Wednesday, March 10, 2010

My Learning Curve In Value Investing

This post is a somewhat reflective one as I mull over my investing journey after switching over to value investing in late 2007. So far, it’s been a rough ride over the last two and a half years with turbulence rocking stock markets and a “lost decade” appearing for many countries, thus shaking the core of beliefs which many had on the stock market always giving a positive return over time.

For me, this journey is poignant as I slowly but surely learn more about investing, understanding companies, applying lessons learnt, reviewing mistakes and improving my fundamental analysis skills. Somehow, at this point in time, I still feel that I have so much more to learn from many veterans in the field of value investing about how to select good companies which are being offered by Mr. Market at reasonable prices. I have had my share of “hits” and also the painful “misses”, to illustrate to me that there is an almost infinite number of companies out there and one can only do so much with the amount of time he has on his hands. There is always going to be a constant trade-off between quality time with family and loved ones, and time being devoted to the careful and thorough analysis of companies and one’s shareholders and portfolio. It is a delicate balance which I do not wish to disrupt, as the dangers of getting too absorbed in analysis and investing can take a toll on one’s social life and psychological well-being. Life is more than just about making money!

Gentler Learning Curve

Over these 2 years, I have noticed that my learning curve for investing has become less steep, and knowledge acquisition is also less rapid. When I first started out on my journey, my mind was like a sponge and was eagerly soaking up all pertinent and relevant information about value investing. I had a voracious appetite for books on Warren Buffett beliefs and techniques, Benjamin Graham’s margin of safety, Peter Lynch’s classification of companies, Charlie Munger’s thought processes and frameworks and Phillip Fisher’s scuttlebutt, and would also trawl the Internet for bits of information to enhance my critical thinking and analytical skills.

However, as my knowledge base increased, the learning curve also became gentler and I now have the inherent knowledge on valuing companies, understanding their business model and knowing where and what to look for. It has become so much easier and less tedious for me as I acquire more experience and practice in sieving out relevant information and zooming in on important ratios or numbers, and this all helps to reduce the amount of time spent on research and the efforts put into churning up a valid assessment of companies. Back in late 2008, I was struggling with my analysis of Tat Hong and took a whole two months to put together a rational analysis comprising tables with numbers and an analysis of the business (of course, there was much procrastination in between as well!). In 2009 the amount of time required for analysis was narrowed down to a few weeks, and for the most recent Kingsmen analysis it took about a week or so to compile all the numbers, obtain all the facts and put them in my head for churning and analysis. Part of the reason for the faster analysis time is also because I have all the spreadsheet templates ready on Excel to plug in the relevant numbers, and discussions on value investing forums have taught me how to make use of other important metrics and ratios to enhance my understanding of the Company.

Inclusion of Competitive Analysis

One major flaw in my previous analyses of Tat Hong, MTQ and GRP was the lack of a suitable framework and information for analysing competitors, which are a very important aspect of any investment thesis. Previously, I used the Porter’s 5-Forces model and the trend in revenues and numbers to justify a case for a strong competitive moat which was unlikely to be assailed by competitors. This has turned out to be both flawed and also insufficient as I have since found out that Tat Hong does not have such high barriers to entry after all (i.e. there are many smaller crane companies around which can be easily set up to buy/sell/rent cranes and heavy equipment) and that the industry itself is fragmented with no major players. If I had insisted on doing a proper competitive analysis framework back in 2008, I might have weighed the company differently on “cons” and may have been more cautious in my decision to invest in it.

For MTQ and GRP, I had used the stability in revenues and long-term trend of net profits and dividend history to assure myself that both companies had a competitive moat and that they were operating in a niche industry for which their products/services would be in consistent demand. This was also not an ideal analytical scenario to be used as the historical stability of revenues may not indicate future stability, and that I should have instead probed further into each company’s competitors to see how they were doing, and what plans they had for growing their own businesses. In short, I failed the “scuttlebutt” test which Phil Fisher proposed, which is to actively seek out competitors to the companies you wish to invest in and interview THEM on how they view the industry and competition. Admittedly, this would be time-consuming for someone like me with a full-time job.

Some suggestions I received for improving on my competitive analysis was to obtain extract competitor information from analyst reports, and surprisingly this turned out to be a very good source as analysts would normally use peer comparisons to justify their PER ratings. I realized that analyst reports would give a good laundry list of competitors which one could then focus on and drill down further to analyze and compare them on their strengths and weaknesses (thanks for cif5000 for this information). Another area was to do some independent research on the Internet for competitors or to use basic reasoning, observation and common sense to identify competitors. For example, for Kingsmen’s case I had already known about Cityneon being a credible competitor; while Pico Far East’s name can be seen on most major events as I walk around town. So it pays to keep one’s eyes and ears peeled all the time!

