Friday, October 23, 2009

Ezra – Full Divestment, Rationale and Lessons Learnt

This was not supposed to be such a quick follow-up post to my just concluded Analysis of Ezra’s FY 2009 financials, but certain corporate actions made by the company necessitated my immediate action and attention and which compelled me to act.

Securing of US$1 Billion Chim Sao FPSO Project by EOC

Immediately after my posting on Wednesday morning October 21, 2009 of Part 2 of my analysis and rationale for partial divestment, Ezra dropped a bombshell by announcing that its 48.5% associated company EOC had clinched the much talked-about Chim Sao FPSO deal, which was worth US$527 million for the first 6 years and US$477 million assuming an option is exercised to continue for another 6 years. Thus, the total value of the contract is US$1,004 million over 12 years, or if smoothed out equally, will represent revenues (not profits) of about US$83.7 million per year. The worrying aspect of this announcement is how EOC are going to fund the conversion of a deadweight tonne oil tanker into an FPSO as they are already very highly geared (2.31x as at August 31, 2009). It immediately became clear to me that EOC (through Ezra) would have to do some fund-raising to be able to take on this project, and I was proven right (see next section on Issuance of Convertible Bonds).

Note that although the press releases from Ezra and EOC both tout the value of the contract and talk about stable revenue contributions and asset utilization for at least the next 6 years, I actually analysed the situation and came up with a different perspective:-

1) Assuming additional revenues of US$83.7 million per year, and assuming a very healthy net margin of 20% (gross margin for Offshore Support Services is 38% as at August 31, 2009, so 20% is reasonable to assume for net margin, albeit a little optimistic), this means an additional US$16.74 million worth of profits accruing to EOC each year. Since Ezra owns only 48.5% of EOC, this means they only recognize an additional US$8.12 million per year on a Group basis. This only constitutes about 11.6% of their core FY 2009 net profit, and thus cannot be considered very significant. This is because of the risks to be factored in when taking on a project of such massive size (see point 2).

2) The first FPSO deal clinched by Ezra and announced in 2006 experienced many delays and hiccups as first gas took very long to achieve, and in fact it was only today (October 22, 2009) that Ezra announced that the client had commissioned and accepted the FPSO, with almost a year of delay between deployment to production of first gas. Originally, it was announced that Lewek Arunothai would contribute to 1Q 2009 revenues; but this has since been pushed back all the way to 1Q 2010. This demonstrates the technical difficulty of operating an FPSO, and for the Chim Sao Project the complexity may again lead to delays of a similar nature.

3) Note that EOC mentions that the FPSO would be owned by “4 entities”, though it does not give details of these entities and whether they are part of Ezra Group. Assuming that the entities are external parties, this may imply that EOC may only share up to 25% of the revenues accruing from the FPSO. This makes Point 1 assumptions drop by 75% to just about US$2 million accruing to Ezra Group per year.

4) The EOC announcement also mentions that EOC and a Vietnamese partner will be operating the FPSO, which essentially means the risks are borne by EOC in terms of operational capabilities and execution. Note that a delay similar to the one experienced by Lewek Arunothai could result in additional costs and damages should the client decide to pursue legal action (which I assumed did not happen, but one cannot assume the same for Chim Sao Project).

Viewed from this perspective, it would appear that the deal may not be as lucrative as envisaged, especially if it comes from the angle that the revenues accrued to Ezra Group may not be significant (pending more clarity on the 4 entities and shareholding structure for the new FPSO), but that EOC is taking on a large portion of the costs and risks relating to the financing and operation of the FPSO. There is also concern from yours truly on EOC’s ability to finance an FPSO since its gearing was so high, and I was frankly very surprised that they clinched the deal, as during the EGM I had brought up the point to Management that I did not think EOC would be able to handle the second FPSO as it was highly geared (they did not give me a reply on this).

Issuance of 5-Year 4% Convertible Bonds Worth US$100 Million

As predicted, Ezra announced on the morning of October 22, 2009 that it would be issuing (through DBS), 5-year 4% convertible bonds worth US$100 million, presumably to fund the FPSO as well as for expansion and general working capital purposes. The details can be found in the release on SGXNet, so please check it out on your own. Effectively, they argued, the convertible bond would lower their gearing when converted (conversion price set at S$2.50 per share) to just 8%, and “strengthen their Balance Sheet”. Perhaps they also forgot to mention that in the case where the bonds are NOT converted, they represent even more debt being piled on to their books (Ezra is now taking up the gearing since EOC is already massively over-leveraged). And even if they are converted, the only reason gearing drops is because the share capital base increases by 55.86 million while debt drops as a result of the conversion. So in effect shareholders have to choose between even more debt (and associated interest expense of 4% per annum) or 8.5% dilution based on the existing issued share capital of 658 million shares.

