Category: Investing Analysis

I’ve read about the investment firm First Eagle Investments and its legendary portfolio manager, Jean-Marie Eveillard, many years ago. But I was not familiar with Matthew McLennan, currently an important leader in First Eagle’s stock market investment team, until I came across his interview with William Green for the Richer, Happier, Wiser podcast series on The Investor’s Podcast Network.

During their nearly two-hour conversation, McLennan and Green covered plenty of high–quality ground and I had many takeaways that I wish to share. Here goes!

Using gardening as an analogy for the importance of having a long-term mindset in stock market investing

McLennan: I mentioned that my grandfather was a gardener and he passed that skill on to my mother and this little home that we built, she was an ardent gardener in this home. As a child, I always wondered why she went to the effort because there was always some issue. There were drought conditions or the bamboo root would spread to somewhere where it wasn’t meant to be or there was some weird fungus or virus. She was always having troubles.

Whereas, there’s a gentleman who lived next to us who mow his lawn every week and it just looked pristine and clean. We had another house behind us at the bottom of the rainforest where he just lived amidst the rainforest. I didn’t realized the wisdom of my mother’s long-term strategy when I came back to the house some 20 years later with children, my children. The garden had really grown into this resplendent beautiful space. It had been selectively curated over time. Whereas, the house next to me was still being mowed. The lawn was still being mowed every week. But there was nothing to show for all of this activity. He was like the active manager turning over the portfolio once a week.

The gentleman who’d had his house down the hill behind us had some fire damage I heard at some point. The passive strategy of just letting the forest go around you wasn’t necessarily the safe strategy my mother had worked in all of these fire buffers and things. Selectively curating something and letting time take its course is something that doesn’t seem like a very well-rewarded activity in the short term. When you step back and let time play out, it can be very rewarding.

The scientific principle of entropy is a useful framework for thinking about the longevity of companies

McLennan: Entropy is probably one of the few absolute truths. It’s a second law of the thermodynamics that any form of order is essentially transient. And perhaps it’s the fight against entropy that’s sort of gotten me interested in old master art or great wine that can survive for generations, from vineyards that have been planted for generations, or a business that has a slow fade rate relative to the typical business.

But if you think about the economy as an ecosystem, rather than as machine, productivity happens every year, productivity growth, and over the last century, we’ve grown productivity close to 2% a year. But the dark symmetry of productivity is that the existing pool of companies won’t control a future profit pool in perpetuity. New businesses get created that chip away at the margins at existing incumbency. And so entropy is a fundamental principle and investing. And when you go through business school and learn about asset pricing, you’re really only taught to think about beta risk or systemic risk. But idiosyncratic risk is interesting to think about as well.

And in fact, entropy is a form of systemic risk because change in the economy and the overall improvement in the economy imputes that existing companies will grab a smaller share of the future pie given enough time. And so I’ve focused a lot on this question. And the paradox of it is that buying businesses that have been around for a long period of time, that have demonstrated persistence, in some ways, can be a safer strategy than trying to buy a business that’s growing a lot today because many of the businesses that are growing a lot today are in industry verticals where market share positions move around a lot. And so by definition, your ability to capitalize their terminal earnings at any given period of time is low because easy come, easy go, as it would relate to market share shifts.

And so we do like to try and focus on businesses that have a stickiness to their market share over time, high customer retention rates, to try and slow the curve of entropy. And we approach it with a great deal of humility and respect, and we recognize that even our favorite ideas are going to get disrupted at some point or another.

Digital wealth could co-exist with financial assets

McLennan: Most wealth before the industrial revolution was stored in real assets, land, art, precious metals, livestock. And then we created all these financial assets which were essentially the crypto of the time. They were virtual claims. The original companies were beneficial claims of trusts on underlying assets. And so this was kind of arcane and abstract at the time, but financial assets came to coexist alongside real assets. They didn’t disrupt totally, they coexisted.

And if digital assets are another concentric circle around financial assets and real assets, it doesn’t mean that real assets will disappear and it doesn’t mean that all financial assets will disappear. I think what we’re going to see is the emergent coexistence.

Emerging economies often don’t “emerge”; the problems with China’s economy today

McLennan: Well, it’s not clear to me that China will become, and even if it does sustain its position as the world’s largest economy. And I think a lot of people are presuming that will happen, but it’s not clear to me that happens. I think one of the things that’s interesting is if you look at a list of emerging markets and of 50 years ago and look at a list today, very few emerging markets actually emerge.

