Patience My Friend… Patience

By Creator:Jan Gotard (artyzm.com) [Public domain], via Wikimedia Commons

My trigger finger’s itching.

With the Hang Seng Index’s P/B below 1.0 for the first time since 1998’s Financial Crisis, dollar cost averaging into Hang Seng Index just seems like a very good idea, considering how Hang Seng Index’s P/B never went that low even during 2003 SARS epidemic, 2008 Financial Crisis and 2011 European Sovereign Debt Crisis.

But I have to keep asking myself, “What’s the better alternative to investing money into the Hang Seng Index today?”

And I think there are a few things to consider when asking that question:

Hang Seng Index is cheap based on historical P/B or even CAPE (cross-reference current CAPE of 14.9 versus historical average CAPE of 18.6), but the only ways to unlock value (ever-improving fundamentals, positive sentiment, dividends) don’t look promising overall.

Hang Seng Index is not very moaty. Of the 50 constituents, the only Wide Moat company is Hong Kong Stock Exchange according to Morningstar. This relates to the ever-improving fundamentals and positive sentiment points aforementioned as Hang Seng Index’s constituents will have a tough time growing earnings let alone maintaining earnings during tough economic conditions, which ultimately would make sentiment bad and drag price multiples down.

The only positive side is the dividend part of the equation.

The historical average of 30 Year US treasury yield is 5.45%. The implied current month-end weighted average dividend yield of Hang Seng Index is 4.77%, which means Hang Seng Index only needs to grow dividends 0.68% to perpetuity to match 30 Year US treasury’s historical average yield.

However, Hang Seng Index has precedence of cutting dividends when things are rough (Tracker Fund of Hong Kong’s dividend dropped from $0.68 / share in 2008 to $0.54 / share in 2009). If we assume Hang Seng Index will cut dividend yield double the rate from last time’s cut (20.59% to 41.18%), then Hang Seng Index’s discounted dividend yield is 2.8%. Considering that Hang Seng Index only needs to grow dividends 2.65% to perpetuity to match 30 Year US treasury’s historical average yield, it doesn’t seem too hard considering Hong Kong’s average inflation rate of 4.51% from 1981 to 2015.

But compare that to my alternatives, Hang Seng Index looks bad.

I always compare every investment to Berkshire Hathaway, since I think it’s the moatiest company out of the 186 Wide Moat stocks listed in the US, rated by Morningstar and evaluated by me.

And there is no way the Hang Seng Index is more attractive than Berkshire Hathaway, even with today’s valuation.

Berkshire Hathaway’s P/B is currently 1.24 ($125.62 share price / $101.23 book value). Even if we take the most conservative book growth CAGR from the past 1 year, 3 year, 5 year and 8 year growth (which is 10.31%) and discount the P/B to the buyback floor of 1.2 P/B set by Warren Buffett, you’re still looking at a 9.98% return based on growth alone.

That just crushes anything that the dividend side of Hang Seng Index can offer.

In terms of the moatiness of Berkshire Hathaway, it’s very hard to find any company that can top it. If subsidiaries are to Berkshire Hathaway what constituents are to Hang Seng Index, then there’s no competition as many Berkshire Hathaway subsidiaries posses wide moats even if they were stand-alone businesses.

This allows Berkshire Hathaway to unlock value through the ever-improving fundamentals protected by its wide moat, which also allows for a better chance for positive sentiment to find favor with Berkshire Hathaway over time.

So all I can say is, patience my friend… patience. Think things through by challenging decisions and assumptions through calculations and you might find a different picture that would save you from a world of hurt.

[Disclaimer]

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

Advertisements

One comment

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s