Old Investing Advice Gems from Wallstraits days

[Temperament]

hi d.o.g. From the last paragraph, it seems that you calculate the margin of safety using some other valuation methods. Can I know what they are? Or are you now more actively managing your portfolios to reduce the conservative requirement of margin of safety?

To repeat myself:

"I only believe that, based on their track record, their current balance sheet and the price I am paying, my future investment results will at least be satisfactory."

This seems pretty self-explanatory and conservative to me. I'm not asking for the moon - as long as we do not encounter depression-type conditions, the companies I choose will do OK, and assuming I don't pay too much to buy in, I will do OK too.

I would like to know how do you determine at what price to buy if you do not do intrinsic value calculation through DCF?

Also, I believe DCF can be done on companies with predictable cash flow for the past 5-10 years. With such predictability, we can project the cash flow into the future to get the intrinsic value. Since we might not have perfect projections due to random errors, we use a margin of safety (I prefer MOS of at least 25% for stable companies). What's your take on this? Thanks.

I did not say I do not use DCF. It is merely one of the many tools available. A good carpenter carries a toolbox with many different tools to cope with different situations. A good investor should do no less. So he should be familiar with DCF, P/E, P/B, Dividend Yield etc.

In my own experience I have seldom found companies whose operations were stable enough to be DCF-able. I already mentioned the shipping trusts and KGT as examples of DCF-able securities. Most companies' cash flows are too unpredictable for DCF to be of any real use. The old Wallstraits members who subscribed to the Intellivest service saw in real time how most of the Intellivest portfolio companies did NOT live up to the expectations of the DCF analysis.

Use the right tool for the right job. As Charlie Munger has said, to a man with a hammer, everything looks like a nail. Sometimes the object in question IS a nail and the hammer works great. But many other times it isn't and the results are unlikely to be good. So don't be a man with a hammer (an investor who can only DCF) - carry a toolbox (learn to use many valuation methods).

I understand that DCF can't precisely calculate the present value of the company, but it does give some indication with certain assumption as long as the earning/cashflow is not too volatile.

Herein lies the HUGE caveat: "as long as the earning/cashflow is not too volatile". A random survey of say 30 companies over the last 5 years will make it abundantly clear that earnings and cashflow ARE very volatile. In other words the usability of DCF is more the exception than the rule.

DCF depends on the discount factor used, doesn't it. How does one arrive at what value to use?

Aha. You have found the devil in the details of DCF. In theory the discount factor is taken as a premium to the long-term government bond rate, on the basis that the long-term goverment bond represents a risk-free return and is therefore the floor in terms of required return. In practice the premium to be used varies wildly as different people ascribe different premia to country risk, business risk, forex risk, governance risk, commodity price risk, interest rate risk etc.

As a result you end up with "garbage in garbage out". With DCF and an arbitrary discount rate you can get any NPV you want. This leads to DCF being popular for (ab)use by consultants in M&A deals - if the buyer WANTS to buy, the consultant will obligingly project future cashflows optimistically and use a low discount rate so that NPV is very high and the purchase price looks like a discount.

"I only believe that, based on their track record, their current balance sheet and the price I am paying, my future investment results will at least be satisfactory."

I like the above saying very much. It looks quite simple and direct but it not easy to follow through- especially on the price i am paying.
Ha! HA!

[PassiveReturns]

Interesting but too complicated for me

[specuvestor]

My 2 cts worth in the discussion of DCF and discount factor

Required rate of return is probably the largest pitfall in forecasting as it is highly correlated with interest rate environment

Thats because it is academically intrinsically linked to what statistically historically the market is requiring for the listed stock. Loaded sentence but it also shows the problems involved. Historically equity returns has been 8-12% but volatile. The "genius" of Madoff was he offering 8% straight line for equity product.

Some people do the reverse by calculating what is market implied rate of return for the stock and see if that is reasonable

But value investors do know that it has to be MINIMUM the inflation rate. So most back of the envelope calculation is based on this premise (or they simply sum up the cashflows and use a simple discount) but more importantly is the MOS ascribed to the valuation which is an art cause it is a qualitative judgement based on the asset quality and industry certainty

Thats another reason why a sustained non volatile inflation is a key goal of modern central bank policy making

[investor101]

One of the things I remembered from the old WallStraits is the the 'sage' sometimes does not follow his own advice. Trades stocks instead of long-term investments.

