Chapter 27: Theory of Common stock investment

According to the the authors, stock analysis are commonly impaired by 2 factors:

• The instability of the tangible assets as most of the time, they are not worth the exact market value when the company is distress or deflation in economy
• The difficulty of estimating the intangibles assets and most of the time, they do not worth as much as what the management sees. However there are some exceptions where a company worth depends on its intangibles such as Coca Cola.

Author classify speculative stock as:

• It paid no dividends
• Earnings where irregular and sometimes its profits may cover barely its expenses
• A stated part of its stated value represented no actual investment in business

Author classify investment stock as:

• Earnings where stabke abd in excess of dividends paid
• Having a satisfactory record of dividend handouts to investors
• each dollar of stock was backed by a dollar or more of actual investment in business

Value investing focus on recurring income instead of focusing on growing of principal. Use past records and earnings to determine and estimate the value of a stock instead of forecasting the future earnings.

New era theory

• In this era, investors look for investments by looking at dividends and believe that it has a slight bearing upon the value
• No relationship existed between assets and earning power, asset value was entirely devoid of importance
• Pas earnings are use to estimate what changes were likely to take place in future and not using it to estimate the stability of a company

There are a few obstacles trying to forecast earnings are:
The law of diminishing returns
Increased competitiveness from competitors
The ups and downs of the economy cycle where the company stock may look impressive due to the fact that it is at the top cycle of the economy cycle and as the law of nature states, what goes up will go down eventually. Therefore beware of buying at this time and the fall of the economy cycle will bring down the profits of the company

Graham and Dodd, Security Analysis Chap 5: Survey and Approach

This is typically a short chapter discussing about the difference between bonds and stock by the gurus.

They have identified that many investors regard bonds as a safe investment which leds to investor to believe that bonds carry assurance against loss.This line is extracted from the book: Safety depends upon and is measured entirely by the ability of the debtor corporation to meet its obligations

They stated that bonds are not consider to be safe if it does not have these critera:
Good earning power of a company
A business with abundant of assets

A bond bought at a low price works like a common stock due to its coupon payments which act like dividends & the appreciation of bond price to par is the same as a common stock with its value appreciating

A bond bought with at high price, callable or convertible is not consider as safe investment as these may be some of the possibilities that an investor might face:

1. investor may overpay for the bonds
2. the calling of the bonds by the issuer can force the investor to look another investment & put a stop to his recurring income
3. lastly, the investor faces reinvestment risk as when his bonds are called, he is force to invest his capital at a lower rate

To sell or not to sell in this bear market.

The date is 15-03-2011. For the past few weeks, negative news keep spewing in affecting the markets day by day.

• Firstly Chinese govt trying to introduce new regulations to minimize the growth of inflation, their property market.
• Unfavored weather patterns results in low produce which increase the price of commodities. 
• Libyan uprising results in the spike of oil price. 
• Spanish downgraded 1 notch by Moody on Mar 10 2011
• Earthquake & tsunami in Japan. 
• Today news reported about the meltdown of Japanese nuclear reactors and fear of radiation send world markets in red numbers.

The first thing that pops in my mind is how much have i lost. I'm an investor following the techniques of value investing. Even i have the fear of losing money, looking at my live watch-list a few hours ago thinking, 'Why i never liquidate my portfolio a few days earlier'.

Closing off the watch-list, i recalled that my goal is long term investing. Due to fear, i have forgotten that i should invest long term when i started to inject my funds into the market.

I opened up my book, Value investing by James Montier. I'm a fan of his articles and his articles can be found here

His works are based on behavioral investing and he has shared some of his ideas and advice in his books.

In his book (Value Investing) on page 210, he has shared that short term underperformance is often the by-product of a sensible investment process. For instance, if everyone else is trying to guess the next quarter's earnings and you are exploiting a long time frame, you may find yourself staring at the wrong end of a bout of underperformance.

He has stated that even on a 3 year horizon, between 20% and 30% of best long term managers were in the bottom decile.

So for me or even you in this case, and you are using fundamental & value techniques to invest and current looking at the red numbers in your portfolio, FRET NOT!!! You are not alone.

In the James Montier Book again, Value Investing, he included a section on page 209 showing the list of value investors (source from guru focus) performance of stocks bought in the last 12 months for Year 2009 Feb. (My book states the date of published was Feb 2009, so i assume this list of value investors bought their funds between 2008 to 2009).

• Bruce Berkowitz: -9%
• Mohnish Prabai: -38%
• Richard Rogriguex: -21%
• Tweedy Browne: -13%
• Jean-Marie Eveillard: -7%
• and a few more which i will not list here

I checked my analysis again to see if i can uncovered anything i have missed, and calculated that right now my portfolio is down by -12.9%.
Even experts are having unrealized negative returns in their portfolio and strongly believe in their visions of long term investing based on their experiences, so why should i, who is not even an expert has to fear about.

