Achieving 100% increase in portfolio value over 5 years

My Investing Objective

My objective in investing is to double my portfolio value every 5 years.   Essentially, this means a 100% return on my investment every 5 years.    What does this mean in practice?

Payback period of 5 years:   It means getting a payback on my investment every 5 years.  If I invested $1000 today, I hope to receive back $1000 over the next 5 years, excluding my capital.  My payback period is 5 years for the investment.

Return of Investment of 100%:   Another way is saying my return on investment over 5 years is 100%.  This means at the 5th year, my investment of $1000 should have grown to $2000.  This will give a return of investment of 100% over 5 years or a return on investment of 20% per year in simple average terms.

Discount cash flow method (CAGR of 15%):   I can also use the discount cash flow method too.  For my initial investment of $1000 to grow to $2000, what is the compound annual growth rate required to achieve this return?  Alternatively, working backwards, if the expected final value of the portfolio at the 5th year is $2,000, what is the discount rate that will give a Net Present Value of $1,000 (the initial investment amount)?  The answer to both questions is about 15% per year.



What is the average return of the stock market annually for the historical long term basis?

It is about 10.5% annually.  If one invests into the stock market for the long term, one can expect to compound at an annual return of 10.5% over the long term.

However, this market return is a highly volatile one, especially for those with a short investing time horizon.  In a 1-year investment time horizon, the return of the market can be an upside of 50% or the downside equivalent of 1/3rd.  That is, your portfolio value of $1000 can gain $500 (giving you a final portfolio value of $1500) over 1 year or your $1500 portfolio value can lose $500 (giving a final portfolio value of $1000) over 1 year.

However, if your investment time horizon is 10-years or more rolling, the market volatility is less and you can expect no losses.   Over a 10-years time horizon, the returns of the market are as depicted in the chart below, ranging from a high of  19.4% to a low of 1.2% , with the average at 10.5%.  Over a 25-years time horizon, the returns of the market are between the high of 17.2% and the low of 7.9%, with the average at 10.5%.

Two Prongs Approach

How to achieve the 100% increase in portfolio value over 5 years?

For this, a two prongs approach is employed.

• (A)  Stock selection is an important part of this.  
• (B)  The other equally important, is portfolio management.  

Both are important in your investing.  Many focus a lot of their time on stock selection and failed to realise the importance of portfolio management in achieving their investment return objectives.



How can one achieve a compound annual return of 15% per year or an annual return of 20% per year in simple average terms for periods of 5 years running in stock market investments?


What strategies should be employed to achieve the 100% returns on your investment every 5 years, consistently and safely (without taking excessive risk, that is, low risk and high return situations)?

A.  Stock Selection 

1.  Asset allocation

Asset allocation is important.  If you allocate 100% of your investment into fixed incomes (like bonds or fixed deposits), you are unlikely to achieve this 15% compound annual return over 5 years.   These fixed income products protect your capital (but not against inflation over the long run) but their returns are too small to achieve your objective.

You have little choice but to allocate your asset into products that can give you higher returns over time.  I suggest an asset allocation of 40% Equity and 60% Fixed Income Products for those who are conservative and loss adverse.   For those who are super-conservative, maybe in the early learning stages of their investing or those in retirement, a 20% Equity and 80% Fixed Income Product portfolio can be employed.   For super-investors, the like of Warren Buffett, who knows what they are investing, the asset allocations are little in cash/ cash equivalent/ fixed income products and mostly into equity.  Buffett keeps enough cash to take advantage of opportunities that can present unexpectly at any time.


2.  Fixed Income Products

This have been mentioned above (1).  These include your fixed deposits and bonds.  Preferred shares are included here too.


3.  Blue chips bought at reasonable prices

These are companies that have done well over a long period.  They are profitable and their businesses are predictable.  They also give regular dividends.  They are generally matured companies that have captured their share of their business in their market sector.  They do grow, though slowly when compared to their early days or to the smaller successful companies.  Most of these companies grow at single digit growth rates.  Their business revenues per year generally exceed $5 billion or more.

You should choose one that has a minimum growth rate of 7%, preferably more.  Since most of these companies do give dividends (generally the dividend payout ratio in these companies are high), you can look for dividend yields of between 2.5% to 3.5%., averagely 3% or more.  Adding these two figures still fall short of your expected returns of 15% per year.  Yes, and if you re-invest your dividends (not necessarily into the same companies that give them), you can achieve this compound annual return of 15%.   In general, you can expect 50% of the total returns from these investments to be from the dividends and the rest from capital appreciation.  Don't ignore the impact of dividends on your total return, this can be significant indeed.




What other further strategies can one employ to achieve the compound annual return of 15% or more, doubling your portfolio value every 5 years?


4.  Buying blue chips at bargain prices during a market downturn or when the market is obviously low

The stock market prices are influenced by market sentiments.  There are periods when the market players are very pessimistic about the market.  During these times, good stocks are also sold down and their low prices in the market are unrelated to their business fundamentals.

Provided you as an investor can be disciplined and rational in your approach and know the difference between price and value, you are presented with this opportunity to buy good and great blue chips at bargain prices.   The lower the price you pay to own these companies, the higher you can expect your returns to be.  Yes, certainly buying these blue chips during market downturn will reward the smart or aggressive intelligent investor with higher returns, and deliver to them the compound annual return of 15% or more per year which they are seeking in their investing.


5.  Buying growth stocks at reasonable prices. (Growth Investing)

These are companies that are growing their businesses very fast (>15% per year or more).  Where can you find them?

A small startup company in the early stages without profits to show and sucking in a lot of capital is full of risk and with unpredictable future returns.  Those who invest in these should know the business well and be willing to take the risks.  They should be prepared to lose 100% of their money if things do not play out well.  Investing in these start-ups is speculation.   We shall focus on investing.

A successful startup will soon enter an explosive growth phase.  The growth can be very fast indeed (perhaps growing between 40% to 30% annually).  In the very early stages of this rapid growth, they absorb a lot of capital to support their fast growth.  Though profitable, they retain all the earnings and often need to sought new equity capital and also debt to grow their businesses.

This explosive growth phase will eventually attenuates.  They are still growing at a rapid pace, between 20% to 15%.  By this stage, these companies are profitable and generating positive (and hopefully growing) free cash flows.  They retain a portion of their earnings for growth and are now able to distribute some or more of their earnings as dividends.  In general, look for those companies distributing 30% to 70% of their earnings as dividends and are still growing rapidly between 20% to 15% per year.

