Conrad Raj
05:55 AM Aug 18, 2010
Today Exclusive
SINGAPORE - In what is said to be one of the biggest losses yet at a Singapore casino, a local businessman lost $26.3 million over three days of gambling in June. This included a staggering $18 million that he burned in one day alone, playing baccarat - a card game - at $400,000 a hand.
According to documents that Today has obtained, the businessman's tale of woe began in March, just weeks after Resorts World Sentosa (RWS) opened, when he was granted a credit line of $500,000 by the casino.
The Singaporean, who is consulting a top local law firm about possible legal action against the casino, claimed that the casino at no time performed any background checks on his credit-worthiness or his financial capacity. He had simply filled in an application form, deposited $100,000 and handed over a signed blank cheque, he claimed.
Subsequently, in April, the casino increased his credit line to $2 million, he told his lawyers. In his 50s, the businessman is a managing director of a multi-million-dollar company.
Over the weeks, he reportedly won or lost several hundred thousand dollars each time he visited the casino, with his losses running as high as $6 million in the course of a single session. To draw on his credit line, he said, he signed a form and was given the requisite amount of chips.
In early June, he made his biggest loss of $18 million yet in one session. Two days later, he went back to the casino and recouped some $3.7 million - but then two days after, he lost a further $11 million.
At one point during this third session when his losses crossed the $4-million mark, so the businessman claimed, his girlfriend started crying and pleaded with one of RWS' senior officers to stop providing him with more chips on credit.
The same officer, he claimed, had repeatedly assured him over the course of the gambling sessions that the casino was prepared to extend him further credit, even though his limit had long since been exceeded.
Of his $26.3 million loss, the businessman repaid $10 million almost immediately.
The businessman claims to have then met with RWS chief executive Tan Yee Teck, who offered him a "rolling figure" - which amounts to a discount - of $3.3 million.
According to the legal documents, dated July 22, the gambler owed RWS some $13 million at that point in time. It is unknown if the debt has since been settled.
When contacted, an RWS spokesperson said the group does not comment on its customers.
The businessman's lawyers have advised him to explore if an amicable resolution can be reached with the casino. But they also think he may have a case of negligence, breach of contract or breach of statutory duty against the casino.
Under the Casino Control (Credit) Regulations, an operator who enters into a credit agreement with a patron should, apart from specifying a credit limit, develop and implement criteria to assess the patron's creditworthiness. The operator must also have approval procedures for any increase in the credit limit.
In the lawyers' view, by substantially exceeding their client's earlier limits - by more than 60 times the original limit of $500,000, and 15 times the April limit of $2 million within a few hours to enable him to continue gambling "RWS had encouraged irresponsible gambling and had breached the duty of care owed to" the businessman.
RWS' conduct of continuing to pile on credit effectively rendered the concept of a credit limit meaningless, the lawyers argued. This was more so as the person in question was not in the proper frame of mind to decide on the increases, they said.
In other countries, there have been several instances of patrons suing casinos for their losses, cases which the courts have dismissed. Courts in other jurisdictions have noted among other things, that the casino was not bound to protect a gambler from his desire to wager his wealth.
Despite this, the Senior Counsel from the local law firm recommended writing to RWS. "In the letter, the issues concerning RWS' failure to promote responsible gambling ... can be raised. Hopefully, this may encourage RWS to offer a haircut that would be acceptable to you ..." he wrote.
Genting Singapore's turned in a sterling net profit of $397 million for the quarter ended June 30, compared to a loss of $50.7 million a year ago. Revenues rose to $979 million from $120 million a year ago.
According to DMG Research, at the current rate, Singapore is already the second largest casino market in Asia after Macau, and could overtake the Las Vegas strip as the second largest casino market in the world after Macau in the next two to three years. The firm estimates that the two casinos here rake in over $16 million a day.
Wednesday, August 18, 2010
Sunday, August 15, 2010
Judging value in small and mid-cap space
Sunday, 15 August 2010
By TEH HOOI LING
SENIOR CORRESPONDENT
Small caps are inherently riskier, and during a downturn a lot of smaller companies get whacked harder
I SPOKE to Singapore-based value fund Lumiere Capital earlier this year. During the interview, one half of its founders, Wong Yu Liang, said: 'If you look at the measurement for the FTSE Small Cap Index, it has dropped 80 per cent from top to bottom. During the Great Depression, the price decline was 89 per cent. So we had a Great Depression in the small-cap sector in Singapore.' Mr Wong's contention was that there was still a lot of value in the small and mid-cap space.
