Friday, June 22, 2007

ROE Part 2

ROE can also be used to gauge a company’s organic growth rate. This means how fast the company can grow without relying on external factors like M&A, gahmen support, tax relief, Toto winfall, father mother sponsorship or anything else other than its own profits.

Remember that Net Profit, though a volatile no. due to multiple manipulation from sales, to operating costs, to interest and tax, does measure the profit that should go to shareholders if the accounting is done with integrity. And Net Profit is actually added to Shareholders’ Equity at the end of the year.

So Return on Equity or ROE which is

Net Profit / Shareholders’ Equity

tells you how the growth rate of shareholders’ equity has been, in the past 1 year. Now if past ROE is a good gauge for future ROE, we can then assume that next year’s Shareholder Equity will grow exactly by its ROE right? Savvy huh! This is the critical part, usually, high ROE will not last into the future bcos things always mean revert. But if you tracked this particular Co. which had ROE of 20% for the past 20 yrs, then maybe you can quite safely assume next year it will be 20% as well. Btw, ROE of 15-20% is sort of a long term average that things mean revert to. If the Co. has like ROE of 50%, then probably it will mean revert to 20% after some time.

Ok, analogy time. Say Co. X has a ROE of 20% for the past 20 yrs and shareholders’ equity of $100 at the end of Year 20. Since ROE has been 20% for donkey years, we can assume that it is also 20% in Year 21. And Voila, it IS 20% and Co. X earns $20 in net profit. Assuming the Co. X pays no dividend, this $20 is then added back to shareholders’ equity at the end of Year 21 and so Co. X shareholders’ equity becomes $120. In Year 22, Co X again earns 20% of $120 in net profit which will again be added back to its shareholders’ equity and become $144. Shiok huh!

So as you can see, ROE measures the growth rate of the company’s shareholders’ equity if the company does not distribute out net profits as dividends. (If it does, the growth rate simply becomes ROE x (1 – payout ratio), where payout ratio is between 0-100%.)

So when a company has an ROE of 20% and can maintain that, it means that the company can grow its equity base organically by 20% every year (i.e. without relying on M&A etc). Sounds attractive right? This is another reason why people look at ROE so much.

PS: Shareholders’ equity can grow by 20% per year doesn’t mean that stock price will also grow by 20% per year, There is difference between performance of the company and the performance of the stock!

ROE Part 1

This is probably the last important financial ratio that I have not touched on. You are wondering just how many financial ratios did Wall Street come up with right? Well this is different, this is the famous ROE and its equally famous Du Pont decomposition, chim huh?

Ok, Return on Equity or ROE measure the return that can be earned by the portion of shareholders’ money in the company. Mathematically, it is defined as

Net Profit / Shareholders’ Equity

This is totally different from earnings yield so pls don’t get confused. ROE has to do with the financial performance of the company while earnings yield deals with the performance of the stock. Over the long run (i.e. very long lah, like 20 yrs or more), both should converge, but fundamentally they measure different things.

So why is ROE important? Bcos it measures the profitability of the company with respect to shareholders’ funding. Equity capital comes at a cost (just like debt) and a company with a low ROE runs the risk that it cannot earn its cost of capital (equity in this case) and this means that the company is in deep shit.

As an analogy, say Investor T decides to invest in this Company S and T demands a 8% return over the long run. If you are asking why 8%, don’t ask bcos it introduces a lot of chim stuff like CAPM and more Nobel Laureates which will make it quite complicated. So let us save that for another post.

So T wants 8% but say this S is actually quite crappy and can only do 5% return. This means that T is not adequately compensated for investing in S bcos S is a in a risky business and T might as well have put the money in a bank or perhaps invest in a structured product tied to the growth rate of ministers’ pay which could have given T 8% return or more. So that’s bad news for S bcos equity funds will pull out and S may have to cease operations. So in order for S not to cease operating, it must has a ROE at least as high as its cost of equity.

In other words, a company should earn its cost of equity in order to justify its existence to shareholders. The higher the ROE, the easier for the company to earn its cost of equity and the better the company is as an investment. This concept can be expanded to the cost of capital of the company, where we bring in the cost of debt together with the cost of equity. So a company has to earn a return more than its cost of capital to justify its existence to both shareholders and debtholders.

There are other ways to look at ROE and we shall examine them in later posts.

Price Earnings Ratio and Earnings Yield (Again!)

One way of using Price Earnings Ratio (PER) is to look at its inverse: Earnings Yield. This has been discussed in a previous post, but I would like to emphasize the importance of Earnings Yield, hence the PER strikes back. Do not under-estimate the power of PER… Ok ok, let’s move on.

Earnings yield is the inverse of Price Earnings, meaning when I say I will only buy stocks with PER of 18x and below, I am actually saying I will only buy stocks with earnings yield of 5.6% and above. Or stocks that will give me 5.6% return over the long run. (1/18 is 0.056 or 5.6%, this is what I meant by the inverse)

Consider the China market now. Its PER is over 40x. This means that the Chinese farmers and the Chinese students are willing to buy stocks that will actually only give them 2.5% return (1/40 is 0.025 or 2.5%). They might as well put their money in fixed deposit in Singapore! The other time when the PER of a market reached 40x was during the dot com bubble. Of course, with bubbles, you can never know when it will break, so 40x can go even higher, to 100x. And with China, it may be possible bcos there are maybe another 8bn farmers and students waiting to open brokerage accounts. This is the perfect Greater Fool Game, if you are those who like to play this game.

Earnings yield can also be incorporated with the risk-free rate to calculate the equity risk premium, i.e. the excess return to investors who are willing to risk their money to get better return, hence a risk premium. Remember higher risk, higher return. For STI, the earnings yield currently is roughly 5% while the risk free rate is roughly 3%, so investors are being compensated an additional 2%, the equity risk premium, for investing in risky equities or stocks. That’s actually quite low by historical standards. Equity risk premium should be around 3-5% on average.

For the case of our lovely China, the risk-free rate is now roughly 3% while the market earnings yield is 2.5%. This means that the equity risk premium is actually negative! 2.5% minus 3% gives -0.5%. You are being penalized to invest in risky equities. This is higher risk lower return! What an ingenious break-through!

However, I must stress that a lot of this stuff is academic talk and offers little help in the real world, China’s equity risk premium can go to -3% for all you know, meaning the stock market can still double from current levels.

But earnings yield is a very handy concept to use when you want to gauge the potential return that you will get from your investment (if you hold for the long term). Next time you want to buy a stock with PER 30x, ask yourself, am I ok with this stock giving me a mere 3.3% return over the long term? I would advise you to go open fixed deposit!

The Holy Grail in Asset Management: Producing Alpha

Producing Alpha is also known as Beating the Market in Layman’s Language. We shall talk about Alpha and Beta later on.

