Thursday, 31 October 2013

The value of patience

Price-value gap

Theoretically, with higher trading volumes, the price-value gap should narrow due to better price discovery.   Yet, in reality, this is not the case.

The increase in trading activity actually widen the price-value gap; often increasing the noise in the system and leading to spikes in volatility that we see often in the stock market.

An explanation, which is not surprising, is the majority of market participants are speculators and not investors.  

Rather than narrowing the price-value gap through better price discovery, the exact opposite is the result.

What can you do as an investor?

In this world, an investor who is hostage to short-term performance pressures will feel nothing but discontent.

The only requirement for successful play is the willingness to adopt a different set of rules.  

Of these, none is more important than the value of patience.

Let's learn from Buffett:  Having a patient attitude to investing

Time and patience, two sides of the same coin - that is the essence of Buffett.

His success lies in the patient attitude he quietly maintains toward both Berkshire's wholly owned business es and the common stocks held in the portfolio.

In this high-paced world of constant activity, Buffett purposefully operates at a slower speed.

Learning points

A detached observer might think this sloth-like attitude means forgoing easy profits, but those who have come to appreciate the process are accumulating mountains of wealth.  

The speculator has no patience.

The investors lives for it.

The best thing about time is its length.

Intelligence alone is not enough to ensure investment success.

The counterpart of emotion is rationality.

The size of the investor's brain is less important than the ability to detach the brain from the emotions.

"Rationality is essential when others are making decisions based on short-term greed or fear.  That's where the money is made," says Buffett.

Buffett tells us that successful investing does not require having a high IQ or taking the formal courses taught at most business schools.

What matters most is temperament.  And when Buffett talks about temperament he means rationality.

The cornerstone to rationality is the ability to see past the present and analyze several possible scenarios, eventually making a deliberate choice.  That, in a nutshell, is Warren Buffett.

Those  who know Buffett agree it is rationality that sets him apart from the rest.

Roger Lowenstein, the author of Buffett:  The Making of an American Capitalist, says, "Buffett's genius is largely a genius of character - of patience, discipline and rationality."

A proposed initial personal financial plan for a young graduate.

A proposed initial personal financial plan for a young graduate.

1.  Get a job that you enjoy and are passionate in..
2.  Grow in your chosen career.
3.  Save as much as you possibly can.
4.  Start investing in your financial education early.
5.  Start investing early once you know how to and safely.
6.  Compound your investments at > 15% per year.
7.  Buy a small car initially.
8.  Stay with parents or rent initially; even for those who are married.
9.  Build and grow a big initial investment capital first.
10. Acquire your first home once you have reached this level.
11. Continue to invest and acquire more assets subsequently.
12. Periodically, reassess your career, business and financial situation.

Tuesday, 29 October 2013

Buffett's confession

Buffett's advice and investment principles have proven, time and again, to be a safe  for millions of investors.

Occasionally misaligned investors will yell out, "But it's different this time!" and occasionally they will be right.

Change is constant, but these investment principles have endured.

"That is why they are called principles,"  Buffett once quipped.

From the 1996 annual report of Berrkshire Hathaway:  
"Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher, five, ten, and twenty years from now.  Over time, you will find only a few companies that meet those standards - so when you see one that qualifies, you should buy a meaningful amount of stock."  

You cannot find a better touchstone than that.

Buffett's confessed that "what I do is not beyond anybody else's competence."   

Yet, it is extraordinary how resistant some people are to learning anything, even when it is in their self-interest to learn!.

Additional notes:

Buffett invariably follows the same strategy.

He looks for companies:
1.  he understands.
2.  with favourable long-term prospects,
3.  that are operated by honest and competent people, and,
4.  that are, importantly, available at attractive prices.

Saturday, 26 October 2013

Four steps to prepare for a crash

But for the sake of argument, let’s pretend that Time’s cover is wildly bullish and did send a legitimate bear signal to the world. Or maybe tapering will sink stocks.

What would be the proper course of action for investors in a bear market?

1. Understand your time horizon

If you invested 10 years ago for an event this year, you might seriously consider selling your stocks and converting them to cash — but that’s regardless of where you think the market is going. If you need the money in the short term, it doesn’t belong in the market. If you have longer than a few years to invest, don’t worry about a crash as long as you…

2. Make sure your stops are in place

The Oxford Club recommends a 25% trailing stop loss. The stops protect gains as stocks rise and ensure that no single position results in a devastating loss. Since stocks are up so much over the past four years, even if you do get stopped out, you should get out with a profit. This strategy also ensures that you have plenty of cash to get back into the market at lower prices. During the financial crisis, Oxford Club Members were stopped out of positions in 2008 and took profits on many stocks that had risen during the previous bull. That freed up capital to get back in during the lows of 2008 and 2009, resulting in some huge winners, including Discovery Communications (Nasdaq: DISCA), up 255%, and Diageo (NYSE: DEO), up 171%.

