Wealthy or rich?

This is a follow up post from the last post. The question goes like this:-

Imagine a farmer has bought a goose for $36 that lays one egg each day that one can sell for $0.01. Only a few months after he bought the goose, a second farmer comes along and offers to buy the goose for $54. Should the first farmer sell his goose which can help him derive regular income for the next 15 years (assuming the goose can live another 15 years)? The potential capital gains is 50% for the first farmer if he sells.


What if yet a third farmer comes along and offers to buy the first farmer's goose at $72. The potential capital gains is 100% if the first farmer sells his goose.

Should the first farmer sell his goose, and to the second or third farmer does he sell should he decide to sell?

As I mentioned before, everyone is entitled to their own choice in making decisions, especially investment decisions depending on their personality and financial objectives. However, I believe there is an objective way of looking at things, doing things that really make good sense.

The first farmer in my humble opinion should sell his goose to the third farmer. If no farmers come along to offer him a higher price for his asset (the goose) which is currently generating recurring cashflow for him, he should stick to his asset since it is giving him a consistent 10% yield annually (assuming his yield can be always adjusted to account for inflation maintaining a consistent 10% annual yield). The second farmer offered him a capital gain potential which is much lower than the third farmer.

The third farmer's offer of 100% potential capital gain for the first farmer is attractive enough for him to let go of his cashflow generating asset. By doing so, he will now receive $72 for his goose. Assuming the price of a goose has not increased yet, the first farmer should go back to the market and buy back two geese now with $72. With two gesse in his hand, he can now receive more recurring cashflows, in fact double the amount of recurring cashflows he once received with only one goose.

Of course, one may question is there likely to have such a person as the third farmer who will offer a potential capital gain of 100% to the first farmer. In life, anything can happen. All kinds of people exist. Some are shrewd, some are impulsive, some are careful, some are careless, some are calculative and yet some are generous. So, such a third farmer character may not always come along. The idea here is 'may not' but does not mean 'do not'. There is still a probability for one to capitalise on a substantial capital gain (in magnitude of at least 100%) just that this scenario does not happen easily.

When this happens for the farmer's case, he should grab the chance to realise his capital gains. And, the important thing here is after he has got his capital gains, he went back to buy two geese with his money. For the first farmer, he saw the importance of recurring cashflow income in his business of selling eggs. So, he places his priority on building his cashflow generating assets (his geese). Capital gains is but only an icing on the cake, good to have only if it is really good to have. In his case, the capital gains has allowed him to further his acquiring of more cashflow generating assets.

So, come to the conclusion of the matter. Invest for both cashflows and capital gains. The foundation of investment is on building up and generating good amount of recurring cashflows. To accelerate this purpose, capital gains on any assets must be reinvested to acquire more cashflow generating assets. Then, this makes some good sense to go for capital gains in addition to just collecting cashflows alone from investments.

The problem with many is that one can be blinded by immediate gratification of a capital gains and tip the scale in favour of always going for capital gains in investments. This brings me to the title of this post, "Wealthy or rich?".

To be wealthy, one has to acquire cashflow generating assets. It does not matter how much in total value one's assets is. It is not the total value of assets that matter, but the yield on the assets one is receiving that matters. A person may only have for example $500,000 in total value for all his assets. However, if he is receiving $250,000 annually from all his cashflow generating assets, he is getting a yield of 50% (this is just for illustration - it is not easy to get such high yields).

On the other hand, one who is rich has a lot of money, but no cashflow generating assets. For example, one can be a millionaire with $1,000,000. But he may not be receiving any cashflows at all if all his money is held as money. So, effectively, his yield is 0% annually. No cash flows into his pocket since he does not own any cashflow generating assets. But, cash is constantly flowing out of his pocket. He has to use his money somehow if not for buying luxury items, at least for minimal survival needs.

For such a person, he is rich but not wealthy. The problem with him is that his money will be drained out sooner or later through his expenses. Another invisible force that is slowly draining away his money is inflation. Due to the US free printing of currency, the value of currency will be eroded. More money is flooding the market as time goes by. So, even if this person does not use a single cent of his $1,000,000, the same $1,000,000 will not be worth this amount some years down the road because one has to use more money to buy the same goods and services in future. That is why prices of houses has increased through the years. It is not the houses that have increased in value, but our money that has decreased in it's value due to printing of currency and inflation. We have to use more money to buy the same type of house in future.

So, be wealthy or rich? To be wealthy means deriving good amounts of recurring cashflows from cashflow generating assets. To be rich means having a lot of money, pure money that can potentially erode in value until zero with the passing of time.

Investing for capital gains or cashflows??

I am thinking hard recently as to whether to invest for capital gains or cashflows. I believe everyone should know the meaning for capital gains. Buy a stock at a certain price and then sell at a higher price at a later time. The duration to hold the stocks can be short or long depending on the amount of capital gains one desires. I have also touched on how much capital gains one should preferably aim for (for a trading mindset or long term investing mindset) in an earlier post based on my own research.

As for cashflows, I am referring to the dividends one receives for all his stock holdings in his portfolio. This question is important to ask as we are surely approaching the next bear market anytime in future. Nobody knows when. But, everybody should know the "bear will surely wake up from hibernation" sometime in future. The valuation for most if not all stocks will be send to the depths again during the next bear market. Again, nobody knows how much the extent of the next bear market in terms of duration and damage to valuations of equities globally.