Personally, I feel that this may not be the last time Ezra heads to the capital markets for fund raising, and it is making me very uncomfortable as to how the Group persistently and consistently raise money through financing activities and not operating activities. Their cash burn rate is basically very high and the Group seems to thrive on issuance of shares and increasing their debt. I had once erroneously assumed that Ezra would be able to achieve stable positive operating cash inflows once they had stopped their fleet expansion and tied up their long-term charters; but it seems that this was not to be. Their relentless focus on expansion by taking on the second FPSO and also the purchase of Ice Maiden confirms that more dilutive fund-raising is on the cards, and probably a lot more debt will be loaded on both EOC and Ezra’s Balance Sheets. This is an unacceptable situation to me as an investor.

Other Pertinent Factors

As mentioned in my last post analysing Ezra’s financials, the receivables level has remained persistently high for the last few quarters which shows that revenues are recognized aggressively, while cash collections have taken a back seat. This is a very alarming trend and may indicate some problems with collection even though, as Ezra states, their clients are reputable multi-national oil companies and oil majors who would (presumably) have no problems in paying on time. As their Energy Services Division was the fastest growing division for FY 2009, and since most of the ballooning in receivables came in during FY 2009; it would be safe to assume that this division had the longest credit terms extended, and it is currently doubtful as to whether these receivables are collectible.

During the EGM, Management had also mentioned that their Vung Tau yard would take a back seat and would be left as a Greenfield project. This was somewhat surprising as my understanding was that Saigon Shipyard was already fully utilized and excess capacity for fabrication contracts could be channelled to the new yard instead. This could imply that there is no urgency to build up their new yard, or there is a lack of funds to develop this yard further without once again tapping the secondary market.

Ezra’s Business Model – High Revenue and Profit Growth at the expense of Positive Operating Cash Inflows and Balance Sheet Strength

Ezra’s business model is inherently as described in the title above – boasting high CAGR growth in revenues and profits but most of the time neglecting their Balance Sheet and Cash Flows. Frankly, this had not changed since FY 2005 when they conducted their sale-and-leaseback transactions to free up cash and quickly expand their fleet, and they are now finding ways to get cash from the markets and from loans once again. The old-fashioned method of funding growth through recurring operating cash inflows seems to have been forgotten in their relentless quest to secure higher profits and revenues. This is an untenable situation for me as an investor and my original rationale for investing in Ezra (with the flawed assumption that it would cease aggressive asset buildup and instead build up a war chest of cash) is now gone.

Full Divestment and Lessons Learnt

As a result of the explanations above, and coupled with the discomfort I felt during the EGM, I have fully divested my position in Ezra today at a price of S$2.05, booking a gain of 226% of the remaining portion of my stake (the previous batch was sold at S$2.01 on October 16, 2009). The total realized gain on divestment of Ezra is around 222% for my entire stake, and taken over 4 years this amounts to approximately 55.6% per annum. This will be fully reflected in my month-end October 2009 portfolio review.

Notwithstanding the fact that I had booked a gain on the divestment of Ezra, I will still classify Ezra as an investment mistake and model “case study” on the type of companies to avoid investing in; due to the fact that such an aggressive model does not constitute a prudent value investment and also the fact that leverage is so high (blended gearing of EOC + Ezra) makes this a very risky investment whether during good times or bad. There is much to learn as I mull over my efforts and analysis over the last four years; including analysing all quarterly reports, reading all Annual Reports, attending all AGM/EGM and speaking to key Executives of the Company. Another minor point I would like to bring up is also of the “marketing” and “glossy” nature of the press releases churned out by the Company, similar to those which I mentioned for Swiber (which I had divested in August 2009). A lot of the positives and optimism has been factored into Ezra’s share price at this point in time, and it is trading at a dangerously high valuation considering there are so many risks in execution and also with a weak Balance Sheet and Cash Flows.

As a result of what I had learnt, it would seem that I had been speculating rather than investing as my original premise for investment was itself flawed. In short, I was mistaking myself to be investing when actually my grounds for investing did not conform to value investing principles. For this, I am regretful and will endeavour to learn from this mistake and avoid repeating it when analysing future companies for investment. More focus will be placed on Balance Sheet strength, net cash position and recurrent operating cash inflows instead of just Profit and Loss and margin numbers.

Acknowledgements

I would like to express my gratitude to Donmihaihai and d.o.g. (initials for “Disciple of Graham”) for highlighting salient aspects of Ezra’s Balance Sheet and Cash Flows to me and which helped to complement my own research into Ezra. Donmihaihai’s post on Ezra can be found here, while d.o.g.’s take on Ezra is detailed in this link, in which I had also contributed my thoughts, views and opinions. I humbly accept constructive criticism for making this post, but be warned that any post which constitutes troll behaviour will be immediately and irrevocably deleted without further warning.

Disclaimer: All views expressed above are personal and do not constitute a recommendation to either buy or sell shares of Ezra. I will not be held responsible for any actions relating to the profits or losses made as a result of relying on this blog post. Note that such decisions involve hard-earned money and should not be taken lightly or frivolously.

60 comments:

James said...

You are going through the same path as I had when I started value investing. What I thought was value was not so and many of my so called gains from "value investment" is actually the result of an overall uptrend in the market.

Suggest Anthony Bolton's book especially on the section on why he considers technical analysis important that if he were on a desert, he would rather rely on charts than on fundamentals. This is none other than a top fund manager from Fidelity.

jfhl

Musicwhiz said...

