Melynn - Philosophy on investing part 6

I have been looking at my past trades stretching back to the first very trade I have made since year 2007 which was the bull period. Back then, I always thought I am good stock picker whereby nearly all stocks I bought were multi baggers earning me 20-30 % return in a few months leading me to have an illusion that everything is within my control. During that period, I also tend to think stocks will move as per my expectation, ie picking stocks which is fundamentally sound and buying them no matter how over valued they seem to be by coming up with an estimated price near the present as a support. Therefore whenever I have made a decision, I will find evidence to support it rather than finding ways to refute it. This might sound counter intuitive as the norm will be buying stocks based on evidence instead..

Eventually, when stocks started to plunge a few basis point everyday, I will still see it as a form of correction and cost average it as I believe the value will revert back to the mean eventually. I was apparently suffering from gambler's fallacy where I thought a stock will recover after a few days of consecutive big plunge when in fact, it wont. All these are said on hindsight but i hope I can improve my investment by acknowledging my mistakes soon and correct them.

Nevertheless, i never doubt value investing despite not practicing it firmly. I hope to improve this method by mixing momentum and value together to avoid from incurring opportunity cost by holding on undervalued securities that languish a long time before recovering. Instead of bottoming fishing where a price can always go lower than my estimated price, why not wait for the price to raise a bit (momentum) before entering? Ideally, I would want to pick the highest momentum stocks with the cheapest valuation.. Possible? Downside is that by adopting this strategy, I will inevitably follow the fool game so an important thing is to exit when the expectation is different from the reality on a large scale.This is easier say than done and its something which I have yet to figure out

Firm fundamental investors will buy/hold a stock in an indefinite period and assumption is that large emphasis is placed on the stock fundamentals and not the price volatility but thinking from another perspective, a prolonged plunge in stock price will affect the fundamentals too isn't it.

I will share more thoughts on Soros reflexivity philosophy in the next post which I happened to come across a few days back. Also note that each of my posts might be jumbled up or not related to one another as I am just trying to pen down whatever thoughts that came across my mind so I will like to apologize in advance if it causes any confusion. 



Reproduced with permission from http://melynn-lynch.blogspot.com 

Philosophy on Investing part 4

I have been looking at my past trades stretching back to the first very trade I have made since year 2007 which was the bull period. Back then, I always thought I am good stock picker whereby nearly all stocks I bought are multi baggers earning me 20-30 % return in a few months which leads me to have an illusion that everything is within my control. During that time, I also tend to perceive stocks will move as per my expectation, ie picking stocks which is fundamentally sound and buying them no matter how over valued they seem to be by coming up with a estimated price near the present as a support. Therefore whenever I have made a decision, I will find evidence to support it rather than finding ways to refute it. This might sound counter intuitive as the norm will be buying stocks based on evidence instead..

Eventually, when stocks tend to plunge a few basis point everyday, I will take it as a form of correction and cost average it as I believe that the value will revert back to the mean eventually. I was apparently suffering from gambler's fallacy then whereby I thought a stock will recover after a few days of consecutive big plunge when in fact, it's not. All these are said on hindsight but i hope I can improve my investment by acknowledging my mistakes soon and correct them.

Nevertheless, i never doubt value investing even though i am not a firm practitioner. I hope to improve this method where I can mix momentum and value together to avoid from incurring opportunity cost by holding on undervalued securities that languish a long time before recovering. Instead of bottoming fishing where a price can always go lower than my estimated price, why not wait for the price to raise a bit (momentum) before entering? Ideally, I would want to pick the highest momentum stocks with the cheapest valuation.. Possible? Downside is that by adopting this strategy, I will inevitably follow the fool game so an important thing is to exit when the expectation is different from the reality on a large scale.This is easier say than done and its something which I have yet to figure out


Firm fundamental investors will buy/hold a stock in an indefinite period and assumption is that large emphasis is placed on the stock fundamentals and not the price where it is perceived as noise but thinking from another perspective, a prolonged plunge in stock price will affect the fundamentals too isn't it.


