Sunday, May 20, 2007

Misleading and Irresponsible Reporting on Stock Market "gains"

Today's Sunday Times featured an article in the main section (not the "Invest" section) titled 'Stock Boom can mean $100K profit in 4 months'. While scanning through the article, so many glaring omissions and inconsistencies were detected that I felt compelled to blog about it. It seems that whenever I see such articles in the papers talking about so called "huge windfall" in the stock market, I just feel like going on a rant as I feel it is irresponsible and preposterous.

For thos who may not have read the article, the article mentions 3 individuals who have "made money" in the current bull run (STI closed at a new all-time high of 3,512.40 as at last Friday May 18, 2007, not that I actually bother about STI, but just stating it as a point of reference). The first individual is named Mr. B.K. Tan and he is a self-employed 40-year old living in a 3-room HDB flat. Apparently, he has just made himself S$100k within 4 short months from share trading (note this word). The article goes on to say that he has plenty of company in the ranks of Singapore's "stock trading elite". And what may this elite be ? Those who excel in trading stocks which are moving up relentlessly ? Has someone somehow forgotten that in a bull market, even a 10-year old kid can pick a stock in the market and it will go up ? Thus, it would seem this group of elite may have scarificed success for actual critical thinking, considering that stock trading has now been made ever so much simpler with the bull run.

Mr. Tan had bought DBS at $9 back in 2003 and sold out at $24 last week, earning a profit of $15 per share. In addition, he has also made money from SingTel and ComfortDelgro. What was NOT mentioned was his initial capital and his % returns, which I feel is a more important gauge of his success as an investor. For example, if one started out with S$1 million to invest and obtained $100k, it is a 10% return, which is considered average in a bull run. Also, the article blatantly states that he bought DBS in 2003, yet it claims he made $100K "in 4 months". Maybe it should have been "in 4 years" instead ? If so, that would dilute the % gains he has made as it has to be divided by 4 per annum, and further expressed as a %, it may not seem that spectacular at all.

The point I am trying to drive at is this: journalists should go ahead and do their reporting, but this article appears to omit some very important aspects of a person's investing, and seems to glamorize short term quick windfall gains against long-term prudent investing practices. While people may argue that there is nothing wrong with a large gain in a short period of time, this kind of reporting may cause the ignorant and uninitiated to take larger than normal risks, in the mistaken belief that money is so easy to make in the markets. I guess the queues at the Toto and 4-D booths would thin out and everyone would just head on down to open their multiple brokerage accounts to begin trading for a living. Cynical ? Maybe. But it just may be an eventuality if this bull run continues !

The other 2 people featured are a Mr. Goh Tian Hin, 67 with 2 children, who has earned an average of S$20k per month since January (again, the % return and initial capital are not stated). What's more disturbing is the line which says "most of Mr. Goh's profits are re-invested in stocks". With high valuations running rampant and diminishing margins of safety, ploughing all the profits back into the stock market may turn out to be a bad proposition in the long run. This would imply that he had previously purchased with a good margin of safety, then cashed out for a S$20k profit every month, then re-invested that profit all right back into the market. Well, if that's the case, then we can't take the S$20k profit as "realized" can we ? Over the medium-term, if he can manage to consistently grow his earnings by S$20k per month, then we can safely conclude that he has managed to get "newfound riches". Remember that "riches" are fleeting especially when one follows the "greater fool theory", by investing at ever-increasing market prices without a good sense of the "margin of safety" concept.

Finally, the article mentions a 22 year old NTU undergraduate from the faculty of business called Mr. Terence Lim, who started trading (note the word again) in stocks in August 2006 and has since made S$1,500. Onec again (and I am tired of mentioning this), there was no mention of his initial capital or his % return on investment. But if he had really started in August 2006 and only managed to gain S$1,500 considering the super-bull run thus far, then I would say it is very likely that most of his gains were the result of numerous trades which cancelled each other out, leaving a net effect of S$1,500. Frictional costs such as brokerage fees and commissions would have further eaten into his profits, causing a further reduction in profits. Again, the article mentions that he has "re-invested" his money into stocks, another indication that a trading mentality was used, disregarding valuations.

