Monday, October 30, 2006

Is saving a thousand monthly enough?

A friend posted me a question last week if saving a thousand a month is enough. The answer is it depends on the spending habit and lifestyle of the individual. Let’s see what does saving a thousand a month till your retirement age – assuming to be at age 55 – brings and provides you for the rest of your life. There are some important assumptions in order for this estimation of savings for retirement fund to work out. 1) Assumed you stop working at age 55 and live till age 70, 2) The risk free interest rate (government bonds will provide a higher interest than Fixed deposit) is to be at an average of 3% throughout, 3) the savings done is started from age 29 and all of it are to be reinvested yearly till the age of 55 and each year, you are to save $12,000, and 4) at the age of 55, the sum which has been grown and saved to then will have to be disciplinarily spent equally from age 55 up to age 70.
If one starts saving $12,000 yearly from age 29 up to age 55, you will have a sum of about $503,000 by then. Assuming now you are at the age of 55 and you anticipate you will not live beyond 70, how much can you spend monthly for this $503,000 to last you for the rest of your life? You have 180 months to live from age 55 to 70. Does it means you should then switch your savings from bonds or Fixed Deposits to normal savings accounts and spend about $2793 ($503K divide by 180 months)? It will be a big mistake if that is done.

Let’s see why it is a mistake. At age 55 – which is 28 years later – the total sum ($503,000) which is saved by then does not have the same value compared to the day you started out saving. Thus, the next question to ask is “what is the present value of the $503,000 worth at today’s value?” If you apply an average inflation rate of 2% yearly and discount the sum of $503,000 back to today, it is worth roughly $295,000. In other words, you have about $295,000, at today's value, to spend for the rest of the 15 years from age 56 to 70. At today’s value, it means you can afford to spend about $1640 per month with this amount. If you are a single and live in a bare minimum house, it should be enough to last till the age of 70. Then when you hit your retirement age, you must still maintain your discipline in controlling your yearly spending to about $34K at age 56, $34.9K at age 57, $35.6K at 58 and so on. The yearly spending will increase by about 2% yearly to cater for inflation and ultimately, at age 70, your yearly spending will be about $45.1K. However, to not, there is no difference in value between the amount of $45.1K at age 70 or $34K at age 56 because it is eaten up by inflation which is assumed to be at an average of 2%. All these yearly spending are equal to a present value of today at about $19.6K. So if at the age of 55 and if you decide to lose your discipline and forget to continue to put in a higher yielding sort of risk-free interest investments, the amount will not last till the age of 70.
So, is this enough? It boils down to your lifestyle and your commitment by then. But most likely, it will not be sufficient because one cannot be sure his lifespan is up to 70. Then it takes a lot of discipline since the amount is just treading on the line But the biggest problem is not saving or growing the fund, it is maintaining one’s discipline and controlling the urges and temptations which is the trap for many. Anyway in my opinion, saving a thousand dollar monthly is way too little if you can only grow it at a normal interest rate.


Some businesses are amazing when profits are reported. Investors alike focus too much on the Income Statement and forget the Balance Sheet. Why is it so? Take for example, at time, businesses report X amount of profit but then there is a decrease in Shareholder's Equity. Isn't this a cause for further concern and investigation for those who are planning to buy into the business or those who already have a stake?
There are many such cases happening without any benefit to the investors. Imagine, if you operate a bakery business and spent $100K on machinery, supplies and so on. At the end of year one, your income statement shows a profit of $15K, while your shareholder equity shows $80K. In such cases, I think it is apparent something is not correct. Though such discrepency can be attributed to a number of reasons, for example, full distribution of all profits, depreciation policy, incorrect expensing policy and so on. Earnings per share or profitability is not a safe or good enough measure towards valuing the performance of the business. What will be a better measurement is the performance of the management's ability to increase the value of the shareholder's equity or net asset value per share over time.
Another matter that is frequently being promoted is a particularly pernicious practice. That is trumpeting EBITDA (Earnings before interest, taxes, depreciation and amortization). Doing so implies that depreciation is not truly an expense, taking it as a "non-cash" charge. That's absurd. In truth, depreciation is viewed as a particularly unattractive expense because the cash outlay it represents is paid up front, before the asset acquired has delivered any benefits to the business. Imagine, if you will pay all your employees for the next ten years of their services at the start of the year (similar to the way you would lay out cash for a fixed asset for a useful period of 10 years). In the following years, compensation would be a "non-cash" expense - a reduction of a prepaid compensation asset established in the first year. Would anyone argue that the recording of the expense in years 2 through ten would be simply a bookkeeping formality?

Wednesday, October 25, 2006

Intelligent investing is like farming

For people who practice intelligent investing, they are like farmers. They plant seeds and wait for the crops to grow. At all times, the harvest is heavily dependent on the weather. It can comes early or a little late. If the crops are a little late in starting due to adverse weather, they do not tear up the fields and plant something else. To do so will be akin to double diaster. They just sit back and wait patiently for the crops to pop out of the ground, confident that it will eventually sprout.
However, for most investors, they do not take the attitude of the farmers. Most people seek instant gratification in almost everything they do including investing. When most buy a stock, they expect it to goes up instantly. If it does not, they sell it and get something else. The majority are akin to the drivers on the freeway, zooming in and out to get ahead of others. Sometimes they are ahead just for the moment, then bam "they collide head-on.
Another major difference between Intelligent Investing and the herd or unintelligent investing is Intelligent Investing requires the mettle to buy those stocks that the majority do not want to own. These stocks are out of favor, unsexy and frown upon. Of course, they are. If not, why else would they be cheap? When you go to a cocktail party and the talk turns to recent stock picks, one guy says "I bought so and so tech stock at $8 in the morning and it closed at $10." Instantly, he appears to be a genius. Forget about so and so tech stock has no decent sales, no profits to show for, no track record and is a diaster waiting to happen. Then you feel a little foolish to say "I bought so and so stock at half of book value and 6 times earnings." Most likely, you'll be greeted with a big yawn and frown upon. Sex sells even in the stock market and most want to own the latest sexiest issue. ICBC being the most recent. We shall see what it will produce. People will be correct in the short term, but in the long term, fundamentals will correct all unjustified valuations.
Why is it that only a handful of people practice Intelligent Investing? Firstly, Valued stocks are as exciting as watching grass grows. Then there is nothing sexy and sophiscated in Intelligent Investing. Conversely, it is supposedly to be sophisicated in the unintelligent way of investing where many mistake the more sophisicated it is, the better it is for the returns. Too many lack the key ingredient which is patience and too often, they do not read or study enough to understand what it takes to succeed. Then again, the iron rule in life is only the top few make it to the top. So as always proven historically, the top percentile are made up of investors who practice Intelligent Investing. That is why there are always few people who do it the correct way. If everyone were to do it correct, Intelligent Investing will cause average returns.

