Category: General Investing

The company with the deepest pockets often wins.

Having more money than your competitors can further your technology advantage, allow you to market more aggressively to get a stronger network effect, or simply to scale up production more quickly.

This is why founders can be found scrambling around Silicon Valley trying to raise capital. But raising capital is not reserved solely for privately held startups. 

In fact, many fast-growing public companies are increasingly looking for ways to raise capital cheaply, be it through debt or secondary equity offerings.

Raising capital through secondary equity offerings

One of the more common ways to raise money in today’s market is through a secondary offering. A secondary offering is simply the sale of new shares to investors by an already public-listed company. This is especially appealing for a company when its stock price has increased to a lofty valuation, a likely phenomenon for tech stocks in today’s market.

We need to look no further than one of 2020’s hottest stocks, Tesla Inc (NASDAQ: TSLA). The electric vehicle company took advantage of its rising stock price to raise money no less than three times last year. Tesla first raised US$2 billion in February at a split-adjusted share price of around US$153. It quickly followed that up in September and December, raising another US$5 billion each time as its share price soared.

Despite raising around US$12 billion in capital through secondary offerings in 2020, Tesla’s effective dilution to shareholders was likely less than 5% from all the offerings combined. This is a huge advantage that Tesla has over its competitors. 

The leading electric vehicle company now has deeper pockets, giving it the ability to scale production faster and to invest more to improve its battery and software technology. 

Tesla is not the only company that has taken advantage of soaring stock prices. Singapore’s e-commerce and gaming company, SEA Ltd (NYSE: SE), and communications API leader, Twilio Inc (NYSE: TWLO), are just two other examples of prominent large companies that have pounced on their soaring share prices to raise relatively inexpensive capital through secondary share offerings.

Debt markets

Another way to raise money is through the debt markets. Rather than diluting shareholders, bond offerings and bank loans are another way to raise capital. 

Even though companies incur interest expenses and will eventually need to pay back their creditors, debt does not dilute shareholders. In addition, the current low-interest-rate environment enables companies to issue bonds or take up loans at very competitive rates.

Netflix Inc (NASDAQ: NFLX) is an example of a company using the debt market effectively. In the past few years, Netflix’s operating cash flow was negative, as it was spending heavily on content creation. As such, the company needed more capital. Netflix CEO Reed Hastings and his team decided that rather than dilute shareholders through equity offerings, it would issue high yield bonds to pay for its expenses. The result was that the company managed to get the required capital, whilst not diluting existing shareholders. 

Although Netflix’s balance sheet may look weak because of the debt, the streaming giant has a clear path to free cash flow generation and should be able to start paying off some of its debt this year.

Over the longer term, Netflix shareholders could start reaping the returns of management’s careful planning and the fact that they were not diluted from Netflix’s debt offerings.

A mix of both?

So far I have discussed companies that have raised capital through secondary share offerings and debt. Another way for companies to raise capital is through an instrument that could be considered a mix of both – and it may be the best way to raise capital.

Convertible bonds are bonds that can be converted to shares at a certain date or when a certain event occurs. These bonds tend to have very low coupon rates and if converted, are usually done so at a large premium to current share prices.

For instance, leading website creation company, Wix.com Ltd (NASDAQ: WIX) raised US$500 million in August 2020 by issuing convertible bonds that are due in 2025.

Get this. The bonds have a 0% coupon, meaning that Wix does not pay any interest to bondholders. On top of that, these bonds convert to Wix shares at a whopping 45% premium to Wix’s last reported share price prior to the announcement of the sale of the bonds.

As such, if the bonds do get converted to shares, the amount of dilution is lower than if the company simply offered a secondary offering which is usually priced at a discount to current share prices.

Why then would anyone want to buy such an instrument? Personally, I much rather buy equity directly than to own convertible bonds. Nevertheless, convertible bonds do serve a purpose for more risk-averse investors.

