Friday, June 17, 2022

Why Share Repurchase Matters?

I remembered watching a TED video about James Randi about homeopathy. On stage, he swallowed a whole bottle of sleeping pills. However, the pills are much more diluted than the actual medicine, and even ingesting the whole bottle of pills does not have any fatal consequences.

You can watch that TED video here: https://youtu.be/c0Z7KeNCi7g

The company’s shares can have the same effect. If the company keeps issuing new shares, this will dilute the net profit that each share provides.

As such, I will prefer to the company does the opposite; reduce the number of outstanding shares. Thus each share will get a large net profit in the future. This is usually called share repurchase or share buyback.

Benefits

Like eating medicine or supplement, we are expecting some form of benefits for our health. There are benefits to share repurchase for the shareholders.

Can only be done by using Cash

A company that generates a lot of cash can do a lot of things to improve its business or it can return value to its shareholders.

A dividend is the most direct and tangible way to provide value to the shareholders.

Share repurchase is another way to return value to their shareholders too, but it isn’t so directly.

Regardless, to buy back their shares from the open market, they have to use cash.

In this case, how they get their cash is important. I will look out at their operating cash flow and their free cash flow. If the company has a lot of operating cash flow and free cash flow, this means the company’s core operations are generating cash for the company.

There are other ways to generate cash, for example, borrowings or raising more capital by issuing more shares. These methods of generating cash aren’t sustainable in the long run.

Improving the Metric

This is kind of technical. Let’s imagine a company has the following:

·         1000 shares outstanding

·         Net profit $1000 for the year 2000

As such the Earnings per share (EPS) for the year 2000 is $1 (Net profit $1000 / 1000 share outstanding)

Then in 2001, this happened:

·         900 shares outstanding

o   The company brought back 100 shares with cash

·         Net profit $1000 still for the year 2001

Then in 2001, their EPS will become $1.11 (Net profit $1000 / 900 shares outstanding)

Despite the net profit does not increase from the year 2000 to 2001. However, the EPS has improved simply because the company brought its shares back.

This affects Return on Equity (ROE) and Return on Asset (ROA) metric too.

Investors use these metrics, EPS, ROE, and ROA to evaluate the company.

Compounding Effect

The previous section demonstrates how buying shares improved the metrics like EPS.

Let’s see what will happen if the company keeps doing that over a few years. The table below shows that if the company keeps buying at 10% of the outstanding shares.

 


Assuming that the net profit does not increase over the years, just decreasing the outstanding shares improved the EPS over the years.

If the company can prosper and increase its net profit, the effect of compounding is more potent. The below shows that if the company manages to increase its net profit yearly just by 1%.



This shows that as long as the shareholder keep holding on to their shares, the shares will be more valuable in the future.

Scarcity

As the company buys back its shares, there is a lesser amount of shares in the open market.

This means that whoever keeps holding on to the shares will have a larger percentage of ownership of the company.

Usually, if there are lesser sellers in the market, the buyers will have to buy at a higher price for the share. As the demand is higher than the supply, the price of the share may rise.

Shareholders don’t have to pay a cent!

The company will buy back its shares with the company’s cash. The shareholders are not required to pay for this action.

That being said, that doesn’t mean this action is free, just that the company is paying for it, reducing their cash for shares.

Tax?

As the company buyback their share, it isn’t a payment to the shareholders, unlike a dividend. As a Singaporean Investor in USA-listed companies, the dividend is taxable. At the time of writing (17/6/2022), there is a 30% withholding tax on my USA company's dividends.

Which isn’t an income to the shareholder; as such there isn’t a tax on it.

Drawbacks

Although supplements are good for health, overconsuming certain vitamins may have negative health outcomes.

Similarly, companies can benefit from buying back their shares. But it isn’t an action that can be used every time and in every situation. There are drawbacks if the company applied share repurchase inefficiently.

Can only be done by using Cash

If the company is unable to generate excess cash, it may not consider this action. Improving their business operation should be their focus.

If the company uses loans to buy back its shares, I probably have to listen carefully to its rationale. This course of action is usually considered unwise. If I am not satisfied with the reason, I will skip this company.

Not at any Price

The company will benefit more if it buys the share at an undervalued price.

However when comes to intrinsic value, it can be subjective. As everyone values the same investment differently.

As such, if the company management is ridiculously optimistic about their company share, they may just buy the shares recklessly.

This may reduce the efficiency of their money.

For example:

A company has allocated $ 1 million to buy back its shares.

That company’s Book Value per share is $100 per share. For simplicity’s sake, let’s take that as the company’s intrinsic value.

It also has 10 million outstanding shares.

Assuming the company’s net profit is $10 million.

As such, depends on the Price to Book (PB) value the company brought the shares:



As such, the table shows that as best as possible, if the company can buy their shares as cheap as possible, they can buy more shares back. The effects of their share buyback will be more effective on the EPS.

As such, it isn’t a good idea to just buy the shares at any price. Buying it cheap against the intrinsic value is more efficient.

However, there is more than 1 way to valuate a company. If the management wants to buy the shares back, they can easily justify with a very optimistic valuation and then buy back the shares.

Summary

The share buyback is a good sign for the company in general. The company must have the cash to buy back shares. If the company is generating a lot of cash from its operations, this can compound to those shareholders who still holding on to their shares.

What price does the company buy is the issue. However, even if the company pays a high price for its shares, it is still in favor of the shareholders. Just that it isn’t that efficient.

As best as possible, the company should buy its shares back as cheaply as possible. Of course, life isn’t as smooth as we wish to be. We can only prepare for the good and bad things to come. 

Sunday, June 5, 2022

Taking a Peek at Utility

I am taking a peek at Utilities Companies in USA and Singapore.

