Thursday 20 December 2012

Warren Buffett: We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.


What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur.  The timing of these epidemics will be unpredictable.  And the market aberrations produced by them will be equally unpredictable, both as to duration and degree.  Therefore, we never try to anticipate the arrival or departure of either disease.  Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.

As this is written, little fear is visible in Wall Street.  Instead, euphoria prevails - and why not?  What could be more exhilarating than to participate in a bull market in which the rewards to owners of businesses become gloriously uncoupled from the plodding performances of the businesses themselves. However, stocks can’t outperform businesses indefinitely.

Buffett allocates funds in ways that build per share intrinsic value.


At Berkshire, our managers will continue to earn extraordinary returns from what appear to be ordinary businesses.  As a first step, these managers will look for ways to deploy their earnings advantageously in their businesses.  What's left, they send to Charlie and me.  We then try to use those funds in ways that build per-share intrinsic value.  Our goal is to acquire either part or all of businesses that we believe we understand, that have good, sustainable underlying economics, and that are run by managers whom we like, admire and trust.

Warren Buffett: Intrinsic Value and Capital Allocation


Intrinsic Value and Capital Allocation


     Understanding intrinsic value is as important for managers as it is for investors.  When managers are making capital allocation decisions - including decisions to repurchase shares - it's vital that they act in ways that increase per-share intrinsic value and avoid moves that decrease it.  This principle may seem obvious but we constantly see it violated.  And, when misallocations occur, shareholders are hurt.     

     For example, in contemplating business mergers and acquisitions, many managers tend to focus on whether the transaction is immediately dilutive or anti-dilutive to earnings per share (or, at financial institutions, to per-share book value).  An emphasis of this sort carries great dangers.  Going back to our college-education example, imagine that a 25-year-old first-year MBA student is considering merging his future economic interests with those of a 25-year-old day laborer.  The MBA student, a non-earner, would find that a "share-for-share" merger of his equity interest in himself with that of the day laborer would enhance his near-term earnings (in a big way!).  But what could be sillier for the student than a deal of this kind?

     In corporate transactions, it's equally silly for the would- be purchaser to focus on current earnings when the prospective acquiree has either different prospects, different amounts of non-operating assets, or a different capital structure.  At Berkshire, we have rejected many merger and purchase opportunities that would have boosted current and near-term earnings but that would have reduced per-share intrinsic value.  Our approach, rather, has been to follow Wayne Gretzky's advice:  "Go to where the puck is going to be, not to where it is."  As a result, our shareholders are now many billions of dollars richer than they would have been if we had used the standard catechism.

     The sad fact is that most major acquisitions display an egregious imbalance: They are a bonanza for the shareholders of the acquiree; they increase the income and status of the acquirer's management; and they are a honey pot for the investment bankers and other professionals on both sides.  They usually reduce the wealth of the acquirer's shareholders, often to a substantial extent.  That happens because the acquirer typically gives up more intrinsic value than it receives.  Do that enough, says John Medlin, the retired head of Wachovia Corp., and "you are running a chain letter in reverse."    Over time, the skill with which a company's managers allocate capital has an enormous impact on the enterprise's value.  Almost by definition, a really good business generates far more money (at least after its early years) than it can use internally.  The company could distribute the money to shareholders by way of dividends or share repurchases.  Often the CEO asks a strategic planning staff, consultants or investment bankers whether an acquisition or two might make sense.  That's like asking your interior decorator whether you need a $50,000 rug.

Warren Buffett: Book Value and Intrinsic Value


Book Value and Intrinsic Value


     We regularly report our per-share book value, an easily calculable number, though one of limited use.  Just as regularly, we tell you that what counts is intrinsic value, a number that is impossible to pinpoint but essential to estimate.

     For example, in 1964, we could state with certitude that Berkshire's per-share book value was $19.46.  However, that figure considerably overstated the stock's intrinsic value since all of the company's resources were tied up in a sub-profitable textile business.  Our textile assets had neither going-concern nor liquidation values equal to their carrying values.  In 1964, then, anyone inquiring into the soundness of Berkshire's balance sheet might well have deserved the answer once offered up by a Hollywood mogul of dubious reputation:  "Don't worry, the liabilities are solid."

     Today, Berkshire's situation has reversed: Many of the businesses we control are worth far more than their carrying value.  (Those we don't control, such as Coca-Cola or Gillette, are carried at current market values.)  We continue to give you book value figures, however, because they serve as a rough,  understated, tracking measure for Berkshire's intrinsic value. 

     We define intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life.  Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future cash flows are revised and as interest rates move.  Despite its fuzziness, however, intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.