3. Review your portfolio

If you haven’t done so in a while, take a look at the stocks in your portfolio. Make sure the companies are still operating at a high level. If you own Perpetual Dividend Raisers — stocks that raise their dividend every year — examine when the company last raised its dividend. If the company is continuing its streak of annual dividend raises, generally speaking, you should be fine for the long term.

4. Be ready to buy when things are bleak

It takes a lot of guts to buy stocks when it feels like the market is falling apart, but that’s how the biggest gains are made. Whether you’ve raised capital by selling stocks whose stops were hit, or you have money set aside, buy stocks after a market slide. You might not catch the bottom, but since stocks go up over the long haul, getting them at a discount will add significantly to your returns. Regardless of the predictability of the magazine cover theory or any other signal, long-term investors should not get caught up in the day-to-day market noise. You will make money as long as you don’t panic in the face of a sell-off.

Marc Lichtenfeld is a senior analyst at Investment U. See more articles by Marc here. - See more at:

Friday, 25 October 2013

Equity Risk Premium: Stock bubble? No way, says Alan Greenspan

Stock bubble? No way, says Alan Greenspan

Former Federal Reserve chairman Alan Greenspan says the stock market has room to rise from record levels.

“In a sense, we are actually at relatively low stock prices,” Mr Greenspan, who guided the central bank for more than 18 years, told Bloomberg Television overnight. “So-called equity premiums are still at a very high level, and that means that the momentum of the market is still ultimately up.”

The Standard & Poor’s 500 Index advanced 23 per cent this year through yesterday, pulling within a percentage point of its 23.5 per cent surge in 2009, amid speculation the Fed will delay cuts to its monthly bond purchases until the labour market improves.

Mr Greenspan said the stock market was “just barely above 2007” and the average annual increase in stock prices “throughout the postwar period” was 7 per cent, which leaves room for a rise.

“Price-earnings ratios are not hugely up,” he said. The market has “gone up a huge amount, but it’s not bubbly,” according to Mr Greenspan.

Mr Greenspan, 87, served at the Fed during an era dubbed the “Great Moderation” for its economic stability. In a December 1996 speech, after seven straight quarters of gains in the S&P 500, Mr Greenspan posed a question about how the Fed can know “when irrational exuberance has unduly escalated asset values.”

In the final years of Greenspan’s term, which lasted from 1987 to 2006, a massive housing bubble developed as home prices more than doubled between 2000 and 2006, according to the S&P/Case-Shiller home price index.
Mr Greenspan said today’s housing market doesn’t show the same conditions as it exhibited leading up to the housing crash, and is lending stability to the US economy.

“The level of construction has come up quite substantially, but it’s still only a third of where we were at the previous top,” Mr Greenspan said. “While housing has been a major contributor to what stability we have in the economy, it has not moved considerably.”

Purchases of new US homes rose in August, capping the weakest two months this year, showing the fallout from mortgage rates at a two-year high is cooling the real-estate rebound. Sales increased 7.9 per cent to a 421,000 annualised pace following a 390,000 rate in the prior month that was less than previously estimated, Commerce Department data showed September 25.

Mr Greenspan also praised Fed vice-chairman Janet Yellen, whom President Barack Obama has nominated as the next head of the central bank, both in the Bloomberg interview and in an earlier interview on CNBC.

“She’s a very bright lady,” Mr Greenspan said of Ms Yellen on CNBC. “I think she will surprise everybody, I mean in a positive way.”


Read more:


Equity valuations relative to bond market

When is the market over-valued?

Wednesday, 23 October 2013

Warren Buffett: Why stocks beat gold and bonds

February 9, 2012:

In an adaptation from his upcoming shareholder letter, the Oracle of Omaha explains why equities almost always beat the alternatives over time.
FORTUNE -- Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire Hathaway (BRKA) we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power -- after taxes have been paid on nominal gains -- in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability -- the reasoned probability -- of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a nonfluctuating asset can be laden with risk.

Investment possibilities are both many and varied. There are three major categories, however, and it's important to understand the characteristics of each. So let's survey the field.
Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as "safe." In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.

Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as "income."

