- “Lots of money being printed but very little wealth. Wealth comes from innovation and elbow grease not higher asset prices.”
- “Don’t be fooled, central bank credit creation increases asset prices but it doesn’t create wealth.”
- “Wealth’s not cre8(a)d w(ith) high(e)r asset prices but w(ith) productiv(i)ty;labor;innovati(o)n. High(e)r asset prices due 2(to) lo(w) inter(e)st rates (a)r(e) fi(ct)ktitIio)us wealth.”
As an example, a small compression in margins can cause a big distortion to stock price, particularly if you purchase at the peak. Nike, which just reported earnings, is off almost 10% for the day when they reported a lower margin (not a lot lower but about 2% lower in gross margin). For those who bought at the peak of $115 thinking that margin cannot be compressed, and extrapolated from the recent past, this is a toxic cocktail. So they learn the old lesson the old way, through their wallets and is down almost 25% in less than three months.
- We work on patience and maintain discipline by not chasing for return that does not sufficiently compensate for the risk we take - even if our portfolio lags behind the market in the short to medium run.
- We focus on doing what we think are the right things even if it looks wrong in the eyes of others, and not what looks right or relative.
- We do not look to beat the market all the time. We only look to beat the market at the right time, particularly, we aim to significantly outperform the market on a downturn and hope to maintain with, or even underperform the market on an upswing.
- We are dedicated to measuring our performance on a full economic cycle (i.e., a long market cycle that goes through thick and thin) against the market benchmark.
- We do not allow others to tell us what to buy, what to sell, when to buy or when to sell, especially on a baseless manner. Although we pay attention to what they say because it gives us an inkling what the market is doing and if what they are doing is sensible or not, and we position ourselves accordingly.
- We make our own decisions on how we think about the business and the value that is expected from the price we pay or sell. We eat our own cooking. Others who tell us what to do usually do not eat the cooking with us.
- We do not rely on others to measure our performance, we evaluate ourselves by what we say we will do in our core beliefs that will bring us long term performance excellence on an absolute basis.
Another hardly-asked question is how did the portfolio achieve its results. Most of us tend to just focus on the headlines. For example, if you compare the following arbitrary portfolios handled by different managers:
- Portfolio A returns 50% in first half 2012.
- Portfolio B returns 2% in first half.
- Portfolio C returns 2% in first half.
- Portfolio A 50% return was largely achieved by placing a significant portion of assets in a "hot" stock with minimal revenue and has yet to generate any earnings to show for. However, it is "hot" and much pursued after by market participants because of its perceived attractiveness with novel technological capabilities that has the "potential" to grow exponentially.
- Portfolio B is up only 2% and underperformed the major indices by 4-6% because the manager deemed the current state of affair as risky, especially with a dearth of compelling buys. He, thus, allocated, less than 50% into equities, with the rest lock in safe havens like cash or short-term treasuries, while biding for his time.
- Portfolio C underperformed at the same rate as Portfolio B. However, the results for Portfolio C was achieved very differently from B. The manager for Portfolio C is almost fully invested, with only 10% cash or less. However, most of his equities turn out to be duds and most of the securities are not in safe-haven securities like consumer staples or the stable type of stocks. Most are in cyclicals. And it returns 2% versus the major indices return of 6-8%.
If we are to chose which manager to hand out money to, we will hand our money to Manager B. If there are only two choices - Manager A and C - we will chose C. Over our dead body will we ever chose A.
- Have we been conservative in a seemingly expensive market and be brave in a seemingly chaotic one? Check. Compared to early 2009 to mid 2011 when we were fully invested, we shifted gears starting mid 2011 to more cash, peaking at 35% cash, but has since dropped but we are still rather conservative holding 28% cash. We will increase or decrease depending on how hot or cold the market is, or if we can find cheap buys even if the market is hot.
- Have we been able to resist chasing after returns for the sake of keeping up with the Jones and be satisfied to underperform in an up market and outperform in a down market which is the strategy to long-term outperformance in a full economic cycle? Check. Our portfolio has so far shown the characteristics to underperform when the market takes a huge step forward and outperform when the market takes a huge step back. And over a period of time, we have delivered results that are satisfactory, and so far been absolute. Here are some examples:
The above examples demonstrated, thus far, that we are able to deliver satisfactory results by paying attention to risk. This is achieved by 1) outperforming the market on its way down, and 2) matching or slightly underperforming the market on its way up. We wait for unforced errors and pick up the free lunches - maybe not free but for a dime or significantly less than its intrinsic value.
