CAGR: The Good, The Bad And The Ugly

CAGR: The Good, The Bad And The Ugly

by Rick Wayman (Contact Author Biography)

Compound annual growth rate, or CAGR, is a term that gets used when investment advisors tout their market savvy and funds promote their returns. But what does it really show? This article will define CAGR and discuss its good and bad points.

CAGR Defined
The CAGR is a mathematical formula that provides a "smoothed" rate of return. It is really a pro forma number that tells you what an investment yields on an annually compounded basis; it indicates to investors what they really have at the end of the investment period. For example, let's assume you invested $1,000 at the beginning of 1999 and by year-end your investment was worth $3,000, a 200% return. The next year, the market corrected, and you lost 50% and ended up with $1,500 at year-end 2000.

What was the return on your investment for the period? Using the average annual return does not work. The average annual return on this investment was 75% (the average of 200% gain and 50% loss), but in this two-year period you ended up with $1,500 not $3,065 ($1,000 for two years at an annual rate of 75%). To determine what your annual return was for the period, you need to calculate the CAGR.

To calculate the CAGR you take the nth root of the total return, where "n" is the number of years you held the investment. In this example, you take the square root (because your investment was for two years) of 50% (the total return for the period) and get a CAGR of 22.5%. Table 1 illustrates the annual returns, CAGR, and average annual return of this hypothetical portfolio. The lower portion of the table illustrates how applying the CAGR gives the number that equates the ending value of the initial investment.

Table 1

Figure 1 is a graphical representation of Table 1 and illustrates the smoothing effect of the CAGR. Notice how the lines vary but the ending value is the same.

Figure 1

The Good
CAGR is the best formula for evaluating how different investments have performed over time. Investors can compare the CAGR in order to evaluate how well one stock performed against other stocks in a peer group or against a market index. The CAGR can also be used to compare the historical returns of stocks to bonds or a savings account.

The Bad
When using the CAGR, it is important to remember two things:

• the CAGR does not reflect investment risk
• you must use the same time periods.

Investment returns are volatile, meaning they can vary significantly from one year to another, and CAGR does not reflect volatility. CAGR is a pro forma number that provides a "smoothed" annual yield, so it can give the illusion that there is a steady growth rate even when the value of the underlying investment can vary significantly. This volatility, or investment risk, is important to consider when making investment decisions.

Investment results vary depending on the time periods. For example, amazon.com (AMZN) could be viewed as a great investment if you were smart enough to buy it in December 1997 at $4.52 and sell it in April 1999 at $105.06 for a 2,224% gain. If you bought the stock in September 1998 at $13.28 and still have it in your portfolio today, you would be about even. If you bought AMZN in late 2000 and still have it today, you would have lost 88% (from $115 to $13).

To demonstrate both CAGR and volatility risk, let's look at three investment alternatives: a blue chip (General Electric), a dotcom (Yahoo) and the five-year Treasury bond. We will examine the CAGR and average growth rate for each investment (adjusted for dividends and splits) for the five years ending December 31, 2001. We will then compare the volatility of these investments by using a statistic called the standard deviation.

Standard deviation is a statistic that measures how annual returns might vary from the expected return. Very volatile investments have large standard deviations because their annual returns can vary significantly from their average annual return. Less volatile stocks have smaller standard deviations because their annual returns are closer to their average annual return. For example, the standard deviation of a savings account is zero because the annual rate is the expected rate of return (assuming you don't deposit or withdraw any money). In contrast, a stock's price can vary significantly from its average return, thus causing a higher standard deviation. The standard deviation of a stock is generally greater than the savings account or a bond held to maturity.

The annual returns, CAGR, average annual return, and standard deviation (StDev) of each of the three investments are summarized in Table 2. We will assume that the investments were made at the end of 1996 and that the five-year bond was held to maturity. The market priced the five-year bond to yield 6.21% at the end of 1996, and we show the annual accrued amounts, not the bond's price. The stock prices are those of the end of the respective years.

Table 2

Because we have treated the five-year bond like a savings account (ignoring the market price of the bond), the average annual return is equal to the CGAR. The risk of not achieving the expected return was 0.0 because the expected return was "locked in". The standard deviation is zero also because the CAGR was the same as the annual returns.

General Electric (GE) shares were more volatile than the five-year bond, but not as much as YHOO's. The CAGR for GE was slightly less than 20%, but was lower than the average annual return of 23.5%. Because of this difference, the standard deviation was 0.32.

Yahoo (YHOO) outperformed GE by posting a CAGR of 65.7%, but this investment was also more risky because the stock's price fluctuated more than GE's. This volatility is shown by the high standard deviation of 3.07.

The following graphs compare the year-end prices to the CAGR and illustrates two things. First, the graphs show how the CAGR for each investment relates to the actual year-end values. For the bond, there is no difference (so we didn't display its graph for the CAGR comparison) because the actual returns do not vary from the CAGR. Second, the difference between the actual value and the CAGR value illustrates investment risk.

Figure 2

Figure 3



Figure 4


In order to compare the performance and risk characteristics between investment alternatives, investors can use a risk-adjusted CAGR. A simple method for calculating a risk-adjusted CAGR is to multiply the CAGR by one minus the standard deviation. If the standard deviation (risk) is zero, the risk-adjusted CAGR is unaffected. The larger the standard deviation, the lower the risk-adjusted CAGR. For example, here is the risk-adjusted CAGR comparison for the bond, GE and YHOO:

Bond: 6.21%
GE: 13.6% (instead of 19.96%)
YHOO: -136% (instead of 65.70%)

This analysis shows two things:

•While the bond holds no investment risk, the return is below that of the stocks.
•GE appears to be a preferable investment than YHOO. YHOO's CAGR was much greater than GE's (65.7% versus 19.9%), but because YHOO shares were more volatile, its risk-adjusted CAGR is lower than GE's.

While historical performance is not a 100% indicator of future results, it does provide the investor with some valuable information.

The Ugly
Things get ugly when the CAGR is used to promote investment results without incorporating the risk factor. Mutual fund companies emphasize their CAGRs from different time periods in order to get you to invest in their funds, but they rarely incorporate a risk adjustment. It is also important to read the fine print in order to know what time period is being used. Ads can tout a fund's 20% CAGR in bold type, but the time period used may be from the peak of the last bubble, which has no bearing on the most recent performance.

Conclusion
The CAGR is a good and valuable tool to evaluate investment options, but it does not tell the whole story. Investors can analyze investment alternatives by comparing their CAGRs from identical time periods. Investors, however, also need to evaluate the relative investment risk. This requires the use of another measure such as standard deviation.

by Rick Wayman, (Contact Author Biography)

http://www.investopedia.com/articles/analyst/041502.asp

'Stockmarkets climbing wall of worry'

'Stockmarkets climbing wall of worry'
The market action we have seen unfolding so far is very similar to the recovery from the March 2003 lows at the end of the ‘dotcom’ bear market.

By Jeff Hochman, director of technical analysis, Fidelity
Published: 2:49PM BST 29 Jul 2009


If that analogy holds, we can expect to see some market gyrations in the short term as investors wait for further evidence of economic and corporate improvement, which may be a few months away. Markets always have to climb this wall of worry and the fear of being left behind will become increasingly strong.

There is a risk that markets could fall by around 5pc, however this should be seen as a buying opportunity.

The alternative scenario is that markets stay fairly flat, within a trading range, before trending higher as each piece of new data adds weight to the evolving recovery story.

Renewed investor interest has helped emerging markets to move up strongly, so much so that they may see some short-term consolidation in what remains a strong secular story.

There is a considerable amount of money waiting on the sidelines in money market funds. This missed the first stage of the rally but it can be committed to the market once conditions improve.

Around two thirds of the money is institutional and some of it will be specifically allocated to cash, but a big chunk of it is cash that it is likely to be used for reallocating to equities.

By any historical standards, investors are currently holding extreme levels of cash at a time when the yield is modest. In the past, when cash levels have either met or exceeded the value of the equity market, this has marked a significant low.

http://www.telegraph.co.uk/finance/personalfinance/investing/5932634/Stockmarkets-climbing-wall-of-worry.html

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KAF-Seagroatt returns to RM12m profit in fourth quarter

KAF-Seagroatt returns to RM12m profit in fourth quarter

Tags: fourth quarter KAF-Seagroatt & Campbell Bhd

Written by Financial Daily
Friday, 24 July 2009 09:53

KUALA LUMPUR: KAF-SEAGROATT & CAMPBELL BHD [] returned to profitability, with a net profit of RM12.12 million in its fourth quarter (4Q) ended May 31, 2009 versus a net loss of RM37,000 in the previous three months to Feb 28, 2009 due to higher volume of transactions and writeback in allowance for the diminution in the value of equity.

