Choosing Numbers, Beauty Contests and Stock Markets

I once attended a class where the professor asked us to play a game. It was a pretty simple game on the surface. Everyone was asked to choose a number from 1 to 100. The person who chose a number that is closest to 2/3 of the average number that everybody chose will win the game.

Now how should one choose such that it would maximize one's chances of winning?

Well, first you must determine what is the average of everyone's number choices. There were about 100 students in the class, so assuming everyone randomly chooses a number, probably the average will be close to 50. So 2/3 of 50 will be 33.

But wait a minute. If everyone thinks similarly and chooses 33 then the average will be 33 and 2/3 of the average then becomes 22.

Hey wait a second, if everyone then chooses 22, the 2/3 of the average will then become 2/3 of 22 which will be 15. And so the reasoning goes.

So in the end, I chose one, based on the above logic. Of course, I did not win the game. The real winning number, was somewhere between 22 and 33 (I forgot the actual no.). So what went wrong? And what the hell has it got to do with Beauty Contests and the Stock Markets?

Let's talk about the Beauty Contest first. The great economist John Maynard Keynes came up with this concept to explain the stock market. So this Beauty Contest is also sometimes known as the Keynesian Beauty Contest.

Btw Keynes is a big name in economics, if you don't know him. Shame on you and pls go check him up on Wikipedia.

Anyways during Keynes time, some newspaper in London publishes 100 pretty faces and asks its readers to choose which face would likely be the pretty face that most readers choose.

So there are people who would simply choose who they think are the prettiest. However that's quite unlikely to win bcos we all have different tastes right? Xiang Yun may be your favourite but I like Fann Wong. Ah Beng may like Auntie Zoe and Ah Seng likes Wong Li Lin. (Ok as you can see, I belong to a dinosaur generation and has no clue who are the new stars.)

So some smarter readers will naturally try to guess who they think the general public will choose as the prettiest face. And just like our number game, even more sophisticated readers can even go further, and choose the face that other readers will choose as who they think the general public will choose as the prettiest face. And one can further increase the order of the guessing game.

Ok if you have been reading intently this far, you would have guessed that the stock market works in a similar fashion. Well that is if you want to pick a winning stock tomorrow, or next week or even in the next 6 or 12 mths.

Basically you can throw fundamentals out the window. Technicals may help a bit but what's gonna make you big bucks is to guess what everyone else is thinking and be a step ahead. The winning stock will be one which the market participants think will have the rosiest earnings growth in the near future. It does not necessarily mean that the stock will actually deliver the rosiest earnings. Just what everybody thinks is what it counts.

Actually the market mostly likely works in the 3rd order: ie the winning stock will be one which most market participants expects most other market participants to like a lot. This is chim, right?

Today, these are your alternative energy, oil exploration, frontier stocks etc.

It does not make sense to go too high into the order bcos the market cannot be too sophisticated as there will always be some uncles, aunties and amateurs choosing their own favourite pretty face (or their own favourite stock). That's why choosing 1 in the number game will not win.

In the stock market, it means that you shouldn't be buying stocks of a company that provides the core component for a high-end analytical equipment used to detect uranium in some desert. And as you know, uranium is used for nuclear power generation - the hot, sexy story in today's environment. The market is not sophisticated enough to think so far ahead. Even though you may be right and the company may have a genuine investment thesis.

This means that you shouldn't be thinking too far ahead of the market. You should be 1 step ahead but not 5 steps ahead. Well, that is if you want to pick winners in a short time frame: ie from 1 day to 6 to 12 mths.

In summary, the stock market works like the beauty contest in the short term. It's the ultimate guessing game and chances of you getting it right is not high unless you have that flair or talent. But over the long run (ie 5 yrs and above lah), stock prices have to reflect fundamentals: earnings growth, shareholders' return and companies' true intrinsic values. And value investing ensures that you have better chances getting that part right.

Zoe, Fann, Li Lin can be Queens of Caldecott Hill but Mother Theresa, Florence Nightingale, Helen Keller are the real winners in life's beauty contest.

Don't get caught in a bubble - Part 3

The 3rd bubble that we will talk about would be Singapore's own property bubble in 1996-1997. This is the most interesting example bcos it is the only 1 in my 3 examples whereby prices have surpassed the previous peak.

However that doesn't mean that investors who invested at the peak did ok. In fact most people will still be under water. But at least, they have much better chance to recover their capital even though their compounded return will still be quite miserable.

The Singapore property bubble actually started in 93-94 when Asia experienced tremendous boom. In fact, four economies were given a very special name - Asian Tigers (or was it Dragons?) due to their spectacular double digit growth. They are of course, our beloved motherland, Korea, Hong Kong and Taiwan. Even so the rest of the region enjoyed high growth. Singapore properties were snapped up by Malaysians, Indonesians, Taiwanese and closer to 1997, of course, the Hong Kongers, who feared major upheavals following Hong Kong's return to China.

Well that's of course just part of the story. Many many factors came into play and even today we cannot say for sure what caused the spectacular rise and fall of the Little Red Dot's real estate prices.

Besides that foreign demand story, the other factor would of course be the lack of supply of property at that time. Back in the early 90s, HDB was lagging behind the curve (as usual) and cut down on building new flats even though demand for flats remained high as the economy grew. So, young couples were made to wait 4-5 yrs for their flats after they get married. And meanwhile the Govt expects more babies when young couples have to dunno-live-where for 4-5 yrs after getting married.

Also back then, private condos project developments were not built by the truckloads (probably approval wasn't that easily given that HDB's thinking was always about 3 yrs behind). So there was a general lack of supply and huge demand from both foreigners and young married couples. And as they say, the rest is history.

Property prices went through the roof. The highest end luxury stuff was like S$2,000 psf and even prices in undesirable locations like Boon Lay, Hill View also hit S$800-900psf, HDB in Bishan sold for a record $800k or so. There was no general price index that I could find but some charts indicated that if we use 1993 prices as 100, prices in 1997 were 120% or so higher.

After that, again a confluence of factors push prices down by roughly 50% (like HDB building 150,000 new flats in Seng Kang and Punggol when they realized they were wrong to stop building flats 5 yrs ago), only to rebound significantly in 1999 and 2000 and then went into a gradual decline until it bottomed at 2005. Prices at 2005 were 30% below its peak in 1997. Of course, things turned around in 2006 and 2007 with en-bloc, Integrated Resorts, Middle East investors, F1 and the other usual Ra-Ra stuff.

See Chart 1 for the whole history of our roller coaster ride!
http://www.hktdc.com/econforum/sc/sc070301.htm

And so today average prices finally exceeded the peak made in 1997 after 11 years, Well that's kinda good news when comparing to other bubbles, where usually, the previous peak was never surpassed. Nevertheless, if you have bought some of those luxury high end stuff at $2,000 psf, today you might be able to sell at $2,500 psf (that's a big assumption since your property will be 11-yr-old while some other cool stuff are just next door and brand new). So your return will be 25% after 11 yrs which is about 2%pa. Abt the same as fixed deposit today.

Well that's great right considering most other bubbles you usually don't see your capital.

So, moral of the story: Don't ever ever get caught in a bubble!

Don't get caught in a bubble - Part 2

The 2nd bubble that we will talk about is the one that is most familiar to many of us. This bubble goes by many names, the dot com bubble, tech bubble, IT bubble etc but I shall call it the TMT bubble (as some in the financial industry calls it). TMT stands for Tech, Media and Telco (I think), and it is named as such bcos these are the sectors that rallied the most during those days in 1999 and 2000.

The index representative of this bubble is, of course, the NASDAQ, where most of the tech stocks are listed. Names like Microsoft, Cisco, Oracle, Amazon, Yahoo! etc. At the peak, NASDAQ was roughly at 5,000+. Again today it trades more than 50% discount of its peak at 2,200+ (though it is a good 100% up from its bottom at 1,100) So again even if you had bought 30% below its peak, you would still be under water today.

It remains to be seen whether the tech stocks will suffer the same fate as Japan, ie never surpassing the previous high. It is now 8 yrs after the bubble bursted, and the NASDAQ has since risen 90% from its low. If it takes another 8 yrs to rise another 90%, this will bring NASDAQ close to 4,200. So perhaps those who bought at 5,000 can actually breakeven after 16 yrs.

Then again, the annual compounded rate of return will be quite bad right? In fact it will be 0% IF it breaks even at 5,000 after 16 long years. If you hold out longer, maybe the return can creep up to 2-3%pa. So in order to reach an average return of 8%pa, perhaps you will have to hold 100 yrs or so.

Moral of the story: don't get caught in a bubble!

Don't get caught in a bubble - Part 1

Investing in stocks or real estate or any other asset class is a good thing most of the time. Over time, most "well-known" investable asset classes give a good real rate of return (ie a return that can beat inflation lah). Ok the other caveat here is "well-known" asset classes, ie dont go and invest in wine or art, jewellery etc, chances are you are likely not to see your money again.

Just some ballpark no.s to play with, historically these asset classes have been able to generate these returns (nominal not real and they also include dividend or other forms of yield, real return will be these no.s - inflation rate)

Stocks 10%pa
Real Estate 12%pa
Private Equity 15%pa
Bonds 5%pa
Commodities 8%pa

However, as we all know, these are historical AVERAGE returns, There is no guarantee that the future will be like the past. It may not be possible for us to enjoy these returns going into the future. In fact if you had invested at the wrong time, there is a chance that you will never get close to these rate of returns.

Of course the wrong time willl be ********drumrolls******** investing at the peak of some bubble. I shall highlight three real life examples on how investing at the peak of some bubble will make sure that you will earn a meagre return over a long period of time.

