknown to many, the changes in our emotions are dictating our actions, which rationally should be determined by the real fundamentals.


Distancing from recent losers
The recent global financial crisis resulted in losses in almost every asset class, and many investors cut their losses and regretted having invested in those assets. Losses were seen in every bourse. Institutions and high net-worth individuals redeemed their investments from hedge funds.

Unit trust investors avoided high-risk equity funds and opted for guaranteed structured products. Bond investors also saw losses due to a perceived increase in credit risk. Bond investors avoided lower grade bonds in favour of AAA and government bonds. Even low-risk money market funds were faced with massive redemptions early this year, as investors were fearful of possible bank failures. All these have passed ,and investors now are more rational as the economy is obviously recovering gradually.


Following recent performers
The exit from market losers benefited the strong performing asset classes — one of which is gold, which has performed well after the financial crisis. It is common for investors to avoid recent, poorer-performing investments and chase after stronger performers. Investors believe that those investments which have performed well recently will continue to do well.

This recency bias influenced many unit trust investors to put in more investment during the bull market when funds were showing strong gains. Similarly, during the bear market, unit trust investors were avoiding this investment for fear of further losses. Instead of buying low and selling high, unfortunately, unit trust investors always fall prey to recency bias and perform the opposite. Similar mistakes were also made in other forms of investment where investors chase after strong performers.

Unknowingly, the psychological weakness of investors cause many investors to adopt the wrong investment approach. What investors need to do is diagnose the degree of recency bias they suffered, and how to control such deficiency.


Ang has 20 years’ experience in research and investment. He is currently the chief investment officer of Phillip Capital Management Sdn Bhd.


This article appeared in The Edge Financial Daily, November 2, 2009.

http://www.theedgemalaysia.com/business-news/152639-investors-suffer-from-recency-bias.html

Monday 27 July 2009

Growing with growth stocks




Growing with growth stocks

Tags: Ang Kok Heng

Written by Ang Kok Heng
Monday, 27 July 2009 00:26

AXIATA Group Bhd, formerly TM International Bhd (6888), will cap capital expenditure (capex) at RM4.4 billion this year, in a move to cut costs amid a slowdown in the region's economies. "There are a few things we are doing given the economic situation — we are reducing capex from RM5.4 billion to RM4.4 billion, re-looking all operating costs and benchmarking ourselves to know where we stand," Axiata president and managing director Datuk Seri Jamaludin Ibrahim said.

Malaysia's third-placed mobile operator DiGi Telecommunications is planning to spend more than RM1.1 billion (US$318.9 million) in 2009, Reuters reports.

PPB GROUP BHD [] is planning to spend RM293 million on capex this year, its chairman Datuk Oh Siew Nam said. He said the group's flour-making subsidiary FFM Bhd, has been allocated RM173 million to build new flour mills in Kota Kinabalu, Sabah, and Jakarta, Indonesia.

Food-based QL RESOURCES BHD [] has earmarked RM280 million as capex for its current fiscal year and the next, deemed pivotal to spur its regional merger and acquisition (M&A) plans, and to improve its manufacturing facilities. Some RM130 million and RM150 million are allocated for the financial years (FY) ending March 2010 and 2011, respectively.

TA ANN HOLDINGS BHD [] plans to spend up to RM189 million in 2009, with most of the money going into oil palm PLANTATION []s, group managing director and chief executive officer Datuk Wong Kuo Hea said

TOMEI CONSOLIDATED BHD [] has budgeted about RM10 million for capex this year in a bid to expand amid the economic slowdown, the jeweller's group managing director Ng Yih Pyng said. "The amount allocated will be used mainly for our outlet expansion and also to improve our information TECHNOLOGY [] (IT) system," he told StarBiz in an interview.

Top Glove Corp Bhd chairman Tan Sri Dr Lim Wee-Chai said the group had allocated some RM80 million for capex, which would include organic expansion and potential acquisitions. TENAGA NASIONAL BHD []'s capex this year amounted to RM3.75 billion to RM4 billion, lower than RM4.5 billion previously. UMW HOLDINGS BHD [] plans some RM600 million in capex this year to beef up its oil and gas (O&G) business, according to managing director and chief executive officer Datuk Dr Abdul Halim Harun.

