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How To Find Multi-baggers?

Just a few multi baggers in your stock market portfolio can make a world of a difference. Here are some factors I consider when looking for a mutli bagger.

The term, multi-baggers, when applied to the stock market, was coined by legendary investor Peter Lynch in his book One up on Wall Street.

It refers to a stock that delivers more than a 100% return on our investment. Seasoned investors will tell you that just having a few multi-baggers in your portfolio can make a world of a difference.

Imagine if you had used just 1% of your portfolio to buy Netflix in 2007 at US$2.57 per share. You’d have a 163-bagger in your portfolio today. That 1% position will now be worth 163% of your initial portfolio. Even if the other 99% of your portfolio went to zero, you’d still be sitting on a positive return.

But how do we unearth such long-term winners? Here are some things that I consider when looking at which stocks can be multi-baggers over the next few years.

Potential market opportunity

The amount of revenue that a company can earn in the future is a key factor in how valuable the company will be worth.

As an investor, I’m not focused on quarterly results or what percentage year-on-year growth a company achieves in the short-term. Instead, I’m more focused on the total addressable market and how much the company could make a few years out.

Let’s take Guardant Health as an example. The company is one of the leading liquid biopsy companies. It has non-invasive tests to identify cancers with specific biomarkers for more targeted therapy. In addition, the company is developing non-invasive tests that could detect early-stage cancer, which has a market opportunity of more than US$30 billion a year. Together with its late-stage precision oncology test, Guardant Health has a market opportunity of more than US$40 billion in the US alone.

Guardant Health is still in its infancy with just US$245 million in revenue in the last 12 months. If its early-stage cancer tests gain FDA approval and is adopted by insurance companies, Guardant Health could easily increase its sales multiple folds.

Clear path to profitability

Besides increasing revenue, companies need to generate profits and cash flow too. As such, investors need to look at free cash flow and profit margins.

For fast-growing companies that are not yet profitable, I tend to look at gross margins. A company that has high gross margins will be more likely to earn a profit during its mature state.

Using Guardant Health as an example again, the liquid biopsy front-runner boasts 65% gross margins on its precision oncology testing. Such high margins mean that the company can easily turn a profit with sufficient scale as other costs decrease as a percentage of sales.

An enduring moat

To fulfil its potential, the company needs to be able to fend off its competition. A moat can come in the form of a network effect, a superior product, a patent or other competitive edges that a company may have over its competitors.

On a side note, I don’t consider first-mover advantage a moat unless it operates in an industry where a network effect is a valuable moat.

In Guardant Health’s case, the company’s tests are protected by patents, which prevents other companies from copying their products.

Management that can execute

Potential is one thing, but can the company execute its plans? This is where management is important. The company’s CEO needs to have a clear vision and execution plan.

Management is a touchy subject and requires a lot of subjective analysis. My blogging partner, Ser Jing, wrote an insightful article recently on how we can assess the quality of management.

Comparing current market cap with the potential market cap

Finally, after identifying a company that has a high probability of growing sales and profits multiple folds, we need to assess if its current market cap has room to grow into a multi-bagger.

It’s no use buying into a company that has all its future earnings baked into its market value.

If Guardant Health can increase its sales to just 20% of the US$40 billion addressable market in the US alone, and generate a 25% profit margin, it will earn US$2 billion in profit annually.

Assuming the market is willing to give it a price-to-earnings multiple of 30, that translates to a US$60 billion market cap.

At the time of writing, Guardant Health’s market cap is around US$8.3 billion. If Guardant Health can execute its growth strategy well over the next 5 to 10 years, it can become a multi-bagger.

Final words

Multibaggers can be the difference between a market-beating portfolio and an average one.

However, finding a multi-bagger is not easy. The company needs to tick many boxes. And even so, there is always the risk that the company does not fulfil its potential. In Guardant Health’s case, biopharmaceutical companies have to jump through many hoops to earn the honey pot at the end of the rainbow.

For the liquid biopsy market, Guardant Health needs its early-stage cancer test clinical trials to (1) meet its primary end goals, (2) gain regulatory approval, (3) earn trust from insurance companies and finally ,(4) be adopted by clinicians. These hurdles will not simply fall over and there are risks that the company will fall flat in any one of these.

As investors, we therefore, need to consider the risk-return profile of a company before deciding if the it makes sense for our portfolio.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

3 Easy Analogies To Understand The Stock Market

Investing in stocks is often made overly complex. Here are 3 easy analogies using real-world phenomena to help you understand the stock market.

The word “analogy” is defined by the Cambridge Dictionary as a “comparison between things that have similar features, often used to help explain a principle or idea.” It is a useful way for us to understand a topic that’s complicated or new to us.

One topic that is often made overly complex is investing in stocks. Fortunately, I have three analogies – sourced from greater minds – that can help us cut through the fluff and get to the point about the core of stock market investing.

Watching the right thing

The first analogy is from Ralph Wagner, who ran the US-based Acorn Fund from 1970 to 2003. During his tenure, he led Acorn Fund to an impressive annual gain of 16.3%. This is also significantly better compared to the S&P 500’s return of 12.1% per year over the same period.

Wagner once said:

“There’s an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch.

But in the long run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the dog watchers, big and small, seem to have their eye on the dog, and not the owner.”

In Wagner’s terminology, the stock price is the pooch, while the underlying business of the stock is the owner. Instead of watching the dog (the stock price), we should be focusing on the owner (the business).

My favourite example of this is Warren Buffett’s investment conglomerate, Berkshire Hathaway. The chart below shows the percentage change in Berkshire’s book value per share and its share price for each year from 1965 to 2018. There were years when the two percentages match closely, but there were also times when they diverged wildly. A case of the latter is 1974, when Berkshire’s book value per share grew by 5.5% even though its share price fell sharply by 48.7%.

*Source: Berkshire Hathaway 2018 shareholders’ letter*

In all, Berkshire’s book value per share increased by 18.7% per year from 1965 to 2018. Meanwhile, its share price was up by 20.5% annually over the same period. An input of 18.7% had led to a similar output of 20.5% over the long run despite wide differences at times during shorter timeframes.

Predictions are hard

Dean Wlliams is the owner of the second analogy. There are only two things I know about Williams. I couldn’t find anything else about him online – if you know more about him, please reach out to me! First, he’s an investor who was part of Batterymarch Financial Management. Second, he wrote one of the best investment speeches I’ve ever come across. The speech, delivered in 1981, is titled Trying Too Hard.

Here’s the analogy:

“The foundation of Newtonian physics was that physical events are governed by physical laws. Laws that we could understand rationally. And if we learned enough about those laws, we could extend our knowledge and influence over our environment.

That was also the foundation of most of the security analysis, technical analysis, economic theory and forecasting methods you and I learned about when we first began in this business. There were rational and predictable economic forces. And if we just tried hard enough… Earnings and prices and interest rates should all behave in rational and predictable ways. If we just tried hard enough.

