Sound Investment

BRING ON THE BEARS

Since March 2013, the Dow has hit numerous all-time highs. But on December 20, it did something it had never done before. It hit an all-time high in inflation-adjusted terms.

The Dow has recovered from the Internet bubble, 9/11, the Enron scandal, the housing bubble and the global financial crisis.

Are we just lucky? Hardly. Most investors don't understand the incredible resilience of equities

Imagine, for instance, that you invested equal amounts in the U.S. stock market, the British stock market, the German stock market and the Japanese stock market on the eve of World War II.

Thirty years later the returns on your Japanese and German stocks were virtually the same as the performance of your American and British stocks, even though Japan and Germany suffered national devastation and near-total economic collapse. (For the full story, read Jeremy Siegel's Stocks for the Long Run.)

How can this be? Here's the basic formula: All people have economic needs: food, shelter, clothing, healthcare and so on. Business owners, venture capitalists and public shareholders are motivated by rational self-interest to meet those needs.

The private sector promises that you can have anything you want if you just provide enough other people with what they want. What a beautiful system.

After the Crisis

When the recent financial crisis hit, business managers took the appropriate actions. They laid off unnecessary personnel. They cut discretionary costs to the bone. They refinanced their debt at lower levels. It was clear that even a modest uptick in sales would cause net income to soar. And that's exactly what has happened. Over the last four years, the companies that make up the S&P 500 have experienced record profits and record profit margins, as well as record profits as a percentage of GDP.

Just imagine if we had never experienced the two severe bear markets between March 2000 and October 2002 and between July 2007 and March 2009. If instead the Dow had merely eked out an annual return of a couple percent a year for the last 14 years, we wouldn't have had all these terrific buying opportunities.

When Stocks Go On Sale

Bear markets are a gift. Yet too many investors - nervous, afraid and cowed by the national media's sensational coverage - are reluctant to act.

I've never understood this. If a sweater goes on sale, you buy it. If a bottle of wine goes on sale, you buy it. If a convertible goes on sale, you buy it. But if the markets go on sale, you rush to sell your stocks or sit on your hands?

Explain How That Makes Sense.

In my former life as a money manager, I was amazed that the clients who refused to buy into one bear market also refused to buy into the next one... and the one after that. Their decisions were emotional rather than rational. Unfortunately, emotions are almost always wrong.

If you want to make money, serious money, in the stock market, you have to be a rational optimist. Understand that the economy will expand and contract. Interest rates and inflation will rise and fall. Stocks will roar and then plunge. That's just the way things are.

But go back to fundamentals. We all have economic needs. Businesses exist to fulfill them. (And innovate to create new ones.) Business owners and shareholders (that's us), not to mention consumers, reap the rewards.

As President Harry Truman famously said, "The only thing new in the world is the history you don't know."

Good investing,
Alex

Are Big Caps Better Than Small Caps?

Some things in life never change. Some things will always divide communities. For instance, cat lovers will never agree that dogs make better pets. And fans of the Rolling Stones will never admit that the Beatles made better music.

In the world of investing, the divide over big and small cap stocks is unlikely to narrow, ever. Small cap investors will always insist that the best part of investing is to unearth the next Jardine Matheson or discover the future Keppel Corporation while they are still tiddlers.

Reinventing the wheel

Big cap fans, on the other hand, argue over the futility of looking for the next stock market heavyweight. After all, stock market giants already exist. So why bother trying to reinvent the wheel.

Of course size isn't everything. Big caps, or companies with a sizeable market value, have unique qualities just as smaller outfits have their outstanding qualities and attributes too. There are also, it should be said, disadvantages associated with both.

Many investors favour big companies because they are perceived to be less risky. These are businesses that have been around the block several times over; done a lot of heavy lifting in their day and have been tested almost to the point of destruction and still lived to tell the tale.

However, critics like to point out that large companies are not exactly immune from risk. And they have a point. Companies such as Enron, MCI WorldCom and Lehman Brothers were once large companies before they disappeared up their own balance sheets.

