How do we measure returns? The simplest way is to measure the principle at the start and then the market value at the end. e.g.
Beginning Value (BV): S$1m, 1 Jan 2008
Ending Value (EV): S$1.5m, 24 Sep 2010
Returns: (1.5 - 1)/1m = 50%
What if there was cash inflow or outflow in the interim?
BV: S$1m, 1 Jan 2008
Market Value (MV): S$1.5m 1 Jan 2010
Cash inflow: S$10m 1 Jan 2010
EV: S$11.6m
If you use the previous method, returns was actually 50% before cash inflow but fell to (S$11.6 - 11m)/11m = 5.45%
Due to the large cash inflow, the base has increased from S$1m to 10m. The performance of 50% from 1/1/08 to 1/1/10 has been dwarfed because of the cash inflow of 10m on 1/1/10.
The best way is to do a time-weighted return (TWR):
BV: S$1m, 1/1/08
MV: S$1.5m, 1/1/10
Return from 1/1/08 - 1/1/10: (1.5 - 1)/1 = 50%
Cash inflow: S$10m, 1/1/10
BV: S$11.5m, 1/1/10
EV: S$11.6m, 24/9/10
Return from 1/1/10 - 24/9/10: (11.6 - 11.5)/11.5 = 0.87%
Total Return = ((1+0.5)*(1+0.0087))-1 = 0.51305 or 51.3%
Annualised return = ((1.51)^(1/(964/365)))-1 = (1.51^(1/2.64))-1 = 16.89% per annum
Why 964? That is the number of days from 1/1/08 to 24/9/10. 2.64= number of years.
Saturday 25 September 2010
Saturday 18 September 2010
Basel 3 Will Hit Western Banks the Most
Ability of banks to pay dividends will be curtailed to preserve capital. Already, we are seeing DBS issue script dividend instead of cash.
Asian banks have average equity Tier 1 ratio under Basel 3 of around 9% vs 7.1% for Australia, 5.7% for Europe and 3.4% for Japan.
KBC, Credit Agricole, Soc Gen, Commerzbank and Deutsche Postbank look like they will issue much more equity, further diluting common shareholders.
At this point, I'd rather be a perferred share holder, convertible bond or bond holder of banks than to buy its shares.
Monday 13 September 2010
Chronological Prediction of What Will Happen To the Residential Property Market
This is what I think will happen post 30 Aug 2010, the most hard-hitting measures ever implemented since 1996:
1. HDB prices: PRs who own overseas properties will not buy HDBs. They will turn to mass market condos or rental of HDBs / mass market condos. Rental yields for HDBs and mass market condos will increase in 2010 right till 2011.
Singaporeans who intend to buy HDBs or condos will have to make hard choices; either buy HDBs and sell their existing condos and forego the option to enter the private property market for the next 5 years, OR hope the government will roll back some measures soon, or stick to condos. I believe most will stick to private property because 5 years of MOP is too long.
HDB prices should moderate, eventually correct in 2012 to the tune of more than 10% when the supply glut hits. The glut will continue until 2013 / 2014. I don't think there's much upside from hereon. At most, HDB prices will rise around 5 - 10% until mid 2011 when the EXTRA supply comes on stream.
2. Mass market condos: Obviously, more funds will be channelled into mass market condos. Those condos who's prices stay below S$1m. But it will be offset by the fact that borrowing for 2nd homes have been cut to 70% from 80%. This means only the first time buyers will not be affected.
Again, the supply glut will come onstream in 2012. But 2011 is the beginning of TOP for most of the transactions made in 2009. And there was a LOT of transactions; more than 14k.
There's also the problem of interest rate rises in 2011 that will hit affordability. I reckon mass market condos may rise another 10 - 15% max before falling more than 15% in 2012.
3. Luxury condos: They are the least affected. I don't believe the government intends to control this area because it is the domain of the rich and the foreigners. To build Singapore up as a playground for the rich, there must be lots of entertainment outlets, casinos, resorts, a thriving private banking industry and yes, luxury properties with fantastic facilities and views. Marina Bay Suites, The Cove, etc all appeal to the jet setters.