For those whose objective is to achieve a compound annual return of 15% per year or more and doubling their portfolio value every 5 years, focusing their effort in this segment will be most appropriate and rewarding.  These are the small-cap and mid-cap companies in the stock market.  Always ensure that their businesses have economic moats that are deep and wide (these confer them their durable competitive advantage)   Many of these companies have business revenues less than $500 million per year (small businesses).  There are also companies with business revenues between $500 million per year and $5 billion per year (middle sized companies).


6.  Buying undervalued companies (Value Investing)

You can adopt the strategies of the bargain hunters (the value investors of Benjamin Graham).  Benjamin Graham uses the simple comparison of price versus the book value and buy with a margin of safety of 30% or 50% discount to the book value.  However, he also uses other criteria in his selection too (look these up).

When do bargains appear?

An obvious time, is during period of pessimism.  Think John Templeton.  "Buy your stocks during periods of maximum pessimism. "   The general market is sold down and you can expect to find more bargains during this time than during the period when the market is in an exuberant mood.

As for specific stocks, there are also times when the market may view these stocks very unfavourably.  The company may have run into difficulties during that period.  The fundamentals of the company maybe temporarily or permanently impaired.  There maybe some fraud discovered.  The company may have made an acquisition which is perceived negatively.  The company's product may be in the news for the wrong reasons.  There are so many reasons that can cause the company to be in the news for the wrong reasons.

To profit from these, the investor needs to assess the congruence between the news and the price.   Maybe the company is punished appropriately, and the price is reflecting its value.  On the other hand, the company maybe punished inappropriately and the price is too low relative to its given intrinsic value.  Here lies your opportunity to capture the gains offered by this bargain, should you be proven right and the other investors re-priced this company to its appropriate price.  A margin of safety of 30% gives you an upside potential gain of 50% and a margin of safety of 50% gives you an upside potential gain of 100% when repricing occurs.

I personally, feel it is more challenging to be a value investor than a growth investor.  You have to be right about the company that has recently fallen from grace.  You have to be right and others are wrong to profit from this opportunity.  What if, you are wrong and the others are right?  Also, it may take a very long time for the market to reprice your stock, even though you are right.  The longer the time for this repricing to occur, the lower is your annualised return.  These stocks generally need to be sold once their prices approached their intrinsic value.  You need to sell them at the right time too to capture the maximum potential gains.   All these difficulties are not faced by the growth investors who bought their high quality growth stocks at reasonable prices, and holding them for the long term, if not forever.

In the above paragraph, my thinking is guided by this quote from Warren Buffett:

"It is better to pay a little too much for something that is a very good business than it is to buy some bargain but really a company without much of a future."



All the above strategies can be employed regularly in the market.

There are also various strategies that can be employed to achieve 15% per year return over the long term to grow your portfolio value 100% over the period.  However, these are infrequent and often less accessible to me as a lay-person investor.   Among these are:

7.  Purchasing well-secured privileged senior issues (bonds and preferred shares) offered at bargain prices.

8.  Purchasing in special situations which you have good knowledge of:  Mergers, arbitrages and cash pay-out.



I strongly believe that the paths below will not help me in my objective to grow my portfolio value 100% over 5 years with the degree of certainty that I want.  Accordingly, they are speculations which I would avoid.  These are:

A.  Avoid buying IPO.  "Its probably overpriced"!

B.  Avoid trading in the market.  This is a negative sum game in my book.  Those who indulge in this, as a group or aggregate, will generally lose money over the long term.

C.  Avoid buying growth stocks at high prices.  Growth stocks are liked by many and often maybe trading at high prices.  It hurts your portfolio if you pay a rosy price to acquire these stocks especially when they are popular and in the news.  "You can never get a bargain on a stock that is popular."  Be patient and disciplined, you will have the opportunity to acquire the same stock at a better price.


B.  Portfolio Management

This is equally important and contributes to achieving your investment objective of doubling your portfolio value every 5 years.

Maintaining a concentrated portfolio of stocks

I maintain a concentrated portfolio of about 10 carefully chosen stocks.   The turnover of this portfolio is generally very low indeed, reflecting the nature of the stocks selected.  I am not in a hurry to churn the stocks in my portfolio to grow my net worth quickly, as compounding over the long term at 15% per year translates into very big incremental absolute returns in the later part of the long period of my investing time horizon.

Having a few stocks allow me to focus and monitor the businesses of these companies more closely.  It also gives me the courage to put in large amounts of money into each of these stocks in my investing.


Why 10 stocks?   I will just invest in the best stocks that give the most upside to downside reward to risk ratio and potential high returns.   Over diversifying into too many stocks will give one the market returns, thus, maybe diluting your potential returns that can be derived from this strategy.

As there are only 10 stocks, each stock will have a potential value weighting of 10%.  Meaningful investing means investing at least 3% of the total portfolio value into each stock.  Too small an investment into a stock is meaningless as even a 100% gain in the stock contributes to an insignificant gain to the whole portfolio value.

Do I sell when a particular stock is proportionally too high in value in my portfolio?  Not really, unless for good reasons (see below for, when to sell).  In my portfolio, a particular stock has at one stage a 30% value of my whole portfolio and it was still undervalued.  I am willing to ride my good fortune or accept the risk of a over-represented good quality undervalued stock in my portfolio.

There are many benefits from having a long term successful portfolio.  It allows you to capture the capital appreciations and the dividends of the portfolio over a long time.  The dividends of the portfolio is a big amount and this attenuates the fluctuating returns of the portfolio in a bear market.  Compare to traders who bet a certain amount and made a 100% gain, their gains probably paled to insignificant to the dividends of a successful long term portfolio.  The dividends annually dwarf the gain of any single successful trade of a frequent trader.



When to sell

As mentioned, these stocks are rarely sold.  However, there are occasions when selling is needed.

A stock will be sold if its fundamentals have deteriorated permanently and the management is unlikely to turn it around anytime soon, example, in a year.  This stock should be sold quickly and the action requires one's urgent attention.  To not do so may cause financial harm to your portfolio.  On certain occasions, for example, fraudulent accounting, one should just sell first and think later.

Selling an overpriced stock is also a good portfolio management move.  The price is already too high and its upside potential maybe little or none and you are only facing its downside risk of loss, while invested in this stock.  You should sell partially or totally, and replace this stock with another with an equal or a better quality and with a better upside reward to downside loss ratio and potential higher returns.  This improves the quality and the potential returns of your portfolio.   This will ensure that you can achieve your 15% compound annual return in your portfolio value, doubling the value in 5 years.

On certain occasions, you may have identified a very good stock to invest into that is severely undervalued.  It is of high quality and the upside reward to downside loss ratio is very much in your favour.  It is selling very cheaply and your potential future return is going to be very very high.  You have great confidence in your stock pick and wish to put a lot more money to ride on this big bet that has presented itself.  You may then sell some of your existing stocks with still good upside to downside ratio to reinvest the money into this new stock with better upside to downside ratio and potential higher return.   Again, this will ensure that you are always improving the quality and returns of your portfolio.

