Thursday, January 22, 2009

Is an Investment a mistake due to an Uncertain Future ?

I guess I didn't know how to describe what I am about to say, thus the very vague and clumsy title above ! But dear reader, perhaps by now you would have read about the global financial crisis, the sub-prime contagion and be bombarded by endless information about bank bailouts, auto bailouts and what-nots. This is how I define "uncertain future", and as I go along my investment journey, I realize that what confronts me as an investor is not just my ability to analyze and select good companies, but to be able to assess their future potential and survival to a certain extent. Let me elaborate further.....

As investors, our role and job is to assess the ability of companies to grow their earnings and ensure a steady stream of cash flows. Our returns will then be based on the capital appreciation of the shares (representing part ownership of the Company) as well as any dividends accrued over the years. Looking at past data is always easy and it is a cinch to crunch past numbers in order to attain some semblance of being able to identify a good company. However, the fuzzy part of investing is not in analyzing the past, but in predicting the future. Businesses are subject to constant change from a myriad of factors, and stakeholders are forever interacting with the company and altering its intrinsic value, thus I realized that the notion of "the fundamentals are still the same" is misleading; due to the fact that changes in the external environment and within the company itself would cause some degree of shift in its so-called "fundamentals".

With the advent of ths current severe economic downturn and sharp recession, visibility has suddenly been greatly reduced. It's as if 2 years ago in 2007 we were driving a Porsche in clear fine weather, but now the skies have darkened considerably, it's pouring and a fog has sprung out from nowhere to ensnare the unwary driver (investor). Not to mention that the Porsche has probably been downgraded to a battered 10-year old spluttering Ford car ! As an investor who used to be certain about the future potential of the companies I own, I suddenly find myself thrust in the middle of a dense fog with no sign of lifting, and there is no clear visible path to take. Thus, the best thing to do is to tread slowly and uncertainly through the mist, all the while monitoring the humidity and whether the mist threatens to turn into a deadly airborne plague. This analogy aptly describes what I had gone through in the past 12 months as the global financial turmoil engulfed all my companies, rendering many of their plans useless and forcing them to change course and steer clear of danger.

Going through my list of companies, Ezra and Swiber's long-term plans are now in jeopardy due to the slump in oil prices to US$40 per barrel, thus threatening oil and gas E&P into deeper waters which both companies had planned for. This caused Ezra to cancel 3 out of 5 of its MFSV and Swiber to postpone the construction of its Equatorial Driller. Boustead is affected by the oil and gas slump (even though they managed to clinch S$65 million worth of contracts recently) and also the property slump as they are into multi-industry. Tat Hong, being in the construction industry, also issued a profit warning as equipment sales weakened and the operating environment became more challenging. Pacific Andes and China Fishery are affected by the global trade slump and many countries are not importing due to trade financing drying up, thus their expansion plans may also be in danger. Last but not least, First Ship Lease Trust is the most affected as the global shipping industry has almost come to a standstill, with many vessels lying idle amid an over-supply as bulk shipping dries up. As a result, not only has the Trust been unable to grow, it has also been beset with problems such as potential client default (bankruptcies), loan to debt covenants and also loan repayments. Looking back, their aggressive payout was unsustainable in light of the worsening conditions, and the business model was flawed as I only thought about the upside and did not consider the hazardous effects of the downside. So, as a result, I burnt my backside.

So when do such events translate into investment mistakes ? As Warren Buffett said, you only know who's been swimming naked when the tide goes out, and I got caught nude quite flat out on some of my investments. For others, fortunately, I was wearing swimming trunks. FSL Trust immediately comes to mind as being my most recent and regrettable mistake as I under-estimated the risks of the business model; now I may have to wait 5 years just to break even on my investment (and that's assuming the Trust survives this downturn, of which there is slim chance). Another mistake is Pacific Andes, which I did mention in a previous comment that I had paid too much for, even though it is a good company. Its margins are too low, leverage too high and could not generate enough cash flows to justify my over-priced purchase.