     To see how historical input (book value) and future output (intrinsic value) can diverge, let's look at another form of investment, a college education.  Think of the education's cost as its "book value."  If it is to be accurate, the cost should include the earnings that were foregone by the student because he chose college rather than a job.

     For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its economic value.  First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that figure an estimate of what he would have earned had he lacked his education.  That gives us an excess earnings figure, which must then be discounted, at an appropriate interest rate, back to graduation day.  The dollar result equals the intrinsic economic value of the education.

      Some graduates will find that the book value of their education exceeds its intrinsic value, which means that whoever paid for the education didn't get his money's worth.  In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed.  In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.

     Now let's get look at Scott Fetzer, an example from Berkshire's own experience.  This account will not only illustrate how the relationship of book value and intrinsic value can change but also will provide an accounting lesson.  Naturally, I've chosen here to talk about an acquisition that has turned out to  be a huge winner.

    The reasons for Ralph's success are not complicated.  Ben Graham taught me 45 years ago that in investing it is not necessary to do extraordinary things to get extraordinary results.  In later life, I have been surprised to find that this statement holds true in business management as well.  What a  manager must do is handle the basics well and not get diverted.  That's precisely Ralph's formula.  He establishes the right goals and never forgets what he set out to do.  On the personal side, Ralph is a joy to work with.  He's forthright about problems and is self-confident without being self-important.   He is also experienced.  Though I don't know Ralph's age, I do know that, like many of our managers, he is over 65.  At Berkshire, we look to performance, not to the calendar.  Charlie and I now keep George Foreman's picture on our desks.  You can make book that our scorn for a mandatory retirement age will grow stronger every year.

Warren Buffett: "Avoid these bargains."


Bargain Price


In the final chapter of The Intelligent Investor, Ben Graham wrote:  "Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety." Many years after reading that, I still think those are the right three words. The failure of investors to heed this simple message caused them staggering losses.
    
In the summer of 1979, when equities looked cheap to me, I wrote a Forbes article entitled "You pay a very high price in the stock market for a cheery consensus." At that time skepticism and disappointment prevailed, and my point was that investors should be glad of the fact, since pessimism drives down prices to truly attractive levels. Now, however, we have a very cheery consensus. That does not necessarily mean this is the wrong time to buy stocks: Corporate America is now earning far more money than it was just a few years ago, and in the presence of lower interest rates, every dollar of earnings becomes more valuable. Today's price levels, though, have materially eroded the "margin of safety" that Ben Graham identified as the cornerstone of intelligent investing.

     My first mistake was in buying control of Berkshire. Though I knew its business - textile manufacturing - to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965, I was becoming aware that the strategy was not ideal.

     If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the "cigar butt" approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the "bargain purchase" will make that puff all profit.  Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original "bargain" price probably will not turn out to be such a steal after all.

     I could give you other personal examples of "bargain-purchase" folly but I'm sure you get the picture:  It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. Now, when buying companies or common stocks, we look for first-class businesses, with enduring competitive advantages, accompanied by first-class managements.

     In a difficult business, no sooner is one problem solved than another surfaces - never is there just one cockroach in the kitchen.  Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return.

The investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost.  Therefore, remember that time is the friend of the wonderful business, and the enemy of the mediocre.

Market value, business value, Short-term & Long-term Market Returns and the effects of GDP Growth

Long-term stock market growth (by most measures of return, 10-11% annually) can be explained by adding together the following:
  • GDP growth of 3 to 5%
  • Productivity growth of 1 to 2%
  • Long-term inflation in the 3 to 6% range

In the short-term, depending on the value of alternative investments, such as bonds, real estate, and so on, market value may actually rise faster or slower than business value. And inflation also tampers with market valuations.

So can markets grow at 20% per year? 

Not for long. It isn't impossible for the markets to rise 20% in a given year or two, but such growth year after year is hard to fathom if the economy at large is growing at only 3 to 5% annually. 

But for a particular stock? 

Sure, it's possible. If the company is building a new busines or is taking market share from existing businesses, 20% growth can be quite realistic.

But forever? 

Doubtful. Some call this "reversion to the mean" - sooner or later, gravitational forces will take hold and a company will cease to grow at above-average rates. As an investor, you must realistically appraise when this will happen. 


GDP

You can and should expect, in aggregate, that the total value of all businesses would rise roughly in line with the increase in the size of the economy, as represented by gross domestic product (GDP). This is true.

Business value grows further through increases in productivity.

The value of market traded businesses could rise still more if the businesses grew their share of the total economy - as Borders Group and Barnes and Noble have grown their share of the total book selling business in the previous decade.



Main point:  
Business value and market value of a company grow further through increases in productivity (better profit margins) and through growing its market share (higher revenues).

GDP Growth and Market Return

Economic Growth: Great for Everyone but Investors?