I checked the numbers. The Small Cap Index hit a peak of 1,045.38 points on July 12, 2007. After the world's financial system seized up following the collapse of Lehman Brothers, it plunged to 236.76 points by March 12, 2009. That, to be exact, is a decline of 77 per cent. Not quite as bad as the Great Depression - but bad enough. In comparison, the Mid Cap Index was down 76 per cent, while the bluechip Straits Times Index (STI) shed 67 per cent during that period.
Just as swiftly as prices came down, so they recovered. But there have been different degrees of recovery for companies of different sizes. From the low of 2007, the Small Cap Index has rebounded 126.5 per cent. Its bigger counterpart, the Mid Cap Index, surged 143.2 per cent. And the giants of the stock market, the STI components, just about doubled from the bottom. From another perspective, as at Thursday's prices, the STI was just 20 per cent away from its peak in 2007. But the Mid Cap Index was still 31 per cent below its 2007 peak. And the Small Cap Index? It was still a whopping 49 per cent away from its 2007 high.
Since I'm at it, I decided to compare the performance of these three indices from different starting points up to this week. The charts show the movements of the three indices over time from various starting points. As you can see, the Small Cap Index is almost consistently at the bottom - that is, the worst-performing index.
For example, from Aug 31, 1999 until this week, the Small Cap Index actually lost 42 per cent of its value. In contrast, the Mid Cap Index was up 43 per cent, while the STI gained 38 per cent.
The Small Cap Index under-performed both the Mid Cap Index and the STI in all but one of the past 11 years, assuming one had invested at the start of each year since 2000 and held on until this week. Only from the start of 2009 until now did the Small Cap Index manage to pip the STI. And it never matched the performance of the Mid Cap Index. Perhaps current depressed valuations for small-cap stocks have something to do with index's dismal return numbers. So I calculated the rolling one-year, two-year, three-year and five-year returns of the three indices between Aug 31, 1999 and Aug 12, 2010. There were, for example, 2,498 one-year periods between that period. And there were 2,248 two-year periods, and so forth.
I then found out the median return of the various holding periods for the three different indices. From the second table, you can see that again, the Small Cap Index is the worst performer. The median one-year holding period was -4.1 per cent. This compared with 11.2 per cent chalked up by the Mid Cap Index, and the 9.3 per cent by the STI. In other words, for one-year holding periods, the Small Cap Index under-performed the Mid Cap Index by a whopping 15.3 percentage points, and it trailed the STI by 13.4 percentage points.
The under-performance of the Small Cap Index over two-year holding periods was even bigger, at 27.8 percentage points relative to the Mid Cap index and 15.4 percentage points relative to the STI.
Logically, the findings make a lot of sense. Small caps are inherently riskier. They don't generally have the wherewithal to defend their turf should a bigger competitor decide to come in. Bankers and suppliers are generally less forgiving of smaller companies. And smaller companies generally do not have the capacity to dangle a big enough carrot to attract top management talent. Which is why during a downturn, a lot of smaller companies get whacked harder. And some of these whacks can be fatal.
Smaller companies also typically face an uphill task in trying to grow to the next level. The lack of suitable management talent may be one factor. Then there is the lack of experience in managing expansion, in pacing growth at a sustainable level, instead of trying to go for far too much, far too fast. As a result, many smaller companies get tripped up when an unexpected downturn comes along. The big caps of course have a sturdier ship to steer through choppy waters. Hence their returns are typically rather decent.
But the bigger returns can be had from mid-cap companies. These are companies that have gone through the growing pains, chalked up the enough experience to manage growth, and have relatively larger pool of financial resources and more muscle to get up to the next league. My findings confirmed a previous study I carried out. Earlier this year, I looked at the returns of stocks in Singapore over the past 10 years based on the various groups' initial market caps. I found that stocks with market cap of between $1 billion and $5 billion to be in a sweet spot from which to grow their business. They were the best-performing group in the 10 years to 2009. Of the 27 stocks in that category, the median total return was 10.1 per cent compounded every year for the past 10 years. The average was 10.9 per cent. The return included dividend yield.
I noted then that the second best hunting ground for stocks likely to survive the market's ups and downs was in the $500 million to $1 billion market-cap range. The median return of the 18 stocks in that group was 6.8 per cent a year for the past 10 years, with the average at 4.5 per cent. Companies smaller than the $500 million market-cap level have, on average, yielded negative returns in the past 10 years. While size matters, companies that are too big can find it cumbersome to grow as well. Of the 10 companies whose market cap exceeded $5 billion at the start of 2000, the median return was 2.9 per cent a year, and the average was -0.6 per cent.
Hence the past 10 years' record shows that on the whole, investors have a better chance of picking a decent 'buy-and-hold' candidate among companies with market cap of $500 million and above. The chance of picking a 10-year winner there is 75 per cent, whereas for stocks smaller than $500 million, the chance of landing a winner is about 46 per cent.