Cash is also considered an asset class in the portfolio.  Where the market is so overpriced and you cannot find a stock that provides safety of capital and promises of a satisfactory return better than cash, building up a cash reserve is appropriate for that period.  The time when I was in 100% cash (or 0% equity) has never happened before and this should be a very unlikely event.  This probably can only happen in markets as was in 1996 or 1997 when the market was bubbly and irrational; even then, I was not 100% in cash then.


Confronting a Bear Market or severe Market Decline

Market price is volatile.  That is certain.  Also, a good quality growth stock over the long term should build its intrinsic value.  That is also certain to a high degree of probability.

Should I be in 100% cash when the market is a bubble in exuberant territory?  Should I sell before or when the market crashes?  Do I have the uncanny ability to time the market in these periods?

In general, it is very difficult to know if the market is fairly valued, overvalued or undervalued most of the time.  There are a few instances when you might know that the market is obviously too overvalued or too undervalued, however, these are extreme circumstances and rare events (example, in 1996/97 when it was obviously overvalued, in 1998 when KLCI was 300 points when it was obviously severely undervalued, and in Sept 2008 the Lehman crisis, when the market was severely undervalued and at the capitulation point.)

However, for one who is invested into individual stocks, these market fluctuations are meaningful to the extent that in a low market you have the chance to buy the stocks cheap and in a high market you have chance to sell the stocks at high prices.  You can adopt this strategy of pricing the market, that is,  buy low and sell high.  Equally productive and less taxing on your skill, is just buy low and do not sell; and of course, do not buy high.  The latter too is an effective strategy, especially since you are buying and holding only good quality growth stocks with durable competitive advantage.  You are betting on and aiming to capture the fantastic earning powers of your invested companies over the long term of 5, 10 or more years.

Even if the market is overvalued,  you can sometimes still buy undervalued stocks.  Of course, during this time, there are less of these undervalued stocks in the market.

Do you sell ahead of the falling market?   Only if you have the ability to know this with certainty.  Can you do so consistently?  Of course not.   A reasonable strategy is to make as much money as you can in any market, whether it is trending up or down.  Also, be prepared for the appearance of the bear when you are in the bull market period.  When the bear does appear, be prepared to see your portfolio value going down even 50% from its peak.  (For this reason, do not buy stocks on margins.  You never know when a bear market may appear decimating your net worth due to your leverage.)  Your consolation is you will have so much gains already in your long term portfolio, this 50% decline in portfolio value does not cause the loss of your initial capital.  However, your portfolio intrinsic value is definitely worth more than the market value of your portfolio in a bear market which is determined by the emotional market low prices of the period.  You can still sleep well and actually take advantage of the bear market to buy good quality growth stocks that are now offered at ridiculous bargain prices.  When the market normalises, as it should, you are once again, a winner.


The biggest threat to your portfolio - YOURSELF

The biggest threat to your portfolio value is actually yourself.  With the right knowledge and skill, you can invest safely and profit from the market over the long term.  The long period of compounding will certainly make you very rich indeed.



Conclusion

The above are my philosophy and strategies to grow my portfolio at a compound annual return of 15% per year, doubling my portfolio value 100% over 5 years.

Look at the single chart above that depicts market returns.  Over the 25 year long term investing horizon, the stock market has returned between 17% and 8% annually, averaging 10.5%.   By employing the strategies above, I have chosen to capture the gains offered by the top half of this range, that is, between 10.5% to 17%.  With dividends reinvested, this 15% compound annual return is achievable.

Of course, Benjamin Graham has counselled, "It is not difficult for the intelligent investor to achieve  modest returns (to get market return, use low cost market index funds) but when they aim for better returns, they might find that rather than getting better results, they might in fact fair worse than the average."

Those who are defensive investors should just stay with a simple asset allocation of fixed income (2) and blue chips (3) above.#   Those who are willing to put in the diligent effort, should still stay with an asset allocation of fixed income (2) and blue chips (3) and they can include into their investing all the others mentioned (4, 5, 6 & 7).

Be reminded to always stay within one's circle of competence.  You should be able to define the boundary of this circle and never stray out of it.

Finally, should a "big fat pitch" opportunity that is within your circle of competence appears, you should have the cash and the courage to take advantage of it.  I believe you can with the right preparation, philosophy and strategy.


May your investing be as successful, with a bit of good luck thrown in.



#(P/S:  For those who are not comfortable choosing their own stocks, they should choose a low cost index linked fund for the equity portion of their asset allocation.)

When to Sell?

When to Sell?

Selling “Myths”
• MYTH – Once a stock has doubled our investment it is time to sell.
• MYTH – Wait until a stock is back to even before selling.
• MYTH – Sell if the stock price falls 10% (or some other %) below the
purchase price.
• MYTH – Only sell when your Stock Selection Guide (SSG) says “Sell.”
• MYTH – If a company is meeting our growth expectations, then do
not sell.
• MYTH – Don’t sell a stock until you have found a good replacement.
• MYTH – Sell everything when we are going into a bear market.
• MYTH – Don’t sell because it’s a “good company.”

Valid Reasons to Sell
• When something is truly wrong with the
business and it won’t likely be fixed within a
year
• When the stock price has risen so much that
future gains are unlikely.
• When you find a better stock. Frequently this is
a back‐door way of exiting a weak holding.

How can you become a better seller?
•Write it down – have written rules for selling just like you do
when buying
•For an investment club – rotate stock assignments so one person
isn’t identified with “her” or “his” stock
•Remember, stocks are a means to an end. The goal is to grow
your wealth. You aren’t being disloyal to a stock if you sell it.


http://www.betterinvesting.org/NR/rdonlyres/12386A1B-284F-4E75-B02C-D9396B363B26/0/StockUpFeb2015Slides4pp.pdf

World's eight richest as wealthy as half humanity, Oxfam tells Davos

Monday, 16 January 2017 | MYT 8:17 AM

While Gates exemplifies how outsized wealth can be recycled to help the poor, Oxfam believes such "big philanthropy" does not address the fundamental problem.

DAVOS, Switzerland: Just eight individuals, all men, own as much wealth as the poorest half of the world's population, Oxfam said on Monday in a report calling for action to curtail rewards for those at the top.

As decision makers and many of the super-rich gather for this week's World Economic Forum (WEF) annual meeting in Davos, the charity's report suggests the wealth gap is wider than ever, with new data for China and India indicating that the poorest half of the world owns less than previously estimated.

Oxfam, which described the gap as "obscene", said if the new data had been available before, it would have shown that in 2016 nine people owned the same as the 3.6 billion who make up the poorest half of humanity, rather than 62 estimated at the time.

