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Found some stuff on my pc.
Couple of things.
1. I did not save who wrote what.
2. If there are any objections to this posting, please do remove (yes, you don't need my permission)
I just feel these are gems that should not be lost.
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http://www.wallstraits.com/community/vie...231&page=1
( don't bother clicking on the link.
)
Investment lessons learnt this year and advice for newbies
When I just started investing late last year, this was the first investment website I stumbed upon. I was greatly influenced by its FA bent and the eloquent arguments from fellow forummers.
I have some advice for newbies from personal experiences as a newbie.
There are certain practices advocated by FA proponents that newbies need to be careful of. (If you are a grandmaster like d.o.g or Sage, you can ignore the warnings below. I need your advice more than you need mine. This post is more for the benefit of newbies)
The first one is with regards to averaging down. FA proponents like to say when the share price of one of your holdings goes down, you should buy more because it has become cheaper. So, when prices are depressed, you should be happier because you can buy more of the same good thing more cheaply.
You could try that if you have sufficient grounds to be so confident of your investment. But if you are just starting out as a newbie like me, please cut your losses and don't compound your mistake. You make a purchase, the share price goes down -> probably you made a mistake. Who are you, little junior, to argue against the market? If you are a newbie, assume you are an idiot waiting to pay school fees and don't average down. Cut your losses!!
Perhaps the most valuable advice that I have received from FA proponents is to know your investments very well and avoid those which you only vaguely understand. If you know your investments with the depth that Warren Buffett has with his, then you can average down with less worry.
One of my mistakes was to make investments based on superficial understanding. True, I read prospectus, annual reports and even taught myself accounting so that I could understand financial reports better. Most of my investments were made based on favourable financial ratios without a deep understanding of the business nature. I did not try out the company's goods and services. I don't know if the company's customers, employees, suppliers are satisfied with it.
My main fault as a newbie was to be over-confident. I thought after reading and learning so much, I was ready. I thought I could be as good as the masters and followed one of their strategy -- concentrate your eggs in one basket and watch that basket carefully. Once again, I reiterate that such a strategy is meant for the masters. If you are an amatuer, it is safer to assume that you are an idiot and to protect yourself from stupidity, please diversify. By putting all your eggs in one basket, you may have fatally injured yourself by catching all the falling knives with one hand.
Some FA practitioners do not have a stop-loss policy. They use a similar argument - if a good thing becomes cheaper, I should buy more instead of selling it away.
The TA approach "Cut your losses and let your profits run" is worth considering. It is a safe way to protect your capital. Sell after your losses reach 10% of the intial capital outlay no matter what. After all, he who fights and runs away may live to fight another day. In fact, by adopting such an approach, you could protect yourself against CAO, Informatics and Auston.
Unfortunately, I did not follow the advice above. I waited until fundamentals have clearly decayed before thinking of selling. In the meantime, I continued to average down as the price slided down. When the financial report was out, fundamentals did look bad but ALAS!!, it is too painful to sell now.
This is one of the problems with FA. You can only make decisions an a quarterly or half-yearly basis which by then, the price may have slid to a psychological unacceptable level to sell.
FA proponents like to say making decisions based on price movement is nonsense. Say, the management has been trying to hide important fundamental data from the financial reports for as long as they can. The silent accomplices - auditors and independent directors - who are on their payroll prefer to close one eye or both eyes as long as they have ready excuses to plead ignorance and other disclaimers when the situation implodes.
The poor FA practioner will continue to average down, thinking that he is profiting at the expense of the foolish irrational market. Meanwhile, the insiders are selling the stock down to the sucker - that foolish guy averaging down.
In such a situation, the TA practioners will be safe. Having observed that the price has been in a downtrend caused by insiders selling down, they would have already sold out before the bombshell explodes. In the cases of CAO, Informatics and Auston, the price chart has shown an obvious downtrend before the explosive truth was out.
Are there any other advice and warnings fellow forummers can share with future newbies?
PS: I do not want to get into a TA vs FA debate. If any FA proponent thinks I am wrong, please point it out objectively without making personal remarks. I am still learning and am considering using a mixture of both FA and TA at the moment.
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I agree that averaging down is a scary thing. When you buy a stock like you buy a business (which means price is only one small component of your overall analysis) and the price falls-- what I do is ask myself "if the business is failing"? A falling stock price may be a sign of danger as other savvy investors see flaws with the business model, increasing competition (usually seen as narrowing profit margins), etc. Or, sometimes it is an over-reaction to what you believe is a temporary setback, like rising commodity prices.
If, after raising your skeptical antenna, you continue to believe your business is on track to continue its long term growth and build shareholder value... than the proper (if corageous) thing to do is buy more shares at the now more attractive price. After all, it is the same business you previously liked at a higher price.
If, on the other hand, your heightened skepticism results in some important questions needing answered-- maybe about intensifying competition or rising raw material costs-- you might want to sit back and wait and study further. But, cut loss on rumors and whims isn't likely to make you wealth. Often, you will be selling into weakness with the irrational crowd without confirming any business weaknesses. A cut-loss system, or any other system that doesn't require careful analysis and thought, is not very wise and not very FA-ish.
An example... Warren Buffett accumulated shares of the Washington Post during the 1970s recession, and bought more during a newspaper union employee strike. He saw these as temporary troubles, while others were cutting losses. He is now up more than 10-fold. He bought American Express during troubled times, he bought Geico Insurance when it was in trouble too. He looked at the falling share prices in each case, and decided to buy more, because he believed the businesses were sound and their troubles temporary. He was usually right.
Most important aspect of FA... be careful you only buy good businesses at fair prices (our 8-step screen, built on Mr. Buffett's wisdom). If you get this right, you eliminate most worries about cutting losses. Step 2... remember Ben Graham's advice... "Never buy a stock simply because it has risen sharply in price or sell one because it has fallen sharply in price. The opposite advice would be wiser."
Sage
My portfolio performance this year, based on paper losses, has caused great pain. What saved me from financial disaster was knowledge in Personal Finance.
The first book that a investing newbie should read should be in the area of Personal Finance, not investment or accounting. He should analyze his personal financial situation first before analyzing any companies.
In this regard, fellow forummer Dennis has done us a great favour by posting several useful articles on Personal Finance.
Allocating my savings into categories like investible funds (can be lost 100%) and emergency reserves (used in times of unemployment and unexpected medical fees) prevented me from recklessly averaging down as doing so will force me to dip into the emergency reserves.
Imagine someone who had not done a prior analysis of his personal situation and continued to pump in his savings as stocks become cheaper or simply to bet big to recover earlier losses. So what even if he turns out to be right? Before the stocks recovered, he might be forced to sell out at a loss if he suddenly needs money due to loss of job or health.
An investor should understand his personal finances better than the finances of any company that he invests in.
