Growth Investing versus Value Investing

The year 2020 has been truly unprecedented. In the short span of a year, a contagious virus has been declared a pandemic, infecting nearly 70 million people and killing almost 1.6 million globally. Countries went on lockdowns and global travel evaporated, leading to job losses and unemployment skyrocketing by the millions. A large part of the remaining working population had to adapt to working from home instead of a centralized workplace. Vaccines were concocted in record time with governments granting emergency use approval across various parts of the world. We are in the depths of a recession, yet the US financial markets seem to make no indication of this, with major indices breaking through their All-Time-Highs week after week.

The whirlwind of events and somewhat disjointed behaviour of the stock markets forces a re-think of one’s beliefs and values around the topics of financial markets and investing methodologies. Unabashedly loss-making companies have seen their share prices bid up multi-fold, with the likes of Sea Limited (SE) and CrowdStrike Holdings (CRWD) returning 397% and 264% respectively year-to-date. Even the famous Warren Buffett – whose conservative value-investing style I have largely modelled myself after – seemed to have succumbed to the growth faction with his latest high-profile bet in Snowflake Inc. (SNOW), a similarly loss-making company trading at valuations uncharacteristic of typical Buffett buys.

My investment journey thus far has taught me much. From a naive young investor studying only Earnings-Per-Share (EPS) and Book-Value-Per-Share (BVPS) trends, I have evolved to look at other financial metrics which are crucial in helping to determine the investment-worthiness for a given company. Yet, the developments of 2020 has brought me to uncharted waters, fuelling much self-doubt and challenging my long-standing notions of what makes a good investment. As someone who has eschewed loss-making companies, I find myself forced to scrutinize my strategy against the backdrop of these hypergrowth portfolios making gains hand over fist.

My Investment Strategy re-visited

The key pillars of my investment strategy are:

1. Identify Growth Industries
2. Look for companies with proven financial track record
3. Hone in on the companies trading at reasonable valuations. The rest goes to the watchlist.

Essentially, what I try to do is to identify value amidst growth. By keeping a watchful eye on Price-to-Earnings (PE), Price-to-Book (PB), and Price-to-Free-Cash-Flow (PFCF) metrics, I cautiously avoid ‘overpaying’ for stocks by committing a purchase only when prices are at or below historical valuations.

If this sounds like an oxymoron to you, well, maybe it is. The truth is, these ‘growth’ stocks trade above historical valuations for the most part, and prices only fall to the ‘buy zone’ very ephemerally during times of crises. This means that I find myself sitting on the sidelines most of the time, waiting and watching woefully as markets trend higher while I miss out on all the fun.

Using the example of Alphabet Inc. (GOOGL) and assuming this company passes criteria 1 & 2 stated above, let us do a little exercise and try to spot buying opportunities using the charts that my computer program has generated.

Alphabet Inc. (GOOGL)Download

With the dashed lines interpreted as the ‘historical average’ valuations over past 7 years, we observe that the share price of Alphabet Inc. has on rare occasions fallen substantially enough such that the PE/ PB/ PFCF ratios deem it a reasonable buy. The circled areas coincide with the height of US-China trade war, and most recently (not marked in chart above) this occurred again during the pandemic stock market rout in March 2020. As you can see, buying opportunities are few and far between using this investment strategy. I was fortunate enough to buy into Alphabet Inc. in March and its shares have soared almost ~70% since.

How has my portfolio performed, you ask? Not great, truth be told.

From inception in May-2018 to-date, we’re looking at a meagre 11.2% unrealized gain. Comparatively, we see that both the Vanguard Growth (VOOG) and Vanguard Value (VOOV) ETFs have outperformed my own stock-picking endeavours. If I take a step back from bashing myself, I’d concede that my portfolio had a major ‘value tilt’ in its early days and only started looking at growth seriously from early this year. Convenient excuses aside, the fact stands that I have indeed been a sub-par fund manager.

Also from the above chart, one can see that Growth Investing has indeed outperformed Value Investing both pre- and post-pandemic in this 3-year timeframe by a factor of 2.6x. This is a significant deviation from a longer timeframe comparison spanning a century, where Value’s 1,344,600% returns has outstripped Growth’s 626,600% returns since 1926. Therein begs the question: Is Value Investing dead?

The Value Trap vs Growth At Any Cost?

While Value Investors chase bargain deals in the attempt to ‘buy a dollar for 50 cents’, one ought to be careful not to fall into a value trap. One possible example of this could be Singapore Airlines Limited (C6L.SI), which was running a consistently negative Free Cash Flow and stagnant per-share Revenue and Earnings even pre-pandemic. Compare this against similarly-sized (based on annual revenues) Southwest Airlines Co. (LUV) in the charts below. I rest my case.

Singapore Airlines Limited (C6L.SI)Download

Southwest Airlines Co. (LUV)Download

As the endless debate of Growth versus Value rages on, my personal experience thus far tells me to steer away from a full-out value setup. To doggedly chase value, without adequate consideration of macro worldly developments, seems to be a fool’s errand. Case in point is Singapore Press Holdings (T39.SI) and the decreasing relevance of printed newspapers, leading to rapid deterioration of business fundamentals since the advent of digital alternatives.

Singapore Press Holdings Limited (T39.SI)Download

On the other hand, pursuing a ‘Growth At Any Cost’ approach the likes of some hypergrowth companies seem to be a risky proposition in itself too. When would these companies ever turn a profit, if at all? Should logic still have a place in today’s erratic markets, an investor would naturally expect portfolio companies to be profitable eventually. Unless, of course, it’s all a dangerous game of ‘pass the parcel’ and the final recipient ends up with a boatload of worthless shares and a painful lesson learnt.