Why so? It isn’t going to grow or prosper like those sexy tech companies. Nor does it have the hype either. Unless Elon Musk tweets about those companies out of the blue.

But in theory, at least some people believe that the Utility sector has some advantages:

·         A defensive sector

·         Produce goods and services with inelastic demand

However, because of the Utilities’ characteristics, they do have some problems:

·         Very heavily regulated

·         Very Capital intensive

Defensive Sector

In theory, the Utility sector underperformed when the market rallies. However, when the market falls, the Utility sector remains relatively resilient.

From Gurufocus, this is the overall performance for the past 10 years. VOO is the ETF for S&P500, while VPU is the ETF for the Utility sector.  


How do I know if this theory is true or otherwise?

Maybe I just need to look at the recent months. Thanks to the Fed’s rising interest rates, the overall market share price is dropping.


Well… looks like the Utility sector (VPU) doesn’t fall as much compared to S&P 500’s VOO.

What about a rally?

I am using 1/1/2020 to 1/1/2021, a recent rally and it does show that while VOO is improving by 51%, VPU was only 18%.

Although I only did a comparison for the recent times, it does seem Utility is kind of resilient.

Inelastic demand for their products and services

What is Inelastic demand?

It is when the demand or consumption of a certain product or service remains relatively the same even when the price has increased.

For example, 30 eggs were priced at $6.50 back in Feb 2022. However, in April 2022, it has become $7.05. But customers still bought relatively the same amount of eggs daily. (At least for me though.)

Although in May 2022, some supermarkets' 30 eggs prices had gone down to $6.75, I still consumed roughly the same amount of eggs monthly.

Thus, my demand for eggs is pretty inelastic.

The Utility sector products and services have similar characteristics. They provide electricity, gas, and water. Not only are they difficult to give up, but they are extremely difficult to adjust our consumption without resulting a big impact on our daily life.

Very Heavily Regulated

Because the Utility’s products and services are inelastic, in economic terms. This results in 3 important implications.

Not sensitive to income growth or economic activity

Usually, when the public becomes wealthier, they may indulge more. For example, dine out in the restaurant more often, or buy the latest luxury watch.

The utility may not able to enjoy a lot of this additional spending from their customers. Drinking more water probably is the last thing in their mind when they strike a lottery.

Vice versa, if the public received a pay cut, they may spend less. Instead of dining out, they may cook at home, which is cheaper. However, the utility may not suffer a huge reduction in their customer demand. The customers may consume lesser, but there is a level of consumption needed to maintain their basic needs.

Thanks to this factor, the Utility sector is relatively resilient during an economic downturn.

Natural Monopoly

Utilities are a fine example of a natural monopoly.

Natural monopolies can appear when one company is much more efficient than other competitors in providing the goods or services to the market. Even without unfair business practices that company will over time become a monopoly due to the market conditions.

This may happen in two ways:

1.       The company takes advantage of the industry’s high barrier to entry, thus creating a “moat” around its business operations. One example is the high cost involved. A water utility needs a lot of machinery, and a pipe network, to satisfy the water safety requirement set by the government and hire a large number of specialists, engineers, and technicians.

2.       The company is producing at a scale so large that it is so much more efficient than small-scale production. And that company satisfies all the available market demand. Thus, the small-scale producers can’t compete due to cost.

Utilities tend to be a natural monopoly thanks to the high cost involved and it doesn’t make sense to have another company compete against it. Sooner or later, one company will remain either the competitor bankrupt, give up or merge with a superior company.

Regulations

As Utilities will naturally become a monopoly, they may abuse their unique position and may raise prices without control. Thus, the government will have to step in to ensure there is no such abuse. As Utilities are essential, almost irreplaceable, and vital to the economy, as this gives the government a very strong reason to regulate them. To ensure the utilities are reliable, cost-effective, and still affordable enough for everyone.

But are Utility companies good?

Whether a company is good is subjective. However, in my case, I look for a company that can is it:

·         Profitable?

·         Good cash flow generation?

·         Able to grow?

I take references from the utilities in the USA first. And let’s see if we can find any patterns. Sadly, there are too many utilities listed in the USA, I just use the top 4 market cap and see if I can learn anything from it.




In this case, I will be looking at NextEra Energy (NEE), Duke Energy (DUK), Southern Co (SO), and Dominion Energy (D).

USA Utilities: Profitability?


The overall trend looks like the companies are growing their revenue.



But their net profit doesn’t grow as much as their revenue. But profitable MOST of the time.

USA Utilities: Cash Flow?

Looking into their cash flow from operations can give us an idea of how much cash it generates from their operations.


Most of the time they are generating an increasing flow of cash into the companies.


However, their free cash flow is another story… as Free cash flow is the reminding cash after cash flow from operations deduct from capital expenditures, this shows that to remain in business, utilities need to re-invest themselves. Re-invest itself… Heavily. 

USA Utilities: Growing?

This is a bit tricky… what metrics show that the company is growing?

Maybe let’s look at their cash.



The result is a kind of mix, SO’s cash is growing over time. D’s cash is maintained at a certain range. But overall, most of their cash has wide volatility.

Let’s look at other areas, like their property, plant and equipment. They need these to provide their utility service to the public. 



Well… this assets liner is increasing over time. Generally speaking for all the companies.

Retained Earnings are another way to check whether the company is growing.



Looks like only NEE has a good growth in its retained earnings. While the others are still growing, but not as explosive as NEE.

Singapore Utilities



Philip Securities newsletter email has sent me some suggestions, I will be looking at SembCorp Industries Limited (U96), Keppel Infrastructure Trust (A7RU), China Everbright Water Ltd (U9E), SIIC Environment Holdings Ltd (BHK), and lastly Union Gas Holdings Ltd (1F2).

Now in Singapore, let’s see if we can find any insights. Same as the USA’s Utilities, I will be looking at their profitability, cash flow and whether can they grow.