I will share more thoughts on Soros reflexivity philosophy in the next post which I happened to come across a few days back. Also note that there might not be a link between my each of my posts as I am just trying to pen down whatever thoughts that came across my mind so I will like to apologize in advance if it cause any confusion. 

Investment Diary

From today onwards, I will try to pen down all my trades made to experiment my system. This can help me think through my thoughts more systematically and improve on it.. All the trades made will be used with real money to ensure the accuracy of the system as it takes my own emotions into consideration unlike paper trade whereby I can trade any amount I wish to and not losing anything.. My first trade is made based on purely technical factor..

1. Stock Bought

Keppel Corp (Listed in Singapore market)

2 Reason for buying this 
Strong volume, good intra day trend and high possibility of breaking the resistance. Purely technical..

3. Estimated holding period
1day .. Just trying out my system therefore does not want to risk too much by holding it overnight... 

4. Entry Point
Purely technical again... Bought at point where volume increased and the resistance seems to be breaking..  Experimenting whether entry point is critical...  Price paid : $5.49

5. Selling Point
Set at a tight stop loss at 5% which is $5.2

6. How much was the stock sold
Sold at 5.71 at the end of day.. Deducting commissions(193.26), earned a profit of $906.74

Food for thoughts

1. What if the stock plunge 20% intra day ? Will I hold on to it and wait for it to rebound? Will I have sufficient money to pay the contra sum..
I will definitely sell it even if it plunges 20% as one important factor in determining the success of a system is to adhering to it.

2. Astronomical commission incurred.. 
Is it worth to buy and sell within a day when a commission of nearly $200 is incurred. Its like 20% of the profit. The stock has grown approx 4% from my purchase....

3. How do I determine my position..
Defining the maximum amount I can lose. Probability of the stock going down more than 10% is low for the day in my opinion as the market is very bullish. Hence my purchase has unlimited upside and limited downside. The position is determined using the amount i can lose multiply by 10.

Summary
Although I made a profit from this trade but I'm fully aware that this is due to luck.. All the above aspects need to be improved to have a more defined system to increase my probability of buying a good stock and also overcome possible emotions (i.e greed,fear) ..... 

Following are the immediate tasks which I need to undertake to improve my system

1. Need to come up with a more elaborate method to derive the position size
2. Need to determine the selling point..
3. Defining time horizion.. Intra day is definitely not suitable for me.

Philosophy on Investing part 3

The aggressive search of a holy grail for a perfect strategy to enter the market has been everyone's dream but is it really as important as position sizing(money management) and defining the selling point where one will not be entrapped in his own emotions(greed, fear)?

My first part in my journey to create my own system will begin with entry point... Under entry point, following are the questions I need to go through.... 

1) Stock fundamentals

a) Analyze the company's 5 year annual result and come up with a basic analysis like the one I earlier posted for Tat Hong...        

b) Come up with an estimated price using DCF model and relative models like (P/E, P/B, P/S). Only used as a guideline as the estimates are derived using past info therefore might not be very accurate..   

c) Analyze the company's latest quarterly posted result

d) Possibility of the stock price getting doubled. Like improving results current price at a huge discount..     

e)  Market Capitalization..

2) Technicals
a) Determine the volatility using  indicator like ADR.
b) Using moving average to determine the buying point.. Might conflict with fundamental as I will probably be buying "higher"     
c) Volume analysis
d) Analyze the trend and momentum

3) Big Picture
a) Macro econ indicator
b) Current market sentiment (Bullish or Bearish)

4) How much should I buy? How can this be determined? Any way to derive this figure based on fundamentals..

5) Always think "how much will I lose" by taking this position instead of "how much can I win"

6) Should I cost average when price plunges drastically?

7) Determine the amount I would risk.

The only way which I can think of now to blend this 2 technique is to design a sort of point system.. Assuming, I'm a mid term investor(holding period < 1 year) and have more confidence in fundamental than technical. I can start by weighing my system more towards fundamental (70%) than technical (30%) and only buy the stock when the total points exceed certain predefined benchmark. This is just an idea. I am still unsure how can I go about doing this.. Will explore more on this option and improve on it... 