The article seems to inter-change the words "trading" and "investing" as if they were the same thing. What irks me most is that most people do not even distinguish between the 2 terms ! To them, trading and investing are synonymous ! Let me quote exactly what Benjamin Graham said of investing: "It is a process by which thorough analysis will show a safety of principle and offer a satisfactory return, anything else is speculative". Quantitative analysis of numbers, financial results, income statements, balance sheets, ratios and cash flow statements have formed the basis of modern fundamental analysis of companies, and Benjamin Graham was advocating a thorough analysis to minimize losses and to ensure a reasonable rate of return. Thus, by this definition, trading will be considered speculation as it involves guessing the psychology of the crowd and whether they will continue to follow the greater fool theory; while investing is a methodical examination of a company's numbers to ascertain if it has the potential to reap returns to shareholders. Of the 2, I have chosen the latter because it offers safety of principle and a possible better than market return on my investment.

A quick comment on such articles periodically written by ST and BT. The way the words are construed would normally imply that quick gains and riches can be found through short-term trading methods within the stock market. Not many articles have been written detailing the value investing process and how long-term wealth can be achieved through carefu analysis, patience and proper temperament. Most articles, to my chagrin, are heavily skewed towards reporting on short-term results, glorifying quick gains, putting market pundits and punters on a pedestal, and harping on the ease of winning money in a bull market.

One can only observe that the significant increase of such articles in recent months points towards a disturbing conclusion: that of irrational exuberance, and imminent market collapse. While I would not go so far as to predict market conditions (I hate doing that, and try to avoid it if friends ask), I would say that a bull market is usually in its final stages when news reports are not longer cautious, do not have disclaimers (unlike this article) and offer endless, mindless optimism.


Anonymous said...

Dear Sir,

I have been reading your bogs on a regular basis. It has always been good reads! Keep it up.


musicwhiz said...

Hi dream,

Thanks very much for your comments. Have a great week !



la papillion said...

hi musicwhiz, i've been reading up on your blog posting too. Found them insightful :)

Just to encourage you to keep posting and doing what you do, cheers!

Fighter said...

Hi musicwhiz,

Well written!
Thanks for your posting about Sunday's article.


nenix said...

hi. Nice article there.. Agree with you fully that trading and investing are two different things..

SJ reader said...

Musicwhiz, glad to have found your posts again. I was wondering where did you disappear to. You used to post in the value investing thread. So I track only that tread (didn't realise you post also on a few other threads which I don't follow). I found out only today abt your blog. Good work. In fact, excellent work.

I totally agree w you. One cannot assess how successful it is w/o mentioning initial capital. That was my reaction to the 100K profit. Coincidentally I have passed a remark to my family member that perhaps his initial capital was $1m, which mean lousy profit.

musicwhiz said...

Hi sj reader,

Thanks for your compliments and comments. I only post in selected threads for companies in which I have a stake in, and ignore the rest as they move too quickly anyway. Anyhow, most people on SJ are traders, not value investors.

Jolly Jester said...

Yes I agree initial capital is important and that is left out.

Perhaps another very important thing is what amount of leverage (margin trading, CFDs, warrants, options)was used to obtain the profit? Higher leverage = higher risk/return, and if not managed properly can make one go into debt as quickly as one earned the big bucks.

musicwhiz said...

Hi jolly jester,

Yes, thanks for pointing it out. Some people use leverage (margin) to increase their winnings, but this is a double-edged sword as it can also magnify your losses as well. Thus, people who use margin should use it wisely and carefully in order to avoid being burnt badly.

Berkshire said...

In Berkshire 2002 annual report

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of
effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know
that overstaying the festivities - that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future - will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the
clocks have no hands.


Yes, i agree that the media report are very misleading and casues many people to act without thinking or further investigation. It is taken in the general society that reading will cause smartness and reading the media is one such avenue. But to be truly wise, a wise investor will always select the best material to read. And if he is to read everything, he will be able to seperate the real thing from all the noices. In many things in investing, most are noises, little are what that truly matters.

To understand investing better, I personally recommend this book, Bull by Maggie Mahar. One of the most fantastic book on what really matters and what causes certain behavior in investing. And media is what causes certain investing community behavior.