Month: October 2015

Crossroads… Keep Diversifying or Start Concentrating

By Carsten Tolkmit from Kiel, Germany (crossroads) [CC BY-SA 2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h32m / day (147 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 7h08m / day (7h28m, 7h45m, 6h11m)

The situation is this. I’m currently monitoring 154 Wide Moat stocks and my personal stock portfolio has 10 Wide Moat stocks.

So the question is, do I keep diversifying and invest small sums in new undervalued stocks that pop up (which implies that each stock’s max weighting is 0.65%)? Or do I start concentrating and enforce a maximum no. of stocks allowed?

The problem with starting to concentrate is how to execute it. The biggest obstacle I face is whether or not to re-balance when we have a bear market. That way I would be permanently locking in my losses on stocks that were bought at severely undervalued prices to begin with.

And as we’re on the topic of bear market, do I concentrate during a bear market (eg. buy only from the top 10-20 stocks available) or do I just diversify like crazy (equal sums in each undervalued stock, which theoretically would be bountiful)?

As of now, I’m leaning towards the Mohnish Pabrai method of diversifying like crazy during bear market (when opportunities or abundant) whilst concentrating during bull markets (when opportunities are scarce). If opportunities are abundant, I just invest equal sums in numerous opportunities. If opportunities are scarce, then each stock’s max weighting will be 3.33%-5.00% when buying while the rest of the portfolio goes to cash.

I think diversifying like crazy during “any money put to work in late 2008 could have been a 4x“, and I’m open to the idea of leveraging up during a bear market to capture the once / few in a lifetime opportunities since “If you are going to be a very concentrated investor, you should not use leverage”.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

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Minimize Effect of Negative Sentiment on Price

By Verlag von Wilhelm Jacobsohn, Breslau [Public domain], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h32m / day (145 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 7h34m / day (3h23m, 10h43m, 7h28m)

I’ve proclaimed before on this website that “If Wide Moat Div Yield + Growth > Discount Rate, Forget Market Timing“.

While I still stand by the rationale behind the article, it still bothers me that negative sentiment could drive prices down and kill my total returns. It’s the reason behind researching on “How to Deploy Lump Sums of Money” with a rule for deploying capital over a certain period of time.

That’s because Stock Return = Sentiment * Fundamentals + Dividends, Fundamentals being things like Earnings and Book Value while Sentiment is the Multiple applied to the Fundamentals such as P/E and P/B.

Which is why I’ve been experimenting with researching wide moat stocks at 10 year low P/B.

So besides controlling the returns through valuing the Dividend stream and ensuring the Fundamentals are strong, if I can buy stocks that are already surrounded by heavy negative sentiment such as 10 year lows, although I can’t predict if the sentiment can get any worse, but the fact that it is in the 10 year lows means that I have a large margin of safety in terms of Sentiment.

As for why 10 year low P/B instead of other things such as P/E or P/FCF, it’s because earnings can be cyclical or volatile, which makes it hard for a fair apple to apple comparison among companies of different industries. Book value on the other hand fluctuates much less than earnings, and a  great company theoretically should continue to build upon its book value in the long run throughout the good and bad times.

So the strategy? Demand that the current P/B is lower than the 10 year low P/B. As for current P/B, use the lesser of the latest annual report book value and the latest quarterly report book value. If book value didn’t grow over 10 years, then use the lowest book value in 10 years for P/B calculation.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

My Experiences with Hong Kong Net Nets So Far

By Diliff (Own work) [GFDL (http://www.gnu.org/copyleft/fdl.html) or CC BY 3.0 (http://creativecommons.org/licenses/by/3.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h35m / day (143 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 7h20m / day (6h34m, 3h23m, 10h43m)

I’ve invested in a bunch of net nets since talking about them in September 23rd 2015.

Here are a few things that I’ve learnt:

  • Diversification is always a good idea
  • Either Margin of Safety or Due Diligence
  • Prepare for Illiquidity
  • Volatility is much higher

So why was Diversification a good idea? Benjamin Graham always recommended 30 stocks for a Net Net stock strategy because these beaten down stocks worked well on aggregate but could easily blow up if less diversified. I went less diversified than Benjamin Graham (5% max weighting / stock = implied 20 stock portfolio), but still offering quite a bit of diversification.

