Portfolio Update

Weigh Pros and Cons and then Follow Your Instinct

By Dean Hochman from Overland Park, Kansas, U.S. (arrows) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons

I read this article [1] that talked about how you should make decisions that utilized both your logic and instinct, where instead of mutually excluding each other from the decision, you should do a pros and cons list first, but then later on still go ahead to make a decision based on your instinct, because if your instinct compels you to make a decision over another even after a thorough logical analysis, it probably has some merit.

Funnily enough, soon after reading that article, I made two big decisions within a very short time frame concurrently which were completely opposite to each other – one being a consensus between logic and instinct, the other adhering to instinct even after the logical analysis.

Either way, the commonality of both decisions involved lots of unwarranted fear, and my experience in life so far has taught me that where fear is way overblown, it’s usually the right decision. I think this was the crucial deciding factor to following my instincts for both decisions.

Without spilling any details on both decisions (they are still in process and have lots of details that have yet to finalize), I think there were a few interesting takeaways from both decisions.

For both decisions, having had the time to think through the pros and cons way ahead of time of making either decisions meant that when decision time came, I had an anchor to navigate the very rapid decision making.

For the big decision that had a consensus between logic and instinct, the need for follow-up came fast and furious. I got a huge status update on my big decision yesterday morning, and I realized that I needed to get confirmations from 3 different people within the next 2-3  days. So even though I was still processing all the excitement, nervousness and stress from getting the big status update, I had to very aggressively find opportunities to talk to those 3 different people about confirmations.

Each subsequent conversation actually got tougher and tougher to execute purely from an emotional point of view, since I was already overwhelmed with emotions from the big status update, so every time each follow-up conversations went well it just added even more emotions to my existing bucket of excitement, nervousness and stress. Thankfully over all these years of learning to override at certain critical moments my bodily reaction of wanting to slow things down and process, I got the job done. And I think without having done the detailed pros and cons beforehand while I was not being rushed really helped, because I could just trust my assessment that was done beforehand and just focus on the execution.

To a lesser extent, the same applied to my big decision that only adhered to instinct. I knew it was the right thing to do lest I end up regretting not taking action, and for the certain few vulnerable moments where I really start questioning myself, I just pushed onward knowing that action begets action, and more or less once you start things kicking you can’t stop. That helped me achieve significant progress to getting to where I want.

For the big decision that had a consensus between logic and instinct, it really showed me what a black swan would look like.

For someone who prides in having a probabilistic worldview, who incorporates probability into decision making all the time, and who shares with people the human flaw of under-estimating black swans and over-estimating regularity, I still found myself a little shook from this explosion of information, emotions and need to make multiple quick decisions.

To be fair, I probably dealt it much better than any version of me up to this point could’ve dealt with it, since in terms of results I absolutely nailed it. But in terms of emotions I’m just currently a wreck, as I’ve had sleepless nights since Tuesday just trying to process everything.

But now that these few days of frantic quick decisions have been done, the consequences are starting to emerge. The timeline of the consequences has been pushed earlier by potentially half a year, which put lots of plans I had in mind out of whack. In hindsight I should’ve prepared more for black swans like this, but I’m lucky that I already started with my preparations long time ago so that I’m not fully naked now that the tides are going out.

For the big decision that only adhered to instinct, the key deciding factors of going against my pros and cons was realizing that most of the cons needed verification before deciding they were truly cons and applying a regret-averse framework to the decision.

I actually delayed making the decision for months. My initial pros and cons analysis showed that going ahead with the decision would just lead to catastrophe down the road. And since I’ve always predominantly used a value investing philosophy of “avoid catastrophe risk and the upside will take care of itself”, it made sense to not proceed.

But recent conversation with my friend made me question my assessment of catastrophe risks. Essentially it was made very clear that my assessment were based on lots of assumptions that I didn’t even verify. It’s one thing to know for sure that pharma companies have the catastrophe risk of misstep in R&D pipeline that could cause a permanent fall of grace due to a beginning of a vicious cycle of lack of blockbusters which lead to lack of R&D and so forth, but it’s another thing to think that some risks are definitely catastrophe risks without even considering the possibility of workarounds / compromises.