In the last fifty years a new physics came along. Quantum, or subatomic physics. The clues it left along its trail frustrated the best scientific minds in the world. Evidence began to mount that our knowledge of what governed events on the subatomic level wasn’t nearly what we thought it would be. Those events just didn’t seem subject to rational behavior or prediction. Soon it wasn’t clear whether it was even possible to observe and measure subatomic events, or whether the observing and measuring were, themselves, changing or even causing those events.

What I have to tell you tonight is that the investment world I think I know anything about is a lot more like quantum physics than it is like Newtonian physics. There is just too much evidence that our knowledge of what governs financial and economic events isn’t nearly what we thought it would be.”

Newtonian physics – the laws of nature governing our daily life – is neat and tidy. You can calculate gravity, air resistance, motion etc. with precision. This is how NASA managed to calculate precisely how long it would take for a spacecraft to travel from Earth to Pluto. In January 2006, NASA launched the New Horizons spacecraft, which reached Pluto in July 2015. The five billion kilometre journey “took about one minute less than predicted when the craft was launched,” according to NASA.

Quantum physics – the laws of nature governing atomic or subatomic particles – is far messier. When I first learnt about quantum physics in school, I was fascinated by the idea that it is impossible to simultaneously measure a particle’s position and velocity. In fact, the act of measuring a particle itself can change the thing you’re trying to probe.

What Williams is trying to bring across in his analogy is that investing is messy, just like quantum physics. Investing does not lend itself easily to tidy predictions, such as those common in Newtonian physics. This is shown clearly in the tweet below by investor Ben Carlson.

Have to imagine these numbers will reverse at some point for China pic.twitter.com/DgNdBil7uA
— Ben Carlson (@awealthofcs) November 11, 2014

The case for long-term thinking

The third analogy comes from Jeremy Grantham, the co-founder and investment strategist of the asset management firm GMO. At the end of 2014, GMO managed US$116 billion in assets.

Financial journalist Maggie Mahar shared the following quote from Grantham in her excellent book Bull: A History of the Boom and Bust, 1998-2004:

“Think of yourself standing on the corner of a high building in a hurricane with a bag of feathers. Throw the feathers in the air. You don’t know much about those feathers. You don’t know how high they will go. You don’t know how far they will go. Above all, you don’t know how long they will stay up…

…Yet you know one thing with absolute certainty: eventually on some unknown flight path, at an unknown time, at an unknown location, the feathers will hit the ground, absolutely guaranteed. There are situations where you absolutely know the outcome of a long-term interval, though you absolutely cannot know the short-term time periods in between. That is almost perfectly analogous to the stock market.”

Making sense of short-term events in the stock market is practically impossible – just like how it’s impossible to tell how a feather will travel when it’s in the air. But over the long run, it’s easier to make sense of what’s going on in the stock market. Over time, richly valued stocks and stocks with poor business results tend to come down to earth, while stocks with underlying businesses that do well tend to rise significantly. This is similar to how a feather will hit the ground eventually.

3 Lessons Learnt From 1 Painful Investing Mistake

The share price of Chipotle is up by 80% since the time I bought, but I lost 15% on my investment. Here are my lessons learnt from this painful mistake.

I’ve made my share of mistakes while investing that ended up as expensive lessons.

In this article, I share one particularly painful mistake and three lessons that I took from it.

What happened?

In October 2015, I bought shares of Chipotle Mexican Grill Inc (NYSE: CMG). At that time, Chipotle’s share price had fallen 25% from its peak following a Salmonella outbreak at one of its outlets. As such, I managed to pick up shares at US$564 per share, compared to the previous high of US$749.

I had been eyeing Chipotle for some time and thought that it was a great opportunity to buy shares.

Chipotle was a fast-growing fast-casual restaurant chain in the US that still had a huge market opportunity to expand into. Its food – Mexican fare- were popular and its comparable sales stores were consistently in the mid-to-high single digits or higher. The company was ambitiously expanding its store footprint in North America. I also thought the decline in its share price was unwarranted and that its sales would not be that greatly impacted due to an isolated food-safety incident.

Unfortunately, Chipotle suffered a few more setbacks shortly after I bought my shares. The company reported another four separate E- Coli and norovirus outbreaks at its restaurants.

The news spread across the country and customers started being cautious about going to Chipotle.

A challenging period for Chipotle and selling my shares

What I thought was going to be a mild bump on the road for Chipotle, ended up being an extended period of depressed sales. The effects of negative publicity hurt Chipotle’s bottom line hard. Chipotle reported its first quarterly loss as a public-listed company in the first quarter of 2016.

Same-store sales declined 30% from a year ago. Marketing campaigns to get customers back in stores were not cheap either.

Stores that once had long queues were now empty and Chipotle had to resort to country-wide marketing campaigns and offering 1-for-1 burrito deals to bring customers back. The efforts had minimal impact and I was getting worried that customers will not come back.

Unsurprisingly, investors were getting nervous too. Chipotle’s share price fell from the price I bought to a low of US$370 in mid-2016.

Chipotle’s share price eventually climbed to US$483 in May 2017 and I took the opportunity to sell my shares. At that time, Chipotle’s shares – despite having a price 15% lower than my purchase – still seemed too expensive for me. Chipotle’s shares traded at 48 times forward earnings (due to the depressed earnings at that time) and I lost confidence in the company’s growth prospects.

A turn of fortunes

This is not a story of me buying a company that ended up a poor investment. It actually is a tale about me not giving my investment time to fulfill its potential.

I knew from the get-go that Chipotle was well-loved by customers. An American friend of mine who was living in Europe at that time constantly told me the thing he missed most about the US was Chipotle.

Chipotle was a brand that was loved – and its customers would eventually come back. After a change in CEO in March 2018, Chipotle’s fortunes changed dramatically. Its marketing efforts started to pay dividends. The company grew its online sales channels, and drive-throughs fueled an increase in sales.

Same-store sales improved. In the fourth quarter of 2019, Chipotle’s same-store sales increased by 13.4%, a third consecutive quarter of double-digit growth.

You can probably guess what has happened to its share price. Chipotle’s shares today trade at around US$1,050 apiece, more than double the price I sold my shares at.

Lessons learnt

Although I technically lost only 15% of my investment in Chipotle, I had in fact missed out on a near-100% gain by selling early. That’s an extremely expensive mistake, especially when I consider that I would have been much better off doing nothing, rather than actively trying to manage my portfolio.

From this experience, I took away three important lessons.

Lesson 1: Companies with great products are more resilient

Customers love Chipotle. That’s an important reason why Chipotle was well-placed to recover from the bad press after the food-safety outbreaks at its restaurants. In addition, Chipotle was determined to improve its food safety and the steps taken also regained customer confidence.

