myinvestingnotes.blogspot.my (Bullbear Buffett Stock Investing Notes)

Keep INVESTING Simple and Safe (KISS) ****Investment Philosophy, Strategy and various Valuation Methods**** The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.

Saturday 14 January 2017

Central elements to a Value Investing Philosophy

The three central elements to a value investing philosophy:

1) A "bottom-up" strategy

2) Absolute (as opposed to relative) performance

3) A risk averse approach

Bottom-Up Investing

Most institutional investors use a top-down approach to investing.

That is, they try to forecast macroeconomic conditions, and then select investments based on that forecast.
This method of investing is far too prone to error, and doesn't allow for a margin of safety.
For example, a top-down investor must be correct about the big picture, draw the correct conclusions from that big picture prediction, correctly apply those conclusions to attractive areas of investment, correctly specify specific securities, and finally, beat other investors to the punch who have made the same predictions.
In addition to these challenges, top-down investors are buying based on concepts, themes and trends.
As such, there is no value element to their purchase decisions, and therefore they cannot buy with a margin of safety.

On the other hand, bottom-up investors can apply a margin of safety and face a limited number of questions, e.g. what is the business worth, what is the downside etc.

Absolute Performance

Institutional investors are judged based on their performance relative to their peers or the market.

This results in a short-term investing horizon.
Thus, if an investment opportunity appears undervalued but the value may not be recovered in the near-term, such investors may shun such an opportunity.

Absolute investors don't judge themselves based on their performance to the market, which results in a short-term investing horizon.

Instead, they focus on investments that are undervalued, and are willing to wait for that value to come uncovered.

Risk

In the financial industry, returns are expected to correlate with risk.

That is, you cannot generate higher returns without taking more risk.
Downside risk and upside potential are considered to have the same probability (an implication of using beta, a measure of a stock's volatility versus the market).

Value investors think of risk very differently.

Downside risk and upside potential are not necessarily the same.
Value investors seek to exploit this key difference by buying stocks with strong upsides and limited downsides.

Read:

Seth Klarman - Margin of Safety

Read also:

The Philosophy of Value Investing and Why It Works

What is Value Investing?

The terms used to describe value investing don't require any accounting or finance background.

Value investing is described as paying 50 cents for a business worth $1.

Warren Buffett's analogy using the maximum allowable weight of a bridge is used to illustrate how this margin of safety works:

"When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000-pound trucks across it. And that same principle works in investing."

Margin of Safety (buying at a discount) is of utmost importance

What allows value investors to apply a margin of safety while most speculators and investors do not?

Again using a Buffett analogy to illustrate this:

A long-term-oriented value investor is a batter in a game where no balls or strikes are called, allowing dozens, even hundreds, of pitches to go by, including many at which other batters would swing. Value investors have infinite patience and are willing to wait until they are thrown a pitch they can handle—an undervalued investment opportunity.

Value investors do not buy businesses they do not understand, nor ones that they find risky. For example, they will avoid technology companies and commercial banks.

Value investors will also invest where their securities are backed by tangible assets, to protect them from downside risk.

Because the future is unknown (e.g. a business worth $1 today might be worth 75 cents or $1.25 tomorrow), there is little to be gained by paying $1 for this business.

The margin of safety (buying at a discount) is therefore of utmost importance.

Value investors gain an advantage when many:

do not buy with a margin of safety,
remain fully invested at all times, and
trade stocks like pieces of paper with little regard to the underlying asset values.

Read also:

Philosophy of value investing. Need to have clear strategies too.

Buffett's first two rules of value investing:

1) Don't Lose Money

2) Never Forget Rule #1

While it is easy to say these rules, by themselves they don't help investors.

The future is uncertain.

These are always unknown:

future GDP growth rates,
inflation rates, and
other relevant factors to stock price returns.

Furthermore, stocks are junior securities to debt and other firm obligations, making their future values even more uncertain.

Stocks are certainly not risk free.

The investors need to have clear strategies, which they can follow, that will help them follow the above rules of Buffett's.

Read also:

How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s

How the Wall street created the junk bond market investment fads?

In the early to mid-1980's, Wall Street firms pushed junk bonds on investors.

They touted the positive historical results of high-yield debt.