The first bubble that we are going to introduce here is probably the biggest bubble in recent history (yes even bigger than the dot com bubble) in terms of magnitude. There are two asset classes involved: real estate and stock market (as usual btw) and sadly these asset classes never ever recover close to its peak even after 19 long years.

Yes this is the Japanese bubble which ended in 1990 when everything collapsed. At the peak of the bubble, the Nikkei was close to 40,000 and real estate prices in Tokyo reached close to USD 140,000 psf. (Okay so Singapore is not so bad lah, only SGD 3,000+ psf this time round, we are about 2 more digits away).

Today the Nikkei stock index hovers around 13,000 levels and Tokyo real estate prices are on par with Singapore's SGD 3,000+ psf. A lot of Japanese that invested in real estate near the peak had to finance their mortgage with maturities stretching 2 lifetimes ie the sons have to continue to pay the father's mortgage.

Imagine if you have bought stocks or real estate even at 30% below its peak level, you will still not see your capital today, and the sad truth is, perhaps you will never ever see your capital again.

As for the stock market, the Nikkei declined steadily over the next 13 yrs after it cracked in 1990 and eventually reached a bottom at around 8,000 in 2003. So even if you DCA all the way down, you may not have broken even today. Subsequently, it rebounded to 18,000 before declining back to 13,000 today.

Moral of the story: Don't get caught in a bubble, but easier said than done right?

To be continued...

DCA: When the market down, BUY MORE!

Value investors rejoice when the markets go into correction mode. Bcos that means they can pick up good businesses at bargain prices. Logically and intuitively, this makes perfect sense, but somehow our ape-evolved brains are not wired to think that way.

When the markets have rallied for some time and it goes down, we panic. When they subsequently rebound, we curse and swear that why didn't we buy more during the correction. And when the markets go into correction mode for 3 years, we get totally not interested in the markets. Many don't ever return to invest, even though it's the best chance they got against inflation.

So some have come up with a method to counter this flaw and help us invest wiser. It's called Dollar Cost Averaging or DCA for short. It simply means that you put the same amt of money to buy stocks/UT/index funds etc at fixed time periods.

The logic is that although you lose money when the markets go down, bcos you put the same amt again after it has declined, you buy more of the stock/UT/index fund, and over time, since all markets will rise, you will earn the market average return of 8-10%.

However, one must be wary that it's also detrimental if you cut it too thinly ie if you DCA every mth, you end up paying a lot of commission bcos sometimes for UT there is a sales charge for every transaction, and for stocks the bid-ask or the $20 transaction cost kills you. This is what brokers will recommend bcos it generates more commission dollars, so beware!

I have 2 recommendation to improve on DCA that I hope will help most pple.

1) This is just reiteration. Don't cut it too thinly, ie maybe at least once a year and buy more at one go, like maybe roughly $10k at one go. Imagine if you DCA every mth at $1k. You pay 2% sales charge, or you pay $20 on transaction at the brokerage, which is also 2%, you are giving the return away, investment earn only 8%pa on average. So it has to be a huge amt to offset these costs. At $10k, the $20 becomes 0.2% + some bid-ask which ends up maybe like 0.8% or something. Alas, for UT or funds that charge 2%, too bad, $10k you still pay 2%. So avoid funds with huge sales charge.

2) Buy more when the markets are down. Instead of DCA-ing the same amt. You can buy more when markets are down ie. in 2000 you really DCA a minimum amt, 2001 you increase your DCA to 120%, 2002 to 140% of original, 2003 another increment etc. Of course, on hindsight, that's easy. We knew what happened already. How about now? Do you increase your DCA amt next year if the markets are down? Chances are if it goes down in 2008 it's gonna go down in 2009 as well right? But I guess one simply has to strengthen the will to increase DCA when the markets are down and lighten up when the markets are rally. That way, it will enhance return and help you hit 8-10%pa over the long run.

More on inflation

In the last post, we talked about how inflation will hurt us badly. Today we shall discuss some countermeasures.

So inflation is a major issue if you think hard about it. All your savings goes down the drain and you are back to square one. You think you save S$1mn for your retirement and that should be enough. But hey 30 yrs from now, S$1mn cannot even buy HDB, Bcos the value of S$1mn in 2038 is worth only S$300,000 in 2008 and basically you might even have lost money even though you saved like mad for the past 30 yrs. What the heck! What should we do?

Actually there is nothing much we can do, except to invest in stocks and real estate properties. Historically these are the only two asset classes that can keep up with inflation. With stocks, you are buying pieces of companies and good companies will create value for their shareholders, inflation or not. The same goes for real estate.

There are some other unconventional methods to beat inflation completely original from this blogger so just read for fun and implement at your own risk!

1) You can increase your debt! Inflation helps debtors bcos the money they owe also decline in value, so if you borrow tons of money before inflation kicks in, next time you only need to pay back less than what you borrowed in real terms. But you must not put them in your bank and earn fixed D bcos then your fixed D also decline in value and you suck thumb. So you must borrow money and spend them asap, like buying Prada bags and Ferragamo shoes and satisfy your immediate desires! So maybe not much help to build your retirement nest.

2) Buy stuff that will retain its value over time, this means buying things like limited edition Rolex watches, silver, gold, white gold, platinum jewellery or other maybe pure gold bars. (Not diamonds btw, if the real supply of diamonds are released into the global markets, 1 carat diamond is worth as much as 1g of sand, the perceived high value of diamonds can be regarded as the biggest marketing gimmick in our times. Sorry girls, diamonds are worthless, contrary to what you think).

So back to the original solution: nothing beats buying stocks and properties to combat inflation, so keep your savings in these asset classes. The rest of the asset classes like cash, bonds, other currencies sadly will not help much.

The return of inflation

Most of us never really lived through periods of high inflation, thanks to very effective central banks throughout the 80s until today. But with recent rise in commodity prices translating to higher food prices, higher raw material prices, higher property prices, higher taxi fare, higher this, that and everything else, inflation may be coming back to haunt us. And believe me it's gonna be scary.

It is generally accepted that mild inflation is actually good for the economy bcos it helps increase wages, improve productivity, encourage employment and keeps the economy churning along and all is well. But usually this means inflation of 2-3% per yr or something. And if wages increase by 5% per yr then it is a real increase over inflation and everybody is happy!

However, this time round, the world, and hence Singapore (or maybe more Singapore) may be going into a period of not-so-mild inflation. This means inflation of maybe 5-10% per yr. Although not as bad as hyperinfation, this has very drastic consequences for value investors, or rather, everybody.

A bit of digression here. Hyperinflation refers to inflation getting totally out of whack and hence the value of the currency of the sovereign entity goes down the drain. This means that in people's eyes, the currency has no value and becomes as good as banana money (read further down to know more abt this) or simply worthless paper. The worst case of hyperinflation is of course Germany in the 1920s when the inflation rate was 10^27 times.

For those who fail to comprehend the significance of this, it means that $1 today get reduced to 1/1,000,000,000,000,000, 000,000,000,000 of its value. To put it in another way, even if you are a gozillionaire in Deutsche Mark, ie you have 1 million billion trillion Mark, all you have becomes $1 at the end of the day.

Basically your money is worth even less that the paper used to manufacture the note.

In Singapore, of course, we have our infamous case of the banana money issued by the Japanese military during WWII. Luckily or unluckily $1 of banana money becomes only 1/1,000 of its value by the end of Japanese occupation.

Well all these seems a bit far-fetched and probably we will not see such dramatic times again. So back to the real story, if inflation hits us at 5-10% per yr what happens? Well let's work with 8%pa (I like my blog name you see). This means that your money loses 8% of its value every year. Basically in 6 yrs, every dollar you save becomes 50c. Even if you invest wisely and earn 8%pa return, it only means that your $1 stays at its original purchasing power.

In reality $1 you invest becomes $1.08 after 1 yr but your Kopi-O also jump from $1 to $1.08 so effectively your investment did not help you build up your wealth.

Lemmings falling off the Cliff!

Lemmings are small rodents usually found in the Arctic. They breed very quickly and when their population reaches a certain critical mass, they are known to commit mass suicide by leaping off the cliff. (Although according to Wikipedia, it is proven that this was not the usual behaviour of lemmings but rather something propaganded by media to create sensational news.)

Anyways this strange behaviour of Lemmings excited many social scientists bcos they have found similar behaviour in people living on a small island south of Malaysia. But since there are no cliffs around, these people employ foreign maids and constantly abuse them for pleasure. Some experts believe that overcrowding and the pursue of status and material wealth leads to such inexplicable symptoms.

Ok let's move on to something related to stocks.

As you would have guess, in financial markets, participants exhibit Lemmings' strange behaviour as well by mindlessly following others' irrational actions. In most aspects of normal life, most people behave rationally when looking to buy a car, a fridge, whatever. They collect information, talk to others, get viewpoints but ultimately come up with a decision that is usually rational.

However when it comes to stocks, somehow, independent analysis becomes a taboo. People like to follow what others are doing. When the market is shouting buy, buy, BUY into the peak, they simply react like Lemmings, rushing ahead regardless and then when they see the Cliff, they happily jump over it, just like all the other Lemmings ahead of them who jumped. (Of course participants won't literally see a Cliff until they fell off it as the market tanked.)

Strange huh?

I think this has got to do with greed (and not overcrowding or pursue of status though). For the general public, they seldom come in contact with stocks, investments in their daily lives but in times of bubbles, unscrupulous bankers, brokers, agents will start calling them up and sell them dumb products at the peak of markets. And they get sucked in bcos of the dumb freebies and all. I guess it's also human nature to get easily persuaded by friends (selling insurance policies) or sweet young bankers (selling some dumb structured pdts). So it's difficult to really fault the general public.