So instead of being stuck in fantasy mode, it made me want to investigate the actual reality.

Also the fact that I looked at the decision from the perspective of my death bed to see if I would regret not making the decision showed a strong sign of potential regret, I figured I should go ahead since I can accept failure but not regret.

[Footnote]

[1] I unfortunately can’t find the link of the article… It’s one of the few unfortunate incidents where I remember the article but can’t find the source anymore.

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Catalysts and Greater Fool Theory

Laughing_Fool(https://commons.wikimedia.org/wiki/File:Laughing_Fool.jpg)

Once a security is purchased at a discount from underlying value, shareholders can benefit immediately if the stock price rises to better reflect underlying value or if an event occurs that causes that value to be realized by shareholders. Such an event eliminates investors’ dependence on market forces for investment profits. By precipitating the realization of underlying value, moreover, such an event considerably enhances investors’ margin of safety. I refer to such events as catalysts. – Seth Klarman

Feedback loops can be either negative or positive… a positive feedback process is self-reinforcing. It cannot go on forever because eventually the participants’ views would become so far removed from objective reality that the participants would have to recognize them as unrealistic. – George Soros

If you are not sure who the fool is in a trade or complicated investment, there is likely a fool and that fool is likely to be you. – Terrence Yang

Once in a while you stumble upon a crazed frenzy of people suddenly bidding the shit out of stocks within an extremely short period of time.

We’re witnessing it right now with the Hong Kong stock market.

Usually I don’t pay attention to such crazed frenzy since a bubble that’s been growing in size rapidly is still a bubble. I simply hate over-paying for things.

But what if the crazed frenzy is targeting under-valued stocks or stock markets? I’ve always thought the Hang Seng Index was under-valued before this crazed frenzy, either from an absolute valuation perspective [1][2] or a relative valuation perspective [3]. What stopped me from buying it was because I didn’t really like the quality of companies in the Hang Seng Index [4].

But when a catalyst like the crazed frenzy we’re now experiencing appears, it really piqued my interest since as Seth Klarman mentions, a catalyst that quickens a stock or stock market to rise to full value reduces risk for investors.

The risk with going into a bubble is momentum begets momentum, since people’s belief (we’re in a bull market) drives action (invest) that drives reality (bull market rises even more), which leads to a game of Greater Fool Theory. According to Investopedia’s definition of Greater Fool Theory, “it is possible to make money by buying securities, whether overvalued or not, and later selling them at a profit because there will always be someone (a bigger or greater fool) who is willing to pay the higher price.” So if I don’t have a game plan of when to go in and when to go out, I could become the fool in this game.

To prevent myself from being the fool, I needed to do fundamental analysis to make sure that: 1) My entry point is under-valued and 2) My exit point is full value. The reason being that if I entered at an under-value point, if I find myself still holding onto the stocks after the bubble bursts, it will still generate a decent return. The reason for exiting at full value instead of continuing to hold on until over-valuation is because the whole point of going in a bubble is to take advantage of a catalyst that realizes under-valuation to full valuation at a short period of time, so there’s no point to linger on after missions is accomplished.

Either way, as Mohnish Pabrai always says, “Heads, I win; Tails, I don’t lose much“.

Having decided I was going to play this game of Greater Fool Theory, three questions had to be asked. What do I invest in? What is the entry point? What is the exit point?

So what do I invest in?

I decided to forego individual securities. I have 7 Hong Kong stocks on my watchlist, but they were either over-valued or not in great financial health before this crazed frenzy even began.

Which left me with the Hang Seng index since I don’t touch individual stocks that I don’t follow myself, so a basket of stocks to protect myself against ignorance seemed like a good idea even though potential returns would diminish.

What is the entry and exit point?