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I think the need for commonsense is the lesson that was drummed into me again this year. I began investing this year in the Singapore market, with the general idea that this was one way to try and gain exposure to the growth story in China. My first pick in the Singapore market was one highly recommended in these forums viz unifood, which promptly began its precipitous descent soon after I bought it - Murphy's law. While I think I had carried out appropriate due diligence on the stock before purchase, I overrode my commonsense caution in (a) purchasing against my contrarian instincts when the stock was more at a high than a low (and China stocks were the rage), and (b) continuing to average down on the basis of the stock's apparent cheapness on all metrics and latterly the expectation of a cyclical turnaround.
In other words I didn't factor in sufficiently the risks associated with "China" stocks and the requirement to get such stocks at very significantly cheaper prices than one would normally anticipate. And I disregarded commonsense largely entirely in building a more risky Chinese share unifood into a larger than appropriate proportion of my portifolio.
Of course no stock is guaranteed (the key rationale for some degree of diversification) and unifood's news went from bad to worse, and, in light of real concerns I now to have about the probity of management in light of recent developments, I have sold out of unifood at a significant loss. This will pull my portifolio performance this year into the red.
(This is not to state that unifood may not be a great performer over the next year or two, but I will probably not be going along for the ride!)
So - think for yourself - and use commonsense.
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here is the reply to the above posting:
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Hi Mug Punter,
I walked the same bloody path as you did this year. Not only that, I bought this pig on the high end of the trading range this year and refused to sell when it traded higher. I thought this pig was cheap even if it sold at $0.70. I don't think I was wrong if one is to consider the usual financial metrics for stock analysis.
I have done my fair share of homework. I have read its prospectus, annual reports and followed its announcements diligently. I even picked up accounting knowledge to understand financial reports better.
Despite its solid financial reports, there were indeed warning signs about United Food. I even related them to a close friend and yet I ignored it even when I could have sold this pig at a comfortable profit.
The warning signs were insider selling by multiple substantial shareholders of substantial portions of their shareholdings around the same period.
Although major shareholders can sell for whatever personal reasons, how can multiple shareholders have personal reasons to sell at around the same time? Also, each of them were selling significant portions of their shareholdings. Isn't it too coincidental that all of them need so much money at the same time?
Probably, it was something that these insiders know or going to do that prompted them to sell to suckers like me, for example.
I am still hammering myself for not selling(at a good profit) when I actually saw the warning signs.
Why didn't I sell then? For the same usual reasons that have been repeated throughout human history since time immemorial - overconfidence, greed, ego ...
More thoughts for newbies and others:
(a) Try not to invest in stocks with money you will need for lifestyle purposes. (I do not use my investment money for lifestyle costs at all and expect that to remain the case for the next 10 to 15 years; that way I am unaffected by considerations other than the merits of the particular stocks and markets).
(b) Use commonsense – for instance don’t put all your eggs in one basket (I once recall looking at the performance of a terrible fund manager, who’d lost 98% of his clients’ funds in the previous 5 years; unbelievably he had more than 80% of the little funds he had left – must have been an estate’s funds – tied up in one unproven technology stock). You must diversify to at least some extent. (I like to diversify inter alia through stocks in different countries and industries, some big cap some small cap. Although I have taken a real beating with unifood (down $20K) this year, my overall portfolio performance despite fairly aggressive investment is down around 7% in 2004 - a very poor result, but not a disaster).
© Do your own research – that way, if you know that a company has eg rock solid fundamentals you will not be shaken out of the stock if it unexpectedly falls in price. (I like to average down but must express caution in this regard – it is possible to increase your exposure to what may turn out to be a dud stock). Look at the stock firstly as a business of which you are (an admittedly limited) part owner.
(d) Be consistent and patient – what goes down usually comes up again (Again, that terrible fund manager had actually come at the top of the averages one year. China stocks were flavour of the month earlier, now they are out of favour. Their turn will come again. Hone a strategy that suits you and stick to it. (I am now inclined to an FA approach but using TA to determine exit and entry points, and relative market exposure). Don’t sell at the lows unless there is good reason. It often pays to be contrarian – often the best bargains are those stocks that nobody wants, the unloved. Train yourself to enjoy stock and market downturns. As Warren Buffett says, you will pay a high price for a cheery consensus).
(e) Some may disagree but I always like to be part cashed up – downturns are part of the scenery in investing and having cash enables you to take advantage of bargains as they arise.
(f) Most of all, investing should be fun – I don’t mean fun in the sense that it is a dilettante exercise, but rather fun in the sense that Warren Buffett (who despite his assertions works very hard) “tap dances to work every dayâ€. (That is not to say that one should get carried away by enthusiasm or despair - investing is best when rational and dispassionate). Enjoy this exciting game of investment. If your results this year were not too good, learn from your mistakes; you may have a bumper year next year.
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Hi teachme,
I like your objective self-assessment. Although I have much to learn about investing, the past 8 years have provided some useful experience for allocation of my funds.
Ever since I was legally able to buy stocks I have always invested a substantial portion of my money in the stock market (90% or more) and have always put money into a few stocks (even though I didn't know its called focused investing until recently).
One way I use to manage the allocation of my funds is to classify stocks into various categories:
- Cat 1: stocks which by the nature of their business, balance sheet & operating history give me full confidence in the company (eg. SIA, Robinsons)
- Cat 2: stocks which have strong balance sheets and results but which may not have a sufficiently long operating history or whose scale of operations is relatively small and hence do not warrant full confidence (eg. Aussino, Osim, Grandbanks Yatchs, TeleChoice)
- short term investments with limited downside risks (Osim's call option on Global Active is an example, with a potential gain of 10% in 2 mths)
When I identify an opportunity, I would classify them into one one of the above categories. For each category, I have established arbitrary maximum allocation limits (eg. 30% for Cat 1, 20% for cat 2 & 10% for cat 3).
If I identify a Cat 1 stock, instead of buying 30% at one go, I would buy say 20% and only if the stock price falls by 20% would I purchase the balance 10%.
In addition, if the stock continues to fall after I have acquired 30% and assuming this fall does not change my view of the stock I would not acquire any more shares, for the reason that taking too large a position in any company would constitute a gamble no matter how save I think the investment is.
The basic idea is that you do not want to be wiped out by any single decision and there should always be a limit to how much exposure we have to any company, no matter how save the investment appears or how low its price.
The limits used for the various categories can be modified to suit the individual investor's risk appetite and comfort level, eg. you may set a limit of 20% for Cat 1 stocks and acquire an initial stake of 15% and the balance of 5% if the stock falls substantially. Once the 20% is hit, acquire no more shares of that company.
Personally I would not allocate more than 10% of my portfolio to any one China stock. From fundamental anaylsis these companies appear to be cash-rich with strong growth potential.
But for many of us we have not even seen the products they manufacture. Nor do we understand the Chinese business environment the companies operate in. How then can we claim to have sufficient understanding of the company to justify a significant allocation of funds.
[ My comment: Another good advice! How well do we really understand the business of the company that we want to invest in? ]
In addition, much of these Chinese companies' cash is placed with state-owned banks which are technically insolvent (Golden Agri was a cash rich indonesian company that almost went bust because it deposited with a bank related to its parent co. which went bankrupt).
