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Investing, come what May
MAY is the season of spring, of hope, when a long winter fades and green leaves begin appearing on bare branches.
Unfortunately, after a magnificent rally this year, cheap value stocks are far harder to find compared to five months ago ("Cash-rich firms offer value investors options", Dec 14, 2016).
The data seems to be telling us that there is a synchronised economic upswing in both the developed and the emerging worlds.
Anecdotally, sentiment has improved noticeably and order enquiries are up. But in Singapore, the domestic economy remains subdued with rising unemployment.
So, as the birds chirp louder and flowers blossom in the stock market, I am trying to do three things.
One: Stay invested
As the saying goes, investing is about time in the market, not timing the market.
This is simply because any predictions might turn out to be horribly, amusingly wrong.
The Royal Bank of Scotland (RBS), at the beginning of January last year, advised investors to "sell everything" except high quality bonds.
Well, what do you know? On a 11/2year horizon, January pretty much marked the bottom. Thanks, RBS!
Nobody knows if the next crash will happen tomorrow and then RBS will have the last laugh. As another saying goes, even a broken clock is right twice a day.
Yet selling everything is not a good idea especially if you have a diversified portfolio of cash-generating businesses with minimal debt.
If you are not exposed to the market, there is never a really good time to start deploying capital.
Sure, one Really Bad Time to start investing was at the peak of the dotcom boom in 2000. It took more than 12 years for the tech-heavy Nasdaq Index to recover from that one.
Still, recover it did, and investors learnt a thing or two about tech stocks and bubbles.
If you had begun investing in 2000, surely you would have invested in 2001, 2002, 2003, 2004 and 2005, too? You might have done pretty well. Ditto for the global financial crisis and the years after.
Rather than waste precious energy (and broker commissions) deciding when to buy or sell everything, having a few core companies or indices to buy and hold can prove rewarding.
However, humans will always have the urge to gamble.
Two: Put numbers to names
So, if you must gamble, at least gamble with some odds in mind.
Many of us, myself included, have been guilty of buying stocks just because "it feels like it can go up more". Another problematic way of thinking is, "Oh, it's already so high, it surely can't go up further".
What determines low or high, or what is cheap or expensive, are current and expected financial ratios.
You can't run away from numbers. You have to try to look ahead. And you have to figure out if there is a coherent story to be told about your stock. It will be far easier to commit to buying more of company X if your thought processes go like this:
"After accounting for cash that takes up half its market capitalisation, X is trading at just six times last year's earnings. Historically it has traded at 10 times. Even though its business is suffering declining margins amid industry challenges, X will have opportunities as international brands expand in the region. With a double-digit ex-cash free cash flow yield, I think it is worth initiating a position."
"Y is trading at 15 times projected earnings, or more like 13 once its sizeable net cash balance is taken into consideration. Y is a blue chip, cash-generative company that has one business that deserves a multiple of 20 and another business that's getting severely disrupted and is probably worth just 10 times earnings to be safe. All things considered, its current price is a fair entry level because of population growth, strong free cash flows, an increasingly asset-light model and a 4 per cent dividend yield."
Three: Prune speculative bets
If you come from Benjamin Graham's school of value investing, you might think of a stock's market capitalisation as being made up of two components: A "value" component and a "speculative" component.
The value component arises from assets on the balance sheet, as well as a conservative judgment call based on the firm's business model, historical earnings and potential earnings.
The speculative component comes from animal spirits and the business cycle. Sometimes, an electronics company traditionally valued at 7 times earnings is now trading at 14 times because earnings are expected to double over the next few years.
Nobody knows when that will happen, or what the growth rate will be. One can only make educated guesses. In terms of reported earnings, nothing has happened yet. Investors are just speculating, and that speculation will increase or decrease with each earnings report.
Today, the speculative component of value is rising across many industries. If you are lucky enough to hold such stocks as they shoot up, sometimes the best thing to do is nothing until you find something better.
Yet there are some companies being speculated upon which are much more, well, speculative than others.
These include companies with low profit margins, high debt levels, and mysterious business models.
As the 2017 rally matures, it is prudent to start scaling back some of those bets.