In 2010, by comparison, it took the combined assets of the 43 richest people to equal the wealth of the poorest 50 percent, according to the latest calculations.

Inequality has moved up the agenda in recent years, with the head of the International Monetary Fund and the Pope among those warning of its corrosive effects, while resentment of elites has helped fuel an upsurge in populist politics.

Concern about the issue was highlighted again in the WEF's own global risks report last week.

"We see a lot of hand-wringing - and clearly Trump's victory and Brexit gives that new impetus this year - but there is a lack of concrete alternatives to business as usual," said Max Lawson, Oxfam's head of policy.

"There are different ways of running capitalism that could be much, much more beneficial to the majority of people."

SUPER-CHARGED CAPITALISM

Oxfam called in its report for a crackdown on tax dodging and a shift away from "super-charged" shareholder capitalism that pays out disproportionately to the rich.

While many workers struggle with stagnating incomes, the wealth of the super-rich has increased by an average of 11 percent a year since 2009.

Bill Gates, the world's richest man who is a regular at Davos, has seen his fortune rise by 50 percent or $25 billion since announcing plans to leave Microsoft in 2006, despite his efforts to give much of it away.

While Gates exemplifies how outsized wealth can be recycled to help the poor, Oxfam believes such "big philanthropy" does not address the fundamental problem.

"If billionaires choose to give their money away then that is a good thing. But inequality matters and you cannot have a system where billionaires are systematically paying lower rates of tax than their secretary or cleaner," Lawson said.

Oxfam bases its calculations on data from Swiss bank Credit Suisse and Forbes. The eight individuals named in the report are Gates, Inditex founder Amancio Ortega, veteran investor Warren Buffett, Mexico's Carlos Slim, Amazon boss Jeff Bezos, Facebook's Mark Zuckerberg, Oracle's Larry Ellison and former New York City mayor Michael Bloomberg.- Reuters

Read more at http://www.thestar.com.my/business/business-news/2017/01/16/world-eight-richest-as-wealthy-as-half-humanity/#CUOyoDtqH3pY4q2E.99

Pump and Dump activities of the market operators in Bursa

Saturday, 25 March 2017
What’s cooking in penny stocks
BY TEE LIN SAY

Bursa Malaysia saw overall turnover hitting a staggering 6.01 billion shares on March 20 – the biggest one-day volume since August 2014.

BURSA Malaysia has underperformed for the past three years, largely due to the outflow of foreign funds.

The foreign funds started coming back five weeks ago and subsequently trading volumes on the exchange picked up. Bursa saw its overall turnover hitting a staggering 6.01 billion shares on March 20 – the biggest one-day volume since August 2014. Total turnover was valued at RM3bil.

Unfortunately though, the good always attracts the depraved. Sure, foreign funds are here, but so are the much dreaded “pump and dump” operators.

The presence of the operators who churned out the volume was so immense that it prompted Bursa to come out with a warning to brokerages to not facilitate such activities. The exchange particularly mentioned about social websites that promote these stocks.

So just what are these “pump and dump” operators all about?

Well, they are perhaps a group of people who operate on creating hype and building up fevered excitement around a (usually) small company, where insiders can subsequently unload overvalued or worthless shares to unsuspecting investors.

So let’s say these pump and dumpers identify a cheap stock. Typically it has no earnings but rides on offering big “potential” for upside.

What they do is to cheaply acquire a large position in a company. 

• Then they begin informing the public about this company via e-mail and Internet stock sites. 
• They also start trading shares of these companies,
• Combined together, these activities create the perception that something big is brewing in that fledgling little company.

So the share price skyrockets, doubles, triples or quadruples even. Along the way, the operators dump their stock and make a fat profit for themselves.

That is more or less the modus operandi.

In the last few weeks, stocks that have hogged the volumes and gainers list are those in the sectors of construction, property, technology, logistics and e-commerce. The themes play out every few days before rotating to the next sector.

Brokers say it is more likely that the pump and dumpers are in some of the fintech stocks.

“The majority of the construction stocks, all said and done, have fundamentals and orderbooks to back their earnings. Furthermore, there are real construction contracts to be dished out this year and next.

“The same cannot be said for the tech stocks, where a lot of it is going up purely on potential and speculation,” said one broker.

Caution by the authorities

The authorities are vigilant of the current situation, and over the week, cautioned that “pump and dump” activities are circulating through the social media.

In a circular to the heads of dealing and compliance of stockbroking companies, the stock exchange said it discovered certain groups of market participants using the social media and Internet trading to carry out manipulative activities, which included “pump and dump” schemes.

The circular said that the operators of the “pump and dump” schemes, which are transacted through the social media, would typically begin by spreading false or misleading statements, news or rumours in investor blogs, chat groups – such as Telegram, WhatsApp, WeChat, electronic bulletin board postings or online newsletters – to entice or recommend unsuspecting investors to buy stocks which are touted as “hot” picks.

This, it said, was to facilitate the disposal of the stocks that they had accumulated earlier at higher prices.

Bursa said operators would often post their own researches and make unsubstantiated statements, promotional news or hearsay to gain the confidence of their followers and lure them into following their stock tips.

Bursa said the operators were persuasive in the chatrooms to entice people into buying the stock with the end goal of running up the prices.

When the stock price is pumped up due to an increase in trading volume, the operators behind the schemes will sell their stocks before the hype stops.

“The exit of the operators will cause the price to plummet while innocent investors who bought high and sold low will lose their money,” it added.

Bursa said it wanted to share the observations with brokers so that they become aware of such activities and alert their representatives and clients to exercise caution and diligence.

So what’s cooking?

Now, the latest batch of stocks being “peddled” by financial blogs and social media are those perceived to be beneficiaries of the Digital Free Trade Zone (DTFZ) where Jack Ma’s Alibaba will have a presence.

Prime Minister Datuk Seri Najib Tun Razak and Ma launched the DFTZ on Wednesday, which is expected to generate trade worth US$65bil (RM286bil) by 2025. It is expected to double the export growth of small and medium businesses by 2025 and create 60,000 jobs. It will also create a new Kuala Lumpur Internet City to house 10,000 Internet firms and 25,000 tech professionals in Bandar Malaysia.

Using these big numbers and the China factor, blogs have started talking up the likes of Dataprep Holdings Bhd, GHL Systems Bhd, Rev Asia Bhd, Cuscapi Bhd, Malaysia Airport Holdings Bhd, AirAsia Bhd, DKSH Bhd and Tropicana Bhd, among others.

The share price of Malaysia Airports Holdings Bhd (MAHB) going up isn’t all surprising.