Thus, I would conclude that a murky outlook does not necessarily render one's investment a "mistake", unless one assesses the facts again in light of the current circumstances and finds out that one paid too much for the risk one is undertaking. Recessions will come and go as part of a normal capitalist society's business cycle but companies which are well-prepared and dextrous can navigate the fog safely and emerge into the sunlight. Right now, I certainly hope that my prior research on the company's Management and policies can help my companies get through this unusually horrid storm.

23 comments:

pau said...

i must say that your 'confession' is one of the most honest and heartwarming one in this time of crisis. You have earned my respect from all your past postings but this seals it even more.

In good times, there were many investing bloggers who put their analysis and calls in the posts. Some are really respectful and great in their writings, but most of them fade in times of crisis. It's disappointing to see them disappear when pple seek some direction from some gurus.

Your honest opinions are cherished and you have certainly put in due diligence in your analysis. Even Buffett suffered huge drops in his portfolio when he invested in crisises too.

Take heart and continue posting. I'm sure in the long run, you would do well, both in your investments and as a reputation as an investment blogger.

paul
www.passivelifeincome.com

cif5000 said...

Nice summary.

Let say you have the chance to deploy $100k of funds now. Where would it be and why? given that you had already learned much from this crisis?

PanzerGrenadier said...

Musicwhiz

For all the ANAL-ysts out there who DON'T RISK THEIR OWN MONIES making calls on target prices etc... At least you have the guts to make the call and buy/sell based on your own assessment and convictions.

Share prices are a reflection of expectation of future earnings plus whatever available information at the point in time. Even our mightly GIC and Temasek made even worse blunders, pouring our precious reserves into US banks when they were all in ICU. Now if Temasek and GIC did a mark to market for their reserves as some people have done based on available information, those investments alone wiped out hundreds of BILLIONS of our taxpayers/citizens RESERVES.

And guess what, Mdm Ho Ching gets to keep her job. :)

You are doing a great job and I respect you for it!

Be well and prosper.

(Forgive my rant on the GIC/Temasek/Ho Ching thingie).

SGDividends said...

Hi Musicwhiz,

Great post. Don't worry, one will always be wiser after some hiccups and its a refreshing change to hear someone admit, think retrospectively and share about what one has learnt.

For the record. Tat Hong is still ok lah...hehe

SGDividends No 2

Professor said...

Hi MusicWhiz,

I was really touched by your post.

As I always keep telling you, very well written.

Anyway, i will take a look at your portfolio and provide you my thoughts / recommendations by mail.

Regards

V

Ricky said...

Heh, no more Anonymous postings. For a while, i half-expected to see a barrage of those flooding in to say "I told you those stocks were crap!" Those nameless people don't realise what they are just armchair critics.
I think writing a blog and standing by your own recommendations with real cash is tough. 2008 was on "hindsight only", a real bad time for investing fresh capital.
Personally, my own cash portfolio is down like 50% or more.
But while we're lamenting loss of money, some people around us don't even hold a job or have trouble making ends meet. Maybe it's time to lift up our eyes to help meet real needs for our neighbours?
Bill gates and Warren B. have reached the pinnacle and realised that it's always more blessed to give than to receive. Generosity and a giving spirit grants a fulfilment in our souls that no amount of money will give. This year, i hope to bless some of the unfortunate people.
Remember: Money is never enough.
Sorry for the rant :)

Mr ICICI said...

ricky, i think the anonymous setting was disabled.

anyway, musicwhiz, hope you keep on posting and keep your chin up. i like reading yr thorough and top-notch analysis.

glad you realise value investing is not that straight forward or as simple as just analysing hard data or just looking at information that are readily available.

and i think it's important to note that the US market is a world of a difference compared to the SG market. and that means what worked for warren buffet in the US market doesn't mean it will work in the SG market. SG listed companies r mainly in the cyclical industries, small cap, small market share and not much of a history, unlike the US companies.

hence, for sg market, u need a different kind of investing methods, or even a hybrid of methods, to make sure u don't get yr ass burnt again and again. and u can start by modelling yr methods from veteran investors in asia like oei hong leong (he gave an interview a few months ago and said in this crisis, the worst thing to do is to average down. wise words indeed......), lee ka shing and many others (all except the Madam sitting at capital tower..). even warren buffet adjusts his investing style when it comes to non-US companies. look how fast he exited from petrochina....

