Chong Ser Jing, Author at The Good Investors : Page 15 of 24

3 Great Investing Lessons From My Favourite Warren Buffett Speech

Warren Buffett is one of my investing heroes.

He’s well known for producing incredible long-term returns at Berkshire Hathaway since assuming leadership of the company in 1965. What is less well-known is that he ran his own investment fund from 1957 to 1969 and achieved a stunning annualised return of 29.5%; the US stock market, in comparison, had gained just 7.4% per year over the same period.

Buffett has given numerous speeches and interviews throughout his long career. My favourite is a 1984 speech he gave titled The Superinvestors of Graham-and-Doddsville. I want to share three great lessons I have from the speech.

On what works in investing

Buffett profiled nine investors (including himself) in the speech. These investors invested very differently. For example, some were widely diversified while others were highly concentrated, and their holdings had no significant overlap.

There were only two common things among the group. First, they all had phenomenal long-term track records of investment success. Second, they all believed in buying businesses, not tickers. Here’re Buffett’s words:

“The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market.”

I firmly believe that there are many roads to Rome when it comes to investing in stocks. A great way is to – as Buffett pointed out – look at stocks as part-ownership of a real business. This is what I do too.

On risk and rewards

I commonly hear that earning high returns in stocks must entail taking on high risks. This is not always true. Buffett commented:

“It’s very important to understand that this group had assumed far less risk than average; note their record in years when the general market was weak.”

A stock becomes risky when its valuation is high. In such an instance, the potential return of the stock is also low because there’s no exploitable gap between the stock’s price and its intrinsic value. On the other hand, a stock becomes less risky when it’s priced low in relation to its intrinsic value; this is also when its potential return is high since there’s a wide exploitable-gap. So instead of “high risk / high return,” I think a better description of how investing works is “low risk / high return.”

It’s worth noting that a stock’s valuation is not high just because it carries a high price-to-earnings (P/E) or price-to-sales (P/S) ratio. What is more important here is the stock’s future business growth in relation to the ratios. A stock with a high P/E ratio can still be considered to have a low valuation if its business is able to grow significantly faster than average.

On why sound investing principles will always work

Will sharing the ‘secrets’ to investing cause them to fail? Maybe not. This is what Buffett said (emphasis is mine):

“In conclusion, some of the more commercially minded among you may wonder why I am writing this article. Adding many converts to the value approach will perforce narrow the spreads between price and value. I can only tell you that the secret has been out for 50 years, ever since Ben Graham and David Dodd wrote “Security Analysis”, yet I have seen no trend toward value investing in the 35 years I’ve practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult.”

Surprisingly, it seems that human nature itself is what allows sound investing principles to continue working even after they’re widely known. Investing, at its core, is not something difficult – you buy small pieces of businesses at a price lower than their value, and be patient. So let’s not overcomplicate things, for there’s power in simplicity.

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.

A Quick Thought On “Expensive” Software Stocks

Are young software companies expensive?

A few days ago, I was mucking around with historical data on Alphabet, the parent company of the internet search engine of our time, Google. I found some interesting data on this company that led to me writing this short but hopefully thought-provoking article.

Alphabet was listed in August 2004 and closed its first trading day at a share price of US$50. By 31 January 2005, Alphabet’s share price had risen to US$98, and it carried an astronomical price-to-earnings ratio of 250. On 31 January 2005, Alphabet’s revenue and profit were respectively US$2.67 billion and US$222 milion, giving rise to a profit margin of 8.3%.

Today, Alphabet’s share price is US$1,418, which represents an annualised return of 19% from 31 January 2005. Its P/E ratio has shrunk to 29, and the company’s revenue and profit are US$166.7 billion and US$34.5 billion, respectively, which equate to a profit margin of 21%.

Today, many software companies – especially the young ones categorised as software-as-a-service (SaaS) companies – carry really high price-to-sales ratios of 30 or more (let’s call it, 35). Those seem like extreme valuations, especially when we consider that the SaaS companies are mostly loss-making and/or generating negative or meagre free cash flow. If we apply a 10% net profit margin to the SaaS companies, they are trading at an adjusted P/E ratio of 350 (35 / 0.10).

But many of the SaaS companies today – the younger ones especially – have revenues of less than US$2.7 billion, with huge markets to conquer. The mature SaaS companies have even fatter profit margins, relative to Alphabet, of 30% or more today. So, compared to Alphabet’s valuation back then on 31 January 2005, things don’t seem that out-of-whack now for SaaS companies, does it? Of course, the key assumptions here are:

The young SaaS companies of today can go on to grow at high rates for a long period of time;
The young SaaS companies can indeed become profitable in the future, with a solid profit margin.