A Middle Ground

“You will go most safely in the middle.”

Publius Ovidius Naso

In the wise words of Roman poet Publius Ovidius Naso, “You will go most safely in the middle“. Where I see myself treading is in neither extremities, but in the middle path where I seek to pay reasonable prices for Growth companies. This strategy has worked for me in 2020 and is what I feel most comfortable with. At the same time, I’ve learnt not to quickly dismiss loss-making hypergrowth companies, but instead keep a lookout for early signs of profitability and possible investment opportunities.

2021 And Beyond

Moving into 2021, I am cautious of governments’ monetary policies and the possible devaluation of currencies due to unrelenting fiscal stimulus in many parts of the world. In the US, the Federal Reserve has created an additional 3 trillion dollars of liquidity in 2020 alone to combat the pandemic-induced recession. All these excess cash has to go somewhere and they often wind up chasing the limited assets of this world, leading to broad-based inflation across various asset classes.

Federal Reserve Balance Sheet

Detractors claim that the Central Banks can easily undo the excess capital once all these blows over, but will they have the courage to do what is ‘right‘ over what is ‘popular‘? After all, a contractionary monetary policy can cause financial hardship for some citizens whose votes – directly or indirectly – policymakers chase.

If we believe in this premise, one should avoid holding too much cash – which depreciates over time relative to assets – and buy into into financial instruments that can ride the inflationary wave. On that front, I reckon some of Singapore’s Real Estate Investment Trusts (REITs) are really sensible options that can benefit from a low interest rate environment and excess liquidity in the markets.

What are your thoughts to the above? If this post resonated with you, feel free to like, comment, and share with your friends! Thanks for reading!

Micro-Mechanics Unveiled: High Profitability and Robust Balance Sheet

Micro-Mechanics (Holdings) Ltd. (5DD.SI) is a relatively unknown company that is not often discussed among personal finance enthusiasts and community groups. In fact, it is so obscure that its daily trading volume over the past 3 years was mostly less than 10k shares exchanging hands. As luck would have it, I chanced upon this company over a year back when experimenting with Yahoo Finance Stock Screener and Micro-Mechanics piqued my interest due to its exceptionally high Return On Equity exceeding 20%, a remarkable feat for a local company. Today, I’d like to share my investing approach employing Fundamental Analysis and the key qualifiers I look out for, working through an example using Micro-Mechanics.

The Business

As stated on its website, Micro-Mechanics (Holdings) Ltd. serves the semiconductor industry by providing chip manufacturers the necessary ‘consumable tools and parts used in the assembly and testing of semiconductors‘. In addition, it also provides custom manufacturing of ‘precision parts and assemblies on a contract basis to OEMs in the aerospace, semiconductor, laser and medical industries‘.

If this is confusing for you, you’re not alone. Here’s a TLDR version; it manufactures stuff used by manufacturers in the manufacturing process.

_{That didn’t help, did it?}

The Financials

As usual, I’ve run the charts for Micro-Mechanics using the computer program I’ve built – read about it here – and we’ll be using those charts to analyze Micro-Mechanics.

Micro-Mechanics (Holdings) Ltd. (5DD.SI)Download

Growth

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As seen from the charts, Micro-Mechanics has stable and growing per-share Revenue, Earnings, Book Value and Free Cash Flow. As a bonus to income investors, Dividends-per-share has also been increasing gradually.

Now, to be completely objective here, most people would not consider Micro-Mechanics as a ‘growth’ company. The Revenue-per-share has only grown at a compound annual growth rate of ~5%, which means that it hasn’t materially increased its sales year-on-year over the past 10 years (9 compounding cycles). On the other hand, Earnings and Free Cash Flow seem to be faring much better, clocking in ~13% and ~35% CAGR respectively over the same period. This seems to suggest that the company has become increasing profitable/efficient hence leading to earnings growth outstripping revenue.

Depending on each investor’s growth & risk appetite, one may set minimum growth thresholds in these per-share metrics in order to qualify/disqualify a company as an attractive investment. When looking out for growth, personally I tend to favour companies with 15% CAGR in its per-share Revenue and Earnings, and at least 10% CAGR in Tangible Book Value and Free Cash Flow.

Profitability

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As mentioned earlier, what really caught my eye for Micro-Mechanics was how profitable this company was as observed from its Return On Equity. Hence, we would like to delve deeper into the ROE components using DuPont Analysis, looking at Net Margin, Asset Turnover, and Financial Leverage.

We observe that Micro-Mechanics enjoys a healthy and increasing profit margin exceeding 20%, which basically means it gets to pocket $0.20 for each dollar of sales received. Asset Turnover is a measure of the company’s revenue-generating efficiency, while Financial Leverage indicates the willingness of the company to use debt to fund operations and growth. Nothing out of the ordinary for Micro-Mechanics on the latter two. Multiplied together, we obtain its 22% ROE for FY2019. Personally, I prefer to look at Return On Invested Capital which strips out the distorting effect of leverage. We observe that Micro-Mechanics clocks a healthy 20% ROIC for FY2019, which has also been increasing over the years.

What we see in our holdings, rather, is an assembly of companies that we partly own and that, on a weighted basis, are earning about 20% on the net tangible equity capital required to run their businesses.

