2015

Rusmin from the Fifth Person did a great re-cap on the SGX (Singapore Stock Exchange) AGM 2015, which I was not around to attend this year.

SGX: 8 Things I Learned from its AGM 2015

I would like to talk briefly about his first point which I’ve reproduced here

SGX has a dual-role as a regulator which protects the interests of shareholders of publicly listed companies in Singapore and as a profit-driven enterprise that is held accountable to its own shareholders.

I’ve previously been critical of the failure for the authorities to protect minority shareholders. Investors in S-Chips have seen little recourse. The Blumont Saga has dragged on with little updates to minority shareholders.

Justice
Has Justice Been Served?

One of the few updates on it is a case involving Goldman Sachs, and Quah-Su Ling, CEO of IPCO who indirectly involved in the penny stock rout.

So imagine my horror when I read in the newspapers that the SGX was actively seeking more listings from Chinese firms. Considering the sad and sorry tale of financial and corporate fraud of Chinese firms listed overseas, this was depressing.

Still, its hard to blame the SGX, and Rusmin’s point highlights it:

The only stable recurring business for SGX is market data which contributes 10% of the revenue and corporate action services (i.e. processing dividends) which contributes 4.6% of revenue.

A lot of SGX’s revenue derives from activity. The same inherent problem with getting non-bias advice from a barber arises.

If you ask him whether you need a hair cut, what can he say?

SGX must perform its regulatory role, in protecting shareholders. And yet, if listing requirements are too strict, firms will find it increasingly harder to list, thereby reducing their own profits.

Who is going to complain?

The shareholders of the SGX board which are there for a profit sharing motive.

In a way, I pity the whoever takes the role of the CEO of the SGX. As Prof Mak Yuen Teen wrote in his article

A couple of years ago, I met the retired CEO of a listed stock exchange which, like SGX, has dual roles of a regulator and operator. I asked him whether he thought there was a conflict between the two roles.

He replied: “Of course there is, but I couldn’t say it when I was the CEO.”

I think the problem with the current situation is pretty clear.

What puzzles me more is why haven’t the authorities moved to rectify the situation by simply seperating the regulatory role of the SGX into an independent body.

After all, that’s the standard operating practise of most countries.

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I used to do these presentations regularly during my time in UCL (University College London). Its always great fun to share what I’ve learnt over the years. I get to review and re-look the concepts that deal I with daily.

 

Teaching has always been the best form of learning for me.

One of my favourite parts about these sharing sessions is the Q & A.

There’s a huge gap between theory and practise. Something which I struggled with when I first started too. I remember having an accounting related question on Free Cash Flow vs Owners Earnings that was unresolved for over two years.

I touched about how big that gap can be briefly in my podcast on the perils of index investing, and why its so hard.

You can check it out here:

One of the members of the audience had a great question which commonly comes up:

Is it better to buy cheap companies at good prices,
or wonderful companies at fair prices?

What Warren Buffett Thinks

He’s said this a number of times over the years in various interviews. Here’s the thing though.

I don’t think this is an end all be all statement that conclusively settles the debate. Let’s consider a few things:

  • Academic research shows that investors who invest in “wonderful companies” tend to under-perform “terrible value companies” 
  • Buffett’s track record running his investment partnership far exceeds his track record when he changed styles at Berkshire Hathaway in the last 2 decades
  • He has bought “cheap stocks” from time to time in his own personal account

I tend to find that wonderful companies are easy to spot. Markets tend to be very good at identifying such companies.

What they are not so good are at pricing them appropriately, and investors often end up paying too much for growth.

Not to mention that companies with true “competitive moats” are not easily identifiable.

The Only Thing That Is Constant Is Change

Industries change. Technology changes. What’s a moat might not be one 10 to 20 years from now. Buffett has invested in plenty of companies that have seen their moat being eroded over time.

That’s probably why Buffett tends to stick with things that tend to change glacially.

Like food & consumer products (Kraft, Gilette, Coca-Cola), transport (BNSF), and retail banking (not investment banking!) operations (Wells Fargo, Bank of America).

He’s gone out on a limb to say that he doesn’t invest in technological companies. IBM doesn’t count in my book. If you read his interviews, he tends to see it more as a service provider. But that’s a story for another day.

At the end of the day, I think the peril of investing like Buffett is that we are not Buffett.

He took decades before he slowly shifted to his current style of investing, has an unparalleled network, incredible intellect and a vast amount of knowledge accumulated from decades of non-stop reading.

