Asset Management & Trading Education for KLSE

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QL Resources

Published by dirtydog May 4th, 2008 in QL Resources. 0 Comments

After a several month hiatus I have managed to start posting company scores again. This is because my efforts have been more focused on the volatility we have been experiencing recently, where making money has been more about market timing rather than balance sheet analysis.

Anyway, in case you are not aware of this counter, it has shot up lately as it is growth company set to ride what I call the second wave of the commodity boom (i.e. commodity processing as opposed to producing). Generally speaking, the market is pricing in the theory that companies along the supply chain should be next to benefit from rising commodity demand as commodities are processed for consumption. Palm oil millers and feed processors, for example, are seen to be less exposed to commodity prices, but still benefit from rising commodity demand.

QL resources has both, and a strong balance sheet to boot. As you can see, it is a rapidly growing company benefiting from rising profit margins.

But is it a good buy?

Although it scores a worthy 9 on my scoresheet, its important to notice that revenue growth has actually slowed compared to its profit margin, and it is already trading at a relatively high PE. Another thing to watch out for is its effective tax rate, which is abysmally low. This sets alarm bells ringing because you have to wonder how real a company’s profits are if the taxman is happy to only collect 11% of it.

Happy trading!

The waiting game..

Published by dirtydog April 14th, 2008 in Investment Notes. 1 Comment

It is just so amusing to hear all the research reports coming out now touting shares again, when 3 or 4 weeks ago we did not hear so much as a pip out of them. What has changed between now and then? Absolutely nothing. Except that prices seem to have stopped going down. If you feel that your analyst or broker has just started to make recommendations again only because prices are more stable, then be careful because if they had any conviction in their recommendations they should have advised you to buy when the prices were on their way down, not on their way up.

Anyway for me it’s just a waiting game now to see how things shake out over the first quarter. All eyes are now focussed on upcoming quarterly reports and I am happy to stand aside and just wait for reports to come and looking hard to see how events in the last few months have affected the balance sheets and earning of our companies. Although the Malaysia economy is still sound, the question is whether commodity and hence palm oil prices will remain supported this year. If so, I will keep adding to my palm oil companies. If not, then I will probably continue looking at staples. Either way I am not considering small caps yet.

It’s important to take a step back sometimes and not get sucked into bear rallies thinking that we have reached a bottom and I am just not sure whether we have or not. As an anecdote when Herbie Hancock played with Miles Davis there were a couple of numbers which Herbie would confide in Miles saying that there were areas where he just didn’t know what to play. In response, Miles would just say “If you can’t think of anything to play then just don’t play.” So here I am… not playing and waiting.

If you’re interested, head over to C-span and check out Ben Bernanke’s senate hearing interview, which has provided a very candid assessment of the current financial situation in the US and frank disclosure of the facts behind the Bear Sterns bailout. Very interesting stuff..

Just go to the link here and click on the top 2 search results which come up.

Economic vs Financial Markets - Is the end in sight?

Published by dirtydog March 28th, 2008 in Investment Notes. 0 Comments

When analysing financial markets, it’s important to also keep one eye on the economy, because financial markets are not the same as economic markets. In financial markets, there is only one consistent measure of value: price. However, in economic markets the measure of value is more subjective, and is contained in the question “How well is the economy doing?”. To answer it, analysts use a variety of indicators such as GDP, exports, industrial production, consumer price index etc. etc.

At uncertain times like this, being able to analyse the economy can sometimes provide a sane benchmark against which to asses whether things are overvalued or undervalued. This is because a large component within financial markets is “expectation”. Put simply, investors will pay more for a company if they expect it to do well in the future regardless of what it currently says in the company’s financial statement. There is no such thing for economic indicators, which only look backwards.

So if you look at our current economic indicators, there is actually quite a lot to feel comfortable about, because both Industrial Production and International Trade has been growing steadily in 2007 (thanks to our palm oil), and at the global level even though the US may be in a recession, high commodity prices and exports are providing evidence that emerging markets are slowly starting to consume more and more goods, thereby taking up the responsibility of becoming the world’s consumer and keeping demand alive.

The question we have to ask then, is if that is the case then why are financial markets in distress? Well, it began with the credit crisis - a phenomenon which would theoretically have been confined to financial markets, were it not for the fact that it happened on such a grand scale that it is affecting the ability of banks and creditors to lend money to mom and pop - retailers and other bricks and mortar businesses.