If the stock market rallies, I believe the luxury segment will continue to rise by 15 - 20% until 2012. This prediction holds as long as the government does not impose a capital gains tax. If it does, then the foreign funds may flow elsewhere. Right now, Singapore's luxury segment is probably one of the most affordable among the developed countries. That's how the wealthy in the region compare. Mortgages are not an issue.
2012 - 2014, or when the bear market arrives, this segment will fall the most, to the tune of say 20 - 30%.
4. Landed: Perhaps if you can afford it, this is the best segment to invest because supply is constrained. Rental yields are usually very low for landed properties so it is through pure capital appreciation due to supply constrains. This segment is likely to be less affected by the latest measures and may rise by 15 - 20% until 2012. I don't foresee this segment falling much even in a bear market. Maximum drop will probably be only 10 - 20%.
Right now, there's not much upside to residential properties. Even if you leverage 5x, your upside will be around 60% max. Stocks may achieve similar returns in the same period, with greater liquidity.
I would gun for HK properties for greater volatility and less government intervention, although I wouldn't try it now.
1. HDB prices: PRs who own overseas properties will not buy HDBs. They will turn to mass market condos or rental of HDBs / mass market condos. Rental yields for HDBs and mass market condos will increase in 2010 right till 2011.
Singaporeans who intend to buy HDBs or condos will have to make hard choices; either buy HDBs and sell their existing condos and forego the option to enter the private property market for the next 5 years, OR hope the government will roll back some measures soon, or stick to condos. I believe most will stick to private property because 5 years of MOP is too long.
HDB prices should moderate, eventually correct in 2012 to the tune of more than 10% when the supply glut hits. The glut will continue until 2013 / 2014. I don't think there's much upside from hereon. At most, HDB prices will rise around 5 - 10% until mid 2011 when the EXTRA supply comes on stream.
2. Mass market condos: Obviously, more funds will be channelled into mass market condos. Those condos who's prices stay below S$1m. But it will be offset by the fact that borrowing for 2nd homes have been cut to 70% from 80%. This means only the first time buyers will not be affected.
Again, the supply glut will come onstream in 2012. But 2011 is the beginning of TOP for most of the transactions made in 2009. And there was a LOT of transactions; more than 14k.
There's also the problem of interest rate rises in 2011 that will hit affordability. I reckon mass market condos may rise another 10 - 15% max before falling more than 15% in 2012.
3. Luxury condos: They are the least affected. I don't believe the government intends to control this area because it is the domain of the rich and the foreigners. To build Singapore up as a playground for the rich, there must be lots of entertainment outlets, casinos, resorts, a thriving private banking industry and yes, luxury properties with fantastic facilities and views. Marina Bay Suites, The Cove, etc all appeal to the jet setters.
If the stock market rallies, I believe the luxury segment will continue to rise by 15 - 20% until 2012. This prediction holds as long as the government does not impose a capital gains tax. If it does, then the foreign funds may flow elsewhere. Right now, Singapore's luxury segment is probably one of the most affordable among the developed countries. That's how the wealthy in the region compare. Mortgages are not an issue.
2012 - 2014, or when the bear market arrives, this segment will fall the most, to the tune of say 20 - 30%.
4. Landed: Perhaps if you can afford it, this is the best segment to invest because supply is constrained. Rental yields are usually very low for landed properties so it is through pure capital appreciation due to supply constrains. This segment is likely to be less affected by the latest measures and may rise by 15 - 20% until 2012. I don't foresee this segment falling much even in a bear market. Maximum drop will probably be only 10 - 20%.
Right now, there's not much upside to residential properties. Even if you leverage 5x, your upside will be around 60% max. Stocks may achieve similar returns in the same period, with greater liquidity.
I would gun for HK properties for greater volatility and less government intervention, although I wouldn't try it now.
Sunday 12 September 2010
Dividends beating bond yields in US by most in 15 years
Published September 8, 2010
Dividends beating bond yields in US by most in 15 years
(NEW YORK) More US stocks are paying dividends that exceed bond yields than any time in at least 15 years as profits rise at the fastest pace in two decades.
Kraft Foods Inc and DuPont Co are among 68 companies in the Standard & Poor's 500 Index with payouts that top the 3.78 per cent average rate in credit markets, based on data since 1995 compiled by Bloomberg and Bank of America Corp.