Any company can crash, and the value of any share can go to zero. So size will not protect you from the excesses of management and the dangers of the economic cycle.

That said, large companies are, in general, less prone to fail. Their more reliable revenue streams, coupled with a better and broader customer base and access to dependable funding, could help to provide stability and make forecasting more predictable.

The only rooster in the henhouse

Most big caps also have commanding positions in their respective markets. In some cases they may even have near monopoly status, which means they get to enjoy all the advantages of being the only rooster in the henhouse.

But there are downsides to being big. There always are.

The price for greater dependability is richer valuations. Consequently, investors will often have to stump up if they want a piece of a Straits Times Index company. And many do, which is why blue chips tend to command a premium and stay expensive.

Another obvious detraction of large caps is slower growth. Companies whose products and services can be found just about everywhere are going to find it harder to expand. Small caps, on the other hand, have a lot more room to grow, and that expansion is usually achieved organically.

And there is more bad news to come.

Investors, on the whole, prefer businesses that are easily understandable. However, big companies have a terrible habit of complicating their businesses with mergers and acquisitions.

Stay alert

Quite often these large companies have little choice but to bolt on new businesses to grow. The upshot could be complex accounts that can even puzzle professional number-crunchers.

Whether you like big caps or small caps, Warren Buffett has a useful tip for you. "He once said that he would never take a swing at a ball when it is still in the pitcher's glove. In other words, find out as much as you can about the businesses you would like to invest in.

Investing opportunities are around us all the time be they large caps or small caps. The key is to stay alert to the opportunities.

Investing guru Peter Lynch famously said: If you stay half-alert, you can pick the spectacular performers right from your place of business or out of the neighbourhood shopping mall, and long before Wall Street discovers them".

He was referring to small caps but his advice applies to large caps too. So stay alert.

Foolish best
David Kuo
Director, Motley Fool Singapore

Dividend vs Share Buyback

Dividends are a tangible indication that a company is putting the interests of its shareholders close to the top of its agenda.

Thing is, paying dividends is a big commitment and a huge obligation for any company. Once a business has embarked on a dividend-paying strategy, it can be difficult to either reduce or scrap payments later on.

Compare the payment of dividends with share buybacks. Some might argue - and rightly so - that mathematically there is little to choose between the two. In both cases, surplus cash is returned to shareholders, albeit in different ways.

Through a share buyback, the number of outstanding shares is reduced. Consequently, the remaining shares on the market should be worth more, which should boost the value of your investment.

However, dividends, unlike share buybacks, represent real cash in the pockets of shareholders, which should also boost the value of your investment. In other words, you are getting money back from the company but in a more direct way.

Crucially, though, when companies use money for buybacks rather than paying, say, a higher divided, they are reducing your control and increasing theirs.

Consequently, as a shareholder in a company that makes use of share repurchases, you are relying on managers to repurchase shares at the right time. But with dividends it is you, rather than the company, that will be in control over how your cash is allocated.

GEMS, POTENTIAL GEMS OR LADDER AND SNAKE STOCKS

Past 5 years performance of these stocks:

SARINE
20/1/2009 at 8 cents - 24/1/2014 at $2.02
From the chart Sarin moving uphill with minor profit take all the way up.
Sarine 5 years increased by 2425% - GEM

ERATAT
20/1/2009 at 8.5 cents - 24/1/2014 at 10 cents
During the 5 years Eratat had increased up to 26.5 cent on 26/1/2011 and goes down hill to as low as 7.8 cents on 3/9/2012.
Eratat 5 years performance increased by 17.6%. - Ladder and snake stock

MIDAS
20/1/2009 at 48.5 cents - 24/1/2014 at 47.5 cents
During the 5 years Midas had touch high at $1.13 on 12/4/2010
Midas 5 years performance downed by 2% - Lader and snake stock