First of all, bondholders will get their principle back even if the company’s shares fall below the conversion price. They also have a more senior right to the company’s assets should the company run into financial trouble – this provides additional downside security for investors. The convertible aspect of the bonds also offers bondholders “equity-like” upside if Wix’s share price rises beyond the conversion price. However, bondholders are paying a huge premium for the hedge, which I personally would not want to do for my portfolio.

Closing words

The ability to raise capital cheaply is a competitive advantage for a company that is often overlooked by investors.

Having deep pockets could give companies a leg up against their competition in a time when scale and technology are increasingly important.

Shareholders may sometimes frown on companies that are issuing new shares or taking on more debt. But if the company uses its newfound financial muscle to good effect, the new capital could be the difference between emerging a winner or ending up as an obsolete wannabe.

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 Tesla, Twilio, Netflix, and Wix.com. Holdings are subject to change at any time.

Technology is changing the world, fast. The COVID-19 pandemic has accelerated software and other technology adoption around the globe. And this is likely just the beginning of a multi-year trend. With this in mind, here are some tech trends that I am keeping an eye on.

Programmatic advertising

Programmatic advertising is a way to automatically buy digital advertising campaigns across a wide spectrum of publishers rather than from an individual publisher. Instead of going to a specific vendor to reserve a digital space on their website, advertising real estate is aggregated in ad exchanges where they can be bought or sold. Programmatic advertising software, in turn, communicates with these ad exchanges to buy and sell these advertising spaces, streamlining and optimising the advertising campaigns for advertisers.

In 2021, a whopping 88% of all digital display advertising in the USA is projected to be transacted via programmatic advertising.

According to Research And Markets, the global market for programmatic advertising platforms is estimated at US$5.2 billion in 2020 and is expected to reach US$33.7 billion in 2027, a nearly 31% compounded annual growth rate.

Alphabet (NASDAQ: GOOGL)(NASDAQ: GOOG), the parent company of Google, is likely going to be a key beneficiary of this as they dominate the programmatic advertising space with their Adwords platform. Amazon Inc’s (NASDAQ: AMZN) demand-side platform for advertisers has also gained market share in recent years. But we shouldn’t write off independent specialised programmatic advertising companies such as The Trade Desk (NASDAQ: TTD).

A key advantage that an independent programmatic advertising platform such as Trade Desk has over Google Adwords is that it is truly independent, so it will help ad buyers purchase the best digital ad-spaces the platform can find for the buyers’ needs. Google Adwords, on the other hand, may have a preference for Google properties, which may not be the best properties for ad buyers on certain occasions.

Whatever the case, with programmatic advertising exploding in popularity, there will likely be room for multiple winners in this space.

Solar energy

Under the Paris Agreement, participant countries have set a goal to limit global warming to an increase of preferably less than 1.5 degrees celsius compared to pre-industrial levels. This can only be achieved if more of the electricity the world produces comes from clean sources.

One of the most reliable sources of clean energy will be the sun. Solar power is 100% clean, renewable, and reliable. As such, governments around the world are creating policies to incentivise greater use of solar energy for homes and for commercial purposes.

Just as importantly for uptake, the cost of solar energy is coming down. According to the International Renewable Energy Agency, since 2010, the cost of energy production has dropped by 82% for photovoltaic solar and 47% for concentrated solar energy.

Global solar production capacity has also risen from 40GW in 2010 to 580 GW in 2019, suggesting the global demand for solar energy is taking effect. China continues to lead this space, accounting for 35.4% of the global market in 2018. This is driven by huge government initiatives in China in a bid to accelerate clean energy adoption.

In the USA, with the environment-conscious Democratic party taking the majority of the Senate, political observers expect greater impetus for the US government to support solar power.

Companies such as First Solar (NASDQ: FSLR), SolarEdge (NASDAQ: SEDG), JinkoSolar (NYSE: JKS), Enphase Energy (NASDAQ: ENPH), and ReneSola (NYSE: SOL) could stand to benefit.

Electric vehicles

In a similar vein to solar energy, electric vehicles are a cleaner alternative to ICE (internal combustion engine) vehicles. In the past, electric vehicles were slow to gain adoption due to the high cost of batteries and slow charging times. There were also the concerns of short range (distance that can be driven before the vehicle requires charging again) and poor charging infrastructure for electric vehicles due to a lack of charging stations.