Philosophy on Investing part 2

My first step in devising a new strategy is to think through what are the factors that caused a stock to surge and what are the factors that caused a stock to plunge.. Intuitive it sounds but all these are some points which I missed out previously.

As far as I know, there are currently 2 school of well known thoughts - Fundamental analysis and technical analysis... Is it possible to fuse these 2  together to determine the buying and selling price even when they are contradicting in nature usually? To start off, I am thinking of segregating the fundamental factors into Short Term and  Long term. Short Term factors are like - Latest quarter result posted by the company, macro economic sentiment, industry trend. This list is not exhaustive as I am still in the process of researching.. Long Term factors are like 5 year company financial results, macro trend, potential to be a market leader and etc..

For technical analysis, I will also segregate the factors into short term and long term.. I am still a greenhorn in this area and I know that by mixing technical and fundamentals will definitely invite criticisms but in today's volatile market, I believe by having the knowledge to apprehend charts will let me know more on other investors' psychology. Some short term factors I can think of are  momentum indicators like MACD, moving average to determine the support and resistant and long term factors are like the 5 years trend of the stock.

The reason why I think mixing these 2 school of thoughts is important because I used to overlook a point in fundamental analysis. I used to think that only fundamentals affect stock price but stock price actually affect the fundamentals too because a low stock price will affect the company's ability to raise equity resulting in taking more debt and also might affect the company's reputation too as a company with low stock price may deemed to be "lower quality". I also hope by combining the both strategies, I can avoid the mistakes of behavioral finance pitfalls

So how can I actually determine the entry price and exit price using the mentioned strategies. Also how can I determine the position sizing to manage risk?

Philosophy on Investing

This unprecedented 2009 financial crisis have helped me to learn quite a bit through the hard way.. My portfolio total value has shed around 50% since inception so I have been wondering is it a wrong move to buy and hold? It's always easy to answer such question on hindsight using present information which are unavailable at that point of time. I was and still a firm believer of fundamental analysis but with the lack of information which are sometimes inaccessible to retail investors, can we still make a soundly judgement ? How confident can we be that the stock is still fundamentally sound when it's fundamentals are changing dynamically. I will try to improve on my current strategy based on the following points which I will be exploring further.

1. Lack of risk management 
Need to think of a way to spread my portfolio risk.. Having say that, I don't intend to over diversify or use beta/variance to diversify risk..  I'm thinking of aligning fundamental analysis to risk management.

2. Emotions(behavioural finance)
Investors are sometimes their own worst enemies and personally, I am a victim of my own emotion (i.e averaging down a company's stock even when its prospect seems to be not as good as last time) .. Best way to overcome such problem is to create a system and stick to it rigidly.

3. Strategy
I am currently using fundamental analysis to buy/sell stocks but personally, I think there are some downsides for retail investors like me to use this 100%.(i.e a we are just minorshare holders therefore we cant actually change the company fundamentals like what the great sage Waren Buffett does) .Can technical analysis blend with fundamental even though they oftenly contradict each other? Need to devise a rule to sell stocks..... 

My journey to create a strategy starts here and I will be using the stock market to experiment it.. When I first started investing, I have used paper trading to test my strategy but for now, I think real $$ should be used instead because emotions will be involved and this is one point which I hope to overcome.  I will try to jot down all my findings andthoughts and if possible , I hope readers (if any) can give some feedback .. Criticisms are strongly welcomed

Tat Hong Fundamental Analysis

Below are the basic qualitiative analysis I have done for Tat Hong and based on the factors, I will consider buying between the range from 0.52 to 0.55.