Hi James,

Thanks for your comment. May I find out from you on what you discovered about "value" and did that eventually help you on your journey to becoming a value investor? I also understand your point about "skill" versus "luck".

Yes, I have heard of Anthony Bolton, supposedly he is the "Warren Buffett" of the UK Market. I will check out his book thanks.

Though I am rather confused - you seem to be advocating some form of Technical Analysis even though you claim to be a value investor? Hope you can elaborate on that, please.

Thanks,
Musicwhiz

JW said...

Hi MW,

would like to reference to some of your older posts first (see, I do read them ;) )

First, value trap. Were you trapped?
Second, gambler's fallacy. Did you buy because you thought it was value, and made a 'gamble' that you were right?


Ok, now back to my own views. Value investing part:
You might be wrong in your analysis earlier as you claimed, but I believed you had done it correctly. Value investing allows you some margin of safety, such that if your analysis goes wrong, you could still exit with profit. This, I believed, happened. You had a comfortable margin of safety.

And good management of portfolio here.


Ok, trading part:
You will never be wrong taking profit off the table. 226% is what many would dream of.

2nd, I refer you to what I charted for STI.
http://1.bp.blogspot.com/_MpWUhDNsH98/Stdi1Nq3_GI/AAAAAAAAAyo/M0IcFerppTM/s1600-h/STI+monthly+chart.JPG

For longer term investors, it's indeed prudent to take some money off the table now, because (fundamentally) valuations are starting to run high and (technically) the index is approaching 15 years resistance.


I'm sure you roughly know my style from my comments so far, combining FA with some form of TA. My most recent target would be accumulating Starhub for longer term dividend investing, and the fundamental reasons, I will be posting on my blog this weekend. The dividend yield has now come down to a very attractive rate, but why am I not buying in yet? TA is telling me there is likely more downside to come, and because of that, I will bid my time to buy at a more attractive price. In case I was wrong, I could always wait for the next opportunity. Investments (or trading) are always about patience, in waiting, in buying and in selling.


Anyway, congrats on your profits! ;)

simon said...

although you probably dread to hear this, but i think u r fantastic at market timing. u seem to make so much more money from changes in share price alone rather than fundamental analysis! =)

without sounding sarcastic, i think you might have hit the right recipe to make money!. buy a company, thinking it's a value investment, and then divest after realising u made a mistake after all. haha.

James said...

I read your blog with interest. From what I see, you are obviously intelligent and spend a lot of time thinking about issues.

However, as I have discovered over the years, the market which is the aggregate of all participants is actually the only wisdom you need. Barton Biggs also had a book which wrote about using the wisdom of the markets. This is why the market was able to rally before everyone accepted that the worst is over.

So today, I no longer use value techniques but only use them as a supplement ie. to confirm that the stock I am interested in is not in some dire financial straits. Otherwise, you will see that price momentum and other uses of technicals together with money mgt which you have now started to think about is all that is needed to consistently make money from the market.

Not to say I was not profitable using value but after using the new methods, I have not looked back since. Given that you are a smart person, I am sure you will discover this in your own time. Until then keep at it...

I was like you not too long ago... Late 20s and desiring for financial independence from a job.

Well I have achieved that only through my persistance in wanting to "crack" the code of the market. I financially managed to do it after 10 years and have not looked back since. Keep it up and be open. Value investing is overated really...

I wish you well.

Musicwhiz said...

Hi JW,

Well, I think Ezra cannot be classified as a value trap, as value traps are companies which seem to have value but are actually duds. In this case, it's probably errorneous analysis and conclusions about this supposed value investment which led to the mistake. As for Gambler's Fallacy, I don't really see how it fits this case.

Well, there are opinions floating out there which state that there was no margin of safety (it is illusory) because Ezra was not a value investment to begin with! If you see if from that perspective, then I am afraid they are correct. As for portfolio management, yes I am still learning but I realize it's an essential skill as an investor.

I took profits because of a drastic and adverse change in fundamentals, or rather - it was the realization of this and discomfort during the EGM which prompted my actions. Of course, I cannot complain about the gains but what I am saying is that the principle of it was that I had screwed up my view of Ezra and was thinking that all along I was "investing" when it may have been so. This can be pretty subjective and not everyone may agree. :)

For Starhub, you may wish to analyze the fundamentals more before you decide to buy, as the yield alone may not be sustainable due to loss of EPL and also being the only telco not to have the iPhone. I cannot really comment on technicals, but I do agree one needs patience when dealing with Mr. Market.

Thanks,
Musicwhiz

Musicwhiz said...

Hi Simon,

I will treat your comment as a tongue-in-cheek one, because I feel you cannot be serious about me doing market timing! Please note that selling because of a change in fundamentals does not constitute market timing in any way. For me, I will not hesitate to sell if I do not feel comfortable with the business of the company and how it is conducted (or how capital is allocated). I do not make a conscious effort to time the market.

