Thursday, January 26, 2012

My Value Investing Journey

It has been about 4.5 years since I first started serious blogging about investing and investment, and since then it has been a very steep learning curve for me in terms of acquiring knowledge, improving my analysis and sharpening my focus on companies. At the same time, I had also acquired important character traits and temperament which also aided in my journey to compound and grow my money. I guess this second-last post is to summarize my journey so far, and to collate all that I had learnt. I will also be penning down my plans in the medium-term, and how I plan to grow my portfolio; along the way I will also talk a bit about personal finance and its importance in helping one achieve one’s money goals.

Acquiring the right skill set and mind set for value investment

I guess you could say that I started out on the “right” path for investing by taking a Bachelor’s degree in Accountancy, for it laid down the basic foundation for me to read, understand and interpret financial statements, which are the language of business. Along the way, I also obtained my Masters in Business Administration (MBA), which further enhanced my knowledge and understanding of businesses and how they operate. I credit my alma mater with providing me with concrete, real-life examples of companies, their corporate strategies and business models for me to analyse as part of group projects and assignments. At the same time, I also took up many modules (as an elective) on marketing such as consumer behaviour and promotional marketing, and thus understand better how companies market and sell their products, target markets, market segmentation and product positioning strategies. All these constitute my “skill set” and competency for investing, which I feel is very important if one wishes to pursue value investing.

Additionally, reading up many good books on value investing and the value philosophy such as “The Intelligent Investor” also helped me to build up and solidify my framework for prudent and conservative investing. I guess my other name for value investing would be “sustainable investing” as it can take you through economic cycles relatively unscathed. While it is not a method which can grant you instant riches, it can help you to avoid crippling losses and prevent you from becoming poor. Therefore, it is a slow and steady way to wealth, which gels very much with my psychology as well – I was never a showy person who needed to fling my wealth around or to prove that I can earn lots of money.

Acquiring the right mind set for investing took a little more time, and was noticeably tougher because after all, this is psychology and emotions we are talking about (mentioned in detail in my previous post), which is not something you can easily imbibe into your life. It was only through reading books like “Your Money and Your Brain” and going through a real-life (harrowing) experience of a full bull-bear cycle (while being fully vested all the way) did I manage to cultivate the necessary tolerance to pain, discipline, patience and calmness in order to survive the emotional ups and downs thrown out by Mr. Market. So for those who are working on the psychological aspect of investing, do not be discouraged – continue to read and learn about your own psychological and emotional make-up, while at the same time testing your reactions in real-life investing situations (by analysing and putting real money down, not phantom funds). Please understand that the process of acquiring the right mind set will take time, and one should not rush the process.

Improving savings rate and embarking on lessons in personal finance

Over the years, as I learnt and read up more on personal finance, I also began to improve my own tracking and monitoring (and control) of my own finances. Blogging about it also helps, as it crystallizes my thoughts and embeds the concepts deep within my cranium. Over the years, I can boldly declare that my income had not risen as much as I had hoped for (sadly), but as a result of living a relatively simple lifestyle, I have been able to save (on average) about 45% to 50% of my take-home salary (after deductions for CPF). The same is also done for my wife, who lets me manage her finances on her behalf. With this savings habit, it has translated into a lot of buffer and financial security, even during periods of sudden distress (such as the hospitalization of my daughter middle of last year). I am glad that this habit of “paying myself first” has afforded me the luxury of having a cash hoard with which to tap in case of emergencies, and it also acts as a good source of funds for investments into equities should juicy opportunities come by.

Besides the afore-mentioned savings habit and prudent spending, I had also, over the years, begun to meticulously track various aspects of my finances, which was detailed in a previous post. Whether it be my mortgage loan, equity portfolio, passive income, cash flow or CPF Balances, I have spreadsheets for them and can monitor the balances at any time, instead of waiting for the official statement to arrive from the relevant Government bodies (HDB, CPF, MND). These have helped me to gain a better grasp of various financial aspects of my life and made it easier for me and my wife to understand our financial situation at any point in time.

In keeping with a prudent (and healthy) lifestyle, I have avoided purchasing a car during my entire adult working life; and instead choose to take public transport, walk or cycle to my destinations. This is not only a good method of conserving the environment (greenhouse gas emissions are on the rise globally), but it also allows me to enjoy more of Singapore. Cycling allows you to go to places seldom accessible by car, while public transport allows one to see a microcosm of life in our hectic and frenetic little Red Dot. Of course, most times I see people absorbed in their iPhones and Blackberrys, but observing people has been one of my little hobbies and public transport allows me to do so, while cutting costs as well.

Along the way, I have also avoided being trapped by materialism – I have no branded items myself.