Nobody can guarantee these assumptions to be true. But for me, looking at Alphabet’s history and where young SaaS companies are today provides interesting food for thought.

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.

3 Lessons From A Stock That Was Held By 3 Legendary Investors

The three legendary investors I’m talking about here are Warren Buffett, Benjamin Graham, and Shelby Davis.

Buffett is perhaps the most well-known investor in the world today, so he does not need an introduction. Meanwhile, his late mentor, Benjamin Graham, is revered as the father of the discipline of value investing. The last investor, Davis, is less known. In a recent article, The Greatest Investor You’ve Never Heard Of, I introduced him this way:

“I first learnt about Shelby Cullom Davis sometime in 2012 or 2013. Since then, I’ve realised that he’s seldom mentioned when people talk about the greatest investors. This is a pity, because I think he deserves a spot on the podium alongside the often-mentioned giants such as Warren Buffett, Benjamin Graham, Charlie Munger, and Peter Lynch.

Davis’s story is well-chronicled by John Rothchild in the book, The Davis Dynasty. Davis started his investing career in the US with US$50,000 in 1947. When he passed away in 1994, this sum had ballooned to US$900 million. In a span of 47 years, Davis managed to grow his wealth at a stunning rate of 23% annually by investing in stocks.”

The stock mentioned in the title of this article is GEICO, an auto insurance company that was fully acquired by Buffett’s investment conglomerate, Berkshire Hathaway, in 1995. In 1976, Buffett, Graham, and Davis all owned GEICO’s shares.

The GEICO link

Back in 1975, GEICO was in serious trouble due to then-CEO Ralph Peck’s decision to relax the company’s criteria for offering insurance policies. GEICO’s share price reached a high of US$61 in 1972, but by 1976, the share price had collapsed to US$2. The auto insurer lost US$126 million in 1975 and by 1976, the company had ousted Peck and was teetering on the edge of bankruptcy. Davis and Graham both had invested capital in GEICO way before the problems started and had suffered significant paper losses at the peak of GEICO’s troubles.

After Jack Byrne became the new CEO of GEICO in 1976, he approached Buffett to come up with a rescue plan. Byrne promised Buffett that GEICO would reinstate stringent rules for offering insurance policies. Buffett recognised the temporal nature of GEICO’s troubles – if Byrne stayed true to his promise. Soon, Buffett started to invest millions in GEICO shares.

The rescue plan involved an offering of GEICO shares which would significantly dilute existing GEICO shareholders. Davis was offended by the offer and did not see how GEICO could ever return to profitability. He promptly sold his shares. It was a decision that Davis regretted till his passing in 1994. This was because Byrne stayed true to his promise and GEICO’s share price eventually rose from US$2 to US$300 before being fully acquired by Berkshire Hathaway.

The GEICO lessons

Davis’s GEICO story fascinated me, and it taught me three important lessons that I want to share.

First, even the best investors can make huge mistakes. Davis’s fortune was built largely through his long-term investments in shares of insurance companies. But he still made a mistake when assessing GEICO’s future, despite having intimate knowledge on the insurance industry. There are many investors who look at the sales made by high profile fund managers and think that they should copy the moves. But the fund managers – even the best ones – can get things wrong. We should come to our own conclusions about the investment merits of any company instead of blindly following authority.

Second, it pays to be an independent thinker. Davis stood by his view on GEICO’s future, even though Graham and Buffett thought otherwise. Davis turned out to be wrong on GEICO. But throughout his career, he prized independent critical thinking and stuck by his own guns.

Third, it is okay to make mistakes in individual ideas in a portfolio. Davis missed GEICO’s massive rebound. In fact, he lost a huge chunk of his investment in GEICO when he sold his shares. But he still earned a tremendous annual return of 23% for 47 years in his portfolio, which provided him and his family with a dynastic fortune. This goes to show that a portfolio can withstand huge mistakes and still be wildly successful if there’s a sound investment process in place. In The Greatest Investor You’ve Never Heard Of, I wrote:

“The secret of Davis’s success is that he started investing with a sound process. He was an admirer of Benjamin Graham, Buffett’s revered investing mentor. Just like Graham, Davis subscribed to the discipline of “value investing”, where investors look at stocks as part-ownership of businesses, and sought to invest in stocks that are selling for less than their true economic worth. Davis’s preference was to invest in growing and profitable companies that carried low price-to-earnings (P/E) ratios. He called his approach the ‘Davis Double Play’ – by investing in growing companies with low P/E ratios, he could benefit from both the growth in the company’s business as well as the expansion of the company’s P/E ratio in the future.