I believe it is always wise to think one step ahead and make preparations for something that is certainly to come. So, this raises the question of whether one should go for capital gains or cashflows. I have heard from a friend who has invested through a few market cycles of bull and bear holding on to his same stocks which were bought many years ago. He told me that the valuation of his stocks now compared to his initial bought in valuations many years back is higher. However, the difference in valuation is not much. He does agree that it would be wiser for him to sell at the height of a bull market locking in his capital gains and buy back again during the depths of a bear market and keep repeating the same process through the few market cycles he had seen. The only problem is even as he knew about this simple possible strategy, he did not commit himself to do it and so left his stock holdings through the years to the mercy of the many market cycles.

However, one thing he commented is that he still receive good amount of dividends from his stock holdings and the total amount of dividends had increased through the years. Of course, he does reinvest his dividends and make further capital investments to buy more stocks through the years so his total amount of dividends received has been growing through the years.

So, back to the same question again. Invest for capital gains or cashflows? My answer is a consolidation of thoughts from all my earlier blog posts based on the summation of all my research so far. I do not count myself as a knowledgeable investor as knowledge is never ending and I am always learning new things about investment everyday. The answer I arrived at is that one should invest for both capital gains as well as cashflows.

Both ways of investing, for capital gains or cashflows, have their merits and shortfalls. Capital gains of a substiantial amount (at least 30% for short-term trading and 100% for longer term investing) can help to lift one's net worth in his stocks portfolio at a fast rate. However, one does not always have the good fortune to buy into a stock that can have such magnitude of capital gains (please note that I am discussing based on the Singapore stocks market; other stocks market such as the US stocks markets may have much wider swing in valuations). Even with penny stocks, it is also not a guarantee to see substantial capital gains even after one has bought into a penny stock with a popular theme or fundamentals (whatever you call it). So, investing for substiantial capital gains has a low chance of realisation. Nevertheless, one can still lower his expectations and sell any stocks at a lower capital gains as long as it is still attractive enough for the holding period in consideration. Also, selling stocks for capital gains does make sense when one is trying to escape an impending bear market. Why leave it to chance and let the valuations of one's stock holdings that has increased have the potential to drop back to the original bought in valuations or even lower?

Thus, investing for substantial capital gains though having a low strike chance, is still well worth the effort to do so to accelerate one's rate of return on his investments. The other way of investing for cashflows has it's own merits as well. Cashflows investing is a stable consistent way of deriving recurring income from one's portfolio. Cashflows income is difficult to build in the initial stages but when one's stocks portfolio size is big enough, the amount of regular dividend income one can derive is not to be looked down upon. However, when investing for cashflows, one needs to hold his dividend paying stocks for a long term to keep building and sustaining his dividend income.

The frustrating question comes when his dividend paying stocks have risen so much in valuations to allow him to have the possibility to capitalise on a substantial capital gains by selling off his regular dividend income paying stocks. Imagine a farmer has bought a goose for $36 that lays one egg each day that one can sell for $0.01. Only a few months after he bought the goose, a second farmer comes along and offers to buy the goose for $54. Should the first farmer sell his goose which can help him derive regular income for the next 15 years (assuming the goose can live another 15 years)? The potential capital gains is 50% for the first farmer if he sells.

What if yet a third farmer comes along and offers to buy the first farmer's goose at $72. The potential capital gains is 100% if the first farmer sells his goose. I believe we might have reach a simple conclusion ourselves whether the first farmer should sell or not, and if he sells, to which farmer should he sell.

For those interested to share your ideas as to what action the first farmer should take, you can drop in your thoughts under the comments for this blog post. 

Lastly, my conclusion is that one should invest both ways, for capital gains and cashflows. An analogy for this is that cashflows represents a normal car while capital gains represents a turbo engine that can be fitted to the car. The turbo engine can not be fully utlilised during the entire duration of operations of the car as it will cause the car to overheat and wear out very fast. But, if the car does not have a fitted turbo engine, it cannot achieve another quantum leap in it's maximum speed and torque. So, use both capital gains and cashflow investing to one's advantage. A basal amount of cashflows from recurring dividend income is always welcomed. In addition, some capital gains can also help to accelerate the rate of return on one's investments.

PS: Please note that this post is just a simple discussion and by no means an indepth discourse on both ways of investing. There are certainly more considerations (e.g. investor's individual personality and financial objectives to look at when investing).

Built to last.....what makes an enduring business?

I read up on this book "Built to last" long time ago and find it a good read. It talks about what makes certain businesses last for a long time. I cannot remember details of the reading but some parts of the book are still vivid in my mind. I guess remembering and internalising the essence in any reading is more important than trying to recall all details of the read.

In my sharing below, I shall present the information I got from the reading together with my own reflections.

What makes an enduring business last for long?

1. A strongly cherished vision that does not change and is not easily changed through time.
2. A great succession plan ensuring vision of the company is passed on from predecessors to successors.
3. Focus on getting the right people onto the train (company) and getting the wrong people off the train quickly.
4. Ability to allow each employee to discover what they are best at and let them do what they are best at.
5. Keeping to the core business that the company is best at and most suitable for.


1. A strongly cherished vision that serves a great meaningful purpose

Every great company has a strongly cherished vision that does not change through time. To be able to achieve this, the vision must be a great one that can endure the test of time. Everyone in the company owns the vision and it is clearly communicated from top to bottom in the company. The success of an enduring company depends on how much ownership the employees of the company have of it's vision. For example, a great pharmaceutical company has the vision of "we seek to save lives by offering the best possible drugs at affordable prices so that no one will suffer poor health or die because he cannot afford to pay for drugs." The vision must be strongly cherished by every employees in the company and all the routine business activities revolve around fulfiling the vision. Whenever anyone speaks about the company, they tell of it's vision. Whenever anyone acts in the course of the business, they act in the interest of fulfiling the vision. The vision is why the company existed from start and it is the only reason the company will continue to exist.

