Investing in the stock market is not always sunshine and butterflies. Steep draw downs happen. But learning to endure pain can be hugely rewarding.
Much ink has been spilt about the great benefits of investing in the stock market. We constantly read about the power of compounding, how investing in stocks can help you beat inflation and the beauty of passive income from dividends.
But there’s a flip side to all this. Stock prices will fall every so often.
The size of the drawdowns can be big and they can happen frequently. It’s inevitable and will always be part and parcel of the stock market.
That’s what makes long term investing so hard
Fundsmith is the UK’s largest fund by assets under management and also one of the country’s top-performing funds. Its annualised return since inception (from November 2010 to May 2020) is 18.2%, compared to the MSCI World Index’s gain of 11.2% per year.
Its investment philosophy is summed up by three simple but profound investing principles: (1) Buy good companies, (2) Don’t overpay, and (3) Do nothing.
But Fundsmith is quick to point out that though their investment philosophy may sound easy, it is anything but. In fact, Fundsmith says that the most difficult part is following its third principle – doing nothing.
As investors, we are so caught up in the day-to-day commentary about the market that doing nothing to your portfolio is so mentally difficult. One of the reasons why this is so because investors tend to try to avoid pain as much as possible. It’s human nature.
Infants enter the world with a natural instinct to avoid pain. Think of the time you touched a hot surface, and immediately retracted your hand. This is just one example of our bodies reacting to pain.
In his book Thinking Fast and Slow, Daniel Kahneman refers to our instinct of avoiding pain as System 1 thinking, which is the automatic and fast-thinking part of the brain. But this instinct, though very useful in certain situations, can cause us to make very bad decisions in the stock market. Instead, we should force ourselves to think logically and more in-depth when it comes to investing, using the slow, logical thinking part of the brain- what Kahneman terms System 2.
“There are several areas of life where the best strategy is to accept a little pain as the cost of admission. But the natural reaction is to say, “No, no, no. I want no pain, none of it.”
The history of the stock market is that it goes up a lot in the long run but falls often in the short run. The falls are painful, but the gains are amazing. Put up with one and you get the other.
Yet a large portion of the investing industry is devoted to avoiding the falls. They forecast when the next 10% or 20% decline will come and sell in anticipation. They’re wrong virtually every time. But they appeal to investors because asking people to just accept the temporary pain of losing 10% or 20% – maybe more once a decade – is unbearable. The majority of investors I know will tell you that you will perform better over time if you simply endure the pain of declines rather than try to avoid them. Still, they try to avoid them.
The upside when you simply accept and endure the pain from market declines is that future declines don’t hurt as bad. You realize it’s just part of the game.”
Opportunities created
Yet, it is this same aversion to pain that creates opportunities in the stock market. My blogging partner, Ser Jing, wrote in an article of his:
“It makes sense for stocks to be volatile. If stocks went up 8% per year like clockwork without volatility, investors will feel safe, and safety leads to risk-taking. In a world where stocks are guaranteed to give 8% per year, the logical response from investors would be to keep buying them, till the point where stocks simply become too expensive to continue returning 8%, or where the system becomes too fragile with debt to handle shocks.”
In other words, the fact that stocks are so volatile is why stocks can continue to produce the kind of long-term returns it has done. Investors are put off by the volatility, which causes stocks to be frequently priced to offer premium returns.
Final words
Investing in the stock market is never going to be a smooth journey. Even investing legends have endured huge drawdowns that have resulted in their net worth moving up and down. Warren Buffett, himself, has seen billions wiped out from his net worth in a day. Yet, his ability to accept this pain and invest for the long-term makes him able to reap the long-term benefits of investing in stocks.
Morgan Housel perhaps summed it up best when he wrote: “Accepting a little pain has huge benefits. But it’ll always be rare, because it hurts.”
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.
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.
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.
The US benchmark interest rate is back to an all-time low. How should we invest, and what returns can we expect over the long run?