But all of this has changed.

The infrastructure in many countries have slowly taken shape while the specifications of electric vehicles are improving at a tremendous pace. Most prominently, charging times, range, and cost have all improved, leading to greater demand from environmentally conscious consumers.

In addition, governments have stepped in to implement policies to encourage the sales of electric vehicles. California has gone as far as to ban the sale of new gasoline-powered vehicles by 2035.

Global passenger electric vehicle sales jumped from 450,000 in 2015 to 2.1 million in 2019. But there is still huge room for growth. In 2020, only 2.7% of total vehicle sales were electric. That figure is expected to rise to 10% by 2025. In the next decade, more than 100 million electric vehicles are expected to be sold around the world.

Tesla (NASDAQ: TSLA) is the largest electric vehicle player in the market, delivering close to 500,000 vehicles in 2020. But this is just the beginning. Tesla is ramping up production quickly, breaking ground on new factories in Berlin and Texas. It is also expected to start production of vehicles in its New York factory which used to be solely for solar panels.

On top of that, its Shanghai and Fremont factories are both not producing at full capacity yet. The two existing factories can increase their annual output in the next few years. Some are projecting Tesla to deliver between 840,000 to 1 million cars in 2021.

With no shortage of demand and no need for advertising (due to incredible consumer mind share), ramping up production will lead to more car sales and more revenue and gross profits for Tesla.

Tesla has also recently taken advantage of its soaring share price to raise new capital. It raised at least US$10 billion in the second half of 2020 through issuing new shares, and these moves provides the company with ammunition to accelerate its production capacity further.

But Tesla is not the only electric vehicle company in town. In the USA, legacy automobile manufactures such General Motors Company (NYSE: GM) and Ford Motor Company (NYSE: F) have been investing in their own electric vehicle models.

Global giants, Toyota (TYO: 7203) and Volkswagen (ETR: VOW3), have also signalled their intent to pivot their business. Other pure play electric vehicle startups in China such as Nio (NYSE: NIO), Li Auto (NASDAQ: LI), and  Xpeng (NYSE: XPEV) are also jostling for a piece of the pie. Analysts estimate that there will be 500 different models of electric vehicles globally by 2022.

Whatever the case, multiple winners are set to emerge from this fast-growing space.

Conscious eating

Sticking to the same theme of environmentally conscious consumers, fake meat is becoming the next big trend in conscious eating.

Fake meat refers to either plant-based protein, or lab-grown cell-based protein. In the plant-based space, proteins are extracted and isolated from a plant and then combined with plant-based ingredients to make the product taste and look like meat. Examples of plant-based proteins are Beyond Meat (NASDAQ: BYND) and Impossible Meat.

In lab-grown cell-based meat, an animal cell is extracted from an animal and grown in lab culture. This technology is still not yet in mass production as far as I know, but Singapore was the first to approve lab-grown meat for commercial sales.

Although fake meat is clearly better for the environment, consumer take up has not been rapid due to the high cost of production. Like electric vehicles, in order for fake meat to truly become mainstream, it needs to reach or exceed cost parity with traditional meat – and it needs to taste good.

Temasek-backed Impossible Foods is on the path to reduce cost to consumers. Earlier this year, Impossible Foods announced that it will be lowering prices by around 15% for its open-coded food service products, its second price cut since March 2020.

Another key driver of growth is the sale of fake meat in restaurant chains. McDonald‘s (NYSE: MCD) has decided to debut its own plant-based meat alternative called McPlant in 2021, which Beyond Meat helped to co-create.

According to the research firm, Markets and Markets, the plant-based meat market is estimated to be US$4.3 billion in 2020 and is projected to grow by 14% per year to US$8.3 billion by 2025.

Final words

We are indeed living in exciting times. The world is so dynamic and with new technologies and trends emerging, companies at the forefront of these shifts in demand are primed to reap the rewards.

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, Alphabet, The Trade Desk and Tesla. Holdings are subject to change at any time. Holdings are subject to change at any time.