There were major differences between the debts of fallen angels versus newly issued bonds from fragile companies.

Debt from fallen angels:

trades at a discount to par,
downside risk is reduced.
at the same time, the potential for capital appreciation is large.

Newly issued debt from marginal companies

does not share in these above characteristics.

How Wall Street can create investment fads, only to leave investors much poorer when the tide goes out.

That didn't stop Wall Street from pushing this form of debt (newly issued debt from marginal companies), nor did it stop investors from ponying up and falling victim to these issues.

The number and size of junk bond issues grew, despite the fact that this asset class was untested by an economic downturn, which should have made investors cautious.

Investors were happy to gobble up zero coupon bonds (where the interest accrues to the issuer but is not paid out until the bond comes due) despite the clear risks!

It took the downturn of the early nineties to wipe out those who were too eager to pay for assets that were risky.

Faulty Logic using EBITDA propelled the Speculation

One way investors were prodded into purchasing such securities were valuation measures based on EBITDA.

Rather than considering cash flow or earnings, companies were valued using this accounting measure which doesn't include depreciation expenses.

A company paying its debts from EBITDA is slowly liquidating itself (as it can't make capital expenditures) and leaving itself susceptible to a credit crunch.

Such fads will undoubtedly occur in the future, and those who are able to avoid them will do well.

Read also:

Understanding these changes in the investment world allows investors to earn superior returns

The changing scenario in the investment world

The investment world has changed over the last several decades.

From 1950 to 1990, the institutional share of the market rose from 8% to 45%.

During the same period, institutions comprise 75% of market trading volume.

The short-term mindset of the institutional investors

The institutions are hampered by a short-term mindset.

Here are some reasons.

1. Money managers tend to be rewarded not on what they return to clients, but rather as a percentage of their assets under management.

A larger base of cash actually makes it more difficult to generate returns.

Thus there is a conflict between what's best for the manager and what's best for the investor.

2. Institutional investors are also "locked into a short-term relative performance".

Frequent comparative rankings among institutional investors forces a short-term mindset, as a long-term view can quickly send a manager to the unemployment line.

As a result, these managers act as speculators rather than investors.

They try to guess what other managers will do, and try to do it first!

Only the brokers, who benefit from frequent trading, win this, as short-term market fluctuations are random.

3. Institutional investors are also constantly compared (and comparing themselves) to index benchmarks.

Due to this relative comparison, they tend to prefer being close to 100% invested, even if things don't look cheap on an absolutely basis, which hurts investors when stocks are expensive.

4. Money managers rarely invest their funds along with their clients.

In this conflict of interest situations, it is clear that the management firm wins.

Economist Paul Rosenstein:

"In the building practices of ancient Rome, when scaffolding was removed from a completed Roman arch, the Roman engineer stood beneath. If the arch came crashing down, he was the first to know. Thus his concern for the quality of the arch was intensely personal, and it is not surprising that so many Roman arches have survived."

Read also:

What's good for Wall Street is not necessarily good for investors.

How Wall Street does its business?

It has a very short-term focus.

For example, Wall Street makes money up-front on commissions (not from long-term performance).

Therefore the Wall Street will always push for churn and will always push "hot" investments.

Is this business model fundamentally wrong?

Some argue that there is nothing fundamentally wrong with this business model.

After all, many professionals make money in this manner without being responsible for the long-term results.

It is, however, important that investors recognise this Wall Street bias, or they will be robbed blind.

This business model also encourages very short-term thinking, and a bullish bias.

If stocks are going up, Wall Street is able to make more in the form of commissions.

This bullish bias is seen in the percentage of stocks that are recommended by analysts versus those that are deemed "sells".

There are many examples of Wall Street's short-term bullishness that props up prices of various securities, but where those prices eventually fall dramatically.

Take Home Message for Investors

Investors are advised to keep Wall Street's biases in mind when dealing with the Street.

Investors are to avoid depending on the Street for advice.

Read also:

Speculators, Investors and Market Fluctuations

Speculators versus Investors

Mark Twain mentioned the two times in life when one shouldn't speculate: "when you can't afford it, and when you can!".

Speculators buy in the hopes or assumptions that others will want to buy the same asset (be it a painting, a baseball card, or a stock) later.