Davis also recognised the importance of having the right behaviour. He ignored market volatility and never gave in to excessive fear or euphoria. He took the long-term approach and stayed invested in his companies for years – even decades, as you’ll see later – through bull and bear markets. Davis’s experience shows that it is a person’s behaviour and investing process that matters in investing, not their age.”

Breaking the rules

There’s actually a bonus lesson I want to share regarding GEICO. This time, it does not involve Davis, but instead, Graham. In Graham’s seminal investing text, The Intelligent Investor, he wrote (emphases are mine):

“We know very well two partners [Graham was referring to himself and his business partner, Jerome Newman] who spent a good part of their lives handling their own and other people’s funds on Wall Street. Some hard experience taught them it was better to be safe and careful rather than to try to make all the money in the world. They established a rather unique approach to security operations, which combined good profit possibilities with sound values. They avoided anything that appeared overpriced and were rather too quick to dispose of issues that had advanced to levels they deemed no longer attractive. Their portfolio was always well diversified, with more than a hundred different issues represented. In this way they did quite well through many years of ups and downs in the general market; they averaged about 20% per annum on the several millions of capital they had accepted for management, and their clients were well pleased with the results.

In the year [1948] in which the first edition of this book appeared an opportunity was offered to the partners’ fund to purchase a half-interest in a growing enterprise [referring to GEICO]. For some reason the industry did not have Wall Street appeal at the time and the deal had been turned down by quite a few important houses. But the pair was impressed by the company’s possibilities; what was decisive for them was that the price was moderate in relation to current earnings and asset value. The partners went ahead with the acquisition, amounting in dollars to about one-fifth of their fund. They became closely identified with the new business interest, which prospered.

In fact it did so well that the price of its shares advanced to two hundred times or more the price paid for the half-interest. The advance far outstripped the actual growth in profits, and almost from the start the quotation appeared much too high in terms of the partners’ own investment standards. But since they regarded the company as a sort of “family business,” they continued to maintain a substantial ownership of the shares despite the spectacular price rise. A large number of participants in their funds did the same, and they became millionaires through their holding in this one enterprise, plus later-organized affiliates. Ironically enough, the aggregate of profits accruing from this single investment decision far exceeded the sum of all the others realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions.”

Graham’s investment in GEICO broke all his usual investing rules. When there was usually diversification, he sank 20% of his fund’s capital into GEICO shares. When he usually wanted to buy shares with really cheap valuations, GEICO was bought at a price “much too high in terms of the partners’ own investment standards.” When he usually sold his shares after they appreciated somewhat in price, he held onto GEICO’s shares for an unusually long time and made an unusually huge gain. So the fourth lesson in this article, the bonus, is that we need to know our investing rules well – but we also need to know when to break them.

What We’re Reading (Week Ending 28 June 2020)

The best articles we’ve read in recent times on a wide range of topics, including investing, business, and the world in general.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 28 June 2020:

1. Growth Without Goals – Patrick O’Shaughnessy

Jeff Bezos is an incredible figure. He is known for his focus on the long term. He has even funded a clock in West Texas which ticks once per year and is built to last 10,000 years—an ode to thinking long-term.

But I now realize that the key isn’t thinking long-term, which implies long-term goals. Long-term thinking is really just goalless thinking. Long term “success” probably just comes from an emphasis on process and mindset in the present. Long term thinking is also made possible by denying its opposite: short-term thinking. Responding to a question about the “failure” of the Amazon smartphone, Bezos said “if you think that’s a failure, we’re working on much bigger failures right now.” A myopic leader wouldn’t say that.

My guess is that Amazon’s success is a byproduct, a side-effect of a process driven, flexible, in-the-moment way of being. In the famous 1997 letter to shareholders, which lays out Amazon’s philosophy, Bezos says that their process is simple: a “relentless focus on customers.” This is not a goal to be strived for, worked towards, achieved, and then passed. This is a way of operating, constantly—every day, with every decision.

2. Never The Same – Morgan Housel

The halt in business has been stronger than anything ever seen, including the Great Depression. But the Nasdaq is at an all-time high.

The story isn’t over. And it’s political, so it’s messy. But in terms of quickly stemming an economic wound, the policy response over the last 90 days has been a success.

There’s been the $600 weekly boost to unemployment benefits.

The Fed expanding its balance sheet by trillions of dollars and backstopping corporate debt markets.

The $1,200 stimulus payments.

The Paycheck Protection Plan.

The airline bailouts.

The foreclosure moratoriums … on and on.

I don’t care whether you think those things are right, wrong, moral, or will have ugly consequences. That’s a different topic.