For taxpaying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor's visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It's noteworthy that the implicit inflation "tax" was more than triple the explicit income tax that our investor probably thought of as his main burden. "In God We Trust" may be imprinted on our currency, but the hand that activates our government's printing press has been all too human.

High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments -- and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.

Under today's conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, primarily of the short-term variety. At Berkshire the need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be. Accommodating this need, we primarily hold U.S. Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions. Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

Beyond the requirements that liquidity and regulators impose on us, we will purchase currency-related securities only if they offer the possibility of unusual gain -- either because a particular credit is mispriced, as can occur in periodic junk-bond debacles, or because rates rise to a level that offers the possibility of realizing substantial capital gains on high-grade bonds when rates fall. Though we've exploited both opportunities in the past -- and may do so again -- we are now 180 degrees removed from such prospects. Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: "Bonds promoted as offering risk-free returns are now priced to deliver return-free risk."

The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer's hope that someone else -- who also knows that the assets will be forever unproductive -- will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce -- it will remain lifeless forever -- but rather by the belief that others will desire it even more avidly in the future.

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth -- for a while.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the "proof " delivered by the market, and the pool of buyers -- for a time -- expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: "What the wise man does in the beginning, the fool does in the end."

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.

Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today's annual production of gold command about $160 billion. Buyers -- whether jewelry and industrial users, frightened individuals, or speculators -- must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil (XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Admittedly, when people a century from now are fearful, it's likely many will still rush to gold. I'm confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.

Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard "cash is king" in late 2008, just when cash should have been deployed rather than held. Similarly, we heard "cash is trash" in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.

My own preference -- and you knew this was coming -- is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See's Candy meet that double-barreled test. Certain other companies -- think of our regulated utilities, for example -- fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.

Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See's peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Our country's businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial "cows" will live for centuries and give ever greater quantities of "milk" to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well).

Berkshire's goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety -- but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we've examined. More important, it will be by far the safest.

This article is from the February 27, 2012 issue of Fortune.

Saturday, 19 October 2013

Confessions of a bargain hunter, Seth Klarman

June 23, 2012
By Nathan Bell
In the offices of an unmarked high-rise building in Boston sits Seth Klarman, surrounded by stacks of papers and books, which, by his own admission, are at risk of toppling over and crushing him at any instant.
Klarman is the founder and president of the phenomenally successful Baupost Group, a $29 billion ”deep value” hedge fund. It has produced 19 per cent annual returns, and every $10,000 given to Klarman at inception in 1982 is worth about $1.85 million today – and this was achieved while carrying extremely high levels of cash (more than 50 per cent at times) and using minimal leverage.
So how did he do it?
Know your seller
The financial markets are fiercely competitive, with millions of investors, traders and speculators around the world trying to outwit one another. Klarman concluded that since prices are set by the forces of supply and demand, rather than buy something and wait for someone to demand it at a higher price, why not wait for an irrational supplier to sell it to you for any price? Hence, Klarman looks for assets that people are being forced to sell or avoid, often as a result of fear or institutional constraints.
You can apply this principle by looking at heavily sold or avoided opportunities closer to home.
For example, stocks at the bottom of the S&P/ASX 200 are kicked out and replaced on a regular basis and, since index funds can hold stocks only over a certain size, newly removed stocks from the S&P/ASX 200 are sometimes driven down in price because of the selling pressure from such funds.
To make matters better, owing to regulation many super funds often cannot invest in smaller companies and such stocks are rarely followed by analysts. Servcorp resides on Intelligent Investor’s buy list and falls into this category.
Some institutions are also forced to ignore debt instruments unless they achieve a certain credit rating, even though they might offer an attractive risk-reward profile. You can take advantage of this by investing in income securities in a downturn, when large price falls create great opportunities such as those in 2009, for example, the Goodman PLUS, Dexus RENTS and Southern Cross SKIES hybrid securities.
Tax-loss selling (in Australia, this tends to occur in June, at the end of the financial year) can cause irrational mispricing in already beaten-down stocks. Cheap blue chips that could be this group next week include Computershare, QBE Insurance and Macquarie Group.
Competitive advantage
The difference between great investors and mediocre ones is only a few percentage points in terms of judging things correctly. Klarman realised he would have to bring something different to the game to win: a ”competitive advantage”.
”I will buy what other people are selling,” Klarman says. ”What is out of favour, what is loathed and despised, where there is financial distress, litigation – basically, where there is trouble.”
An inexperienced individual will have little success using such a tactic. After all, how many of us have four years to spend analysing Enron’s accounts? Instead, look for inefficiencies you can exploit.
Most market participants have a narrow, short-term view and are driven by fear and greed. So your edge is having a longer-term perspective and controlling your emotions. These two advantages will help you pile on the performance points over the professionals. Both have been invaluable to Klarman.
Cash is a weapon
Holding cash is perhaps Klarman’s most famed characteristic.
However, contrary to what you might expect, Klarman holds cash so it can be used in a concentrated manner when the right opportunity arises. This is because while value investing outperforms in the long run, Klarman quips that ”you have to be around for the long run … [you have to make sure] you don’t get out and you are a buyer”.
Despite the complexity of some of his investments, Klarman’s underlying approach is not complicated, although that is far from saying it is easy.
He says Baupost has outperformed ”by always buying at a significant discount to underlying business value, by replacing current holdings as better bargains come along, by selling when the market value comes to reflect its underlying value, and by holding cash … until other attractive investments become available”.
Nathan Bell is the research director at Intelligent Investor, intelligent 