Every great enduring company grows out from it's vision. It feeds from it's vision just as a green plant depends on sunlight to exist, because it is that strongly cherished vision by all employees that allows the company to even exist. A great enduring vision ensures the company endures. The vision creates value for all it's employees from top to bottom. Every employee enjoys their work because they enjoy fulfiling the meaning of the vision in every little detail of their work. For the great pharmaceutical company example above, the top management enjoy coming out with strategies to keep the company researching on the best possible drugs to cure deadly diseases. The management seeks ways to sell the drug directly as far as possible to the patients so as to minimise distribution costs so that any cost savings can be passed on to the patients and the drugs can be bought at affordable prices. The researchers work hard at coming out with the best possible drugs to save lives. The sales and marketing team enjoy helping to bring the drugs to sell at places where it is most needed and not because it is most lucrative.

Therefore, from top to bottom in a company, everyone believes strongly in the same vision and they know they must live out the vision in the way they work. Anyone who deviates from the vision cannot belong to the company. The vision serves a great purpose and the purpose is not always the case of profitability for the business. In the example of the great pharmaceutical company, it's vision serves the purpose of cherishing and helping to save lives.


2. A great succession plan ensuring vision of the company is passed on from predecessors to successors

A great vision must stand the test of time. Thus, enduring companies always ensure they have a great succession plan to groom talents from within the company who will rise up to steer and lead the company to continue to grow on it's vision. As such, successors of CEOs most often come from within the company since these capable people have long embraced the vision of the company and now they will rise up to take on the most important responsibility to lead the company to grow on it's vision.


3. Focus on getting the right people onto the train (company) and getting the wrong people off the train quickly

Great enduring companies take pains to hire the right people who will embrace their vision. Hiring is a very important process as the right people hired will help the company to continue it's growth. Hiring the wrong people who do not believe in the vision of the company will slowly erode away the vision and corrupts the rest of the employees who believes in the vision. So, it may not be always a matter of hiring based on talents alone. The right talented people must be hired so that there is a good fit with the vision of the company. So, hiring is a very important process that must be done with upmost care as it is always easy to get people onto the train (company) but hard to get the wrong people off the train (company). However, when a wrong hire has been done, the company must quickly dismiss the wrong people to avoid the wrong people corrupting the rest of the employees to deviate from their cherished vision. Thus, hire slowly with careful consideration for a good fit into the vision of the company (apart from considering needed talents) and quickly dismiss any wrong hire to ensure the vision of the company can be preserved. Anyway, the wrong hire will function at their best eventually in another company that they can be of good fit to it's vision.


4. Ability to allow each employee to discover what they are best at and let them do what they are best at

Great enduring companies after hiring the right talented people, ensure their employees enjoy what they do best in the company. Every person is unique having their unique personality, beliefs, strengths and weaknesses. So, not everyone is made for the same job. The worker that functions the best functions out of the best job that he enjoys doing. So, care must be taken not only to ensure a good hire that is a good fit into the vision of the company. Care must also be taken to ensure the right hire can function at his best in the job that he enjoys doing his best in. It may take time to find the best fit into a suitable job role in a company. However, it is worth the effort and time to allow every employee to find a suitable job role so that they can function at their best.


5. Keeping to the core business that the company is best at and most suitable for

Just as it is important to ensure every employee does what he is best at, great enduring companies understand they must do what they are best suited at and do it even better than it's competition. Thus, they stick to their core business and continue to grow better at doing their core business. They are usually leaders or aspiring leaders in their market. They are careful not to deviate too far out and become distracted from becoming best at doing it's core business that it is suited at doing. Thus, every acquisition and merger has to be under very careful consideration by the company to ensure a good fit so that the company does not deviate from it's vision and core business that it is best suited at doing.

Conclusion

Be it on a personal level or organisational level, realise a great vision that one truly cherishes and commit to doing one's best at it and even becoming one of the best at doing than others. It may not always be a must to be at the top. Just being able to function at one's best in something one believes passionately in is already a bliss.

Value, value and still value........

What is the most important thing investors should look out when investing? I had the fortune to meet up with and had a short chat with a venture capitalist. It was indeed an eye-opener to hear from how professional investors think and act. The conclusion I have from the short but eye-opening chat can be summarised into one important word "value".

Value, value and still value. This word got me pondering hard for quite a while. One simple word but it carries a very important and heavy essence to investing. It challenges my long held principles to investing and set me thinking hard whether I have captured this important essence to investing - that is always to think of the value of any investment.

I learnt something very important about value. If an investment is not valuable at all, do not invest in it, run away from it, not to mention even thinking of it for any longer moment. To ascertain whether an investment is valuable, it may not mean one must analyse the investment to perfection. Sometimes, the more analysis one goes through to justify an investment is good may mean that more reasons have to be dug out to prove one's correctness about the investment. Do not get me wrong. I am not trying to say one should not analyse every investment. Afterall, investing must be a careful activity. However, sometimes, good things that are obvious about an investment even to a layperson may already mean an investment is obviously valuable.

So, analyse each investment with care. However, value may be somehow always noticeable. If it is not noticeable, one may need to question why an investment is not obviously valuable and needs the careful analysis to unlock it's value? Value is where there is a protected strong demand for the existence of a business. Everybody from all the working staffs in the business to the customers and any other interested parties it serve depend on the business and continues to derive value from the existence of the business. If such a business cannot be replicated by other potential competitors (ensuring high barrier to entry), thus is the value of the business.

So, think value, value and still value. Invest in really valuable businesses.

The "Six Sigma" approach.

Is this a special sign used by some secret agents?

No, this is Six Sigma, an initiative used by some companies.