A few months back, the US Federal Reserve slashed its benchmark interest rates to between 0% and 0.25%. The last time it was this low was in late 2008, during the throes of the Great Financial Crisis. Now, with the near-term economic impact of the COVID-19 crisis still unknown, there’s also the possibility that the benchmark interest rate in the US could move into unprecedented negative territory.
This gives us investors a dilemma. In this low rate environment, should we invest in higher-returning but riskier asset classes, or stick to lower-risk but ultra-low-yielding investments?
The search for higher returns
Interest rates are an important determinant in the long-term returns of most asset classes. In a low-interest-rate environment, corporate bonds and treasuries naturally have low yields. Holding cash is an even less attractive proposition, with bank interest rates almost negligible.
In a bid to get higher returns, stocks may be the best option for investors.
How much is enough?
According to Trading Economics, interest rates in the US had averaged at 5.59% from 1971 to 2020. Meanwhile, the S&P 500 returned approximately 9.3% annually during that time. In other words, investors were willing to invest in stocks to make an additional 4% per year more than the risk-free rate.
This makes sense, given that stocks are also more volatile and are considered a riskier asset. Investors, therefore, will require a return-premium to consider investing in stocks.
But interest rates then were much higher than they are today. With the benchmark interest rate in the US now at 0% to 0.25%, what sort of expected returns must the stock market offer to make it an attractive option?
I can’t speak for everyone but considering the options we have, I think that as in the past 50 years, a 4% spread over the risk-free rate makes stocks sufficiently attractive.
The big question
So that naturally leads us to the next question. Can investing in the S&P 500 index at current prices give me a 4% premium over the current risk-free rate.
Sadly, I don’t have the answer to that. The S&P 500 is a basket of 500 stocks that each have their own risk-reward profile. With so many moving parts, it is difficult to quantify how the index will do over the long run. Similarly, other indexes are difficult to predict too.
However, I know that there are individual companies listed in the global stock markets today that could provide an annual expected return of much more than 4% over the risk-free rate.
By carefully building a portfolio out of such stocks, I think investors can navigate safely through the current low-interest environment and still come up with decent returns over the long term.
A few months ago, my blogging partner, Ser Jing, shared his investment framework that helped him build a portfolio of stocks that compounded at a rate that is meaningfully higher than 4% a year (19% to be exact) from October 2010 to May 2020.
Using a sound investment framework, such as his, to build a portfolio may be all you need to navigate through this low-interest-rate climate.
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.
Glove manufacturers have seen their share prices climb to all-time highs in recent months because of Covid-19. Has the market gotten ahead of itself?
The glove manufacturing industry has been one of the few beneficiaries of the Covid-19 outbreak. Share prices of glove manufacturers have skyrocketed in the past few months (some are up more than 100%!) with many of them touching record highs earlier this month.
The share price performance is backed by solid business results as shown by the table below.
Source: Respective company’s earnings results
The four glove manufacturers I’ve studied – Riverstone, Top Glove, Hartalega, and Supermax – have seen sharp increases in revenue. These companies have not only benefited from a rise in sales volumes, but also an increase in the average selling prices of their gloves. The increase in demand has also resulted in their factories operating closer to full capacity, which have resulted in greater economies of scale and fatter margins.
Growth to continue for the next few quarters
Although the spread of Covid-19 is slowing down in parts of the world, demand for rubber gloves is expected to remain high as authorities place greater emphasis on hygiene and prevent a rapid spread of the virus.
In its earnings results for the quarter ended 31 May 2020, Top Glove said:
“The Group’s extraordinary performance was attributed to unparalleled growth in Sales Volume, on the back of the global COVID-19 pandemic. Monthly sales orders went up by some 180%, resulting in long lead times, which went up from 40 days to around 400 days, whereby orders placed now would only be delivered over a year later.
However, Top Glove has endeavoured to allocate capacity to as many countries as possible, to ensure its life-saving gloves reach those most in need, while also prioritising its existing customers. It also accommodated requests from various governments of hard-hit countries who approached the Group directly to procure gloves.”
Will the growth last?
The near-term outlook for glove manufacturers looks distinctly positive but the question is: How long will it last?