Nine lessons to learn from Seth Klarman

So what do we know about how Klarman invests? Here are some insights into his approach.

What’s your advantage over others? 

The investment markets are crowded. Thousands of professional investors spend their days trying to find the next big thing, but they can’t all win. In order to get ahead you need to do something or know something that others don’t. This is not easy. Are you really smarter than the crowd?

Buy what others are selling

Going against the crowd can be profitable. People often sell assets due to temporary, short-term factors. This offers opportunities for investors who can take a longer view. Examples of such situations are litigation, fraud, financial distress and ejection from an index.

Go where others don’t

Following on from the above two points, it makes logical sense that you are unlikely to make a lot of money buying FTSE 100 shares, as professional investors follow them too closely. Look at lots of different asset classes. For example:
• Opportunities often exist in ‘spin offs’ – smaller businesses sold by bigger companies. Professional investors often sell holdings in these companies because they are too small and this temporarily depresses their value, spelling a buying opportunity.
• Research bonds in bankrupt companies: often these bonds sell for a fraction of what they are worth. If the company is turned around, investors can make massive gains. There are often similar opportunities in distressed property.
• Don’t confine yourself to domestic markets. Foreign markets are often less crowded and can be subject to levels of political and regulatory uncertainty that present opportunities. In the preface to the sixth edition of Benjamin Graham and David Dodd’s book, Security Analysis’, Klarman uses the example of South Korea in the early 2000s where investor pessimism saw multinational companies selling for as low as one or two times their annual cash flow. Smart investors made a killing buying these stocks.

Focus on risk before you start thinking about returns 

Research shows the pain of losing 50% of your money far outweighs the pleasure to be had from making a 50% return. To be successful as an investor you must focus your research on the risks of a company’s business model and its industry. Remember that the first rule of investment is not to lose money. Also remember – and this is particularly pertinent to technology companies – that today’s good business may not be tomorrow’s winner (see my colleague Tim Bennett’s points on the importance of economic moats for more on this).

You are buying a stake in a business, not a piece of paper 

Investment success comes from buying the cash flows of businesses for less than they are worth. These cash flows come from the real world, not punting numbers on a computer screen. So focus on free cash flow rather than profits. And look at balance sheets to see risks like too much debt or big pension fund liabilities.

Know when to sell

Value investors start selling when assets are 10-20% below what they think they are worth. Owning fully valued assets is a form of speculation – you are betting on someone paying more than they are worth, not on the market recognising the true value of the assets.

Don’t invest with borrowed money 

The ability to sleep well at night is more important than a few more percentage gains.

Don’t rely on the market to provide your investment returns 

If bond coupons or stock dividends (paid out by companies) can provide a large chunk of your returns, you are less reliant on fickle and volatile markets for capital gains. Buying bonds below their redemption value is another good strategy.

Don’t be afraid to do nothing

Always hold cash when cheap assets are scarce. Be prepared to wait.

Monday, 14 October 2013

Margin of Safety - The Three Most Important Words in Investing (Benjamin Graham)

Margin of Safety

1.  Knowing how to compute intrinsic value is just the beginning of valuing a company.

2.  You will be able to appreciate intrinsic value more accurately only when it is deducted from the market price to determine its margin of safety.

3.  Having a margin of safety does not guarantee a successful investment, but it takes care of downside to minimize errors.

4.  It helps to eliminate capital losses or reduce investment risks.

5.  When you have a margin of safety, it will serve as a buffer for any investment and leave room for errors in the event that wrong assumptions were made during the period of valuing a stock.