I will be showing 1 chart with all 5 Singapore utility companies, and 1 chart without Sembcorp Ind (U96). The reason is that I would like to compare all of these companies together, but U96’s data is larger than the other companies, which distorts the chart for the other 4 utility companies. So I will show another chart without U96 to have a better view of the other companies.

Singapore Utilities: Profitability?

Let’s look at their Revenue first.



While Sembcorp (U96) has had huge swings in its revenue over the years, it is the largest out of the 5.

Apart from Union Gas (1F2) seems to grow its revenue the slowest. Otherwise, the rest seems to be quite ok. They can grow their revenue.





Although U96 has the biggest revenue, its net profit doesn’t seem to match its revenue size and suffer a loss in the year 2020. Keppel Infrastructure Trust (A7RU) has also suffered losses in the recent 2 years too.  Otherwise, these companies usually are profitable.

Singapore Utilities: Cash Flow?



Unable to see a clear pattern, but there are times some companies will have negative cash flow from their operations.






Their free cash flows show a similar pattern as their operating cash flow.

Singapore Utilities: Growing?

Again, let’s have a look at the cash



While U96 has the most amount of cash, the rest of the companies (most of them actually) manage to increase their cash in hand.

 



All of them increased their property, plant and equipment, but U96 and A7RU increased their property, plant and equipment more than the rest.

 


Only BHK’s retained earnings are performing well. A7RU is getting worse and worse. Weird… A7RU is profitable but its retained earnings aren’t accumulating.

Observation

Singapore Utilities and USA Utilities are different.

USA Utilities are performing in their operating cash flow, able to invest in themselves and grow their retained earnings.

Singapore Utilities, although their operating cash flow isn’t consistent, can increase their cash in hand. They do invest in themselves, but their retained earnings aren’t that consistent.


Well… recently I learned that, if it isn’t obvious then stay away.

I guess for Singapore Utilities, I probably stay away. It isn’t obvious to me that these companies are prospering.

But for the USA Utilities, there are more than what I just found. Maybe I can spare some time to search for some interesting companies that might be worthy of deeper research.

Your Humility,
Manferd

 

Sunday, April 24, 2022

Lessons from Ji Xiang Ang Ku Kueh


I attended an Ang Ku Kueh (AKK) lesson on 17/4/2022. I joined the lesson purely for fun and was curious about how to make AKK.

Apart from learning how to make AKK, Ji Xiang's boss also shared with my class how his family started this business and how they maintain and tried to expand his business.

I am very impressed by their business. The food business in Singapore is extremely competitive and cutthroat. Let alone able to survive for more than a generation. I have to say; that just surviving more than 10 years is already an achievement.

Apart from making AKK, these are the business lessons I learn from Ji Xiang AKK.

Starting out

Ji Xiang's boss shared with my class what and how his parents, the founders and first-generation boss of Ji Xiang, did in the beginning.

His father felt they had too much free time while at home and decided should make some AKK sell. His father will delegate the tasks among the family members. In short, no one was allowed to slack.

They made and managed to sell their AKK pretty well. So well that they tried to increase their production to the point they used their HDB flat’s corridor space for the ingredients. I can see that Ji Xiang's boss enjoys telling his family story. It must have brought fond memories.

Until the NEA officer came and told them they can’t do this.

The family saw their business was good, and despite the NEA officer telling them to stop, they find other means to do their business. They borrowed money from their relatives and set up a shop to sell their AKK.

Different Generation, Different Mentality

Ji Xiang's boss told us that his parents woke up at 2 am to come to the shop and start cooking. For certain fillings, they do not wish their employees to know the recipe. So they came much earlier to cook and get the fillings done. Once the employees reached and they can work on other processes.

To his parents, they believed the success of their business was based on the recipes. As such, they guarded the recipes closely. They worried that if employees would know the recipes, they can set up a rival shop and be a direct competitor against them.

Now, Ji Xiang's boss told us, they all come to work at 6 am. Nor do they care if anyone knows the recipes. In fact, the recipes were forced to change as the government told them to reduce the sugar content, an effort against the diabetics. Ji Xiang's boss is aware that his generation and the younger generation probably don’t want to set up a shop like his and sell AKK, or maybe any other kuehs. Long working hours and no air conditioner is already a huge hurdle for most people.

Making their work easier

Ji Xiang Boss showed us the production area, where the kuehs are made.

Ji Xiang AKK sold a lot of different flavors, which means they have to make different filings. Thus, they have to accommodate different cooking processes. For example, peanut fillings require peanuts to be ground finely while sambal fillings required some stir-frying.

Some ingredients can be ordered according to the specification they want, helping them reduce their workload. For example, they can order finely ground peanuts, instead of buying whole peanuts and ground them in the kitchen.

But some fillings have to cook on site. Coconut and sambal fillings need to make fresh daily as they spoil easily. Not only that, they have to make the dough, mold the kueh and steam them.

Ji Xiang's boss proudly presented to us the machinery they have. 

“The steamers we have now used much less gas compared to the traditional steamers we used at first.” He said proudly.

He then touched the lower part of the steamer to show us how safe and cool it is.



“These steamers only direct the steam and heat to the steamer basket above, making it energy efficient. While the traditional steamers will radiate heat around it, making the people working in this area perspire a lot and have to drink a lot of water.”

I am sure he worked in this area before and experienced the discomfort for a long period. I am sure he felt these steamers are worth every single penny.

He shared some other machinery too. A freezer that can go -40ᵒC, a wok that looks like a cement mixer, and the machinery that leaves the biggest impression on me is a banana leave cutter. Ji Xiang's boss shared that his father used to make a banana leafcutter that used a car jack. Now the banana leaf cutter uses a hydraulic instead.