Based on comments made by Top Glove, the glove manufacturing industry as a whole probably has a large backlog of orders. This will provide them with steady revenue streams and high margins for the next few quarters. However, what happens after this?
It is likely that this current spike in orders is a one-off occurrence. Some countries are stocking up in case there is a second wave of Covid-19, while others that have yet to feel the full effects of the pandemic are preparing for the worst. But when this blows over, glove demand could fall- maybe not to pre-pandemic levels – but likely below the current unsustainably high levels.
Frothy valuations
As mentioned earlier, glove manufacturers have seen their share prices skyrocket recently.
The table below illustrates the price-to-annualised earnings ratios of the same four glove manufacturers I had mentioned. I used the most recent quarterly earnings to calculate the annualised earnings for these companies.
Source: Author’s calculation using figures from Google Finance
As you can see, each of these companies have an annualised P/E ratio of close to 30 or higher. Although I understand the optimism surrounding glove manufacturers, to me, their share prices have surged to what seems like rich valuations.
There is also the risk that if demand falls, the glove manufacturers will see average selling prices drop to more normal levels leading to lower gross margins.
I also want to point out that part of the expansion in the glove manufacturers’ profit margins was the lower price of butadiene, a key raw material used in the production of nitrile-based gloves. As glove manufacturers have little control over the price of this commodity, there is an additional risk that if butadiene prices return to previous high levels, profit margins will decline.
Final words
The stars seem to have aligned for glove manufacturers. Not only has demand increased, but gross margins have also been boosted by lower raw material prices. It is also likely that the demand for rubber gloves will continue to be high for an extended period of time. And with the large backlog of orders, glove manufacturers will have their hands full for the next few quarters.
However, there are still risks worth noting. Current fat profit margins may not be sustainable over the longer term. When capacity eventually catches up to demand, average selling prices are likely to fall and margins will normalise.
On top of that, the glove manufacturers’ share prices have surged to all-time highs and they are currently sitting on extremely rich valuations. To me, it seems that much of the upcoming profit growth of glove manufacturing companies has already been priced in.
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.
In the stock market, you may find companies trading at less than the cash it owns. But they don’t neccessarily make good investments. Here’s why.
When I first started investing, the “deep value” style of investing resonated with me. This style involves buying shares in a company that is trading at a discount to its net cash. It seemed like a sensible thing to do.
Buying a dollar for less than a dollar sounded like a common-sense approach that couldn’t go wrong.
But the net cash is just one aspect of a company. The company could be burning cash at unsustainable rates and destroying shareholder value. In this case, buying said company below its net cash will still turn out to be a bad investment.
Given this, investing in a company should not be based purely on its net cash but on the future cash flows that the company can generate.
How can a company be worth less than the cash it owns?
This is why I believe that it may even be possible for a company to be worth less than the net cash on its balance sheet.
If a company is burning money every year and management does not make any changes, it will eventually run out of cash. Shareholders will then be left with nothing. In other words, a company with a lot of cash but a terrible business model that does nothing but destroy shareholder value should very reasonably trade less than its net cash. The example below can illustrate my point.
Company ABC has $10 million in cash and no debt. However, it is going to burn cash at a rate of $1 million a year over the next 10 years. How much should this company be worth?
Using the discounted free cash flow method and an 8% discount rate on future cash flows, the company is worth only $3.29 million. That’s a 67% discount to its net cash.
Valuation screens only tell half the story
So how should we apply this to our investment decisions? I think the key takeaway is that we should not base our investment decisions solely on the valuation of a company.
A company may look cheap using traditional valuation metrics, but in reality, it may not be cheap if you take into account the future cash flow of the company.
For example, even the trailing price-to-earnings ratio may not be a good indicator of a company’s cheapness. “Trailing earnings” is a historical figure. John Huber of Saber Capital Management brought up a great point in a recent video interview.
In the past, trailing earnings for many companies were a good guidepost for future earnings. This was why the price-to-earnings multiple was used to value a company.
