Tuesday, February 14, 2017

Let's talk about Money and Gold too!

A very Happy Valentine's Day to all!

This is a continuation of the previous post.

In the last post, we discussed asking some really fundamental questions about companies to see if they stood the test:

1. Does the company help improve the well-being of its customers?

2. Does the company add value fundamentally in ways that make all lives better?

3. If the company did not exist, would the world cease to functional properly in some ways?

These questions help us explore fundamental concepts that are really the basic tenets of life. These things are more fundamental than money or our notions of countries, democracy or even human rights, which are essentially concepts of the collective human consciousness. A dog or a monkey has no interest in money or where the country boundaries lie between France and Germany. But they do know kindness, reciprocity, value add and love. These are the true fundamentals in life. In my opinion, if investing is deviated too far from these, then it didn't make sense and would ultimately fail.

Minions at Genting's Universal Studios Singapore

Let's take a look at Genting, a stock which had been discussed previously as cheap and perhaps a good buy. But how does it fare against the three questions posted above? Does the company help to improve the well-being of its customers? Well, that's really tough. How does gambling help improve one's well-being. I would really scratch my head here. In fact, gambling would destroy one's well being and also affect those around him, especially his family. Especially if he suffers from gambling addiction and is forced into debt and other woes.

Does the company fundamentally add value to make all lives better? Again, it is hard to see how a gambling resort add value to all lives. Perhaps it adds value to its employees by creating jobs and its shareholders, but not all lives, and definitely not those who were addicted and driven to debt and detrimental ways. So, if the company did not exist, would the world cease to function properly? In the last example, Dairy Farm, we could argue that some neighbourhoods might face disruption, until the competitors fill the gaps. But for Genting, even if all the hotels and theme parks disappear tomorrow, does it matter?

I would argue it doesn't. Life goes on. Perhaps the tens of thousands of Genting's employees might need to find new jobs but for the rest of the world, it really didn't matter if Genting disappeared. That's the sad truth. Having said that, vice stocks have created the best value for shareholders. Hence this is a philosophical argument whether we, as responsible and astute investors, want to own vice stocks that fundamentally do not add value to the world.

Ok, food for thought but let's move on.

In the last post, we also discussed the concept of money. Money is a trust system that is established over millennia by humans to faciliate transactions using currency mediums like sea shells, gold, or in today's context electronic ones and zeroes. There is a very remote risk that the system might fail, as it did in Germany during the 1920 hyperinflation, or in Singapore after WWII when banana money issued by the Japanese became worthless when the Japanese lost the war. During the Global Financial Crisis of 2009, we were very close to the collapse of the global monetary system.

Hence as astute investors, it might make sense to put a small portion of our investable assets into something that would mitigate this risk. Some very notable investors had always advocated having some money in gold although Warren Buffett, the Oracle of Omaha himself, never approved this idea. However as a risk mitigator to the collapse of the global financial system, it really does make sense, to buy gold, as a hedge. Yes, while gold will not compound its value over time - a block of gold will be the same block after 10, 20, 50 years, it will store and retain value in the improbable event that everything breaks down and all our bank notes, all our zeros in our banks, all our electronic stock and bond certificates fail to register.

In that same vein, we should think about investing into valuable stuff in the real, physical world that would still be essential for living - hard assets like land, modes of transport - motorcycles, electric vehicles and perhaps, value creating assets like solar panels or power storage like Tesla's Powerwall. The idea is that if the global financial system does fail and we are going back into the Dark Ages, then we need stuff that would be useful in sustaining lives. Land to plant food, means of transport, energy etc. Of course, this is a very, very remote scenario. It is more likely that life goes on for the next 100 years. But the idea is that we shouldn't rule things out. It make sense just to put 1% of our assets or less into these. In the most practical terms, maybe we should just hold some physical gold.

Bollywood actress purchasing gold from a Gold ATM

Gold is an unique asset class. It represents the ultimate store of value because its status had been independently verified and had since evolved together with the collective human consciousness over time. Almost all ancient civilizations used gold as a status symbol, in decorating temples and tombs alike. In modern times, it was the standard for the global currency exchange and even when that broke down, it remained as a safe haven asset class in times of crisis. It is the universal currency for all which would transcend failures of the financial system. So, do buy some physical gold from the local jewellery store. Remember, it shouldn't be a gold ETF, but real physical gold! 500g would cost roughly S$25,000 and fits in the pocket, which could be a good start.

So rather than buying roses, maybe it's worth buying some gold accessory for your Valentine today! That would kill two birds with one stone! Investment and love does go together! Again, a very happy Valentine's Day!

Tuesday, January 31, 2017

Happy CNY! Let's talk about Money!

Wishing all readers a very happy Chinese New Year! Happy CNY, Huat Ah!

Sapiens: A Brief History of Humankind by Yuval Noah Harari was a book published in 2014 that became a New York Times Bestseller and has been translated into 30 more languages. I have read the book twice and found it intriguing enough to discuss it here as some of the concepts were not just refreshing but relevant to investing. The author Harari cited that the inspiration for his book came from Guns, Germs and Steel by Jared Diamond, which was also a New York Times Bestseller which I had also read and was also another eye-opening book for those interested in the history of the human species.

Book Cover of Sapiens

Both books talked about how humans managed to achieve what we achieved today looking back in time from the Stone Age, exploring social cooperation, the advent of verbal communication, the genesis of writing, domestication of animals and other important technologies and concepts. In this post, we shall explore one of the most important concepts that humans came up with and its implication on investing - the concept of money. According to Harari, money does not exist in the real world beyond humanity. Harari introduced this concept from an interesting angle. He implored us to think not as humans but as other species on this planet such as giraffes, rabbits, octopuses and when we think as animals, we then realize money doesn't matter. Giving $1,000 to a monkey means nothing to him. He would be happier with a banana!

Hence money is a concept that doesn't exist in the real world beyond our collective human consciousness. This is very much like imaginary country borders ie countries themselves and imaginary lines such as the Equator or the Greenwich Meridian.