Investors buy the cash flow the investment returns to its owner. (As such, a painting can never be an investment by this definition!)

Stock Market Bubbles

Bubbles in the stock market form due to faulty logic that first propels speculators to bid up prices followed by the inevitable bursting which destroys the wealth of many.

What determines whether an investor will make money in the market or not?

The answer is his psychological make-up.

If he does his own stock analysis and views the prices offered by Mr. Market as an opportunity to buy low and sell high, he will do fine.

If Mr. Market's offering prices guide the investor's outlook of what the stock price should be, he should get someone else to manage his money!

Market fluctuations

Most market fluctuations are the result of day-to-day distortions between supply and demand of particular stocks, not of changes in fundamentals.

Investors who take advantage of these distortions by focusing on the fundamentals will be successful.

Those who invest with their emotions are sure to fail in the long-run.

Read also:

Thursday 12 January 2017

Various Value Investing Strategies - a Review

Many value investing strategies to employ in the market place:

Stocks

1. Net-net of Benjamin Graham eg. Poh Kong in 2009

2. Deep value investing in secondary issues (but beware of value traps). eg. KAF before 2014

3. Buying blue chips at bargain at certain market sell down period. eg. 1998, post SARS, 2008/2009

4. Buying growth stocks at reasonable price (GARP). eg. PetDag in 2005

5. Special situations: Arbitrage, M&A, turnarounds, bankruptcy restructuring. e.g. turnarounds HaiO in 2005/6, GCB in 2009, Latexx in 2008, acquisition of MOX

6. Joel Greenblatt magic formula investing: Screen for stocks with high ROIC and high EY

Bonds

High quality bond with good yield sold at below par value.

Low quality (junk) bond with good yield available at severely discounted value. eg. Plus Bonds before being redeemed by the government bailout, RBS bond yielding 8% available at a discount to par.

Cash

Stay with cash if you have nothing better to buy. Your default mode.

Teach yourself to THINK in PROBABILITIES and in MULTIPLE SCENARIOS.

Without question, Buffett's success is tied closely to number.

"One of the advantages of a fellow like Buffett is that he automatically thinks in terms of decision trees and the elementary maths of permutations and combinations." (Charlie Munger)

Most people do not.

It doesn't appear that the majority of investors are psychologically predisposed to thinking in multiple scenarios.

They have a tendency to make decisions categorically while ignoring the probabilities.

Thinking in probabilities

Thinking in probabilities is not impossible: it simply requires attacking the problem in a different manner.

If your investing assumptions do not express statistical probabilities, it is likely your conclusions are emotionally biased.

Emotions have a way of leading us in the wrong direction, especially emotions about money.

But if you are able to teach yourself to think in probabilities, you are well on your way to being able to profit from your own lessons.

Not often will the market price an outstanding business or any other outstanding businesses substantially below their intrinsic value.

But when it does occur, you should be financially (have the CASH) and psychologically prepared (have the COURAGE) to bet big.

In the meantime, you should continue to study stocks as businesses with the idea that one day the market will give you compelling odds on a good investment.

"To the Inevitables in our portfolio, therefore, we add a few Highly Probables." (Buffett)

My 18 points guide to Successfully compounding your money in Stocks

Be a good stock picker.
Think as a business owner.
Always look at value rather than the price. Do the homework.
Buy and hold is alright for selected stocks.
Compounding is your friend, get this to work its magic.
Mr. Market is there to be taken advantage of. Do not be the sucker instead. BFS;STS.
Always buy a lot when the price is low.
Never buy when the stock is overpriced.
It is alright to buy when the selected stock is at a fair price.
Phasing in or dollar cost averaging is safe for such stocks during a downtrend, unless the price is still obviously too high.
Do not time the market for such or any stocks.
By keeping to the above strategy, the returns will be delivered through the growth of the company's business.
So, when do you sell the stock? Almost never, as long as the fundamentals remain sound and the future prospects intact.
The downside risk is protected through only buying when the price is low or fairly priced.
Tactical dynamic asset allocation or rebalancing based on valuation can be employed but this sounds easier than is practical, except in extreme market situations.
Sell urgently when the company business fundamental has deteriorated irreversibly.
You may also wish to sell should the growth of the company has obviously slowed and you can reinvest into another company with greater growth potential of similar quality. However, unlike point 16, you can do so leisurely.
In conclusion, a critical key to successful investing is in your stock picking ability.