No doubt a few of the present crop of China stocks will prove to be great investments. But as far as investing in these companies is concerned, for the average S'porean investor, a diversification strategy is probably more sound than focus investing. If we are honest with ourselves, most of us do not really have a sufficient understanding of their business environment & pdts.
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here is a posting by d.o.g
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Investment Lessons Learnt This Past Year (2004)
As we begin a new year, perhaps we can all take a moment to look back at how our own investment skills have been enhanced over the past year. Doubtless there were many surprising developments in our respective portfolios, both pleasant and unpleasant. UOL and CAO are obvious examples of such unexpected developments.
While it's tempting to engage in mine-is-bigger-than-yours comparisons, I think it will be more meaningful for each of us to share what we learnt this past year, in investment terms, rather than relate our respective gains or losses for 2004.
Sharing knowledge enriches us all, while comparing portfolio returns will merely generate envy and resentment. I'm not ashamed of my 2004 returns, but putting up the numbers won't help anyone learn anything. (FWIW I ended 2004 in the black, though my returns were far behind what I got in 2003.)
Back to investment lessons:
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1. When fundamentals deteriorate, sell NOW. [ hear! hear!]
I had several holdings whose fundamental operations deteriorated significantly during the past year i.e. the negative events were not one-off in nature. That made their current prices unattractive from an investment viewpoint. Some holdings I sold as soon as I could, the others I held for a while before deciding to sell. In each case, I realized a net loss, but where I hesitated to sell, my eventual loss (in percentage terms) was larger.
So I've learnt, in a rather expensive way, that it's better to sell too early than too late.
2. The market leader is not always a good investment.
One of my holdings was the dominant player in its domestic market. However, the management expressed reluctance at the AGM to either gun for more market share at home, or to expand aggressively overseas. It preferred instead to maintain its market share while waiting for cheap overseas investment opportunities to come along.
Yet it seemed to me that it would only be a matter of time before foreign rivals would muscle in on its home turf. Without overseas operations to either counter-attack its rivals, or cross-subsidize a price war at home, there didn't seem to be much promise in its future.
(Building a castle and defending it with a big moat is all well and good, but without an army out there attacking rivals and capturing other castles, it's inevitable that eventually a big enough invasion force is going to show up, and then either destroy the castle utterly, or force it to surrender.)
Indeed, a foreign challenger had recently come ashore, and the management didn't seem to have any good answers at the AGM as to how they were going to fight it off.
The company was (and still is) well-capitalized, but I felt that its current conservative strategy did not augur for a prosperous long-term future. So I walked away. After factoring in dividends, I had eked out a small gain.
The lesson? Management at a leading company can get too comfortable.
3. AGMs and EGMs are a valuable source of information.
Though material information such as profit forecasts cannot be disclosed, it is possible to obtain an update on operations, especially with regards to seasonal trends and whether the outlook is good or difficult.
It is also the only time when investors will be able to ask the management questions face-to-face. There is a lot of difference between off-the-record answers given on the spot, and answers carefully prepared and sent via email.
In addition, one has the opportunity to listen to other investors who can also put forward questions that one has not thought of. There is no monopoly on investor intelligence; other investors can and do ask good questions. Of course, one must be patient - most of the questions asked are either irrelevant (share price) or redundant (already in the annual report).
The meetings I attended provided me with enough information to change my analysis of the companies. In most cases, I opted to change the level of my holdings, either selling out or buying more.
The bottomline: Take every opportunity given to talk directly to the management.
4. The margin of safety must be sufficient.
I learnt the hard way that the margin of safety can only be sufficient when there are multiple criteria for investment. An excellent profit margin, an efficient management, stupendous growth potential, a good dividend policy and a low price are individually insufficient to justify an investment decision. They should all be present to some degree, but more importantly, strength in one area cannot offset weakness in another.
It is difficult to make a good investment out of paying a high price for growth. Nor can efficient management replace a sound dividend policy, and certainly a low price is no panacea for a weak profit margin. Each investment criterion must in itself be satisfactory, and several should be more than satisfactory, before one can invest with the confidence that one's principal is appropriately protected, with a good potential for satisfactory returns.
I invested in a few holdings this year on the basis that cheap valuations, stable businesses and good dividend policies could offset low profit margins; this proved to be unsound, with each of these companies subsequently running into problems which severely eroded their earnings. Going forward, I no longer think it worthwhile to invest into a company that has a red flag or black mark in one or more investment criteria. There are many companies that do not exhibit these problems; why knowingly buy a flawed company?
(I must however acknowledge that "vulture investment" into distressed securities can be extremely profitable for the expert. But these constitute "special situations" and are not a part of normal investment activity.)
Key point: The margin of safety must be provided by multiple criteria.
Some investment thoughts [from 2004]:
1) When an industry is favourable and you want to invest in that industry, go for the stock that are market darlings/market leaders and avoid obscure stocks. The reason being since you are expecting favaurable news from that industry, it make sense to hold market darlings as good news will certainly move the hot stocks more than the obscure ones. Similarly, provided that valuations aren't too expensive, hot stocks may not fall as much as obscure stocks when bad news hit.
2) Whenever there is an insider, especially if it is the management, selling significant number of stocks, you should follow suit.
3) Set a stop loss limit and a time stop limit, whenever possible. Use stop loss limit to think over whether to carry on the investment. Use stop time limit to either set a fixed time for losing stocks to rise again, if you can't bear to sell, and if the losing stocks hasn't moved in that specific time, sell.
4) Don't diversify for the sake of diversification. If the added stock isn't at least as good as existing stock holdings, it may be better to add on to current stock holdings. Likewise, before adding a newly discovered stock, see whether if the new stock is better than your existing ones.
5) In the stock market, sometimes if you encounter something that is too good to be true, attack it from all angles to see whether it is really too good to be true. If it can withstand the attacks, quickly acquire significant portions of the stock.
6) If somebody offer a takeover offer for a value stock, it may be better to reject the offer and wait for the offer to end. Normally if the company is not delisted in the end, the share price often is higher than the takeover offer.
7) And lastly, due to personal impatience, it may be better to wait for a catalyst before buying to shorten the waiting time.
Excellent principle to base on when sharing investment lessons. It is most frustrating to learn that other people are blessed with the Midas touch (everything they buy turns to gold) while I am cursed with the Midget touch (everything I buy shrinks in size).
However, I am not afraid to tell everyone that I should be crowned Emperor Midget for FY2004 as simple psychology tells me that this is the best consolation that I can offer to those who lost money during this period. (When someone is down, a good way to console him is to tell him you are worse off than him).
Thank you d.o.g, LynchBuffetFisherGraham and many others for your valuable inputs.
When this thread was started, it had the intention of helping newbies to avoid getting hurt.
I think this is not possible. Investment is very much psychological. No books can tell you what investment styles suit your personality. You can read as much as you can, ask as many questions as you can from the gurus but since everyone's personality and ability differs, what they practise may not be suitable for you. Basically, a newbie will have to learn from the school of hard knocks to discover himself and fine-tune the style that fits him.