Sorry but I feel you sound sarcastic nonetheless! Why should anyone in his right mind buy a company assuming it's a value investment, and spend so much effort in researching and attending AGM/EGM, only to find out he was wrong? It's emotional draining and psychologically quite hard to take, frankly. Maybe I might be taking this too seriously, but I spent a lot of time mulling over what went wrong and how I can improve.

Regards,
Musicwhiz

Musicwhiz said...

Hi James,

First of all, thank you for the compliment.

Next, I would like to add that everyone has their view of the market and their own ways of making money from it. Some use TA, others FA, and yet others a combination of both. My view is that one should use whichever method which suits one's abilities, competencies and temperament. While I do respect those who can time the market effectively (and you seem to be one of them), I know ultimately that I am pretty lousy at this and do not have the interest to study markets and market psychology as much as I would like to study companies.

What you have described is akin to momentum investing, correct me if I am wrong. Using technicals to "ride the wave and trend" and buying high and selling higher based on market sentiment and charts pretty much describes this technique aptly. While I do not wish to debate the merits of this method as it can turn out to be a long drawn-out argument, what I do like to state (categorically) is that this style is not suitable for me. Portfolio Management is an integral aspect of investing, yes, but momentum investing is a different ball game altogether.

Actually I am very happy for you that you've found a method which works for you. For me, I am probably still evolving my investment style and I will not necessarily turn to TA; in fact I believe I may just need to fine-tune my criteria and avoid making silly mistakes. Please also note that I am a new investor with less than 5 years of experience in the stock market. You could say I started late, but better late than never.

I am in my early 30's now and I do desire financial independence but it's not something which is easy. What I am trying to say is that investing is just one aspect of this, which I think you neglected to mention. Saving, living below your means and having insurance are equally important, as is living a life of quality, relationships and happiness. People are more important to me than money, because memories are usually filled with people and events rather than physical possessions.

Thanks for your encouragement - I know you mean well and your intentions are good. Value investing is not over-rated, in fact I think that Singapore may not be the best place to practise it to its full potential due to the nature of our companies (not global) unlike many USA companies like P&G, Apple etc. This means that value investing has a limited impact here as a company in Singapore cannot truly achieve a competitive "moat". So perhaps I would venture to say that one should modify value investing to suit the local context, instead of writing it off as irrelevant or insignificant.

I say this because I do know a few very successful value investors who have thrived on their methods, and I am still learning from them. Even if it takes the next 10 years, I will continue to learn and improve. I have the determination and perserverence.

Thanks and Regards,
Musicwhiz

James said...

I wish you well in your ongoing journey.

I achieved financial independence solely through my trading gains which multiplied very quickly after I adopted a new philosophy and approach to the market.

I was once an avid reader of company annual reports devouring them like novels until I realised one day that all this effort was not translating into the desired high impact returns.

Now that I am living off solely on investment income, absolute returns and always consistently being profitable is key. This is something that value investing cannot provide. As I say if you want to get there, you need to be open. We can always reinvent ourselves.

Listen when someone like Anthony Bolton says that technicals are important.

Rgds.

Jeremy Ow Tai Pang said...

Hi MW,
You stated your reasons quite clearly for divestment of Ezra Holdings. I practise value investing same like you. I believe it works same like other investment philosophies (e.g. momentum investing). There are not just one way to approach the market. However, the investor has to live out the investment philosophy and use it in the correct manner. I believe you have lived it out because you had a margin of safety and also you divested upon potential permanent deteroriation in the fundamentals of a company. These are already principles of value investing at work. So, it is no wonder that you still have a comfortable return after divestment being a true blue value investor in practice.

Compounding is the ultimate strength of the value investing philosophy. Value investors keep looking for value bargains on excellent companies and the longer the company performs and the investor has regularly invested in the same company or other excellent companies at undervalued periods with gains from dividends or fresh capital, he can expect his investment returns to compound over a long period and enlarge his invested capital base over time. This is compounding at work that serves to keep the value investor's investments growing at accelerated pace provided that he constantly practise value investing carefully to capitalise on compounding effect. Just my two cents worth of sharing! I wish you all the best in your investments!

Musicwhiz said...

Hello James,

My definition of "Financial Independence" may differ from yours. What you describe is regular income derived from consistent trading gains, which you had obtained from your understanding and interpretation of Mr. Market. My definition is to obtain a steady PASSIVE regular income which can sustain me and my current lifestyle, meaning income from sources such as rental and dividend which are passive by nature. To me, trading is still a form of active income (which you have described) and requires "work"; though of course in your case you make it sound effortless due to your own developed and time-tested system. Still, I cannot help but classify your methods as an active income and so the traditional definition of Financial Independence may not apply strictly in this case. Just my views.

I also do not agree with you that value investing cannot provide consistent returns. Just because it had not done so for you (and to the extent which you had hoped), does not mean it may not work for somebody else. As I did mention, I do know of people who have practised value investing successfully, and they have their own philosophy and style which may or may not combine elements of TA.

Though I respect what you have to tell me about technicals and Anthony Bolton, I stand firm that everyone should have their own system. I definitely will read up on him though in the end, whether I use technicals or not should be based solely on my personal comfort level and temperament.

Thanks,
Musicwhiz

Musicwhiz said...

