Author: Chong Ser Jing

Investing In Stocks Is A Lot Like Lending Your Friend Money

There are similarities between how we invest in stocks, and how we determine if we should lend somebody money.

Note: This article is a collaboration between The Good Investors and The Woke Salaryman. It was written by me and edited by He Ruiming. An earlier version of this article was first published in The Woke Salaryman.

Investing in stocks is sometimes made unnecessarily complex.

But really, if you boil it down, it’s basically making an educated guess on whether you’ll see your money return to your hands (hopefully more than the initial amount). 

So, we decided to come up with an analogy that you might find all-too-relatable –  lending your friend money. 

Okay, but before the nitpickers start, we have a few caveats to make.

There are key differences between investing in companies and lending money that we will disclaim upfront. Namely:

  • Lending and getting your money back (hopefully) involves a short time frame, but investments are often for the long term
  • Lending can be an emotional decision; investing emotionally is often a bad idea
  • You’d expect to get 100% of your money back when you lend people money, but you’d expect more from your investments 

Now that we’ve gotten that out of the way, let’s get straight to it.

These are the things that both investors and prospective lenders might wanna look out for when parting with their money. 

Factor 1: The industry they are in 

First things first. The industry they’re in matters, because that affects how much income they will be getting.

Are they exposed to a growth industry, or one that’s stagnated and going through rapid decline?

For example, you’d prefer to lend money to someone who’s working to develop productivity software as opposed to someone who works at a print newspaper. One has the potential for a lucrative career path. The other’s best days are over. It’s obvious who is more likely to return your money.

Similarly, when investing in stocks, the industry that the company is exposed to is important.

Being in a large and/or growing industry means that it’s easier for a company to grow.  But companies that are in a sunset industry have little room for expansion, and may meet their demise sooner than later.

Factor 2: The stability of their income

The next thing you think about is the stability of income.

Are they working at an established technology company as a software developer, or are they a freelance developer who relies on gigs?

Don’t get us wrong. Freelancing can be highly lucrative, but it may not be as stable as working at an established company – and having a stable income increases the chances that they can repay you.

When applied to the stock market, having stable income (in other words, having recurring revenues) is better than having income that comes from unpredictable sources (such as depending on big sporadic projects for revenue). 

Having recurring revenues means that a company’s management team is able to better budget for growth investments for the future, without worrying that the business may fall into a rut.

Remember – investors love predictability.

Factor 3: Their financial strength

Is your friend laden with a heavy mortgage, car loan, and/or credit card debt?

If so, it’s going to be really difficult for them to repay you, as compared to somebody who has minimal financial liabilities at the moment. After all, if they already owe so many people/organisations money, what is the likelihood you’ll get your money back?

In a similar way, companies can also be either heavily in debt, or be flushed with cash and assets.

I prefer a company with a strong balance sheet – (aka more cash than debt). This simple trait makes a company antifragile, in my opinion.

Antifragility is a term introduced by Nassim Taleb, a former options trader and author of numerous books including Black Swan and Antifragile. Taleb classifies things into three groups:

  • The fragile, which breaks when exposed to stress (like a piece of glass, which shatters when dropped)
  • The robust, which remain unchanged when stressed (like a football, which does not get affected much when kicked or dropped)
  • The antifragile, which strengthens when exposed to stress (like our human body, which becomes stronger when we exercise)

Companies too, can be fragile, robust, or even antifragile. 

The easiest way for a company to be fragile is to load up on debt. If a company is heavily indebted, it can crumble when facing even a small level of economic stress.

On the other hand, a company can be robust or even antifragile if it has a strong balance sheet that has minimal or reasonable levels of debt. During tough times (for whatever reason), having a strong balance sheet gives a company a high chance of surviving. It can even allow the company to play offense, such as by hiring talent and winning customers away from weaker competitors, or having a headstart in developing new products and services. In such a scenario, companies with strong balance sheets have a higher chance of emerging from a crisis – a period of stress – stronger than before.

Factor 4: Their cash flow

Also linked to financial strength is cash flow – which refers to the cash they have left from their income after all expenses are deducted. 

Example: Let’s say your friend has a promising career, a high income, and little debt. However, they’re still living paycheck to paycheck because of an extravagant lifestyle.

This makes lending money to them riskier. In the event they lose their job, they might have to sell some of their stuff to get by. It also won’t be easy for them to change their lifestyle to make sure they have sufficient savings to repay you.

Similarly, when investing in stocks, I’m focused on the free cash flow that a company can generate.

All things equal, a company with higher free cash flow is more valuable than one with lower free cash flow.

Factor 5: Their income growth

Some people continuously upskill throughout life and improve their earning power – whether it’s through new skills, networking or starting a business. Others get stuck in jobs they dislike for years and take no action because of learned helplessness.  They suffer from little job and income progression. 

(To be clear, there’s nothing wrong with a person not wanting to improve their income over time. For instance, there could be cases where a higher income would mean a trade-off of lesser family time.)

But simply for our context, we’d prefer if the person we are lending money to has a history of growing their income.

In stock market investing, I too want to look for companies with a proven track record of growth. 

This is because I believe that businesses that are winning tend to have a certain momentum that allows them to carry on winning. Think about it. If you’re a talented employee working in a company that’s struggling, would you prefer to stay put, or join a competitor who’s flourishing?

What happens is that businesses that are winning stand a higher chance of attracting talented employees, which allows them to carry on winning, which allows them to continue to attract talent, and so on and so forth.

Factor 6: Integrity and history of personal growth

Is your friend a trustworthy and dependable person? Or one of those people who are infamous for owing people money, dodging calls, and going on radio silence? 

Make no mistake: Character and track record are incredibly important, and cannot be ignored.

Yet another important aspect about their character is attitude towards personal growth. We touched on this earlier, but it’s important to bring it up again. If your friend is someone who’s willing to constantly reinvent themselves, they’ll likely be able to enjoy a growing income stream in the years ahead. This makes it even more probable that they are willing and can afford to repay you. 

It’s the same with companies.

I am attracted to a company with a management team that has demonstrated integrity, capability, and innovativeness.  Each of these factors is important: 

  • A management team without integrity can fatten themselves at the expense of shareholders. 
  • A management team without capability is bad for self-explanatory reasons.
  • Without innovation, a company will struggle to grow and can easily be overtaken by competitors.

The logic behind this investment framework

What we need to understand is that the fundamental nature of the stock market is a place to buy and sell pieces of a business.

What drives stock prices over the long run is the stock’s underlying business performance. If the business does well, the stock should do well, eventually. Conversely, if the business does poorly, the stock will fare poorly too, eventually. 

The word eventually is important, because a stock’s price can swing all over the place, in an unpredictable fashion, in the short run. 

But over the long run, the underlying business performance of a stock acts like gravity for the stock’s price, with the direction of pull (upwards, downwards, or sideways) determined by the state of the business.

Read more about my investing methodology here and here.

A final word

These last few paragraphs have nothing to do with investing in stocks, but it has something to do with lending money. We wrote this article with the intention to help make investing more easily understandable. 

That said, all of us need to realise that unlike stock market investing, lending money is often an emotional decision.

And if emotions now come into the picture, then all that logical decision-making-framework needs to be thrown out the window. The important question to answer becomes: “Am I willing to never see this money again if I lend it to my family/friend in need?”

If the answer’s yes, then you need to hope that you’re not encouraging reckless or wanton financial behaviour in your family/friend by lending them money. If the answer’s no, then you may be denying them of a second (or third, fourth, fifth) chance they might desperately need for a breakthrough in life. 

For that reason, the decision to lend money is incredibly difficult to make – it’s much harder than investing in stocks, and we hope you’ll always make the best decision for yourself and the person-in-need who’s knocking on your door.

The Woke Salaryman: But just to be on the safe side, when in doubt, don’t lend. 

Stay Woke, Salaryman

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Making Sense Of Technology Stocks’ Recent Volatility

What’s really going on with the recent big declines in the shares of technology stocks?

Note: Data as of 8 March 2021; an earlier version of this article was first published in The Business Times on 17 March 2021

Technology stocks in the USA have not been in the good graces of market participants in recent weeks. Take for instance, the NASDAQ index, which has a heavy weighting (nearly half) toward companies in the technology sector. The index closed at a high of 14,095 this year on 12 February 2021, before falling by 10.5% to 12,609 on 8 March.

Many technology companies’ share prices fared far worse over the same period. E-signature specialist DocuSign’s share price declined by 27%. Peloton, which sells its eponymous internet-enabled indoor bikes, saw its share price fall 34%. Latin American e-commerce powerhouse MercadoLibre, digital payments provider PayPal, and e-commerce enabler Shopify, were down by 30%, 24%, and 26%, respectively. Fiverr, which runs an online platform to connect freelancers with businesses looking for freelancing services, experienced a 39% drop in its share price.