I guess it is best for the investing newbie to start young and start small. Sooner or later, he is going to lose $$$. That's when he learns what is suitable for himself and create an investment screening process of his own.
Excellent principle to base on when sharing investment lessons. It is most frustrating to learn that other people are blessed with the Midas touch (everything they buy turns to gold) while I am cursed with the Midget touch (everything I buy shrinks in size).
However, I am not afraid to tell everyone that I should be crowned Emperor Midget for FY2004 as simple psychology tells me that this is the best consolation that I can offer to those who lost money during this period. (When someone is down, a good way to console him is to tell him you are worse off than him).
Thank you d.o.g, LynchBuffetFisherGraham and many others for your valuable inputs.
When this thread was started, it had the intention of helping newbies to avoid getting hurt.
I think this is not possible. Investment is very much psychological. No books can tell you what investment styles suit your personality. You can read as much as you can, ask as many questions as you can from the gurus but since everyone's personality and ability differs, what they practise may not be suitable for you. Basically, a newbie will have to learn from the school of hard knocks to discover himself and fine-tune the style that fits him.
I guess it is best for the investing newbie to start young and start small. Sooner or later, he is going to lose $$$. That's when he learns what is suitable for himself and create an investment screening process of his own.
IMHO, analysis-wise, there are a few ways to score a multi-bagger:
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1. Fads. The company goes from undervalued to overvalued e.g. PE rises from 5 to 30. 6-bagger even without any change in operations. This can happen very rapidly and disappear equally rapidly. The current fad seems to be water. A couple of years back it was anything remotely Chinese. Right now in Hong Kong it seems to be casinos. Example fad stock: Hyflux.
2. Rapid growth. The company grows quickly. With good management and favorable industry conditions, this is quite possible. A sustained growth rate of 20% per year for 10 years would give a 5-bagger without changing PE. Example rapid growth stock: Venture.
3. Cyclical industries. Exemplified by steel, commodities, shipping, and semiconductors. All these are highly volatile, with the result that when times are bad, they are really bad, and when times are good, they are really good. The valuations tend to swing wildly also, with the result that it's possible to pick up sound companies cheaply when times are tough, and then unload them expensively when conditions are rosy and valuations are high. Example cyclical industry stock: Noble.
4. Turnaround stories. Companies that are on the brink of disaster often have either negative earnings or sky-high PEs due to miniscule earnings. Nobody wants to touch them with a ten-foot pole. But when things get straightened out, everybody wants back in. Example turnaround story: can't think of one, though Lindeteves-Jacoberg might be a future candidate if their current restructuring works out.
5. Asset plays. Companies undervalue their assets on their balance sheets for years, and nobody takes any notice. One day, a savvy corporate raider (like a certain Mr Oei) shows up and pushes for restructuring to unlock value. Example asset play: NatSteel.
Side notes:
I'd place NOL in the cyclical category, because NOL's woes weren't really solved by restructuring, but by an upturn in freight rates. To me, a turnaround story is one where the rest of the industry - except this particular company - is doing OK. Ford, for example, was a turnaround story at least twice, being saved by blockbuster products (Model A and Taurus) at a time when other automakers were doing fine and eating Ford's lunch.
I also placed Hyflux in the "fad" category because valuations have grown much faster than earnings. Certainly Hyflux could turn out to be a rapid growth story, but right now I think it may be more fad than fabulous.
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There are probably more methods, but that's all that comes to mind for now. What should be clear is that the 5 methods already described call for different types of analytical skills.
#1 and #3 are clearly dependent on market sentiment. Those who understand human psychology can probably put these methods to good advantage, getting in and out of the market as favorites change.
#2 is the "default" stock type; it typifies the company that most investors try to look for - a well-managed company in a growing industry.
#4 and #5 are "special situations" - they don't occur all the time, but when they do they can be very profitable. Much patience is needed, both to study the usually complicated situation and then come to a conclusion, as well as to wait for the expected developments to occur. Once they occur, though, there's little or no further profit to be had, and the investor has to exit and find a new target.
I admit I am terrible at #1 and #3. For #1, it makes me uncomfortable to gamble on being able to buy high and sell higher - the greater fool theory. For #3, I have very little knowledge of any specific industry, which means I have little sense of when the industry is going to go up or down. So I'm always afraid that I'm investing at the peak.
#4 requires an intimate understanding of both the business and the management's ability - not easy if you're not familiar with that industry. #5 looks like easy money - study the balance sheet, run the numbers, and wait. The problem: I'm too impatient (as others have noted *grin*).
That leaves me with #2 - trying to find a rapidly growing company. The problem: good companies in a sunrise industry are seldom sold at a reasonable price. So I guess that given my reluctance to overpay for quality, I won't be seeing too many multi-baggers in my lifetime. But that won't stop me from trying.
One has to balance Fisher: "buy, the price will look cheap in a few years" - against Graham: "buy cheap now, so that you won't lose much later". Fisher liked to compound a few holdings manyfold over several years. Graham preferred to compound many holdings 30-50% each, over 1-2 year periods per security.
I suppose in the end the decision will turn on how well you know/trust the company. If you can confidently predict where the company will be in several years, or fully believe the management, and work backwards from there, then an apparently high price today in terms of PE, P/NTA etc. would still be acceptable.
But if you do not have a deep understanding/trust in the company, then it would be prudent to apply a discount i.e. demand a lower relative valuation now so that a loss or dimunition of principal is unlikely even if your projections of the future are off. I prefer to err on the side of caution, so almost all my shareholdings are in low-PE type companies.
f. I prefer to err on the side of caution, so almost all my shareholdings are in low-PE type companies.
found an update on this posting...
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Here's one more: beware companies in cyclical industries. If you don't know when to get out, don't go in.
The rise and fall of HG Metal should be instructive. The full-year results show a stunning reversal of fortunes, from a $10.7m profit in 1H05 to a $5.1m loss in 2H05.
Why? Simple - the steelmaking industry is now in an overcapacity situation. In the past couple of years, steelmakers in China have been in a building frenzy. Result: the Chinese have basically finished their import-substitution for low- to mid-grade steel, and are now exporting their output. The result? Plunging steel prices. High-grade steel still retains a price premium, but for how long, nobody knows. Eventually the Chinese will also figure out how to make high-grade steel, and then it's another race to the bottom. I wonder if even Mittal Steel can deal with this, short of buying a steelmaker in China itself.
Anyone buying into HG Metal soon after IPO would have had a real roller-coaster ride. Such is the life of companies in commodities. It should be clear that investors in this type of companies would need, how should we say, nerves of steel (haha).
What lessons can we learn that are transferable i.e. not steel-related? Look at industries that use vast amounts of capital, have little/no pricing power and have a long lead time:
shipbuilding
property
oil refining
oil/gas exploration and production
industrial chemicals
railroads
and so on. Be very careful and study the industry properly before putting money in. Otherwise, if you enter at the wrong time, it's hard to get out with your capital intact. I'd add power generation/transmission to the list as well, but it's usually regulated so the cycle is largely invisible to investors.