I chanced upon the "Six Sigma" approach when I was doing some reading. What does "Six Sigma" means? It is an initiative used by some companies to better their bottom line by ensuring consistency and improving standards in quality of their products and services to better meet customers' needs.

The actual "Six Sigma" approach can be complicated involving statistical calculations in the use of this initiative. However, the whole approach can be viewed in simplicity and adopted into the running of a company.

Jack Welch, an ex-CEO of General Electrics has used this Six Sigma approach in the running of General Electrics during his reign as a CEO. Basically, the whole approach can be summarised into the following steps.

1. Define the problem at hand.
2. Measure where one is at currently in the defined area of problem and also where one wants to arrive at.
3. Analyse what is the root of the problem.
4. Improve on the procedures of doing things so as to solve the problem.
5. Control the new procedures very strictly to ensure the problem is exterminated for good.

The acronyms for the steps can be easily remembered as Dumb Managers Always Ignore Customers.

As mentioned earlier, the Six Sigma approach seeks to better the bottom line of a company by ensuring consistency and improving standards in quality of their products and services to better meet customers' needs.


1. Define the problem at hand

For ease of explaining, I shall use an example of a pizza outlet based on my reading. A manager noticed that sales of pizzas has been decreasing over a period of time. He and his team proceeds to define the problems causing it. Based on gathering feedback from customers (which is very important to find out the needs of customers), they find that the pizzas are not evenly cooked and some parts were more burnt than other parts. There was also feedback that the time taken to serve the orders for pizzas was a bit slow.

With more than one problem at hand, the Six Sigma approach seeks to tackle the problem of priority. How does one define which problem is of priority over others? The problem that is of priority to tackle is the one that hurts the bottom line the most and once solved can improve the bottom line of a company the most compared to solving other problems. Thus, the manager and his team decided to focus on solving the quality issue of the pizza which is ensuring the pizza is evenly cooked. In using Six Sigma, usually the management focuses all energies and resources on solving one problem at hand each time, the problem of most priority that can show the most improvement to bottom line once solved. Once the problem of priority is solved does the company proceeds to tackle other problems of lesser priorities.


2. Measure where one is at currently in the defined area of problem and also where one wants to arrive at

After defining the problem, the company seeks to run statistical analysis to see how far the company has deviated from what they hope to achieve. For example, using the earlier illustration, how many pizzas out of the total pizzas produced daily that failed to meet the expectations of an evenly cooked pizzas. From churning out some statistical calculations (which is too complicated beyond what can be explained by a layperson like me), the company can know where it stands currently in terms of performance. The more deviation from the expected standards, the lower the sigma is awarded for the company. Sigma represents amount of variance from a set standard. A low score on sigma (e.g. one sigma) represents that there is too much variance from the desired standard. The ideal case is a full Six Sigma that represents almost no variance from a desired standard. In the case of the pizzas, it means almost all pizzas are evenly cooked according to required standard and only negligible number of pizzas failed the standard.



3. Analyse what is the root of the problem

After measuring the amount of variance from a desired standard, the manager and his team proceeds to analyse carefully what has gone wrong that caused their pizzas to be unevenly cooked. They finally zoom in to the root of the problem, an issue with the pizza baking machine and procedure of handling the pizzas. They have been using kitchen helpers to help to move and flip pizzas through a large pizza baking machine. Although the time intervals to move and flip pizzas are under a strict protocol whereby kitchen helpers have to stick strictly to the time intervals to manage the movement and flipping of pizzas in the pizza baking machine, there are still occasional times when kitchen helpers missed the timings and so pizzas do not get evenly cooked. This method of baking the pizzas introduces possibility of uneven baking and is not ideal.

After anaylsing what is the root of the problem, the team then proceeds to anaylse what is a way of solving this problem. They came out with the idea of using a conveyor belt system to move the pizzas through the pizza baking machine. By using such a system, the movement of pizzas through the pizza baking machine can be controlled with regularity and precision. This system ensures an improvement in the baking of pizzas to ensure each pizza is evenly cooked.



4. Improve on the procedures of doing things so as to solve the problem  

After analysing and finding a solution to the problem, the team then proceeds to implement the solution which is purchasing and installing the conveyor belt system into it's pizza baking machine. Sometimes, there may be more than one ideal solutions to the root of problem. The company then adopts the best solution, one that proves to have the least cost ensuring most savings, and best results to the bottom line of the company. It may not always be the case of cost savings when choosing a solution to take. Sometimes, as long as there is a boost to the bottom line, a fair amount of resources is used to install the needed solution to tackle the problem.


5. Control the new procedures very strictly to ensure the problem is exterminated for good


After installing the solution to the identified problem, strict control procedures are implemented to ensure that the same problem has no chance of surfacing again. For the pizza baking machine case, it may mean having an extra reserve pizza baking machine with conveyor belt system that will replace the existing conveyor belt system immediately should any faults occur anytime. Afterall, if the most important problem has been solved providing the greatest improvement to bottom line, the company should ensure the most important problem does not surface again anymore to hurt the bottom line.



People Process in running Six Sigma

To ensure the Six Sigma approach can be of practical use instead of just another one of many airy-fairy initiatives companies take that is more of show than practical use, the Six Sigma project has to be run specifically by a dedicated group of important personels in the company. These personels are carefully selected as their focus and effort with be solely on running the Six Sigma project since what can be more important to a company than  it's bottom line.

The selected personels involve people from the top management all the way to the bottom staff. The whole company must be in concerted effort in running the Six Sigma initiative so that the initiative is well supported from the top management all the way to bottom staff. Personels running this intiative have to be carefully selected and these are people usually all-rounders who have both management skills and technical skills. In running the Six Sigma project, it must be well-supported by resources, and understanding and support from top management that once each Six Sigma project is completed, the company will see improvement to it's bottom line. By doing so, this ensures each Six Sigma project once embarked upon can be fully completed and not halted half-way, since it is a time and resource consuming process.