Revenue jumped 129% to RM6.78 million from RM2.96 million. No final dividend was proposed.

For the year ended May 31, 2009 (FY09), KAF-Seagroatt posted a net loss of RM2.96 million versus a net profit of RM17.49 million in FY08, while revenue fell 53% to RM19.73 million from RM42.54 million.

The group’s financial year-end was changed from March to May, starting with the 14-month period ended May 31, 2008. The stock was untraded yesterday, while it closed at RM1.18 on Wednesday.


This article appeared in The Edge Financial Daily, July 24, 2009


----

Tough times ahead but KAF won't cut jobs
By Chong Pooi Koon
Published: 2008/11/12




There's no way any brokers are going to maintain the 2007 or 2008 earnings into 2009, says KAF-Seagroatt's managing director Datuk Khatijah Ahmad


STOCKBROKING firm KAF-Seagroatt & Campbell Bhd (5096) will make a smaller profit in the year to May 2009 as market volume dwindles, but it will not cut jobs even as it anticipates the next three years to be tough.

Instead, managing director Datuk Khatijah Ahmad sees an opportunity to hire and strengthen the staff force of the research-driven broking house as other global banks start to retrench amid the financial crisis.

"There're no job cuts or pay cuts although the bonus may not be as good as last year's. We want to retain good people," Khatijah said after a shareholder meeting in Kuala Lumpur yesterday.

KAF-Seagroatt made RM17.5 million net profit in the 14 months to May 31 2008 on revenue of RM42.5 million.
Khatijah said, however, that such earnings would not be sustained this year.

"The foreign investors are leaving or have left, the volume has dropped in the equity market. There's no way any brokers are going to maintain the 2007 or 2008 earnings into 2009," she said.

The global financial market is in unchartered waters and, until the foreign investors return to Malaysia, there's little catalyst for the stock market.

"One should be prepared for a very slow market. As long as we are not losing money and can maintain the business, we should be fine," Khatijah said.

KAF-Seagroatt is a low-cost operator and can ride out the market trough in the next few years through earnings from its solid balance sheet, she added.

As at May this year, its total current assets were more than double its current liabilities and the broker has had no borrowings.

Khatijah is also not too concerned over the investment revaluation loss after its asset prices were marked-to-market, which dragged the company to a first quarter net loss of RM4.7 million.

"These are blue-chip shares that pay good dividend. It'll be silly to liquidate in this bottoming market," she said.

http://www.btimes.com.my/Current_News/BTIMES/articles/kafo-2/Article/

Kossan owns up to wrong judgment

Kossan owns up to wrong judgment

Tags: forex hedging Kossan Lim Kuang Sia

Written by Tony C H Goh
Monday, 27 July 2009 11:05

KUALA LUMPUR: KOSSAN RUBBER INDUSTRIES BHD [] chief executive officer Lim Kuang Sia has owned up to making a wrong judgment in carrying out speculative foreign exchange (forex) hedging.

“It is not the company’s policy to engage in speculative hedge, and we assure our investors that this kind of wrong judgment call will not happen again,” he told The Edge Financial Daily in a telephone interview last Friday.

Lim was responding to analysts’ reports that the glove maker may incur an estimated forex loss of RM8 million to RM9 million in the second quarter ended June 30, 2009 (2QFY09), after having written off RM12 million in similar losses in 1QFY09.

The losses spilled over from last year when Kossan hedged its receivables at an average contract of RM3.37 to the US dollar in anticipation of further weaknesses in the US currency. Instead, the dollar strengthened against the ringgit.

Lim said he did not expect any major impact from the forex losses this year.

“We are confident that the forex losses will fizzle out by the end of this financial year. In fact, a turnaround is expected to begin from the second half of this year and what happened was something that is common for industries that are involved in exports,” he said.

OSK Research said in its latest update on the company that FY09 would be a challenging year for Kossan, as it had to deal with unforeseen events such as a factory fire in May that disrupted much-needed production and the slowdown in the automotive sector that dampened demand for its technical gloves.

However, the research house said the problem of forex losses was not unique to Kossan, citing the example of ADVENTA BHD [] which incurred a forex loss of RM4.3 million in 1QFY09 and also in 2QFY09, which wiped out more than 50% of its quarterly net profit.

Other major glove makers such as Top Glove Corp Bhd, Supermax Corp Bhd and HARTALEGA HOLDINGS BHD [] were also believed to have suffered forex losses although their hedging exposure was less significant, according to OSK Research.

Lim said Kossan’s business strategies, including capacity expansion and a better product mix, were paying off. He anticipated supply to remain tight this year but said the positive results of its measures would be reflected in the next fiscal year, as the company’s internal projections were on track.

Kossan’s plant is running at around 95% of capacity and it expects to produce 9.3 billion to 9.5 billion gloves this year, an increase of 8%-10% from 8.5 billion last year. About a quarter of its total production would consist of higher-end nitrile gloves.

Nitrile gloves fetch a better selling price of US$27.50-US$28.50 per 1,000 pieces, compared with US$24-US$25 for natural rubber gloves. It also offers 10% to 15% higher margin than conventional rubber gloves.

OSK Research is maintaining a buy call on Kossan with a target price of RM4.48, in anticipation of the turnaround next year and the overall favourable view on the glove industry. The research house added that it was keeping Kossan’s FY09 forecast of RM62.5 million in net profit on revenue of RM964.7 million unchanged, until confirmation on the actual amount of forex loss.

“We believe investors would be buying the stock now for next year rather than 2009. There should also be recovery in the automotive sector, which will spur demand for its technical rubber products, and the overall recovery in the global economy should boost the demand for gloves, especially from the non-medical segment,” said OSK Research.

It said some of the growth catalysts for FY10 would include the commissioning of all its 22 new lines, which should be running at optimum level, thus enlarging its nitrile contribution to 40% from 25% now.


This article appeared in The Edge Financial Daily, July 27, 2009.

Running ahead of fundamentals?

Running ahead of fundamentals?


Written by Ellina Badri, Isabelle Francis & Surin Murugiah
Tuesday, 28 July 2009 23:51

KUALA LUMPUR: Regional markets continued to rise on July 28, driven by high liquidity but some analysts caution that equities may have run ahead of fundamentals.

Some hint of profit-taking emerged as Japan’s Nikkei 225 snapped its nine-day run and dipped 0.01% to 10,087.26 points. European markets turned negative in early trade on July 28, dragged down by losses in energy stocks.

Hong Kong’s Hang Seng Index gained 1.84% to 20,624.54, Shanghai’s Composite Index added 0.09% to 3,438.37, South Korea’s Kospi rose 0.13% to 1,526.03, Taiwan’s Taiex Index advanced 1.62% to 7,142.63 and Singapore’s Straits Times Index was up 1.84% to 2,624.04.

Macquarie Research, in a report titled When depositors become investors on Monday, said liquidity was returning to Asia and global emerging markets.

It said the fund flow numbers for the week ended July 22 showed that liquidity returned to Asia, ex-Japan and global emerging markets with net weekly inflows of US$973.2 million (RM3.41 billion) and US$1.1 billion, respectively.
This reversed the net outflow trend of the past four weeks, it said.

It said Greater China (China, Hong Kong and Taiwan) funds saw their biggest inflows since December 2007 (US$213.3 million), adding that sentiment towards China remained positive, with investors looking to achieve a broad and diversified exposure.

“In our view, the market conditions continue to be driven by liquidity rather than fundamental factors. Importantly, foreign investors are not the only source of liquidity,” it said, adding that domestic sources were also playing an important role, as depositors were switching from time deposits to demand deposits.

“Interest rate differentials between time and demand deposits are narrowing. With the opportunity cost of liquidity low, a greater proportion of funds are moving to liquid assets (demand deposits),” it said.

The research house also said while liquidity conditions were often a function of economic fundamentals, in the very near term there was the obvious potential for more money to chase equities despite what it viewed as elevated valuations.

“The yield gap between the earnings yield and the deposit rate expanded to an historical high. Despite elevated valuations, the significant yield differential between equities and bank deposits could induce investors to continue to switch from bank deposits to equities.

“Retail participation could rise further. The low returns on alternative investments, such as bank deposits, as well as the strong market momentum, were two likely drivers of the increase in retail investor participation,” it said.

Macquarie said the strong liquidity was pushing Asian equities to stretched valuation levels.

“We think a strong recovery in global final demand is now priced in.