While it may be intuitive to presume strong economic growth translates into strong stock market performance, the evidence suggests otherwise.

By Alex Bryan | 12-19-12

By 2050 the world's population is projected to reach 9 billion, up from 7 billion today. Nearly all of that growth will come from emerging markets, where living standards are rapidly improving. Although these markets have experienced large capital inflows, they still have a long way to go to match developed countries' levels of capital and wages. Consequently, emerging markets will likely continue to grow faster than developed markets for the foreseeable future. While this growth may lift hundreds of millions out of poverty and spur investment and innovation, evidence suggests investors may be left behind.
Alex Bryan is a fund analyst with Morningstar.

Jay Ritter, a professor at the University of Florida, documented a negative relationship between economic growth and stock market returns in his seminal research paper, "Economic Growth and Equity Returns," published in 2005. Ritter's findings are no fluke. Using real gross domestic product data from the Penn World Tables and stock market returns, as proxied by the total return version of each market's MSCI country index, I found a weak negative correlation between GDP growth and stock market returns for 41 countries from 1988 to 2010. This relationship is plotted in the chart below. However, excluding China (the outlier at the bottom right of the chart) brings the correlation close to zero.




While the strength of these relationships is sensitive to the start and end dates of the sample period, the general findings are fairly robust over long time horizons. It's clear that higher economic growth does not necessarily translate into superior stock market returns over the long run.

Reasonable Assumptions?
This result should not be surprising given the strong assumptions that would be required to make the jump from GDP growth to stock market returns. In order for this relationship to hold, corporate profits as a share of GDP and valuation ratios would need to remain stable over time. Second, current shareholders' ownership stake of total corporate profits would also need to remain constant. In other words, there should be no dilution from new share issuance, private and public companies would need to grow at the same rate, and there could be no new enterprises or initial public offerings. All existing publicly listed companies would also need to generate substantially all of their revenue and profits from the domestic economy.

The Link Between Economic Growth and Profitability
In a closed economy, it would be reasonable to expect that total corporate profits would grow at a similar rate as the economy in the long run. Although the share of corporate profits relative to GDP fluctuates over time, it tends to revert to the mean. Profits cannot persistently grow faster than the economy because they would crowd out all other economic activity and attract new competitors. Similarly, total corporate profits should not grow slower than the economy in the long run, as firms exit unprofitable businesses, allowing those remaining to preserve margins. Of course, it is inappropriate to assume that any country United States investors have access to is closed. The largest companies listed in most countries tend to be multinational firms that generate a large portion of revenue and income outside their host country. For instance, the constituents of the S&P 500 generate close to 40% of their profits outside the U.S. This international exposure means that profits can grow at a different rate than the domestic economy, even in the long run.

Even if aggregate corporate profits grow in sync with GDP, dilution can prevent shareholders from enjoying the benefits of growth. Creative destruction is essential to economic growth. In aggregate all companies that are publicly listed today will grow slower than the economy because new entrants drive much of that growth. Between the time these new companies are launched and publicly listed, their growth dilutes most investors' ownership interest in the economy. Flagrant dilution of corporate earnings through employee stock grants and seasoned offerings is also a very real risk, particularly in developing countries with a tradition of poor corporate governance. Additionally, earnings growth can only create value if it allows firms to generate returns that exceed their cost of capital. High reinvestment rates may enhance both corporate and domestic economic growth but destroy shareholders' wealth through inefficient capital allocation.

Is Growth Already Priced In?
Growth expectations influence stock market valuations. Valuations are rich when investors expect strong growth. However, as developing economies mature, their growth rates slow and valuations tend to decline. Consequently, even when countries realize their expected growth rates, their stock markets may not keep pace.

The impact of lofty growth expectations on valuations can create a treadmill effect, whereby fast-growing economies must realize high growth in order to generate a competitive rate of return. For example, in the mid-1980s the so-called Asian tigers had experienced two decades of rapid growth and investors had high expectations for future growth. In contrast, several countries in Latin America were facing severe inflation, a debt crisis, and low expectations for future growth. As a result, according to research published by Peter Blair Henry and Prakash Kannan in "Growth and Returns in Emerging Markets," in 1986 Latin American stock markets were trading at 3.5 times earnings, while the Asian markets were trading at 18.3 times earnings. Over the next two decades, Latin American stock markets posted more than twice the annualized returns as the Asian markets, despite experiencing lower GDP growth over that horizon. This was because Latin American countries implemented economic reforms that allowed them to exceed investors' low expectations. Conversely, the Asian markets performed in line with investors' high expectations, which were already priced in.