Well I guess the lesson learnt from the Lemmings is this: always think on your feet and dont blindly follow the front Lemming (or the sweet young banker leading you) down the cliff. (Which makes me think about the condo called The Cliff, so those staying there are Lemmings of the property market?)

Defensive stocks

In different markets, different sexy terms come into play. I guess the latest infatuation on Wall Street in recent months has been "defensive stocks". Defensive stocks usually refer to stocks that will see stable profits even during times of trouble, ie like the past few months lah. These would be stocks in industry sectors like: consumer staples ie your food, beverage, razor blades etc. The thinking is that people need to eat, drink and shave no matter what right? Stock market down means everybody goes without food? Unlikely, so these are defensive stocks.

The other sectors are like pharma (your diabetic patient needs his pills regardless of stock market woes), utilities (eh, obvious I hope, we need electricity even during bear markets) etc. So you get the idea, things that we can't do without even during an economic downturn.

So what are things that we do without during the downturn? Well it actually differs for different entities on this planets. For example, Ah Beng who made money punting property and bought himself two Ferraris will still drive his Ferraris and buy Prada bags for his Ah Lians even though his latest punt has gone wrong and he has a $4mn mortgage but his condo at Sentosa is worth probably <$1mn and his monthly salary is $5k. So to him, Ferraris and Prada bags are still things that HE cannot do without even during a slowdown. But for most people and for the stock market, consumer non-staples (like car, furniture, luxury products, massage chairs, high tech goods etc) usually see profit decline.

Also most of the darling sectors that rallied during 2003-07 bull market ie oil exploration, shipping, property etc. One reason would be bcos credit is drying up and most of these sectors require a lot of credit financing to grow their profits. Of course, some experts may beg to differ, these sectors are in a secular boom and some silly sub-prime trouble is not going to derail their "sexy" story. Well... this blog is big enough for differing biews, so share your thoughts if you have some. The other type of defensive names would be stocks that pay high dividend, has huge amts of cash on their balance sheet, or stocks that generate huge cashflow regardless of business cycles

Hurray! Buffett is World Richest!

This is a time for the world's value investors to rejoice. Our hero, Warren Buffett has become the world's richest man, overtaking Bill Gates, Founder of Unpopular Vista and Insecure Windows and Carlos Slim, Monopoly Tyrant oops Tycoon of Mexico. Of course, Lady Luck has got a lot to do with this, here are a few facts to support the thesis:

1) Microsoft has eaten full full and got nothing better to do, so decided to launch a bid for Yahoo! which aggrevated a lot of investors bcos it's quite a stupid move given that Yahoo! is like yesterday's darling (ie like Demi Moore or Alicia Silverstone, does anybody remember them anyways?). Hence Bill Gates lost like 20% of his net worth in a couple of days and got relegated to No.2. Or was it No.3?

2) Thanks to the sub-prime crisis, investors are desperately looking for safe haven to park their money to hide away from the storm, and where's a better to place than to hide with the Guru? So Berkshire stock rallied like nobody's business and our hero became No.1.

So that's that, fellow value investors buck up and follow your idol and the road to riches will be short ride.

Er, wait a minute, although this blogger believes that value investing is a good way to help you grow your wealth, there are a few things that Buffett can do while most of us cannot. So the road ahead is always not that short I'm afraid. The philosophy is important, but it may not reach the same destination depending on the execution. Here's a few tricks that Buffett can use but we cannot:

1) Buffett can buy over whole co.s and ask mgmt to pay out excess cash to Berkshire. This is a very powerful tool as we all know that mgmt simply cannot be trusted to handle shareholders' money. We have seen so many examples of good co.s generating good cashflow only to see it squandered away on useless ventures. I think the most aped example would be Microsoft. Bill Gates must be cursing Steve Ballmer to death now for doing the Yahoo? deal. Shareholders are so much better off if Microsoft just generate cash and return them to shareholders.

Well this trick is something that you and I cannot do. But it is a good philosophy to bear in mind and remember to apply this, if it is ever applicable in our lives. I guess one example would be property. If you are holding a property that can generate rental yield of 15%. I guess you should never sell this property unless it's like a super real estate bubble in which your property will fetch as much price as the whole of Bintan or something. Except for that scenario, you should never sell something that gives you 15% yield bcos in 6 yrs you get back your principal and the ppty will continue to generate 15% per yr for as long as you own the property!

2) Buffett's investment actions follow the self-fulfilling prophecy. There are websites, blogs, analysts, TV programs, cell groups following Buffett's every investment moves and hence whenever Berkshire makes a move, a lot of people will simply charge and buy with the Sage of Omaha. So is it a wonder why whatever Berkshire buys always goes up? Of course, this is also due to Berkshire's brand name. ie whenever Berkshire buys something, it is a stamp of recognition that the stock or investment is undervalued and money is to be made.

In other words, at a certain stage when a famous investor or fund manager becomes so successful, his success will simply feed onto itself bcos a lot mindless followers will simply support him and validate his investment decisions. Again this is something that we cannot do, yet. You see, this blog will become a sensation in time and start recommending stocks which will then send its own army of mindless followers to buy and the early birds here will reap the rewards. Haha fat dream right?

Well hope is a good thing, and all good things never die. (taken fr Shawshank Redemption by Stephen King) So keep hoping!

Shareholders' Equity

The balance sheet is basically an elaborated display of a simple equation.

Assets - Liabiilities = Shareholders' Equity or simply Equity

What this means is that whatever assets that a company owns, subtracting whatever the company owes, gives you what's left for shareholders. This is also known as the book value of the company.

Shareholders' Equity is usually at the bottom right of the balance sheet (Assets on the left side, Liabilities on the top right) and is usually broken down into the following sub components:

Common stock
Paid in capital
Retained Earnings
Preferred stock
Treasury stock
Others: there are actually a lot more complicated stuff but I will just lump it under others and we will talk about that on another day.

Common stock and paid in capital are usually thought of as the original capital of the company. Common stock is the no. of outstanding shares multiplied by its par value which is usually some arbitrary no. like $1 and paid in capital is usually the proceeds received during IPO or subsequent secondary equity financing.

Retained earnings would be the impt sub-segment to know. Needless to say, retained earnings comes from net profit (from the P&L statement). So what this means is that retained earnings should be as big as possible. If you see a company that has an original capital of say $1mn but retained earnings is like $80mn or some big no. then you know this co. has created tons of value for shareholders. And conversely, if paid in capital is bigger than retained earnings, either this firm is still very young, or it has continously raised new money from shareholders ie old shareholders keep getting their stake diluted and the business model's sustainability is questionable

Preferred stock is basically a stock pays dividend forever and is usually not a big sub-segment. Thus it pays to find out why a co. might have a huge preferred stock capital.

Treasury stock is a negative entry (ie the $ amt here is negative not positive) in shareholders' equity and it arises only when a company does share buybacks. This is a good sign bcos it signifies that the company has its shareholders in mind and is using share buyback as a way to return capital to its shareholders.

Step-By-Step Company Analysis

This is an expansion of a previous post on how to do a detailed company analysis.

Company CheatSheet

The zero-th step for company analysis is actually a quantitative stock screen. Poems have a good system to come up with a list of stocks. As for what criteria to use, the post mentioned above has a list which I would recommend pple to use. The screen should include both company specific financial ratios and valuations.

So you put in the criteria, the the system churns out a list of companies. Then you can select any co. that has a nice sounding name or maybe it is in a good industry and study it. It will probably take you 3-4 days (if you have a full-time job and can only spare limited family time to do this ECA) to read the annual report and broker's reports try to understand its business.

Ratios: when doing the screen, you would have included a few financial ratios, but the trick is to actually look at all other ratios, if something bothers you, ie this co's interest coverage ratio or asset turnover is too low. Then perhaps its not wise to invest in the stock.

Next is to focus of qualitative stuff. Some things that I would look for are:
1) Whether the company is in the right regional markets / right industry ie places where there is still a lot of growth, less competition and co. has pricing power.

2) Market share of its products, it is better to be either No.1 or No.2 in its field bcos anything else, it has no pricing power nor the competitive edge over its competitors. Of course, all industries are different, sometimes, the market is such that there is no mkt leader and can never have one.

3) Its business moat / competitive advantage / barrier to entry of its business, the company needs to have that edge where no one can ever get close to them. For Toyota the edge is its manufacturing capabilities, it can make a cheap, reliable and fuel efficient car targeting the mass affluent, and no one else can do that. But the European cars fight with another edge: branding and image. Think Porsche, Ferrari, Lamborgini.

4) Its management, their compensation scheme and their past actions. Has the mgmt been friendly towards shareholders? Have they issued options or other means to dilute shareholders' stake indiscriminately? Any directors resigned?

5) Clarity of its annual report. Sometimes, the annual report of the company can be very flashy but it does not tell you the impt things. ie. the company is trying to hide. It then pays to avoid these co.s.

Of course, the list goes on and on. And as you gain experience as an investor, you refine your thinking, and know what to look out for: the warning signs, the best practices, the business moats and whether the businesses are sustainable.

There are really so many things that you should look out for and even after that it pays to let things cool for a while, re-visit the company after some time, or after when the stock has fallen a lot. Especially in the Ra-Ra markets of 2006-2007.

So when I have decided that this is a company that I should own, I will wait for a good time to buy. When valuation gets cheap enough. Usually I only look at PER. So if the sustainable forward PER is cheap enough, I will buy. This is the most important step as a wrong entry price will decide if this stock is a 10 bagger or just a 1.5 bagger (after 10yrs).

