Monday, 31 December 2012
1. Buy companies that have disciplined plans for achieving dramatic long-range profit growth and have inherent quailities making it difficult for newcomers to share in that growth.
2. Buy companies when they are out of favour.
3. Hold a stock until either (a) there has been a fundamentall change in its nature (e.g., big management changes), or (b) it has grown to a point where it no longer will be growing faster than economy as a whole.
4. De-emphasize the importance of dividends.
5. Recognise that making some mistakes is an inherent cost of investment. Taking small profits in good investments and letting losses grow in bad ones is a sign of abominable investment judgement.
6. Accept the fact that only a relatively small number of companies are tryuly outstanding. Therefore, concentrate your funds in the most desirable opportunities. Any holding of over twenty stocks is a sign of a financial incompetence.
7. Never accept blindly whatever may be the dominant current opinion in the financial community. Nor should you reject the prevailing view just for the sake of being contrary.
8. Understand that success greatly depends on a combination of hard, intelligence, and honesty.
Monday, December 31, 2012
Sunday, December 30, 2012
Price-to-book worth a look
Buying shares trading below book value can pay off if the firms are profitable in long run
Published on Dec 30, 2012
By Teh Hooi Ling
Last week, we showed that consistently buying the basket of stocks whose prices are lowest relative to their earnings would allow you to vastly outperform a buy-and-hold strategy for the Straits Times Index.
Price-earnings (PE) ratio, as the name suggests, measures the value of the company relative to the earnings it is generating.
Another valuation metric used by the market relates to the assets that the company has.
Let's go back to the example of the ABC coffee shop which made $50,000 profit this year. We established that paying $250,000 for the coffee shop - five times its earnings - is cheaper than paying $500,000 (10 times its earnings).
Today, we will look at the balance sheet, the financial statement which shows the assets and liabilities of ABC.
Let's say ABC has cash of $100,000 in the bank. It also has inventory (the canned drinks, beer and coffee that it has stocked up) worth another $100,000. Assume also it has paid a rental deposit of three months which came up to $100,000. Its other assets include its ice-making machine, the refrigerator, the coffee machine, tables and chairs, and so on. In total these assets have a value of $200,000.
So on the assets side, ABC has $500,000.
But not all of the $500,000 is funded by the equity of ABC's owner, Mr Tan. He has taken out a bank loan of $100,000, and he owes his suppliers $100,000.
So, taking out ABC's liabilities, the coffee shop's net assets, or book value of its equity, is $300,000.
So if you offer to pay $250,000 for ABC coffee shop, then you are offering to pay only 83per cent of its book value. That's a discount of 17 per cent. If you agree that Mr Tan has valued his assets - the refrigerator, coffee machine and so on - fairly, then you are getting a bargain if he is willing to sell the coffee shop to you at $250,000.
However, if you put in a bid of $500,000, then you are offering to pay 1.7 times above the book value, or a 70per cent premium over the book value. To offer this kind of price, you have to be very confident that the business can generate good profits from its assets.
Again, if ABC is a listed company and it has one million shares listed, then its book value per share is 30 cents ($300,000/1,000,000). If the shares are trading below 30 cents, say 25 cents, then they are trading below book value at just 0.83 times price-to-book (PTB).
That buying stocks with low PTB pays handsomely has been proven time and time again. It was first discovered in 1992, when US professors Eugene Fama and Kenneth French published a breakthrough study on the use of PTB ratio as a predictor of a company's future stock performance.
Their study showed convincingly that the lower the company's ratio of PTB value, the higher its subsequent stock performance tended to be.
"No other measures had nearly as much predictive power - not earnings growth, price/earnings, or volatility," they said, with data supporting the claim.
Does Singapore exhibit the same pattern? Well, I repeated the test I did with the PE ratios last week.
I rank all the stocks listed on the Singapore Exchange every year based on their PTB ratios. I then put them into 10 equal groups. Stocks with the lowest PTBs go into Decile1, second-lowest into Decile2 and so on. The following year, I rank the stocks again based on their PTBs at that time, and group them into 10 groups again. The process is repeated every year from 1990 until 2012.
Again, assume we started with $100,000. The first $10,000 goes into the stocks in Decile1. At the end of the first year, we liquidate that portfolio and roll over the profits to the Decile 1 stocks for the second year. Ditto for stocks in the other deciles.
The accompanying chart shows the results. The $10,000 in March30, 1990 used to invest in the baskets of stocks with the lowest PTB every year for 22 years would have grown to $355,135. That's a compounded annual return of 17.6 per cent. Money invested in the second basket, or Decile2, grew to $108,830 for a return of 11.5 per cent a year.
Remember last week, we showed that consistently buying the lowest PE stocks in Singapore turned $10,000 into $199,847 for a return of 14.6 per cent a year during the same period?
So buying low PTB stocks beats buying low PE stocks as a strategy!
But truth be told, buying low PTB stocks is a much more difficult thing to do than buying low PE stocks. Low PE stocks are profitable companies. For low PTB stocks, many times, they trade below their book values precisely because they are not making money.
But many of such stocks eventually turn around because of the phenomenon called mean reversion. Very high profit-margin companies will see their profits come down to the mean, or average levels, over time as competition enters the market. Loss-making companies will restructure or be taken over, and become profitable again.
But be warned that some of the low PTB stocks will go bankrupt. So for this strategy to work, one has to take the portfolio approach: that is, buy a basket of such stocks, and let the gains from the winners make up for those which go kaput.
But many times, profitable companies also trade below their book values. During the dot.com bubble in the late 1990s and early 2000, many of the bricks-and-mortar companies were trading at below book. Even today, many real estate developers are trading below their book values. Perhaps it will pay to take a closer look at what assets they are holding.
hooiling@sph.com.sg
Buying low PTB stocks is a much more difficult thing to do than buying low PE stocks. Low PE stocks are profitable companies. For low PTB stocks, many times, they trade below their book values precisely because they are not making money.
Thursday, December 27, 2012
Analysis: Ordinary folks are losing interest in stocks
Associated Press
December 27, 2012
Andrew Neitlich is the last person you'd expect to be rattled by the stock market.
He once worked as a financial analyst picking stocks for a mutual fund. He has huddled with dozens of CEOs in his current career as an executive coach.
During the dot-com crash 12 years ago, he kept his wits and did not sell.
But he's selling now.
"You have to trust your government. You have to trust other governments. You have to trust Wall Street," says Neitlich, 47. "And I don't trust any of these."
Defying decades of investment history, ordinary Americans are selling stocks for a fifth year in a row. The selling has not let up despite unprecedented measures by the Federal Reserve to persuade people to buy and the come-hither allure of a levitating market. Stock prices have doubled from March 2009, their low point during the Great Recession.
It's the first time ordinary folks have sold during a sustained bull market since relevant records were first kept during World War II, an examination by The Associated Press has found. The AP analyzed money flowing into and out of stock funds of all kinds, including relatively new exchange-traded funds, which investors like because of their low fees.
"People don't trust the market anymore," says financial historian Charles Geisst of Manhattan College. He says a "crisis of confidence" similar to one after the Crash of 1929 will keep people away from stocks for a generation or more.
The implications for the economy and living standards are unclear but potentially big. If the pullback continues, some experts say, it could lead to lower spending by companies, slower U.S. economic growth and perhaps lower gains for those who remain in the market.
Since they started selling in April 2007, eight months before the start of the Great Recession, individual investors have pulled at least $380 billion from U.S. stock funds, a category that includes both mutual funds and exchange-traded funds, according to estimates by the AP. That is the equivalent of all the money they put into the market in the previous five years.
Instead of stocks, they're putting money into bonds because those are widely perceived as safer investments. Individuals have put more than $1 trillion into bond mutual funds alone since April 2007, according to the Investment Company Institute, a trade group representing investment funds.
Selling stocks during either a downturn or a recovery is unusual. Americans almost always buy more than they sell during both periods.
Since World War II, nine recessions besides the Great Recession have been followed by recoveries lasting at least three years. According to data from the Investment Company Institute, individual investors sold during and after only one of those previous downturns—the one from November 1973 through March 1975. And back then a scary stock drop around the start of the recovery's third year, 1977, gave people ample reason to get out of the market.
The unusual pullback this time has spread to other big investors—public and private pension funds, investment brokerages and state and local governments. These groups have sold a total of $861 billion more than they have bought since April 2007, according to the Federal Reserve.
Even foreigners, big purchasers in recent years, are selling now—$16 billion in the 12 months through September.
As these groups have sold, much of the stock buying has fallen to companies. They've bought $656 billion more than they have sold since April 2007.
Companies are mostly buying back their own stock.
On Wall Street, the investor revolt has largely been dismissed as temporary. But doubts are creeping in.
A Citigroup research report sent to customers concludes that the "cult of equities" that fueled buying in the past has little chance of coming back soon. Investor blogs speculate about the "death of equities," a line from a famous BusinessWeek cover story in 1979, another time many people had seemingly given up on stocks. Financial analysts lament how the retreat by Main Street has left daily stock trading at low levels.
The investor retreat may have already hurt the fragile economic recovery.
The number of shares traded each day has fallen 40 percent from before the recession to a 12-year low, according to the New York Stock Exchange.
That's cut into earnings of investment banks and online brokers, which earn fees helping others trade stocks. Initial public offerings, another source of Wall Street profits, are happening at one-third the rate before the recession.
And old assumptions about stocks are being tested. One investing gospel is that because stocks generally rise in price, companies don't need to raise their quarterly cash dividends much to attract buyers. But companies are increasing them lately.
Dividends in the S&P 500 rose 11 percent in the 12 months through September, and the number of companies choosing to raise them is the highest in at least 20 years, according to FactSet, a financial data provider. Stocks now throw off more cash in dividends than U.S. government bonds do in interest.
Many on Wall Street think this is an unnatural state that cannot last. After all, people tend to buy stocks because they expect them to rise in price, not because of the dividend. But for much of the history of U.S. stock trading, stocks were considered too risky to be regarded as little more than vehicles for generating dividends. In every year from 1871 through 1958, stocks yielded more in dividends than U.S. bonds did in interest, according to data from Yale economist Robert Shiller—exactly what is happening now.