The family squeezes their brain juice to find ways to increase efficiency.

Yet, not all problems can be solved by machines

Ji Xiang's boss did admit he did think of designing a machine or production line to make the AKK itself. After letting a heavy sigh, he explained, “Technically speaking, I believe it is achievable. But the R&D and the testing involved with this machine, I don’t think it is feasible.”

After I tried making the AKK, I understood the difficulties of making a presentable AKK. I have to take the oily pink dough, put it in the filling, shaped it in the appropriate shape, put it into the mold, shake the kueh out delicately, and put it into the steamer basket carefully.

The oily pink dough, unlike pasta dough, is very delicate, soft, and pliable. There is an advantage to this. If the kueh isn’t shaped satisfactorily, you can take it out and start all over again. But because the dough is so pliable and any small accidental touch on the kueh will easily deform it. Thus, wasting time and effort.

I am sure Ji Xiang’s boss and his family have thought of an idea to solve this problem. I am also sure they did consult some professional help. They probably found the drawback or the cost not feasible for them.

Production isn’t the only thing they have in mind. At first, Ji Xiang’s boss thought his parents were paranoid when they want to change the kueh mold. The old molds are wooden and the kueh will have a Chinese word imprinted on it. I can’t recall what word it is.

They changed the mold into a pink plastic with a 寿 instead. 寿 means longevity.

Turns out his parents' actions were justified. Ji Xiang’s boss found out that a nearby kueh seller lied to her customers that the AKKs she selling were from Ji Xiang.

Business is still good

Yet their business sales are still good. Of course, there are days they are unable to sell all their kuehs, what they did is that they gifted the rest to nearby shops. It is their policy to only sell their kuehs on the day it is made.

The shop is located at Bugis, and there is a lot of foot traffic. And the place where the lessons were conducted is open for everyone to see. While I was making the kuehs, I noticed there were a lot of curious passers-by who took a look at the shop, were interested in what is going on, interested in the different flavors available, etc.

Culture, once forgotten, is there a way to get it back?

Ji Xiang’s boss is planning to open his third shop somewhere. I am sure he was considering expanding his business not just to prosper. But also to ensure the meaning of AKK and certain Chinese cultures are not lost.

There is one special AKK, called Ka Ta Kueh. Ji Xiang’s Boss explained to us that these types of kuehs are made to celebrate a baby’s first birthday. These kuehs were used for Chinese gods’ offerings and later on, the baby will wear new shoes and step on the kuehs.

“Stepped on it, then cannot eat already ar?” I asked cheekily.

“Stepped already still can eat” Ji Xiang’s boss answered with a straight face. I think he means it.

I never heard of this culture until Ji Xiang’s boss told us. I wondered whether other countries like China and Taiwan still have this culture maintained. And also probes me to think, about what other cultures were forgotten over time, thanks to the result of government policies and technological advancement.

I guess he still put this on the menu to ensure this culture is still remembered in Singapore.

Reflections

I strongly believe that doing F&B business in Singapore is a Herculean task. To make it survive for many years deserved an award on its own.

Thanks to Ji Xiang’s boss sharing, his family overcome these challenges, not only with the creative usage of machinery. They too recognized there are other elements about F&B that isn’t just food itself. Ambiance the shop provides, the purpose of maintaining the culture before it becomes forgotten, and most important of all, enjoying what they like to do.

Although I didn’t get to see his smile, (we were masked up, thanks to Covid's safety measures), I can still feel that he enjoy this simple AKK making.

I also find it interesting enough that when it comes to technology, it always manages to disrupt the traditional businesses, making them obsolete, and thus, tradition is lost and forgotten.

In Ji Xiang’s case, they use technology to maintain this tradition and culture instead.

 

Thursday, April 14, 2022

What I learn from ’10 Golden Rules for Financial Success’ by Garry Moore

 A small spoiler alert, the book is sharing a lot of Christian quotes. If you are comfortable with that, you might want to give this a miss.

Although I am not a Christian at the time of writing, that shouldn’t stop me from learning anything useful for me. Especially when much of the financial wisdom was shared by Sir John Templeton.

I try to keep my blog post as religion-neutral as possible. Nowadays, netizens find fault in anything and everything and become very sensitive.

So, (taking a deep breath)… the first thing I learned from this book is…

Worries hurt

The author cites a lot of examples during the time he wrote the book. The book I bought was published in 1996. I was secondary 2 then, the pre-internet days when arcade and pagers were still around.

In general, in Author’s view, people worried and still worrying now I believe are:

1.       About the Government

a.       People tend to think that government policies will negatively affect them.

2.       About the current events

3.       About their jobs being replaced by foreigners that migrated to their country

4.       About their jobs being moved out of their country

a.       For example, it is cheaper to have the factor to open in other countries instead of the USA. Thus, the USA factory is closed and open in other countries.

5.       About their jobs being replaced by better machinery, creative destruction, or disruptive technologies.

As people are worried about the above mentioned, they tend to use their money ineffectively. They worried their money will lose value and thus invest in government bonds or gold. And these yield lesser or perform worse than companies’ shares.

Author and Sir John admitted that other factors influence them to make sure decisions. For example:

1.       Their religious teachings or belief systems.

2.       The way media (including social media now) portray the government, politicians, and current affairs.

3.       Their family and/or friends shared their ideas/opinions over coffee or dinner.

For example, one guy may have a negative opinion of the government and may have exaggerated the situation to his friends. Or the newspaper company put negative headlines to attract more sales for their newspaper (in a social media context, clickbait).

Thus people or investors may have a different or unrealistic view of the situation, government, or the economy in general, which leads them to invest ineffectively.

As Such, Sir John believed that being pessimistic isn’t a virtue when comes to investing. He suggested having a realistic view when it comes to investment instead.