It's not easy but it's rewarding when you get it right.

Whipsaw

Actually the fear of getting whipsawed is so great that it causes a lot of investors to make silly mistakes. But if you think about it, even if you really get whipsawed, it's not a big deal except for the psychological factor. Say you cut loss at 10% and the stock subsequently rallied, so you would have lost just 10%. But if you did not cut loss and stock continues to decline, you will eventually lose maybe 50-60%.

Let's for argument sake, make the example a bit more mathematical. Say you bought a stock at $10 and it plunges to $8. There is a 50% chance that it may rebound 50% to $12 and 50% chance that it plunges another 50% to $4.

If you cut loss, you lose $2
If you are right in waiting out the storm, you make $2
If you are wrong and the stock continue to plunge you lose $6

Let's assume it's 50:50 between the $2 and -$6, your expected return of not cutting loss is $-2 (0.5*2+0.5*-6), which doesn't make you better off than if you had cut loss. Actually it's probably 70-80% chance that it will go down. Logically thinking stock at $10 which had gone down to $8 should continue to decline bcos something had gone wrong in the first place. So unless a new positive catalyst appears, the stock will not rally.

However the fear of getting whipsawed is so great that it blurs the rational mind. If the stock did rebound and go back to $12, most pple would rather kill themselves than to admit that they only lost $2. This fear of getting whipsawed makes us hold on to our losses longer than we should.

Mr Market and the ice-cream machine

Global stock markets are technically in a bearish mode, defined as falling 20% below the previous peak. The other well-known technical indicator is 2 consecutive quarters of negative GDP growth equals recession. Guess most pple know this one right?

In this kind of market, it is natural that most participants feel very down. Especially those who don't have a clue about stocks, trading, investing and entered the markets hoping to make a quick buck bcos their friends/colleagues did just that. Or maybe they heard stories of how pple made quick bucks buying COSCO, hold it for a few weeks and made a couple thousand dollars.

Well, now the stories become how pple loss 50% of their portfolio in one month and in absolute terms translate to $15,000-$30,000. They are in so much pain that they cannot eat, cannot sleep, don't want to hear anyone mention sto.., sorry you are not allowed to finish the word. Ok, if you know any of these people, ask them to come here and this blogger shall play Uncle Agony today.

Buffett and his predecessors like to use this term Mr. Market to describe the stock market. For more info on Mr. Market, click the hyperlink. Well the point I want to make here is that Mr. Market, or rather the stock market is like the Hokkien auction coordinator. He keeps shouting prices day in day out. And the prices are dictated by his emotions and they are usually not rational ie. they do not reflect the true value of the stocks.

For now, let's digress a bit. Let's say you bought this ice-cream machine that makes you fantastic vanilla ice-cream that you can sell for $5 per ice-cream, for many many yrs. Then someone comes over today and tells you, "Hey your ice-cream machine is only worth 50 cent, sell me now!", what do you do? Of course you ignore this mad guy right? Then suddenly next day he appears and again tells you, "Hey your ice-cream machine is worth $10,000, sell me now!" In fact, he will come everyday and quote you a price. So should you go happy like a bird when he says it's $10,000 today, and go appetiteless, sleepless, depressed when he says it's 50 cents tomorrow?

Well if you didn't know what you have bought and couldn't care less and the only thing in your mind when you bought it is that you think you can sell it few weeks later at a 15% profit, then, you should be appetiteless, sleepless, depressed bcos now you can only sell it at 50% lower than the price you pay.

But the good news is, if you hold on to it long enough (like 20 years), it's got a good chance that it may cross your buying price. Bcos the average return for stocks is 5-10% per year, so even if it dropped 50% this month, in a worst case scenario, say if the stock only goes up for 5% per year for the next 20 years, it will rise by 100% and reach your buying price. Meanwhile you can decide if you should be appetiteless, sleepless, depressed for the next 20 years. So that's consolation from Uncle Agony. Doesn't help much I guess, hehe.

But if you took pain to calculate how much your ice-cream machine is worth. And took pain to do research, to wait for a good price to buy the machine. Even if conditions are bad today and you can only sell your machine for less than its true worth, you know it's ok. Bcos you know some day, its value will be recognized.

Of course, humans cannot escape from emotions. Even the most experienced value investors feel the pain when their stocks decline 50%. However it is the philosophy that is important here. When the market is shouting that you are wrong, your stock is worth 50 cents, it doesn't mean that you have to be depressed. Re-look into your analysis and see if there is any truth. Usually there isn't, so be resolute and ignore the noise. It is your ice-cream machine, your stock, you don't need someone to tell you how much it's worth. It make take years to prove your point, that's investment, that's the stock market. You have to live with that in order to play this game.

Free Cash Flow Yield or FCF

One advanced but quite useful financial ratio that has not been discussed on this blog is the Free Cash Flow Yield. This no. tries to determine how much return can an investor expect after the company has made its money and invested what it needs for future operations. It also gives an indication of how much the dividend yield could be.

This ratio is not called an advanced ratio for nothing. For those who think investment is easy, well sorry, you have to read maybe 5-6 posts on this blog in order just to understand this one. I have added the links on all the keywords. Anyways, here's the basic.

A company generates cashflow based on its day-to-day operations. Eg. a hawker selling bar chor mee gets money fr his customers. This no. is called Cashflow from Operations.

Next, he needs to spend some of this cashflow on equipment to maintain its operations (bowls, knives, noodle cutting machine etc.) This no. is called Capex which is the short-form for capital expenditure.

When you deduct Capex from Cashflow from Operations, you get a no. called the Free Cash Flow. Basically, that's what's left that can be distributed to shareholders or to pay down debt. If the company has no debt, it's basically money that can be paid to the shareholders.

Next we try to compared Free Cash Flow or FCF with the stock price. So you divide FCF by no. of shares. You get the Free Cash Flow per share. This is similar to dividing Net Profit by the no. of shares to get the EPS.

And finally, you divide the FCF per share by the stock price to get the FCF yield. This is similar to EPS divided by stock price to get the earnings yield, the inverse of the all-famous PE ratio. So we all know, the higher the earnings yield, the better, bcos it means more return of investors. Similarly the higher the FCF yield means more money back to investors.

Empirically FCF yield of 5-8% would indicate that the co. is quite good in terms of managing its cashflow and capex. If you get lucky you may find co.s with 10-12% FCF yield. What this means is that this business keeps churning out cash and yet you need not invest in a lot of new stuff to keep it going. This is the kind of businesses that value investors like. See's Candy would be an example that Buffett would place here. In Singapore, I think Vicom would be a good example. No. of cars keep increasing, but not much new investment needed to check more cars.

Sadly, I would guess that 30-40% of all listed co.s would have a negative free cash flow yield, bcos most businesses require a lot of capex just to keep going. The prime example would be semiconductor and/or tech businesses. Every few yrs, technology advances and companies just have to keep investing just to stay competitive. 6" wafers to 8" then to 12". Everytime to inch size changes, all the eqmt have to change. Is it a wonder why Chartered cannot make money?

So that's FCF yield, a good indicator of whether the co. is good or bad at generating cashflow for investors. But it's quite troublesome to calculate this and usually stock screens don't have this ratio easily available although it's on Bloomberg.

To Cut or Not To Cut

In Value Investing, you NEVER cut losses. If you have analysed the company and have determined that it is a good buy, and you bought it. If it goes down, you should be buying MORE of the stock. Since it is cheaper now. Well, that's provided everything is still the same since the time you did your analysis.

But for most novice investors, including this blogger, our analysis is usually flawed. There is probably something that we missed. Remember the market is not stupid. In fact we all know the saying don't we, "The market is always right." If you bought a stock, and it falls 20-30%, chances are something is wrong with the company, at least in the next few mths (well the market is very short-term focused also). And it pays to redo your analysis.

Well if you are willing to wait out the storm (which may take years), then all is well, it may go down 20-30%, but eventually it will come back, and it will surpass your cost price, in time. If you are a true blue value investor, and you think the co. fundamentals have not change when you decided to buy it back then, and if you got the GUTS, then BUY MORE of it.

For those not so true blue value investors, well you may want to follow some trading rules, ie to cut loss at a certain level. Some recommend 10%, some 15% below the price you bought, depending on how much pain you can endure. Hehe. But remember the tighter the cut loss level, the easier it gets triggered and the easier you get whipsawed. Btw whipsaw means you sell after the stock tanked 15% and then it goes to rally 100% and you go and bang your head on every wall you see.

Cutting loss is actually also rational in some ways bcos you can buy more of the stock at a cheaper price. If the stock is now $10 and you used $1000 to buy 100 shares. It drops to $5. And you use another $1000 to buy 200 shares. So you have 300 shares.

But if you cut loss when it drops to $8. You get back $800. It drops to $5 and you use the original $800 plus another $1200 you get to buy 400 shares! In both cases, you spend $2000 but if you cut loss and buy back at a lower price, you get more shares!

Having said that, it is not easy to cut loss bcos of the psychological factor. This is well studied in behaviour finance. People tend to hold on to their losses far longer than they should. And they take profits too early. Bcos if they cut loss, they have to admit they were wrong, realized their mistakes. But if they simply hold on, it's not realized, there is still HOPE that it will turn around. Vice versa, for profits, once they locked in, they would have proven a point, they got it right. And the right to brag about it later on. So pple always take profit too fast. It is in the wiring of our ape evolved minds. A seasoned investor tries to overcome this malfunction and makes the money.

Of estimates and consensus thinking

I attended an investment session where the instructor asked the class (of around 20 pple) to estimate the size of Thailand vs Singapore. Was it 50x bigger? Or 100x bigger? Or 500x or what?