http://myinvestingnotes.blogspot.com/2012/07/my-18-points-guide-to-successfully.html

11 Lessons From Peter Lynch

Peter Lynch taught me:

1. Behind every stock is a company. Find out what it’s doing.
2. Never invest in any idea you can’t illustrate with a crayon.
3. Over the short term, there may be no correlation between the success of a company’s operations and the success of its stock. Over the long term, there’s a 100% correlation.
4. Buying stocks without studying the companies is the same as playing poker – and never looking at your cards.
5. Time is on your side when you own shares of superior companies.
6. Owning stock is like having children. Don’t get involved with more than you can handle.
7. When the insiders are buying, it’s a good sign.
8. Unless you’re a short seller, it never pays to be pessimistic.
9. A stock market decline is as predictable as a January blizzard in Colorado. If you’re prepared, it can’t hurt you.
10. Everyone has the brainpower to make money in stocks. Not everyone has the stomach.
11. Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.

Lynch’s advice had a profound effect on my stock market approach. He taught me that investment success isn’t the result of developing the right macro-economic view or deciding when to jump in or out of the market. Success is about researching companies to identify those that are likely to report positive surprises.

Capital Expenditure

A great company with a Durable Competitive Advantage will have a ratio of Capital Expenditures to Net Income of less than 25%. Less is better.

Capital Expenditures are expenses on:
- fixed assets such as equipment, property, or industrial buildings
- fixing problems with an asset
- preparing an asset to be used in business
- restoring property
- starting new businesses

A good company will have a ratio of Capital Expenditures to Net Income of less than 50%.

A great company with a Durable Competitive Advantage will have a ratio of less than 25%.

Less is better.

Benjamin Graham's 113 Wise Words

The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement."

Philip Fisher's Wise Words

"The refusal to sell at a loss, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process.

More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous."

(Common Stocks and Uncommon Profits)

The Ultimate Hold-versus-Sell Test

Here is the overriding primary test, followed by observations on why it is so critically important:

Knowing all that you now know and expect about the company and its stock (not what you originally believed or hoped at time of purchase), and assuming that you had available capital, and assuming that it would not cause a portfolio imbalance to do so, would you buy this stock today, at today's price?

No equivocation. Yes or no?

Answers such as maybe or probably are not acceptable since they are ways of dodging the issue. No investor probably buys a stock; they either place an order or do not.

Here is the implication of your answer to that critical test: if you did not answer with a clear affirmative, you should sell; only if you said a strong yes, are you justified to hold.

Some thoughts on Analysing Stocks (KISS)

Ideally a stock you plan to purchase should have all of the following charateristics:

• A rising trend of earnings dividends and book value per share.
• A balance sheet with less debt than other companies in its particular industry.
• A P/E ratio no higher than average.
• A dividend yield that suits your particular needs.
• A below-average dividend pay-out ratio.
• A history of earnings and dividends not pockmarked by erratic ups and downs.
• Companies whose ROE is 15 or better.
• A ratio of price to cash flow (P/CF) that is not too high when compared to other stocks in the same industry.

Margin of Safety Concept: Stocks should be bought like groceries, not like perfume

The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.

Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

myinvestingnotes.blogspot.my (Bullbear Buffett Stock Investing Notes)

Saturday 14 January 2017

Central elements to a Value Investing Philosophy

The Philosophy of Value Investing and Why It Works

Philosophy of value investing. Need to have clear strategies too.

How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s

Understanding these changes in the investment world allows investors to earn superior returns

What's good for Wall Street is not necessarily good for investors.

Speculators, Investors and Market Fluctuations

Thursday 12 January 2017

Various Value Investing Strategies - a Review

Teach yourself to THINK in PROBABILITIES and in MULTIPLE SCENARIOS.

Thinking in probabilities

All equity security investments present a risk of loss of capital

The Ultimate Hold-versus-Sell Test

Some thoughts on Analysing Stocks (KISS)

Benjamin Graham

Sell the losers, let the winners run.

Investment Style

Warren Buffett

Political and Economic News

Interesting Blogs