And there’s a whole host of reasons for this and there’s, in fact, there was an interesting book on this called Why Nations Fail by Robinson and I think Acemoglu MIT economist. And one of the tells of a country that’s managed to sort of grow and benefit from capitalism and the spread of property rights and all those sorts of things. There’s an inherent pluralism and a political process that gives voice to multiple constituencies. And historically at least if you haven’t had that, it’s been difficult to sustain growth to develop market levels. And ultimately if you have some form of authoritarian regime, it’s impeding to the very notion of creative destruction because if there’s a rent seeking regime, it has to retard at some point in time, creative destruction to preserve its own existence.

And so I think if you were to ask if Hayek still lived and you were to ask him, will China become and sustain its position as the world’s largest economy? I think he’d be very weary of making that prediction. And so I think that China is set with quite a few problems right now despite the fact that there are opportunities, this self-inflicted wound with the COVID policy response and the lockdowns. There is dramatic adjustment going on in the real estate sector and that market is very overbuilt. And they had a clamp down on the entrepreneurial class and which has really led to sort a derating of that sector.

Through a study of history, there’s a risk of China and the USA coming into conflict

Green: And you seem pretty concerned as a fan of Thucydides and his views on history, you seem pretty concerned about some kind of mounting inevitability to a conflict between the US and China sort of echoing the Spartan Athenian kind of conflict that we saw thousands of years ago.

McLennan: Well I think if you read Thucydides what’s compelling about it is that it was written before 400 BC and a lot’s changed since then. Obviously technology is dramatically different today from what it was back then. On the other hand, human behavior and human wiring hasn’t changed that much. And I get the analyst on our team to read the book because it shows you the common mistakes that people make. Hubris, dogma, acting with haste. And I use that as a template to get people to think about doing the opposite with their temperament, having humility to accept uncertainty, being a patient investor, being flexible, not dogmatic about just investing in one particular part of the world or one particular industry. 

And so I think there’s a lot we can learn from Thucydides and I think what he showed us is that the fear of war is often the cause of war, and especially when you have two competing regimes. And I certainly hope we don’t see that emerge, but Nancy Pelosi’s visit to Taiwan and the response is clearly flashing some warning signs here that I think we can’t ignore in totality.

How to improve your thinking

McLennan: So I think the first thing is you have to create time to reflect. And it’s easier said than done. We all have busy schedules. We could all spend all of our time doing a subset of our jobs. And so first you just have to, in the mental hierarchy of things, acknowledge that some time spent on reflection is important. And in fact, as I think about it, what, if I were a client? What would I want Matt or any of the team members to be spending their time on? And I’d want them to be spending some meaningful amount of their time on reflection so that they’re seeing the world through a different prism.

The second thing is that it doesn’t happen linearly. Even though I try to religiously schedule some time for reflection on certain days of the week or certain times of the day, reality intervenes frequently. And so you have to squeeze it in while you can but, and it’s not even linear in that context.

So I might go through some years where I’m reading voraciously, I read many books in a year. And then I go through other years where I get into four or five books but I don’t complete any. And I’m actually spending most of my time to your point before raking the zen garden, and trying to order my thoughts. And I do keep many notes that essential attempts to sort distill what I’ve learned from different works and tying it together in a philosophy that makes sense. And sometimes I’ll wake up at five o’clock in the morning and I’ll just spend two hours trying to refine one element of a mental model. And so part of it is creating time to absorb new ideas, many of which have come from great people that you never got the chance to meet, but you can at least read their books.

And the other part that’s equally important is to synthesize. And it’s the same notion if you’re going to visit a company that you, you’re going to Tokyo and visiting a bunch of companies, you have to spend the time preparing for it and the time to make sense of what you’ve learned after the fact. And so it’s not enough just to read a lot. You have to try and think about it and distill it and it’s both of those things.

And then sometimes you just get stuck. You feel like you’re not necessarily making a leap forward in your understanding. I don’t know if you’ve gone through the process of learning another language, often it feels like you get this window of stasis and then all of a sudden in a non-linear way you take a stair step function up and you’re seeing things in a new light.

And so I think often when you’re feeling stuck, it makes sense to do something different, to travel somewhere, to do something physical. I like to play backgammon against the computer from time to time and sometimes it takes doing something different. A friend of mine, Josh Waskin said sometimes the ember needs to withdraw before the flame comes back up. And so I think it’s a combination of all those things, prioritization of reflection, realizing that it’s not just about reading but equal measure must be spent to synthesis and making sense. And then the final thing, recognizing that it’s a kind of step function process where you need time to step outside.

And Lord Dening, one of the great English judges said, “Let not our vision be clouded by the dust of the arena”. Sometimes you’re just too much in the thick of something to make sense of it all and sometimes you’ve got to leave the snow globe, let it settle and then come back. And so those are the ways I try to do it and it feels rather imperfect. I’ve been at this for decades now and I feel like I’m just beginning and I feel like I’m so far behind in so many dimensions that it’s humbling.