However, the divergence today between future earnings and past earnings is huge. There are numerous companies being disrupted, while well-run technology companies are building new and rapidly growing markets for themselves. In today’s world, past earnings may not be a good representation of future earnings for many companies anymore.
How to apply this principle?
As investors, our goal is to buy companies at a discount to their real value. But that value can no longer be derived largely from using metrics such as the price-to-book or price-to-trailing earnings ratios. We need to look at the company’s likelihood in generating future free cash flow.
Instead of focusing my energy looking at historical ratios, I try to dig deep into a company’s business, its competitive moat, market opportunity, and the ability of management to grow or at the very least maintain said company’s cash flow. By doing so, I get a better understanding of how much free cash flow a company could generate in the future and the probability it can achieve these projections.
These factors will eventually determine the real value of a company in the long-term, and not its historical earnings nor book value.
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.
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.
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.
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:
Source: Robert Shiller data
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.
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.
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’sgreatest secret in investing.
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, the author, own all the shares mentioned here (except for Spotify). I will be making sell-trades on most of the stocks mentioned here for reasons that are explained in this article.
With the S&P 500 now up year-to-date, is it a good time to short the market?
On 8 June 2020, the US stock market’s NASDAQ index closed at an all-time high, while the S&P 500 showed a profit for the year. There’s a big mismatch between what is going on in the American stock market and economy, so some investors may be asking if now’s a good time to short stocks.
(To short a stock means to invest with the view that its price will fall.)
These are unprecedented times. But before you start shorting stocks, here is a reminder of the risks of shorting.
“The market can remain irrational longer than you can remain solvent”-John Maynard Keynes
I think its important to remind ourselves that shorting a stock can provide an upside gain of 100%, but it has unlimited downside risk.
If you short a stock and it climbs by more than 100%, you would have lost more than 100% of your starting capital. And that may happen more often than you imagine. Hertz, the car rental company that filed for bankruptcy protection last month, has seen its share price climb by more than 600% from its 26 May 2020 low.
Let’s also not forget that even if your short position ultimately ends up correct, you will need to endure stomach-churning volatility. This could cause you to have to put up much more capital – to maintain the short position – in order to earn a small return. In addition, if the stock climbs and you run out of cash to back your position, your broker could force-close your position, leaving you with a loss.
It may also take years for a short position to eventually pay off, giving investors a very small annualised return if the stock does fall.
Professional investors are not immune to huge losses
Bill Ackman’s Herbalife bet comes to mind.
Herbalife is a company that sells nutritional products through a multi-level marketing scheme. In this marketing model, consumers can earn a commission by referring friends to purchase the company’s products.
Ackman believed that Herbalife was so aggressive in recruiting sellers that most of its sales came from people who wanted to earn from the commissions, and not because they wanted to use the products they bought. These “customers” simply bought the products so that they could try to sell them and earn commissions.
Ackman started his short on Herbalife in 2012 and gave a now-infamous 3-hour long presentation in 2014 on why he believes the company is a pyramid scheme. A pyramid scheme is effectively a scheme where only the top of the pyramid gets rich at the expense of those at the bottom of the pyramid.
Although I personally believe that Herbalife’s marketing methods were aggressive and could be labelled as unethical, it wasn’t illegal. Ackman’s Herbalife bet was also made more complicated when billionaire investor Carl Ichan took a long position and snapped up over a quarter of the company’s shares.
First of all, it is extremely difficult for Ackman or the authorities to prove that Herbalife was operating a pyramid scheme as long as there was a product at the end of it all. In this case, even though many Herbalife distributors ended up buying nutritional products that they did nor consume, the company can say it was legitimately selling the products to them.
It may not be an ethical business (in my eyes) but the authorities did not think it was a fraudulent one either. Ackman’s fund, Pershing Square, ended up losing US$1 billion on its short bet on Herbalife.
Short (but painful) squeeze
Short positions may also face sudden spikes in a stock’s price arising from a short squeeze. A short squeeze happens when a stock rises in price, forcing short sellers to close their positions. This, in turn, causes the stock price to rise further, leading to more short sellers being forced to close their positions.