Tuesday, October 24, 2006

Lessons from American's best business leader

Warren Buffett, the legendary Chairman of Berkshire Hathaway, stunned the world this summer when he announced to contribute roughly US$40 billion of his fortune back to society. For years, he was not known to be a philanthropist. However, his intention is cleared right from the start - even before he was known as the Oracle of Omaha. In a biography of him, The Making of an American Capitalist, Roger Lowenstein noted how he was worried about his future fortune in the way of distributing back to society. Warren once commented on Andrew Carnegie's grace: "Huge fortune that flows in large part of society should be in large part be returned to society." Being a spendid investor that he is, he is not so much a spendid allocator in the distribution of charity funds. However, as what he always practices - being great in staying in spots or his "circle of competency" - he found the best person in his view to manage his fortune which he donated back to society - Bill Gates and Foundation. Just like he acquires businesses, he is never good in operating or managing a business - though he did once during his long career when Saloman Brothers was on the brink of bankrupcy - he is second to none in spotting a fantastic manager operating a great business. And this is the basic strength of him in building from nothing to something since he started out in investing.
Such bold moves are typical of Buffett. He rarely invests for the short term or changes his mind. When he invests, he will hardly sells the business away. He will keeps the business forever. He once quiped "Our favourie holding period is forever." What he values besides the value of the business is he must treats the employees in a fair way. By buying and selling businesses, employees will suffer. As is so evident in so many take-over deals, jobs are cut in the name of rationalizing and so on. In the field of investing, PATIENCE is the key to success. And in this, it could means holding a business forever without taking a single cent out or selling out a great business. Think for the moment, if you own the picture "Mona Lisa" and today it is worth $10M, and you sell it today, the cash you receive today will be only $10M assumming you do not reinvest or do anything. But if you hold on to the picture, knowing this is the only piece of art in the universe, the value can only increase with time. Thus, it makes no sense for the owner to sell away the art today or in the future unless someone is paying him a great premium. Everyday that he holds on to the art, his net worth will be increasing. So in the case of holding a great business, if you sell today, you are throwing away all the future value that it may be worth. Then think of this case, if you spend a dollar today, you are not only throwing away the dollar worth of face value, you are also throwing away the potential value of what it can earns in the future. These cases are truly nothing but a lose-lose situation.
What he says is what he does. These wisdoms are all-so-evident in his current holdings. To name a few, See Candies (since 1970s), Coca Cola (since 1988), American Express (Since 70s), Geico (Since 70s). If you had put a dollar in Berkshire at the start, the dollar is worth more than $7000 today. If one does not have the patience, he will have regreted his action tremendously.
Notably, Buffett goes beyond his mentor (the late Benjamin Graham) in many times, particularly in two. He focuses on companies with a sustainable competitive advantage and believes the quality of its leadership is integral to its value. To understand the quality needed for leadership, it is way beyond the capability of the manager, there are so many managers who are very smart people but yet they fail the owners because of walking the "low road". I would suggest to read "The Warren Buffett CEO" to get an understanding the making of a great manager.
Unlike the vast majority of acquirers, Buffett retains its management. Being a master evaluator of people, he asks "Do you love the business, or do you love the money?" This is such a logical and basic question that many people fail if they will answer truthfully. In this question, I'm pretty sure many would chose money over what they love to do. However, there is nothing wrong with loving money but it should not be the driving factor taken to be your motivator. If you do what you love, you will have a better chance of succeeding, and when you succeed, you get rewarded. However, if you do it the other way, by doing something which you do not love but maybe you think it can makes lots of money, you may stand a lesser chance to succeed. Because when you do something you do not like, chances are you will not be able to do it to your maximum capability because you will not be motivated. So logically, your returns will be less. And if you are able to link it all up, by doing what you love, you will get your reward. So if you do what you love, you do not have to worry about rewards because it will comes to you naturally. Then if it comes naturally, why do a person needs to even think about loving money? That is so secondary.
Another Buffett wisdom is to live life simply while doing what he has a passion for. When you have a passion, you learn everyday. That's how greatness is acheived. Greatness can never be achieved if learning is ceased. However great a person can be in his field, mistakes will always be lying in wait, but that is not a terrible matter, in fact, it is a great thing to set the ground for improvement.
What is less familiar to the public on Buffett is his generousity of spirits to others, from students comtemplating their careers to CEOs facing difficult challenges. Consider this example, Vitaliy Pereverzev of Kazakhstan was part of an investment club that recently traveled to Omaha to meet Buffett and have lunch at Gorat's, his favorite restaurant. When his classmates started having pictures taken with Buffett after lunch, Pereverzev realized he had left his camera back in the Berkshire Hathaway boardroom. Rather than sending a staff person, Buffett offered to drive Pereverzev himself. And he took the opportunity to provide the young Kazakh with some counsel. "Vitaliy, you have to do what you love. I do not want to live like a king. I just love to invest," Buffett said. "Money aside, there is very little difference between you and me in terms of lifestyle. I eat simple meals. I drive a regular car. I make decisions, and, yes, I, too, make mistakes." Then Buffett offered the young student advice he won't forget: "Be a nice person, Vitaliy. It's so simple that it's almost too obvious to notice. Look around at the people you like. Isn't it a logical assumption that if you like traits in other people, then other people would like you if you developed those same traits?"
Another example was Anne Mulcahy of Xerox told me about her encounter with Buffett shortly after becoming CEO in 2001. Facing a liquidity crisis with $18 billion in debt, Mulcahy was under intense pressure to declare bankruptcy. Determined to save the company she loved, she made a "cold call" to Buffett, who invited her to Omaha for a chat. Mulcahy later confessed that she had hoped Buffett would put money into Xerox, in spite of his well-known aversion to investing in technology companies. But the advice she got proved more valuable. After listening patiently to her problems for two hours, Buffett told her, "You're thinking that the investors, bankers, and regulators are the people you need to survive. Put them all aside, and give priority to talking to your people and your customers about what is wrong and what you have to do." For the next six months, Mulcahy did just that as she toured the country, rallying support for changes required to restore the company. Xerox stock continued to decline, but she was unfazed. Ultimately, Buffett's advice proved fortuitous as Mulcahy warded off bankruptcy, paid back $10 billion in debt, and continued to invest for the long term. Xerox stock tripled in value.
All these lessons are extremely deceptively simple but yet neglected. These pieces of leadership advice reflect Buffett's wisdom and generousity : His lessons are often the simplest and the most empowering. Like his business partner, Munger quoted: "Simple ideas carry the most freight."
What Buffett does is like an artist. As he quoted: ""Berkshire is my it should look the way I want it to when it's done." If one has a passion, it is just like having an artwork that can be painted and altered for the better with every passing day. That is the amazment of how one can live their lives to the fullest and most fulfilling live. When he started out, it was all about his personal growth mostly, now with where he is, it is more about growing others and giving back to society. In Buffett, he is the Michael Jordan for many facets of life. He teaches the basic way to the better half of life, the principles in staying in the middle of the field and not taking corners, the joy of seeing others grow along while maintaining personal growth, having a passion in what you do, growing a little smarter compared to where you were the night before and most importantly giving back what society has given to him.

Sunday, October 22, 2006

Cost of capital

To an investor, what is the cost of capital and how is it measured? These are two very basic questions that an investor must ask themselves and understand what it means to them in order to allocate one’s capital in the most optimal manner that one can manage to.
I suggest you to think about it before reading on and then see how much the following differs from yours. Could capital cost mean the interest rate paid by the business or any additional cost associated with raising the capital? Could it be the cost of borrowing? Interest expense?
First of all, all the above are incorrect and to be able to understand the cost of capital to an investor, the basic meaning of certain facts must be clearly defined. In fact, to a business, bank loans, interest, bonds issued, etc., are not a cost to the capital or shareholder's equity or constitute as part of the shareholder's equity. Strictly speaking, capital of a business refers to the shareholder's equity. If you know your financial interpretation well enough, shareholder's equity is the net residue amount available to the common stock shareholders after deducting all liabilities. In fact, such cost to the business should be classified as cost of loans, not capital. To make sense of this, ask yourself a question: "Does a business pay cost of borrowing from the shareholder's equity?" The only business that pays from shareholder's equity is those who are losing money, i.e. they have to eat into the shareholder's equity. So if a company is making money, it too means they are increasing shareholder's equity, so how can that be a cost to the capital (shareholder's equity)? Then again, the net income has already accounted for all kind of expenses used in the course of business. So if it is accounted for, to account it again as a cost of capital, it is double counting.
An investor must be able to distinguish the cost of capital for the business from the cost of capital for themselves. The theory running the cost of capital is the same from the business side as well as the investor side. Essentially, it is an opportunity cost of the capital which is retain in the business and if it can generate better returns compared to an alternative means.
To an investor in a business, capital is all about what is invested today to churn out more for the future. Thus, cost of capital means the ability of a business to create more than a dollar of value for every dollar invested or earnings that are retained. Of course this alone does not determine if the cost of capital will be to an investor's advantage or not. Then you have to think if a dollar is worth more in your hands, or if retaining in the business will produce more than in your hands. It means if the business retains a dollar of profit, they must be able to churn out more than what it can as if it is in your hands. So if you can churn out at a rate better than the business, the company would have failed you.
Many investors literally mistake the interest rates of the loans of a business as the cost of capital, where in fact, it is the cost of loan. By further questioning the nature of this, such cost of loan is in fact factored in when you get your earnings reported at the end of the fiscal year. Ultimately, as an investor, these earnings are used to calculate your return on equity. So by considering the cost of loans as your cost of capital is flawed. This should be discounted and you must be able to roughly determine what you can produce versus what the business can produce. If the business produces less than what you can produce if the capital is in your hand, you could have done better than them.
This may be intangible but it is important for an investor to grasp the meaning. To an investor, the cost of capital is the cost of lost opportunities if the company performs worst than you. If they perform better than you, there is no cost of capital. And I think an excellent and fair management should view it from an investor point of view whereby they do not hold investors back from what they can actually perform.
You may mentally argue that this is so intangible. But if you are looking for something tangible to compare, one of the tangibles is the risk-free interest rate. At minimal, a business must outperform the returns of the current risk-free interest rate. If a business cannot outperform the return of a risk-free interest rate investment, what sense does it makes for one to work so hard when you have an alternative where you can do nothing but “shaking legs” while you can earn just as much as working so hard?

