Monday, March 30, 2009

The Oracle of Omaha Has Something To Say About Market Forecasting

"I am not in the business of predicting general stock market or business fluctuations. If you think I can do this (even Buffett cant do it!), or think it is essential (nobody can predict what the market will do especially in the short term and it is not important!) to an investment program, you should not be in the partnership."

We dont buy and sell stocks based upon what other people think the stock market is going to do (I never have an opinion) but rather upon what we think the company is going to do. The course of the stock market will determine, to a great degree, WHEN we will be right, but the ACCURACY of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on WHAT should happen, not on WHEN it should happen.

In our department store business I can say with considerable assurance that December will be better than July. (Notice how sophisticated I have already become about retailing.) What really counts is whether December is better than LAST December by a margin greater than our competitors' and what we are doing to set the stage for future Decembers (always try to widen your competitive advantage).

However, in our partnership business I not only cant say whether December will be better than July, but I cant even say that December wont produce a very large loss (investment in stocks and we cant control the stock prices). It sometimes does. Our investment are simply not aware that it takes 365-1/4 days for the earth to make it around the sun. Even worse, they are not aware that your celestial orientation (and that of IRS) requires that I report to you upon the conclusion of each orbit (the earth's - not ours). Therefore, we have to use a standard other than the calendar to measure our progress.

This yardstick is obviously the general experience in securities as measured by the Dow. We have a strong feeling that this competitor will do quite decently over a period of years (Christmas will come even if it's in July) and if we keep beating our competitor we, we will have to do something BETTER than "quite decently". It's something like a retailer measuring his sales gains and profit margins against Sears - beat them every year and somehow you'll see daylight.

Source: Buffett Partnership Limited - Letter to Partners - July 12, 1966

my views are highlighted

Friday, March 27, 2009

Market Forecasting Made Easy

Have you ever heard your friend or relative says, " This ABC stock (bought at RM1) will reach RM2 in 1-2 years time." Then have you ever wonder how they know that this ABC stock will go up in the future? Or they just pluck the figures from the tree?

Someone (lets call this someone Forecaster) told me last year that stock A, listed on Bursa Malaysia, will go up to RM2-3 in 2 years time, when it was selling at RM0.88. I asked "How do you know that?" Then Forecaster explained to me, "Based on technical analysis, I believe A will go up to RM2-3 in 2 years time." In my mind, I was thinking, "Wahh, looking at a chart can tell you about the future of the stock price, unbelievable! If that's the case, I better stop working and look at charts all day long to become rich faster."

Forecaster further explained to me that one reader in a blog also has the same thinking and is very confident with his forecast (this reader sounds like fortune teller)! After doing some fundamental analysis on stock A, I told Forecaster "This stock has poor fundamental - high debt ratio, making losses, inconsistent profits, poor management etc.. I think you shouldnt buy at first (thinking if directly asking him to sell will result to dissent)." But he argued and fought back, pouring more of his energy in protecting his selection of stock. Well, human behavior is like that, I didnt blame him. Maybe my way of explaining/advising was incorrect. Nobody like to be criticized or condemned, remember this.

It has been more than six months since Forecaster bought stock A. Today, it hovers around RM0.20 (-77%). The stock needs to increase more than 4 times its current level JUST to break even! And more than 10 times to reach RM2! Of course you can say short term performance is not important and you still have about 1.5 years to prove that you are right. But to HOPE for a company with POOR fundamental to increase 10 times in value is like a wishful thinking to win the Sport Toto 6/52 jackpot.

To choose the right stock to buy, technical analysis is not the way. Heed Warren Buffett advice, "I realised that technical analysis didnt work when I turned the chart upside down and didnt get a different answer." The next time before you decide to buy a stock, make sure you do your homework. Analyse the figures and facts of the company. You are not right because some important individuals agree with you. You are right because of your FACTS and REASONS.

Tuesday, March 24, 2009

Time To Buy Stocks?

Malaysians used to look at the indicators in the US market to determine whether their own market will go up or down. And it is considered a useful guide for many years due to the significant positive correlation between DowJones and KLCI. But that is not what I am going to discuss now.