Not only that, for the small-cap stocks that didn't make it, the likelihood of them tanking royally is greater. Today's findings show that perhaps one year is too long a holding period for small caps.
By TEH HOOI LING
SENIOR CORRESPONDENT
Small caps are inherently riskier, and during a downturn a lot of smaller companies get whacked harder
I SPOKE to Singapore-based value fund Lumiere Capital earlier this year. During the interview, one half of its founders, Wong Yu Liang, said: 'If you look at the measurement for the FTSE Small Cap Index, it has dropped 80 per cent from top to bottom. During the Great Depression, the price decline was 89 per cent. So we had a Great Depression in the small-cap sector in Singapore.' Mr Wong's contention was that there was still a lot of value in the small and mid-cap space.
I checked the numbers. The Small Cap Index hit a peak of 1,045.38 points on July 12, 2007. After the world's financial system seized up following the collapse of Lehman Brothers, it plunged to 236.76 points by March 12, 2009. That, to be exact, is a decline of 77 per cent. Not quite as bad as the Great Depression - but bad enough. In comparison, the Mid Cap Index was down 76 per cent, while the bluechip Straits Times Index (STI) shed 67 per cent during that period.
Just as swiftly as prices came down, so they recovered. But there have been different degrees of recovery for companies of different sizes. From the low of 2007, the Small Cap Index has rebounded 126.5 per cent. Its bigger counterpart, the Mid Cap Index, surged 143.2 per cent. And the giants of the stock market, the STI components, just about doubled from the bottom. From another perspective, as at Thursday's prices, the STI was just 20 per cent away from its peak in 2007. But the Mid Cap Index was still 31 per cent below its 2007 peak. And the Small Cap Index? It was still a whopping 49 per cent away from its 2007 high.
Since I'm at it, I decided to compare the performance of these three indices from different starting points up to this week. The charts show the movements of the three indices over time from various starting points. As you can see, the Small Cap Index is almost consistently at the bottom - that is, the worst-performing index.
For example, from Aug 31, 1999 until this week, the Small Cap Index actually lost 42 per cent of its value. In contrast, the Mid Cap Index was up 43 per cent, while the STI gained 38 per cent.
The Small Cap Index under-performed both the Mid Cap Index and the STI in all but one of the past 11 years, assuming one had invested at the start of each year since 2000 and held on until this week. Only from the start of 2009 until now did the Small Cap Index manage to pip the STI. And it never matched the performance of the Mid Cap Index. Perhaps current depressed valuations for small-cap stocks have something to do with index's dismal return numbers. So I calculated the rolling one-year, two-year, three-year and five-year returns of the three indices between Aug 31, 1999 and Aug 12, 2010. There were, for example, 2,498 one-year periods between that period. And there were 2,248 two-year periods, and so forth.
I then found out the median return of the various holding periods for the three different indices. From the second table, you can see that again, the Small Cap Index is the worst performer. The median one-year holding period was -4.1 per cent. This compared with 11.2 per cent chalked up by the Mid Cap Index, and the 9.3 per cent by the STI. In other words, for one-year holding periods, the Small Cap Index under-performed the Mid Cap Index by a whopping 15.3 percentage points, and it trailed the STI by 13.4 percentage points.
The under-performance of the Small Cap Index over two-year holding periods was even bigger, at 27.8 percentage points relative to the Mid Cap index and 15.4 percentage points relative to the STI.
Logically, the findings make a lot of sense. Small caps are inherently riskier. They don't generally have the wherewithal to defend their turf should a bigger competitor decide to come in. Bankers and suppliers are generally less forgiving of smaller companies. And smaller companies generally do not have the capacity to dangle a big enough carrot to attract top management talent. Which is why during a downturn, a lot of smaller companies get whacked harder. And some of these whacks can be fatal.
Smaller companies also typically face an uphill task in trying to grow to the next level. The lack of suitable management talent may be one factor. Then there is the lack of experience in managing expansion, in pacing growth at a sustainable level, instead of trying to go for far too much, far too fast. As a result, many smaller companies get tripped up when an unexpected downturn comes along. The big caps of course have a sturdier ship to steer through choppy waters. Hence their returns are typically rather decent.
But the bigger returns can be had from mid-cap companies. These are companies that have gone through the growing pains, chalked up the enough experience to manage growth, and have relatively larger pool of financial resources and more muscle to get up to the next league. My findings confirmed a previous study I carried out. Earlier this year, I looked at the returns of stocks in Singapore over the past 10 years based on the various groups' initial market caps. I found that stocks with market cap of between $1 billion and $5 billion to be in a sweet spot from which to grow their business. They were the best-performing group in the 10 years to 2009. Of the 27 stocks in that category, the median total return was 10.1 per cent compounded every year for the past 10 years. The average was 10.9 per cent. The return included dividend yield.