My calculation of fair value of the Hang Seng index using 2015 March data was a range between $30.33 to $39.74. So my entry point was essentially any price below $30.33 and I would fully exit by $39.74.

And that is what happened. I’ve entered a position in Hang Seng Index at $27.70. I don’t foresee myself adding upon the position any further during this crazed frenzy. Let’s see how this turns out.

Footnotes

[1] eg. ~11 P/E as of today translates to 9% Earnings Yield. Even if you cut it in half into 4.5% Earnings Yield, it’s extremely likely that Hang Seng Index can grow 1.5% annually until perpetuity, ensuring at least a theoretical 6% return until perpetuity (Note that the Earnings of P/E is extremely easy to manipulate and volatile, so don’t 100% rely on P/E ratios. But for explanation purposes it is used as it’s easy to understand)

[2] A 6% discount rate is used if the risk-free US 10 Year Treasury Yield is yielding less than 6%. Right now it is at 1.96%. This benchmark is recommended by Joel Greenblatt.

[3] ~11 P/E compared to a mean of ~14.5 P/E. Historical P/E can be found here: http://www.hsi.com.hk/HSI-Net/HSI-Net

[4] Don’t get me wrong, Hang Seng Index companies are profitable and good. I just don’t think they are world class calibre (eg. Google, Visa, Mastercard).

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

Currently holds stocks in Tracker Fund of Hong Kong (SEHK: 2800)

Investment Thesis On Why I’m Buying HSBC Stock

I’ve been buying into HSBC stocks for the past 2 months. I won’t disclose the amounts, but I bought equal amounts of shares for each month. I am considering buying more in the near future.

Gameplan Overview

Type of Play: Buy and Sell (Buy – valuation’s way too cheap due to recent news | Sell – HSBC isn’t a great company to hold forever)

Maximum Holding Period: 2 Years

Off the Cuff Analysis

I thought HSBC was a story worth looking into back in February when I was compiling a list of companies that provided products / services I couldn’t live without, and HSBC showed up [1]. The stock was price below tangible book, so my first instinct was it was undervalued.

As Joel Greenblatt mentioned in “The Little Book That Still Beats the Market”, the minimum return any investor should demand is 6% when 10 year US Treasury Yields are below 6%. At around 5.3% Dividend Yield during mid-Feb, HSBC stock was basically priced under the assumption that to get a 6% return, HSBC only needed to grow 0.7% in Dividends until perpetuity [2]. In my mind that seemed too conservative considering HSBC was growing its dividends in the past 5 years (2009-2013) at around 8% and has only cut dividends in its very long history of dividends thrice, once during the Dot Com bubble and twice during the 2008-2009 financial crisis, events that were extremely abnormal.

I think that was a flaw I would want to avoid in the future since such simple calculations and thinking was all it required for me to get into HSBC.

Then the poor interim results were released, Swiss Bank allegations started showing up, and a decrease in dividend growth (around 2% growth) was announced all around early March, and the stock price started to plummet. I started to panic since I didn’t do enough research, thought and calculations to give me the conviction to hold onto the stocks, so I decided to really dig deep in research before I came to the conclusion of whether to buy more, hold or sell.

Analyzing Short Term Pessimism

The 1st question I had to ask myself was, was the short term pessimism warranted? To answer that I had to dig deep into the three issues aforementioned.

For the poor interim results, the majority of the 17% decrease in profits from $22.6 billion to $18.7 billion could be explained by the $3.7 billion in fines paid out. Undoubtedly, I think the possibility of HSBC having to continue to pay out fines for other emerging legacy issues (eg. pre-Stuart Gulliver era issues) is very real in the short term future, but the frequency and amount of fines will decrease over time.