And that was important since I basically chose my Net Nets purely on quantitative measurements without too much due diligence, namely:

  • Is NCAV / share less than 2/3 of Price?
  • Has the Company generated profit in each of the past 5 years?
  • Has the Company grown book value over 5 years?
  • Has the Company paid dividends in each of the past 5 years?
  • Does the Company have a 5 year average Debt : Equity ratio below 1? (Later added)
  • Is NNWC less than Price? (Later added)

Which brings me to the point that I’m glad I demanded a huge Margin of Safety. I didn’t do much Due Diligence, but demanding the first four aforementioned criteria helped screen out most Net Net stocks which were crappier in quality. In hindsight I should’ve studied more about the dangers of Hong Kong value traps before executing (I’ve learnt a lot from Mark Lin from Seeking Alpha, and I’m not compensated for sharing this), but over all I think a huge Margin of Safety has allowed me to make mistakes and learn as I invest without killing my returns.

Another thing that was a first time experience for me was Illiquidity. When I later added the other criteria (eg. Debt and NNWC) and realized one stock that I should sell immediately due to it completely failing my new criteria, it took me 3 days to exit my position. Compared to the minutes I needed to exit positions as long as the price was equal to market price, it really helped me internalize the lesson of never investing with money you’ll be needing in short term. If you’re strapped for cash, not being able to exit your positions will kill you, and that’s the price to pay if you want higher potential return since this illiquidity is the reason why many investors will avoid the stock and thus reducing competition.

Another thing I’ve never experienced was the high Volatility. All my previous stock purchases were usually blue chip large cap stocks which exhibited relatively low volatility, so it was quite interesting to see my Net Net stocks rise and drop from 5%-15% in single days. Thankfully I’ve played enough poker to be callous to paper losses, but I would’ve so panicked if I didn’t have that kind of training beforehand.

So what’s my verdict for Hong Kong Net Nets? I much prefer to continue buying Wide Moat stocks to be very honest. It requires less monitoring (You HAVE TO sell your Net Nets once it hits fair value as soon as possible if a good return is to be guaranteed, which requires frequent monitoring) and the margin of safety is much higher (it’s very hard to completely annihilated a 20 stock portfolio filled with extremely financially healthy companies with extremely durable moats).

That being said, if I can’t find Wide Moat stocks available, I’d still go for Net Nets that are of decent quality (profitable low debt companies that pay dividends). After all, my edge as an investor right now is only my capital structure and patience, which allows me to enter illiquid micro to small cap stocks and patiently wait for the returns.

I should keep maximizing my tiny bit of investor edge as much as possible while it lasts. It’s the most logical thing to do at this stage of my investment journey.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

I Still Have Regret

By Specialtoyoutoyou (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h34m / day (140 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h51m / day (7h51m, 9h09m, 9h34m)

I don’t remember why, but I felt melancholy one day and went through my old emails back in Secondary up to beginning of university.

And when I stumbled upon the email exchanges I had with my good friend Tahsin, my heart just sank. The last email he sent me was 2010 and I realized I never wrote him back.

He passed away on 2012 Oct 21st due to food poisoning.

I always keep telling people I don’t regret any decision I’ve ever made in life since all those experiences have made me who I am today.

But when I was reading my email exchanges with Tahsin, it struck me how I was wrong. I so regret not continuing to exchange emails, or even reply his last email back in 2010 when he asked me how was life in HKUST.

When you and the other party is still alive, you can still attempt to rectify mistakes. Whether the action is successful or not doesn’t matter because at least you could do whatever you could.

That’s what happened with my other friend Frances, who committed suicide on 2012 May 14th, which I’ve come to terms with through realizing there wasn’t much I can do after going through counseling and seeing the situation in a different perspective. To a certain extent, you knew it was a lingering possibility since she was depressed and seeked me out to learn more about Christianity (why I’ve abandoned Christianity is an another story altogether).

But accidental death? You don’t see it coming, and it just hits you much harder.

And death is the ultimate. Whether you believe in the afterlife or not, my dead friends aren’t going to write back.

Authentic Relationships Are Important For Me

By Balaji Kasirajan (Own work) [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h34m / day (140 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h51m / day (7h51m, 9h09m, 9h34m)

I remember telling my friend over dinner that the question that I keep hearing that supposedly helps you identify your passion has never made sense to me. “If I were to die tomorrow, I’d spend time with family and friends today, as simple as that.”

“Maybe your passion is family and friends?”

A light bulb went off. Maybe that is what I’m passionate about.

And I think a very big reason of why I’m so obsessed with saving, investing and ultimately achieving financial freedom is not because I desire the Ferraris or Lamborghinis in life, but because it literally gives me freedom to be who I am without fearing any repercussions that threaten my survival.

