In Search of Fair Value

One can get carried away when there are quite a few undervalued stocks after the recent market pullback. I certainly am not the only one who can see tremendous value in chinese stocks after it has been steadily declining since 2008. When it comes to stock picking, pick the winners or wonderful companies at fair value. Stay away from laggards at all cost. 
It is the perfect time to reflect on a wise saying:

It's Far Better to Buy a Wonderful Company at a Fair Price than a Fair Company at a Wonderful Price - Warren Buffett

Recently bought a piece of ChinaLife insurance, which is undervalued by the way. It is THE biggest life insurance companies in the world and i see great potential for it to grow in the near future as lower middle class people in China begin to be able to afford insurance policies. Another reason for investing in insurance is because of the nature of its business, which i like. Its the best kind of business after casino business because people will continue to pay you monthly until he/she reaches their retirement age of their policy lapses. Can i call it legalised "protection money"? However negative my viewpoint may be of this kind of business, i still acknowledge that the business model behind insurance companies has huge potential to make returns even during a market downturn. Therefore you many notice that insurance companies even if affected by market swings, are usually the first companies to bounce back. Anyway i am taking a long term view of China Life insurance and anything below HKD19/share is a fair value for a wonderful company. Below is the chart. I must say it is not the best technical analysis but i see strong support around HKD18, it keeps bouncing off around that price.

I should also give you example of a company i am staying away from. Petrobrasil (PBR) which recently broke through its lowest price of $13.50. I just dont know where the bottom is anymore because it is an great price for a company that is just not doing well. And if you look at the chart below from 2002, it seems the bottom was actually around US$3/share.

In terms of companies listed in SGX, HPH trust is still cheap because i see shipping business picking up rest of the year. And as talks between China and US to improve trade relations continue, trading volume will go up for the rest of this year. Take positions early and get out as soon as everyone else starts getting greedy. Because people are still fearful now, which tells me to do exactly the opposite. Also the VIX (volatility index) is going down, which if you already know indicates that we might see market uptrend soon.(below 15 is good, below 10 even better)

How much higher can S-REITs Go?

Recently I have been paying attention to Singapore REITs because i am invested in some of them for over a year. Having also taken profit too early on Suntec REIT, i wonder if I should have adjusted my exit strategy. 

Fellow blogger KFC1973-Stock wrote an article today: "REIT Sector Still outperform the benchmark"
 
If you read the article, S-REITs have beaten the broader market YTD and i believe it has been outperforming the benchmark for a couple of years now. This makes me worried, because i look at valuations, for me it is starting to get overvalued. One has to remember that during the 2008 crash, almost all REITs got slashed pretty badly (almost 60-80% for some). So definitely REITs are vulnerable to market crashes...no doubt!  

I suppose when looking at REITS, we value it based on dividend returns above price. Isnt that why people are still buying overvalued REITS because it still pays out more than 5% dividends?
REITs start to get unattractive as their dividend rate drops and this is inversely proportional to its market price. I would still HOLD onto several REITs because of their potential but I'll be out as soon as dividend rate drops below 4%. One more thing, very important... As soon as interest rates go up, its game over! Cost of borrowing goes up, dividend yields will drop. REITs will be in trouble.

Of course i regret selling First REIT and Suntec REIT too early. They are trading much higher then my profit taking target. Sigh*
In my portfolio, I consider Hospitality REITs one of the strongest in Singapore and i would hold on to them. Industrial REITs would be the first to go as soon as their dividend rate drops! Remember they were the worst affected during a market crash. Look at graph below from FSM; Pick up REITs when price is low, dividends are high. In 2009 average dividend yield from S REITs was super high!

Disclaimer: I have long positions in Far East Hospitality, Ascott Residence Trust, Cache Logistics, Sabana Shari'ah REIT. Please do your own due diligence before investing.
 

Tips to Identify Undervalued Stocks

How do we know which stocks are undervalued? 

I usually use these tips below to determine valuation to a certain degree:

1. Price-to-book < 1
2. Forward P/E < 15
3. Price/Free-cash-flow < 5
4. Decent EPS growth for the last 5 years
5. EPS forcast for next 5 years > 0%
6. Payout ratio is below 20%

Sometimes you can get all the information out there. Most commonly i use P/E ratio to judge whether the stock is being overbought or oversold. These values are usually available on the web, but if you are like me, you may build an excel spreadsheet to easily tabulate all the information using the simple equations below:

Price to book ratio = (Stock price)/(Total Assets - Intangible Assets & Liabilities)

 

Forward P/E = (Market Price per share)/(Expected earning per share)

 

EPS = (Net Income-Dividends on preferred stock)/(Average outstanding shares)

 

Payout Ratio= (Dividend per share)/(Earnings per share)

 

Over the last 2 years, I have learned how to value stocks properly without having to pay hundred of $$$ to financial courses. Anyone can learn how to do it for themselves!