The spike in price can be sudden and swift, and many short sellers will have no choice but to close their positions with a hefty loss.
An example that comes to mind is Tesla’s stock.
Tesla has been one of the most shorted stocks in recent years. However, there have been numerous days when Tesla’s stock has seen a sharp and swift rise in price.
Some of these sharp rises were due to good news coming from the company. But it’s likely that the increases also had contributions from short sellers being forced to close their positions.
Final words
We are living in strange times. The S&P 500 is now showing a positive return so far in 2020, while the NASDAQ is above its pre-COVID-19-crisis level. With many economies still in partial lockdown, investors are wondering why stock prices are not reflecting the current economic contraction.
However, if you are tempted to short the market, it is important to know the risks involved.
Shorting can be a profitable activity, but is also filled with risks. Personally, as a long-term investor, instead of trying to make a little money shorting stocks, I prefer buying quality stocks for the long term where the odds of success are much more heavily stacked in my favour.
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.
Companies that have a great view on how we live, work, spend, and play have recently shared important clues on how a post COVID-19 world could look like.
The title of this article is a topic that I think many investors badly want to know.
I don’t think anyone has a firm answer. But we can get important clues from the comments that some companies have shared in recent times. I’m referring to companies that have a great view on how we live, work, spend, and play.
“As COVID-19 impacts every aspect of our work and life, we have seen two years’ worth of digital transformation in two months. From remote teamwork and learning, to sales and customer service, to critical cloud infrastructure and security, we are working alongside customers every day to help them stay open for business in a world of remote everything. There is both immediate surge demand, and systemic, structural changes across all of our solution areas that will define the way we live and work going forward.”
“Throughout the quarter, we saw consumption continue to increase across the platform and growth of the number of hosts, containers metrics traces and logs, for example, have remained consistent with historical trends.
We started to see some negative effects in impacted industries such as travel, hospitality and airlines. But we’ve also seen substantially increased usage from other categories such as streaming media, gaming, food delivery and collaboration, as these customers scaled up their operations in this environment.
We also saw a surge of usage and surge in accounts in March in response to COVID that we expect could be more transitory in nature and may normalize over time.”
“In the past month, there has been unprecedented demand for our products and services. Our transactions are up 20% year-over-year, with branded transactions up over 43% more than double pre-COVID levels in January and February. On May 1st, we had our largest single day of transactions in our history, larger than last year’s transactions on Black Friday or Cyber Monday.
Our net new actives hit record highs in April, surging over a 140% from January and February levels, averaging approximately 250,000 net new active accounts per day. For the month of April, we added an all-time record of 7.4 million net new customers. I don’t want to lose sight of the fact that we also had a record Q1 adding 10 million net new accounts, but that will pale in comparison to the 15 million to 20 million net new active accounts we anticipate adding in Q2…
… We had a very strong January and February, with FX-neutral revenues growing by an average of 18% and TPV growing at 26%. We began to see some COVID-19 impacts in late February, but the strength of our overall business outweighed cross border weakness coming out of China. However, all that changed as we exited the first week of March.
Shelter-in-place and social distancing became the norm across the globe, and as one economy after another effectively shut down, we saw a substantial revenue decline, predominantly in our travel and ticketing verticals. Some of our important customers, including Uber, Airbnb and Live Nation saw rapid decreases in transaction volumes…
… As I mentioned earlier, we began to see a very noticeable shift in our results toward the end of March and throughout April. We saw dramatic increases in our daily net new actives and overall engagement levels. Our daily number of transactions accelerated throughout the month growing from the beginning of April until month end by 25% with 7.4 million net new actives, record engagement and transaction volumes and 20% revenue growth. I would characterize April is perhaps our strongest month since our IPO.”
“We’ve seen our customers rise to the occasion too. While shelter in place orders have slowed foot traffic to our sellers, they found new ways to keep their doors open, retain staff and serve customers. Retailers, wine shops and QSRs launched online ordering by building websites in less than a day for delivery and curbside pickup. Larger full service restaurants opened community markets to sell raw ingredients, produce and food staples through online stores, even Michelin Star restaurants like Chez Panisse in Berkeley.