To me, my source of joy has always been being genuine to others and myself, and having lots and lots of authentic relationships. I try be as genuine and authentic as possible in life and work, but there’s always a lingering few areas where I’m unable to speak my mind fully without incurring repercussions that threaten my survival.

I don’t lie per se, but I’m forced to not speak the full truth.

And using the power of “start small“, I’ve built up my discipline muscle to the point where I’m actively systematically reaching out to friends I’ve known but haven’t talked to for a long time. After all in my experience, friendships that aren’t maintained just die or cool down, and it becomes very difficult to revive it back to the warmth it had before once it cools down.

I don’t want to die knowing I could’ve had one more catch up with my friends.

Jack Ma’s Advice on What to Do for Different Life Stages

World Economic Forum at en.wikipedia [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0), GFDL (http://www.gnu.org/copyleft/fdl.html) or CC BY-SA 2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h33m / day (139 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h19m / day (7h57m, 7h51m, 9h09m)

This interview excerpt from Jack Ma really made think.

“Before 30 years old, follow somebody… before 30 years old, it’s not which company you go, it’s which boss you follow, it’s very important… From 30 to 40 years old… you’re working for yourself if you really want to be an entrepreneur… If you’re 40 to 50 years old, you have to do all the things that you are good at, don’t try to jump into a new area, it’s too late, you maybe successful but the rate of dying is too big. When you are 50 to 60 years old, work for the young people, because young people can do better than you, so rely on them, invest on them, making sure they’re good. So when you are 60 years old, spend time for yourself, on the beach, sunshine (laughter) it’s too late for you to change normally”.

Theoretical Max Return vs Actual Achievable Return

By Roberto Croce (Roberto Croce) [Public domain], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h32m / day (137 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h14m / day (6h53m, 9h53m, 7h57m)

I think a lot of times people forget that the best investment strategy isn’t one that has the highest theoretical max return (eg. ~38% return from net net stocks), but the investment strategy that suits your temperament.

This is because every investment strategy (similar to poker) requires a certain period of time (a.k.a. a full cycle) before luck / unluck weeds out and the actual returns to fully surface. And unfortunately for most people, not everyone can stick with any investment strategy through thick and thin to reap the full benefits at the end of each cycle.

Some investment strategies maybe too illiquid, some requiring too much inactivity, and some requiring too much monitoring. The list of reasons why not every investment strategy suits everyone is endless.

That’s why I stick to wide moat stocks and diversify. I like to make one good decision (buy a great company at a bargain price) and not have to do much for the rest of time (why I like wide moat stocks). I like to feel comfortable that my portfolio can survive black swan events (why I like wide moat stocks and diversification). I like to study moats (why I like wide moat stocks). I like to spread my bets (why I like diversification). I like to know the buy and sell price of each of my stocks (why I like individual stocks).

Also knowing I had a fidgety temperament, I intentionally / unintentionally played tons of poker using a loose passive style to become callous to losing hands and internalize the lesson that short term losses are okay as long as your strategy generates long term profits.

Playing loose passive meant that I got to take a look at quite a lot of hands (which shielded whether I had great hands or not), and playing passive helped minimize the max. loss / hand while enticing others to raise heavily and frequently to try to scare me away. A lot of times I would be “scared away”, but when I hit the motherload pre-flop or after the flop, my aggressive competitors were in for a world of hurt.

And it made me truly understand what Charlie Munger meant by “Experience tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of that lifetime“. Internalizing that lesson has ultimately made me a better poker player, but also a better investor.

And what’s better is, compared to poker where I had to pay a fee (when checking) to get the chance to participate in an opportunity to make money and was forced to pay to wait (big blinds / small blinds), the chance to participate in the stock market and waiting for a fat pitch is literally free

Going forward, these are going to be strong reasons why I’ll have a good chance to stick with my investment strategy through thick and thin and reap the benefits over a full cycle.

So what’s left? Hope I can actually walk the talk rather than talk the talk. This blog and my imaginary stock portfolio will be my testimony.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

Understanding T.Rowe Price

By Dean Biggins, U.S. Fish and Wildlife Service [Public domain], via Wikimedia Commons

Warren Buffett / Charlie Munger’s Four Filters + Risk Factors

  1. Understand the Business
  2. Enduring Competitive Advantages
  3. Able and Trustworthy Managers
  4. Risk Factors
  5. Bargain Price = Margin of Safety (I will not explore this as everyone should devise their own fair value)

1. Understand the Business [Updated Oct 17th 2015]

T.Rowe Price is an asset management firm that serves individual and institutional clients mainly in the form of US mutual funds and other investment portfolios (separately managed accounts, subadvised funds, collective investment trusts, target-date retirement trusts, Luxembourg-based funds for non-US investors, variable annuity life insurance plans etc.). Of the 746.8 billion USD assets under management (AUM) as of 2014 Dec 31, Mutual funds currently occupy 63.95% while other investment portfolios occupy 36.05%.

