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.

Search for the Bottom

Taiwan’s God of share market 胡立阳 say there are 4 stages when Fed tapering the QE. First is the rumour of QE tapering, second is the reaction of the stock market increase volatility because the rumour is getting more real, 3rd is the actual tapering of QE where the stock market plunge further, 4th is the increase of interest rate where not only stock market plunge further, the housing market also drop.

I believe we can apply some of this concept on the search for the bottom as well. First is the initial plunge of the stock market. 2nd is people enthusiastically ask about bottom fishing., but stock market continue to plunge 3rd is stock market continue to plunge, most of the people already sold and they will warn anyone who want to buy not to buy. There is so many pessimism and skeptical surrounding as there is no recovery hope. 4th stock market range bounce at certain level with great volatility and volume rise. That is when there is huge change hand of stock ownership from those pessimistic people to optimistic people. Stock ownership structure change to those savvy and long term investor. That should be the bottom! Of course those skeptical and pessimistic people remain their believe. They will always ask, can drop further or not? don't put all in one basket etc etc. They only started to want to come in after the stock market has rebound significantly.

Deep discount stock?

I believe we will always better off buying a operating business than buying a undervalue non operating asset. Non operating asset is like a dead pool of water. Operating asset is like free flowing of water. We won't get anywhere betting the dead pool of water. However, we explore new things constantly by following the flow of the water. I want my resources to follow the flow of water, not the dead pool of water, because I don't know when the dead water will get refreshed. In other words, I don't know when the non operating asset value will get unlocked. The owner may not really want to unlocked the value forever, may be because of family tussle, ownership pride, or conservativeness etc. By waiting for the unknown, I feel it is like buying jackpot, too much uncertainty. Investing should be base on certainty of return. I rather buy good operating asset with good price than buy non operating asset with deep discount price.