All that matters here is that people’s perception of what policymakers are capable of doing when the economy declines has been shifted higher in a huge way. And it’s crazy to think those new expectations won’t impact policymakers’ future decisions.

It’s one thing if people think policymakers don’t have the tools to fight a recession. But now that everyone knows how powerful the tools can be, no politician can say, “There’s nothing we could do.” They can only say, “We chose not to do it.” Which few politicians – on either side – wants to say when people are losing jobs.

3. What comes after Zoom? – Ben Evans

I think this is where we’ll go with video – there will continue to be hard engineering, but video itself will be a commodity and the question will be how you wrap it. There will be video in everything, just as there is voice in everything, and there will be a great deal of proliferation into industry verticals on one hand and into unbundling pieces of the tech stack on the other. On one hand video in healthcare, education or insurance is about the workflow, the data model and the route to market, and lots more interesting companies will be created, and on the other hand Slack is deploying video on top of Amazon’s building blocks, and lots of interesting companies will be created here as well. There’s lots of bundling and unbundling coming, as always. Everything will be ‘video’ and then it will disappear inside.

4. The Anatomy of a Rally – Howard Marks

There’s no way to determine for sure whether an advance has been appropriate or irrational, and whether markets are too high or too low. But there are questions to ask:

Are investors weighing both the positives and the negatives dispassionately?
How do valuations based on things like earnings, sales and asset values stack up against historical norms?
Is that optimism causing investors to ignore valid counter-arguments?
Is the market being lifted by rampant optimism?
Are the positives fundamental (value-based) or largely technical, relating to inflows of liquidity (i.e., cash-driven)?
If the latter, is their salutary influence likely to prove temporary or permanent?
What’s the probability the positive factors driving the market will prove valid (or that the negatives will gain in strength instead)?

Questions like these can’t tell us for a fact whether an advance has been reasonable and current asset prices are justified. But they can assist in that assessment. They lead me to conclude that the powerful rally we’ve seen has been built on optimism; has incorporated positive expectations and overlooked potential negatives; and has been driven largely by the Fed’s injections of liquidity and the Treasury’s stimulus payments, which investors assume will bridge to a fundamental recovery and be free from highly negative second-order consequences.

5. Locusts Are A Plague Of Biblical Scope In 2020. Why? And … What Are They Exactly? – Pranav Baskar

Locusts have been around since at least the time of the pharaohs of ancient Egypt, 3200 B.C., despoiling some of the world’s weakest regions, multiplying to billions and then vanishing, in irregular booms and busts.

If the 2020 version of these marauders stays steady on its warpath, the United Nations Food and Agriculture Organization says desert locusts can pose a threat to the livelihoods of 10% of the world’s population.

The peril may already be underway: Early June projections by the FAO are forecasting a second generation of spring-bred locusts in Eastern Africa, giving rise to new, powerful swarms of locust babies capable of wreaking havoc until mid-July or beyond.

6. As Businesses Reopen, We Should Reopen Our Minds – Chin Hui Leong

Even as the ground beneath businesses shift, we should recognise that some of the key qualities we seek as investors will remain unchanged.

We still want to have good management teams at a company’s helm who are willing to adapt to new realities, innovate, and pivot their business accordingly.

Similarly, a business with strong financials and steady free cash flow rarely goes out of style, as cash would provide the company with the all-important financial firepower to turn strategy into reality.

These factors remain timeless.

And we have to keep learning.

We will continue looking for instances and data points that will either validate or break our assumptions on how things may change in the future.

It’s an ongoing process that we, as investors, have to adopt and be willing to change our mind if the situation calls for it.

Ultimately, keeping an open mind and a long term view is key.

New, unexpected developments could take shape in ways we cannot predict ahead of time.

7. Transcript: Jeremy Siegel – Barry Ritholtz and Jeremy Siegel

RITHOLTZ: And I thought I recall didn’t Ben Bernanke specifically saved that to Milton Friedman at some …

SIEGEL: Absolutely. During his 90th birthday. He was the head of ceremonies for his 90th birthday party. He stood up — and this is well before the financial crisis. Milton Friedman died in 2006. Before the financial, it was 2004, he was 90, stood up in front of a group of people. I couldn’t be there because of another engagement and I kicked myself for not being there.

But he said, Milton, the influence of your book and I’m going to promise you, the Great Depression shouldn’t have happened and because of what you did and wrote, it’s not going to happen again. We will not let it happen again.

He said that in 2006 to the face of Milton Friedman — I mean, 2004. Two years later, Friedman passed away. Two years later, Bernanke had to take the playbook from that mammoth monetary history and put it into effect and saved us from the Great Depression.