Saturday, October 21, 2006

Success by means of short-cuts?

To begin, someone once quoted this about Mr. Charlie Munger: "You live in the centre of the field, you don't take corners." Many people mistake luck for success and success for luck. First of all, what is true success? It should be something that is both sustainable and growing.
Sustainable means being able to withstand the test of time. Growing means having long term growth. In many cases of so-called success, it is not the case. To name a few, Worldcom, Enron, Citiraya, Creative, US Airways and so on. They have their success stories in a limited way. These businesses achieved success but they are not sustainable or growing, a few are long-gone. Some went through restructuring, some are struggling. They may have enjoyed success for a short time but that is not what success is all about. There are so many businesses that do not grow after some time and then they decline. Are these real success? But then no business probably can really grow forever but it is also important that the business must be able to sustain market share and main its strength to survive. But many do not.
True success are companies that can stand the test of time, for example, Berkshire Hathaway, Coca Cola, Pepsi Cola, Wringley, Wal-mart, businesses where they hold the key and moot.
Then many times, people mistake potential growth as a means for success - think of those tech biz in the 90s-, thinking it will give them the short cut needed for success. Yes, it may give them success in a quick way but it just isn't sustainable. Then when things fall apart, the stack of cards too give way. But that's the nature of things, the temptation of short-cuts are way too much. Then if you think about it, the time taken to find short-cuts in life will cost much more than others who do it the right way. Worst still, many of these people never manage to find any ways to the success by the means of short-cuts.

Thursday, October 19, 2006

Belts and suspenders approach

In stock picking, the "belts and suspenders" approach is a commonly used method advocated by the creator to the way of intelligent investing. This approach is also known more commonly as the "margin of safety" approach.
In this method, an equity investor should treats how the way he purchases business like the way he purchases groceries in a supermart. If 100 grams of beef fillet goes for $1 every once a year, then a shopper should buy as much as he can. Normally, the fillet would perhaps costs $3 per 100 grams. Thus, in investing, it must be treated in the same mentality. But sadly, this seems to be the only area where people are manic-depressive - investors chase price when it goes up and sells when it comes down.
For Benjamin Graham, he is only interested to buy stocks selling for less than intrinsic value. If a company is worth X, he will only invest in it for less than X. This is his margin of safety - his "collateral." If he was wrong, or if some unforeseen event reduced his estimate of the company's value, he wanted a cushion. He wanted "belts and suspenders" for his stocks. The premise was that if he bought shares in a business for less than they were worth to a knowledgeable buyer of the entire company, he had a margin of safety.
Buying stocks at below its intrinsic value will certainly produce a superior result compared to those who did not. However to start with, an investor must certainly strive to be a knowledgeable owner. Being knowledgeable ensures an investor knowing where he can acquires more than what he pays.
Here's how investing below intrinsic value causes superior results. As most investors are aware, most businesses increase their net worth or intrinsic value over time. If intrinsic value is your benchmark, you can profit in two ways. First, the value of the shares you own will increase while you own them - works very much like compounding effect. Second, if the price of the stock rises from less than intrinsic value to intrinsic value over time, you will have a win-win situation. But, if you pay full price for the stock - a price equals to its intrinsic value - your future gain may only be limited to the company internal rate of growth and the dividends it may pays you. But an investor must always be aware that in equity investing, "value adding" does not exist, it's merely just a system for wealth-transfer between the parties engaged. Investors who trade among themselves are never adding any business value to the company. Think of it critically, if there are only 10 investors in a room trading stocks. Whatever price they pay in order to buy a business from the other sellers, the price which they pay do not go into the business, it ends up in the seller's pocket. So the buyer does not adds any value that the business is already conducting, neither does the seller takes any value away from the business. What has changed hands is only the ownership from one to another without any thing taken out or pump into the business. The only "value-adding" activity that has happened was to the seller who managed to offload his stake at a higher price than he had paid for.
If you think of the S&P 500 index as a giant conglomerate with 500 divisions, you will observe that over long periods, its earnings have grown on average 6% yearly. Typically, 3% of the increase has come from the growth of gross national product, and 3% from inflation. Thus, the intrinsic value of the S&P 500 thought as a single company increases about 6% a year. In addition, the S&P 500 pays a dividend. Historically, the dividend yield of the S&P 500 has been in the range of 3% to 4%. If you take the sum of the long-term earnings growth of 6% and the dividend yield of 4%, you get a long-term annually compounded return of about 10%. This is the return investors in an index fund should logically and realistically expect to make over the long term. Of course, to be able to make the 10% return, they must stay in the fund long enough. Investing in stocks is unlike putting your money in a savings account. In a savings account, both your principal and returns are fixed. You will not see fluctuation to its value at any time. However, in stock investing, returns and principal will fluctuate perpetually from year to year, sometimes dramatically. The 10% return is only an average of some bang-up years and some gut-wrenching years. So if an investor is the sort who chases prices and time the market by buying and selling, I can guarantee he or she will perpetually be underperforming the market to the extent of losing a chunk. Here's the logic. For these investors, they only buy when price is on the up, and then sell when it is on the down. How can they even expect to make much or any profit, or even to the extent of matching the market performance, when the logic is not correct? Essentially, it means they buy stocks during the boom years, normally at a price that is already "drum" way up, and then they sell when stocks are downhill. Now you must be asking how did they do such a foolish thing? This is really a psychological factor that is almost peculiar to only investing. Investor feels good when prices are drummed up and during such times, they feel great to pump in money because they feel prices will always be on a perpetual upslope. Conversely, it is the same when conditions are depressed. Investors feel prices will perpetually fall or at minimal will remain flat for a long time, thus, they think by selling when prices are going down, they can buy it back later when they are further down. But sadly, when prices go even lower, they are afraid to buy it. Frankly, any one without some fundamental logic will never be able to benefit from the field of investment in the long run. In the short run, they may be smart, but in the long run, intelligent investment will be correct.
What an investor would like to have is some mechanism that forces you into the market when stocks are cheap and eases you out or keep you on the sideline when they are dear. And the premise and principal of this mechanism is the same for all intelligent investor, that is to buy a business at below intrinsic value - i.e. having a margin of safety or belts and suspenders. Getting in at the bottom of the stock market always produces superior results than getting in at the top.
None of the other approaches can produce a better constant long-term result than the way of intelligent investing. There may be many other "sexier" approaches in investing but like the old Chinese saying goes "good to see, lousy to eat."