There are actually 2 games that are being played in town. The absolute return game that most retail investors and hedge funds play and the relative return game that most monkeys on Wall Street play.

The absolute return game has simple rules, bring me 20% return per annum. That’s the target. For retail guys, if you can do that and can sustain that performance for 20yrs (i.e. earn 20%pa for 20yrs), good for you, your track record is among the best in the world, probably you are a multi-millionaire now and you should really think about doing some philanthropy.

It is actually quite difficult to have negative return in the absolute return game if your investment horizon is longer than 10yrs. But we hear of so many folks losing their pants in stocks and investments. Why? Bcos most pple buy the hottest stocks in the markets, usually paying peak prices and of course after the fad, the stocks nosedive. Same for property speculators who bought 500sqf condos at $2000 psf during 98 and their successors buying 500sqf condos at $3000 psf today. (Actually even if you bought at these peak levels, if you could hold it out long enough, you would not have lost your principal.)

The relative game is a funny game. The rules state that you win when you earn a return that is better than the market return. If the market return 10% this year, you must bring in at least 10.1%. Conversely, if the market return is -10%, even if you lost -9.9% of your money, you have beaten the market and hence become a Big Swinging Dick (i.e. a hero lah), but in reality you have lost money. Btw the market return is usually proxied by an index like STI or Hang Seng or Nikkei etc.

In investment lingo, the excess return earned over market return is called Alpha. (whereas market return is called Beta). On Wall Street, Alpha is like the Holy Grail of Investing. Everybody is looking for it. Some knows where it is but they will never share with others their secrets. Some thinks that it doesn’t exist.

Tons of monkeys play this relative game of Alpha hunting and ironically 90% of them lose out to the market over the long run. In one particular year, some monkeys can beat the market flat, they earn 20-30% on top of market return but the next year, they become shit, and remain like shit for the next 5 years. Seems like to Holy Grail does not exist after all.

But yet we always hear of people who can do it. They can produce Alpha (earn excess return over the market), not just 1 year or 2 years but 10-20 years. People like Warren Buffett, Peter Lynch, fund houses like Pimco, Citadel etc. Is it possible that the Holy Grail actually exists?

Well, one theory says NO. These Alpha producers are just part of the statistics. If you conduct an experiment for 1,000 monkeys to flip coins, and the winners are the monkeys who can flip the most no. of heads. After 1 round, there will be 500 monkeys who managed to flip heads, that’s probability and statistics. By the same logic, after 8 rounds, there is bound to be 2 or 3 monkeys that actually flipped 8 consecutive heads. Are they skilled coin-flipping monkeys or just part of the statistics? So if we think of the stock market as the coin-flipping experiment, Warrren Buffett, Peter Lynch, Jim Rogers, Pimco and the whole lot of Alpha producers may just be part of the statistics. Actually nobody ever beats the market.

I would like to believe that true Alpha producers do exist. They are the outliers because of the effort they put into sharpening their thinking, enhancing their investment process and improving their rigorous analysis. They belong to the top 10% (of all market participants who beat the market) because they earned it. We have seen this in schools, in income distribution, in sports etc. The best of the best are there bcos they earned it. For the top investors 8%pa return is not good enough and they strive for more. Just as for top students, a pass is not enough. They want straight A's. And top income earners strive to earn the next million. They don’t just lament about how come their salary increment is only 5% this year. They constantly seek to improve themselves and come out with ways to earn more money.

Yes, if you want to beat the market, you need to work harder than the market. (And some luck help, of course). But for those who are not so diligent, the good news is the market return is 8%pa on average. You earn this 8% simply by buying indices. That’s probably the closest to get a free lunch, ever.

Back to basics: Price to X, where X equals earnings, sales, cashflow etc

A lot of first-time readers to this blog has feedback that a lot of issues discussed here are too complicated and difficult to understand. I must stress that it is always easier to start reading from my earlier posts and then build on from there as your understanding of the concepts improve.

Nevertheless, to make it easier for new value investors wannabies, I will re-visit old topics to help illustrate the concepts (paiseh to the old-timers here, I will try to add new insights into these re-visit posts as well)

So the topic to revisit today is Price to X, where X equals earnings, sales or cashflow etc. In the earlier post, we talked about the most famous one of them all, Price Earnings Ratio or PER. Today let’s try to further understand this ratio and also try to examine the other siblings.

The price of the stock, as we know, is meaningless. SIA is $18, SMRT is $1.9, SGX is $8. It tells you it cost $18,000 to buy 1 lot of SIA but that’s as helpful as telling you that a property in Istanbul cost 200 million Lira. You have no idea whether it’s expensive or cheap right? (Unless you are a Turkish property agent who specializes in Istanbul and know the SGD Lira exchange rate.)

Everything needs to put into perspective. In the stock market, the convention is to divide the stock price by something else. This something else can be sales, earnings, cashflow etc. This is analogical to the psf used in property. Price is divided by floor size so that a common basis for comparison can be established.

So for the case of the Price Earnings Ratio or PER, Price is divided by the Earnings Per Share or EPS of the company. The lower the PER, the cheaper the stock. (same for property, the lower the psf, the cheaper.) Historically PER ranges from 10x to 40x for whole markets and 2x to 1000x or more for individual stocks. My rule of thumb is if the stock’s PER more than 18x, I think is too expensive for me and I won’t buy the stock if even has the most wonderful growth story.

In the heydays of the dot com boom, most companies don’t have earnings so the Price to Sales ratio was invented to gauge whether the dot com company is cheap or not. Analysts got so ingenious that someone even came up with Price to Eyeballs ratio i.e. Price of stock divided by no. of eyeballs viewing the website. Like that also can!

Of course after Enron and other multi-billion fraud cases, people started to realize actually earnings may not be reliable bcos co.s can always cook their books. So they look at Price to Cashflow, bcos co.s can make up earnings but cashflow is presumably harder to manipulate. Or so they thought!

Investment horizon

Studies have shown that it is quite pointless to time the market if you have a long investment horizon. Btw investment horizon is simply the time when you start putting your money into some stocks or other investments until the time when you sell or divest them.

For simplicity sake, we would just focus on investing in stock markets, and not so much of investing in one stock, or other asset classes.

From 1950 to 2000, if you invest in a stock index (e.g. the S&P500) and your investment horizon is only 1 yr, i.e. you buy in any particular year and sell 1 yr later, your returns can fluctuate from -50% to +25%.

This means that if you are damn bloody good at market timing and started investing in at the bottom of the cycle, (e.g. 1998 to 1999), then your return can be 25%, in 1 yr. And if you are damn suay, and started at the peak of the cycle (1996 b4 Asian Financial Crisis), your return can be as bad as -50%, whoa that's why so many pple get burnt by stocks huh.

