Investment Learning Points

Dear readers,
I am shifting all the investment learning points from the sidebar of my blog into this dedicated post so as not to overcrowd the sidebar of my blog. This is also to allow further updating and expansion of my investment learning points in this post as my investment experience grows. Please return periodically to this post for updates on my investment learning points. I wish all readers a fruitful investing journey!

INVESTMENT LEARNING POINTS

Investment techniques

Focused investing:- Invest heavily in only a few stocks (10 stocks or lesser) that are perceived to be most promising.

Value investing:- Invest in stocks only when their price is below their intrinsic value to pay less than what the shares of a company is worth, and achieve greater returns.

Cut loss:- Short-term investors should adopt a strict cut-loss measure to sell out shares that have decreased by a certain pre-determined amount in price to prevent incurring huge loss.

Emotions kill at investing.  

Never catch a falling knife.

It is difficult if not impossible to accurately time a market bottom.

It is always prudent to analyse business fundamentals underlying a stocks before purchasing the stocks.

Average down only when stock prices are already significantly undervalued. Never average down on a free falling bear market to prevent catching a falling knife.
 
Cheap price may not mean value buy. Always check for any permanent problems with underlying business of stocks to make sure one is not inheriting a failing business.

For a diversified investment approach, an investor can consider exchange traded funds (ETFs).


An investor should live out an investment philosophy suitable to his personality so as to make investment decisions based on his philosophy and not emotions.

Avoid rebalancing of one's portfolio. Have the courage to ride the winners and weed out losers constantly.

Avoid high turnover in trading one's portfolio. Transaction costs is a drag to investment returns.

Value investing provides a protective margin of safety.


An investor may misjudge a company's intrinsic worth, so he should always seek to invest at share prices below the estimated intrinsic value per share of a company to gain a margin of safety to account for possible error in overestimating intrinsic worth of a company.

Buy-and-hold strategy can work well if an investor has applied it properly knowing when to buy, when to hold and when to sell a stock or investment product.

Compounding is an amazing effect that serves to grow an initial investment many times over in value through reinvestments. The higher the compounded annual rate of returns and the longer the time period of compounding, the higher will be the final value of an initial investment.

The stock market is not always efficient. Prices of stocks can be traded at ridiculously low or high valuations at times.

The stock market is random. Stock prices may not always follow through trends and can change suddenly. Make use of market price fluctuations to one's advantage.

Valuation techniques
 
Hunt for stocks with high current and future projected yields on investment:-
Take current EPS divide by current share price and multiply by 100% to calculate current yield. Take future projected EPS (after certain number of years) divide by current share price and multiply by 100% to calculate future yield. That will be the future yield of returns on an investor's investment dollars.

One can estimate the intrinsic value of a company by using the discounted cashflow method (DCF method). This valuation technique assumes that a business is worth the present value of all it's future projected cashflows. A note when using the DCF method is that future cashflows are only estimates and the estimated intrinsic value per share of a company using DCF is ONLY an estimate at best. Thus, value investors should invest at a margin of safety below the estimated intrinsic value per share of a company.

Fundamental Analysis

Free cashflow = Net cash from operating activities - Capital expenditure

Look for companies that shows consistent growth in net cash from operating activites while maintaining low capital expenditure, and has consistent high return on equity (ROE).

Ability to consistently generate high free cashflows from a business allows the cash to be reinvested in the business or to be paid as dividends to shareholders.

Return on equity (ROE) is an important metric for measuring a company's profitability. Consistently high ROE (15% or more) for many years of a company's operating history is desirable. An investor should also take note of a company's financial leverage when using ROE to make sure a company is not risky by taking on excessively high amounts of debts.

It is important to examine trends in the financial statements of companies over a period of time (e.g. last 5 to 10 years) to uncover any consistency or inconsistency in the economics of a business. A one-off recent spectacular performance by a company may not necessarily indicate consistency to perform in future. Similarly, a one-off recent underperformance may not necessarily indicate permanent deterioration in business fundamentals. Be aware of non-recurring exceptional items in any financial statements that may undermine or overestimate a business's true economics. Always look for possible consistency in the business fundamentals and make sure the consistency is still intact.

Net asset value (NAV) per share also known as book value per share or equity value per share is the value of a company's assets less the value of its liabilities.

Net asset value (NAV) = Total assets - Total liabilities
It is a misconception that shareholders of a company should get back the NAV per share worth of compensation upon winding up a company. This is because assets of a company may be sold at lower firesale prices than its carrying price stated in financial statement upon winding up the business. Shareholders may get back lower than NAV per share value of compensation or even no compensation upon winding up of a company after it has paid off all liabilities.

One should consider the liquidity of a company to evaluate it's short-term financial health. To do so, one can consider the types and proportion of current assets held by the company such as cash and cash equivalents, short-term investments (e.g. equities held for trading), account receivables and inventory. Cash and cash equivalents are the most liquid current assets that can be readily converted into cash while inventory are the least liquid current asset that is most difficult to convert into cash. The company that can readily convert it's current assets into cash will be able to meet it's current liabilities ensuring good short-term financial health. 

