Tuesday, October 03, 2006

Thoughts on investing and current market (Part 3)

Another thing to note, when you see an influx of funds by people who do not usually talk about stocks, it is the time when the euphoria really begins. When there is an excess of money to buy stocks, there is no other way but up for stock prices. The reason is very simple. If you understand how the mutual fund industry works, all they want is new funds. For instance, like the local banks where they promote lots of different funds. If next year, out of the blue, everyone in Singapore wants to invest in a fund, they bring into the market with a lot of money. Where is the money going to go to? Sit idle? Goes to buying bond and earning its interest? Hell, no way, fund managers must find a way to invest the newly acquired funds for the customers. So when the supply of the stock is the same, all the fund managers will be fighting for a slice of the limited cakes. Thus, price of equity goes upwards. Now you may ask the reason they still buy when price is overdriven. Simple, they can’t afford not to. They are on losing ground whichever side they stand on. So for them, they’ll have to join what all others are doing. So when they fall they go down together, and they won’t look as bad. In some way, it’s in the fund manager interest to follow the herd, even if he thinks the herd is wrong. In the worst case scenario, he will go up in flames along with everyone else. And no one will fault him. Alternatively, if he dares to think outside the box, and do what he believes is the best long-term interest for his clients, he takes the chance of being “wrong and alone.” In the mutual fund industry, time is not the friend of the fund manager. In a market that focuses on the moment, the last 6 months is all that matters. So to speak, clients will not give money managers a chance to prove their case with time even if in future, the performance will be better than the others. Secondly, when investors invest, they expect their money to be in stock, not in liquid, if it is in liquid, the investor will withdraw the money and find someone else. This amounts to losing a business. Here, shall mention another Warren’s message – “The stock market is a no-call strike game. You don’t have to swing at everything – you can wait for your pitch. The problem when you are a fund manager is that your fans (investors who put money with you) keep yelling, “Swing, you bum.”

Thus far, the mutual fund only allows 4 paths for its managers to walk. 1) You can be right and with the crowd – which is fine. 2) You can be right and alone – and then you are a hero. 3) You are wrong and with the crowd, which isn’t actually so bad. When everyone is down, it doesn’t hurt (the fund manager career either because you’ll be ranked together with everyone) to be down. 4) Or you can be wrong and alone and then you’ll look like an idiot. The last option is the ignominious fate that a career-conscious fund manager strives to avoid at all cost even by knowingly buying stocks at a high price that is stack against the odds. So for most money managers, they do what the whole of Wall Street does best – by playing to the gallery; playing to how the fans and crowd dictates them to play. Wall Street does what they does best – being the best salesman. When you assume the role of a salesman, all they care about are sales – investor’s interest counts for nothing. On Wall Street – a community where quality control is not prized – will sell investors anything that they will buy.

Not that all mutual funds operates in this typical manner, but those who do not are too few and far between. It takes a hero to divert from where everyone else is moving. The strange thing with people is they do not mind falling together no matter how hard the pain is. But if anybody who has the intention to put his money in the care of a fund manager, the model example of this caretaker must at minimal be of the same standard as Jean-Marie Eveillard and Charles de Vaulx of First Eagle Fund. They were the heroes in the late 90s when most mutual funds are supporting the equity market while they are out in a huge way. What they say is impressive with action “At least we lost half of our shareholders - rather than losing half of our shareholder’s money.” “We only appeal to defensive investors, people who are worried about losing money than they are eager to make as much money as possible because we are not aggressive investors.”

Then as a value investor, it is also important to know the every basic of what can test your faith in the idea of intelligent investing. When everyone else is doing better than you in a bull market, naturally most people will feel down. Not because they are earning more, but because almost everyone is abandoning the creditability of a great idea. Like what Eveillard mentioned “I don’t mind seeing professional investors I respect doing better than me. To see people I did not respect doing better than me – this is totally discouraging.” When you encounter this, this is when it tests your discipline in your method of investing. To make money out of something you do not believe in is not really fun first of all, then it puts you in a very precarious position. Another Warren’s quote “I would rather be certain of a good result than to be hopeful of a great one.” Do something that is certain, not hopeful. The journey does not ends tomorrow, the day after, a year later or 20 years later, it ends the day you are immobilize. So, for something to last that long, you must have a solid foundation and idea to do it right. You can have a revolver with a bullet in 6 chambers pointing to your head, and then you shoot it yearly. The more you shoot with each time, your chances of survivor lessens. Assuming you survive the first 4 years, when it comes to the 5th year, you only stand a 50% chance of survivor. That is because it is something you have no means to predict in the safest way. But if you chose to do that, you must know when to give up. Being greedy will definitely harm you. It is important to know the level of greed moves in opposite direction of odds and sanity. So when you get greedy, odds and sanity decreases. In life, it is like a poker game where you must know when to give up even if you have a much-loved hand. Life is also a series of opportunity cost. Whatever you give up, you gain in something else.

If the present valuation is the same as in the late 90s, it is surely overpriced now. For most people, they think stocks are ever-ascending, on paper, at least, it shows. But in reality, the real people who gain are those who took their winnings home before the party ends. The vast majority historically holds on – as they are told by the press, the brokers, the gurus. For those who cash out, they may have missed the peak but they missed the wreak that follows suit.