Gratitude helps

It is natural to worry, but we tend to worry excessively. But being grateful for what we have helps against our ‘over worrying minds’.

Author and Sir John pointed out in the book that the USA economy was so much better than before. The USA was, and in my opinion, is improving. But a lot of people, are either not aware or misled by other sources. I admitted that I once believed otherwise when I saw S&P500 reach a new high; I don’t think it is sustainable and avoid USA companies. That was back in 2016.

However, as I learn more about investing and the economy. I am convinced otherwise.

I am sure if I present my case with a set of information and data points; I will be challenged and proven wrong by naysayers easily. Regardless of how I present the information.

However, that isn’t my point of this section, nor is what the author and Sir John are driving at. They pointed out that being grateful, and being positive helps in getting more opportunities and chances to be given to us.

Imagine hiring someone to help you with your chores, would you prefer to hire?

Someone cheerful, always happy to help, and showing great appreciation when you pay him?

Or someone who is always grumpy, always mumbling negative things around him and frowning when you pay him?

I do prefer to hire the cheerful chap and probably give him a tip if he goes for the extra mile. The other guy? I most likely will label him toxic.

But ‘Gratitude’ can be easily ‘buried away’ as we have more expectations or wanted even more good things. In short, taking the things I have for granted.

The author cited an example that a company has gained 20% more net profit compared to the last year’s net profit. However, the share price dropped because the analysts expected the company to perform 30% more net profit instead.

This may create a vicious cycle of ‘Never Enough’.

Thus, I am learning to be grateful for what I have now. I do know what I have may not last forever, and there are a lot of people willing to fight tooth and nail to be in my place. My position isn’t a very glamourous position, but I am still grateful for what I have. Although I still want more, that shouldn’t stop me from being grateful.

Money can do more than I think

Author and Sir John believed that there are things that are more important than just making money.

They do willing to lend or buy bonds to a cause that they believed in. For example, buying bonds that are meant to build a bridge for a certain town. Although the interest rate or coupons may not be a lot, the money can help the construction company and create convenience for the town folks.

Thus, creating a value that can’t exactly be bought by money, yet it was required money to achieve.

Helping business is another way of doing more. As the business grows, it can employ more employees. Resulting in creating more jobs, feeding more people, and helping the economy too. So when you invest in a company, you are helping the company to grow indirectly.

Although we focus on making more money, money sometimes can do more than just make more money for us. We can also help society in one way or another by investing in a cause we believe in.

I admit that the notion is very noble, but it is kind of out of my league at the time of writing. So I hope that I can reach a stage where my money is sufficient enough to help society in a certain the future.

 

Sunday, January 9, 2022

Book review: There’s always something to do: the Peter Cundill Investment Approach

 The book shared some of Peter Cundill’s interesting investments, which expose some of his investment strategies and thinking processes. The book does leave a deep impression on me. As such, let me share some of the things I learn.

Net-Net FTW (for the win)

Interestingly enough, the book doesn’t provide a special formula. Not some secret techniques to generate a lot of returns. Peter’s approach to investment was very simple in fact, just using Net-Net.

The Net-Net approach is very simple. Just buy companies that are cheaper than their working capital.

However, it isn’t easy to implement. As I found companies that are satisfied strictly on Net-Net, I often found myself uncomfortable with the companies. For example: worried that the company is unable to grow in the future or the company is losing business due to the other forces like retail gaming shops losing out to online gaming distributors.

Peter naturally learned this from Benjamin Graham and was convinced that net-net was an extremely reliable method of investing. As net-net uses information based on the balance sheet, and if the net-net requirement is satisfied, the company is considered cheap compared to what the management already paid for.

Discount Cash Flow and Projection into the Future

Peter was aware of Discount Cash Flow. Peter was well aware that the analysts and financial community devote a lot of time to finding out what may happen in the future.

He did not use these methodologies because he found them unreliable. He felt that it is more productive to find companies that are already cheap in terms of Balance Sheet. Assets that the company already owns.

This displays his conservative investment approach. While many, including me, invest and hope the investments grow in the future, Peter finds investments that are already cheaper than what is already paid for, with disregard of the future prospect.

Which leads to…

His Margin of Safety

Reading his book makes me wonder, do everyone have a different meaning of margin of safety?

His definition of Margin of Safety: “The difference between the price we pay for a stock and its liquidation value gives us a margin of safety. This kind of investing is one of the most effective ways of achieving good long-term results.

While I have been using Discount Cash Flow to determine the company’s intrinsic value, my Margin of safety is the very last variable in the calculation and will reduce that value.

However, in his approach, he determined the company's intrinsic value as the liquidation value. The difference he pays for the investment and the investment liquidation value is his margin of safety.

In my opinion, his approach is very much more conservative compared to mine.

His Quirks

I noticed Peter was a curious person. Thanks to his curiosity, he tended to dig farther, researched more, and understands the situation better.

In my opinion, because of his curiosity, he gained an edge. This edge allows him to reduce the risk of his investment by increasing his knowledge. In another word, he increased his circle of competency.

In the course of his investment journey, he learned a lot from his friends and mentors, most notably Benjamin Graham and Sir John Templeton. He was likable and humorous, which allows his friends and mentors willing to share their thoughts and information without reserves, which also helps in expanding his circle of competency.

He also kept an open mind in investing. He was willing to invest in anything and in anywhere as long as there is a margin of safety for it.

Most interesting Case Study: Panamanian Sovereign Debt

The most interesting case I read in this book is that he invested in Panamanian Sovereign Debt.

Before I carry on, Graham and Dodd's framework analyze from balance sheets, which means the information is readily available and has a team of experts to ensure the information is accurate and a set of laws to follow.