Ricky said...

Hello Mr ICIC,

oops, i didn't know MW already disabled the option, thanks for pointing it out.

I think you make a good point, there are also differences in the financial systems/structures to consider. US markets are far more flexible in terms of position sizing and liquidity. Important considerations for investors who seek to manage their risks properly according to their own financial situations.

A reservist friend of mine recently commented on my purchase of SPH two weeks ago. He said don't go against the trend, esp when the longer term trend converges with the shorter term trends in showing that the whole market is in a major downward trend. As is the case now.

Spare yourself the pain of buying a falling knife. Price of the stock is determined by the collective perceptions of the market participants on the company and not the value of the company per se.

As investors, take note of such aberrations of the market and take advantage of it, not get taken advantage of! Practically, use consolidation patterns or reversal patterns on the various time frame charts to find a good entry price for your investment. Patience, once the due diligence is done, is of utmost importance.

Personally, i think it's not good to exclude either FA or TA entirely from the investment strategy. FA tells us which companies are worth investing in, TA tells us when to buy/sell.

A hybrid method mentioned by Mr ICIC combining your in-depth analysis of the companies and macro-economy, along with simple comparisons of longer term moving-averages with shorter term one could yield significantly better results.

I understand you are a value investor, it's just a suggestion ok? No offence to your investing principles :)

PanzerGrenadier said...

Hi Musicwhiz

Wishing you and your readers a Happy and Prosperous Lunar New Year of the Ox filled with HEALTH, HAPPINESS AND WEALTH!

Be well and prosper.

quailmaster said...

Hi,
I think we should continue to invest cos now we can get more stocks at "sale" prices.
Since the market might fall further, I think we can adopt a dollar cost averaging strategy b investing a fixed amount every month, instead of investing one lump sum

BL Trading Team said...

I wish you a prosperous new year.

My advice to my readers for 2008 is to avoid stocks, this is the same advice for 2009.

musicwhiz said...

Hi Paul,

Thanks for visiting and also thanks for your comments, I take them to heart especially during this prolonged crisis with poor visibility for all companies.

For me, being honest and open is one of the attributes I truly believe in, whether it be for investing or other aspects of my life. There is no use hiding behind a veneer of infallibility when the global crisis has impacted almost everyone; thus it is better to come out in the open to admit the mistakes I'd made, and to better learn from them.

No worries, I will continue to blog about my investment process and portfolio and to give updates as my investment journey evolves.

Regards,

Musicwhiz

musicwhiz said...

Hi cif5000,

Assuming I had 100K, I would invest in companies with lower debt and good recurring cash flows. This is what I have learnt from the crisis - not to invest in companies which are over-leveraged and have short-term debt which is too high. Of course, there is a delicate balancing act when it comes to such leveraged companies and sustainable competitive advantage (high barriers to entry).

Regards,
Musicwhiz

musicwhiz said...

Hello Panzer,

Haha well Temasek and GIC also made mistakes when investing - I guess no one is perfect ! Problem of course is that those are aour National Rserves built up from the blood sweat and tears of our fore-fathers !

As for sticking by my philosophies and my analysis, yes I will continue to do so but of course will adjust my investment criteria to take into account the new things I've learnt over the last couple of months. It's a good wake-up call and makes me a more alert investor.

Happy Lunar New Year to you and your family too ! Say "Hi" to your baby girl for me....I know she is your pride and joy. :)

Thanks,
Musicwhiz

musicwhiz said...

Hi SGDividends,

Thank you. I do agree one will be much wiser if one learns from mistakes, and also judicously avoids repeating them again in future.

Regards,
Musicwhiz

musicwhiz said...