The reason being ties into why I feel that pessimism from the Swiss Bank allegations is too much. First of all, most of the issues HSBC currently faces that warrant fines were created prior to Stuart Gulliver’s (current CEO) era, so to think that these are the fault of the current senior management is ludicrous. Secondly, Stuart Gulliver has been extremely consistent, transparent and swift about disclosing and dealing with the legacy and new problems since taking over, selling 77 businesses, reducing headcount from 310,000 to 257,000, de-layering the organization structure, reducing HSBC Swiss private bank’s assets and number of clients down 70% way before allegations came out and even cutting his own annual bonus when HSBC was found to have paid ~400M pounds due to the currency rigging scandal under his reign. If the issues were the current senior management’s fault and future issues aren’t actively prevented from happening, then the pessimism is warranted.

Also the fact that Stuart Gulliver is questioned as incompetent to run HSBC by UK MPs is completely ridiculous. If Stuart Gulliver is “unfit” to lead HSBC just because he opened a Swiss account to avoid HSBC non-Swiss staff to pry into how much he earned and hold it under a Panama company to stop HSBC Swiss staff to peek into his Swiss account, then I don’t know who else is competent in ability and integrity to lead HSBC. The man paid all his taxes, and as one of HSBC’s top earners, can’t he enjoy some financial privacy?

As for potential low dividend growth in the short term, it is only a serious concern if I bought HSBC stock with very little to no margin of safety. Buying in at $72.7 HKD / share (~5.3% Dividend Yield) meant that dividends only needed to increase by 0.7% / year until perpetuity to get me my 6% return, which is still very do-able even when HSBC only grew its dividends by 2% from 2013 to 2014.

Analyzing Long Term Staying Power

After thinking through the short term pessimism, the next question I have to ask is, what are the factors that will allow HSBC to keep growing dividends by at least 0.7% until perpetuity? Using Charlie Munger’s Four Filters, I broke down HSBC as follows:

1. Understand the Business & 2. Sustainable Competitive Advantages

HSBC is run under 4 divisions, namely Retail Banking & Wealth Management, Commercial Banking, Global Banking and Markets and Global Private Banking. The greatest advantage that HSBC has over its nearest competitors is where it is situated geographically (namely Asia and Developed Markets), as its closest competitors in the region (Standard Chartered and Citibank) are nowhere near in scale in terms of network in Asia and between Asia and Developed Markets.

The second great advantage that HSBC has over its competitors is its synergy between divisions, where customers can constantly be cross-sold across different divisions’ products or services seamlessly under one platform. As a HSBC customer for 15 years (since Year 2 in Primary), I can testify that people might complain about services and all the advertisements, but people nevertheless stay in the HSBC system for convenience, where people are willing to pay the extra fees just to be able to do savings, checkings, credit card, investments, mortgages, loans, insurances across different countries all in one platform.

Which leads to a huge looming threat to HSBC that must be mentioned. If HSBC doesn’t solve its image of being horrible at service, sooner or later the synergy between divisions will break down if people start leaving HSBC for better alternatives. People are staying because the alternatives suck even more, not because people are really happy with HSBC services.
3. Able and Trustworthy management

I have no doubt about the integrity of Stuart Gulliver and Douglas Flint (current Chairman). If you’ve read the what they say in annual reports and interviews since taking over in 2011 and compare it to what they have done, there is absolutely consistency with doing what they said they were planning to do. Also a fact that many people seem to overlook is the fact that HSBC is conservatively financed, always exceeding Basel requirements in terms of Tier 1 Capital ratios. I really like conservatively financed companies.

4. Bargain Price and Margin of Safety

As mentioned earlier, I demand at least 6% returns when 10 year US Treasury Yields are less than 6%. Being priced at 5.3% dividend yield meant that HSBC only needs to grow 0.7% dividends until perpetuity to get me my 6% return from dividends alone.

Considering all of the four factors aforementioned, I bought more stocks mid-March at $66.1 HKD / share (~5.8% dividend yield) since the implied dividend growth of 0.2% until perpetuity seemed ridiculously low.