Wednesday, October 18, 2006

Secrets to greatness

In the most of many cases, greatness is tied to having a certain innate special and ungodly given natural ability. Yes, in a certain way it is but for people in this class, they are really in a special ungodly class of their own. Having said that, they too have a certain factor that contributes significantly to their greatness which all normal people can adopt. What I am talking about are patience, hard work and undying interest to learning and discovering.
When you think of people like Warren Buffett, Tiger Woods, Michael Schumacher, Michael Jordan and so on. They have a common characteristic among them. They never stop learning, and they learn from their mistakes to improve on their strokes and way of playing.
Buffett once mentioned that he is "wired up at birth to allocate capital." No doubt, this ability is almost certainly exclusive to him. But he too mentioned "Success in investing doesn't correlate with I.Q....once you have an I.Q of more than 125, those are wasted....Once you have ordinary intelligence, what you need is the temperament..." In this temperament, I reckon it goes two ways; firstly, one must have the continuous interest to seek for improvement; secondly, one must be able to control the urges that got most other investors into trouble.
Buffett, for instance, is famed for his discipline and the hours he spends studying financial statements of potential investment targets. One must understand that talent doesn't mean intelligence, motivation or personality traits sorely. It's also an innate ability to do some specific activity especially well - in Warren and Munger terms "being able to stay within your circle of competency."
In virtually every field of endeavor, most people learn quickly at first, then more slowly and then stop developing completely. Yet a few do improve for years and even decades, and go on to greatness. Initially, they learn at almost the same pace as the others, then after some time, the others realize the guy has gone way ahead of them. It is not because of his intellect, it may be because of his perseverence to never stop his interest towards learning. Once you lose the "spark", you lose your interest.
I'm unsure if many people realize certain things. What can actually keeps an interest going? I find this comment very interesting from the current CEO of Boeing who was also a former top executive at both 3M and GE, James McNerney. He quoted in Fortune: "Another is that success and achievement can feed on themselves. It feels good to keep succeeding. It feels great to see the people you work with grow and achieve." When one achieve success, big or small, they feel great and it inspires them to do more to keep the ball rolling and to do it better. That is what he meant by success and achievment feeds on themselves.
Then a question was posted by Fortune to McNerney: "What have you observed about those who grow and those who don't? Can you tell in advance who they'll be?" His answer was "No, you can't always tell in advance. It generally gets down to a very personal level - openness to change, courage to change, hard work, teamwork. What I do is figure out how to unlock that in people, because most people have that inside them. But they [often] get trapped in a bureaucratic environment where they've been beaten about the head and shoulders. That makes their job narrower and narrower, so they're no longer connected to the company's mission - they're a cog in some manager's machine."
Having a certain intelligence is certainly a base to success. But that alone will not cause success. A conclusion from a British research on people who achieve greatness was "nobody is great without work.....There's no evidence of high-level performance without experience or practice."
The best people in any field are those who devote the most hours to what the researchers call "deliberate practice." It's activity that's explicitly intended to improve performance, that reaches for objectives just beyond one's level of competence, provides feedback on results and involves high levels of repetition. If you think of Winston Churchill who was Britain PM during World War 2, he was a great orator, he too practiced his speeches compulsively. Then the great pianist, Vladimir Horowitz supposedly said, "If I don't practice for a day, I know it. If I don't practice for two days, my wife knows it. If I don't practice for three days, the world knows it."
Many great athletes are legendary for the brutal discipline of their practice routines. Tiger Woods is a textbook example of what the research shows. Because his father introduced him to golf at an extremely early age - 18 months - and encouraged him to practice intensively, Woods had racked up at least 15 years of practice by the time he became the youngest-ever winner of the U.S. Amateur Championship, at age 18. Also in line with what has been said so far, he has never stopped trying to improve, devoting many hours a day to conditioning and practice, even remaking his swing twice because that's what it took to get even better.
So far, it seems to implies that achieving greatness is not that tough but why does it seems to be so tough or almost impossible? Think in a critical manner. For most people, work is already hard enough without pushing even harder. Those extra steps are so difficult and painful that they almost never try or get done. That's the way it must be. If great performance were easy, it wouldn't be rare. Which leads to possibly the deepest question about greatness. Then another characteristic is people are afraid from committing mistakes which is a "pooh-pooh" thing to me. Greatness comes from knowing your mistakes, acknowledging it and finding ways to avoid it. Success in a large part comes from learning from mistakes and also knowing where you do not want to go to.
While it is easy to understand an enormous amount about the behavior that produces great performance, it is also essential to understand where that behavior comes from. I think that has got to do with emotional factor more than any thing else. Once one can find a way around the emotional and psychological factor that has been grounding the characteristics needed to achieve something good, then chances are results will definitely be much better. Strangely, that idea is not popular. People hate abandoning the notion that they would coast to fame and riches if they found their talent. But that view is tragically constraining, because when they hit life's inevitable bumps in the road, they conclude that they just aren't gifted and give up.
Maybe we can't expect most people to achieve greatness. It's just too demanding. But the striking, liberating fact is that greatness isn't reserved for a preordained few. It is available to you and to everyone.

Tuesday, October 17, 2006

Business and investing quote of wisdom of the week

Quote from Berkshire Hathaway 1992 Annual Report:
"What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor need to do very few things right as long as he or she avoids big mistake."
In here, I reckon Warren is pointing out to investors to make take all measures to ensure they know what they are investing in so as never to lose money. "Never to lose money" is the all important mindset and the "big mistake" that an investor must avoids at all cost even if it means staying on the sideline by sucking thumb till called upon.

Monday, October 16, 2006

When wishing beats investing

Some of the best investors spend most of their time not buying stock. Instead, they isolate superior companies and study them day in and out. Then, they wait. Eventually, a spike in oil prices or a miss in earnings will drive the stock price down - only then they buy. Everyone else seems to be doing the opposite. They focus on the ticks and let the market dictate them instead of letting the market serve them.

Sunday, October 15, 2006

From peddling computers to alternative investments

Deal computer provided a case study in just how costly options programs can become. In 1998, Michael Deal took home 12,800,000 options - in addition to the nearly $3.5 million in salary and bonuses. That year Deal himself received 21% of all the stock options granted by the company to its employees. A year earlier, Deal had announced that it was expanding its share buyback program - even though its shares were trading at almost 40 times projected 1997 profits. The next year, the company paid $1.5 billion to buy back 149 million shares.

In business school theory, companies give out stock options in order to ensure employee loyalty and retain top talent - making them part of the family where they hold a stake in the business and thus feel more attached to it. Moreover, while receiving options, Deal was also selling his Deal stock - some 8 million shares in 1998 alone. But why was he, wearing his founder's hat, selling stock while in his managerial garb he sucks up so many options?

In fact, 1998 was a good year for Michael Deal to begin giving serious thoughts to diversification of this holding. A year earlier, Deal's shares had led the S&P 500, gaining 216%, and in '98, Deal once again ran at the head of the pack, gaining 248%. But this would be the stock's golden year. From the end of '98 through to spring of 2000, Deal shares would rise only 58% and then plummet. By the end of 2000, they had lost 70% of their value. In the summer of '03, Deal still traded below its Dec '98 high.

By Sep of '98, worldwide computer sales continued to climb, but prices were falling. It is due to saturation of the market. Nevertheless, Deal's shares were changing hands at 67 times the previous year earnings and 49 times book value.

Meanwhile, in order to try to offset the cost of buying back its shares, Deal decided to gamble on its own stock. In an effort to make buyback less expensive, the company decided to use derivatives options that gave them the right to purchase Deal shares at a preset price for a defined period of time. They began buying call options. In call options, it gives the holder of the options the right, but not an obligation, to buy a share at a preset price over a predefined period of time. If the stock continued to climb, that preset price would wind up being lower than the actual market price which they would otherwise have to pay if they are to purchase it through the normal market channel.

Deal's foray into the options market did not stop there. To pay for the call options, the company began selling "put" options - an option which gives holders the right to sell the share to the option's writer - on its stock. The "puts" gave the the buyer the right to sell the stock back to Deal at a preset price over a specific period of time. If the share price fell during that time, the investor who bought the "puts" would win the bet, but if the share continued to surge, the revenues the company raised by selling the puts would become pure profit. This profit will then be used to pay the call options at the strike price of the call options. For a while, the strategy paid off. In one quarter, Deal made more by selling options than by peddling computers.