While Johnson & Johnson sold 10-year debt at a record low interest rate of 2.95 per cent last month, shares of the world's largest health products maker pay 3.66 per cent.
The combination of record-low interest rates, potential profit growth of 36 per cent this year and a slowing economy has forced investors into the relative value reversal. For John Carey of Pioneer Investment Management and Federated Investors Inc's Linda Duessel, whose firms oversee US$566 billion, it means stocks are cheap after companies raised payouts by 6.8 per cent in the second quarter, data compiled by Bloomberg shows.
'That's the tug-of-war that's going on right now,' said Peter Vanderlee, a money manager at ClearBridge Advisors, a unit of Baltimore-based Legg Mason Inc, which oversees US$659 billion. 'If we are going into a double-dip recession, maybe we're not as cheaply priced as one would suggest. The other side of it is that if we're just experiencing a slowdown, but we're avoiding a recession, then prices are clearly attractive.'
The last time the number of S&P 500 companies paying dividends above the corporate bond rate approached the current level was in March 2003, data compiled by Bloomberg shows. That was just after the start of a bull market in which the equity index more than doubled over five years.
Bank of America Merrill Lynch's US Corporate Master Index has returned 9.5 per cent this year, compared with the S&P 500's gain of 0.4 per cent, including dividends. Since 1995, bonds in the index have yielded an average of 6.2 per cent, compared with S&P 500 dividends of 1.8 per cent.
The relationship flipped after the Federal Reserve cut its target rate for overnight loans between banks close to zero and consumer prices fell by the most in six decades, helping send interest on 10-year Treasury notes as low as 2.42 per cent last month. -- Bloomberg
Dividends beating bond yields in US by most in 15 years
(NEW YORK) More US stocks are paying dividends that exceed bond yields than any time in at least 15 years as profits rise at the fastest pace in two decades.
Kraft Foods Inc and DuPont Co are among 68 companies in the Standard & Poor's 500 Index with payouts that top the 3.78 per cent average rate in credit markets, based on data since 1995 compiled by Bloomberg and Bank of America Corp.
While Johnson & Johnson sold 10-year debt at a record low interest rate of 2.95 per cent last month, shares of the world's largest health products maker pay 3.66 per cent.
The combination of record-low interest rates, potential profit growth of 36 per cent this year and a slowing economy has forced investors into the relative value reversal. For John Carey of Pioneer Investment Management and Federated Investors Inc's Linda Duessel, whose firms oversee US$566 billion, it means stocks are cheap after companies raised payouts by 6.8 per cent in the second quarter, data compiled by Bloomberg shows.
'That's the tug-of-war that's going on right now,' said Peter Vanderlee, a money manager at ClearBridge Advisors, a unit of Baltimore-based Legg Mason Inc, which oversees US$659 billion. 'If we are going into a double-dip recession, maybe we're not as cheaply priced as one would suggest. The other side of it is that if we're just experiencing a slowdown, but we're avoiding a recession, then prices are clearly attractive.'
The last time the number of S&P 500 companies paying dividends above the corporate bond rate approached the current level was in March 2003, data compiled by Bloomberg shows. That was just after the start of a bull market in which the equity index more than doubled over five years.
Bank of America Merrill Lynch's US Corporate Master Index has returned 9.5 per cent this year, compared with the S&P 500's gain of 0.4 per cent, including dividends. Since 1995, bonds in the index have yielded an average of 6.2 per cent, compared with S&P 500 dividends of 1.8 per cent.
The relationship flipped after the Federal Reserve cut its target rate for overnight loans between banks close to zero and consumer prices fell by the most in six decades, helping send interest on 10-year Treasury notes as low as 2.42 per cent last month. -- Bloomberg
Risk Appetite is Back
Risk appetite is back big time. The JPM Non Investment Grade Index fell to 590. The last time it fell this low was back in Jan 2008. If the risk appetite measure works, the MSCI World Indexd could rise between 15 - 20% very soon! For emerging market indices, the rise could be betwee 30 - 60%!
Let's wait and see what happens. I'm piling on my risk trades and some of you have followed suit. Good on you. In summary:
Equities: time to pile on to emerging market and Asia ex Japan stocks. Increase your asset allocation to 75% from 60%.
