To succeed in any kind of investments, you need to know the correct way of valuing. With real estate, the best measures are: 1) net operating income (gross yield – all expenses) spread over 10y govt bond yield. 2) supply and demand balance, 3) future development, 4) comparables.
My take for Singapore real estate is as follows 2013: you will see rental yields start to fall due to oversupply. 2014: yields will continue to fall but prices hold steady due to liquidity. 2015: rental yield will fall from 2.9% in 2013 to 2.0% in 2015. Mortgage rates may surpass yields and we could see prices start to correct 10 – 20%. 2016: perfect storm in Singapore / Iskandar?? This may coincide with a time when Europe / US are growing steadily and hiking rates.
For stocks, you need to look at 1) comparables in terms of PE, Price to book, ROIC, ROE, 2) historical PE, dividend yields, Price to book, ROIC, ROE, 3) macro factors, 4) technicals. I prefer method 2 because relative valuation can be nonsensical because when an entire sector is overvalued, you can keep justifying why you should buy. That happened when I was an analyst back in 1998 – 2001 and saw how my industry colleagues justify PCCW at 100x PE.
Remember this, when the PE is single digit, price to book is below 1.5x it is difficult to fall by a lot. However, when PE is over 18x, price to book > 2.5x, it’s like buying a house at 2% yield in Iskandar / Singapore, hoping that a “greater fool” will buy from you at a higher price but without any cash flow from rental. Once expectations are very high, PE multiples are extended, a SINGLE DISAPPOINTING EVENT CAN CAUSE STOCKS TO TUMBLE 50 – 60%. In 2007, I was extremely bearish on the stock markets because price to book was at the highest I’ve seen since 1999. But nobody talked about valuations then.
The day will come when we will have to be bearish, when valuations don’t make sense (PE > 18x, dividend yield < 2%, price to book > 2.5x), but the day is not now. Stocks are still cheaper than bonds. Interest rates can only go up. But stocks’ valuations can go up a lot more before we consider them expensive.
Read this article
As the valuation guru Aswath Damodaran puts it: "If you do not believe in intrinsic value and make no attempt to estimate it, you have no moorings when you invest. You will therefore be pushed back and forth as the price moves from high to low. In other words, everything becomes relative and you can lose perspective."
The professor of finance at Stern School of Business at New York University adds: "Without a core measure of value, your investment strategy will often be reactive rather than proactive. Crowds are fickle and tough to get a read on. The key to being successful as a (momentum trader) is to be able to read the crowd mood and to detect shifts in that mood early in the process. By their nature, crowds are tough to read and almost impossible to model systematically."
Gap between value and price
But the gap between a business's value and its price can remain for a long time. The timing of the closing in the gap is never certain. According to Prof Damodaran, you can reduce your exposure to it by, one, lengthening your time horizon; and two, providing or looking for a catalyst that will cause the gap to close.
PUBLISHED JULY 13, 2013
SHOW ME THE MONEY
Stay strong and keep herd mentality at bay
Understanding the worth of the business is key, especially when the share price slumps below intrinsic value
SENIOR CORRESPONDENT (HOOILING@SPH.COM.SG)
A friend gave me the book The Value Investors: Lessons from the World's Top Fund Managers by Ronald Chan not too long ago.
In the chapter on Tweedy, Browne, one sentence caught my attention. The line is: "Tweedy, Browne presents empirical evidence to show that 80-90 per cent of investment returns have occurred in spurts that amount to 2-7 per cent of the total length of the holding period. The rest of the time, stocks' return have been small."
Anecdotal observations on my part seems to suggest that this is true, at least for certain types of stocks. One very distinct example came to mind.
Portek International was listed on the Singapore Exchange in 2002 at 30 cents a share. For pretty much the next nine-and-a-half years, it traded at around 40 cents. In mid-2008, it traded above 60 cents before plunging to a low of 15 cents in February 2009. Investors who bought the stock at its initial public offering and sold any time before the second half of 2011 can't be said to have made a phenomenal amount of returns from that investment.
But throughout that period, the company's founder Larry Lam was tirelessly building up the company's logistics infrastructure and network in Africa. In September 2011, Japan's Mitsui & Co paid $213.5 million, or $1.40 a share, to take Portek private. The Japanese trading company had wanted the quick access into Portek's assets in Gabon, Algeria and Rwanda.