Lesson 2: Give companies time to prove their worth

I held Chipotle’s shares for a mere one-and-a-half years. That’s not enough time to allow a company to prove itself. I should have been more patient and given management more time to turn the company around. Given that Chipotle was a brand that customers loved, it was only a matter of time before queues started returning.

A well-known Warren Buffett quote comes to mind: “Time is the friend of the wonderful company, the enemy of the mediocre.”

Lesson 3: Forget about quarterly results- think long term

Wall Street’s focus on quarterly results can lead to wild gyrations in the stock prices of companies. This miss by a penny, beat by a penny compulsion can lead to a significant price-value mismatch between a company’s long term value and its share price.

Clearly, my decision to sell Chipotle’s shares was because I was focused on the company reporting negative same-store sales growth over a year, rather than looking much further into the future.

Final thoughts

“The trick is, when there is nothing to do, do nothing.”
Warren Buffett

It is often tempting to actively manage our portfolios. But moving in and out of stocks due to short-term gyrations in price and earnings is a fool’s game. It is not only time-consuming, but may also end up as expensive mistakes. I certainly learnt that the hard way with Chipotle.

I hope that by sharing some of the lessons I learnt from this mistake, other investors will not fall victim to the same expensive mistake that I made.

My blogging partner, Ser Jing, also wrote a great article about why he owns Chipotle shares. His fortunes with this company were very different from mine. You can head here to find out why he still owns shares in Chipotle.

What We’re Reading (Week Ending 24 May 2020)

The best articles we’ve read in recent times on a wide range of topics, including investing, business, and the world in general.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 24 May 2020:

1. The Three Sides of Risk – Morgan Housel

At a conference a few months ago I was asked what skiing taught me about investing. This was on stage, where you can’t ponder your answer – you have to blurt out whatever you can think of.

I didn’t think skiing taught me anything about investing. But one incident came to mind…

…But it opened my eyes to the idea that there are three distinct sides of risk:

The odds you will get hit.
The average consequences of getting hit.
The tail-end consequences of getting hit.

The first two are easy to grasp. It’s the third that’s hardest to learn, and can often only be learned through experience.

But once you go through something like that, you realize that the tail-end consequences – the low-probability, high-impact events – are all that matter.

2. Doordash and Pizza Arbitrage – Ranjan Roy

In March 2019 a good friend who owns a few pizza restaurants messaged me (this friend has made appearances in prior Margins’ pieces). For over a decade, he resisted adding delivery as an option for his restaurants. He felt it would detract from focusing on the dine-in experience and result in trying to compete with Domino’s.

But he had suddenly started getting customers calling in with complaints about their deliveries.

Customers called in saying their pizza was delivered cold. Or the wrong pizza was delivered and they wanted a new pizza.

Again, none of his restaurants delivered.

He realized that a delivery option had mysteriously appeared on their company’s Google Listing. The delivery option was created by Doordash…

…. But he brought up another problem – the prices were off. He was frustrated that customers were seeing incorrectly low prices. A pizza that he charged $24 for was listed as $16 by Doordash…

… If someone could pay Doordash $16 a pizza, and Doordash would pay his restaurant $24 a pizza, then he should clearly just order pizzas himself via Doordash, all day long. You’d net a clean $8 profit per pizza

3. Mental Models – Oliver Sung

Surfing

You won’t be able to surf if you don’t catch the wave. And if you do catch it, you can stay on it for long. The trick is catching the one that lasts the longest as early as possible and not to get off. Microsoft was a result of a 16-year-old catching a wave of software revolution right on the edge.

Cockroach Theory

When bad news are revealed, there may be many more related negative events yet to be revealed. There’s never just one cockroach in the kitchen.

Minsky Moment

A sudden collapse of asset values marking the end of a credit cycle or an economic cycle.

Framing

The way a question or situation is framed can determine your response and lead to an action decided based on whether the options are presented with positive or negative connotations. Mixed with the narrative fallacy, framing can turn out dangerous for errors in decision making and might be used as power over other’s behavior.

Hindsight Bias

Also called creeping determinism, it’s the tendency of overestimating one’s ability to have predicted an outcome that could not possibly have been predicted. Hindsight bias is dangerous because it hinders one from learning from past mistakes. If we feel like we knew it all along, it means we won’t stop to examine why something really happened.

4. Our weird behavior during the pandemic is messing with AI models – Will Douglas Heaven

It took less than a week at the end of February for the top 10 Amazon search terms in multiple countries to fill up with products related to covid-19. You can track the spread of the pandemic by what we shopped for: the items peaked first in Italy, followed by Spain, France, Canada, and the US. The UK and Germany lag slightly behind. “It’s an incredible transition in the space of five days,” says Rael Cline, Nozzle’s CEO. The ripple effects have been seen across retail supply chains.

But they have also affected artificial intelligence, causing hiccups for the algorithms that run behind the scenes in inventory management, fraud detection, marketing, and more. Machine-learning models trained on normal human behavior are now finding that normal has changed, and some are no longer working as they should.

5. Common Myths About the Federal Reserve – Cullen Roche

Myth #5 – The Fed “Manipulates” Interest Rates

It’s very common to hear that the Federal Reserve “manipulates interest rates”. This is based on the idea that interest rates would be better “set” if they were controlled by a private market instead of a government entity like a Central Bank. Unfortunately, this is based on a lack of understanding of banking and central banking.

A Central Bank is little more than a central clearinghouse where payments settle. Before there were central banks payments between banks were settled at private clearinghouses. The problem with this arrangement was that banks would stop settling payments during financial panics and this would exacerbate depressions. A central bank leverages government powers to ensure that this doesn’t happen. The 2008 financial crisis was a great example of this. When private banks stopped lending to one another the Fed operated as the “lender of last resort”. This meant that even though many banks were insolvent mom and pop could still buy necessities via the banking system because most banks didn’t stop operating thanks to the Fed’s backstop. Had the Fed not lent to firms in need the crisis would have bankrupted even the largest banks and the economy would have certainly entered a substantially more catastrophic crisis. You literally wouldn’t have been able to buy anything unless you had cash under your mattress.

In order to operate as a central clearinghouse the Fed needs to set an overnight rate at which it lends to banks. Since the Fed requires most banks to utilize this system the banks naturally try to lend their reserve deposits which puts downward pressure on overnight interest rates. Therefore, the natural rate of interest on overnight loans is 0% in the Fed Funds market. This means the Fed actually has to manipulate rates HIGHER from this 0% rate. This is not theoretical, this is simply a mathematical reality of a system with a Fed Funds market in which banks operate within this closed system.

6. Why Walking Matters—Now More Than Ever – Shane O’Mara

What we probably don’t realize is that walking can be a kind of a behavioral preventive against depression. It benefits us on many levels, physical and psychological. Walking helps to produce protein molecules in muscle and brain that help repair wear and tear. These muscle and brain molecules—myokines and neurotrophic factors, respectively—have been intensively studied in recent years for their health effects. We are discovering that they act almost as a kind of fertilizer that assists in the growth of cells and regulation of metabolism. They also reduce certain types of inflammation.