Buffett, 2018

Another metric that got my attention was its Earnings-to-Net-Tangible-Equity-Capital, something which Warren Buffett mentioned in Berkshire Hathaway’s Annual Shareholder Letter. As shown data table circled in the red box above, Micro-Mechanics has consistently been achieving this ‘Buffett qualifier’ over the past 6 years. Very attractive indeed.

Balance Sheet

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Moving on to Micro-Mechanics’ Balance Sheet, what we observe is a really solid piece of work. Its Current Ratio and Quick Ratio are both firmly above 3, which means that the company has adequate cash and liquid assets to pay off its dues for up to 3 years without needing to raise additional capital! Alongside this, we note that Micro-Mechanics has negligible debt which is observed from its low Long-Term-Debt-to-Equity Ratio, and further to that the 0 values in Interest Coverage and Debt-to-Earnings Ratio (in red box) reinforces this fact.

In uncertain times such as the ongoing Covid-19 pandemic, such a stable Balance Sheet really gives investors assurance that even with short-term earnings volatility the company will not need to resort to destructive fundraising à la NCLH.

Personally, I look out for companies with Current Ratio exceeding 1.2, Interest Coverage exceeding 5 (or equals to 0 in this case), and Debt-to-Earnings Ratio less than 5.

Valuation

Now, we have gotten this far to discuss Valuation. This means that the earlier pre-requisites of Growth, Profitability, and Balance Sheet strength has been adequately evaluated, and for which Micro-Mechanics is deemed to have passed. The next step for us is to consider how much we ought to be paying for a slice of the company, something that can really impact the overall performance of our stock pick. Contrary to popular belief, there is such a thing known as ‘overpaying’ for a company and its stock. Unfortunately too many retail investors fall into the hype trap and choose to participate in buying frenzies that more often than not leave them deep in the red.

The way that has worked for me thus far is to draw references from the company’s own historical valuation estimates, in terms of Price-to-Earnings, Price-to-(Net-Tangible)-Book, and Price-to-Free-Cash-Flow ratios. Usually, I’ll look back 7 years to derive the respective historical estimates.

With Micro-Mechanics, we observe that its current valuations (calculated by dividing current price by trailing-twelve-months’ figures) have way exceeded its historical estimates in all 3 valuation metrics. Take Price-to-Earnings ratio for example, we note that the historical estimate PE figure is 9.56, while it is currently selling for 19.7 PE at its current price of S$1.97 (as of 4th August market close).

We can further derive a target price estimate by multiplying historical valuation estimates with the average of the past 3-year per-share metrics. Using PE estimates, we would thus be looking at [(0.09+0.12+0.11)/3] x 9.56 = ~S$1.02. A similar exercise for PNTB and PFCF gives us a target price between ~S$0.89 to ~S$1.02. Thus, if nothing material has changed recently about Micro-Mechanics business prospects, one might not want to commit a purchase at current prices.

It is important to note that stock valuation is more art than science. In the method I described above, it simply the concept of reversion to mean. If we believe that the historical estimates hold any merit, then we should buy the stock when current prices are trading at or below the historical target price estimates derived above, and refrain from buying (or even sell it) when current prices way exceed the price estimates.

Some people believe in the concept of Discounted Cash Flow to derive price targets which has been popularized by MBAs and the like. However, this in itself has its limitations as a slight change in the cash flows and discount rate inputs will lead to drastic differences in valuation outcome. All I can say is, to each his own.

Closing Thoughts

In writing this post, I hope to share a structured way of stock analysis and valuation with the hopes that our investing community will benefit from the thought process that I have articulated here. This is just one approach out of many, but I sincerely hope that more people will be able to learn and make informed investment decisions through sharing like these by myself and other sensible thought leaders.

As an added benefit, I would like to share with you the data resource that I am using in my stock analysis. You can request for similar charts and tables as illustrated above for the other companies that you’d like to analyze, absolutely free-of-charge! Simply hop over to this request form and I’ll send it across once I’ve received your request.

Happy investing!

Reflections on S$100,000 milestone

This week marked a small but symbolic milestone that I have been aspiring towards for a while now. With my latest purchase of Autohome Inc. (ATHM) on 1st June, I have officially crossed the ‘sacred’ $100k line that is often hailed as a significant first step in the investing world. After all, in the wise words of Charlie Munger himself, “The first $100,000 is a b****.” With a very fortunate streak of luck, my portfolio was able to ride this week’s exceptional gains and propel towards $110k as the macroeconomy showed signs of recovering coming out of global lockdowns. Autohome alone surged 24% in the 5 days since I bought it, providing me some initial validation of my stock selection strategy.

Autohome Inc (ATHM)Download

To be sure, I don’t consider myself an exceptional investor. I have my fair share of gains and losses as well – think NCLH – and I have barely put together a 5% overall portfolio gain despite much efforts over the past 2.5 years. Nonetheless, characteristic of the most perverse of mankind, I consider this a worthy challenge to undertake and will continue to partake in active stock-picking for the foreseeable future against the better advice of seasoned investors.

A peek into my portfolio’s gains/losses

Lesson 1: Think Big, Think Global

In my opinion, one of the biggest mistakes of would-be investors is to invest in the Straits Times Index (STI). Despite the hype on many popular financial blogs such as Seedly describing our local index as a low-risk way to expose oneself to the investment realm, this cannot be further from the truth. The argument that STI, being diversified, is better able to withstand economic shocks and hence lower risk than individual stock-picking is simply flawed and myopic. You see, risk should not just be measured in terms of how badly a portfolio falls during market turmoils, but the opportunity cost of owning an underperforming portfolio is inherently risker than most people realize. You can read my thoughts on STI here.