In terms of investment strategies, T.Rowe Price only focuses on equities and fixed income, providing options that range from purely equity or fixed income to a mix between both. Of the 746.8 billion USD AUM as of 2014 Dec 31, stock and blended asset occupy 77.65% while fixed income portfolios occupy 22.35%.

2. Enduring Competitive Advantages [Updated Oct 21st 2o15]

T.Rowe Price’s biggest competitive advantage is its Reputation, with most of its related competitive advantage derived from its Reputation. The other significant competitive advantage T.Rowe Price has is its Disciplined capital allocation.

One competitive advantage that derives from T.Rowe Price’s Reputation is an extremely happy customer base (National Association of Retirement Plan Participants ranked T.Rowe Price as “most trusted” retirement plan provider in 2014, and 86% of customers would recommend T.Rowe Price to friend / relative for one to one consultation), which helps with customer stickiness through thick and thin as clients stay put with a brand they are familiar with during times of uncertainty.

T.Rowe Price’s Reputation also helps it grow its AUM, which helps gives it scale for cost efficiency as the 26th largest asset management firm globally. Its AUM growth rate (using Dec 31 2014 as cut off date) is 7.89% (1 year), 15.13% (3 year CAGR), 13.81% (5 year CAGR) and 12.25% (10 year CAGR).

This Reputation also helps T.Rowe Price attract and retain a fund management team that have an average of 19 years of investment experience and 13 years’ tenure with T.Rowe Price and contributed to 74% of its mutual funds outperforming comparable Lipper average on total return for a 3 year period and have 82% of assets given a four to five star rating from Morningstar.

All three of these Reputation related competitive advantages creates a virtuous cycle that continually feeds each others’ increasing strength.

Another competitive advantage that cannot be ignored is T.Rowe Price’s Disciplined capital allocation. T.Rowe Price has rarely engaged in acquisition activities, and has a shareholder friendly dividend policy that has seen its dividend grown year on year for 29 consecutive years.

3. Able and Trustworthy Managers [Updated Oct 1st 2015]

One aspect of T.Rowe Price’s management was explored in the aforementioned “Disciplined capital allocation” section below “2. Enduring Competitive Advantages”.

The other aspect of T.Rowe Price’s management is Financial prudence, which is different to disciplined capital allocation in a sense that I view capital allocation as offensive (deploying capital to generate more capital) while I view financial prudence as defensive. As of 2014 Dec, T.Rowe Price’s zero debt and dividend payout ratio of 38.20% provides huge margin of safety for T.Rowe Price to navigate unforeseen negative circumstances.

4. Risk Factors [Updated Oct 19th 2015]

The biggest risk to T.Rowe Price is purely on its ability to recruit and retain talents that can continuously succeed in the world of investing.

Making matters more difficult, T.Rowe Price is heavily exposure to US Equities, which accounts for 69.40% of its total assets under management (685.18 billion USD in US Equity and 61.62 billion USD in int’l Equity), arguably the “most transparent, efficient and competitive (stock market)… in the world“. The implication is that T.Rowe Price needs to recruit and retain the absolutely best talents available in order to outperform not only its competitors, but also the extremely efficient US stock market.

And as of Oct 19th 2015, there is concern about T.Rowe Price’s ability to differentiate itself admist competitors in the war for talent.

Compared to its direct competitors as listed in Yahoo Finance and top 3 biggest competitors as listed in Morningstar (namely Fidelity Investments, The Vanguard Group and American Century Companies and BlackRock, Bank of New York Mellon, and Blackstone Group), T.Rowe Price’s Glassdoor score is 3.5 versus Fidelity’s 3.7, Vanguard 3.3, American Century’s 4.0, BlackRock’s 3.6, BNY Mellon’s 2.8, Blackstone Group’s 4.0 (Competitor average score of 3.57).