So maybe that's normal, and the past five decades were the aberration.
People who think the market will snap back to normal are underestimating how much the Great Recession scared investors, says Ulrike Malmendier, an economist who has studied the effect of the Great Depression on attitudes toward stocks.
She says people are ignoring something called the "experience effect," or the tendency to place great weight on what you most recently went through in deciding how much financial risk to take, even if it runs counter to logic. Extrapolating from her research on "Depression Babies," the title of a 2010 paper she co-wrote, she says many young investors won't fully embrace stocks again for another two decades.
"The Great Recession will have a lasting impact beyond what a standard economic model would predict," says Malmendier, who teaches at the University of California, Berkeley.
She could be wrong, of course. But it's a measure of the psychological blow from the Great Recession that, more than three years since it ended, big institutions, not just amateur investors, are still trimming stocks.
Public pension funds have cut stocks from 71 percent of their holdings before the recession to 66 percent last year, breaking at least 40 years of generally rising stock allocations, according to "State and Local Pensions: What Now?," a book by economist Alicia Munnell. They're shifting money into bonds.
Private pension funds, like those run by big companies, have cut stocks more: from 70 percent of holdings to just under 50 percent, back to the 1995 level.
"People aren't looking to swing for the fences anymore," says Gary Goldstein, an executive recruiter on Wall Street, referring to the bankers and traders he helps get jobs. "They're getting less greedy."
December 27, 2012
Andrew Neitlich is the last person you'd expect to be rattled by the stock market.
He once worked as a financial analyst picking stocks for a mutual fund. He has huddled with dozens of CEOs in his current career as an executive coach.
During the dot-com crash 12 years ago, he kept his wits and did not sell.
But he's selling now.
"You have to trust your government. You have to trust other governments. You have to trust Wall Street," says Neitlich, 47. "And I don't trust any of these."
Defying decades of investment history, ordinary Americans are selling stocks for a fifth year in a row. The selling has not let up despite unprecedented measures by the Federal Reserve to persuade people to buy and the come-hither allure of a levitating market. Stock prices have doubled from March 2009, their low point during the Great Recession.
It's the first time ordinary folks have sold during a sustained bull market since relevant records were first kept during World War II, an examination by The Associated Press has found. The AP analyzed money flowing into and out of stock funds of all kinds, including relatively new exchange-traded funds, which investors like because of their low fees.
"People don't trust the market anymore," says financial historian Charles Geisst of Manhattan College. He says a "crisis of confidence" similar to one after the Crash of 1929 will keep people away from stocks for a generation or more.
The implications for the economy and living standards are unclear but potentially big. If the pullback continues, some experts say, it could lead to lower spending by companies, slower U.S. economic growth and perhaps lower gains for those who remain in the market.
Since they started selling in April 2007, eight months before the start of the Great Recession, individual investors have pulled at least $380 billion from U.S. stock funds, a category that includes both mutual funds and exchange-traded funds, according to estimates by the AP. That is the equivalent of all the money they put into the market in the previous five years.
Instead of stocks, they're putting money into bonds because those are widely perceived as safer investments. Individuals have put more than $1 trillion into bond mutual funds alone since April 2007, according to the Investment Company Institute, a trade group representing investment funds.
Selling stocks during either a downturn or a recovery is unusual. Americans almost always buy more than they sell during both periods.
Since World War II, nine recessions besides the Great Recession have been followed by recoveries lasting at least three years. According to data from the Investment Company Institute, individual investors sold during and after only one of those previous downturns—the one from November 1973 through March 1975. And back then a scary stock drop around the start of the recovery's third year, 1977, gave people ample reason to get out of the market.
The unusual pullback this time has spread to other big investors—public and private pension funds, investment brokerages and state and local governments. These groups have sold a total of $861 billion more than they have bought since April 2007, according to the Federal Reserve.
Even foreigners, big purchasers in recent years, are selling now—$16 billion in the 12 months through September.
As these groups have sold, much of the stock buying has fallen to companies. They've bought $656 billion more than they have sold since April 2007.
Companies are mostly buying back their own stock.
On Wall Street, the investor revolt has largely been dismissed as temporary. But doubts are creeping in.
A Citigroup research report sent to customers concludes that the "cult of equities" that fueled buying in the past has little chance of coming back soon. Investor blogs speculate about the "death of equities," a line from a famous BusinessWeek cover story in 1979, another time many people had seemingly given up on stocks. Financial analysts lament how the retreat by Main Street has left daily stock trading at low levels.
The investor retreat may have already hurt the fragile economic recovery.
The number of shares traded each day has fallen 40 percent from before the recession to a 12-year low, according to the New York Stock Exchange.
That's cut into earnings of investment banks and online brokers, which earn fees helping others trade stocks. Initial public offerings, another source of Wall Street profits, are happening at one-third the rate before the recession.
And old assumptions about stocks are being tested. One investing gospel is that because stocks generally rise in price, companies don't need to raise their quarterly cash dividends much to attract buyers. But companies are increasing them lately.
Dividends in the S&P 500 rose 11 percent in the 12 months through September, and the number of companies choosing to raise them is the highest in at least 20 years, according to FactSet, a financial data provider. Stocks now throw off more cash in dividends than U.S. government bonds do in interest.
Many on Wall Street think this is an unnatural state that cannot last. After all, people tend to buy stocks because they expect them to rise in price, not because of the dividend. But for much of the history of U.S. stock trading, stocks were considered too risky to be regarded as little more than vehicles for generating dividends. In every year from 1871 through 1958, stocks yielded more in dividends than U.S. bonds did in interest, according to data from Yale economist Robert Shiller—exactly what is happening now.
So maybe that's normal, and the past five decades were the aberration.
People who think the market will snap back to normal are underestimating how much the Great Recession scared investors, says Ulrike Malmendier, an economist who has studied the effect of the Great Depression on attitudes toward stocks.
She says people are ignoring something called the "experience effect," or the tendency to place great weight on what you most recently went through in deciding how much financial risk to take, even if it runs counter to logic. Extrapolating from her research on "Depression Babies," the title of a 2010 paper she co-wrote, she says many young investors won't fully embrace stocks again for another two decades.
"The Great Recession will have a lasting impact beyond what a standard economic model would predict," says Malmendier, who teaches at the University of California, Berkeley.
She could be wrong, of course. But it's a measure of the psychological blow from the Great Recession that, more than three years since it ended, big institutions, not just amateur investors, are still trimming stocks.
Public pension funds have cut stocks from 71 percent of their holdings before the recession to 66 percent last year, breaking at least 40 years of generally rising stock allocations, according to "State and Local Pensions: What Now?," a book by economist Alicia Munnell. They're shifting money into bonds.
Private pension funds, like those run by big companies, have cut stocks more: from 70 percent of holdings to just under 50 percent, back to the 1995 level.
"People aren't looking to swing for the fences anymore," says Gary Goldstein, an executive recruiter on Wall Street, referring to the bankers and traders he helps get jobs. "They're getting less greedy."
Sunday, December 23, 2012
In buying low PE stocks, beware of value trap
While stocks with the lowest PEs generally offer the best returns, there are duds as well
23 Dec 2012 16:40
TEH HOOI LING
Last week, we discussed one of the measures used by the market to value stocks – the price-earnings or PE ratio. We noted that the market likes high-growth companies and accords them a higher earnings multiple.
The higher the price a stock trades at relative to its current earnings, the more difficult it is for it to meet the market’s expectations. As such, the higher the probability its share price will underperform.
In one of my finance courses years back, the lecturer told us that we should distinguish between a growth stock and a growth company.
Most times, growth companies are not growth stocks, because the hype of the growth has been worked into the share price.
Growth stocks, on the other hand, are stocks whose price will grow because they have unappreciated value or business fundamentals. We want to buy growth stocks but not necessarily growth companies.
Using a hypothetical example, we showed how a 21 per cent downgrade in earnings can potentially cause a 62 per cent plunge in stock price in a high PE stock, and how a 5 per cent upgrade in earnings can lead to a 150 per cent jump in share price for a low PE stock.
So what proof is there that this is actually happening in the market, that buying low PE stocks pays?
Well, I carried out a study of the stocks listed on the Singapore Exchange in the last 22 years.
I ranked all the stocks listed here based on their PEs every year. The ranking is done at the end of March so as to capture companies with financial year ending Dec31.
I then clustered them into 10 groups with equal numbers of stocks. Decile 1 is made up of stocks with the lowest PEs. Decile 2 has stocks with the second-lowest PEs, and so on. Stocks with the highest PEs go into Decile 10. I then tracked the performance of these stocks a year later. The average return of the stocks in each group was taken.
Let’s assume that I start with $100,000 in 1990. After doing the ranking on March30 that year, I put $10,000 equally in the stocks in Decile 1.
At the end of March in 1991, I liquidate these stocks and put my pot of money, including dividends received in that past year, into the basket of stocks with the lowest PE in that year. The next $10,000 is allocated to stocks in Decile 2 and so on. I keep doing that for the next 20 years.
The accompanying chart shows the performance of the 10 baskets of stocks with the return rolled over for 22 years.
The $10,000 put into the lowest PE stocks would have grown to $199,847. That’s a compounded annual return of 14.6 per cent a year. Guess what the bonus is? Low PE stocks on average also have higher dividend yields.
The second basket of stocks, those with the second-lowest PEs, returned 10.1 per cent a year. Not too bad. It grew the original $10,000 to $83,684. (Please note that all the calculations exclude transaction costs.)
How would someone who consistently goes for the high PE, glamour stocks have done? Well, they managed to grow their original $10,000 to just $16,766 for a compounded annual return of a mere 2.4 per cent a year. That doesn’t even quite beat inflation.
In comparison, buying and holding the Straits Times Index from March 1990 until March this year would have yielded you a capital appreciation of about 4 per cent a year. Add in dividends of say 3 per cent a year, and your $10,000 invested in the STI would have grown to $44,300 over that time, with the dividends reinvested in the market.