“While hard signs of demand recovery are absent, we would ‘lean into’ the current rally, progressively reducing beta as equity markets move further and further away from levels justified by economic fundamentals,” it said.

On Malaysia, Macquarie said the yield gap, which it defined as 12-month forward earnings yield minus demand deposit rate, had widened further. “Admittedly, the domestic monetary base could be the next potential source of liquidity driving up the market,” it said.

Scott Lim, MIDF Asset Management chief executive and chief investment officer, agreed that the market was liquidity-driven, and valuations were getting stretched.

“The bulk of the rally has reflected liquidity more than fundamentals. Apart from liquidity and efforts by governments to increase access to financing, there is nothing much else driving the market.

“Investors have grounds to be cautious. Either fundamentals have to catch up with valuations, or valuations have to come down to meet it. Either one has to give,” he said.

Lim added that the liquidity was trying to rebuild a bubble, potentially the biggest one of all, but certain markets such as China were showing they were ready to stage a fierce formation of a stock market bubble.

However, Merrill Lynch Global Wealth Management Asia-Pacific investment strategist Stephen Corry said the next six months would still present buying opportunities in equities, regardless of it being an extended bear market rally or the start of a new bull market.

Corry was bullish on emerging market stocks, driven by recovery numbers in terms of car sales, while financial stocks remained favourites.

However, he cautioned that strong corporate earnings growth would need to be supported by equities’ current valuations.

Light crude oil rose nine cents per barrel to US$68.47 as at 6.20pm. Crude palm oil futures for third-month delivery gained RM42 per tonne to RM2,140.

At Bursa Malaysia, the FBM KLCI jumped 1.38% or 15.95 points to 1,172.38, its highest level since July 1 last year, led by gains by blue chips.

TA Securities technical analyst Stephen Soo said the immediate resistance level was 1,188 with the next level at 1,200. He said the respective support levels would be 1,165 and 1,148.

Turnover rose to 1.12 billion shares valued at RM1.63 billion. Gainers led losers by 491 to 194, while 249 counters traded unchanged. Market capitalisation over the last 12 trading days increased by RM60.48 billion to RM876.75 billion. The FBM100 [] gained 100.83 points to 7,689.37 and the FBM Emas added 103.69 points to 7,905.20.

Among the major gainers, SIME DARBY BHD [] and UMW HOLDINGS BHD [] added 25 sen each to RM8.15 and RM6.30, IOI CORPORATION BHD [] was up 22 sen to RM5 and GENTING BHD [] gained 15 sen to RM6.70.

MALAYAN BANKING BHD [], BUMIPUTRA-COMMERCE HOLDINGS [] Bhd and PUBLIC BANK BHD [] rose 10 sen each to RM6.55, RM10.20 and RM10.40, respectively, while Genting Malaysia Bhd added 12 sen to RM3.

PPB GROUP BHD [] was the top loser, shedding 20 sen to RM14.30; KFC HOLDINGS (M) BHD [] fell 15 sen to RM7.35, TALIWORKS CORPORATION BHD [] lost 13 sen to RM1.61, while LOH & LOH CORPORATION BHD [] and LEBAR DAUN BHD [] fell 12 sen each to RM4.18 and 60 sen.

KNM GROUP BHD [] was the most actively traded stock with 56.8 million shares done. It fell one sen to 89.5 sen.


From the Edge Malaysia

Tips for retail investors to stop losing money in stock market

Wednesday July 29, 2009
Tips for retail investors to stop losing money in stock market



IN the stock market, there are two main types of investors – smart investors and retail investors. While smart investors have been able to make money from the stock market, the majority of retail investors suffer losses most of the time.

As the market saying goes, only one out of 10 investors can make money from the stock market. The rest always incur losses in the stock market.

Some retail investors believe they can make quick money from the stock market. They believe that investing in the stock market is one of the best ways to accumulate wealth in a short period of time.

However, due to lack of proper financial training, investing knowledge and intelligence, they always find themselves at the losing end. When they are excited about investing, the stock market may be nearing to the peak.


On the other hand, when they are suffering losses, losing patience about investing and intending to cut their losses in the stock market, the market may be touching the bottom, and that, in fact, is supposed to be the best time to invest.

A majority of retail investors seldom pay attention to the stock market. They will only start doing so when newspapers or TV news headlines show that the market is touching a new high.

Driven by greed and the thought of making fast money, they will follow their friends or tips from their brokers to invest without paying much attention to the fundamentals of the stocks.

Due to lack of discipline to cut losses, more often than not, they find themselves holding on to a lot of poor quality stocks when the market collapses to a very low level.
(My comment: By sticking to high quality stocks, one hardly ever have to sell or to cut loss. However, it is extremely important to buy these stocks at bargain prices. Buying them at high prices may mean holding these stocks at a loss in the early years and also accepting a potentially lower compound annual return over the long term.)

We believe that the majority of retail investors do buy a mixture of good and poor quality stocks. However, they tend to hold on to poor quality stocks and sell the good ones when the stock market collapses.

This is because when the stock market crashes, poor quality stocks will drop much faster than good fundamental stocks.

Most retail investors find it difficult to sell poor quality stocks as the stocks may drop far lower their buying prices within a short period of time.

As retail investors refuse to admit their mistakes, they will hold on to these stocks, hoping to break even again in the future.

Unfortunately, they overlook one important market saying, which is: What goes up may come down, what goes down may never go up.

We may have emotional feelings about stocks but we should not refer to our purchase prices to determine whether we can cut our losses.

Our purchase prices are only important to us; they mean nothing to the overall market.

As our purchase prices may be much higher than those of other investors, even though we may not be able to sell the stocks, other investors, especially the company owners, can still liquidate their stocks.

We need to be careful when trading in speculative stocks especially those with prices that are much higher than the book values of the companies. The book value of a company reflects the owners’ costs in the company.

Hence, even though the stock prices tumble to a very low level, as long as the prices are still higher than the book values, a lot of company owners can still liquidate the stocks as their market prices are still higher than the cost invested.

For example, assuming the stock of a company is at the book value of only 30 sen and the stock price before the rally is 50 sen.

Due to the bullish sentiment and speculative play, the stock price may be pushed up to RM3. If our purchase price in the company is RM2, selling lower than RM2 means cutting a loss.

However, unfortunately, a lot of retail investors, instead of cutting losses continue to average down their purchase prices.

They may start averaging down their purchase prices at RM1.50, RM1, 80 sen and 50 sen.

If the company has poor fundamentals and has been incurring huge losses over a long period of time, averaging down our purchase prices this way means we will be incurring more losses.

While we are doing this, the owner of company can still sell the stock at 50 sen as his investment cost is only 30 sen!

(My comment: Therefore the importance of cutting loss early should your stock fundamentals suddenly deteriorated or should you realise that you have made a mistake in buying a stock.)

(My comment: Another reason why buying a share at a bargain price is important. The margin of safety is there, ensuring that any loss to your capital is minimised. Buying at a low or bargain price ensures the probability of upside is greater than that of downside. Also, the potential for greater reward should the upside be realised, and the minimisation of loss should the downside be realised.)

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting


http://biz.thestar.com.my/news/story.asp?file=/2009/7/29/business/4407802&sec=business

Be a shrewd investor

1. For individual stocks: buy low and sell high.
2. For the portfolio of stocks, through the strategy of rebalancing and asset allocation: buy when the market is obviously low and sell when the market is obviously high.
3. Refrain from buying when the stock or market, is obviously highly priced.
4. Even in a high market, you may be able to seek and buy undervalued stocks.
5. A beaten down stock maybe worth a look. The price may have discounted all the negatives making it undervalued, provided its long term fundamentals are intact.
6. It is common for stock price to fluctuate; prices can go down by a third from the high and go up by 50% from its low. A true investor cannot hope to profit from this on a consistent basis. He invests for the long term dividends and long term appreciation in the stock price.

Business Valuations versus Stock-Market Valuations: Summary

1. The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements.
2. The speculator's primary interest lies in anticipating and profiting from market fluctuations.
3. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices.
4. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.
5. It is far from certain that the typical investor should regularly hold off buying until low market levels appear, because this may involve a long wait, very likely the loss of income, and the possible missing of investment opportunities.
6. On the whole it may be better for the investor to do his stock buying whenever he has money to put in stocks, except when the general market level is much higher than can be justified by well-established standards of value.
7. If he wants to be shrewd he can look for the ever-present bargain opportunities in individual securities.
8. Aside from forecasting the movements of the general market, much effort and ability are directed on Wall Street toward selecting stocks or industrial groups that in matter of price will "do better" than the rest over a fairly short period in the future.
9. Logical as this endeavor may seem, we do not believe it is suited to the needs or temperament of the true investor - particularly since he would be competing with a large number of stock-market traders and first-class financial analysts who are trying to do the same thing.
10. As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years.
11. The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances.
12. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored.
13. He should never buy a stock because it has gone up or sell one because it has gone down.
14. He would not be far wrong if this motto read more simply: "Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop."