These essential molecules are produced by movement and the increased brain and body activity created by movement. If you’re not moving about, placing heart and muscle under a bit of positive stress and strain, these molecules aren’t produced in sufficient quantities to perform their roles.

7. Pandemics & Markets: Part II – Jamie Catherwood

As news of the Spanish Flu began to spread, a September 28, 1918 issue of The Commercial and Financial Chronicle regrettably stated:

‘An epidemic of Spanish influenza has checked business to some extent, but is not expected to be lasting. The Department of Health of this city has just voted $25,000 to fight influenza, which it calls pneumonia in epidemic form. It is said to be in reality the old-fashioned grippe [flu].’

In hindsight we all know how inaccurate this prediction turned out to be, but it is mind boggling to think about how someone could think this so shortly before the Spanish Flu took the world by storm.

Well, this quote inspired me to do a little further digging into what, if any, of the major themes and questions we’re asking today were also prevalent during the Spanish Flu of 1918. Turns out there is a lot in common!

My 7 Timeless Investing Rules For Stocks After 10 Years In The Market

We’re living in uncertain times. To help deal with the uncertainty, here are seven timeless investing rules for the stock market.

It’s now nearly 10 years since I first started investing in stocks for my family in October 2010. During this period, I also helped pick stocks professionally (from May 2016 to October 2019) while I was at The Motley Fool Singapore.

I’ve developed 7 personal investing rules for the stock market throughout these years that I think are timeless. I also think these rules are worth sharing now, since there’s so much uncertainty about the future with the world living under the shadow of COVID-19. In no particular order, here they are:

Rule 1: Focus on business fundamentals, not geopolitical and macroeconomic developments

Peter Lynch, the legendary manager of the Fidelity Magellan Fund from 1977 to 1990, once said:

“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”

Focus on business fundamentals to find great companies because it is great companies that produce great long-term stock market returns.

Warren Buffett’s investment conglomerate, Berkshire Hathaway, saw its book value per share increase by 18.7% per year from 1965 to 2018. In those 53 years, there was the Vietnam War, the Black Monday stock market crash in 1987, the “breaking” of the Bank of England, the Asian Financial Crisis, the bursting of the Dotcom Bubble, the Great Financial Crisis, Brexit, and the US-China trade war, among many other important geopolitical and macroeconomic developments. Over the same period, Berkshire’s share price increased by 20.5% per year – the 18.7% input led to a similar 20.5% output.

Rule 2: Think and act long-term

I believe that the stock market has a fundamental identity: It is a place to buy and sell pieces of a business. This also means that a stock will do well over time if its business does well. So to excel in investing, we need to identify companies that can grow strongly over the long run.

Jeff Bezos once said:

“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”

I believe Bezos’s quote applies to investing too. The simple act of having a long-term mindset gives us an advantage in the market.

Investing for the long run also lowers the risk of investing in stocks. In a column for The Motley Fool, Morgan Housel shared the chart below. It uses data for the S&P 500 from 1871 to 2012 and shows the chance that we will earn a positive return in US stocks for various holding periods, ranging from 1 day to 30 years. Essentially, the longer we hold our stocks, the higher the chance that we will earn a positive return.

The caveat here is that we must be adequately diversified, and we must not be holding a portfolio that is full of poor quality companies. Such a portfolio becomes riskier the longer we stay invested, because value is being actively destroyed.

Rule 3: Don’t obsess over valuation – instead, focus on business quality

I think it’s far more important to be right about the quality of a business than it is to fret over its valuation. Yes, overpaying for a stock doesn’t make sense. But I think many investors don’t realise that certain stocks can carry what seems like high valuations and still do very well over a long period of time.

Terry Smith is an investor I respect greatly. He is the founder, CEO, and CIO (Chief Investment Officer) of Fundsmith, a fund management company based in the UK. In his 2013 letter to Fundsmith’s investors, Smith wrote:

“We examined the relative performance of Colgate-Palmolive and Coca-Cola over a 30 year time period from 1979-2009. Why 30 years? Because we thought it was long enough to simulate an investment lifetime in which individuals save for their retirement after which they seek to live on the income from their investment. Why 1979-2009? We wanted a recent period and in 1979 it so happens that Coca-Cola was on exactly the same Price Earnings Ratio (“PE”) as the market – 10 and Colgate was a little cheaper on 7x.

The question we posed is what PE could you have paid for those shares in 1979 and still performed in line with the market, which we took as the S&P 500 Index, over the next 30 years?

We found the answer rather surprising – it was 36x in the case of Coke and 34x in the case of Colgate when the market was on 10x. Another way of looking at it is that you could therefore have paid a PE of 3.6x the market PE for Coke and 4.9x the market PE for Colgate in 1979 and still matched the market performance over the next 30 years.

The reason is the differential rate of compound growth in the share prices (to a large extent driven by growth in the earnings) of those companies over the 30 years. They compound at about 5% p.a. faster than the market. You may be surprised that this differential can have such a profound effect upon the outcome. It’s the magic of compounding.”

Rule 4: Don’t use leverage

The stock market can move in surprising ways more often than we imagine.

On 12 August 2019, Argentina’s key stock market benchmark, the Merval Index, fell by a stunning 48% in US-dollar terms. That’s a 48% fall in one day.

According to investor Charlie Bilello, the decline was a “20+- sigma event.” Mainstream finance theories are built on the assumption that price-movements in the financial markets follow a normal distribution. Under this statistical framework, the 48% one-day collapse in the Merval Index should only happen once every 145,300,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000 years. For perspective, the age of the universe is estimated to be 13.77 billion years, or 13,770,000,000 years.

If we invest using leverage, we may be ruined whenever stocks lurch violently in their unpredictable yet more-frequently-than expected manner.

Rule 5: Volatility is normal

Volatility in stock prices is a feature of the stock market and not a bug. I say this because even the stock market’s best winners exhibit incredible volatility. We can see this in Monster Beverage, an energy drinks maker listed in the US.

Monster Beverage’s share price was up by 105,000% from 1995 to 2015, making it the best-performing stock in the US market in that timeframe. In another column for the Motley Fool, Morgan Housel shared how often Monster Beverage had experienced sickening drops in its share price:

“The truth is that Monster has been a gut-wrenching nightmare to own over the last 20 years [from 1995 to 2015]. It traded below its previous all-time high on 94% of days during that period. On average, its stock was 26% below its high of the previous two years. It suffered four separate drops of 50% or more. It lost more than two-thirds of its value twice, and more than three-quarters once.”

Wharton finance professor Jeremy Siegel once said that “volatility scares enough people out of the market to generate superior returns for those who stay in.” There really is nothing to fear about volatility. It is normal.

