Wednesday, March 25, 2009

When the going gets tough, the tough get....going ?

Investors who have stayed with my blog for the entire duration of the bear market (yes, 16 months so far) and have been invested fully throughout will probably be wondering if there is ever any light at the end of the tunnel ! The fact is that market conditions are always dictated by Mr. Market and he follows economic cycles to determine his mood swings, and whether he decides to pay a high price or a very low price for a business. As investors, our job is to evaluate the underlying business and not pay too high a price for it, in order to maintain margin of safety. The bear market and sharp recession has challenged my notion of margin of safety and also afforded me some insights into my investment choices, some of which I would admit to be mistakes which could have been either avoided or mitigated. When the going gets tough, frankly usually the tough get going (i.e. exit the market). But I am not about to succumb to Mr. Market's manic mood swings, even though the psychological effects of his swath of destruction have pummelled many an investor (including myself). A back to basics analysis would tell one if holding on and averaging down is wise; or if one should just cut loss and re-deploy the funds.

A more obvious boo-boo made by yours truly was to purchase companies which leveraged heavily for fast growth. Evidently, this strategy worked well during times of economic expansion and with the availability of easy credit. However, with a severe credit crunch under way and banks being unwilling to lend, these highly leveraged companies became prime candidates for implosion, due to their inability to refinance their short-term debt and also the cash flow burden which they had to bear in the meantime. Companies like Ezra, China Fishery and Swiber which geared up to expand found that the going was very tough over the last 6 months, to the extent that I did perspire quite a bit and went through a few sleepless nights wondering if they could pull through the crisis. Though Ezra and Swiber employed sale and leasebacks, there's no argument that operating lease expenses would still represent a major cash flow drain, while they still have bank loans to service and refinance. China Fishery had to issue senior notes at about 9.25% interest rate (extremely high), and though they are due in 2013, the huge interest expense is eating up valuable cash at an alarming rate. If not for the fact that China Fishery had good net margins and a lot of their debt is collateralized using their own vessels, plants and inventories, I suspect they may face financial problems similar to the ones recently faced by S-Shares.

So it's apparent from the above that my choice of companies with such heavy leverage has been less than exemplary, and my original focus on value investing may have been viewed by some skeptics as little more than a distorted version of Peter Lynch's "Growth Investing"; albeit with high risk ! Since the job of the value investor is to minimize risk in his investments by requiring a good understanding of a business with little or no debt, I am somewhat guilty of violating this rule ! But we live and learn and it's not the end of the world because of these errors of judgement; I take it in stride and will make sure I am more wary of such complex financing schemes and such high leverage when evaluating future potential companies.

With the current bear market reaching new lows in early March 2009, I did take the opportunity to re-balance my portfolio by purchasing more of Tat Hong and Boustead; as they are more established and cash-rich. This has boosted my stake in both companies to levels above that which I own in Ezra and Swiber; and this acts as a buffer in case Ezra and Swiber encounter any critical problems in managing their debt. As for China Fishery, the recently declared bonus issue of 1 for 10 shares will allow me to average down my cost at no extra cash outlay. Just for info, Tat Hong was purchased on March 3, 2009 at 53 cents and Boustead was purchased on March 9, 2009 at 46.5 cents. This has reduced my cost in Tat Hong and Boustead to 68 cents and 55 cents respectively, and will be updated in my month-end portfolio review.

This bear market and unprecendented crisis has taught me a lot about companies, how they operate, risks and valuations. It's a very enriching learning experience though it will probably end up being an expensive one if anything untoward happens to my companies (touch wood !). As we are not out of the woods yet, there is still some potential for trouble though the probability has been greatly reduced since October 2008.

There will be more of such candid admissions in the months to come, and sometimes I feel I could compile my own "mistakes checklist". For readers out there, please feel free to criticize (constructively, please) and give advice. We are all learning as we go along.


SaGu said...

Do consider to exit investing in Ezra during this short rally without incurring any losses and just a small returns. Use them to rebalance your portfolio. You don't have the same option on Swiber which you must continue to hang on and pray that it survives through this long recession.

Just my thoughts,
That's SaGu

BL Trading Team said...

I said it many times that 2009 is not the time to buy stocks. I had advised my readers to stay out of stocks since early 2008.

Forex trading is the key to wealth management in 2009 or beyond (if this recession persists on for another 3-4 years)

newborn1000 said...

Done give up on investing


Market Uncle said...

I'd think one have no idea what he does not know at the very juncture of decision making. Hence, what seems perfectly rationale at the moment we invest, only to realise our 'mistake' sometimes later.

All companies can choose to grow organically, on leverage or by merger and acquisition. There are actually no right and wrong, just successful and unsuccessful cases. Successful ones could be deemed as taking calculated risk, unsuccessful cases as over aggressive ones.

Given current credit crunch brought by a prolonged period of market excesses, what works well just turn drastically wrong at the last moment.

Not all highly leveraged companies will die, by luck or skill, some will survive. Thus its just a matter of just holding out and let the initial margin of safety (whatever left of it) and diversification to save ourselves.

The only consolation I had is at least I resisted the idea of borrowing to invest right from the start. :)

musicwhiz said...

Hi SaGu,

Thanks for your thoughts. Actually, when I meant re-balancing, I was referring to increasing my positions on "safer" companies which can weather the credit crunch rather than selling some of my other companies.

It may seem like an opportunity cost but I have confidence that they can emerge stronger after this crisis.

Anyway, I still have cash for investing but I need to be patient again for good bargains.


musicwhiz said...

Hi BL Trading Team,

Once again, you appear to make an announcement on forex trading. I've mentioned many times that blatant advertising will not be tolerated, but it seems you persist.

Please try to comment more constructively on the post or on related investing issues. Thanks.


musicwhiz said...

Hi newborn1000,

You referring to yourself, or me ?


musicwhiz said...

Hi Market Uncle,

Thanks for visiting, very pertinent points you raised. This reminds me of a question I posed on a forum some time back - when does conviction become stubbornness ? Some said it's conviction when you are later proven right, but stubbornness when you are proven wrong. Which means this question is rather contextual isn't it ?

We won't know if we're right or wrong about our investment choices till many years later. That's the problem with many people ranting on that we're stubborn and holding on to losers. If facts present themselves which require a change of mind, then yes we should admit we were stubborn. But so far the facts have not shown that I need to take such drastic steps, thus I am using conviction to stay steadfast and weather out the recession.

On companies that use leverage, some need it less than others and still can manage growth. I admit I should have been more discerning when it came to selecting companies, but there's no turning back now. We can only move forward and I will be more careful in future.

I agree on your last point - NEVER borrow to invest. That's a no-no for me too.