He wanted to prove a point. The true answer will lie in the range of everybody's estimate. Bcos someone was bound to get it right. Well his point was quite valid, in the end, the answer did lie within the range of everyone's estimate.

But what was more striking to me was that most estimates are wrong and some VERY WRONG. For those dying to know how big is Thailand vs Singapore, well it's actually 73x. The closest estimate was 50x. And only one guy got that close. Some had it 10,000x. My estimate was 400x.

This made me think very deeply about the nature of estimates. And more specifically, estimates of future earnings of listed companies. We know that the sell-side or brokers have their army of analysts to forecast listed companies' earnings for next yr, or 2 yrs out. Maybe, just maybe the analysts' estimates on a listed company's EPS that we, and most investors rely on, might usually be wrong as well. And it's logical that they should be wrong. Bcos estimates, by virtue that they are estimates, are usually wrong!

Of course, you may argue that analysts have access to information since they get to talk to industry people, competitors, company management etc. Well the analogy with Thailand vs Singapore may not be quite right today, since we have Google and Wikipedia.

But imagine if it were the Stone Age and the class was given 1 yr to walk Thailand and Singapore and come up with an estimate, how likely is it for the class to get it right? Probably as likely as the analysts to get next yr's EPS right, right? Which implies that estimates based on some info but INCOMPLETE info is not much help and that's the way it should be.

So consensus thinking and crowd thinking, by logically extending the argument, can actually be usually wrong. This can be quite scary bcos most of us (well some of us) usually follow others' action thinking that they did their homework so we are safe. E.g. I will go for a stall with a respectable queue in front of the shop at an unfamiliar hawker centre. As for financial markets, there is this thinking that even if we are wrong, so would most others and so it shouldn't be that bad.

Now based on the recent poll, I guess most pple would agree that Singtel is a bad investment since most pple thought that Singtel gave back 0% return since IPO. But guess what, the actual answer is more than 44% return since IPO, which is at least 3%pa based on the price of Singtel when the poll started (around S$3.60). Bcos Singtel gave back lots of dividend and capital back to shareholders during the 15 years it was listed. Since then, Singtel reached a new high of S$4.00 or so. That's another 10%. So again, most people are wrong. Ok you may argue 3%pa is not very attractive, esp after putting your money there for 15 yrs. Well its better than fixed D, and the point here is actually estimates are usually wrong, just a reminder.

Also it's a mere 15 years since Singtel IPOed. Statistically, it's not really that significant yet. Yes in order to be of statistically significant, the track record has to be 18 yrs or more! If you hold on to Singtel for the next 3 yrs or more, maybe the annual return will converge 8%pa or something.

So I guess the moral of the story here is this: Don't trust what most people do, they are usually wrong. Do your own homework and come up with the logical conclusion. Or you can visit this blog (which tries to post accurate logical conclusion on most stuff) more often.

The Efficient Market Revisited

There has been a lot of debate since the 1950s whether markets are efficient or not. Btw, if you are asking what the heck is an Efficient Market, you can read this posts first.

Label: Modern Portfolio Theory

Ok Efficient Market. Essentially, some academics came out with this theory that nobody can earn a superior return than the market return (ie average investment return) over an extended period of time bcos markets are damn bloody efficient. ie if there is an inefficiency (or a discrepancy between price and value), eg a stock is worth $5 but is only trading at $3, people will simply keep buying the stock until it is fairly valued. So no matter how hard you try, you can only earn the average index/market return if you invest in stocks/bonds whatever, which is about 8%pa.

As with academics, they made it complicated. So they came up with three forms of Efficient Market which I have forgotten what they are. But the message is nobody can beat the market whether you use fundamental analysis, or technicals or whatever intelligent tools you can come up with. So even if you managed to spot one inefficiency, you are just lucky and you won't be able to do it over and over again. The academics dare you to prove them wrong man! They really do! And sadly I think they are winning. Not 100% but quite close.

Having said that, actually there is a flaw in the EMH, or Efficient Market Hypothesis. The flaw is that the markets are not efficient to begin with. It becomes efficient bcos the market participants are constantly taking out the inefficiencies. Imagine 1 million investors/speculators in the market and everyone just managed to spot 1 price/value discrepancy, then the market will be quite efficient already right?

So the markets become efficient bcos there are lots of participants taking out the inefficiencies all the time. The thing is that most participants can probably pick out 1 or 2 inefficiencies during a certain time frame but not a hell lot over long periods. Hence in general, markets are quite efficient to any one person.

But what if they are those who can consistently spot inefficiencies and earn the difference between price and value? Does that mean that the market is not efficient? In my opinion, the markets are still efficient it's just that this group of people have superior tools to enable them to pick out more inefficiencies than others. Of course for those still blur blur one, we are talking about value investors.

One reason why value investors can do this is bcos of their investment philosophy and investment horizon. Most pple nowadays go for instant reward, taking quick profits. They are not interested in owning businesses, waiting for its value to grow over time. They want profits NOW. Hence although a lot of people may know about value investing, they either

1) don't believe it works; they just don't believe in the owning business thingy
2) may not want to practise it bcos it takes too long to see the fruits
3) they think they are practicing value investing but they still buy and sell stocks like oranges or mobile phones or cars

So those Superinvestors for Graham and Doddsville patiently buy businesses while the world revolves around trading stocks like oranges or mobile phones or cars and Voila! They beat the major indices flat with their 30 yr track record of 25-40%pa. But sad to say, there are probably only a handful of these people and they don't really have a strong statistical argument against the Almightly Efficient Market.

Conclusion: The markets are not 100% efficient but they are efficient enough such that you don't get a free lunch if you don't work hard enough for it. Work hard = read books / annual reports, do a lot of macro, industry, company analysis etc.

Barriers to Entry

To determine whether a company has a business moat ie whether it can defend its turf when competitors come in, we look at what is called Barriers to Entry, one of Porter's 5 Forces. I have identified a few common barriers but I must point out that the list is not exhaustive. Other barriers exist and it takes experience and knowledge to identify them. Again, investing is about life-long learning and hard-work. It is not about get-rich-quick.

Market share
This is the most basic edge a company can have over its competitors. When a company is the No.1 or No.2 in its field, it is simply much more difficult for the laggards or any newcomers to try enter their market. Esp if there are only 2 or 3 big players in the market. This is bcos standards are set and relationships have already been established, and the laggards and newcomers don't have the resources or time to beat the leaders.

Technological edge
This edge can be manifested in several ways. It can be simply authentic technological capabilities, like Toyota with its hybrid technology which it was the first to developed and remain the leader today. Or it can be superior manufacturing technology which allows the company to make stuff cheaper yet have similar or better quality. Like Samsung's LCD TVs.

High initial investment cost
Some businesses require very high start-up cost and this naturally deters competition. Oil/mineral exploration, wafer fabs, a telco network etc. It is simply not business that any Tom, Dick, Harry can start. Sometimes, it can only be started by the government. So when a business can earn a good return and its in one of these high start-up cost sectors, hmm, maybe it can be interesting.

Brand
This is one of the best barriers a company can ever build. Buffett prides his See's Candy, commenting how people will always buy See's Candy even when it keep raising prices. Great brands like Coca Cola, Louis Vuitton, Rolex and our beloved Ipod are simply immune to competition. No matter what the competitors do, people will still buy Coke to drink, LV bags, Rolex watches and the Ipod over Creative Mp3 players.

Regulations
This is the most tricky barrier. Sometimes it works very well for the company in question, but sometimes it simply screw things up. The investor has to become a political analyst to get this one right. Eg. oil fields in Indonesia and Russia. Although major co.s like Shell etc negotiated for rights to sell the oil in these fields some years ago with the respective govts, the contracts were void since oil prices shot through the roof. In the case of Russia, the rights were forced to be sold back to Russian co.s. Suck thumb right? Some value investors stay away from highly regulated sectors altogether.

So, as mentioned, there are other barriers and it takes time and experience to identify them. But when you know the company has got a good business moat, earns a good return, and reward shareholders, then go for it. In Singapore, some co.s that comes to mind would be your mass transport stocks, newspaper, telcos etc.

Index Investing vs Stock Picking

Our guru, Warren Buffett doesn't really like the idea of buying indices bcos it is not really investing per se. He thinks most pple stand a better chance if they follow simple investment rules like those governing Value Investing. But not everyone can be like him.

Another reason why some prefer stock picking is: index fund investing simply takes all the fun out of investing. It is like skipping the appetizer, the soup, the main course and going straight to the dessert. Investment is about pitting your wits against the market right? What's the point of just parking some money in some indices that move only 1% each day?

Well for most folks who really have no time to read up and study but yet want to say they are doing investments, it would be better for them to go buy index funds rather than spend the money on some structured pdts or unit trusts recommended by ignorant / totally unethical bankers that will probably give them poorer or even negative returns.

But for those reading this blog, well, we are different right? We are here to learn to pick stocks and beat the index. Sad to tell you the truth, chances of that happening is roughly 10%. This is a very well documented result and there is even a book that argues if you give darts to some monkeys and they simply throw the darts on some newspaper with all the stock quotes to "pick stocks", the resulting portfolio will do as well as the average fund manager's portfolio.

Nevertheless, the valiant shall not be discouraged. There is Value Investing and there are those Superinvestors fr Graham and Doddsville that made it right? Why not me? Well there are probably tens of millions of golfers around the world, why are we not like Tiger, Vijay or Phil? It takes years of hardwork to be good at anything. Value investing and/or stock picking is no exception.

