Monday, August 4, 2014

Finding value in tough investment outlook

SINGAPORE: Singapore sovereign wealth fund GIC, which manages more than US$100bil of the city-state’s foreign reserves, on Saturday warned of a tough investment outlook over the next decade as global central banks withdraw ultra-easy monetary policies.

GIC said the prices of all major asset classes have been inflated by the massive stimulus measures, and now face weak future returns.

“Global financial markets have been recovering strongly from the 2008/09 global financial crisis, supported by low interest rates and unconventional monetary policies,” GIC said in its annual report. — AFP



In the face of withdrawing the massive stimulus measure, the inflated asset will have weak future return. The inflated asset market value itself, however do not directly related to the underlying businesses. If the underlying business borrow a lot of money, the rise in interest rate during the global tightening of money supply over the next decade (forecast by GIC) will have impact on the negative side of the business earning. That will again impact negatively on the asset value.

Therefore, those businesses with inflated market value and borrow excessively to expand or whatsoever insensibly will see weak return or negative return over the next decade.

Inflated market value happens when the investor or buyer bid the price of the asset high anticipating the earning ability of the asset will improve excessively or continuously over long term. For example, the business is forecasted to generate over 20% return over 10 years is considered excessive in valuation point of view. Some may say the industry prospect is good because of the demand supply imbalance or because of the trend, however one must take into serious consideration that we live in the world of constant changes. Everything change and never one can predict things with certainty over 5 years beyond. It is therefore sensible to forecast conservatively the future earning of the businesses.

There are also assets that are sold very high price in anticipate of the rising wages of the buyers, or the anticipate entering of the richer buyer community. In the inflation environment, or good economy growing environment, it is very sensible. But be careful that it may change rapidly when the growth expectation wane. When the inflation start to rise because of previous years of monetary stimulus across the world, the central bank will be forced to raise interest rate and tighten monetary policy. But as long as the economy grow in a fashionable way, there will be no problem. But when the economy started to slow down because of the inflation pressure, there will be a dilemma. The central bank will not be able to do monetary stimulus because of high inflation environment, and the interest rate is high, and the economy is slowing down, that will be like India. Doing business will become very difficult because of high funding cost, defensive policy by government to protect the local. Foreign investor, funds just exit.

In that situation, businesses with quality service or product and low or no debt will be the winner. They are able to take advantage of the depreciated currency and increase their competitive advantage in the export market. The increase in sales will offset or more that offset their low debt servicing obligation. Thus their businesses improve in those situation. In fact, those businesses are expected to generate profit in whatever market situation, consider that their product or service has the competitive edge in the global market and can continuously adding new and retain existing customers.

Finding those quality businesses may not be very difficult as you can probably find a few on the big established companies that dominated the local market or big established multinational companies. The difficult thing is finding those quality business companies that sell or trade at cheap valuation. Every people like those companies. That's why their selling price will not be cheap, but often too expensive. It is easy to find those companies that are valued at excessive valuation. Investors are often too optimistic and value the company as the company can grow indefinitely at high growth rate. While the company underlying business continue to be good, but because it cannot produce the growth as the investor had hope for because of the market situation or industry prospect change, the return of the investor get will be low.

So, it is consider very lucky if you can find a company that have such a wonderful business with quality, competitive service or product, with low debt in the company, that sell or trade at very conservative valuation. (for example, no grow or 2,3% grow scenario). It doesn't really matter which state economy cycle we are in. It is a treasure!








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