Hi Jeremy,

Nice to meet another fellow value investor, and thanks for sharing your views on my post.

Hmmm, as to whether I have followed value investing principles, the jury may be out on this one. One can argue that since Ezra did not constitute a value investment, there was to be an ethereal margin of safety which I thought to exist but actually did not. Assuming that their receivables translate into bad debts, this would technically wipe out a large chunk of their profits and if any of the risk factors came into being (e.g. delays in delivery of AHTS etc), this would have a very adverse business impact on the company. While one may view my purchase price as having a comfortable margin of safety, perhaps I can only say so in the context of having treated Ezra as a true blue value investment, of which it is obviously not. Nevertheless, what I can confess is that throughout my 4 years of owning Ezra, I had felt that I had sufficient margin of safety. (Sorry for the rambling, just trying to express what I feel!)

Yes I agree with you on compounding. That is one aspect which trading does not build on, unless you argue that traders recycle their capital and use that to grow (but it's somewhat different eh?). Value investors need to constantly put their capital at work and find good bargains and good companies, so it's always a learning process.

In the meantime, it's back to the drawing board. I will be researching 2 companies to see if they fit the bill, and will rope in my spouse to help me as well because time is really not an asset I have a lot of!

Thanks once again for your encouragement.

Regards,
Musicwhiz

JW said...

Hi MW,

thanks for your comment on Starhub. I did a quick calculations for Singtel and believed that they might only even out the amount paid to BPL and ESPN if they charge an average of $27.78 per subscriber. Hence, I believe Starhub might actually 'benefit' financially. Consumers are the one who lose out in the end.

http://wealthbuch.blogspot.com/search/label/Starhub


For value investing, I would suggest that you could probably take a look at FCGY in rmao or cna forums. He trades with fundamentals instead of technicals, and he's doing very very very well... I think you know who he is. His holding period is shorter, but the profits looks very well. Zero TA, lots of FA, but profits just as much as momentum traders.



Hi James,

I would consider trading (actively) as active income as well, although it is very rewarding.

Wealth Journey said...

James,
Can you start a blog to share your experience on active investing?
I'm interested to learn!

H said...

Hi MW,

Thank you for sharing your thoughts! I was just wondering why would you still keep some Ezra when you sold based on fundamentals.

And yes, I do know of successful value investors; & your focus do remind me of one of them. Keep up your good work MW! thanks for sharing!

HH

wee said...

MW,

With your peseverance, i sincerely feel you will attain FI faster than you have thought.

I am a learning value investing practitioner just like you, and like many I live and breath warren buffett's methods.

I noticed somehow (perhaps unknowningly) you select a few companies are capital intensive, or have poor balance sheets. You may want to re-look at your screening criteria.

I wish you all the best in your journey.

wee

wee said...

James,

I read with interest about how value investing doesn't work in your case as well as technical analysis.

If possible, would you share with us your value investment principles back in those days when you were practicing Value? What did you look for in a company, what sort of valuations were you prepared to pay, and what are your expected and actual holding periods.

Although I practice Value, I sincerely think that technical analysis and market timing could work (to me George Soros is a living example). However, I also believe that it is not necessarily Value versus Tecnical, and people can prosper with whatever that they are comfortable with. What failed to work for you could be possibly be explained if we understand a bit more about your circumstances.

Personally i do not believe that Value is over-rated. In fact, when i did a simple poll in my office, for those that buy stocks (there are about 10 that I know) none of them believe in Value other than me. Most feel that market is irrational and reading annual reports are a waste of time. How can Value be overrated then?

wee

Musicwhiz said...

Hi JW,

Thanks for the tip. You mentioned FCGY who trades with fundamentals, but it sounds like an oxymoron to me. How does one "trade with fundamentals"? Anyway I will check him out on rmao forums.

Thanks,
Musicwhiz

Musicwhiz said...

Hi Wealth Journey,

I've learnt that people with "winning" systems seldom care to share them in real life. By implication, this means that those who preach winning systems in the newspaper probably do NOT have one, and thus need to sell themselves through courses to earn money from participants rather than through their own system.

Regards,
Musicwhiz

Musicwhiz said...

Hello HH,

Nice of you to drop by. Thanks for your confidence in me, and for believing that "value" can work well over time. Guess I am still a little too young and "green" to be able to invest properly, and probably need more time and exposure to big bad Mr. Market. :)

Cheers,
Musicwhiz

Musicwhiz said...

Hi Wee,

Thanks for the encouragement too, and for visiting.

You are absolutely right on me choosing companies with poor Balance Sheets. I had thought that high barriers to entry would be a sufficient reason to justify my purchases of Ezra and China Fishery back then, but apparently there is no excuse for a poor Balance Sheet and qustionable Cash Flow Statements.

I am heartened to know that there are other value investors such as yourselves out there in Singapore. For me, it's been close to impossible to find one - everyone I know believes in trading and TA rather than value investing. It's also quite a wonder to me if all of them or even a majority of them manage to make money consistently, yet they keep trying nonetheless. No one seems to believe in value anymore, after the sharp financial crisis.