But having said all that, stock picking is simply too fun to give up for many, including this blogger. Bcos even when you get just one stock right, it's more than enough satisfaction even though you may get another 10 stocks wrong hehe! It is like having kids, I guess. You lose sleep for 10 nights, there are the wailings, the worries when the baby is sick, worries when the baby is too fat, too thin etc. But in the end, that one smile is all it takes to make those sleepless nights and worries worthwhile. Emotional dividend yield 1000%, hehe!

So back to stock picking, although the chances of picking the 10 bagger is pretty slim, we can enhance our chances by sticking to the right investment philosophy. Well the tried and tested method that worked is of course *drumrolls* value investing lah. But it doesn't mean you studied all the literature about value investing then you will make money. Ah Beng knows the golf strokes and theory, but can he beat Tiger? Value investing just increase your chances. Of course, other investment philosophy may work too. After all it's a free market and there are pple who made millions out of day trading.

Maybe the trick is to have a certain % of your portfolio in indices and the rest in stock picking. That way you get to enjoy the best of both worlds. The index part of the portfolio will ensure you earn a good average return of 8-10% and the stock picking gives you the kick you want. So work hard, Tiger is not as high up as you think!

And how to tackle private bankers?

The private banking industry is booming in Asia and more so in Singapore. Hence we see banks like Citi, UBS, HSBC hiring bankers by the truckloads. They hope that their legions of private bankers will be able to capture AUM (Asset Under Management) and then they can churn their clients to collect lots of fees. Btw, that won't be the official stance, the official stance would be to help HNWIs (high net worth individuals), manage their wealth, do tax planning, investments etc. Sadly, 99% of them (my own guess) will fail to do their jobs.

Traditionally the private banking industry has done good segmentation and actually the name, "private banker" is only reserved for those in the highest hierachy, ie bankers that serve the richest clients, the UNHWI (ultra high net worth individuals, whoa, that's a cool acronym right? Go tell your wife/gf that you will become a UNHWI someday, hehe).

But now, everyone wants to call themselves private bankers, so even those behind the counters whose jobs are to con aunties and uncles into buying some crazy pdts by offering them free umbrellas call themselves private bankers.

Anyways, the job of the private banker is to help clients manage their wealth. But their commission is based on two criteria. 1. How much money they can con their clients to put with the bank. 2. How many pdts they can con their clients to buy.

The second criteria is what makes it most unethical bcos they must continuously sell clients new pdts in order to hit their tgts. ie like maybe 10 pdts per mth or something. And next mth, it's another 10 pdts. So they have to ask the client to buy pdt A today, sell pdt A next mth, then buy pdt B and sell B next mth and buy back pdt A etc. But we know that investments can only generate good return over the long run right? Btw long run means 10 to 20 yrs hor. If you buy and sell stuff mth in mth out, you are just generating comission for the banker, which is what they want and will not help you build your retirement nest egg.

So what is the best way to tackle the private bankers and the best way to do investment? The short answer is you don't have to talk to private bankers.

For most people, the best way to invest would be to buy index funds that have the lowest fees. Index funds are funds that try to mimick the performance of an index, like the STI, Hang Seng, Nikkei, S&P500 etc. They don't employ fund managers who claim that they can beat the benchmark, they just buy whatever is inside the index and hence most of these funds have no sales charges and minimal mgmt fees.

In Singapore, MAS has made some regulations on unit trusts/funds that cap the sales charge at 3% or something. That's actually still too high bcos investment on average only give you 8% per annum. So you pay on 3% on your first year of performance, you are left with 5%, that's a mere 2% better than fixed D! Imagine buying a PC and you need to pay the salesman 20-30% ie $200-300 of commission! On top of them, you pay 1% mgmt fee every year, usually for fund managers that will underperform the benchmark. So my own personal policy is to refrain from buying unit trusts whenever possible. But sometimes, unit trust can help you gain access to some sub-sectors that are not easily investable, eg. environment/green stocks or energy stocks etc.

Look for index funds that have 0% sales charge and probably 0.5-0.8% mgmt fee per year. Lower fees mean higher return back to you. One of the biggest index fund seller in the world is the Vanguard Group. It may be hard to get their pdts in Singapore though. That's when you get the help of the private banker, ask them to source all the index funds available. If they are any good in the first place, they can help you. My guess is: it's more difficult than striking lottery.

After you buy the fund, just leave it there. Don't be bothered by the daily or weekly or even monthly fluctuations, over the long run, all indices will go up, if history is any accurate, you will earn 8-10% per annum, ie you double your money every 6 to 8 yrs. When you have more money to spare, you should just buy more of the same. Of course, you can exercise some judgement and buy indices of growing economies, like China, India etc. Or diversify globally, ie. have some of these hot economies, but also of US and Europe and Singapore.

That is the simple truth about investment, just buy index funds, and you will do ok. Disappointed huh, why so much hype around financial advisers and private bankers right?

But what about stock picking? Next post!

And how to tackle private bankers?

The private banking industry is booming in Asia and more so in Singapore. Hence we see banks like Citi, UBS, HSBC hiring bankers by the truckloads. They hope that their legions of private bankers will be able to capture AUM (Asset Under Management) and then they can churn their clients to collect lots of fees. Btw, that won't be the official stance, the official stance would be to help HNWIs (high net worth individuals), manage their wealth, do tax planning, investments etc. Sadly, 99% of them (my own guess) will fail to do their jobs.

Traditionally the private banking industry has done good segmentation and actually the name, "private banker" is only reserved for those in the highest hierachy, ie bankers that serve the richest clients, the UNHWI (ultra high net worth individuals, whoa, that's a cool acronym right? Go tell your wife/gf that you will become a UNHWI someday, hehe).

But now, everyone wants to call themselves private bankers, so even those behind the counters whose jobs are to con aunties and uncles into buying some crazy pdts by offering them free umbrellas call themselves private bankers.

Anyways, the job of the private banker is to help clients manage their wealth. But their commission is based on two criteria. 1. How much money they can con their clients to put with the bank. 2. How many pdts they can con their clients to buy.

The second criteria is what makes it most unethical bcos they must continuously sell clients new pdts in order to hit their tgts. ie like maybe 10 pdts per mth or something. And next mth, it's another 10 pdts. So they have to ask the client to buy pdt A today, sell pdt A next mth, then buy pdt B and sell B next mth and buy back pdt A etc. But we know that investments can only generate good return over the long run right? Btw long run means 10 to 20 yrs hor. If you buy and sell stuff mth in mth out, you are just generating comission for the banker, which is what they want and will not help you build your retirement nest egg.

So what is the best way to tackle the private bankers and the best way to do investment? The short answer is you don't have to talk to private bankers.

For most people, the best way to invest would be to buy index funds that have the lowest fees. Index funds are funds that try to mimick the performance of an index, like the STI, Hang Seng, Nikkei, S&P500 etc. They don't employ fund managers who claim that they can beat the benchmark, they just buy whatever is inside the index and hence most of these funds have no sales charges and minimal mgmt fees.

In Singapore, MAS has made some regulations on unit trusts/funds that cap the sales charge at 3% or something. That's actually still too high bcos investment on average only give you 8% per annum. So you pay on 3% on your first year of performance, you are left with 5%, that's a mere 2% better than fixed D! Imagine buying a PC and you need to pay the salesman 20-30% ie $200-300 of commission! On top of them, you pay 1% mgmt fee every year, usually for fund managers that will underperform the benchmark. So my own personal policy is to refrain from buying unit trusts whenever possible. But sometimes, unit trust can help you gain access to some sub-sectors that are not easily investable, eg. environment/green stocks or energy stocks etc.

Look for index funds that have 0% sales charge and probably 0.5-0.8% mgmt fee per year. Lower fees mean higher return back to you. One of the biggest index fund seller in the world is the Vanguard Group. It may be hard to get their pdts in Singapore though. That's when you get the help of the private banker, ask them to source all the index funds available. If they are any good in the first place, they can help you. My guess is: it's more difficult than striking lottery.

After you buy the fund, just leave it there. Don't be bothered by the daily or weekly or even monthly fluctuations, over the long run, all indices will go up, if history is any accurate, you will earn 8-10% per annum, ie you double your money every 6 to 8 yrs. When you have more money to spare, you should just buy more of the same. Of course, you can exercise some judgement and buy indices of growing economies, like China, India etc. Or diversify globally, ie. have some of these hot economies, but also of US and Europe and Singapore.

That is the simple truth about investment, just buy index funds, and you will do ok. Disappointed huh, why so much hype around financial advisers and private bankers right?

But what about stock picking? Next post!

So how to tackle the insurance agents?

I thought maybe I should provide some (even though still imperfect) answers to my questions in the last post.

On insurance, if the agent cannot help you then who can? For my own journey, I talked to other agents, then I talked to friends, and find out more from the net and newspaper and talked to experienced folks to try to get to the truth.

At first I thought surely there would be some good agents out there. After all, some agents do earn big bucks by selling insurance right? Sooo, I called up pple, asked for appointments, but soon realized that they were all the same. They are TRAINED to sell you the useless stuff, and TRAINED to "taiji away" the difficult questions.

Whenever I asked about term insurance, they would say,

"Oh, but they only cover you until 60 you know?"
"But after 60, my kids are grown up, I don't need too much insurance." I say.
Then they change topic, "But if you buy this life plan, it's like a savings plan, you still get your money back, plus 3-4% per year."
"But meanwhile I pay $2,000 per yr for the next 20 yrs to earn 3-4%? And get covered for $50,000?"
"$50,000 coverage will grow to $50,512 over time! Ok what about this investment link product, it is very good blah blah blah"
What the heck...