6.  Capital preservation is the first rule in investing.

7.  We invest only when the risk is reduced to its minimum.

8.  In investing, we need to have good protection (insurance) for our investments - a margin of safety.

9.  The wider the margin, the more protection we will have.

10.  With a margin of safety, the success in investing is not dependent on the exact intrinsic value; the margin of safety serves as better protection against wrong assumptions.

11.  A margin of safety is affected by intrinsic value and the market price.

12.  When the intrinsic value and share price of a company change, the margin of safety will change.

13.  These are three most important terms when using margin of safety:  Undervalued, Fair Value, and Overvalued.

14.  Undervalued:  Intrinsic value $1.  Market price $0.50

15.  Fair value:  Intrinsic value $1.  Market price $1.

16.  Overvalued:  Intrinsic value $1.  Market price $1.50.

17.  There is no hard-and-fast rule regarding how much margin of safety needs to be in place in order for you to become a prudent investor.

18.  Obviously, a 50% margin of safety will generally be better than paying a fair price (0% margin of safety) for the same company.

19.  The wider the margin of safety, the better you will be protected should a financial crisis hit, or when you make a wrong assumption.

20.  However, there are companies, like blue-chip companies that are unlikely to sell at a bargain price with a margin of safety of more than 50%.

21.  Since most blue-chip companies are not growth companies, they will normally trade at a fair price or even be overvalued, rather than being priced at a bargain price, even during times of crisis.

22.  Warren Buffett's statements about quality companies:  "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

23.  The best time to have a great margin of safety is when the market is depressed or when a company is heavily punished by the market due to bad news.

24.  Remember Ben Graham, the market is there to serve us and not to guide us.

25.  You should take such period of market sell-down or stock sell-down as an opportunity to scoop up bargain stocks.

26.  During this period, average investors would not dare to enter the stock market, for fear that prices would continue to drop.

27.  Be greedy when others are fearful!

28.  Understandably, it can be very difficult to make a purchase when the investment mood and environment are shrouded with negativity.

29.  Investors who can overcome this and take action regardless of market pessimism will definitely become very successful.

30.  Teach and prepare yourself to buy growth companies at a low price (undervalued) and sell them ( if you intend to ) when the price is higher or overvalued.

31.  Teach and prepare yourself to avoid buying a stock when it is overvalued (e.g. negative margin of safety).

32.  Warren Buffett once said, "It is better to be approximately right than precisely wrong."

34.  Caution:  Calculating the intrinsic value should be used only to determine WHEN investors want to enter or exit the stock market.  It should not be used to determine the QUALITY of the stock.

35.  The price is mainly determined on market sentiments and not the quality of the stock.

36.  During the 2008-2009 crisis, some growth companies did not continue to grow after the price correction, owing to the respective growth factors of companies.

37.  On the other hand, there are growth companies that continue to grow consistently even in a bear market.

Margin of Safety (Intrinsic value / Market Price)

>50%         ACTION: BUY (undervalued)
50% - 0%  ACTION:  BUY/HOLD (fair value)

> -10%      ACTION:  SELL/HOLD (fair value-overvalued)
> - 50%     ACTION:  SELL (grossly overvalued)