I noted then that the second best hunting ground for stocks likely to survive the market's ups and downs was in the $500 million to $1 billion market-cap range. The median return of the 18 stocks in that group was 6.8 per cent a year for the past 10 years, with the average at 4.5 per cent. Companies smaller than the $500 million market-cap level have, on average, yielded negative returns in the past 10 years. While size matters, companies that are too big can find it cumbersome to grow as well. Of the 10 companies whose market cap exceeded $5 billion at the start of 2000, the median return was 2.9 per cent a year, and the average was -0.6 per cent.
Hence the past 10 years' record shows that on the whole, investors have a better chance of picking a decent 'buy-and-hold' candidate among companies with market cap of $500 million and above. The chance of picking a 10-year winner there is 75 per cent, whereas for stocks smaller than $500 million, the chance of landing a winner is about 46 per cent.
Not only that, for the small-cap stocks that didn't make it, the likelihood of them tanking royally is greater. Today's findings show that perhaps one year is too long a holding period for small caps.
Why it’s hard to get rich quickly
Sunday Times Singapore, 15 Aug, 2010, Sunday
YOUR LETTER
Why it’s hard to get rich quickly
I refer to the previous Sunday’s article, ‘Stock investing is different from gambling’. Mr Brennen Pak did a good job of explaining some of the differences between gambling and investing.
There are more. Most importantly, gambling is a zero-sum game where one party wins, the other loses and a middleman takes a cut. The middleman’s cut means the games are actually negative sum – sure lose.
Singapore Pools and the casinos take large cuts, which means sure lose quickly. It’s a sucker’s game, but Singapore Pools has the redeeming quality that its income goes to causes which benefit the nation.
Most dangerous are zero-sum games that look like investments but are actually gambling. Examples are derivatives such as futures, options and structured warrants. Currencies are also zero-sum.
It means that for each dollar lost by one person, a dollar is won by a counter-party. Subtract commissions and less than $1 is won. The zero-sum game becomes negative sum and, like gambling, it is sure lose.
Sellers argue that derivatives are for short-term trading, and can make money if it is somehow possible to see into the future. The problem is, it’s not. Studies have shown that predicting the short-run prices of equities – like shares and property – is not possible without insider information, which is hard to come by and usually illegal to use for trading.
The long run is a different story. Positive returns are practically a sure thing for equities and have averaged around 9 per cent a year over the past 30 years. It is why a buy-and-hold strategy works for shares and properties. It works for bonds too, where returns are more certain but lower.
One could also try to buy and hold derivatives for the long run by rolling over the contracts year after year. The problem is that commissions pile up with each rollover and would eventually drain the initial capital until it’s a total loss. That is the story for equities and derivatives for the long and short runs.
Equities are sure win in the long run. All other strategies are sure lose.
Sorry, but it’s hard to get rich quickly.
Larry Haverkamp (Dr Askmoney)
YOUR LETTER
Why it’s hard to get rich quickly
I refer to the previous Sunday’s article, ‘Stock investing is different from gambling’. Mr Brennen Pak did a good job of explaining some of the differences between gambling and investing.
There are more. Most importantly, gambling is a zero-sum game where one party wins, the other loses and a middleman takes a cut. The middleman’s cut means the games are actually negative sum – sure lose.
Singapore Pools and the casinos take large cuts, which means sure lose quickly. It’s a sucker’s game, but Singapore Pools has the redeeming quality that its income goes to causes which benefit the nation.
Most dangerous are zero-sum games that look like investments but are actually gambling. Examples are derivatives such as futures, options and structured warrants. Currencies are also zero-sum.
It means that for each dollar lost by one person, a dollar is won by a counter-party. Subtract commissions and less than $1 is won. The zero-sum game becomes negative sum and, like gambling, it is sure lose.
Sellers argue that derivatives are for short-term trading, and can make money if it is somehow possible to see into the future. The problem is, it’s not. Studies have shown that predicting the short-run prices of equities – like shares and property – is not possible without insider information, which is hard to come by and usually illegal to use for trading.
The long run is a different story. Positive returns are practically a sure thing for equities and have averaged around 9 per cent a year over the past 30 years. It is why a buy-and-hold strategy works for shares and properties. It works for bonds too, where returns are more certain but lower.
One could also try to buy and hold derivatives for the long run by rolling over the contracts year after year. The problem is that commissions pile up with each rollover and would eventually drain the initial capital until it’s a total loss. That is the story for equities and derivatives for the long and short runs.