Another significant risk to T.Rowe Price is that most of its business is done in the form of mutual funds. Actively managed mutual funds are structurally designed to have a hard time beating the market due to over-diversification, high fees vs passive funds, mandatory cash on hand, closet indexing, and high taxes due to turnover rate. It’s a reason why 86% of actively managed mutual funds fail to beat the market.

If T.Rowe Price fails to keep beating the market and peers due to limitations of the mutual fund structure, it would seriously deteriorate its reputation and any competitive advantages that come with it (customer attraction, customer stickiness, talent recruitment, talent stickiness and scale).

Moat Based on Talent is Risky Business

By Got Talent (Own work) [Public domain], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h30m / day (135 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h32m / day (9h55m, 8h47m, 6h53m)

In all fairness, moat based on anything possesses a certain amount of risk.

But a moat based on talent? Compared to moats as listed by Morningstar such as Network Effect, Intangible Assets, Cost Advantage, Switching Cost and/or Efficient Scale, a moat based on talent just has too many moving parts that reduces the robustness of the moat.

And why is too many moving parts a bad thing? Any system that relies on more moving parts is more prone to break down than a system that relies on less moving parts simply due to probability. If your reliability target rate is 90%, you only need a 90% reliability rate if your system has 1 moving part, 94.87% reliability rate each for 2 moving parts, 96.55% reliability rate each for 3 moving parts and so on… [1]

And how is a moat based on talent a moat that has many moving parts? You need to continuously recruit, retain, retrain and retire people constantly. And even so, if you diligently do your utmost best to do the 4Rs, it doesn’t guarantee that your talents are able to perform in all kinds of environments. Couple with the fact that the war for talent is not showing any signs of decreasing intensity, a moat based on talent will only continually shrink (my hypothesis) until perfect competition sets in and destroys any sustainable market beating value a company can have.

And that’s how I felt when I was working on a “Understanding T.Rowe Price” (still work in progress) post after doing one for ExxonMobil.

So the inevitable question thus emerges… why the hell do I bother to hold T.Rowe Price if it’s moat is based primarily on talent? Well besides a moat based on talent, it does possess a famous brand (great for attracting clients and talents and also stickiness where clients stay put with a brand they are familiar with during times of uncertainty) and also scale ($730 billion USD assets under management makes it the 26th largest asset management firm globally).

But considering its business model’s success is heavily reliant on talent, it is something to pay close attention to.

[Footnotes]

[1] 1 moving part = 0.9, 2 moving parts = 0.9487 * 0.9487 = ~0.9, 3 moving parts = 0.9655 * 0.9655 = ~0.9

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

Platinum – Why Large Margin of Safety Saved My Ass

English Wikipedia, original upload 6 April 2005 by Mb1000

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h30m / day (133 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h00m / day (5h55m, 8h10m, 9h55m)

In “Imaginary Stock Portfolio – Oct 1 2015” I made an unconventional investment in platinum as compared to my usual equity investments. I did the same in my actual personal portfolio.

The premise was simple – platinum’s price was 42% below its average cost of production back in Oct 2nd. There was no way in hell platinum’s price wouldn’t revert back above average cost of production due to simple economic supply and demand dynamics.

The only question was how long it will take to revert. Based on my experience, markets are extremely efficient if not 100% efficient as proposed by Eugene Fama’s Efficient Market Hypothesis, so it’s very likely for the price to revert within 2-3 years as Joel Greenblatt has observed.

The only problem was… the margin of safety was less than I thought.

I made the investment decision within literally 10 minutes of reading “Unconventional Investments“ from Base Hit Investing and after doing a simple Google search on price of platinum versus cost of producing platinum.

But I’ve made further research into platinum fundamentals, and I realized that average cost of producing platinum was not uniform across many sources, and I discovered the cost of production figure I used was in the middle of the curve.

This made me uncomfortable. Every time I make an investment, I always choose the most conservative figure available. There’s simply too many unknown and unknowable variables that can ruin my returns, which is why I demand such large margin of safety.

Thankfully, the initially large 42% margin of safety saved my ass. Even after I used the most conservative cost of production figure I could find, I still had 16.13% margin of safety (as of Oct 18th).

Since I’m a strong believer in Seth Klarman’s philosophy of never waiting until full value realization to reap profits and re-invest in positions with larger margin of safety, I’ll be extremely open to the idea of selling my position in platinum to invest in other potential investments (it has produced 7.98% return on my cost basis so far for my personal portfolio).

The problem of course is that I’m having a hard time finding new attractive investment opportunities to soak up such funds. In the meantime I’ll just hold onto platinum until it does fully realize in value.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)