Money is a concept that has been refined by humans over the ages. Cavemen started with barter trade, then used stones and sea shells, which then evolved into gold, then bank notes, then electronic ones and zeros today. It works only because it is based on a communal trust that humans created. The trust that these stones, or gold, or notes represent claim checks on the society which other humans can swap for goods and services. It works only because all humans believe in the same concept. It is a collective myth we invented to facilitate transactions. It didn't work all the time. In the Stone Age, when the currency medium didn't register, money didn't work. For instance when another tribe didn't value exotic sea shells, the transaction broke down. Similarly, when hyperinflation exploded in Germany in the 1920s, bank notes became worthless. Perhaps gold is the only universal transactable currency that could transcend time and all other currency mediums. 

During the Great Financial Crisis when Lehman went bust, we were quite close to the moment that the whole global monetary system and this whole concept of money might break down. If that happened, then all our monies, all the bank notes, all the zeroes in our bank accounts meant nothing. So, if we think deeply about this, we have to be more holistic in the way we handle our finances. As astute investors, we need to think at a more fundamental level.

Family bonding

One perspective would mean following true fundamental concepts like reciprocity, value add, being healthy and able, helping and bonding with others. These are concepts that resonate with all living things, not just homo sapiens. If we treat animals like dogs and horses well, they will reciprocate in kind. If we make ourselves useful, able, we can always extend help and bond with anyone. Bacteria can exist as they too are playing useful roles in the world, like decomposing waste. During this CNY festive season, we are also rekindling family bonds, reconnecting with people that had made a difference in our lives. Reciprocity, being useful, bonding with others, these are the true fundamentals in life.

When we start thinking at this basic level, it then make sense to link these values back to buying companies that are applying these concepts. Facebook and Tencent create huge value add by trying to bond people digitally, making connections using technologies. Tiffany provides true value when the little blue box is presented by the giver to his significant other, which will become a testimony of their love for each other - you are my only one true love. 

Tiffany's ad and slogan

Expanding on this theme, perhaps it is worth asking these few questions when we want to invest in a company that we had researched well:

1. Does the company help improve the well-being of its customers?

2. Does the company add value fundamentally in ways that make all lives better?

3. If the company did not exist, would the world cease to functional properly in some ways?

Framing the questions in such basic terms can really give us another perspective on our investments. Take the Dairy Farm Group as an example. The Group operates Cold Storage, Guardian Pharmacy (Mannings in Hong Kong), Giant, Seven Eleven, Ikea and GNC amongst others retail big brands in South and East Asia. Does the company improve the well-being of its customers. Well, more or less, yes. We buy daily necessities, medicine, even furniture from the Group. Even though online e-commerce had taken over some of its share, we still pretty much need to shop at some of the outlets of the Dairy Farm Group.

Dairy Farm Brands

Does the company add value fundamentally to make all lives better? Well, this is harder to answer. Obviously all the chicken and fish on sale in Cold Storage wouldn't agree. But for most humans, perhaps yes again. So I would half check this box. The last question would always be the most interesting: so if Dairy Farm disappears tomorrow, how is the world affected? So imagine, there's no more 7-11, Giant, Guardian tomorrow. Well, there might be some impact, some inconvenience to some people. Yes, there is still Cheers, NTUC Fairprice and Watsons but I guess some neighbourhood might find it really disrupting. Perhaps the disruption would create havoc for some people for a month or so as people scramble to do shopping at other locations until Dairy Farm's competitors come in the fill the gaps. So, yes, for some, the world do cease to function properly, at least temporarily. 

So in all, I would say that Dairy Farm scores a 2 to 2.5 out of 3 here. This is a company that fundamentally adds value. Alas, valuation is a big hurdle with PE at more than 20x and EV/EBITDA at mid to high teens. With the stock jumping a good 15+% in the last month, value investors would think twice buying now. 

Next post, we look at companies that would fail this test and also explore other concepts related to universally true fundamentals!

Next post is out!

Tuesday, January 10, 2017

Health and Wellness: A Secular Trend

Happy New Year and Welcome 2017!

As a semi follow-up to the previous post, let's expand on the health and wellness theme that was discussed. There are two key factors to health and wellness: diet and sports. Ideas for diet would be about nutrition. Stocks could be Nestle, GNC (the supplement company) or maybe Danone. But in this post we focus on the second factor: sports. Or more specifically, sportswear including sports shoes.

To illustrate an important point about sports related industries, the following two charts on bicycles tells a good tale. As we know, cycling has become really big globally with major bike events and more and more enthusiasts joining this sport. It's enjoyable while giving our bodies good workouts but most importantly it's another way to show status. The bike, which can cost five figures, the attire, the tours, all adds to the glam surrounding cycling. It has all the right ingredients and is perhaps the good showcase for most health and wellness stock ideas.

The charts below depict the trends on Taiwanese bicycle exports. Yes, Taiwanese bikes are now the best in the world. The top chart shows unit prices in dollars and the bottom shows the total export value. As we can see, average unit prices had gone from $100 to almost $500 and in value terms, the industry grew 3x in the span of 15 years. Sports cycling as with jogging or other competitive sports is an industry where manufacturers have a lot of pricing power. This is a result of good marketing, constant innovation, as well as consumer mentality in paying up for performance and value. It's good business.

Prices only go up in sports!

Sportswear and shoes is a similar secular growth sub-industry having being shaped by the two giants, Nike and Adidas, over the decades to be oligopolistic and hence all the more capable of maintaining and raising prices by providing innovation and value add to the consumers. Consumers are willing to pay because they see tangible benefits. Well, actually there's both tangible and intangible benefits. For tangible benefits, running and basketball shoes would be the most obvious examples. Almost everyone would pay up for a better pair of shoes given that poor quality ones simply dis-integrate after a few uses. Bad shoes result in pain or sometimes even injuries. So who wouldn't pay up for Air Jordan or Adidas Ultra Boost for marathons? Well, as for intangible benefits, as teenagers and twenty-somethings, shoes and sportswear became bragging rights. Air Jordan was just a must-have for all basketballers! Right?

To further prove the point, the following chart shows the long term share price of Nike stretching back to 1981 (Adidas chart looks the same as well). We can see how this phenomenal firm had just compounded value over time and should continue to do so. In fact, the no.s are too small to be read from the chart. So let's put them in words here. In 1981, adjusted for splits, the stock was trading in the cents, like 10 cents. In 2000, after the dotcom bust, it was a few dollars, like $4. Today, Nike is trading at $51 with a market cap of USD 86bn! In other words, putting $1,000 in Nike in 1981 would be worth $510,000 today! Nike, as a stock idea, is simply a no-brainer. Just buy when the stock falls. At 4% FCF yield today, it's not too bad, but if we want a bit more margin of safety, maybe we should target closer to 5% FCF yield i.e. enter closer to $42. If it ever gets there, we should just close our eyes and buy this winner.

