Beat the market

You need to hold a different view with the market to beat the market. Meaning you need to be pretty much a contrarian.

Becoming rich by investing in stock market? Not so easy, in fact very difficult

If you are thinking of becoming rich by investing, it is a very tough and long road. When you look at people around you, how many people is actually investing in stock market and become really rich, virtually none. The fact is, there is an expectation mismatch when people talking about stock market. Many people see stock market as a place to gain quick return and become rich quickly. Hence they are seeking answers from the expert which stock is about to rise, whether the market will be good or bad in the near term. They want to buy and sell and take advantages of the rising market. They want to buy and sell taking advantage of the undervalue stock that are about to be discovered by examining the market sentiment or reading analysis report by expert. They want to sell when the stock reach their target price, when the market sentiment change or expert said its time to sell and take profit.

So in order to fulfill these “investors” needs, many stock seminar inviting experts to talk about the market direction in next half of the quarter or year. This kind of seminar normally is fully seated. Economists and reporters around the world are talking about the latest economic numbers and next year forecast. There is actually no problem with economic numbers as it gives you indication of the economic cycle we are in. But when they link it with the stock market, the excitement of the stock market movement often induce the investor to take short-term action whether to buy or sell. When I listen to the stock market commentary, often what I heard is the expert talk about the recent corporate action taken by the company and what does it mean for the stock price, in the immediate term; whether this is the right time to buy or sell, base on the stock price chart over 6 months, 1 year or few years back period. They are drawing lines and lines, trying to project where will be the next price movement.

All of the above activities are trader’s activity, whether the buy and sell period is half year, 1 year, or few years. It is not about how long your invest, it is the how you treat and see investment as it is that determine whether you belong to trader camp or investor camp. One cannot say they are long term investor just because they hold long term but they base their buying and selling action on the above considerations. They are not necessary financial illiterate. A lot of them have sharp business mind, they read balance sheet and financial statement. But they are actually take advantage of the pricing mismatch. They may be a value trader. Some of the trader common traits are:

1. They often run like hell when the market tide turn and if they are lucky enough to run before the market or stock price down, they will be very happy to tell you how good or lucky they are timing the market. If they are being caught in market downturn, they will often hold their share and wait for market to rise again.
2. They talk about business in a very near term basis, like 1 to 3 years. Anything beyond that is too uncertain for them to consider. It is irrelevant to them, as they are free to move their capital to other pricing mismatch stocks.

Occasionally I do practice these traits when I see obvious opportunities for short-term gain. But I am not a fan of trader. I like to look at stocks, as I would like to own some part of the company. I like to discover the potential of the company as what the company might become 10 years from now, and watch it grows. Just like watching my child grow from small to big. However, the discovery of this type potential company is a tedious process. Some traits below:

1. You find the company is strong financially;
2. You find the company has good product or service;
3. You believe the company product or service can compete with the big boys out there;
4 You find there is a lot of room/market for the company to grow for a very long time.
5. You find the management is capable in day to day operation; has strong marketing team, have the ability to innovate and improve the product and service, and have long term vision how to grow the company to further up level.
6. You discover that the company valued their investor.

When you truly believe the company possesses all the traits above sustainably, it would have taken you lots of time (may be 1 to 3 years). I normally invest more as I find more of these traits in the company. And I try to sell out if along the road, I discover the company doesn’t possess some of these traits. I will do my valuation as to decide when to buy and sell the stock.

But the traits above are desired and well known among investment industry. So it is natural that all the listed company tries to portray themselves having all the traits. That is why I often skeptical about management’s or expert talk. I believe time will tell. Careful observation of the company action over a period of time and personally examine the product and service and compare it with the top quality product of service in the market will show the competitiveness of the company in long term perspective.

When you truly believe the company, you will not sell in any market situation. You only sell when the company starting to lose the above traits. Along the way for me to become truly believe in one company, the company stock would have become major shareholding of my investment portfolio as I will accumulate when I firm up my believe. Bad market sentiment will only be seen as a good opportunity to buy more if the valuation drop to attractive level.

Back to can we become rich in stock market question.
For trader, to become rich, you need to continuously right about the market timing, and increase the bet every time you get richer. But, the danger is, 1 or 2 time big wrong about the market timing will send you hopeless about the stock market.

For long-term investor, to become rich is the company you bet on need to have high compounded growth in size and profit for a long time, and you need to buy cheap or when investor ignore it, usually when

1. The size is still small when nobody noticing,
2. The company is in trying times preparing for new product/service, when failure occur along the way,
3. Market downturn when every stock good or bad drop simultaneously
4. After Restructuring of the company to become more efficient, better new management.

I think the probability of choosing the right company to invest in and at the same time choosing correct entry timing is probably as low as trader getting rich.
No matter which path you prefer, trader or investor, it is very difficult to become really rich by investing. If someone really becomes rich mainly by investing, despite very good luck, it is because of continuously, years and years, decades and decades of hard work and passion.

To invest long term, we need to have faith

Whatever you do, if you intent to stay long term, you have to have faith. Marriage, work, career, hiking, practising, investing. It is very easy to lose focus and sway away if you do not have strong faith.

You have to believe in something. For investing, if you do not have faith in China, you would have given up on China after so many years of dismal China stock market performance. Those have faith understand that dark will be followed by dawn. The longer the dark is, the nearer the dawn is. They believe that China is progressing and will continue to do so in gradually opening up, and this is a no returning path until China fully achieve its full potential. And they believe now is still the early day. Only this kind of faith will enable them to invest long term in China.