Conclusion

I was amazed when I read that there is such an initiative around that works relentlessly projects after projects, each time to keep focusing on improving the bottom line of a company. I am thinking that such an approach may have some learning points in applying into the life of an individual to keep improving how an individual works.

Price can lie, volume of transactions does not lie........

There are two basic parameters when one is looking at any particular stock counter during a trading day, it's price and volume of transactions. These two parameters may change during each trading day. And, the price and volume over a period of trading days are almost always different (unless the stock counter is an illiquid one).

For every stock market participants, we are affected by the price and volume of transactions of any particular stock counter. Like it or not, the stock market is an open market for all to participate, so it is a supply and demand principle at work in the many transactions of any stock counter listed on the stock exchange.

Since we are looking at supply and demand in the stock market, we need to know how many outstanding shares of a company is traded on the stock market, also known as it's free float. One also need to know whether this free float is likely to increase or decrease in the future. If free float increases, more shares will be flooding into the market from the particular stock increasing it's supply of shares in the market. On the other hand, shares buy back by the company will ensure some shares are retreated from the market and decrease the supply of shares in the market.

By examining the daily volume of shares transacted for any stock counter, one can also see some insights into the supply and demand situation for any stock counter. When large volume of trasactions occur and the daily volumes of transactions over a period of time experience steady growth, coupled with a growing stock price, the stock is in demand. Just looking at growing price alone over a period of time may be misleading, unless it is supported by a growing volume of transactions over the same period of time too. This shows that "volume of transactions cannot lie" as these are actual recorded transactions of trades made for a particular stock counter over a period of time. However, the "stock price may lie" whereby it is increasing over low volumes of transactions showing the growing price may not be well supported and there may not be a good demand for it's shares just by looking at growing stock price alone.

On the other hand, a decreasing stock price coupled with increasing volumes of transactions over a period of time may mean the demand for the shares of a stock is decreasing. Market participants keep selling the shares by volumes upon volumes at lower and lower prices indicating the desire to get out of a stock. We see this phenomenon in the last bear market when the volume of transactions was large over the entire period of the bear for decreasing stock prices.

So, when one looks at the fluctuating stock price of any counter next time, remember that the "stock price can lie" and an increasing stock price or decreasing stock price may not mean anything. However, when one looks at the volume of transactions together with the changing stock price over a period of time, one sees  the whole picture of the supply and demand for a stock as "volume of transactions does not lie" as it indicates how many shares are changing hands to cause the stock price to increase or decrease.

No matter whether one is a long term or short term market participant, it can be rewarding to estimate the demand for the shares of a stock to know whether one can invest into a stock by checking out if it has growing demand and stock price. Next time, when someone gets excited by an increasing stock price or decreasing stock price, be forewarned that changing stock price may not mean anything much when one does not look at the daily volumes of transactions over the same period of time. Be careful of getting trapped by the fluctuating stock prices when looking at it alone.

The big players.

In the stock market, there are small and big players. Small players are retail investors while big players may be instituitional investors or other high net worth investors. When a stock is chosen by big players to be invested in, the stock may follow certain behavioural dynamics in it's price. If small players like the common retail investors can pick up some simple behavioural dynamics of the big players in a certain stock, they can ride on the strength of the big players and derive profits by understanding the mechanics of how big players invest in certain stocks.

Usually big players invest in a sequence as follows:
1. Selection of a potential stock to invest in.
2. Period of accumulation.
3. Period of flushing out weak players.
4. Period of pushing up a stock price.
5. Period of unloading the stock at a suitable higher price.

Selection of a potential stock to invest in

Big players like to select stocks that can rise in stock price. What are stocks that can rise in stock price? Most often, these are stocks with a current or near future popular theme. Some ages back, we have stocks like the internet stocks which were chased like crazy having their stock prices pushed to sky high. It is not always the case that a stock must have a popular theme to be selected, just that it is very common to "fish at a river that have many fishes" (where there is a popular theme for the stock). Another consideration is that the stock price must be suitable to invest in so that there is some room for appreciation in the stock price (usually this may involve investing onto a bull run when the general market sentiment is bullish).

Period of accumulation

After a stock is selected, there is a period of accumulation by the big player. The period of accumulation can be long as the big player patiently buy up slowly and accumulate a large number of shares over a period of time. By accumulating slowly, the stock price is prevented from being pushed up too fast.

Period of flushing out weak players

Sometimes, if the big player cannot accumulate a substantial amount of shares at low prices, it can push up the stock price a little bit (e.g. by 10% price appreciation) and buy in from short-term investors who are willing to let go their shares after getting a 10% profit. During this period of flushing out weak players, big player can also create a resistance point whereby it suppresses the stock price from going higher by some amount of selling. Weak players once seeing the stock price appreciate a little followed by a little bit of falling in prices, quickly sell their shares to lock in some amount of profits and avoid loss. In doing so, the big player continues to accumulate some more shares to build up their position. The objective of the big player is to accumulate a major portion of the shares so that when the price appreciates later, it being the biggest player will have the most reward from the gain in stock price.

Period of pushing up the stock price

Once the big player is satisfied that it holds a large enough portion of the stock, it goes through a period of pushing up the stock price. This move will see the stock appreciate by a large magnitude. Some smaller players who have not leave the scene yet will get their rewards from riding on the wave of the stock price movement.