The US market went up about 7% yesterday. Every investor and speculator, i believe, expect the local market to follow the huge rally in US (but of course not the same percentage point). KLCI up 2.5% yesterday. Today, maybe the market can go up much more, 3-4%?? I said "maybe" because I dont know whether the market will go up or down. Honestly, I also "think" it will go up (lol). The result? This morning the market went up 1.4%! I am right (proud?), so does everyone out there. So what?? Why should you be happy when the market goes up? Do you have any shares to sell? Then why so excited?

Time to ponder: "Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to BUY wisely when prices fall sharply and to SELL wisely when they advance a great deal." - Benjamin Graham

As a buyer, shouldnt you be excited when the market goes down? The low prices provide you the opportunity to buy more of the same stock. Just like shopping, you should buy more when there is SALES. Why are you not buying when you see - Sales!! Discount up to 90%!! 50% off !! 70% off !! In my opinion, the best time to buy stock is when the market goes DOWN, not UP. Like this, you can buy LOW and sell high; not buy HIGH, sell higher (or LOW)!

Time to ponder: "Our business is making excellent purchases - not making extraordinary sales." - Warren Buffett

In the first half, the market closed at 877.4, down 0.90 points or 0.1%. Now you should be happy if you dont have shares to sell.

Saturday, March 21, 2009

Things to Avoid in Stock Investing

My takes on THINGS TO AVOID in stock investing include:
  • Buy high, sell low @ Buy when everyone is buying and vice versa. Lets say you invest when KLCI is at 1,300 (even every coffeeshop aunty and uncle is actively buying stocks). Why not you buy when KLCI is at 800 (when the same group of people is inactive in the market)? Plus dont buy when stock price suddenly goes up a lot and sell when it goes down significantly. Nobody can predict short term stock price movements.
  • Averaging down even after the fundamentals of the company are deteriorating.
  • Listen to your broker or friends - decide for yourself, and dont blame others for your losses - because its your own action and money, not others.
  • Never cut loss - easier said than done, most investors just couldnt afford to cut loss. Set your cut loss price and just do it. Short term pain is better than long term pain.
  • Buy without target price in mind. You have to set your target price and sell some, if not all, when the stock price triggers your target price. Make sure your target price is way above the stock price, preferably above 100%. I am talking about long term investment, 5-10 years, not 6 or 12 months.

Recommended reading for weekend:

Seven pitfalls to avoid in stock investing

Mistake No. 1: Ignoring catalysts
According to Curtis, the No. 1 mistake is ignoring catalysts that drive companies’ earnings. He says proper valuation, calculating price/earnings (PE) ratios, and running cash-flow spreadsheets only provide half the picture when selecting a stock, as they merely depict where a company stands at that point in time and not, more importantly, where it is heading.

Therefore, in addition to a quantitative evaluation of a company, investors need to do a qualitative study to determine which catalysts will drive future earnings.

Take for example, Astro All Asia Networks plc. The counter, not unlike countless others, has been on a steady downtrend since January 2008.

It seemed to matter little that it was offering a dividend yield of some 7%, had cash of RM1.06bil and achieved record domestic subscriber base of 374,000 as of January this year.

While from a valuation perspective, one may deem the counter an attractive buy, but its share price kept falling. Why? Because investors were more concerned over its operations in Indonesia and the high provisions it has had to make. It recently announced a wider-than-expected loss of RM529mil for financial year ended Jan 31, 2009, largely due to losses from its Indonesian venture.

However, some analysts believe the company will return to the black in the current year (no further writedowns expected) and that it may declare higher dividends in the absence of any major capital expenditure requirement.

Mistake No. 2: Catching the falling knife
Buy when everyone is selling. That is easier said that done. Too often, investors buy in before all of the bad news is out, or before the stock stops its freefall.

“New lows in a company’s share price often beget further new lows, as investors see the shares dropping, they become disheartened and sell their shares. Waiting until the selling pressure has subsided is almost always your best bet to avoid getting cut on a falling-knife stock,” says Curtis.

