Investment philosophy: Don't predict earnings, find companies with predictable earnings
- Original Post from Don't anyhow

Investment philosophy

The price of stocks are a sum of three parts

1) Quality of the company
2) Future earnings of the company
3) Value of the stock

1) Quality of the company

- Quality of the company consists of 2 components
- The current industry the stock is in
- The historical/current financial health of the company

The current industry the stock is in involves checklists such as
- Stability of the industry
- Monopolistic/Oligopolistic nature of the company
- Company's branding

The historical/current financial health of the company
- Earnings track record (net margins, volatility in earnings, historical growth etc)
- Debt (interest coverage, D/E etc)
- Productivity (ROE, ROA)
- Cash flow (FCF, growth of OCF, expenditure on capex)

Summary: The quality of the company is used as a screen to find out which companies to look at. As a retail investor/long term holder we do not try to predict the future earnings. Thus investing in companies that have great positioning in the market + financial health gives us confidence that the company can deliver on its predicted earnings

2) Future earnings of the company

This literally decides the value of the stock, however its where people have the biggest folly. Sticking to Warren Buffet's principle, we do not try to predict the future, especially for companies that are in cyclical industries or have lumpy earnings.

Thus we rely heavily on the quality of the company, the rationale being: If a company (think JNJ) has a dominant position in the market, good financial health, and has been growing at a rate of 5% a year, there's a high chance its going to grow at 5% a year in the future

3) Value

The problem about identifying good companies with steady growth is 1) There isn't too many of them 2) They are usually properly valued. Even though they would tend to grow in the future (Stock gets cheaper as earnings increase), we would like to purchase a 'wonderful company at a fair price'.

This involves not comparing it with its peers (which are not accurate, probably not in the same position as the firm) but against history, where by logic, if the firm grows constantly, its P/E should be fairly constant. The P/E, forward P/E bands of these stocks rarely fluctuate.

Thus, our job is easy
1) Find stocks that fit our criteria
2) Use consensus estimates/ check its not too far off from historical growth
3) Buy it when its cheap.

You would realize my method is the same as bonds. Or 'equity bonds' as warren buffet likes to call it. As bonds have a universal method of valuation,myjob is to find companies that act like bondsand buy it on the cheap.

Selling criteria

Generally, selling criteria is harder than buying. Here's an example, when you see a stock like comfortdelgro trade at lets say 12x (way below its historical average), because of a crisis or whatever, you buy the stock. But when to sell it, 14x, 18x, 22x? That's a harder one to answer

2 criteria
1) When stocks go above a certain value
2) When the fundamentals of the company change

1) When stocks go above a certain value
This is an easy one, usually the stocks i look at usually revert to the mean, when a stock goes 20%+ its historical p/e level its usually time to sell. Give or take. Here's an easy way to think of it:

- stock's earnings is expected to growth 5% yearly
- stock is trading 20% above average p/e
- assume stock will revert back to average

This means that the earnings has to grow 5% for 4 years for the stock to do.... nothing.

2) When the fundamentals of the company change

This is infinitely harder to do, but totally crucial. You would realize the quality of the company is the main/sole reason I like the stock (future earnings + value just tell us when to buy the stock).

Once the quality of the company or the industry changes, you should get out of the stock. This is fairly hard to do, quarterly earnings fluctuate, perceived threats may occur, but identifying a structural shift and a potential de-rating is what thats important.

Warren buffet follows this extremely strictly, he did not sell coke, amex, p&g (aka his untouchables) even though they have constantly exceeded point 1. But he dumps stocks without mercy once he sees 2). Tesco & Walmart got dumped the second he realized there's a structural shift to online retailing.
He dumped airlines the second he realized that discounters are destroying the entire model.

There is no fixed method of doing this, but if your company has constantly missed earnings (2 Quarters is a good gauge) on losing market share, change in regulation, mgmt. doing stupid things, then its time to worry.

Summary: Don't anyhow.

Its the same thing as sticking to your circle of competence. I don't know how to predict earnings, so instead of doing so, I find companies that have predictable earnings and a good track record. I don't try to make 20-30% returns, or pick 'multibaggers', I instead try not to lose money and sleep easy at night.