In other words, buying a basket of low PE stocks would allow you to vastly outperform the Straits Times Index.
But note: Some stocks trade at low PEs for a reason. They could be value traps, in that their stock prices would go lower as the company’s operations continue to falter.
Many of the S-chips, or China stocks listed in Singapore, were trading at very low PEs. And as we all know, many of them have bombed. Those still listed are trading at very low PEs because the market doesn’t quite trust the numbers due to the poor corporate governance issues of their peers.
Meanwhile, some stocks trade at PE of 100 times or 200 times because they are transitioning from a loss-making patch to profitability.
So when we look at PEs, it is also important to look at the quality of earnings, and the sustainability of the earnings. We will talk about how to ascertain the quality of earnings in a future article.
But all things being equal, holding a low PE stock beats holding a high PE stock.
Just to give you an idea of which stocks made it to the lowest PE stock list in 1990. They were Dairy Farm, QAF, SIA, Jardine Cycle and Carriage, Jardine Strategic, Hongkong Land, and Boustead.
Stocks which made it to the second-lowest PE group were Jardine Matheson, Mandarin Oriental, ICP, Chemical Industries, Sing Investments & Finance, UOB, The Hour Glass and Wing Tai Holdings.
In recent years, however, the low PE stocks are made up mostly of micro cap stocks, or as mentioned S-chips. So, investors have to be more discerning in making sure that the underlying business is sound before buying into these low PE stocks.
Next week, we will look at another valuation metric used by the market to value stocks and we will see how they perform vis-a-vis the low PE strategy.
hooiling@sph.com.sg
23 Dec 2012 16:40
TEH HOOI LING
Last week, we discussed one of the measures used by the market to value stocks – the price-earnings or PE ratio. We noted that the market likes high-growth companies and accords them a higher earnings multiple.
The higher the price a stock trades at relative to its current earnings, the more difficult it is for it to meet the market’s expectations. As such, the higher the probability its share price will underperform.
In one of my finance courses years back, the lecturer told us that we should distinguish between a growth stock and a growth company.
Most times, growth companies are not growth stocks, because the hype of the growth has been worked into the share price.
Growth stocks, on the other hand, are stocks whose price will grow because they have unappreciated value or business fundamentals. We want to buy growth stocks but not necessarily growth companies.
Using a hypothetical example, we showed how a 21 per cent downgrade in earnings can potentially cause a 62 per cent plunge in stock price in a high PE stock, and how a 5 per cent upgrade in earnings can lead to a 150 per cent jump in share price for a low PE stock.
So what proof is there that this is actually happening in the market, that buying low PE stocks pays?
Well, I carried out a study of the stocks listed on the Singapore Exchange in the last 22 years.
I ranked all the stocks listed here based on their PEs every year. The ranking is done at the end of March so as to capture companies with financial year ending Dec31.
I then clustered them into 10 groups with equal numbers of stocks. Decile 1 is made up of stocks with the lowest PEs. Decile 2 has stocks with the second-lowest PEs, and so on. Stocks with the highest PEs go into Decile 10. I then tracked the performance of these stocks a year later. The average return of the stocks in each group was taken.
Let’s assume that I start with $100,000 in 1990. After doing the ranking on March30 that year, I put $10,000 equally in the stocks in Decile 1.
At the end of March in 1991, I liquidate these stocks and put my pot of money, including dividends received in that past year, into the basket of stocks with the lowest PE in that year. The next $10,000 is allocated to stocks in Decile 2 and so on. I keep doing that for the next 20 years.
The accompanying chart shows the performance of the 10 baskets of stocks with the return rolled over for 22 years.
The $10,000 put into the lowest PE stocks would have grown to $199,847. That’s a compounded annual return of 14.6 per cent a year. Guess what the bonus is? Low PE stocks on average also have higher dividend yields.
The second basket of stocks, those with the second-lowest PEs, returned 10.1 per cent a year. Not too bad. It grew the original $10,000 to $83,684. (Please note that all the calculations exclude transaction costs.)
How would someone who consistently goes for the high PE, glamour stocks have done? Well, they managed to grow their original $10,000 to just $16,766 for a compounded annual return of a mere 2.4 per cent a year. That doesn’t even quite beat inflation.
In comparison, buying and holding the Straits Times Index from March 1990 until March this year would have yielded you a capital appreciation of about 4 per cent a year. Add in dividends of say 3 per cent a year, and your $10,000 invested in the STI would have grown to $44,300 over that time, with the dividends reinvested in the market.
In other words, buying a basket of low PE stocks would allow you to vastly outperform the Straits Times Index.
But note: Some stocks trade at low PEs for a reason. They could be value traps, in that their stock prices would go lower as the company’s operations continue to falter.
Many of the S-chips, or China stocks listed in Singapore, were trading at very low PEs. And as we all know, many of them have bombed. Those still listed are trading at very low PEs because the market doesn’t quite trust the numbers due to the poor corporate governance issues of their peers.
Meanwhile, some stocks trade at PE of 100 times or 200 times because they are transitioning from a loss-making patch to profitability.
So when we look at PEs, it is also important to look at the quality of earnings, and the sustainability of the earnings. We will talk about how to ascertain the quality of earnings in a future article.
But all things being equal, holding a low PE stock beats holding a high PE stock.
Just to give you an idea of which stocks made it to the lowest PE stock list in 1990. They were Dairy Farm, QAF, SIA, Jardine Cycle and Carriage, Jardine Strategic, Hongkong Land, and Boustead.
Stocks which made it to the second-lowest PE group were Jardine Matheson, Mandarin Oriental, ICP, Chemical Industries, Sing Investments & Finance, UOB, The Hour Glass and Wing Tai Holdings.
In recent years, however, the low PE stocks are made up mostly of micro cap stocks, or as mentioned S-chips. So, investors have to be more discerning in making sure that the underlying business is sound before buying into these low PE stocks.
Next week, we will look at another valuation metric used by the market to value stocks and we will see how they perform vis-a-vis the low PE strategy.
hooiling@sph.com.sg
Monday, December 17, 2012
Watch PE when valuing a company
Markets jack up the price earnings ratio in expectation of growth and this, in turn, boosts the share price
17 Dec 2012 09:39 TEH HOOI LING
Groupon spurned Google and went for a public listing instead. For a while, it appeared that Groupon had made the right decision. - REUTERS
How does the market value a stock?
Take the example of Groupon, the online coupon service provider. This year, its stock price sank by some 80 per cent – from above US$20 (S$25) to below US$5.
Back in 2010, Google wanted to buy Groupon for US$8 billion.
But Groupon spurned Google and went for a public listing instead. For a while, it appeared that Groupon had made the right decision.
On the first day of its trading, its shares surged to US$26, giving it a market value of US$16.7 billion. Now Groupon is only valued at about US$2.8 billion.
So within one year, nearly US$14 billion disappeared from the value of Groupon, the company.
How did that happen?
Well, it’s got to do with market’s expectation of its future growth.
Bloomberg reported recently: “As competition intensifies and demand wanes, analysts see (Groupon’s) revenue growth slowing to 0.6 per cent in 2015, down from 45 per cent in 2012 and the 1,233 per cent average in the past two years.”
It’s rare to have a company that can sustain a growth of 30-40 per cent a year for a long time.
If it is a high growth market, you can bet that a lot of new entrants will be attracted to it – unless there are licensing rules or intellectual property restrictions to stop them from coming in.
Otherwise, new entrants would compete for market share, drive down prices, and crimp a company’s growth.
When growth slows, valuation falls.
Stock analysts and the stock market use various methods or metrics to value a company.
The most common metric is the price-earnings (PE) ratio.
Say there is a coffee shop called ABC. This year, ABC raked in sales of $500,000. After deducting all its costs, the owner – say a Mr Tan – made a net profit of $50,000.
Next year, Mr Tan has a big marketing campaign planned for his coffee shop. With the campaign, he reckons he can increase traffic to his shop, and raise his prices as well.
He forecasts sales will go up to $725,000 and net profit to $65,000. Mr Tan wants to sell his coffee shop. How much would you pay for it?
If you pay $250,000, then you are paying five times the historical earnings of the coffee shop, or a PE of five ($250,000 divided by $50,000). Based on this past year’s earnings and assuming it stays constant, you’ll take five years to get back your initial investment.
If you pay $500,000, you are paying a PE of 10 times. This means you will take 10 years to get back your capital.
But if you believe Mr Tan’s forecast, that the coffee shop’s earnings will grow by 30 per cent to $65,000 next year, then a price tag of $250,000 translates to a prospective or forecast PE of just 3.8 times.
Potentially, you can get back your investments in 3.8 years, or shorter if the earnings continue to grow the year after.
So in expectation of the growth, the market will jack up the PE ratio today.
One theory has it that a stock should trade at a multiple equivalent to its sustainable growth rate.
If the company can grow at 10 per cent a year, then it should trade at 10 times earnings. Twenty five per cent a year, and the valuation goes up to 25 times.
But as we have discussed, growth is not guaranteed.
A lower growth outlook poses a double whammy for prices of high PE stocks.
Say ABC is a listed company with one million shares. So its earnings per share (EPS) is $50,000 divided by one million shares. That works out to 5 cents a share.
The market is bullish about ABC and is expecting it to grow its EPS by 40 per cent next year to seven cents. To take into account its fast growth, investors value the stock at 25 times its forecast earnings. That would put its share price at $1.75.
But subsequently the global economy slowed down, or news emerged that a new formidable competitor has entered the market.
Now the outlook for the company is less certain. Analysts start to downgrade ABC’s forecast growth to, say, 10 per cent.
That would put its forecast EPS next year at 5.5 cents. Lower growth also means lower multiples of, say, 12 times. Hence, the share price would fall to 66 cents.
A 21 per cent downgrade in earnings forecast could lead to a whopping 62 per cent decline in share price!
What you want to be is on the other side of the equation. Buy a stock when it is trading at, say, five times its EPS of 5 cents, that is, at a price of 25 cents a share.