Unlike listed companies, Sovereign nations do not have such available information. Despite so, Nations do have assets, like a workforce, a manufacturing capacity, farms, mineral mines, and most important of all, the ability to levy taxes.

Conventional investors may not like to invest in such bonds. There are several factors, for example, information isn’t available, Political in another country may differ from investors’ home country. As such, Sovereign bonds' credit rating may not be that accurate. As the credit rating influence the bonds’ yield, this may not reflect as accurately too.

Now, on the Panamanian debt case study, throughout the 1970s and at the very beginning of the 1980s, was regarded by the USA as a favored nation with whom it was prepared to do business as well as an ally in the region.

In 1985, General Manuel Noriega, who was the leader of Panama then, was implicated in political murder and drug trafficking had alienated the United States’ administration. This caused the USA’s aid to be withdrawn. As the aid withdrawal, adding to the political turmoil in the nation had a weakened Panama’s economy and impaired the country’s ability to service its outstanding debt.

As the situation worsens result in an attack on US Embassy in Panama City, some American lives were lost. President Reagan then froze all Panamanian assets in US banks and suspended payments on the use of the canal. The Panamanian debts default shortly. The situation turns so bad the US troops took control of the Panama Canal.

Then on 1990’s Christmas Eve, the USA invaded Panama, ousted Noriega, and restored order to the city.

Peter took great interest in these developments. He took months to research and he found something mouth-watering.

The frozen cash assets belonging to Panama in US Banks were almost enough to satisfy the outstanding defaulted obligations! Once the country was able to work on their economy and thrive, the new Panama government will receive control of the Panama Canal from the USA which took control thanks to the political turmoil.

In Peter’s quote:

Markets can be overvalued and still keep on getting more expensive for quite a while, or they can be undervalued and keep getting cheaper, which is why investing is an art form, not an exact science.

Even when the Republic of Panama dollar-denominated debt trading at just over 50 cents by early 1992, which he believed had a very considerable and solid margin of safety, he did not buy it straight then. By 1992 December, the dollar-denominated debt had fallen to below 35 cents and Peter stepped in and accumulated an average price of 39 cents.

He sold them in May 1995 with a gain of 121%.

In short, he used Graham and Dodd's framework on Sovereign Debt. I am sure he can use the framework on other assets classes (not sure about cryptocurrency though) as long as he has the information and can determine the Margin of Safety.

Summary

It is interesting to read this book. I believe that Peter’s approach is simple, Net-Net for-the-win. But just following the net-net formula may not be enough. He leveraged on his quirks: his curiosity, his humour, and his discipline on having Margin of Safety (you can call it stubbornness too), to his advantage in his investment journey.

Although he was disciplined on having a Margin of Safety in all investments he made. He was flexible to use the Net-Net philosophy or framework and apply it to other assets that were hard to research on.

As the book is derived from Peter’s 200 hand-written journals, the book is mainly focusing on his thought process and viewpoints.

My viewpoints

I am inspired by this book. The way he approached Distressed Sovereign Debt is a work of art.

Although it may be hard to find a group of companies that satisfy the Net-Net requirements. But I was strongly reminded that as an investor, you can give yourself a certain edge if you improve yourself.
Improve yourself to be healthy.
Improve yourself to be a better person.
Discipline yourself in a certain principle, for Peter’s case is the Margin of Safety.
Be flexible in thinking.

As the market always changes, so we must adapt and be able to profit from it. 

Saturday, December 18, 2021

December is the month of reflection. For the year 2021.

 What a year! Gamestop share price goes to the moon event. China government crackdown on tech and Evergrande possible failure. There are a lot of things happening this year. I probably can’t recall all of them. But let’s see…

Gamestop

Gamestop is a retail company that sells games related items. My friend and I always talked about the good old times where we used to buy games, comics, and related accessories from Comics Connection. When the Comics Connection management decide to cease operations, I didn’t miss it, as I can read manga online and buy games from Steam. You can say I am not a loyal fan of Comics Connection.

Gamestop is facing the same problems for years. The gaming industry has faced piracy issues and seemingly found a way to deal with it, by selling digital copies of their game and letting the customer download the games online straight. Not only the sellers can mark that digital copy they just sold with a digital code called DRM, but they also find a way to add value to the games they sold. For example, you can modify it, enhance it, play with friends and strangers, and maybe more.

It isn’t that a physical copy does not have its value. But usually, its value is more for a collectible. CDs and DVDs will deteriorate over time, making it not a good way to store information. Recognizing this, the gaming industry assists their customer by keeping a record of what they brought. Even if the customer’s pc was formatted and lose the game installed, the game platform can still allow the customer to re-download it without any cost.

It is no wonder the retailers, especially Gamestop, faced such overwhelming difficulties to maintain their revenue. Their best bet is selling physical products, like console and console accessories.

Hedge funds anticipate the Gamestop may go out of business (or whatever their reason is), and short the stock. And they short it heavily.

And Reddit’s Wallstreetbets comes into play. Not only did they explain what is going on, but they also create this perfect storm called the Short Squeeze.

Fast forward to November, the US government conduct an investigation and there are a lot of interesting findings.

The short squeeze did happen, but the Hedge funds are not ruined.

The short squeeze does cause the Gamestop share price to go up quickly, but Hedge funds were able to exit from their position and cut losses quickly too. They did suffer a loss, but it isn’t to put them to destruction. The remaining ride upwards was created by the demand of the buyers.

As value investors, we are advised not to short a stock. As the potential loss can be infinite while the gain is limited. Gamestop is one of short position worst nightmare. Thus serving as a great reminder to value investors.

The Hedge funds did a great job in sticking to their plans and did not suffer total ruinations. I think the lesson here is to stick to your exit plan when the market does against you and don’t hesitate. In other words, discipline.