From IPO till the privatisation, including the yearly dividends paid, an investor would have made an annual compounded return of some 23.5 per cent a year from Portek. That's equivalent to growing one's money by some six times within that nine-and-a-half years. But the catch is, the bulk of the returns came at the very end, when there was an offer to take the company private.
It has to be said that the company did pay decent dividends. Based on the average price of about 40 cents a year, dividends over the years averaged about 7 per cent. Only in one year - 2007 - was dividend cut sharply.
So even without the takeover, Portek had been a decent investment. And eventually, the timing was ripe to have the assets taken off it by the Japanese group. It just so happened that in the last few years, countries in the African continent have managed to get their politics more right than before. Consequently the world at large has rediscovered its interest in the lost continent. There is an element of luck in the timing of everything.
Had the countries that Portek was in been mired in civil wars, then there might not be buyers for its assets. Worse still, the assets may be expropriated.
In this case, the outcome was a happy one.
Another example of an outsize return which came in a short spurt of time was recounted to me by an ex-colleague this week. He was reminiscing about his career and shared the time in the early-70s when there was a massive bubble in the local stock market. Then, OCBC shares traded to a high of $50 each. My colleague shared that Metro traded to about $26 during that period.
He had bought four lots of Metro at about $2-plus. After he bought them, the stock fell, and he panicked. When the stock price came back up to near his purchase price, he quickly sold them. Lo and behold, soon after, the shares surged to $26 each.
"Four lots at $26, that's about $100,000. I could have bought a bungalow and retired then," he lamented. Had he done that, Singapore's media industry would have been much poorer for it. As things turned out, he has enjoyed one of the most illustrious careers in journalism in Singapore. No one is likely to surpass what he has accomplished, that's my bold prediction. Anyway, that's another story.
Numerous times, we have experienced ourselves, or we hear our friends expressing regret that - soon after disposing of a stock, the price would surge.
I think stocks which saw their investment return that came in spurts are typically less liquid stocks, which are under the radar of most analysts and investors. For the big cap stocks which are very well-followed, the price appreciation tends to be more gradual - unless there is a huge bubble. Then, even the big cap stocks would be lifted way above their intrinsic values.
So how does one keep faith in a stock when it has done nothing much in terms of share price in, say, the nine years that you've held it?
Understanding the worth of the business, be it on its own, or its value as a cog in a bigger machinery, is key to keeping one anchored. Owning shares is equivalent to owning a slice of a real business.
As the valuation guru Aswath Damodaran puts it: "If you do not believe in intrinsic value and make no attempt to estimate it, you have no moorings when you invest. You will therefore be pushed back and forth as the price moves from high to low. In other words, everything becomes relative and you can lose perspective."
The professor of finance at Stern School of Business at New York University adds: "Without a core measure of value, your investment strategy will often be reactive rather than proactive. Crowds are fickle and tough to get a read on. The key to being successful as a (momentum trader) is to be able to read the crowd mood and to detect shifts in that mood early in the process. By their nature, crowds are tough to read and almost impossible to model systematically."
Gap between value and price
But the gap between a business's value and its price can remain for a long time. The timing of the closing in the gap is never certain. According to Prof Damodaran, you can reduce your exposure to it by, one, lengthening your time horizon; and two, providing or looking for a catalyst that will cause the gap to close.
On lengthening one's holding period, the ideal situation is to have a stock which pays you to wait, not unlike Portek.
And if one of those sleepy stocks that one owns suddenly woke up one day and sprung up sharply to a level closer to its intrinsic value, one should be ready to take that opportunity to lock in one's return. A missed opportunity could mean a wait of another three or four years!
In previous articles, I've used the measure of dividend yield divided by price-to-book to identify stocks which pay investors to wait. The higher the measure, the greater the "value" of the stock. Some readers have written in of late for an updated list following the recent market correction.
I've compiled the list to go with this week's article. I've added an additional screen for the debt levels of these stocks. Those with higher debt to equity ratios are dropped in view of the fact that interest rates may rise. There aren't many stocks in the big cap sector that pay good dividends and yet still trades at below their book value. So the stocks in the list are the smaller cap stocks.