But one of the good things about his website was that I stumbled upon 2nd Chance stock there and bought heavily into it. Made my money back a few years later from the annual dividends. Still vested.

[brattzz]

but if there is a clear chance of a money making trade, why not?

there's always % of opportunity funds for punts,

[CityFarmer]

but if there is a clear chance of a money making trade, why not?

there's always % of opportunity funds for punts,

I agree, but with a slightly different perspective.

The principle of value investing, is look for low risk value stock, and buy cheap. It doesn't say "must" hold long term. Long term holding is a mean, not the end

FYI, "arbitrage" deals are part of Mr. Buffett investing activities, during the time the AUM isn't as huge as current one.

[Musicwhiz]

I agree, but with a slightly different perspective.

The principle of value investing, is look for low risk value stock, and buy cheap. It doesn't say "must" hold long term. Long term holding is a mean, not the end

FYI, "arbitrage" deals are part of Mr. Buffett investing activities, during the time the AUM isn't as huge as current one.

I've been reading books on the concept of risk and also digesting Howard Marks and his "risk revisited" write-up. The irony is that when something is considered "risky", you may not necessarily get a better reward. If not, it will not be "risky" in the first place! So he argues that it is the expectation of higher rewards which makes people feel that something is more "risky". If you observe what most investors gravitate towards, it is the hot, new and hip industries or companies which can command the most attention (or eyeballs, in the case of the Internet). But the fact that everyone is chasing the same thing means that the potential returns are significantly diluted (due to unrealistic expectations creating an over-valued situation). Therefore, I'd argue that technically speaking, investments with low risk can only exist when the expectation of reward is low, and therefore this makes the investment "cheap". Neglected companies which are churning out good cashflows but which are "boring" seem to qualify.....

The thing about "long-term" is not just for the sake of holding it for a period of time to justify an investing "bent". Businesses take time to grow and prosper, and time is after all the friend of the great business and the enemy of the weak, so one has to hold an investment for a decent amount of time to be able to see the effects of compounding. Anything less would be speculative (as it would mean the multiple has expanded without an underlying growth in earnings - all that has changed as the expectations).

[money]

There are three broad areas where a company may allocate its capital:
1. Saving it to increase its financial security
2. Spending it on growth
3. Distributing it to shareholders as a reward

Past and present data has shown that Penguin has focused its resources on 1 and 2, which means very little left for 3. In other words, the lack of dividends is the price that shareholders are paying for growth and stability. Penguin is in growth mode because it is what Jeffrey Hing wants to do.

Some of the more adventurous companies sacrifice 1 to satisfy 2 and 3. And some do this aggressively by using loans.

I don't suppose there is a correct weightage of capital allocation to be followed -- there are pros and cons to over-weighting one rather than the other -- but it should be noted that there are implications for the decisions that management makes. For (prospective) shareholders of a particular company, being aware of how the company allocates its capital will give them a more realistic risk/reward expectation.

For Penguin shareholders, this means not expecting bumper special dividends -- even on good years -- for reasons mentioned. Though they are certainly welcome.

In any case, given the rather adequate level of management compensation in general, few SMEs have an interest in putting a high priority on rewarding shareholders. 

This is also the case at the individual level, where aspiring wealth accumulator promote a high saving rate, which is then used to purchase stocks for growing income/wealth. These people also eschew wasteful spending on items such as cars and gourmet coffee, which is the corporate equivalent of dividend distribution (money that you're not going to see again).

---

Although Penguin is likely to still be around in the next 10 years, the business -- and the value of the business -- of Penguin is not certain. So a shareholder could be holding the stock for 10 years, receive some small dividends along the way, and then see that the share price has not changed much. Or it could. I don't know.

SPH is another business that I think will still be around in the next 10 years. Vicom is yet another. But which of these will give the shareholder the greatest return? Being able to survive is only one of the many ingredients necessary for a good stock, and therefore does not entirely signal good returns. 

---

I have little to offer on the prospects of Penguin. But my thought on ship building is that it is a generally difficult business. 

On the demand side, there is no question that there will be demand for passenger ferries and mid-sized ships of varying industrial/military functions. The issue for Penguin is how much it can benefit from these demand. Over the past 10 years -- where there are both good and bad years -- the returns generated by Penguin does not seem compelling. Shareholders (and prospective shareholders) need to ask themselves why this is the case, and why the next 10 years will be any different.  