- S&P500 is currently flat from the closing of April 2011 of 1363.61 (peak for 2011), while our portfolio is up 3% while maintaining a cash level of 25 to 35% for most of the period.
- S&P500 is currently down 3.3% from the closing of April 2012 of 1408.47 (close to the peak for the first half), while our portfolio is up 1% while maintaining a healthy cash balance of 25 to 28% for the period.
- In an up market, we are likely to underperform the benchmarks but we will not be unhappy, instead we are satisfied although it may be emotionally tough but we understand our goal. For example:
- If measured from market low: From end September 2011 (market low) to now, S&P500 is up 20.4%, while we are up 14.4% while maintaining a cash level of 15 to 32%.
- If measured from the high to the low in 2011: From end April 2011 to end September 2011, S&500 is down 17% while we are down 10%.
- Did we dig for gems regardless of market's temperature? Check. We will never throw out the baby with the bath water under any conditions. Mastercard and Visa were bought at a valuation that is likely to produce mid-teens return for the medium term even though it reduces our kitty.
- Have we exercised patience, and analyze thoroughly before buying or selling ? Need to work on. We could have been better but we take it as a learning curve. Although we had done reasonably well for most of the stocks that we sold based on what we think it is worth, there is, however, one which we committed an elementary error – Anheuser Busch Inbev. It is not because we feel terrible that the stock has surged to over $79 (we sold at $64.6) but rather for the failure to do a proper analysis when we sold and then learnt later that we left significant value on the table. We do not feel terrible just because a stock surges from the price we sold. Two other stocks that we disposed have also gone up – Starhub (sold at S$3.28) and SIA Engineering (sold at S$3.87) – but these two are likely to be, at best, fully valued. We do not see how Starhub and SIAE earnings can grow at the same pace as how the stock prices suggest, particularly, Starhub because they have run out of tax assets and need to pay tax in cash very soon, but sure, they have better levers than the other telcos which they can pull to increase debt which may benefit shareholders.
- Coca Cola – We took the opportunity to add KO at an average price of about $67. We would not have added more Coca Cola had Pepsico price not been within 3 to 4% percentage less than KO because we do not think it is prudent to reduce cash holding significantly for a stock that is only slightly undervalued. But compared to Pepsico, KO is a better bet if KO is selling for only 3-4% more than PEP. Therefore, to fund the purchase, we reduced our then-significant exposure to Pepsico and bought into Coke. Although, we have since reduced roughly 2/5 of KO. Today, the difference between KO and PEP is about 10%, down from 15% earlier, in favor of KO. And let's not misinterpret this as a technical play or based just on the difference in prices. Rather, it is a comparison of which stock provides a better value if the price of Coke is 3-4% more than Pepsico. At $67 for KO, it is selling at almost the same multiples with PEP at $64-$65 and KO eps growth is brighter than PEP. This was prior to PEP's reduced earnings guidance. In total KO return 14.8% for the first half, and comprised about 13% of the total gain for the portfolio.
- Mastercard and Visa – Stakes were accumulated in January 2012. Return for the two shares is 17.6% since acquisition. This group comprised about 20% of portfolio total gain.
- United Overseas Bank – Up 25.5% for the first half. Makes up 24.4% of portfolio gain. However, the performance is much less stellar if measured from cost, up only 6.6% (although if measured in SGD terms, it is up 10%) since acquisition during second half of 2011.
- Berkshire Class B – Up about 9.2% for the first half. Comprised slightly over 9% of total gain. However, it is up by only 4.3% from cost. Shares were acquired at different times, with two-thirds acquired in May 2011, and the rest acquired in Jan 2011 and earlier.
- Haw Par – Up 17% year to date. Contributed 5% of total portfolio gain.
- Pepsico – Up 6.5% for the remaining shares. However for those shares that were sold, it was sold at a lower price ($65.74) than the price at the start of the year ($66.35), therefore, it lowered the gains for the remaining Pepsi shares.
- Remaining gains came from smaller positions such as DirecTV, Reckitt Benckiser, Becton Dickinson (partially sold), CSX (sold), Anheuser Busch Inbev (sold), Amgen (sold) and some opportunistic stocks like St. Jude Medical, Starhub, SIA Engineering and Baxter which are all sold.
- Opportunistic stocks – St. Jude Medical was acquired for $32.5 in December 2011 and was sold at a gain of 10.5% the next month. Baxter was similarly bought in December 2011 at $48.11 and sold two months later for a gain of over 16.8%. SIA Engineering was acquired in January 2012 for $3.38 and sold in March for a gain of 13.3%. Starhub was bought in January 2012 and sold recently in June 2012, for a gain of 20%. These four opportunistic stocks comprised about 7% of total portfolio gain.