Equities are sure win in the long run. All other strategies are sure lose.
Sorry, but it’s hard to get rich quickly.
Larry Haverkamp (Dr Askmoney)
In search of super returns in stocks
By Teh Hooi Ling
Sun, Aug 15, 2010
The Business Times
ONE way to value a company is to ascertain how much abnormal earnings - that is, earnings above the cost of its capital - it will be able to generate in the future. This stream of abnormal earnings is then discounted to its present value. Add that number to the current book value of the capital and you arrive at how much the company is worth.
This way of calculation has intuitive appeal. It implies that if a company can earn a rate of return that is equivalent to its cost of capital, then investors should be willing to pay no more than the book value for the stock.
Book value is the original capital invested by the company in its various assets to start up its business after taking into account depreciation.
On the other hand, if the company is able to generate earnings above its cost of capital, then investors should be willing to pay more than the book value of its assets. Conversely, if a company's net earnings cannot even cover its cost of capital, then investors will only invest in the company if it is trading below its book value.
We can see how much the market is valuing a company by comparing the market value of its equity, that is its market capitalisation, with the book value of its equity.
So if a company's market cap is $100 million, and the book value of its equity is $50 million, then this company is trading at two times its book value. This measure is also referred to as the price-to-book (PTB) ratio.
A PTB ratio of two times implies that investors are confident that the company can earn significantly above its cost of capital for a sustained period of time.
We can actually derive the formula for PTB from the abnormal earnings formula. The latter says that to arrive at what a company's shares are worth, we take the current book value of its equity, and add the discounted future stream of net profits which is in excess of the cost of equity. The discount rate used is the cost of equity.
So if we scale the formula with book value on both sides, we get PTB value on the left-hand side, and abnormal return on equity (ROE), among other things, on the right-hand side.
This suggests that a company's PTB ratio is a function of three factors: its future abnormal ROE, the growth in its book equity, and its cost of equity.
Abnormal ROE is defined as ROE less the cost of equity.
Firms with positive abnormal ROE are able to invest their net assets to create value for shareholders, and as mentioned earlier, will have a PTB ratio greater than one.
ROE-PTB: What's the link?
The whole point of what has been said so far is to show that there is a strong relationship between PTB ratios and ROEs. Companies with high ROE should trade at higher PTB ratio compared with those with lower ROE.
So perhaps one way to spot mispricings by the market is to identify stocks with high ROE but low PTB ratio.
Will such a strategy pay off? Well, I did some back-testing and the results are phenomenal.
I download the ROEs and PTBs of all the companies listed on the Singapore Exchange from 1990 until 2007. These are the yearly numbers on Jan 1 of each year.
I then divide the ROE numbers with PTBs, and rank the stocks based on that number. The top-ranked stock would have the highest ROE relative to its PTB. The lower-ranked stocks would have low ROE and high PTB.
I then split all the stocks equally into 10 groups. The first group, or the first decile, is the top 10 per cent of stocks with the highest ROEs relative to their PTB ratios. The 10th decile comprises those with the lowest ROEs and highest PTB ratios. Then there's a group of loss-making companies.
Compounded returns
Assuming that an investor did this on Jan 1, 1990. Based on data from Thomson Financial Datastream, there were 39 stocks then. After ranking them, he invested $100 in the top four stocks with the highest ROE/PTB.
On Jan 1, 1991, he did the same screening again. Then he divested the initial four stocks and reinvested the proceeds into a new batch of stocks with the highest ROE/PTB.
And he consistently did that for the past 17 years. How do you think his $100 would have grown to? A whopping $34,048.
That's a compounded return of 41 per cent a year. The above calculations did not take into consideration transaction costs. If it did, a huge chunk of profits would disappear.
But the point is, there is a very clear relationship between stock returns and ROE/PTB. As can be seen from the chart, the top 10 per cent of companies with the highest ROE/PTB turned $100 into $34,048 in 17 years.
The next 10 per cent managed to grow the pot to $4,710 - that's still quite a decent 25 per cent a year. The following 10 per cent, or the third decile, managed $958 for a return of 14 per cent a year.
And as we move to stocks with lower and lower ROE/PTBs, the return shrinks correspondingly.
The fifth decile grew only 3.8 per cent a year and the 10th decile - the 10 per cent of the market with the lowest ROE/PTB - shrank the $100 to just $25. It is very clear from the findings that it doesn't make sense buying stocks with low ROE and high PTB.
This screening process takes into consideration the underlying earnings capacity of a company in relation to how the market is valuing the company. Those with high ROE but low PTB are clear cases of mispricing. That's why the back-testing shows such a phenomenal performance.