The capex planned by companies is mainly for future expansion. It is this capex that generates business and hence earnings growth for a company. Earnings growth is the main attraction in equity investment.

Stock grows
One of the main duties of the management is to grow the company. When a company is operating at full capacity, additional capex is needed to grow the earnings. The funds for capex could be internally generated or from borrowed capital. This type of reinvestment is the yearly expansion budget of a company. Every incremental investment will provide additional return which will add to the existing profit of a company.

Some companies may be faced with diminishing return which occurs when profitability falls over time either because of more competition or less lucrative investment return. So long as the return on investment (ROI) is higher than the bank's interest rates, there is value added from the expansion plan.

But the ROI of most investments is expected to be much higher than the bank's interest rates since every investment comes with a certain amount of risk. When ROI is substantially higher than borrowing rates, it will make sense to borrow to enhance business returns. Every capex may be viewed individually from the ROI point of view such that the return must be worth the effort and risk taken. In many cases, the return may not be immediate and some may even suffer losses for the initial few years before profit starts to flow in.


Growth stocks pay less dividends
Because of the need to grow, growth stocks normally pay less on dividends so that a larger portion of the profit is retained for future expansion. The amount of dividend paid to shareholders as a percentage of the profit is known as dividend payout ratio. The dividend payout of a growth stock could be less than 50% while some may be as low as 20%.

Generally, a stock with low dividend payout and low dividend yield is expected to have higher earnings growth. On the other hand, a stock with high dividend payout and thus high dividend yield has lower earnings growth. In this way, growth stocks tend to have higher price appreciation than high-dividend yield stocks.

It is not uncommon to come across management's explanation to its shareholders on the reasons for keeping some of the profit for future expansion. As every company has its own expansion plans, the company usually conserves some cash for future use and pay the balance to shareholders. In this way, there is no need to raise money from shareholders via rights issues for expansion purposes.

In certain cases, although the company may post profit, it may not have sufficient free cashflow to pay dividend, as the profit is just an "accounting profit". In this case, the "profit" is tied up in inventories or receivables and hence it cannot be paid to shareholders. A good company is one which can pay relatively high dividends and yet able to continue to provide reasonable growth.

More capex, higher growth
There are also many listed companies which did not pay high dividends and yet their earnings growth was mediocre. If the capex is not well spent, the earnings growth may not be forth coming. Although failed projects may not be entirely the fault of the management, a good manager should also avoid or minimise such losses.

More importantly bad investment should not be repeated. Unfortunately, it is not uncommon to see several companies listed on Bursa Malaysia which did not seem to get any of their investment strategies right year after year. The poor ROE (return on equity or shareholders' fund) in the past and non-improvement in ROE over the years prove the failures of the management to deliver basic economic profit to shareholders.

At the beginning of this article, several companies disclosed their capex requirements for the year. For a growth stock, the capex is likely to be higher relatively to its size. For the selected companies, we have listed them in Table 1. We have divided the capex by market capitalisation (a measure of value of a company) and also by fixed assets. Although these ratios may not be conclusive to determine which stock is a better growth stock, they provide some ideas on the expansion plans.



It should be noted that the low capex of a company in a particular year may not necessarily denote lower earnings growth going forward. It could be due to the adequate capacity for the time being or less need to expand due to the prevailing market conditions. Some companies may not be capital intensive and hence less need to spend as much.

Expansion path
Listed companies have many options to grow. They can grow organically through natural expansion or by way of acquisition. The growth can be financed by internally generated funds, borrowing or a combination of both. They may also issue new shares to acquire the target company or call for rights issues to finance the expansion (see Chart 1).



It is not uncommon for a company to move downstream by adding value to what it produces, for example, to process its products further. It can also go upstream to procure its own raw materials so as to be in a better position to control its supplies. A company facing limited growth in its existing business may also venture into new businesses to remain relevant. This type of diversification can also be useful to stabilise the cyclical business nature of a company.