Going by the same logic,
If you invest for 5 yrs, your returns fluctuate from -3% to +23%.
If you invest for 10 yrs, your returns fluctuate from +1% to +19%.
If you invest for 25 yrs, your returns fluctuate from +8% to +17%.
If you take the average of all these returns, it is roughly 10%.
In fact average return for S&P500 over an 80 yr period is 10%pa.

As you can see, the risk or volatility of return decrease when the time period gets longer. Even if you had invested at the peak in the stock markets, you will at least get 8%pa for the investment horizon of 25yrs.

Of course if you hold your investment even longer, return converges to 10% (don't ask me how long hor, beyond 25yrs is the realm of academia, and it doesn't really make much sense in on our 3min MTV cultured Earth).

The common man concept of investment is hold for 2-3mths, make a profit and run. I really don't know how to define this? Some call it trading, some call it speculation or gambling, some call themselves chartist whatever. In my humble opinion, if you do this 100 times, most likely you will lose money on 50 trades. If you are damn good, you lose money on 48 trades. But you can cut loss fast on the 48 losing trades while you let your profits run on your 52 winning trades. If you can do this, you can still be a Big Swinging Dick, and probably can earn 10mn with a capital of 10k in 3yrs. And you can start writing books and give talks on how you actually did it, and challenge Adam and Clement to see who has a better track record!

If you like to hold your investments for 2-3yrs, it is still not good enough. Bcos if you invest your money in a down mkt, then you will probably not see light and get very frustrated. Maybe a lot of pple that we know belong here bcos we started investing in 2000, the peak of the biggest bubble in the history of mankind where a few trillion dollars worth of wealth is lost in 1 yr. So if you lost some money here, don't be demoralized, what you lose is a fraction of a fraction of a fraction of a few trillion dollars. We are talking about wealth with 12 zeros here.

If you hold your investments for 10yrs, I would say you are getting close to be a true value investor. Esp if thoughts are given to which markets to buy, which specific stocks to buy. There is still a chance that you will earn only 1%pa for 10yrs, if you invested in the absolute peak of the mother of all stock market bubbles, then you are damn sway and I suggest you go seek enlightenment and become a monk and forget about making money. But by and large, most of us can earn around 8%-12% on our total portfolio after 10yrs bcos that's the return for stock markets in general.

So after all this crap, I guess the moral of the story here is,

1) Long investment horizon you have, go for buy-and-hold and you will earn a decent return over the invested period, hopefully at least 10yrs, the longer the better.

2) You can try to time the market and succeed, you will be able to retire in 3 yrs but chances of that happening is quite remote and you might as well construct an impressive 3mth investment track record then start doing $5000 courses to teach pple how to invest, that way you earn more, faster!

On Technical Analysis or TA

One of the books recommended on this blog has this interesting story about technical analysis or TA. A professor ask a class of students to play a game. They are all given each a pencil, paper and a coin. They are to draw a stock chart with stock price at $1 starting from Day 1. Every toss of a coin represents how the stock will do for that day, and if it lands on head, the stock price goes up 3%, if it lands on tail, the stock price goes down 3%. And from there, they can plot the stock charts for 100 days (i.e. 100 tosses).

Guess what the resulting charts look like?

They look exactly like actual stock charts with famous patterns like head and shoulders (btw this is not a shampoo brand hor, this is a technical signal in stock charts), double tops, double bottoms, flag formation, cup formation etc.

Why is this so?

According to the professor, in the short run (short run means anything less than 10 yrs hor) stock prices move on positive and negative news, and news flow as such are random, like tossing a coin. Hence by looking at how the stock has moved in the past cannot help you predict what it will do in the future. On every new day, the stock has 50% chance of going up and 50% chance of going down, (like tossing a coin), depending on whether good or bad news will come out on that day. So how can you try to determine which way it will go by seeing what coin toss you have done in the past 10 or 20 days?

Then why is there all those studies about technical analysis, head and shoulders, double tops etc? To give them the benefit of the doubt. I think these things work a bit. They probably work 52% of the time and fail you 48% of the time. Btw these are quite good statistics bcos if you go casino it becomes more like 80:20, meaning 80% chance you will lose.

The main reasons why TA work are probably:

1) self fulfilling prophecy: people think that they work and then strive to make it happen, eg when you see a double bottom, you and 10,000 other TAcians buy the stock, of course it goes up.

2) human/investment crowd psychology does not change: this is the basis for TA as explained by TA textbooks, support and resistance levels are formed bcos investor crowd psychology dictates these levels until the next driver pushes the stocks to another paradigm.

But having said that, we must understand that stock markets are complex systems and hence TA can only help you win 52% of the time. There are times that TA can drive the stock prices, and there are times other information like macro outlook, earnings announcement, sentiments etc drive the stocks.

TA is only marginally useful in predicting short run stock peformance and not useful at all in predicting long term stock performance. On the other hand, value investing has zero use in predicting short run stock performance but gives you a little bit of an edge in predicting long term stock performance (probably 54% or so). The good thing about value investing is if you have done work homework, even if you are wrong, you will not lose your shirt.

Balance Sheet and Asset Allocation of a Singaporean Family

Before we go into the asset allocation , let’s take a look at the balance sheet of the Singaporean family. BTW I made all the no.s up and it is not based on any official statistics and no scientific/accounting methodology has been used to come up with the no.s. So please take them with a bucket of salt ok?

Anyways here it is:

Balance sheet of a typical Singaporean family
Assets
Cash & CPF $25,000
Stocks $25,000
Car $45,000
Other assets $5,000
HDB $400,000

Liabilities
Mortgage $350,000
Car Loan $50,000

Shareholders Equity $100,000

Thanks to the real estate recovery in the last 1 year, the typical household now sees some positive equity (as compared to past 10yrs of negative equity for a lot of Singaporean households)

So if we take a look at just the asset part we come to realize that a typical asset allocation/portfolio mix of a Singaporean family is about as interesting as watching a big snake poo-poo. i.e. not interesting at all lah! Anyway, in percentage terms, this would be

5% cash
5% stocks
10% in totally worthless depreciable assets like 1 x Automobile, 2 x Plasma TV and 32,000 credit card points exchangeable for 1 x 60GB white silly looking music player which is also worthless. (btw all these are under Other assets).
and
80% real estate (HDB flat)

If we apply what we have learnt about Modern Portfolio Theory, diversification and Markowitz, the Singaporean household is really quite undiversified and the fortunes of the household is basically determine by how much this little red dot is worth in the eyes of the world.

Fortunately our Government (with a capital G one, don’t pray pray) realizes this (maybe 10 yrs ago) and has planned to make the little red dot the favourite spot for foreigners to come and work and/or invest in our real estate. In concrete terms, 2 important policies made it all successful.
1) The 2 x Integrated Resort (IR) projects
2) The decision to grow our population from 4mn to 6mn pple
And as they say, the rest is history.