RITHOLTZ: How incredibly prescient in 2004.

SIEGEL: Wow. Yes. Wow.

My Daily Routine

What a typical day looks like for me.

A reader of The Good Investors sent me a message on LinkedIn recently asking what my daily routine is like. The reader mentioned that there’s likely to be strong interest in what goes on in a typical day for me.

I have no idea if there really will be reader-interest in this topic. But I thought why not write about it anyway. A few years from now, it will also be fun to look back at this.

So, I’m usually up by 7am or earlier. There are two things that I tend to do once I’m awake (besides washing up!): (1) Meditate, and (2) catch up on my favourite Twitter accounts.

I don’t have an active Twitter account. But one of the great things about Twitter is that anyone can still access the platform and read tweets. Over the past 1.5 years or so, I’ve found Twitter to be an amazing place to catch up on great articles on life, business, technology, and more. It is also a wonderful resource for condensed pieces of knowledge. Some of the people I follow on Twitter are (in no particular order):

Usually, there will be a lot of good articles shared through these accounts. I will then read through them.

As for meditation, I have found it to be profoundly useful in helping me deal with the stresses in life with equanimity. Sometimes, I meditate first before catching up on Twitter. Then there are days where I catch up on Twitter first, read the articles that pop up there, and then meditate.

When both activities are done, it’s usually around 9:30am. This is when I start my reading/research/writing on companies for my just-launched fund’s investment activities, or for articles for The Good Investors. The wonderful thing about investing for a living, and writing an investment blog as a passion project, is that the work done for both activities often overlap in huge ways. I see it as killing two birds with one stone!

I will usually stop around 12:30pm or 1pm for lunch, then resume the research/writing. Some days, I start working out around 4pm. But if I’m not working out at 4-ish, then I will continue my investment research/writing till 6:30pm or so and then work out. I try to exercise every day.

Dinner typically starts at 7:30pm for me. After dinner I will hang out with my loved ones. After which, I carry on reading till I sleep. Some days I will be watching Youtube before bed. It depends on my mood. But even when I’m watching Youtube, I often will think about something like “Hang on, from my morning reads, I remember Company ABC having a unique management team. Let’s do some research!”… And off I go into a rabbit hole.

Bedtime for me is around 11:30pm or 12 midnight. And then it all starts again!

My daily routine has changed over time. Just 3 years ago, exercising at the gym would be the first thing I do in the morning after waking up. But now I prefer to exercise at a time when my energy is waning (late afternoon or early evening). I prefer to use the time when my mind is the most alert for reading/research/writing. Who knows when my routine will change again. But for now, this is what works for me!

Webinar: “Active vs Passive Investing: Lessons Learned with Ser Jing”

A recent webinar with Samuel Rhee, Chairman and Chief Investment Officer of Endowus, to talk about active investing versus passive investing.

Endowus is a roboadvisor based in Singapore. In March 2020, Jeremy and myself had the pleasure of meeting Samuel Rhee and Chiam Sheng Shi. They are Endowus’s Chief Investment Officer and Personal Finance Lead, respectively.

On 17 June 2020, I participated in a webinar hosted by Endowus, where Sam and I talked about active investing and passive investing. I want to thank Sam and the Endowus team (especially Sheng Shi) for their kind invitation. Sam is one of the wisest investors I’ve met, and I learnt a lot from him in our 1.5 hour conversation.

Active versus passive is one of the hottest topics in the investing world today and Sam and I covered a lot of ground during our session. Check out the video of our chat below!

Some of things we talked about include:

My journey in active investing
Sam’s journey in the active investing world before Endowus
The “Three P’s of Institutional Investing”
Advantages that institutional investors have
Endowus’s focus on doing three things very well for their investors: Access to great investment products; providing good evidence-based investing advice; and lowering costs for investors
The foundational building blocks of Endowus’s service. In particular, Sam dug deep into Endowus’s innovative full trailer-fee-rebates and how that benefits individual investors. Trailer fees are fees that a fund manager pays to an investment advisor or investment products distributor – and these fees come directly from the investors who purchase the funds. I admire Endowus for rebating the trailer fees it receives, because these fees are a huge hidden cost that eats into the returns investors earn; the presence of trailer fees is also a big reason why fund management fees are so high in Singapore.
Endowus’s investment philosophy:
- Maximise returns by minimising cost
- Enduring belief in power of markets
- Time in markets vs market timing
- Asset allocation is everything
- Strive for the efficient frontier
- Diversification improves risk-return
- Optimise based on personal risk tolerance
- Know your limitations
My investment philosophy
Traits of a good active investor
Etymology for the words “invest” and “投资” (Mandarin word for invest) and how this may be affecting investor-behavior in Western and Eastern societies.
Capital-flows into active vs passive funds
Evidence showing why active investing often fails
- My thoughts on why it’s still possible to beat the market
The reasons why previously successful active managers end up underperforming
My book recommendations for new investors: Thinking, Fast and Slow by Daniel Kahneman, and One Up On Wall Street by Peter Lynch.
The importance of having low costs in the investment products we’re investing in
How Endowus provides industry-leading low cost investment solutions for investors
Investors’ behavioural mistakes during the COVID-19-driven market panic seen in the first half of this year
The important distinction to be made between the terms “active” and “passive” when applied to investing. Passive investing is often understood to be the use of passively-managed index funds as the preferred investing vehicle. But is someone who often jumps in and out of these index funds a truly passive investor? Is a person who picks stocks, but who then holds these stocks patiently for years, active or passive?
How I manage cash in an investment portfolio
On hindsight, are there any changes to our investments we wish we had made during the market panic in the first half of 2020
Endowus’s desire to constantly improve their offerings for investors whenever they find better investment products.

Why We Do What We Do

Investing-disasters that affect individual investors are often preventable through investor education. This is why The Good Investors exists.

I woke up at 6:15am this morning. One of the first few things I saw on the web shook me. Investor Bill Brewster wrote in his Twitter account that his cousin-in-law – a 20 year-old young man in the US – recently committed suicide after he seemed to have racked up huge losses (US$730,000) through the trading of options, which are inherently highly-leveraged financial instruments.

A young life gone. Just like this. I’ve never met or known Bill and his family before this, but words can’t express how sorry I am to learn about the tragedy.

This painful incident reinforces the belief that Jeremy and myself share on the importance of promoting financial literacy. We started The Good Investors with the simple goal to help people develop sound, lasting investing principles, and avoid the pitfalls. Bill’s cousin-in-law is why we do what we do at The Good Investors.

In one of my earliest articles for The Good Investors, written in November 2019, I shared an article I wrote for The Motley Fool Singapore in May 2016. The Fool Singapore article contained my simple analysis on the perpetual securities that Hyflux issued in the same month. I warned that the securities were dangerous and risky because Hyflux was highly leveraged and had struggled to produce any cash flow for many years. I wish I did more, because the perpetual securities ended up being oversubscribed while Hyflux is today bankrupt. The 34,000 individual investors who hold Hyflux’s preference shares and/or perpetual securities with a face value of S$900 million are why we do what we do at The Good Investors.

Whatever that happened to Bill’s cousin-in-law and the 34,000 individual investors are preventable with education. They are not disasters that are destined to occur.

Jeremy and myself are not running The Good Investors to earn any return. Okay, maybe we do want to ‘earn’ one return. Just one. That people reading our blog can develop sound, lasting investing principles, and avoid the pitfalls. “A candle loses nothing by lighting another candle” is an old Italian proverb. We don’t lose anything by helping light the candle of investing in others – in fact, we gain the world. This is why we do what we do.

R.I.P Alex.

A Useful Observation For Sembcorp Industries Shareholders: The Troubling State Of Its Energy Business

Sembcorp Industries (SGX: U96) dominated the business headlines in Singapore last week. The utilities and marine engineering conglomerate announced on 8 June 2020 that it would be completely spinning off its marine engineering arm – Sembcorp Marine (SGX: S51) – through a complex deal.

As part of the deal, there will be an injection of capital into Sembcorp Marine via a rights issue. Prior to the announcement, Sembcorp Marine was already a listed company in Singapore’s stock market, but it had Sembcorp Industries as a majority shareholder.

I won’t be explaining the deal in detail because others have already done so. My friend Stanley Lim has created a great video describing the transaction for his investor education website Value Invest Asia. Meanwhile, another friend of mine, Sudhan P, has written a great piece on the topic for the personal finance online portal Seedly.

What I want to do in this article is to share an observation I have about the state of Sembcorp Industries’ business. I think my observation will be useful for current and prospective Sembcorp Industries shareholders.

The market cheers

On the day after the Sembcorp Marine spin-off was announced, Sembcorp Industries’ share price jumped by 36.6% to S$2.09. So clearly, the market’s happy that Sembcorp Industries can now be a standalone utilities business (the company has other small arms that are in urban development and other activities, but they are inconsequential in the grand scheme of things). It’s no surprise.