The following year, assuming the company makes 5.5 cents, the market starts to notice it.
Analysts become excited about the company and think it can grow its EPS by 15 per cent to 6.3 cents the year after.
And they think the company deserves a PE of 10 times because of its higher growth and consistent record.
So the price goes up to 63 cents. Voila! You’ve made 150 per cent return on your investment!
Next week, I will show the performance of consistently buying a basket of low PE stocks over a period of 22 years.
It’s pretty impressive.
hooiling@sph.com.sg
Friday, December 14, 2012
Amid low rates, REITs soar as business trusts struggle
14 December 2012
SINGAPORE - With investors desperate for yield in a prolonged low-rate environment, shares of trusts have surged in Singapore and elsewhere in Asia. But that enthusiasm has been largely focused on real estate investment trusts (REITs) and has not been reflected in demand for business trusts.
In Singapore, 90 per cent of the assets in a REIT must be fully developed and already drawing income. Business trusts, meanwhile, can house assets such as ports, ships or water management facilities, as well as real estate. But these assets may still be under development and the returns tend to be less predictable.
"In the current risk-averse environment, people are flocking to buy into high-yielding bonds. With that kind of mentality, the stable structure of a REIT is more appealing, compared to the business trusts," said Ms Vivian Lam, partner in the corporate department of international law firm Paul Hastings.
"Business trusts are more difficult to understand and are a more complicated asset class in terms of assessment for investors."
Singapore-listed REITs have current yields of between 6 and 7 per cent, compared with an interest rate of about 0.25 per cent on Singapore dollar deposits over a 12-month period. That kind of stable yield has kept investors interested in REITs. Yields on business trusts tend to be even higher, reflecting greater risk.
Still, in recent months, planned business trust offerings in Singapore by a shopping mall operator, an aviation company and a telco have been delayed.
Last month, Japanese shopping-mall operator Croesus Retail Trust delayed the US$650 million (S$793.5 million) initial public offering (IPO) of a business trust of shopping malls because of uncertain markets, people familiar with the transaction said. The yield being offered was between 7 and 8 per cent, they said.
In the same month, GE Capital Aviation Services, the jet leasing arm of General Electric of the US, pushed back its planned US$750 million IPO in Singapore. This was due to general wariness about aircraft being a depreciating asset, on top of lack of interest in IPOs in general, people involved in this transaction said.
Both GE and Croesus declined to comment.
In July, India's Reliance Communications postponed a plan to list its undersea cable assets in a Singapore IPO of up to US$1 billion. The company had been offering a yield of around 11.5 per cent, twice the average yield of other Singapore-listed business trusts and REITs.
Mr Christopher Wong, Senior Investment Manager at Aberdeen Asset Management in Singapore, said the less familiar asset classes were a harder sell for investors. "Although there's a chase for yield, investors are getting more discriminating about the underlying assets," he said.
In Hong Kong, a planned US$800 million business trust listing of serviced apartments by billionaire Li Ka Shing called Horizon Hospitality Holdings was pushed back last month. The company said it postponed its plan to raise money with a Hong Kong IPO and was considering "other options" for the assets.
In general, business trusts that have been listed in Singapore have not done well after their IPOs.
Religare Health Trust, a collection of hospitals owned by Indian hospital chain Fortis Healthcare, is down 3.9 per cent from its October IPO price. Perennial China Retail Trust, whose portfolio includes some offices and shopping malls still under construction, is down 22.9 per cent from its IPO price since listing last year. Hutchison Port Holdings Trust, which holds the port assets of Mr Li, is down 24.3 per cent from last year's IPO price.
In contrast, many REITs have done well. Singapore's Far East Organization and Ascendas group listed their hotel and serviced-apartment assets in the second half of this year through REITs. Far East Hospitality Trust and Ascendas Hospitality Trust are up 8.1 per cent and 4 per cent, respectively, from their IPO prices.
DOW JONES
SINGAPORE - With investors desperate for yield in a prolonged low-rate environment, shares of trusts have surged in Singapore and elsewhere in Asia. But that enthusiasm has been largely focused on real estate investment trusts (REITs) and has not been reflected in demand for business trusts.
In Singapore, 90 per cent of the assets in a REIT must be fully developed and already drawing income. Business trusts, meanwhile, can house assets such as ports, ships or water management facilities, as well as real estate. But these assets may still be under development and the returns tend to be less predictable.
"In the current risk-averse environment, people are flocking to buy into high-yielding bonds. With that kind of mentality, the stable structure of a REIT is more appealing, compared to the business trusts," said Ms Vivian Lam, partner in the corporate department of international law firm Paul Hastings.
"Business trusts are more difficult to understand and are a more complicated asset class in terms of assessment for investors."
Singapore-listed REITs have current yields of between 6 and 7 per cent, compared with an interest rate of about 0.25 per cent on Singapore dollar deposits over a 12-month period. That kind of stable yield has kept investors interested in REITs. Yields on business trusts tend to be even higher, reflecting greater risk.
Still, in recent months, planned business trust offerings in Singapore by a shopping mall operator, an aviation company and a telco have been delayed.
Last month, Japanese shopping-mall operator Croesus Retail Trust delayed the US$650 million (S$793.5 million) initial public offering (IPO) of a business trust of shopping malls because of uncertain markets, people familiar with the transaction said. The yield being offered was between 7 and 8 per cent, they said.
In the same month, GE Capital Aviation Services, the jet leasing arm of General Electric of the US, pushed back its planned US$750 million IPO in Singapore. This was due to general wariness about aircraft being a depreciating asset, on top of lack of interest in IPOs in general, people involved in this transaction said.
Both GE and Croesus declined to comment.
In July, India's Reliance Communications postponed a plan to list its undersea cable assets in a Singapore IPO of up to US$1 billion. The company had been offering a yield of around 11.5 per cent, twice the average yield of other Singapore-listed business trusts and REITs.
Mr Christopher Wong, Senior Investment Manager at Aberdeen Asset Management in Singapore, said the less familiar asset classes were a harder sell for investors. "Although there's a chase for yield, investors are getting more discriminating about the underlying assets," he said.
In Hong Kong, a planned US$800 million business trust listing of serviced apartments by billionaire Li Ka Shing called Horizon Hospitality Holdings was pushed back last month. The company said it postponed its plan to raise money with a Hong Kong IPO and was considering "other options" for the assets.
In general, business trusts that have been listed in Singapore have not done well after their IPOs.
Religare Health Trust, a collection of hospitals owned by Indian hospital chain Fortis Healthcare, is down 3.9 per cent from its October IPO price. Perennial China Retail Trust, whose portfolio includes some offices and shopping malls still under construction, is down 22.9 per cent from its IPO price since listing last year. Hutchison Port Holdings Trust, which holds the port assets of Mr Li, is down 24.3 per cent from last year's IPO price.
In contrast, many REITs have done well. Singapore's Far East Organization and Ascendas group listed their hotel and serviced-apartment assets in the second half of this year through REITs. Far East Hospitality Trust and Ascendas Hospitality Trust are up 8.1 per cent and 4 per cent, respectively, from their IPO prices.
DOW JONES
Monday, December 10, 2012
Balancing amount of liquidity held
10 Dec 2012 10:18
TEH HOOI LING
Keeping a lot in cash is risky but the market rewards you if you can supply it in a liquidity squeeze
The stock market, like life in general, overvalues glitz, glamour and grand promises. It undervalues groundedness, consistency and conservatism. People and companies which just do the work and deliver results are oftentimes overlooked. Consequently, we have the phenomenon of low-risk, high-return investments.
But one risk that the market seems to price more accurately, or in other words, one risk that the market will reward investors for taking is liquidity risk. That is the risk of you not being able to cash out any time you want without losing part of your capital.
Cash and bank deposits have little liquidity risk. You can take your money out any time and in exactly the same amount that you put in – unless of course the bank has fallen into financial difficulties and is in danger of going kaput. Then you may lose your deposits.
Otherwise, you are assured of getting back your money. This is one reason why bank deposits’ returns are so low. They are “safe”.
“Risk” assets, or assets whose prices fluctuate with the market, are different. These assets include equities and real estate. Mr Ben Inker, co-head of the asset allocation team at US asset management firm GMO, put it this way: “Equities cost you money at such an inconvenient time. The worst returns to equities come in recessions (bad), financial crises (very bad), depressions (very, very bad), and major wars (not good at all).
“While the average return to the S&P 500 since 1900 was a reassuring 6.6 per cent real, at those times when you were most at risk of losing your job, your bank account, your house or your life (during wars), you could rely on equities to be piling on the misery.”
Therefore, it is only rational for equity holders to demand, and be rewarded with, a decent return for taking that very unfortunate return path. Such a path of return also applies to assets like investment real estate. At a time when the economy is bad, your rental income is falling, you are not sure if you can hold on to your job, and you want to raise cash by selling your property, there are no buyers – unless you sell it cheap.
But there is a flip side. The flip side is, if you have cash when everyone else is trying to raise it, your money can go a long way. Put another way, if you can provide liquidity when the market most needs it, you will be amply rewarded. It’s the same with help extended to someone in dire straits. That help will be well-remembered and appreciated and, most times, repaid generously.
So when do we usually see a liquidity squeeze in the market? Well, when there is a shock and panic and everyone is rushing to get out of the market at the same time.
Do we have a liquidity squeeze now? Perhaps in a small way, in the sense that everyone is hoarding cash and not putting that liquidity to use, especially in the equity markets. This suggests that those who are willing to take that risk may be well rewarded.
Shocks and panic typically happen at the least expected times. In stock markets, it usually happens in the midst of a euphoric bull market when the last sceptic has been won over. We haven’t had that feeling in the stock market since 2007.
A savvy investor told me once: Bull markets are the time to accumulate cash.
“A lot of people have got it wrong,” he said. “They borrow more and more during a bull market. This goes back to school, which tells us that, in a bull market, we must gear up in order to get a high return on equity. Of course, if it is a sustained bull market, one can make a lot of money.