As a born-and-bred Singaporean, I don’t mean to throw shade at our local firms, but the truth is that I struggle to find good companies to invest in based on my stringent selection criteria. In landlocked Singapore that is close to its maximum population capacity, the market that local firms serve is small and limited if they don’t venture abroad for vast pastures. As a result, most companies I’ve come across struggle to achieve even 10% compound annual growth rate in per-share Revenue, Earnings etc.

Think about that for a moment. Let’s assume that Share Price largely grows proportionately to Earnings i.e. fixed Price-to-Earnings ratio. For Company A that grows earnings at 15% annually, you can double your invested capital in a mere five years based on gains in share price. Yet if Company B is only growing its earnings at 5% CAGR, you’d be looking at an arduous fourteen years to achieve the same capital appreciation. Would you rather wait fourteen years or five?

Daily Percentage Gain/Loss comparison of STI vs S&P 500.

As an illustration of my point can be found in above chart. This is plotted in the timeframe where I started building my portfolio (first purchase in May-2018) up until now, with all prices adjusted back to SGD using daily exchange rate. To plot the above, I simply created ‘two versions of myself’ whereby instead of making my own stock purchases I took my money instead to buy either STI (ES3.SI) or S&P 500 Index Fund (VOO). We observe that the US stock market has consistently outperformed our local index, and the post-pandemic recovery is much more pronounced. In fact, if we had simply purchased STI consistently across the past 2 years, we would still be tallying in a sad 6% loss. For a longer timeframe comparison, you can refer to this post.

The point is this. As a Singaporean investor, don’t be fixated about investing within the confines of our local bourse. Be willing to look beyond our borders and you may just find that better rewards await.

Lesson 2: Stock-picking is not recommended

Yes, I acknowledge that this is the exact contrary of my intention to continue active stock-picking as mentioned above. At this moment of writing, I have just emerged from an absolute stock market carnage with my portfolio at its lowest point having reached -23% on 23rd March. One can only imagine how excruciating that must have felt back then, to see a quarter of one’s invested savings being wiped out. This emotional rollercoaster has a tendency to throw off most would-be investors and steer them clear of the stock market for many long years, depriving them of the possible gains of staying invested.

Further, I have just completed reading the book ‘The Intelligent Investor’ by Benjamin Graham, what is known as a rite of passage for resolute investors. Anyone who has read the same would know that Graham spent literally half the book persuading the reader that he – the reader – does not know better and would be better off passive-investing in a diversified Exchange Traded Fund (ETF) tracking the US stock market. Very encouraging indeed, Ben.

Once again being the skeptic that I am, I put together a comparison of my own stock-picking endeavours against ETF alternatives and, lo and behold, Graham was right all along.

Daily Percentage Gain/Loss comparison of my portfolio versus others

Likewise, this chart was plotted with the same methodology described above – four alternative investments – and adjusted back to SGD using daily exchange rates. Evidently from above, I really did underperform the US stock market and would have gotten better gains (and better sleep) had I simply bought into S&P 500. As investors, we tend to overestimate our stock-picking ability and cause ourselves unnecessary suffering and monetary loss.

How do I passive-invest and still retain exposure to Singapore’s market?

Once again, I do fully recognize and identify with the Singaporean investor’s desire to want to invest locally. After all, it seems natural to make those investment gains in local currency since one’s daily expenses is paid with the same SGD. To that end, I have observed that our local Real Estate Investment Trusts (REITs) are actually very sound financial instruments with average dividend yield ~5% which can really help to supplement one’s income or provide additional investing capital. I shared in an earlier article on how to select good REITs and buy them at the right price, you may want to check it out here. For passive investors, the Lion-Phillip S-REIT ETF (CLR.SI) makes an excellent choice to diversify across the stronger Singapore REITs.

Ideally, one should have a mix between S-REITs and S&P 500 for income and growth respectively. The dividends obtained from REITs could be used to buy into S&P for compounding growth.

Daily Percentage Gain/Loss comparison of Composite Portfolio versus others

As an illustration, we construct a ‘Composite Portfolio’ (represented by blue line in chart) that has its invested capital distributed on a 1:1 ratio between S-REITs (CLR.SI) and S&P 500 (VOO). We observe that this portfolio holds up remarkably well against others in terms of its share price appreciation – we have not yet even considered that REITs typically have higher dividend payouts which would no doubt propel it higher in relative terms. This indeed does represent a very sensible option I would highly recommend.

What if I am still thick-headed and want to stock-pick on my own?

Congratulations, you found a friend in me. Now be warned, this isn’t something to be taken lightly. There are multiple considerations one has to factor in when making an investment decision, such as the company’s Growth, Profitability, Debt, and Liquidity. I do have a structured framework in analyzing companies which I may share in a separate post, considering how painfully lengthy this one already is. Nonetheless, as an aspiring stock-picker you could get a pretty good headstart with these data charts that I’m providing as a free resource.

Til next time!