Period of unloading the stock at a suitable higher stock price

Once the big player has managed to push up the stock price, it has to unload it's shares to finish this whole cycle of investment. So, there is a period of unloading whereby the big player slowly sell off it's shares to other unwary investors. Usually unwary retail investors after seeing the stock price has appreciated by a large magnitude, may become filled with greed and buy from the big players hoping that the stock price can continue to appreciate further. Little do they know that the game has just ended, so these unwary retail investors become the final people to carry the shares at a "high price", shares that will not appreciate further but almost often depreciate after the big player has left the scene.

Conclusion

By understanding the mechanics of how big players work, a retail investor can be better informed and be wary of certain behavioural dynamics in the stock price movement over a period of time. The big players are a force not to be trifled with as these are players with extremely large capital to inject into a stock. So, it pays to understand how they work so as to ride on their success and get a pie of their gains.

Going for the "big win"......It's occasional, but pays well........

Many investors are mediocre players in the market struggling to fulfil "bread and butter" rates of returns on their investments. Many lament that the stock market is full of many "dangers" and "pitfalls" making winning consistently in the stock market an imagination too far to be reached. This is because many market participants fail to go for the "big win", and instead thrive on the many small winnings. When one big loss comes their way, it swallows up whatever small winnings they had in the past, so they end up breaking even or at most making only a meagre net return on their investments.

Why do many market participants fall into this trap of making only multiple small winnings only to find themselves run into the risk of losing back all their small winnings or even suffer a net loss on their capital when a big loss comes their way? It all boils down to the habit of thinking in making investment decisions. The thrill of immediate winning is more enjoyable than suffering immediate loss.

There are two general types of participants in the market, the short-term players who trade actively and long-term players who invest with a longer time horizon. No matter who is participating, all short-term and long-term players both face this problem of falling into the trap of making multiple small winnings only to suffer a bigger loss that trims off the winnings eventually.

For short-term players, the emotional side of the trader tends to disrupt the objective system of trading. It is known to many traders that it is important to stop loss with a small tolerance level (e.g. stop-loss around 10% or even lesser) and let trailing-stops work their way for a winning stock so as to maximise the returns. If the trader does not stick to such strict rule of the game which works on the principle of making a "big win" by using trailing-stops and promptly stopping any losses by strict "stop-loss" measure, then the "big win" effect cannot be realised.

For such emotional traders, it becomes the other way round, making the occasional "big loss" because they let a small loss snowball into a big loss, and making multiple small winnings since they are not able to resist the thought of not realising their immediate gains if any from their winnings. Their consolation after every small win is that, "What can go wrong with taking immediate profits off the table since I have the money in my pocket?". There is nothing wrong with taking profits. However, there is something wrong when taking multiple small profits cannot cover up a big loss eventually. So, to ensure consistency in making "big wins", work on maiximising returns from each winning using trailing-stops and ensure one is covered on the downside by using strict "stop-loss" measure. A simple illustration: if a trader aims for at least 30% returns on each single trade before realising the profits, this returns from that single trade can cover up for 3 losing trades with a "stop-loss" at 10% each. If the stop-loss is more stringent (e.g. stop-loss at 5%), then the cover up on the losing trades is even better with each winning trade. So, the old adage for traders, "let your winnings run and losses stop promptly" is very applicable for making the "big win" when it comes to playing the stock market on a shorter time frame.

For longer term market participants, when does one sell? Aim to sell at a returns of at least 100% on invested capital. Since one is going for a longer haul, it does not make sense to sell at a lower rate of returns. To achieve such returns is not an easy feat. How many market participants can resist the temptation of sitting on unrealised returns for long? Again, their consolation being human is all the same, "What can go wrong with taking immediate profits off the table since I have the money in my pocket?". There you go again. Same excuse, no matter so called long-term players or short-term players, all being humans fall into the tendency of emotional judgment when it comes to investment decisions.

So, no matter long term or short term market participants, there is always this tendency of realising profits too early and stopping losses too late. In doing so, they seems to work along the line of making multiple small winnings and big occasional losses such that their overall investment performance is mediocre at best.

If one has the patience and fortitude to hold the ground after selecting the right stocks at a suitable attractive valuation, only going for the "big win", just a 100% realised returns each year on one single stock in one's portfolio (provided one does not diversify to many stocks: maximum 7 stocks) for a few consecutive years and reinvested, can compound one's portfolio at an alarming rate of return.

So, always be patient to wait for right price to buy (during a bear market or major correction) and right price to sell (at least 100% returns on a single stock) to maximise the gains. Afterall, what is the purpose in investing if one only aims for a meagre returns from the stock market after taking on a bigger risk than other safer investments such as bank deposits? If one is fearful and impatient to wait for a larger magnitude of returns before realising profits and/or is adverse to loss taking which is sometimes necessary, then the stock market may not be suitable for such a person who may be better off putting his hard-earned money into safer investments that he can sleep soundly every night without worries.

A word of caution for readers: there are other considerations such as holding period, fundamentals of a stock and general market sentiments, so please take my sharing with a good dose of caution when going for the "big win".

Franchising and Licensing Asia 2010 trade exhibition @ Marina Bay Sands, Singapore

I will be visiting the Franchising and Licensing Asia 2010 trade exhibition, to be held at Marina Bay Sands, Singapore from 21 - 23 October 2010 (Thursday to Saturday) to get some ideas and exposure, and perhaps potential opportunities on franchising and licensing. Admission is free.

Getting a franchise is a good way for starting entreprenuers to learn from an established business model. It minimises the risk of start-up failure by adopting an established business with proven track record. Of course, there is no such thing as a risk free business or investment. The entreprenuer still have to learn and work smart and hard to better his business even through a franchise. Of course, the learning is more structured since he has an established business system (based on the franchisor) to follow.