But of course, a firm's ROE is affected by such factors as barriers to entry in their industries, change in production or delivery technologies, and quality of management. These factors tend to force ROEs to decay over time. But since in the above testing, the holding period is just one year, the decay is not so much a factor.
So the next time you study a stock, look at its ROE relative to its PTB as well. If the ROE is high, but its PTB is high as well, then perhaps the good fundamentals have been reflected in the share price. However, if you find a stock with high ROE but relatively low PTB, then you may potentially have on your hands an undiscovered gem.
The writer is a CFA charterholder. She can be reached at hooiling@sph.com.sg.
Sun, Aug 15, 2010
The Business Times
ONE way to value a company is to ascertain how much abnormal earnings - that is, earnings above the cost of its capital - it will be able to generate in the future. This stream of abnormal earnings is then discounted to its present value. Add that number to the current book value of the capital and you arrive at how much the company is worth.
This way of calculation has intuitive appeal. It implies that if a company can earn a rate of return that is equivalent to its cost of capital, then investors should be willing to pay no more than the book value for the stock.
Book value is the original capital invested by the company in its various assets to start up its business after taking into account depreciation.
On the other hand, if the company is able to generate earnings above its cost of capital, then investors should be willing to pay more than the book value of its assets. Conversely, if a company's net earnings cannot even cover its cost of capital, then investors will only invest in the company if it is trading below its book value.
We can see how much the market is valuing a company by comparing the market value of its equity, that is its market capitalisation, with the book value of its equity.
So if a company's market cap is $100 million, and the book value of its equity is $50 million, then this company is trading at two times its book value. This measure is also referred to as the price-to-book (PTB) ratio.
A PTB ratio of two times implies that investors are confident that the company can earn significantly above its cost of capital for a sustained period of time.
We can actually derive the formula for PTB from the abnormal earnings formula. The latter says that to arrive at what a company's shares are worth, we take the current book value of its equity, and add the discounted future stream of net profits which is in excess of the cost of equity. The discount rate used is the cost of equity.
So if we scale the formula with book value on both sides, we get PTB value on the left-hand side, and abnormal return on equity (ROE), among other things, on the right-hand side.
This suggests that a company's PTB ratio is a function of three factors: its future abnormal ROE, the growth in its book equity, and its cost of equity.
Abnormal ROE is defined as ROE less the cost of equity.
Firms with positive abnormal ROE are able to invest their net assets to create value for shareholders, and as mentioned earlier, will have a PTB ratio greater than one.
ROE-PTB: What's the link?
The whole point of what has been said so far is to show that there is a strong relationship between PTB ratios and ROEs. Companies with high ROE should trade at higher PTB ratio compared with those with lower ROE.
So perhaps one way to spot mispricings by the market is to identify stocks with high ROE but low PTB ratio.
Will such a strategy pay off? Well, I did some back-testing and the results are phenomenal.
I download the ROEs and PTBs of all the companies listed on the Singapore Exchange from 1990 until 2007. These are the yearly numbers on Jan 1 of each year.
I then divide the ROE numbers with PTBs, and rank the stocks based on that number. The top-ranked stock would have the highest ROE relative to its PTB. The lower-ranked stocks would have low ROE and high PTB.
I then split all the stocks equally into 10 groups. The first group, or the first decile, is the top 10 per cent of stocks with the highest ROEs relative to their PTB ratios. The 10th decile comprises those with the lowest ROEs and highest PTB ratios. Then there's a group of loss-making companies.
Compounded returns
Assuming that an investor did this on Jan 1, 1990. Based on data from Thomson Financial Datastream, there were 39 stocks then. After ranking them, he invested $100 in the top four stocks with the highest ROE/PTB.
On Jan 1, 1991, he did the same screening again. Then he divested the initial four stocks and reinvested the proceeds into a new batch of stocks with the highest ROE/PTB.
And he consistently did that for the past 17 years. How do you think his $100 would have grown to? A whopping $34,048.
That's a compounded return of 41 per cent a year. The above calculations did not take into consideration transaction costs. If it did, a huge chunk of profits would disappear.
But the point is, there is a very clear relationship between stock returns and ROE/PTB. As can be seen from the chart, the top 10 per cent of companies with the highest ROE/PTB turned $100 into $34,048 in 17 years.
The next 10 per cent managed to grow the pot to $4,710 - that's still quite a decent 25 per cent a year. The following 10 per cent, or the third decile, managed $958 for a return of 14 per cent a year.
And as we move to stocks with lower and lower ROE/PTBs, the return shrinks correspondingly.