Nike long term share price

What is more interesting might be another up and coming competitor - Under Armour or UA in short. Under Armour has taken the world by storm in the last few years as an alternative to the two giants. People like its logo, the cool apparel designs and its new challenger status. Especially for the millennials, Nike and Adidas were what my parents wore, I wear Under Armour. Then their parents also started wearing UA. The firm's revenue went from USD 100m in 2003 to close to USD 5bn today. A 50x increase though still 1/6 of Nike's whopping USD 33bn annual sales. It did all the right things, going into the different verticals like basketball, running, cross-training and trying on golf and soccer. It seeks endorsements from athletes and celebrities and now boasts a cool list from Stephen Curry to Andy Murray to Dwayne Johnson a.k.a The Rock. Essentially following the playbook that Nike and Adidas had written in the 1980s and the 1990s. 

What's more, it had also appealed to the girls with feminine designs, taking on Lululemon Athletica and winning. Lululemon is less than half of Under Armour in sales and seemed more about sexiness than sports. UA did not start with a niche like yoga and hence had a broader base and the financial power to expand rapidly across regions and categories. Not to mention that getting sponsors need money, a lot of money. Especially when UA likes to get a whole slew of femme fatale sportswomen and fashion models. 

Under Armour femme fatale spokespersons

In fact the reason why it dropped so much and gotten interesting it's bcos it spent too much money and the markets got worried. Share price collapsed from a high of $45 earlier last year to $25 today. This is yet another example of unpredictability. If analysts were asked to guess early in 2016, who could have known that the all powerful Under Armour would fall 40%?

Well in order to take on the two giants (Nike and Adidas), UA went on a crazy capex spree, spending over $800m in the last three years. Not just on new stores but also on R&D and more endorsements. Again, take a good look at the top female athletes and models in the world above that UA found to help further boost its popularity with women, something that Nike and Adidas had not been as strong. Its stable of female spokepersons include Lindsey Vonn, Gisele Bundchen and Kelley O'Hara, all eye candies, definitely didn't come cheap. That's the game. Pay up and pay more so that the competition just falls off! UA is just taking the Nike, Adidas sponsorship game to another level.

Lindsey Vonn, the beautiful skiier, is especially motivational given her trial and tribulations with injuries and sacrifices. She started training at 7 and debut in the Winter Olympics at 17 in 2002 with high hopes but did not win any medals as with Olympic debut since it's more just for experience. In 2006, she crashed during practice and was heli-evacuated but came back after just two days to compete, finishing 8th. She won a Olympic Spirit Award for her grit. In 2010, She finally got her first Olympic medal, deservedly a gold, after 18 long years. Our Joseph Schooling suddenly seemed so fortunate yah? Under Armour's commercial pitch was just about making it into awesome story-telling. Here's her poster from UA: I will not be underestimated. Damn, so cool!

Lindsey Vonn, world champion skiier
Under Armour's own story is also quite inspiring. It was founded in 1996 by its current CEO who was an American football player himself. He noticed how synthetic fiber was superior as he wore them while playing. At 23, he started his business selling sports apparel made from synthetic fiber in the trunk of his car. He first targeted performance apparel for American footballers in schools, then branched out to baseball and finally mass consumers. Today, UA makes shoes, caps, socks as well as performance apparel for athletes and laypeople from youth to professionals. 47% of its customers are female and over 36% are college graduates who like to spend and can and will spend a lot to look good and feel good.

That's Under Armour. If it continues to grow, the stock shouldn't be at $25. It's market cap is currently a mere USD 12bn vs Nike at USD 86bn. Given that the industry would continue to grow and UA should grow faster, we can expect UA to be more like half of Nike at some point in the future (say five years). Okay at least 1/3 perhaps. Regardless whether it's 1/3 or 1/2, this would mean that UA market cap should be closer to at least 33% of Nike's i.e. at c.USD 28bn  (more than 100% upside) and that's assuming Nike stops growing which won't happen. So UA would be worth even more. 

Some might argue that's too optimistic. Let's use a different lens.

Looking at its own FCF, UA had not achieved stability as yet given its huge capex needs. In good years, it managed USD 100-200m of FCF but in others, it burned cash. However if its growth materializes, revenue should hit 10bn (slightly less than 1/3 of Nike's), NP should hit 600-800m and FCF should then stabilize at a tad lower at 500-700m, which means that we are getting c.5% FCF yield at today's market cap. Again, it's not unreasonable valuations.  

Well, having said all that, a thorough analysis of UA is warranted to make the numbers more concrete. And the risk that UA falters like the rest of the tier two sports brands remains real. Some tier two brands remain tier two forever because they simply cannot compete with Nike and Adidas. In US, we have New Balance, Sketchers, in Japan we have Asics and Mizuno and China... Remember China and all its hype about Li Ning and Anda? It's definitely safer to bet with Nike or Adidas. UA is more about higher risk higher return! There would be a limit to its downside though because if UA gets too cheap, someone would just buy it out.

This author doesn't own UA yet. 

Wednesday, December 21, 2016

2016 in Review: Most Unpredictable Year Ever!

2016 has to go down in history as the worst year for forecasters ever. Who would have predicted that the China market would collapse 25% in the first month of the calendar year, after dropping 40% in 2015, then only to rebound by year end? And the Bank of Japan reducing interest rates into negative territory, pulling 20-30% of the global bond market into negative yields. And commodities! Oil from $100 skyfalling to $30 and then back to $60, bringing the rest of the resource stuff - iron ore, copper, coal up, up and away!

Then Duterte, a maverick who became President of Philippines amongst high hopes, saw his country becoming the worst performing ASEAN stock market of the year. Then Brexit happened. But then again maybe it's not possible after all due to technicalities. Or it might take a full 10 years to fully exit. Then a King died, and a Cuban dictator whose reign lasted 10 US Presidents also died. Then a best selling phone became a grenade. And the other best selling phone can't use conventional earphones to listen to music. This was the company that transformed music listening with the iPod. Then Donald Trump won, and Renzi lost, and then India decided that its notes would not be legal tender anymore - a move that caused widespread panic among small businesses and rural folks. Gosh!