So what does it mean for the Singaporean family that is trying to push its asset allocation closer to the efficient frontier? Well if you believe in the almighty of our beloved Government, you can buy more real estate, hopefully somewhere overlooking Marina Bay and Sentosa. If your bet is right, forget about efficient frontier and the rest of the crap, you can start writing your own blog about how you made it and how this blog sucks.

If you believe in Markowitz and diversification, then it’s better to think of how to diversify the portfolio from real estate. Alas, this is not easy bcos RE will probably make up a huge chunk of your asset portfolio and you can only either save a lot more money to invest in stocks or other asset classes, or sell your property and downgrade. I admit both are not very realistic lah. But it’s important to keep this in mind though. And when you have the means to diversify, you should do it.

Asset Allocation

As a seasoned value investor (for those who have been following this blog, hopefully you have become one), asset allocation is a must-know.

Remember we talked about portfolio theory, Markowitz, efficient frontier and the kind of crap. Umm well, actually not that crappy, got win Nobel Prize one, don't pray pray ok. For those blur, read this post. Now in order to earn a return that is on the efficient frontier, meaning the portfolio is so efficient whatever you put in goes straight into your bank account x 10% and then gets immediate giroed to pay your credit card bills.

No, to earn a return on the efficient frontier means that this return can be earned with the least risk possible. Say if you target 10% return, but your portfolio risk is 25% while the risk of a portfolio on the efficient frontier is only 15%, then you loogie big time, bcos your portfolio is not efficient at all and you should really go put some oil on your money to make it run smoothly or something.

So how do we make our portfolio efficient? The answer lies in asset allocation. Asset allocation simply means determining how much to put in different asset classes such that the risk and return will be optimal, i.e. the portfolio is on the efficient frontier.

Back in the good old days when we have only 3 asset classes, the classic answer is 50% stocks, 40% bonds and 10% cash or some similar variation, say 60% stocks, 30% bonds and 10% cash etc. But today, we have 10,000 asset classes, so things are not so simple anymore. An efficient portfolio probably looks like this

40% stocks
10% bonds
10% hedge funds
10% real estate
5% private equity/venture capital
5% commodities
5% gold
5% cash

For a more scientific asset allocation, go google for Havard Endowment’s asset allocation, and you can see how the pros do it. If you want to be better then on top of the above mentioned asset classes, maybe you should consider adding

1% art and antique
1% wine and coke bottles
1% watches and diamond rings
1% krisflyer miles
1% adopted chinese brilliant kids
1% securitized future cashflow from this blog

Ok that’s just for fun hor, don’t follow blindly. The point that is being illustrated here is that current wisdom advocates finding more asset classes that are uncorrelated and then putting some portion of your portfolio in them. (This post has more info). The truth is for the retail investor, finding exposure to asset classes other than equities, bonds and real estate is actually not that easy. Most hedge funds and private equity funds will not accept retail money. But I always believe that when there is a will, there is a way. If you think you really want a well diversified portfolio then you will find ways to do it. Next post of a typical asset allocation for a Singaporean household, watch this space!

Forward PER

PER may be a simple concept but its application can actually be quite complicated. For those who need some refresher course on the PER, it is the Price Earnings Ratio of a stock. It tries to determine the cheapness of the stock by dividing the stock price by its earnings per share (or EPS). For more info, read this post.

Now the issue here, which have never really been discussed in detail in this blog all thanks to this blogger who conveniently left it out, is which EPS should we use to calculate PER? Is it the latest historical EPS announced by the co.? Or what?

The answer is the expected EPS in 1 yr's time (not announced by the co. yet, i.e. it is not in the annual report). The resultant PER is also called the forward PER. The reason is very simple. The stock market always look forward, not backward. It is the culmulation of the expectations of all the players in the market. Hence when using the expected EPS of the stock in 1 yr's time to calculated PER, we roughly get a good sense of the market's expectation of the value of the stock.

BTW, this expected EPS (also called the consensus EPS) is usually the average of all the sell-side analysts EPS estimates for the next year and this no. can be easily pulled off bloomberg or other financial information providers. Now of course you may argue, sell-side is good-for-nothing and their estimates are usually wrong. Then naturally you can do your own homework and come out with your own expected EPS in 1 yr's time and use that to calculate the stock's forward PER. Well that won't be too hard right?

Also, you may ask why 1 yr? Why not 2 yr or 10 yr? Well actually you can use any year you want, if you can forecast correctly the EPS of the stock in 10 yr's time. You should use that. For some business, you can, and you should. But when you are looking at a stock for the first time, it would be easier to get the consensus EPS estimate and get a rough sense of the stock's forward PER. As a rough gauge, I would consider anything less than PER 18x as cheap and I would not buy any stocks that is trading at more than PER 18x.

The truth about being rich

Most of us dream about becoming rich. We want to be able to afford every desire we have. i.e. wine and dine at fancy restaurants, buy that Prada bag, that pair of Ferragamo shoes and that dream house and that dream car.

But not many people get there. Somehow we are always just one step behind the Joneses (or the Queks, or the Khoos for that matter). Somehow, the next pay rise didn’t really improve our quality of life as we expected it to. Why is that so?

The truth is being rich is a relative game. You are only rich when those around you are poorer than you are.

To illustrate, 10 yrs ago if you drove a nice Civic or Sunny, you would be considered rich and successful. You are on your way to attain the 5Cs. Good job, keep it up. But today, Ah Beng drives a Civic too and you suddenly realize you are driving an Ah Beng car. And so, you must upgrade to get back into the inner circle of the rich and successful.

This is means that the standard to become rich has gone up.

In other words to reach the status of being rich is a moving target. You need to run faster, work harder, work smarter than everyone else, so that you can earn more money and join the premier league. To become rich is a rat-race and it only gets harder.

10yrs ago, if you earned $4000 a mth you will be in the top decile of Singaporean earners. Today you need to earn $7000. Even if we consider inflation is 5% per year (which is a lot, long-term average is only 3%), $4000 10yrs ago should be equivalent to only $6000 today. But if you earned $4000 in 1997 and your earnings power improved by 50% to $6000 today, you would have become poorer because you have been relegated to the 2nd decile. (You would have beaten inflation but bcos you didn’t beat the other Singaporeans who are now earning $7000, you actually become poorer.)

So that’s why we cannot stop running on that treadmill and the worse thing is, the speed keeps increasing as you run!

Now let’s suppose that we actually made it. We have managed to earn truckloads of money and kept our status in the premier league, year in year out. No sweat. In the statistics our income grew from $7000 to $20000 per mth. Woopee!