Sembcorp Marine’s business performances have been dreadful in recent years. The sharp decline in oil prices that occurred in 2014 – something not within Sembcorp Marine’s control – has been a big culprit. Another key reason – a self-inflicted wound – was Sembcorp Marine’s decision to load up on debt going into 2014. The table below shows Sembcorp Marine’s revenue, profit, cash, and debt from 2012 to 2019:

*Source: Sembcorp Marine annual reports*

Getting rid of Sembcorp Marine will allow Sembcorp Industries’ utilities business (the segment is named Energy) to shine on its own. But there’s a problem: The economic quality of the Energy segment has deteriorated significantly over time. This is the observation I want to share. Let me explain.

Low energy

There are two key reasons why I think Sembcorp Industries’ Energy segment has gone downhill.

First, over the six year period from 2013 to 2019, the Energy segment’s revenue and power production and water treatment capacities all grew – the power production capacity even increased substantially. But the segment’s profit did not manage to grow. In fact, it had declined sharply. Sembcorp Industries does report a separate profit figure for the Energy segment that excludes exceptional items. But the exceptional items are often gains on sale of assets and/or impairment of asset values. To me, these exceptional items are not exceptional; they reflect management’s day-to-day decision-making in allocating capital.

The table below shows the Energy segment’s revenue, profit, power capacity, and water-treatment capacity in each year from 2013 to 2019:

*Source: Sembcorp Industries’ annual reports*

Second, the Energy segment’s return on equity has fallen hard from a respectable 19.3% in 2013 to a paltry 5.3% in 2019. Here’s a table illustrating the segment’s return on equity for this time period:

The sharp fall in the Energy segment’s return on equity, coupled with the decline in profit, suggests that the economic quality of the segment has worsened materially over the past few years.

Some final words

It’s unclear to me how much of the Energy segment’s power and water capacities were actually in operation as of 2013 and 2019. So it’s highly possible that most of the increase in the capacity-figures seen in the period are mostly for projects that are still under development.

If this is the case, then there may still be a big jump in the Energy segment’s profit and return on equity in the future. But if it isn’t, then the business performance of the Energy segment in the past few years is troubling. If the Energy segment’s numbers can’t improve in the future, the overall picture for Sembcorp Industries still looks overcast to me even if Sembcorp Marine is no longer involved.

How Did US Stocks Fare When America Stumbled?

US stocks have been rising recently despite the US experiencing economic hardship and societal turmoil. Is this a unique case?

Healthy is not the best word to describe the condition of the US right now.

The US accounts for around 28% of all the COVID-19 cases in the world, despite making up just 4% of the global population. Its economy – the world’s largest – officially entered a recession in February this year, and its current unemployment rate of 13.3% is significantly higher than what it was during the depths of the Great Financial Crisis of 2008-09. The US is also currently in conflict with the world’s second largest economy, China, over multiple issues. Making matters worse for America, the unfortunate death of George Floyd in May while in police custody has sparked large-scale civil unrest across the country over racism.

And yet, the NASDAQ index closed at a record high on 10 June 2020. Meanwhile, the S&P 500 is today just a few percentage points below its record high seen in February 2020 after bouncing more than 37% from its coronavirus-low reached in March.

This massive disconnect between what’s going on in the streets of America and its stock market has left many questioning the sustainability of the country’s current stock prices. Nobody has a working crystal ball. But I know for sure that this is not the first time the US has stumbled.

1968 is widely recognised as one of the most turbulent years in the modern history of the US. During the year, the country was in the throes of the Vietnam War, prominent civil rights activist Martin Luther King Jr and presidential hopeful Robert F. Kennedy were both murdered, and massive riots were taking place. It was a dreadful time for America.

How did the US stock market do? The table below shows the S&P 500’s price and earnings growth with January 1968 as the starting point. I have a few time periods: 1 year; 5 years; 10 years; 20 years; and 30 years. You can see that growth in the earnings and price of US stocks over these timeframes have been fair to good.

The following are charts of the S&P 500’s performance over the same time periods, for a more detailed view:

It’s worth noting too that the S&P 500’s CAPE (cyclically-adjusted price-to-earnings) ratio in January 1968 was 21.5. This means that the rise in US stocks in the time periods we’ve looked at were not driven by a low valuation at the starting point. Today, the S&P 500’s CAPE ratio is 28.5, which is higher, but not too far from where it was in January 1968. (The CAPE ratio divides a stock’s price by its inflation-adjusted 10-year-average earnings)

I’m not trying to say that US stocks will continue to rise from here. A new bear market may start tonight, for all I know. I’m just trying to show two things.