Bonds: lighten up on emerging market and Asian bonds to 10%. Stick to preferred shares, convertible bonds, never ever into investment grade, long-dated bonds.
Alternatives: Load up on gold because inflation is going to rise in 2011 and the west is going to print money. Load up on oil on consumption recovery next year. Buy industrial metals because of infrastructure investments in BRIC. Buy agricultural commodities due to changing weather and population growth.
Volatility funds is a hold. We will slowly add more as the stock market rises.
Friday 10 September 2010
The Wonders of Living in the City
We recently bought a place called Riverside Piazza. It's a little mixed development project across the street from Brewerkz, situated at Riverwalk. 5 minutes from Clarke Quay MRT. 5 minutes from Riverwalk, the latest restaurant cum party place.
There are plenty of good eateries around the area; Jumbo, Brewerkz, Hooters, Hot Stones. Also, there are many pubs; e.g. Beer Market, Mulligans, Pump Room. There is currently a Taiwan food fair that attracted huge crowds.
But across Merchant Road, at Merchant Square, it is a dead town. Club Momo used to be there and there were big crowds. But it's closed down 2 to 3 years ago. The pubs around the area are very quiet. Why is it that business at Merchant Square is quiet, while just across the street, Riverwalk is rip roaring? This inequity may not last. Parc Regis is a 4-Star hotel that will open in a month or two's time.
But across Merchant Road, at Merchant Square, it is a dead town. Club Momo used to be there and there were big crowds. But it's closed down 2 to 3 years ago. The pubs around the area are very quiet. Why is it that business at Merchant Square is quiet, while just across the street, Riverwalk is rip roaring? This inequity may not last. Parc Regis is a 4-Star hotel that will open in a month or two's time.
It is a hotel cum office development just next to the project. Further along Merchant Road, just next to the Tan Si Chong Su Temple, another site was recently sold for hotel development. The area will see more commercial and retail action in several months' time. It is 5 minutes walk from 2 MRT stations, Chinatown and Clark Quay. It is 10 minutes' walk from Raffles Place. 2 minutes from an entertainment centre. When Parc Regis is completed, rental yields will rise because people want to live near where they work. There will be more demand from corporate leases.
Let's look at the prices around that area:
Soho @ Central: around S$1800 - 2200 psf. Leasehold. New. Panaromic view. Excellent location. Condo facilties. You pay for what you get.
Riverwalk Apartment: Around S$1400 - 1700psf. Leasehold. 1990 (old). Good view. Just across the street from Clarke Quay MRT. Condo facilities. Nearer to the city.
Riverside Piazza: Around S$950 - 1100 psf. Leasehold. 1994 (old). No view. Across the street from Clarke Quay MRT. No facilities.
UE Square: Around S$1100 - 1300psf. Freehold. Old. Not much view. 15 - 20 minutes walk from any MRT (i.e. not walking distance). Full facilities.
If you have a limited budget and but want a unit bigger than 1000sf for your family, 2 bedrooms or more, the obvious choice is to gun for Riverside. A 1000sf unit in Riverside will cost you only S$1.1m, but 1.6m in Riverwalk, S$1.8m in Soho @ Central and S$1.3m at UE Square with no MRT station nearby.
The Wife and I tried walking from my home to dinner at Riverwalk last night. Within 3 minutes, I reached Soho @ Central. Resisted the temptation to try out the Taiwan Food Fest. But I swore that I caught the whiff of smelly Toufu which brought back the memories HK / Taiwan / Beijing. Had a great dinner at Hot Stones. Walked to Beer Market for some beer. By midnight, I was a little high. Inevitably saw some friends / ex colleagues at the Beer Market / Riverwalk. Always seem to bump into friends there. The best thing was I didn't need to drive home after drinking Alcohol. I didn't need to leave my car at the carpark and hail a cab home. WE COULD WALK HOME!
It's a feeling you'd never get if you lived in, say Yishun, Ang Mo Kio, or Pasir Ris (no disrespect to those who live there). I've lived in Pasir Ris, Yishun, Marine Parade before. The CTE is a nightmare to drive every morning. It jams up after 8am and there will almost always be an accident. It's also a nightmare to drive home at night because there's only 1 highway serving the north. I can't understand why a condo in the north can sell for over S$1000psf in Ang Mo Kio because it's too far from the city. Toa Payoh and Braddel are at the fringes so location is good. Bt Merah, Redhill, Dakota, Lavendar, Holland V is cool. But any thing beyond 10km from the city is a no-no. A sea view is good too. Those HDBs along Marine Parade and Telok Blangah are priceless, and deserve their currently high prices.
