Oct 31st, 2008 by AhYap
It looks like I am going to miss my target of writing 12 posts in a year. Wahahaha. I can’t even manage to write 1 post per month. BTW, if you google sohai, my sohai post is ranking as #1 now (sometimes #2). Thanks Google for its recognition to this meaningful word. Hopefully one day dictionary.com and wikipedia.com will also include the definition to their database.
Back to what I want to write today. What does the so-called ‘financial crisis’ means to you as an ordinary investor? What does the 50%+ fall of the whole world stock market (30% fall in October 2008 alone) means to you? Is my popular 20% compounded growth plan still relevant? Is my review on ICAP a rubbish? What about all the value investing posts that I have been writing?
Instead of answering them directly, let’s ponder some interesting facts that newspaper won’t be publishing and you won’t see them as headlines in NTV7 news.
What investing gurus are saying?
Gurus from all over the world are using almost the same word to describe the current crisis. It is not ’sad’, not ‘disappointing’, not ‘bad’, not ’scary’ but ‘exciting’! They are using the word exciting to describe the current stock market.
Ken Heebner a guru who compound more tan 20% per year for many years is actually buying bank stocks!
What did Seth Klarman, another great value investor said a few days ago (just before the market tank another 10% in a day)?
“Normally, as a buyer you have to compete with a lot of very, very smart competitors,” said Mr. Klarman. “But many of the smartest people are on the sidelines now because of redemptions, margin calls or panicked-out-of-their-mind selling. So you don’t have to be as smart as you did before. You just have to be in the game.” article link
What he said contains a lot of intelligence that you need to understand. Let me explain the whole concept in AhYap’s style.
Perspective #1 – What happened when you are forced to only sell and are not allowed to buy
I have condemned mutual funds many times but I have to do it again because now you will learn the most. Unlike ICAP, mutual fund is open ended. That means the fund size can increase and decrease depending on how many people willing to pour money into it or take money out of it. So a mutual fund as large as RM 100 million can shrink their size to RM10 million if the holder want to take the money out from it.
In normal days, mutual fund usually invest only 70-90% of their money and keep the remaining in cash. The prospectus will specify the percentage that need to be invested. Say a mutual fund that specify that they need 90% of money invested in the stock market all the time, they have to follow that and make sure 90% of money in the stock market, no matter if the stock market is overvalue or undervalue.
The problem is that when time of panic selling comes, 10% cash is not enough for redemption (the fund doesn’t have enough money to pay to his holders who sell the mutual fund). So where do they get the money to pay them? They have to sell stocks to get money in order to pay them. So when more and more and more people what to get out of mutual funds, the fund managers have no choice but to keep on selling their stocks no matter what is the price! The fund managers may think a stock is cheap at RM3 but are forced to sell it at RM1 because someone want to get out from the fund.
The ice ball roll bigger when more and more people want to get out of the mutual fund. The continue selling from the mutual fund creates a big SUPPLY but the DEMAND is very low. Everyone what to sell but no one what to buy! They ask for lower and lower price. Price tank. Market tank.
The fund manager might be very intelligent in investing. But he can’t do a shit even if he is as good as Warren Buffett. Because he has no choice! He can only be at the sideline watching. First he is forced to sell at cheaper price. Second he cannot buy anything that he think is cheap because he has no money to buy! Money flow out quickly from the fund and no new money flow into it.
When you are in mutual fund, you are partnering with many Ah Beng and Ahmad that you don’t know (maybe just live next door to you) and what they do affect your investment.
How have margin calls affected the stock market? Many people borrow money to buy stocks and use the stock they bought as collateral. Same thing as you borrow money to buy your house and use your house as collateral. Problem is when the value of the collateral drops to a certain value, they are required to either increase the collateral (pump in more money) or sell stocks to reduce the borrowings to the acceptable margin level, which is what we called ‘margin call’ [i.e. your broker call you and tell you that you don't have enough margin].
Unfortunately most people don’t have money to pump in! If they have the extra money, why would they need to borrow? So they have no choice but to sell no matter what is the price! The key phase that is same as the mutual funds, ’sell no matter what is the price!’.
This creates another surge is selling orders that crash the stock market. And mind you, it is not you and me the small little guy that have only RM23 in Maybank account that is margin called but the BIG guys that control billions of dollars! These guys run hedge fund (unregulated but leveraged mutual funds) that borrow a lot of money to invest! These guys are forced to sell because their collateral (stocks they bought) are no longer enough to cover their borrowings.