What’s behind the declines?

Rising interest rates have often been cited as the key reason for the recent turmoil in technology stocks. The US 10-year Treasury yield, an important interest-rate-marker, had increased from 1.20% on 12 February 2021 to 1.59% on 8 March 2021.

There’s plenty of attention being paid to interest rates because of its theoretical link with stock prices. Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since bonds, being an alternative to stocks, are providing a good return. On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return.

Some stocks in particular, such as high-growth companies that depend on the future growth of their long run cash flows for the lion’s share of their value, are theoretically even more sensitive to changes in interest rates. The technology companies I mentioned earlier that have experienced sharp falls in their share prices belong to this category.

Beneath the hood

But a few things are worth pointing out about the idea of interest rates being a massive driver for the recent volatility seen in technology stocks.

Firstly, the US 10-year Treasury yield was at less than 0.70% at the end of March 2020, which was near the nadir of the pandemic panic that the financial markets experienced last year. So in less than one year, the US 10-year Treasury yield had doubled and then some. The NASDAQ index, meanwhile, gained 64% from the end of March 2020 to 8 March 2021.

Secondly, the real relationship between interest rates and stock market valuations is nowhere near as clean as what’s described in theory. Yale economist Robert Shiller, who won a Nobel Prize in 2013, has a database on interest rates and stock market prices, earnings, and valuations going back to the 1870s. According to his data, the US 10-year Treasury yield was 2.3% at the start of 1950. By September 1981, it had risen to 15.3%, the highest rate recorded in Shiller’s dataset. In that same period, the S&P 500’s price-to-earnings (P/E) ratio moved from 7 to…  8. That’s right, the P/E ratio for the S&P 500, a broad-based US stock market index, increased slightly despite the huge jump in interest rates.

(It’s worth noting too that the S&P 500’s P/E ratio of 7 at the start of 1950 was not a result of earnings that were temporarily inflated.)

Yes, I’m cherry picking with the dates for the second point. For example, if I had chosen January 1946 as the starting point, when the US 10-year Treasury yield was 2.2% and the P/E ratio for the S&P 500 was 19, then the theoretical relationship between interest rates and stock market valuations would appear to hold up nicely.

But what I’m really trying to say with the first and second points are these: Interest rates have a role to play, but it is far from the only thing that matters and; one-factor analysis in finance – “if A happens, then B will occur” – should be largely avoided because clear-cut relationships are rarely seen.

So what’s really going on?

The recent volatility in technology stocks might be due to stocks simply doing what stocks do: Experiencing wild price fluctuations. 

Even the stock market’s greatest long-term winners have also been through periods of sickening declines. We can look at two US-based companies that are well-known to Singaporeans: Amazon.com (NASDAQ: AMZN), the e-commerce and cloud computing juggernaut, and Netflix (NASDAQ: NFLX), the global streaming services provider. In the 10 years ended 8 March 2021, Amazon.com and Netflix’s share prices were both up by 1,670%. By any measure, they have both been massive long-term success stories.

But in that period, both companies saw their share prices decline by 20% or more from a recent high on at least six separate occasions each. So in the past decade, Amazon.com and Netflix – two US-listed stocks with massive long-term gains – have both experienced share price falls of 20% or more every 1.7 years on average.

An important takeaway for investors here is that volatility is a feature of the stock market. It’s something normal. Accepting this can also lead to a healthy change in our mindset toward investing in stocks. Instead of seeing short-term volatility in stocks as a fine, we can start seeing it as a fee – the price of admission, if you will – for great long-term returns. This is an idea that venture capitalist Morgan Housel (who also happens to be one of my favourite finance writers) once described. 

So what should investors focus on now when it comes to technology stocks?

If you’re an investor in US-listed technology stocks, it has been a painful few weeks. In times like these, it’s easy to forget that stocks represent partial ownership of businesses. It’s important to remember what stocks represent, because it will be the performance of a stock’s business that will ultimately determine where its price ends up. Earlier, I said that clear-cut relationships in finance are rarely seen – this is one of those rare times.

We can take some cues from Warren Buffett. The legendary investor gained control of Berkshire Hathaway in May 1965. At the start of that year, the US 10-year Treasury yield was 4.2%, according to Shiller’s data. I mentioned earlier that the highest interest rate seen in Shiller’s dataset for the US 10-year Treasury was 15.3% and that occurred in September 1981. From 1965 to 1981, a 21.4% annual increase in Berkshire’s book value per share drove a 25.1% annual jump in the company’s share price. 21.4% in, 25.1% out, over a 17 year period (1965-1981), despite the massive increase in the yield for US 10-year Treasuries. 

So if you’re interested in technology stocks or are currently invested in them, focus on their business fundamentals while knowing that their share prices are going to be all over the place in the short run. Will their businesses grow materially in the years ahead? And are their current valuations sensible in the context of your estimation of their growth? The answers to these questions will be far more important to technology stocks’ future prices in the long run compared to where interest rates are headed.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in the shares of Amazon, DocuSign, Fiverr, MercadoLibre, Netflix, PayPal, and Shopify. Holdings are subject to change at any time.

The Stock (or is it “Stonk”?) Market Is Rigged: So What?

The stock market has been a rigged game for a long time. But it doesn’t matter for investors. We can unrig this. We can still win.

I need to get this off my chest. Over the course of January 2021, the financial markets saw the incredible Wallstreetbets vs Hedge Funds battle play out. The battle arena included stocks (or is it “stonks”?) such as Gamestop and AMC. I won’t rehash the whole episode. 

What I want to get off my chest is something I’m saddened by: The danger that many retail investors could lose their faith in the financial markets because of what’s happening in Wallstreetbets vs Hedge Funds. I’ve already seen people commenting (read here and here) that the market is “rigged” and that they are losing their faith in the system. Well the thing is, the market has been rigged for a long, long time but – and this is important – it does NOT matter. Two examples come to mind.

A long, long time ago…

The first involves Joseph Kennedy, the patriarch of the famous Kennedy family in the political scene of the USA. The family includes the US president, John F. Kennedy. 

In the 1930s, Kennedy played an actual con-game with the US stock market. This is recounted by Morgan Housel in an article he wrote for The Motley Fool:

“The repeal of prohibition in 1933 was bound to benefit companies that made supplies needed to make alcohol. One was a bottling company called Owens-Illinois. Rather than investing in directly in Owens-Illinois, [Joseph] Kennedy purchased shares of a company called Libbey-Owens-Ford.

“Libbey-Owens-Ford was an entirely separate company, which manufactured plate glass for automobiles, not bottles, but its name was close enough to the bottle glass company to fool unwary investors,” writes biographer David Nasaw. On news of the repeal, Kennedy and his partners traded shares back and forth between each other, pumping up trading volume to draw attention. That caused other investors to buy shares “on the mistaken belief that they were buying shares of Owens-Illinois, the bottle manufacturer.” After a surge, Kennedy dumped Libbey-Owens-Ford with a $1 million inflation-adjusted profit and invested the proceeds in his original target, Owens-Illinois.”

Not so long ago

The second involves convicted con-man Jordan Belfort, of The Wolf of Wall Street fame. In the late 1980s and early 1990s, Belfort used a similar technique – buying and selling the same block of shares between partners to manipulate share prices – to run his fraudulent stock market brokerage firm, Stratton Oakmont.

One of the companies that Belfort and his cronies ran his scams on was the shoe-fashion designer outfit Steve Madden. Belfort and gang took Steve Madden public in December 1993 via a pump-and-dump scheme. They owned up to 85% of Steve Madden leading up to the IPO, and dumped all the shares right after the listing, raking in US$23 million in a very short amount of time. Big money. But is it really?

Stocks, not stonks

This is where it gets interesting. According to Yahoo Finance, Steve Madden’s share price was less than US$1 right after its IPO in 1993. Today, Steve Madden’s share price is nearly US$34, and 85% of the company would be worth nearly US$2.4 billion.

Belfort could have been a legitimate billionaire had he held on to his Steve Madden shares, instead of being a convicted con-man who had to spend a few years of his life behind bars. And all that happened because of Belfort’s inability back then to see what the stock market really is – a market for participants to own pieces of living, breathing businesses.

Coming back to the deplorable behaviour of Joseph Kennedy, Housel wrote in the same article for the Fool (emphasis is mine):

“Companies didn’t report much information in the 1930s, but archive documents show Libbey-Owens-Ford earned somewhere around $1.1 million in profit in 1933. By 1985, profits were more than $70 million. Getting tricked by Kennedy didn’t matter much if you were willing to wait.”

