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.
