Published on Feb 16, 2014
... and those whose businesses you already know something about
By Goh Eng Yeow Senior Correspondent
Betting on a new management to turn around a struggling business rarely works in practice.
So every time someone comes to me with a sexy story of how a company boss plans to rescue an ailing listed firm, I greet it with considerable scepticism.
In my long career as a financial writer, I have rarely come across a case where it makes sense to throw good money after bad, and hope that the glory of a failing company can simply be restored with a change of ownership.
To me, it would make better sense for an investor to stick to throwing good money at already well-run companies if he wants to get a decent return on his investment. That is because good businesses tend to stay good, even if they sometimes find themselves run by managers who fail to live up to expectations.
It led to a wry observation by legendary investment guru Warren Buffett that "when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact".
So, in any successful investment strategy, the key rules are: buy into only the best companies, stick to business sectors which enjoy predictable earnings and higher-than-average growth, and pay a fair price for the investment.
The principles may sound simple but sticking to them is easier said than done.
That brings me to another point about successful investments: How do you identify the best companies to invest in? For a start, you should stick to companies involved in businesses you already know something about.
Looking back at the milestones in his life recently, CNBC business commentator Jim Cramer noted that when he started out in his career, he was enthralled with a Florida orange grower which he knew next to nothing about.
He said: "It seemed to be compelling so I bought 10 shares. A week later, a frost hit, wiped out the crop and my investment was cut in half. I was devastated."
Undaunted, he cut his losses and used the remaining capital to buy into a clothing firm that he had read about, only to see his money halving again when the company reported a bad set of earnings.
He then reflected on what went wrong and realised that he had invested in companies whose businesses he had not understood. He said: "What did I know about growing oranges? Very little. What did I know about women's fashion? Less than what I knew about oranges."
Mr Cramer's observation seems so obvious that you would think most investors would have worked it out for themselves. But they seem intent upon immediate gains as they go about chasing after the next sexy stock in sight.
Part of the problem, I believe, is the obsessive focus on the short-term such as the next set of earnings numbers which, in turn, triggers a flood of calls by analysts advising investors what they should do with their stocks. It certainly helps the broker to churn up his commission income while doing nothing to grow an investor's nest egg.
Yet, what will really determine a company's fortune is the quality of its earnings growth over the long term, and not the quarterly profit figures which send analysts into a tizzy.
But if you expect the research reports you get from your broker to offer you such insights, you will be sorely disappointed.
Fortunately, it is not too difficult to spot investment gems. As I noted in an earlier column, some of my best investment ideas come from observing the habits of consumers, including my own.
It led me to buying stocks such as Cerebos Pacific (which has since been delisted) and British American Tobacco (Malaysia) whose businesses outperform incrementally year after year - but reward their shareholders with a solid dividend payout while doing so.
Investment opportunities abound all the time. The key is to stay alert when they knock on your door.
During the recent stock market wobble, my broker sent me a list of the names of the blue chips which had sunk to their lowest price levels in a year.
There were a few familiar household names which caught my attention. They included OCBC Bank and the Singapore Exchange in the financial sector, and defensive plays such as the Hong Kong-based Dairy Farm, which owns the Cold Storage supermarket chain here.
Now, some of these names enjoy commanding positions in their respective businesses which have been tried and tested over the decades as the stock market was rocked by one financial crisis after another.
For prudent investors, the best time to get blue chips on the cheap is when the market suffers from financial turmoil. It may thus be worth your while to stay alert, as wild price swings become the norm again on the stock market.
Goh Eng Yeow is the author of Small Change: Investment Made Simple