How to deal with living in a world of complexity

McLennan: If we go back to Wolfram and complexity theory, something that was just a blinding revelation to me when I read that his book, A New Kind of Science was that he was studying deterministic systems. So what I mean by that, think of an Excel spreadsheet where a cell could be different colors based on the behavior of cells around it, but there’s an underlying formula. And he did thousands and thousands of simulations of what the patterns would be for different formulas.

And what he found was really interesting, which was that only a small fraction of the formulas produced linearity. And most of science is built on regression and looking for linear relationships, but this is the minority of reality. And then there was a bigger subset but still small where there was some sort of nested cyclicality to the patent but not a hundred percent neat.

So I think the business cycle, we know it, there’s an ebb and flow, but we can’t call it precisely. And then the vast majority of the patents of these cellular automata in these spreadsheets were effect, They looked like they were random but they were driven by a given formula. And what’s interesting is if something as linear, you can predict it in the future with a small number of observations. If something has a nested cyclicality with more observations, you can kind of predict the skew in it, but not necessarily exactly where it will be.

But if something’s truly complex, it would take you more observations than actually exist in reality playing out to backwards induce the formula. And he came up with this notion of the computational irreducibility that basically, even though there’s a formula behind the patent, it’s effectively random unless the formula because it would take you more steps to observe it than to figure it out. And so the reason I mentioned this upfront is that number one, there’s a realization that there’s a lot that we can’t know unless you actually know. 

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 don’t have a vested interest in any company mentioned. Holdings are subject to change at any time.

Tencent released its 2022 second-quarter results last week and the headlines sounded pretty dire.

“Tencent woes mount even after US$560b selloff” – The Business Times

“Tencent’s workforce shrinks for first time in nearly a decade” – Bloomberg

“Tencent, the $370 billion Chinese tech giant, posts first ever revenue decline” – CNBC

If you’re just reading these headlines in isolation, you might think that Tencent is in dire straits. But that’s really not the case. On closer inspection, I think there a number of positives to take away from Tencent’s latest results.

Revenue growth will probably return after China’s lockdowns ease

Tencent’s revenue was down 3% to US$20 billion in the second quarter of 2022. This was the first time Tencent reported a decline in revenue but this shouldn’t have been a surprise. Most of Tencent’s revenue is derived in China and in the bulk of the second quarter of 2022, parts of China were still in COVID lockdowns.

There’s a common misconception that as an internet services company, Tencent will not be impacted by lockdowns. But this is far from the truth.
One of Tencent’s biggest revenue and profit drivers is its payments ecosystem, otherwise known as its Fintech segment. This is highly dependent on commercial activity and also includes offline payments. During lockdowns and when China’s economy is weak, this segment of Tencent’s business suffers. Conversely, when the economy reopens, the growth of Tencent’s payment business should start to reaccelerate. 

Tencent also has a huge advertising business. When the economy stalls, advertisers cut back on marketing spending. In the second quarter of 2022, Tencent’s advertising revenue declined by 17%. Again, this should reverse when China’s economy improves.

Margins will get better

Tencent’s operating profit declined 14% during the quarter to US$5.5 billion, excluding exceptional items. Although this may seem alarming on the surface, there are signs that Tencent’s margin will climb in the future.

The company has been actively cutting costs and improving efficiency. In the second quarter of 2022, Tencent’s sales and marketing expenses dropped by around US$300 million. There were other cost-cutting initiatives, such as right-sizing the number of employees, stopping loss-making businesses, outsourcing unprofitable projects, optimising server utilisation, and exercising more prudence with content production in Tencent’s long-form content segment.

All of these cost-saving initiatives should lead to better margins for Tencent from the next quarter onwards.

Management is also confident about its Gaming business

Tencent’s revenues from both the domestic and international games segments were flat. The domestic games business was hampered by regulatory restrictions. For international games, the challenge came from the reopening of economies worldwide. 

On the domestic front, the regulatory environment is starting to improve as there has been a resumption of the issuance of licenses for new games. In June this year, it was reported that China had issued 60 licenses to new titles, which is positive news for game developers such as Tencent.

In addition, Tencent’s current gaming franchises still have highly-engaged audiences, with engagement numbers for both domestic and international games being relatively high. 

Tencent’s capabilities in digital gaming gives management confidence that the company is well positioned for growth once the challenging environment laps.

Share buybacks good for shareholders

Besides a likely turnaround in its business, Tencent has been using its capital to buy back shares. I think this is a value-accretive initiative given the fact that Tencent’s shares are relatively cheap compared to the value of its business and the potential free cash flow it could generate.

For perspective, Tencent has a market cap of around US$370 billion now. Its investments in public and private companies are worth around US$150 billion. This means the rest of Tencent’s business has a value of around US$220 billion, which is merely 12 times that of Tencent’s annualised operating profit for the second quarter of 2022. With Tencent’s operating profit likely to improve from here, the stock looks undervalued.