Oppa Gangnam Style!

Even in the last two weeks of the year, unpredictable bad news can't seem to stop. A refugee decided to bulldoze people in a truck in Germany, the European country that had accepted the most number of refugees in Europe. This event itself might cause the downfall of the most powerful woman in the world, maybe bring about the breakup of Europe? So would it be Brexit first or Breakup first? Elsewhere a Russian ambassador got assassinated while his President enjoys onsen in Japan with his Japanese pet dog. The same President, in the presence of his gracious hosts, then tells the host country straight in the face he won't return the islands his country confiscated controversially during WWII. WTF?!?

Perhaps the only good thing that came out of the year was that a small country no more than a little red dot on the world map managed to clinch its first ever Olympic gold medal as a butterfly against the world's fastest swimmers, who all got silver. Well, this was predicted by some in the swimming inner circles (the gold though, not the three silvers). Yeah! One prediction gotten right.

It goes back to an old point made here - prediction is futile. The future is a set of probabilities. There are a few outcomes and one would become real. The point of investing, is not to predict but to achieve a good expected return. This means, know all the possible outcomes. If A becomes real, what happens. If B becomes real, what happens. Bet such that the expected return will be okay. Say if A comes true, we are neutral. If B comes true, we make a ton of money. If C comes true, we lost 20%. So it's worth a bet. It also means, reading and knowing a lot and making many, many investment decisions over our lifetimes such that in the end, our average expected return will be good enough.

For most people who are new to the game, they like to ask about the future. What would happen? Is USD going to strengthen or weaken? Is STI going to hit 3,000 or not? Then talking heads come in and fill the gap. These amateurs then love it! But the truth is, nobody knows! Who could have predicted Brexit will happen, Trump will win, China will crash and rebound, oil will crash and rebound, commodities will rally big time and the best performing Asian market in 2016 is Thailand - after their King died? 

 Thailand: 2016 best performing Asian market in rollercoaster fashion

Hence it's not about predicting, it's about preparing well. This means reading widely, discussing with like-minded friends, understanding dynamics, then looking for opportunities where expected returns might be very good. One highlighted idea last month was Vietnam (or rather Vietnam property). If the high probability future that the country becomes another Asian Tiger (like Korea, Taiwan, HK, Singapore and needless to say, China) materializes, we have huge, huge upside (like 5x). If it doesn't we lose some money (maybe 30%) in the worst case scenario. That's very good expected return.

To digress a bit, one other big trend that is beyond prediction worth mentioning is the health and wellness trend in our lifetimes. As the global population ages, more and more people think about health and wellness and are willing to spend a lot more to maintain their health. This is a huge positive trend that spans across various sectors including supplements, retail, healthcare, apparel and even IT. Fitbit is a multi-billion company and was worth USD 6bn at its peak! Alas it was overhyped and now collapsed to a smaller USD 1.6bn market cap, but still big.

The two most important aspects of health are actually just diet and sports which doesn't really cost a lot of money but our current consumerism mentality makes sure that we spend as much as possible and be as glam as possible while pursuing our pink of health! Think of the huge supplement and sports apparel industries. Today, running is not putting on our sneakers and just do it, it is about wearing nice Under Amour shirts and 2XU compression pants, equipped with Fibit, mobile phone straps, great shoes and finally posting the run on Facebook! It's a whole new ball game!

But, diet is really the more vital aspect. This author would highly recommend reading this book titled the The Enzyme Factor by Dr Shinya Hiromi. It is compact, easy to read and comes with pure simple logical diet tips that should just be followed by everyone. As a surgeon for 40 years, Dr Shinya crystallized a simple fact: cutting out cancerous body parts did not cure cancer. The "cure" is good diet, good lifestyle. Just to share one tip out of the many in the book: eat a lot more fruits and eat less meat.

The Enzyme Factor

According to this doctor, fruits are created by Mother Nature to be eaten. Hence it contains all the best nutrients and enzymes for living creatures to be absorbed into their bodies. A diet filled with variety of fruits like tomatoes, apples, oranges, bananas, avocados supplemented with other vegetables and small amount of meat would be very healthy and his patients who followed his diet never get cancer relapses. Fruits are also easily digested and hence doesn't burden our digestive systems while meat, esp red meat is very hard to digest and a lifetime of eating meat ultimately causes cancer and/or illnesses. If we look at the structure of our teeth, we have only 4 out of 32 adult teeth that are suitable for eating meat. That's our incisors. Hence our meat to all food ratio is determined by evolution, it should be just 1/8 of our diet. Literally, food for thought huh?

Back to prediction and preparation, a good life is also about preparing well. We cannot predict markets but doctors/nutritionists can surely predict how people fall sick and eventually succumb to what kind of terminal illnesses just by looking at their diet and lifestyle. Stressful lifestyle with lots of tobacco eventually leads to cancer. Alcohol leads to liver problems. Meat lovers get heart diseases or colon cancer. Maintain a lifetime healthy diet, exercise and live stress-free. That's the best preparation against cancer and other big diseases.

It's all about preparing well for a good second half, to use soccer parlance. Yes, we are all more or less hitting half-time, and the score is 0-0! Okay maybe 2-0 for some. Time to strategize! As humans, we tend not to think too far ahead, usually thinking a few years ahead would be considered a feat. No one thinks more than 10 years ahead. When we are in our twenties, all we can think about was money, fun, glam. It never crossed my mind that I would be a father in a few years, have an ass full of debt from the home mortgage and how should I prepare for it. Now that I think back, it's really a miracle that things worked out without much preparation.

To sign off, let's talk about 2017. Remember it's not prediction but preparation. It's not easy but let's try. In my view, 2017 could see the rise in animal spirits given the very bad 2016. Investment appetite especially with the US economy recovering could pull parts of the world up. Although China and Europe should remain tough with the bad debt issues still haunting the financial sectors. So what's the preparation needed? Maybe look to deploy a bit into secular sectors, like health and fitness. Meanwhile in Singapore, 2017 could be the year the property oversupply hits a peak after which the no. of new condos would drop. Hence it might mean it's the bottom for the property market. It's could be the last chance to buy Singapore property before it becomes way too expensive. So, be prepared!