Possibilities of Returns

So what are my possibilities of returns in the future? If I only take dividends into consideration (eg. never selling), then you can split my possible situations into a spectrum of pessimism and optimism, which could be something like this:

Possibilities of return of all my HSBC stocks (Dividends Only)
– Cut 50% and stagnant afterwards = 2.775% return until perpetuity (Extremely Pessimistic)
– No dividend growth and no cut = 5.55% return until perpetuity (Pessimistic)
– 4% growth (half of 5 year average growth) = 9.55% return until perpetuity (Optimistic)
– 8% growth (5 year average growth) = 13.55% return until perpetuity (Extremely Optimistic)

When to Sell

I am going to sell my HSBC stocks within 2 years. As mentioned earlier, HSBC has cut dividends before when times were rough and its poor reputation in services and price means that HSBC still possesses huge market shares because its competition sucks instead of because HSBC is great.

If HSBC can become better in the latter section before it hits my selling price, I might consider, but there are no signs of that as of now.

And the prospect of being able to sell within 2 years excites me, because the fact that not only do I have a good deal through dividends alone (since I don’t have to pay dividend taxes on UK stocks), I can also potentially earn more through capital gains. So when do I sell to capitalize on such capital gains?:

When to sell?
– When 10 year US Bonds return > target return (target return is 6% for the HSBC stocks)
– When current dividend yield + half of 5 year dividend growth is less than target return while better investment opportunity arises (want to make sure I don’t hold onto stocks for too long by waiting for stock price to rise to needing 5 year dividend growth instead of half of that to get my target return)
– When holding period of 2 years is up

How to do Better
So as you can read, I did make a mistake of investing initially with only off the cuff analysis. I was lucky that I went in with a large margin of safety and that further research and analysis proved me right, but I can’t count on such luck in the future.

Also in terms of execution, I would’ve probably bought less stocks per purchase in the future. Doing this allows me to dollar cost average into more months as the stock price keeps plummeting. Currently I’ve tied up significant capital already in HSBC stocks, and that’s 2 months. This means I might not be able to get even cheaper bargains if HSBC stock prices continue to slide (which is very likely).

[Footnotes]

[1] The reason why I can’t live without HSBC is because as someone who lives in Hong Kong and has Canadian nationality, the ATM and retail bank branch network of HSBC is unparalleled in Hong Kong, while HSBC’s retail bank presence in Canada means I can easily transfer funds between the two places.

[2] I used a Dividend Growth formula, which is Fair Price = Dividend / (Discount Rate – Growth Rate). Discount Rate is another way of saying what return I demand from my investment

[Disclosure]

I am long HSBC

[Disclaimer]

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

Plan of Action From Now Until NCAV stocks

I’ve had a life changing revelation on October 2nd 2014 in terms of what investing strategy I should be adopting for a small portfolio like mine. Read specifically under  the “Why I think I’m taking too much risk” section of “I Fucked Up On My Investment Thesis“.

To transition into a NCAV stock does pose a problem, which is I don’t have enough capital to actually construct a well diversified portfolio of NCAV stocks. NCAV stocks rely on diversification since a batch of NCAV stocks generating positive returns is needed to offset failures of certain NCAV stocks when the failure rate is ~20%.

Before I have the funds to construct an 8 stock portfolio (you can find out why at least 8 stocks here), I will invest in Vanguard HK’s regional index funds that are below the maximum Graham Number (P/E * P/B = 22.5) and hedge overvaluation by 2% cash for every 1% overvaluation.If all regional index funds are overvalued, I’ll just accumulate cash.

This process will continue on until I have enough money to construct a 8 stock portfolio and there are 8 stocks that meet the most stringent of conditions. I will then proceed to liquidate all my index fund shares and start my global NCAV stock strategy.

[Disclaimer]

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

I Fucked Up On My Investment Thesis

I really hate to admit it, but I don’t think The Link REIT is as great as a company as I originally thought. I also think I’m taking up too much risk.

Why I change views on The Link REIT

In my essay on why I thought The Link REIT was a great company, I was wrong in my analysis on The Link REIT’s Favorable Long Term Economics.