On top of that there is also the (separate and more worrying) fear of inflation, caused by high commodity prices driven partly by a weak dollar and partly by surging demand in the emerging markets. The fear here is that inflation will cripple the ability of the emerging economies to continue demanding more goods, thereby causing more businesses to suffer and result in a depression.

As a result, investors are staying away from the financial markets and causing weaknesses in share prices, and thus the conclusion is that even though the economy can be said to be chugging along just fine, fear has caused financial markets to disconnect from the economy, because it expects the economy to suffer and for economic indicators to turn down in 2008.

What I have just described are the first phases in a bear market cycle, which has several phases each characterised by its own specific brand of fear. The first type of fear is a knee-jerk reaction, usually starting from a single event (such as the the poor results from banks resulting in writedowns and the sub prime fiasco) which then spreads to a second type of fear of something more fundamental (such as fears of liquidity and inflation worries). As traders, we will start to consider whether the end of the cycle of near when market fears which reach such deep levels.

But be careful, because it’s important to understand what we mean when we say that the end is near because firstly just because the end is near doesn’t mean that there will be a bull anytime soon. And secondly just because we are near doesn’t mean that there can not be a further drop in prices. As traders we need to wait for evidence of a turnaround - which will be the subject of another post.

So my opinion is that there is one more fear to come, and that is when we look at the most recent evidence that emerging market economies are slowing along with exports (China’s industrial production figures and imports are already down in 2008) and people start to expect both the US and China’s economies to stall. But, that won’t come quickly because there will be bear market rallies every now and then as the Fed and other central banks and governments take whatever measures they can to avoid this possibility and making it extremely difficult to pinpoint the exact moment when the market bottoms.

So, I still intend to gradually start accumulating shares over the entire period of the market bottom, and eventually going into 100% equities.

Bought Digi

Published by dirtydog March 12th, 2008 in Digi. 0 Comments

I have now raised my cash equity ratio up to 65% and bought into the post election panic by snapping up Digi for $21.20 on Monday and then $21.50 yesterday, giving me an average price of $21.35. Today it is already up to $23 as investors wake up and realise that opposition is a good thing for the economy.

Opportunities to buy into good companies like this for cheap are few and far between and should be taken advantage of. If you do that for every counter in your portfolio you will die a rich man.

Election Victory?

Published by dirtydog March 10th, 2008 in Investment Notes. 1 Comment

A few weeks ago almost every research house on the street were publishing recommendations on how to play the election in the stock market. Their reasoning was that the government will continue to pump prime the economy. So GLCs such as UEM, ECM, YTL Corp, ICP were being touted. Here’s what DB analysts had to say at the time:

“The election outcome is unlikely to be too surprising and hence, we believe it is unlikely to rock the market. We continue to believe the market will remain defensive amidst global volatility. “

Guess what? Over the weekend they all had a crash course on why one shouldn’t play the market on events and a reminder that they are analysts and not prophets. At last count UEM - down 20%, YTL - down 12.5%, ECM - down 19.8%.

So how does one prepare against such events? Well, the answer is not so clear-cut, but as always, it involves looking at the market and examining the writing on the wall. Last year we had the sub-prime crisis markets such as Japan and US reached a top. And remember the frightful few days when the Hang Seng lost 7000 points from 30,000 just on liquidity scares alone? Since then all those markets have been bearish. There are times when you just have to call a bear a bear.

Now, at trading school they always teach you to avoid developing any views on market direction based on news alone and that it is always the market’s reaction to the news which is important and not the news itself. So although the election results don’t actually have any impact on government policy, the market’s reaction to it is extremely negative. Every week there are many news events. Election results are only one of them (albeit very important), economic results, company results, political news etc. etc. Predicting whether the market will react to any one set of news, and if it does so, in which direction, is extremely difficult. But my point is that if you have a set of collective events which the market has been reacting to negatively starting from the sub prime crisis to the write downs of financial institutions to the liquidity scare, then it is likely that the bears will continue to react negatively to news going forwards.

In the case of Malaysian election results this is no different. If you put yourself in the shoes of an international hedge fund manager, you will not know who the DAP or PAS is, much less its candidates. You may have heard of Anwar Ibrahim, but you would not know much about his views - in particular whether he was business-friendly or not. And when you hear that the opposition has upset the government in its worst performance in 50 years, you’d probably be wondering whether there was something wrong with the country. Who cares? Hong Kong is looking cheap at moment. Let’s play it safe and put our money there…

If I had to surmise why the stock market is down today, this would be reason.