The (mis)adventures of NCLH

It was 28 February 2020. The Covid-19 pandemic was grabbing headlines internationally, wreaking havoc and leaving dead bodies in its wake. There was fear in the markets, which by then has dropped nearly 13% from its all-time-high in just 7 trading days. Having kept a stock watchlist for a while now, I have been sitting out of the market and watched painfully as my target companies’ share prices marched steadily upwards in the 2019-2020 bull-run continuation, berating myself for not taking action in late 2018 at the height of the US-China trade war when stock prices took a hit. Yet now, finally, opportunities have started to surface again due to the virus situation. One company in my list stood out as particularly attractive.

Norwegian Cruise Line Holdings (NCLH)Download

Norwegian Cruise Line Holdings (NCLH) has fallen by 33% in the same 7-day window and a whopping 42% from its January high. This wasn’t some run-off-the-mill, underperforming company whose share price crash was long overdue. No, we’re talking about a company which has achieved 13% compounded annual growth rate in Revenue Per Share, and a blistering 50% CAGR in Earnings Per Share in the ten-year period between 2010-2019. Cashflow-positive for the past 4 years. Net Margin and Return On Equity was at a healthy 15%. Based on historical Price-to-Earnings and Price-to-Book ratios, the company’s shares should have been trading at an estimated 60USD/share. I was staring at a deep discount for NCLH while other stocks in my watchlist were nowhere near their respective target prices. “Be fearful when others are greedy and greedy when others are fearful”, the classic Buffett quote egged me on. This was an opportunity of a lifetime and I shall not sit idle like I did before. That evening, I bought 100 shares at 33.45USD/share and celebrated as the stock closed 10% higher overnight. Little did I know I would be in for a rough ride.

“Be fearful when others are greedy and greedy when others are fearful”

Buffett, 1986

Over the next couple of days, NCLH lost its ground and dived downwards, erasing my gains and then some. I chanted ‘be greedy’ to myself as I bought another 100 shares at 29.5USD/share, nearly 12% lower from my last purchase price just days ago. The emotional turmoil was unimaginable as I watched my enlarged stake in NCLH dwindle, its price having collapsed to single-digit by mid-March. I was now sitting on a ~70% loss achieved in half-month, what must have been a world record in stock market losses. It didn’t help that multiple Class Action lawsuits have been filed against NCLH on behalf of shareholders; nor that NCLH wouldn’t be receiving government bailout money due to it being incorporated in Bermuda instead of in the US.

Mistake #1: Liquidity Concerns

While NCLH operating results were good, one aspect that I may have overlooked is its Balance Sheet, or liquidity to be very specific. Being in the travel industry, they were the hardest hit by the coronavirus and would likely not resume business for some time with the extension of a no-sail order by Centers for Disease Control and Prevention (CDC) in the United States. With no incoming revenue, its debt obligations nonetheless continue to surface like clockwork. This was a possibly fatal combination especially for highly-indebted companies like NCLH. In fact, the company only had a Current Ratio of ~0.20 going into the crisis, and that was when business was still operating normally. With revenue completely cut off now, NCLH wouldn’t be able to pay its obligations due within the year, setting it on a destructive path of raising more capital through debt or equity. Either way, it would be devastating for existing shareholders as high interest rates or massive share dilution would erode earnings moving forward.

Furthermore, as of December 2019’s financial statements, the company had sizeable debt equivalent to 7 years of their Earnings Per Share. Put in another perspective, this meant that NCLH had to continue making money at its 2019 capacity for at least the next 7 years just to cover debts, before actually ‘breaking even’ and starting to generate value for its shareholders. And that was before the coronavirus. In comparison, Apple and Amazon has a Debt-to-Earnings ratio of 2, Alphabet has 0.10, and Facebook has debt equivalent to a mere 1% of its 2019 earnings.

Mistake #2: Averaging Down

Tempted by the continued fall in share prices, I saw an even better deal on 6th March and decided to ‘average down’ my NCLH purchase to increase my potential upside. Committing to another buy just because I’m already invested, without adequately re-evaluating the risks and scrutinizing my earlier assessment. I’ve fallen prey to the sunk cost fallacy, a common mistake made by many amateur investors and human beings in general. In this decision, I’ve failed to consider the forward-looking prospects of NCLH and very myopically focused on its past results, thus culminating in a painful paper loss that would no doubt be hard to recover from.

Hindsight 20/20

As the saying goes, hindsight is always 20/20. It’s always easy to look back and say what has gone wrong, but those might not be immediately apparent to us at the crucial decision-making moment if we do not know where to look. Thus, I’m documenting these down as a future reminder to self so that hopefully, I won’t make the same mistake as I did.

Looking back, I would also acknowledge another subconscious factor that led me to leap onto NCLH. As the market started falling, NCLH was the first company that fell within target price among those on my stock shortlist. It was definitely not among my top choices, but with the the others still seemingly far away I was wary of losing this opportunity waiting for another that may never arrive. That would be reminiscent of my late-2018 self and I was desperate not to repeat that mistake. This desperation could have driven me towards an impulse buy, wasting away the capital I could otherwise have conserved for something better. As Richard Branson nicely puts it, “Business opportunities are like buses — there’s always another one coming along”. And come along they sure did, as I subsequently managed to buy into Google and Facebook through the market turmoil in March 2020.

“Business opportunities are like buses — there’s always another one coming along”

Branson, 2012

As at the time of writing, several major developments has occurred.

Warren Buffett has revealed that he sold all of Berkshire Hathaway’s airlines stock at a substantial loss, a vote of no-confidence in the travel industry’s near-term prospects due to the Covid-19 uncertainty. A parallel could be drawn for cruiseliners including NCLH, and it is no doubt a troubling sign when the world’s most revered investor cuts loss on the industry.