Sunday, 13 October 2013

Reality check on debt mountain of Malaysian households

Saturday October 12, 2013 

Reality check on debt mountain

A YOUNGSTER came to me recently to seek views about his financial stress. He says the first thing he does when he gets his pay cheque is to repay loans, including a car loan, credit card payments and personal loan. Owning a house is on his wish list, but it is yet to be realised.
His case mirrors many similar situations faced by Malaysians nowadays, not only confined to the younger generation. It has become a concern to the authorities as our household debt ratio against the GDP (gross domestic product) has reached an all-time high of 83% as of March this year, the highest for a developing country in the region. In comparison, Indonesia’s household debt ratio stands at 15.8%, Hong Kong at 58%, and Singapore at 67%, according to Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz’s comment recently.
While we are concerned about the high debt level, we should also take a closer look at the root cause. What is underneath the “debt mountain” and how can we address the issue?
The major components of household debt are housing, car, personal and credit card loans. According to Bank Negara statistics, as at April 2013, the total residential housing loans taken by Malaysians is RM316.2bil, passenger car loans amounts to RM145bil, personal loans stand at RM55.8bil, and credit card loans at RM32.3bil.
In terms of debt ratio for the four components mentioned above, housing loans account for 57.5% of the total debt, with car, personal and credit card loans accounting for 26.5%, 10% and 6% respectively (see chart).
As housing loans seem to be the biggest contributor to household debt, there are already several measures being put in place to cool the housing sector and to curb mortgage growth.
However, if we take further steps to scrutinise the breakdown of the loans, and study the interest incurred in absolute terms, and the appreciation or depreciation in value of the underlying assets, we will soon discover the source of the real burden.
Property is truly an asset, compared with a car, personal loan or credit card spending in which the value of the purchases depreciates over time.
According to the Malaysian House Price Index by the National Property Information Centre, the overall housing price in Malaysia has increased by an average of 5% every year since 2000. Thus, servicing a housing loan is like paying for “good debt” as the asset will gain in value in the long term and eventually protect us against the inflation.
On the other hand, based on car insurance calculations and accounting practice, the value of cars depreciates about 10% to 20% per year. This means that the car loan and interest is paid for item that is contracting in value every year, it is a liability instead of an asset.
In addition, based on our current structure, the average interest rate for housing loan is 4.2%. If we apply this rate across the board, the absolute interest incurred for RM316.2bil housing loan will be about RM13.3bil a year, which is only 43% in terms of absolute interest paid compared with its loan amount component of 57.5%. Whereas, personal loans which account for only 10% of the total household debt, would incur absolute interest of 22% of overall household debt due to its high interest rate of 12%.
As mentioned in some of my previous articles, the younger generation is advised to purchase a house instead of a car first. Let’s visualise this via the following scenarios.
Let’s assume a young couple which has a household income of RM6,000. The ideal mortgage (housing loan) repayment is always one third of the income, i.e. RM2,000.
After deducting RM2,000 from their income, they will still have RM4,000 household income available.
If the couple decides to own a car, the loan repayment, petrol, parking and maintenance fees are most likely to come up to RM1,000 to RM1,500 depending on the types of car they are getting.
This leaves the family with a household income of only RM2,500 to RM3,000 provided they are just owning one car instead of two.
With the same household income, if the couple decides to utilise public transport, the monthly transport expenses may be in the range of RM300 to RM400 for two persons. They will still have a household income of RM3,600 every month after paying for house loan interest and transportation cost.
To help lessen the debt burden of the rakyat, the authorities must accelerate the effort of providing comprehensive public transportation network including MRT, buses, mini buses and taxis, to reduce public dependency on private vehicles.
A total review on the cost of car and motorcycle ownership in Malaysia would also help reduce this debt burden.
For households that wish to reduce their debt level, they should avoid the temptation of instant gratification, and instead should place importance to assets that grow in value.
When we look in detail at the household debt level of the nation, it provides more insights than the headline number at first glance. Sometimes, it is as simple as to differentiate the “healthy” debt from the rest to make a significant difference in our financial position.
FIABCI Asia-Pacific Regional secretariat chairman Datuk Alan Tong has over 50 years of experience in property development. He is also the group chairman ofBukit Kiara Properties. For feedback, please email

Friday, 11 October 2013

Public Bank advances to new all-time high again

Friday October 11, 2013
Public Bank advances to new all-time high again

KUALA LUMPUR: Shares of Public Bank Bhd rose to an all-time high in early Friday trade, helping to underpin the FBM KLCI’s advance as investors remained upbeat about the prospects for the banking group.

At 9.48am, Public Bank was up 12 sen to RM18.20 with 205,700 shares done while its foreign shares rose 14 sen to RM18.20 with 77,600 shares traded.

The KLCI rose 9.91 points to 1,785.83. Turnover was 484.44 million shares done valued at RM245.56mil. There were 317 gainers, 111 losers and 212 counters unchanged.

StarBiz reported Public Bank looked to have settled one aspect of its succession planning when it recently appointed Quah Poh Keat as deputy chief executive officer II.

The appointment of Quah, a former independent director of the bank, suggests he could be a leading candidate to succeed managing director and chief executive officer Tan Sri Tay Ah Lek when he retires.

StarBiz also reported that the recent price gains were linked to rumours that may include the prospect of allowing Chinese banks to acquire stakes in Malaysian banks.