MAHB will be teaming up with Cainiao Network, the logistics arm of e-commerce giant Alibaba Group where both companies will develop a regional e-commerce and logistics hub in the KL International Airport (KLIA) Aeropolis, as part of the DFTZ initiative.

This is not to say that all the thematic stocks that have moved up sharply are absent of fundamentals, but certainly the element of speculation is huge.

One of the sharpest rise was seen in business process outsourcing solutions provider Efficient-E Solutions. Its share price went up 72.41% or 21 sen in one day to 50 sen on Thursday. It was also the most actively traded counter of the day with 208.04 million shares being traded.

While it is true that Singapore Post Ltd is the largest shareholder in Efficient E-Solutions with a 20.8% stake, and in turn, Alibaba Investment Ltd has a 14.41% stake in Singapore Post, nonetheless fundamentally wise, nothing appears to be happening within the company.

It remains a loss-making company, posting RM10mil loss for its financial year ended Dec 31, 2016 from a previous net profit of RM44mil.

Meanwhile, companies like Cuscapi Bhd and Rev Asia Bhd are riding on the DFTZ wave by virtue of connections.

For Rev Asia, the link is through its parent company Catcha Group, which has been chosen to be the master developer for the Kuala Lumpur Internet City, a component of DFTZ.

It is also uncertain how software solutions provider Cuscapi, which is primarily involved in business management solutions software for the food and beverage industry, will benefit from DTFZ.

The company, however, posted a widening loss of RM36mil for financial year 2016, from a loss of RM24mil the year before.

Perhaps the most drastic of all moves are that of little Dataprep, which has seen its share price run from 25.5 sen on March 15 to reach its high of 65 sen on March 23. It has also been on a phenomenal run. At its last price of 62 sen, the stock still only has a market capitalisation of RM259.2mil.

The main reason being touted for Dataprep’s rise is because its owner, Tan Sri Lim Chee Wah, the son of Genting founder Lim Goh Tong, is a major shareholder of the 20 billion yuan (RM13bil) Genting Secret Garden Resorts project in China.

Genting Secret Garden Resort is an all-season holiday and skiing resort, which will be an important venue for the Beijing Winter Olympics 2022. It is located at the outskirts of Zhangjiakou city in Hebei Province.

The price is rising because Dataprep is Lim’s only Malaysian-listed company. His other private vehicle, VXL Group, is also a major investor in Secret Garden. There are now rumblings in the blogs that there could be a potential transfer of assets and Dataprep could be a beneficiary.

Read more at http://www.thestar.com.my/business/business-news/2017/03/25/whats-cooking-in-penny-stocks/#ISQLBq8rX8xBO8Xe.99

Concentrated portfolio of stocks or Index funds or Mutual/Hedge funds

How should I invest in the stock market?

Should I invest in my own selected stocks and manage my own portfolio?

Should I entrust my money to the fund managers in mutual funds or hedge funds?

Or, should I just buy an index-linked fund or an ETF?

Investing in mutual funds and hedge funds

The problem here is, as an aggregate, these funds underperform the market, after taking into consideration the costs incurred.  

Over a one year period, these costs maybe small, but over a long period, these costs compounded into a huge amount that is leaked out of your portfolio, not available to you to reinvest into your portfolio.

It is generally sound to avoid these funds, since there are better alternatives.

Investing in index linked funds or ETF

Index linked mutual funds have on the aggregate given you the chance to capture the returns of the market at low costs.    

They have in general outperformed the mutual funds and hedge funds, as a group over the long term.

Due to recent awareness of the performances of the mutual funds and hedge funds due to the higher costs involved, more and more money are flooding into index linked funds or ETFs.

Investing in a concentrated portfolio of  a selected group of stocks

I believe this is possible for those with a good and sound philosophy and method; who are hardworking, knowledgeable and disciplined.

These constitute less than 5% of the investors in the market.

An example of a sound philosophy:

• Know the business you are investing.
• The business has durable competitive advantage.
• The management has integrity and are capable.
• The company is available at a fair or bargain price.
• The investing time horizon is long term (> 5 years or more).
• Dividends are reinvested.

The stock markets have returned averagely about 10.5% per year for a long period.  The returns of the stock market over the short term is extremely volatile; inflation over this short period is small.   On the other hand, the returns of the stock market for any 5 years or more rolling period have always been positive.   Those who choose the "good quality stocks" bought at "bargain prices" can expect to perform better than the average and should have returns better than the 10.5% per year.

In summary:

1.   If you are knowledgeable, do invest on your own.

Own a concentrated portfolio of good quality stocks (those with durable competitive advantage).

Do not overpay to own them.

Keep them for the long term, reinvest the dividends, and allowing compounding to give you the higher returns.

2.   If you are not so knowledgeable, but still intelligent in your investing.

Go for index linked funds.

Do you have the uncanny ability to pick out the best mutual or hedge fund managers?  If you have, you may wish to park your money with them.  If not, avoid these products altogether and go for index linked funds or ETF.

KEY PRINCIPLES TO INVESTING IN A STOCK

In this article we look at the four keys that we believe every stock investment should have. These are not new things but rather the core principles that successful investors have been following for decades.

1.  Invest in sectors and industries that you understand –

Becoming an expert in certain areas of the market will give you an upper hand when it comes to selecting stocks to buy. This is like a foundation for all other steps that follows. Pick a given sector or industry and try to get information on it as much as possible. This will enable you to make informed decision when it comes to buying stock.

2.  Find companies with a Long-Term Competitive Advantages –

Companies with long-term competitive advantage have an ”economic moat” i.e. Economic protection. These companies have the following advantages:

• A recognized brand.
• The ability to produce products cheaper than anyone else.
• The ability to sell their products cheaper than anyone else.
• Barriers to entry that make it difficult for competitors or new companies to compete.
• The opportunity to grow at a cheaper cost than anyone else.
• A duopoly situation where two companies dominate the industry like Airbus or Boeing.
• Networking effect where the users of the product or service makes the business more valuable like Google.

3. Look for companies with Excellent Management –

This can be done by reading annual and quarterly reports and studying the history of the company’s current management in an attempt to understand what the management is currently doing and what they may do in the future. You can look at the following:

• The management’s history of decision-making. Do they have a track record of someone who we would actually hire if given a choice?
• Understanding how management is compensated. Is their compensation based upon the success of the firm?
• Ensuring that management is shareholder friendly. Do they do things that have the best interest of shareholders in mind?
• These questions will help you to answer the question as to whether or not we trust the management enough to purchase the stock.

4. Buy When the stock is at a Good Price. Discounted to Intrinsic Value —

Find stocks that are currently trading below the market price. If you can be able to find stocks that are trading below their intrinsic value and have the other three core principles then we would have the formula for a sound stock investment. If you find a stock with the first 3 principles but is not trading below the market price, then it is better you wait. Any investor should know that the price at which he/she pays at, is a critical piece of investing. If you get it wrong then the investment will have a hard time making money.