Distilleries and taylors shifted to selling personal protective equipment like hand sanitizer and masks. Hairdressers and beauticians moved to video appointments to advise on self-styling. Over the past six weeks we’ve also seen Cash App customers come together like never before. Folks are donating the strangers in need through social media, fundraising for charities, small businesses and churches and tipping artists during online performances…
“While GMV through the point-of-sale (POS) channel declined by 71% between March 13, 2020 and April 24, 2020 relative to the comparable six-week period immediately prior to March 13, as most of Shopify’s Retail merchants suspended their in-store operations, Retail merchants managed to replace 94% of lost POS GMV with online sales over the same period. Retail merchants are adapting quickly to social-distance selling, as 26% of our brick-and-mortar merchants in our English-speaking geographies are now using some form of local in-store/curbside pickup and delivery solution, compared to 2% at the end of February.”
“A great example of this is what we did with the state of Illinois, which was a notable win in the quarter for both workforce and customer identity. With the onset of the pandemic, Illinois needed to ensure it could securely manage its remote workers and secure the identity and access of several state agencies. The state had numerous disparate legacy identity systems across its agencies, which caused friction for its employees, contractors and citizens. Illinois selected Okta to be their identity standard, which will streamline their operations with a single unified identity platform.
With Okta’s customer identity solutions, Illinois’ citizens will have a secure, seamless experience when accessing their government resources. And with Okta’s workforce identity, the state’s employees and contractors will be able to more efficiently do their jobs…
… In just 36 hours, we helped FedEx deploy the Okta Identity Cloud to enable more than 85,000 remote and essential employees to connect to critical applications amid increased demand during the crisis…
… We were one of the first companies to host a large and virtual event, two events if you include our Investor Day. It was an unexpected and challenging task, but both events were incredibly successful, and our customer and investor feedback was amazing. We had nearly 20,000 registrations for Oktane20 Live, which is over 3 times what we had been expecting for the in-person event…
… As we look forward to the rest of this year and beyond, when this crisis is over, we don’t expect organizations to revert to their prior ways of working. We have no doubt that a much higher percentage of workforces will be connecting remotely, and we see that as an inevitable long-term trend.”
“I think if you look at some of the metrics around commerce in North America, I know that e-commerce has been, kind of, trending up from 10%, 11%, 12% over the last few years of total commerce. I think it just jumped to something like 25%, 27% of all commerce. That trend is not going away.”
“Looking at things, a different way, our newly booked room nights, which exclude the impact of cancellations, were down over 60% year-over-year in March and down over 85% in April. This gives you a clear indication of how much our business is currently impacted by this crisis.
That being said, while the virus’ impact on travel is unprecedented, I am confident that this crisis will eventually end and people will travel again. Travel is fundamental to who we are and while it may take some time to return to pre-COVID-19 levels, we will get there eventually. And then we’d expect travel to continue to grow thereafter…
“New bookings revenue for full second quarter may vary from April’s results depending upon the level of travel demand and accommodation availability we experience in May and June. As Glenn noted, we’re seeing some stability on newly booked room night growth trends with the year-on-year decline rate being quite consistent for our April after reducing rapidly through the first quarter. We believe that domestic travel will rebound sooner than international travel as we expect travelers to look to their home country or region first for safe travel option.”
“The effects of the pandemic have been far-reaching and the world is looking to life sciences companies for solution. The industry is less affected financially than many others and remains relatively strong overall, but it is certainly a time of significant change as many of the industry processes become more virtual. Healthcare providers and patients are delaying many non-essential visits and elective procedures. When comparing February to April in the US using Crossix data, doctor visits were down by more than 50%. This is impacting some life sciences companies more than others depending on their product portfolio.