Unrigging a rigged game

The stock market has been a rigged game for a long time. But it doesn’t matter for investors. This is because stocks – not stonks – have still managed to build tremendous wealth for investors legitimately despite the presence of the rigging. Since 1930, the S&P 500 (a broad stock market index in the USA) has turned a $1,000 investment into a massive US$4.97 million, including dividends. This works out to a handsome return of 9.7% per year.

There’ll likely be no end to having unscrupulous stock market manipulators pop up to rig parts of the market. But having patience, being diversified and disciplined, and having the view that stocks represent partial ownership of real actual businesses that will do well over time if the businesses do well (and that will crumble if the businesses crumble) makes it possible for you to unrig a rigged game. And, like we’ve seen with Libbey-Owens-Ford and Steve Madden, even companies that are the victims of manipulation can still do great things for investors – if the companies have legitimately good businesses and crucially, the investors are willing to wait.

Please don’t lose faith in the markets!

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned.

My Preferred Way

There are many different ways to invest in the stock market. There’s no right or wrong.

There are many ways to make money in the stock market. There’s no right or wrong.

But given all that is going on in the markets at the moment (Game… *cough*… something… *cough*… Stop…), I had the sudden urge to share my preferred way of operating in the stock market.

I gain joy from the growth in value created by companies that are making the world smarter, healthier, happier, and richer (in any combination), by being a steadfast long-term owner of their shares.

(The Motley Fool deserves a big hat-tip for the statement just above. The Fool’s purpose is to make the world smarter, happier, and richer.)

I don’t want to profit by selling a hot potato to a greater fool so that I would not be the one “left holding the bag,” even if I know the hot potato is very much in demand. I simply derive no joy in doing so.

What’s your preferred way to operate in the stock market?

The Unique Ingredient of Haidilao’s Success: Love

All of Haidilao’s success can perhaps be boiled down to something simple: Its founder Zhang Yong’s magnainomous love toward his fellow man.

Note: This article was first published in MOI Global’s website. MOI Global is a community of thoughtful investors that was created by its chairman, John Mihaljevic. I wrote this piece as part of my presentation for the currently on-going Best Ideas 2021 Conference organised by MOI Global.

I’m thrilled to have the opportunity to present at Manual of Ideas’ upcoming Best Ideas 2021 online conference. The company I’ll be discussing is the Hong Kong-listed and China-based Haidilao (HK: 6862). This article you’re reading now is a short introduction to Zhang Yong, Hadilao’s co-founder and current leader.

What I want to do is to present translations of some of my favourite passages from a 2011 book on Zhang Yong and Haidilao. The book is in Mandarin and is titled “海底捞,你学不会.” Iin English, it means “You Can’t Copy Haidilao”.

First, some background

Hotpot is a popular meal among the Chinese. It involves people – often friends and family – sitting around a big pot of flavourful boiling broth to cook by dipping food items into the broth. Haidilao’s business lies in running its namesake chain of hotpot restaurants. At the end of 2019, the company had 716 restaurants in China and another 52 in other countries and territories around the world, including Australia, Hong Kong, Japan, Singapore, the United Kingdom, the United States, and more. 

I run Compounder Fund together with my co-founder Jeremy Chia and it has a position in Haidilao. Compounder Fund invests mainly in companies that we think can compound the value of their businesses at high rates over the long run (hence the name Compounder Fund!). To us, such companies tend to have the following traits: 

  1. Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market
  2. Strong balance sheets with minimal or reasonable levels of debt
  3. Management teams with integrity, capability, and the ability to innovate.
  4. Revenue streams that are recurring in nature, either through contracts or customer-behaviour
  5. A proven ability to grow
  6. A high likelihood of generating a strong and growing stream of free cash flow in the future

We spend a lot of time looking at a company’s leadership. This is because of our belief that, in nearly all cases, a company’s leadership is the source of its competitive advantage (if any). A company’s current competitive advantage is the result of management’s past actions, while a company’s future competitive advantage is the result of management’s current actions. We study a company’s compensation structure, related-party transactions, and insider ownership to assess integrity. For capability and innovation, we think about how a company has grown its business over time and what really excites us are business leaders who have a unique way of looking at the world.

Zhang Yong is one such exciting business leader, in our view. “You Can’t Copy Haidilao” is written by Huang Tie Ying, a professor at Beijing University. The book is written from Huang’s point of view and it discusses the highly unusual way that Zhang runs Haidilao. It helped us to understand that while Zhang is not perfect, he has an immense kindness and love toward his fellow man, and an unwavering belief in the good of humankind. He had infused these qualities into Haidilao and it had helped him to develop employees who deliver extraordinary service to customers from the heart. And it is this genuine commitment to exemplary service from Haidilao’s frontline service staff that has propelled the company’s growth.

We invested in Haidilao before we came across Huang’s book. But we already saw strong signs that Zhang was unique. For instance, Haidilao’s 2018 IPO prospectus mentioned:

  • The company has industry-leading compensation for employees among all Chinese cuisine restaurants in China.
  • Restaurant managers are primarily evaluated based on customer satisfaction
  • Nearly all of Haidilao’s restaurant managers started working for the company in non-managerial positions (such as waiters, bussers or janitors) and steadily rose through the ranks
  • Restaurant managers share in the profits of the restaurants they manage, but that’s not at all – they enjoy an even larger share of the profits from restaurants that are managed by their first and second-generation mentees 

We cannot confirm if the Haidilao described in “You Can’t Copy Haidilao” is still the same today. But there are also no strong reasons for us to believe that the current Haidilao has completely warped. The hotpot business is not complicated. You do not require a chef in the shop, so nearly anyone can run a hotpot restaurant. It also means that competition is tough. But Zhang Yong has grown Haidilao’s revenue to RMB 26.6 billion (around US$3.98 billion) in 2019, up 56.5% from 2018. Profit was up 42.3% in the same year to RMB 2.3 billion. The company is today a truly massive and global business – when Huang wrote his book, Haidilao was only in China. 

We live in Singapore, so we’ve dined in Haidilao’s restaurants and those of its competitors on many occasions. As much as its competitors try to copy the form of Haidilao’s service, they can’t seem to get its substance. And we think there’s only a tiny sliver of a chance that Haidilao’s competitors can ever truly imitate the company. This is because Haidilao’s substance comes directly from Zhang Yong’s worldview, and it is something unreplicable, since no two humans are ever identical. 

We hope you’ll enjoy the translations I’ve made from “You Can’t Copy Haidilao”. I wanted to do this because I think there’s plenty that we, as investors, can learn from Zhang Yong. I am fortunate to be able to read Mandarin and understand the book’s content (just please do not ask me to speak or write about business in Mandarin!) so I want to pay it forward by introducing the book to the English-speaking world.

And three more things: (1) I want to stress that the translations are my own self-directed attempt, so all mistakes in them are my sole responsibility; (2) I hope I’ve managed to capture Huang and Zhang’s ideas well; and (3) I look forward to sharing more about Haidilao during the conference. Now onto the translations!

Translation: On providing legendary service

Even someone who has worked in Haidilao for only a day would know an aphorism of Zhang Yong’s: “Customers are won table by table.”

Why do we have to win customers table by table? Because every customer in a hotpot restaurant is there for a different reason. Some are couples on a date, some are there for a family gathering, while some are having business dinners. What every customer needs will be different, so how you move each customer’s heart will not be the same.

Zhang Yong has performed every single task that’s required in a hotpot restaurant… He knows that customers have a wide variety of requests. If you strictly follow standard operating procedures, the best result you can hope for is for your customers to not fault you. But you will never be able to exceed their expectations and delight them. For example, no restaurant’s operating procedure will include a free shoe-shining service.

In the early days after Zhang Yong opened his first hotpot restaurant, there was a familiar face who visited. Zhang Yong realised that the shoes of this old friend were very dirty, and so he arranged for an employee to clean the friend’s shoes. Zhang Yong’s little act moved his friend deeply. Ever since, Haidilao has provided free shoe-cleaning services at its restaurants. 

A lady who stayed above a Haidilao restaurant once ate there and praised its chili sauce. The next day, Zhang Yong brought a bottle of the sauce to her and told her that Haidilao would be happy to send her a bottle any time she wants to have it. 

These are the roots of Haidilao’s extreme service standards.

But these differentiated services can only come from the creativity of every employee’s minds.

Having processes and systems are critical when running chain restaurants… Processes and systems can ensure quality control, but human creativity is suppressed at the same time. This is because processes and systems overlook a human’s most valuable asset – the brain.