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:

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.

Positive returns in stocks are never a guarantee. Stay far, far away from anyone who tells you otherwise.

Company-specific risks, such as competition or regulatory risk, plus market-wide systemic risks, such as interest rates hikes and global recessions, pose risks to a stock’s long-term return. These risks result in what I call a wide distribution of outcome probabilities. 

And yet, in today’s stock market, it seems that more and more investors are starting to ignore these risks and go big or even all-in on just a single stock. Some argue that the large spread in returns between winners and laggards makes a concentrated portfolio more appealing.

But before diving headfirst into building a super-concentrated portfolio, consider the following risk.

What is the distribution of outcomes?

Let’s start with the basics.

When I talk about the distribution of outcomes, I am referring to the probability-distribution of the long-term returns of a stock. For example, a company can have a 20% chance to go to zero, a 60% chance to double up and another 20% chance to triple in value over five years (note that the probability percentages add up to 100%).

As such, there is a distribution of outcome possibilities, each with its own probability of occurring.

In the example above, over a five year period, investors in the company have a 20% chance to lose all their money, a 60% chance to double their money, and a 20% chance to triple their money.

Every stock has a different distribution of outcomes. The probabilities of returns and the range of returns will also differ drastically from stock to stock.

You found a great investment… now what?

Most stocks have a curve of different outcomes but for simplicity’s sake, let’s give the example of a stock that has just two possible outcomes.

This particular stock, let’s call it Company A, has a 30% chance to go bankrupt and a 70% chance to triple in value in five years. Simple mathematics will tell you that this is an amazing bargain. A gambler will take these odds any day.

We can calculate the average expected return we get from this stock by multiplying the probabilities with the outcomes. In this scenario, the expected return is 110%* (calculation below) in five years. Annualised, that translates to an excellent 15.9% return per year, which easily outpaces the returns of the S&P 500 over its entire history.

As such, any investor should happily take this bet. But don’t get too carried away. Even though this stock is a great investment, there is still a 30% possibility that we lose our entire investment in this stock. Would you be willing to take that risk?

Diversification reduces the risk

This is where diversification comes into play.

Instead of making a single bet on Company A, we can add another company into the portfolio.

Let’s say we find another company, Company B, that has slightly lower expected returns than Company A. Company B has a 35% chance of going broke and a 65% chance to triple in value, giving it an expected return of 95%**(calculation below).

The table below shows the probabilities of investing solely in Company A or Company B or investing half into each company.

	Company A Only	Company B Only	Half Each
Expected Annual Return	15.9%	14.3%	15.2%
Chance to Lose it All	30%	35%	10.5%

From the table above, we can see that the odds of losing your entire portfolio drops to 10.5% after splitting it between the two companies.

This seems counter-intuitive. Even though you are adding Company B into the portfolio, a stock that has a higher chance of going bust than Company A, the combined portfolio still ends up with a lower chance of going to zero.

The reason is that in order for the combined portfolio to go to zero, both companies need to go broke for you to lose your entire portfolio. The probability of both companies going bankrupt is much smaller than either of Company A or Company B going broke on its own. This is true if the two companies have businesses and risks that are not co-related.

What this shows is that we can lower our risk of suffering portfolio losses by adding more stocks into the portfolio.

Even though investors sacrifice some profits by adding stocks with lower expected returns, the lower risks make the portfolio more robust.

The sweet spot

This leads us to the next question, what is the sweet spot of portfolio diversification? Ultimately, this depends on the individual’s risk appetite and one’s own computation of an investment’s probability of outcomes. 

For instance, venture capital firms bet on startups that have a high chance of failing. It is, hence, not uncommon for venture capital funds to lose their entire investment in a company. But at the same time, the fund can still post excellent overall results.

For instance, venture investments in any single company may have a 95% chance of going to zero but have a small chance of becoming 100-plus-baggers in the future. A single winning bet can easily cover the losses of many failed bets. Given this, venture capital funds tend to diversify widely, sometimes betting on hundreds of companies at a time. This is to reduce the odds of losing all their money while increasing the odds of having at least some money on a spectacularly winning horse.

