(14-06-2016, 10:29 PM)Boon Wrote: Two interesting articles relevant to our discussions, I reckon.
_____________________________________________________________________________________________________________________ Spread Out Risk in Your Portfolio by Company, Not Country By CONRAD DE AENLLEOCT. 9, 2015 http://www.nytimes.com/2015/10/11/busine...untry.html
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Howard Marks' Take on Risk and Reward September 4, 2014 http://www.barrons.com/articles/SB518857...3277429272#
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There are true in the NY Times article, but not applicable to direct-selling market. One of the major risks of direct selling model, is regulation. Direct-selling model is highly regulated by different rules, and regulators in different countries.
I am a fan of Howard Marks'. I concur with his view, on "Unknowable Future" and the following statement
"We're talking about investors' opinions regarding future return, not facts. Risky investments are – by definition – far from certain to deliver on their promise of high returns."
Thus we need to factor in the unknown-able, and opinions, not facts on future return, into the company valuation.
(not vested, optimistic on company future, but not as optimistic as Boon's )
I think the value of HM's article is on how to cope with the "Unknownable Future", rather on the "Unknowable Future" itself.
On risk or uncertainty measuring, I think it is feasible to the extent that it is useful. One can measure whatever it is useful to measure, provided one can accept the need for subjective measures.
__________________________________________________________________________________________________________________ Coping with the Unknowable Future Here's the essential conundrum: investing requires us to decide how to position a portfolio for future developments, but the future isn't knowable. Taken to slightly greater detail: • Investing requires the taking of positions that will be affected by future developments. • The existence of negative possibilities surrounding those future developments presents risk. • Intelligent investors pursue prospective returns that they think compensate them for bearing the risk of negative future developments. • But future developments are unpredictable. How can investors deal with the limitations on their ability to know the future? The answer lies in the fact that not being able to know the future doesn't mean we can't deal with it. It's one thing to know what's going to happen and something very different to have a feeling for the range of possible outcomes and the likelihood of each one happening. Saying we can't do the former doesn't mean we can't do the latter. The information we're able to estimate – the list of events that might happen and how likely each one is – can be used to construct a probability distribution. Key point number one in this memo is that the future should be viewed not as a fixed outcome that's destined to happen and capable of being predicted, but as a range of possibilities and, hopefully on the basis of insight into their respective likelihoods, as a probability distribution. Since the future isn't fixed and future events can't be predicted, risk cannot be quantified with any precision. I made the point in Risk, and I want to emphasize it here, that risk estimation has to be the province of experienced experts, and their work product will by necessity be subjective, imprecise, and more qualitative than quantitative (even if it's expressed in numbers). There's little I believe in more than Albert Einstein's observation: "Not everything that counts can be counted, and not everything that can be counted counts." I'd rather have an order-of-magnitude approximation of risk from an expert than a precise figure from a highly educated statistician who knows less about the underlying investments. British philosopher and logician Carveth Read put it this way: "It is better to be vaguely right than exactly wrong." By the way, in my personal life I tend to incorporate another of Einstein's comments: "I never think of the future – it comes soon enough." We can't take that approach as investors, however. We have to think about the future. We just shouldn't accord too much significance to our opinions. We can't know what will happen. We can know something about the possible outcomes (and how likely they are). People who have more insight into these things than others are likely to make superior investors. As I said in the last paragraph of The Most Important Thing: Only investors with unusual insight can regularly divine the probability distribution that governs future events and sense when the potential returns compensate for the risks that lurk in the distribution's negative left-hand tail. In other words, in order to achieve superior results, an investor must be able – with some regularity – to find asymmetries: instances when the upside potential exceeds the downside risk. That's what successful investing is all about. ________________________________________________________________________________________
Research, research and research - Please do your own due diligence (DYODD) before you invest - Any reliance on my analysis is SOLELY at your own risk.
(15-06-2016, 11:28 AM)CityFarmer Wrote: Good article but what is the reality? I recalled, the recent financial crisis, is due to banking sector. Banking sectors are masters of risk management i.e. VAR. The banks were taking extra risks with "good" risk-reward positions with state-of-art risk management processes, but failed badly.