An Added Consideration: Average market prices and managerial competence.

• Something should be said about the significance of average market prices as a measure of managerial competence.
• The shareholder judges whether his own investment has been successful in terms both of dividends received and of the long-range trend of the average market value.
• The same criteria should logically be applied in testing the effectiveness of a company's management and the soundness of its attitude toward the owners of the business.
• This statement may sound like a truism, but it needs to be emphasized. For as yet there is no accepted technique or approach by which management is brought to the bar of market opinion.
• On the contrary, managements have always insisted that they have no responsibility of any kind for what happens to the market value of their shares.
• It is true, of course, that they are not accountable for those fluctuations in price which, as we have been insisting, bear no relationship to underlying conditions and values.
• But it is only the lack of alertness and intelligence among the rank and file of shareholders that permits this immunity to extend to the entire realm of market quotations, including the permanent establishment of a depreciated and unsatisfactory price level.
• Good managements produce a good average market price, and bad managements produce bad market prices.

Ref: Intelligent Investor by Benjamin Graham

Business Valuations versus Stock-Market Valuations: The True Investor

1. The true investor is in a special position when he owns a listed common stock.
2. He can take advantage of the daily market price or leave it alone, as dictated by his own judgement and inclination.
3. He must take cognizance of important price movements, for otherwise his judgment will have nothing to work on.
4. Conceivably they may give him a warning signal which he will do well to heed - this in plain English means that he is to sell his shares because the prices has gone down, foreboding worse things to come.
5. In our view such signals are misleading at least as often as they are helpful.
6. Basically, price fluctuations have only one significant meaning for the true investor.
7. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.
8. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

Ref: Intelligent Investor by Benjamin Graham

Business Valuations versus Stock-Market Valuations: Critics of the value approach to stock investment

1. Critics of the value approach to stock investment argue that listed common stocks cannot properly be regarded or appraised in the same way as an interest in a similar private enterprise, because the presence of an organized security market "injects into equity ownership the new and extremely improtant attribute of liquidity."
2. But what this liquidity really means is, first, that the investor has the benefit of the stock market's daily and changing appraisal of his holdings, for whatever that appraisal may be worth, and second, that the investor is able to increase or decrease his investment at the market's daily figure - if he chooses.
3. Thus the existence of a quoted market gives the investor certain options that he does not have if his security is unquoted.
4. But it does not impose the current quotation on an investor who prefers to take his idea of value from some other source.

In these 113 words Graham sums up his lifetime of experience

1. Let us return to our comparison between the holder of marketable shares and the man with an interest in a private business.
2. We have said that the former has the option of considering himself merely as the part owner of the various businesses he has invested in, or as the holder of shares which are salable at any time he wishes at their quoted market price.
3. But note this important fact: The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement.
4. (This may well be the single most important paragraph in Graham's entire book. In these 113 words Graham sums up his lifetime of experience. You cannot read these words too often; they are like Kryptonite for bear markets. If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.)
5. Incidentally, a widespread situation of this kind actually existed during the dark depression days of 1931-1933. There was then a psychological advantage in owning business interests that had no quoted market.
6. For example, people who owned first mortgages on real estate that continued to pay interest were able to tell themselves that their invesmtents had kept their full value, there being no market quotations to indicate otherwise.
7. On the other hand, many listed corporation bonds of even better quality and greater underlying strength suffered severe shrinkages in their market quotations, thus making their owners believe they were growing distinctly poorer.
8. In reality, the owners were better off with the listed securities, despite the low prices of these.
9. For if they had wanted to, or were compelled to, they could at least have sold the issues - possibly to exchange them for even better bargains.
10. Or they could just as logically have ignored the market's action as temporary and basically meaningless.
11. But it is self-deception to tell yourself that you have suffered no shrinkage in value merely because your securities have no quoted market at all.

A&P was the largest retail enterprise in America, if not in the world, with a continuous and impressive record of large earnings for many years. Yet in 1938 this outstanding business was considered on Wall Street to be worth less than its current assets alone - which means less as a going concern than if it were liquidated.

1. Returning to our A&P shareholder in 1938, we assert that as long as he held on to his shares he suffered no loss in their price decline, beyond what his own judgment may have told him was occasioned by a shrinkage in their underlying or intrinsic value.
2. If no such shrinkage had occurred, he had a right to expect that in due course the market quotation would return to the 1937 level or better - as in fact it did the following year.
3. In this respect his position was at least as good as if he had owned an interest in a private business with no quoted market for its shares.
4. For in that case, too, he might or might not have been justified in mentally lopping off part of the cost of his holdings because of the impact of the 1938 recession - depending on what had happened to his company.

Ref: Intelligent Investor by Benjamin Graham

* "Only to the extent that it suits his books" means "only to the extent that the price is favourable enough to justify selling the stock."

Business Valuations versus Stock-Market Valuations: The A & P Example

The A. & P. Example.

This was one of Graham's original examples, which dates back many years but which has a certain fascination because it combines so many aspects of corporate and investment experience. Here is the story:

1. It involves the Great Atlantic and Pacific Tea Co.
2. A&P shares were introduced to trading on the "Curb" market, now American Stock Exchange, in 1929 and sold as high as 494.
3. By 1932 they had declined to 104, although the company's earnings were nearly as large in that generally catastrophic year as previously.
4. In 1936 the range was between 111 and 131.
5. Then in the business recession and bear market of 1938 the shares fell to a new low of 36.
6. That price was extraordinary. It meant that the preferred and common were together selling for $126 million, although the company had just reported that it held $85 million in cash alone and a working capital (or net current assets) of $134 million.
7. A&P was the largest retail enterprise in America, if not in the world, with a continuous and impressive record of large earnings for many years.
8. Yet in 1938 this outstanding business was considered on Wall Street to be worth less than its current assets alone - which means less as a going concern than if it were liquidated.
9. Why? First, because there were threats of special taxes on chain stores; second, because net profits had fallen off in the previous year; and third, because the general market was depressed.
10. The first of these reasons was an exaggerated and eventually groundless fear; the other two were typical of temporary influences.
11. Let us assume that the investor had bought A&P common in 1937 at, say, 12 times its five-year average earnings, or about 80.
12. We are far from asserting that the ensuing decline to 36 was of no importance to him.
13. He would have been well advised to scrutinize the picture with some care, to see whether he had made any miscalculations.
14. But if the results of his study were reassuring - as they should have been - he was entitled then to disregard the market decline as a temporary vagary of finance, unless he had the funds and the courage to take advantage of it by buying more on the bargain basis offered.

Sequel and Reflections

1. The following year, 1939, A&P shares advanced to 117 1/2, or three times the low price of 1938 and well above the average of 1937.
2. Such a turnabout in the behaviour of common stocks is by no means uncommon, but in the case of A&P it was more striking than most.
3. In the years after 1949 the grocery chain's shares rose with the general market until in 1961 the split-up stock (10 for 1) reached a high of 70 1/2 which was equivalent to 705 for the 1938 shares.
4. This price of 70 1/2 was remarkable for the fact it was 30 times the earnings of 1961.
5. Such a price/earnings ratio - which compares with 23 times for the DJIA in that year - must have implied expectations of a brilliant growth in earnings.
6. This optimism had no justification in the company's earnings record in the preceding years, and it proved completely wrong.
7. Instead of advancing rapidly, the course of earnings in the ensuing period was generally downward.
8. The year after the 70 1/2 high the price fell by more than half to 34. But this time the shares did not have the bargain quality that they showed at the low quotation in 1938.
9. After varying sorts of fluctuations the price fell to another low of 21 1/2 in 1970 and 18 in 1972 - having reported the first quarterly deficit in its history.

We see in this history how wide can be the vicissitudes of a major American enterprise in little more than a single generation, and also with what miscalculations and excesses of optimism and pessimism the public has valued its shares.

1. In 1938 the busines was really being given away, with no takers; in 1961 the public was clamoring fo the shares at a ridiculously high price.
2. After that came a quick loss of half the market value, and some years later a substantial further decline.
3. In the meantime the company was to turn from an outstanding to a mediocre earnings performer; its profit in the boom-year 1968 was to be less than in 1958; it had paid a series of confusing small stock dividdends not warranted by the current additions to surplus; and so forth.
4. A&P was a larger company in 1961 and 1972 than in 1938, but not as well-run, not as profitable, and not as attractive.