Similarly, in public markets, the same principle applies. Some early-stage companies that go public early have significant upside potential but have relatively high risks. If you are investing in these stocks, then wide diversification is key. 

Key takeaway

Many young investors today see the stock market as a place to get rich quick. This view is exacerbated by the raging bull of 2020 in some corners of the stock market across the world. 

They are, hence, tempted by the allure of making huge wins by concentrating their portfolio into just one or two companies. (You likely have heard stories of many Tesla shareholders becoming millionaires by placing their whole portfolio on just Tesla shares)

Although expected returns may be high, a concentrated portfolio poses substantial risks to one’s portfolio. 

I can’t speak for every investor, but I much rather sleep comfortably at night, knowing that I’ve built a sufficiently diversified portfolio to lower my risk of losing everything I’ve worked for

Nevertheless, if you insist on building a concentrated portfolio, it is important to learn the risks of such a strategy and make sure that you are financially and emotionally prepared with the very real possibility of losses.

*(0x0.3+300%x0.7-100%)=110%

**(0x0.35+300%x0.65-100%)=95%

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 do not have any vested interest in the shares of any companies mentioned in this article. Holdings are subject to change at any time.

Investors often use the price-to-sales multiple to value a company. This makes sense as sales is a proxy for how much cash the company can generate for its shareholders (there’s no way to generate cash without sales). It is also more useful than price-to-earnings when a company is not yet profitable.

However, in the stock market, there is a disparity between the price-to-sales ratios that various companies have.

Take a look at the table below. It shows the price-to-sales multiples of some prominent “retail” companies around the world.

Company	Current price-to-sales multiple
Shopify Inc (NYSE: SHOP)	51.7
Alibaba Group Holdings Ltd (HKG: 9988)	8.9
Amazon.com Inc (NASDAQ: AMZN)	4.6
Costco Wholesale Corporation (NASDAQ: COST)	0.96

As you can see, these four companies trade at remarkably different sales multiples. Costco trades at the lowest price-to-sales multiple of less than 1. This means that if you buy Costco’s shares now, you are paying less than a $1 for every dollar of sales that the company earns.

On the other end of the spectrum is Shopify, which trades at a price-to-sales multiple of 51.7. For every dollar of revenue that Shopify generates, investors need to pay $51.70.

Just looking at this table, you will likely assume that the shares of Costco are much cheaper than Shopify’s. 

But the truth is that the price-to-sales multiple is just one part of the analysis. There are often good reasons why paying a premium multiple may make sense. In this article, I describe some of the main considerations and why you should never look at the price-to-sales multiple at face value without considering these other factors.

Growth

Perhaps the most obvious reason to pay a premium price-to-sales multiple is for growth. A company that is growing revenue quickly should command a higher multiple. 

For instance, take two companies that are generating $1 in sales per share. One company is growing at 50% over the next five years, while the other is growing at 10%. The table below shows their revenues over five years.

	Fast Grower Revenue per share	Slow Grower Revenue per share
Year 0	$1	$1
Year 1	$1.50	$1.10
Year 2	$2.25	$1.21
Year 3	$3.37	$1.33
Year 4	$5.06	$1.46
Year 5	$7.59	$1.61

In this scenario, even if you paid a price to sales multiple of 20 for the fast grower and a price-to-sales multiple of 10 for the slow grower, the fast-grower still ends up as the company with the better value for money. The table below illustrates this.

	Fast Grower Revenue per share	Price paid	Price-to-sales multiple	Slow Grower Revenue per share	Price Paid	Price-to-sales multiple
Year 0	$1	$20	20	$1	$10	10
Year 5	$7.59	$20	2.6	$1.61	$10	6.2

By the fifth year, the price-to-sales multiple based on your share price at cost is actually lower for the fast-grower than the slow grower, even though it started off much higher.

Let’s relate this back to the four companies mentioned earlier.

The table below shows their revenue growth in the last reported quarter.