Re-defining the Concept of a Good Business

As I scour through the universe of companies listed only on SGX to find those of investment quality, it has also made me slowly change my views on what constitutes an investment-grade business; and what makes up a mediocre business. My original view of good businesses were those with so-called high and unscalable moats as they had high barriers to entry. I was looking for companies which were growing profits quickly and had high profit margins, and did not mind such companies taking on massive debts to fuel their growth. This explains my original investments back in 2005-207 of Ezra, Swiber, Pacific Andes and China Fishery.

That view has been seriously challenged not just by the theory to be found in value investing tomes, but also real-life experiences in observing companies with high debt and supposedly high profit margins come under attack, some either falling by the wayside while others imploded quite spectacularly. I have come to realize that businesses with high capital requirements tend to have less free cash flow available, and that internal cash flows are the best for use in growing the business. Growing through M&A should only be done if a Company has exhausted all its organic growth potential. Also, a business which requires light working capital and yet is able to grow and generate FCF may also qualify as a viable investment-grade business; as opposed to a high profit margin business which requires constant large sums of capex.

Over the years, my focus has also shifted from focusing excessively on the Income Statement, to now focusing more on Balance Sheet strength and Cash Flow quality. This is where my knowledge base as a trained accountant comes in handy in reading and interpreting the financial statements!

More Room for Improvement

To sum up, there is still much room for improvement in my techniques and skills. The mistakes I made over the past few years only serves to emphasize how vulnerable I am, and also to reveal how flawed my original techniques were. Luckily, I am happy to say that I am eager to learn and I am not afraid of mistakes, as long as I do not repeat them! Hopefully, in a few more years, I can look back and report that I made major improvements to my investment style and enjoyed much better success.

24 comments:

Castor said...

Dear Musicwhiz,

I am your regular blog visitor. I wanna let you know that, from you I have learned a lot.
Thanks for sharing, and keep updating your blog plz.

By the way, what is ur opinion in Epure Int? Mind to share a brief one?

Musicwhiz said...

Hi Castor,

Thanks for visiting and thanks for the support. Don't worry I will keep updating the blog, but life is getting busier for me now haha.

No opinion on Epure sorry, I have not studied the company in depth.

Cheers,
Musicwhiz

JW said...

Hi MW,

great post! Super solid!

Royston said...

Thanks for sharing, great post!

Musicwhiz said...

Hi JW,

Thanks for visiting!

Cheers,
Musicwhiz

Musicwhiz said...

Hello Royston,

Many thanks for visiting too!

Regards,
Musicwhiz

Ilya said...

Wonderful !

If you still have time, you may find the field of communication very interesting.

Companies like SingTel, Starhub, M1, Telechoice, MemTech, NeraTel. They all provide good dividends.

As you said, the capital requirement is not high.

Thank you for your sharing.

Musicwhiz said...

Hello Ilya,

Thanks for the tip, I may explore that in future.

Thanks for visiting!

Musicwhiz

hyh said...

Hey, 3 years is a mere blimp in history. more lessons, good and bad, ahead.

There is no magic formula. On the contrary, there are many true and tested but conflicting concepts.

Value investing is great (I subscribe to it), proven bt the S&P which over the last CENTURY had double digit CAGR, despite 2 world wars and the great depression. Short term, though, you may take a hit.

Adjust it by looking at the competition may help a bit, but don't forget that only one company in the original Dow Jones index is still around. Many died not because they were not competitive viv-a-vis other player, but that the entire business for all players were wiped out.

More adjustments? Of course, but at the end of the day, it is business acumen and foresight that wins out. A cop out would be to buy ETFs or go for technical analysis. But then, life would be a bore.

Kepp up the good work!

HYH

MOS said...

Hi MusicWhiz,

As "amateur" value investors, sometimes it'd be great to hear how the "professional" value investors do it. Warren is a great teacher but after a while, you get to know most of his lines about investing.

Well, I found this excellent website that I would recommend to everyone.

The "Ben Graham Centre for Value Investing" at the University of Western Ontario, Canada invites professional value investors to talk to their students every year. Each speaker is filmed and you can watch their videos.

http://www.bengrahaminvesting.ca/Teaching_Applications/Guest_Speakers/2009_speakers.htm

Look under "Teaching & Applications"->"Guest Speakers"

Most of the speakers are Canadian but there are some Americans too. My favorites are Walter Schloss and Irving Kahn, who both knew and worked with Ben Graham himself.

(Some of you may be aware of this website, but I think its valuable enough to mention it for the benefit of others)

Musicwhiz said...

Hi hyh,

Haha well I would caution that the Index moves up over time based on survivorship bias, so that's not a really accurate way to look at it. Cosco Corp was just replaced by CapitaMalls Asia in the latest STI revamp, just because it had fallen off the radar of institutional investors.

I'd like to think studiously analyzing businesses can help to achieve long-term decent returns, even though, as you mentioned, only 1 out of the original Dow 30 still survives today in its original form (General Electric).

Thanks for your encouragement!

Cheers,
Musicwhiz

Musicwhiz said...

Hello MOS,

Hey thanks a lot for the link! Yep, all of us are still amateurs. I think even if I was investing for 10-20 years I may still view myself as a "newbie". Because learning is the only constant in life, and one cannot purport to know everything.