On 5th May, NCLH has flagged concern on its ability to continue to operate amidst the shutdown and its mountainous debts, raising possibility that it may seek bankruptcy protection which will may wipe out existing shareholders. Alongside this, NCLH also announced massive fundraising efforts in the form of public share offering at 11USD/share as well as several tranches of bonds including convertibles. Merely a day later, NCLH released a statement that it has raised sufficient capital to keep it operational for over a year without revenue, and that “the additional liquidity alleviates management’s concern about the Company’s ability to continue as a going concern for the next 12 months“.

Needless to say, the terms were not at all favourable to existing shareholders. Looking just at the equity fundraising and assuming the additional allotment option is fully exercised, we would be looking at a 16% dilution for existing shareholders. Not to mention, the issue price of 11USD/share being a far cry away from its market price just months ago. All that, and we have not yet even factored in the convertibles. It’s a bloodshed indeed – a painful reminder that due diligence and good emotional control is necessary to survive the vagaries of the stock market.

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Updated 20th July 2020: With the latest fundraising attempts in July 2020 and assuming additional allotments and convertibles are fully exercised, we would be looking at a share dilution of 45.6%

A Quick Guide to Fundamental Analysis

When I first set out on my investment journey, I was a starry-eyed teen guided by Warren Buffett’s ideas of analyzing the underlying performance of companies. Popularly known as Fundamental Analysis, this concept made perfect sense to me as it gives me a basis for selecting and filtering stock picks. However, I quickly realized that it wasn’t all that easy to follow Buffett’s scripture.

Retail Investors (a.k.a. commonfolk) like myself would know full well that searching for companies’ historical performance data is tough work. While there are tools such as those provided by Bloomberg and Thomson Reuters, these are more often for enterprises as the monthly subscription fees are easily thousands of dollars per month and is unaffordable for most. As a result, I had to prowl through the Annual Reports for each company and maintain an Excel sheet of Earnings-Per-Share and Book-Value-Per-Share data, manually recording each year’s information. Typically, it would take me upwards of an hour to record the 10-year historical data for just these two metrics of a single company – more if the company declares adjustments made to previous years’ data due to accounting changes and the like; it was a nightmare indeed. Nonetheless, I grit my teeth and ploughed on, spending weeks and months to build up a trove of EPS & BVPS data for Singapore-listed stocks for up to 20-30 companies. By the time I was done, data for the new financial year was soon to be in and I had to append or re-work some. It was painful and unsustainable for someone who is investing on the side and having to juggle school or work. It was also unscalable – more companies to analyze meant more time spent.

Prowling Annual Reports & manual entry on Excel Sheets

My journey over the past years has now equipped me with new skills and new insights. I now know that stock picks based purely on EPS & BVPS data is woefully myopic and have suffered painful losses on those – think Ezion Holdings (5ME.SI) at the height of the oil boom in 2014. I have since developed a systematic way of analyzing companies’ fundamentals before committing to a stock purchase, and have created my own computer program in R to help me do this quickly and efficiently by generating charts & tables comprising historical data.

Alphabet Inc. (GOOGL)Download

The Fundamentals – The Basics

Below are some of the financial metrics I believe that an investor should be looking out for. Exact definitions are hyperlinked within.

1. Revenue Per Share: This indicates whether company is making good sales. A company with a strong business should see this metric growing year-on-year. Alphabet Inc. is clocking this at a Compound Annual Growth Rate (CAGR) of ~20% over the past decade!
2. Earnings Per Share: Look out for a company with good earnings capability!
3. Free Cash Flow Per Share: This helps to identify whether a company is actually adding money to the its bank account, taking away (in some sense) any accounting tricks that has been applied. This should ideally grow alongside Earnings & Revenue.
4. Book Value Per Share: Known as the ‘worth’ of the company if it were liquidated, accounting for assets and liabilities. May also include Intangible Assets which measures things like brand value.
5. Net Margin: This measures the profitability of a company as a percentage of sales. Alphabet Inc. gets to pocket $0.20 profit on each dollar sales received.
6. Return On Equity: Serves as an indication of Management’s ability to make money using company’s assets. Should be used in conjunction with other ROE metrics like Net Margin, Asset Turnover etc

Valuation Measures

Once it has been established that the company’s financials are sound, you might want to take it further and look at how ‘cheap’ or ‘expensive’ a company’s stock is trading on the market. It is important to note that this doesn’t merely refer to the price that a stock is selling for, but instead looks at Price Ratios.

1. Price-to-Earnings: Known as the PE multiple, you can use this figure to compare one company against another within the same industry, or compare the stock’s current PE against its own historical values to see how ‘pricey’ it is currently selling at.
2. Price-to-Book: Since the Book Value loosely represents the underlying worth of the company, this is an indicator of how ‘overpriced’ or ‘underpriced’ the company’s stock is selling for.
3. Price-to-Free-Cash-Flow: This metric is more useful for companies with stable Free Cash Flow. It is used in a similar manner as PE.
4. Dividend Yield: For a stable dividend-paying stock, its share price could possibly be guided by its dividends. It is presumed that growing dividends translate to a growing share price, and hence may indicate buying opportunities if yield becomes higher than its own historical norm.

Putting it all together

For someone who is really keen on investing (note: not gambling), looking at the above makes a pretty good start. One could place certain minimum thresholds to filter for good stock picks – perhaps to only invest in companies with Revenue & Earnings growth exceeding 15% CAGR, for example. After identifying these companies, an investor could then place them in a watchlist to monitor for buying opportunities when valuations moderate to sensible levels.