“But it is usually hard to tell whether you’re at the top, middle or just starting. It’s only when it ends, then you know, oh, the end is here.”
So your cash in the bank does serve some purposes. It meets your liquidity needs – your daily expenses as well as when you need emergency funds. Also, over and above the funds kept for your own liquidity needs, some can be set aside to meet the market’s liquidity needs.
In one extreme case, a friend told me of someone he knows who keeps cash all the time only to pile it all into the market when there is a crash. He exits completely when the market recovers. Apparently, he hasn’t done too badly for himself.
It takes a rather extraordinary person to be able to do that. For mere mortals like us, a sensible thing to do, as with everything else in life, is to have a balance.
A disproportionately high cash holding is a risk in itself. With inflation of about 4 per cent, and banks paying you less than 1 per cent, you are losing purchasing power by some 3 per cent a year. At this rate, $1 million cash kept in the bank will decline in value to just $740,000 in purchasing power terms in 10 years’ time. It is like dropping coins as you walk, eat and sleep.
So keep some cash to meet your own liquidity needs as well as to seize any opportunity that may present itself. Put some at “risk” so that it can work for you. How much to put on each side will depend on how cheap you deem an asset class to be.
hooiling@sph.com.sg
TEH HOOI LING
Keeping a lot in cash is risky but the market rewards you if you can supply it in a liquidity squeeze
The stock market, like life in general, overvalues glitz, glamour and grand promises. It undervalues groundedness, consistency and conservatism. People and companies which just do the work and deliver results are oftentimes overlooked. Consequently, we have the phenomenon of low-risk, high-return investments.
But one risk that the market seems to price more accurately, or in other words, one risk that the market will reward investors for taking is liquidity risk. That is the risk of you not being able to cash out any time you want without losing part of your capital.
Cash and bank deposits have little liquidity risk. You can take your money out any time and in exactly the same amount that you put in – unless of course the bank has fallen into financial difficulties and is in danger of going kaput. Then you may lose your deposits.
Otherwise, you are assured of getting back your money. This is one reason why bank deposits’ returns are so low. They are “safe”.
“Risk” assets, or assets whose prices fluctuate with the market, are different. These assets include equities and real estate. Mr Ben Inker, co-head of the asset allocation team at US asset management firm GMO, put it this way: “Equities cost you money at such an inconvenient time. The worst returns to equities come in recessions (bad), financial crises (very bad), depressions (very, very bad), and major wars (not good at all).
“While the average return to the S&P 500 since 1900 was a reassuring 6.6 per cent real, at those times when you were most at risk of losing your job, your bank account, your house or your life (during wars), you could rely on equities to be piling on the misery.”
Therefore, it is only rational for equity holders to demand, and be rewarded with, a decent return for taking that very unfortunate return path. Such a path of return also applies to assets like investment real estate. At a time when the economy is bad, your rental income is falling, you are not sure if you can hold on to your job, and you want to raise cash by selling your property, there are no buyers – unless you sell it cheap.
But there is a flip side. The flip side is, if you have cash when everyone else is trying to raise it, your money can go a long way. Put another way, if you can provide liquidity when the market most needs it, you will be amply rewarded. It’s the same with help extended to someone in dire straits. That help will be well-remembered and appreciated and, most times, repaid generously.
So when do we usually see a liquidity squeeze in the market? Well, when there is a shock and panic and everyone is rushing to get out of the market at the same time.
Do we have a liquidity squeeze now? Perhaps in a small way, in the sense that everyone is hoarding cash and not putting that liquidity to use, especially in the equity markets. This suggests that those who are willing to take that risk may be well rewarded.
Shocks and panic typically happen at the least expected times. In stock markets, it usually happens in the midst of a euphoric bull market when the last sceptic has been won over. We haven’t had that feeling in the stock market since 2007.
A savvy investor told me once: Bull markets are the time to accumulate cash.
“A lot of people have got it wrong,” he said. “They borrow more and more during a bull market. This goes back to school, which tells us that, in a bull market, we must gear up in order to get a high return on equity. Of course, if it is a sustained bull market, one can make a lot of money.
“But it is usually hard to tell whether you’re at the top, middle or just starting. It’s only when it ends, then you know, oh, the end is here.”
So your cash in the bank does serve some purposes. It meets your liquidity needs – your daily expenses as well as when you need emergency funds. Also, over and above the funds kept for your own liquidity needs, some can be set aside to meet the market’s liquidity needs.
In one extreme case, a friend told me of someone he knows who keeps cash all the time only to pile it all into the market when there is a crash. He exits completely when the market recovers. Apparently, he hasn’t done too badly for himself.
It takes a rather extraordinary person to be able to do that. For mere mortals like us, a sensible thing to do, as with everything else in life, is to have a balance.
A disproportionately high cash holding is a risk in itself. With inflation of about 4 per cent, and banks paying you less than 1 per cent, you are losing purchasing power by some 3 per cent a year. At this rate, $1 million cash kept in the bank will decline in value to just $740,000 in purchasing power terms in 10 years’ time. It is like dropping coins as you walk, eat and sleep.
So keep some cash to meet your own liquidity needs as well as to seize any opportunity that may present itself. Put some at “risk” so that it can work for you. How much to put on each side will depend on how cheap you deem an asset class to be.
hooiling@sph.com.sg
Friday, December 7, 2012
In Picking Winning Stocks, Boring is Best
FRIDAY, DECEMBER 7, 2012
By MARK HULBERT
A study of bourses throughout the world concludes that a portfolio of "low-volatility" equities outperforms riskier alternatives.
Chances are that the stock you should be buying for your portfolio right now is one you might have passed on to an elderly relation.
In fact, the portfolios that perform the best, over time, are those that contain stodgy and uninteresting stocks that are the very antithesis of the exciting and volatile issues that get most of the financial press.
That's the main lesson to be taken from a recent study, "Low Risk Stocks Outperform within All Observable Markets of the World." Its authors are Nardin Baker, Chief Strategist at Guggenheim Partners, and Robert Haugen, a one-time finance professor who retired after three decades in academia and is now chairman of LowVolatilityStocks.com.
The researchers focused on how steady a stock was from month to month. Those with the steadiest returns were put in the "low-volatility" category; current examples include energy-producer Dominion Resources (ticker: D) and electric-utility Duke Energy (DUK).
In contrast, a stock that experiences large gyrations in month-to-month performance is put in the "high-volatility" category. Two current examples are Fleetcor Technologies (FLT) and Arena Pharmaceuticals (ARNA).
The researchers found that, in each of 33 countries' stock markets between 1990 and 2011, an investor on average would have made far more money by buying low-volatility stocks than with issues having the highest historical volatilities. And not by just a small amount, either: A portfolio that held the 10% of stocks with lowest historical volatilities did 18% per year better, on average, than the decile containing the most volatile stocks.
Note carefully that this result stands finance theory directly on its head. According to Investments 101, the riskiest stocks — which are, after all, the most volatile — should provide higher returns, on average, than the least risky issues.
What this new study shows, in contrast, is that, far from compensating investors for the countless sleepless nights, the highest volatility stocks tend to produce the worst returns. That's adding insult to injury.
To be sure, Baker and Haugen aren't asking us to throw academic orthodoxy out the window just because of one study, comprehensive as it otherwise is. They point to a series of additional studies over the last two decades, covering stock market history as far back as 1926, that have almost universally come to the same result.
While it's certainly understandable why academia might not have welcomed findings that call into question the very foundation of what they've been taught, we might wonder why real-world investors have not discovered that low-volatility stocks consistently do better than the most volatile ones. One major reason they haven't, according to the researchers, is our tendency to focus the bulk of our attention on the stocks that are volatile and exciting.
As a result, Baker told me "we tend to overpay for the most volatile stocks" — and that, in turn, leads such stocks to be poor performers.
The researchers documented this by carefully measuring the relationship between the performance of a stock and the number of stories about it that had previously appeared on the Dow Jones News Wires. Sure enough, they found a stark inverse correlation: The most volatile stocks garnered by far the most stories and produced the lowest subsequent returns.
In contrast, the least volatile stocks — the ones that consistently proceed to turn in the best returns — are so boring and uninteresting that few if any Wall Street analysts, journalists or even investment columnists are drawn to write about them.
Putting this new research into practice requires us to become conscious of the ways in which we are drawn to the exciting stocks that are in the news, and to be willing to give up our craving for excitement. Are we willing to instead invest in a stock that may hardly ever get mentioned over cocktail conversation or be the subject of any major news story?
If we are, then we can either construct a low-volatility stock portfolio ourselves or invest in an ETF that does so. It's clearly a lot less work for us to go the ETF route. The one with the largest assets in this space is the PowerShares S&P 500 Low Volatility ETF ( SPLV), which invests in the 100 stocks in the S&P 500 with the lowest volatilities over the trailing 12 months.
How would you pursue a low-volatility strategy if you wanted to purchase the individual stocks themselves? To strictly follow the researchers' methodology, you would need to rank all stocks according to their monthly volatilities over the trailing 24 months — and invest in a diversified group of stocks at the bottom of the ranking.
That's a daunting task, to be sure, though Haugen's website (www.lowvolatilitystocks.com) does do the work for you (though it will cost you $9/month).
Happy hunting for boring stocks!
By MARK HULBERT
A study of bourses throughout the world concludes that a portfolio of "low-volatility" equities outperforms riskier alternatives.
Chances are that the stock you should be buying for your portfolio right now is one you might have passed on to an elderly relation.
In fact, the portfolios that perform the best, over time, are those that contain stodgy and uninteresting stocks that are the very antithesis of the exciting and volatile issues that get most of the financial press.
That's the main lesson to be taken from a recent study, "Low Risk Stocks Outperform within All Observable Markets of the World." Its authors are Nardin Baker, Chief Strategist at Guggenheim Partners, and Robert Haugen, a one-time finance professor who retired after three decades in academia and is now chairman of LowVolatilityStocks.com.
The researchers focused on how steady a stock was from month to month. Those with the steadiest returns were put in the "low-volatility" category; current examples include energy-producer Dominion Resources (ticker: D) and electric-utility Duke Energy (DUK).