STRACO
20/1/2009 at 8 cents - 24/1/2014 at 43 cents
From the chart Straco moving uphill with minor profit take all the way up.
Straco 5 years peformance increased by 437.5% - GEM

DUKANG
2/2/2009 at 22 cents - 24/1/2014 at 29 cents
During the 5 years Dukang had touch high at 92 cents on 5/4/2010
Dukang 5 years performance increased by 31.8% - Ladder and snake stock

CORDLIFE
IPO in March 2012 at 49.5 cents - 24/1/2014 at $1.205
Cordlife less than 2 years performance increased by143.4% - Potential Gem

Sarine comes up top among these 5 stocks but not very widely discuss in the forum. Eratat, Midas and Dukang are the most popular stocks hotly discuss in the forum. These 3 stocks which I classified as Ladder and snake stocks. I believe BB and traders are the one that capitalised on these 3 stocks. Newbies are the one who are lossing money or are holding onto these stocks.

Year Of The Horse - Why The Long Face?

Dear Foolish readers,
As the serpent slithers back into the undergrowth of time, we wave a fond farewell to the Year of the Snake and welcome in the Year of the Horse. Yes, it is out with the old and in with the new.

"Out with the old and in with the new" might be the right mantra for Chinese New Year. However, it might not always be the right thing to do with our investments.

In fact, it can sometimes be a case of the older an investment gets, the better it becomes.

Any long-term investor in Keppel Corporation, Sembcorp Marine, Jardine Cycle & Carriage and Genting Singapore will probably be the first to attest to how well those shares have performed. Each of those companies has delivered total annual returns in excess of 20% since the Millennium.

Worth less or worthless?

However, what to do with old and poorly-performing investments can be a prickly topic for many investor.

When we invest, it is not unusual for an asset to be worth less than the price we paid for it. That doesn't necessarily make it worthless. It just means that it is not worth quite as much as when we first bought it.

But once we learn how to handle underperforming assets, we can begin to understand how it can also improve our long-term returns.

Those of you who have been subscribers to Take Stock Singapore since the outset should be familiar with the exploits of hapless Bob.

This is the Bob who complains about the contents of his lunch-box every day but confessed to his colleagues that he personally packs his own lunchtime meals.

This is the same Bob who could not understand why he was unable to sell his red-hot penny stock when he wanted. That is until his broker told him that the reason the stock was rising was because he was the only speculator buying it.

Today, I have another story about Bob.

Penny dreadful

One day Bob's work colleagues invited him to join them for lunch at a newly-opened restaurant. He lamented that he couldn't because he had to spend his lunch break reading a book that was recommended by a friend.

He said it was a badly written book and a truly awful read. But since he had already paid an arm and a leg for the book, he felt obliged to finish reading it, even though he knew it would be a dreadful waste of time.

I wonder how many of us can relate to that. How many of us have sat through a terrible movie simply because we felt we had to because we had already paid good money for the ticket?

Welcome to the world of sunk cost, otherwise known as when to stop throwing good money after bad.

Should I stay or should I go?

The concept of sunk cost is particularly relevant today, when stock markets have been rattled by a sell-off in emerging markets.

Although Singapore is not an emerging market, it has still been affected by events happening elsewhere. So, when we look at our portfolios, it is possible that some of our investments might not be worth as much as when we bought them.

Should we keep them? Should we sell them? Or should we buy more?

The answer is quite simply that it depends. There are times when it makes financial sense to increase our holdings. On other occasions it might be better to cut our losses.

What is important is not the price that we paid for the asset. Instead it is whether the market has mispriced the asset subsequently. Every asset has an intrinsic value. This is its underlying value, which is generated by its future earnings.

Ships Ahoy
If the market value of the asset is less than its intrinsic value, then buying more would, in the words of Warren Buffett, be profiting from the market's folly.

But if you are hanging on because you cannot bear to crystalise a loss, then, again, in the words of Warren Buffett, you would be patching leaks on a chronically leaking boat.