What's an Investor to Do?
In order to benefit from economic growth, investors must identify markets that have the potential to exceed expectations. Russia may fit the bill. The Russian equity market, as proxied by  Market Vectors Russia ETF (RSX), is trading at a paltry 5.6 times forward earnings, making it the cheapest of any major emerging market. Corruption and a taxing regulatory environment have stunted the country's growth and depressed valuations. However, if (and this is a big if) Russia adopts structural reforms similar to those undertaken in Latin America over the past two decades, it could offer investors rich rewards--albeit with high risk.

Even if fast-growing emerging markets do not offer superior risk-adjusted stock market returns, they can provide significant diversification benefits. Over the past 20 years, the MSCI Emerging Markets Index and S&P 500 were only 0.73 correlated. Emerging-markets equities may also offer a long-term hedge against a weakening U.S. dollar.


http://news.morningstar.com/articlenet/article.aspx?id=578607

Sunday 16 December 2012

Several investment instruments can bring in steady returns for both young and old.

@ AsiaOne
Seeking the Holy Grail of passive income
Several investment instruments can bring in steady returns for both young and old. -ST 
Aaron Low

Tue, Oct 23, 2012
The Straits Times


It is the Holy Grail of investing for many of us: Build a big enough nest egg, generate passive income from it and retire comfortably on the steady stream of dividends.

Well, it is not just the Holy Grail for retirees these days; now investors young and old want the reassurance of a steady income after the battering our portfolios have taken in recent years.


The benchmark Straits Times Index may be up 17 per cent since the start of the year, but not before a roller-coaster ride over the past 12 months that left many of us battered and bruised.


Analysts warn that the road ahead looks bumpy, with market movements still likely to be influenced by events and news rather than financial fundamentals.


Mr Kelvin Tay, regional chief investment officer at UBS Wealth Management, says many investors want the safe haven of stable returns in an uncertain market.


"With interest rates so low, much more attention is being paid to what kinds of steady returns they can get in a market like this," he says.


Ms Jane Leung, head of Asia-Pacific at iShares, a subsidiary of asset management firm BlackRock, says that fixed income assets form a valuable core component of diversified portfolios.


"They're favoured for moderate volatility, low correlations with other asset classes and stable cash flows."


These days investors are spoilt for choice when it comes to investing in income assets.


Bonds
Probably the simplest of all income instruments is the humble bond.


In its most basic form, the bond is essentially a loan made by a lender to a borrower. The borrower pays a lender an interest rate and promises to pay back the money to the lender in full, after an agreed period of time.


Bonds can be issued by companies or governments.


For instance, you can buy Singapore government bonds or trade in bonds issued by the Land Transport Authority and the Housing and Development Board on the Singapore Exchange (SGX).


Mr Brian Tan, director of wealth management at financial advisory firm Financial Alliance, says that if people want safety and a steady income stream, look no further than a bond.


The problem is that most bond issues typically come in tranches of $250,000, which put them out of reach for most retail investors.


Similar instruments that are listed on the Singapore Exchange include securities such as perpetual securities and preference shares.


They also pay a fixed coupon rate every year but differ from bonds in that they have different company rights from bondholders.


Companies such as Hyflux and the local banks have issued preference shares through the SGX that pay between 3.9 per cent and 6 per cent a year.


Fixed income funds
A big disadvantage of buying individual bonds is that the investor is exposed to the risk of the company failing.


If the firm goes bankrupt, the investor could potentially lose all the money invested in its bonds.
Buying fixed income mutual funds can help get around this problem.


These funds are typically managed by fund managers, who use their expertise to select a basket of bonds that generate yield.


For instance, JP Morgan's Emerging Market Local Currency Debt Fund invests in debt instruments of various emerging market governments, such as Poland, Turkey and Brazil. Its annualised yield is 7.27 per cent.


Mr Tan believes that for retail investors, getting into a fund is probably the best way of getting exposure to bonds.


"Most investors don't have $100,000 or $250,000 sitting around to invest in the bonds of just one company," he says.


"So funds are a good way of getting exposure."


But mutual funds are not perfect. They do suffer from underperformance, depending on the skill of the manager.


The other issue is that they charge relatively high management c
osts, ranging between 0.5 per cent and 1.5 per cent a year, depending on the asset class and the type of fund.

A fairly recent type of fund, however, drastically lowers the costs of investing with the fund and mostly eliminates underperformance.

Called exchange-traded funds (ETFs), they track indexes, both equities and fixed income, directly. This means that ETFs do not underperform the overall market, but neither do they overperform.


Last year, iShares listed four new fixed income ETFs on the SGX which directly tap the Asian fixed income market.


One is the iShares Barclays Capital USD Asia High Yield Bond Index. Its yield is 7.55 per cent and it charges a management fee of 0.5 per cent. It has returned 17.02 per cent since last December.