Merry Christmas and a Happy New Year!

Wednesday, November 30, 2016

Hierarchy of Financial Needs

Most readers would probably have come across Maslow's famous hierarchy of needs: a pretty neat explanation of how humans should view our existence in terms of our needs. Abraham Maslow, an Amercan psychologist, created this hierarchy as he was trying to understand human nature. 

The hierarchy of needs is usually produced in a pyramid like the one shown below. The theory goes like this: humans have needs and we need to fulfill our basic needs before we can advance to the next level. For example, the most basic needs like food, water, shelter have to be fulfilled before we can think about health, starting a family, owning a property etc. As we move up the hierarchy, we need friendship and connections, develop self esteem and finally achieve what we are supposed to achieve - self actualization. In short, reaching our potential in life.

Maslow's hierarchy of needs

As civilization progressed, most developed countries today, including Singapore, have moved up the pyramid and a lot of individuals do have opportunities to achieve self actualization. Maslow postulated that only 1% of humans would actually succeed. Well, that's probably not far from the truth given that a few hundred million people still live in poverty, in war torn territories, fearing for their lives, wondering if they could eat the next meal. Let's pray for them. However, in developed countries, the population of people who can self-actualize would be much higher, including most readers here.

In the world of personal finance, we can modify the pyramid to map our financial needs following more or less the same rules as the original Maslow pyramid. In this new hierarchy of financial needs, we also need to fulfill the lower levels before we advance upwards. The lowest level corresponds to the very basic and important needs. In life, obviously we need food and water before we talk about other needs. In finance, it's the same reasoning, we should fulfill fundamental needs first. However there would be minor differences as we delve further. 

At the most fundamental level, we first need to build our foundation before anything else. This foundation incorporates, most importantly, stable income which is salary, or for entrepreneurs, cashflow from their core business. Once we have achieved that, we should own our homes or for some countries, make sure that the salary takes care of the rent (unfortunately Singapore might fall into this culture some day as it gets too expensive to own our homes). And as the old adage goes, we also need savings for the rainy days. As a rule of thumb, we should have cash savings of around 12 months of expenses to cater for emergency needs. Since this website started out talking about investment, we often neglect these bread and butter issues. Investment actually comes after we have our foundations built! The following pyramid gives a sense of how the financial needs are ranked.

Hierarchy of Financial Needs

The second level is security, or protection. This is where we make sure we are protected by buying insurance and strive to have more incremental savings (beyond 12 months of expenses) if we can. We also then try to supplement our cashflow by investing these savings, thereby receiving dividends if we buy stocks, or bond coupons if we have bonds. Needless to say, one of the best security is having a second property that gives good rental income. The goal here is that the dividends, coupons, rent received from stocks, bonds, property here would cover expenses some day. It is worth mentioning that salary, by and large, will always be the main source of income. Rich Dad Poor Dad did the world a major dis-service by introducing the concept of passive income. It's a lie. Passive income cannot replace salary or an entrepreneur's main source of cashflow. Even if we reach aforementioned scenario where our dividends, coupons and rent can cover all our expenses, we should still work if we are employable. Of course, we then have the freedom to choose jobs that we find meaningful and hence can truly enjoy.

Insurance is a topic that deserves more scrutiny, but perhaps in another post. The whole industry is made complicated by agents as most of them mis-inform and mis-guide their customers. While it is important to have insurance, it's more important to buy the right ones with the right amount of money! A rule of thumb could be using 5-10% of the overall income to buy the correct insurance (usually term insurance) for good protection. Insurance is ultimately a cost paid to gain protection from adverse events and agents like to use emotional blackmailing to make people pay more than they should. We need to exercise common sense and rationality extremely well when dealing with insurance agents.

At the growth level, the focus for this website, we are actually talking about investing like the great investors - Warren Buffett, David Einhorn, Ray Dalio etc. We think hard and try to pick stocks well - stocks that compound growth and becomes multi-baggers over time. Or we take advantage of rare arbitrage opportunities to compound wealth. Hopefully we beat the markets when we measure ourselves across decades and make really good money. By right, this level should only be attempted when we have fulfilled the lower levels. But we do need stable income from dividends and bonds (at the security level). So, in a sense, there are overlaps. We need a few good stocks to supplement our income at the security level, yet the same capital would help catapult our growth. It's also worth noting that the growth level takes on higher risks to achieve higher returns. 

The highest level, arbitrary termed wealth maximization is about maximizing returns, which means we engage in the highest risks investments which can pay out big amounts, usually by utilizing a small percentage of our net worth (say maybe only 3-5% of our total net worth). For instance, buying long dated options or bio-tech stocks or for high net worth individuals investing in venture capital and the likes. This is a stage where we are prepared to lose the whole amount, but since it's limited to a small percentage of the portfolio, it doesn't really change things. But we have the opportunity to hit the jackpot i.e. like finding the next Facebook or Alibaba. Again, as with Maslow's needs, perhaps only 1% of the global population would reach this stage. 

Over the years, many experts had also reviewed Maslow's original hierarchy and it was proposed that changes should be made to reflect how the world had evolved since Maslow's days. So the new hierarchy looks something like this:

Haha! Yes more fundamental than anything else, today we need WiFi! It comes before the need to eat, sleep and having a shelter. Okay, just kidding. The new hierarchy actually adds to the highest level which is termed self-transcendence or simply transcendence. Later in his life, Maslow and others believed that perhaps self-actualization was not the ultimate goal in life. It was to self-actualize and use that ability to help others. In Maslow's own words:

Self Transcendence - seeks to further a cause beyond the self and to experience a communion beyond the boundaries of the self through peak experience

In our hierarchy of financial needs, perhaps there is a similar transcendence. What is our purpose of accumulating so much wealth when most of our financial needs would probably be finite? Most billionaires have come to this conclusion. They would never finish spending their billions and it might not be such a good idea to simply give it to their sons and daughters, as it kills their motivation to work hard. Hence people like Warren Buffett and Bill Gates actually pledged to give away more than 80% of their wealth to further progress the human race. This is very noble and perhaps an inspiration for us as well. No matter where we are at the hierarchy, we can always transcend and give away whatever we can afford to those who need it more.

Financial Transcendence - giving away what we can afford to help others

Thursday, November 17, 2016

Vietnam Property: 5 Bagger! - Part 2

This is the continuation of the previous post on Vietnam Property.