But once Deal's share price began to plummet, the gamble backfired. In the fiscal year ending Feb 1, 2001, Deal paid an average of more than $43 for the roughly 68 million shares that it bought back that year. Meanwhile its shares were paddling on the open market at an average of $25. Deal's problem did not end there: "The company eventually must buy 51 million more share at $45 - again, well above Deal's current price - through 2004," Barron's reported in 2002. Moreover, a built-in "trigger" provision requires that if Deal drops to $8, the box maker has to settle up all the puts. Deal would have to spend $2.3 billion to cover this: it had $3.6 billion in cash at fiscal 2002's end.

Investors who bought Deal stock thought they were investing in a computer company, not a hedge fund. But unbeknownst to most shareholders, Deal had temporarily turned itself into a company that specialized in high finance - and high risk. Because Deal had gotten involved in the derivatives game, the shares it bought that year cost an extra $1.25 billion - a number that slightly exceeded Deal's net income for the entire year. Under accounting rules then, Deal was not required to show the cost in its financial statements.

Saturday, October 14, 2006

Fundamental law in investing

The Buffettians among us will instantly recognize these rules. Firstly, never lose money. Secondly, never forget rule one.
So why has he been able to say "never lose money" with such a straight face? Is it because his winners have so substantially outstripped his losers? Is it just to boast his ego? None of those.What he is talking about is a state of mind. This is a guy who is a billionaire many times over, and yet if he were to see a nickel in a parking lot he'd bend over and pick it up.
Let's say that Warren Buffett picked up a nickel and invested it in Berkshire Hathaway when he took it over in 1965. Today, that nickel would be worth more than $130. How many nickels would it take to pick up and put to work for you before that particular payoff got to be really enticing? This is why those folks who pooh-pooh Buffett's unbelievable investing record are just wrong, wrong, wrong when they say, "Well, Buffett has access to all this inside information." In 1965, no one gave a damn who he was, he was juat plain Warren Buffett, unknown Midwestern investor, long before he was "WARREN BUFFETT, ORACLE OF OMAHA." And before he became known as a superinvestor, he had to, well, superinvest, by turning nickels into dollars many times over.
"Never lose money" is simply a philosophy for investing. It means something simple: There's no such thing as "play money." You don't go out and speculate on a total flyer. You remain disciplined, whether your account is up or down. No casino-like attitude. There's no such thing as the house's money. It's ALL your money, and it's all to be protected.
Think of an investing dollar this way: If you are 30, and you have an investing dollar and throw it away, you're not only losing the dollar, but you are permanently destroying all of its future value to you. True, you're not Warren Buffett -- each nickel becoming $130 over 40 years is, for most people, extremely unlikely. But it is likely it can become $50 or $20 some 40 years later. When you destroy, thrown away or spend a dollar today, you are also destroying all the future cash flow or intrinsic value that the dollar can produce.
So that means take no risks, right? Not in the slightest. In 2004, Pepsico offered a contestant the chance to win a billion dollars. The odds were fairly slim, but the game wasn't rigged. There was a non-zero chance that Pepsi would have to pay a billion dollars to some extraordinarily lucky contestant. So Pepsi did the reasonable thing: It insured itself against the loss, and the company that carried that insurance was Berkshire Hathaway. Berkshire took the risk for two reasons: First, it could afford to make the payout, and second, the amount Pepsico paid for the insurance was well in excess of the expected payout beforehand. It works like this: chance of paying out is, say 1 in 10,000. So the value of that chance, pre-event, is $1 billion divided by 10,000, or $100,000. So if Berkshire charged Pepsi $300,000 for the insurance, then the net expected gain to Berkshire was $200,000.
It is also important to know where are the risks the company you hold. Don't put yourself at risk of losing money needlessly by failing to have some idea of this for every company you own. If you do not, your investing results will be based largely on blind luck. And sometimes blind luck isn't very lucky at all.

Definition of Call and Put options (Part 2)

Put option provides the holder or owner the right, but not the obligation, to sell a specified amount of an underlying security or asset at specified price within a specified time to the option's writer. Owners of this kind of option are banging on the price of the security or asset to decrease.
Call option is the exact opposite of Puts. Call option provides the holder the right to buy a specified amount of the underlying asset from the option's writer at a specifiied price within a specified period. Holder of this kind of options is hoping for the price of the asset to increase.
Basically, Call and Put options can be written by anyone, even between you and me as long as the owner of the options have the faith that the option's writer is credible enough to settle the contract when called upon.
Imagine if you and me want to do a bet on the future price of Toyota Corolla. You think that the price will increase. I, as the option's writer, is willing to sell you 10 tickets whereby you can chose to buy 10 Corollas at a specified fixed price. Here's how it works.
I sell you 10 tickets with an expiry date that allows you to buy a Toyota Corolla with each ticket. Each ticket will definitely cost a certain amount, say $1000 per ticket. But to exercise or use this ticket to claim your Corolla, the price of the Corolla must hit say $25000 on the open market. Assume the last done price while this deal is written, is $22000. For the owner of this Call option, i.e you are the holder, you are banging on the price to goes up between now to the expiry of the option. If in between, it trades at $28000 and you chose to claim 5 of your tickets, I must buy from the open market to deliver the 5 cars to you. Then if it goes up further to $35000, I must deliver the remaining to you if you chose to exercise. Then there is a trigger clause built in, which states that the writer must deliver all options if price hits $40000, this is to protect both you and me against you not able to claim any if i go illiquid, and me against bottomless loss.
Conversely, Put options work this way. Same case as the Corolla. 10 tickets which cost $1000 each. Total option cost is $10,000. The exercise price is $25000, but this time the last trading price of a Corolla is $28000. So you as the holder is banging for the price to fall as much as possible. If it falls to $20000, and you chose to exercise 5 tickets, you can buy 5 Corollas and deliver to me and I got to pay you $25 grand. Then the trigger clause is say $10,000. I as the option owner must settle this put obligation and you deliver the rest of the cars to me and I pay you $25 grand each.

Thursday, October 12, 2006

Definition of Call and Put options

Call or Put options are a form of contract entered between two parties - the buyer or holder of the contract, and the seller or the writer of the contract. Essentially, such contract provides the right, but not an obligation, to the owner of the contract to either buy or sell a specified quantity of an underlying security or asset at a specified price within a specified time, from or to the writer of the contract. However, such contract is an obligation to the owner. To exercise the contract, there is a strike or exercise price - the price at which the writer must either buy the underlying asset and deliver to the holder, or take delivery of the underlying asset from the holder and pay the holder, if exercised upon by the holder. Usually these contracts are written with a "built-in" trigger clause to protect the contract's writer against bottomless loss. Each of which works differently depending on the holder's intention.
Such form of financial instrument is termed as "sophisicated" investment tools to the investment bankers. Usually, these instruments are available quite exclusively to the important few of those investment private bankers. And these high-worth individuals or organization are pretty naive to fall for such easy trick that is calculated.
Frankly, I term what Mr. Buffett has termed all along for these instruments: "Weapon of destruction" for the finance and investment world. This is also alternatively known as derivatives. Derivatives comes in many different "sexy" term to entice the naive investors. In truth, it should be termed as gamble.
I will explain more on how each option (Call and Put) works individually soon.