In short, the force selling of mutual funds and margin calls has create a big SUPPLY of stocks, contributing to a big fall to the stock market. Because they have to sell disregard of price, but the selling doesn’t have much relation with the underlying value of the stock.
Here comes the intelligent investor.
People who are not forced to sell or who have the courage to buy now has the advantage than those who choose to sell or stupid enough to buy mutual funds all the years. Unlike common mutual fund which is open-ended, ICAP is a closed-end fund. It doesn’t need to sell even a single stock even ICAP shareholders are dumping the share in the market. ICAP can keep anything that the fund manager thinks is cheap and at the same time can utilized the RM50 million cash it has to buy more shares that is selling at big discount. That means the next door Ah Beng who owns 1 million shares of ICAP and dump it crazily in the market yesterday until the market price drop to RM1.20 can’t do a shit to its real value (NAV – RM1.42).
For individual investor who has money right now, you also have the chance to grab stocks that are in big discount. Stock market are currently in 4-5 years low. That means in order to buy something at current price, the last chance is 4-5 years ago.
Perspective #2 – The Gap Between Price and Value
Price is what you pay and value is what you get. You can pay whatever price for anything but what you get is just the value. You can pay RM500 for a Mc Fillet O Fish but what you get is still a Mc Fillet O Fish (RM5.90).
“In the short run, the market is a voting machine, but in the long run it is a weighing machine.”
– Benjamin Graham, The Intelligent Investor
Warren Buffet explains what his teacher said a few weeks ago in CNBC.
“Well, the stock market in the short — my old boss Ben Graham said that in the short-run the stock market is a voting machine, in the long-run it’s a weighing machine. As a voting machine, it responds to people’s emotions. There’s no literacy test for voting. You vote according to how much money you have, not according to how smart you (are.) So the stock market does some very silly things in the short-run. Over the long-run, it behaves quite rationally. And, you know, five years from now, ten years from now, we’ll look back on this period and we’ll see that you could have made some extraordinary buys. That doesn’t mean it won’t get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the American economy, over a period of time, will do very well, and people who own a piece of it will do well. But they shouldn’t own it on leverage. That’s what people have learned in this period, that you’ve got to be able to play out your hand and it’s a big mistake to let somebody else be in a position where they can sell you out.”
Why the gap between price and value will eventually closed? Why it is a “weighting machine” in the long run? Because the longer time goes by, the more OBVIOUS the fact that Mr. Market is mispricing a stock and eventually more and more people will noticed it, buy it and push up the price.
Mohnish Pabrai bought IPSCO for 3 times free cashflow (read my post on PE Ratio), a stock that Pabrai knows the market is mispricing. Since it is a voting machine in the short term, the price may remain low and even drop further for the short term. But what will happened after 3 years? The company would have generated cash that is more then it market capitalization! (market cap: the price the whole company is worth i.e no of shares x share price) That means you are exchanging RM1 for RM1 cash in that company PLUS the factories, inventories, future profits, management, employees, palm trees, Diamond water filter, toilet papers, CEO’s secretary, etc. ALL FOR FREE! At this time, even sohai can notice the value-price gap! It is so obvious.
Pabrai bought it at $45 and sold it for $155. And Pabrai said currently many of his stocks is trading at 1 times free cash flow. How long do you think he needs to wait before things get obvious for others?
Perspective #3 – How many McChicken will be sold in China and India?
Tan Teng Boo organized a seminar last year about his theory on ‘i Capital Long Boom’. After paying a few hundred bucks, you received a ’seminar’ book that look more like a nuclear bomb manual written in Russian. You listen to Uncle Tan speaks for numerous hours about facts and figures and looking at charts and data on the screen that you can never underestand. And yet, ironically, everyone get very excited!
Dump away all the statistics – the nickle comsumption per capita, the price of USD vs Nigeria Naira, the washing machine sold per household, stainless steel nuts and bolts consumption, etc etc etc … Why not just ask yourself a few questions.
How many Nike shoes do you think the China and India man will buy in the next 10, 15, 20 years?
(Hint: China has 1.3 billion people. India has 1.1 billion. India population will surpass China in 20+ years. US population is only 0.3 billion!)
How many chicken (real chicken ok) have to be fried by KFC in the next 10, 15, 20 years?
How many condoms are required by China and India man to make sure they don’t have too many ‘liabilities’?
How many toilet paper do they need? Toothpaste? Hand phones, computer chips, rubber bands, Diamond/Nesh water filter, Crocodile underwear, etc etc etc.