Hello V,

Hehe glad to have touched you, I guess my post was really from the heart and it just came out in one avalanche of emotion ! I did not expect it to generate this amount of emotional response and was quite frankly, pleasantly surprised.

Thanks for your analysis of my companies, I look forward to hearing your views.

Cheers,
Musicwhiz

musicwhiz said...

Hi Ricky,

Yes I turned off the "Anonymous" function as it was distracting to see so many unconstructive comments being posted by trolls.

Actually, even before you mentioned charity, I had already thought about it. There are many less fortunate than us who need our assistance and we should not just focus on our own needs, but also those of other human beings. I do intend to start donating to charities on a regular basis probably some time close to the end of this year.

Regards,
Musicwhiz

musicwhiz said...

Hello Mr. ICICI,

Thanks for your kind compliment, and yes I will endeavour to learn more on value investing in order to constantly improve myself. It's an ongoing process and trust me I analyze my mistakes almost all the time, even on the bus and MRT !

While it is true that USA and Singapore are very different, one should also take note that as locals, we tend to understand the laws and regulations here better as compared to a foreign company. The accounting rules and tax laws may be totally different for US companies, so I hesitate to invest there as there are many aspects of their financials which are so different from Singaporean companies. Of course, one can argue that it should NOT be a hindrance to investing in good companies, but it would still take some time to absorb and one has to "start from scratch" in a way because of the differences in accounting treatment on certain items.

While no company in Singapore can have the same kind of economic "moat" as Coca-Cola or Gilette for example, there are a few companies with a very strong Asian presence, and this should give it a sufficient edge as it competes for business. The downside with such global companies is that it can be complex to analyze and have many sub-divisions (like General Electric for example), thus the complexity may be too much for a single retail investor who does not have as much time as Buffett to read through reams of Annual Reports (cos most of us have a full-time day job) ! So I think we should invest within the limits of our competence and also not stray too far from our home country. The boundaries of economic moat may not be as wide but I am willing to accept a lower return for the uncertainty of growth for such "Asian MNCs".

Cheers,
Musicwhiz

dsea said...

Hi Music Whiz,

Indeed, the shipping trust looks good 12-18 months ago for the yields....and now we are staring at potential bankruptcy. Suffice to say that I am working for free for past 3 years (including generous bonuses thrown in).

(Ever the optimist, or habitual gambler), another shipping stock you can consider is Courage Marine. No significant debt, low depreciations (as they go for 2nd hand ships) and net cash position

thoughts?

DSEA

musicwhiz said...

Hi Ricky again,

Thanks for the suggestion, and yes I have heard of such methods combining TA and FA, but have yet to try it out in the real world. As of this moment, I am not ready to change my investment philosophy.

Thanks,
Musicwhiz

musicwhiz said...

Hi quailmaster,

There's a problem I have with DCA though, because ultimately if you DCA on a company which is losing money and about to get into trouble with creditors (for example the case of Jurong Tech recently), then one would still end up much poorer. One still has to exercise reasonable analytical skill and judgement when seeking a company to perform DCA on.

Either that, or you could DCA on an index fund (e.g. ETF). I think that probably would work. :)

Cheers,
Musicwhiz

musicwhiz said...

Hello BL (Brendan Lee),

I have noted your repeated warnings on equities and your persistence on currencies. I have to say that even though you changed your nick you still sound very recognizable.

I would urge you to contribute more to the topic on hand. If people wished to know more about currencies, I believe they would definitely visit your blog.

Thanks,
Musicwhiz

musicwhiz said...

Hi DSEA,

Sorry to hear about your experience. I am also staring at a potential loss of >50% on shipping trusts as I had not adequately assessed the risks. Oh well, no one else to blame but....myself haha.

As for Courage Marine, the dry bulk sector is pretty cyclical and I do not understand it as well as I would like to. I still prefer to stick to companies like Ezra which have contracts on a longer-term basis.

Perhaps I will revisit Courage Marine in due course, if I have time.

Thanks !

Musicwhiz