Rule 6: Expect, but don’t predict

The financial markets are incredibly hard to predict. So it’s important to me to stay humble. What I do to handle the uncertain future is to expect. The difference between expecting and predicting lies in our behaviour.

A look at history will make it clear that bad things – bear markets, recessions, natural disasters, diseases, wars – happen frequently. But they’re practically impossible to predict in advance. How many people six months ago even thought that a virus would end up crippling the global economy today?

If we merely expect bad things to happen from time to time while knowing we have no predictive power, our investment portfolios would be built to be able to handle a wide range of outcomes. On the other hand, if we’re engaged in the dark arts of prediction, then we think arrogantly that we know when something will happen and we try to act on it. Our investment portfolios will thus be suited to thrive only in a narrow range of situations – if things take a different path, our portfolios will be on the road to ruin.

Rule 7: Be rationally optimistic over the long run

There are 7.8 billion individuals in our globe today, and the vast majority of people will wake up every morning wanting to improve the world and their own lot in life. This is ultimately what fuels the global economy and financial markets.

Miscreants and Mother Nature will wreak havoc from time to time – we’re currently living through one such episode of Mother Nature’s wrath in the form of a coronavirus that mutated and became capable of infecting humans. But I have faith in the collective positivity of humanity. When things are in a mess, humanity can clean it up. This has been the story of mankind’s and civilisation’s long histories. And I won’t bet against it.

My Thoughts On Square Inc

Square Inc has been one of the darlings of the stock market. Despite some risks, here’s why I think the stock has legs to run.

Square Inc (NYSE: SQ) is a fintech company that provides seller tools, financing for small businesses, and peer-to-peer payments for individuals.

It started life as a company that enabled small businesses to accept card payments with a mobile phone and an attached square “scanning device”. Since then, Square has widened its offering to sellers, and launched Cash App, a mobile payment service that allows individuals to transfer money to each other using just their phone.

Square has been one of the darlings of the US stock market, with its share price up around six-fold since the first day it went public in late 2015. The strong adoption of Square’s POS (point-of-sales) system and Cash App’s surging popularity have led to that strong stock performance.

But I think there is still more to come from this fast-growing Fintech firm.

Huge market opportunity for payment growth

As with other payment solutions, Square takes a cut of every dollar transacted using Square’s software.

The more payments Square processes, the more it earns. In 2019, despite a 25% increase in transaction-based revenue growth, Square still accounted for only a small fraction of the total gross payment volume (GPV) in the US. In 2019, Square’s GPV was US$106.2 billion, compared to total US gross sales of more than US$10 trillion.

Square started off as a payment tool for small businesses but has since begun targeting larger businesses, which provides a much larger market opportunity.

Square has done quite well in reaching out to larger businesses. In the first quarter of 2020, percentage of GPV from larger sellers (more than US$125k in GPV) increased to 52%, up from 47% and 51% in the same quarter in 2018 and 2019, respectively.

Cash App growing in popularity

Square launched Cash App in 2013 to compete with peer-to-peer payment services and e-wallets such as Paypal’s Venmo.

Since then, Cash App’s popularity has exploded and has been one of the key drivers of growth for Square. The beauty of payment solutions is that the bigger the network, the more value the system holds for users. Cash App’s growing popularity will be a virtuous cycle for more users and transactions in the future.

The Covid-19 pandemic has also led to an increased adoption for Cash App services. Users now use Cash App as a tool to send funds for fundraising, donations, and to reimburse one another for supplies during this period of social distancing.

Square disclosed that Cash App’s gross profit skyrocketed 115% year-over-year in the first quarter of 2020.

That’s a continuation of a longer-running trend. The charts below show the growth in Cash App’s monthly active users.

In addition, Square has been able to increase the monetisation rate of each active customer it has on its platform.

Cash App is currently available in the US and the UK. However, it was only in March that Cash App allowed cross-border payments, further increasing the value proposition that Cash App brings to the table.

Cash App started small, but has since grown astronomically and now accounts for close to 40% of Square’s total net revenue.

Product-focused management

Square’s CEO and co-founder, Jack Dorsey, is one of the most respected entrepreneurs today. He is also known as the visionary leader behind the popular products that his companies produce. Besides Square, Dorsey is also the co-founder and CEO of the social media platform, Twitter.

While some argue that Dorsey should focus his energy squarely (sorry) on one company, so far the results of Square have been extremely strong. And there is nothing to suggest that Dorsey is out of wits leading two companies at the same time.

Square has also been successful in implementing new features into both its POS software and its Cash App. The increase in revenue and user growth are also testament to Square’s solid execution of its growth strategy.

Solid free cash flow and decent balance sheet

While Square is still reporting a GAAP loss, the company has turned free cash flow positive. The payment solutions provider generated US$101 million, US$234 million and US$403 million in free cash flow in 2017, 2018 and 2019 respectively.

In 2019, it recorded a free cash flow margin of 8%. For a company that is growing revenue fast, I expect its margins to improve in the future.

Square’s balance sheet also remains strong with US$2.5 billion in cash, cash equivalents, and short-term investments in debt securities, as of 31 March 2020. It only held US$1.8 billion in long-term debt, giving it good financial standing to continue to invest in growth.

Black marks?

However, Square is not perfect. Despite reporting strong free cash flow generation, Square’s only GAAP profit was in 2019. The company then returned to the red in the first quarter of 2020 as increase in expenses exceeded revenue growth.

One of the big reasons why the company has been reporting losses but generating cash is its heavy stock-based compensation. Stock-based compensation does not burn cash but it increases the number of outstanding shares and dilutes existing shareholders.

In Square’s case, stock-based compensation has resulted in an increase in the number of diluted shares from 341.6 million in 2016 to 466.1 million in 2019. The dilution has resulted in existing shareholders owning a smaller fraction of the company.

It is normal for fast-growing tech companies to pay out a large chunk of its compensation in shares. That said, Square’s revenue has increased at a faster rate than its stock-based compensation which is a good sign. But the company’s stock-based compensation is still something I’m watching.

In addition, Square also sports an expensive-looking valuation to me. As of the time of writing (20 May 2020), Square had a market cap of US$34.8 billion. That translates to around nine times trailing sales and more than 90 times free cash flow, assuming a 10% free cash flow margin.

I think that Square can justify such a high valuation, but it needs to execute its growth strategy perfectly and any hiccups could see a valuation compression in the stock.

Final words

There are risks, as I mentioned earlier. But there is also much to admire about Square. From a company with ambitions to help small businesses accept credit card payments, Square has grown to a company that offers a wide range of fintech services and now serves individuals through its Cash App.

The company boasts a strong track record of growth, has an innovative leader who is willing to invest in new products, and a balance sheet that is flushed with cash. All of which puts it in a strong position to ride on the tailwinds of the expanding payments ecosystem.