So Why Does Buffett Buy Good Companies at Fair Prices?

My own opinion is that is a constraint he faces in his opportunity set. He has tens of billions to deploy, and billions more coming in yearly. A good problem surely, but his universe of stocks are limited to those in the S & P 500, and maybe some private companies.

Buying cheap stocks wouldn’t move the needle for him at all. 

His lack of investment opportunities at his size is really shows in his relative under-performance compared to his early days managing small sums of money.

Finally, I think there’s a huge distinction between buying a company and buying a stock. If I were a CEO, I wouldn’t want to buy a lousy run-down company too. Think about the headaches of turning it around.

But as the last post highlights, investing in stocks is very different from investing in a business.

Investing in “cheap cigar-butt stocks” might not be fanciful, but where they excel in are the relative ease in which a determined investor can succeed.

I had a nice chat with a fellow value investor in London who recorded his thoughts on the conversation, and kindly allowed me to reproduce it.

Lesson 4: “Mean Reversion”

againstthegods

Prices, in long-term, will return to their mean. This is also John Bogle’s way of looking at the market from a general picture point of view. Moreover, mean reversion will help the investor to identify possible bubbles-wild fluctuations of prices that tend to sky-rocket and then plummet back to earth to reflect a number closer to the real value of the company.

This does not mean that markets are rational.

It means that in long-term, it is the business value that wins and not the short-term market vicissitudes.

Lesson 5: “Free cash flow”

As a new and enthusiastic value investment scholar, I read most of the books on Warren Buffett. Consequently, I heard of a concept called ‘owner’s earning’. Mathematically, this concept is translated into net reported income plus depreciation, amortization and depletion (DAD) charges minus capital expenditure (that is capital that the company needs to stay in business).

Mr. Buffett explained that he uses this measure instead of free cash flow (FCF) because FCF is measured as net income plus DAD charges. However, this is non-sense as one must also account for the costs of doing business. However,

I knew that the free cash flow was defined as cash flow from operating activities minus capital expenditure. Peter Lynch, one of Fidelity’s star managers and a legendary value investor, also uses FCF as operating cash flow less capex. Therefore, confusing hit my mind and I asked Jun Hao if he can clarify this for me. He suggested to use Peter’s Lynch measure for simplicity’s sake.

However, he strongly recommended to measure the FCF for a period of at least 5 years in order to get a sense of how a business is doing: remember free cash flow is the amount of money you as a business owner are left with at the end of the financial year – you cannot pay your bills or buy new business with reported net income but with cash only!

Lesson 6: “Enterprise Value”

Jun Hao suggests that a more accurate way of ascertain the market value of a business is to look at its enterprise value (EV) instead of looking at its market capitalization. Market capitalization is the result of number of shares outstanding times the share price.

However, EV is calculated by adding the net debt to the market capitalization and subtracting the cash and cash equivalents from that number. EV is not to be used on its own: most investors use EV to EBITDA to compare firms with different degrees of financial leverage and to value capital-intensive businesses with high levels of depreciation and amortization.

Jun Hao also cautioned me that EV/EBITDA is not to be used alone but together with P/B, ROIC and FCF.

Lesson 7: “Recommended reading”

Of course, Jun Hao is a very well read individual and he was kind enough to suggest some of his most important books with me. The reading list is as follows: anything Howard Marks from Oaktree Capital Management writes, Bull by Maggie Mahar, Deep Value and Quantitative Value both by Tobias E. Carlisle and There’s Always Something to Do: The Peter Cundill Investment Approach by C. Risso-Gill.

Finally, Security Analysis by B. Graham is outdated. What? Yes, the Bible of investment is outdated: the principles within it were very, very relevant to a particular moment in time and were of immense help in a period of corporate governance and disclosure were a rare thing.

Nowadays, it is nearly impossible to find a company that ticks the boxes of Ben Graham. However, I recommend that the book is still relevant from a historical perspective: learn from history even if we, psychologically, are not programmed to do so – this is another key to long-term success.

I had a nice chat with a fellow value investor in London who recorded his thoughts on the conversation, and kindly allowed me to reproduce it.

Lesson 1: “There is no single way to invest”

This was not necessarily new information to me as I was aware that investment is a profession that results in success if it is combined with one’s personality and view of the world.

