Investors will frequently not know why security prices fluctuate. Must look beyond security prices to underlying business value.

Security prices sometimes fluctuate, not based on any apparent changes in reality, but on changes in investor perception.

• The shares of many biotechnology companies doubled and tripled in the first months of 1991, for example despite a lack of change in company or industry fundamentals that could possibly have explained that magnitude of increase. 
• The only explanation for the price rise was that investors were suddenly willing to pay much more than before to buy the same thing.

In the short run supply and demand alone determine market prices. 

• If there are many large sellers and few buyers, prices fall, sometimes beyond reason. 
• Supply-and-demand imbalances can result from year-end tax selling, an institutional stampede out of a stock that just reported disappointing earnings, or an unpleasant rumor. 

Most day-to-day market price fluctuations result from supply- and-demand variations rather than from fundamental developments.


Investors will frequently not know why security prices fluctuate. 

• They may change because of, in the absence of, or in complete indifference to changes in underlying value. 
• In the short run investor perception may be as important as reality itself in determining security prices. 
• It is never clear which future events are anticipated by investors and thus already reflected in today's security prices. 

Because security prices can change for any number of reasons and because it is impossible to know what expectations are reflected in any given price level,  investors must look beyond security prices to underlying business value, always comparing the two as part of the investment process.


Main Point: 
Investors will frequently not know why security prices fluctuate and must look beyond security prices to underlying business value, always comparing the two as part of the investment process

Speculative-Growth Stocks - How Has the Stock Performed?

Since it started trading in 1996, Yahoo's stock has shot into the stratosphere along with many other Internet stocks in 1999.

It returned over 500% in both 1997 and 1998, and more than 200% in 1999.

Such performance is certainly impressive, but will be hard to maintain.

Speculative growth stocks in general, and Internet stocks in particular, are fragile.  They can crumble on a whisper of bad news and rally on an encouraging rumour, so be prepared for plenty of volatility.

There's not much you can do about that; to get those highs, you have to risk the lows.

Tips on how to invest during turbulent times

Tuesday October 25, 2011

Singular Vision - By Teoh Kok Lin

STOCK markets around the world lately gave investors that sinking feeling again, weighed down by deepening woes of Europe's sovereign debts, an anemic US economy and new fears of a sharp economic slowdown in China.

Many investors sold shares to hold more cash, despite cash earning very little interest. In Singapore for example, six months USD fixed deposits of less than US$1mil earns zero interest in some banks.

In the United States, 10-year Treasury bonds are yielding 2.1% per annum; despite misery returns, many investors prefer the safety of US Treasuries during crisis times, while waiting for policymakers to act boldly and markets to stabilise.

At the same time, we see many economists and other pundits offer a whole host of predictions about today's global financial predicaments. The many predictions range from the slightly hopeful to the pessimistic, right down to the disastrous and absurd.

Does it sound familiar? Did we not hear many such predictions during the 2008/2009 global financial crisis? Who should we listen to? What should one do?

No doubt in hindsight, a few forecasts will be correct; and as the dust settles, many extreme predictions will also likely be forgotten. Yet for investors today, separating much of the “noise” from facts is one of the more tricky parts of steering through these very challenging times.

Fundamentals and valuation takes a back seat during a crisis

Volatile stock markets today are driven by latest positive or negative news flow affecting sentiment. Uncertainties during a crisis causes investment risks to spike, stock investors tend to sell first and ask questions later; fundamentals and stock valuation typically takes a back seat in the short term.

No doubt many investors worry about negative impact to a company's fundamentals in difficult times. For example, a manufacturing company's stock with a present price earning (PE) multiple of six times can change drastically to 60 times PE if earnings were to collapse 90% because of a global financial crisis.

Similarly, a property company's price to book value discount of 60% can easily drop to 30% if asset value is marked down by half in troubled times. Monitoring, reassessments and analysis of a company's financial progress is obviously important during tumultuous times.

Share prices of companies (even those with good fundamentals) may continue to fall indiscriminately, due to many reasons such as panic selling, fund redemption and repatriation. Investors should tread cautiously, even if stock prices may appear to be at very attractive levels.

I relate a challenging experience from the last global stock market plunge. In 2008, I invested in the largest luxury watch distributor and retailer in China (at that time 210 stores and sales amounting to 5.5 billion yuan a year or about 30% market share).

This Hong Kong listed Chinese company sells luxury watches (such as Omega, Longines, Bvlgari) from global brand owners Swatch group of Switzerland and LVMH of France (both by the way are also 9.1% and 6.3% shareholders of this Chinese company respectively).

As the US sub-prime mortgage crisis deepens by end-July 2008, many stocks around the world plunged. This company's shares similarly dropped from HK$2 to HK$1.50 in a matter of weeks.

We vigorously reassessed the company's fundamentals, including visits to retail outlets in China and Hong Kong. The result was an affirmation of our conviction to invest in the company for the long-term, despite short-term price weakness.

By late September 2008, we decided to purchase more shares when valuation proved so attractive at HK$1.15 per share (at a PE multiple of eight times).