Mr Gary Dugan, private bank Coutts' chief investment officer for Asia and the Middle East, says that ETFs should be seriously looked at as an alternative to pure bonds as they are both low-cost and easy to access.


But Financial Alliance's Mr Tan notes that fixed income ETFs are subject to the vagaries of the market as they can be traded freely like stocks and shares.


Asset management firm Franklin Templeton's director of retail sales for Singapore and South-east Asia, Mr William Tan, says that index products lose the ability to benefit from an additional source of returns through currency management.


"In an actively managed fund, portfolio managers are more nimble and able to react to changing market conditions and they can adjust the duration of a bond fund as necessary," he says.


High dividend stocks
While income tends to be associated with bonds and fixed income instruments, experts also point out that high-quality dividend stocks can also form part of an income portfolio.


Mr Dugan says that stocks should form part of any portfolio, even if it is income-focused.


This is because some stocks pay higher dividends than bonds, while allowing for potential capital gains.
One such hot type of stock is real estate investment trusts (Reits), which have soared roughly 30 per cent since the start of the year. Singapore Reits typically pay anywhere between 5 per cent and 8 per cent in distributions a year.


Analysts are mixed on whether Reits are still good buys.


Mr Dugan and Financial Alliance's Mr Tan believe they are fairly priced, given the rally over the past 10 months, and they are cautious about buying them.


But UBS' Mr Tay says that one should buy Reits based on what they offer and not so much whether prices have risen.


"It's really about quality rather than how much prices have run up by," he says.


Outside of Reits, JP Morgan Asset Management's global strategist Geoff Lewis says that it is a good time to diversify into solid dividend-paying stocks.


"We don't think it's too late in the day to get into the theme of income investing. In the current environment of low interest rates, high yields have thrived even while default rates remain low," he says.


"We like firms that can pay a good starting dividend but with the potential to grow both their business and ability to pay good dividends."


aaronl@sph.com.sg



Get a copy of The Straits Times or go to straitstimes.com for more stories.

Friday 14 December 2012

Value Investing: Keep Emotions Out of It


As you evolve your value investing style, keep this in your mind always.


Keep Emotions Out of It


 Thumbs Up Handshake Cash Clap

The wisdom shared is about avoiding emotional attachments to stocks and the businesses they represent.


If you LOVE Dutch Lady#  Smiley , don't invest in it until you like the numbers.  And if the numbers look good and you invest, but they start to look bad later, be able to recognize that.  

Value investors continuously look for the good and the bad and keep their RATIONAL wits about them as they decide to buy and keep their investments.  The purpose of an investment is to achieve a greater financial goal and not to become a "member of the family".

DON'T HESITATE TO ADMIT YOUR MISTAKES.  Value investors admit their mistakes and learn from them.  They take the time to understand what changed (or was overlooked in the first place), and they move on.  

They have a RATIONAL "sell" model and aren't afraid to sell a business when underlying reasons to own it have changed or if the price is way out of line with value.  




# Dutch Lady is a stock in the KLSE.

Stock Performance Chart for Dutch Lady Milk Industries Berhad

Thursday 13 December 2012

Ten Signs of Value

Here are ten "core" signs of value to guide your value investing process.  When all or most signs are present, the business is on the right track.


  1. Steady or Increasing Return on Equity (ROE)
  2. Strong and Growing Profitability
  3. Improving Productivity
  4. Producer, NOT Consumer of Capital
  5. The Right Valuation Ratios
  6. A Franchise
  7. Price Control
  8. Market Leadership
  9. Candid Management
  10. Customer Care


Sunday 9 December 2012

Let's look at reasons to invest in warrants and how to go about it.


Why invest in warrants?

Gearing effect
A hedging tool


As with any instrument, money can be made and lost when trading warrants.

Mr. X, 37, would know. Three weeks ago, he lost about $25,000 in just two weeks after trading in some Straits Times Index warrants.  'Greed made me lose a lot. I was hoping my initial losses could be recovered, but this didn't happen,' he said.



Investors should also be disciplined about taking profits and cutting losses. Investors are advised to monitor their positions closely as warrants tend to move in greater percentage terms than shares.

Mr. P, 32, started trading warrants this year with a principal sum of $15,000.  He made a 25 per cent return in just three days, after he bought DBS Group Holdings and CapitaLand warrants in September. But he lost about $20,000 in two weeks when the stock market nosedived recently. 'I wasn't careful, so I didn't cut my losses fast enough,' he said.


You also need to factor in the timeframe - and be confident that the underlying asset price is set to reach your price target at the same time that the warrant matures.

'If you believe the market is going to have a sharp correction soon, you should choose a short-term out-of-the- money put warrant.'