Wednesday, October 11, 2006

Luck versus skill

This subject may be a little controversial but yet, it is something that is worth to be given a second thought. In everything people do, it is important to distinguish if the factor of success is attributed to luck or to skill. If you have read my earlier article on "Being fooled by randomness", you will perhaps have a slightly better understanding.
At times, we perceive luck-disguised as non-luck (that is, skills) and more generally, randomness-disguised and perceived it as non-randomness.
Consider the words on the first and second set of words of the following.
  1. Luck, randonness, probability, belief, conjection, theory, forecast, lucky idiot, survivorship bias, volatility, noise, induction.
  2. Skills, non-randomness, certainty, knowledge, certitude, reality, prophecy, skilled investor, market outperformance, returns, signal, deduction.
At many times, the first set is mistaken for the second set. We should be more concerned with mistaking the first set for the second set more than the opposite case. You may wonder why the opposite case might not deserve more attention, that is, the cases where non-randomness is mistaken for randomness. The answer is we need to take into account the cost of mistakes; mistaking the second set for the first set is not as costly as in the opposite direction, although it is still an error. Some people believe bad information is worst than no information.
I believe there is an area in which the habit of mistaking luck for skill is most conspicuous, and that is in the world of markets, finance, investments or business. This is an area in which it causes human the greatest confusion and destruction. For instance, we often have the mistaken impression that a strategy is an excellent strategy, or an entrepreneur is endowed with "vision", or a trader is a talented trader, only to realize 99.9% of their past performance is attributable to chance, and chance alone. Ask a profitable investor to explain the reasons for his success; he will offers some deep reasons or ideas of the results. Frequently, these delusions are intentional and deserve to bear the name "Charlatans or phonies."
If there is a cause to this confusion in distinguishing the first set from the second set, it is our inability to think critically and without emotions - at many times, we like to paint a picture so rosy to drum up the positivity to a level to deceive both ourselves and others so that we can feel good for as long as it lasts. Conjectures are many times taken as truth. It is human nature.
In most things we do, subconsciously, there is a fierce fight between the brain (not being fooled by randomness) and the emotion (completely risking being fooled by randomness). To subdue this emotional randomness, the best method is not by rationalizing it, it is to go around it.
There is no clear-cut solution to seperate the truth from the emotional conjectures. The ones who can enlighten us on some of these ruses are those who have walked in front of us and are wise enough to discover them and honest enough to share.
While writing, up to now, this is something that continues to fool me at times, though not as often. But it is something one should be aware of, in order to minimize getting fooled by luck.

Tuesday, October 10, 2006

Business and investing quote of wisdom of the week

"Never throw good money after bad money"
In this, for example, it means if one had made a bad investment in a business with bad economics. He should never invest more money in the business or any new equipment or ideas that are presented to him to turn the business around. In the case of Mr Buffett's purchase of Berkshire Hathaway in the early '60s, the operating managers then kept going to Mr Buffett with proposals to invest in new machineries in the hope to turn the business profitable. However, this is a case where new technologies do not benefit the owners but it will benefits the consumers, think in terms of airline and more recently, computers business. Knowing the new technology will not turn the business profitable, he stood his ground to invest in places where his cash can churn out better.
Another example is the so-called "dollar averaging method" in investing, any method that suggests averaging means you will always be average, if the average of the market is negative, you'll the same as well. And in a way, by constantly pumping in principal, there'll also be time when you are using good money to chase after bad investment or money.

Monday, October 09, 2006

Fallacy of investor's inability to stay still

To start, it is appropriate to mention a quote of Mr. Buffett: "Much success can be attributed to inactivity. Most investors cannot resist the temptation to buy and sell." While his long-time partner and alter-ego once mentioned: "It takes character to sit there doing nothing."
I will present to you the historical information of Walmart from 1993 up to now and how the information at certain point in time will cause investor to react in certain way. I would suggest you to stop reading right here if you think that 11% annual return on capital is a cruise to attain or minute. Most of what are mentioned is with reference to investors who do not have a particular approach to their way of selection towards investment especially for those who are market timers. I do not know of anyone who has practiced the “timing” strategy in a successful way but I’m sure there may be a few of them out there who have done it “successfully.” You will understand why I use inverted commas for successfully if you read my article “Are we being fooled by randomness?” In everything that are practiced, irregardless if it is due to skill or luck, there will always be people who land in the top, middle and bottom percentile.

Assuming if an investor bought Walmart in 1993 at USD14.5, and he is a disciplined investor who held till today, he would have gained 4 times his principle. At USD48 today, his annual compounded return excluding dividend is 11%. However, I dare to bet that majority of the investors would not have the discipline and would have been very active in the first 5 years by not holding on to what they have bought in 1993. Most people cannot stand what the market tells them about the price even if the market at large is incorrect at that point in time.

You can see that from 1993 to 1997, the share price was driven down to USD12.10. Most investors would not have stayed so long. Instead they would just lock in on their losses and hop onto another lane which they think can fast-track them forward.

From 1998 onwards, the share price begins to rise to a peak of about USD53 in the early 00s. At this price, the valuations at then would open the eyes of most value investors, the P/E ranged from 32 to 39, price/book were from 6 to 8 times. However, there are some investors who are so greedy where they will hang on and hoping for the price to increase yet further. In fact, some of such investors are also value investors. I find that there are some investors who practice value investing on the buy side, but they become momentum investors when they sell, saying they'll wait for the market to tell them when it's the right time to sell. Personally, I disagree with such investors who practice value investing on the buy side but lost their way on the sell side. That’s bonkers and greed to me. Just like how interest rates and bond prices interact, in aggregate, sanity and greed moves in opposite direction as returns on capital. There is a very valuable lesson here: "In life, we must learn when to let go even if you have a much-loved card in hand."

Of course, you may mentally argue that it is always "all-so-easy" to think back on hindsight. But in truth, the history always teaches us the best lessons. Yet as always, history is a poor teacher and investors are a poor bunch of students.

Instead of looking through the windshield, there are also a bunch of investors who focused into the rear mirror too much. From 1993 to 1997, the stock price went from USD14.5 to USD12.1. Investors then were probably looking and projecting backwards, feeling discouraged about Walmart. This is what Mr. Buffett pointed out in late 90s for the stock market in 1982 as a whole: “Investors projected out into the future what they were seeing.” Then there were some investors who probably bought high at USD14.5 and with the stock price not going anywhere for so long, they decided to get out of the game. And as is so typical, the symptom of a cat who once sat on a hot stove will never sit on the stove again, whether hot or cold.

The major lesson here is the more you are active, the more you lose out - both on your capital and also on commissions paid to intermediaries - for the general investors at large. Unless an investor knows exactly what he is buying, he is bound to lose if he begins to chase the prices.

By the way, I am not saying that the valuations of Walmart were of good values during the period between 1993 to early 2000s except in year 1996 and 1997. In fact, I’ll not have touched the stocks then. What I am presenting is just a simple case to represent many other situations where the business is a good one but the price were not great at certain time and then it become great after some time. But then those who bought high paid a high price but learnt no lesson in preventing a similar case again. And when the price became undervalued, they lost all their patience and they would have sold off before they got a chance to make some profits – as was mentioned earlier, 1996 and 1997 were the years when valuations got reasonable.

*Note: All stock prices are exclusive of dividends and adjusted for all stock split.

Sunday, October 08, 2006

Defining "Investing" and the correlationship of Interest rate and Stock prices (Part two)

What had happened in the 17 years starting from 1982? A thing that didn't happen was comparable corporate growth in GDP: In this second 17-year period, GDP less than quintupled. But interest rates began their descent, profits began to climb - not steadily but nonetheless with real power. Then by the late 1990s, the after-tax profits as a percentage of GDP were running close to 6%, which is on the upper part of the "normalcy" band historically. And at the end of 1998, long-term government interest rates had made their way down to that 5%.
With these dramatic changes to the two fundamentals that matter most to investors explain much of the more than tenfold increase in stock prices, though not all - if you recall that the Dow went from 875 in 1981 to 9181 in 1998. What was causing this was also human and market psychology. As always, when a bull market is underway and once you reach the point where everyone had made money no matter what system or method he or she followed, a crowd is attracted into the game that is responding not to the fundamentals - that is interest rates and profits - but simply to the fact that it seems a mistake to be out of the equity markets. In effect, these market participants drive the market prices way over the price which fundamentals allow by having the "I can't miss the party" factor.
In a bull market, everybody's expectation is always too rosy. This kind of phenomena will always exist just like how investor will behave in a bear market where they are overly pessimistic. In a bull market, businesses are mostly valued at a multiple many times over its probable earnings. This can be due to the overly rosy picture painted by Wall Street. In valuing a business, investors must practice logic and realism of achievable earnings. You cannot expect to forever realize an annual gain that is more than the actual gain of profit in a business, though in the interim you can achieve purely because of the rosy paintings but ultimately, the actual results will prove it. The inescapable fact is that the value of an asset, whatever its character, cannot over the long term grow faster than its earnings do.
An investor must always be aware that any future returns are always affected and tied to the valuations that you give today.