Thanks,
Musicwhiz

melon said...

Hi Musicwhiz, re: sourcing of info of a company. You mentioned about analyst reports giving you a headsup on the company's competitors. Where do you typically source for such reports? Most of these are paid subscriptions (such as SIAS research).

Musicwhiz said...

Hi Melon,

Remisiers.org does have some free analyst reports. You can check that out.

Alternatively, I can suggest signing up with brokerages to get free reports, or by contacting friends who know of bankers who work in the foreign banks to provide some of the buy-side reports. Admittedly they are not easy to get, but no harm trying!

Good luck!

Musicwhiz

Akatsuki said...

SOOOOOO inspiring!!! T_T
Keep up the good work!

Willie said...

Hi Musicwhiz,
My second posting to your blog. In short, I love your blog posting , so keep it up !!! . I guess everyone inspiration is to become financial free. Free from worrying about $$. I would like to share my 5 cent worth comment here ;p. No matter how complex your fundamental analysis of the company,even if is trading way below the intrinsic values, one most important aspect is to see if the Board of Management are shareholder friendly. I would say 90% of the listed company treats shareholder like dirt. Whether in good time or bad times, it seems like they always have the reasons to raise rights issue, new issues or any other form of dilution which destroy the value of shareholder. In short, u can have a rapid growth company growing 25% per annum. However, on the other hand, they may raise new shares at a turbo rate !! . Value investors like us who hold stock till death do us apart must be extremely cautions on this. Even if the company is trading at below the intrinsic values. This is the lessons that I learn while I gotten incinerated by China stocks. Now I learn my lesson and I will focus on local stock and blue chip. hehe ..

Musicwhiz said...

Hello Akatsuki,

Thanks for visiting!

Regards,
Musicwhiz

Musicwhiz said...

Hi Willie,

Good point! Thanks for the tip on shareholder friendly BOD. But I guess sometimes it can be difficult to ascertain because Management and BOD are usually cordial towards shareholders at AGM, and release information as required by law and SGX. So it can be hard to ascertain if such BOD are truly "shareholder-friendly". Warren Buffett did talk about this at length and it would be good to pick up a book "Even Buffett Isn't Perfect", to get an idea of where he stands. His shareholder letters are also very useful.

Thanks for visiting and the compliment!

Cheers,
Musicwhiz

melon said...

We all have limited time in researching each stock. Ultimately, there may be a thousand gems out there but it takes time to sieve out the good stuff from the bad stuff. As you pointed out, most of us have an active life and would not want to compromise that do achieve our financial goals.

What do you suggest to screen out a number of potential stocks to analyse? For me for Singapore, its Lynch’s way of walking down the street, looking that potentials that arise from FMCG that we use everyday or looking at a certain airline after taking it for a holiday. From there, to go on to dissect them properly. But these probably represent only a small amount of the universe of stocks out there and are a hit-and-miss thing.

There are certainly many screens out there. Most of them apply to the US market. Some people use it just for mechanical investing (such as Greenblatt’s little book that beats the market, dogs of the dow). There are screens for growth, for value, GARP and just about anything else. I do not subscribe to mechanical investing but I think these lists are great for narrowing down a list of viable companies to research such as not to waste your time on sub-part ones.

Any ideas for the Singapore market? Its hard to find free comprehensive market data that is easily manipulated into screens.

Christina said...

Thanks for sharing your story..we should all not be afraid to make mistakes and open ourselves to continually improve for the better. Kudos.

Musicwhiz said...

Hi Christina,

Thank you for your kind words, and thanks too for visiting.

Regards,
Musicwhiz

Musicwhiz said...

Hi Melon,

Thanks for your comment. It's very useful indeed.

Well, for me I usually use the manual method of sieving through all companies' results and then glancing at earnings and Balance Sheet/Cash Flows. Very tedious but then I don't think there's any other way. Certainly if there's a good deal no one will tell you about it. Haha!

Cheers,
Musicwhiz

CaTJedi said...

Hi Musicwhiz,

I am a dedicated follower value investing. I am personally inclined to holding a defensive portfolio which i find difficult to achieve if I were to restrict myself to Singapore Stocks.

Based on the book, The Intelligent Investor, if i were to strictly follow the book, a defensive investor should buy stocks in companies that have market capitalisation rate of at least $10,000,000,000 (in the updated 2003 version), this will restrict me to only 14 companies on SGX.

Can you provide me with any advice?

Musicwhiz said...

Hi CaTJedi,

Haha I think Intelligent Investor was written for the USA market, and thus it would not be practical to use their numbers to extrapolate onto Singapore listed companies.

In terms of a defensive yield portfolio, I think many Singapore companies do qualify. But these are mainly the blue chips with monopolies like SPH or SingPost. Still, it's best to choose carefully before committing. Personally, I am aiming for a 5% yield for FY 2010.

Good luck!

Musicwhiz