Advantages of a franchise for starting entreprenuers are as follows:-
1. Benefits of an established business model with proven track record to follow.
2. Learning from operating a franchise is more structured with help from the franchisor.
3. Lesser risk of failure and more stability since there is a guiding business model to follow instead of self-exploration.

Disadvantages of a franchise for starting entreprenuers:-
1. No freedom in managing business creatively since one has to stick strictly to the business operating protocols from the franchisor.
2. Need to pay franchising fee (usually one-off at the start), any other compulsory start-up cost and training cost, and ongoing royalty (certain % of sales revenue) to franchisor.
3. Need to be bounded by a contract to hold the franchise for a long period of time (which is usually at least a good number of years).
4. Any other binding terms of franchise agreement which are more favourable to franchisor to protect its interest.

Although getting a franchise can be a breeze to aspiring entreprenuers in terms of tapping on an established business model with proven track record, there are many limitations that the entreprenuer will be bounded to. So, aspiring entreprenuers need to consider carefully the pros and cons before deciding whether to take up a franchise.

Simple rule for investing (maintain a strong foundation of a pyramid).

We know of the old adage, "Buy low, sell high." How many investors can be disciplined to put this principle into practice? No wonder only approximately 5% of all stock market participants make the cut and get their deserved returns from the 95% who fail to do so.

How do one buy into the market? When prices are low during bear markets, buy aggressively so as to build a good foundation of shares of selected potentially good companies at cheap valuations. As stock prices increase, buy lesser amount of shares each time as the price heads higher. With each rise in stock price level, the amount of shares purchased must be lesser and lesser. This culminates into an analogy of a pyramid with more shares bought at lower prices and lesser and even much lesser shares bought as prices head higher and higher.

This simple idea of a pyramid buying process is not unknown to many but yet "seems to be unknown" to many. This is because we still hear of many market participants making losses on their investments lamenting the fact that they got caught at high stock prices. To be able to generate returns, one needs to be abnormal compared to the rest of the many market participants. When prices are heading higher and higher, a normal investor will buy more aggressively thinking of only better days ahead. This makes him practise an "inverted pyramid" way of buying when the head is heavy and the base is not able to support the head since more shares were bought at high prices instead of lower prices. With a weak foundation through "inverted pyramid" way of buying, it is no wonder when prices start to head back to lower grounds, the poor investor is left hanging with many shares bought at higher prices, and the probability of capital loss is high.

More shares bought at lower prices and progressively lesser shares bought at higher prices creates a strong pyramid foundation where base supports the head

So, the more abnormal an investor is, refusing to be caught up with greed which is normal to the common crowd who chase after higher stock prices, the higher the chances to avoid risk of capital loss and higher the chances to make returns on investments. Thus, investing is mechanical and boring and made simple with the idea of a pyramid way of buying stocks. Don't be typically normal in investing. Consider being abnormal instead.

Starting a business (let's learn how to become an ultimate investor).

I have been researching on the skills to start and grow a business over the past one year. I am looking forward to consider starting a small business in the coming year. No risk no gain. The aim for me in wanting to own a business is to learn how to start a business, grow it and work towards the business generating sustainable cashflows. So, I will make a small venture out to have my hands wet in doing so. I believe the best way to invest is still to invest as an ultimate investor, that is in owning an entity (a business) that generates returns on my invested capital. The experience that one can get from learning how to start and grow a business is beyond measure. Once a business owner has grasp the art of starting and growing a business, the skills can be applied in future business or investment ventures.

The skills to manage a business can be applied to investments as well. A knowledgeable business owner and entreprenuer can apply his skills in setting up and running a business into analysing investments as well. All road leads to rome. A business owner sees and experiences far more in the frontline to what a business entails than an investor would. So, I hope to learn to become a skillful business owner and apply my future experience in running business also to analysing businesses as investments.

One of my few ambitions was to become an entreprenuer and business owner, so I hope to try it out and make it happen and work. Risk is always present in any businesses. However without risk, there will not be any challenges to make sure one tries to minimise risks and overcome obstacles by continually doing one's best and learning from mistakes and failures along the way.   

This is going to be the best part of my investing journey, to become an ultimate investor investing from the inside of a cashflow generating business. To have a positive cashflow generating business takes time and effort, so I hope to learn how to arrive at it. Everything has to start somewhere just as a child learns to talk and walk. The child will make many falls and finally learn how to walk without giving up. Keep failing by "falling" and learning from the many failures so as to improve on every next "step". It is a natural learning process for a child to be able to walk. It will also be for any new learning in life.

Wearing FA "lens" and TA "lens".......seeing from two different angles of the same market

We have heard of both fundamental analysis (FA) and technical analysis (TA) used by investors (be it retail or professional investors) as working principles of doing stock investments or other forms of investments. More often, we hear also the debate behind the effectiveness of one of these skills over the other in getting investment performance. I have always stayed on a neutral stance though I am applying fundamental analysis in making my investment decisions. I have also researched on TA, though not very extensive yet. I have now got a better appreciation of TA. However, I am not an expert in terms of knowing the inside out of this set of skills.

My discovery so far is that FA and TA are both useful and should be used in conjunction when making investment decisions. The danger is to swing to either side totally, be it TA or FA, and ignore the realities of the one side of the same story (the story about the investment one is making decision on). FA tracks the fundamentals of a company, it's historical business performance and future projected performance based on track record. TA tracks the market sentiments (usually short term basis) towards the performance of the company and it's share price. In doing so, TA also takes into account the larger market in view too (based on ongoing macroeconomics). If one thinks the share price of an excellent company based on FA is undervalued but bought at a time when impending correction of a significant magnitude is likely going to take place based on TA, undervalue can get more undervalue. So, TA does have it's merits and both FA and TA should be used in conjunction to be more effective.