But my dear readers! If you live in Malaysia you will, for once be at an advantage to the international community. We know who DAP and PAS are, we know why they won, we know who won, and we know what they are like. Because of that, most importantly we have information which the international community doesn’t and we will be able to make a better assessment of how things are going to move forwards for Malaysia from here. For once, you will have better information compared to some research analyst working for an investment bank who does not even live in your country or in your world.

Although I encourage you to all make your own assessments as to whether the fears are founded or not, I offer my own analysis.

Firstly, BN still has a majority. It doesn’t have two-thirds anymore, but it is still the ruling party. Secondly, there is no opposition, there are 3 parties (DAP, Keadilan and PAS) splitting the gain between them (albeit pursuing the same election strategy). Thirdly I have not read anything published by any of the parties indicating that they were anti-free market or anti-commerce. No matter how much I try, I cannot imagine a situation where the economy will suffer because of this. The only scenario where this can happen, which is the scenario that BN likes to dwell on, is that it will create tension amongst the local population.

Although I agree that it will, I cannot imagine that this is a bad thing. I mean, we all want our country to remain competitive and we all want our stock market to be strong so that prices can go up. How on earth are we supposed to achieve that without competition? And how can we have a competitive market if we don’t have a competitive government? To me this is the first step in the long road towards real development, and although history will probably not look too kindly on Badawi, I feel that he has been somehow instrumental in helping give Malaysians a real voice this time. Mahathir may be right in thinking that had he still been in power then this would not have happened, but I don’t think that Malaysia would have been a better place. I don’t believe that the opposition are anywhere nearly as strong as they need to be to disrupt the government, and I don’t believe that there is any reason why our companies cannot continue to build and generate profits. I think that it will bring some much needed accountability to the government, and maybe, just maybe, somebody will wake up and realise that they are have to start delivering some results to the people of Malaysia.

I smell blood on the streets, which is my cue for going in. Time to pick up some blue chips for cheap!!

Why Timing The Market Should Be Unimportant

Published by dirtydog February 28th, 2008 in Investment Notes. 0 Comments

These days we hear even more about ‘timing the market’. Ever stopped to ask yourself what this really means? Most people assume it means buying at the bottom and then selling at the top. But that confuses outcome with the process, because how are we supposed to know when the market is at the bottom? Well, would it surprise you if I were to tell you that actually there is no need to guess or think of where the market is headed?

The first reason why there is no such need is this: the diversified portfolio.

Why You Should Have A Diversified Portfolio

The theory behind the diversified portfolio is that it’s not possible to predict when things are at the bottom any more than you can predict how much the Fed will change interest rates. Investors in this school tend to run diversified portfolios which consist of assets spread out across large cap, small cap, international, bonds, commodities etc. and make periodic, regular investments regardless of the performance of the market. The idea is that the portfolio balances itself out regardless of the market movements. You can say that the international portfolio on the left hand side of this blog is such a portfolio. It is something which I have been adding the same amount of money to regularly every month for several years without looking at a single chart or reading a single report and which has earned an average between 8-12% a year. Over the past few months when equities have tanked, the bond and commodity counters have shot through the roof, eliminating the losses on the equities. If you are running a similar portfolio my advice would be to continue buying. If you put the same amount of money into your portfolio every month, you will automatically pick up more assets which are cheap and less which are expensive. Over time, this forces your portfolio to balance itself towards the cheaper assets without you even having to do any research. So over 2008 if I perform the same strategy I will end up buying more equities that I did last year and fewer bonds and commodities automatically, which would be the correct thing to do even from a “market timing” perspective. In that sense I will be buying-low-and-buying-less-when-prices-are-high.If you are one of these investors then stay the course! As the worse thing you can do to the strategy (and your portfolio) is mess with that arrangement, because then you will find that things will not balance out over time and you have inadvertently become an active manager. I would advise you to keep investing regularly throughout 2008.

However as I have said previously you will not be able to follow this strategy if you invest solely in Malaysia. This is because we can only mainly buy equities. So what can the rest of us do?

This brings us onto the next reason why it shouldn’t be necessary to look for timing - Money Management and Bet Sizing.

Money Management and Bet Sizing

Now here I am going to argue that the second reason why you don’t need to guess where the market is going is because the secret to being a successful active manager is that you don’t put yourself in a position where you have to do so. So how is this possible?

Money Management

Real traders will tell you that being good at trading doesn’t involve knowing when the market will go up or what to buy. It involves cutting your losses and letting all the other trades take care of themselves. Although there are many many books on how to develop a trading system, in a way it doesn’t really matter what system you use to enter your trade. The important thing is just knowing when to exit.