What COVID-19 Hasn’t Changed

The emergence of COVID-19 has caused significant changes to our lives, but it does not change the fundamental nature of the stock market.

Note: This article was first published in The Business Times on 13 May 2020.

Our lives have been upended.

Where once we could walk freely and gather in groups, we’re now huddled at home and have adapted to social distancing.

Where once parents would send their kids to school in the morning before heading to work, they now have to assume the tough twin-roles of educator and working-professional at home.

Where once malls and businesses were open, we now see shuttered stores all over town.

COVID-19 has brought tremendous changes to our lives.

And there’s a massive ongoing debate about how investors should be investing because of these changes.

Interest rates are at generational lows, and even negative in some instances. Central banks are racing to keep their financial systems – particularly the credit markets – humming.

Governments are handing out cash to save their economies and many are taking on tremendous amounts of debt to do so. Unemployment has increased sharply in some cases, or are expected to rise significantly.

Adding to the confusion is the massive rally that US stocks have experienced after suffering a historically steep decline of more than 30% in February and March. In Singapore, the Straits Times Index has also bounced 16% higher after falling by 32% from its peak this year in January.

What should investors do?

Plus ça change (the more things change)…

I will humbly suggest one thing.

Instead of focusing on positioning their portfolios to handle the things that are changing, investors should focus on the things that are not changing. This inverted thinking has tremendous value for investors.

Jeff Bezos is the founder and CEO of Amazon.com, the e-commerce and cloud computing giant based in the US. He once said:

“I very frequently get the question: “What’s going to change in the next 10 years?” And that is a very interesting question; it’s a very common one.

I almost never get the question: “What’s not going to change in the next 10 years?” And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time.”

Similarly, we can build a successful investment strategy around things that don’t change in the financial markets.

…plus c’est la même chose (the more they remain the same)

I believe that investors should only invest in things they understand. I only understand stocks well, so they are my focus in this article.

The first stock market in the world was created in Amsterdam in the 1600s. Many things have changed since. But stock markets around the world still share one fundamental attribute today: They are still places to buy and sell pieces of a business.

Having this understanding of the stock market leads to the next logical thought: A stock will typically do well over time if its underlying business does well too. That’s because a company will become more valuable over time if its revenues, profits, and cash flows increase faster than inflation. There’s just no way that this statement becomes false.

The fundamental attribute makes the stock market become something simple to understand.

But it also means that we have to be investing for the long run (with an investing time horizon measured in years) for us to take advantage of the relationship between businesses and stock prices.

Over the short run, the stock market is governed by the collective emotions of millions of investors. That’s not something that can be easily divined.

But over the long run, business-strength prevails.

An enduring investment framework

How then can we find businesses that can grow well over a long period of time, to utilise the unchanging long-run relationship between stock prices and business performances?

I cannot speak for everyone. But what I do is to reason from first principles. What characteristics do I want if I can design my ideal business from scratch?

There are six traits I have come up with, and they have served me well through my years of investing in both a professional and personal capacity. The six traits in a company are:

Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market.
A strong balance sheet with minimal or a reasonable amount of debt.
A management team with integrity, capability, and an innovative mindset.
Revenue streams that are recurring in nature, either through contracts or customer-behaviour.
A proven ability to grow.
A high likelihood of generating a strong and growing stream of free cash flow in the future.

A word of caution is necessary. Companies that excel in all my six criteria may still turn out to be poor investments. It’s impossible to get it right all the time in the investing game. So I believe it is important to diversify, across companies, industries, and geographies.

Don’t put your eggs in one basket

The concept of geographical diversification is particularly important for Singapore investors.

Look at the stocks in our local stock market benchmark, the Straits Times Index. There’s no good exposure to some of the important growth industries of tomorrow, such as cloud computing, DNA analysis, precision medicine, e-commerce, digital advertising, and more.

Chuin Ting Weber, the CEO of bionic financial advisor MoneyOwl, made a great point recently about global diversification. She said that as people who live in Singapore, we already have heavy economic exposure to our country through our jobs. If our investment portfolios also have a high proportion of Singapore stocks, we are taking on significant levels of concentration-risk.

The risks involved

Every investment strategy has risks, mine included.

A key risk is that companies that excel according to my investment criteria tend to carry high valuations. Even the best company can be a lousy investment if its share price is too high. So it’s important to weigh a company’s growth prospects with its valuation.

What’s not changing

The emergence of COVID-19, and the responses that countries around the world have mounted to combat the virus, may have caused huge changes to the growth prospects of many industries.

Travel-related companies, for instance, may suffer for some time until countries reopen their borders to accept international travellers at scale.

But crucially, I think that COVID-19 does not change the fundamental identity of the stock market as a place to buy and sell pieces of a business. So, I don’t think that the presence of COVID-19 changes the long-term relationship between stock prices and business performances in any way.

Most importantly, I don’t see COVID-19 changing humanity’s ability to innovate and solve problems.

There are 7.8 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – COVID-19 or no COVID-19.

This is ultimately what fuels the global economy and financial markets. Miscreants and Mother Nature will occasionally wreak havoc. But I have faith in the potential of humanity – and to me, investing in stocks is ultimately the same as having this faith.

Unless stocks become wildly overvalued, I will remain optimistic on stocks for the long run so long as I continue to believe in humanity.

Economic Crashes & Stock Market Crashes

What’s behind the disconnect between Main Street & Wall Street today?

One of the most confusing things in the world of finance at the moment is the rapid recovery in many stock markets around the world after the sharp fall in February and March this year.

For instance, in the US, the S&P 500 has bounced 28% higher (as of 15 May 2020) from the 23 March 2020 low after suffering a historically steep decline of more than 30% from the 19 February 2020 high. In Singapore, the Straits Times Index has gained 13% (as of 15 May 2020) from its low after falling by 32% from its peak this year in January.

The steep declines in stock prices have happened against the backdrop of a sharp contraction in economic activity in the US and many other countries because of COVID-19. Based on news articles, blog posts, and comments on internet forums that I’m reading, many market participants are perplexed. They look at the horrible state of the US and global economy, and what stocks have done since late March, and they wonder: What’s up with the disconnect between Main Street and Wall Street? Are stocks due for another huge crash?

I don’t know. And I don’t think anyone does either. But I do know something: There was at least one instance in the past when stocks did fine even when the economy fell apart.

A few days ago, I chanced upon a fascinating academic report, written in December 1908, on the Panic of 1907 in the US. The Panic of 1907 flared up in October of the year. It does not seem to be widely remembered now, but it had a huge impact. In fact, the Panic of 1907 was one of the key motivations behind the US government’s decision to set up the Federal Reserve (the US’s central bank) in 1913.

I picked up three sets of passages from the report that showed the bleak economic conditions in the US back then during the Panic of 1907.