Couple of things.
1. I did not save who wrote what.
2. If there are any objections to this posting, please do remove (yes, you don't need my permission)
I just feel these are gems that should not be lost.
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http://www.wallstraits.com/community/vie...231&page=1
( don't bother clicking on the link.
)Investment lessons learnt this year and advice for newbies
When I just started investing late last year, this was the first investment website I stumbed upon. I was greatly influenced by its FA bent and the eloquent arguments from fellow forummers.
I have some advice for newbies from personal experiences as a newbie.
There are certain practices advocated by FA proponents that newbies need to be careful of. (If you are a grandmaster like d.o.g or Sage, you can ignore the warnings below. I need your advice more than you need mine. This post is more for the benefit of newbies)
The first one is with regards to averaging down. FA proponents like to say when the share price of one of your holdings goes down, you should buy more because it has become cheaper. So, when prices are depressed, you should be happier because you can buy more of the same good thing more cheaply.
You could try that if you have sufficient grounds to be so confident of your investment. But if you are just starting out as a newbie like me, please cut your losses and don't compound your mistake. You make a purchase, the share price goes down -> probably you made a mistake. Who are you, little junior, to argue against the market? If you are a newbie, assume you are an idiot waiting to pay school fees and don't average down. Cut your losses!!
Perhaps the most valuable advice that I have received from FA proponents is to know your investments very well and avoid those which you only vaguely understand. If you know your investments with the depth that Warren Buffett has with his, then you can average down with less worry.
One of my mistakes was to make investments based on superficial understanding. True, I read prospectus, annual reports and even taught myself accounting so that I could understand financial reports better. Most of my investments were made based on favourable financial ratios without a deep understanding of the business nature. I did not try out the company's goods and services. I don't know if the company's customers, employees, suppliers are satisfied with it.
My main fault as a newbie was to be over-confident. I thought after reading and learning so much, I was ready. I thought I could be as good as the masters and followed one of their strategy -- concentrate your eggs in one basket and watch that basket carefully. Once again, I reiterate that such a strategy is meant for the masters. If you are an amatuer, it is safer to assume that you are an idiot and to protect yourself from stupidity, please diversify. By putting all your eggs in one basket, you may have fatally injured yourself by catching all the falling knives with one hand.
Some FA practitioners do not have a stop-loss policy. They use a similar argument - if a good thing becomes cheaper, I should buy more instead of selling it away.
The TA approach "Cut your losses and let your profits run" is worth considering. It is a safe way to protect your capital. Sell after your losses reach 10% of the intial capital outlay no matter what. After all, he who fights and runs away may live to fight another day. In fact, by adopting such an approach, you could protect yourself against CAO, Informatics and Auston.
Unfortunately, I did not follow the advice above. I waited until fundamentals have clearly decayed before thinking of selling. In the meantime, I continued to average down as the price slided down. When the financial report was out, fundamentals did look bad but ALAS!!, it is too painful to sell now.
This is one of the problems with FA. You can only make decisions an a quarterly or half-yearly basis which by then, the price may have slid to a psychological unacceptable level to sell.
FA proponents like to say making decisions based on price movement is nonsense. Say, the management has been trying to hide important fundamental data from the financial reports for as long as they can. The silent accomplices - auditors and independent directors - who are on their payroll prefer to close one eye or both eyes as long as they have ready excuses to plead ignorance and other disclaimers when the situation implodes.
The poor FA practioner will continue to average down, thinking that he is profiting at the expense of the foolish irrational market. Meanwhile, the insiders are selling the stock down to the sucker - that foolish guy averaging down.
In such a situation, the TA practioners will be safe. Having observed that the price has been in a downtrend caused by insiders selling down, they would have already sold out before the bombshell explodes. In the cases of CAO, Informatics and Auston, the price chart has shown an obvious downtrend before the explosive truth was out.
Are there any other advice and warnings fellow forummers can share with future newbies?
PS: I do not want to get into a TA vs FA debate. If any FA proponent thinks I am wrong, please point it out objectively without making personal remarks. I am still learning and am considering using a mixture of both FA and TA at the moment.
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I agree that averaging down is a scary thing. When you buy a stock like you buy a business (which means price is only one small component of your overall analysis) and the price falls-- what I do is ask myself "if the business is failing"? A falling stock price may be a sign of danger as other savvy investors see flaws with the business model, increasing competition (usually seen as narrowing profit margins), etc. Or, sometimes it is an over-reaction to what you believe is a temporary setback, like rising commodity prices.
If, after raising your skeptical antenna, you continue to believe your business is on track to continue its long term growth and build shareholder value... than the proper (if corageous) thing to do is buy more shares at the now more attractive price. After all, it is the same business you previously liked at a higher price.
If, on the other hand, your heightened skepticism results in some important questions needing answered-- maybe about intensifying competition or rising raw material costs-- you might want to sit back and wait and study further. But, cut loss on rumors and whims isn't likely to make you wealth. Often, you will be selling into weakness with the irrational crowd without confirming any business weaknesses. A cut-loss system, or any other system that doesn't require careful analysis and thought, is not very wise and not very FA-ish.
An example... Warren Buffett accumulated shares of the Washington Post during the 1970s recession, and bought more during a newspaper union employee strike. He saw these as temporary troubles, while others were cutting losses. He is now up more than 10-fold. He bought American Express during troubled times, he bought Geico Insurance when it was in trouble too. He looked at the falling share prices in each case, and decided to buy more, because he believed the businesses were sound and their troubles temporary. He was usually right.
Most important aspect of FA... be careful you only buy good businesses at fair prices (our 8-step screen, built on Mr. Buffett's wisdom). If you get this right, you eliminate most worries about cutting losses. Step 2... remember Ben Graham's advice... "Never buy a stock simply because it has risen sharply in price or sell one because it has fallen sharply in price. The opposite advice would be wiser."
Sage
My portfolio performance this year, based on paper losses, has caused great pain. What saved me from financial disaster was knowledge in Personal Finance.
The first book that a investing newbie should read should be in the area of Personal Finance, not investment or accounting. He should analyze his personal financial situation first before analyzing any companies.
In this regard, fellow forummer Dennis has done us a great favour by posting several useful articles on Personal Finance.
Allocating my savings into categories like investible funds (can be lost 100%) and emergency reserves (used in times of unemployment and unexpected medical fees) prevented me from recklessly averaging down as doing so will force me to dip into the emergency reserves.
Imagine someone who had not done a prior analysis of his personal situation and continued to pump in his savings as stocks become cheaper or simply to bet big to recover earlier losses. So what even if he turns out to be right? Before the stocks recovered, he might be forced to sell out at a loss if he suddenly needs money due to loss of job or health.
An investor should understand his personal finances better than the finances of any company that he invests in.