BP, is another good company, with comprehensive risk management processes, but we saw the "Deepwater Horizon Oil Spill" crisis, and a "91 percent decline in profit" due to oil slump recently
“To take on more risks in order to generate higher expected returns” is a strategy.
A strategy with high-expected returns generally requires the company to take on significant risks, and managing those risks is a key driver in capturing the potential gains.
I think we might have to look into the failure (or success) rate before concluding what the “true” reality is.
True, some banks did fail by taking on more credit risks but I think this has nothing to do with the tool.
In the case of GFC, credit risk was not the only causes – there were other risk factors such as liquidity risk, regulatory risk, systematic risk etc.
Under the worse case scenario of a negative risk event, if a bank could fail (due to cash flow or liquidity problem or losing all of the original investment) resulting from taking on more credit risks in search of higher returns, it actually means the bank had taken on more risks than it could actual handle.
In the case of BP, it accepted the high risks of drilling several miles below the surface of the Gulf of Mexico because of the high value of the oil and gas it hoped to extract” – I take that this was a success story.
Oil spill and oil slump were not the consequence of pursuing high returns/high risks policy.
True, risk is a function of “unknowable future”. Taking this into consideration, is it appropriate for BWI to pursue the strategy of taking on more “China concentration risk” in search of higher returns ?
To be continued.
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Research, research and research - Please do your own due diligence (DYODD) before you invest - Any reliance on my analysis is SOLELY at your own risk.
17-06-2016, 09:48 AM (This post was last modified: 17-06-2016, 11:13 AM by CityFarmer.)
I am interested to debate on HM's remarks. I concur on the following statement, which essentially a summary of the entire paragraph.
"The answer lies in the fact that not being able to know the future doesn't mean we can't deal with it. It's one thing to know what's going to happen and something very different to have a feeling for the range of possible outcomes and the likelihood of each one happening. Saying we can't do the former doesn't mean we can't do the latter."
The ways to deal with the "Unknowable Future", aren't new to us, as value investing followers. Be conservative in our valuation, buy with sufficient MOS, and be prepared for long-term holding. I still believe there are good hedge against it.
IMO, the company future sales in mid-term, will be volatile, due to the nature of its biz model, and especially so, with a high concentration with two markets. It is the difference between us. I have no intention to convince you, but to present an alternative view to our readers.
Diversity of views should always be welcome and encouraged at VB.
The risk and return profile of BWI as a business entity is not exactly the same as the risk and return profile of a stock portfolio with 100% holding in BWI, because there is an overlay of the “securities market” over it. Market inefficiency is another factor.
Managing BWI as a business and managing a stock portfolio with 100% holding in BWI call for completely different skill sets. These include risk management and risk diversification.
My alternative view or suggestion is: Try analyzing BWI, without the overlay.
In another words, do it from the perspective as if one is the management owner (not from the perspective of a portfolio manager who own the stocks) – especially in dealing with the issue of China concentration risk.
What is the possible maximum value at risk to BWI in a worse case scenario negative risk event in China?
Is the maximum value at risk quantifiable?
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Research, research and research - Please do your own due diligence (DYODD) before you invest - Any reliance on my analysis is SOLELY at your own risk.
The top 5 risks the company faces are identified below:
1) Advertisements that over promise product efficacy Distributors sometimes exaggerate the uses of our products, leading to regulatory intervention.Warnings or penalties might be issued to the company, causing reputation damage or monetary losses, affecting our profitability.The company only publishes product attributes that can be supported for each product on our website.Through trainings and interactions, we also remind our distributors not to over exaggerate about the product's efficacy and keep to the proven functions.
2) Disruption in supply Our head office supplies the regional centers with inventory.A forecast is prepared by the regional center to enable head office to determine how much should be ordered from the supplier. As these forecasts are based on estimates, the regional centers risk facing stock shortage when sales exceed their forecast. On the other hand, ordering too much result in higher storage costs and stock obsolescence.We regularly review sales forecasts, maintain buffer stocks and work with our suppliers to minimize disruptions.