In contrast, a stock that experiences large gyrations in month-to-month performance is put in the "high-volatility" category. Two current examples are Fleetcor Technologies (FLT) and Arena Pharmaceuticals (ARNA).
The researchers found that, in each of 33 countries' stock markets between 1990 and 2011, an investor on average would have made far more money by buying low-volatility stocks than with issues having the highest historical volatilities. And not by just a small amount, either: A portfolio that held the 10% of stocks with lowest historical volatilities did 18% per year better, on average, than the decile containing the most volatile stocks.
Note carefully that this result stands finance theory directly on its head. According to Investments 101, the riskiest stocks — which are, after all, the most volatile — should provide higher returns, on average, than the least risky issues.
What this new study shows, in contrast, is that, far from compensating investors for the countless sleepless nights, the highest volatility stocks tend to produce the worst returns. That's adding insult to injury.
To be sure, Baker and Haugen aren't asking us to throw academic orthodoxy out the window just because of one study, comprehensive as it otherwise is. They point to a series of additional studies over the last two decades, covering stock market history as far back as 1926, that have almost universally come to the same result.
While it's certainly understandable why academia might not have welcomed findings that call into question the very foundation of what they've been taught, we might wonder why real-world investors have not discovered that low-volatility stocks consistently do better than the most volatile ones. One major reason they haven't, according to the researchers, is our tendency to focus the bulk of our attention on the stocks that are volatile and exciting.
As a result, Baker told me "we tend to overpay for the most volatile stocks" — and that, in turn, leads such stocks to be poor performers.
The researchers documented this by carefully measuring the relationship between the performance of a stock and the number of stories about it that had previously appeared on the Dow Jones News Wires. Sure enough, they found a stark inverse correlation: The most volatile stocks garnered by far the most stories and produced the lowest subsequent returns.
In contrast, the least volatile stocks — the ones that consistently proceed to turn in the best returns — are so boring and uninteresting that few if any Wall Street analysts, journalists or even investment columnists are drawn to write about them.
Putting this new research into practice requires us to become conscious of the ways in which we are drawn to the exciting stocks that are in the news, and to be willing to give up our craving for excitement. Are we willing to instead invest in a stock that may hardly ever get mentioned over cocktail conversation or be the subject of any major news story?
If we are, then we can either construct a low-volatility stock portfolio ourselves or invest in an ETF that does so. It's clearly a lot less work for us to go the ETF route. The one with the largest assets in this space is the PowerShares S&P 500 Low Volatility ETF ( SPLV), which invests in the 100 stocks in the S&P 500 with the lowest volatilities over the trailing 12 months.
How would you pursue a low-volatility strategy if you wanted to purchase the individual stocks themselves? To strictly follow the researchers' methodology, you would need to rank all stocks according to their monthly volatilities over the trailing 24 months — and invest in a diversified group of stocks at the bottom of the ranking.
That's a daunting task, to be sure, though Haugen's website (www.lowvolatilitystocks.com) does do the work for you (though it will cost you $9/month).
Happy hunting for boring stocks!
Monday, December 3, 2012
High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says
High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says
By NATHANIEL POPPER and CHRISTOPHER LEONARD
Published: December 3, 2012
A top government economist has concluded that the high-speed trading firms that have come to dominate the nation’s financial markets are taking significant profits from traditional investors.
The chief economist at the Commodity Futures Trading Commission, Andrei Kirilenko, reports in a coming study that high-frequency traders make an average profit of as much as $5.05 each time they go up against small traders buying and selling one of the most widely used financial contracts.
The agency has not endorsed Mr. Kirilenko’s findings, which are still being reviewed by peers, and they are already encountering some resistance from academics. But Bart Chilton, one of five C.F.T.C. commissioners, said on Monday that “what the study shows is that high-frequency traders are really the new middleman in exchange trading, and they’re taking some of the cream off the top.”
Mr. Kirilenko’s work stands in contrast to several statements from government officials who have expressed uncertainty about whether high-speed traders are earning profits at the expense of ordinary investors.
The study comes as a council of the nation’s top financial regulators is showing increasing concern that the accelerating automation and speed of the financial markets may represent a threat both to other investors and to the stability of the financial system.
The Financial Stability Oversight Council, an organization formed after the recent financial crisis to deal with systemic risks, took up the issue at a meeting in November that was closed to the public, according to minutes that were released Monday.
The gathering of top regulators, including Treasury Secretary Timothy F. Geithner and Ben S. Bernanke, the Federal Reserve chairman, said in its annual report this summer that recent developments “could lead to unintended errors cascading through the financial system.” The C.F.T.C. is a member of the oversight council.
The issue of high-frequency trading has generated anxiety among investors in the stock market, where computerized trading first took hold. But the minutes from the oversight council, and the council’s annual report released this year, indicate that top regulators are viewing the automation of trading as a broader concern as high-speed traders move into an array of financial markets, including bond and foreign currency trading.
Mr. Kirilenko’s study focused on one corner of the financial markets that the C.F.T.C. oversees, contracts that are settled based on the future value of the Standard & Poor’s 500-stock index. He and his co-authors, professors at Princeton and the University of Washington, chose the contract because it is one of the most heavily traded financial assets in any market and is popular with a broad array of investors.
Using previously private data, Mr. Kirilenko’s team found that from August 2010 to August 2012, high-frequency trading firms were able to reliably capture profits by buying and selling futures contracts from several types of traditional investors.
The study notes that there are different types of high-frequency traders, some of which are more aggressive in initiating trades and some of which are passive, simply taking the other side of existing offers in the market.
The researchers found that more aggressive traders accounted for the largest share of trading volume and made the biggest profits. The most aggressive scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract.
Large investors can trade thousands of contracts at once to bet on future shifts in the S.& P. 500 index. The average aggressive high-speed trader made a daily profit of $45,267 in a month in 2010 analyzed by the study.
Industry profits have been falling, however, as overall stock trading volume has dropped and the race for the latest technological advances has increased costs.
Mr. Kirilenko warned that the smaller traders might leave the futures markets if their profits were drained away, opting instead to operate in less transparent markets where high-speed traders would not get in the way.
“They will go someplace that’s darker,” Mr. Kirilenko said at the conference. That could destabilize futures markets long used by traders to hedge risk.
A spokesman for the C.F.T.C. said the agency had no comment on the study. But the paper was immediately hailed by Mr. Chilton, who is a Democrat and a critic of recent shifts in the markets.
Mr. Chilton said that the study would make it easier for regulators “to put forth regulations in a streamlined fashion. It’s a key step in the process and it should fuel-inject the regulatory effort going forward.”
Terrence Hendershott, a professor at the University of California, Berkeley, said there was a limit to the importance of Mr. Kirilenko’s work because it focused on profits and did not address the benefits high-speed traders bring.
Mr. Hendershott and many other academics have found that the competition between high-speed traders has helped lower the cost of trading for ordinary investors. But Mr. Hendershott said that limited data available to researchers had made it hard to determine whether the benefits outweighed the costs.
The speed and complexity of the financial markets jumped onto the agenda of regulators after the so-called flash crash of 2010, when leading stock indexes fell almost 10 percent in less than half an hour, before quickly making up most of the losses.
In its first annual report, in 2011, the Financial Stability Oversight Council noted the concerns raised by the flash crash, but not in great detail. This year’s report included a much fuller discussion of the risks posed by the increasing speed and complexity of the financial markets and called for regulators to look for more ways to limit the risks.
Regulators have said that devising new rules has been hard, in part because the trading world has become so complex, making it difficult to determine the total effect that all the innovations have had on traditional investors. Mr. Kirilenko said in an interview Monday that his study was intended to address that.
“We’re not estimating,” he said. “Our data is excellent.”
By NATHANIEL POPPER and CHRISTOPHER LEONARD
Published: December 3, 2012
A top government economist has concluded that the high-speed trading firms that have come to dominate the nation’s financial markets are taking significant profits from traditional investors.
The chief economist at the Commodity Futures Trading Commission, Andrei Kirilenko, reports in a coming study that high-frequency traders make an average profit of as much as $5.05 each time they go up against small traders buying and selling one of the most widely used financial contracts.
The agency has not endorsed Mr. Kirilenko’s findings, which are still being reviewed by peers, and they are already encountering some resistance from academics. But Bart Chilton, one of five C.F.T.C. commissioners, said on Monday that “what the study shows is that high-frequency traders are really the new middleman in exchange trading, and they’re taking some of the cream off the top.”
Mr. Kirilenko’s work stands in contrast to several statements from government officials who have expressed uncertainty about whether high-speed traders are earning profits at the expense of ordinary investors.
The study comes as a council of the nation’s top financial regulators is showing increasing concern that the accelerating automation and speed of the financial markets may represent a threat both to other investors and to the stability of the financial system.
The Financial Stability Oversight Council, an organization formed after the recent financial crisis to deal with systemic risks, took up the issue at a meeting in November that was closed to the public, according to minutes that were released Monday.
The gathering of top regulators, including Treasury Secretary Timothy F. Geithner and Ben S. Bernanke, the Federal Reserve chairman, said in its annual report this summer that recent developments “could lead to unintended errors cascading through the financial system.” The C.F.T.C. is a member of the oversight council.
The issue of high-frequency trading has generated anxiety among investors in the stock market, where computerized trading first took hold. But the minutes from the oversight council, and the council’s annual report released this year, indicate that top regulators are viewing the automation of trading as a broader concern as high-speed traders move into an array of financial markets, including bond and foreign currency trading.
Mr. Kirilenko’s study focused on one corner of the financial markets that the C.F.T.C. oversees, contracts that are settled based on the future value of the Standard & Poor’s 500-stock index. He and his co-authors, professors at Princeton and the University of Washington, chose the contract because it is one of the most heavily traded financial assets in any market and is popular with a broad array of investors.
Using previously private data, Mr. Kirilenko’s team found that from August 2010 to August 2012, high-frequency trading firms were able to reliably capture profits by buying and selling futures contracts from several types of traditional investors.