With so many policy risks in Singapore, it may be better to buy shop houses / strata office spaces instead of residential. Heck,
Anyway, there's not much upside left in most properties in Singapore because further anti-speculative measures hang like Democles Sword over us. Most of the money will flow to stocks. So I'll talk more about stocks in my next posting. Break outs are around the corner.
Thursday 9 September 2010
How to Buy a Lottery Ticket
Sometimes, you invest something that defies logic. Imagine a listed company with no revenues, no earnings, no cash. A company that engages in oil exploration. It's running on cash burn of USD1.9m per year, with no cash in its books. A company that cannot repay its short term debt.
It has 77.7m shares. What if it secures a USD100m contract? Or what if its share of the oil proceeds is USD1m or even 10m per annum? I bought 500 shares at USD0.00468. If it earns even USD1m, its EPS will be USD0.0129. At 20x PE (assuming its growth rate is 20% so PEG is 1x), it's fair price will be USD0.2574. My initial investment of SGD3500 will turn into a princely sum of SGD192,500! What if its earnings is USD10m per annum? Its EPS would be 0.1287. At 20x PE, its share price will be USD2.574! My initial investment of SGD3500 will turn into SGD1,925,002!
That's what I call a lottery ticket! If I lose it all, it won't make a dent in my portfolio. I can deal with that.
What if my portfolio comprises 100 of such "micro penny" stock? If just 1 of them turn into SGD1.925m, I wouldn't mind losing all the rest too! Now that's a pretty impressive return-risk ratio!
It has 77.7m shares. What if it secures a USD100m contract? Or what if its share of the oil proceeds is USD1m or even 10m per annum? I bought 500 shares at USD0.00468. If it earns even USD1m, its EPS will be USD0.0129. At 20x PE (assuming its growth rate is 20% so PEG is 1x), it's fair price will be USD0.2574. My initial investment of SGD3500 will turn into a princely sum of SGD192,500! What if its earnings is USD10m per annum? Its EPS would be 0.1287. At 20x PE, its share price will be USD2.574! My initial investment of SGD3500 will turn into SGD1,925,002!
That's what I call a lottery ticket! If I lose it all, it won't make a dent in my portfolio. I can deal with that.
What if my portfolio comprises 100 of such "micro penny" stock? If just 1 of them turn into SGD1.925m, I wouldn't mind losing all the rest too! Now that's a pretty impressive return-risk ratio!
Wednesday 8 September 2010
The "Magic Formula" Still Works
Published September 4, 2010
Show me the money
The 'magic formula' still works
Updated study shows highest ROE/PTB stocks yield best returns, while stocks with low ROE and high PTB are toxic
By TEH HOOI LING
SENIOR CORRESPONDENT
IN cyberspace, words or ideas have a life of their own. You see, sometimes my articles get picked up by some investment blogs out there. And AsiaOne, the online portal of Singapore Press Holdings, also puts up some of our articles on their pages. So occasionally, I receive e-mail messages about articles published years ago.
One story on which I get quite a few email messages every once in a while is titled 'In search of super returns in stocks'. The article was first published in July 2007.
Last month, AsiaOne put up that article once more on one of its pages, and I again received a number of readers' email messages, some even saying that the article was 'timely'.
Well, given the popularity of the article, I've decided to update the study to see if that strategy had withstood the 'financial crisis of our generation' and whether it still works post-crisis, in an environment described by many as the 'new normal'.
Just to recap. Basically, what I did for that study was to rank all the stocks listed on the Singapore Exchange based on their ratio of return-on-equity (ROE) to price-to-book (PTB) ratio.
(ROE is net profits divided by shareholders' equity, that is the rate of return of shareholders' equity. PTB is the market cap divided by the shareholders' equity, that is how many times the market is valuing the business vis-a-vis the initial amount pumped in by the shareholders.)