Bottom Line

When all the four principles align then the possibilities of making money increase, though this does not guarantee that you will make money but rather increases the probability of making money.


http://www.businessandlifetips.com/2017/04/10/key-principles-to-investing-in-a-stock/

Charlie Munger provided some answers to: Why did Berkshire under Buffett do so well?

1.   Why did Berkshire under Buffett do so well?

Only four large factors occur to me:

(1) The constructive peculiarities of Buffett,
(2) The constructive peculiarities of the Berkshire system,
(3) Good luck, and
(4) The weirdly intense, contagious devotion of some shareholders and other admirers, including some in the press.


I believe all four factors were present and helpful. But the heavy freight was carried by

• the constructive peculiarities, 
• the weird devotion, and 
• their interactions.

In particular, Buffett’s decision to limit his activities to a few kinds and to maximize his attention to them, and to keep doing so for 50 years, was a lollapalooza.  Buffett succeeded for the same reason Roger Federer became good at tennis.

Buffett was, in effect, using the winning method of the famous basketball coach, John Wooden, who won most regularly after he had learned to assign virtually all playing time to his seven best players. That way, opponents always faced his best players, instead of his second best. And, with the extra playing time, the best players improved more than was normal.

And Buffett much out-Woodened Wooden, because in his case the exercise of skill was concentrated in one person, not seven, and his skill improved and improved as he got older and older during 50 years, instead of deteriorating like the skill of a basketball player does.

Moreover, by concentrating so much power and authority in the often-long-serving CEOs of important subsidiaries, Buffett was also creating strong Wooden-type effects there. And such effects enhanced the skills of the CEOs and the achievements of the subsidiaries.

Then, as the Berkshire system bestowed much-desired autonomy on many subsidiaries and their CEOs, and Berkshire became successful and well known, these outcomes attracted both more and better subsidiaries into Berkshire, and better CEOs as well.

And the better subsidiaries and CEOs then required less attention from headquarters, creating what is often called a “virtuous circle.”



2.   What were the big mistakes made by Berkshire under Buffett?

Well, while mistakes of commission were common, almost all huge errors were in not making a purchase, including not purchasing Walmart stock when that was sure to work out enormously well. The errors of omission were of much importance. Berkshire’s net worth would now be at least $50 billion higher if it had seized several opportunities it was not quite smart enough to recognize as virtually sure things.



3.   The next to last task on my list was: Predict whether abnormally good results would continue at Berkshire if Buffett were soon to depart.

The answer is yes.

Berkshire has in place in its subsidiaries much business momentum grounded in much durable competitive advantage.

Moreover, its railroad and utility subsidiaries now provide much desirable opportunity to invest large sums in new fixed assets. And many subsidiaries are now engaged in making wise “bolt-on” acquisitions.

Provided that most of the Berkshire system remains in place, the combined momentum and opportunity now present is so great that Berkshire would almost surely remain a better-than-normal company for a very long time even if:

(1) Buffett left tomorrow,
(2) his successors were persons of only moderate ability, and
(3) Berkshire never again purchased a large business.

But, under this Buffett-soon-leaves assumption, his successors would not be “of only moderate ability.” For instance, Ajit Jain and Greg Abel are proven performers who would probably be under-described as “world-class.”

“World-leading” would be the description I would choose. In some important ways, each is a better business executive than Buffett.

And I believe neither Jain nor Abel would
(1) leave Berkshire, no matter what someone else offered or
(2) desire much change in the Berkshire system.

Nor do I think that desirable purchases of new businesses would end with Buffett’s departure. With Berkshire now so large and the age of activism upon us, I think some desirable acquisition opportunities will come and that Berkshire’s $60 billion in cash will constructively decrease.



4.   My final task was to consider whether Berkshire’s great results over the last 50 years have implications that may prove useful elsewhere.

The answer is plainly yes.

In its early Buffett years, Berkshire had a big task ahead: turning a tiny stash into a large and useful company. And it solved that problem by avoiding bureaucracy and relying much on one thoughtful leader for a long, long time as he kept improving and brought in more people like himself.

Compare this to a typical big-corporation system with much bureaucracy at headquarters and a long succession of CEOs who come in at about age 59, pause little thereafter for quiet thought, and are soon forced out by a fixed retirement age.

I believe that versions of the Berkshire system should be tried more often elsewhere and that the worst attributes of bureaucracy should much more often be treated like the cancers they so much resemble. A good example of bureaucracy fixing was created by George Marshall when he helped win World War II by getting from Congress the right to ignore seniority in choosing generals.



Ref:

http://www.berkshirehathaway.com/letters/2014ltr.pdf

If you are thinking of buying Berkshire shares, please read what Warren Buffett has shared here in his newsletter of 2014.

Today Berkshire possesses:

(1) an unmatched collection of businesses, most of them now enjoying favorable economic prospects;
(2) a cadre of outstanding managers who, with few exceptions, are unusually devoted to both the subsidiary they operate and to Berkshire;
(3) an extraordinary diversity of earnings, premier financial strength and oceans of liquidity that we will maintain under all circumstances;
(4) a first-choice ranking among many owners and managers who are contemplating sale of their businesses and
(5) in a point related to the preceding item, a culture, distinctive in many ways from that of most large companies, that we have worked 50 years to develop and that is now rock-solid.

These strengths provide us a wonderful foundation on which to build.



The Next 50 Years at Berkshire

Now let’s take a look at the road ahead. Bear in mind that if I had attempted 50 years ago to gauge what was coming, certain of my predictions would have been far off the mark. With that warning, I will tell you what I would say to my family today if they asked me about Berkshire’s future.


‹ First and definitely foremost, I believe that the chance of permanent capital loss for patient Berkshire shareholders is as low as can be found among single-company investments. That’s because our per-share intrinsic business value is almost certain to advance over time. 

This cheery prediction comes, however, with an important caution:

• If an investor’s entry point into Berkshire stock is unusually high – at a price, say, approaching double book value, which Berkshire shares have occasionally reached – it may well be many years before the investor can realize a profit. 
• In other words, a sound investment can morph into a rash speculation if it is bought at an elevated price. Berkshire is not exempt from this truth.

Purchases of Berkshire that investors make at a price modestly above the level at which the company would repurchase its shares, however, should produce gains within a reasonable period of time.

• Berkshire’s directors will only authorize repurchases at a price they believe to be well below intrinsic value.
•  (In our view, that is an essential criterion for repurchases that is often ignored by other managements.)

For those investors who plan to sell within a year or two after their purchase, I can offer no assurances,whatever the entry price.