In Malaysia, remember when crude palm oil prices were plunging alongside crude oil? Plantation heavyweights saw their share prices fall, which has yet to subside even now.

This time last year, Sime Darby Bhd was at RM9. Today, it hovers at RM5.55. Asiatic Bhd too was trading at RM7.40 a year ago while today it is RM4.04. IOI Corp Bhd has seen its share price drop from RM6.65 to RM3.82 on Thursday.

For investors who had started accumulating commodities or commodities-related stocks last October, they would have seen their portfolios dip by an average 30%.

For those who accumulated Resorts World Bhd last December, thinking its downside was close, especially since it hit its 52-week low of RM2.15 on Dec 12, how wrong they must have been.
The stock is now trading at its new low of RM1.92 despite its cash pile of RM4.55bil. It continues to be haunted by corporate governance and related-party transaction issues.

Looking purely at the historical PE ratio of a stock can be deceptive. More so when trying to buy a stock at its lowest historical PE. (imo, it is ok to buy a good stock at historical low PE, but it must comes with long term proven record of profitability. Why?? It is usual for every businesses, even good businesses, to experience hiccups in earnings for a year or two. And the future earnings of good businesses are going to be greater than before after a few tough years.)

“This is because if price is constant and earnings continue to drop, then the PE ratio will rise and distort the picture. You never know if you’re buying at the lowest price,” says a head of retail research at a local brokerage.

He says it is better to buy a stock when the related sector bottoms out.
“The way to gauge this point of inflection will be to compare the sectoral data with historicals during previous economic crisis,” he says.

Mistake No. 3: Failing to consider macroeconomic variables

Mistake No. 4: The issue with dilution

Another red flag to look out for are companies that issue millions of shares, hence causing a dilution in earnings per share.

Malayan Banking Bhd (Maybank) fell below RM4 on Monday, the first time in more than a decade, on concerns over its proposed RM6bil cash call and potential hefty impairment losses.
Following the announcement of a rights issue on Feb 24, the stock price has fallen 26% to RM3.98 from RM5.40.

Recall that Maybank has offered a rights issue of up to 2.2 billion new shares on the basis of nine-for-20.

The issue price for its proposed renounceable rights issue is fixed at RM2.74 per share, which represents a 34% discount to the theoretical ex-rights price of RM4.17 per share and a discount of 43% to the closing price of RM4.82 on Feb 24.

AmResearch says Maybank’s estimated earnings per share for the year ending June 30, 2010 will be diluted to 38 sen from 52.2 sen previously.

“The general perception of a company that raises capital during difficult times is that it is desperate and this will have a negative effect on its stock price,” says the retail head.
Curtin instead advises to try seeking companies that are repurchasing stock and, therefore, reducing the number of shares outstanding. This process not only increases earnings per share but also tells investors that the company feels there is no better investment than its own company at the moment.

Mistake No. 5: Not recognising seasonal fluctuations
Most sectors go through booms and bust. In other words, they are cyclical. Investors looking for stocks to buy, need to take into account the sectors that are at present in vogue.

For instance, would it be a good idea to invest in the semiconductor sector, knowing full well there’s a major slowdown in chip sales and a case of layoffs and inventory building up?

In the case of the retail and consumer sector, their sales go up and down depending on which part of the year it is. The year-end school holidays and festivities normally see sales picking up. At other times, sales are fairly staid.

Similarly, would it be wise to invest in a property company when the sector has gone through a five-year bull market, and will probably need to undergo a period of correction before it rises again?

“The fact is that many companies, such as retailers, go through boom-and-bust cycles year-in and year-out. Luckily, these cycles are fairly predictable, so do yourself a favour and look at a five-year chart before buying shares in a company,” says Curtis.

Mistake No. 6: Missing sector trends
While stocks can buck the larger trend, this behaviour usually occurs because there is some huge catalyst that propels the stock.

For the most part, companies trade in relative parity to their peers. This keeps the stock price movements within a trading band.

Let’s say an investor owns a banking stock in Malaysia. While Malaysian banks are not exposed to the huge debts and toxic assets of Citigroup, American International Group or Bank of America, Malaysian banks may likely be affected in a protracted downturn.