But if you think about it, we have just raised the bar for everyone else. So now Ah Beng who was earning $7000 and has only managed to up his income to $10000 has been relegated to 2nd decile. He can afford the Prada bag and the Ferragamo shoes. But now the new standard is Jimmy Choo. So too bad for Ah Beng.

This means that by becoming rich, you have just made a lot of people poorer. And that's why a lot of rich pple give back to the society (at least those who have a conscience.) Bcos they inadvertently contribute to more poor pple in the society.

Is there a solution to this rat-race? I am afraid the answer lies in the realm of enlightenment, inner peace, knowing what is enough for yourself and that kind of philosophical stuff. Not something for the aspiring rich and famous reading this blog perhaps.

Diversification or Diworsification

According to Markowitz (he is a Nobel Prize Winner on Portfolio Theory), diversification is the only way to achieve a higher return at the same level of risk. This actually makes more mathematical sense than common sense, and most value investors do not subscribe to this thinking. Let's try to examine whether diversification is actually diworsification.

To paraphrase the essence of Markowitz's theory, basically it means that if you are only willing to accept the risk that you will lose, say 10% of your principal, and a portfolio of stocks and bonds can give you 8% return, the only way that you can earn more than 8% is to invest in other asset classes like commodities, real estate, bonds, private equity, integrated resorts, submarine fiber optic cables and credit card points. (Ok the last 4 are not socially accepted asset classes btw)

In order to achieve the maximum positive effect of diversification, the asset classes should also move in different directions, i.e. when one goes up the other should go down. This way, say if equity markets crack, hopefully bonds or commodities will still help to offset some losses. Ok we all know that's bullshit right?

Buffett and Peter Lynch (he is a star fund manager at Fidelity some time back, quite famous too) thinks diversification is bullshit too. Lynch calls it diworsification. This is bcos all of us have limited time and resources, and it does not make sense to try to invest in as many field as possible since we can only be an expert in only a handful of them. You should bet your entire net worth only when you find a potential ten bagger (a stock that will rise 10 fold) and only if you are damn sure. This way you maximize your effort in research, make money, feel happy and can go buy that Prada bag for your wife and that Ferrari for yourself.

I kinda think that the truth is again, somewhere in between. Diversification helps to a certain extent, but not as good as what is promised by textbook, but if you don't diversify, chances are that one basket that you put all your eggs will break. (Trust me, Murphy's Law works.)

As individual investors, diversification options are actually quite limited, we do not have access to some non-conventional asset classes like commodities and private equity. Most people will have to stick with bonds, equities and cash. Even so I think there are some benefits that could be reaped. E.g. by investing in stocks in the different sectors or different countries. You don't need a 100 stock portfolio to enjoy the benefits of diversification, the textbook says 30, personally I think anything more than 5 stocks should be good enough.

Of course, when the markets correct, like last week, correlation of all kinds of asset classes that you can think of goes to 1. i.e. everything will crack together, commodities, bonds, stocks, real estate, private equity, Toto, CoE, salaries etc. And diversification fails. But by and large, diversification should help to generate a better return for the same level of risk.

What is the sexy story?

In the world of Wall StreetCraft, people like to talk about stories. What is the sexy story for this stock? They would ask, or has this industry got an interesting story?

Translated into English, it basically means this: Tell me why you are buying this stock and make sure it's a fairy tale that everybody likes.

Peter Lynch, the star fund manager for Fidelity some years back, gave this one piece of advice that has got stuck inside my head ever since I read it. If you cannot explain the why you bought this stock into three sentences, then probably you should not buy it in the first place.

For those who have never heard of Peter Lynch, well I suggest you go look him up at Wikipedia. And don't forget to come back here and click on that Amazon link to buy his book!

So the moral of the story is this: Know why you are buying the stock. The reasons should be simple and easy to understand.

In other words, when you buy a stock, make sure that you know its "story". It should be sexy, it should make people say "wow" and make monkeys drool, as if they see truckloads of bananas. But it should also be realistic and the earnings are real.

Over the years, sell-side clerics in the World of Wall StreetCraft have mastered the art of story-telling. They can really spin an infinite amount of fairy-tales and all of them promise a happy ending.

Things like replacing all wires and connectors in the world with Photonics Technology (i.e. light or photon beams), Satellite Mobile Phones (guess most pple remember this one, and the co called Iridium went bust) and my favorite: 3D Holographic Video Phonecalls: some real life technology akin to Princess Leia sending the distress message through R2D2, which was later picked up by Luke Skywalker in the original Star Wars. Too sexy for for your money huh?

But, ultimately, I personally think there are only 3 kinds of stories around. Those that are real and can make you money and then you REALLY live happily ever after one.

1) Growth story: Simple and straight forward, the company has got growth and it is sustainable, valuation is also still reasonable (not PER of 50 or 80x, but say around 15x). Note: the stories listed above (e.g. 3D Holographic Video) sound like growth, but there is a different name for them. They are called concept stocks. There is only a concept, no earnings or sales to justify the story yet.

2) Restructuring story: Company has a good business but somehow cannot generate profits. i.e. very strong sales but no earnings. But one fine day, new management steps in and decide to do something about it. OP margin doubles. i.e. earnings also double and stock price quadruple. Shiok right?

3) Value story: This story can manifest itself in various ways but the basic idea is that you are buying something worth $100 for $40 or less. The difference between this story and the growth story is that the company usually has little visible growth but still the business is very solid and generates good cashflow.

Scenario or Sensitivity Analysis

This is another no-brainer concept that is given a cool and sophisticated name so that financial advisers and analysts can brag about their knowledge in investment.

For those first-timer to this blog, pls read the relevant posts that are linked here in order to understand what I am trying to say. Most likely this post will overwhelm you if you read it without the background knowledge.

Essentially what you do in scenario or sensitivity analysis is that you try to stress-test your assumptions and see if they work when the state of the world has change.

I guess the easy example here is SIA. In a previous post, I mentioned that SIA earned $1 EPS in 2005 and given that it is trading at $17, this means that its PER is 17x, or an earnings yield of 6% (i.e. you expect SIA to earn you 6% for every dollar you invest.)

Now we need to test how robust is the EPS of $1 (or the earnings yield of 6%), i.e. we want to know if SIA can actually deliver an EPS of $1 when the world has changed. Usually we will set up 3 scenarios.

1) The base case is where the state of the world is as today, goldilocks, not too hot not too cold. In this case, we assume that SIA will continue to deliver the EPS of $1. Hence its PER is 17x and its earnings yield is 6%.

2) Then we have the nightmare scenario where the world goes into recession, i.e. Sept 11 again or some war breaks out. Obviously we have to assume EPS drops to some very low level, maybe $0.10.

3) And finally we have the blue sky scenario where the world prosper and SIA lives happily ever after and EPS becomes an astronomical no, like $10.