Moreover, if anyone interested in investment or finance ought to read books on names such as Charles Munger, Warren Buffett, George Soros, Peter Lynch, John Templeton and Guy Spier (to name a few ‘star’ investors) then it will be even more obvious that the way these people approached the investment profession was in a unique manner that reflects the way they are as persons: from a very philosophical approach taken by George Soros to a journey seeking method adopted by Guy Spier.

However, Jun Hao confirmed this for me: he made it clear that depending on your aim (stable income, capital preservation, etc.) and on how you see the business world (i.e. how pessimistic or optimistic you are about the future of the businesses that you read about) will determine, generally speaking, what kind of investor you will be.

Moreover, he suggested that in order to improve and regardless of what path one chooses to take, reading a wide variety of books, company reports and other materials is necessary – I could not agree more on this point: reading is one of the keys for life-long success.

Lesson 2: “The future is unknown”

Nothing surprising here – some might say that this is an obvious comment. And yet, so many of us tend to allow our emotions to control our faith in our convictions: I recommend to anyone reading this to buy and ready thoroughly Influence by P. Cialdini and Fooled by Randomness by Nassim N. Taleb.

These two books will clarify why we are prone to think that the past is a good base to measure the future and why we tend to overly accentuated our faith in statistics, numbers or any form of scientific information. However, Jun Hao explained to me very clear that industries fall and rise all the time: 15 years ago the planet Earth was running out of oil and we were thinking of exploring Mars for resources.

Today, we have so much oil that supply greatly exceeds demand. Moreover, demand for non-electric cars is increasing and the pace of electric cars to punch through the established market of automobiles is still not strong enough to offer a stable projection as to when in the future the majority of the world’s population will be driving electric vehicles: the future is unpredictable. Therefore, focus on the fundamentals of the business and not on market predictions.

Moreover, Jun Hao made it clear that it is important to make the difference between a good investment and a good business: a good business is not always a good investment and a good investment is not always a good business. For example, Jun Hao explained this situation using Tesla as a model. We both share immense admiration for Elon Musk and for his companies.

However, Tesla is hemorrhaging cash!

A quick look at the financial reports will reveal that cash from financing is consistently positive and that the company is losing money for each car it sells – this means that the company has been raising cash to stay out of liquidation. This achievement is attributed primarily to Mr. Musk’s salesmanship skills. However, despite the company’s noble aim and great skills of Mr. Musk, it makes little sense from an investor’s perspective to put any money in this company: a good business is not always a good investment.

Are Investors Financing Elon Musk’s Iron-Man Dream?

Lesson 3: “Emerging markets and information asymmetry”

The reason why emerging markets are an attractive prospect for investors is because more and more local investors have access to the market but they lack the necessary skills, information and experience to actually engage in a fruitful and productive manner in the stock buying and selling ‘dance’.

Consequently, there is high volatility and many, many mispriced companies. The US market at the moment is expensive because the interest rates are low and investors are overly optimistic about the US economy and market stability.

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It’s been an interesting week, with the elections in Singapore. I am pretty surprised by the extent of the results, with this election being the PAP’s strongest in more than a decade.

DPM Tharman (Finance Minister) had the best speech by fair explaining the economic reality of welfare spending. I really recommend it. Just simple facts and logic of the matter. Politics at its finest:

BBC’s Stephen Sackur gets sucker punched by DPM Tharman at St Gallen Symposium (LINK)

Sackur: Do you believe in the concept of a safety net?

Tharman: We believe in a concept of support for you (people) taking up opportunities. So we don’t have unemployment.

Sackur: I believe in the sometimes simplicity of yes-or-no answers. What about this idea of a safety net? Does Singapore believe in the notion of a safety net for those who fall between the cracks of a successful economy?

Tharman: I believe in the notion of a trampoline (A laughter and silence in the crowd for ten seconds).

Su-Ling (Former CEO of IPCO) v Goldman Sachs International (LINK)

Ever wondered what happen to the Blumont Saga? Well, the offical Singapore investigation isn’t out yet, but here’s a related case involving the CEO of IPCO who got “margin-called” by Goldman. Funnily enough, she happened to own all of the stocks involved in the penny chip rout.

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Singapore Stock-Trade Probe Seen as Test of Credibility (LINK)

Authorities widened the probe this week to include executives from at least four more companies six months after the rout that triggered a plunge of least 87 percent in the shares of Blumont Group Ltd, Asiasons Capital Ltd and LionGold Corp over three days last October.