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Thursday, 10 October 2013

Net Net Working Capital (Value Investing)

Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
“Net Net Working Capital” (NNWC) is one of the first stock valuation screening methods to be defined in the value investing world.  Benjamin Graham also referred to this as Net-Current-Asset Value (NCAV).
The Net Net Working Capital formula may help identify undervalued stocks.  Benjamin Graham actually used the term “Net Working Capital” but current value investors and Graham followers use the terms “net nets” or “Net Net Working Capital” interchangeably.
One value investing strategy of Graham was to purchase stocks that were trading at less than two-thirds of the Net-Current-Asset Value per Share (i.e. less than two-thirds of the Net Net Working Capital Value per Share).  This type of value investing strategy could be thought of as a “liquidation value investing strategy”.  In other words, Graham is proposing that the stock is so cheap that even under a situation where the business was wound down, that the investor would have a such a suitable margin of safety that a return could still be earned.  Of course, Graham is not counting on a liquidation since there are costs associated with that action.  Rather, Graham is satisfied that he is paying nothing for the fixed assets of the business nor is he paying anything for any potential earnings.
According to Graham, The type of bargain issue that can be most readily identified is a common stock that sells for less than the company’s net working capital alone, after deducting all prior obligations.* This would mean that the buyer would pay nothing at all for the fixed assets—buildings, machinery, etc., or any good-will items that might exist.  Very few companies turn out to have an ultimate value less than the working capital alone, although scattered instances may be found.”  (Source:  The Intelligent Investor by Benjamin Graham).
Of course, stocks that are trading below their NNWC may be trading at such low multiples for various reasons (e.g. pending bankruptcy, misstated financial statements, or a host of reasons why investors may be shunning a particular stock).  Regardless, we present the Net Net Working Capital formula and provide further discussion.

Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
Once the NNWC is determined, this amount divided by the number of shares outstanding will provide the NNWC per share.  NNWC per share that is less than the current share price may be an indication of an undervalued stock or a deep value stock.  Graham advocated buying a basket of stocks whose prices traded significantly below NNWC per share (or Net Current Asset Value per Share – NCAV per Share).
The NNWC formula considers that not all balance sheet amounts may reflect current reality.  A 25% discount is applied to accounts receivable as these amounts may not actually be collectible.  In addition, a 50% discount to inventory is applied given that it may be stale or obsolete.  Of course, this is a first screen and potential investors should consider whether further discounts would be prudent.
The estimation or calculation of intrinsic value is as much art as science.  Any investor can run a mathematical screen to identify stocks trading at various metrics that could indicate potential value.  However, it must take keen business sense and deep curiosity to ask why a stock may be trading at the level it is, whether there actually is business value and how much, and what potential catalysts could emerge to unlock value.  The Net Net Working Capital formula is one more value investing tool.
Net Net Working Capital Formula – Further Analysis and Discussion:
Net Net Working Capital is a subset of Graham’s Net Working Capital is a subset of Net Working Capital (also known as Working Capital).
1) Net Working Capital = Current Assets – Current Liabilities
2) Graham’s Net Working Capital = Current Assets – Total Liabilities
3) Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
Note that the results of each formula are presented in a decreasing order.  That is to say Net Net Working Capital will provide the lowest and hence, most conservative, value.  In other words, all else being equal, of the three formulas above, a stock trading below Net Net Working Capital provides the investor with the largest margin of safety.
Value investing is about buying a stock at a sufficient discount to intrinsic value.  Graham’s “Net Working Capital” or the “Net Net Working Capital” formulas can be used as preliminary screens to identify potentially undervalued stocks or deep value stocks.

Tuesday, 8 October 2013

Margin of Safety

'Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.'
Source: "Buffett: The Making of an American Capitalist" (1995)

'If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety.'
Source: 1997 Berkshire Hathaway annual meeting
So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you'd need. If you're driving a truck across a bridge that says it holds 10,000 pounds and you've got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it's over the Grand Canyon, you may feel you want a little larger margin of safety.'

Monday, 7 October 2013

Debunking 5 Common Investor Dilemmas

FORBES | 2/13/2013

Hundreds of investors ask me questions each year about the dilemmas they confront. Their worst problem? Uncertainty. They are traumatized and become emotional or confused to the state of inaction. Even worse, they try to solve a short-term problem in a way that hurts them financially in the long run.

My solution is to keep it simple: Buy the stocks of great companies at reasonable valuations.

Here are five everyday investor dilemmas and my easy stock solutions.

Dilemma: You need cash flow, but it’s a scary world. A ten-year Treasury pays just 1.8%. If you are prepared for some risk, junk bonds pay about 5%, but they tend to get whacked when interest rates rise. Same with lower-yielding but higher-quality corporate bonds.