Summary

Quantitative Analysis

	Discount Rate (Lower the better)	Grade
Profitability	2/4	B
Growth	1/3	A
Financial Health	2/5	A
Cash Flow	4/8	B
Effiency	2/5	A

 

Detailed Quantitative Analysis

Profitability

1. Has the company been generating free cash flow consistently.
Tat Hong has had a pretty good history of generating free cash flow. Free cash flow is negative in year 2003 and 2004 but has recorded a good growth on the
following years. It is still not consistent as they are still plowing most of their money back to capital expanding and this is not a good sign that the firm has much of an economic moat.

2.Has the company generated a consistant increase of operating profit margin and net profit margin 
Company' net profit/operating profit margin has decreased from 21% to 20% but prior to that, they have been increasing consistently.

3. Is the company's ROE more than 10%
Tat Hong's 2008 ROE is 27% and has been increased consistently.

4. Did the company increase financial leverage agressively to get a high ROE
Tat Hong's financial leverage has decreased from 2.08 to 1.88 therefore the ROE is of highest quality. 

5. Is the company's ROA more than 8%
Tat Hong's 2008 ROA is 13% and has been increased consstently.

6. Has the company's operating expense increased drastically over the years
The company total expense is steady at 16 to 17% of sales until year 2008 when it increased to 19%.

7. Is the company's inventory rising faster than sales
Inventory has increased 26 % from last year while sales increased 32%. Although there are exceptions but on the safe side, its better to take this point into consideration
because when a company produces more than its selling, either demand has dried up or the company has been overly ambitious in forecasting demand. Unsold goods will have to get sold eventually, 

8. Has the company's receivables percentage of sales increased more than 20%
Account receivables increased from 11 percent of sales to 13 percent which is a growth of 18%. 

Conclusion : With the likely downturn of the economy, it will definitely affect the crane business therefore I will conservatively grade the profitability as B due to the inconsistent generation of free cash flow and also inreasing of total expense.

Growth

1. Is the company's sales growth more than 15% 
Tat hong's sales has grown at an annual growth rate of 27% over 7 years. 

2. Is the company's operating income growth more tha 15% 
Tat hong's operating income has grown at an exploding rate of 68% over 7 years.

3. Is the company's net profit growth more than 15% 
Tat hong's net income has grow at an exploding rate of 79% over 7 years.

Conclusion : Will expect a decline in growth due to the possible demand crunch but looking on a longer time horizon, I will still grade the growth A.


Financial Health

1. Is the company's financial leveage more than 3
Tat hong's financial leverage has been decreasing consistently over the past 7 years and it is at 1.88 in year 2008. This means that for every dollar in equity, the firm had $1.88 in assets. It borrowed the other 0.88. This is fairly conservative for a company which generates such high ROE.

2. Is the company's debt to equity between 0.5 to 1.5 or smaller. 
Tat Hong's debt to equity is at 0.88 and been decreasing consistently over the years too. 

3. Is the interest coverage more than 5 and been increasing consistently 
Tat Hong's interest coverage has been improving over the years and it is at 12.99 in year 2008. In other words, Tat Hong has earned enough money to cover its interest
obligation 13 times over, which is a pretty safe margin.

4. Is the company's current ratio more than 1.5 and less than 6 
If a company has an excessive high current ratio, it can probably sound some alarm bells because it indicates that the company has a large amount of current assets that
could - and probably should - be invested back into the company . Tat Hong's current ratio is at 1.39 in year 2009 and they have managed to maintain it above one over the past 5 years. Even though the 1.5 mark is not met but this level is still relatively safe.

5. Is the company's quick ratio more than 1
This figure is not really meaningful if used alone as it needs to be compared with other companies in the same industry but generally, a quck ratio higher than 1 puts a company in fine shape. 

Cash Flow 

1. Is the company able to generate improving/consistent operating cash flow to sales 
Tat Hong's ocf/sales for Fy06,07,08 is 6.51%, 6.27% and 10.12%. They have show improvement but it is still not consistent.

2. Is the company able to generate improving/consistent free cash flow to operating cash flow 
Tat hong's free cash flow to operating cash flow for Fy06,07 and 08 is 17%, 68% and 38%. The recent plunge is due to the increased of capital expenditure. There is no 
guideline for this but generally, the higher percentage of free cash flow, the greater the financial strength of the company.