First, stocks can rise even when the world seems to be falling apart. What we’re seeing today – the huge disconnect between Main Street and Wall Street – is not unique. It has happened before. In fact, I’ve written about similar episodes that occurred in 1907 and 2009. Second, we should approach the future with humility. Let’s assume we can travel back in time to the start of 1968. If I told you then about the mess the US would be entering, would you have guessed that, with a starting CAPE ratio of 21.5, US stocks would be (a) 11% higher a year later and (b) 46% higher five years later? Be honest.

No one knows what’s going to happen next. All past crashes look like opportunities, but every future one seems like a risk. There are also always reasons to sell. The best way we can deal with an uncertain future in our investing activities is to adopt a long time horizon, and have a sound investment process in place.

The Greatest Secret In Investing

One of my favourite investing articles is an old piece, written in February 2008, by The Motley Fool’s co-founder, David Gardner. It had the provocative title, The Greatest Secret of All, and an equally provocative lede (emphasis is his):

“Welcome to my article. I’m glad you found it, because it is your lucky day, dear Fool: The greatest secret to easy riches in the stock market is contained right here, below.”

The article does contain the greatest secret in investing, and I implore all of you to read it. I’ll come back to his piece and provide a link to it later. For now, let’s turn to my girlfriend’s investment portfolio.

The portfolio

In early 2019, my girlfriend wanted to build a portfolio of stocks for herself. We started having long conversations about what she can do and how she should be building the portfolio. Eventually, she settled on a list of stocks in the US that she was really keen on, and she made the purchases on the night of 8 March 2019.

The list of stocks are shown in the table below, along with their initial weightings. I merely acted as a sounding board – the stocks were bought by her. She made the final call and the “Buy” mouse clicks.

From the get-go, the portfolio did really well, producing a gain of 20% in just a few short months. There was a brief swoon from mid-July to early-October, but then things picked up again. Her stocks ended up charging to an overall gain of 36% in mid-February 2020. That was when all-hell broke loose.

The fall, and the aftermath

The S&P 500 in the US – the country’s major stock market index – hit a peak on 19 February 2020, before fears over COVID-19 started ripping across the market. By 23 March 2020, the S&P 500 had declined by 34% from peak-to-trough.

My girlfriend’s portfolio was not spared – it tumbled by 29% over the same period. All her previous gains were wiped out in the fall. The portfolio even dipped into the red.

Here’s a chart of the performance of my girlfriend’s portfolio (the blue line; without dividends) and the S&P 500 (the red line; with dividends) from 8 March 2019 to 8 June 2020:

*Source: Google Finance and Yahoo Finance*

As of 8 June 2020, my girlfriend’s portfolio has a 50% gain from its initial value on 8 March 2019, and has comfortably surged past the previous peak seen in February 2020. Meanwhile, the S&P 500 has rebounded strongly from its 23 March 2020 low, but it’s still a little off its high.

The greatest secret, revealed

Some of you may be thinking that my girlfriend had made significant changes to her portfolio in March 2020 that resulted in the strong gains seen in the right-hand part of the chart above. Not at all. Her portfolio had zero changes during the COVID-19 panic. In fact, she has made no changes to her portfolio since she first purchased her stocks on 8 March 2019.

This brings me back to David Gardner’s article, The Greatest Secret of All. The secret that David is referring to is this:

“Find good companies and hold those positions tenaciously over time to yield multiples upon multiples of your original investment.”

The word “tenaciously” needs highlighting. There was a painful period earlier this year when my girlfriend’s portfolio was in the red. She needed tenacity to hold on. To her credit (and it’s all her credit!), she held on. She was forward-looking and never gave in to the prevailing pessimism about COVID-19.

Yes, COVID-19 – and the economic slowdown that has happened globally as a result – was and still is painful for all of us. But she was confident that “this too, shall pass.” Tomorrow will be a brighter day.

She was also confident in the long-term futures of her companies. If you look at the names, these are companies that are building the world of tomorrow. There’s robotic surgery (Intuitive Surgical); DNA analysis and precision medicine (Illumina); e-commerce (Amazon, Shopify, MercadoLibre); digital payments (Mastercard, PayPal, Visa); streaming (Netflix, Spotify); and cloud computing (DocuSign, Paycom Software, Veeva Systems, Twilio etc). There’s more, but I think you get the drift.

What’s next?

The story of her portfolio is not over yet. Only 1 year and 3 months have passed – that’s way too short a time to come up with any high-probability insights. A new bear market may be just around the corner. It’s not our intention to take a victory lap.

But what has happened to my girlfriend’s portfolio throughout the COVID-19 situation – because of her tenacity in being actively patient – is worth bringing up. Because, 10 years from now, her portfolio could very well be another real-life example of David Gardner’s greatest secret in investing.