'If you expect a stock to move up gradually in one to two months' time, you should choose a mid-term at-the- money or a 1 to 5 per cent out-of-the- money call warrant.'


What are the five variables and how do they affect an option's value or premium?

Options values or premiums on puts and calls are function of five variables.  The five variables are:
1.  the underlying asset value,
2.  the risk-free rate,
3.  the standard deviation of the return of the asset,
4.  the option's time to maturity, and
5.  the option's exercise price.

A call option's value will increase with increases in the underlying asset value, risk-free rate, time to maturity, and standard deviation of returns.  However, a call's premium will decrease as the striking price increases.

A put's value will increase with increases in the exercise price, the time to maturity and standard deviation of returns, and decrease with increases in the underlying asset value and risk-free rate.

If dividends are considered, a call's value will decrease with dividends while a put's value will increase.

Friday 7 December 2012

Warrants trading: What you need to know


Cheap investment tools were virtually non-existent in Singapore a few years ago, but a recent growth spurt has sent their popularity soaring. 
Gabriel Chen

Sun, Dec 02, 2007
The Sunday Times

These cheap investment tools were virtually non-existent in Singapore a few years ago, but a recent growth spurt has sent their popularity soaring. Let's look at reasons to invest in warrants and how to go about it.
IF THE experts are right, the current boom in this investment tool is far from petering out.
They say more and more market traders are jumping in, as well as investors looking beyond stocks and bonds to bolster their portfolios.
To get an idea of just how popular they have become, consider this: Warrants turnover on the Singapore Exchange has grown from zero in 2003 to about $3 billion a month now.
The number of active warrant accounts has also shot up more than tenfold, to 20,154 this June from 12 months earlier.
A key attraction of warrants is that they are cheap.
Warrants trade around 20 cents to 30 cents, so the minimum investment for one lot - 1,000 shares - could be as low as $200 to $300.
As with any instrument, money can be made and lost when trading warrants.
For example, say an investor bought a call warrant on stock X for 30 cents with an exercise price of $5. Also, assume the conversion ratio is one to one, which means one warrant can be converted into one share.
The current share price is $5.25.
If the investor holds the warrant to maturity and exercises it, he is effectively paying $5.30 apiece for the shares (30 cents warrant cost plus $5 exercise price).
If the price of stock X stays at $5.25, he will get back 25 cents, so effectively, he will lose five cents ($5.30 minus $5.25).
If the share price falls to $5 or below, he will lose just his investment capital of 30 cents, but no more, even if the share price falls drastically.
On the other hand, if the stock's market price shoots up to $5.35, converting the warrant into a share would mean a five cent profit.
Consultant Peter Ang, 32, started trading warrants this year with a principal sum of $15,000.
He made a 25 per cent return in just three days, after he bought DBS Group Holdings and CapitaLand warrants in September.
But he lost about $20,000 in two weeks when the stock market nosedived recently. 'I wasn't careful, so I didn't cut my losses fast enough,' he said.
Despite the spectacular growth in the Singapore warrants market, Hong Kong is still well ahead because of a flood of China listings there.
Previous attempts to launch warrants trading here in 1995, and again in 1999, tanked for various reasons - including overly stringent listing rules and inadequate investor education.
But three years ago, warrant issuers - some of the biggest players include Deutsche Bank, Macquarie Bank, Societe Generale and BNP Paribas - started to double as market makers.
This means these banks provided buy and sell prices on warrants to ensure that investors had the chance to enter or exit the market.
They also embarked on investor education seminars and dedicated websites featuring trading tools.
How to pick a suitable warrant?
Directional view
Without getting bogged down in technical terms such as 'implied volatility', you should consider one factor when picking a warrant: whether you think the underlying asset is likely to go up or down in value.
Your view will determine whether you select a call warrant or a put warrant.
For example, suppose the Government has announced a new project and the likelihood of CapitaLand securing the project is high.
If you think this is good news for CapitaLand, you could consider buying call warrants on the stock - since you would expect the stock price to rise.
But if you think CapitaLand's share price is more likely to fall, you might want to buy a put warrant.
'Theoretically, if one has a neutral view on a stock, it would not be advisable to invest in warrants,' Deutsche vice-president Sandra Lee cautioned.
Timing
You also need to factor in the timeframe - and be confident that the underlying asset price is set to reach your price target at the same time that the warrant matures.
Take a call warrant, for example. The longer the time to expiry, the more time there is for the underlying asset to appreciate, which in turn will increase the price of the call warrant.
A call warrant that is far 'out-of-the money' with very little time to expiry is considered highly risky. This is because it has an exercise price that is much higher than its underlying price and yet has little time to appreciate.
In contrast, when the call warrant's exercise price is lower than its underlying price, the warrant is regarded as 'in-the-money'.
For both call warrants and put warrants, if the exercise price is equal to the underlying price, the warrants are said to be 'at-the-money'.
'If you believe the market is going to have a sharp correction soon, you should choose a short-term out-of-the- money put warrant,' said Mr Simon Yung, BNP's head of retail listed products sales for Singapore and Hong Kong.
'If you expect a stock to move up gradually in one to two months' time, you should choose a mid-term at-the- money or a 1 to 5 per cent out-of-the- money call warrant.'
Why invest in warrants?
Gearing effect
The biggest advantage warrants trading has over stocks trading is the gearing effect, which means that you can make huge gains from a modest investment outlay.
For example, it can cost nearly $20,000 to buy one lot of DBS shares (assuming a market price of $20 a share).
An increase of 1 per cent in the DBS share price will give you a return of $200.
But if you buy a DBS warrant with an effective gearing of 10 times, it should roughly return the same profit of $200.
The effective gearing indicates roughly how many per cent a warrant price will move if the underlying stock changes by 1 per cent.
In this case, trading in the DBS warrant costs just $2,000 but reaps the same $200 return.
'If the share price moves in your favour, you will get higher returns with a higher level of gearing. But if you get your view wrong, losses will also be greater,' said Mr Barnaby Matthews, Macquarie's head of warrants sales.
Since warrants are typically cheaper than underlying shares, this potentially frees up investors' cash for other purposes.
A hedging tool
Buying a put warrant - which gives you the right to sell the underlying asset later - is like buying an insurance policy for your portfolio, as it protects you from falls in the market.
'If the underlying asset declines, then put warrants will appreciate in price to offset losses suffered by the underlying asset,' said Mr Ooi Lid Seng, Societe Generale's vice-president of structured products for Asia ex-Japan.
For example, one can hold OCBC Bank shares and buy OCBC put warrants. If the OCBC share price keeps falling, losses will be partially offset by the gain in the put warrant price.
As warrants can be used to capture both the upside (call warrants) and the downside (put warrants), they can be used as a tool for risk management in a stock portfolio.
Mr Yung said that warrants can be a perfect instrument for balancing a portfolio's risk profile. 'A portfolio with only bonds, property and stock may not be able to optimise the risk-taking capability of the investor,' he said.