The study notes that there are different types of high-frequency traders, some of which are more aggressive in initiating trades and some of which are passive, simply taking the other side of existing offers in the market.
The researchers found that more aggressive traders accounted for the largest share of trading volume and made the biggest profits. The most aggressive scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract.
Large investors can trade thousands of contracts at once to bet on future shifts in the S.& P. 500 index. The average aggressive high-speed trader made a daily profit of $45,267 in a month in 2010 analyzed by the study.
Industry profits have been falling, however, as overall stock trading volume has dropped and the race for the latest technological advances has increased costs.
Mr. Kirilenko warned that the smaller traders might leave the futures markets if their profits were drained away, opting instead to operate in less transparent markets where high-speed traders would not get in the way.
“They will go someplace that’s darker,” Mr. Kirilenko said at the conference. That could destabilize futures markets long used by traders to hedge risk.
A spokesman for the C.F.T.C. said the agency had no comment on the study. But the paper was immediately hailed by Mr. Chilton, who is a Democrat and a critic of recent shifts in the markets.
Mr. Chilton said that the study would make it easier for regulators “to put forth regulations in a streamlined fashion. It’s a key step in the process and it should fuel-inject the regulatory effort going forward.”
Terrence Hendershott, a professor at the University of California, Berkeley, said there was a limit to the importance of Mr. Kirilenko’s work because it focused on profits and did not address the benefits high-speed traders bring.
Mr. Hendershott and many other academics have found that the competition between high-speed traders has helped lower the cost of trading for ordinary investors. But Mr. Hendershott said that limited data available to researchers had made it hard to determine whether the benefits outweighed the costs.
The speed and complexity of the financial markets jumped onto the agenda of regulators after the so-called flash crash of 2010, when leading stock indexes fell almost 10 percent in less than half an hour, before quickly making up most of the losses.
In its first annual report, in 2011, the Financial Stability Oversight Council noted the concerns raised by the flash crash, but not in great detail. This year’s report included a much fuller discussion of the risks posed by the increasing speed and complexity of the financial markets and called for regulators to look for more ways to limit the risks.
Regulators have said that devising new rules has been hard, in part because the trading world has become so complex, making it difficult to determine the total effect that all the innovations have had on traditional investors. Mr. Kirilenko said in an interview Monday that his study was intended to address that.
“We’re not estimating,” he said. “Our data is excellent.”
For Warren Buffett, the Long Run Still Trumps the Quick Return
By ANDREW ROSS SORKIN
December 3, 2012, 4:54 pm
Donald Bowers/Getty Images for FortuneWarren Buffett at a New York book party for “Tap Dancing to Work,” by Carol Loomis.
“If somebody bought Berkshire Hathaway in 1965 and they held it, they made a great investment — and their broker would have starved to death.”
Warren E. Buffett was sitting across from me over lunch at a private club in Midtown Manhattan last week, lamenting the current state of Wall Street, which promotes a trading culture over an investing culture and offers incentives for brokers and traders to generate fees and fast profits.
“The emphasis on trading has increased. Just look at the turnover in all of the stocks,” he said, adding with a smile: “Sales people have forever gotten paid by selling people something. Generally, you pay a doctor for how often he gets you to change prescriptions.”
Mr. Buffett, 82, is famous for investing in companies that he sees as solid operations and essential to the economy, like railroads, utilities and financial companies, and holds his stakes for the long run. The argument that the markets are better off today because of the enormous amount of liquidity in the stock market, a function of quick flipping and electronic trading, is a fallacy, he said.
“You can’t buy 10 percent of the farmland in Nebraska in three years if you set out to do it,” he said. Yet, he pointed out, he was able to buy the equivalent of 10 percent of I.B.M. in six to eight months as a result of the market’s liquidity. “The idea that people look at their holdings in such a way that that kind of volume exists means that to a great extent, it’s a casino game,” he said. Of course, unlike many investors, he plans to hold his stake in I.B.M. for years.
Mr. Buffett was in a reminiscing mood about a bygone era, in part because he was in New York to make the rounds on television to discuss a new book chronicling his 61-year career, which began in 1951 at Buffett-Falk & Company in Omaha. (After lunch, he was going to visit “The Daily Show With Jon Stewart.”)
The book, “Tap Dancing to Work,” by a longtime journalist and good friend of his, Carol Loomis of Fortune magazine, is a compendium of articles that she and others wrote in Fortune that creates a series of narratives spanning the arc of his career.
Ms. Loomis, who first met Mr. Buffett in 1967 — and whose long career is a story unto itself — also came to our lunch. Ms. Loomis may know more about Mr. Buffett than he knows about himself. (“There’s nothing here you’re going to like,” she said, after surveying the various pies when the dessert cart came around. She was right: he took a quick look and asked if they served ice cream. They did.)
As we talked about the “good old days” — he spoke of some of his early friends who were successful hedge fund investors, like Julian Robertson, who founded Tiger Management — it became clear that he was less enamored of the investor class of the next generation.
When I asked, for example, if there were any private equity investors that he admired, he flatly replied: “No.”
When I asked if he followed any hedge fund managers, he struggled to name any, before saying that he liked Seth Klarman, a low-key value investor who runs the Baupost Group, based in Boston.
“They’re not as good as the old ones generally. The field has gotten swamped, so there’s so much money playing and people have been able to raise money by just saying ‘hedge fund,’” he said. “That was not the case earlier on; you really had to have some performance for some time before people would put money with you. It’s a marketing thing.”
For a moment, he paused, and then posited that if he started a hedge fund today, “I’d probably grow faster, because a record now would attract money a lot faster,” speculating that his record of returns would attract billions of dollars from pension funds and others. But he then acknowledged a truism of investing that he knows all too well, as the manager of an enterprise that is now worth some $220 billion: “Then money starts getting self-defeating at a point, too.”
Until 1969, Mr. Buffett operated a private partnership that was akin in some ways to a modern hedge fund, except the fee structure was decidedly different. Instead of charging “2 and 20” — a 2 percent management fee and 20 percent of profits — Mr. Buffett’s investors “keep all of the annual gains up to 6 percent; above that level Buffett takes a one-quarter cut,” Ms. Loomis wrote. However, in 1969, he announced he would shutter his partnership. “This is a market I don’t understand,” he said, according to Ms. Loomis.
He believed that the stock market of 1968 had become wildly overpriced — and he was right. By the end of 1974, the market took a tumble. Instead, he remained the chief executive of Berkshire Hathaway, one of his early investments.
“If you want to make a lot of money and you own a hedge fund or a private equity fund, there’s nothing like 2 and 20 and a lot of leverage,” he said over a lunch of Cobb salad. “If I kept my partnership and owned Berkshire through that, I would have made even more money.”
Mr. Buffett says he now considered himself as much a business manager as an investor. “The main thing I’m doing is trying to build a business, and now we built one. Investing is part of it but it is not the main thing.”
Today, Mr. Buffett is particularly circumspect about the investment strategies that hedge funds employ, like shorting, or betting against, a company’s stock. He used to short companies as part of a hedging strategy when he ran his partnership, but now he says that he and Charlie Munger, his longtime friend and vice chairman of Berkshire, see it as too hard.
“Charlie and I both have talked about it, we probably had a hundred ideas of things that would be good short sales. Probably 95 percent of them at least turned out to be, and I don’t think we would have made a dime out of it if we had been engaged in the activity. It’s too difficult,” he explained, suggesting that the timing of short investments is crucial. “The whole thing about ‘longs’ is, if you know you’re right, you can just keep buying, and the lower it goes, the better you like it, and you can’t do that with shorts.”
One of his big worries these days is about what’s going to happen to all the pension money that is being invested in the markets, often with little success, in part because investors are constantly buying and selling securities on the advice of brokers and advisers, rather than holding them for the long term. “Most institutional investors, whoever is in charge — whether it’s the college treasurer or the trustees of the pension fund of some state — they’re buying what they’re sold.”
Most pension funds probably didn’t buy Berkshire in 1965 and hold it, but if they had, they would have far fewer problems today. At the end of her book, Ms. Loomis notes that when she mentioned Mr. Buffett’s name for the first time in Fortune magazine in 1966 — accidentally spelling Buffett with only one “t” — Berkshire was trading at $22 a share. Today it is almost $133,000 a share.
December 3, 2012, 4:54 pm
Donald Bowers/Getty Images for FortuneWarren Buffett at a New York book party for “Tap Dancing to Work,” by Carol Loomis.
“If somebody bought Berkshire Hathaway in 1965 and they held it, they made a great investment — and their broker would have starved to death.”
Warren E. Buffett was sitting across from me over lunch at a private club in Midtown Manhattan last week, lamenting the current state of Wall Street, which promotes a trading culture over an investing culture and offers incentives for brokers and traders to generate fees and fast profits.
“The emphasis on trading has increased. Just look at the turnover in all of the stocks,” he said, adding with a smile: “Sales people have forever gotten paid by selling people something. Generally, you pay a doctor for how often he gets you to change prescriptions.”
Mr. Buffett, 82, is famous for investing in companies that he sees as solid operations and essential to the economy, like railroads, utilities and financial companies, and holds his stakes for the long run. The argument that the markets are better off today because of the enormous amount of liquidity in the stock market, a function of quick flipping and electronic trading, is a fallacy, he said.
“You can’t buy 10 percent of the farmland in Nebraska in three years if you set out to do it,” he said. Yet, he pointed out, he was able to buy the equivalent of 10 percent of I.B.M. in six to eight months as a result of the market’s liquidity. “The idea that people look at their holdings in such a way that that kind of volume exists means that to a great extent, it’s a casino game,” he said. Of course, unlike many investors, he plans to hold his stake in I.B.M. for years.
Mr. Buffett was in a reminiscing mood about a bygone era, in part because he was in New York to make the rounds on television to discuss a new book chronicling his 61-year career, which began in 1951 at Buffett-Falk & Company in Omaha. (After lunch, he was going to visit “The Daily Show With Jon Stewart.”)
