The Ten Bagger Principle

Currently I am reading "Beating the Street" by Peter Lynch and John Rothchild. I've finished "One Up on Wall Street". Most investors here would be able to identify with Peter Lynch's investing philosophy for one reason: he encourages an all equity portfolio.

For a background on Peter Lynch, please refer to this link.

The first thing I would like to address is the idea of a bagger. A two bagger will be a stock that multiplies twice, while a ten bagger would be a stock that multiplies itself ten times. It's derived from baseball, although bowling has the same name for the number of strikes you get after a turkey.

Peter Lynch is a strong advocate of the buy and hold strategy, and he has stated that 2 points

1. If an investor goes by the philosophy that he will sell if the stock goes up 50%, he will never be able to obtain a bagger. Likewise if you go by the philosophy of selling the stock when it is a two bagger,you will never be able to obtain a ten bagger.
2. Show him a portfolio with a stop loss of 10%, and he will be able to show you a portfolio that loses 10%.

In light of the financial crisis, the wisdom of the buy and hold strategy has been repeatedly questioned and more mutual fund managers are becoming flexible and not holding as long as they used to.

I personally feel that taking profit is never a bad thing, and buying low and selling high is an excellent strategy (I mean who wouldn't, that's the essential of making money). The question comes is how to time the market. Maybe there are few beings out there with superior ability as compared to most of us investors that are able to tell when is the bottom and the top. And the list of investors that will be able to do that wouldn't have my name on it.

Buying and holding undervalued companies would instead provide a return that wipes out market irrationality and rides through economic boom and bust. The fact is that many of us are unable to time the market. Further evidence can be found here. Finding companies that are undervalued will provide us with the margin of safety for investment, minimizing possible downside and increasing possible upside.

I believe that should there be no external influences such as a requirement for money, selling should only occur if there is a(n) (anticipated) change in the fundamentals of the company or macroeconomic conditions, or that you require to reposition your portfolio. I would like to emphasize that stock picking is important, and sitting on for the ride is extremely important.

I leave everyone with an idea that Peter Lynch was putting across.

If I had 10k, and I invested 1k in 10 companies. If one of the undervalued companies produces a 10x returns, essentially the other 9 companies can be declared bankrupt and I did not make any losses. This is the effect of the ten bagger.

Stock Selection

"A stock that moves is a good stock"

I have always been told that, and over here I would like to cover what I look for when I invest in a company, not in any particular order.

1. What are the prospects of the industry for the next 5 to 10 years.

Over here, what I look into is the products developed by the industry and how likely is the product's usage in the next 5 to 10 years. If chances are the product is going to be around in the next 5 to 10 years, then it's a good investment in that sector. For that reason, I value commodities highly. Another sector that is worth looking into is the food and beverage industry. After all, we all have to eat.

On the same note, I look towards employee placement companies in USA as a play on the job recovery. 2 companies come into mind: Barrett Business Services (Stock Quote: BBSI) and Spherion Corp (Stock Quote: SFN)

2. How large is the company, and what is the likelihood it grows?

For me, I look to invest in small growing companies. I believe that it is one of the most, if not the most, important factor when choosing a company to invest in. If you look at the companies I am investing in, they are not the market leaders in their industry. To me, there's only 1 correct time to buy a market leader in an industry, and that is during a recession when prices are depressed.

There is one exception to the rule, and that happens when I look at companies that would be classified as turnarounds. Turnarounds are companies that used to be market leaders, but now are so depressed due to mismanagement that it would probably be on the verge of bankruptcy.
Three companies come into mind: JC Penney (Stock Quote: JCP), Office Depot (Stock Quote: ODP) and YRC Worldwide (Stock Quote: YRCW).

3. Financials

I base my financial analysis on multiples - P/E and P/B ratios are the most common. Other important things I look at is Cash per Share, NAV per share and the leverage and current ratios. I personally think that Cash Flows, while important, should not be given too much emphasis - on this topic we should look at the Burn Rate of cash, which is an indicator for companies who may face troubles during a recession.