Tips on investing

FIRST, investors should never invest all their investment capital in warrants.
'Generally, we do not advise them to invest more than 10 per cent of their total investment capital in warrants due to the high-risk and high-return nature of warrants,' Mr Ooi said.
Retirees should also not use retirement funds needed to maintain their lifestyle to invest in warrants, as they generally have a lower risk tolerance, he added.
Investors should also be disciplined about taking profits and cutting losses. Mr Matthews advised investors to monitor their positions closely as warrants tend to move in greater percentage terms than shares.
Customer service manager Jason Kua, 37, would know. Three weeks ago, he lost about $25,000 in just two weeks after trading in some Straits Times Index warrants.
'Greed made me lose a lot. I was hoping my initial losses could be recovered, but this didn't happen,' he said.
Finally, investors should attend a seminar or do some reading to ensure that they understand the product before investing.
'Asking the expert before you invest is always a good idea,' Mr Yung said.
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What is a warrant?

WARRANTS are 'derivative' investment products - that is, they derive their value from an underlying asset such as a stock or a market index such as the Straits Times Index.
They give the investor the right to buy or sell the underlying asset from the issuer by paying a specific 'strike' or exercise price within a certain timeframe.
A call warrant gives the holder the option to buy, while a put warrant gives the option to sell.
Take a Keppel Corp call warrant for example.
If the price of the underlying Keppel stock rises above the exercise price before the expiry of the warrant, it will clearly be to your advantage to exercise the right to buy Keppel shares.
If you plan to exercise the Keppel warrant - that is, convert it into a Keppel share - you must do so before the expiration date. Of course, if Keppel's price stays below the exercise price, the warrants will expire worthless.
But investors often do not have to hold warrants to maturity. Normally, they simply buy and sell warrants on the stock market as they move in line with movements in the underlying share price.
'Warrants, unlike shares, have a finite lifespan,' said Deutsche Bank vice-president Sandra Lee. 'For each day the investor holds on to the warrant, the warrant loses some time value.'
Warrants usually have three- to six-month expiry dates.




http://www.asiaone.com/Business/My%2BMoney/Building%2BYour%2BNest%2BEgg/Investments%2BAnd%2BSavings/Story/A1Story20071205-39670.html

http://forum.lowyat.net/topic/1039913/all  (Good notes on warrants)

Warrants Basics


A
At-the-money (ATM) 
A warrant whose strike is near or equal to the underlying security's price.