Requiring employees to strictly follow standard operating procedures means you’re hiring them only for their hands, and not their minds. You suffer the worst losses in such business deals. This is because humans are the worst “machines” – there’s no way a human can be better than a machine at repetitive actions. The most valuable part of a human is the brain. The brain can create and solve problems that processes and systems can’t!

The goal of providing world-class service is to satisfy customers. Since each customer has different preferences in the process of consuming a hotpot meal, it’s not possible to fully rely on SOPs to achieve 100% satisfaction….

… If some customers do not enjoy a free bowl of soya milk and sour plum soup, can we give them a bowl of chicken egg porridge instead? Even if we normally charge for this porridge, an elderly person with weak teeth who receives it for free may remember this considerate act for life!

A customer craves ice cream – can the restaurant’s waiters leave their station to purchase the ice cream from a neighbouring shop? A customer realises he has overordered – can he return a plate of vegetables? A customer wants to enjoy more variety – can she order half-portions? A customer really likes the dining aprons that the restaurant provides guests – can the customer bring one home for her child? 

When faced with these requests that are not included in SOP manuals, most restaurants will just say “No.” But at Haidilao, the waiters are required to exercise their creativity: “Why not?”

I grabbed a few stories from Haidilao’s internal employee magazine to highlight the company’s incredible service standards…

… Zhang Yao Lan from Haidilao’s third Shanghai restaurant says:

“Business was exceptional on a Saturday night. At 7:30pm, the Yu family visited the 3rd room… They ordered quail eggs and as I helped them cook the eggs in the hotpot, I noticed that Aunty Yu ate all the radish strips that came with the eggs. 

I figured that Aunty Yu loves radish strips. So I called the kitchen to prepare the plate of radish strips and I added my own special concoction of sauces. The Yu family were really surprised when I served the radish and asked if they had ordered the dish. I said that it’s a gift from me because I guessed that Aunty Yu likes eating radish strips and that I hope they like it… 

…They were really happy and praised me as they dug into the dish. They even asked how the dish was made… The following month, the Yu family came three times, and even brought their friends (with surnames of Cai and Yang) to Haidilao. See, how magical a plate of radish strips is – it’s helped me win so many customers!”

Translation: On winning over the hearts of employees (and more on providing legendary service)

Zhang Yong was once a waiter. So he understands that every employee is critical in ensuring the delivery of truly outstanding service. Haidilao’s employees are given the freedom to exercise their creativity and even make small mistakes – Haidiao can really touch the hearts of customers only if the company gets the short end of the stick at times.

But this is easier said than done. Haidilao’s employees have travelled far from home and come from villages that are mired in poverty. They have little education, have not seen much of the world, and are often looked down upon, resulting in an inferiority complex. How can Haidilao drive such employees to develop the initiative to provide excellent service for customers?

Zhang Yong said: “The hotpot business requires very little skill… Anyone can do it after some light training if they are willing. The key though, is the willingness. Waitressing is a physically demanding job with low social status and benefits. Most waiters don’t perform well because they had no other choice other than to take up the role. So to ensure that waiters can excel in their role, the focus should not be on the training methods. Instead, it should be on how to develop the willingness in people to take up waitressing jobs. If your employees are willing to work diligently, you win!”

I asked Zhang Yong: “Can you find me a boss who does not want hard working employees? This is the Himalayas for every boss in the world. But it’s rare for any leader to achieve this.”

Zhang Yong replied: “I think that humans have emotions. If you treat somebody well, he or she will treat you well in return. As long as I can find ways to let my employees think of Haidilao as their home and family, my employees will naturally care for our customers.”…

…How can Haidilao get its employees to think of the company as family?

To Zhang Yong, the answer is simple – treat your employees as family. If your employees are your siblings and they have travelled afar to Beijing to work for you, would you house them in underground basements that most people in Beijing are not willing to live in? Of course not. If you have the resources, you wouldn’t bear to let your family members stay in a place that’s humid and lacks proper ventilation. But for many restaurant owners in Beijing, they house their employees in underground basements while they themselves live above ground. 

Haidilao’s employees get to stay in proper housing, with similar living conditions to the locals in Beijing. There are heaters and air conditioning, and Haidilao ensures that there’s no overcrowding. In addition, each hostel has to be within a 20-minute walking distance to the restaurants that the employees work in.

Why? This is because Beijing’s traffic system is complex. Restaurant staff members work long hours, and as young adults, they require ample sleep. Because Haidilao is picky about where its employees stay, there are only a few suitable locations that also happen to be desirable among the locals in Beijing. This has caused some haughty locals in the city to be unhappy. 

There’s more. Haidilao also has specialised employees who take care of the hostels’ housekeeping needs. There’s free internet, TV, and phones too. Haidilao’s employees state that their hostels are akin to hotels with “stars”!

Getting employees to treat your company as family is not as simple as just repeating some words or educating them. Humans are intelligent – your actions will show what you truly mean. Haidilao’s employees come from poor villages. During Beijing’s cold weather season, Haidilao issues hot-water packets to keep these employees’ blankets warm. For some Haidilao restaurants, there are even employees in the hostels who come in the night to fill up the packets with hot water. Isn’t this something that only mothers will do?

If your siblings travel from your village to work in the city, you’ll naturally be worried that they won’t be familiar with traffic and that they will be looked down upon by city folks. Because of this, Haidilao’s training program also includes soft skills such as map reading, how to use flush toilets, how to navigate the transport system, how to use bank cards etc… 

…If your siblings have travelled somewhere far to work, what would happen to their children’s education? Haidilao set up a boarding school in Jianyang, Sichuan, for the children of the company’s employees.

Haidilao does not just take care of its employees’ children, it also cares for its employees’ parents. Haidilao provides a monthly stipend (a few hundred RMB) to the parents of employees who hold the rank of foreman and upwards. Every parent would want a capable child. Homecoming opportunities for Haidilao’s employees are rare. But Haidilao’s monthly stipend gives the parents of these employees a regular opportunity to feel pride for their children. Chinese people are stingy, the villagers even more so. Despite feeling pride, the villagers would only say: “My child is fortunate to have found a good company where the boss treats them as brothers!” No wonder Haidilao’s employees all affectionately call Zhang Yong, “Big Brother Zhang.”   

Translation: On extreme trust for employees

What does it mean to respect people? Does it mean you have to bow to your boss or cheer for your superiors? This is not respect for people – this is only respect for status and power. Respecting people means trusting them.

If I trust your ethics, I would never guard myself against you. If I trust your ability, I would entrust important tasks to you. This is what it means to respect someone! When a person is trusted, a sense of responsibility would arise within. When an employee is trusted, he can treat the company as family.

At Haidilao, employees are not only treated better than at other restaurant companies, but they are also trusted by the company. 

To treat employees as family is to trust them like you trust your family members. You have to show through actions that you trust someone – words are not enough. The only sign of trust is to confer authority. If your birth sister’s helping you to purchase your daily vegetables and meats at the market, would you send someone to supervise her? 

Of course not. So at Haidilao, any expenditure above RMB 1 million will require Zhang Yong’s approval. Anything lower than RMB 1 million is the responsibility of the vice president, finance director, and regional manager. Sectional managers and the heads of the Purchasing and Engineering departments have the authority to sign off on expenditures of up to RMB 300,000, while restaurant leaders can do so up to RMB 30,000. It’s rare to find private sector enterprises that have the confidence to delegate authority to such an extent.

What Haidilao’s peers find the most unbelievable about Zhang Yong is the trust he has in his frontline service staff. Even Haidilao’s ordinary frontline service staff have the power to give customers partial to full discounts without having to seek approval from their superiors. As long as the service staff think it’s appropriate to discount a dish or provide a free dish (or even an entirely free meal), they can do so. This authority means all of Haidilao’s employees – regardless of rank – are effectively managers, because such authority is usually reserved only for managers at restaurants.

In the spring of 2009, I invited Zhang Yong to give a lecture to MBA students in Beijing University. A student asked: “If all your staff can give full discounts for meals, will there be cases where rogue employees provide free meals to their own family and friends?”

Zhang Yong asked the student instead: “If I give you this authority, will you do it?”

The entire class of more than 200 students fell silent. Indeed, with our hands on our hearts: Will you bear to betray such trust in you?

The truth is, the vast majority of people know deep in their hearts that kindness needs to be repaid and they would not betray the trust that others have placed with them. 

Having been a frontline service staff, Zhang Yong understands this logic: If he wants to utilise the minds of his employees, he needs to give them authority. This is because the satisfaction of customers actually rests entirely in the hands of his frontline service staff. It is after all his frontline service staff who interact with customers from the moment they step into the restaurant till they leave. If a restaurant’s manager has to be consulted before a frontline service staff can solve any unhappiness a customer experiences at the outlet, the process itself will only vex the customer further.