On the supply side, there is little in terms of product/technology differentiation, which makes the market very competitive. I suppose it is the same for building a house; I will choose the lowest cost bidder who can provide the highest quality. We can argue that Penguin produces ships of reliable quality, and its financial strength makes it an obvious choice for customers; both of which means Penguin may possess some edge over its competitors. But this does not mean that potential customers will not use competing bids to haggle for lower prices;  so Penguin is not immune to the effects of competition.

There is also the issue of the long-lead time from signing of order, building of vessel, and collection of payment upon delivery. Market conditions can change drastically between signing and delivery. Whether Penguin is protected from negative market conditions depends on the quality of customers it has, and the payment terms on contract. Are a large majority of Penguin's customers the Singapore government? If yes, cheers. If not, who are the larger customers, and what is their ability to pay on delivery?  On payment terms, how much deposit does Penguin require from its customers? And are they expected to pay progressively, along with the percentage of building completion? Certainly, different customers will get different terms. Perhaps some of the VBs here can shed some light on this.

Personally, I have no idea to the kind of customers and contracts that Penguin is exposed to, which means I am ignorant of material risks that they are exposed to. Since I have no idea on the material risks involved, it is not possible to determine whether the market price of Penguin is attractive. Insisting otherwise will be equivalent to me placing a bet on Fulham against an unknown opponent for a 2 to 1 payoff. Unless, of course, I am feeling particularly speculative, and wish to bet that improving stock market and business sentiments will lift its share price.

Personally, i prefer analysing businesses the way Karlmax does, but if Karlmax is at level 10, i am probably at level 2 or 3, still a long way to go.

Just want to add that the markets have an interesting way of deciding how high or low the stock should trade at. One should not ignore that with the numerous posts that highlight the positives, the stock may just shoot up without a change in the underlying business. It is easy to fall into the trap of taking all the positives as being true when the stock price is rising. (Bitcoin is the closest recent example, everything seems to make sense when bitcoin rises above 10k USD, even my close friend started entering the bitcoin market).The worst thing that can happen to any investor is to buy in when the promoters are selling, some promoters genuinely believe, but some are out to create a market to exit.

[karlmarx]

Personally, i prefer analysing businesses the way Karlmax does, but if Karlmax is at level 10, i am probably at level 2 or 3, still a long way to go.

Just want to add that the markets have an interesting way of deciding how high or low the stock should trade at. One should not ignore that with the numerous posts that highlight the positives, the stock may just shoot up without a change in the underlying business. It is easy to fall into the trap of taking all the positives as being true when the stock price is rising. (Bitcoin is the closest recent example, everything seems to make sense when bitcoin rises above 10k USD, even my close friend started entering the bitcoin market).The worst thing that can happen to any investor is to buy in when the promoters are selling, some promoters genuinely believe, but some are out to create a market to exit.

You give me too much credit. I am as much a journeyman as most buddies here.

In any case, analysis is only one part of investment success. I may suffer from poor investment returns, in spite of how well I may analyse. Financial capital/cash flow, desire to learn, ability to sit still (and not perform transactions unnecessarily), and independence of thought and actions, are probably some of the other parts.

[luckystar]

Personally, i prefer analysing businesses the way Karlmax does, but if Karlmax is at level 10, i am probably at level 2 or 3, still a long way to go.

Just want to add that the markets have an interesting way of deciding how high or low the stock should trade at. One should not ignore that with the numerous posts that highlight the positives, the stock may just shoot up without a change in the underlying business. It is easy to fall into the trap of taking all the positives as being true when the stock price is rising. (Bitcoin is the closest recent example, everything seems to make sense when bitcoin rises above 10k USD, even my close friend started entering the bitcoin market).The worst thing that can happen to any investor is to buy in when the promoters are selling, some promoters genuinely believe, but some are out to create a market to exit.

You give me too much credit. I am as much a journeyman as most buddies here.

In any case, analysis is only one part of investment success. I may suffer from poor investment returns, in spite of how well I may analyse. Financial capital/cash flow, desire to learn, ability to sit still (and not perform transactions unnecessarily), and independence of thought and actions, are probably some of the other parts.

Hi KarlMarx, you are the best. I hope you continue doing what you are doing. Your research is very in-depth and insightful. I have benefited a lot from reading your posts. I am sure many others do too. Well done!!!