But don’t just take my word for it. Tencent’s own management has said its shares are very undervalued. In the latest earnings conference call, Martin Lau, Tencent’s president, said:

“We are very focused on returning capital to shareholders given we believe our share price is very undervalued and also undervalued in the context of our investment portfolio. So if you look at what we’ve done year-to-date, we’ve returned around $17 billion, $18 billion to Tencent shareholders. And we’ve been largely neutral in terms of our investments, divestments in other companies, excluding the substantial JD divestiture. So our focus from a sort of investments perspective has been buying back and dividending to our own stock, and that will likely remain the case going forward for some period of time. “

Bottom line

Headlines don’t always paint the full picture. In Tencent’s case, while the headlines conveyed a story of a company in dire straits, Tencent’s business is actually in a strong position to return to growth. The operating climate is challenging but Tencent’s core businesses remain in a good position.

Its shares are also priced at a low valuation, giving management the perfect opportunity to buy back shares and reduce its share count. This should be a long-term benefit to patient shareholders. 

Based on today’s valuation, I think patient shareholders who are willing to hold shares for the long-term will likely be well-rewarded in the future.

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 Tencent. Holdings are subject to change at any time.

We know that investing in high-growth companies can be very rewarding. But there are more ways to make money than investing in growing companies.

A classic example

A great example of a company that has not grown but has still given shareholders sizeable returns is Vicom .

Vicom is a vehicle inspection company based in Singapore. It is mandated by Singapore laws that all cars in the country have to undergo an inspection either annually or once every few years depending on the age of the car. A majority of the vehicle inspection centres in Singapore are run by Vicom, giving the company close to a 75% market share in the sector.

However, because of its relatively high market share, Vicom has limited opportunities to grow. Moreover, in recent years, the Singapore government has targeted zero vehicle growth on the roads to reduce congestion. This has limited the expansion in the addressable market for vehicle inspection in Singapore.

I also suspect that Vicom’s inspection business is regulated by the government, which limits the company’s ability to increase its prices too aggressively.

Because of these reasons, Vicom’s business has been stable but growth has been non-existent. The table below shows Vicom’s revenue and profit since 2012.

The company’s revenue and profit have barely budged for a decade. Yet shareholders who bought Vicom’s shares in 2012 have made a healthy profit.

A decade ago, the company’s share price was S$1.13. Today, they are norht of S$2. As such, Vicom’s shareholders have enjoyed capital appreciation of 82%. In addition, shareholders have collected a total of S$0.751 per share in dividends, which translates to a 66% yield based on the S$1.13 share price.

What’s the catch?

Shareholders who held on to Vicom’s shares for the past 10 years had earned a total return of 148%. And that’s even excluding any potential returns from reinvested dividends.

So why were shareholders so well-compensated despite Vicom not growing in the past decade?

Firstly, Vicom’s shares were trading at a low price a decade ago. At that price, investors could scoop up shares relatively cheaply and earn a decent return simply by collecting dividends.

Secondly, Vicom’s management decided to reward shareholders by paying a much higher dividend per share over time. Vicom had accumulated large amounts of cash on its balance sheet over the years and had little use for it. You can see this play out over the years as Vicom’s dividend payout ratio rose and exceeded 100% in four of the last five years. Management’s decision to pay shareholders a larger dividend caused Vicom’s share price to appreciate as investors were willing to pay a higher price given the higher dividends.

From this, we can see that when investing in no-growth companies, shareholders need to buy at a low valuation and hope for a rerating in the share price to make a capital gain. Oftentimes, a catalyst needs to occur for the share price to appreciate. In Vicom’s case, an important catalyst was management’s change in stance toward its dividend payout ratio.

If you buy Vicom’s shares today, it is unlikely that its share price will appreciate at the rate it did in the past, given the already high valuation of the shares today and the limited opportunity for further dividend growth given the already-high payout ratio.

What to look out for when investing in no-growth companies

Investing in companies that are not growing can still be rewarding. But it is important to know that not all no-growth companies will perform as Vicom did.

When looking at slow-or-no-growth companies, one of the main things to look out for is a low share price. If a company is trading at an unreasonably low multiple, even if its earnings don’t grow, the share price can still appreciate over time.

Next, when investing in slow-or-no-growth companies, it is important to look at the company’s cash position and dividend payout ratio. A company that has more than sufficient cash on its balance sheet is likely to eventually decide to pay that excess cash out as dividends. This provides shareholders with more dividends and can be a catalyst for a re-rating of the share price.

Third, look for a business that is resilient. Vicom’s business has not grown in a decade, but its revenue has not declined either.