Humans are often worried when they’re waiting for a problem to be resolved. So the only way to solve customer-unhappiness at scale is to give frontline service staff the power to deal with problems. More importantly, it is the frontline service staff who best know the whims and fancies of customers. They are the ones who can touch the hearts of customers table by table.

Translation: On treating employees the right way

Zhang Yong has an unwritten rule within Haidilao. And because he is the unquestioned leader of the company, the people within Haidilao believe his words.

He said: “Anyone who has been a restaurant leader at Haidilao for at least a year will receive a “dowry” of RMB 80,000 if they leave the company for any reason.”

I asked: “Even if they’re being poached by competitors?”

Zhang Yong responded: “Yes”

“Why?” His answer completely took me by surprise.

Zhang Yong explained: “The work in Haidilao is incredibly tough. Anyone who can rise to the rank of restaurant leader and above has already contributed significantly to the company.”

In fact, many of Haidilao’s leaders clock in overtime for extended periods and this takes a significant toll on their physical and mental health. Many of them are riddled with health issues even at a young age. Haidilao’s procurement head, Yang Bin, once set a record in 2004 by working for 365 days straight. 

Zhang Yong said: “Every Haidilao leader deserves credit for building Haidilao to what it is today. So we should give people what they deserve when they leave for any reason. If a sectional manager leaves, we provide a reward of RMB 200,000. If a leader with the title of regional manager or higher leaves, the gift will be a ‘hotpot restaurant’ – that’s around RMB 8 million in value.”

I asked, somewhat in disbelief: “If Yuan Hua Qiang [a leader in Haidilao with significant importance] is poached, you will reward him with RMB 8 million?”

“Yes, if Yuan Hua Qiang wants to leave today, Haidilao will reward him with RMB 8 million,” Zhang Yong said gently and plainly, while lowering his head as though deep in thought.

Even though I know Zhang Yong wants to win over every talented individual he encounters, this policy of his is highly unusual – not many will dare to implement it. It seems like if you’re not trying to be different and do what others won’t, you can’t ever win – but even if you do, it does not guarantee success! Zhang Yong walks the extreme path….

…When Haidilao first entered Beijing, the journey was rough. The company fell for a scam in its first real estate deal and lost RMB 3 million. At that time, it was all the cash that Haidilao had. 

“Did you manage to find the culprit?” I asked Zhang Yong.

“So what if we had found him? There was even a retired judge in the group of scammers. We simply were not aware that we had fallen into a trap.”

I continued to ask: “Did you scold anyone after you heard the news?”

Zhang Yong said: “How would I dare to scold anyone?! The Beijing manager was already so anxious that he could not eat for two days. In fact, I did not dare to call him in those few days. I only decided to contact him after I heard that they wanted to kidnap the culprit. I said, are we worth only RMB 3 million? Let’s start doing the real work.”

I followed up: “Did you really not blame him, or feel any pain?”

Zhang Yong replied: “Of course I felt the pain. The sum we lost was all our cash at that point in time. But I really did not blame him. Because if I was the one in Beijing, I would have fallen into the same trap!”

Dear bosses, after reading this, please ask yourself the following: If you had ran into the same situation, would you think this way?

No wonder Haidilao has only ever had to pay its “dowry” to three people in its 10-plus years of operating history, despite having more than a 100 people who qualified for the reward if they had left.

But as a company grows, there will be all kinds of people in it. Haidilao is no exception. Last year, there was a restaurant leader who quit Haidilao to join a competitor who set up shop just opposite her Haidilao outlet. She also brought along her Haidilao restaurant’s kitchen manager, area manager, and other service staff leaders. When she came back to Haidilao to ask for her “dowry,” Zhang Yong refused.

Translation: On priorities

In his 2006 New Year’s address to employees, Zhang Yong said: “If you’re talking to me and your phone rings because your staff is calling you, then you and I will stop our conversation. Your priority should be handling your staff’s issue. If you’re talking to your staff and a customer needs help, you and your staff should end the conversation and focus on the customer’s needs. This is what our list of priorities should look like when I talk about placing customer satisfaction at the centre of what we do. As I grow older, I’ve come to gradually understand the broader meaning of the term “customer” – it includes our employees.

Translation: On evaluating a restaurant business

Zhang Yong has an extremely strange way of evaluating the performance of every Haidilao restaurant. A restaurant’s profit is not part of the assessment criteria that Haidilao’s HQ uses. To add to the weirdness, Zhang Yong does not have any annual company-wide profit targets for Haidilao.

I asked him: “Why do you not assess profits?”

He responded: “Assessing profits is useless because profit is the result of the work we do. If our work is bad, it’s not possible to produce high profits. But if we do good work, it’s impossible for our profits to be low. Moreover, the company’s profit is the end result of all the work performed by various departments. Each department has a different function, so it’s tough to clearly define their contributions. There’s also an element of chance in the profit a restaurant earns. For example, no matter how hard a restaurant leader and his team works, a poorly-located restaurant can’t hope to outperform a restaurant with average-leadership but a superb location. But a restaurant leader and his team have no say in choosing a restaurant’s location. It’s not fair, nor scientific, to insist on assessing a restaurant’s performance based on its level of profit.”

I followed up: “The level of profit depends, at least to some extent, on costs. Each individual restaurant should at least be able to control its costs, right?”

Zhang Yong said:

“Yes that’s right. But in what areas can those below the rank of restaurant leader have the biggest effect? It’s in improving service standards and winning more customers! Lowering costs is not as important as creating more revenue.

As Haidilao started to introduce more SOPs, we also began to assess results more. Consequently, some sectional leaders started to include profit in their evaluation of individual restaurants. When this happened, incidents like the following happened: Brooms for toilets continued to be used even when there were no longer any whiskers for sweeping; the watermelons that we gave to customers for free were no longer sweet; and customers were given towels with holes to dry themselves after using the washroom. 

Why? Because each restaurant has very little control over its own costs. The important cost items in a restaurant – its location, renovation, dishes, prices, and manpower needs – are set in HQ. Rank and file employees can only focus on the little things if you insist on evaluating profit. We noticed this phenomenon before it was too late and promptly stopped using the level of profit as a criterion for performance-assessment. In actual fact, any employee with even a modicum of business sense does care about costs and profits. Even if you merely conduct a basic accounting of profit, everyone is already paying attention to it. So if you make the level of profit a key criterion for performance assessment, it will only magnify people’s focus on profit…

…I asked Zhang Yong: “You do not even look at a restaurant’s revenue when assessing its performance?”

Zhang Yong said: “Yes, our performance criteria does not include profit. But that’s not all. We also do not include revenue as well as other KPIs that are commonly used by restaurant companies, such as spending per customer. This is because these criteria are results. If a business manager insists on waiting for these results to know if the business is doing well or poorly, wouldn’t the food already be cold by the time? Imagine that there’s a polluted river and instead of trying to fix the source of the pollution, you’re only busily filtering, testing, and removing filth downstream. What’s the point?”…

…Zhang Yong said: “Now we only have three criteria for evaluating the performance of each hotpot restaurant. First is the level of customer satisfaction; second is the level of positiveness in the work attitude of employees, and the third is the nurturing of leaders.

I replied: “These are all qualitative criteria. How do you measure them?”

Zhang Yong answered: “Yes, they are all qualitative, so you can only measure them qualitatively. Teacher Huang, I don’t understand why these scientific management tools insist on scoring qualitative things. Let’s talk about customer satisfaction for instance. Do they expect every customer to fill up a survey form? Think about this. How many customers are willing to fill up your form after their meal? Wouldn’t customers’ unhappiness increase if they’re being made to fill up forms? Besides, how believable can a form be if you’re forcing it onto someone? 

I asked: “How then do you evaluate customer satisfaction?”

He said: “We get the direct superiors of restaurant leaders – sectional managers – to conduct frequent yet random visits to the restaurants. The sectional manager and his assistant will communicate at length with the restaurant leader. In what areas have the level of customer satisfaction increased or decreased? Have frequent diners appeared more regularly this month, or less? Our sectional managers were all once frontline service staff who rose to their current roles. They have intimate knowledge when it comes to customer satisfaction.

It’s the same when it comes to employee’s work attitudes. Teacher Huang, if you’re the one doing the assessment, it won’t work. All you’ll see are people running about, with smiles on their faces. But if it’s me, I will be able to tell you: Look at that young chap there with hair that’s too long. This young girl has applied her makeup too sloppily. Some employees’ shoes are dirty. This service staff is standing there in a daze. These are all signs on the level of positivity that employees bring to work, aren’t they?! It’s the same when a restaurant leader assesses his team leaders and when his team leaders assess their team.