 

Few tips To Investment Planning

Investing requires discipline and I cannot stress enough the need to stick to certain set of rules. Lets look at a couple of rules I have agreed to before I began investing. Rule Number 1: Make use of Compounding Compounding is vital to grow your investments over time and anybody can do it as long as you stick to the following principles. In order to compound successfully, you need perseverance, knowledge of how it works and most importantly TIME. One should have the understanding of how compounding actually works so that he/she can stick to a savings and investment plan. I put TIME in bold because unfortunately this is no get-rich-quick scheme, compounding works only through time. But there is a catch, you MUST keep your investment money aside, that means no spending it. Although it may be boring, for people with itchy fingers want to move money around to riskier investment vehicles, just endure until such time as to when you really need the money. It should get a little more interesting after 8 to 10 years of continuous, uninterrupted compounding. Let us look at a typical example i picked out from the internet, you can just google "power of compounding" and get so many examples.  But here's one from ICMARC website:  http://www.icmarc.com/Images/investments/COTW/20080328startsavingearly.gif For someone who starts contributing (annually $4k) into his retirement plan 10 years earlier can expect to compound at least twice the amount if he were to start contributing at a later time. Another study done by Market Logic in US, shows how compounding magic can happen even if you stop contributing on a yearly basis. Let us assume investor (B) opening a retirement fund at age 19. For 7 consecutive years, he contributes $2000  at an average growth rate of 10% (7% + interest). Then he stops putting anymore money into his retirement fund. A second investor (A) makes no contributions until the age of 26 (same age at which investor B stops contributing to his retirement fund) but investor A starts to diligently contribute $2000 annually until he is 65 years old. (assuming the same 10% growth rate. Look at the incredible results in the table below. Investor B ends up with higher return on investment (ROI) than A but he only contributed for 7 years (total: $14,000). Investor B on the other hand kept contributing $2000/year for 40 years. (total of 2000x40 = $80,000). The only difference being that B has had 7 more early years of compounding than A which were worth more than all of investor A's 33 additional contributions.

* If you are below the age of 25 and reading this, i urge you to go and start investing little by little in your own choice of blue-chip stocks. Its not too late for your kids too, I suggest starting early for your kids. It's a study which i wish i discovered earlier because i had a "poor dad" using the definition by Robert Kiyosaki in his popular book "Rich Dad, Poor Dad". Unfortunately my father did not feel that his kids needed to learn about money, he only taught us to save, get a good job and save some more. Having a saving plan running concurrently with your investment plan is very important too, but as a rule, i never keep more than 8 months living expenses in my bank account. Rule Number 2: Try Not to Lose Money This may sound funny to some but i think we should have the mentality of not losing money unnecessarily. If we want to preserve our capital and eventually grow it, we must aim not to lose big money. I have noticed that most people do end up losing money through gambling, ridiculous investment schemes, poorly executed business deals, greed and often times poor market timing. Over the years, there have been so many cases in Singapore where people lost money in the stock market, options, futures, in terrible loans, mindless gambling and in their own business. This rule may be simple, but we have to be disciplined in the way we spend our money and perform due dilligence enterning into any kind of investment. Rule Number 3: It takes Money to make Money  The wealthy investor has a major advantage over the smalltime amateur investor, they have the MONEY. One can argue that actually the wealthy investor does not need the market, somehow the market always moves in their favour. Understand the wealthy investor's mindset, he already has all the income he needs, not depending on the investment outcome, removing all emotions out of the equation. He probabaly has money invested in BONDS, Treasury-bills, Money market funds, Stocks, Real Estate and Other Business shareholdings. The wealthy investor is an expert is seeing VALUE. For example, he would invest in Bonds when its cheap and yields are high or move his money to Stocks when they are cheap with higher yields. With the ultimate goal of acquiring REAL ASSETS, eventually these investors buy real estate, physical gold, jewellery, expensive watches, diamonds and artwork; Things with great value. Another thing is when there is no opportunity presenting itself, they can afford to wait. We need to have patience. What about the little guy with little or no money? They feel pressurised to make money, or SAVE, SAVE, SAVE into a bank. This is madness at current interest rates less than 1%, being offered by banks. When the small investor is not buying overvalued stocks offerting 1-2% yields, he is off to gamble away his hard earned savings like buying lottery tickets or some ridiculous get-rich quick scheme. The small investor is always trying to force the market to do something for him, he is a guaranteed loser. Without understanding VALUES, he constantly overpays swayed by his/her emotions. I like this statement which i found on the internet : "He who understands interest - earns it. He who doesn't understand interest - pays it". The poor guy usually end up in huge debts, making payments on his house, electronic equipments (Thanks to COURTS easy installment plans), loses money gambling...in short always runs after money. So why is it that life is unfair, wealthy people always have the upper hand? I thought the poor always maintain a strict discipline of never overspending. Instead of taking his extra savings and compounding it in smart income producing securities, we always see them in debt. The usual answer is "I'm not making enough money". Although I symphathise on this situation, I know its possible to take two jobs, upgrade your skills, lower your monthly expenditure, do whatever it takes to work towards financial freedom. Be Positive. It makes alot of difference, both in one's mental attitude and in the way one actually handles one's money. Rule Number 4: Investment Value Usually I will suggest that one should stick to the basic compounding system and let it work over time. But if the opportunity arises when the market offer great value, Take it! [like post Dot.Com bubble (2001), Post-Subprime crisis (2008)] I would judge an investment to be of great value if it presents Lower Risk, Attractive Return(yield), Capital Appreciation. The key to making money is definitely to stay liquid, move your money from one market to another, follow the basic rule of buying undervalued investments.