It is mind boggling. The China, India and all other Asian countries will play a big role in the world economies in the future. Tan Teng Boo describe it as something that happened once in a millennium.
Perspective #4 – When Price Drops, It Gets Less Risky, Not More Risky!
Given that you have done a thorough analysis on a stock and you bought it a discount, the stock will not get riskier when the price fall! For example, Mohnish did a research on IPSCO, a cyclical steel company. His analysis read like this -
It was trading at a market cap of 2.5 billion. It had 900 million in excess capital, and was projected to earn 650 million in free cash flow over the next two years, meaning 2.2 billion in cash by the end of that period. Though steel is highly cyclical, one can relatively easily forecast an industry 2 years out just by researching new supply projects and usual demand trends. Afterwards a gray area exists, but at that point it was a true Dhando situation- heads you win, tails you don’t lose much.
Say Pabrai started to buy it at $50 at 3 times free cash flow. After he bought, the price tank immediately to $40 next day. Nothing fundamentally changed about the stock. Price has changed, value is still the same! Yesterday you pay $50 for something that you can buy today at only $40! Is that more risk or less risk? It is actually more rewarding and less risk to buy again at $40! So Pabrai bought more and it tank 50% the next day to $20. So what does that means? Is it end of the world? No! It is getting even less risky and more rewarding to buy at $20. When the stock goes back to $100, you get 100% return if you bought it at $50, 150% return if you bought it at $40 and 400% return when you bought it at $20!
The more price drop, the more rewarding and less risk you have to buy the stock! Of course, the initial requirement is that you are already buying cheap at first and your research is correct. If you buy something that is worth only $10 for $100, even if it tank 50% to $50, it is still expensive! The best example is the stock Bursa Malaysia, people love it so much and push it over PE40! Even if it tank 50%, it is still over PE20 and still expensive. Compare that to Pabrai’s PE3 to PE1.5.
Perspective #5 – Holding Cash Machine is always Better Than Holding Cash!
If you hold cash and put it in your bank account, especially after the market has tanked 40%, what return you can get? Let’s give you a generous 4% return for the next 10 years, and a 6% inflation to eat up your money, you will have a compounded loss of -2% every year! You are seeing more money in you bank account but your buying power has shrinked! Poppiah should be selling at RM4 by then.
Businesses that keep on making money are cash machines. Let’s say you own a well managed palm oil company and the share price is affected by the movement of palm oil price, in the short term the price will be volatile. But in the long term, the demand of palm oil by China and other countries will come back! Unless you expect no one need palm oil anymore, they will eventually be able to generate more and more cash! If you sell good stock at beaten down price, you are like killing the goose for its egg! How much egg can you get from that egg? But if you insist on keeping the goose, eventually it will give you more and more eggs.
Perspective #6 – Why Most Analyst Are Useless and Ugly Creatures!
There are analysts for overall stock market, analysts for individual stocks, analysts for palm oil, for oil, for gold, for currency, for anything. I will tell you one thing and you just go and see yourself for the next few months/years and laugh on it.
What analysts do everyday is to look at what happened yesterday and today and tell you it will happen again tomorrow.
1. When ringgit is appreciating against USD from 3.80 to 3.70 to 3.60 … they will tell you that it will goes to 3.50, 3.40 and 3.30 … and some brave one will say something like, “We will see ringgit at 3.1 by end of the year.” They are just telling you what had happened will happen again in the future. But always they are wrong. Ringgit never touches RM3.1 and will not touch RM3.1 by the end of the year but actually devalue again to 3.3, 3.4… then analysts talk cock again and do what they do, tell you that it will go to 3.5, 3.6, 3.7 … They talk more cock than AhYap.
2. Crude Oil is the best example. When oil hit $70, they tell you it will go to $80. When $80, they tell you it will go to $90. For them it will always be the same direction as yesterday. So when it hit $140, some analysts become very brave and actually set the short term target for oil at $200! Bullshit, oil then quickly fell back to 130, 120, 110 … analysts start to change their cocks and say it will go to 100, 90, 80 … now they say it will go to $50 no matter what the OPEC does!!! You see how they predict the future is just look at last few days. And then they become braver and braver with their prediction and get damn wrong on it. Oil at $50? If you own an oil company that dig oil from the very deep sea for $60 per barrel and the market is selling oil at $50, do you still want to dig? Of course you don’t want to dig and the supply will fall and the price will go up again!