Negative equity is one thing that is a huge red flag, however, I believe that sometimes it does not mean it's the be all and end all of investing. It all depends how the company would fare in the future that matters. I will put one company forward should people wish to study a negative equity B/S that has prospects worth looking into in my opinion: Comforce Corp (Stock Quote: CFS). I believe that it is a possible investment if you are looking into the employee placement industry.

4. Management Policies

On the topic of management policies, I would like to mention Soilbuild as a company that conveys its message across to its investors succinctly. If you do just a little bit of research, you will realise 1 thing - that Soilbuild is focusing on hitting the 40million mark in rental income, and its dividend is based on rental income. If I told you that we aim to pay out a minimum 7 cents a share by 2012, and continue the payment beyond 2012, people who look for a stock with a developer play and would want to collect respectable dividends would look towards the company.

This is what I mean by the management policies. A policy that tells investors what to expect and what they intend to do in the future, especially its future expansion plans, is always a good thing as it reduces the investor's margin of error.

5. Invest In What You Know

The idea is taken from Peter Lynch. When we look at something to invest, we should look around us. Things that work around us, because it will give us first hand knowledge on how good/bad the product is.

For example, if your Toyota has an accelerator problem and you are one of the first users of it, you may wish to find out more about that problem, and an early research would turn out a result that a few people are experiencing the same problem as you. This is first hand information that may tell you that you should sell your shares in Toyota before the issue becomes widespread.

Or if you have bought an OSIM massage set ( I have never used an OSIM massage set), or if you always go to Popular to buy books, or if you get your coffee from Gloria Jean instead of Starbucks because they serve better coffee, all these are indicators that you should do a little bit of digging around about the company, so that equipped with the first hand information, you will be one step ahead of all the analysts.

For this same reason, I do not foresee myself looking towards techonology and semiconductor stocks because I can tell you, that I don't understand what actually happens at all.

The Correction

The current correction has sent my portfolio into negative territory for the first time. Over here, I would like to make some recommendations to help people sleep better at night

Invest with what you can afford

As investors, whatever we plough into our stocks is usually for mid to long term, such that we can weather such corrections. Do invest with what you can afford to lose. If you have trouble sleeping at night, it could mean that possibly that you may have invested too much.

Depending on your age, you may wish to keep about anywhere between 10% to 40% of your holdings in cash. I keep about 10% of my holdings in cash. As such I haven't be losing much sleep.

So what about people trading on margin. I have nothing against margin trading, but likewise, don't overload yourself. Put into your account about 70% of the amount you can afford to lose, and keep the other 30% as cash needed just in case of a margin call. That way, you won't lose sleep over margin calls.

Avoid Contra Trading

Contra trading is to purchase a stock, and before the payment is due, usually within 3 to 5 days, the stock is sold off. The difference between the purchase price and selling price is the amount you keep or you repay, depending on whether you made a gain or a loss.

Contra trading is one of the things that will made you stand on edge. If the tide turns against you, for example if China announces changes in monetary policy, these things cannot be detected by technical analysis. Purchasing the stock there and then is also a mistake, as the company may not have fundamentals to support it through the period of time. It may result in you racking up big losses.

With these 2 pointers, I hope that you will have a better sleep over the next few days as we unwind from this major correction.

Preference Shares

There was an article in OCBC on Investing for Ladies, which focus on preference shares as a source of income for ladies.

What are Preference Shares?

For the uninitiated, the shares that are normally traded on the exchanges are common shares of a company. Preference Shares work slightly differently from these Common Stock.

1) Preferred Stocks receive dividends before Common Stocks. Therefore, you can say that you are first in line to obtain a share of the earnings from the company.

2) In times of insolvency, Preference Shares are entitled to a share of the assets after the debtors have been paid, and receive it before Common Stockholders.

3) Preference shares provide guaranteed dividends should the company announce that dividends are to be paid out to the shareholders. Since dividends are essentially guaranteed, the price fluctuations of the Preference Shares is usually lower than Common Shares. Take note however, that there may be certain occasions that the company does not declare dividends for the year, and you will not be able to obtain your payout. These occasions are few and far between.