3) Sudden discontinuation of key product
Although BWI has a wide range of products, a few products within the range form the major part of revenue. For example, Plum Delite and some products in the DR Secret range of skin care products are huge generators of revenue. Discontinuation of products can arise because of restrictions of certain product ingredients imposed by the authorities. These changes in regulations are not controllable by BWI and unfavorable changes can occur despite having met initial requirements.The product development team keeps track of regulatory requirements of the countries that the company operates in and consistently seeks to enlarge the product range to reduce reliance on any single product.
4) Political unrest
People are divided among the different political parties’ beliefs and a stable government cannot be established to effectively run the country.The army might get involved to temporary control the situation, but until a firm consensus is reached, the country remains unstable. Consumer spending retracts in anticipation of uncertainty to prepare themselves financially for the situation that lies ahead. Foreign investors halt their funds into the country and slow down economic progress.The fiscal policies of the incoming government cannot be determined, resulting in difficulty to position ourselves to benefit from future budget spend. As we are not in the position to influence political situations, we monitor such occurrences and react to them accordingly.
5) Changes in industry licensing requirements
Direct selling activities are usually subject to special licensing requirements in many countries. Any changes in regulations could result in termination or restriction of activities at our lifestyle centres.The impact of such an event is significant although it is not assessed to be likely.The continued operation of our manufacturing facility in BWZ is currently dependent on our GMP certification. Should there be any changes in requirements for example to certification standards, the company might have to incur additional costs to fulfil the authority's requirements.We monitor changes closely to ensure we are in compliance.
Research, research and research - Please do your own due diligence (DYODD) before you invest - Any reliance on my analysis is SOLELY at your own risk.
(17-06-2016, 09:08 PM)Jamesbond008 Wrote: Best World management is coming out to give a presentation to retail investors on 23rd June. Admission is FOC and got free food too.
Thanks for sharing. Just registered.
Just curious, where did you find the information? Couldn't locate it on Financial PR and Best World websites.
20-06-2016, 12:05 AM (This post was last modified: 20-06-2016, 07:59 AM by Boon.)
Country specific risk event like political unrest and change of regulation are risks BWI has to face.
Assuming this risk event would happen in country X (one of the 12 countries in which BWI is operating) at a future time Y.
X (which country?) is an unknown.
Y (when will it happen?) is an unknown.
Assuming further that:
“Z” = Initial investment (or capital) invested by BWI in country X.
“P” = Potential cumulative profit that could be made from now to time Y (i.e. before the risk event) in country X.
“Q” = Estimated permanent loss of potential “future” earning beyond time Y (i.e. after the risk event) in country X.
Under such a risk event, what is the possible maximum value at risk in country X to BWI as a group ?
The worse possible outcome would be permanent termination of all business activities in country X, which could lead to
A)Permanent loss of initial investment “Z” in country X.
B)Permanent loss of potential “future” earning “Q”, in country X.
Due to the nature of DS business model (asset-light, low initial investment costs, low fixed operating costs and high scalability), it takes very little initial investment (costs of setting up overseas office, regional centers and lifestyles centers) for BWI to set foot on a new market (or country).
(Note: in the case of China, additional investment in a GMP manufacturing plant is needed in order to be eligible to apply for a DS license).
After an initial gestation period, once the business has gain traction and become profitable, initial investment could be recouped fairly quickly. If it had not been recouped, its impact and significance is very small.
Hence, risk of permanent loss on initial investment or capital is very low.
How about value at risk on permanent loss of potential “future” earnings in country X, after the risk event?
“Future” earning is future profit yet to be earned. The probability or opportunity of earning this profit, after the risk event, is zero. Hence, does it make sense to talk about how big or small “Q” is ?
By pursuing higher returns (profit) by putting more “Z” at risk is a riskier proposition.
By trading higher returns with less “Z” (or no “Z” or after “Z” had been recouped) is a less risky proposition.
Logically, by trading higher returns with potential “future” earnings should considered to be the least risky proposition, IMO.