If you invest in a company whose profits are declining, the valuation multiple might compress further and what may seem like a value stock will end up as a value trap. On top of that, if profits are declining, management will probably not increase its dividend payout ratio in a bid to use its cash to reaccelerate growth, oftentimes ineffectively.

Lastly, because dividends are a major source of returns when investing in a slow-or-no-growth company, it is important to find companies that are domiciled in places where there is no withholding tax on dividends. For example, if you’re a Singaporean investor, you should not have to pay tax on your dividends. But if you invest in US stocks, there is a 30% tax. As such, it is best to stay away from such companies in the US.

The bottom line

There are many ways to invest in stocks. Although I prefer to pay a higher multiple to invest in growing companies, other investors may prefer to buy no-or-slow-growth companies at a low multiple and wait for valuation re-ratings and/or to collect dividends.

Whichever method you prefer, the main thing is to find a style that you are comfortable with and suits your investing appetite.

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

There’s been plenty of discussion among market participants and business executives over the past few months on the uncertainties confronting the US economy, and how the businesses from various industries in the country will perform in an uncertain economic environment.

For companies that are focused on providing software and/or digital infrastructure, their businesses may continue to shine regardless of the macroeconomic uncertainties thrown their way. I say this based on comments – see below – shared by the leaders of these companies during their latest earnings conference calls that took place over the past two months. There was no specific reason why these companies were chosen, other than me having a vested interest in them.

Adobe (17 June 2022)

I think the other part of the conversation that you all have with enterprise CEOs right now is they all recognize it’s an uncertain time, and that’s the conversation that we have. But despite that uncertain macroeconomic environment, the thing that all of them recognize is that digital is a priority. And they really want to continue to have conversations with us as to how they can do digital. I’ll have Anil maybe add a little bit of what he’s seeing across different verticals as well. But the importance of digital remains undiminished.

Amazon (29 April 2022)

So yes, I mean, we’re continuing to see what the backlog is, right? It’s the increase of AWS [Amazon Web Services] customers making long-term commitments for AWS. At the March period ended, we had $88.9 billion balance for that. So that’s up about 68% year-over-year. And the weighted average remaining kind of life term for those is 3.8 years.

Datadog (5 May 2022)

We believe that digital and cloud projects are still very high priority and are not being de-prioritized, we haven’t seen that. We think we’re still early on. So, with the data we have so far, we think there will be continued strong investment. There is always some volatility across our customer base. Our customer base is very well diversified across industries and we benefited from that over time. So, whereas we’re not macro forecasters and there may well be some sensitivity, we believe the long-term trends in digital migration and cloud will also be very strong throughout that cycle.

Microsoft (27 April 2022)

The second thing is in the conversations we are having with our customers, the interesting thing I find from perhaps even past challenges, whether macro or micro, is I don’t hear of businesses looking to their IT budgets or digital transformation projects as the place for cuts. If anything, some of these projects are the way they’re going to accelerate their transformation or, for that matter, automation, for example. I have not seen this level of demand for automation technology to improve productivity because in an inflationary environment, the only deflationary force is software. So that’s the second micro thing, the tone thing that’s different.

MongoDB (2 June 2022)

That being said, we understand that there is heightened focus on the macroeconomic outlook because of geopolitical tensions, inflationary pressures and the risks of a slowing global economy. Since macro-related questions are dominating investor conversations, it makes sense to share with you what we are seeing as well as to discuss our framework on how we plan to manage through this macro uncertainty. Starting with what we’re seeing in the market. First quarter was a robust quarter for new business. Driving innovation remains a top priority for our customers, and they’re investing in modern technologies to facilitate this. We had strong engagement with the C-suite, and our deal cycles were in line with normal patterns. The tone of our quarterly business review meetings at the start of the second quarter was that of confidence. Our sales force indicated that our message is resonating in the marketplace, and they remain bullish about the opportunities to win new business.

Salesforce (1 June 2022)

And so far, we’re just not seeing any material impact from the broader economic world that all of you are in. Our demand environment where demand is very strong, and if you look over the last 23 years, Salesforce has proven to be incredibly resilient based on this incredible business model. We have an incredible technology model that we have, where we’ve been through all kinds of dot-com crashes and recessions and financial crises and global pandemics and all of you have watched us go through every possible storm, but we continue to weather these storms through the power and strength of our model.

Veeva Systems (2 June 2022)

This is really a long-term thinking move by the customer. They’re thinking of this in 10- and 20-year horizon, so they wouldn’t be really fazed by specifics of the macro environment. So this is about, yes, applications in the clinical area but also in the quality and the regulatory area, not all of our Development Cloud but a big portion of it. So when they’re doing that, it’s a very top-down decision. It’s like building a huge factory. That’s why it’s not affected by the macro environment. And then if you get it, what they’re trying to do, it’s laying the foundation for efficiency, digital efficiency, getting drugs to market faster to help patients. So it’s a long-term play by the customer and sort of executive-level decision.