Defining "Investing" and the correlationship of Interest rate and Stock prices (Part one)

More often than not in investing, many market participants focus too much on what the price of the stock will do rather than what the asset of the business will produce. Many will also focus too much on valuing a single business by valuing it together with the total valuation of the overall market, i.e a business is valued as how the whole industry or economy is performing, hardly on the scale of what the business itself does. When investors follow these strategies, any fool can do a job of similar outcome. When the tide rises, all rises, when it draws back, everyone sinks! On my blog, I shall focus almost exclusively on the valuations of individual businesses, looking only to a limited extent at the valuation of the whole market. The worst is to based one's judgment on a favorite header like "Shares end up mixed due to a lack of leads."
Let's start by defining "investment." The definition is simple but often forgotten: Investing is laying out money now to get more money back in the future - more money in REAL terms, after taking inflation into account.
Now, to get some historical perspective, let's look back into 1964 through 1998 to observe what happened in the stock market. Here you will observe an almost symmetry duration of lean years and fat years. To begin, the first 17 years of the period, from the end of 1964 through 1981, here's what took place in that interval:
Dow Jones Industrial Average
Dec 31, 1964: 874.12
Dec 31, 1981: 875.00
Even though you may be a patient guy and long term investor. That is not an idea of a big move. And here's a very striking and contrary fact: During the 17 years, the GDP of the U.S. - that is, the business being done in the country - almost quintupled, rising by 370%. Or, if we look at another measure, the sales of the Fortune 500 (of course then, the mix of companies were different) more than sextupled. And yet the Dow went exactly nowhere.
This is an amazing phenomena if you look at it just like that. To understand why that happened, we need to look first at one of the two important variables that affect investment results. These acts on financial valuations the way gravity acts on matter.
1) Interest rates. The higher the rate, the greater the downward pull. That's because the rate of return that investors need from any kind of investment are directly tied to the risk-free interest rate that they can earn from government securities. Thus, if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward. The basic proposition is this: What an investor should pay today for a dollar to be received tomorrow can only be determined by first looking at the risk-free interest rate. Consequently, every time the risk-free rate moves by one basis point (0.01%), the value of every investment in the country changes. It is easy to see this effect in the case of bonds, whose value is normally affected only by interest rates. In the cases of equities, real estate or whatever, other important variables are almost at work, and that means the effect of interest rate is usually obscured. Nonetheless, the effect is constantly there though like the invisible pull of gravity. In the 1964 to 1981 period, there was a tremendous increase in rates on long-term government bonds, which moved from 4% in 1964 to more than 15% by late 1981. So there - in that tripling of the gravitational pull of interest rates - lies the major explanation of why tremendous growth in the economy was accompanied by a stock market that went nowhere. Then in the early 1980s, the situation reversed when the then unpopular FED chairman, Paul Volcker, did the heroic thing by breaking the back of inflation, causing the interest rate to reverse, with some spectacular results from 1981 through 1998 - a similar length of period lasting 17 years.
1981 - Interest rate at sky high 15% with Dow at 875
1998 - Interest rate at about 5% with Dow at 9181
2) After-tax corporate profits as a percentage of GDP. This is the second factor which has a bearing on the stock prices during the first 17 years. From 1951 up to 1981, the percentage is always between 4% to 6.5%. Then by 1981, the trend was headed towards the bottom of that band, and finally in 1982, profits tumbled to 3.5%. So at that point, investors were looking at two strong negatives: Profits were sub-par and interest rates were sky-high.
And as is so typical, investors projected out into the future what they were seeing. That's their unyielding habit: looking into the rear-view mirror instead of through the windshield. What they were observing, looking backward, made them very discouraged about the country. They were projecting high interest rates, low profits, and they were therefore valuing the Dow at a level that was the same as 17 years earlier, even though GDP had nearly quintupled.

How is it possible to forecast the long run if you cannot predict the short run?

People always ask what is going to happen next quarter, next year and I think it is really hard to have the faintest of an idea. In general, the short term is unknowable and in an uncertain world, it should be unknowable.
For instance in a financial frenzy, it would certainly not end pleasantly, though we do not know when it will ends. These things are predictable but at uncertain horizons. In other words, you can predict how the ending will be but not the way there or when it will happen.
So why is it so hard to predict the short term than the long term? After all, the long run is made up of a series of short runs.
Think of yourself standing on the edge of a high building in a hurricane with a bag of feathers. Throw the feathers in the air. You don't know much about those feathers and how far they will go. Above all, you don't know how long they will stay in the air. Yet, you know one thing for absolute certainty: eventually on some unknown flight path, at some unknown time, at an unknown location, the feathers will hit the ground, absolutely guaranteed.
There are situations where you absolutely know their outcome in the long run but not the short run of when and how it will ends up to be. Though you cannot predict what happens in the short run, tomorrow, next month or next year. What you can predict with certainty is certain situations will end up in a certain way at an unknown time. What determines when this happens is all dependent on human emotions and madness.
Like Isaac Newton said: "I can calculate the movement of stars but not the madness of men."

Saturday, October 07, 2006

Does this article makes sense?

There was an article in the investment pages featuring a guy trading commodities in the papers on last weekend. This guy quit his full time trading job which pays a 5-figure sum to be a full time commodity investor. Usually, when a person give up something to do some other thing, the some other thing will usually be a job that pays an equally good amount of pay. Assuming this 5-figure sum to be the least of all 5-figure sum - SGD10,000. Then this guy stated: "I am confident of 6 to 8 percent gains a month. And that's a conservative figure."
Now we shall do some basic math which will eventually guides those reading the article to conclude if what is stated makes sense.
To match his previous pay of the least assumption of SGD10,000 per month, he will need a capital of of SGD125,000 or SGD166,667 to achieve a monthly 8% or 6% gain respectively. By stating that it is a conservative figure, it would apparently means it is a very logical and attainable target. If it is really so, in a year time by compounding this gain, his capital of SGD125K will be worth SGD291K in a year, $1.85 million in 3 years time, $11.8M in 6 years time and in ten years, he'll be worth a cool $1.186 BILLION. In 15 years time from now, he'll be worth SGD95 BILLION or USD60B. He is 43 years old today, in 15 years, he is 58. To compare with the current best investors, Mr Buffett, he is worth USD48B today at age 76. His alter-ego and business partner is worth USD1.8B at age 84.
Wow, what an achievement if what is stated makes sense and if simple math with variables given are so easy to achieve. I'll have to find myself a new idol to learn more on. Mr Buffett annual compounded return is about 22% since he started Berkshire Hathaway.
I hope when people read such articles, they should also think about the numbers and logic behind the numbers. Buffett once mentioned: "Things are never what it appears to be, skim milk masquerades as cream."

Importance of a stable and honest government

This was written some time back when we saw one of our regional neighbour who got into certain instability.


By now, you should know while you were asleep last night, a coup was conducted in the heart of TH. Moving from stability to overnight chaos to an uncertain future. What took 14 years to build took a day to destroy - actually it took a mere 2 years or less to turn from stability to chaos. So much from a great future to a bleak one almost overnight.

Anyway what I'm trying to say is many people are not appreciative of many things, especially on the importance of someone who is doing a great job in keeping growth and stability. Keeping in mind no system or people are perfect, it is thus important to know what will be the best option in life by not asking for the sky.

At least in where we are staying, we have probably the best governing party anywhere on earth, beating the US or any democratic country though the bigger countries have a different set of playing field.