As the charts contain both Financial Metrics & Valuation Measures, one can easily see how this could help them in their investment journey. Instead of having to shovel through Annual Reports, many of the required data is already captured in nicely-formatted charts and tables for easy consumption. The playing field is levelled; now the average Joe can start investing. Get your hands on this free data source here.

Valuation of REITs

When the Federal Reserve decided to ease up on its interest rate hikes in September 2018, rate-sensitive assets like REITs have enjoyed a fantastic run-up. In the subsequent 6 months alone, we have observed price appreciation ranging between 6% – 21% for some of the REITs in my watchlist, and the benchmark Lion-Phillip S-REIT ETF (CLR.SI) itself has seen a 11.48% gain. This is understandable – since REITs employ substantial leverage, any increases in interest rates could increase their cost of servicing the loans and in turn reduce their income available for distribution. Constant non-increasing interest rates thus gives investors greater assurance that their investment will continue to yield the same dividends, barring any unforeseen circumstances.

What are REITs?

For a detailed explanation on Real Estate Investment Trusts (REITs), you may refer to this moneysense article which does a good job. I personally prefer to oversimplify in layman terms: Take a property (or a collection of properties) and divide it into a million pieces; owning a unit of REIT is like owning a small piece of said property. Any rental income collected on this property is likewise split among the unitholders in the form of dividends. Aspiring landlords who do not have the capital nor loan facility to purchase an entire property can see why this is a good alternative – it allows one to become a pseudo landlord with small initial capital outlay in the range of $1,000 – $3,000, generating a fairly stable yield usually around 5%.

How much do I pay for a unit of REIT?

As with any publicly-listed company trading on the stock exchanges, the prices of REITs fluctuate according to public sentiment. One may use ‘traditional’ valuation measures such as Price-to-Book ratio, but a more commonly used indicator is the Dividend Yield. However, investors should take caution against superficially using yield as the decision factor as an abnormally high yield – albeit tasty-looking – can signal underlying troubles for the REIT. Case in point is Lippo Malls Indonesia Retail Trust, which had its future earnings and dividend payout capability thrown in doubt due to the revised tax ruling in Indonesia as well as the credit crunch faced by its master tenant and sponsor Lippo Karawaci.

With that in mind, I’d like to share an alternative method that I devised in calculating the desirability of a REIT at current prices. Instead of using dividend yield, I am using a concept called Internal Rate of Return, which you can think of as the compounded interest rate paid to you for keeping your money invested. The ‘risk-free’ benchmark rate we can compare against is the Singapore Savings Bonds, which pays an IRR of 1.39% (May 2020 issue) if you hold to maturity. The question thus becomes obvious: what is the IRR you seek in your investment, and how does your shortlisted REIT measure up at its current price?

A couple of key qualifiers that I employ in conjunction with the IRR measure:

• Is the current dividend payout sustainable? Check using Dividend/FCF ratio, if Dividends exceed Free Cash Flow (ratio >1), possibly unsustainable.
• Is this REIT’s rental business performing well? Check by looking at its Free Cash Flow and Dividend trends, we should see it growing or at least maintaining well.
• Is the underlying property appreciating well? Check by looking at its Book Value trend.

Assuming the above qualifiers hold true, only then will we proceed to calculate the IRR. To illustrate this, have a look at the data charts for Frasers Centrepoint Trust (J69U.SI) which in my opinion meets the criteria.

Frasers Centrepoint Trust (J69U.SI)Download

As you can see from the table, the Dividend/FCF ratio generally sits comfortably ≤1. The accompanying charts also speak well of its underlying asset value and business operations. With that established, we proceed to calculate the IRR.

Valuation using the IRR method

The idea behind this method is simple. We try to estimate how much dividends will be paid out in the remaining lifetime of the specified REIT, consider these dividend payouts as the ‘interest’ paid to us and attempt to calculate this ‘compound interest rate’ – the IRR. To do this, we’ll need to figure out the remaining land lease of the underlying properties, the outstanding debt, the estimated annual dividends, and current price. A couple of assumptions are made in order to simplify the calculations:

• The Book Value remains constant
• The Outstanding Debt remains constant
• The REIT pays constant dividend
• For the last remaining years before land lease expires, it stops paying dividends entirely and instead pares down its debt equally over its final years
• The price of the REIT becomes close to zero near the end of its land lease expiry

You could write out these dividend payouts in a Google spreadsheet and use the in-built IRR calculator to estimate the IRR. In the example of Frasers Centrepoint Trust, we estimate that for upfront cost of $2.05 per unit, we will be getting $0.12 in dividends for the next 64 years (exact calculations omitted). This gives us an IRR of 5.68%, which is better than the risk-free SSB rate. If one is happy with this number, they would buy this REIT at the current price of $2.05 (as of 17th April market close). If an investor has a threshold IRR of 5%, simple try-and-error on the same Google spreadsheet gives a max purchase price target of ~$2.29.

Using the above IRR measure, we go a little further than the superficial and often inadequate act of looking at just the dividend yield alone. This method of calculation accounts for the remaining years in which the REIT can remain in business by incorporating the underlying land lease expiry, and also factors in the amount of debt that the company has undertaken. After all, a 10%-yielding REIT can only cover the investment cost if it continues paying the same over a decade. As investors, it is thus our job to suss out the right picks so we don’t wind up losing our capital in the pursuit of income.