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I think the need for commonsense is the lesson that was drummed into me again this year. I began investing this year in the Singapore market, with the general idea that this was one way to try and gain exposure to the growth story in China. My first pick in the Singapore market was one highly recommended in these forums viz unifood, which promptly began its precipitous descent soon after I bought it - Murphy's law. While I think I had carried out appropriate due diligence on the stock before purchase, I overrode my commonsense caution in (a) purchasing against my contrarian instincts when the stock was more at a high than a low (and China stocks were the rage), and (b) continuing to average down on the basis of the stock's apparent cheapness on all metrics and latterly the expectation of a cyclical turnaround.
In other words I didn't factor in sufficiently the risks associated with "China" stocks and the requirement to get such stocks at very significantly cheaper prices than one would normally anticipate. And I disregarded commonsense largely entirely in building a more risky Chinese share unifood into a larger than appropriate proportion of my portifolio.
Of course no stock is guaranteed (the key rationale for some degree of diversification) and unifood's news went from bad to worse, and, in light of real concerns I now to have about the probity of management in light of recent developments, I have sold out of unifood at a significant loss. This will pull my portifolio performance this year into the red.
(This is not to state that unifood may not be a great performer over the next year or two, but I will probably not be going along for the ride!)
So - think for yourself - and use commonsense.
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here is the reply to the above posting:
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Hi Mug Punter,
I walked the same bloody path as you did this year. Not only that, I bought this pig on the high end of the trading range this year and refused to sell when it traded higher. I thought this pig was cheap even if it sold at $0.70. I don't think I was wrong if one is to consider the usual financial metrics for stock analysis.
I have done my fair share of homework. I have read its prospectus, annual reports and followed its announcements diligently. I even picked up accounting knowledge to understand financial reports better.
Despite its solid financial reports, there were indeed warning signs about United Food. I even related them to a close friend and yet I ignored it even when I could have sold this pig at a comfortable profit.
The warning signs were insider selling by multiple substantial shareholders of substantial portions of their shareholdings around the same period.
Although major shareholders can sell for whatever personal reasons, how can multiple shareholders have personal reasons to sell at around the same time? Also, each of them were selling significant portions of their shareholdings. Isn't it too coincidental that all of them need so much money at the same time?
Probably, it was something that these insiders know or going to do that prompted them to sell to suckers like me, for example.
I am still hammering myself for not selling(at a good profit) when I actually saw the warning signs.
Why didn't I sell then? For the same usual reasons that have been repeated throughout human history since time immemorial - overconfidence, greed, ego ...
More thoughts for newbies and others:
(a) Try not to invest in stocks with money you will need for lifestyle purposes. (I do not use my investment money for lifestyle costs at all and expect that to remain the case for the next 10 to 15 years; that way I am unaffected by considerations other than the merits of the particular stocks and markets).
(b) Use commonsense – for instance don’t put all your eggs in one basket (I once recall looking at the performance of a terrible fund manager, who’d lost 98% of his clients’ funds in the previous 5 years; unbelievably he had more than 80% of the little funds he had left – must have been an estate’s funds – tied up in one unproven technology stock). You must diversify to at least some extent. (I like to diversify inter alia through stocks in different countries and industries, some big cap some small cap. Although I have taken a real beating with unifood (down $20K) this year, my overall portfolio performance despite fairly aggressive investment is down around 7% in 2004 - a very poor result, but not a disaster).
© Do your own research – that way, if you know that a company has eg rock solid fundamentals you will not be shaken out of the stock if it unexpectedly falls in price. (I like to average down but must express caution in this regard – it is possible to increase your exposure to what may turn out to be a dud stock). Look at the stock firstly as a business of which you are (an admittedly limited) part owner.
(d) Be consistent and patient – what goes down usually comes up again (Again, that terrible fund manager had actually come at the top of the averages one year. China stocks were flavour of the month earlier, now they are out of favour. Their turn will come again. Hone a strategy that suits you and stick to it. (I am now inclined to an FA approach but using TA to determine exit and entry points, and relative market exposure). Don’t sell at the lows unless there is good reason. It often pays to be contrarian – often the best bargains are those stocks that nobody wants, the unloved. Train yourself to enjoy stock and market downturns. As Warren Buffett says, you will pay a high price for a cheery consensus).
(e) Some may disagree but I always like to be part cashed up – downturns are part of the scenery in investing and having cash enables you to take advantage of bargains as they arise.
(f) Most of all, investing should be fun – I don’t mean fun in the sense that it is a dilettante exercise, but rather fun in the sense that Warren Buffett (who despite his assertions works very hard) “tap dances to work every dayâ€. (That is not to say that one should get carried away by enthusiasm or despair - investing is best when rational and dispassionate). Enjoy this exciting game of investment. If your results this year were not too good, learn from your mistakes; you may have a bumper year next year.
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Hi teachme,
I like your objective self-assessment. Although I have much to learn about investing, the past 8 years have provided some useful experience for allocation of my funds.
Ever since I was legally able to buy stocks I have always invested a substantial portion of my money in the stock market (90% or more) and have always put money into a few stocks (even though I didn't know its called focused investing until recently).
One way I use to manage the allocation of my funds is to classify stocks into various categories:
- Cat 1: stocks which by the nature of their business, balance sheet & operating history give me full confidence in the company (eg. SIA, Robinsons)
- Cat 2: stocks which have strong balance sheets and results but which may not have a sufficiently long operating history or whose scale of operations is relatively small and hence do not warrant full confidence (eg. Aussino, Osim, Grandbanks Yatchs, TeleChoice)
- short term investments with limited downside risks (Osim's call option on Global Active is an example, with a potential gain of 10% in 2 mths)
When I identify an opportunity, I would classify them into one one of the above categories. For each category, I have established arbitrary maximum allocation limits (eg. 30% for Cat 1, 20% for cat 2 & 10% for cat 3).
If I identify a Cat 1 stock, instead of buying 30% at one go, I would buy say 20% and only if the stock price falls by 20% would I purchase the balance 10%.
In addition, if the stock continues to fall after I have acquired 30% and assuming this fall does not change my view of the stock I would not acquire any more shares, for the reason that taking too large a position in any company would constitute a gamble no matter how save I think the investment is.
The basic idea is that you do not want to be wiped out by any single decision and there should always be a limit to how much exposure we have to any company, no matter how save the investment appears or how low its price.
The limits used for the various categories can be modified to suit the individual investor's risk appetite and comfort level, eg. you may set a limit of 20% for Cat 1 stocks and acquire an initial stake of 15% and the balance of 5% if the stock falls substantially. Once the 20% is hit, acquire no more shares of that company.
Personally I would not allocate more than 10% of my portfolio to any one China stock. From fundamental anaylsis these companies appear to be cash-rich with strong growth potential.
But for many of us we have not even seen the products they manufacture. Nor do we understand the Chinese business environment the companies operate in. How then can we claim to have sufficient understanding of the company to justify a significant allocation of funds.
[ My comment: Another good advice! How well do we really understand the business of the company that we want to invest in? ]
In addition, much of these Chinese companies' cash is placed with state-owned banks which are technically insolvent (Golden Agri was a cash rich indonesian company that almost went bust because it deposited with a bank related to its parent co. which went bankrupt).