There are two chief morals to this story.

1. The first is that the stock market often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors.
   
2. The other is that most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies' performance like a hawk; but he should give it a good, hard look from time to time.

Ref: Intelligent Investor by Benjamin Graham

The more recent history of A&P is no different. At year-end 1999, its share price was $27.875; at year -end 2000, $700; a year later, $23.78; at year-end 2002, $8.06. Although some accounting irregulariteis later came to light at A&P, it defies all logic to believe that the value of a relatively stable business like groceries could fall by three-fourths in one year, triple the next year, then drop by two-thirds the year after that.

Business Valuations versus Stock-Market Valuations

1. The impact of market fluctuations upon the investor's true situation may be considered also from the standpoint of the shareholder as the part owner of various businesses.
2. The holder of marketable shares actually has a double status, and with it the privilege of taking advantage of either at his choice.
3. On the one hand his position is analogous to that of a minority shareholder or silent partner in a private business. Here his results are entirely dependent on the profits of the enterprise or on a change in the underlying value of its assets. He would usually determine the value of such a private-business interest by calculating his share of the net worth as shown in the most recent balance sheet.
4. On the other hand, the common-stock investor holds a piece of paper, an engraved stock certificate, which can be sold in a matter of minutes at a price which varies from moment to moment - when the market is open, that is - and often is far removed from the balance sheet value.
5. The development of the stock market in recent decades has made the typical investor more dependent on the course of price quotations and less free than formerly to consider himself merely a business owner.
6. The reason is that the successful enterprises in which he is likely to concentrate his holdings sell almost constantly at prices well above their net asset value (or book value, or "balance-sheet value").
7. In paying these market premiums the investor gives precious hostages to fortune, for he must depend on the stock market itself to validate his commitments.
8. This is a factor of prime importance in present-day investing and it has received less attention tha it deserves.
9. The whole structure of stock-market quotations contains a built-in contradiction. The better a company's record and prospects, the less relationship the price of its shares will have to their book value.
10. But the greater the premium above book value, the less certain the basis of determining its intrinsic value - i.e., the more this "value" will depend on the changing moods and measurements of the stock market.
11. Thus, we reach the final paradox, that the more successful the companyl, the greater are likely to be the fluctuations in the price of its shares.
12. This really means that, in a very real sense, the better the quality of a common stock, the more speculative it is likely to be - at least as compared with the unspectacular middle-grade issues.
13. (What we have said applies to a comparison of the leading growth companies with the bulk of well-established concerns; we exclude from our purview here those issues which are highly speculative because the businesses themselves are speculative.)
14. The argument made above should explain the often erratic price behaviour of our most successful and impressive enterprises.
15. Our favourite example is the monarch of them all - International Business Machines. The price of its shares fell from 607 to 300 in seven months in 1962-63; after two splits its price fell from 387 to 219 in 1970.
16. Similarly, Xerox - an even more impressive earnings gainer in recent decades - fell from 171 to 87 in 1962-63, and from 116 to 65 in 1970.
17. These striking losses did not indicate any doubt about the future long-term growth of IBM or Xerox; they reflected instead a lack of confidence in the premium valuation that the stock market itself had placed on these excellent prospects.
18. The previous discussion leads us to a conclusion of practical importance to the conservative investor in common stocks.
19. If he is to pay some special attention to the selection of his portfolio, it might be best for him to concentrate on issues selling at a reasonably close approximation to their tangible-asset value - say, at not more than one-third above that figure.
20. Purchases made at such levels, or lower, may with logic be regarded as related to the company's balance sheet, and as having a justification or support independent of the fluctuating market prices.
21. The premium over book value that may be involved can be considered as a kind of extra fee paid for the advantage of stock-exchange listing and the marketability that goes with it.
22. A caution is needed here. A stock does not become a sound investment merely because it can be bought at close to its asset value. The investor should demand, in addition, (1) a sastisfactory ratio of earnings to price, (2) a sufficiently strong financial position, and (3) the prospect that its earnings will at least be maintained over the years.
23. This may appear like demanding a lot from a modestly priced stock, but the prescription is not hard to fill under all but dangerously high market conditions.
24. Once the investor is willing to forgo brilliant prospects - i.e., better than average expected growth - he will have no difficulty in finding a wide selection of issues meeting these criteria.
25. More than half of the DJIA issues met our asset-value criterion at the end of 1970. The most widely held investment of all - American Tel. & Tel. - actually sells below its tangible-asset value as we write. Most of the light-and-power shares, in addition to their other advantages, are now (early 1972) available at prices reasonably close to their asset values.
26. The investor with a stock portfolio having such book values behind it can take a much more independent and detached view of stock-market fluctuations than those who have paid high mutlpliers of both earnings and tangible assets.
27. As long as the earning power of his holdings remains satisfactory, he can give as little attention as he pleases to the vagaries of the stock market.
28. More than that, at times he can use these vagaries to play the master game of buying low and selling high.

Ref: Intelligent Investor by Benjamin Graham

Net asset value, book value, balance-sheet value, and tangible-asset value are all synonyms for net worth, or the total value of a company's physical and financial assets minus all its liabilities. It can be calculated using the balance sheets in a company's annual and quarterly reports; from total shareholders' equity, subtract all "soft" assets such as goodwill, trademarks, and other intangibles. Divide by the fully diluted number of shares outstanding to arrive at book value per share.

Graham's use of the world "paradox" is probably an allusion to a classic article by David Durand, "Growth Stocks and the Petersburg Paradox," which 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 inestor 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.

NTPM

28.7.09

FY ended 30.4.2009

No of ordinary shares: 1,123,200
Recent Price per share: 52c
Market cap: 584.06m
Earnings: 46.305m
Dividend: 38.413m
DPO: 83%

diluted EPS: 4.1c
DPS: 3.4c
NTA: 18c
PE = 12.7
DY = 6.58%
P/B = 2.9x

Historical PE range: (last 5 years) 7.3 - 9.9
Historical DY range: (last 5 years) 8.6% - 6.4%

Cash flow:
CFO: 58m
CFI: 24m
FCF: 34m

PBT/Revenue: 58.7 / 358.6 = 16.4%

STL: 36.4m
LTL: 8.4m
Equity: 203.9m
D/E: 0.22


Over the course of 5 years, the eps of NTPM grew from 2.5 sen (in 2004) to 4.1 sen (in 2009), its compound annual growth rate is 10.40%. (I usually like to study stocks giving an eps growth rate of > 15% per year.)

PEG = PE/EPS GR = 12.7/10.4 = 1.22


Quality and Management indicators are good. A good stock to look further into.

How to value this stock?

It is presently trading higher than its historical PE. Also, its DY has been at the lower end of its historical DY. From the above graph, you can visualise that the rate of growth of its share price has outpaced the rate of growth of its earnings.

Keep this company on your radar screen. Be patient.