*This article was originally published in April 2019 and has since been updated with more recent data.

Where does the STI fail?

From the last post, we made a quick comparison of the different passive investments one could make via ETFs. By backdating the price data of the various ETFs to a common starting point (Date and Initial Capital) and adjusting back to SGD terms, we observed that the Straits Times Index has been the lousiest performer among its peers. In fact, one would have lost some of their initial capital if we were to consider only the price movements and disregard dividends. This begs the question – why exactly has our STI been lacklustre?

To set the context, note that our STI comprises of 30 companies aggregated as one single price data, with each company being represented in a certain unpublished weightage. The share price movements of these 30 STI constituents thus add up (on a weighted basis) to represent the change in STI price. Thus, it may be prudent to analyze the underlying performance of each of these 30 constituent companies to figure out which of these could have caused the drag on the STI.

For quick analysis, I have written a program in R to extract the ten-year historical performance of each company, looking into per-share measures such as Earnings (EPS), Book Value (BVPS), Free Cash Flow (FCFPS), Net Profit Margin, and so on. What I uncovered did not paint a pretty picture.

You see, of this 30 companies, I easily found a handful with languishing business performance over the years. This can be observed from the falling trends in EPS and Net Margin, in some cases even BVPS and Free Cash Flow. With no particular prejudice, I’ll let the following 4 charts do the talking.

Keppel Corporation Limited (BN4.SI)Download

Singapore Airlines Limited (C6L.SI)Download

Singapore Press Holdings Limited (T39.SI)Download

Singapore Telecommunications Limited (Z74.SI)Download

With the example of Singapore Press Holdings, we observe persistently falling Revenue and Earnings with no signs of a turnaround within the 10-year timeframe. I assume this could be due to the decreasing relevance of printed newspapers and the consequent decline in ad revenue derived from this channel; who still reads printed papers these days?!

It’s anybody’s guess whether these companies would experience a business overhaul sometime down the road to rejuvenate their company performance. But as far as the charts can portray, you may want to think twice about owning these companies in your portfolio. By the same principle, you also may not want to keep these companies within the STI if you were given the task to pick and choose the constituents.

Disregarding the unknown weightage of these companies on the STI, it might not be presumptuous to infer that these companies have contributed to the failure of the STI in delivering returns to investors. For the person who is willing to dig deep and study individual company performance, they may just be rewarded with an index outperformance – the ambition of most serious investors.

*This article was originally published in April 2019 and has since been updated with latest data.

Passive Investing

There seems to be a recent fad about passive investing through ETFs among millennials, and it has often been advocated on various financial blogs as the quick & easy way for one to start their investment journey. This belief may have been substantiated by the triumph of legendary investor Warren Buffett in his ‘Million Dollar Bet‘ where his passive investment strategy in a low-cost index fund (S&P 500) beat professional money managers’ funds portfolio.

Index ETFs, or Exchange-Traded Funds, basically mimic the Stock Exchange Index both in the selection of stocks as well as in weightage. For the uninitiated, an Index is usually a selection of the ‘best-performing’ companies used to represent the current state of the market. The size representation of each company in the Index differs and changes from time to time, and it is further understood that non-performing companies may occasionally be dropped from the Index and replaced by better ones. You may start to see why this is brilliant – there is a natural-selection process going on here which purportedly ensures that investors are holding stakes in only the best companies.

I recall a conversation I had with a brilliant friend of mine way back in 2012, where he made the same statement that passive investing would more often than not be the best strategy for most people. He claimed that the world would progress as a whole and the global stock markets would ride the same wave, and that a good investment strategy is to buy an ETF tracking the entire world’s stock market – think Vanguard’s World Stock ETF (VT).

This piqued my curiosity: Is all the hype surrounding passive investing well-substantiated? As a Singaporean investor, do I simply buy into a bank’s Regular Savings Plan for passive investing into Straits Times Index? Am I confident that this is my best bet?

To investigate into this, I have put together some codes on R to chart out the prices for a hypothetical Singapore Stocks portfolio versus the various ETFs. The methodology is to backdate these portfolio and ETFs’ prices to a common starting point (Date and Price), and watch the price movement unfold to-date which is 26th March 2019 at time of writing.

In the above image, we have compared the hypothetical Singapore Stocks portfolio (black) versus Straits Times Index tracker (red), Hang Seng Index tracker (blue), S&P 500 Index tracker (green), and All World Index tracker (cyan). The backdating goes as far back as mid-2011 which is the earliest date that these price data are all available from Yahoo Finance. All prices are adjusted back to SGD according to each day’s exchange-rate.

Surprisingly – or not – we see that some of these Index funds aren’t our best bets within this 8-year timeframe. In fact our money would have decreased if we stuck with the STI – from S$25,375.92 to S$25,273.47 if we look purely at price movements and exclude the dividends. And consider that this is does not yet factor in inflation, which would have further shamed our local index fund.

More importantly, we see that our All World Index Fund (VT) is indeed doing rather well. I suspect my brilliant friend is close to financial freedom by now. The real noteworthy thing here is that our US Index fund VOO has far outperformed everything else, more than doubling the initial capital and further outstripping its closest competitor VT by a factor of 1.5x.

Perhaps passive investing could indeed be the solution for most people, myself included. However, we ought still to choose which Index ETF to bet on so we won’t wind up with a decade-long regret.

*This article was originally published in March 2019.