Regards,
Musicwhiz

Musicwhiz said...

Hi again wee,

Your request to James is sound, though asa I mentioned before I personally think it's neither technicals nor value or even a combination; but a personalized version of what one feels comfortable with. Thus, investing is intensely personal - we should not follow Buffett or Graham just because they did things that way, but should modify it accord to our temperament and circumstances. That said, this of course can be quite a challenge.

Anyhow, I feel that I probably need at least 10 more years to get this right. It's really not as easy as it seems and I am probably just brushing the surface of value investing. There's so much more to learn and so many more people to learn from.

Regards,
Musicwhiz

wee said...

Hi MW,

The fun is in the process; so even if it takes 10 years, its ok to me.

I share your frustration that it is very difficult to find people in Singapore who still believe in Value. Most find it too time consuming, and the Great Crisis of 2008 made lots of people who does not believe in Value go, "see, I told you!"

I have another observation for your consideration. Companies that are capital intensive generally have asset heavy balance sheets and needs substantial cash to grow. Whether they grow at a fast rate or a slow rate do not detract from this basic premise.

Such companies in my view have only average economics. If one practices focused investing (i.e. only holds a couple of stocks) and holds long term, it is importantly to continueously seek out companies with above average economics. As Buffett says, time is a friend of a great business, and an enemy of a lousy one.

And time is the key advantage of a value investor; so don't waste it.

Musicwhiz said...

Hi Wee,

Yes, that is a frustration I share as well. But I won't kid myself to think that my method can do better than theirs. I have to work at it and perservere in order to succeed.

And yes I also agree some of my companies need substantial capital to grow. I will be reviewing my criteria for purchasing and focus more on companies which can sustain and grow through operational cash flows and less through external financing.

Don't worry, I still have time on my side. Not too old just yet!

Cheers,
Musicwhiz

James said...

Let me clarify something. Before changing my investment approach, I was using value principles and when I stopped using it I had achieved a compound annual rate of return of approximately 15% pa.

However, I was not satisfied with that sort of return because I was not having a smooth equity curve. Out of the 7 years of record, I had like 4 up years and 3 down years. What I wanted was 7 up years and this is what I mean by high impact returns.

On my comment that value investing is overrated, I believe that I am more than qualified to say this. In my previous life, I was in private equity which meant that I acquired companies via buyouts and the basis of analysis is always cashflow driven because of the leverage involved. So I know what I am saying when I say value investing is overrated.

The average investor often does not understand what is real value and distinguishing between a company that is only worth a two year trade versus a long term hold. I believe I have more than covered all the pitfalls of value investing in my posts on Wallstraits under jfhl and Larry Livingston.

The biggest problem remains that value criteria is so difficult to establish and one can hardly know he is even right even if he made money.

You will discover this one day.

Btw, I am way past passive income because I have already enough from interest income even if I do nothing. All I am interested is to have consistent year on year growth on my equity curve. That is the challenge that I enjoy.

As to writing a blog, I may do that one day but for now, I contribute as and when I have time. In any case, I am running my monies as a hedge fund.

All the best in your continuing journey!

wee said...

James,
thanks for your clarification.

I hope you can find time to write a bit more about the details as to how one can use TA and consistently beat the market (year in year out like you said). George Soros seems to be able to time the market, but in his books he failed to detail how he does it. Is it a science that can be learnt by anyone with hard work, or is it a hunch or intuition that only the lucky few have?

I look forward to reading your Blog or -- even better -- your book should you decide to invest the time.

regards
wee

Wealth Journey said...

James,

This is something that has been bugging me all the time. And you have certainly highlighted something that I always thought is safer (if i can take the forex fluctuations).

My investment portfolio is worth around sgd$Xmil (Excl. 5yrs living expenses). If I just convert everything to aussie, I can live off the interest component which at 4% (min. base on aussie decade normal rate), the interest comes up to $xx0k annually and after 5yrs will regenerate enough for another 5yrs of my living expenses. I have decided to invest most of it as I would like to double the money and then I will quit the market and live off the interest income.

I am interested to know, why did you decide to have a hedge fund when your interest is enough to live off. Is there something that you are trying to achieve or discover it is better to keep invested?

Do start a blog or share more in wallstraits on your investing methods and views.

Musicwhiz said...

Hi James,

It sounds very impressive indeed, and I didn't realize you posted as "Larry Livingstone" in Wallstraits. That forumer is very highly respected for his trading and I know he has made tons of money - glad to make your acquaintance. Seems my blog is attracting the rich blokes haha!

Well all I can say is if you have your own system it's well and good for you. This does not mean value cannot work; it simply means you have modified it into something different for your own purposes.

All the best too, I am sure you are doing this for the passion and not for the money.

Cheers,
Musicwhiz

Musicwhiz said...

Hi wee,

My personal opinion is that George Soros uses his own theory of "Reflexivity" which is basically his own style for reading the market. It will be difficult if not impossible to emulate him because, as I mentioned, investing/trading is intensely personal.

Just my views.

Musicwhiz

James said...

What I have achieved can definitely be learned and replicated so long as one is ready to put in the long hours of study and actual practice and to keep at it till you succeed.