• Movements of the general stock market during such abbreviated periods will likely be far more important in determining your results than the concomitant change in the intrinsic value of your Berkshire shares. 
• As Ben Graham said many decades ago: “In the short-term the market is a voting machine; in the long-run it acts as a weighing machine.” Occasionally, the voting decisions of investors – amateurs and professionals alike – border on lunacy.
• Since I know of no way to reliably predict market movements, I recommend that you purchase Berkshire shares only if you expect to hold them for at least five years. 
• Those who seek short-term profits should look elsewhere.

Another warning: Berkshire shares should not be purchased with borrowed money. 

• There have been three times since 1965 when our stock has fallen about 50% from its high point. 
• Someday, something close to this kind of drop will happen again, and no one knows when. 
• Berkshire will almost certainly be a satisfactory holding for investors. But it could well be a disastrous choice for speculators employing leverage.

‹ I believe the chance of any event causing Berkshire to experience financial problems is essentially zero.

• We will always be prepared for the thousand-year flood; in fact, if it occurs we will be selling life jackets to the unprepared. 
• Berkshire played an important role as a “first responder” during the 2008-2009 meltdown, and we have since more than doubled the strength of our balance sheet and our earnings potential. 
• Your company is the Gibraltar of American business and will remain so.

Financial staying power requires a company to maintain three strengths under all circumstances:
(1) a large and reliable stream of earnings;
(2) massive liquid assets and
(3) no significant near-term cash requirements.

Ignoring that last necessity is what usually leads companies to experience unexpected problems:

• Too often, CEOs of profitable companies feel they will always be able to refund maturing obligations, however large these are. 
• In 2008-2009, many managements learned how perilous that mindset can be.

Here’s how we will always stand on the three essentials. 

1.  First, our earnings stream is huge and comes from a vast array of businesses.

• Our shareholders now own many large companies that have durable competitive advantages, and we will acquire more of those in the future. 
• Our diversification assures Berkshire’s continued profitability, even if a catastrophe causes insurance losses that far exceed any previously experienced.

2.  Next up is cash. 

• At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity. 
• Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent. 
• American business provided a case study of that in 2008. In September of that year, many long-prosperous companies suddenly wondered whether their checks would bounce in the days ahead. Overnight, their financial oxygen disappeared.
• At Berkshire, our “breathing” went uninterrupted. Indeed, in a three-week period spanning late September and early October, we supplied $15.6 billion of fresh money to American businesses.
• We could do that because we always maintain at least $20 billion – and usually far more – in cash equivalents. And by that we mean U.S. Treasury bills, not other substitutes for cash that are claimed to deliver liquidity and actually do so, except when it is truly needed. 
• When bills come due, only cash is legal tender. Don’t leave home without it.

3.  Finally – getting to our third point – we will never engage in operating or investment practices that can result in sudden demands for large sums.

• That means we will not expose Berkshire to short-term debt maturities of size nor enter into derivative contracts or other business arrangements that could require large collateral calls.
• Some years ago, we became a party to certain derivative contracts that we believed were significantly mispriced and that had only minor collateral requirements. These have proved to be quite profitable.
• Recently, however, newly-written derivative contracts have required full collateralization. And that ended our interest in derivatives, regardless of what profit potential they might offer. 
• We have not, for some years, written these contracts, except for a few needed for operational purposes at our utility businesses.
• Moreover, we will not write insurance contracts that give policyholders the right to cash out at their option. Many life insurance products contain redemption features that make them susceptible to a “run” in times of extreme panic. 
• Contracts of that sort, however, do not exist in the property-casualty world that we inhabit. If our premium volume should shrink, our float would decline – but only at a very slow pace.
• The reason for our conservatism, which may impress some people as extreme, is that it is entirely predictable that people will occasionally panic, but not at all predictable when this will happen. 
• Though practically all days are relatively uneventful, tomorrow is always uncertain. (I felt no special apprehension on December 6, 1941 or September 10, 2001.) 
• And if you can’t predict what tomorrow will bring, you must be prepared for whatever it does.

Ref:
http://www.berkshirehathaway.com/letters/2014ltr.pdf

Warren Buffett's actions in the 2007 - 2008 financial crisis

2007-08 financial crisis

Buffett ran into criticism during the subprime crisis of 2007–2008, part of the recession that started in 2007, that he had allocated capital too early resulting in suboptimal deals.   "Buy American. I am." he wrote for an opinion piece published in the New York Times in 2008.  Buffett called the downturn in the financial sector that started in 2007 "poetic justice".   Buffett's Berkshire Hathaway suffered a 77% drop in earnings during Q3 2008 and several of his later deals suffered large mark-to-market losses.

1. Berkshire Hathaway acquired 10% perpetual preferred stock of Goldman Sachs.  
2. Some of Buffett's put options (European exercise at expiry only) that he wrote (sold) were running at around $6.73 billion mark-to-market losses as of late 2008.   The scale of the potential loss prompted the SEC to demand that Berkshire produce, "a more robust disclosure" of factors used to value the contracts. 
3. Buffett also helped Dow Chemical pay for its $18.8 billion takeover of Rohm & Haas. He thus became the single largest shareholder in the enlarged group with his Berkshire Hathaway, which provided $3 billion, underlining his instrumental role during the crisis in debt and equity markets.

In 2008, Buffett became the richest person in the world, with a total net worth estimated at $62 billion by Forbes and at $58 billion by Yahoo, overtaking Bill Gates, who had been number one on the Forbes list for 13 consecutive years.  In 2009, Gates regained the top position on the Forbes list, with Buffett shifted to second place.

• Both of the men's values dropped, to $40 billion and $37 billion respectively—according to Forbes, 
• Buffett lost $25 billion over a 12-month period during 2008/2009.

In October 2008, the media reported that Buffett had agreed to buy General Electric (GE) preferred stock.  The operation included special incentives: 

• He received an option to buy three billion shares of GE stock, at $22.25, over the five years following the agreement, and 
• Buffett also received a 10% dividend (callable within three years). 

In February 2009, Buffett sold some Procter & Gamble Co. and Johnson & Johnson shares from his personal portfolio.

In addition to suggestions of mistiming, the wisdom in keeping some of Berkshire's major holdings, including The Coca-Cola Company, which in 1998 peaked at $86, raised questions. Buffett discussed the difficulties of knowing when to sell in the company's 2004 annual report:

• That may seem easy to do when one looks through an always-clean, rear-view mirror. 
• Unfortunately, however, it's the windshield through which investors must peer, and that glass is invariably fogged.

In March 2009, Buffett said in a cable television interview that the economy had "fallen off a cliff ... Not only has the economy slowed down a lot, but people have really changed their habits like I haven't seen". Additionally, Buffett feared that inflation levels that occurred in the 1970s—which led to years of painful stagflation—might re-emerge.