I was horrified to only learn of the recent news on September 29th 2014 that The Link REIT sold 5 properties for future purchases and that the previous 4 properties sold last year was to buy 1 property called Lion Rise Mall.

The reason why this realization horrified me is because The Link REIT is forced to consistently make sub-optimal investment decisions due to its REIT status. REITs under Hong Kong law are legally obliged to distribute at least 90% of distributable income, which means that every time The Link REIT sells property, it has to re-invest it immediately lest the cash gets distributed back to shareholders, which also means that when it re-invests the money immediately, the property they buy maybe fair value, but most likely over-valued and definitely not under-valued.

This is because The Link REIT only sells when its property is overvalued, but if your properties on aggregate is overvalued, then the property market in general is most likely overvalued, thus the property The Link REIT buys immediately with the cash will be most likely overvalued as well. No rational person / company sells a property unless they get good money for it or they are strapped for cash.

In the same essay on why I thought The Link REIT was a great company, I said one way The Link REIT could fall from “Great Company” status was if it sold its properties, because:

“The only way you can get dislodged legally by competition is if your strategic locations aren’t strategic anymore (very rare, think of your city’s CBD district and see how frequently it changes places), or most importantly, if you decide to sell your strategic locations and risk never getting a chance to get back into those strategic locations. Property owners are legally allowed to not sell its property regardless of how ludicrously high the offer’s value is.”

So besides The Link REIT not getting great deals in terms of valuations in swapping properties for propertie(s) since everything’s all overvalued, it risks deteriorating its competitive advantage of “control of majority of retail space and car park space situated strategically near dense residential areas covered by MTR stations that most ordinary Hong Kong folk can’t live without” every time it makes a swap deal by being wrong in its analysis of the new properties acquired.

The reason why The Link REIT was so unstoppable was because it basically took over all retail space and car park space originally managed by the Housing Authority (the government body that looks after public housing). If you’re living in public housing, you really don’t have much choice but to use the retail space and car park space nearby. But as The Link REIT moves further away from its core portfolio into new property, the new properties may not have as strong of dependence from nearby residents as the original properties.

If The Link REIT was able to hold onto its cash and wait for properties to be undervalued before pouncing, then that would make the business model great since it would give larger margins of safety in valuation (price paid) and evaluation (competitive advantage) of the new property. Now it just looks decent at best.

 

Why I think I’m taking too much risk

The quote from Charlie Munger to “Don’t go after large areas. Don’t try to figure out if Merck’s pipeline is better than Pfizers. It’s too hard. Go to where there are market inefficiencies. You need an edge. To succeed, you need to go where the competition is low. That’s the best advice I can give to small investors.” has been at the back of my mind consistently for quite some time.

The reason being I felt that I was going after large areas with my bet on The Link REIT, and that the odds weren’t stacked so favorable for me that it warranted an all in. The only realistic areas where I will have an edge would be to buy during a bear market where depressed prices offer huge margin of safety or illiquid markets where NCAV stocks exist.

Charlie Munger’s portfolio during his partnership days were very concentrated just because he only betted aggressively when the odds were ridiculously in his favor.

Reading a Quora answer recently on that one of the best advice to receive for poker beginners was to play Tight-Aggressive (only going in when you’ve got great hands, and aggressively pursuing the win once you’re in) reminded me of Charlie Munger’s quote once again and made me face reality.

I’m going to start reducing my portfolio’s weighting on The Link REIT by stop buying The Link REIT as soon as possible and sell it immediately afterwards. I will start transitioning into a pure NCAV stock strategy soon once I accumulate enough cash.

I’ll bet heavily when I actually have a ridiculous edge. For now, cash will do.