Company	Current price-to-sales multiple	Year-on-year revenue growth rate for the last reported quarter
Shopify	51.9	96%
Alibaba	8.9	30%
Amazon	4.6	37%
Costco	0.96	17%

Based on the figures above, we can see that Shopify has the highest growth rate, while Costco has the slowest.

Margins

The next factor to consider is margins. Of every dollar in sales per share that a company earns, how much free cash flow per share can it generate?

The larger the margins, the higher the price-to-sales multiple you should be willing to pay.

As some companies are not yet profitable, we can use gross margins as an indicator of the company’s eventual free cash flow margin.

Here are the gross margins of the same four companies in the first table above.

Company	Current price-to-sales multiple	Gross Profit Margin
Shopify	51.7	53%
Alibaba	8.9	43%
Amazon	4.6	25%
Costco	0.96	13%

There is a clear trend here.

Based on current share prices, the market is willing to pay a higher multiple for a high margin business.

This makes absolute sense as the value of every dollar of revenue generated is more valuable to the shareholder for a high margin business.

Shopify is a software business that charges its merchants a subscription fee. It also provides other merchant services such as transactions and logistics services. As a software and services business, it has extremely high margins.

On the other end of the spectrum, Costco is a typical retailer that has its own inventory and sells it to consumers. It competes in a highly competitive retail environment and sells its products at thin margins to win market share. Due to the razor-thin margins, it makes sense for market participants to price Costco’s shares at a lower price-to-sales multiple.

Predictability of the business

Lastly, we need to look at other factors that impact the predictability of the business. Needless to say, a company with a more steady revenue stream that recurs every year should command a premium valuation.

There are many factors that can impact this. This includes the business model that the company operates, the company’s brand value, the presence of competition, the behaviour of customers, or any other moats that the company may have.

A highly predictable revenue stream will be valued more highly in the stock market.

Shopify is an example of a company that has a predictable revenue stream. The e-commerce enabler charges merchants a monthly subscription fee to use its platform. It provides the software to build and run an e-commerce shop. As such, it is mission-critical for merchants that built their websites using Shopify. Given this, it’s likely that many merchants will keep paying Shopify’s subscription fees month-after-month without fail. Investors are therefore willing to pay a premium for the reassurance of the predictability of Shopify’s existing revenue stream.

Final thoughts

There is no exact formula for the right multiple to pay for a company. As shown above, it depends on a multitude of factors. 

But the main takeaway is that we should never look at a company’s price-to-sales or price-to-earnings multiples in isolation.

Too often, I hear investors make general statements about a stock simply because of the high or low multiples that a stock is priced at.

These multiples may be a good starting point to value a company but it is only one piece of the puzzle. It doesn’t capture the nuances of a company’s business model, its growth, or its unit economics… Only by considering all these factors together can we make a truly informed decision.

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, Costco Wholesale Corporation, and Shopify. Holdings are subject to change at any time.

The finance community often use the term “passive investing” to apply to investing in index funds. But is investing in an index fund really a “passive” strategy?

Actually not.

Most indexes actually have an active method of selecting their stocks. For example, the S&P 500 only includes the top 500 stocks by market capitalisation that are listed and headquartered in the USA. In addition, the stocks need to have at least four consecutive quarters of profitability.

The S&P 500 is also market-cap weighted. As such, bigger companies have a larger weight in the S&P 500 index, and their returns have a bigger impact on the index’s overall return.

I consider this method of selection and weighting as an active method of selecting stocks. Moreover, the selection criteria are determined by a committee and the committee also has the final say on whether a stock should be included in the index. This was the case for Tesla Inc (NASDAQ: TSLA), which was only included after it reported its fifth profitable quarter (instead of fourth).

Portfolio weighting

Ultimately, these active decisions made by a committee impact the index’s returns. For instance, the simple act of choosing to weight the index based on market cap has had a profound impact on the S&P 500 index over the last 10 years.

The table below shows the returns of the S&P 500 index against the S&P 500 equal-weighted index.

