Value Investing 01 (May 08 - Dec 08)

[fclim]

Hoho, trading in and out ah?

Come, let's watch the price fall to your 80%-90% NAV

ya ya... coz i'm very ill-disciplined... hands and legs itchy *Smack*...

have fun,
fc

[caseyc]

While we're on this topic, does anyone out there know how to properly evaluate banks or financial institutions?

A financial institution is quite a different animal, since cash takes on an additional role of being a "raw material" (to create financial products). Simply looking at book value or ROE doesn't seem enough.... For example, how do u know if the institution is doing proper risk management? A high ROE may simply be the result of taking much higher risk in their loan portfolio.

Appreciate any insights that forummers may have... Otherwise, I'll just stick to my tiny circle of competence

[HengHeng]

You can't take their profits as a gauge from.

Financial instuitions are far too good in hiding and manupulating the number that it makes it pretty difficult for them to be "measured" , by far what i usually do is to look into their assets or book value and earnings power as well as their leverage( which can be cooked)

Anyway one simple word , trust! When u invest in financial instituitions expecially banks. <-- They work on trust and chances are when there is no trust in the markets like now , we have a severe discount on them

[iam802]

I am thinking about the banks as well. Though not the local ones.

Using the US banks as an example, questions that comes to mind:

1. How much bad debts do they really have? Is it quantifiable at this point in time?

2. Now, if it is quantifiable, why is the US govt. injecting funds directly into the banks instead of just buying the bad debts?

3. If govt. injects funds into the banks so that they can lend it out again, that means, the banks is going to continue to leverage. (<< ok, I know that is their core business... to leverage and lend out money)

And, this is where I find it confusing. How is the bad debt going to be resolve?

The bad debts were bad because it cannot be recovered in a very short period of time. Add to that, it was leveraged.

So, like many... I am trying to understand how this crisis is going to be resolved with a magic wand or funds being injected into the banking system.

[HengHeng]

Yes leverage is a very frightening thing expecially being on the wrong side but currently the problem is liquidity and not bad debt.

I think i've mentioned quite sometime back on about bad debts not being declare or unable to declare but since now there is a market for this credit swaps etc etc to be liquidated , personally i would feel more safe to invest in their "book" value now as compared 3 months ago.

[kennynah]

1. How much bad debts do they really have? Is it quantifiable at this point in time?

difficult question... perhaps even the ceos of these banks are not able to fully apprise the amount of bad debt exactly.

2. Now, if it is quantifiable, why is the US govt. injecting funds directly into the banks instead of just buying the bad debts?

this has to do with maintaining liquidity ratio and encouraging banks to begin lending again...imagine they have access to low IR money and can relend this money out for much higher returns.

3. If govt. injects funds into the banks so that they can lend it out again, that means, the banks is going to continue to leverage. (<< ok, I know that is their core business... to leverage and lend out money)

And, this is where I find it confusing. How is the bad debt going to be resolve?

The bad debts were bad because it cannot be recovered in a very short period of time. Add to that, it was leveraged.

So, like many... I am trying to understand how this crisis is going to be resolved with a magic wand or funds being injected into the banking system.

all banks lend more than their actual liquid assets combined. this act of leveraging did not cause this current problem. the entire episode could be thought of as banks unscrupulously selling mortgages to people who could ill afford them. well at least, the carrot dangled was for the interests payable on the mortgage in the initial 3 years to be veru enticing and then when the ARM was adjusted after 3-4 years, that monthly instalment then became way too expensive for most "low" income folks. these people shd never have taken a loan more than they could afford in the first place. It's like i know a very young couple with a total income of <S$7K and they loaned to their noses to buy a 5Rm flat at Bishan. Should anyone of them suddenly go jobless, they will have a hard time servicing this loan even at current HDB rate and imagine that after 3 years, that loan's IR component jumps by 100%.

so, as a result of many defaults on these mortgage loans, the banks could not recuperate their loans. When they cant receive the money and with the housing value very precipitously dropping in value, the loaning banks were hit doubly hard...no money from customer and the house is worth signifcantly lesser in the open market.

these companies who bought CDO (with mortgage assets as the underlying) assets suddenly find themselves in a bind bcos these assets became practically worthless as a result of the languishing housing market. no one wants these CDO anymore, and no one could value these CDO assets since there is now not even an OTC market for them; ie there's no ability to "mark to market" these assets.

banks who had some of these CDO assets and used them as credit swaps vehicle with counter parties caused great damage to those counter parties, who now have in their hands worthless paper. these counter parties had to accept losses as well.

so, in order to resolve this mess in its entirety, 1st and foremost, the housing market MUST first recover. house values must go up. the default rate level must tapper off and reduce.

pardon my poor habit of giving sesquipedalian answers

ps : GR and I spoke about this previously and we both agreed that one indicator to watch is $HGX

[caseyc]

H2, thanks for the insights.

by far what i usually do is to look into their assets or book value and earnings power as well as their leverage( which can be cooked)

Fair enough, but these numbers don't quite reveal the quality of their risk management, which (IMHO) is vital in deciding whether to invest in a bank or not.