Capital gain can be volatile
From an investor's perspective, the ROI is the dividend income received regularly and the capital gain from price appreciation.

For a high-dividend stock, the dividend yield is similar to assured return received, say 4% per annum. The capital gain, normally smaller for a high- dividend stock, is like a bonus on top of the dividend.

For growth stock, the dividend yield is smaller (see Chart 2) and capital gain is what an investor mainly aims for. Unfortunately, capital gain can be very volatile, since the share price could be influenced by market sentiment. Furthermore, as the business risk of a high-growth company is normally higher, the expected price appreciation will depend on the results of the expansion plan. Most investments provide both income and capital gain. Examples are unit trusts, bonds, PROPERTIES [] and foreign currencies.



There are also several investments which do not provide income. These are merely trading instruments. They include commodity trading, gold and similar types of commodity which bet purely on the price appreciation. Investors who "invest" in gold thinking that this is a good investment, must bear in mind that gold does not provide income, it only provides capital gain (or speculative gain). A kilogramme of gold remains a kilo after several years. A growth stock (provided it is a true growth stock and not speculative stock), on the other hand, will grow over time and will not be the same after several years.

Fixed-income instruments don't grow
Most investment grade stocks provide some growth. Even a low-growth high-dividend yield stock may have small growth. If the growth is only 2% per year, the dividend received is also likely to grow by 2% per annum. In this example, assuming the dividend yield is 4% per annum, a 2% growth in dividend will mean that after five years, the dividend yield will increase to 4.4%. As such, growth does make a difference in the return.

In the case of fixed-income instruments such as fixed deposits (FD) with the bank, the FD rate is fixed during the period of placement. If a one-year FD yields 3%, it is 3%. If the interest rate remains the same, the same FD will continue to give 3% return the following year.

While interest rate may go up one year later after the FD matures, it may possibly go down as well. There is no growth factor in FD placement. Some may argue that the growth in savings from interest rate is compounding. The compounding effect by reinvesting the interest earned is similar to the compounding effect achieved by reinvesting the dividend earned in the case of investing in a high-yield stock which may still provide some growth.

Some stocks don't grow
While investing in FD is a constant yield investment, there are also many stocks which don't grow over time. Unfortunately, the earnings of many stocks listed on Bursa Malaysia are very sluggish and they don't seem to increase even after ten years. It is a disappointing fact. These companies remain more or less the same after one or two rounds of the economic cycle. They seem to struggle with the same business year in year out.

Investing in non-growth stocks is like investing in FD with the same yield. The only difference is that non-growth stocks usually do not provide high dividend as they are not well-managed and hence their operating cashflow may not be stable. The lack of confidence to generate sufficient and consistent cashflow prevents these companies from paying higher dividend.

Some stocks degrade like their retiring owners
One of the reasons why some companies degrade and show stagnant earnings is the lost of drive (the oomph!) when the key promoters retire or on the verge of retiring. The lack of successors either among the owners' scion or from other professionals could not propel the companies forward. In some cases, the children who took over the businesses were not as capable as the founders were. As a result, these successors acted merely like a caretaker. Not only were they not able to grow the business, some of them were not even able to defend the companies' market shares.

Investing in non-growth stocks is already bad, investing in negative-growth stocks is even worst.

Investment provides yields and capital gains
In short, investment provides yields and capital gains. Some investments like FD provide pure yields but no growth at all. Some investments like gold and commodities only provide capital gains but not income. Pure capital gain investment is more speculative in nature and is not suitable for the buy-and-hold strategy. Trading strategy is more appropriate for this type of investment and market timing is crucial. Many other investments provide both yield and capital gain.

Yields are like a bird in hand and capital gains are like birds in the bushes. Some capital gains are easier to anticipate, while some capital gains are less predictive.

Ang has 20 years' experience in research and investment. He is currently the chief investment officer of Phillip Capital Management Sdn Bhd.


http://www.theedgemalaysia.com/business-news/129607-growing-with-growth-stocks.html