That short squeeze happened because there was a lot of information out in the market. Thus, it is important to know that a lot of information is out in the public and people can use this information against or for you. Thus, we need to be prepared for our worst-case situation too.

Although the hedge fund had closed their short positions, some participants were still under the impression that the hedge fund was still in the position and out to punish/revenge against them or profit from them by pushing the price higher. The actual short squeeze is short-lived, but the rally is coming from the bullish participants instead. This information is only revealed after the US government concluded its investigation. What I learn from this is that reliable and conclusive information is kind of takes time to surface.

The market participants have all kinds of reasons to join this event and created this short squeeze. As such, although this is a piece of old advice that the market is irrational. We can never know how many people doing this for money or revenge. However, the result is the Gamestop rally.

Chinese Government Crack Down

There are a few companies that were under the Chinese Government crackdown. Alibaba and Tencent's share prices were affected severely. While the Chinese Government’s main goal is to ensure the country can prosper further, the internet keeps churning out a lot of conspiracy theories and blaming the Chinese Government. I think the biggest causality is the education companies that were listed. With a stroke of a pen, the Chinese Government mandates they have to be non-profitable organizations.

Money is important but…

As investors, we are out to make money. As business owners, we want to provide certain goods or services to earn our income. Although I am not a parent, I understand why parents wish to provide the best education for their children so they can earn their keep in the workforce.

But as a government, they consider quite a several factors. In this case, they have to ensure that future businesses can grow and prosper. They also have to ensure the future generations’ mental well-being. It isn’t an easy job and people love to criticize and blame the government.

As such, the government’s job is to protect their citizens, be it from external forces but also themselves. There are times that people are pretty bad at making good decisions for them; they make choices that may harm them instead of benefiting them.

Thus this leads too…

As the Chinese government has a different approach compared to the USA government, the market deems that the Chinese government is too unpredictable for their own companies and thus these Chinese companies are sold in fear.

This emphasizes what the market doesn’t like: uncertainty. With no end to the crackdown insight, I believe a lot of the Chinese companies will carry on being depressed.

S&P500 is tough to beat

I admit I have no control over the performance of my stocks. I can analyze and pick a company that is prospering and growing. But that doesn’t mean the stocks I brought will increase their share price regardless of how long I hold them. I may go through a serious screening and research on the companies I am looking at, there is still no guarantee it will perform.

Luckily, most of the stocks I did bought did increase their prices. Not immediately, but over some time. And luckily, after a few months, which is considered fast by most standards.

Although I am lucky, I am still underperforming on some of my stocks if I were to compare against S&P500.

As such, maybe for next year, I have to consider the following pointers to improve on:

·         Who has beat S&P500 consistently?

·         What has beat S&P500 consistently?

·         Are those strategies able to copy or mimic easily?

·         Are those strategies safe?

Reflection

December is the month of reflection. What an interesting year. Full of opportunities and I learned a lot from observing the market. But I do need to buck up a bit and find ways to improve myself.

While I do wish I make use of my time more efficiently, I do manage to learn something and have fun in the process. Because of investing, I manage to find more time to improve my health by exercising more, playing games I had not played for a long time, and had coffee sessions with new and old friends.

Some of the ‘homework’ made previously paid off. And I shouldn’t stop there. I should keep on the lookout for good companies that will grow. But I think most important of all; still, keep an open mind to learn different things. Something that might help me beat S&P 500 performance. 

Monday, March 1, 2021

What I learn from Warren Buffett’s 2020 Shareholder letter

Warren Buffett’s shareholder letters are always filled with wonderful information and insights. This year's letter is no different, and I learned quite a few things.

Here are a few things I learn from Warren Buffett’s 2020 Shareholder letter.

$42.5 billion earnings in 2020

There are 4 components to Berkshire Hathaway (BRK)’s earnings:

1.       Operating Earnings, which is $21.9 billion

2.       $4.9 billion of realized capital gains

3.       $26.7 billion gain from an increase of net unrealized capital gains from BRK’s stocks

4.       Finally, an $11 billion loss from a write-down in the value of a few subsidiaries and affiliate businesses that BRK owns.

Buffett pointed out that the operating earnings are important, despite it isn’t the biggest source of earnings.

Despite these earnings, Buffett keeps in mind another important factor, but which isn’t included in their financial statements, the businesses’ Retained earnings that BRK invested. Especially those shares they brought from the public stock exchange.

As these companies use those retained earnings to:

·         Expand their business

·         Make acquisitions

·         Pay off debt

·         And to repurchase their stock

These actions build value to the companies and, of course, to BRK.

What I learn from this is that:

·         Regardless of the good fortune you received from other sources (e.g. share price rise), focus on what matters most. In this case, businesses should focus on their operating earnings.

·         Sometimes, important things aren’t recorded in financial statements. Look beyond the financial statements at times.

o   In BRK’s case, the retained earnings from its marketable shares.

Buffett acknowledged he made a mistake

In 2016, BRK brought Precision Castparts (“PCC”), and Buffett claims that he paid too much for the company.

Although Buffett still believed that he brought a fine company with good management running it. 

However, Buffett was too optimistic about the PCC’s profit potential and have to write down $11 billion.

I doubt this will be Buffett's last mistake of the same kind.

What I learn from this:

·         Is to own up and admit your own mistake.

·         Overpaying for a business is very possible in investing.

·         As such, buying a good or great company is more important.

Conglomerate

Buffett shared a little history about conglomerate, which most have label BRK as.

Conglomerates usually buy 100% of companies they are interested in.

However, there are 2 problems to this:

·         Most truly wonderful businesses have no interest to let anyone take over them

·         This result in Conglomerates buying mediocre businesses

o   Businesses that may not have the economic moat

To make matters worse, Conglomerates may find themselves having problems paying these mediocre businesses. As such some of these Conglomerates find another way to businesses cashless.