The book, “Tap Dancing to Work,” by a longtime journalist and good friend of his, Carol Loomis of Fortune magazine, is a compendium of articles that she and others wrote in Fortune that creates a series of narratives spanning the arc of his career.
Ms. Loomis, who first met Mr. Buffett in 1967 — and whose long career is a story unto itself — also came to our lunch. Ms. Loomis may know more about Mr. Buffett than he knows about himself. (“There’s nothing here you’re going to like,” she said, after surveying the various pies when the dessert cart came around. She was right: he took a quick look and asked if they served ice cream. They did.)
As we talked about the “good old days” — he spoke of some of his early friends who were successful hedge fund investors, like Julian Robertson, who founded Tiger Management — it became clear that he was less enamored of the investor class of the next generation.
When I asked, for example, if there were any private equity investors that he admired, he flatly replied: “No.”
When I asked if he followed any hedge fund managers, he struggled to name any, before saying that he liked Seth Klarman, a low-key value investor who runs the Baupost Group, based in Boston.
“They’re not as good as the old ones generally. The field has gotten swamped, so there’s so much money playing and people have been able to raise money by just saying ‘hedge fund,’” he said. “That was not the case earlier on; you really had to have some performance for some time before people would put money with you. It’s a marketing thing.”
For a moment, he paused, and then posited that if he started a hedge fund today, “I’d probably grow faster, because a record now would attract money a lot faster,” speculating that his record of returns would attract billions of dollars from pension funds and others. But he then acknowledged a truism of investing that he knows all too well, as the manager of an enterprise that is now worth some $220 billion: “Then money starts getting self-defeating at a point, too.”
Until 1969, Mr. Buffett operated a private partnership that was akin in some ways to a modern hedge fund, except the fee structure was decidedly different. Instead of charging “2 and 20” — a 2 percent management fee and 20 percent of profits — Mr. Buffett’s investors “keep all of the annual gains up to 6 percent; above that level Buffett takes a one-quarter cut,” Ms. Loomis wrote. However, in 1969, he announced he would shutter his partnership. “This is a market I don’t understand,” he said, according to Ms. Loomis.
He believed that the stock market of 1968 had become wildly overpriced — and he was right. By the end of 1974, the market took a tumble. Instead, he remained the chief executive of Berkshire Hathaway, one of his early investments.
“If you want to make a lot of money and you own a hedge fund or a private equity fund, there’s nothing like 2 and 20 and a lot of leverage,” he said over a lunch of Cobb salad. “If I kept my partnership and owned Berkshire through that, I would have made even more money.”
Mr. Buffett says he now considered himself as much a business manager as an investor. “The main thing I’m doing is trying to build a business, and now we built one. Investing is part of it but it is not the main thing.”
Today, Mr. Buffett is particularly circumspect about the investment strategies that hedge funds employ, like shorting, or betting against, a company’s stock. He used to short companies as part of a hedging strategy when he ran his partnership, but now he says that he and Charlie Munger, his longtime friend and vice chairman of Berkshire, see it as too hard.
“Charlie and I both have talked about it, we probably had a hundred ideas of things that would be good short sales. Probably 95 percent of them at least turned out to be, and I don’t think we would have made a dime out of it if we had been engaged in the activity. It’s too difficult,” he explained, suggesting that the timing of short investments is crucial. “The whole thing about ‘longs’ is, if you know you’re right, you can just keep buying, and the lower it goes, the better you like it, and you can’t do that with shorts.”
One of his big worries these days is about what’s going to happen to all the pension money that is being invested in the markets, often with little success, in part because investors are constantly buying and selling securities on the advice of brokers and advisers, rather than holding them for the long term. “Most institutional investors, whoever is in charge — whether it’s the college treasurer or the trustees of the pension fund of some state — they’re buying what they’re sold.”
Most pension funds probably didn’t buy Berkshire in 1965 and hold it, but if they had, they would have far fewer problems today. At the end of her book, Ms. Loomis notes that when she mentioned Mr. Buffett’s name for the first time in Fortune magazine in 1966 — accidentally spelling Buffett with only one “t” — Berkshire was trading at $22 a share. Today it is almost $133,000 a share.
Getting good returns without too much risk
03 Dec 2012 06:39
TEH HOOI LING
How does one get good return from an asset? Well, the more cheaply you can acquire a good asset, the higher your return will be. Your dividend yield is higher, your capital appreciation is higher. - REUTERS
What is risk? The conventional definition of risk in finance literature is price volatility. But to super-investor Warren Buffett, risk is the permanent loss of capital.
Unless you need to cash out at very depressed market levels, or the investments or stocks/companies you own have no more capacity to recover, price volatility is just noise in the market, says Mr Buffett.
On the other side, what is return? Return to an investor is the income you get from your investment, as well as the rise in the price of the investment. Of course, you’d want to be able to get back at some point the entire sum of the capital you put in as well.
How does one get good return from an asset? Well, the more cheaply you can acquire a good asset, the higher your return will be. Your dividend yield is higher, your capital appreciation is higher.
Next question. When you get a good asset cheap, what are the chances of you suffering a permanent loss of your capital? Small. Hence, your risk is low.
So, to get good returns, does it mean we have to take high risks? Not necessarily!
It is very common for us to miscalculate the probabilities and act less than rationally because of our tendency to, among other things, prefer excitement over staidness, to want instant gratification instead of staying for the long haul, and to seek “safety” in numbers, that is, to just follow the crowd.
Take Apple. Given how well the stock has done, I’m sure most of us wish we had the stock in our portfolios, preferably from as early as 10 years ago. A sum of US$10,000 (S$12,200) invested in November 2002 in that “fruit company” – as Forrest Gump described it – would have grown to US$750,000 today.
But nobody could have predicted back then how well Apple would do. This is but one of the many trajectories that the company could have taken in the intervening 10 years. It could have gone the way of Nokia.
In expectation, as scholar and investment expert Nassim Taleb puts it, a dentist is considerably richer than the rock star, the hedge fund manager who made it with one big bet or the successful entrepreneur. “One cannot consider a profession without taking into account the average of the people who enter it, not the sample of those who have succeeded in it,” he says.
We talk about Apple today because it has succeeded. And that’s how typically a stock comes onto the radar of a novice retail investor. The stock is in the news because the company has had three or four years of good growth, or has a novel concept. Our friends and family members talk about the stock because it is in the hottest industry today.
But most times, such stocks will prove to be a less-than-satisfactory investment.
A few things are at play here. One, because of their promise, the hype factor and the fact that many people are chasing after them, the prices of these stocks or asset classes are bid up. They become expensive.
Two, because their prices are bid up and the market’s expectations for them are so high, everything must go right for them. Any little disappointment – and they will definitely run into some – will cause the stock prices to fall. The higher they are, the further they can fall.
Three, being the darlings of the stock market does something to the managements of the companies. Their egos become a bit bigger, they take a few more risks and they become a tad more tyrannical. Thus, the seeds of their downfall are sown.
Studies after studies have shown that, on average, investing in stock-market darlings, buying into high-growth companies, chasing after the latest investment fads, does not pay. Instead, it’s the boring stocks, the neglected stocks, the shunned stocks, that give investors the greatest upside.
Contrast companies that promise world domination with the unexciting ones that cough up consistent cash flows without the need for massive capital expenditure on a regular basis. Without a doubt, the latter group is a much better bet.
Which stocks have been the best performers on the Singapore Exchange in the past 10 years? They include the likes of Dairy Farm, the pan-Asian retailer that runs the Cold Storage chain in Singapore; Vicom, the largest technical testing and vehicle inspection firm in Singapore; and Raffles Medical Group.
An investment of $10,000 in Dairy Farm 10 years ago would be worth about $240,000 today, with dividends reinvested in the stock. Not too shabby.
There you have it – you can have your cake and eat it. You can get good returns, without taking on a lot of risk. So a strong conviction is required.
Just a note: Some of the stocks mentioned above have risen so much in the past 10 years, they might not be that cheap anymore. Hence, they might not be as “low-risk” as before. And their returns are unlikely to be as spectacular as in the past 10 years.
And so, the search continues for the next batch of safe and good stocks.
hooiling@sph.com.sg
Saturday, December 1, 2012
The Perfect Income for Happiness? Try $227K for Singapore residents
By Robert Frank | CNBC
Saturday, 1 December 2012
More than one study has tried to determine the financial price of happiness. Some look at wealth. Others look at income.
One well-publicized study last year put the optimal income for happiness at around $75,000. Rising income, it turns out, produces greater happiness until you get to around $75,000. After that, there are diminishing returns, with more income leading to little or no gain in real happiness.
This is a fraught question, of course. "Happiness" itself is not easily defined, and money, as the winners of this week's Powerball jackpot will tell you, doesn't always guarantee it. And the financial requirements for happiness usually depend on geography, peer groups and other external factors.
The latest to weigh in on the issue is Skandia International's Wealth Sentiment Monitor. It found that the global average "happiness income" is around $161,000 for 13 countries surveyed. The United States wasn't specifically measured.
But there was a wide range of answers depending on the country. Dubai residents need the most to feel wealthy. They said the needed $276,150 to be happy. Singapore came in second place, with $227,553, followed by Hong Kong, with $197,702.
The region with the most modest needs for happiness is Europe. Germans only need $85,781 to be happy, placing them lowest on the list. The French need $114,000, while the British need $133,000.
The survey doesn't ask about total wealth needed to feel happy. But it does ask about the amount of wealth needed to feel "wealthy." Globally, the average amount needed to feel wealthy was $1.8 million.
Singaporeans took the lead on the "wealth" needs, with $2.91 million needed to feel wealthy. Dubai ranked second with $2.5 million, followed by Hong Kong with $2.46 million.
Surveys show that among Americans, most say they need $1 million or more to feel wealthy.
All of this shows that wealth and financial happiness is not an absolute number, but is relative to your peers and surroundings. Living in Dubai, with all those oil barons and oligarchs, the needs are higher.
In Germany, where wealth is more evenly distributed, the needs are not as high.
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