B
Break-even point
That implies the price level at which the investor will break-even on warrant expiry; for instant, the investor will make profit if the closing price is higher than strike price.

Broad Lot
The minimum number of warrants that can be traded on the Singapore Stock Exchange.

C
Call
A call warrant provides the holder with a right, but not an obligation, to buy a stock/index at a pre-determined strike price on maturity date. However, currently most of the warrants are cash settled.

Conversion ratio
It indicates the number of warrants related to one share of the underlying that the holder is entitled to buy or sell.

D
Delta
Delta measures "how much the warrant price will move for a one dollar move in the underlying security". The delta of a call warrant has an upper bound of 1.00 (decimal format) or 100% (percent format) and a lower bound of zero. A call warrant with a delta of 1.00 will move up or down one full point for each full point move up or down in the price of the underlying security. A call warrant with a delta of zero should move negligibly, even if the underlying security makes a relatively large move. Warrants that are at-the-money have a delta of approximately 0.50.

For put warrants, the delta lies between -1.00 (or -100%) and zero. A rise in the underlying security will bring about a drop in the price of a put warrant.

E
Effective Gearing
A warrant's effective gearing is the relative percent change in a warrant's value for a given percent change in the price of the underlying security. A warrant's effective gearing is not constant and is higher for warrants which are out-of-the-money and/or close to expiry.

Expressed mathematically:
Effective gearing = gearing x delta
G
Gamma*
It is the rate of change of the portfolio's delta with respect to the price of the underlying asset.

Gearing
The ratio of the share price to the warrant price (multiplied by the conversion ratio, if applicable).
Gearing =___________share price__________
   warrant price x conversion ratio
H
Hedging
A trade designed to reduce risk, for instance, a put warrant may act as hedge for a current holding in the underlying asset.

I
Implied Volatility
Implied volatility is the volatility anticipated by the financial markets. The higher the implied volatility, the higher the value of the warrant.

Implied volatility is also the volatility implicit in the market price of the warrant. For warrants of similar terms, the higher the implied volatility, the more expensive a warrant is.

In-the-money (ITM)
A warrant with the strike below (for a call warrant) or above (for a put warrant) the price of the underlying security.

Intrinsic Value
For a call warrant, the amount that equals to the market value of the underlying security less the strike. For a put warrant, the amount that equals to the strike less the market value of the underlying security. The intrinsic value corresponds to the amount by which a warrant is in-the-money.

L
Last trading Day
The last trading day of a structured warrant is the fifth trading day prior to the maturity date. After the last trading day, investors will not be able to buy or sell the structured warrant in the market.

M
Maturity Date
It is the expiry date of a warrant.

O
Out-of-the-money (OTM)
A warrant with the strike above (for a call warrant) or below (for a put warrant) the price of the underlying security.

P
Premium
The percentage by which the underlying share price needs to have moved at maturity for the investor to break even.
Premium for a call warrant (%)

=[strike + (warrant price x conversion ratio)] - share pricex 100%
                                          share price


Premium for a put warrant (%)
=share price - [(strike - (warrant price x conversion ratio)]x 100%
                                          share price

Put
A put warrant provides the holder with a right, but not an obligation, to sell a stock/index at a pre-determined strike price on maturity date. However, currently most of the warrants are cash settled.

S
Strike Price
It is the price at which the warrant-holder to buy (a call) or to sell (a put) the underlying asset. However, currently most of the warrants are cash settled.

T
Theta*
It is the rate of change of the value of the portfolio with respect to the passage of time with all else remaining the same. Theta is sometimes referred to as the time decay of the portfolio.

Time Value
The portion of a warrant's price that is not accounted for by the intrinsic value.

U
Underlying Asset
The listed company or stock index that the warrant is issued on.

V
Vega*It is the rate of change of the value of the portfolio with respect to the volatility of the underlying asset.

Volatility*
A measure of the uncertainty of the return realized on an asset.

*Source: Options, Futures, and other derivatives (Fifth edition), John C. Hull

http://sg.warrants.com/singapore/home4/basic/glossary01.html

Thursday 6 December 2012

Are you amazed at what goes on without the public knowing?

Come and see ‘land grab’ plots, Tee Yong told


December 05, 2012


Chua was challenged to pursue reparations for Selangor if it can be shown that BN parties had profited from the 24 plots of land involved. — File pic
KUALA LUMPUR, Dec 5 ― DAP’s Tony Pua today invited MCA’s Datuk Chua Tee Yong to visit the 24 plots of land in Selangor that were allegedly sold to the Barisan Nasional (BN) coalition in a suspected multi-million land grab scandal.

http://themalaysianinsider.com/malaysia/article/come-and-see-land-grab-plots-tee-yong-told/