When things like political instability happens, the people who gets affected the most are the ordinary folks - those working class folks. For the smart and able people, it doesn't affect them much though probably they get by with a little lesser but they don't get squeeze out. But if you think about it, political instability cannot happens just with the vote of the important few, it takes the ground to move them. So most likely, it is the ordinary folks who are not happy that gives an opportunity for the opposition to revolt. For people who are lazy, always complaining and always expect others to hand them things, any chance like that to happen, they definitely will not be on the ruling party side. But ultimately the one who suffers the most will be people like those who keep complaining. Because the very fact is the ones who need the most support or help from a good government are the ordinary folks who are not very able to make things happen by themselves. Take for example, the recent generous give-outs by our government, who needs this the most? It is always the ordinary folks. Where does this money comes from? It is from the past performance of the investment done by the government body on behalf of the people with the people money. People complain about government keeping all their money. Frankly, I whole-heartedly support this system. Without this, if the government don’t set aside this sum of money and instead give all back to the people, a large majority will not be able to handle or keep their money in their pocket, not to mention about growing the fund. This is human nature in large part because of the temptation to use it. Assuming all money is given back to the population, I am sure most people will not have the discipline to keep the money for the future. So they will most likely spend a chunk of it and then when they get into trouble, they expect more from the government. By then, if the population really needs financial help from the nation, the nation will not have a safety net to draw on. They will have to find ways to help solve this problem. Most likely, they will increase taxes, both from the businesses and the individuals who are the high earners. In the end, when taxes are more, businesses will chose not to operate here, it drives away potential businesses too, then the highly capable people will also feel being marginalized and probably look elsewhere with it benefits them more.

In any good system, it is appropriate to acknowledge "an ounce of prevention is worth a pound of cure.". Lacking this simple idea, even if the system can do great for a few years while sweeping the negativities beneath the surface, and when judgement day comes, a pin always lays in wait for any past decisions which were not sound. When the pin meets the bubble, no subsequent brillance can undo the damage.

Another thing, a lot of people always think that life is never fair. Well, truly, it is never fair in life. What can be fair is how you make things happen. And also, if you think about it, the moment you are born in this world, it is not fair because of the fact that people are given a different hand based on where they are born, not their ability to survive. We being born in Singapore are a lucky bunch, given a great hand as a headstart. If you were born in India, Africa or China, you’d be fighting tooth and nails over the basic needs for survivor. In fact, to be in SG, you are plain lucky, only 4 million out of billions can be in SG. So what's the probability? Then if things are on a level playing field, I'm pretty sure the majority of Singaporeans are of ordinary ability compared to the billions in India or China. So if you live there, you'll have a hell of a time. In fact, I think many young people here are extremely ignorant, they do not know much about what is happening in the region or in the world. Most will be able to identify with Brad Pitt, Paris Hilton, Kobe Bryant, David Beckham more than they can identify Susilo Bambang Yudhoyono, Gloria Arroyo, Shinzo Abe or Ban Ki Moon. But I can vouch that many of the Mainland Chinese are so much smarter and streetwise in terms of business and world knowledge even though some of them may actually even be so-called less educated than many of us. Just a few days back, my friend ask me what is S.A.R, he thought it refers to SARS, it's pathetic that our knowledge is really that limited. And if China really prosper to the same level as us, they thoroughly deserve the honor.

Not that I am a pro government supporter through and through. I'm a staunch supporter for what they had done for the good of the majority. Nobody on earth can caters to the need of everyone, if someone can do that, that fellow has got no principle because the system will be sway left to right and back all the time.

Friday, October 06, 2006

Can there be more lawyers than people in New York?

Someone once mentioned that there are more lawyers than people in New York. Is this possible? Definitely not. A sentence structured this way is very easy to understand and tells the answer. Assuming that all businesses in the USA are sold as an index stock, then if the sentence is - The value of the index stock is more than the value of all profits generated by all the businesses - is this possible? Think through it. Simple logic in life says: "The subset value of a product can never exceeds the aggregate value of the product. We will certainly encounter a math problem which will be unsolvable."

Between Dec 1899 to Dec 1999, the Dow went from 65.73 to 11,497 representing a compounded yearly increase of 5.3%. In aggregate, the return on stocks can never be more than what a business can churns out in aggregate. No doubt some people can invest better than some others but in aggregate, the return can never be more than 5.3% in stock investing for all the investors combined. Those who perform better than 5.3% are those who took home more from the same piece of pie at the expense of those who perform less than 5.3%. Moreover, in reality, investors as a whole cannot even hope to match this aggregate (5.3%) that a business earns. This is because in stock investing, there are intermediaries where a cut is paid for and all of these cuts are part of the aggregate that the business produces. In other words, in stock investing, it is wrong to assume that all the profits will go to the investors' pocket, part of it (a pretty substantial ratio) goes into the pockets of those who facilitate the trade.

Certainly, there are many times when the value of the subset far exceeds the value of the product. Those are the moments where logical math encounters a problem that will be addressed through time. So what is driving this mistake? It is none other than emotions. When emotions come into play, it deviates the facts that would otherwise be logical. What would then brings the facts back to reality? A pin will always lays in wait for every emotional bubble when people realize they have drifted too far off. Market is like a pendulum swinging from unsustainable emotions or optimism to unjustified emotions or pessimism, the centre between these two extremes is the efficient and logical point. The pendulum will never remains stagnant at a single point. Firstly, Wall Street will never allows it to be so. When there is no story, there is no dough. Somehow a story must always be created to generate interest to swing the pendulum to the side which is normally not to the general investor's interest.

Are we being fooled by randomness?

This subject is something that most of us will have experienced somehow or rather at some point in life. So what we shall try to answer is the hidden role of chance we encounter in life and in the market. It is hard to escape from being a fool of randomness. Many times, at certain things we see, we mistake success is due to methodology or at other times we mistake it to randomness. Examples include some of those successful investors, salesmen, real estate agents, and so on. Often, many are fooled by any form of nonsense that is polished, refined, original and tasteful because of emotions. A handful of people are capable of looking through this trick of emotion that is associated with probabilities outcome and by doing so, they confine themselves from falling into the trap of randomness.

Suppose in a national coin-flipping contest there're 4 million contestants and each of them will all wager a dollar each. Each morning, they all call the flip of a coin. If they call correctly, they win a dollar from those who called wrong. Each day the losers drop out, and on the subsequent day the stakes build as all previous earnings are put on the line again. After ten flips, there'll be approximately 3900 people in Singapore who have called their flips correctly for 10 times in a row. They each would have won slightly over $1000.

Now this group of winners will perhaps start to get a little puffed up on what happened, human nature being what it is. They may try to be humble, but at some parties, they will occasionally admit what their technique is, and what marvelous insights they bring to the field of flipping.

Now assuming that the winners continue to play the game for another 10 days, we will have roughly 4 people surviving the game. Each will have a little over a million dollars. After 20 days of flipping, a dollar becomes a million. By then, this group will probably have lost their heads. They may write books on "How I turned a dollar into a million in 20 days working 30 seconds a day?" Worst yet, they may start jetting around the world to give seminar taking in say $2000 per audience on efficient coin-flipping and tackling skeptical people with "If it can't be done, why are there 4 of us?"

But then this group of skeptics may be rude enough to bring up the fact that if 4 million orangutans had engaged in a similar exercise, the outcome would be still much the same - 4 egotistical orangutans with 20 straight winning flips.

From the above what I am saying is many successful events may or may not be due to randomness. We must never mistake success as randomness or vice versa. Sometimes we mistake randomness as success and success as randomness. In identifying if things are due to randomness, think about this, 1) if you had taken 4 million orangutans distributed roughly as the population of Singapore; b) if 4 winners were left after 20 flips; and c) if you found 3 came from a particular zoo somewhere, you would be pretty sure you were on something. So you would probably go out and ask what the zookeeper feeds them, whether they had special exercises and so on. So, if you found any really extraordinary concentrations of success, you might want to see if you could identify concentrations of unusual characteristics that might otherwise be casual factors. Almost certainly, if a case of concentration of characteristics in a particular group who are left standing, this is not due to randomness. d) if all 4 winners turns up from different zoo with no particular set of knowledge, these orangutans can still turn their achievement attributed to randomness to fooling others into doing the same thing while getting paid for in seminars. Those others who subscribe to these random winners may get fooled by these 4 orangutans' random success as real workable means to achieving the same kind of success. By the time they realize the trick of randomness driving the 4 orangutans' success, they will have learned nothing but luck and perhaps some painful lesson which costs a bomb. I believe some of these orangutans lay in the classified section.