The fifth decile grew only 3.8 per cent a year and the 10th decile - the 10 per cent of the market with the lowest ROE/PTB - shrank the $100 to just $25. It is very clear from the findings that it doesn't make sense buying stocks with low ROE and high PTB.
This screening process takes into consideration the underlying earnings capacity of a company in relation to how the market is valuing the company. Those with high ROE but low PTB are clear cases of mispricing. That's why the back-testing shows such a phenomenal performance.
But of course, a firm's ROE is affected by such factors as barriers to entry in their industries, change in production or delivery technologies, and quality of management. These factors tend to force ROEs to decay over time. But since in the above testing, the holding period is just one year, the decay is not so much a factor.
So the next time you study a stock, look at its ROE relative to its PTB as well. If the ROE is high, but its PTB is high as well, then perhaps the good fundamentals have been reflected in the share price. However, if you find a stock with high ROE but relatively low PTB, then you may potentially have on your hands an undiscovered gem.
The writer is a CFA charterholder. She can be reached at hooiling@sph.com.sg.
Saturday, August 7, 2010
September Is The Worst Month For Stocks
(Source: The Prag Cap)
This chart illustrates the Dow Jones` average performance for each calendar month since 1950. It is worth noting that the worst calendar month for stock market performance is fast approaching.
Friday, August 6, 2010
Retirement math: How much you really need
Are people actually running out of cash when they retire?
Fri, Aug 06, 2010
Reuters
Those scary studies keep on coming: The latest one from the Employee Benefit Research Institute drives home the same message as many others: Americans won't have enough money for retirement.
The EBRI study said that nearly half of older baby boomers approaching retirement risk running out of money in their golden years.
But is that really true?
Are people actually running out of cash when they retire?
Are those findings a cause for panic, or can small adjustments around the edges fix the problem?
Like most other retirement studies of the frightening genre, the EBRI report did make a few calculating short cuts that might have made the situation look worse than it is.
For example, EBRI weighed only retirement accounts and home equity, ignoring any other savings that families might have accumulated.
It also assumed that all workers would retire at 65.
I am not picking on EBRI. In general, its methodologies are sound, and more measured than the typical "OMG, it's a retirement disaster!" studies put out by some insurance and investment companies.
But, in general, it isn't the methodology of these studies that is troubling, but the ideas behind them.
They assume, for example, that people will blithely spend their nest eggs at a fixed rate until the day they wake up at 87 or 92 with no money left. And they suggest that retirement is an all-or-nothing proposition: You either can afford to bring your lifestyle into retirement, or you can't.
They don't focus -- or often, even acknowledge -- that retirement is a series of budgetary trade-offs, just like the first 2/3 or 3/4 of life.
So sure, stash away as much as you can -- the more cash you can spend in the last third of life, the better. But instead of panicking and worrying about retirement, take a more logical approach.
The basic math of official retirement planning goes like this: Take your current monthly spending, subtract your expected Social Security payment, and the remainder is what you need to pull out of your retirement fund every month in your first year of retirement.
Multiply that figure by 12, to get the amount you'd need to withdraw in a year.
Multiply that by 25, and that's the size of the nest egg you need to leave work with, to insure that your money never runs out.
Yikes! No wonder everyone's scared.
Here are some mitigating points.
You'll spend more than you think for a while, but not forever.
Retirement planners make much of the first few years of retirement, when you spend on everything from leisure clothes to long-deferred cruises to all those household projects you didn't have time to do when you were working.
But by mid-retirement, many of those expenses disappear.
By the time a person passes 75 years of age, his spending is almost half of what it was for the years between 55 and 64, according to figures from the Bureau of Labor Statistics.
Older retirees spend about 76 percent of what people between 65 and 74 spend. So you can aim to take more out in earlier years and take less out in later years.
You won't want to stay in your house forever.
You may, but not many people do. So at some point in mid or late retirement, you can sell your home, downsize, and add your accumulated equity to the pot of money you have to spend (lowering your expenses along the way.)
Even if you do want to stay in your home forever, new and improved reverse mortgage products will allow you to tap that equity at some point along the road.
You can make little adjustments that will stretch your money further.
You can increase your annual retirement income by about 7 percent for every year that you defer retiring, says research from T. Rowe Price.
Just working a small part-time job and delaying the start of your Social Security benefits for one year will raise the size of your benefit check by about 8 percent for life.
If you keep a little bit more of your portfolio in the stock market over long periods of time (even after you retire), that will help it to last longer.
You can protect yourself against actually running out of money with a few well-chosen products.
A small, low-fee, immediate annuity bought with part of your savings once you are retired will insure that some money comes in every month.
A solid long-term care policy will insure that if you do need extensive care in your later years, you won't have to demolish your family nest egg to get it. It will be protected for your spouse or your kids.