3. Is the company's cash flow coverage improving
The following are the various cash flow coverage I'm covering.

	FY05	FY06	FY07	FY08
Short term Debt Coverage	0.06	0.15	0.14	0.23
Capital Expenditure Coverage	0.64	1.21	3.28	1.63
Dividend Coverage	1.20	2.93	0.83	2.23
Capex + Cash Dividend Coverage	0.42	0.85	0.67	0.67

he short-term debt coverage ratio compares the sum of a company's short-term borrowings and the current portion of its long-term debt to operating cash flow. Tat Hong's short term debt coverage has been improving consistenly thorughout the past 4 years and this is a good sign. 

The capital expenditure coverage ratio compares a company's outlays for its property, plant and equipemtn(PP&E) to operating cash flow. Tat Hong's capital expenditure coverage has been increasing for the past 3 years till last year where it plunged quite substaintally due to increase of capital expenditure. 

For conservative investors focused on cash flow coverage, comparing the sum of a company's capital expenditures and cash dividends to its operating cash flow is a stringent measurement that puts cash flow to the ultimate test. If a company is able to cover both of these outlays of funds from internal sources and still have cash left over, it is producing what might be called "free cash flow on steroids". This circumstance is a highly favorable investment quality. Tat Hong's ratio has been hovering at the level below 1 which tells us that they are not able to fully coverage the capex and divided with the generated operating cash flow but nevertheless, the ratio is still at a decent level. 

Conclusion : Based on the above, Tat Hong has a good record of generating free cash flow and also its cash flow coverage ratio has been improving over the years but still, its coverage is not at the ideal range and also the free cash growth is inconsistent therefore to be conservative, I will give a B grade. 

Effiency

1. Is the company's cash conversion cycle inproving consistently over the last few years

It is a metric that expresses the length of time, in days, that it takes for a company to convert resource inputs into cash flows. This metric looks at the amount of time needed to sell inventory, the amount of time needed to collect receivables and the length of time the company is afforded to pay its bills without incurring penalties.

	FY05	FY06	FY07	FY08
Days Sales Outstanding (days)	72	58	51	53
Days Inventory (days)	198	177	168	174
Payables Period (days)	162	156	159	175
Cash Conversion Cycle	107	79	61	52

Company's CCC has improved consistently over the years and by looking at each of the figure, Tat Hong is quicker at collecting what is owed, better job at moving inventory and also keeps its own money a bit longer. This consistency indicates the management's effiency in using short term assets and liabilities to generate cash.

2. Is the company's turnover ratios improving consistently over the last few years

	FY05	FY06	FY07	FY08
Receivable Turnover	5.08	6.29	7.09	6.89
Inventory Turnover	1.84	2.06	2.17	2.10
Fixed Asset Turnover	1.98	2.34	2.02	2.03
Asset Turnover	0.74	0.85	0.77	0.76

Like most ratios, the true value of the information isn't really there unless you make a comparison across the industry but generally, the higher, the better.

Conclusion : Based on the ratios above, it shows that Tat Hong has improved on its effiecncy consistently, indicating the management's ability therefore I will give a A grade in this aspect.

Valuation

Multiples

	Current	Target	Target Price
Book Value per share	0.63	0.5	0.44
Operating Cash Flow per share	4.38	4.00	0.51
Free Cash Flow per share	11.36	11.00	0.54
Price Earnings per share	2.79	2.50	0.50
Price sales per share	0.44	0.40	0.51

A target price of $ 0.50 is derived based on the average of the multiples above. 

Cash flow growth rate	0.05	0.08
Margin Of safety	0.15
Overselling rate	0.13
Discount rate	0.14	0.12

Discount rate of 0.11 derived based on the quantitative fators. Given today's uncertainty, i will set the discount rate as 0.14 from year 1 to year 5 following by 0.12 from year 6 to year 10.

Per Share Value	0.62
Margin of Safety	0.53
Consider Selling	0.70