Twilio (5 May 2022)

I think, obviously, if like the economy were to dip into like some sort of significant recession, we’re not necessarily immune from that. But what we see based on both our internal studies, and we alluded to the customer engagement report as well as a number of external studies, is that digital transformation remains a top boardroom priority. That obviously benefits Twilio as a variety of companies look to invest in their engagement strategies going forward. And we’re not — it’s not like we don’t see the macro environment, whether it’s economic or geopolitical, but we just think this business is extremely well positioned to capitalize on ongoing companies’ digital transformation efforts.

Zoom Video Communications (24 May 2022)

[Question:] I’m wondering, have you seen any paring back or moderation of investment from some customers in light of growing macro concerns? And if so, has it varied by either geography or customer size?

[Answer:] I mean we really have it — especially in enterprise, we have continued to see strength in renewals as well as additional new customers and expansion into additional products. So we really haven’t seen that in terms of concern. I think we’ve heard from other people that what they’re really focused on might be — if they’re limiting spending, it’s focused more around potentially hiring or travel. And of course, Zoom is a great alternative if they’re focusing on limiting internal travel. And so we really haven’t seen that impact today.

Final thoughts

One underlying theme among the comments seen above is that companies continue to invest in their digital transformations, and they are doing so despite the uncertainties that abound, such as the risk of a recession in the USA. This is a tailwind for businesses that are providing the tools for organisations to embrace the digital world. 

The economic news coming out of the USA has been bleak of late. Only time can tell if technology companies are able to grow their businesses even in the face of a weak economic environment. At the very least, their managers are confident.

It’s worth noting too that there’s at least one precedent of a software company posting admirable growth rates even when the economy was weak. This happened during the Great Financial Crisis of 2008/09, when the USA’s real GDP fell by 4.3% from a peak in the fourth quarter of 2007 to a bottom in the second quarter of 2009. The unemployment rate also rose from 5% in December 2007 to 10% in October 2009. While the US economy was in trouble, Salesforce’s revenue grew by 51% in 2007, 44% in 2008, and 21% in 2009. Salesforce provides customer relationship management software over the cloud and it was able to grow rapidly during the financial crisis because its software was better than incumbent solutions.

If software and digital infrastructure companies today are able to provide better solutions for their customers than what they’re currently using, they could continue to grow even if the economy worsens from here, just like what happened to Salesforce a dozen years ago. But even if they struggle to grow in the near term, the long run picture still looks healthy. According to Microsoft’s CEO Satya Nadella, around 5% of global GDP is currently spent on technology. It’s hard for me to imagine this percentage going down in the years ahead – what do you think?

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

Warren Buffett once said: “If you’re making a good investment in a security, it shouldn’t bother you if they closed down the stock market for five years.”

With the US stock market in a bear market, these words ring louder than ever. But, I would go even further and suggest that the truly long-term investor shouldn’t bother even if the stock market closed forever. Yes, you heard that right- forever.

Even if we are never able to sell our shares, a truly good investment (bought at the right price) should still pay off over time as companies pay their shareholders dividends.

For example, let’s say you bought shares of the Singapore-listed hospitals owner Parkway Life REIT back in 2007 at its offering price of S$1.28 per share. After you made your investment, the Singapore stock market completely closed down and you were left holding on to your shares with no way to sell them. Since then, you would have collected a total of $1.46 per unit in dividends (technically, a REIT’s dividends are called distributions, but let’s not split hairs here).

Today, even if you are not able to sell your shares, you would still have more than made up for your investment and continue to be entitled to future dividends.

This is the goal of the long-term investor. I do not hope to simply sell off an asset at a higher price to a higher bidder; instead, I’m comfortable holding the asset for its cash flow.

But what if your stock doesn’t pay a dividend now? The same concept should still apply. This is because companies may be in different phases of their life cycle. A growing company may not pay a dividend when it’s growing rapidly. But after some time when excess cash builds up in its coffers over time, it can start paying that cash to patient shareholders.

If the stock market closed down forever, patient shareholders of these “non-dividend-paying” companies will still ultimately start receiving dividends, which ideally should eventually exceed what they paid for the shares. 

However, not all investments pay off. Some investors may have paid too much for a stake in a company. And some high-growth companies that may look promising may never generate enough cash to reward shareholders.

In times like these, I think of another quote from Buffett: “It’s only when the tide goes out that you learn who has been swimming naked.”

In today’s market, investors who only bought a stock hoping to sell it to a “greater fool” at a higher price with no actual cash flow fundamentals behind the stock are unlikely to make back their capital.

Whenever I invest in a stock, I always think about how much cash flow it can potentially generate and whether I can make back what I paid for it simply by collecting the cash flow that I am entitled to over the years. This way, I will never be bothered about dips in share prices as I know I will eventually get more than paid off even if no one offers to buy the shares in the future.