We have established the following in the last post:

1. Vietnam has a huge and hungry population and is on the growth trajectory to be a developed country. GDP will continue grow at high single digit and property prices at a multiple of that over time. It might be the last Asian Tiger in our lifetimes.

2. The development of the Ho Chi Minh City (HCMC), mirrors the development of Shanghai. With the east of the city growing much faster: the analogy of Pudong and Puxi vs HCMC's District 2 and District 1. At current $2,000 psm, we can expect prices to see $10,000 psm in the future when HCMC becomes like Shanghai or Bangkok.

One big secular trend behind this is also the urbanization of Vietnam. As a country develops, its population moves from the rural farmlands to urban cities. Urbanization ratio over time climbs over 50% to reach 60-70% eventually. Vietnam today is at 34%. As we already know, Vietnam has a population of 94 million of which only a mere 8 million lives in HCMC (another 7.5m in Hanoi). As the country urbanizes we can expect HCMC population to explode. Most big cities in the world houses 15-20 million people when we include the sub-urban population, HCMC should see its population increase at least 50% over the next 5-10 years. 

Big Picture: HCMC City 

This is a major point because it debunks the over-supply argument. Most amateur investors would point to the enormous number of property development in the two big cities and say that over supply would come and prices would collapse. But when we think about how 5 million or even 10 million people would eventually find homes in HCMC, or for that matter Hanoi, over supply would never be an issue over a long enough time frame. Besides we are investing in the Central Business District or CBD, the core of the city where land will be limited. It is too easy to paint a bear story without seeing the big picture. 

Today, Vietnam is at an inflexion point. It's GDP per capita has almost doubled from $1,300 in 2010 to $2,200 today (chart below) and is likely to hit the all important $3,000 in a few years where the demand for cars, properties and modern goods takes off. The Vietnamese government relaxed regulations and allowed foreigners to own properties in 2015 and started to privatize many state own enterprises in 2016. These are all important milestones for growth. We can pretty much say that Vietnam is all out to transform from a developing to a developed country. 

Vietnam GDP per capita

If history is any guide, Vietnam would continue to grow its GDP at a high single digit, not unlike China in the 1990s and 2000s and its GDP per capita would reach $10,000 to 15,000 in time. The same chart above shows how it has grown steadily over the years but still at a low $1,300 which is lower than Indonesia, South East Asia's largest economy at $3,500 GDP per capita and Philippines, another rising star at $2,800 GDP per capita. The difference is that Vietnam is going to be another manufacturing hub, from shoes, to white goods to electronics. The formula that has proven to work as we saw how South Korea, Taiwan and needless to say China transformed their economies that way.

Coupled with the reasons hitherto, Vietnam stands to prosper and Ho Chi Minh City, being the commercial centre, stands to benefit the most. There is an estimated five or six new condominium developments coming on-stream in the next 1-2 years that are targeting foreigners. The HCMC property market is finally recovering after its huge decline as it was dragged down by the Global Financial Crisis (GFC). The Singapore developers already has some successes with a few earlier project launches, building on Singapore's brand name and property development prowess. One of the prominent project in District 2 called The Nassim launched by the Jardine Group targeting the luxury segment had done really well (more than 90% sold) and is set to redefine HCMC's luxury segment with potential for astronomical price increase.

The Nassim

The cherry on the cake is the affordability as a result of the low quantum of these projects. The Nassim, is going for c.$200,000-400,000 per unit and for the less luxurious projects, a state-of-the-art 90 square metre condominium can be bought for c.$150,000 - a quantum that can't even buy a 2 litre car in Singapore. Such is the irony of life. This is the function of Vietnam still being a frontier market and perhaps a reflection that everything in Singapore is really too expensive.

Well, if the story is so good, why isn't everything sold out?

As described before, there's always risk. Nothing is certain in investing and the future, though painted here as rosy and prosperous, is always but "one of the probably futures". The future is a set of probabilities. There isn't just one but many possible futures. When pundits predict one future and it turns out to be correct, more often than not, it's just luck. The true expert, points out all the possible futures and assign accurate probabilities, knowing that one of them would come true and how to bet in a win-win manner. The high probability future of Vietnam is that it succeeds as another Asian tiger and we get our 5 bagger. There is always another chance that it would falter. The government reforms could fail and the Vietnamese Dong collapses again and the story is pushed out for another decade. Or infighting in the Communist party resulting in some power struggle and the politics is thrown into disarray. If these futures pan out, unfortunately, the money put in would see substantial losses. The author would attribute a 10-20% chance of this happening. But still, the risk reward profile is highly favourable. It's 5 bagger vs losing say 30% of the capital. More likely than not though, investors won't lose their pants. There is always a buyer to sell to if the price is low enough.

The other major concern for investors at this juncture is actually financing. Because the Vietnamese economy only started to open up, there is actually no means of financing. There is no such thing as a mortgage in Vietnam today. The mortgage market is non-existent and the banks don't know how to do it. This is the state of affairs in frontier economies. However over time we can expect the Vietnamese banks to introduce mortgages and future investors would have it easier. Without mortgage or financing means, investors must put in 100% of the cash needed and be subjected to full currency risk. The Vietnamese Dong is ultimately an emerging market currency, the exchange rate is volatile and the bid-ask spread is very wide. These are the costs to investing. Although if the story pans out as we have discussed, then such trivial should be overlooked. Why think about a 3% spread or a 10% currency depreciation when the return is going to be 500%?

The other risk is the possibility of intermittent rental income.

As alluded to in the previous paragraphs, Vietnam is only starting to open up very recently. There is no concept of mortgage yet. Global manufacturing firms only started to setup shop 1-2 years ago. The rental market is only for expats working with the global firms. Most Vietnamese people are still living in villages and couldn't afford rental. The rich and famous Vietnamese are actually fellow investors in these luxury properties and they are not about to rent. They just buy properties when they need to stay in the city. Hence while the rental yield is touted to be a good 6-8%, actual rental would be a function of how good the property agents are, whether they can secure good tenants working for MNCs. The rental market is thus highly competitive given the new capacity for these luxury condos coming in the next 1-2 years.