Wealth Journey

Just a further clarification. I have cash set aside that through just interest income already provides for more than I need every month.

The rest of the monies are managed as part of a hedge fund. Why do I do it and so called take "risk". Because I can do it consistently and because I will be very bored since I am retired when I am in my 30s. Hope that clarifies.

Musicwhiz said...

Hi Wealth Journey,

You sound like a very experienced individual yourself, and very rich too no doubt.

Wow that makes 2 people in this comments box thread who have achieved financial freedom, and all around my age. I have some catching up to do....!

Cheers,
Musicwhiz

Musicwhiz said...

Hi James,

Just curious about what you have described about yourself - may I find out what your "seed capital" was before you managed to grow it to the current size?

Also, I take it that putting your money in a hedge fund at least gives you something to do, and at the same time the interest income allows you to pursue your passion. I guess I have some ways to go. :)

Regards,
Musicwhiz

Ricky said...

MW, you have my respect. To know what suits you and to have the perserverance to stick with your system. Wish you all the best :)

Musicwhiz said...

Hi Ricky,

Thank you !

Cheers,
Musicwhiz

James said...

I probably started with around 1m. The starting capital is not as important as the rate of your compounded return. When you can achieve 40 plus compounded returns, even a small seed amount grows into a huge amount quickly. The magic number for me is 42% since you do this twice, and you can double your money. So each time I start a campaign, I target to get 42% return. A typical campaign for me is approximately 5 to 6 mths.

wee said...

MW,

you have made my point about George Soros. I have briefly browsed through his book on his theory, but i am no closer to knowing how he does what he does.

At the recommendation of James, I have also obtained and read the book by Anthony Bolton. Again, I did not see him explain in detail how he does his TA, and how he use it consistently to profit from the market. In fact, 80% or more of the book talks about his FA.

James said...

Go read How to make money in Stocks by William O Neil. If you can even master 70% of what is in there, you are on your way to high impact returns!

Musicwhiz said...

Well James, you are one truly blessed individual to be able to enjoy financial freedom so young while others in your age group are still slogging in the rat race. Guess I have a lot to learn on how to achieve this!

42% per annum sounds better than Warren Buffett. That's really a very incredible return! For me, I am more conservative - 8% per annum (including dividends) is quite sufficient for me. If I can achieve something better than this, I consider it a bonus.

Thanks,
Musicwhiz

Musicwhiz said...

Yep Wee,

I feel that no matter how much we read about how these "gurus" made their money, we are probably unable to emulate it ourselves. This is because we are inherently different people from them! The good thing is that they try their best to distill their internalized knowledge into a book to spread the good cheer to everyone; but the bad news is that we the readers need to know how to modify what we read to suit our own knowledge and temperament. Internalizing something is a lot more difficult than it sounds. Trust me I have got experience on this myself trying to internalize the teachings of value investment.

Regards,
Musicwhiz

James said...

8% pa? That is too low a return given the risk that you are taking (known and more importantly unknown) not to mention the hours you spend pouring over annual reports and other fundamental information.

Put it another way if one wanted 8% return, all one needs to do is to buy a diversified basket of corporate bonds and add a little leverage and you can get 8% return with less risk and volatility.

You really need to rethink your return considerations.

In private equity, we typically target 25% to 30% returns and there we control the company's cashflow.

It is one thing to be conservative but another thing if you are under estimating the risks you are bearing.

Hedge funds generally target a consistent 15% because they tend to hedge out most of their positions. You are fully exposed to market risk and you are satisfied with 8%? Think again.

Musicwhiz said...

Hi James,

While you do have a point, I must emphasize that even getting a +ve return in the stock market is not easy, much less a consistent 8% per annum. Of course, you can mention corporate bonds or private equity (pre-IPO) but only accredited investors such as yourself have privvy to such deals. Normal retail investors like us without access to either privileged or private banking do not have access to such products as well as opportunities. Hence, I would not expect a spectacular return like that of hedge funds (15% per annum).

In your opinion then, considering the amount of research I do, what return do you think I should be gunning for and why?

Thanks,
Musicwhiz

James said...

One must not be shut himself out of opportunities because of his or her lack of perceived access to private banking tools. Trust me, it is over rated. If those investment advisors were worth their salt, many would be investing their own money.

Take UOB preferred stock listed on SGX. It gives one a yield of over 5% depending on your entry price. There is also DBS and other instruments out there that one can construct a portfolio mimicking a corporate bond portfolio. Add a little leverage and viola, you can get a consistent 8% without much work and volatility.

In addition, if you believe in long term investment, you can simply open a brokerage account such as interactive brokers and sell put options on a well established index such as the S & P 500 and earn consistent income. This is a fairly safe approach because you can choose to sell options 30% or more below the current level.

So there are many ways one can make consistent money in the market without excessive risk if only you would think out of the box and not treat investment in "equities" as a be all and end all.

I started without access to any private bankers and even today do not use any of their services. I make all investment decisions myself.