So do you own productive assets you are happy to own forever?

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

Two weeks ago, I was told that my relative had invested in Singapore Post’s (SGX: S08) recently issued perpetual securities.

I thought it would be helpful for my relative if I shared a factual breakdown of the numbers. I also figured that my sharing could be done on The Good Investors to benefit any reader who happens to have invested in or are interested in the same perpetual securities. Before I start, it’s important to note that some key details of the perpetual securities are complex, and I cannot guarantee that my understanding of them is correct. But I think I’m still able to give a good rundown of what’s happening. Here goes!

1) Total sum raised by Singapore Post: S$250 million, excluding any relevant fees

2) Distribution to be paid by Singapore Post for the perpetual securities: There are different distribution rates that Singapore Post will be paying, depending on the time frame:

• There are three time frames. The First Time Frame is from 6 April 2022 to 6 July 2027; the Second Time Frame is from 6 July 2027 to 6 July 2047; and the Third Time Frame refers to 6 July 2047 and beyond.
• For the First Time Frame, Singapore Post will be paying a distribution rate of 4.35% per year.
• For the Second Time Frame, there are a series of Reset Dates, with 6 July 2027 termed the First Reset Date. Each subsequent Reset Date occurs in five-year intervals from 6 July 2027. From 6 July 2027 to the Second Reset Date, Singapore Post will be paying a distribution rate of 2.183% per year, plus 0.25% per year, plus the 5-year SORA-OIS that is seen on 6 July 2027. From the Second Reset Date to the Third Reset Date, Singapore Post will be paying a distribution rate that works out to 2.183% per year, plus 0.25% per year, plus the 5-year SORA-OIS that is seen on the Second Reset Date. For subsequent Reset Dates, the same dynamic for the distribution rate applies. The acronym “SORA-OIS” stands for the Singapore Overnight Rate Average Overnight Indexed Swap. The SORA is an important interest-rate benchmark in Singapore for pricing loans and debt products in the country and the rate can be found here. The SORA-OIS is a derivative of SORA, so the term “5-year SORA-OIS” refers to the SORA-OIS with a 5-year tenor. Unfortunately, I can’t find any publicly-available pricing data for the 5-year SORA-OIS.  
• For the Third Time Frame, there are also Reset Dates that occur at the same five-year intervals. From 6 July 2047 to the next Reset Date, Singapore Post will be paying a distribution rate of 2.183% per year, plus 1.0% per year, plus the 5-year SORA-OIS that is seen on 6 July 2047. From the next Reset Date to the next-next Reset Date, Singapore Post will be paying a distribution rate of 2.183% per year, plus 1.0% per year, plus the 5-year SORA-OIS that is seen on the next Reset Date. For subsequent Reset Dates, the same dynamic for the distribution rate applies.

3) Implication of the distribution to be paid by Singapore Post: As mentioned, the distributions for the Second Time Frame and Third Time Frame involve a fixed distribution rate ranging from 2.433% (2.183% plus 0.25%) to 3.183% (2.183% plus 1.0%). Both are lower than the distribution rate for the First Time Frame. Meanwhile, the distribution rates for the Second Time Frame and Third Time Frame also have a floating-rate component that depends on the 5-year SORA-OIS – and the 5-year SORA-OIS can fluctuate with time. Because of these dynamics, the overall distribution rate for the Second Time Frame and Third Time Frame could be lower than the rate for the First Time Frame.

4) When will the distribution of the perpetual securities be paid by Singapore Post: Singapore Post will pay the distribution twice every year, on 6 January and 6 July in each year.

5) Will Singapore Post return the capital: Singapore Post can choose to redeem the perpetual securities any time within three months of 6 July 2027, or on each distribution-payment-date that comes after 6 July 2027. But Singapore Post has no obligation to redeem the perpetual securities. This means the capital an investor uses to invest in the perpetual securities will be permanently locked up inside Singapore Post if the company does not redeem them. Of course, there’s the option for the investor to sell his or her perpetual securities on the open market – but in this scenario the sale price would be determined by market conditions as well as the business-health of Singapore Post.

6) When will the perpetual securities be available for trading on the Singapore Exchange: The perpetual securities were listed for trading on 7 April 2022.