This is the first set (emphasis is mine):

“Was the panic of 1907 what economists call a commercial panic, an economic crisis of the first magnitude?..

… The panic of 1907 was a panic of the first magnitude, and will be so classed in future economic history…

… The characteristics which distinguish a panic of that character from those smaller financial convulsions and industrial set-backs which are of constant occurrence on speculative markets, are five in number:

First, a credit crisis so acute as to involve the holding back of payment of cash by banks to depositors, and the momen- tary suspension of practically all credit facilities.

Second, the general hoarding of money by individuals, through withdrawal of great sums of cash from banks, thereby depleting bank reserves, involving runs of depositors on banks, and, in this country, bringing about an actual premium on currency.

Third, such financial helplessness, in the country at large, that gold has to be bought or borrowed instantly in huge quantity from other countries, and that emergency expedients have to be adopted to provide the necessary medium of exchange for ordinary business.

Fourth, the shutting down of manufacturing enterprises, suddenly and on a large scale, chiefly because of absolute inability to get credit, but partly also because of fear that demand from consumers will suddenly disap- pear.

Fifth, fulfilment of this last misgiving, in the shape of abrupt disappearance of the buying demand through- out the country, this particular phenomenon being pro- longed through a period of months and sometimes years…

…For the panic of 1907 displayed not one or two of the characteristic phenomena just set forth, but all of them…

Here’s the second set:

“During the first ten months of 1908, our [referring to the US] merchandise import trade decreased [US]$319,000,000 from 1907, or no less than 26 per cent, and even our exports, despite enormous shipment of wheat to meet Europe’s shortage, fell off US$109,000,000.”

This is the third set, which laid bare the stunning declines in industrial activity in the US during the crisis:

“The truth regarding the industrial history of 1908 is that reaction in trade, consumption, and production, after the panic of 1907, was so extraordinarily violent that violent recovery was possible without in any way restoring the actual status quo.

At the opening of the year, business in many lines of industry was barely 28 per cent of the volume of the year before: by mid- summer it was still only 50 per cent of 1907; yet this was astonishingly rapid increase over the January record. Output of the country’s iron furnaces on January 1 was only 45 per cent of January, 1907: on November 1 it was 74 per cent of the year before; yet on September 30 the unfilled orders on hand, reported by the great United States Steel Corporation, were only 43 per cent of what were reported at that date in the “boom year” 1906.”

Let’s now look at how the US stock market did from the start of 1907 to 1917, using data from economist Robert Shiller.

*Source: Robert Shiller data; my calculations*

The US market fell for most of 1907. It bottomed in November 1907 after a 32% decline from January. It then started climbing rapidly in December 1907 and throughout 1908 – and it never looked back for the next nine years. Earlier, we saw just how horrible economic conditions were in the US for most of 1908. Yes, there was an improvement as the year progressed, but economic output toward the end of 1908 was still significantly lower than in 1907.

April-May 2020 is not the first time that we’re seeing an apparent disconnect between Wall Street and Main Street. I don’t think it will be the last time we see something like this too.

Nothing in this article should be seen as me knowing what’s going to happen to stocks next. I have no idea. I’m just simply trying to provide more context about what we’re currently experiencing together. The market – as short-sighted as it can be on occasions – can at times look pretty far out ahead. It seemed to do so in 1907 and 1908, and it might be doing the same thing again today.

What to Make of Singapore Airlines’s FY19/20 Earnings Results

SIA’s latest earnings saw the airline record one of its worst quarterly losses: Key points from its earnings update and what should investors do now.

Last week, Singapore Airlines (SGX: C6L) announced a sobering set of results for the quarter ended 31 March 2020. SIA’s latest earnings showed an operating loss of S$803 million on the back of a 21.9% fall in revenue.

I’ve got to say, though, that these figures were not unexpected. Earlier this year, SIA announced that it had grounded more than 90% of its passenger fleet as the COVID-19 pandemic effectively halted most passenger air travel around the world.

To prepare for the sudden drop in revenue, the airline also announced that it was raising up to S$15 billion from existing shareholders. The timely injection of cash will save the company from insolvency but shareholders will still have to endure a tough few quarters ahead.

Government support cushioned the blow

Things could have been much worse had the Singapore government not stepped in to support the aviation industry. Under the jobs support scheme, the government co-funds 75% of the first S$4,600 of wages paid to each local employee for 9 months. SIA was one of the beneficiaries of this scheme.

Through the scheme, its employee expenses for the quarter were lower by 62% to S$273 million. However, this was not enough to save the company from reporting a loss for the quarter.

Part of the reason was that SIA reported a large mark-to-market loss from surplus hedges that arose due to the recent sharp fall in oil prices. This reversed most of the cost savings that SIA got from government support, capacity cuts, and other cost-savings measures. In addition, despite a fall in activity, SIA still has a lot of fixed costs, and recorded high depreciation and aircraft maintenance expenses of S$798 million.

How does the loss impact shareholders

The huge bottom-line deficit resulted in a sharp decline in the company’s book value per share. The book value per share fell from S$10.25 on 31 December 2019 to S$7.86 as of 31 March 2020.

That’s a 24% drop in just three months. In addition, the 3-for-2 rights issue at S$3 per rights share will further dilute the company’s book value per share.

Based on my calculation, and excluding further losses in coming quarters, the dilution will cause SIA’s book value per share to drop to around S$5.

A difficult path ahead

Unfortunately for SIA shareholders, the path ahead is uncertain. In its press release, management said:

“There is no visibility on the timing or trajectory of the recovery at this point, however, as there are a few signs of an abatement in the Covid-19 pandemic. The group will maintain minimum flight connectivity within its network during this period while ensuring the flexibility to scale up capacity if there is an uptick in demand.”

In addition, management highlighted that there could be more fuel hedging losses due to weak near term demand. With half of the second quarter of 2020 over, and SIA still grounding most of its planes, I think that the next reporting quarter could be even worse than the last.

More worryingly, with no end in sight, SIA could see poor results up to the end of 2020 and beyond.

The worse is not over for the airline and I expect revenue to be much lower in the second quarter of 202,0 and losses to exceed the S$803 million recorded in the first quarter. Given this, diluted book value per share could even fall to the mid-S$4 range (or worse) after the losses are accounted for next quarter.

Final thoughts

The aviation industry is one of the most badly-hit sectors from the COVID-19 pandemic. Warren Buffett announced earlier this month that he sold all his airlines stock after admitting he did not factor in the risk that airlines faced. Their low-profit margins and capital intensive nature made them highly susceptible to cash flow problems should disaster strike.

SIA has certainly not been spared.

The only comfort that shareholders can take is that, with Temasek promising to buy up all of the company’s non-exercised rights, SIA will have sufficient capital to see it through this difficult period. But even so, the airline looks likely to suffer more losses and book value per share declines. Given all this, shareholders are unlikely to see its share price return to its former glory any time soon.