The only so-called setback when you go against the crowd is you are almost alone. The crowd may provide you warm because you are inside the herd. But one of the few greatest advantage is time is your friend while it is the foe of those who does not practice value investing.

To summarize all the above, you can glean from it that investing is really one of the most diverse subject on earth, if not the most. It encompasses human psychology, basic arithmetic skills, discipline, patience, general knowledge, economics, and much more. For those who think investing is just about figures, then it is same as the principle of the man with the hammer who deals with everything like a nail – just hammer it in. Well, the problem with hammering all nails in is you have a problem of pulling the nail out when it is hammered at the wrong place.


fishman said...

Hi! I saw your link and comments in 8percent's blog and thought I drop by to take a look, since you seems to be interested in similiar topic of investing..

Wow I must say you have really being studying trading! Only browse through roughly.. there's simply too much to read!

I'll certainly drop by often and hope to gain some more insight from you. Meanwhile, you're invited to visit my blogs! ;=)

Keep the posts coming and all the best!

fishman said...

By the way, I like your blog title very much! How you find as much success as them!

Berkshire said...

Thanks Fishman for dropping by. I will be adding your a link to your blog if you do not mind. Hopefully, to learn something from people who practise value investing.

fishman said...

Hi! Of course you may add a link to my blog! If fact I was about to ask you the same thing!

Btw, are you a professional writer or something? You write alot and really fast!

Saw your recent comment in 8%'s blog about the 5.3% returns thingy. Very insightful! But that led me thinking. "How can I then ensure that he beats the Dow returns consistently?"

Berkshire said...

Hi Fishman, I'll be glad if you can link my blog to yours.

Haha, I ain't a professional writer nor in the finance profession. A lot of these ideas do not originate from me, I read up alot on what I think I agree with and can make sense out of those ideas where these successful people have practiced it in the correct way.

As for beating the indices, I would suggest any investor to ignore what the dow or any indices is performing. Look up and value a business on its fundamentals and its value. In fact, the best way to buy a business is to first look at the financial statements, then determine a fair price from there and then you look at how much it is trading for. If lets say you determine that Biz A is worth $10 per share. And then when you look at the trading price and it trades at $8 per share. You should buy as much as you can since the price is already below what you think is a great value.

The reason why I suggest to ignore the indices as much as you can is to avoid being too obsess with being sucked into something that will cause you to deviate from what you would logically do to achieve a decent result. Like the saying, if you are obsessed with a promise towards achieving some numbers, you will most likely end up trying to make up for the numbers. So somehow to make up the numbers, you will end up doing something foolish.

Personally, I do not mind not beating the indices but of course beating it gives a sense of satisfaction. What is more important is I should take care of my Long Term aim rather than the short term of beating the indices year after year. If the long term and short term goal conflicts, the long term must take precedence.

By the way, I am working in a normal paying job which I have no interest. My interest lies in increasing knowledge in investing to build a future where I do not need to rely on anyone else.

fishman said...

Well said! I too would hope to achieve my financial goal of financial independence one day.

Hey your investing style really sounds like guru Buffett! I also don't believe in trading.

But how to value a company correctly? My thoughts is that Bluechips is the safest to start off with, do you agree? And how to buy shares in the first place?!

Berkshire said...

Hi Fishman, yes, I'm almost a fanatic of Buffett's way of investment and in general way of thinking. I think what he preaches sound very much logical to me and it makes so much sense. To practice something, you must be able to understand it fully in order to succeed in it.

I do not think that blue chips provides the best value. I think all shares provide a fair value or bargain at certain point in time. Even cigarette-butt stocks provide great value if you can buy it really cheap enough.

Look at Coca Cola in the late 90s, they were trading at 60 to 80 dollars US at a price/earnings ratio of almost 50 at its peak coupled with a price to book ratio of almost 10 or more. Now the price is about USD45. It has been trading around this price since 2000. Coke is definitely one of the best blue chip stocks in the whole world. So besides dividend which you earn, you would have remain flat in capital gain if you bought at USD45 in 2000, or worst still, paper lost if you had bought at its peak in late 90s.

I always like to buy stocks which has reasonable valuation. But firstly, the business must be sound and be able to survive for the next 15 years. I do not like any business which is so called emerging or growth. Names like growth and emerging are just some sexy words to disguise the fragile underlying business fundamentals beneath the surface.

For the very basic of business and financial valuations, the best book to build the basic foundation is by Benjamin Graham "The Interpretation of the Financial Statement". Very easy book to read and understand. No big jargons.

Charlie Munger once said: "A great business at a fair price is better than a fair business at a great price."

Berkshire said...

Hi Fishman, to buy shares, you must open an account with any of the stock brokering firms. Uob Kay Hian, DBS Vickers, Philips Security and so on. If you want, I can recommend my Kay Hian broker to you. He is pretty good, at least his customer service is great compared to some other i used previously.

fishman said...

Hi Berkshire, thanks for your offer! I don't mind having the contact but at the moment I won't be investing in shares yet. Reason being I feel that I don't know it enough yet.

Benjamin Graham. Isn't that Buffett's mentor in Uni?

Berkshire said...

Hi Fishman,

Yes, he is Buffett mentor in College. In fact, Buffett was the only student who got A in his class.