I then split the stocks with positive ratios into 10 equal groups. The first group, or the first decile, would be the first one-tenth of stocks with the highest ROE/PTB ratios. The 10th decile would be those with the lowest ROE/PTB ratios. Then the last group is made up of loss-making companies.
I did the ranking every year based on the companies' data as at the beginning of the year, starting from 1990 until 2006. I then calculated the average return of the stocks in the various groups a year later.
The object of the study is to find out what the returns for an investor would be if he or she were to consistently buy the 10 per cent of stocks in the market which had the highest ROE/PTB, or the lowest such ratio, or any of the other groups of stocks in between.
So $100 each would be invested into the 11 groups of stocks at the beginning of 1990. By the end of that year, the portfolios would be liquidated, and the money would be reinvested into the next 11 groups of stocks the following year. Money from Decile 1 would be reinvested back into the Decile 1 stocks the next year, and so forth. The process continued until 2006. No transaction costs were taken into account.
Super returns
The results of investing in the highest ROE/PTB stocks were phenomenal. It yielded one of the best returns - if not the best - of all the various strategies I've tested all these years.
The investor who invested his $100 into Decile 1 stocks - that is, stocks with the highest ROE relative to their PTB in early 1990 - would have grown that amount to a whopping $34,048 by the end of 2006. That's a compounded return of 41 per cent a year. How many fund managers can actually match that?
The returns get progressively smaller for stocks with lower ROE/PTB. The relationship is very clear - the lower the ROE/PTB, the lower the return.
While the top 10 per cent of companies with the highest ROE/PTB turned $100 into $34,048 in 17 years, the next 10 per cent managed to grow the pot to just $4,710. Still, that's quite a decent 25 per cent a year.
The following 10 per cent, or the third decile, managed $958 for a return of 14 per cent a year between 1990 and 2006. The fifth decile grew only 3.8 per cent a year and the 10th decile - the 10 per cent of the market with the lowest ROE/PTB - shrank the $100 to just $25.
So has the recent financial crisis messed things up? I updated the portfolios' performance by including data from the last three years.
The year 2007 was a good year for stocks, and particularly the 10 per cent of the market with the highest ROE/PTB. The 36 stocks in there chalked up the highest average return of 118 per cent. The rest managed an average return ranging from 17 per cent to just over 50 per cent.
The following year, 2008, was the eye of the storm where the financial crisis was concerned. There was no escape. All stocks were down. But the consolation was, again, the highest ROE/PTB stocks as a group suffered marginally smaller losses. It plunged by 55 per cent. The range for the rest of the groups was an average loss of 53 per cent to 68 per cent.
Last year was again a good year for stocks. The highest ROE/PTB stocks rebounded by 121 per cent. That's second to Decile 2's 144 per cent return. The range of returns for all the groups was between 40 per cent and 144 per cent.
So, between 1990 and 2009, consistently buying the 10 per cent of stocks with the highest ROE/PTB year after year grew $100 to $74,229. That's a compounded annual return of 39.2 per cent a year. The next 10 per cent of stocks grew to $7,984, for a return of 24.5 per cent. (The power of compounding is amply illustrated here as well. A 15 percentage-point difference a year turned into a factor of 10 in 20 years' time.) The third 10 per cent grew by 12.7 per cent a year to $1,099.
Meanwhile, stocks with the lowest ROE/PTB shrank the initial $100 to just $25. In other words, stocks with low ROE and high PTB are toxic!
What's in the formula
In response to this article, a few readers have written in to point out that if we simplify ROE/PTB, it actually becomes earnings yield, or the inverse of price-earnings ratio.
Reader Darrell Lim gave the example of four companies. All have ROEs of 20 per cent, but each is valued differently by the market. The first at PTB of 0.5 time, and next at one time, the third at 1.5 times and the last company at two times book.
'If I'm expecting a 20 per cent ROE, but my PTB is 0.5, it means that even if the company performs as it should and its ROE for the following year is 20 per cent, I'm actually getting a 40 per cent return on investment - assuming market values tend towards true book values (or higher) in the long run,' he said.
Perhaps that accounts for part of the returns - stocks trading up to their book value.
I also have a number of readers writing in to ask where they can find PTB figures for companies. We can calculate that by taking the share price divided by the net asset value per share of the stock. Or as reader Nigel Tan pointed out to me, the data can be found on the Reuters website (http://www.reuters.com/finance/stocks/lookup? ). Just type in the company's name and select the company you want from the list which pops up.