I even got one agent who claimed to have advised millionaires on how to buy insurance and still give me stupid recommendations. So in the end, I gave up. I started talking to friends and read up. And here are some conclusions that I gathered.

Use less than 10% of your annual salary on insurance, I recommend 5%. But agents will quote you 20%, saying its MAS regulation. I find it hard to believe. I don't spend 20% of my annual salary on ANYTHING, not even mortgage! 20% on insurance? WTF!

But for 5% you have to try to maximize coverage, it has to be at least 5 times your annual salary to be meaningful. So this is tough job for 99.999% of all insurance agents. Try to find one who can do that, someone young, willing to work hard and help you. My experience: no agent can, so you gotta do it yourself. And that is to buy SAFRA insurance, one of the cheapest around.

Don't get swayed by the agents. They try to bend your rules, like 5% is not enough! Or you cannot see it that way, bcos this 20% will go to your savings blah blah. They should follow your rules, not the other way.

Don't buy investment linked products, usually you overpay for commission and stuff. If you want to do investment, do it separately.

Agents like to blackmail emotionally. Like if you die, your family how? Your kids so young how? And they will say, "I know one friend, cancer, no insurance, pay $200,000 etc". Stop them. I KNOW it's a disaster to die without insurance. But tell me the facts. The premium, the coverage etc. And Get me the cheap value-for-money policy, damn it!

So the ideal scenario, if your annual household income is say $60,000, spend $3,000 on insurance, buy minimal life (you need life policy to get term), say $20,000 and get lots of term, say $250,000. So you spend $3,000 to get insured for $270,000. That's probably an ok deal.

Not sure if most rational people are doing this. Pls comment ok!

Asking a Best Denki salesman whether you need a LCD TV

If you walk into Best Denki or Harvey Norman and ask the salesman whether you need a $3,000 LCD TV, what do you think he will say? He will immediately recommend you the $8,000 50 inch Samsung High Definition LCD TV, and give you 1,001 reasons why you NEED that TV. Right?

I guess the message here is that the salesman cannot tell you whether you NEED a LCD TV. His job is to sell you the TV NOT to determine if you need one.

But our world is a strange place. In so many areas of our lives, esp those related to finance, we ask the salesman whether we NEED something and we expect them to have our interest at heart and tell us the answers. Think about the following questions.

Is it logical to ask the insurance agent what kind of insurance is suitable for you?
Is it logical to ask your broker or his analysts which stock to buy?
Is it logical to ask your private banker how you should manage your wealth?
Is it logical to ask an investment banker whether your co. should do M&A?

In most to these cases, the salesperson, middleman thrives on activity. This is bcos he takes a cut or commission on the transactions that take place. So it is NOT in his interest that he recommend you the best thing. Bcos it will not generate future activity. He needs activity to earn his keep.

The insurance agent wants to revisit you every yr so that he can sell you another policy even though he sold you one last year that would have taken care of your lifetime need. And he will only sell you a life policy or an investment link one even though a term policy makes more sense for you. Bcos the commission on those pdts are much higher.

The analysts change their ratings every 3 mths bcos that's their job. Their job is not to identify the long term winner. Their job is to churn and create lots of buy and sell orders. So it is not in their interest to help investors identify the real 10 baggers (stocks that will rise 10 folds). Even if there are genuine analysts out there who believe they should help investors, the system is in place to discourage them. That's life dear.

Similarly the private bankers cannot help you grow your wealth. Their job is to sell you investment products and earn their keeps. They need to sell new products every yr to hit their annual targets. So naturally they will recommend you to buy this, sell that and buy back what you sold etc year in year out. Even though investments can only generate good return by investing for the LONG TERM.

As for companies, when they reach a stage where organic growth becomes difficult, they seek to do M&As. But the investment bankers they consult to do M&A are at best, well, not much better than the Best Denki salesman. They cannot help to identify which good co.s to buy. Their job is to make deal, not to help the CEOs find bargain M&A. That's why most M&A fails (though they look good on paper).

So how? I am still searching for an answer, but by talking to people who have gone down the same path sometimes help, esp those that have more experience in life and have succeeded (ie. not a bloke lah, but getting advice fr a bloke may still be better than getting advice fr private bankers). People who have bought so many insurance policies and finally know what is really good. People who have talked to so many private bankers and finally know not talking may be the best. And of course, when you have the answers, contributing your answers to this blog will help too!

More Margin of Safety

A frequently asked question on value investing and how to calculate intrinsic value is this: how can you be so sure that the co's intrinsic value is this and at this price it is a good investment?

For those not so sure what the hell is going on, read these first
Value Investing
Intrinsic Value
Good Investment

Well, the truth is, you are never sure, you can spend 20 days calculating the intrinsic value of the company and become so sure that the stock is undervalued. So you buy and the stock tank 20%. Shiok huh?

Intrinsic value goes hand in hand with margin of safety. Bcos you can never be sure whether you really got the intrinsic value right, you need to have a margin of safety. ie you will only buy the stock if the current price is way, way, WAY below your calculated intrinsic value. As a rule of thumb, I recommend 40-50% below your calculated intrinsic value.

Buffett used the example of building a bridge. If you know that the maximum weight of vehicles that will cross the bridge is 10 tons (based on historical statistics), will you build a bridge that will support 10 tons or a bridge that will support 30 tons?

That is margin of safety.

Ben Graham, the grandfather of value investing once said this: if you need to surmise value investing into only 3 words, it would be "margin of safety". It is THAT important.

Unfortunately, most investors don't really have this concept in mind. Even those who are very experienced. I guess it's not easy partly bcos have a strict margin of safety rule forces you to pass on many investment ideas even if they are quite good. And when you see them rally 100% after you decided NOT to buy them, wah shiok right? Now every wall you see has a purpose. For you to bang your head hard on it! Haha!

But having a margin of safety will make very sure that you will not lose your shirt. Even if you are damn wrong on your intrinsic value, you may lose a bit of money, the stock may tank 20%, but it won't tank like 80% and chances are after it tank 20% it will creep back up again, it will not bankrupt you. That's the strength if you have a huge margin of safety.

Why Quant may work?

In the previous post, we discussed how to construct a quant portfolio. Now let's try to understand why some thinks that it can work (ie it can outperform the market).

Well first, we must get the right factors though. If you screen for something like stocks that has hit 52 weeks high, or stocks with highest volume, or other funny factors, good luck. You have got the GIGO (Garbage in Garbage out) model. The model is only as good as the inputs.

What people usually believes as good inputs are like Low PER, Low PBR, High ROE, High cashflow, High OP margin, High EPS growth etc.

So there are roughly 400 stocks traded in Singapore and you only buy the top 50 with the lowest PER and highest ROE. What this means is that you are buying stocks that are cheap relative to all others and have the highest return potential relative to all others. And you do this every 6 mths, weeding out those that falls off the top 50 and adding new winners in. Theoretically, you SHOULD outperform the market.

But you don't. Murphy Law's works huh.

Well a few reasons. First of all, the data used are either historical or poor estimates. For PER, usually we get the 1-yr forward PER, which is basically the sum of estimates of all the analysts out there. And we know analysts are, well, like private bankers, GFN right? (GFN: Good-for-nothing). As for ROE, usually that's a historical no. so ROE may have changed, or dropped to below those of other stocks.

Second, to beat the market is a zero-sum game. You need to beat most of the other participants in the markets. This means you need to move faster than most other participants. Now when do you think these quant models were first used? Do you think you are one of the early birds using these models? The answer is NO btw. So investors have used this model since the last Ice Age, and here we are re-inventing the wheel and expecting to beat the market. That's not quite possible right?

But there is still hope.

The markets today, as with our world, has gotten very short-sighted. Thanks to MTV and instant noodles. Most people seek instant gratification. They are not interested in growing apple trees and waiting to eat apples years later. They are not interested in stocks that will only payback after 10 yrs.

So as we all know, the markets are unpredictable in the short term but follows earnings growth in the long run. The quant models, if used over long periods of time, should beat the market (esp if the rebalancing period is also stretched, so you don't get killed by transaction costs) bcos most other participants won't wait that long.

Quant Portfolio Construction

One of the more scientific ways to invest is to actually create a quant portfolio and simply rebalance it periodically. Sounds very chim huh? But it's actually quite straightforward. But unfortunately, it is not exactly suitable for retail investors unless

1. You have tons of money
2. You have tons and tons of money

Well, but it's still quite useful to know how quant works, so don't yawn. And don't click the "x" at the top right corner.

Quant is simply the short-form for Quantitative and it is named as such because it uses mathematical models to drive investment decisions. Quant can be very successful because it reduces emotional influences (screw Mr Market man!) and can generate as well if not better an investment performance as fundamental analysis or other types of investment analysis. (Woah that's a statement huh?)

As a very simplistic introduction, we introduce a 2-step quant portfolio construction process here.

1. Use criteria or factors like PER, PBR, ROE, EV/EBITDA to screen out a list of stocks and buy the top 30-50 stocks.

2. Rebalance the portfolio after the pre-determined period like 6 mths or 1 year etc. (ie repeat Step 1 after 6 mths or 1 year.)

Ok, analogy time, say we want to create a 50 stock portfolio and rebalance it every 6mths and we want to use 2 factors, Low PER and High ROE.

For retail, Poems have quite a good screen in its system so can just utilize that. If not, can ask those good-for-nothing Citibank/UOB privilege sweet-young-bankers to generate these screens. Of course, that's like trying to strike Toto, bcos chances are, they ARE good-for-nothing.

Anyways, so you get this list of stocks, and just simply buy the top 30-50 names on it depending on how many stocks you want to hold. But it has to be at least 30 names in order to smooth out the idiosycracies of individual stocks. So now we know why you need lots of money, to buy that 30-50 stocks.