After that, if you like doing math, you can acsribe probabilities to each of the state and calculated the expected EPS of SIA. For me, I am just interested in the nightmare scenario. I want to know if it happens, is SIA still cheap. Obviously, if the nightmare scenario comes true, SIA can only earn me 10c for every $17 of the stock, I might as well buy Singapore T-bills. Hence I will not buy SIA.

The fun part here is how to ascribe an EPS to the nightmare and blue sky scenario. What is the appropriate no.? Is 10c low enough for the nightmare scenario? In which case PER goes to 170x and earnings yield become 0.6%? Or is it 1c, then PER goes to 1700x. Woah, that’s better than Google at its peak (PER 400x or so I think).

I would say the success rate of this kind of analysis only gets better with experience. It also depends on your view of the world and your emotional state and personality. A conservative investor will think that EPS goes to zero and hence will not buy SIA, bcos he thinks SIA will simply drop like a rock if another catastrophe strikes. A greedy and bullish investor who have only seen bright and sunny days will think that SIA will fly no matter what happens. And he will say SIA is still very cheap at PER of 17x.

The Power of Compound Interest

When asked what is mankind's most wonderful invention, Einstein's answer was "compound interest". Guess most people wouldn't want to argue with Einstein, unless you think you can win a Nobel Prize too. But what's so good about compound interest?

For those lao jiao value investors, sorry for writing this simple post which you all would already know and swear by it.

Ok, for those value investors wannabies, this post is gonna change your life. So get ready.

If you buy $10,000 of Singapore govt T-bills (i.e. govt bonds or Treasury bills) today, it earns you 3% interest, bcos of compound interest, it will become roughly $24,000 in 30yrs. Without compound interest, it's just $19,000. That's 55% difference (14 divided 9). If you put it in the bank, it earns 0.025% and becomes $10,700 in 30yrs. You might have as well put it under your pillow.

Now imagine if you can save $10,000 every year to buy T-bills for the next 30 yrs, and they give 3% interest. Do you know how much it will become?

It will be close to $500,000.

If you save $20,000 every year and buy T-bills for the next 30 yrs, you get close to $1,000,000. If you invest and get 5% instead of 3%, you get close to 1.5mn, if you invest as well as an average investor on Earth, i.e. you earn 8%pa, you get $2.5mn. If you invest as well as our hero, Warren Buffett, you get 24%pa and you get *drumrolls* $65mn. That puts you in the top 30 richest Singaporean list.

This is the power of compound interest.

You don't have to do a lot, save enough, earn a good rate of return, and just wait. You will be a millionaire in 30 yrs. Now that seems quite easy right?

So why we don't see millionaires all over Singapore? Well actually they ARE all over Singapore but too bad we are not one of them. There are a few reasons:

1) Discipline: Most pple, after working long and hard for one month will grab their paycheck and spend it on some gadget or some luxury bag worth $7 selling for $700 to reward themselves, including this blogger here. Who has time to think about saving for 30 yrs?

2) Diligence: Putting the money you saved in fixed deposit is not enough. Only when there is some campaign, you get 3% but usually it's only 0-1%. So you have to put them in T-bills and rollover every few months. That's difficult. Imagine spending your precious weekends in banks to rollover these stuff. Now we have POEMs, so pls go open an account today. But still, it's a hassle.

3) Time: Now compound interest works best when the time period is long enough. Warren Buffett took 50 yrs, for the illustration above, you need 30 yrs. Most pple can only have some savings after major cash outflows like wedding, buying a house, having kids etc. So even if you start at 25, you will only become a millionaire at 55.

So that's why it seems easy but it's not. But there people who does this and got there. Their parents started for them when they were like 10 yrs old, and when they are 40, they become millionaires. Well, don't blame your parents, just make sure you try your best to help your children! Hehe.

Marketable and Investment Securities

Marketable and Investment Securities is probably one of the most neglected rows in the balance sheet after the "others" column. I mean most people look at cash, shareholder's equity, assets. If they have any more free time, they look at debt, accounts payables and receivables and inventory. Who has got time to figure out marketable and investment securities?

Well in most cases, even if you don't figure them out, it doesn't really matter. That's why most people don't look at them. They only matter when the daughter (or son) becomes more important than the parent. Now what the hell does that mean?

Marketable and Investment Securities refer to stock holdings of the company. Marketable simply means the company has no intention in holding them for the long-term and would sell them when it's appropriate. Investment securities are usually holdings of subsidiaries or affiliate co.s and the parent company has no intention of selling them.

Now bcos of accounting rules, these holdings may be accounted for at cost (i.e. at prices when the parent acquired them) or at market value 1 yr ago (i.e. when the book closed last yr). In some cases, the market value of these holdings may have grwon to be quite significant, e.g. 50% of the parent's market cap or more. Such cases would arise when the stock market enters a rally trend, or circumstances like acquisition offer or simply bcos the subsidiary grew so much faster than the parent.

So essentially when you buy the stock, you get a lot of "freebies" that comes along in its balance sheet. And investors love this kind of stuff. One good example would be Yamaha Corp, the musical instruments maker.

Yamaha Corp owns 20% of Yamaha Motors, the motorcycle maker. And Yamaha Motors market cap is now a few times more than that of Yamaha Corp, its parent co. bcos of its cheap and quality motorcycles are selling like hotcakes all over the world. So when you buy Yamaha Corp, you are actually buying its musical instrument business, plus a huge freebie: shares in Yamaha Motors.

However, this value may or may not be unlocked bcos Yamaha Corp may want to hold on to its shares of Yamaha Motors, instead of selling it and returning the cash back to shareholders. In that case, you can only suck thumb.

How much money to you need - Part 2

This is the sequel to my first post on this blog. There is actually another way to think about how much money you would need in a lifetime and it's quite logical (well at least to me...).

Assuming that you would be working 2/3 of the time in your entire life, you should be saving at least 1/3 of your pay. The key word here is AT LEAST. Bcos we must not forget inflation.

Now say if you are currently 30 yrs old, you earn $3000 per mth, you expect to retire at 60 and live until 75, i.e. you work 30 yrs out of 45 yrs of your life (2/3) and have no income for the last 15 yrs (1/3 of 45). You should be saving at least 1/3 of your pay i.e. $1000 in order to maintain your current lifestyle until the day you go to heaven (or wherever you want to go that won't need money from Earth... hehe).

Why is this so? Bcos the 1/3 that you save for 30 yrs (which amts to $1000 x 12 x 30 = $360,000) will be just enough to cover you for the next 15 yrs when you don't work at all ($360,000 /(15 x 12) = $2000 = the amt you are spending now every mth). That is assuming no inflation.