For example, a simple stop loss strategy involves selling when the prices close below the low of the 3rd previous candle. This applies whether you are trading by the minute, hour, day or week. So assume that I have bought a share on Monday and am trading by the day. I will sell my position on Wednesday if the price closes below the lowest price which traded on Monday. It’s as simple as that.

Now anyone who follows this simple rule will be out of the market very frequently. Yes, it can be frustrating, and yes, your trading commissions will eat into your capital, but you will not get wiped out and the rate of your losses will slow right down enough to let the winning trades have a chance to work their magic.

But you will not be able to make money if you follow this strategy alone. This is because trading commissions will eventually eat up all your capital, so what can you do to help the situation?

Bet Sizing
Stopping yourself out all the time is not profitable unless you enjoy slowly bleeding to death. You have to do something else to make sure that the money you lost is more than made up by the winners. From experience, I can tell you that just leaving the winners as they are would not be sufficient as eventually they too will get stopped out. It will prolong the inevitable because you will make small amounts, but eventually commissions will eat them away too. So, you should add to your winning positions. This will increase the chances of you making even more money as you are buying into a stock that is showing strength. A simple rule involves just taking the money you obtained from closing out your losing trade and then putting it into the ones which have not yet been stopped out. I personally will just add however much money I get across all counters that are still making money. So, say I sell a share and get $100, and I have 5 shares that haven’t been stopped out yet. So I will add $20 to each share. Simple as that.

Now I dare say that if you follow this system you will make certainly make money. In fact, I even know pure technical traders who just buy everything without even investigating the companies and spend all their time cutting out the losers and adding to the winners without even so much as looking at the index or reading any report or newspaper, or making any guesses over where the market will go.

Conclusion

As you can see, either by employing a diversified portfolio and just adding to it regularly, or being more active and selling the losers whilst adding to the winners, you are automatically disciplining yourself to manage your money without even knowing where the market is headed.

But remember that in some ways it’s never really the strategy that works or doesn’t. It’s your application of it that makes all the difference. The most important thing here is to stick to your system and not deviate. Most people fail to do this and lose money.

Happy Trading!

Dlady

Published by dirtydog February 16th, 2008 in Dutch Lady. 0 Comments

Yesterday I changed my cash equity ratio from 40/60 to 50/50 and added DLady to my portfolio. This is because DLady is what we call a consumer staple, which are countercyclical stocks. After all, no matter what the economy we all need to eat. The only downside is that consumer staples are very rarely growth stocks so I am not expecting this one to shoot for the sky. Also with a PE of nearly 18 I am not exactly picking up this one for cheap. But the hope is that it will maintain its earnings in the face of an economic downturn.

I have also added the breakdowns to the portfolio so you can see the proportion of cash I have invested in each stock.

Happy Trading!

A Comment on Research Reports

Published by dirtydog February 15th, 2008 in Investment Notes. 0 Comments

Here are some extracts from research reports I have gleaned over the last few days:

“We expect the government to continue pump priming into 2008″

“While CPO prices continue to break new records, above RM3,400/t presently, our concern is that earnings could peak this year.”

“Election stocks may see some selling pressure”

“According to a poll conducted by a local daily, Malaysian voters are most concerned about the cost of living, social issues, the crime rate and illegal immigrants.”

What do they all have in common?

These statements are all unquantifiable. And they do not deal in facts. Only opinion. I would not buy stocks based on opinion anymore than I would buy a television or car just because the salesguy in the shop thinks is good.

It’s important to understand that research reports are published by brokers and banks, whose only source of income lies in providing banking or broking services to their clients. Put simply, the more a client trades, the more money a broker or bank makes. Also, hedge funds and institutional clients have fairly short horizons because they have to compete with one another and report their performance monthly or even daily to attract investor attention.

Whilst I do not believe that research is published solely to encourage investors to trade, the client-centric focus of brokers and banks necessarily means that they have to pander to shorter term investors, which is why the majority of reports contemplate issues and news which are only relevant in the next 6 - 12 months. Therefore it is no surprise that research reports are all focusing on construction, election and commodity plays.

The problem with this is that it creates a herd effect as the majority of investors will base their investment decisions on the same criteria. Worse, analysts also get comfort from the masses in that if everyone recommends palm oil IOI corp, then the research analyst who also does so will not suffer as much rebuke if the price of the stock tanks, compared to if he or she went out on a limb and recommended a small unknown company manufacturing electronics, for example.