I guess u could argue that if the bank takes on huge risk without proper mgmt, it will eventually hit their earnings and that will be reflected in the FR. But as the subprime crisis show, some rotten apples can take years to surface. Prior to that, it decorated the income stmt with wonderful earnings.

Anyway one simple word , trust!

Sadly, this is how the uncles/aunties in Hong Lim park got into trouble. Sigh.

pardon my poor habit of giving sesquipedalian answers

K, i've respected your Hokkien for a long time.... but now your england has graduated to the same league as Lena's

[la papillion]

Keep your style, fade your fashion

It's simply not fashionable to invest in debt-ridden companies now.

Investment are like clothes. There are investments themes that come and go with the vicissitudes of fashion wear. From my short history of market experience, I already can see the different main fashion themes which are hot at different periods.





In the bull market, there are many many themes. Sector rotation, I think that's what they call it. I used to pay attention to companies belonging to a certain sector, like construction plays, oil plays, property plays etc, and look out for companies in those sector that had not run up. I had the misfortune to take part in the construction play leading right to the end of year 2006/2007 and consequently became the last fool holding the unwanted babies. Despite the many themes, the underlying premise of buying is based on PE.

Let me explain. When the market conditions are bullish and prices of stocks are breaking their 52 week high, it's simply not fashionable to invest in P/B kind of stocks. PE values are all time high, so to entice investors to put their monies, low PE stocks are trumpeted as the next growth stock to run up. I've not personally seen another metric used in bullish times locally, which is Price to revenue P/R ratio, though I read that in the telecom/dot.com era in 1990s, there are plenty of such analysts keen on this metric. It's not unexpected isn't it? When prices are so high, and earnings haven't begun to catch up on the prices, the best way to show value is to use some metrics that are independent of the earnings and/or profitability of the companies in question, but instead based on the rapid growth of the companies (never mind profitability, it'll catch up).

However, when the tide turns in a bearish market, fashion police of the investing realm dictate that P/B becomes the new yardstick of measurement. Book value defined as total assets - total liabilities, becomes the fashionable thing to valuate companies. We hear of analysts saying about the P/B of banks or properties counters or reits or whatever being at all time low, compared with SARS, Asian financial crisis, dot.com era or other similarly bearish times. I reasoned that this is the case because the market price of the company are supported by the assets owned after all the liabilities are paid to creditors. As such, P/B ratio becomes the valuation metric of choice when market conditions are bad.

The current aversion towards debt-ridden companies resulted in the relentless selling across the board of such companies regardless of business economics. Shipping stocks seem to be whacked hard for being in the wrong kind of business in the wrong time. S-shares, which are singapore listed china companies, are whacked down hard after the scare by Ferrochina and China painting & dyeing company. That means if you're a s-share and a shipping company, you're doubly screwed. YZJ and Cosco are two examples that spring to my mind.

I also noticed that dividends, ignored during bull market, are back in vogue when times are bearish. Analyst are always touting the high dividend yield of certain companies as being defensive. Reits, most showing double digits yield, are sold to investors as offering higher yields than the miserably low interest rates offered by savings account. The reason we don't talk about dividend yields during bullish times is two-fold - first being that the prices are marked up so high that the yields are nothing to boast about. Second, the capital gains from sheer price appreciation is much more tempting and lucrative than the steady and slower dividend gains.

Here's a summary of some of the metric mentioned and the times they are in vogue:

1. Price earnings ratio P/E = bull
2. Price revenue ratio P/R = bull
3. CAGR growth or CAGR revenue % = bull
4. Price to book P/B = bear
5. Cash per share = bear
6. Dividend yield % = bear
7. Liquidity ratios like current, quick, gearing = bear

One can take advantage of this whimsical swings in the investing realm in two ways. The first is to trade (long/short) the fashion trends by identifying possible candidates. For example, after ferrochina announced its death note, a few days in a row, s-shares was shorted furiously down to crisis levels, especially those debt ridden companies. Another way to take advantage of this is to always prepare one's portfolio for the bear. Chasing the price of companies so as to ride on its growth story is not exactly preparing for bearish times.

Fashion fade, but style is forever - Yves Saint Laurent

Have your own style, don't keep chasing after fashions. By the time the fashion magazines announced what is the hottest for this season, that season is over. Don't be caught wearing last season's wear.

[winston]

Not sure whether you have heard of the mini-skirt & "loud clothings" indicator for investing.

When you see a lot of mini-skirts and "loud-clothings" around you, it means that the people in that time period are more daring and more willing to take on more risks.

[la papillion]

Oh yes, W, heard of that one. There's even a chart in ken fisher's book, called hemline indicator I think. But sounds weird that wearing short skirt means taking more risks. More risks more rewards for our female friends? hoho!