So if you do not target to get at least 15% pa, then you are better off creating a relatively safe portfolio from preferred shares, bonds and reits (those that are lowly geared but provide relatively high yields) and then ignore the stock fluctuations of the REIT.

bert said...

hi james....why do you include reits?

James said...

A reit which has low gearing and a good portfolio of properties with stable rental income is actually a fairly safe investment proposition.

Witness the wannabe average property investor whose dream is to own a property and collect rental income and retire.

The reit allows you to do all that without taking gearing on your own account and without the hassle of dealing with the tenants and yet benefit from a diversified stream of income from various properties. Essentially a fractional piece of a property without the associated hassles. Why not a reit if you just want to generate 8% to 10% without too much risk?

wee said...

James,

One question if I may - how does one use leverage in your example too boost returns to 8% if the preferred stocks yield only 5% or so? Do you have some other ideas other than the conventional margin leverage offered by the local brokers (which costs 6% currently)?

Thanks
wee

James said...

Increase your leverage from your property and use the cash to increase your investments and hence your yield.

The interest rate from the property loan is the cheapest you can get.

Createwealth8888 said...

Hi James,

Are you refering to Home Equity loan as leverages?

Musicwhiz said...

Hi James,

Thanks, I shall target 15% per annum then. Whether I can actually do it or not is the question of course, I do not think I can be as savvy as you are after describing the various methods to get a better return.

And I also do not know how to use leverage to maximize my returns.

Thanks,
Musicwhiz

Musicwhiz said...

Actually 8888 and James,

I think borrowing against your home has its risks as the property value can drop and the bank can ask for a top-up.

Correct me if I am wrong, but this kind of method entails a healthy risk appetite and one must know the property market very well.

Regards,
Musicwhiz

James said...

Yes home equity loans.

Actually, one need not go crazy and borrow to the hilt. Taking out 50,000 to 100,000 against your home should be fine. In any case, so long as you can service your loan and your overall leverage is not over 90%, banks will be reasonable and not require a top up even if your value falls. From the bank's perspective, it is all a risk assessment and what is good business sense.

If you can show that you and your spouse have good stable income, they will not ask you to top up.

Musicwhiz,

In life, there is nothing so difficult that we cannot learn. Just because you do not know how to use leverage or so called more sophisticated strategies does not mean you cannot read up and learn.

One's success is proportional to the effort that you are willing to put in.

If you think that success came to me easily, think again because all I achieved is due to relentless hard work and self study.

Open your mind to new ideas and techniques. Only then you can break new ground. Imagine how the world can progress if no one out there was willing to challenge conventional wisdom and take everything as given.

Musicwhiz said...

Hi James,

Thanks for the advice. For now, I will try to be as good as I can in what I do before I branch out to try other things. I feel I can't even get value investing right; so I'd better not be too ambitious or I might end up as a "Jack of all Trades, Master of None".

Thanks!

Musicwhiz

James said...

You are welcome.

All the best.

Anchovies said...

Hi all

Good discussion.

Preference shares does not always pay the % interest. After certain years it becomes floating and theres also a chance that they might not get paid.

Also, you might not be able to sell it at par too.

Leveraging that would mean adding additional risk for the extra return?

Musicwhiz said...

Hi Anchovies,

I didn't know that about preference shares. Anyway they are still shares after all - if something bad happens to the company secured creditors get their money back first. That said, the 3 local banks' preference shares should be safe enough, provided you don't lose out on the capital loss (should there be any).

As for the leverage part, yes there will be higher risk for higher return; but currently I do not believe in using leverage. I need to build up my capital base first; it's currently much too low.

Regards,
Musicwhiz

Createwealth8888 said...

http://createwealth8888.blogspot.com/2009/04/eight-immortals-crossing-sea-each.html

China has an idiom, the named “the eight immortals crossing the sea, each obviously its energy”.

Ensure you have ENERGY to cross the sea.

Musicwhiz said...

Hi Createwealth8888,

Thanks, I guess you are referring to each person having his/her own special capabilities and that we should work on them to become better over time.

I will do so. Appreciate the advice.

Regards,
Musicwhiz

CK said...

Hi.

After reading the way you presented this post, I thought you may be interested in this book: Billion Dollar Lessons

It captures the spirit of Charles T. Munger who said:"All I want to know is where I'm going to die so I'll never go there."

Enjoy learning,
CK

Musicwhiz said...

Hi CK,

Thanks for the recommendation. Charlie Munger is indeed a powerful figure in investing and WB's right-hand man. Will check out this book written by him.

And yes I do enjoy learning and will continue to do so.

Cheers!

Musicwhiz

CK said...

Hi MW.

My mistake for not typing my comment clear enough; "Billion dollar lessons" are written by Paul B. Carroll and Chunka Mui.

I used Charles T. Munger's quote for the purpose of this book's lesson.

In any case, if you like to read books on Charles Munger, there are currently two available that are endorsed by him in poorcharliesalmanack.com

Just to let you know that my original order of these two books are still lost in transition and they had compensated me with another two books with express shipping. Conclusion: order with Express shipping.

Musicwhiz said...

Hello CK,

Sure thing, thanks for the tip!

Cheers,
Musicwhiz