And going back to my original point, an investor should have very clear criteria based on what he will buy and sell, whether it be a car, television, property or shares.

So firstly I don’t think that anyone can predict where commodity prices will be at the end of 2008 with any certainty, or whether the government’s pump priming (which, incidentally, is something that the government has always been doing as long as it has been around) will benefit a particular company - after all who cares whether a company gets its projects from the government or from another organisation or as a sub-contract?

And would it matter where in the election cycle we would be or where commodity prices are? If a company has good assets capable of generating quality cashflow for a long period of time, can organise its internal structure and debts well enough to make good profits and is valued cheaply, then would that not be the safest place for your money compared to all other types of companies?

Prisoner’s Dilemma

Published by dirtydog February 4th, 2008 in Investment Notes. 0 Comments

First of all I’d like to wish everyone a Happy New Year… May you have a fortunate year coming u ahead.

Judging from volumes, it seems that many investors are unloading or rotating into defensive sectors for the New Year. The question is will the bulls be raring to go again after the CNY? There does not seem to be a clear view from the street as yet, but many blue chip counters have been demonstrating classic symptoms of technical breakdown - which is characterised mainly by a fall below a moving average and the majority of bears out there being technical analysts as a result. These traders will be out of the market and waiting for consolidation.

Value investors however, should pay attention. Because with the technical traders out of the market, any bullish action after CNY will have to be generated by you. The question therefore is, do the value investors consider things cheap enough yet? If you’re not familiar with this type of analysis, it’s called the Prisoner’s Dilemma and breaks down as follows:

Assume that there are two prisoners in a room. Both are given the option of either laying the blame on the other or staying silent. If both lay the blame on each other, then both get 2 years. If both stay silent, then both get 6 months. If one blames the other and the other stays silent, then the prisoner who blames the other will go free and the prisoner who stays silent will get 5 years. From the perspective of each prisoner, the theory states that it is always preferable to betray the other. This is because if he stays silent, then he runs the risk of being put away for 5 years. If he betrays, then the maximum penalty he will get is 2 years, with the potential upside that he will walk away a free man.

Of course investing in the stock market is not as simple, but the thought processes are fairly similar in that each investor will balance his options in the light of what other people are doing, and pick the course of action which best upside and the least downside. Whether you are out of the market, partially in, or fully invested, the secret lies in being able to determine which prisoner you are right now…

Book Review: Against the Gods

Published by dirtydog January 28th, 2008 in Book Review. 0 Comments

When this book was published, I was an active fx day trader who relied on technicals and economics to make my trading decisions. It was difficult to see how this book would be of any use to me so I passed up on reading it.

As my trading grew, my interest also expanded to other areas. First, to equities, where I learnt how to put a value on a company and now, to portfolio management, where I am learning how a combination of assets in my portfolio affects its level or risk and reward.

One of the key lessons in portfolio management is that when you combine a bunch of assets together the level of risk and reward in the portfolio is not just a product of the individual risk and reward profiles of the assets. In other words, it is possible to decrease the risk and increase the reward of the company by combining several assets which, if owned individually would produce the same reward but be riskier to hold. This book does a magnificent job of tracing how mankind developed theories of risk management such as this from the earliest beginnings. As such, it is a great book if you want to understand what risk management is and how it has evolved.

Then about 4/5’s into the book, the author goes onto explain subsequent research, especially on how human beings make decisions, improperly and sometimes irrationally. For me, this is the most interesting part, because as any trader will tell you, the market not always rational because human beings themselves are not rational.

Let me provide an example:

Suppose that a family is on a beach during a vacation, alongwith a hundred other families. Their child, alongwith several hundred other children are paddling in the water. Suddenly at a distance, there is a tsunami and the warning goes out to the families, who realise that the tsunami is almost upon them. There is only a slim chance that each family will be able to rescue their own child from the water because of the time it takes to locate the child. Let’s assume that only 4/10 families will be able to do so before the wave hits. However, it is possible that instead of trying to locate their own child, each family just rescues the child which is closest to them. This cuts down on the time taken to rescue a child and makes the whole process more effective. And if every family did this, the probability of the child surviving shoots up to 8/10. Twice as likely to survive.

However if the child were yours, would you adopt this strategy? The interesting this is that most people will say no.This is because human beings prefer to avoid loss rather than to seek a gain, and explains a lot about why people hold onto losing positions when they trade.

Questions like this are being considered at the forefront of the finance world, and whilst I do marvel at how far human beings have developed in their ability to play games and trade I am in awe of how little we still know about what drives financial markets.