As you can see, the market-cap weighted index far outpaced the equal-weighted one. This is because larger stocks, which have a bigger weighting in the market-cap-weighted index, have outperformed their smaller counterparts over the last 10 years.

Choosing the right index 

All of which points to the fact that not all indexes are made equal.

Each index has specific selection criteria and a specific method of weighting its constituent stocks. Ultimately, these are active choices made by the committee building the index. 

As investors, we may think that “index investing” is a passive strategy.

But indexes are not completely passive. The stocks within an index have been picked based on criteria that are “actively” chosen.

Even in Singapore, the Straits Times Index (STI), which is a commonly used indicator of the health of Singapore’s stock market, may not be truly representative or passive.

The rules for inclusion into the STI are based on a stock’s market cap, liquidity, and a minimum amount of voting rights in public hands. As such, the stocks selected in the STI are actually picked by the committee based on a selection methodology that they have actively chosen.

Index investing is actually “active”

Ultimately, investing in any index is not a truly passive way to invest. The exposure you gain is based on active decisions made by the index committee that built the index.

In addition, with so many indexes available, choosing an index to invest in is also an active decision made by the investor. Within the US alone, there are funds that track the S&P 500, S&P 500 Equal Weight, MSCI USA, MSCI USA Equal Weighted Indexes, and many more. Each of these indexes has performed differently over the last 10 years.

Index investing is, hence, not truly “passive”.

By investing in any index, you are actually making an “active” decision that the “active” selection and weight criteria used in that particular index will work best for your investment needs.

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 do not have a vested interest in the shares of any companies mentioned. Holdings are subject to change at any time.

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 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.

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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.

One of the age-old questions in investing is how widely should we diversify. Unfortunately, it seems that even the best investors can’t seem to agree on this.

Legendary investor Charlie Munger is famous for being a supporter of a concentrated portfolio. He once said:

“The idea of excessive diversification is madness. Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.”

In 2017, Munger said that he owned just three positions in his personal portfolio – Berkshire Hathaway, Costco, and an investment in Li Lu’s investment partnership (which itself is highly concentrated).

At the opposite corner, we have other renowned investors who practised wide diversification and yet still achieved stunning results. For example, there’s Peter Lynch, who earned a 29.2% annualised return in his 13-year tenure managing the Fidelity Magellan Fund from 1977 to 1990. In his later years managing the fund, Lynch held as many as 1,400 stocks in the portfolio. 

Concentration and the risks

I recently had a short conversation with a friend on this topic of diversification. My friend is a proponent of having a concentrated portfolio, believing that we should not dilute our best investment ideas.

I agree that a concentrated portfolio may give you the best chance of higher returns. If you manage to build a sizeable position in a stock that becomes a multi-bagger (meaning a stock with a return of 100% or more), your return will obviously be better than if you had diluted your portfolio with other companies that ended up with lousier gains.

But we shouldn’t ignore the fact that having a concentrated portfolio can also magnify our losses. If your concentrated portfolio included a large position in a “big loser”, or perhaps in a fraud case such as Luckin Coffee, your portfolio-level return will very likely lag a more diversified portfolio.

Higher concentration = Higher variance

According to research by Alex Bryan from Morningstar, there is no real significance between a fund’s portfolio-concentration and performance.

What Bryan’s research did conclude was that more concentrated funds had a wider variance of returns. This means that concentrated funds had a higher chance of “blockbuster” returns but also had a higher risk of ending up with very poor performance. Bryan explains (emphases are mine):

“The risk in manager selection actually increases with portfolio concentration. So, while we didn’t find a link on average between performance and concentration, the dispersion of potential outcomes increases with portfolio concentration. So, really highly concentrated managers can miss the mark by a really, really wide range.

I think the other point to remember is that more highly concentrated portfolios tend to have greater exposure to firm-specific risk, and on average, that’s not well-compensated. So, again, you really want to keep an eye on risk and make sure that the manager that you hire is taking adequate steps to try to manage that risk that comes with concentration.”

How does this relate to the individual investor?

At the end of the day, how concentrated our portfolios should be depends on our risk appetite, skill, goals and ability to take on risk.