I have long advocated a safer approach if yield is what you crave. Buy big-cap stocks. I like America’s largest wireless carrier, Verizon (VZ, 44), which has a 4.75% dividend yield. With Verizon, you can expect single-digit growth from a diversified group of consumer and business offerings, plus a boost from added wireless spectrum.

Like any stock, Verizon isn’t immune to short-term volatility, but in the long term it will deliver. It’s cheap at 1.1 times annual sales and 15 times my estimated 2014 earnings. Beats T bonds by a mile.

Dilemma: The Federal Reserve is printing money, and the country’s going to hell. Your daughter just got a nose piercing and a facial tattoo. The prospect of inflation has you terrified. How can you invest in the ugly realities of neo-America?

Not with gold—it doesn’t actually do anything, and during 85% of its long history it has lost money. Do you flee America? Poland is doing great, but the language is difficult. Mexico? Better take your gun.

The solution, of course, is to diversify globally, and one of the best ways I know to stave off inflation is buying in Deutschland. The Germans have little tolerance for inflation. I like Germany’s fast-growing SAP (SAP, 80). It’s the global market-share leader in enterprise software for business operations and customer relations.

Crowd-think sees faltering growth due to competition. That was also the view one, three, five and ten years ago. Don’t fall prey to the doubters—the stock sells for 20 times my estimate of 2013 earnings with a 1.2% dividend yield.

Dilemma: Your other daughter—the good one, from wife No. 2—is adorable, just 7, and you want to put away something for her college years that she will appreciate.

In a decade we may think back on Facebook as a great fad, but Coca-Cola KO +0.11% (KO, 38) is a stock with staying power!

It’s truly one of the original global buys, but it’s as American as apple pie. It should continue to grow at low rates until long after your daughter proudly gives you grandkids. It sells at 16 times my 2013 estimated earnings with a 2.6% dividend yield.

Dilemma: You’re intrigued by exciting, fast-growing emerging markets, but you’re also worried about terrorists, drug dealers, corruption and lousy roads.

Buy Ecopetrol (EC, 61), one of the largest petroleum companies in the world, based in Colombia. But don’t worry about Colombia’s narco issues. Ecopetrol is an experienced local operator. I last recommended it Sept. 21, 2009 at $26, but it should continue to prosper. It sells at 13 times my estimated 2013 earnings.

Dilemma: how to find another great stock despite a well-diversified portfolio.

Buy Walt Disney DIS +2% Co. (DIS, 55), the world’s largest media firm by revenue. It’s big and easy to understand. Slow growth, but superbly managed and diverse in its field, and by definition fun! It’s just 13 times my estimated September 2014 earnings with a 1.4% dividend yield.

Money manager Ken Fisher’s latest book is Markets Never Forget (But People Do) (John Wiley, 2011). Visit his home page at

Ken Fisher: The Only Three Questions that Count: Investing by Knowing What Others Don't

The Only Three Questions that Count: Investing by Knowing What Others Don't is a book on investment advice. It was released in December 2006 and spent three months on The New York Times list of "Hardcover business bestsellers" .[1] It was also a Wall Street Journal and a 'BusinessWeek best seller.[2]
In the book, Fisher says that because the stock market is a discounter of all widely known information, the only way to make, on average, winning market bets is knowing something most others don’t. The book claims investing should be treated as a science, not a craft, and details a methodology for testing beliefs and uncovering information not widely known or understood. The book’s scientific method consists of asking three questions:
  1. What do I believe that’s wrong?
  2. What can I fathom that others can’t?
  3. What is my brain doing to mislead me?
The first question addresses common investing errors, the second shows how to try and find bettable patterns which others may misinterpret, and the third deals with behavioral finance, pointing out cognitive errors such as overconfidence and confirmation bias.
Other issues covered include high P/E ratiosdebt; the federal budgettrade, and current account deficits; the U.S. dollarhigh oil pricesemerging marketsgold; and the U.S. economy.
Book reviews have also appeared in the Financial Times, which stated "you get the impression that its author, Ken Fisher, does not often find himself short of things to say. The stream of consciousness that flows through the book can be distracting but it is impressive and certainly never dull."[3] Forbes Magazine which said "Fisher's key insight is that investment is not a craft that can be mastered by merely accumulating information."[4] and Canada's National Post which says that the book " dispels more than a dozen ... myths".[5]

From Wikipedia, the free encyclopedia


  1. Jump up^ The New York Times list of "Hardcover business bestsellers"
  2. Jump up^ BusinessWeek best seller
  3. Jump up^ Financial Times book review
  4. Jump up^ Forbes Magazine book review
  5. Jump up^ National Post book review