No doubt a few of the present crop of China stocks will prove to be great investments. But as far as investing in these companies is concerned, for the average S'porean investor, a diversification strategy is probably more sound than focus investing. If we are honest with ourselves, most of us do not really have a sufficient understanding of their business environment & pdts.
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here is a posting by d.o.g
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Investment Lessons Learnt This Past Year (2004)
As we begin a new year, perhaps we can all take a moment to look back at how our own investment skills have been enhanced over the past year. Doubtless there were many surprising developments in our respective portfolios, both pleasant and unpleasant. UOL and CAO are obvious examples of such unexpected developments.
While it's tempting to engage in mine-is-bigger-than-yours comparisons, I think it will be more meaningful for each of us to share what we learnt this past year, in investment terms, rather than relate our respective gains or losses for 2004.
Sharing knowledge enriches us all, while comparing portfolio returns will merely generate envy and resentment. I'm not ashamed of my 2004 returns, but putting up the numbers won't help anyone learn anything. (FWIW I ended 2004 in the black, though my returns were far behind what I got in 2003.)
Back to investment lessons:
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1. When fundamentals deteriorate, sell NOW. [ hear! hear!]
I had several holdings whose fundamental operations deteriorated significantly during the past year i.e. the negative events were not one-off in nature. That made their current prices unattractive from an investment viewpoint. Some holdings I sold as soon as I could, the others I held for a while before deciding to sell. In each case, I realized a net loss, but where I hesitated to sell, my eventual loss (in percentage terms) was larger.
So I've learnt, in a rather expensive way, that it's better to sell too early than too late.
2. The market leader is not always a good investment.
One of my holdings was the dominant player in its domestic market. However, the management expressed reluctance at the AGM to either gun for more market share at home, or to expand aggressively overseas. It preferred instead to maintain its market share while waiting for cheap overseas investment opportunities to come along.
Yet it seemed to me that it would only be a matter of time before foreign rivals would muscle in on its home turf. Without overseas operations to either counter-attack its rivals, or cross-subsidize a price war at home, there didn't seem to be much promise in its future.
(Building a castle and defending it with a big moat is all well and good, but without an army out there attacking rivals and capturing other castles, it's inevitable that eventually a big enough invasion force is going to show up, and then either destroy the castle utterly, or force it to surrender.)
Indeed, a foreign challenger had recently come ashore, and the management didn't seem to have any good answers at the AGM as to how they were going to fight it off.
The company was (and still is) well-capitalized, but I felt that its current conservative strategy did not augur for a prosperous long-term future. So I walked away. After factoring in dividends, I had eked out a small gain.
The lesson? Management at a leading company can get too comfortable.
3. AGMs and EGMs are a valuable source of information.
Though material information such as profit forecasts cannot be disclosed, it is possible to obtain an update on operations, especially with regards to seasonal trends and whether the outlook is good or difficult.
It is also the only time when investors will be able to ask the management questions face-to-face. There is a lot of difference between off-the-record answers given on the spot, and answers carefully prepared and sent via email.
In addition, one has the opportunity to listen to other investors who can also put forward questions that one has not thought of. There is no monopoly on investor intelligence; other investors can and do ask good questions. Of course, one must be patient - most of the questions asked are either irrelevant (share price) or redundant (already in the annual report).
The meetings I attended provided me with enough information to change my analysis of the companies. In most cases, I opted to change the level of my holdings, either selling out or buying more.
The bottomline: Take every opportunity given to talk directly to the management.
4. The margin of safety must be sufficient.
I learnt the hard way that the margin of safety can only be sufficient when there are multiple criteria for investment. An excellent profit margin, an efficient management, stupendous growth potential, a good dividend policy and a low price are individually insufficient to justify an investment decision. They should all be present to some degree, but more importantly, strength in one area cannot offset weakness in another.
It is difficult to make a good investment out of paying a high price for growth. Nor can efficient management replace a sound dividend policy, and certainly a low price is no panacea for a weak profit margin. Each investment criterion must in itself be satisfactory, and several should be more than satisfactory, before one can invest with the confidence that one's principal is appropriately protected, with a good potential for satisfactory returns.
I invested in a few holdings this year on the basis that cheap valuations, stable businesses and good dividend policies could offset low profit margins; this proved to be unsound, with each of these companies subsequently running into problems which severely eroded their earnings. Going forward, I no longer think it worthwhile to invest into a company that has a red flag or black mark in one or more investment criteria. There are many companies that do not exhibit these problems; why knowingly buy a flawed company?
(I must however acknowledge that "vulture investment" into distressed securities can be extremely profitable for the expert. But these constitute "special situations" and are not a part of normal investment activity.)
Key point: The margin of safety must be provided by multiple criteria.
Some investment thoughts [from 2004]:
1) When an industry is favourable and you want to invest in that industry, go for the stock that are market darlings/market leaders and avoid obscure stocks. The reason being since you are expecting favaurable news from that industry, it make sense to hold market darlings as good news will certainly move the hot stocks more than the obscure ones. Similarly, provided that valuations aren't too expensive, hot stocks may not fall as much as obscure stocks when bad news hit.
2) Whenever there is an insider, especially if it is the management, selling significant number of stocks, you should follow suit.
3) Set a stop loss limit and a time stop limit, whenever possible. Use stop loss limit to think over whether to carry on the investment. Use stop time limit to either set a fixed time for losing stocks to rise again, if you can't bear to sell, and if the losing stocks hasn't moved in that specific time, sell.
4) Don't diversify for the sake of diversification. If the added stock isn't at least as good as existing stock holdings, it may be better to add on to current stock holdings. Likewise, before adding a newly discovered stock, see whether if the new stock is better than your existing ones.
5) In the stock market, sometimes if you encounter something that is too good to be true, attack it from all angles to see whether it is really too good to be true. If it can withstand the attacks, quickly acquire significant portions of the stock.
6) If somebody offer a takeover offer for a value stock, it may be better to reject the offer and wait for the offer to end. Normally if the company is not delisted in the end, the share price often is higher than the takeover offer.
7) And lastly, due to personal impatience, it may be better to wait for a catalyst before buying to shorten the waiting time.
Excellent principle to base on when sharing investment lessons. It is most frustrating to learn that other people are blessed with the Midas touch (everything they buy turns to gold) while I am cursed with the Midget touch (everything I buy shrinks in size).
However, I am not afraid to tell everyone that I should be crowned Emperor Midget for FY2004 as simple psychology tells me that this is the best consolation that I can offer to those who lost money during this period. (When someone is down, a good way to console him is to tell him you are worse off than him).
Thank you d.o.g, LynchBuffetFisherGraham and many others for your valuable inputs.
When this thread was started, it had the intention of helping newbies to avoid getting hurt.
I think this is not possible. Investment is very much psychological. No books can tell you what investment styles suit your personality. You can read as much as you can, ask as many questions as you can from the gurus but since everyone's personality and ability differs, what they practise may not be suitable for you. Basically, a newbie will have to learn from the school of hard knocks to discover himself and fine-tune the style that fits him.
