Waiting for the perfect pitch - Looking at yield on one's investment

I shall discuss 2 sections here. First section is on the concept of "waiting for the perfect pitch". Second section is on recognising the perfect pitch, on when to invest based on looking at long term yield on one's investment.

First section:- "Waiting for the perfect pitch."
Warren Buffet describes wise investing as having a punch card with limited number of lifetime investment decisions (20 times perhaps). Each time a decision is made, the card is punched once. One can only excecute at most 20 investment decisions in one lifetime (each decision maybe a single buy or sell order). Once exhausted the 20 limited number of decisions, one cannot carry out any more investment actions. Though unrealistic, this really paints a strict investing principle of "one should only invest when it is wise to do so, otherwise do nothing". It also makes one thinks very carefully before making each investment decision.

Further to the punch card example, a more suitable demonstration of "waiting for the perfect pitch" describes a baseball batter who needs to constantly decide when to swing his bat at the ball. Warren Buffet describes a famous baseball batter who divides the batting range into many smaller square sections where the ball can fall into when flying towards him. This baseball batter only swings his bat when the ball is flying into a few particular square sections that give him a very high probability to hit the ball for a perfect pitch. Otherwise, he does nothing.

Investing is wise only after it is given thoughtful and careful consideration as shown in the punch card and baseball examples. One only invest when there is a high probability of winning (making excellent returns) and low probability of losing one's capital. As such, Warren Buffet also has two golden rules for his investment:- First rule is never to lose money. Second rule is never to lose money too.

A point to note is that this concept of "waiting for the perfect pitch" cannot be misinterpreted and wrongly applied. For example, a contra player in the stock market may buy heavily into the stock of a particular company after a good news is released about the company thinking the stock price will soar on short-term. He thinks he is betting heavily since he has a perfect pitch. However, Buffett's intention for using this concept of "waiting for the perfect pitch" applies mainly to a long term nature of investing (e.g. he makes his perfect pitch to buying a company stocks not for a short-term speculative gain). His investments are mostly held for long term compounding returns, and his idea is to buy particular stocks when it is most attractively priced for its value with great long term potential for excellent returns.


Second section:- "Recognising the perfect pitch - when to invest based on looking at long term yield on one's investment."
There are many ways to determine whether a stocks is most attractively priced for its value to make good one's investment. One can look at price-earnings ratio (P/E), price-book ratio (P/B), intrinsic value (which is subjectively determined). Traditionally, the lower the P/E ratio (10 and below) and P/B ratio (1 and below), the more attractively priced is a stocks for its value.

Through my reading of investment books, I came across a book based on Buffett's wisdom of recognising when is the perfect pitch. One can look at the long term yield on one's investment. E.g. One buys a share of a company (e.g. XYZ company) at $1 and the company has a earnings per share (EPS) of $0.10. This means for every $1 dollar invested, one expects to receive $0.10 returns on the $1. The current yield on this investment will be ($0.10/ $1) X 100% = 10%. Is this a good deal?

If shares of another company LMN is priced at $1 per share and EPS is $0.20, the investor gets $0.20 for every $1 invested. The current yield is 20%. This is definitely a better deal than the earlier one. Of course, the investor does not get the full $0.20 returns per share physically on his $1 invested per share. Only dividends is given back to the investor and all remaining earnings of a company is usually used as retained earnings to further grow its business. However, as long as the investor remains invested, he still has interest to the full earnings (dividends already given to him plus any earnings not given to him but retained by the company).

It gets a bit tricky when we look at the growth of earnings per share (EPS). EPS of company XYZ is projected to be growing at a compounded rate of 20% per annum while EPS of company LMN is growing at compounded rate of 5% per annum. After 10 years, the EPS of company XYZ will be $0.62 while that of company LMN will be $0.33. So, an investor with company XYZ will have a future yield after 10 years of 62% on his initial $1 per share invested getting $0.62 on every dollar invested. On the other hand, an investor with company LMN though starting with a higher yield of 20% will only end up with a yield of 33% in 10 years time (not a significant increase in yield of returns).

In conclusion, one can look at current yield and future yield to determine whether a company is worthy of being a "perfect pitch".

I bought into the shares of Keppel Corp during March 2009 @ $4.05 per share. Illustrated below is the 6 years record of EPS for Keppel Corp.

2003: $0.511,     2004: $0.603     2005: $0.721     2006: $0.954      2007: $0.715       2008: $0.69

Therefore, my current yield based on year 2008 EPS is ($0.69/ $4.05) X 100% = 17.0%
Based on the 2003 EPS and 2008 EPS, the annual compounding rate of growth in EPS over this 5 year period is 6.19%. Assuming Keppel Corp keeps growing its EPS at this compounded rate per annum, its EPS after another 10 years will be $1.258.
My future yield will be ($1.258/ $4.05) X 100% = 31%.

31% yield may not be too impressive. However, it is still a decent figure getting 31% future yield per annum and growing still. Some stocks were trading at even higher yield based on their EPS and share price (more than 20 %) during March 2009. To an astute investor who can recognise high yielding stocks (current yield more than 20%) that can grow their EPS at high compounded annual rate (10% or more), it may not be too surprising to see the future EPS of such company may even reach the initial share price an investor paid for. By then, the investor that holds onto his shares may get a 100% yield ($1 returns for every original $1 invested).

Discussion points:- Wait patiently for the best chance to invest which is waiting for the perfect pitch. Otherwise do nothing.

One of the way to recognise the perfect pitch is to look at current yield and future projected yield. Buy stocks only when their current yield is high (more than 20%) and their EPS is projected to grow at high compounded annual rate (more than 10%). Thus, one should expect to get a high future yield on one's original invested capital (assuming one holds the shares long term and the company is still performing well).