So to end this topic, what have i done to ensure that my portfolio is alright and i should be patient? As followers of value investing should understand that value investing and patience goes hand in hand.

• I check my analysis, how i derived my estimated value again and checked if the company has any new problems surfacing.
• Ask myself, what caused the market to dive down. Is it the industry problems, world-wide news or company issues?
• Ask myself again, when i start to invest, am i investing for long term or speculate for short term? If long term, why bother about negative news that will temporary affected the market?

Lastly as what James Montier has mention on page 127:

Investors should consider trying to adopt the Buddhist approach to time. The past is gone and cannot be change as well as the future is unknown and we must focus on the present. The decision to invest or not should be a function of the current situation, not governed by our prior experiences. Our brains looks to be wired to focus on short term and fear loss. These mental hurdles are the barriers to sensible investment decision in a bear market.

Graham and Dodd, Security Analysis Chap 3 & 4: Survey and Approach

In this book, Chapter 3 covers on where to look for information for fundamental investors. His list of sources of information are:

• SEC
• Standard & Poor, Fitch or other statistical agencies
• Federal Trade Commission
• Committee on interstate & Foreign Commerce
• Commercial & Financial Chronicle
• Requests for information directly from the company
• Looking at its registration statements and prospectus

In Chapter 4, they covered on the difference between Investment and Speculation.

1. Graham believes that buying securities with the hope of profiting in a short period of time is deemed as speculation.
2. A slow growth in value & constant dividends does not mean it is a bad investment
3. Graham approach to investing is to hold long periods and focus on dividends for constant income and growth in share price for appreciation which he considers as investment
4. Looking towards a quick rise in value & despise dividends can lead to speculation.
5. Margin of safety is the most important concept to embrace in investing. One of his views is to reduce the loss of capital.
6. Safety of margin is much more easier to estimate and adjust if the company holds tangible assets
7. So when to sell? Graham sells when the market price is higher than the intrinsic value. This intrinsic value is the value which Graham estimates from the company financial statements
8. The value of the security derived from calculating or estimating does not means that it can be consider as a total safety factor. The industry & business may have certain risk that is unable to use maths or numbers to calculate. Therefore this leads to diversification to reduce the risk.
9. Blue chip companies are not consider safe investments all the time. Demand and economy change with time, so does business. If the blue chip business is not able to catch up with the changing times, sooner or later the company will be out of business

Lastly Graham views on Investment Value, Speculative value and Intrinsic value.
For ecxample, a security is selling in the market at $38. $38 is the investment value. Suppose after estimating, the intrinsic value is $25. Therefore $13 will be consider as speculative value. The reason why it is speculative value is because this value is appraise by the general market and every individual investor judgement.

Using Price to Sales ratio to value a security

I decided to take CFA mainly because i believe that it can help me to improve my fundamental analysis. Therefore i have been introduce to many mathematical formulas such as P/E ratio, P/S ratio, etc.

P/E ratio is useful if the company is earning profits. If a company P/E is negative, investor can use the P/S ratio (Price to sales ratio) to guage the security value. I have read that sales revenue is not easy to manipulate or distort as EPS and book value, which are significantly affected by accounting conventions.

However i have accidentally found that P/S ratio does not show to be a very good metrics even when the financial statements are not manipulate. It depends on the way how the business is conducted. This is one of my personal experience.

I started an online selling business by creating and program a online shopping cart a few years ago. After a few years, i decided to wind up the online selling business, therefore i decided to sell off all my inventory to get back some of the capital i invested.

So i decided to sell my inventory in discounts。 In the end, my revenue for the past 2 months surge to high volumes. At this point of time, i recorded my revenue once i received the cash in my bank account. I don't keep receivables!!!(this shows i keep an extremely conservative accounting. heehee...)

So lets apply this scenario to a listed company. If the company use this method to increase revenue, buying items at cost price of $10 but sell at $9, is the company growing?
Does this surging of revenue which will lower the P/S ratio alert investors that this is a good buy? I don;t think so.
Anyway ratios are use to gauge and compare. Using it as a buying decision is a wrong move.