Nevertheless, if the main scenario pans out, then the return should be in the tune of a few hundred percent and missing one or two years of rental yield of 6-8% shouldn't move the needle too much. To reiterate, this is a five bagger story. Vietnamese properties in Ho Chi Minh today sells at $2000 psm but should reach $10,000 psm which is closer to what global cities like Shanghai, Taipei and Bangkok is selling at. Such opportunities don't come often. 

Seize the day!

Read from the first post! This author owns a property in HCMC.

Saturday, October 29, 2016

Vietnam Property: 5 Bagger! - Part 1

Here's an investment opportunity of a lifetime, yes once in a lifetime. If there is one post that you should read in 2016, this is the one. It's about Vietnam - the last Asian Tiger.

For most of us in sunny Singapore, Vietnam is probably not on most people's radar. It's not as vibrant as Bangkok and the rest of Thailand, there is no historical site like Angkor Wat or Borobudur, hence not as big a tourist attraction. There are also no famous beaches, and no theme parks. Even the traditional costume Ao Dai (pic below) doesn't appeal much (sorry Vietnamese ladies) because it is an obvious rip-off of the Chinese cheongsam with an added disadvantage - showing less skin. Also, the investment story sort of pales against Myanmar's, which we saw a huge hype that started when Ms Aung San Suu Kyi was allowed to run office after spending 21 years under house arrest. Of course, Myanmar's property prices actually skyrocketed since 2012. Meanwhile, Vietnam had major issues after the Global Financial Crisis (GFC) which it still hasn't fully recovered from. It's currency, the Dong depreciating big time, the nascent property bubble burst and most investors then were still licking their wounds.

Vietnamese lady in Ao Dai

So what's the story now? Well here's the plot. In the past few years, China has gotten really expensive as a manufacturing base and global MNCs were looking for alternatives. Vietnam has a huge and young population (c.100m! Almost as big as Japan!) that is highly literate, hardworking and hungry. The Communist government has also seen how successful China has become and strived to modernize Vietnam. It's the same roadmap that all the past Tigers had followed, including our own beloved motherland's plan: start with manufacturing, lure MNCs with cheap workforce and government support, built up the skills of the people and put money in their pockets. As the nation prospers, GDP per capita compounds and property prices skyrocket. South Korea, Taiwan, Hong Kong and Singapore all prospered. Before the Asian Tigers, we had Japan and after, China, the biggest dragon of them all, basically following the "manufacturing to first world status" master plan. These countries succeeded following the same path transforming from developing to developed countries. So will Vietnam.

What's more: Vietnamese are also descendants of Han people, known for their tenacity and vigour. They will work hard and compete hard. Vietnam is also a coastal country with access to the vast oceans (as with all the other Tigers), which allows it to export manufactured products and import goods for internal consumption when the economy grows and its people become rich enough to buy good stuff. Hence it is highly probable than not that Vietnam will be as successful as all the Tigers and Dragons before her, if not more successful. She will also most likely be the last Tiger of our lifetimes, barring North Korea opening up. That's another story for another day though.

But why property?

Well, stocks are also possible, but I believe the property story is easier to understand and probably gives higher ROIC and lower risk as we shall discuss below. As the country develops, not all regions will grow as quickly, it's good to bet on the commercial centre of the nation - usually the one or two main cities. Stocks are more difficult to capture one or two city's growth. In the case of Vietnam, the commercial centre that we are talking about is the Ho Chi Minh City (HCMC). This is a beautiful city originally named Saigon but changed to be named after the Father of Vietnam - Bac Ho, who led the country to freedom by defeating the Americans after a bloody ten year war. Or rather it was the Viet Cong, using guerrilla tactics against modern technology that won the day. The Vietnamese dug elaborated labyrinth of tunnels beneath American camps and surprise attacked them until the US soldiers were so fed up that they decided to wipe out Vietnamese by the villages. Elderly, women, kids were all not spared. (Well, that's an over-simplification but for more, check out Wikipedia or google My Lai Massacre).

Bac Ho on a T-shirt

That's all history btw. The war ended in 1975 and the country started to rebuild after decades of trial and error, the last effort thrown off course by the GFC and set the country back for a few years. But today, HCMC is a spiralling city, something like Singapore in the 1960s, Shanghai in the 1980s and Bangkok some years ago. Motorbikes, rather than cars, jammed up the roads, high rise buildings are starting to pop up and road side stores and shophouses co-exist to provide local food and international cuisines. In today's world, we also see the co-mingling with global brands and modern concepts. Starbucks and designer cafes littered downtown HCMC and Zara and H&M have also setup their flagship stores. So this is the first important point - at the rate the city develops, we should see more modernization and property prices go up multiple folds.

Today, HCMC property prices range from $2,000 to $4,000 psm or per square metre (the convention used in Vietnam). In comparison, Shanghai is at $10,000 or more per square metre, Taipei is at $8,000 psm, Bangkok high end properties are at $6,000-9,000 psm. Needless to say, Singapore and Tokyo are much higher at $12,000 psm or more. If HCMC becomes on par with any one of these cities, we can expect HCMC properties to be multi-baggers. At the very least, it should double. 

Now let's look at HCMC in detail, this is where it gets even more interesting.

Ho Chi Minh City (HCMC) is divided into two halves much like most major cities by a river. The Saigon River runs through it like a snake and the old city was mostly built on the west of the river. This is very much like Shanghai where Puxi was the old town and Pudong was designated as the new CBD, given that land was abundant and bare, so the government could designate and plan much better without historical baggages.

Stylized HCMC map

In HCMC, the old CBD (marked as CBD in a white circle above) was labelled District 1 or D1 while the new areas were labelled District 2 to 7 (D2-7). District 2 (D2) is the most interesting, spanning from the north east to the east with parts of it already connected to the upcoming metro network. The stylized map above from Capitaland's Vista Verde project shows it better. D2 spans from the area near the top two bridges are where current expat communities and international schools are located with metro lines being built to where Vista Verde stands, which is supposedly near the new CBD. Capitaland, Keppel as well as other developers are building multiple projects in the areas mentioned above. The price for some projects starts at $2,000 psm while District 1 prices are now at $4,000 psm and above.