I further probed: “So their rewards depend on these qualitative assessments?”

Zhang Yong replied: “It’s not just their rewards. Their promotions or demotions also depend on the three criteria. Think about this. How can most waiters have a positive work attitude if their restaurant leader is an unfair person? And how can customers be happy if they are served by waiters who are not positive at work? The revenue and profit numbers for such a restaurant will definitely be bad. There’s no need to wait for the numbers to be out to replace the restaurant leader or remind him that he needs to change his ways. And even if the numbers are good, it has nothing to do with the restaurant leader. We’ve had cases where we are unable to promote restaurant leaders who run very profitable restaurants. This is because they are unable to groom talent. The moment these restaurant leaders step away from their restaurants, problems occur. For these restaurant leaders, we may even demote them despite the high profits their restaurants are producing.”

Translation: What it means to truly care for employees

In 2006, Haidilao’s directors decided to establish a union. Unions are supposed to belong to employees, but Zhang Yong gave Haidiao’s union a unique mission. During the birth of the union, he said some important things:

“The 11 restaurants we have welcomed 3 million customers last year. The vast majority of these customers visited our restaurants because of the people working in Haidilao. This is proof of the excellent caliber of many of Haidilao’s employees. Since we have so many outstanding colleagues, shouldn’t we group them together, so that we can rely on them to influence even more people to remain at Haidilao and continue working hard (this is Zhang Yong’s purpose for setting up the union)? Because of this, I need the cream of the crop to join the union. The union should be an excellent organisation within Haidilao (Zhang Yong can really innovate!)…

…Every union member needs to understand this simple logic. We’re not caring for our employees to carry out the company’s orders. We’re doing so because we truly understand that we’re all human. And every human being needs to care and to be cared for. This care stems from a belief, and that is “all men are created equal.”

If our union members understand this point, then we’ll know that the union should not only be caring about the little things, such as taking care of employees when they have a small illness. What’s even more important is for the union to provide a platform for them to change their destiny. And to change their destiny is to win more diners for Haidilao with all their might. To open more restaurants so that there are more opportunities for career growth for the people of Haidilao to change their destiny. This is what it really means to care for employees.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Haidilao. Holdings are subject to change at any time.

6 Things I’m Certain Will Happen In The Financial Markets In 2021

There are so many things that can happen, but here are six things that I’m certain will happen in the financial markets in 2021.

In December 2019, I published 6 Things I’m Certain Will Happen In The Financial Markets in 2020. The content of the article is a little cheeky, because it describes incredibly obvious things, such as “interest rates will move in one of three ways: sideways, up, or down.”

But I wrote the article in the way I did for a good reason. A lot of seemingly important things in finance, things with outcomes that financial market participants obsess over and try to predict, actually turn out to be mostly inconsequential for long-term investors. I thought the article is important to help investors develop perspective on what’s going on in the markets, so I shall write one again for 2021! If you’ve read the 2020 version, you’ll find a lot of the content to be similar – but you can treat it as a refresher anyway! If this is new to you, then let me introduce you to my absolutely broken but still useful crystal ball…

Here are six things I’m certain will happen in 2021:

1. There will be something huge to worry about in the financial markets.

Peter Lynch is the legendary manager of the Fidelity Magellan Fund who earned a 29% annual return during his 13-year tenure from 1977 to 1990. He once said:

“There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of the newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”

Imagine a year in which all the following happened: (1) The US enters a recession; (2) the US goes to war in the Middle East; and (3) the price of oil doubles in three months. Scary? Well, there’s no need to imagine: They all happened in 1990. And what about the S&P 500? It has increased by nearly 950% from the start of 1990 to today, even without counting dividends. 

And as a reminder, 2020 has been a year of upheavals in the global economy. Nearly the entire world is currently struggling with COVID-19 and the pandemic has caused significant contractions in economic activity in many countries, with unemployment also being a serious problem. The USA is one of the worst-hit countries, yet the US stock market has risen. From the start of 1990 to December 2019, the S&P 500 was up by around 800% without counting dividends. The gain from the start of 1990 to December 2020, as I showed just above, has increased to 950% – in the midst of an unprecedented pandemic. 

There will always be things to worry about. But that doesn’t mean we shouldn’t invest.

2. Individual stocks will be volatile.

From 1997 to 2018, the maximum peak-to-trough decline in each year for Amazon.com’s stock price ranged from 12.6% to 83.0%. In other words, Amazon’s stock price had suffered a double-digit fall every single year. Meanwhile, the same Amazon stock price had climbed by 76,000% (from US$1.96 to more than US$1,500) over the same period.

If you’re investing in individual stocks, be prepared for a wild ride. Volatility is a feature of the stock market – it’s not a sign that things are broken. 

3. The US-China trade war will either remain status quo, intensify, or blow over.

“Seriously!?” I can hear your thoughts. But I’m stating the obvious for a good reason: We should not let our views on geopolitical events dictate our investment actions. Don’t just take my words for it. Warren Buffett himself said so. In his 1994 Berkshire Hathaway shareholders’ letter, Buffett wrote (emphases are mine):

“We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. 

Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.

But, surprise – none of these blockbuster events made the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. 

Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.”

From 1994 to 2019, Berkshire Hathaway’s book value per share, a proxy for the company’s value, grew by 13.9% annually. Buffett’s disciplined focus on long-term business fundamentals – while ignoring the distractions of political and economic forecasts – has worked out just fine.

4. Interest rates will move in one of three ways: Sideways, up, or down.

“Again, Captain Obvious!?” Please bear with me. There is a good reason why I’m stating the obvious again.

Much ado has been made about what central banks have been doing, and would do, with their respective economies’ benchmark interest rates. This is because of the theoretical link between interest rates and stock prices.

Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since the alternative to stocks – bonds – are providing a good return. On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return. 

But if we’re long-term investors in the stock market, I think we really do not need to pay much attention to what central banks are doing with interest rates.  

There’s an amazing free repository of long-term US financial market data that is maintained by economics professor and Nobel Prize winner Robert Shiller.

His data contains long-term interest rates in the US as well as US stock market valuations going back to the 1870s. The S&P 500 index is used as the representation for US stocks while the cyclically adjusted price earnings (CAPE) ratio is the valuation measure. The CAPE ratio divides a stock’s price by its inflation-adjusted average earnings over a 10-year period.

The chart below shows US long-term interest rates and the CAPE ratio of the S&P 500 since the 1880s:

Source: Robert Shiller

Contrary to theory, there was a 30-plus year period that started in the early 1930s when interest rates and the S&P 500’s CAPE ratio both grew. It was only in the early 1980s when falling interest rates were met with rising valuations. 

To me, Shiller’s data shows how changes in interest rates alone can’t tell us much about the movement of stocks. In fact, relationships in finance are seldom clear-cut. “If A happens, then B will occur” is rarely seen.

Time that’s spent watching central banks’ decisions regarding interest rates will be better spent studying business fundamentals. The quality of a company’s business and the growth opportunities it has matter far more to its stock price over the long run than interest rates. 

Sears is a case in point. In the 1980s, the US-based company was the dominant retailer in the country. Morgan Housel wrote in his recent blog post, Common Plots of Economic History :

“Sears was the largest retailer in the world, housed in the tallest building in the world, employing one of the largest workforces.

“No one has to tell you you’ve come to the right place. The look of merchandising authority is complete and unmistakable,” The New York Times wrote of Sears in 1983.

Sears was so good at retailing that in the 1970s and ‘80s it ventured into other areas, like finance. It owned Allstate Insurance, Discover credit card, the Dean Witter brokerage for your stocks and Coldwell Banker brokerage for your house.”

US long-term interest rates fell dramatically from around 15% in the early-to-mid 1980s to around 3% in 2018. But Sears filed for bankruptcy in October 2018, leaving its shareholders with an empty bag. In his blog post mentioned earlier, Housel also wrote:

“Growing income inequality pushed consumers to either bargain or luxury goods, leaving Sears in the shrinking middle. Competition from Wal-Mart and Target – younger and hungrier – took off.

By the late 2000s Sears was a shell of its former self. “YES, WE ARE OPEN” a sign outside my local Sears read – a reminder to customers who had all but written it off.” 

If you’re investing for the long run, there are far more important things to watch than interest rates.

5. There will be investors who are itching to make wholesale changes to their investment portfolios for 2021.

Ofer Azar is a behavioural economist. He once studied more than 300 penalty kicks in professional football (or soccer) games. The goalkeepers who jumped left made a save 14.2% of the time while those who jumped right had a 12.6% success rate. Those who stayed in the centre of the goal saved a penalty 33.3% of the time.