我决定采取注册CFA课程，主要是因为我相信它可以帮助我提高我的投资基本分析。因此，我已介绍，如 P/E 比率，P/S 比率等许多数学公式。
 
P/E 比值是有用的比率要是公司赚取利润。如果一家公司的 P/E 为负，投资者可以使用 P/S 比率 (Price to Sales ratio) 来衡量安全值。我已阅读过，销售收入不容易操纵或歪曲为 EPS 和账面价值，这是显着的会计惯例的影响。

这是我个人的经验之一, 我偶然发现，P/S 比值不显示是一个很好的指标，即使在不能操纵财务报表。这取决于企业是如何进行的方式。


几年前, 我开始通过创建和程序一个在线购物车网上销售业务。经过几年的投入，决定结束我的网上销售业务，因此我决定卖掉我所有的库存，以取回一些我的资本。

所以我决定打折出售库存。结果，收入在2个月上升到高容量。在这个时候，我一旦收到了现金，我立即记录收入进入帐户。 应收账款在我的帐户里是不存在的。

因此，让我申请此方案的上市公司。如果公司使用此方法来增加收入，买10元的按成本，价出售的物品在9美元，公司是在成长吗？公司有在真正的赚钱吗？ 这是否会是个好投资？我觉得那不是个好投资。

总之比率来衡量和比较,用 P/S ratio 作为购买决定是一个错误的举动。

Financial Analysis and adverse opinion from auditors for a SGX counter:

Recently there has been an uproar about the presentation of financial statements from some companies listed in SGX.
China HongXing recently has been suspended due to the fact that they have noted irregularities in the cash and bank balances, accounts receivables, accounts payables,and other expenses during the course of their audits.

Frankly speaking, China HongXing is in my pending to buy list based on the facts that by just merely scanning through their past 5 years finance statements, I found that the stock is currently trading below their net asset value. Plus they have lots of liquid cash in their holdings and manage to give out dividends during bad economic times.

Next on 9 Sept 2010, HongXing has published an article stating that it secures an order of about 1 billion RMB in trade fair. The company has also stated it secures a few contracts in the trade fair. It seems that this company is doing very well.

However on Oct 14, the company auditors resign (A Red Flag) followed by on Feb 21 2011, it announce the resignation of the assistant secretary (Another Red Flag).

25 Feb 2011 announced halt and a week later, counter suspended for trading. All these information can be found in SGX, under company announcements section, therefore the figures are accurate at the point of time when i retrieve the statements from SGX website.

This proves to be a wake up call for me. Initially i told myself this counter may be a good buy based on the attractive reasons i have listed above. After trading for so long, i realized that i started to skip to check if the accounts are manipulated before i start to analyze the estimated fair value of the counter.
Therefore i started to analyze the company again to check what are the red flags in the statements. The list below are what i have found out.

• For Year 2008 and 2009, the company has been presenting their non audited annual statements
• Negative free cash flow from year 2005 to 2008 and with a sudden increase of FCF in 2010
• Inventory increase by 20 days in year 2009
• In Yr 2008, statement states a negative CFO. In Yr 2009, it suddenly states a 400% increase
• The sudden increase in their Prepayments, Deposits and Receivables with RMB528,000 in 2006 to RMB278,665 in 2007. A cont increase of 300% in 2008 and suddenly a drop of 90% in 2009. It states that these prepayments are for distributors. I suspect future prepayments are include in 2007 and 2008, which cause 2009 to have less prepayments and increase the CFO
• Furthermore there is no explanation regarding about Prepayments, Deposits and Receivables.
• Based on the past years balance sheet, the accruals in liabilities are increasing  every yr except in yr 2009 with a sharp decrease of 40%.
• Suspect that the company is creating of cookie jar reserves in liabilities. The decrease in liability and expense will increase the net profit in the income statement and inflate the CFO.

My analysis above are based on my calculations and assumptions. Therefore i'm not responsible for any errors. However if any of you guys find that there are discrepancies in my analysis, pls do comment on it so that i can improve or learn something new.

Coming to the end of this topic, this suspension really woke me up and I'm glad i realize this mistake which leads me to put more efforts into fundamental analysis to reduce the probability of making errors. However who never make mistakes? Only through errors, i can improve in my analysis.
So to all people who practice fundamental analysis out there. If you do make mistakes here and there, take it as a lesson. Don't give up. A person who never makes mistakes is never consider a season veteran. :)

Graham and Dodd, Security Analysis Chap 2: Survey and Approach

Most people should have know or heard about this book Security Analysis which is compiled by Graham and Dodd. I have start reading this book some time ago and sometimes i find the text hard to comprehend and therefore spent more time reading the text again and again trying to understand what they are trying to project to the readers.

I decided to post summary of some chapters over here hoping someone can discuss with me about the topics in this book or i can read the chapter summary if i'm free while i'm on the go.

Nevertheless, i shall start on the chapter: Survey and Approach.
Both gurus state that How an individual looks at an investment depends on the 4 elements, mainly: Price, Time, Personality and Security.

Price is always the decision factor to an investor. Some may invest due to the fact that the price is low and the investor has these limited funds to invest, or the price volatility is high caused the investor to think that he may have the chance to profit if the price continue to rise.
However the gurus also state that the decision to invest base on price volatility is a wrong concept as they have contribute to a higher probability of paying to much for a security

Time is an issue that may affect the conclusion in many ways.
A company may be a good company presently but it may become a bad company or vice versa due to market conditions and management style.
Economy changes with time. Example can be during my time, toys are the hot property for children in the 80s. Toys' R'us investing in toy business make big bucks. However these days, video gaming is the current hot topic for kids, not toys or action figurines anymore.