Investment philosophy of Warren Buffett

Warren Buffett's writings include his annual reports and various articles.

Buffett is recognized by communicators as a great story-teller, as evidenced by his annual letters to shareholders. He warned about the pernicious effects of inflation:

"The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation, or pays no income taxes during years of 5 percent inflation."

— Buffett, Fortune (1977)


In his article "The Superinvestors of Graham-and-Doddsville", Buffett rebutted the academic efficient-market hypothesis, that beating the S&P 500 was "pure chance", by highlighting the results achieved by a number of students of the Graham and Dodd value investing school of thought. In addition to himself, Buffett named Walter J. Schloss, Tom Knapp, Ed Anderson (Tweedy, Browne LLC), William J. Ruane (Sequoia Fund, Inc.), Charles Munger (Buffett's own business partner at Berkshire), Rick Guerin (Pacific Partners, Ltd.), and Stan Perlmeter (Perlmeter Investments).



In his November 1999 Fortune article, he warned of investors' unrealistic expectations:

Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like—anything like—they've performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate—repeat, aggregate—would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%!

— Buffett, Fortune (1999)

Index funds and active management - Warren Buffett is a vocal critic of active management.

Towards his later life, particularly following the global financial crisis of 2007-8, Buffett became an increasingly vocal critic of active management, i.e., mutual funds and hedge funds. 

Buffett is skeptical that active management and stock-picking can outperform the market in the long run, and has advised both individual and institutional investors to move their money to low-cost index funds that track broad, diversified stock market indices. 

Buffett said in one of his letters to shareholders that "when trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients."

In 2007, Buffett made a bet with numerous managers that a simple S&P 500 index fund will outperform hedge funds that charge exorbitant fees. By 2017, the index fund was outperforming every hedge fund that had made the bet against Buffett by a significant margin.

Active Management Blues (CNBC)

http://video.cnbc.com/gallery/?video=3000610137

Budgeting in different types of organization

In very large organizations, hundreds of managers may be involved in the budgeting process, and the complete budget will probably be a very thick document.


Budgeting when done well is time well spent

This involvement takes a lot of management time but, if the budgeting is done well, it is likely to be time well spent.

This is because the budget will probably be a realistic one, and because after approval the managers should feel committed to it.


Budget is approved - What happens next?

• When the budget has been approved, individual managers are responsible for their section of it.  the responsibility is like a pyramid.
• At the base of the pyramid are the most junior managers, supervising a comparatively small section, perhaps involving expenditure only.
• These junior managers should, however, have some knowledge of the overall budget and objectives.
• In the middle may be more senior managers and divisional directors, each with a wider area of responsibility for achieving the complete budget objectives.  If everyone else meets their targets they will have an easy job.

Budget must be relevant

Budgets should be designed to meet the needs of a particular organization and its managers.

For example, a large school could well have an expenditure budget of about $4 million.

• There will be little income and the budgeting emphasis will be on capital expenditure and revenue expenditure.  
• The main aims will be informed choice and value for money.

Main Principles of Budget for the Large and Small Companies

• The main principles devoted to the budget of a large company can also be used by a small organization.  
• There will be fewer managers involved, and less paper, but the same procedures should be followed.

After the budget has been approved ... what comes next?

After the budget has been approved, what comes next?  Quite possibly nothing at all.

This is a pity but it does not mean that the budgeting exercise has been a complete waste of time.

• The participants will have thought logically about the organization, its finances and its future.
• Some of the detail will remain in their minds and influence their future actions.
• Nevertheless, the budgets will be much more valuable if they are used in an active way.  

Regular performance reports should be issued by the accountants.

• These should be in the same format as the budgets.
• It should give comparable budget and actual figures.
• Variances should also be given.
• All levels of management should regularly review these figures and explain the variances.
• Significant variances will pose the question of whether corrective action needs to be taken.

Budgets do not necessarily have to be done just once a year.

They may be updated, reviewed or even scrapped and redone as circumstances dictate.

Cash Flow Forecast and the Balance Sheet Forecast

Cash-Flow Forecast

When the profit budgets are complete, it is important that a cash budget is prepared.

This is a Cash-Flow Forecast.  (click to understand this)

In practice, the profit budget and cash budget are linked.

• The profit budget cannot be completed until the interest figure is available.
• This in turn depends on the cash budget. 
• The cash budget depends partly on the profit budget.
• Dilemmas like this are quite common in budgeting.

It is usual to put in an estimated figure for interest and then adjust everything later if necessary.

This can be very time-consuming and budgeting is much simpler if it is computerized.

Several hours' work can be reduced to minutes and management is much freer to test budgets with useful "what if" questions.


Forecast Balance Sheet

Accounting rules stated that every debit has a credit.

It follows that every figure in the budgets has a forecast consequence in a future Balance Sheet.

It is normal to conclude the budgets by preparing a month-by-month forecast Balance Sheet and bankers are likely to ask for this.

It may be that some aspect of the Balance Sheet is unacceptable and a partial re-budget is necessary.

In practice, top management is likely to review and alter some aspects of the budgets several times.

The Capital Expenditure Budget

This is extremely significant in some companies, less so in others.

It will list all the planned capital expenditure showing the date when the expenditure will be made, and the date that the expenditure will be completed and the asset introduced to the business.

Major contracts may be payable in installments and the timing is important to the cash budget.

A sum for miscellaneous items is usually necessary.  For example, major projects might be listed separately and then $15,000 per month added for all projects individually less than $5,000.

Within the capital expenditure budget, timing is very important.

Expenditure affects cash and interest straight away.

Depreciation usually starts only on completion.

Revenue Expenditure Budgets

Revenue expenditure includes cost of sales (direct cost or variable cost) and overhead cost (indirect cost).

The cost of sales will consist of direct wages, items bought for resale, raw materials and others.

The Sales, Finance, and Administration Departments will make up the overhead budget.

In practice, this overhead budget is likely to be divided into three, with a different manager responsible for each section.

As with all the other budgets, each manager should submit a detailed budget for the section for which he or she is responsible.

As with the other budgets (e.g. sales budget), top management should give initial guidance on expected performance and policy assumptions.

For example, a manager might be told to assume a company-wide average pay rise of 5% on 1 January.

The Sales Budget

This should be in sufficient detail for management to know the sources of revenue.

The figures will be broken down into different products and different sales regions.

Each regional sales manager will have responsibility for a part of the sales budget.

Before the sales budget is done it would be normal for top management to issue budget assumptions concerning prices, competition, and other key matters.

The sales budget will be for orders taken.

There will usually be a timing difference before orders become invoiced sales.