Interestingly, only 6% of the keepers whom Azar studied chose to stay put in the centre. Azar concluded that the keepers’ moves highlight the action bias in us, where we think doing something is better than doing nothing. 

The bias can manifest in investing too, where we develop the urge to do something to our portfolios, especially during periods of volatility. We should guard against the action bias. This is because doing nothing to our portfolios is often better than doing something. I have two great examples. 

First is a paper published by finance professors Brad Barber and Terry Odean in 2000. They analysed the trading records of more than 66,000 US households over a five-year period from 1991 to 1996. They found out that the most frequent traders generated the lowest returns – and the difference is stark. The average household earned 16.4% per year for the timeframe under study but the active traders only made 11.4% per year.

Second, finance professor Jeremy Siegel discovered something fascinating in the mid-2000s. In an interview with Wharton, Siegel said:

“If you bought the original S&P 500 stocks, and held them until today—simple buy and hold, reinvesting dividends—you outpaced the S&P 500 index itself, which adds about 20 new stocks every year and has added almost 1,000 new stocks since its inception in 1957.”

Doing nothing beats doing something. The caveat here is that we must be adequately diversified, and we must not be holding a portfolio that is full of poor quality companies. Such a portfolio burns our wealth the longer we stay invested, because value is being actively destroyed.

6. There are 7.8 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life.

This is ultimately what fuels the global economy and financial markets. Miscreants and Mother Nature will wreak havoc from time to time. But I have faith in the collective positivity of humanity. When things are in a mess, humanity can clean it up. This has been the story of mankind’s and civilisation’s long histories. And I won’t bet against it. 

Mother Nature threw us a huge problem this year with COVID-19. Even though vaccines against the virus have been successfully developed, it is still a major global health threat. But we – mankind – managed to build a vaccine against COVID-19 in record time. Moderna, one of the frontrunners in the vaccine race, even managed to design its vaccine for COVID-19 in just two days. This is a great example of the ingenuity of humanity at work.

To me, investing in stocks is the same as having the long-term view that we humans are always striving, collectively, to improve the world. What about you?

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of Amazon. Holdings are subject to change at any time.

The “Mystery” of Investing Simplified

Two individuals with a deep passion for investing, talking about all-things investing.

In early October this year, I recorded a podcast with Kelvin Seetoh, co-founder of Growth Investing Mastery, an investment education services provider. The podcast is for GIM’s recently-launched podcast series, Growth Investing Secrets. I’ve known Kelvin for a few years and he’s one of the brightest young investors I know. The title of this article is the title that he gave for the podcast.

During our conversation, we covered a lot of ground, including:

  • How I became so passionate about investing
  • How I developed the confidence to be a stock picker
  • What it means to be “active” vs “passive”
  • The underappreciated traits of good investors
  • How I think about my geographical exposure in my investing activities
  • A deep dive into my investment framework
  • Why “copying” others is important
  • How to think about loss-making companies
  • My guiding light for portfolio construction, which is a phrase from David Gardner:  “Make your portfolio reflect your best vision for our future.”
  • How I think about which industries or sectors to focus on
  • How I navigated through the COVID-19 crisis

All credit goes to Kelvin for leading the conversation masterfully! You can check out the podcast here, which was published yesterday. I hope you’ll enjoy the session with Kelvin – I absolutely did! 

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I may have vested interests in the companies mentioned during the podcast.

Bright Future For Tech Stocks In Post-COVID world

It is doubtful that companies will stop their digital transformation simply because the threat of COVID-19 has been removed.

Note: This article was first published in The Business Times on 25 November 2020; data as of 19 November 2020

On 9 November 2020, Pfizer announced a wonderful development for mankind. Trial results from the pharmaceutical giant’s COVID-19 vaccine candidate, developed together with Bio NTech, showed that it could be 90% effective in preventing infection.

A week later, Moderna revealed that its COVID-19 vaccine candidate was 94.5% effective in trials. This was followed by an update from Pfizer a few days later that its vaccine candidate was actually 95% effective .

COVID-19 is still a serious global health threat. Pfizer and Moderna’s vaccines have yet to pass regulatory approvals at the time of writing (19 November 2020). Both companies have said too that they can supply their respective vaccines at scale only in 2021. Pfizer’s vaccine candidate also poses a significant logistical challenge since it needs to be transported and stored at an extremely cold temperature of minus 70 degrees celsius .

But, we can at least see some light at the end of the tunnel now.

A celebration – for some

The stock market welcomed Pfizer’s announcement. In the USA, the S&P 500 index was up by as much as 3.9% in the next trading session following the release of Pfizer’s vaccine trial data, before closing with a 1.2% gain. Singapore’s stock market barometer, the Straits Times Index, climbed by 3.7%. But the warm reception did not extend to all corners of the market. The stock price of e-signature specialist DocuSign sank by 14.7% despite the S&P 500’s 1.2% gain.

There were also painful drops of 13.6% and 17.4%, respectively, in the stock prices of e-commerce software provider Shopify and video conferencing platform Zoom Video Communications. These are just some examples of the sharp stock price declines that many US-listed technology companies faced immediately after Pfizer shared the great news about its COVID-19 vaccine trial.

The future for tech stocks?

COVID-19 has led to restrictions on human movement in many countries around the world. Many technology companies benefitted as their products help people to live, work, play, and consume better from home. In late April this year, Microsoft’s CEO Satya Nadella famously said that he saw “two years’ worth of digital transformation happening in two months”.

As a microcosm of what happened with technology companies, DocuSign, Shopify, and Zoom saw their stock prices jump by between 133% and 577% from the start of 2020 to the end of October.

If Pfizer and Moderna’s vaccines are as effective as their trial results suggest, then COVID-19 could cease to be a worry for society in the near future.

Technology companies would then lose a powerful tailwind. This train of thought, along with the sharp difference in the movement of the broader market and technology stocks after Pfizer’s announcement, may prompt a question among many investors: Should we invest in technology stocks in the post-COVID world?

Better question

From my perspective, many of the tech companies whose stock prices were pummelled after Pfizer’s good news are creating or riding on powerful long-term trends.

For instance, before COVID-19, DocuSign was already providing e-signatures to a growing number of companies. Retail merchants were already flocking to Shopify in droves to create an online or omnichannel retail presence to meet consumer demand. A large and growing number of people and companies were already experiencing the joys of a well-built video conferencing app through Zoom.

From 2017 to 2019, DocuSign’s customer base increased by 57% from 373,000 to 585,000. Shopify’s merchant base jumped by two-thirds from 609,000 to over one million; and Zoom’s customers with more than 10 employees tripled from 25,800 to 81,900 . The trio, and many other tech companies, were growing before COVID-19 because their products and services are superior to how things are done traditionally.

When we’ve solved COVID-19, will the advantages that these technology companies have over the traditional ways still hold? I humbly suggest that this is the better question to ask, compared to whether we should we invest in tech stocks in the post-COVID world. This is because the question hones us in on a key driver of a company’s stock price over the long run: Its business performance. Answering this better question can help us determine if any particular technology company’s product or service will enjoy growing demand in the years ahead. With growing demand comes a higher chance of earning higher revenue, profit, and cash flow.

You will need to figure out your own answer to the better question, but my reply to it is “yes”. Will companies really stop their digital transformation and be content with or revert back to more archaic ways of conducting their business simply because the threat of COVID-19 has been removed? I doubt so.

What lies ahead

Some technology companies aren’t worth investing in because they already or will struggle to grow their businesses meaningfully over the long run. The trick lies in separating the wheat from the chaff.

Technology stocks could also be in for more pain in the months or even the next one or two years ahead. Short-term stock price movements are unpredictable. But as a long-term investor, I’m focused on what the businesses of technology stocks could look like five to 10 years from now. For me, the future looks bright, with or without COVID-19.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in the shares of DocuSign, Microsoft, Shopify, and Zoom Video Communications. Holdings are subject to change at any time.

Ant Group’s Botched IPO: The Risk Of Investing In China

Earlier this week, the Ant Group IPO was suspended. It highlights an important risk of investing in China that investors need to know.

Ant Group’s massive initial public offering (IPO) was stopped cold in its tracks earlier this week.

Ant Group, a fintech company backed by Alibaba and its co-founder Jack Ma, was supposed to list its shares in the stock exchanges of Shanghai and Hong Kong today. The IPO was slated to raise a mammoth sum of at least US$34 billion for the company. What happened instead was the Shanghai Stock Exchange suspending Ant Group’s listing on Tuesday, followed shortly by the same action from the Hong Kong Stock Exchange.