Market Fluctuations of the Investor's Portfolio

1. Every investor who owns common stocks must expect to see them fluctuate in value over the years.
2. The behaviour of the DJIA since our last edition of Intelligent Investor was written in 1964 probably reflects pretty well what has happened to the stock portfolio of a conservative investor who limited his stock holdings to those of large, prominent, and conservatively financed corporations.
3. The overall value advanced from an average level of about 890 to a high of 995 in 1966 (and 985 again in 1968), fell to 631 in 1970, and made an almost full recovery to 940 in early 1971.
4. (Since the individual issues set their high and low marks at different times, the fluctuations in the Dow Jones group as a whole are less severe than those in the separate components.)
5. We have traced through the price fluctuations of other types of diversified and conservative common-stock portfolios and we find that the overall results are not likely to be markedly different from the above.
6. In general, the shares of second-line companies fluctuate more widely than the major ones, but this does not necessarily mean that a group of well-established but smaller companies will make a poorer showing over a fairly long period.
7. (Today's equivalent of what Graham calls "second-line companies" would be any of the thousands of stocks not included in the Standard & Poor's 500-stock index. A regularly revisited list of the 500 stocks in the S & P index is available at http://www.standardandpoors.com/. )
8. In any case, the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years.
9. (Note carefully what Graham is saying here. It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% from their highest price - regardless of which stocks you own or whether the market as a whole goes up or down. If you can't live with that - or you think your portfolio is somehow magically exempt from it - then you are not yet entitled to call yourself an investor.)
10. (Graham refers to a 33% decline as the "equivalent one-third" because a 50% gain takes a $10 stock to $15. From $15, a 33% loss [or $5 drop] takes it right back to $10, where it started.)
11. A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer.
12. But what about the longer-term and wider changes? Here practical questions present themselves, and the psychological problems are likely to grow complicated.
13. A substantial rise in the marke is at once a legitimate reason for satisfaction and a cause for prudent concern, but it may also bring a strong temptation toward imprudent action.
14. Your shares have advanced, good! You are richer than you were, good! (1) But has the price risen too high, and should you think of selling? (2) Or should you kick yourself for not having bought more shares when the level was lower? (3) Or - worst thought of all - should you now give way to the bull-market atmosphere, become infected with the enthusiasm, the overconfidence and the greed of the great public (of which, after all, you are a part), and make larger and dangerous commitments?
15. Presented thus in print, the answer to the last question is a self-evident no, but even the intelligent investor is likely to need considerable will power to keep from following the crowd.
16. It is for these reasons of human nature, even more than by calculation of financial gain or loss, that we favour some kind of mechanical method for varying the proportion of bonds to stocks in the investor's portfolio.
17. The chief advantage, perhaps, is that such a formula will give him something to do.
18. As the market advances he will from time to time make sales out of his stockholdings, putting the proceeds into bonds; as it declines he will reverse the procedure. These activities will provide some outlet for his otherwise too-pent-up energies.
19. If he is the right kind of investor he will take added satisfaction from the thought that his operations are exactly opposite from those of the crowd.
20. (For today's investor, the ideal strategy for pursuing this "formula" is rebalancing.)

Ref: Intelligent Investor by Benjamin Graham

Formula Investment Plans

1. In the early years of the stock market rise that began in 1949-50 considerable interest was attracted to various methods of taking advantage of the stock market's cycles.
2. These have been known as "formula investment plans."
3. The essence of all such plans - except the simple case of dollar averaging - is that the investor automatically does some selling of common stocks when the market advances substantially.
4. In many of them a very large rise int he market level would result in the sale of all common-stock holdings; others provided for retention of a minor proportion of equities under all circumstances.
5. This approach had the double appeal of sounding logical (and conservative) and of showing excellent results when applied RETROSPECTIVELY to the stock market over many years in the past.
6. Unfortunately, its vogue grew greatest at the very time when it was destined to work least well.
7. Many of the "formula planners" found themselves entirely or nearly out of the stock market at some level in the middle 1950s. True, they had realized excellent profits, but in a broad sense the market "ran away" from them thereafter, and their formulas gave them little opportunity to buy back a common stock position.
8. (Many of these "formula planners" would have sold all their stocks at the end of 1954, after the US stock market rose 52.6%, the second-highest yearly return then on record. Over the next five years, these market-timers would likely have stood on the sidelines as stocks doubled.)
9. There is a similarity between the experience of those adopting the formula-investing approach in the early 1950s and those who embraced the purely mechanical version of the Dow theory some 20 years earlier.
10. In both cases the advent of popularity marked almost the exact moment when the system ceased to work well.
11. We have had a like discomfiting experience with our own "central value method" of determining indicated buying and selling levels of the Dow Jones Industrial Average. (Note that, in referring to his "discomfiting experience," Graham is - as always - honest in admitting his own failures.)
12. The moral seems to be that any approach to moneymaking in the stock market which can be easily described and followed by a lot of people is by its terms too simple and too easy to last.
13. (Easy ways to make money in the stock market fade for two reasons: (1) the natural tendency of trends to reverse over time, or "regress to the mean," and (2) the rapid adoption of the stock-picking scheme by large numbers of people, who pile in and spoil all the fun of those who got there first.)
14. Spinoza's concluding remark applies to Wall Street as well as to philosophy: "All things excellent are as difficult as they are rare."

Ref: Intelligent Investor by Benjamin Graham

Buy-Low-Sell-High Approach

1. We are convinced that the average investor cannot deal successfully with price movements by endeavoring to forecast them.
2. Can he benefit from them after they have taken place - i.e., by buying after each major decline and selliing out after each major advance?
3. The fluctuations of the market over a period of many years prior to 1950 lent considerable encouragement to that idea.
4. In fact, a classic definition of a "shrewd investor" was "one who bought in a bear market when everyone else was selling, and sold out in a bull market when everyone else was buying."
5. This viewpoint appeared valid until fairly recent years.
6. Between 1897 and 1949 there were ten complete market cycles, running from bear-market low to bull-market high and back to bear-market low.
7. Six of these took no longer than four years, four ran for six or seven years, and one - the famous "new-era" cycle of 1921-1932 - lasted eleven years.
8. The percentage of advance from the lows to highs ranged from 44% to 500%, with most between about 50% and 100%.
9. The percentage of subsequent declines ranged from 24% to 89%, with most found between 40% and 50%. (It should be remembered that a decline of 50% fully offsets a preceding advance of 100%.)
10. Nearly all the bull markets had a number of well-defined characteristics in common, such as:(1) a historically high price level,(2) high price/earnings ratio,(3) low dividend yields as against bond yields,(4) much speculation on margin, and(5) many offerings of new common-stock issues of poor quality.
11. Thus to the student of stock-market history it appeared that the intelligent investor should have been able to identify the recurrent bear and bull markets, to buy in the former and sell in the latter, and to do so for the most part at reasonably short intervals of time.
12. Various methods were developed for determining buying and selling levels of the general market, based on either value factors or percentage movements of prices or both.
13. But we must point out that even prior to the unprecedented bull market that began in 1949, there were sufficient variations in the successive market cycles to complicate and sometimes frustrate the desirable process of buying low and selling high.
14. The most notable of these departures, of course, was the great bull market of the late 1920s, which threw all calculations badly out of gear.
15. Even in 1949, therefore, it was by no means a certainty that the investor could base his financial policies and procedures mainly on the endeavor to buy at low levels in bear markets and to sell at high levels in bull markets.
16. It turned out, in the sequel, that the opposite was true.
17. The market's behaviour in the past 20 years has not followed the former pattern, nor obeyed what once were well-established danger signals, nor permitted its successful exploitation by applying old rules for buying low and selling high.
18. Whether the old, fairly regular bull-and-bear-market pattern will eventually return we do not know.
19. But it seems unrealistic to us for the investor to endeavour to base his present policy on the classic formula - i.e., to wait for demonstrable bear-market levels before buying any common stocks.
20. Our recommended policy has, however, made provision for changes in the proportion of common stocks to bonds in the portfolio, if the investor chooses to do so, according as the level of stock prices appears less or more attractive by value standards.
21. (This policy, now called "tactical asset allocation," is widely followed by institutional investors like pension funds and university endowments.)

Ref: Intelligent Investor by Benjamin Graham

All those who forget are doomed to be reminded

1. Without bear markets to take stock prices back down, anyone waiting to "buy low" will feel completely left behind - and, all too often, will end up abandoning any former caution and jumping in with both feet.
2. That's why Graham's message about the importance of emotional discipline is so important.
3. From October 1990 through January 2000, the Dow Jones Industrial Average marched relentlessly upward, never losing more than 20% and suffering a loss of 10% or more only three times. The total gain (not counting dividends): 395.7%.
4. According to Crandall, Pierce & Co., this was the second-longest uninterrupted bull market of the past century; only the 1949-1961 boom lasted longer.
5. The longer a bull market lasts, the more severely investors will be afflicted with amnesia; after five years or so, many people no longer believe that bear markets are even possible.
6. All those who forget are doomed to be reminded; and, in the stock market, recovered memories are always unpleasant.
   