Gaining a better understanding of behavioural finance

From my very first bad trade and mistake made in Yellow Pages (panicking and selling at a loss), to my current situation in handling potential bad news coming from my companies, I have realized and been aware of the importance of emotional control and psychology in investing. This is why I had starting reading up fervently on a new branch of economics and finance called Behavioural Finance as early as 2008, and picked up books such as Your Money and Your Brain by Jason Zweig, and also wrote many posts on aspects of behaviour, emotions and psychology. Value investing is not complete without the proper temperament and emotional framework, no matter how expert an analyst you are. There are people around me who I would proclaim to be much better at analysis, discounted cash flow and other arcane methods of valuing companies; but they love the thrill of speculation and therefore may be ill-suited for the value investing process.

Behavioural Finance also exposes our weaknesses and frailties when it comes to making decisions involving money, and how humans love to sabotage themselves when it comes to financial decision-making. A thorough understanding of heuristics, biases, fallacies and illusions can help us to better control our base instincts in order to make more rational choices which would benefit us in the long-run (though it may cause severe pain in the short-term). Humans also prefer certainty and this is why we read about so many “predictions” and “forecasts” once the Year of the Water Dragon arrives. I also read about many people flocking to fortune-tellers to find out what they should do in the coming year. Ultimately, the choices you make will influence the outcome of your investments, and uncertainty is actually the friend of the rational buyer because it creates situations in which pricing of the security is below intrinsic value (discounted for an unknown future).

Thus, I am glad to have been endowed with knowledge on behavioural finance and feel that as a result of this knowledge, I have also become a more calm and objective investor.

Acquiring knowledge on alternative investments – Bonds and RCPS

Through the years, and after countless conversations on value forums regarding investments, I had also picked up considerable knowledge on other forms of investments such as RCPS (Redeemable Convertible Preference Shares) and bonds (fixed income instruments). Healthy and constructive debates over the months and years have provided me with a good foundation of knowledge which I am actively and rapidly building on. Knowing about such investments gives greater breadth to my own portfolio and allows me to include other asset classes in order to buffer the portfolio in case of any extreme and adverse events. Also, as one ages, one should shift their portfolio towards a mix of equity and bonds as an old investor may not have the luxury of time to sit out a protracted and prolonged bear market. Therefore, knowledge of alternative investments is important to have in our arsenal should we decide to deploy our monies. (I do not consider Gold and Silver as investments as they do not generate cash flows for the investor – it is essential a buy higher, sell higher mentality which I classify as speculation).

Learning about portfolio management, asset allocation and portfolio rebalancing

The important aspects of portfolio management (monitoring my companies, and adding shares to more promising ones), asset allocation (to equity and fixed income components, in the future perhaps) and portfolio rebalancing (switching out of a lousy investment in favour of a better one) are all essential skills which an investor needs to have in order to ensure a consistent decent long-term return on his portfolio.

Investing for Growth and Yield – A Potent Combination

Over the years, I have learnt the power of investing for both growth and yield; and the combination can grow one’s wealth over time above the rate of inflation. Of course, the balance between growth and yield is a delicate one, but the companies within my portfolio all have some measure of growth even as they pay half-yearly dividends. The key to sustainable growth is to ensure the Company has a competitive edge, honed either through years of experience in serving customers or else through the build up of strong customer relationships or a wide network of branches and client locations. Not to be forgotten is also the concept that growth should not be too fast and furious, but should be steady and well-paced. An organization which focuses too much on top-line growth, for example, may end up being too aggressive and would fizzle out over time, destroying shareholder value in the process.

The secret to being able to sustain a decent yield yet offer growth is in the cash flow statement. As they say, the devil is in the details and it pays for the investor to closely study the cash flow statement in detail; not just for two consecutive years in comparison but to do a ten-year historical study if possible. This is to glean information about the Company’s ability to generate strong, consistent and healthy FCF and if they are more than sufficient to cover average capex required to keep the Company up to speed in terms of technology and knowledge acquisition. For companies which can generate excess cash flow, this means that they have sufficient resources to plough some of that cash back to grow the operations and ROE, while also afford to pay out some of the cash as dividends as a reward to shareholders. It is my job to search for more of such companies which are being sold by Mr. Market at a decent discount to intrinsic value.

Imbibing good lessons and practices from other esteemed value investors

I would like to take this opportunity to thank the many value investors and bloggers over the years who have contributed to my knowledge base and also injected in me a healthy scepticism regarding companies and corporate announcements. There are also people who provided constructive criticism and allowed me to rethink on my choices and decisions, and have ultimately steered me towards the correct path in terms of thinking about investing. Some of these people have also advised on aspects of personal finance which have helped to guide me to build up my savings and war chest.

These people are (in no particular order of merit): d.o.g., dydx, donmihaihai, Nick, Drizzt, cookieguy, la Papillion, tvf, dantzig, notti_boi and Munger (nicknames). For those I had inadvertently left out, please be assured that all of you had some part to play in making me a better investor, and ultimately a better person as well. Thank you very much.