Hence, does it make any business sense to give up the pursuit for a bigger “P” NOW, in fear of loosing a bigger “Q” in the FUTURE?
Does it make any sense for one to be fearful over losing "Q", some future earnings that one has not yet earned and would never be able to earn, after the risk event ?
Window of opportunities to maximize “P” in any country exist only before a risk event. If one does not capitalize on it, it would be too late after the risk event.
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http://buffettfaq.com Question 45: Could you give us your definition of stock market risk Answer: We think first in terms of business risk. The key to Graham's approach to investing is not thinking of stocks as stocks or part of the stock market. Stocks are part of a business. People in this room own a piece of a business. If the business does well, they're going to do all right as long as long as they don't pay way too much to join in to that business. So we're thinking about business risk. Business risk can arise in various ways. It can arise from the capital structure. When somebody sticks a ton of debt into a business, if there's a hiccup in the business, then the lenders foreclose. It can come about by their nature--there are just certain businesses that are very risky. Back when there were more commercial aircraft manufacturers, Charlie and I would think of making a commercial airplane as a sort of bet-your-company risk because you would shell out hundreds and hundreds of millions of dollars before you really had customers, and then if you had a problem with the plane, the company could go. There are certain businesses that inherently, because of long lead time, because of heavy capital investment, basically have a lot of risk.Commodity businesses have a lot of risk unless you're a low-cost producer, because the low-cost producer can put you out of business. Our textile business was not the low-cost producer. We had fine management, everybody worked hard, we had cooperative unions, all kinds of things. But we weren't the low-cost producers so it was a risky business. The guy who could sell it cheaper than we could made it risky for us. We tend to go into businesses that are inherently low risk and are capitalized in a way that that low risk of the business is transformed into a low risk for the enterprise. The risk beyond that is that even though you identify such businesses, you pay too much for them. That risk is usually a risk of time rather than principal, unless you get into a really extravagant situation. Then the risk becomes the risk of you yourself--whether you can retain your belief in the real fundamentals of the business and not get too concerned about the stock market. The stock market is there to serve you and not to instruct you. That's a key to owning a good business and getting rid of the risk that would otherwise exist in the market. You mention volatility--it doesn't make any difference to us whether the volatility of the stock market is a half a percentage of a point a day, or a quarter percent a day, or five percent a day. In fact, we'd probably make a lot more money if volatility was higher because it would create more mistakes in the market. Volatility is a huge plus to the real investor. Ben Graham used the example of Mr. Market. Ben said that just imagine that when you bought a stock you in effect bought into a business where you have this obliging partner who comes around every day and offers you a price at which he'll either buy or sell and that price is identical. No one ever gets that in a private business, where daily you get a buy-sell offer by a party. But you get that in the stock market, and that's a huge advantage. And it's a bigger advantage if this partner of yours is a heavy-drinking manic depressive. (laughter) The crazier he is, the more money you're going to make. So, as an investor, you love volatility. Not if you're on margin, but if you're an investor you're not on margin, and if you're an investor you love to get these wild swings because it means more things are going to get mispriced. Actually, volatility in recent years has dampened from what it used to be. It looks bigger because people think in terms of Dow points, but volatility was much higher many years ago than it is now. The amplitude of the swings used to be really wild and that gave you more opportunity. Charlie? [CM: Well it came to be that corporate finance departments at universities developed the notion of risk-adjusted returns. My best advice to all of you would be to totally ignore this development. Risk had a very good colloquial meaning, meaning a substantial chance that something could go horribly wrong, and the finance professors sort of got volatility mixed up with a bunch of foolish mathematics and to me it's less rational than what we do. And I don't think we're going to change.] Finance departments believe that volatility equals risk. They want to measure risk, and they don't know how to do it, basically. So they said volatility measures risk. I've often used the example of the Washington Post's stock. When I first bought it in 1973 it had gone down almost 50%, from a valuation of the whole company of close to $170 million down to $80 million. Because it happened pretty fast, the beta of the stock had actually