The more concentrated our portfolios, the greater the possibility of extreme returns – both on the upside and the downside. Are you willing to take on this risk and can you mitigate the risks with your ability to select stocks? These are some questions to ask yourself.

Ultimately, thinking about your needs, investment expertise, and circumstance will help you decide what level of concentration works best for 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 Costco.

Compounding is amazing, isn’t it? Just look at the graph below. It shows the nominal growth of the S&P 500, a prominent US stock market barometer, in the last 150 years.

What’s interesting about the chart is that the S&P 500’s growth accelerated over time. That’s exactly how compounding works. Nominal growth starts off slow but increases over time.

The chart below of the S&P500 over the last 150 years shows the same thing as above, but in logarithmic form. It gives a clearer picture of the percentage returns of the stock market over the same time frame.

The log-chart of the S&P 500 over the past 150 years is a fairly straight line up. What this tells us is that even though the return of US stocks have accelerated nominally, there was a fairly consistent growth in percentage terms over the time studied.

How do stocks compound?

This leads us to the next question. How?

In order to produce a 10% annual return for shareholders, a company that has a market value of $1 million needs to create $100,000 in shareholder value this year. The next year, in order to compound at the same rate, the company now needs to create $110,000 in shareholder value.

That figure grows exponentially and by year 30, the company now needs to create $1,586,309.30 to keep generating a 10% increase in shareholder value.

On paper, that seems outrageous and highly improbable. However, based on the historical returns of the stock market, we see that the S&P 500 has indeed managed to achieve this feat.

The reason is that companies can reinvest the capital they’ve earned. A larger invested capital base can result in larger profits. As long as they can keep reinvesting their earned capital at a similar rate of return, they can keep compounding shareholder value. 

But here’s the catch…

Although I’ve given an example of how a company can compound shareholder value over time, it really is not that simple.

Not all companies can create more shareholder value every year. In reality, corporations may find it hard to deploy their new capital at similar rates of return. Businesses that operate in highly competitive industries or are being disrupted may even face declining profits and are destroying shareholder value each year if they reinvest their capital into the business.

In fact, most of the returns from stock market indexes are due to just a handful of big winners. In 2014, JP Morgan released an interesting report on the distribution of stock returns. The report looked at the “lifetime” price returns of stocks versus the Russell 3000, an index of the biggest 3000 stocks in the US over a 35-year period.

What JP Morgan found was that from 1980 to 2014, the median stock underperformed the Russell 3000 by 54%. Two-thirds of all stocks underperformed the Russell 3000. The chart below shows the lifetime returns on individual stocks vs Russell 3000 from 1980 to 2014.

Moreover, on an absolute return basis and during the same time period, 40% of all stocks had a negative absolute return.

Even stocks within the S&P 500, a proxy for 500 of the largest and most successful US-listed companies, exhibited the same. There were over 320 S&P 500 deletions from 1980 to 2014 that were a consequence of stocks that failed, were removed due to substantial declines in market value, or were acquired after suffering a decline. The impressive growth you saw in the S&P 500 earlier was, hence, due to just a relatively small number of what JP Morgan terms “extreme winners”.

That’s why diversification is key

Based on JP Morgan’s 2014 report, if you picked just one random stock to invest in, you had a 66% chance to underperform the market and a 40% chance to have a negative return.

This is why diversification is key.

If historical returns are anything to go by, diversification is not just safer but also gives you a higher chance to gain exposure to “extreme winners.” Just a tiny exposure to these outperformers can make up for the relative underperformance in many other stocks.

Last words

Compounding is a game-changer when it works.

But the reality is that not all stocks compound in value over a long period of time. Many may actually destroy shareholder value over their lifetime. A useful quote from Warren Buffet comes to mind: “Time is the friend of the wonderful business, the enemy of the mediocre.”

Given the wide divergence of returns between winners and losers, we can’t take compounding for granted. By diversifying across a basket of stocks with a sound investment framework, or by buying a fund that tracks a broadly-diversified market index, we reduce our downside risk and increase our odds of earning positive returns.

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.