3. Malaysia’s analysts like to predict palm oil prices. From RM2,000 to RM2,500 to RM3,000 to RM4,000. For them it is always a one way street. The it tanked from RM4,000 to RM3,000 to RM2,000 and to now RM1,500! And you are right! An analysts say it will hit RM1,200 by March 2008. They are getting braver with their prediction. If you own a palm oil company and the cost of production is RM1,400, will you still want to produce more and sell it for only RM1,200?
Look at ICAP Now – The No Brainer Investment.
In my review of ICAP stock, I mention that you might be late to the boat because the returns goes too far from the normal courseline. But you know what? In less than a year, the boat is back! Not only it is back, it is actually parking just outside your gate.
The last 2 days, some Ah Bengs dropped their balls in Jusco, became so fearful and start dumping their significantly undervalued ICAP in the open market, pushing the price down to only RM1.20! The NAV (the real value) of ICAP on the closing of Wednesday was so much higher at RM1.42! And the overall portfolio of ICAP rise a lot on Thursday, which is at least 3% making the real NAV on Thursday closing something more than RM1.47! Selling at RM1.20, that is a BIG 18% discount! You are buying RM1.47 with only RM1.20. For those who sell, they are selling something worth RM1.47 for only RM1.20! How crazy is that.
With the portfolio of ICAP already significantly undervalued (many stocks that ICAP owns trade below PE5), ICAP is a no brainer buy now especailly there are Ah Beng wants to sell you for another 18% discount! Remember, price and value gap will have to closed when it becomes obvious! ICAP can’t be sold at RM1.20 when its NAV continues to go up. [Mind you, it is almost impossible to own ICAP at RM1.20 from the open market from the first day it is launched, because it rarely trade below RM1.20. People are willing to pay a high premium of RM0.20 for RM1 cash it is holding]
Do you think ICAP at RM1.20 can deliver 20% compounded return to you for the next 20 years easier or ICAP at RM2.20?
Do you think ICAP at RM1.20 is riskier than when it is RM2.20? Do you think it is riskier to buy RM1.47 for only RM1.20 or to buy RM2.20 for RM2.40?
Do you have the balls to be greedy? Greedy for the no-brainer low risk, high return investing.
(Bonus) Perspective #7 – The Cyclical Fear and Greed and the Money Sitting Sidelines
People think that they are rational but actually they are emotional. If they are logical, why would you sell something worth RM1.00 to someone for only RM0.50? And that happens all the time in the stock market. In stock market, people are drive by the emotion of fear and greed, especially noticable in the short term, when everyone become heavily short-sighted even with coke-bottle-thick glasses.
Not only people are greed and fear, but most of the time they become over-greed and over-fear, pushing stock prices to illogical level and they still think it is logical. Fortunately, people are also very forgetful. The emotion can’t last forever and soon they will realized that they are overdoing it and things can change drastically after that. The market swings from over-greed to over-fear and from over-fear for over-greed. It happens again and again for many decades. It is ‘cyclical’ in nature and it will happen again and again in the future.
When you invest in times of over-fear, you will max up your investment return. When people are in fear, the tends to take the money out from the stock market and put it under thier pillow to feel safe and ‘peace of mind’. Most money are out of the market now. They are the money sitting at the sidelines, waiting for the sky to be clearer before they decide if they want to get back in.
Everyone is waiting for the sky to get clearer – the wait and see approach. Sooner, the first guy will say, “Hey, I think it is clear now and I want to get back in.” Then the second, the third and then a stampede of people rushing to pour the money back to the market. When loads of money that is sitting at sidelines start flowing back to the market, it will push up the price. And that make sense we should buy stocks when there are loads of cash at the sidelines, and not when the sky get clearer!
(More Bonus, actually more saliva) Perspective #8 – The stock market can fall another 50%! But does that matter?
As I said, people are irrational and emotional although they always think they are not. The stock market can easily tanked another 50% next week or next month! Unless there is a meteor that crashed to the earth and killed half of the population, the world will get better and better in the future. Even if Obama get assasinated tomorrow, the US market may tank 20% in a day but life goes on and he can be easily replaced.
With all these new perspectives given to you, why would a 50% in the short term (1 week, 1 month, 1 year) matter to you when you have a high confidence that in 10 years, 15 years, 20 years you will be doing very well with what you have buy today?
You have RM100k invested for the 20% game plan. The market drops 50% in a year and you are left with RM50k. You condemn AhYap for writing a blog to con you (for 2 years) but at least you stil keep the money invested. The plan fails to compound at 20% but it does 15%. In 20 years, you have RM1.6 million.