Those who can invest long term in company, private or public, must have faith in the company business and people. So much so that they will not withdraw their investment when the company is in crisis mode or making losses. If it is a private business owned by your family members and relative, or you are one of the founders, you probably have the faith to succeed and failed together. If you are investing in public company, your faith is more easily shaken when bad thing happen. To invest long term in a public company, you have to believe the management team has the reputation of responsibility, accountability, and capable to drive the company forward to greater height, the company must have the unique competitive strength and able to innovate over a long term period. Although that was base on historical track record that cannot guarantee future success. That is the only thing we can rely on to believe in. For a safer consideration, the company must have good hard asset which is demandable and can expect to generate sustainable profit, and you believe that the management is acting in every possible way in favour of shareholder.

Hence, if you are doing your own investing, to have faith, we have to understand the economics, the business, the people, and have the interest to continue follow the news. It is normally very hard if you are not familiar with investing. All people are busy doing their own work. They normally rely on other people to give them investment advise, hire a financial advisor, or invest through professional fund management company. However, even that, they have to have strong faith in their friend who give the advise, to the financial advisor who serve them, or to the fund management company. If they do not have strong faith, when their investment performance is not satisfying, they will just sell and lose faith. They may lose faith on their friend's advise, lose faith in financial advisor personnel, lose faith to the fund management industry. They might even stay out of investment and become conservative. But for those who are not so extreme, they will switch between financial advisor, switch fund management company, listen to other friend advice. Their investment will never long term. They are happy and buy when the investment rise in value, and sell when the market is bad. Or they close their eye when the investment turn bad, not trying to understand what happen.

To be success in everything including investment, we have to go through high and low, knowing what to do in each cycle and occasionally adjust our strategy. We have to know our direction clearly, have full faith that we will reach there. Then we have to sail through every high and low before we can reach our destiny.

Return VS investment timing

Of course we can analyse each company business and its other non operating asset to come out with our valuation. But the valuation depends on our expectation, and our expectation is influenced by current market situation. Of course we can made our investment decision according to our valuation, whether it is overvalue or undervalue. To be safe, we try to tweak our expectation towards conservative when we do valuation for investment purpose, and tweak our expectation towards more aggressive when we do valuation for the purpose of selling.

But most of the time, we underestimate extremity of investor behaviour as how undervalue the valuation will go, and how overvalue the valuation will go. So we tend to buy in too early and sell out too early. We also underestimate how good the economy will bring and sell too early; and underestimate how severe the economy will go down and buy too early. And economy is always the most decisive factor to determine how much return one will make.

The best return is is made during investment in the bottom of the business cycle, and sell during the peak of the business cycle.
The second best return is made during investment in dip along the business cycle.
The third best return is made during investment in confusion of market, but we realised that the future is still promising.

It is very easy to misjudge the economy stage. We loss money if we invest but don't see the economy downturn coming or underestimate the severity of the downturn. We incur huge opportunity cost if we hold too much cash and don't realise the economy is actually slowly moving upwards or underestimate the prosperity of the economy.

Thought of monetary tightening impact on company valuation

Current world is flushed with money, supply of money is so large that interest become so low. It pushed up all the asset price.
When tightening happen, supply of money reduce. It put pressure on asset price.

Those company with high asset dependent base, its valuation will suffer.
It is because company usually finance the asset with financing. Tightening will not just putting pressure on the asset value, but will cause the interest rate to rise, which then reduce the EBIT coverage ratio and affect rating. Thus interest rate paid by the company will likely raise faster than the general interest rising trend. This will raise the cost of capital of the company too. Higher interest payment will reduce the future cash flow, and the reduced future cash flow discounted by higher cost of capital, further reduce the firm value.


Those company with asset light business model will outperform.

Bank will take a hit as its collateral asset under price pressure.

Insurance will likely do well as its liabilities is not asset base, but either event base or personal life base, and its income will rise upon rising interest rate.

Productivity, efficiency improvement?

There might be nothing to be cheer about when a company say want to do something to improve its efficiency. It is just part of competition in business world. If all your competitors has the same access to new technology and technology supplier; as long as your competitor has the financial resources, they can improve their efficiency as your company do too. The margin improvement you hope to enjoy will be eliminated when your competitors can afford to sell cheaper to gain market share because of higher margin. You will then sell cheaper to protect your market share and thus your margin improvement gone.

Unless you develop your own technology in house, kept it secret or apply patent to protect it, you are likely not able to enjoy the improve margin.

Buying on dividend yield, good or bad?

Sometimes we select stock base on dividend yield. We might say this business looks to be able to generate good and stable cash flow over previous years. Even the growth is not high, but it is slow and steady, at least without severe drop as it seems historically. Due to that, in low interest rate environment, we might think that 6, 7 % dividend yield return is a very attractive rate. In other cases, we might find other small company that can provide dividend yield up to 8% to 10%. Again look at the historical track record, it seems quite stable.

But is it really safe? Unexpected can happen. Even the strongest business can drop in challenging economy time. Earning can turn and cash flow reduce. Even if the company is still strong and stable, the drop in cash flow will prompt the management to reduce the dividend payment, hence drop in dividend yield. Bear in mind that challenging economy comes in cycle, some very long that we can't recall the history if we are not aware of it. When it come, it can stay long too. We are not just suffering from drop in dividend yield return, but also drop in share price. Many times, the drop can be severe and takes a long time to recover. Even more so apply to small company. Small company is vulnerable to strong economy headwind. When the headwind is strong enough, it is common for those small companies that once afford to pay dividend into losses. If the challenging economy last for long, it can bankrupt the companies.

Hence, i feel buying into dividend is not very good. We need to buy into business/company that has visibility future growth prospect that offer undervalue price, or buy into stable business that offer substantial undervalue price. If really want to buy into dividend yield, buy those strong and stable business that can afford to pay over 10% dividend yield, because most of the time, it is undervalue. Only undervalue stock provide margin of safety cushion, not dividend yield.