So that's Step 1. And after 6 mths, simply do the screen again, and buy the top 30-50 names. Of course, if the same stock appeared on the first list. You don't sell off what you hold and buy back the same stock lah. Unless you are trying to please your good-for-nothing Citibank/UOB privilege sweet-young-bankers or something.

So simple as that, if you can do this based on some winning factors (that's the catch huh!). Chances are you can make some money. May or may not beat the market average (to do that, the odds are slightly better than finding a good-for-something sweet-young-banker), but you should not have negative return if you invest over the long run (ie 20 yrs or more).

The Razor-and-Blade Model

In this post, I would like to introduce a familiar business model (for most value investors) that can help most investors in their analysis of companies. It is also a model that entrepreneurs should seriously adopt when they want to start their own businesses. It is a very basic model that can help generate good recurring income and is probably a sign that the company will be in the business for a long, long time and not those fly-by-night bubble tea shops where you see them today but not tomorrow.

This business model is known as the razor-and-blade model. Well for the uninitiated, this is the model where you sell the low profit margin razor at a cheap price and then earn back the money by selling the blades at a high margin.

Though mundane as it may sound, this model has proven itself time and again that it can generate stable cashflow and earn a good margin. Unfortunately, as the guru used to say, it’s hard to teach a new dog old tricks. So a lot of businesses don’t employ this model.

This model plays on the human mindset by enticing people to buy something, usually having the impression that it should be expensive at a low price. Then after “locking-in” the customer, the co. sells him consumable products at a higher margin. However, our ape-evolved minds cannot relate that instantly and we still think we are getting a good deal.

For example, we buy a mobile phone at S$199 thinking that it’s quite value-for-money given a lot of sophisticated stuff goes inside this cool piece of plastic and electronics (So the phone is the razor here). However, we then need to buy the blades (talk-time) that cost us $30-50 a month! And worse still, we are lock-in for 2 years! So is it really value-for-money if you think of the whole package? Hmmm…

Sounds like it’s a bit unscrupulous? Feel like you are being treated unfairly? But hey, that’s life, folks. Become a shareholder of the company then and screw the management during AGM! That’s why I own Singtel! Haha!

Anyways, besides the telcos, today we see various businesses employing this simple model, including our favourite Ipod (selling you the Ipod/razor, then the songs/blades), Canon printers, Playstation and Nintendo games, anti-virus softwares etc. But at the macro level, not a hell lot of businesses are doing this. Well of course, sometimes the nature of the business does not allow the adoption of the model, like the retail business. Which also implies that maybe that’s why retail businesses cannot earn a hell lot of money. Sadly when Singaporeans say they want to be entrepreneurs, most people think of retail businesses like restaurants, bubble tea (*gosh*) and clothings etc. My guess is only 1 in 20 retail shops will actually "succeed" ie earn as much as a full-time job after adjusting for time and effort put in.

The razor-and-blade model also manifests itself in different versions but the crux remains at its ability to generate recurring income stream. This is best exemplify by Dell, which recently announced that it wants to provide IT services to its clients instead of simply selling them the box (ie the PC lah). So in this case, the PC is the razor and the servicing contract is the blade. So Michael Dell really got some Liao one ok? Don’t pray pray!

Maintenance contract is actually a very good razor because it usually last for 2-3 yrs and hence securing the stable cashflow from the client for that time period, like the telcos (btw telcos is short-form for telecommunications companies like Singtel, Starhub hor). And with minimum extra capex or cash outflow, you actually get this money rolling in.

So next time when you see a business with a razor-and-blade model, remember to give it some credit bcos chances are it will still be earning money even when the crunch comes, unlike a lot of other businesses which will probably go into red. Especially those hot sectors nowadays, like RE related construction where majority of co.s involved don’t really have a business moat and are rising simply bcos it’s high tide now.

Investment, Golf and Hardwork!

Let's try to relate investment with a sports like say Golf. To put some things in comparison, we have

Golf Set = Bloomberg, Excel Spreadsheet, Brokers' charting tools
Golf Swing Techniques = Fundamentals, Valuation, Technical analysis
To win the game of Golf = a lot of hardwork and luck
To beat the Market = a lot of hardwork and luck

When you first start at golf, you will suck big time. You probably bought a golf set that cost S$299 and try out on the driving ranges. In investment, this is like engaging your local broker and their cock-up systems with their technical charts and then dabbling into your first purchase.

Then you realize that you need to put in more time and effort to actually play golf meaningfully and this is when you start to engage instructors to improve your swing, you read up golf books and practice a lot. In investment, this is where you also try to learn from other investors, attend sessions, read books, buy some software and really get your hands dirty with all the financial statements and valuation analysis. Or charts and RSI and MACD for the technicians.

So after a few years of practice, you are ready to compete with other golfers. Say there is a competition for all the world's golfers from beginners like yourself to pros like Tiger, where do you think you will stand? Will you beat say 50% of all the golfers? Or 80%? Or 99%? Similarly in investment, after a few years of doing some real company analysis and trading, can you earn average market return of 8-10%pa? Or the best returns of around 25-40%pa (over the long run ie. 10yrs or more)?

The success rate of being able to beating the average will correlate with the amount of hardwork you put in to either golf or investment.

What determines why Tiger beats the average? Most golfers know the swings and techniques like Tiger does. (Most investors know all about fundamental and technical analysis). Most golfers use the same tools (golf sets) like Callaway/Mizuno/TaylorMade golf sets. (Most investors use the same Excel/Bloomberg/Brokers' charting tools.)

Tiger beats the average golfer through a lot of hardwork and beats the best of the best golfers through luck. Some might argue talent is impt but studies have shown that talent may help but ultimately it's hardwork.

I think a lot of pple know Tiger started golf at the age of 3, and trained hard everyday to win his first championship at 18. That's 15yrs of hardwork btw. But he did not stop there, he continued to work hard to perfect his swing so that he can better himself. So if you are not training that hard, is it a wonder why you cannot beat him?

Don't believe? Read this article.

But at the pros level, Tiger, Vijay, Phil etc, everybody is training as hard as everyone else. So in the end, whoever wins the championship is probably a matter of luck.

So in investment, if you are spending 1-2hrs a day reading some annual reports, doing simple brainstorming about how the world will change tomorrow and how your investment will do, can you beat the market average of 8-10%pa? Of course the market is made up of some aunties and uncles, some novices, some semi-pros, and also pple like Buffett, Lynch, Soros, Jim Rogers, Peter Lim who spent their lives thinking about how the world will change and are very good at it. If you work hard enough, probably there is a chance to beat the average even though you cannot beat the best of the best.

As a side note, passively investing in indices will give you 8-10%pa which is quite good and this is actually one of those rare free lunches in life. Minimal effort for earning an average return!

If you do put in a lot of hardwork, so much so that you think you are in the league of the best investors globally including Buffett, Lynch, Soros, Jim Rogers, Peter Lim etc, then you can only beat these pple if you have luck. Studies have shown that only 10% of all investors can actually beat the average return of 8-10%. So it's a lot of hardwork to be in this top 10%. And to stay there, give a big smile to Lady Luck and hopefully she smiles back!

Which EPS to use? (for calculating PER)

Which EPS to use? (for calculating PER)

We are back to my favourite topic on PER (Lao Jiao value investors are yawning right?). But I think I need to clarify one issue on PER (which stands for Price Earnings Ratio) which I KIVed for some time. For the un-initiated on PER, pls refer to this post.

Ok in short, PER is simply stock price divided by its earnings per share and it measures the cheapness of a stock. The stock price does not tell you anything about whether the stock is cheap or not!

Now to determine Price is easy, this is the all impt Price that you get from TVs, Yahoo, Your broker's system. Singtel is $3.30, SMRT is $1.75, even grandmas know this.

But EPS? Where to find this? And which year's EPS should we use?

For the sake of newbies, we go back to Finance 101. EPS is actually the net profit for the company for the year, divided by its no. of outstanding shares. These no.s are usually inside the company's annual report.

However, things published in annual reports are dated, ie. We can only get last yr's EPS. In the stock market, nobody likes to look at the past. The market is always forward looking. So we need to know next yr's EPS.

This next yr's EPS is usually an average of all the analysts' estimates which are usually not available for most folks but are easily accessible from financial service providers like Bloomberg, Reuters and Thomson One.

As convention, the PER that is usually quoted is the 1-yr forward PER (ie. Next yr's PER using analysts' estimates of 1-yr forward EPS). But for growth stocks, ie. the company is growing its profits really fast, then the 1-yr forward PER is usually too ex. Then you need to look at 3-yr forward or even 5-yr forward PER so that it gets reasonably cheap.

But it's always very dangerous to use such futuristic PER bcos the probability of error will be very very big. You may think that you are buying a 10x 5-yr forward PER stock but if the company fails to grow in its 3rd and 4th year, then Ha Base, 10x become 30x PER and the stock plunge 60%!

As for value investors (or rather any prudent investors), we should be determining what is the long-term sustainable EPS and hence what is the PER of the stock today.

There is no magic formula here to help you predict the long-term sustainable EPS. For the professional investment analysts, they talk the company's management, study their markets, do some research and analysis and try to come up with a sustainable EPS, and still usually get them wrong. So for the simple folks, what's the chance that you can get it right? Not much higher than winning Toto.

Nevertheless, that doesn't mean that you shouldn't try though. Bcos when you can get an estimate for this EPS, and apply a margin of safety, if the stock is still reasonably cheap after that, then probably it's safe to buy. But with investment, nothing is for certain, so you may still be wrong. Well at least, you learn from your mistakes.