****Growth stocks as a class has a striking tendency toward wide swings in market price (II)

The striking thing about growth stocks as a class is their tendency toward wide swings in market price.

But is it not true, that the really big fortunes from common stocks have been garnered by those 

• who made a substantial commitment in the early years of a company in whose future they had great confidence and 
• who held their original shares unwaveringly while they increased 10-fold or 100-fold or more in value?

The answer is "Yes."  

Click to see:
10 Year Price Chart of Top Glove

But the big fortunes from single company investments are almost always realised by persons who have a close relationship with the particular company - through employment, family connection, etc. - which justifies them

• in placing a large part of their resources in one medium and 
• holding on to this commitment through all vicissitudes, despite numerous temptations to sell out at apparently high prices along the way.

Click to see:
5 Year Price Chart of Top Glove
2 Year Price Chart of Top Glove
1 Year Price Chart of Top Glove
6 month Price Chart of Top Glove
3 Month Price Chart of Top Glove
1 Month Price Chart of Top Glove


An investor without such close personal contact will constantly be faced with the question of whether too large a portion of his funds are in this one medium. 

Click to see:
5 Year Price Chart of Top Glove
2 Year Price Chart of Top Glove
1 Year Price Chart of Top Glove
6 month Price Chart of Top Glove
3 Month Price Chart of Top Glove
1 Month Price Chart of Top Glove


Each decline - however temporary it proves in the sequel - will accentuate his problem; and internal and external pressures are likely to force him to take what seems to be a good profit, 


Click to see:
5 Year Price Chart of Top Glove
2 Year Price Chart of Top Glove
1 Year Price Chart of Top Glove
6 month Price Chart of Top Glove
3 Month Price Chart of Top Glove 
1 Month Price Chart of Top Glove 

but one far less than the ultimate bonanza.

Click to see:
10 Year Price Chart of Top Glove



Comments:

1. Be a good stock picker.  
2. Think as a business owner.
3. Always look at value rather than the price.  Do the homework.
4. Buy and hold is alright for selected stocks.
5. Compounding is your friend, get this to work the magic for you.
6. Mr. Market is there to be taken advantage of.  Do not be the sucker instead.  BFS;STS.
7. Always buy a lot when the price is low.  Doing so locks in a higher potential return and minimise the potential loss.  But then, if you have confidence in your stock picking, you would have picked a winner - it is only how much return it will deliver over time.
8. Never buy when the stock is overpriced.  Not observing this rule will result in loss in your investing.  This strategy is critical as it protects against loss.
9. It is alright to buy when the selected stock is at a fair price.
10. Phasing in or dollar cost averaging is safe for such stocks during a downtrend, unless the the price is still obviously too high.
11. Do not time the market for such or any stocks.   Timing can increase returns and similarly harms the returns from your investment. It is impossible to predict the short term volatility of the stock, therefore, it is better to bet on the long-term business prospect of the company which is more predictable. 
12. By keeping to the above strategy, the returns will be delivered through the growth of the company's business. 
13. So, when do you sell the stock?  Almost never, as long as the fundamentals remain sound and the future prospects intact.    
14. The downside risk is protected through only buying when the price is low or fairly priced.  Therefore, when the price is trending downwards and when it is obviously below intrinsic value, do not harm your portfolio by selling to "protect your gains" or "to minimise your loss."  Instead, you should be brave and courageous (this can be very difficult for those not properly wired)  to add more to your portfolio through dollar cost averaging or phasing in your new purchases.  This strategy is very safe for selected high quality stocks as long as you are confident and know your valuation.  It has the same effect of averaging down the cost of your purchase price.  However, unlike selling your shares to do so, buying more below intrinsic value ensures that your money will always be invested to capture the long term returns offered by the business of the selected stock.
15. Tactical dynamic asset allocation or rebalancing based on valuation can be employed but this sounds easier than is practical, except in extreme market situations.  Tactical dynamic asset allocation or rebalancing involves selling at the right price and buying at the right price based on valuation.  Assuming you can get your buying and your selling correct 80% of the time;, to get both of them right for a profitable transaction is only slightly better than chance (80% x 80% = 64%).  Except for the extremes of the market, for most (perhaps, almost all of the time), for such stocks, it is better to stay invested (buy, hold, accumulate more) for the long haul.
16. Sell urgently when the company business fundamental has deteriorated irreversibly. (Reminder:  Transmile)
17. 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 14, you can do so leisurely.
18. In conclusion, a critical key to successful investing is in your stock picking ability.  To be able to do so, you will need to acquire the following skills:

• To formulate an investing philosophy and strategy suitable for your investing time horizon, risk tolerance profile and investment objectives.
• The knowledge to value the business of the company.  
• The discipline to always focus on value.
• The willingness to do your homework diligently.
• A good grasp of behavioural finance to understand your internal and external responses to the price fluctuations of the stock in the stock market.
• A good rational thinking regarding the risks (dangers) and rewards (opportunities) generated by the price fluctuations of the stock in the stock market.

Top Glove Insider action:

Tan Sri Dr. Lim Wee Chai

Disposed 26/1/2007 100,000
Acquired 14/2/2007 34,540,661 (Bonus issue)
Disposed 6/4/2007  6,300,000
Acquired 9/5/2007 1,000,000
Acquired 22/6/2007 500,000
Acquired 12/7/2007 438,900
Acquired 18/7/2007 403,900
Acquired 25/7/2007 157,200
Acquired 12/9/2007 200,000
Acquired 18/9/2007 580,000
Acquired 24/3/2008 50,000
Expiration of ESOS-options 29/4/2008

(The only ESOS-option not converted and expired were those noted on 29/4/2008.  After this date, Mr. Lim continued to convert ESOS-options at regular intervals and did not buy or sell other shares of his company.  The large sale of shares in 6/4/2007 followed the large bonus issue Mr. Lim acquired on 14/2/2007.)

Click to see:
5 Year Price Chart of Top Glove
10 Year Price Chart of Top Glove

From the price chart of Top Glove, we can draw the following points:

The price of Top Glove peaked at around $14 at the beginning of January 2007.
It dropped to around  $9 in February 2007.
In April 2007, the price was around $9.20 when Mr. Lim sold 6,300,000 shares; he did not sell at the highest price possible.
In May 2007, the price was around $8.95, Mr. Lim bought back 1,000,000 shares.
The share price continued dropping to $6.00 in September 2007; Mr. Lim bought back 580,000 shares.
Mr. Lim continued to buy from May 2007 to September 2007 a total of 2.9 million shares.
It was obvious that even Mr. Lim phased-in his buying of the shares at various prices, rather than timing the buying of his shares at the lowest price.

****Growth stocks as a class has a striking tendency toward wide swings in market price (I)

The striking thing about growth stocks as a class is their tendency toward wide swings in market price.


Click to see:
1 Year Price Chart of Top Glove
2 Year Price Chart of Top Glove
5 Year Price Chart of Top Glove



The main characteristic of the stock market in the last few decades has been the injection of a highly speculative element into the shares of companies which have scored the most brilliant successes, and which themselves would be entitled to a high investment rating.  (Their credit standing is of the best, and they pay the lowest interest rates on their borrowings.)

The investment caliber of such a company may not change over a long span of years, but the risk characteristic of its stock will depend on what happens to it in the stock market.

The more enthusiastic the public grows about it, and the faster its advance as compared with the actual growth in its earnings, the riskier a proportion it becomes.

But is it not true, that the really big fortunes come from common stocks that have been garnered by those who made a substantial commitment in the early years of a company in whose future they had great confidence, and who held their original shares unwaveringly while they increased 10-fold or 100-fold or more in value?

Click to see:
10 Year Price Chart of Top Glove

Growth Stocks and the Defensive Investor

The term 'growth stock' is applied to one which has increased its per-share earnings in the past at well above the rate for common stocks generally and is expected to continue to do so in the future.

Some authorities would say that a true growth stock should be expected at least to double its per-share earnings in 10 years, that is, to increase them at a compound annual rate of over 7.1%.

Obviously stocks of this kind are attractive to buy and to own, provided the price paid is not excessive.

The problem lies there, of course, since growth stocks have long sold at high prices in relation to current earnings and at much higher multiples of their average profits over a past period. This has introduced a speculative element of considerable weight in the growth stock picture and has made successful operations in this field a far from simple matter.

In the past, the "best of common stocks" actually lost 50% of its market price in a 6 months' market decline.

Other growth stocks have been even more vulnerable to adverse development; in some cases not only has the price fallen back but the earnings as well, thus causing a double discomfiture for those who owned them.