According to a recent report, almost US$940 billion has been erased from the value of emerging market equities since the US Federal Reserve signalled in May that it would start scaling back bond purchases.

There are two ways of looking at that.

One the one hand there could be lots of leaking boats having trouble staying afloat in the absence of cheap money. On the other hand, there could be lots of undervalued boats just waiting for us to profit from the market's folly.

Knowing the difference between the two could improve your long-term returns.

Foolish best
David Kuo
Director, Motley Fool Singapore

When Will The Market Turmoil End?

Dear Foolish readers

If you thought that Ben Bernanke was going to exit quietly from the global stage, then you could not have been more mistaken. The Federal Reserve chief's parting gift to the world was to set in motion the winding down of America's monetary easing activities.

He started it. So it is only right that he ends it too.

After pumping what has amounted to several trillion dollars into global economies, Bernanke has said that enough is enough. He believes that there is now sufficient money sloshing around the world to start driving economic growth in the US.

And he is probably right.

Signs of life

Consumer spending in the US is growing and a rise in exports would suggest that the world's largest economy is starting to put the worst of the 2008 recession behind it. Employment in the US is gradually improving, though more needs to be done, and America's housing market is showing signs of life.

America is growing again, albeit in fits and spurts. However, not everyone is delighted with the Federal Reserve's decision to taper. India's central bank governor, Raghuram Raja, has blamed the US and other western nations for the financial tremors that have shaken emerging markets.

From Russia to South Africa, and from Argentina to Turkey, emerging markets have been noticeably rattled by the withdrawal of easy money. This has caused the Russian rouble to drop to its lowest level for five years. In Turkey, the central bank has had to double interest rate in an attempt to prop up its fragile currency.

Global markets appear to be in panic mode and investors are left wondering how they should act.

Should I stay or should I go?

Some have bailed out. Some are hanging on in the hope that the market rout might be short-lived. However, the smart investor will be looking for buying opportunities.

The question we should be asking ourselves right now is whether we believe that the world economy will be better and stronger in five years' time.

If you believe it could be, then the correct response to the market turmoil is to focus on companies that can capitalise on growth in the US. We might also want to look for businesses that could exploit the nascent recovery in Europe.

Additionally, there are many firms that could take advantage of China's biggest policy shift for two decades - a move from international demand to more sustainable and controllable growth based on domestic consumption. And lest we forget, Japan is waking up from twenty years of deep sleep.

A 30-second guide

Legendary investor Peter Lynch once said that that if you spend more than 13 minutes analysing economic and market forecasts, then you have just wasted 10 minutes. So here is a potted guide to what is happening in the world. It should take no more than 30 seconds to summarise.

Together, the economies of the US, the Eurozone, China and Japan account for almost 60% of the world's economic output. And if the global economy can grow at around 3%, it would imply that the size of the world economy could double from around $70 trillion today to around $140 trillion by 2038.

Over the next 24 years, as the global economy doubles in size, there will be many winners and there will undoubtedly be some losers too.

Our job as a private investor is to identify winning stocks from the vast pool of shares available to us. You can't do that properly if you are constantly distracted by worries about political and economic events and the gyration of global stock market indices on an hour-by-hour and minute-by-minute basis.

Investing secret

Within the Straits Times Index, there are no fewer than 27 companies that generate revenues and profits outside of Singapore. These include Global Logistic Properties, which derives most of its revenue from China and Japan and Sembcorp Industries, which does as much business outside of Singapore as it does within.

Others that include SingTel and ComfortDelGro have been increasing their global exposure to diversify their geographic risk.

The upshot is that market turmoil should not be seen as a threat to your wealth. Instead, it should be viewed as a golden opportunity to start bolstering your long-term returns.

The secret to investing, which is really not a secret at all, is to buy when prices are low. That rarely happens when everything is going swimmingly. It inevitably occurs when the world is wallowing in worry, which is precisely what it is doing now.

Foolish best
David Kuo
Director, Motley Fool Singapore