Prices of stocks changes with time or cyclical.

Personality of the investor affects the way he looks at an investment. If the investor looks at making quick bucks, he may venture into speculating instead of investing

Security, both of them touch on by asking, In what business is this company doing and on what commitment that it proposed? Be it preferred stock, bonds or common stocks.
The reason is because there are differences between the 3 of them. Preferred stock ranked above common stock but it have no voting power in corporate matters. Price in common stock then to appreciate more compare to preferred.
Discussing about company business and management, they stated that for eg: automobile industry company in an unfavored industry due to competition can be a good company if it has stable assets and strong earning power.

1. Less money is lost when investors purchase unattractive enterprise on attractive terms.
2. Judge an investment based on its value and margin of safety.
3. Blue chips companies does not mean that they will stay on forever.
4. Prices of companies will correct in time to come.
5. Risk of a security cannot be explain all by using mathematical formulas such as P/E ratios, Beta or standard deviation.
6. Reading and analyzing companies' financial statement does not guarantee the security will price fairly, soundly or high earning power. Companies have ways to manipulate the numbers.
7. The primary goal of a value investor is not to make big or short term profits but to minimize the probability of losing his capital.
8. The element of stability means that past results are not easily upset by unexpected developments
9. If price is higher than analyzed figures, security may experience no margin of safety
10. Figures are important as well as deciding factors of an economy, industry, management and madness of investors

Wonders of Time Value of Money and Compounding Interest

I'm currently taking CFA lvl 1 and among the topics in the CFA lvl 1 curriculum, i find that one of the topics that can greatly help us is 'Time Value of Money'.
Basically it focus on how compounding interest and the time we have can greatly benefit us if we can make use of this knowledge in managing our money.
Naturally it will be a very great advantage if we have a lot of time in our hands as well as some cash.

A lot of us know that inflation is always around us. However many of us prefer to keep our money in bank due to the fact that most of us are risk averse.
However if we can make use of value investing techniques and invest for long periods, most of the time we can avoid heavy loses due to timing or fear.

I have listed down a few calculations which i did discuss with my gf on how to invest and save in order to enjoy a sum of $3500 every month for 20 years.I hope  i will read this article any time if needed anywhere and help you guys if you happen to chance upon this article.

通货膨胀率是一个隐形的大强盗。 它不会光明正大的抢你的钱，它会偷偷的贬低钱的价值。
一个非常好的例子， 就是十年前，一碗面只卖两块钱。今天的十年后，一碗面就卖了三块三毛钱。
十年后的两块，已经不再有十年前的价值了。
为了避免贬低钱的价值， 我们能做的就是：
第一：自己开生意
第二：赌博
第三：投资

要开个生意，就要有生意的头脑和一些有创造力的好点子。
去赌博的话，就要承受和面对很大的风险
要不然，就用另一个方法，那就是投资。可是投资不是没有风险的。
要减少风险方法， 就是长期投资和使用 'Value Investing'。

在我读CFA Lvl1的时期中，我觉得在那么多的课题中，一个对我们有帮助的，就是资金的时间价值(Time Value of Money).
以下是资金的时间价值的算法，只要每个月投资一笔基金持续34年，复合年均增长率在6%， 我们可以在老年拥有20年
的基金，每个月能拿大约$3500的钱来养老不做工。
当然要实现 这个梦想，就要提早的投资和长期投资。

The Minimum return that we hope to get from the investment, we set it to 6%.
Therefore every stock you purchase the returns must not be less than 6% and
compounded using 6%.

Inflation rate mostly average around 2% throughout every yr in singapore.
Nominal returns 6 %
Find the real return using this formula:
nominal rate = real rate * inflation rate
Real returns =(1.06)/(1.02) = 3.92%

================================================================
Assuming we want to have $3500($42000 per year) every mth for retirement
at age 62 and expected to leave the earth at age 82.
I set $3500 per mth is because we need to set aside for medical bills just in case.

The amount that we need now is:
N=20, I/Y= 3.92, PMT= 42000, Present value will be $597,393.

Converting the present value above to set the value on par to inflation
rate of 2%:
N=34, I/Y=2%, PV = 597,393, Future value = $1171293
This amt $1,171,293 is the amount we need to have in order to have $3500
after we retire in order to get $3500 every mth for 20 years in today
value.

Next using the above amt, we calculate the amt in today value, we need to
save at 6% interest rate compound yearly for 34 years.
N=34, I/Y=6%, FV = 1,171,293, PMT = $11,242
Every year, WE NEED TO SAVE $11,242 which is $936.83 monthly.