Unfortunately, as the global financial crisis worsened, the company's shares continued to plunge and bottomed to a low of HK$0.51 by Nov 26, 2008.

This stock eventually recovered back to HK$2 per share (by June 1, 2009) and went on to exceed HK$5 per share by late 2010. The company's share prices recovered partly because Asian equities rebounded quickly in 2009, but also reached new highs because the company's fundamentals continue to improve with strong sales (+49%), profitability (+26%) and expansions (+140 stores to 350 stores) from 2008 to 2010.

A lesson if you will that during a crisis, one should be prepared for short-term (weeks and months) stock market volatility.

It is essential for bargain hunters to have long-term holding power, good understanding of company fundamentals and strong conviction on a company's prospect. In the long-term, we know fundamentals and valuation does matter.

How does one invest during a time of crisis?

My approaches to investing in turbulent times are:

Search for and invest (when valuations are attractive) in well managed companies that will not only survive but emerge stronger from crisis times;

Be prepared to stomach stock market volatility in the months ahead;

Have a longer term investment horizon (perhaps two to three years); once this crisis dissipates, reap the rewards as stock markets recover.

In Asia, macroeconomic fundamentals likely will remain resilient as many Asian economies have strong foreign currency reserves, coupled with more fiscal and monetary policy options to support growth.

China is also likely to withstand any fallout from Europe better than most would think. China's economy is still growing at a strong 9.1% gross domestic product growth for the third quarter of 2011; speculations about China's economy crashing may be somewhat premature at this stage.

Similarly, I think many established Asian companies have sufficient resources be it cash, borrowing powers or human capital, to emerge out of these turbulent times faster and stronger than before.

I believe with increasingly attractive valuation, the investing risk-reward equation (potential downside risk versus long term return prospects) favors Asian equities in the long run. I have confidence investing in Asia's fundamentals and Asian companies for many more years ahead.

Teoh Kok Lin is the founder and chief investment officer of Singular Asset Management Sdn Bhd

The more you know about your psychological biases, the better you can function in the volatile stock market.

Everyone has opinions and psychological biases.  However, people may not know their own biases.

The more you know about your psychological biases, the better you can function in the volatile stock market.

The entire market may be influenced by psychological reasons, not by fundamental reasons alone.

From an investment perspective, the bottom line is that the market will continue to fluctuate and give you solid opportunities every so often.

Value in the long run is determined by fundamentals, while short-term gyrations reflect market participants' psychological weaknesses, such as herding.  

Knowledge is the best antidote to making wrong decisions.

If you are a long-term investor, the rational thing to do is to make decisions based on long-term fundamentals of the business.

Growing at 15% a year - what does this entail?

To achieve a 100% gain in your investment over 5 years, the initial capital has to grow at a compound rate of 15% per year. This means that an initial $100 investment will be worth:

$1.15 at end of year 1,
$1.33 at end of year 2,
$1.52 at end of year 3,
$1.75 at end of year 4, and
$2.01 at end of year 5.

Though the fund managers usually benchmark their fund performances to a certain index, most individual investors should look at the absolute return.

The return on your investment is unlikely to rise in a straight-line upwards. Volatility in the return is to be expected. The return spurts over certain times, declines over certain times, and remains unmoved over certain times.  However, the return over a long time is less volatile and generally relates to the earnings of the business of the invested stock.

What does 15% per year looks like in real-time? Excluding the dividend yield from the calculation, it is actually an average of 1.25% per month appreciation in the share price. The 15% may be returned in a consistent manner or there maybe periods of spurts delivering part or all the returns over many short periods. Do not get disheartened if a stock moves only 1% or 2% per month, it is the consistency in its return that adds to a big return. On the other hand, do not be overly excited by the big returns over a short period. For the long-term investors, it is more important that over a long time, the price of the stock reflects the improving earnings fundamentals of your selected stocks.

To double your initial investment in a stock in 5 years means also selecting a stock that will double its earnings in 5 years. For those who are directly in business, to grow a business consistently over many years is indeed very challenging. The matured large companies are less likely to deliver such growths. Therefore, for those investors seeking such growth rates in the earnings of their stocks, they will need to look at mid-cap stocks or smaller companies where growths can be faster in the early stages of their business life.

It is not difficult to make 7 or 8% returns yearly in your investment in stocks.  However, to grow at 15% or more, this can be very challenging indeed, but not impossible even for the non-professional investors.

Past Market Movements: Prices Can Be Very Volatile

Examination of Past Market Movements of Malaysia KLSE
What can we learn from the history of overall market movements in the Malaysia KLSE?

1. Generally Upward Trend
2. Trends Not Consistent
3. Irregular Price Patterns
4. Prices Can Be Very Volatile
5. Prices Move Volatile Upward
6. Big Booms Are Irregular

-----

4. Prices Can Be Very Volatile

The price movements even within a year can be considerable - the average is 38%.

The minimum movement within a year is still 19% from the highest to the lowest which is about six times greater than the average dividend yield.

This means that price changes can very quickly wipe out any return provided by dividend.

This means that the value of one's investment can vary considerably from year to year.

One must be able to sustain such losses if one wishes to invest in shares.