Hence similarly if you want to retire at 50 and die at 70 (which means you work 20 yrs and don't work 20 yrs) you would need to save at least 50% of your pay. Which probably means 90% of Singaporean cannot retire at 50 and die at 70, bcos if they want to retire at 50 they must die, say at 55 in order not to rely on their children or the state or any other entity to support them. How fun.

So what happens when we take inflation into account? Well it simply means you have to save more, or make your money work harder (i.e. invest lor). If inflation is 3%, then for every dollar you save, it must earn 3% every year until you retire. If you believe in this blog which says investment earns 8%, then all is well.

If you intend to cover inflation by saving more, it gets tricky bcos inflation goes on yearly but you only save the same amt every month. This means that for Year 1 you will need to save 3% x 30 (yrs) = 90% more and Year 2 you need to save 3% x 29 (yrs) = 87% more and so on (i.e. Year 1 you need to save $1900 per mth, Year 2 you need to save $1870 per mth and so on).

But you only earn $3000 per mth remember? How to save $1900? It cannot be done, so the answer is you should spend less, much lesser than the original $2000 per mth. As a rule of thumb, I think saving 50% of your salary should be quite ok. Which then means a lot of pple in Singapore are probably not ok... Count on me Singapore, count on me to go broke before 50!

Discounted Cash Flow or DCF

Discounted Cash Flow or DCF is the most complicated way to value a stock and also probably quite useless to most people. Well, not if you are good at math or if you are called Buffett or Graham or Dodd. Buffett uses very simplified DCF to try to value stocks and is probably quite good at it, given how much he has earned (umm, in case you don't know, it's about 1/3 of what the whole of Singapore earns). Too bad he doesn't blog.

Well I guess I would just try to describe the concept of DCF, bcos the math will simply freak out a lot of people. But having said that, it's probably A level or 1st year university math so if you really want to know, can google it and try to figure it out.

Ok the concept is basically adding up all the cashflow over the life of the firm and try to determine how much it is today.

Perhaps it is easier to use an example:

Firm A will generate $1 of cashflow over the next 50 yrs, what is its value (or intrinsic value) today?

Well the simple answer is simply $1 x 50 = $50 (QED).

Ok, but how can be so simple?

Now we must understand that $1 next year is not the same as $1 today. And $1 two years out is also different. The difference is due to interest.

So $1 next year is actually equal to $0.97 today bcos if we put $0.97 in the bank today, it will earn 3% interest and become $1 next year. And $1 two years out is roughly $0.93 today bcos if we put $0.93 into the bank today, it will earn 3% interest in 1 yr, and both the interest and principal after Year 1 will earn another 3% interest, which brings the total to $1 two years from now.

So once we calculated the present value of all those future $1 (50 of them), we add them all up and we get the intrinsic value of the firm. For the above example, the answer is $25.7.

If you are wondering how to get $25.7, key this "=PV(3%,50,1,0)" in Excel and it will spit out the answer. Need more help, pls email me.

Well, not so hard after all I guess. But the questions below will make you realize what makes it hard.

First, how the hell do we know if Firm A can actually earn $1 every year for the next 50 yrs? And what will the interest rate be in 50 yrs time? And why only 50 yrs, shouldn't a company exist longer than that?

So that's the hard part, for every input, there is some uncertainty. With DCF, you can have infinite no. of inputs, and that's uncertainty times infinity. How fun. Personally I prefer to stick with PER and EPS estimates.

Industry Life Cycle

According to Buddhism, there are four phases in Life: Birth, Aging, Sickness and Death. The funny thing is, business schools teach a similar theory about industries.

This is the what makes investment interesting I guess. It is not just about making money. It encompasses knowledge from different fields like philosophy, religion, social science, accounting, economics, finance etc. Which means you have to know a lot before you can invest and make money. Investment is about knowledge. Investment is also about your style, your view of the world and about your ability to stomach losses and conquer your greed.

Okay, back to the main topic, so similar to Buddhism, industries follow a four phase life cycle:

1) Infancy: Few players, growth rate: 10-20% e.g. Fuel Cell
2) Growth: Many players, growth rate: 50-400% e.g. LCD TV
3) Mature: Ogliopoly, growth rate: 5% e.g. Oil majors like Shell
4) Decline: Ogliopoly, growth rate: -5 to 0% e.g. Photo film

Industries can be broken down into these four phases and depending on which phase an industry or company is in, we can see some characteristics pertaining to that phase and frame our expectations accordingly.

1) Infancy: This phase marks the beginning of a new industry, technologies are only recently discovered and business models are still evolving. Growth is limited due to limited demand and lack of funding and interest. Usually marks the 1st 5-10 yrs of a new industry.

2) Growth: At a certain point, an infant industry hits an inflexion point and starts to grow spectacularly. Competitors also start to enter the industry causing prices to come down. But declining prices lead to even stronger demand for products. Stock market starts to get very interested at this stage. Growth phase usually marks the next 10-30 yrs of strong growth.

3) Mature: A growth industry will eventually mature when penetration rate reaches a certain level and/or demand runs out. Growth rate declines to single digits. Weak players exit the business as they cannot compete at low prices and low sales volume. Industry usually consolidates to a few strong players.

4) Declining: This is similar to death in Buddhism life cycle. The industry cannot continue to exist as there is no longer any demand for its products.

It is important to note that these are theories. They do not work perfectly in the real world. Some industries go from Infancy and straight to Decline (e.g. MD players?). Some enjoy growth for 40-50 yrs (autos: is it still growth or mature?). Some industries reach mature stage in 3 yrs (Internet auctions, online stores?). Some industry simply cannot fit into any phase (e.g. consulting?).

Once we understand which phase an industry or company is in, we can better size up its growth potential, investment return and other big picture aspects.

Dividend yield

Dividend yield is the stock dividend per share (DPS) divided by its share price. E.g. if Company A gives 10c dividend in 1 yr and its share price is $1, then its dividend yield is 10%.

Alas, as we all know, no stock will give a 10% dividend yield, even if it does, it cannot last because the company may not generate enough cash every year to pay this huge dividend. But if you do find one, let us know, and this blog will have to be renamed as "10% per annum (dividend only)".

Globally market dividend yield ranges from 2-4%, but some individual companies do give much higher yield (usually that also mean the company has not much growth prospect). In Singapore the average dividend yield is also around 3-4%, which is not much higher than fixed deposit rate, but actually quite ok by global standards.

Personally I think dividend is very important because it may be the only form of incremental income for a value investor (who prefers to buy and hold stocks). If a company does not pay dividend, there is no way to get cash out of your investment except by selling the shares. But if you would like to hold the shares because you think the company will continue to grow, what can you do? Value investors also need cash to buy groceries right? Not much use holding on to stock certificates until you are one leg into the coffin, isn't it?