To assess the short-term financial health of a company whether it has current assets able to meet it's current liabilities, one can look at a few financial ratios and calculations such as current ratio, quick ratio and cash conversion cycle.

REITs investing

When investing in REITs, do not just focus on annualised distribution yield alone which can be misleading since it changes according to the REIT's traded unit price which can fluctuate. Instead focus on core fundamentals such as:-
- performance of trends of growth over the years in the amount of income distribution to unitholders, rental revenue and net property income.
- average income yield of properties in the REIT,
- occupancy rates over the years,
- track record in refinancing loans on time,
- gearing of less than 40 plus %,
- diversified rental income sources from different types of tenants,
- built-in rental escalation,
- security deposits on rental,
- long average rental lease period to expiry,
- no large number of rental leases (expressed as % of gross rental income) expiring over any single year,
- no significant overcontribution from a single tenant,
- honest and capable management that are shareholder friendly,
- interest coverage ratio of more than 1.5,
- low interest rate on borrowings, 
- consistent growth in EPU and DPU (examine carefully the reason if there is a dip in EPU and DPU for a particular year).
Also seek to invest significantly below the NAV of the REIT to gain a margin of safety.

Rights issue

Rights issue is an invitation by a company to it's shareholders or other investors to purchase more shares in the company at a discounted price to the current market price of it's shares.

Look for rights issues that are supported by full underwritting from an investment bank. This ensures that the company / REIT raising the rights issue can obtain it's funding regardless of whether the rights shares/ units are eventually undersubscribed or oversubscribed.

Theoretical ex-rights price is an estimated stock price after factoring in the effect of the rights issue. One can use the theoretical ex-rights price to compare with one's eventual average holding price after purchasing new shares through the rights issue to make sure one's eventual average holding price is not too steep above the theoretical ex-rights price.

Check carefully whether a rights issue consists of renounceable or non-renounceable rights. Renounceable rights offer existing shareholders the choice to sell their rights entitlement to other investors during the nil-paid rights trading period should they not want to hold the rights to purchase the new offered shares. This is so that existing shareholders that do not want to exercise their rights to purchase new shares can receive some compensation for the eventual dilution of their investment in the company.

To determine how much is the rights entitlement worth, take the difference between the theoretical ex-rights price per share and the rights issue price per share. An existing shareholder (who does not want to purchase new shares) should seek to sell his rights entitlement above this calculated rights entitlement value during the nil-paid rights trading period. On the other hand, a new investor (who wants to purchase new shares) should seek to buy at below the rights entitlement value for a bargain.

Be careful of companies that frequently raise rights issue only for paying down debts. This may signal problems with the financial health of the company. Rights issue is preferred for reasons such as fulfiling acquisition and growth plans. This ensures potentially increased future shareholders' earnings from yield accretive ventures.

Cash conversion cycle

Cash conversion cycle measures how fast a company sells its goods (inventory), how fast it collects payments from goods sold (receivables), and how long it can hold on to the goods before it has to pay its suppliers of goods (payables).

Cash conversion cycle = Days in Inventory + Days in Receivables - Days Payable Outstanding

Red flags to look at when assessing the cash conversion cycle include increasing days in inventory, low inventory turnover, high number of days in receivables and low number of days in payable outstanding, all these escalating for prolonged period of time which may damage the business resulting in significant losses.

One should compare the cash conversion cycle for similar competitive businesses in same industries and sectors to have a fair comparison on which business has a better cash conversion cycle than its competition, since cash conversion cycle may differ widely if comparing businesses in very different industries and sectors.

Generally, lower number of days for the cash conversion cycle is preferred over a higher number of days.

Industry analysis

There are five competitive forces driving industry competition. These forces drive returns in an industry to a perfectly competitive level, thus constraining any companies in an industry from achieving supernormal returns. These five competitive forces are:-
1. Bargaining power of buyers (customers)
2. Bargaining power of suppliers
3. Threat from potential entrants
4. Threat from substitutes of products or services
5. Intense competition among existing companies in an industry

It is important to check whether a company has both strong bargaining powers as buyers of goods/ services and suppliers of goods/ services before investing in the company. Bargaining powers as buyers and suppliers affect the competitiveness and margins of the company.

To deal with the threat from potential entrants into an industry, existing companies engage in two strategies:
1. Sending clear message to the new entrants that if they cross over a certain tolerance line they will be subjected to strong retaliatory attack until they are driven out of the industry.
2. Putting different types of barriers in the path of new entrants.

An investor has to consider in his assessment of a company whether it is facing much intense competition with rival companies in an industry based on different possible factors promoting competition. Intense competition reduces returns in an industry.

An investor needs to consider any potential threat from substitutes of products or services to an existing company to see whether the company has downside pressure to it's margins due to such threats.