Sometimes, when a company buys over another company, what they can do are:

·         Pay full cash for the company.

o   For eg: if a Conglomerate is interested in ABC company.

o   And the ABC company worth $1million.

o   Conglomerate pays full cash $1million for it.

·         Pay shares for the company.

o   For eg: if Conglomerate is listed and the average share price is $50 for the past few months.

o   The ABC company is worth $1million again

o   Conglomerate pay ABC shareholders 20 thousand of their shares to them ($50 x 20,000 = $1 million) instead of cash

·         Pay part-cash, part-shares for the company.

o   For example, ABC company is worth $1million again

o   Both parties agree that Conglomerate pay $1/2 million in cash and $1/2 million in shares(which will be 10,000 shares)

Usually, the Buyer has to pay a premium to the other company. For example, ABC Company is worth $1million but the ABC shareholders only willing to sell it for $2million. Otherwise no deal

Conglomerates have to find a way to pay up. They may not have the cash all the time. As such, part-shares or full share deals are offered.

Some Aspiring conglomerateurs may result in creative accounting to portray conglomerate business are better than it is, thus making their shares more valuable than they should be.

As such, when they may a deal with a company they wish to buy with shares, they have more ‘dollars’ in the discussion.

For example:

·         Conglomerate shares’ intrinsic value $50

·         But because they employed creative accounting, the market assumes the Conglomerate share worth $150 and currently trading at that price

·          ABC Company is willing to sell the company at $2million, despite worth $1million.

·         Conglomerate offers a deal for full shares at $125/share (instead of $150 current trading price) with 16000 shares.

·         Naturally, the ABC shareholders will want this, as the current price of the Conglomerate share is $150, they got $25/share more than they asked for. $150 x 16000 shares = $2,400,000, which is $400,000 more!

·         However, if based on Conglomerate’s actual intrinsic value, which is $50/share

·         Conglomerate paid $800,000 worth of share value.

Buffett also notes that Wall Street loves this type of deal, as the fees it generates and the press loves to promote such business management as geniuses to hype up the interest.

Buffett explained that BRK doesn’t mind owning part or all of a business. As long as it is a good company with good management.

He is convinced that owning a part of a wonderful business is better than owning 100% of a business that is struggling. It is more profitable, more enjoyable, and far less work to do. In short, it is easier.

What I learn from this section are:

·         Buy a wonderful business with great management is easier

·         Conglomerates may resort to creative accounting to achieve a better deal

·         In investing, make your life easier by keeping things simple. You aren’t rewarded with harder difficulty.  

What is creative accounting?

Creative accounting capitalizes on loopholes in the accounting standards to falsely portray a better financial status of the company.

Berkshire Hathaway’s 4 core businesses

Buffett explains that BRK has 4 core businesses that hold the most of BRK’s value:

·         Property/casualty insurance operation

·         Burlington Northern Santa Fe Railway Company (BNSF)

·         5.4% ownership of Apple

·         Berkshire Hathaway Energy (BHE)

Property/casualty insurance operation

BRK’s insurance fleet operates with more capital than its competitors worldwide. Along with the cash BRK received annually from non-insurance businesses allows the BRK insurance sector to employ equity investment strategy heavily. While its competitors must focus on bonds due to both regulatory and credit-rating reasons.

Buffett explained that because of the low yield, some even negative returns, bonds are giving in the current market condition; bonds investors should reconsider their strategy.

BRK has $138 billion of insurance “float” to deploy in its investment. Although the money doesn’t belong to BRK, BRK can still use it and earn more returns.

Burlington Northern Santa Fe Railway Company and Berkshire Hathaway Energy

Buffett recently learned that BRK has the highest property, plant, and equipment amount in the USA. The second is AT&T.

This comes with high capital expenditures and depreciation costs for many years. For example, BNSF will experience damages to their tracks due to extreme weather and have to pay for the cost of maintenance. BHE has to rework its outdated grid for renewable energy.

Despite so, both companies, BNSF and BHE, deliver good returns despite the nature of business.

Although asset-heavy companies can be good investments, Buffett prefers business that requires:

·         minimal assets to conduct high-margin business

·         able to scale sales volume with little capital required

Apple

Buffett explained the power of repurchases.

BRK has been buying Apple Shares from 2016 to 2018; BRK has 5.2% of Apple.

However, because Apple has been buying back its shares, at no cost to BRK, that stake increased to 5.4%.

BRK has also repurchased back its “A” Shares. This has the same effect on investors, increasing investors’ ownership of BRK.

However, because BRK owns Apple shares, which Apple does its share repurchasing, will also help BRK investors to increase their Apple ownership.

This compounding effect between these 2 companies comes at no cost for BRK investors.

What I have learned from this section:

·         Bonds investors need to relook at their strategy

·         Assets-heavy companies can be profitable

·         Buffett prefers business that requires minimal assets to conduct high-margin business and able to scale sales volume with little capital required

·         Insurance companies have a way to use other-people-money to make more money for them.

·         The share buyback is another element of compounding interest.

In Summary

Warren Buffett focuses heavily on the business's operation performance, despite BRK’s capital gains are the largest earnings.

Some things are important but aren’t reflected on the financial statements, for example, the reinvestment from the earnings and the repurchasing shares the companies have done. Although they are out of sight, doesn’t mean it isn’t working for you. Retained earnings and share repurchasing are elements of a company doing their ‘compounding interest’ for you.

Bonds don’t seem to be a good deal at the moment in general.

As much as possible, invest in companies that can scale their revenue with little capital and gain a high margin. But that doesn’t mean assets-heavy companies are a bad investment.

My major takeaway is that the most important he is focusing on is to find great business first. Understand how the business works, what are their strength and weakness. Then follow the business. This makes life easier.


Why Share Repurchase Matters?

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