I guess it is best for the investing newbie to start young and start small. Sooner or later, he is going to lose $$$. That's when he learns what is suitable for himself and create an investment screening process of his own.
Excellent principle to base on when sharing investment lessons. It is most frustrating to learn that other people are blessed with the Midas touch (everything they buy turns to gold) while I am cursed with the Midget touch (everything I buy shrinks in size).
However, I am not afraid to tell everyone that I should be crowned Emperor Midget for FY2004 as simple psychology tells me that this is the best consolation that I can offer to those who lost money during this period. (When someone is down, a good way to console him is to tell him you are worse off than him).
Thank you d.o.g, LynchBuffetFisherGraham and many others for your valuable inputs.
When this thread was started, it had the intention of helping newbies to avoid getting hurt.
I think this is not possible. Investment is very much psychological. No books can tell you what investment styles suit your personality. You can read as much as you can, ask as many questions as you can from the gurus but since everyone's personality and ability differs, what they practise may not be suitable for you. Basically, a newbie will have to learn from the school of hard knocks to discover himself and fine-tune the style that fits him.
I guess it is best for the investing newbie to start young and start small. Sooner or later, he is going to lose $$$. That's when he learns what is suitable for himself and create an investment screening process of his own.
IMHO, analysis-wise, there are a few ways to score a multi-bagger:
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1. Fads. The company goes from undervalued to overvalued e.g. PE rises from 5 to 30. 6-bagger even without any change in operations. This can happen very rapidly and disappear equally rapidly. The current fad seems to be water. A couple of years back it was anything remotely Chinese. Right now in Hong Kong it seems to be casinos. Example fad stock: Hyflux.
2. Rapid growth. The company grows quickly. With good management and favorable industry conditions, this is quite possible. A sustained growth rate of 20% per year for 10 years would give a 5-bagger without changing PE. Example rapid growth stock: Venture.
3. Cyclical industries. Exemplified by steel, commodities, shipping, and semiconductors. All these are highly volatile, with the result that when times are bad, they are really bad, and when times are good, they are really good. The valuations tend to swing wildly also, with the result that it's possible to pick up sound companies cheaply when times are tough, and then unload them expensively when conditions are rosy and valuations are high. Example cyclical industry stock: Noble.
4. Turnaround stories. Companies that are on the brink of disaster often have either negative earnings or sky-high PEs due to miniscule earnings. Nobody wants to touch them with a ten-foot pole. But when things get straightened out, everybody wants back in. Example turnaround story: can't think of one, though Lindeteves-Jacoberg might be a future candidate if their current restructuring works out.
5. Asset plays. Companies undervalue their assets on their balance sheets for years, and nobody takes any notice. One day, a savvy corporate raider (like a certain Mr Oei) shows up and pushes for restructuring to unlock value. Example asset play: NatSteel.
Side notes:
I'd place NOL in the cyclical category, because NOL's woes weren't really solved by restructuring, but by an upturn in freight rates. To me, a turnaround story is one where the rest of the industry - except this particular company - is doing OK. Ford, for example, was a turnaround story at least twice, being saved by blockbuster products (Model A and Taurus) at a time when other automakers were doing fine and eating Ford's lunch.
I also placed Hyflux in the "fad" category because valuations have grown much faster than earnings. Certainly Hyflux could turn out to be a rapid growth story, but right now I think it may be more fad than fabulous.
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There are probably more methods, but that's all that comes to mind for now. What should be clear is that the 5 methods already described call for different types of analytical skills.
#1 and #3 are clearly dependent on market sentiment. Those who understand human psychology can probably put these methods to good advantage, getting in and out of the market as favorites change.
#2 is the "default" stock type; it typifies the company that most investors try to look for - a well-managed company in a growing industry.
#4 and #5 are "special situations" - they don't occur all the time, but when they do they can be very profitable. Much patience is needed, both to study the usually complicated situation and then come to a conclusion, as well as to wait for the expected developments to occur. Once they occur, though, there's little or no further profit to be had, and the investor has to exit and find a new target.
I admit I am terrible at #1 and #3. For #1, it makes me uncomfortable to gamble on being able to buy high and sell higher - the greater fool theory. For #3, I have very little knowledge of any specific industry, which means I have little sense of when the industry is going to go up or down. So I'm always afraid that I'm investing at the peak.
#4 requires an intimate understanding of both the business and the management's ability - not easy if you're not familiar with that industry. #5 looks like easy money - study the balance sheet, run the numbers, and wait. The problem: I'm too impatient (as others have noted *grin*).
That leaves me with #2 - trying to find a rapidly growing company. The problem: good companies in a sunrise industry are seldom sold at a reasonable price. So I guess that given my reluctance to overpay for quality, I won't be seeing too many multi-baggers in my lifetime. But that won't stop me from trying.
One has to balance Fisher: "buy, the price will look cheap in a few years" - against Graham: "buy cheap now, so that you won't lose much later". Fisher liked to compound a few holdings manyfold over several years. Graham preferred to compound many holdings 30-50% each, over 1-2 year periods per security.
I suppose in the end the decision will turn on how well you know/trust the company. If you can confidently predict where the company will be in several years, or fully believe the management, and work backwards from there, then an apparently high price today in terms of PE, P/NTA etc. would still be acceptable.
But if you do not have a deep understanding/trust in the company, then it would be prudent to apply a discount i.e. demand a lower relative valuation now so that a loss or dimunition of principal is unlikely even if your projections of the future are off. I prefer to err on the side of caution, so almost all my shareholdings are in low-PE type companies.
f. I prefer to err on the side of caution, so almost all my shareholdings are in low-PE type companies.
found an update on this posting...
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Here's one more: beware companies in cyclical industries. If you don't know when to get out, don't go in.
The rise and fall of HG Metal should be instructive. The full-year results show a stunning reversal of fortunes, from a $10.7m profit in 1H05 to a $5.1m loss in 2H05.
Why? Simple - the steelmaking industry is now in an overcapacity situation. In the past couple of years, steelmakers in China have been in a building frenzy. Result: the Chinese have basically finished their import-substitution for low- to mid-grade steel, and are now exporting their output. The result? Plunging steel prices. High-grade steel still retains a price premium, but for how long, nobody knows. Eventually the Chinese will also figure out how to make high-grade steel, and then it's another race to the bottom. I wonder if even Mittal Steel can deal with this, short of buying a steelmaker in China itself.
Anyone buying into HG Metal soon after IPO would have had a real roller-coaster ride. Such is the life of companies in commodities. It should be clear that investors in this type of companies would need, how should we say, nerves of steel (haha).
What lessons can we learn that are transferable i.e. not steel-related? Look at industries that use vast amounts of capital, have little/no pricing power and have a long lead time:
shipbuilding
property
oil refining
oil/gas exploration and production
industrial chemicals
railroads
and so on. Be very careful and study the industry properly before putting money in. Otherwise, if you enter at the wrong time, it's hard to get out with your capital intact. I'd add power generation/transmission to the list as well, but it's usually regulated so the cycle is largely invisible to investors.