For example, a particular stock price advanced 5 times (from $5 to $256 i.e 50x) as fast as the profits (from 40 cents to $3.91 per share i.e. 10x); this is characteristic of popular common stocks. Two years later, the earnings had dropped off by nearly 50% and the price by 80%.

For growth stocks, wonders can be accomplished with

• the right individual selections, 
• bought at the right levels, and
• later sold after a huge rise and 
• before the probable decline.

But the average investor can no more expect to accomplish this. In contrast, Benjamin Graham think that  the group of large companies that are 

• relatively unpopular and 
• therefore obtainable at reasonable earnings multipliers, 
• offers a sound if unspectacular area of choice by the general public.

Ref:
Intelligent Investor
by Benjamin Graham

Choosing a Discount Assumption

Choosing a discount assumption

In theory, the discount rate should be your own personal cost of capital for this kind of investment. If you have a million dollars and can invest it with no risk in a Treasury bond at 6 percent, your cost of capital is the risk-free 6 percent you would forgo by not investing in the bond. So the implied cost of your dollars made available to invest in Business XYZ starts at 6 percent. Financial types refer to this opportunity cost as the risk-free cost of capital.

But implicitly, Company XYZ common stock is riskier than the bond investment. Sales, earnings, and myriad other intrinsic things can change, as can markets and the market perception of XYZ’s worth. So an equity premium is added to the risk-free cost of capital rate. In effect, the total cost of capital is your required compensation, or hurdle, for the opportunity you’ve lost by not buying the bond, plus the assumption of risk by investing in XYZ.

Much has gone into identifying appropriate risk premiums and the like. Modern portfolio theory and its reliance on beta – a measure of relative stock price volatility – doesn’t really do much for most value investors. (Remember: Price doesn’t determine value.)

The keep-it-simple-safe (KISS) approach used by most value investors, including Warren Buffett, is to discount at a relatively high rate, usually higher than the growth rate. Buffett uses 15 percent as a discount, or “hurdle” rate – investments must clear a 15 percent “hurdle” before clearing the bar. The 15 percent hurdle incorporates a lot of risk, especially in today’s environment of relatively low interest rate and inflation. Conservative value investors usually use discount rates in the 10 to 15 percent range.

As you build and run models, you’ll see firsthand how the discount rate affects the resulting intrinsic value. Here are a few points to remember:

• The higher the discount rate, the lower the intrinsic value – and vice versa.
• The second-stage discount rate should always be higher than the first stage. Risk increases the farther out you go.
• If you choose an aggressive growth rate, it makes sense also to choose a higher discount rate. Risk of failure is higher with high growth rates.
• If the discount rate exceeds the growth rate, intrinsic value will be low and implode more quickly the larger the gap. Aggressive growth assumptions with low discount rates yield very high intrinsic values.

If you’re worried about earnings and earnings growth consistency and want to factor it in somehow, but don’t want to do a deep statistical analysis on a zillion numbers, Value Line does one for you. At the bottom right corner of the Value Line Investment Survey sheet is a figure called “Earnings Predictability” if the Survey covers the company you’re evaluating.

It’s really a statistical predictability score normalised to 100 (100 is best, 0 is worst). A score of 80 and higher indicates relative safety; below 80 means that you may want to attenuate growth rates or bump up the discount rate to account for uncertainty.

Here again is the set of growth and discount assumptions used for an example. Consistency is important, but growth rates will vary for each company, and discount rates may change also with differing risk assessments.
First-stage growth 10%
Second-stage growth 5%
First-stage discount rate 12%
Second-stage discount rate 15%

Ref: Intrinsic Value Model

Growth Stocks Paradox

David Durand, "Growh Stocks and the Petersburg Paradox," The Journal of Finance, vol. XII, no. 3, September, 1957, pp. 348-363.

This classic article compares investing in high-priced growth stocks to betting on a series of coin flips in which the payoff escalates with each flip of the coin.

Durand points out that if a growth stock could continue to grow at a high rate for an indefinite period of time, an investor should (in theory) be willing to pay an infinite price for its shares.

Why, then, has no stock ever sold for a price of infinity dollars per share?

Because the higher the assumed future growth rate, and the longer the time period over which it is expected, the wider the margin for error grows, and the higher the cost of even a tiny miscalculation becomes.