What We’re Reading (Week Ending 17 May 2020)

The best articles we’ve read in recent times on a wide range of topics, including investing, business, and the world in general.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

Here are the articles for the week ending 17 May 2020:

1. Why the Most Futuristic Investor in Tech Wants to Back Society’s Outcasts – Polina Marinova

As humans, we construct this very linear narrative where you say, “I did X, and then I did Y, and it led to Z.” If you’re really intellectually honest, it’s really this crazy ball of randomness. You just never know. So randomly, there was a guy in my investment banking group whose dad worked with a famous investor. We got to pitch that famous investor, whose name was Bill Conway, one of the co-founders of the Carlyle Group.

Bill’s disposition at the moment when we met was one of enthusiasm and support for a bunch of young entrepreneurially naive guys. And he bet on us. What that meant was helping us capitalize our management company, which would become Lux Capital.

2. Does Covid-19 Prove the Stock Market Is Inefficient? – Robert Shiller & Burton Malkiel

The economics profession has an explanation for this difficulty based on the idea that markets are “efficient.” If markets are perfect, prices will incorporate all publicly available information about the future. Speculative prices will be a “random walk,” to borrow a phrase from the physicists and statisticians. The changes in prices will look random because they respond only to the news. News, by the very fact that it is new, has to be unforecastable, otherwise it is not really news and would have been reflected in prices yesterday. The market is smarter than any individual, the theory goes, because it incorporates information of the smartest traders who keep their separate real information secret, until their trades cause it to be revealed in market prices…

… EMH [Efficient Market Hypothesis] does not imply that prices will always be “correct” or that all market participants are always rational. There is abundant evidence that many (perhaps even most) market participants are far from rational. But even if price setting was always determined by rational profit-maximizing investors, prices (which depend on imperfect forecasts) can never be “correct.” They are “wrong” all the time. EMH implies that we can never be sure whether they are too high or too low. And any profits attributable to judgments that are more accurate than the market consensus will not represent unexploited arbitrage possibilities.

3. Israeli engineers created an open-source hack for making Covid-19 ventilators – Chase Purdy

A team of scientists in Israel this week unveiled what they’re calling the AmboVent-1690-108, an inexpensive ventilator system made from a handful of off-the-shelf items. Project leader David Alkaher also heads the technology work of the Israeli Air Force’s confidential Unit 108, which is comprised of electronics specialists. Whereas a typical hospital ventilator costs around $40,000, the AmboVent system can be made for about $500 to $1,000…

… More on the makeshift side, the French sporting goods company Decathalon has been selling scuba gear to the Rome-based Institute of Studies for the Integration of Systems, where it’s being enhanced with 3D-printed valve parts to make basic ventilator systems. The institute notes the devices are only for emergencies where it’s impossible to find official healthcare supplies.

4. The Most Important Stock Investment Lessons I Wish I Had Learned Earlier – Safal Niveshak

Tony shares the story of an Arabic date farmer he met who had inherited an orchard that had about a thousand trees. As the farmer was showing Tony around his orchard, and took him to something like a hundred trees that were recently planted, Tony asked him out of curiosity, “How long will it take this tree to bear fruit?”

The farmer replied, “Well this particular variety will bear fruit in about 20 years. But that is not good enough for the market. It may be about 40 years before we can actually sell it.”

Tony replied, “I have never heard this. I did not know this. Are there other date trees that would produce faster?” Meanwhile, he looked at all those trees that were being harvested and realized that this farmer could not have possibly planted them.

The farmer tells Tony, “Okay. Here’s my grandfather and my father, great grandfather.”

5. Does Better Virus Response Lead to Better Stock Market Outcomes? – Ben Carlson

I went through each of these lists to check the year-to-date performance of each country’s stock market to see if there is any correlation between getting a handle on the virus and stock market performance in 2020. I looked at both ETF and local currency performance..

… I guess my main takeaway after going through the data is this — the stock market is rarely a good gauge of the health and strength of your country, especially when dealing with a crisis like this.

The stock market is not the economy but it’s also not its citizens or government leaders or crisis response team either.

6. The Great Depression – Gary Richardson

An example of the former is the Fed’s decision to raise interest rates in 1928 and 1929. The Fed did this in an attempt to limit speculation in securities markets. This action slowed economic activity in the United States. Because the international gold standard linked interest rates and monetary policies among participating nations, the Fed’s actions triggered recessions in nations around the globe. The Fed repeated this mistake when responding to the international financial crisis in the fall of 1931. This website explores these issues in greater depth in our entries on the stock market crash of 1929 and the financial crises of 1931 through 1933.

An example of the latter is the Fed’s failure to act as a lender of last resort during the banking panics that began in the fall of 1930 and ended with the banking holiday in the winter of 1933. This website explores this issue in essays on the banking panics of 1930 to 1931, the banking acts of 1932, and the banking holiday of 1933.

7. One Young Harvard Grad’s Quixotic Quest to Disrupt Private Equity – Richard Teitelbaum

Bain’s investment process was flawed, according to the report. For example, for a prospective target to pass muster, the firm required a projected internal rate of return of 25 percent over the life of the investment. That was a common projected IRR. “The first thing I noticed was this massive dispersion of returns,” Rasmussen says. Bain would generate seven or eight times on some of its investments, but with others, zero, and the number that hit the 25 percent return bogey was infinitesimally small. The upshot was thousands of man-hours wasted modeling investment outcomes because the forecasts were inevitably wrong.

There was another surprise. The single best predictor of future returns had nothing to do with the amount of leverage employed, operational changes, company management, or even the underlying soundness of the business. The driver of superior returns was the price paid by the private-equity firm — companies purchased at a lower ratio of price to earnings before interest, taxes, depreciation, and amortization tended overwhelmingly to outperform.

The cheapest 25 percent of private-equity deals based on price-to-Ebitda accounted for 60 percent of the industry’s profits. Cheap buys made good investments. “With the inexpensive ones, there’s a margin of safety,” Rasmussen says.

The firm’s touted skills for selecting companies, arranging financing, and improving operations proved to be a mirage. Instead the best private-equity deals relied on a simple formula — “small, cheap, and levered,” as Rasmussen puts it. He expected the study to prompt major changes at the firm. “Now that we have the data, how do we change our behavior?” he wondered.

8. Young Bulls and Old Bears – Michael Batnick

What do Bill Gross, Sam Zell, Jeremy Grantham and Carl Icahn have in common? They’re all old, they’ve all had brilliant careers, and they’re all bearish on the stock market. (From April 2016)

Whether it be in music or in sports or in markets, the prior generation never thinks “kids” will ever measure up. Even Benjamin Graham- the man who basically invented value investing- fell victim to the “get off my lawn syndrome.”

From Roger Lowenstein’s Buffett: The Making of an American Capitalist.

“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham & Dodd” was first published; but the situation has changed”

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.