Not surprisingly, Public Bank Bhd, Maybank and Bumiputra-Commerce Holdings Bhd have come under heavy selling pressure on negative newsflow and a worsening economic outlook.

Financial valuations in Malaysia have pulled back substantially from a peak of 2.5 times price-to-book (P/B) in January 2008 versus 1.2 times P/B currently.

Hence, if other banks are experiencing certain negative perceptions or problems, most likely the Malaysian banks will also be affected. The same is true if the situation was reversed.

Mistake No. 7: Avoiding technical trends
Learning basic technical analysis can be very useful when deciding to take a position in a stock. For instance, would you bet heavily on stocks on Bursa Malaysia when the Dow Jones Industrial Average is trending down every day? Curtis says investors don’t have to be a chartist to be able to perform technical analysis.

“A simple graph depicting 50-day and 200-day moving averages as well as daily closing prices can give investors a good picture of where a stock is headed,” he says.

He advises investors to be wary of stocks that trade close to their average as it usually means it can sink even lower. The same can be said to the upside. Also, when volume trails off, so does the stock price.

“Sticking purely to fundamental analysis can be detrimental to one’s portfolio,” says the retail head.

He says technical analysis measures the real demand and supply for a particular stock. “It helps guide investors to determine the exit and entry points,” he says.

Can we use technical analysis to predict future stock price movements? Or technical analysis is just useless? More on my mistake using technical analysis in the next article.

Full article:

Thursday, March 19, 2009

Excerpts from Berkshire Hathaway Annual Report 1980

"The value to Berkshire Hathaway of retained earnings IS NOT determined by whether we own 100%, 50%, 20% or 1% of the businesses in which they reside. Rather, the value of those retained earnings is determined by the use to which they are put and the subsequent level of earnings produced by that usage. ....... If a tree grows in a forest partially owned by us, but we dont record the growth in our financial statement, we still own part of the tree."

"As we have noted, we evaluate single-year corporate performance by comparing operating earnings to shareholders' equity WITH securities valued at cost. Our long-term yardstick of performance, however, includes all capital gain or losses, realized or unrealized. We continue to achieve a long-term ROE that considerably EXCEEDS the average of our yearly returns. The major factor causing this pleasant result is a simple one: the retained earnings of those non-controlled holdings we discussed earlier have been translated into gains in market value."

"We believe that short-term forecasts of stock or bond prices are USELESS. The forecasts may tell you a great deal about the forecasters, they tell you NOTHING about the future."

Wednesday, March 18, 2009

Business Valuation and Mr. Market

According to Warren Buffett, you just need to learn two courses in business school.
1. How to Value A Business
2. How to Think About Mr. Market and How to Deal with the Volatility

So finance students, go and ask your lecturers on these subjects. If you cant get a good answer from your lecturer, then maybe you should change school. In my opinion, good lecturers seldom rely heavily on textbook, but more to his/her own real life experience.

Views on Risk
We learned in college that Beta is risk. But, Warren Buffett said Beta is not risk. Risk is not knowing what you are doing. If you can understand how a business works, then your risk will be lower and vice versa. Beta shows the volatility of a stock. The higher the beta, the more volative is the stock. But a high beta stock does not necessarily means that it is a risky stock. If a good company with proven long term record of profitability drops by 50%, does it meant that it is a high-risk stock and you should avoid it? But what if the company's future prospect remains intact - good to excellent? Maybe you can slowly accumulate at low levels? Dont let Mr. Market to decide for you, you must decide for yourself. Ask yourself why you invest at this price, write it down. You must be certain why you are paying this business for this price. Or else, dont buy.

If you really know how to value a business, then investing in stock market is good for you. Although historical financial performance of a company doesnt guarantee future performance, at least it acts as a good guide for business valuation. Absent the proven long term track record, how do you justify your investment? Investing is easy, but making money in stock market is not that simple. If you really want to make money by investing in stock market, you need to know something about the business that not everyone's know.
"There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time. No man can have adequate reasons for buying or selling stocks daily - or sufficient knowledge to make his play an intelligent play." - Jesse Livermore