And for those who are wondering which are the stocks with the highest ROE/PTB now, I've included the top 10 per cent here. Like the back-testing, I didn't filter out any stocks. As such, we have stocks whose earnings were boosted by extraordinary items or companies with some corporate governance issues. So do your home work before rushing in to buy any of the stocks listed here.
The writer is a CFA charterholder
Show me the money
The 'magic formula' still works
Updated study shows highest ROE/PTB stocks yield best returns, while stocks with low ROE and high PTB are toxic
By TEH HOOI LING
SENIOR CORRESPONDENT
IN cyberspace, words or ideas have a life of their own. You see, sometimes my articles get picked up by some investment blogs out there. And AsiaOne, the online portal of Singapore Press Holdings, also puts up some of our articles on their pages. So occasionally, I receive e-mail messages about articles published years ago.
One story on which I get quite a few email messages every once in a while is titled 'In search of super returns in stocks'. The article was first published in July 2007.
Last month, AsiaOne put up that article once more on one of its pages, and I again received a number of readers' email messages, some even saying that the article was 'timely'.
Well, given the popularity of the article, I've decided to update the study to see if that strategy had withstood the 'financial crisis of our generation' and whether it still works post-crisis, in an environment described by many as the 'new normal'.
Just to recap. Basically, what I did for that study was to rank all the stocks listed on the Singapore Exchange based on their ratio of return-on-equity (ROE) to price-to-book (PTB) ratio.
(ROE is net profits divided by shareholders' equity, that is the rate of return of shareholders' equity. PTB is the market cap divided by the shareholders' equity, that is how many times the market is valuing the business vis-a-vis the initial amount pumped in by the shareholders.)
I then split the stocks with positive ratios into 10 equal groups. The first group, or the first decile, would be the first one-tenth of stocks with the highest ROE/PTB ratios. The 10th decile would be those with the lowest ROE/PTB ratios. Then the last group is made up of loss-making companies.
I did the ranking every year based on the companies' data as at the beginning of the year, starting from 1990 until 2006. I then calculated the average return of the stocks in the various groups a year later.
The object of the study is to find out what the returns for an investor would be if he or she were to consistently buy the 10 per cent of stocks in the market which had the highest ROE/PTB, or the lowest such ratio, or any of the other groups of stocks in between.
So $100 each would be invested into the 11 groups of stocks at the beginning of 1990. By the end of that year, the portfolios would be liquidated, and the money would be reinvested into the next 11 groups of stocks the following year. Money from Decile 1 would be reinvested back into the Decile 1 stocks the next year, and so forth. The process continued until 2006. No transaction costs were taken into account.
Super returns
The results of investing in the highest ROE/PTB stocks were phenomenal. It yielded one of the best returns - if not the best - of all the various strategies I've tested all these years.
The investor who invested his $100 into Decile 1 stocks - that is, stocks with the highest ROE relative to their PTB in early 1990 - would have grown that amount to a whopping $34,048 by the end of 2006. That's a compounded return of 41 per cent a year. How many fund managers can actually match that?
The returns get progressively smaller for stocks with lower ROE/PTB. The relationship is very clear - the lower the ROE/PTB, the lower the return.
While the top 10 per cent of companies with the highest ROE/PTB turned $100 into $34,048 in 17 years, the next 10 per cent managed to grow the pot to just $4,710. Still, that's quite a decent 25 per cent a year.
The following 10 per cent, or the third decile, managed $958 for a return of 14 per cent a year between 1990 and 2006. The fifth decile grew only 3.8 per cent a year and the 10th decile - the 10 per cent of the market with the lowest ROE/PTB - shrank the $100 to just $25.
So has the recent financial crisis messed things up? I updated the portfolios' performance by including data from the last three years.
The year 2007 was a good year for stocks, and particularly the 10 per cent of the market with the highest ROE/PTB. The 36 stocks in there chalked up the highest average return of 118 per cent. The rest managed an average return ranging from 17 per cent to just over 50 per cent.