Many clinical trials have been delayed to avoid nonessential patient visits to doctors, in-person visits by sales reps or clinical research associates to doctors have also largely stopped. These changes are causing patients, doctors and the industry to rapidly adopt digital strategy. Necessity is creating innovation. Using Crossix data, we see that telemedicine increased rapidly in the US from less than 1% of doctor visits in February to more than 30% of visits in April. Doctors and patients are getting used to a mix of in-person and digital interactions and are finding it productive.
Using Veeva Pulse data from Veeva CRM, we see that in the US remote meetings between pharma and doctors with CRM Engage are up more than 30 times, and Approved Email communications are up more than 2 times from February to April. Doctors are telling us they find digital meetings effective and they look forward to a mix of in-person and digital interactions once things get back to normal. It’s good to see the healthcare systems and the life sciences industry evolving so rapidly. It was a very busy quarter for Veeva.”
““People, after having been stuck in their homes for a few months, do want to get out of their houses; that’s really, really clear,” Airbnb Inc. Chief Executive Officer Brian Chesky said in an interview. “But they don’t necessarily want to get on an airplane and are not yet comfortable leaving their countries.”
Airbnb saw more nights booked for U.S. listings between May 17 and June 3 than the same period in 2019, and a similar boost in domestic travel globally. The San Francisco-based home-share company is seeing an increase in demand for domestic bookings in countries from Germany to Portugal, South Korea, New Zealand and more. Other companies, including Expedia Group Inc.’s Vrbo and Booking Holdings Inc. are also seeing a jump in domestic vacation-rental reservations…
… International sojourns usually planned months in advance are being replaced with impulsive road trips booked a day before and weekend getaways are turning into weeks-long respites, Chesky said. Previously, a New Yorker might have headed to Paris for a week in June. Now they are going to the Catskills for a month. “Work from home is becoming working from any home,” he said.”
“Especially, from January 20, 2020 until February 20, 2020, local governments issued strict control measures… Shortly after February 20, 2020, when orderly resumption of work took place across the country, an increasing number of restaurants started to resume their operations while demand from consumers also gradually recovered. However, as some of consumer demand continued to be negatively impacted by hygiene concerns and quarantine measures, the ongoing closure of universities, and work-from-home policies that applied to many of our high frequency consumers, the order volume still had not fully recovered to its normal levels by the end of March 2020…
… In spite of the short-term negative impacts, we strongly believe that the COVID-19 pandemic will play a positive role in the industry’s long-term development. On the consumer side, the pandemic has further accelerated the cultivation of consumption behavior, helping to further educate some of our targeted potential consumers in a positive way… Notably, we have seen increasing consumer preference for high ticket size categories during the pandemic due to the increasing adoption of food delivery for formal meals, further diversification of high-quality supplies on our platform and growing preference for branded restaurants…
… On the merchant side, the overall catering industry was severely disrupted in the first quarter of 2020… More notably, the pandemic has further accelerated the digitization process, especially for many branded restaurants with high quality supply, which have traditionally focused on in-store dining instead of delivery services. In the first quarter of 2020, a large number of premium restaurants, highly-rated restaurants, chain restaurants, Black Pearl restaurants and five-star hotel restaurants, which did not have or had very limited food delivery services, initiated food delivery operations as their primary vehicle for business operations due to the pandemic. Participation by these restaurants increased high-quality supply on our platform in the long term, while we reinforced our importance to small- and medium-sized independent restaurants as food delivery almost became their sole source of income during the pandemic.