Ostensibly, Ant Group’s IPO process was stopped after Jack Ma gave a speech during a financial conference in Shanghai in late October. In his comments, Ma had essentially labelled the Chinese financial system and regulations as antiquated. This presumably angered the Chinese government because Ma was quickly summoned for a meeting with the country’s financial regulators. And then came the news of the fintech firm’s stalled IPO.

I see Ant Group’s predicament as a manifestation of the risk of investing in China that investors need to contend with. I’m often being asked about my opinions on investing in Chinese companies. I think there are wonderfully innovative companies in China with tremendous growth prospects that can make for excellent investment opportunities. But will I want to make Chinese companies the majority of my portfolio? No. This is because I think that Chinese companies have to deal with unique political and regulatory risks that companies based in democratic environments do not. And these risks, if they flare up, could easily derail a Chinese company’s business.  

A recent Bloomberg article on the Ant Group IPO-debacle contained the following passage:

“The consequences came this week. On Monday, Beijing’s top financial watchdogs summoned Ma and dressed him down. Beijing also issued draft rules on online micro lending, stipulating stricter capital requirements and operational rules for some of Ant Group Co.’s consumer credit businesses.”

Based on Bloomberg’s reporting, the Chinese government has effectively made it more difficult for Ant Group to grow. But what’s more important is that the Chinese government has appeared to also pull the plug on Ant Group’s IPO for now. I just don’t see how something similar – where a company’s IPO process is killed at the very last minute because the company’s public-face had made some unflattering comments about its home country – can happen in a democratic environment. 

This article is not meant to discuss the investment merits of Ant Group. Instead, it’s simply meant to highlight what I think is a critical risk of investing in China that investors need to know: Chinese companies face unique politically-related risks that are not to be trifled with. And Ant Group just happens to be a prominent example.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have no vested interest in Ant Financial or Alibaba. Holdings are subject to change at any time.

My First Investing Loss

A conversation with Dollars and Sense on what I learnt from my first investing loss, and why I’m doing all that I am in the financial services industry.

I was recently interviewed by Timothy Ho, co-founder of the personal and business finance online knowledge portal Dollars and Sense. The interview is part of Dollars and Sense’s #MyFirstLoss interview series. With permission, I’ve reproduced my conversation with Timothy here. We covered a number of topics, such as the losses I’ve made in investing, and why I decided to start The Good Investors with Jeremy. You can  head here for the original interview.

Interview

Timothy Ho (Timothy): We always start this column with the same question. Do you remember the first time you made a loss in your trades? #MyFirstLoss

Chong Ser Jing (Ser Jing): I remember all the losers in my portfolio. My first-ever transactions in the financial markets were made in October 2010 for my family’s investment portfolio, and they were the purchases of six US stocks. Even back then, I invested with the mindset of a long-term business owner. I saw, still see, and will always see, stocks as partial ownership stakes in actual businesses.

From October 2010 to June 2020, the portfolio of the six stocks expanded to more than 50 with regular capital infusions. But the selling happened rarely. I only sold eight stocks, and only two of these sales were voluntary – the rest of the sales happened because the companies were being acquired.

My aversion to selling is by design – because I believe it strengthens my discipline in holding onto the winners in my family’s portfolio. Many investors tend to cut their winners and hold onto their losers. Even in my earliest days as an investor, I recognised the importance of holding onto the winners in driving my family portfolio’s return. Being very slow to sell stocks has helped me hone the discipline of holding onto the winners. And this discipline has been a very important contributor to the long-run performance of my family’s portfolio.

I think it’s important that investors focus on portfolio-level returns instead of the gains and losses produced by individual stocks they own. It’s a guarantee that we will make mistakes when investing. But the key is to make sure that the decisions we do get right can significantly outweigh the ones we get wrong.

Timothy: You have been writing full-time since 2013. Was the motivation to continue writing the reason why you started The Good Investors after the closure of The Motley Fool Singapore?

Ser Jing: When I was in university, I realised I wanted a career in the investment world. I have a deep passion for investing. I see the financial markets as an intellectual puzzle to solve, and by learning about companies, I get to have a front-row seat to observe how the world is changing. For example, there’s a company in the USA that is currently applying electric fields to the human body to treat cancer – how cool is that!?

But at the same time, I wanted my involvement in the investment world to be something where I could positively impact as many lives as possible. This mindset has not changed, and it was a big reason behind my motivation to join the Motley Fool Singapore in January 2013. The Motley Fool has a strong purpose that its employees believe in. Back then, the Fool’s purpose was to help the world invest better. Today, it is to make the world smarter, happier, and richer. Both are wonderful.

During our careers at Fool Singapore, Jeremy and myself experienced first-hand how important financial education is for Singapore’s public. Many people do not understand investing and bumble their way through the financial markets, leading to a deterioration in their financial health – and the scale of the problem was larger than I thought before I joined the Fool. When Fool Singapore closed, Jeremy and I felt that we still have plenty to offer in terms of investor education and we needed to continue doing our part. We just think it’s the right thing to do.

Timothy: Besides the website, you also started the Compounder Fund for accredited investors earlier this year. What was the reason for doing so?

Ser Jing: For many years while I was at Fool Singapore, I had been exploring a fund management business. My vision was to help spearhead a fund management business for Motley Fool Singapore. At the Fool, I thought we were excellent at serving the DIY (“do it yourself”) investors – we provide investment research and ideas, and these DIY investors can make their own decisions. But I also believed (and I still do) that there’s an even larger group of investors in Singapore who require a fully-outsourced investment solution because they do not have the time, energy, capability, or interest to invest by themselves. It’s true that there are many investment funds in Singapore, but it’s rare to find one that I think is investing soundly (global in nature, and invests with a focus on long-term business fundamentals). This is why I thought it’s essential for Fool Singapore to build a fund management business in Singapore – but nothing concrete on the front ever got started when I was with the company.

When Fool Singapore closed, I thought, “Why not try it out on my own?” I approached Jeremy and shared my ideas and he was on board from Day 1. To Jeremy and myself, Compounder Fund is more than just a business – there are strong social objectives we want to accomplish too, such as having fees that decline as assets under management grow, and running the fund very transparently to play our part in investor education. These objectives will be hard for us to meet in a commercial setting (there will be commercial pressure), so it’s better if we did it ourselves where we had only ourselves to answer to, and where the measurement of success of the fund goes beyond how much fees it can generate.

Timothy: As someone who has been writing about investing for so long, and also manages investment monies on behalf of investors, what are some common mistakes that you see investors and traders making?

Ser Jing: I think one of the common mistakes that investors and traders commit is not putting in the effort to understand market history.

If they look at market history, they will realise that stocks are volatile creatures. Volatility is in their nature. But crucially, this volatility has occurred even when stocks have gone on to generate fantastic returns. A great example is the energy drinks maker Monster Beverage (which Compounder Fund does not own). From 1995 to 2015, its stock price grew by 105,000%. But in those years, its stock price fell by 50% or more on four separate occasions. If they understand that volatility is part and parcel of the game, then perhaps they wouldn’t be so stressed out over short-term market declines.

Also, if they looked at market history, they will understand that the world is always in a state of crisis. As the saying goes “History is just one damn thing after another.” Uncertainty is always around. But how many times have you heard someone say that they prefer to wait for the dust to settle before they invest? The thing is, if you wait for the robins, spring will be over. Peter Lynch also once said that “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Timothy: What should investors or traders be mindful of during this volatile COVID-19 period?

Ser Jing: I think it’s important to be mindful of our own emotions. As I alluded to earlier, volatility tends to bring out harmful emotionally-driven investment behaviours. Put in place a system where decisions are made based on business developments and not stock price movements.

Another thing to be mindful of would be companies with weak balance sheets. Antifragility is a term introduced by Nassim Taleb, a former options trader and author of numerous books including Black Swan and Antifragile. Taleb classifies things into three groups:

  • The fragile, which breaks when exposed to stress (like a piece of glass, which shatters when dropped)
  • The robust, which remain unchanged when stressed (like a football, which does not get affected much when kicked or dropped)
  • The antifragile, which strengthens when exposed to stress (like our human body, which becomes stronger when we exercise)

Companies too, can be fragile, robust, or even antifragile. The easiest way for a company to be fragile is to load up on debt. If a company has a high level of debt, it can crumble when facing even a small level of economic stress. On the other hand, a company can be robust or even antifragile if it has a strong balance sheet that has minimal or reasonable levels of debt. During tough times (for whatever reason), having a strong balance sheet gives a company a high chance of surviving. It can even allow the company to go on the offensive, such as by hiring talent and winning customers away from weaker competitors, or having a headstart in developing new products and services. In such a scenario, companies with strong balance sheets have a higher chance of emerging from a crisis – a period of stress – stronger than before.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.