7) Can Singapore Post afford to pay the distribution attached to the perpetual securities: I can calculate with certainty that the distributions for the perpetual securities for the First Time Frame will cost Singapore Post S$10.875 million annually (4.35% of S$250 million). But it is impossible to answer definitively whether the company can afford to pay the distributions. The best an investor can do is to determine the riskiness of the perpetual securities by looking at Singapore Post’s financial condition. On this front, there are a few things to note, both positive and negative (data’s from Tikr):

• On the positive end, Singapore Post has been generating positive operating cash flow in each financial year going back to at least the last 10, and each year’s operating cash flow is comfortably higher than S$10.875 million as shown in Table 1 below.
• On another positive end (though this is only slightly positive), Singapore Post has a balance sheet with slightly more cash than debt; as of 30 September 2021, the company’s cash and debt stood at S$465.0 million and S$308.4 million, respectively.
• On the negative end, Table 1 makes it clear that Singapore Post has failed to produce any sustained growth in operating cash flow for a long time.    

8) Can Singapore Post choose to not pay the distributions attached to the perpetual securities: Yes, Singapore Post can, at its sole discretion, choose not to pay the distributions – and it can choose not to pay the distributions in perpetuity. But doing so comes at a massive cost to Singapore Post; for example, the company will not be allowed to pay any dividend to owners of its ordinary shares. But since Singapore Post can still choose to not pay the distributions on the perpetual securities, in the worst case scenario, an investor who invests in the perpetual securities could find his or her capital permanently locked up in Singapore Post, and yet receive zero income. 

9) Final word: To repeat, what I’m doing here is merely providing a factual breakdown of Singapore Post’s latest perpetual securities based on publicly available information – I’m not trying to make a case for or against an investment in them. To whoever’s reading this, I hope laying out these numbers will help you make a better-informed decision on Singapore Post’s latest perpetual securities.

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

Tencent distributed most of its stake in JD.com to its shareholders earlier this year. If you are a shareholder of Tencent, you would notice new shares of JD.com deposited in your account.

What now?

Investors who were given the JD.com shares can now decide if they want to hold on to the shares or simply sell them.

Here’s what you should know before making a decision.

What is JD.com

JD.com is one of the largest e-commerce companies in China. The company started as a traditional brick and mortar retailer in 1998 before transitioning online in the early 2000s. JD.com focused on selling its own electronics inventory and built out a wide logistics network.

Today JD.com is also a marketplace for third-party sellers who want to leverage the company’s massive base of more than 500 million annual active users. 

Unlike Alibaba which is an asset-light business that relies heavily on third-party logistics players, JD.com primarily uses its own logistics capabilities after years of investments building warehouses and expanding its logistics network. This makes JD.com a formidable force in China’s e-commerce scene.

Growing fast

The e-commerce giant recorded a 27% increase in net revenue to RMB 951.6 billion in 2021. Its annual active customer accounts also grew 20.7% to a whopping 569 million. 

From 2018 to 2021, JD.com’s net revenue compounded at 27% per year and annual active customer accounts grew 23% annually. 

There have been broad-based growth across JD.com’s business. All of its segments – including retail, logistics, and new businesses – have recorded strong growth.

Innovation and competition

JD.com is well-known as an e-commerce brand that specialises in electronics. But building from that niche, the company has executed admirably to expand into different product categories.

The tech-focused company has also seen its early investments in logistics paying off as it is now able to offer quick deliveries and has control of its own fulfilment. It also offers its logistics capabilities to its third-party sellers and other customers who want to leverage its sprawling fulfilment network.

JD.com competes with other e-commerce companies in China such as Alibaba and Pinduoduo, but JD.com has been able to hold its own against these other giants.

Innovation also seems to be ingrained in the company’s DNA as JD.com has consistently used technology and data to improve its logistics capabilities and it is also constantly moving into new businesses to leverage on its large user base. It is now building out its JD Health business for telemedicine and has also established a strategic partnership with Shopify to allow Shopify’s merchants to list their products on JD.com. Shopify is a Canada-based global e-commerce software services provider.

Bearing fruit

JD.com’s early investments are starting to bear fruit. It started to generate a chunky stream of free cash flow in the last couple of years.

In the last two years, JD.com generated a combined RMB 61 billion (US$9.6 billion) in free cash flow. This includes JD.com’s increased investments in capital expenditures for business-expansion this year.

Valuation

With China stocks still out of favour, JD.com’s shares are now trading well below their all-time highs. As of 21 March 2022, JD.com’s share price of HK$239 translates to a market cap of HK$748 billion (US$96 billion). At this price, JD.com trades at around 23 times trailing free cash flow.

Conclusion

The distribution of JD.com shares by Tencent to its shareholders have left many investors holding on to shares of a company that they may not be very familiar with. The above summary provides investors with a quick brief of the company and its fundamentals and its valuation.

Although there is still a lot of uncertainty surrounding China at the moment, I think JD.com shares at this valuation still provides investors with a good risk-reward ratio. Nevertheless, each investor is different and investors should do their own due diligence and make a decision based on their own portfolio situation.

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. Of all the companies mentioned, I currently have a vested interest in Tencent and JD.com. Holdings are subject to change at any time.