On the delivery front, although delivery capacity was not the bottleneck for our food delivery business during the pandemic, delivery cost per order increased both on a quarter-over-quarter basis and a year-over-year basis as a result of the increased incentives paid to delivery riders working during Chinese New Year and pandemic situations, additional costs associated with anti-epidemic measures, and the decline in order density. However, the pandemic has accelerated the adoption of new delivery models and stimulated technological innovation. As a leader and promoter of on-demand delivery, we pioneered the launch of contactless delivery services, which received widespread acceptance and recognition from consumers, merchants and local governments. In addition to helping to mitigate the hygiene risks for both consumers and delivery riders, the contactless delivery model improves delivery efficiency and creates more opportunities for the exploration of diversified delivery models and new technology for autonomous delivery…
… During the pandemic, our in-store business was more severely challenged in comparison to the food delivery segment, and its recovery was noticeably lagging behind that of the food delivery segment. As the majority of the in-store service categories are classified as discretionary or entertainment-related services, which usually involve close contact with others and/or large crowds, both supply and demand remained low in the first quarter of 2020 due to consumers’ hygiene concerns and local governments’ restrictions…
… As the leading platform in local services, we began to work with local governments in March 2020 to launch the Safe-Consumption Festival and issued vouchers to consumers to use in local services, especially in restaurant dining, which sustained the most impact during the pandemic. We believe that consumer vouchers could not only stimulate one-off consumptions, but also have strong leverage effects that stimulate the recovery of the overall consumption demand in relevant regions and industries….
… While local accommodation and business travel activities, especially in lower-tier cities, have started to gradually rebound at a faster pace along with the general recovery process, consumers were still taking conservative measures and postponing travel-related activities and expenditures even after the peak of the pandemic. To further support industry recovery, we leveraged our platform capabilities and launched the Safe-Stay Program. Under the Safe-Stay Program, we established precautionary measures and increased service capabilities for our partner hotels, such as the adoption of strict health precautions for all employees and consumers, close tracking of consumer information, free booking cancelations, and discounts for additional nights.”
“We engaged a new public sector customer, the Department of Labor in one of the largest U.S. states to help transform its previously complex and lengthy process for handling emergency unemployment benefit. Supported by DocuSign eSignature, the department distributed over $500 million in benefits to more than 500,000 residents in less than one week. We enabled hundreds of U.S. national and regional financial institutions to accept applications for Small Business Administration loans more efficiently. In one of those large banks, we were involved with over 0.5 million loan applications, 75% of which were signed in less than 24 hours.
We worked with a regional telecom provider using DocuSign Intelligent Insights, which is our contract analytics tool to analyze potential pandemic-related risks in thousands of their supplier contracts. Finally we helped a European telemedicine provider issue e-prescriptions and online sick leave certificates by using our video identification capability to confirm the patients’ identities…
… Some of the healthcare opportunities were big. If you think about the situation where you’re trying to — you’re now trying to do COVID-19 testing and you’ve never been an organization that did that kind of testing before, and now you say, “I got to figure out a way to get people’s information and get them to fill out forms, Oh! but I don’t want to touch them, I don’t want to touch anything they’ve touched, I also need a digital solution for doing that.” And we had sales cycles that happened in that in a matter of days, where people came to us, explained that business need that they had, or that healthcare need that they had and we were able to get up and running that use case.”
“As you can imagine, customers in the hospitality and travel have exhibited very unusual patterns during this period. First, there were spikes in volume as airlines and hotels dealt with rebookings and canceled flights during the transition from pre-COVID-19 into travel restrictions and shelter-in-place protocols. Then, there was a sharp decline as business slowed. Another example is that ridesharing saw a large decline during this time, with offsets in many cases by sharp increases in demand for food delivery, curbside pickup and retail logistics. In addition, telehealth and work-from-home contact centers saw a pickup of adoption during this time.
While we are cautiously optimistic, no one can predict what exactly will transpire in the back half of the year given the uncertainty of the macroeconomic environment…
… We’ve seen companies across multiple industries adapt in real time due to COVID-19. Digital transformation projects that could have taken years such as transitioning from an on-trend contact center to the cloud instead took a weekend. Developers and companies big and small got to work, reconfiguring the world for a work-from-home and nearly 100% e-commerce reality.
Let me give you just a few use cases across various industries that we’ve helped our customers win over the last couple of months. With shelter-in-place and social distancing going into effect, demand for telehealth solutions has soared. Virtual care became a new reality for doctors, nurses, clinicians and millions of patients around the world. And Epic, the company that supports the comprehensive health records of 250 million people, mobilized to build its own telehealth platform powered by Twilio’s programmable video. The solution allows providers to launch a video visit with a patient, review relevant patient history and update clinical documentation directly within Epic.”
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.
