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.