 

Great Company – The Link REIT (SEHK:823)

**I’ve changed my stance on The Link REIT since October 2nd 2014. You can read the reasons why by clicking here

Why I think The Link REIT is a “Great Company”

Benchmarked against these filters:

Favorable Long Term Economics & “Recession Proof” Company Products / Services: Control of majority of retail space and car park space situated strategically near dense residential areas covered by MTR stations that most ordinary Hong Kong folk can’t live without – 153 medium to lower tier shopping centres amounting to ~11 million square feet of retail space and ~80,000 car park spaces (as of August 8th 2014)

Able and Trustworthy Management: REIT structure that legally restricts The Link REIT from deviating from focusing on income-generating properties. Such strict monitoring enforces predictable and legal management behavior

“A business that any idiot can run” if the company can’t attract/retain great talent: It’s a simple system (buy medium to lower tier shopping centres / car park spaces -> renovate -> collect rent -> repeat) that must be screwed up really badly by idiots in order for it to die

What would cause The Link REIT to fall from “Great Company” status?

1. If The Link REIT sells its property

In the world of Investment Properties (“property (land and/or buildings) held to earn rentals or for capital appreciation (or both)“), if your main mode of income is rental income, your competitive advantage is measured upon how many strategic locations you can own and subsequently earn rent upon.

The only way you can get dislodged legally by competition is if your strategic locations aren’t strategic anymore (very rare, think of your city’s CBD district and see how frequently it changes places), or most importantly, if you decide to sell your strategic locations and risk never getting a chance to get back into those strategic locations. Property owners are legally allowed to not sell its property regardless of how ludicrously high the offer’s value is.

2. If The Link REIT loses its REIT status AND starts diversification away from core operations (eg. Investment Properties)

A simple definition but not entirely accurate definition of what a REIT is legally allowed to do is it can only take part in operations that focuses on income-generating properties. The legal structure forces The Link REIT to run it’s simple, boring but very effective system of “buy medium to lower tier shopping centres / car park spaces -> renovate -> collect rent -> repeat”.

If it loses its REIT status, it gives freedom to management to do basically whatever it deems is in the best interests of the company, which may end up not being the case if it starts diversifying into more sexy businesses that doesn’t increase its competitive advantage as time passes by and/or doesn’t as effectively generate returns for shareholders as boring alternatives (eg. think cyclical businesses like Hotels or Property Development).

I vastly prefer effective systems with sexy shareholder returns than sexy systems with ineffective shareholder returns.

I also purposefully stay away from Hotels, Property Developers or high-tier Investment Property companies because their businesses are highly affected based on the busts and booms of economic cycles and might possibly die during one of the busts. I’d only buy them for short term capital appreciation if there’s no great companies left to buy at discounted prices.

If The Link REIT thus strives to become or enter the fields of Hotels, Property Development and/or high-tier Investment Properties, they become a company that I purposefully wanted to stay away from in the first place.

What’s a “Great Company”?

Warren Buffett describes great companies as those that will “dominate their fields worldwide for an investment lifetime. Indeed their dominance will probably strengthen (over an investment lifetime)” in his 1996 Berkshire Hathaway’s Chairman’s Letter, companies that are worth owning for a full investment lifetime until the qualities that made the company an “Inevitable” deteriorates beyond repair. Of course, I don’t think an “Inevitable” has to dominate globally if all or a majority of its operations can be insurmountable locally (eg. Wells Fargo as of August 8th 2014).

It’s very easy to identify “Great Companies”, but rare to find “Great Companies” at discounted price.

The implications of both statements is that if you find a “Great Company” selling at discounted prices, get in as aggressively as possible because it will get priced way over-valued soon since most people can identify “Great Company” but can’t measure the intrinsic value properly.

An example would be Amazon (as of August 8th 2014), which only gets better and better at predicting what to cross-sell and up-sell with every further purchase done on Amazon which feeds data to its algorithms; everyone can see how it’s a great company that’s really hard to kill. However, it’s P/E ratio of 829.94 (as of August 8th 2014) means that if Amazon can 100% efficiently convert its earnings into book value and/or dividends and that earnings stayed the same forever, it would take 829.94 years for Amazon’s stock to repay its shareholders.

*Disclosure* I own stocks in The Link REIT (as of August 8th 2014)