- The above reflects the positions with positive returns. The total return for the above positions produced a gross gain of 9.7% year to date. But this is offset by some positions with losses Net result as shown along with Dow Jones Industrial Average as a comparison:
- Losers for first half includes:
69% of the losses comes from Norfolk Southern, Pepsico (related to the shares sold to fund KO), and Celgene. Of the 3 main loss contributors, we hold a larger position in Norfolk and Pepsi compared to Celgene. Unfortunately, after purchasing at $73, it fell through the roof to a low of $59, and is now $64 and change,. This is mainly because of a delay to gaining new marketing approval for extended use in the E.U for its top selling drug . But at $59 or below, we stand ready to add because we think it has a strong line of current commercial drugs and also a decent pipeline that serves to extend use for existing drugs and also new drugs in trials.
- Norfolk Southern (-1.4%),
- Western Union (-5.4%),
- Google (-3.6%),
- Celgene (-12%),
- Tesco PLC (-2.1%),
- Singapore Land (-1.8), and
- Molson Coors (-1.6%).
- Mastercard and Visa
Now take Mastercard as an example and assume growth slows to 10%, earnings by 2015 would then be $27.4 per share. In order to lose money, the stock must sell below 13.5x in 2015 and growth rate must slow to 10% for us to show a loss. Of course, if such a scenario happens, we will be extremely glad to double, triple or even quadruple our stake for a business that still carries a 10% growth rate and sells for a very reasonable 13.5x earnings.
- Norfolk Southern Railway
The tables clearly demonstrate the strength of all of the rail franchises on either side of the coasts through a full economic cycle. The pricing power held up well even in the face of market distortion in the years 2007 to 2009. Revenue per unit in 2009 is 7.7 to 10% more than 2007 for all the railroads even with unit volume falling 20% from 2007. Moreover, total volume in 2011 was still 10% less than its previous peak in 2006. Volume today is around the same as it is in 2003. One of the “concerns” on railroads, particularly the eastern railroads, was recently directed at the decline in coal volume which is likely to be secular rather than cyclical, as long as coal cannot compete with natural gas as a fuel for energy. Just this week, Rex Tillerson, CEO of Exxon Mobil, sort of admitted his mea culpa in going big into natural gas. However, the decline in the coal franchise (over 40% of total volume) is offset by growth in the overall merchandise businesses, particularly very strong growth in vehicle/car carloads with year to date volume growing in excess of 20%. In the latest weekly traffic report from the Association of American Railroads, the total coal carloads for year to date is down 10.8%, but the decline which started since 2011, is levering off. In the week of 25, coal volume is down only 0.4%. So any future decline in coal is bound to have a much lesser impact to total volume, and may even be accretive to volume if there's an untick. Although utilities are using less coal, coal is not going to go away totally, coal makes up 45% of electric energy sector in the U.S in 2011, down from 49% in 2007. According to an outlook released in January 2012 by EIA, coal is forecasted to generate 39% of all electricity generation over the next 25 years. Others are forecasting even lower - expecting coal to fall to 30% of all U.S electricity generation by 2020. Utilities are the major buyers of coal – buying more than 90% of coal mined in the U.S.
- Singapore and other stocks – M1, Singapore Land and Tesco (small positions)
- Bought M1 at S$2.42 early in the year. Received S$0.079 in the meanwhile as dividend and stock ended June 2012 at $2.56. M1 was bought along with Starhub at the same time, but Starhub has been sold in June 2012 at S$3.28, which appreciated from S$2.72.
- Singapore Land was bought at S$5.65 in Feb 2012 . Highly discounted from book value. Sells for a reasonable 10x cash flow. A majority amount of predictable revenue such as rental and hotel operations which can cushion the impact of the cyclical property development business. Excluding property development income, the predictable segments earns about S$0.50 to S$0.54, about 10.5 to 11x earnings multiple.
- Tesco is the giant UK retailer with international operations in Thailand, Malaysia and other parts of Asia and Europe. Bought Tesco in Jan 2012 at-the-then-3-or-5-year-lows at £3.155 per share or about 9x expected earnings. While we wait for the management to turn the UK retail business around, we get paid over 4% in dividend. Surely, a turnaround in retail is never a sure-thing. Just look at Carrefour, they even cut dividend. But in Tesco, we shall see. I believe fundamentally, they are not as bad as Carrefour. There's a reasonable chance for them. And that's why this is not a huge bet but a small one.