Also, by paying dividend, the company shows that it has its shareholders in mind. Excess capital is always returned to shareholders if it cannot be put into better use. Of course, a growth co. needs ALL the money to invest and grow, and they don't pay dividend. Investors sometimes take that excuse, but usually also taken for a ride. However some growth company do grow big and when they are ready, they pay dividend as well, e.g. Microsoft.

However, Berkshire Hathaway has never paid dividend since Singapore got independent because its owner-manager, our hero Warren Buffett, thinks that he can use put the money into better use. And he has done that.

Since most if not all companies are not like Berkshire, we should expect them to return investors some of the money the firm has earned.

Industry Food Chain

This reminds me of primary school days, when the small fish eats plankton and the big fish eats the small fish and all the crap right? Well with production and business, it's almost the same.

Industry food chain refers to the process by which raw material is being passed through different manufacturers as semi-finished products and finally being made into end-products for the consumer. The most famous one is the semiconductor food chain. But since this food chain is far too complicated, even for sell-side semiconductor analysts, I shall use another relative simple one.

Honey -> Bee -> Bird -> Human

Ok, ok, before you click the "x" at the top-right corner,

Wafer suppliers -> Foundry -> Chip makers -> Consumer electronics

Well that's the simple semiconductor food chain, but what makes the actual chain so complicated is that at every level, there are equipment suppliers and fabless design houses and testing equipment makers and OEM manufacturers so the whole thing turns into a huge spider-web which is good for putting around your workstation to impress sweet young secretaries.

Ok, but what's so useful about learning this? The short answer is Bottleneck. By understanding the food chain we can find out where is bottleneck. i.e. the point in the food chain when there is less capacity than demand, or where there is limited no. of players and hence they have the bargaining power over everyone else. (See Porter 5 Forces.)

Take the example of the hard-disk drive (HDD) industry. HDD is part of the huge spider web within the IT/semiconductor food chain. If we take a closer look at its food chain specifically, it is something like

Materials (Magnets, metal screws, glass discs)
-> Components (recording heads, motors, connectors)
-> Hard-disk drive makers (Seagate, Western Digital etc)
-> Consumer electronics (PC, Ipod, HDD-DVD recorder etc)

There are currently only 5 or 6 players globally in the assembler space. Seagate being the market leader with 40% share, followed by Western Digital and some Japanese and Korean players. However there are countless material suppliers, component makers, as well as consumer electronics players.

2 years ago when Ipod became the No.1 item on everyone's wishlist and when Flash memory was still too expensive, HDD was in super short supply. A bottleneck formed at the assembler space gave HDD assemblers huge bargaining power over its suppliers and customers.

As we can expect, HDD assemblers' stock prices shot through the roof together with Apple and those who have bought these assemblers laughed their way to the bank. Well that is if they sold, today flash memory is rapidly replacing HDD and we all know what is happening now.

Porter 5 Forces

Michael Porter, elder brother of Harry Potter, wrote and published a book in 1980 called Competitive Strategy that helped frameworked how we should look at an industry and the forces that interact with the various companies in the same industry. Ok, just kidding hor, Michael Porter is a real academic while Harry Potter is a wizard in a bestselling septology i.e. a story with seven episodes!

Well what Mr Porter said was somewhat common sense but they will nevertheless teach it in business school and set 1 exam question on this per semester. Anyways, the canonical Porter's five forces are

1) Existing competitive rivalry between industry players
2) Threat of new market entrants
3) Bargaining power of buyers
4) Power of suppliers
5) Threat of substitute products (including technology change)

An industry leader/formidable player should be able to tackle all the forces with ease. As an example, let's look at the aircraft makers: Airbus and Boeing.

1) Rivalry between these two players: yes they are somewhat bitter rivals, but on the whole, because there are only two players, price competition is quite limited, and profitability remains high.

2) New market entrants? Not likely, since they are the leaders with all the experience, no airline will think of getting planes from new entrants. Well maybe African airlines buying cheap Russian planes, but overall, not a big threat.

3) With over 100 airlines, basically the airlines don't have any bargaining power. Boeing and Airbus set the price, airlines just accept. If they don't there will be 99 airlines waiting to buy anyway.

4) Suppliers, well depending on the parts, suppliers can be quite powderful. Especially high-end stuff like engines etc. Hence they (Boeing and Airbus) may lose out here.

5) Substitute? Er like flying cars? Or high-speed broomsticks? Well sorry this is not Hogwarts, so in short, no threat from substitutes.

So Boeing and Airbus are in a good position, of the 5 forces, they have the upper-hand in 4 of them. Of course, this is just one aspect to look at one industry. Will be introducing more!

Company Cheatsheet!

According to Philip Fisher, one of Buffett's teachers (besides Ben Graham), you cannot never compile a cheatsheet for a company. You have to constantly sniff out info on the company, keep talking to anybody and everybody, from suppliers to customers to employees etc. So analysing a company probably takes like two gozillion years and Frodo have completed the Mt Doom trip like 15 times.

In our world of MTV and instant gratification. Nobody has time for this crap right? So yours truly here has compiled a the ultimate cheatsheet to look at when you first lay your eyes on a company.

I must stress that this cheatsheet is not exhaustive. There are probably another 1,001 things that you should look at. But it should be a good way to start. Also remember than the time you spent researching a company is inversely proportional to the risk that you will lose money. i.e. more research less risk.

But then again who has time to wait for Frodo to go Mt Doom 15x considering we don't even have time to make babies. So I have also kindly calculate the optimal time to spend research a co.

This would be roughly 30 hrs for beginners and 10 hrs for more lao jiao people. But after analysing, this does not mean that you should buy or sell the stock immediately. You should wait for a good time to enter or exit. Investing needs patience, so watch less MTV.

Anyway, to save you from more bull shit, here's the list.

Company specific factors
Mkt cap greater than S$100mn
Operating Profit greater than S$10mn
OPM greater than 10%
Dividend yield greater than 4%
D/E Ratio less than 1x
Growth greater than 5%
ROE greater than 15%
ROA greater than 5%
(Usually these factors can be put into a screening tool to screen out companies that meet these criterias, but I have not found a free screening tool yet... if anyone can find one, pls inform me ok?)

Qualitative factors
Industry climate and firm's position
Strengths and weaknesses of the firm
Major risks for the firm

Valuations
PER less than 18x
PBR less than 4x
EV/EBITDA less than 10x
(These can be put into the screening tool as well)

There are a few things to take note. Even if a firm fails to meet 1 or 2 criteria, it doesn't mean that the stock is lousy. If there are good reasons, it is still a buy. If you try to find a stock that meets everything, probably there won't be any. That's why the each criteria is actually not too strict to begin with. Also, qualitative info matters, that's why it pays to read annual reports, research reports and business news.