You can live a good retirement life on a budget.
You can do everything from downsize to one car to cut back on restaurant meals.
You can grocery shop with coupons, wait for sales to buy clothes and housewares, and do your own mending, lawn mowing (at least in early retirement) and more -- you know, the kinds of things you already do.
You can take in a roommate, move in with the same kid who moved in with you after college, eat more popcorn and less meat.
You can camp and fish on vacation or couch surf at the homes of all of your old friends, instead of flying to Europe or cruising the Caribbean.
None of those alternatives will ruin your life, or even diminish your fun.
Remember that you have reasonable options that will help your money last far longer than the spreadsheets say it will.
Fri, Aug 06, 2010
Reuters
Those scary studies keep on coming: The latest one from the Employee Benefit Research Institute drives home the same message as many others: Americans won't have enough money for retirement.
The EBRI study said that nearly half of older baby boomers approaching retirement risk running out of money in their golden years.
But is that really true?
Are people actually running out of cash when they retire?
Are those findings a cause for panic, or can small adjustments around the edges fix the problem?
Like most other retirement studies of the frightening genre, the EBRI report did make a few calculating short cuts that might have made the situation look worse than it is.
For example, EBRI weighed only retirement accounts and home equity, ignoring any other savings that families might have accumulated.
It also assumed that all workers would retire at 65.
I am not picking on EBRI. In general, its methodologies are sound, and more measured than the typical "OMG, it's a retirement disaster!" studies put out by some insurance and investment companies.
But, in general, it isn't the methodology of these studies that is troubling, but the ideas behind them.
They assume, for example, that people will blithely spend their nest eggs at a fixed rate until the day they wake up at 87 or 92 with no money left. And they suggest that retirement is an all-or-nothing proposition: You either can afford to bring your lifestyle into retirement, or you can't.
They don't focus -- or often, even acknowledge -- that retirement is a series of budgetary trade-offs, just like the first 2/3 or 3/4 of life.
So sure, stash away as much as you can -- the more cash you can spend in the last third of life, the better. But instead of panicking and worrying about retirement, take a more logical approach.
The basic math of official retirement planning goes like this: Take your current monthly spending, subtract your expected Social Security payment, and the remainder is what you need to pull out of your retirement fund every month in your first year of retirement.
Multiply that figure by 12, to get the amount you'd need to withdraw in a year.
Multiply that by 25, and that's the size of the nest egg you need to leave work with, to insure that your money never runs out.
Yikes! No wonder everyone's scared.
Here are some mitigating points.
You'll spend more than you think for a while, but not forever.
Retirement planners make much of the first few years of retirement, when you spend on everything from leisure clothes to long-deferred cruises to all those household projects you didn't have time to do when you were working.
But by mid-retirement, many of those expenses disappear.
By the time a person passes 75 years of age, his spending is almost half of what it was for the years between 55 and 64, according to figures from the Bureau of Labor Statistics.
Older retirees spend about 76 percent of what people between 65 and 74 spend. So you can aim to take more out in earlier years and take less out in later years.
You won't want to stay in your house forever.
You may, but not many people do. So at some point in mid or late retirement, you can sell your home, downsize, and add your accumulated equity to the pot of money you have to spend (lowering your expenses along the way.)
Even if you do want to stay in your home forever, new and improved reverse mortgage products will allow you to tap that equity at some point along the road.
You can make little adjustments that will stretch your money further.
You can increase your annual retirement income by about 7 percent for every year that you defer retiring, says research from T. Rowe Price.
Just working a small part-time job and delaying the start of your Social Security benefits for one year will raise the size of your benefit check by about 8 percent for life.
If you keep a little bit more of your portfolio in the stock market over long periods of time (even after you retire), that will help it to last longer.
You can protect yourself against actually running out of money with a few well-chosen products.
A small, low-fee, immediate annuity bought with part of your savings once you are retired will insure that some money comes in every month.
A solid long-term care policy will insure that if you do need extensive care in your later years, you won't have to demolish your family nest egg to get it. It will be protected for your spouse or your kids.
You can live a good retirement life on a budget.
You can do everything from downsize to one car to cut back on restaurant meals.
You can grocery shop with coupons, wait for sales to buy clothes and housewares, and do your own mending, lawn mowing (at least in early retirement) and more -- you know, the kinds of things you already do.
You can take in a roommate, move in with the same kid who moved in with you after college, eat more popcorn and less meat.
You can camp and fish on vacation or couch surf at the homes of all of your old friends, instead of flying to Europe or cruising the Caribbean.
None of those alternatives will ruin your life, or even diminish your fun.
Remember that you have reasonable options that will help your money last far longer than the spreadsheets say it will.
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