   

Ref: Intelligent Investor by Benjamin Graham

The famous Dow theory for timing purchases and sales

1. The famous Dow theory for timing purchases and sales has had an unusual history.
2. Briefly, this technique takes its signal to buy from a special kind of "breakthrough" of the stock averages on the upside, and its selling signal from a similar breakthrough on the downside.
3. The calculated - not necessarily actual - results of using this method showed an almost unbroken series of profits in operations from 1897 to the early 1960s.
4. On the basis of this presentation the practical value of the Dow theory would have appeared firmly established; the doubt, if any, would apply to the dependability of this published "record" as a picture of what a Dow theorist would actually have done in the market.
5. A closer study of the figures indicates that the quality of the result shown by the Dow theory changed radically after 1938 - a few years after the theory had begun to be taken seriously on Wall Street.
6. Its spectacular achievement had been in giving a sell signal, at 306, about a month before the 1929 crash and in keeping its followers out of the long bear market until things had pretty well righted themselves, at 84, in 1933.
7. But from 1938 on the Dow theory operated mainly by taking its practitioners out at a pretty good price but then putting them back in again at a higher price. For nearly 30 years thereafter, one would have done appreciably better by just buying and holding the DJIA.
8. In our view, based on much study of this problem, the change in the Dow-theory results is not accidental. It demonstrates an inherent characteristic of forecasting and trading formulas in the fields of business and finance.
9. Those formulas that gain adherents and importance do so because they have worked well over a period, or sometimes merely because they have been plausibly adapted to the statistical record of the past.
10. But as their acceptance increase, their reliability tends to diminsh.
11. This happens for two reasons: First, the passage of time brings new conditions which the old formula no longer fits.
12. Second, in stock-market affairs the popularity of a trading theory has itself an influence on the market's behaviour which detracts in the long run from its profit-making possibilities.
13. (The popularity of something like the Dow theory may seem to create its own vindication, since it would make the market advance or decline by the very action of its followers when a buying or selling signal is given. A "stampede" of this kind is, of course, much more of a danger than an advantage to the public trader.)

Ref: Intelligent Investor by Benjamin Graham

Timing is of no real value to the investor unless it coincides with pricing

1. There is one aspect of the "timing" philosophy which seems to have escaped everyone's notice.
2. Timing is of great psychological importance to the speculator because he wants to make his profit in a hurry. The idea of waiting a year before his stock moves up is repugnant to him.
3. But a waiting period, as such, is of no consequence to the investor.
4. What advantage is there to him in having his money uninvested until he receives some (presumably) trustworthy signal that the time has come to buy?
5. He enjoys an advantage only if by waiting he succeeds in buying later at a sufficiently lower price to offset his loss of dividend income.
6. What this means is that timing is of no real value to the investor unless it coincides with pricing - that is, unless it enables him to repurchase his shares at substantially under his previous selling price.

Ref: Intelligent Investor by Benjamin Graham

Comment:

For the investor who sold at the high of the market, "timing" is of no real value, unless it enables him to repurchase his shares in the future at substantially lower than his previous selling price.

Many good quality stocks, badly sold down during the recent severe bear market, have risen above their previous highs.

Those who sold good quality stocks in the recent severe bear market would not have benefited unless they have also bought these shares back at substantially lower prices during the depth of the bear market.

Pros and Cons of Market Forecasting

1. A great deal of brain power goes into this field, and undoubtedly some people can make money by being good stock-market analysts.

2. But it is absurd to think that the general public can ever make money out of market forecasts.

3. For who will buy when the general public, at a given signal, rushes to sell out at a profit?

4. If you, the reader, expect to get rich over the years by following some system or leadership in market forecasting, you must be expecting to try to do what countless others are aiming at, and to be able to do it better than your numerous competitors in the market.

5. There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he is himself a part.

The forecasts of "market strategists" became more influential but not more accurate

1. In the late 1990s, the forecasts of "market strategists" became more influential than even before. They did not, unfortunately, become more accurate.

2. On March 10, 2000, the very day that the NASDAQ composite index hit its all-time high of 5048.62, Prudential Securities's chief technical analyst Ralph Acampora said in USA Today that he expected NASDAQ to hit 6000 within 12 to 18 months.

3. Five weeks later, NASDAQ had already shriveled to 3321.29 - but Thomas Galvin, a market strategist at Donaldson, Lufkin & Jenrette, declared that "there's only 200 or 300 points of downside for the NASDAQ and 2000 on the upside." It turned out that there were no points on the upside and more than 2000 on the downside, as NASDAQ kept crashing until it finally scraped bottom on Octorber 9, 2002, at 1114.11.

4. In March 2001, Abby Joseph Cohen, chief investment strategist at Goldman, Sachs & Co., predicted that the Standard & Poor's 500-stock index would close the year at 1,650 and that the Dow Jones Industrial Average would finish 2001 at 13,000. "We do not expect a recession," said Cohen, "and believe that corporate profits are likely to grow at close to trend growth rates later this year." The US economy was sinking into recession even as she spoke, and the S & P 500 ended 2001 at 1148.08, while the Dow finished at 10,021.50 - 30% and 23% below her forecasts, respectively.

Comment: We cannot predict with certainty what the future will bring, but we can take some comfort that in the long run, it will be alright.

Market Fluctuations as a Guide to Investment Decisions

1. Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings.

2. There are two possible ways by which he may try to do this:

• the way of timing and
• the way of pricing.

3. By timing we mean the endeavor to anticipate the action of the stock market – to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downwards.

4. By pricing, we mean the endeavour to buy stocks when they are quoted below their fair value and to sell them when they rise above such value.

5. A less ambitious form of pricing is the simple effort to make sure that when you buy you do not pay too much for your stocks. This may suffice for the defensive investor, whose emphasis is on long-pull holding; but as such it represents an essential minimum of attention to market levels.

6. We are convinced that the intelligent investor can derive satisfactory results from pricing of either type.

7. We are equally sure that if he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator’s financial results. This distinction may seem rather tenuous to the layman, and it is not commonly accepted on Wall Street.

8. As a matter of business practice, or perhaps of thoroughgoing conviction, the stock brokers and the investment services seem wedded to the principle that both investors and speculators in common stocks should devote careful attention to market forecasts.

9. The farther one gets from Wall Street, the more skepticism one will find, we believe, as to the pretensions of stock-market forecasting or timing.

10. The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking. Yet in many cases he pays attention to them and even acts upon them.

11. Why? Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market and because he feels that the brokerage or service forecast is at least more dependable than his own.

Ref: Intelligent Investor by Benjamin Graham

Price Changes in Common Stocks

This is an important subject.

Through historical survey of the stock market's action over the past many years, we hope to learn what the past record promises the investor - in either:

• the form of long-term appreciation of a portfolio held relatively unchanged through successive rises and declines, or,
• in the possibilities of buying near bear-market lows and selling not too far below bull-market highs.

The Investor and Market Fluctuations

The investors in these assets need not take market fluctuations into account.

1. To the extent that the investor’s funds placed in high-grade bonds of relatively short maturity – say, of seven years or less – will not be affected significantly by changes in market prices, and need not take them into account.
2. This applies also to his holdings of US savings bonds, which he can always turn in at his cost price or more.

The investors in these assets need to take market fluctuations into account.

1. His longer-term bonds may have relatively wide price swings during their lifetimes, and
2. his common-stock portfolio is almost certain to fluctuate in value over any period of several years.
3. The investor should know about these possibilities and should be prepared for them both financially and psychologically.
4. He will want to benefit from changes in market levels –

• certainly through an advance in the value of his stock holdings as time goes on, and
• perhaps also by making purchases and sales at advantageous prices.
• This interest on his part is inevitable, and legitimate enough. But it involves the very real danger that it will lead him into speculative attitudes and activities.
• It is easy for us to tell you not to speculate; the hard thing will be for you to follow this advice.

Let us repeat what we said at the outset: If you want to speculate do so with your eyes open, knowing that you will probably lose money in the end; be sure to limit the amount at risk and to separate it completely from your investment program.

Ref: Intelligent Investor by Benjamin Graham

Growing with growth stocks

Growing with growth stocks

Tags: Ang Kok Heng

Written by Ang Kok Heng
Monday, 27 July 2009 00:26

AXIATA Group Bhd, formerly TM International Bhd (6888), will cap capital expenditure (capex) at RM4.4 billion this year, in a move to cut costs amid a slowdown in the region's economies. "There are a few things we are doing given the economic situation — we are reducing capex from RM5.4 billion to RM4.4 billion, re-looking all operating costs and benchmarking ourselves to know where we stand," Axiata president and managing director Datuk Seri Jamaludin Ibrahim said.

Malaysia's third-placed mobile operator DiGi Telecommunications is planning to spend more than RM1.1 billion (US$318.9 million) in 2009, Reuters reports.

PPB GROUP BHD [] is planning to spend RM293 million on capex this year, its chairman Datuk Oh Siew Nam said. He said the group's flour-making subsidiary FFM Bhd, has been allocated RM173 million to build new flour mills in Kota Kinabalu, Sabah, and Jakarta, Indonesia.

Food-based QL RESOURCES BHD [] has earmarked RM280 million as capex for its current fiscal year and the next, deemed pivotal to spur its regional merger and acquisition (M&A) plans, and to improve its manufacturing facilities. Some RM130 million and RM150 million are allocated for the financial years (FY) ending March 2010 and 2011, respectively.