What does these all mean? For example, if Company A has a preference shares that is labelled Company A 5% NCPS, it means that should Company A announce the distribution of dividends to Common Shareholders, Preference Shareholders will be entitled to 5%p.a. of the offer price of the security (you can find this information on SGX). As such, Preference Shares can be considered as a fixed income security.

For the Kiasu Singaporean, it just means that you are always at the front of the queue for the dividend payout.

Why Invest in Preference Shares?

For more risk averse people, Preference Shares provide a source of fixed income. This form of passive income appeals to them as the risks are low. I encourage people who have spare cash lying around to invest in Preference Shares.

Furthermore, compared to fixed deposits or investment linked insurance, Preference Shares are more liquid, as one can sell of the shares in order to obtain your investment, which most of the time would be almost equal to the initial investment.

Risks of Preference Shares

There are occasions when Preference Shares become totally worthless. For example, Citigroup's Preference Shares were excellent to hold onto, but since the financial crisis, the Preference Shares are essentially worthless because the main attraction, and thus price, of the Preference Shares are determined by the dividend payout. Since Citigroup is unable to announce dividends, the Preference Shares have become worthless.

Furthermore, as Preference Shares show little signs of capital appreciation, during a bull run, preference shares may not provide a large return as compared to Common Stock. Another point to note is that Preference Shares does not give you voting rights. That is a small tradeoff for a fixed income, don't you think?

Having said that, as I am more of a risk taker, I do not advocate dividend investing. However, for more risk averse people, Preference Shares is an excellent way to start off a portfolio for a fixed income.

This article was requested to be done for someone dear to me. Hope it will help everyone out there who are looking for passive income.

Share Price and Company Operations

How does the Share Price affect Company Operations?

A Share Price does not affect the daily operations of the company. What the share price does is to provide a reflection on how much a person will pay to lay claim on a percentage of the earnings, and should the company wind up, a percentage of the assets after the debtors are paid off.

Companies secure funding from the public through Initial Public Offerings, Secondary Offerings as well as Issuance of Rights. These are methods to obtain funding from the general public. In return, they give up a percentage of their ownership of the company.

What does the Share Price tell you?

The share price tells you how much a person would pay to obtain the percentage of earnings by the company. Therefore, if the company performs well or has high growth prospects, I would pay more to obtain a share in that company. As long as the company is improving its year on year performance, the value of the firm increases, as should the share price. A lagging share price due to inefficient markets provides opportunities for value investors.

How we lay claim to the earnings of the company is through its dividends, and/or by divesting our holdings.

Why does the Share Price not reflect the Company's Value?

There are many occasions where the Share Price does not reflect the company's value. This results in the company being overvalued or undervalued. This is due to the inefficient market hypothesis.

For overvalued companies, what will usually happen is that once the hype is over, or if investors feel that there are other undervalued options out there, the company's share price will correct, resulting in a drop.

For undervalued companies, what will happen is that should people discover that the company is underpriced, and in layman's terms, value for money.

"Price is what you pay, Value is what you get". I always keep that in mind and assess if it is possible for the company to increase its value, before deciding if I am overpaying or underpaying.

Non-Dividend Paying Companies - Good or Bad?

There are some companies that do not pay dividends. These companies could be capital intensive companies where they need to retain cash for expansion purposes. These companies could also issue rights more often than others in order to finance its operations. It results in money outflow from the investor without much money inflow.

So why should we still take into account non dividend paying companies? Companies that do not pay dividends are not necessarily bad. As the company turns in better returns, the value of the company will increase, as will the share price once the company is noticed. This would mean capital gains for investors. Furthermore, once companies have matured, they may change their policy such that they provide dividends.

Dividend Investing?

I do not advocate dividend investing as it requires a large capital to obtain substantial returns. Furthermore, REITs (one of the higher yielding stocks) are also affected by the downturn. The performance from Dec 08 to Feb 09 can be found here.