The decision making process need not be complicated and clouded by one skill, be it FA or TA over the other. These two skill sets are not contracdictory in nature. They are just skill sets for the investor to use. The investor is the one who manages the use of these two sets to the best of their use so as to make the best possible investment decision at a particular point of time. By doing so, the investment decision hopefully is better thought out in thoroughness. So, I will not say I use FA or TA. I will say I use my prudence in making investment decisions. FA or TA, both are just skill sets for the investor to use, and both are effective and makes investment decision making more thorough if the investor is careful not to be confused emotionally by the use of one technique or the other. 

Just a parting note, in a bear market like last time, no amount of FA can save an investor from watching his portfolio depreciate sharply in value. In such occasional moments, probably TA can offer help in terms of allowing the FA investor to put on another pair of lens to look from the other side of the same situation to make his investment decision on how to navigate the bear market. Wear FA lens or TA lens to see the market? Both exist for the same reason, to allow the practioner of the skill set to garner good returns from making his investment decisions. The trick lies in the user, not the type of "lens" as both lens can and should be used..........

Who is an ultimate investor?

As investors in the stock market, one is conditioned to think and act like a 'normal' investor. One thinks of buying and owning shares of a public listed company. By doing one's due diligence and through buying and selling shares of companies over the market, an investor seeks to maximise his returns from his invested capital. However, no matter what, he can never be as profitable as the founders of a public listed company who have built up and owned the business and got it public listed at a premium price significantly much higher than their initial invested capital in the start-up of the business.

We often heard of P/E ratio (price/ earnings ratio) of 10 and above for the shares of a company during it's IPO (initial public offering). At the onset of being public listed, the premium that retail investors would be paying is already 10 to above 10 times of the earnings per share of a company that goes into public listing. So, it is usually the founders and owners of the company who benefit the most to getting their company to be public listed since the net worth of their business has tremendously mulitplied by 10 times or more. This is the reward the founders and owners can receive for spending so much effort to start up and build up a business for public listing.

Thus, who is the ultimate investor over here? It is the ones who have started and built up a successful business that goes into public listing. For such founders and owners of the business, they invest from the inside of their business and sell shares of their business to other investors at premium pricing. So, as much as one is conditioned to think that being a successful retail investor is already a wonderfully side to investing, it is as much a reality to know that it is the ulimate investors who are the really more successful investors since they invest from the inside of their business rather than invest from the outside which retail investors do.

In conclusion, the ultimate investor is one who adopts the risk and learns to start a business and invest from the inside of their business directly to grow their business generating revenue and income for themselves. On the other hand retail investors no matter how successful they are can only be at most average investors since they can only invest from the outside of a business and have no controlling interest in a business. No matter how good retail investors are, it is ultimately the ultimate investors (as business founders and owners) who receives the most from their business since they have the controlling interest and sell shares of their businesses to other retail investors who often pay a much higher premium and have 'almost no say' in the business. So, should one be an ultimate investor who learns to start and grow businesses selling shares of his businesses to other investors at higher premium or be the outside investor who buys shares offered by ultimate investors of businesses at high P/E ratio without any controlling interest and relies entirely on the fate of the business run by ultimate investors?..................

For those who are still visiting this blog.

I guess many who have visited my blog will be wondering what happened since I did not update my blog for almost a year already. I have been thinking that blogging takes up time and I wanted to put my time to other uses. I want to thank those who are still dropping by now and then, and hope the blog articles I wrote a year ago are useful to you. The investing concepts put across in the articles did certainly served me well over the past 2 years plus of my investing journey. My portfolio size has since grown steadily by virtue of value investing and also idea of compound interest growth. I am looking to more learning and confirming of the value investing philosophy moving forward to see how it works in my portfolio investment growth.

The stock market is now moving into higher grounds. It is now time to plan and consider strategies to prepare for the next bear market, of which no one knows when it will come (within next one year or perhaps more than one year's time?). In value investing, I firmly believe one need not sell off all the shares and completely move into cash upon the onslaught of bear market. It is all about prudent judgement of how much shares to sell in proportion to one's portfolio size. Ideally, the value investor should sell only when shares are overvalued and there is not much more premium for share price appreciation resulting in more capital gain based on fundamentals of a company. However, there is also the consistency of dividend income yield to consider. If the shares of a company in one's holdings are generating more than 10% of stable dividend yield, then it may make sense not to liquidate the shares or only liquidate part of the shares even during a bear market. Notice I use the qualifier "may". It all depends on the investing objective and time horizon of the investor whether he is financially able to ride out the bear market and still enjoy the dividends while watching his shares depreciate in value temporarily, but not necessarily below his original holding value since he may have bought ages ago at a much lower share price.

So, for a value investor who choose to ride through the bear market, does that mean he can do nothing and only watch the value of his portfolio depreciate. It may not be so. There are some strategies to navigate the bear market (e.g. tools like put option, CFD and other investing methods). The true test of an investor is not during the bull market when almost all shares appreciate in value and any investors (whether educated or not in investing skills) can easily obtain his/her returns from the market. The true test for an investor is during a bear market when he/she can still make returns participating in the bear market while others are fleeing into safety zone or watching their portfolio bleeds and can do nothing much about it.

Let's see how much more legs this bull can have to still run. Meanwhile, let's continue to watch the game while preparing oneself emotionally and mentally (with strategies in place) for the next bear to come.

True investing is mechanical and boring, seeking to make stable consistent returns over a long time frame in all conditions of the markets, running on the engine of compound interest growth.