TA ANN HOLDINGS BHD [] plans to spend up to RM189 million in 2009, with most of the money going into oil palm PLANTATION []s, group managing director and chief executive officer Datuk Wong Kuo Hea said

TOMEI CONSOLIDATED BHD [] has budgeted about RM10 million for capex this year in a bid to expand amid the economic slowdown, the jeweller's group managing director Ng Yih Pyng said. "The amount allocated will be used mainly for our outlet expansion and also to improve our information TECHNOLOGY [] (IT) system," he told StarBiz in an interview.

Top Glove Corp Bhd chairman Tan Sri Dr Lim Wee-Chai said the group had allocated some RM80 million for capex, which would include organic expansion and potential acquisitions. TENAGA NASIONAL BHD []'s capex this year amounted to RM3.75 billion to RM4 billion, lower than RM4.5 billion previously. UMW HOLDINGS BHD [] plans some RM600 million in capex this year to beef up its oil and gas (O&G) business, according to managing director and chief executive officer Datuk Dr Abdul Halim Harun.

The capex planned by companies is mainly for future expansion. It is this capex that generates business and hence earnings growth for a company. Earnings growth is the main attraction in equity investment.

Stock grows
One of the main duties of the management is to grow the company. When a company is operating at full capacity, additional capex is needed to grow the earnings. The funds for capex could be internally generated or from borrowed capital. This type of reinvestment is the yearly expansion budget of a company. Every incremental investment will provide additional return which will add to the existing profit of a company.

Some companies may be faced with diminishing return which occurs when profitability falls over time either because of more competition or less lucrative investment return. So long as the return on investment (ROI) is higher than the bank's interest rates, there is value added from the expansion plan.

But the ROI of most investments is expected to be much higher than the bank's interest rates since every investment comes with a certain amount of risk. When ROI is substantially higher than borrowing rates, it will make sense to borrow to enhance business returns. Every capex may be viewed individually from the ROI point of view such that the return must be worth the effort and risk taken. In many cases, the return may not be immediate and some may even suffer losses for the initial few years before profit starts to flow in.


Growth stocks pay less dividends
Because of the need to grow, growth stocks normally pay less on dividends so that a larger portion of the profit is retained for future expansion. The amount of dividend paid to shareholders as a percentage of the profit is known as dividend payout ratio. The dividend payout of a growth stock could be less than 50% while some may be as low as 20%.

Generally, a stock with low dividend payout and low dividend yield is expected to have higher earnings growth. On the other hand, a stock with high dividend payout and thus high dividend yield has lower earnings growth. In this way, growth stocks tend to have higher price appreciation than high-dividend yield stocks.

It is not uncommon to come across management's explanation to its shareholders on the reasons for keeping some of the profit for future expansion. As every company has its own expansion plans, the company usually conserves some cash for future use and pay the balance to shareholders. In this way, there is no need to raise money from shareholders via rights issues for expansion purposes.

In certain cases, although the company may post profit, it may not have sufficient free cashflow to pay dividend, as the profit is just an "accounting profit". In this case, the "profit" is tied up in inventories or receivables and hence it cannot be paid to shareholders. A good company is one which can pay relatively high dividends and yet able to continue to provide reasonable growth.

More capex, higher growth
There are also many listed companies which did not pay high dividends and yet their earnings growth was mediocre. If the capex is not well spent, the earnings growth may not be forth coming. Although failed projects may not be entirely the fault of the management, a good manager should also avoid or minimise such losses.

More importantly bad investment should not be repeated. Unfortunately, it is not uncommon to see several companies listed on Bursa Malaysia which did not seem to get any of their investment strategies right year after year. The poor ROE (return on equity or shareholders' fund) in the past and non-improvement in ROE over the years prove the failures of the management to deliver basic economic profit to shareholders.

At the beginning of this article, several companies disclosed their capex requirements for the year. For a growth stock, the capex is likely to be higher relatively to its size. For the selected companies, we have listed them in Table 1. We have divided the capex by market capitalisation (a measure of value of a company) and also by fixed assets. Although these ratios may not be conclusive to determine which stock is a better growth stock, they provide some ideas on the expansion plans.



It should be noted that the low capex of a company in a particular year may not necessarily denote lower earnings growth going forward. It could be due to the adequate capacity for the time being or less need to expand due to the prevailing market conditions. Some companies may not be capital intensive and hence less need to spend as much.

Expansion path
Listed companies have many options to grow. They can grow organically through natural expansion or by way of acquisition. The growth can be financed by internally generated funds, borrowing or a combination of both. They may also issue new shares to acquire the target company or call for rights issues to finance the expansion (see Chart 1).



It is not uncommon for a company to move downstream by adding value to what it produces, for example, to process its products further. It can also go upstream to procure its own raw materials so as to be in a better position to control its supplies. A company facing limited growth in its existing business may also venture into new businesses to remain relevant. This type of diversification can also be useful to stabilise the cyclical business nature of a company.

Capital gain can be volatile
From an investor's perspective, the ROI is the dividend income received regularly and the capital gain from price appreciation.

For a high-dividend stock, the dividend yield is similar to assured return received, say 4% per annum. The capital gain, normally smaller for a high- dividend stock, is like a bonus on top of the dividend.

For growth stock, the dividend yield is smaller (see Chart 2) and capital gain is what an investor mainly aims for. Unfortunately, capital gain can be very volatile, since the share price could be influenced by market sentiment. Furthermore, as the business risk of a high-growth company is normally higher, the expected price appreciation will depend on the results of the expansion plan. Most investments provide both income and capital gain. Examples are unit trusts, bonds, PROPERTIES [] and foreign currencies.



There are also several investments which do not provide income. These are merely trading instruments. They include commodity trading, gold and similar types of commodity which bet purely on the price appreciation. Investors who "invest" in gold thinking that this is a good investment, must bear in mind that gold does not provide income, it only provides capital gain (or speculative gain). A kilogramme of gold remains a kilo after several years. A growth stock (provided it is a true growth stock and not speculative stock), on the other hand, will grow over time and will not be the same after several years.

Fixed-income instruments don't grow
Most investment grade stocks provide some growth. Even a low-growth high-dividend yield stock may have small growth. If the growth is only 2% per year, the dividend received is also likely to grow by 2% per annum. In this example, assuming the dividend yield is 4% per annum, a 2% growth in dividend will mean that after five years, the dividend yield will increase to 4.4%. As such, growth does make a difference in the return.

In the case of fixed-income instruments such as fixed deposits (FD) with the bank, the FD rate is fixed during the period of placement. If a one-year FD yields 3%, it is 3%. If the interest rate remains the same, the same FD will continue to give 3% return the following year.

While interest rate may go up one year later after the FD matures, it may possibly go down as well. There is no growth factor in FD placement. Some may argue that the growth in savings from interest rate is compounding. The compounding effect by reinvesting the interest earned is similar to the compounding effect achieved by reinvesting the dividend earned in the case of investing in a high-yield stock which may still provide some growth.

Some stocks don't grow
While investing in FD is a constant yield investment, there are also many stocks which don't grow over time. Unfortunately, the earnings of many stocks listed on Bursa Malaysia are very sluggish and they don't seem to increase even after ten years. It is a disappointing fact. These companies remain more or less the same after one or two rounds of the economic cycle. They seem to struggle with the same business year in year out.

Investing in non-growth stocks is like investing in FD with the same yield. The only difference is that non-growth stocks usually do not provide high dividend as they are not well-managed and hence their operating cashflow may not be stable. The lack of confidence to generate sufficient and consistent cashflow prevents these companies from paying higher dividend.

Some stocks degrade like their retiring owners
One of the reasons why some companies degrade and show stagnant earnings is the lost of drive (the oomph!) when the key promoters retire or on the verge of retiring. The lack of successors either among the owners' scion or from other professionals could not propel the companies forward. In some cases, the children who took over the businesses were not as capable as the founders were. As a result, these successors acted merely like a caretaker. Not only were they not able to grow the business, some of them were not even able to defend the companies' market shares.

Investing in non-growth stocks is already bad, investing in negative-growth stocks is even worst.

Investment provides yields and capital gains
In short, investment provides yields and capital gains. Some investments like FD provide pure yields but no growth at all. Some investments like gold and commodities only provide capital gains but not income. Pure capital gain investment is more speculative in nature and is not suitable for the buy-and-hold strategy. Trading strategy is more appropriate for this type of investment and market timing is crucial. Many other investments provide both yield and capital gain.

Yields are like a bird in hand and capital gains are like birds in the bushes. Some capital gains are easier to anticipate, while some capital gains are less predictive.

Ang has 20 years' experience in research and investment. He is currently the chief investment officer of Phillip Capital Management Sdn Bhd.


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