If we trace the development of Pudong, we can perhaps see where HCMC D2 will go. Pudong started development in the 1990s when the Chinese government realized they needed to grow the city to cope with the development of the country. Pudong was ideal given its proximity as well as the availability of raw land. Today Pudong commands higher prices than Puxi which is why HCMC D2 could see prices leapfrog that of D1 and go even higher. Bearing in mind that both D1 and D2 prices will keep going up as the economy grows which means that D1 can go from $4,000 to $8,000 psm while D2 can go from $2,000 to perhaps $10,000 psm ie five bagger.

Of course this process will take many years as development of a new CBD would not be just a 1-2 year affair. While it is possible for stocks to achieve similar returns, it would take a lot more effort trying to analyze which stocks could do that with better risk reward profiles. It's also more difficult to buy Vietnamese stocks given that its stock market is still too nascent and lacks liquidity and depth. 

Next post we look at some other factors and the risks, stay tuned!

Thursday, October 20, 2016

SIA Engineering - Part 2

This is an continuation of the previous post on SIA Engineering (SIAEC).

As described in the last post, SIA Engineering has a solid business model that helps global airlines maintain their fleet. SIAEC's business moat is built on strong branding, economies of scale, efficiency which churns out high free cashflow and a high return on equity (ROE). It's also worth noting that the business is somewhat counter cyclical - when the macro economy slows and air travel is reduced, the airlines send more of their aircrafts for overhaul. This is shown in the same table (used in the last post as well) below which has 2010 and 2011 having strong FCF despite the world going into a slowdown after the GFC.

Okay, as promised, we would need to explain the rest of the table in this post.

For readers well-versed in DCF which stands for discounted cashflow, the calculations would be straight forward but for others, let's just walk through this a bit. We have described the left columns which are just historical FCF and we have the FCF projections under FCF Proj. Right in the middle we have the column "Discounted" with numbers starting from 245, 250, 254... finally ending with 235 and 225. This is essentially discounting all the future cashflow into today. Hence the term: discounted cashflow model or DCF model. The concept of discounting is the opposite of money earning interest. In finance, a dollar today is worth more tomorrow bcos money can earn interest. Putting into government bonds will earn 2% (well used to be easier, now we need to put it for 30 years to earn 2% per year, but still, there's interest income/return on capital). In any case, since future dollars are worth more, we should discount future cashflow back to today's dollars. The discount rate used is 8%. This is depicted as the WACC at the top right.

Now as to why do we use 8% to discount is a major convoluted academic argument. To some, it's still inexplicable, like why is Singapore's first ever gold medalist Joseph Schooling standing inconspicuously in a midst of pilots and Singapore Girls at his own celebration party. Humble as he is, Joseph probably doesn't give a damn how all these attention seeking corporates are leveraging off his big win. That's story for another day. In a similar vein though, the world's greatest investor Warren Buffett doesn't give a damn about the convoluted academic argument about discount rates.

(Note: SIA Engineering is a separate entity from SIA)

But we need to explain WACC. WACC stands for the weighted cost of capital which is literally the cost of capital taking into account of the two type of capital: debt/bonds and stocks/equity. Capital is not free. Debt investors ie bondholders typically want to earn a low single digit return as their capital is more or less protected. Shareholders however stand to suffer permanent capital loss and hence it had been argued that the return that they earn should be a high single digit, which is why for our purpose, we have put in 8%, this knowledge site's namesake. For more, pls read this long article - Value Investing.

There are few more numbers that require some explanation: VCF, TV and IV (boy this is getting dry, but that's real investing, so bear with it!). VCF stands for the value of the cashflows projected which is essentially summing up the numbers in the discounted column. TV stands for Terminal Value.  This is the value of all the cashflows the firm will earn starting 2023 into perpetuity. Since we determined the cashflow from 2016 to 2022 (that's VCF), we need to determine the rest, and since firms can last forever, that's captured in the terminal value (TV). There is a formula for this:

TV = FCF*(1+Growth) / (WACC-Growth)

As explained, WACC is also the discount rate of 8% (for simplicity let's just put WACC = discount rate), and Growth at the far right is at 2%. The Growth here is an important number. It is also called Terminal Growth, which means the final growth rate for the firm into perpetuity. In theory, this should be GDP growth ie only 2-3% or even 0% for some countries. There is no such thing as 10% terminal growth. Since nothing grows 10% into perpetuity (it gets too big and overwhelms everything else!). Finally we are getting close to the end.

The same table again for easy reference

Now that we have the TV we add VCF, TV and the net cash of the firm, we can finally get to its intrinsic value or IV. To be exact, it's the intrinsic equity value of the firm. Again it's:

VCF + TV + Net Cash = IV

In this case it would 1714 (VCF) + 3535 (TV) + 560 (net cash) =  5809 (IV). SIAEC has 560m of cash which gets added (if it's debt we need to subtract). As stated, we then get to the IV of S$5.809bn and by dividing by the number of shares, we get to an IV per share (IVPS) of $5.2, or a 36% upside! This is the conclusion of the last post. SIAEC is a BUY.

But wait, all this number crunching, how accurate can it be? Isn't prediction futile? The answer is yes. As explained in the last post, all this number crunching is to just have a sense, most probably the numbers won't turn out right. In 2022, we shall see, more than half of those numbers would be wrong. So keep reading on, just eight more years! DCF modelling is just that - to give a sense. In fact, we should be doing multiple models. So here's another one below. This is the bear case model which have the starting FCF at a much lower S$200m and the T4 growth at only 5% for three years and then future growth at 2% which is same as the terminal growth. So for this model as you can see, the IVPS drops to $3.8 which means that there is no upside. Some might argue that's not conservative enough and we adjust the terminal growth to 1% and IVPS drops to $3.5 which was the stock price low in the last few years.

SIAEC's Bear Case

As you can see, the range of intrinsic value per share is from $3.5 all the way to $5.2. Now we are on to something. We have perhaps established that the risk reward is favourable. If things go really badly, the stock might drop to $3.5 ie 10% downside from here. But if things go well, then we have 36% upside or more. There could be a good bet here.

This is the crux of investing. We cannot predict the future. The future is a set of probabilities. We want to bet such that if it pans out the way we think it should pan out, then we make good return. But if it doesn't we don't get killed. In SIAEC's case, if it crashes to $3.5 and we lose 10%, we can easily make that back with two years of dividends.

This is why we love moat companies that pays dividends!

SIA Engineering - Part 1 

The author owns SIA Engineering since 2013.