The following year, 2008, was the eye of the storm where the financial crisis was concerned. There was no escape. All stocks were down. But the consolation was, again, the highest ROE/PTB stocks as a group suffered marginally smaller losses. It plunged by 55 per cent. The range for the rest of the groups was an average loss of 53 per cent to 68 per cent.
Last year was again a good year for stocks. The highest ROE/PTB stocks rebounded by 121 per cent. That's second to Decile 2's 144 per cent return. The range of returns for all the groups was between 40 per cent and 144 per cent.
So, between 1990 and 2009, consistently buying the 10 per cent of stocks with the highest ROE/PTB year after year grew $100 to $74,229. That's a compounded annual return of 39.2 per cent a year. The next 10 per cent of stocks grew to $7,984, for a return of 24.5 per cent. (The power of compounding is amply illustrated here as well. A 15 percentage-point difference a year turned into a factor of 10 in 20 years' time.) The third 10 per cent grew by 12.7 per cent a year to $1,099.
Meanwhile, stocks with the lowest ROE/PTB shrank the initial $100 to just $25. In other words, stocks with low ROE and high PTB are toxic!
What's in the formula
In response to this article, a few readers have written in to point out that if we simplify ROE/PTB, it actually becomes earnings yield, or the inverse of price-earnings ratio.
Reader Darrell Lim gave the example of four companies. All have ROEs of 20 per cent, but each is valued differently by the market. The first at PTB of 0.5 time, and next at one time, the third at 1.5 times and the last company at two times book.
'If I'm expecting a 20 per cent ROE, but my PTB is 0.5, it means that even if the company performs as it should and its ROE for the following year is 20 per cent, I'm actually getting a 40 per cent return on investment - assuming market values tend towards true book values (or higher) in the long run,' he said.
Perhaps that accounts for part of the returns - stocks trading up to their book value.
I also have a number of readers writing in to ask where they can find PTB figures for companies. We can calculate that by taking the share price divided by the net asset value per share of the stock. Or as reader Nigel Tan pointed out to me, the data can be found on the Reuters website (http://www.reuters.com/finance/stocks/lookup? ). Just type in the company's name and select the company you want from the list which pops up.
And for those who are wondering which are the stocks with the highest ROE/PTB now, I've included the top 10 per cent here. Like the back-testing, I didn't filter out any stocks. As such, we have stocks whose earnings were boosted by extraordinary items or companies with some corporate governance issues. So do your home work before rushing in to buy any of the stocks listed here.
The writer is a CFA charterholder
Friday 3 September 2010
Upheavel in Singapore Residential Property Market & Stocks Have Turned Around
What a week. I had to shift house. Then I was hit by the property measures. Sheez. It's the most draconian policy since 1996, when a 20% cash down payment was required and capital gains tax was slapped on buyers. Sep 2010, cash down payment has been raised to 10%, second mortgage LTV has been reduced to 70%, worse, a private property owner must disposed of his property within 6 months if he wishes to buy a HDB. Luckily the policy applies to transactions that occur after 30 Aug 2010.
2012 is the Amegeddon of Singapore residential property. There will surely be a slide in prices. I don't see much upside for the rest of 2010 and 2011 anyway except for the core central regions. Simple math tells us that around 15k of private condos will be completed in 2012 and another 16k of HDB will TOP. Our population growth is around 80 - 100k per annum (garment policy). Average household size is around 3.5. So Singapore can absorb 22 - 23k of new houses (HDB + pte) per annum.
Oh, and stock markets are in the clear again. Time to buy. AUDUSD has signalled a buy and HY credit spreads have suddenly reached Apr 2010 low. But NOT EVERYTHING IS A BUY. I'll contact you on which markets are in a clear uptrend.
2012 is the Amegeddon of Singapore residential property. There will surely be a slide in prices. I don't see much upside for the rest of 2010 and 2011 anyway except for the core central regions. Simple math tells us that around 15k of private condos will be completed in 2012 and another 16k of HDB will TOP. Our population growth is around 80 - 100k per annum (garment policy). Average household size is around 3.5. So Singapore can absorb 22 - 23k of new houses (HDB + pte) per annum.
Oh, and stock markets are in the clear again. Time to buy. AUDUSD has signalled a buy and HY credit spreads have suddenly reached Apr 2010 low. But NOT EVERYTHING IS A BUY. I'll contact you on which markets are in a clear uptrend.
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