increased, and a professor would have told you that the company was more risky if you bought it for $80 million than if you bought it for $170 million. That's something I've thought about ever since they told me that 25 years ago and I still haven't figured it out. (laughter) •Source: BRK Annual Meeting 1997 •URL: •Time: May 1997 ------------------------------------------------------- One key aspect to risk is how long you expect to hold an investment, i.e., stock in Coca Cola might be very risky if bought for a day trade or to hold for only a week. But, over a 5 or 10 year period it probably has almost no risk at all. The myth that volatility of a stock somehow equates to risk was discussed. In fact, volatility often creates great opportunity, in Buffett's view. The following comments on risk in investments were in the 1993 Annual Report, on page 14: "Charlie and I decided long ago that in an investment lifetime it's just too hard to make hundreds of smart decisions. That judgment became ever more compelling as Berkshire's capital mushroomed and the universe of investments that could significantly affect our results shrank dramatically. Therefore, we adopted a strategy that required our being smart- and not too smart at that - only a very few times. Indeed, we'll now settle for one good idea a year. (Charlie says it's my turn.) The strategy we've adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as "the possibility of loss or injury". Academics, however, like to define investment "risk" differently, averring that it is the relative volatility of a stock or portfolio of stocks - that is, their volatility as compared to that of a large universe of stocks. Employing data bases and statistical skills, these academics compute with precision the "beta" of a stock - its relative volatility in the past - and then build arcane investment and capital-allocation theories around this calculation. In their hunger for a single statistic to measure risk, however, they forget a fundamental principle: It is better to be approximately right than precisely wrong". For owners of a business - and that's the way we think of shareholders - the academics' definition of risk is far off the mark, so much so that it produces absurdities. For example, under beta-based theory, a stock that has dropped very sharply compared to the market - as had Washington Post when we bought it in 1973 - becomes "riskier" at the lower price than it was at the higher price. Would that description have then made any sense to someone who was offered the entire company at a vastly-reduced price? •Source: BRK Annual Meeting 1994 •URL: •Time: May 1994 ------------------------------------------------------- "We regard using [a stock's] volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return. Some great businesses have very volatile returns -- for example, See's usually loses money in two quarters of each year -- and some terrible businesses can have steady results. [Munger: "How can professors spread this? I've been waiting for this craziness to end for decades. It's been dented, but it's still out there."] If someone starts talking to you about beta, zip up your pocketbook." •Source: BRK Annual Meeting 2001 •URL: •Time: April 2001 ------------------------------------------------------- We think the best way to minimize risk is to think. Our default is [to have our capital] in short-term instruments and only do something when it makes sense. •Source: BRK Annual Meeting 2004 Tilson Notes •URL: •Time: April 2004 ------------------------------------------------------- [RE: Beta] Volatility does not measure risk. The problem is that the people who have written about and taught volatility do not understand risk. Beta is nice and mathematical, but it’s wrong. Past volatility does not determine risk. Take farmland here in Nebraska: the price of land went from $2,000 to $600 per acre. The beta of farms went way up, so according to standard economic theory, I was taking more risk buying at $600. Most people would know that’s nonsense because farms aren’t traded. But stocks are traded and jiggle around and so people who study markets translate past volatility into all kinds of measures of risk. The whole concept of volatility is useful for people whose career is teaching, but useless to us. Risk comes from the nature of certain kinds of businesses by the simple economics of the business, and from not knowing what you’re doing. If you understand the economics and you know the people, then you’re not taking much risk. Munger: We’d argue that what’s taught is at least 50% twaddle, but these people have high IQs. We recognized early on that very smart people do very dumb things, and we wanted to know why and who, so we could avoid them. [Laughter] Buffett: We are willing to lose $6 billion in one catastrophe, but our insurance business over time is not very risky. If you own a roulette wheel, you sometimes have to pay 35-to-1, but that’s okay. We would love to own a lot of roulette wheels. •Source: BRK Annual Meeting 2007 Tilson Notes •URL: •Time: 2007
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Research, research and research - Please do your own due diligence (DYODD) before you invest - Any reliance on my analysis is SOLELY at your own risk.
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