Plans and Strategies for the Future (three to five years later)

With portfolio rebalancing and management already explained in a previous section, I guess the question would be – what will I be doing with my portfolio and how do I intend to grow it and nurture it to achieve my personal goals? My current portfolio stands at about $250,000 in cost and $259,000 in market value. Assuming a 5% yield (conservative), that would generate an average of $12,500 a year in dividends, meaning around $1,000 monthly. My target and goal would be to increase this to $2,000 per month of passive income, which translates to about $24,000 per annum. For this to happen, either yield has to increase or else if yield remains constant, then the portfolio size has to at least double to $500,000.

I plan to go about this in two ways – organic growth of the portfolio through an increase in the share prices of the underlying securities; as well as additions to the portfolio from time to time through savings and bonuses obtained from my profession (i.e. day job). The organic growth aspect will come about through time as my companies grow their business operations and also their top and bottom line. As for regular additions to the portfolio, these will be made at opportune times when Mr. Market is absolutely manic and pessimistic, in order to achieve an adequate margin of safety. The plan is to add at least $50,000 on average to the portfolio per year, to scale up the portfolio to a cost of $500,000 within 5 years (when I hit age 40). By then, I anticipate that the market value of the portfolio could see a 10% gain over cost, or be about $550,000. Assuming a constant yield of 5%, annual passive income would then hit my target of $25,000 per year.

The reason for this rather lofty target is to ensure that as I grow older and am faced with more responsibilities (e.g. kids’ education) and more chances of being laid off, I also grow my asset base and passive income source so as to reduce reliance on my active income from my day job. This also will eventually free me up to do what I really want in my life- whether it be starting my own business (dealing with music and CDs no doubt!) or travel around the world. Financial Freedom can be achieved in my lifetime with discipline and patience, and for myself, without the use of leverage.

13 comments:

Temperament said...

Hi MW,
For me for all the things in this article i like best is:
"Freedom can be achieved in my lifetime with discipline and patience, and for myself, without the use of leverage".

Unquote:-
i tell you surely you can do it your way. i have been doing it and still is doing it. And you started so much earlier. You will be definitely do so much better and reach your "Financial Freedom" earlier.
NB: That's not to say using "leverage" won't work, but some of us don't mind to do it a bit slower so that throughout our journey we can eat and sleep better, more consistently.
Shalom & Cheers!

Singapore Man Of Leisure said...

You know yourself best MW!

Walk your own path and at your own pace. Own time own target!

Onwards!

B said...

MW

You have the discipline and determination to succeed.

May we hear your success stories sooner than your anticipated time.

B

Royston said...

Hey MW,

Thanks for sharing! Have personally benefited from your insightful sharing and analysis of the companies in your portfolio!

Royston

Guru said...

I think accountants have the safest job and is one of the recession proof/ best jobs ,every firm needs them, I don't think there is a huge risk of being laid off if you are one..? I make sure my kid be an accountant when he grows up ha

Musicwhiz said...

Hi Temperament,

Hey thanks very much for your words of encouragement!

Regards,
Musicwhiz

Musicwhiz said...

Hi SMOL,

I will miss your frank and interesting remarks. You take care too and all the best!

Cheers.

Musicwhiz

Musicwhiz said...

Hi B,

Thanks for the kind words. And also for the support for my blog all these years.

Musicwhiz

Drizzt said...

hi MW, the 50k mentioned is it a total of your wifey and your contribution?

Singapore Stock Picker said...

Could you drop me a line at sgxstockpicker at gmail dot com? Would like to ask some questions not related to this post.

many thanks

Musicwhiz said...

Hi Royston,

Thanks too for your support all these years. Keep up your blog! I do visit periodically as well!

Regards,
Musicwhiz

Musicwhiz said...

Hi Guru,

Well, accountants these days are a dime a dozen, and more of them are coming in from countries such as China, India, Myanmar and Indonesia to compete with locals. It's simply not enough to just get an accounting diploma or degree, but it's essential to build up competencies in other areas too.

And unless you climb to the top of the food chain (e.g. CFO, Finance Director), accountants generally are paid crappy salaries and have to work very long hours, especially during closing for financial year.

Regards,
Musicwhiz

getrichdiva said...

Hi Musicwhiz,

I'm glad I come across this post! I'm glad we are of the same profession (who say accountants can't make money). I feel that it's admirable how you never embrace materialism in our current society. I also share your view on simple living and of not getting a car in Singapore.

It's sad that you are no longer blogging, but your blog posts serve as a good read and valuable lessons for newbies like me.

And most of all, thanks for reading my blog and for being so encouraging :)

Cheers,
Jasmine