TLDR version: (step 2 is actually the hardest)
1) Pick good quality companies with predictable earnings
2) wait for the price to fall
3) Buy it when its cheap.

$Inv Beve Biz EURO S(J0T.SI)

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Possibly The Worst Time to Invest – 5 Years On
- Original Post from (The) Boring Investor

US-China trade wars, Hong Kong protests, US yield curve inversion, etc. You probably would be thinking now is a bad time to invest. I had the same feelings 5.5 years ago in Dec 2013, when the Dow Jones Industrial Average was then near an all-time high and interest rates near an all-time low. You can read more about it in Possibly The Worst Time to Invest. Nevertheless, I still went ahead to initiate a plain vanilla passive portfolio comprising 70% in global equities and 30% in global bonds. In 2015, I also added a more spicy passive portfolio comprising 70% in US equities and 30% in Asian bonds.


Each year, I would blog about whether that decision in Dec 2013 turned out to be correct or not. Each year, the blog post would say the passive portfolios were up and there is inherent defence mechanism to manage the fearsome stock market crashes through portfolio rebalancing. These once-a-year blog posts on this series almost sound like a broken record.


This year, the plain vanilla portfolio is up by 39.5% since inception 5.5 years ago, while the spicy portfolio is up by 34.7% since inception 4 years ago. You can read about last year's figures in Possibly The Worst Time to Invest – 4 Years On.


Each year, there are bound to be events that worry us and stop us from investing. But each year, the stock market would somehow manage to shrug off the worrisome events and continue its upwards march, reaching new highs which previously seemed unimaginable along the way. A couple of years later, would you still remember the events that stopped you from investing? Do you still remember the taper tantrum in 2013, the threat of Grexit and yuan devaluation in 2015, the shock Brexit vote and US presidential election in 2016? Some of these events have faded from memory, and some people might wonder what was the fuss that stopped anyone from investing in 2013/ 2015/ 2016, etc. But when these events were playing out, the mood was cautious and the stock markets were falling. A couple of years from now, would most people still remember the US-China trade wars, Hong Kong protests and US yield curve inversion that are causing the stock markets to drop currently?


There will be a time when the stock market crash really arrives. But no one can predict reliably when it will arrive. The best way to deal with it is not to stop investing, but to have a good defence mechanism in place while investing.




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Would I Invest in Astrea IV 4.35% Bonds?
- Original Post from (The) Boring Investor

Recently, Temasek launched a Private Equity (PE) bond for retail investors known as Astrea IV 4.35% bond. It is the first PE bond open to retail investors. Would I invest my money in this bond?


First of all, let us understand what this bond is all about. This bond is issued by Astrea IV Pte Ltd, an indirect wholly owned subsidiary of Temasek, to hold a portfolio of PE investments. The investments are managed by 27 General Partners in 36 PE funds and invested in 596 companies. 86.1% of these funds are invested in buyouts, with 12.3% in growth equity and 1.6% in private debt.


Buyout funds are funds that privatise publicly listed companies, cut the excesses in the companies and streamline their operations to make them more efficient, and seek to exit the companies by selling them or listing them again. An example is Amtek Engineering, which was delisted from SGX in 2007 after being bought out by a PE fund, and was relisted as Interplex Holdings in 2010. And the story did not end there. Interplex Holdings itself was delisted in 2016 after being bought out by another PE fund.


The issuer, Astrea IV, has 3 classes of bonds, as follow:


  • Class A-1 - SGD242M 4.35% senior bonds that are open to retail investors and which are the subject of this post.

  • Class A-2 - USD210M senior bonds open only to Institutional and/or Accredited Investors. Class A-2 bonds have the same seniority as Class A-1 bonds.

  • Class B - USD110M bonds junior bonds open only toInstitutional and/orAccredited Investors.



The structure of the bonds is such that Class A bonds have priority to interest payments and bond redemption. In addition, it can borrow money from banks to make interest payments in the event that there are insufficient cashflows to do so. Moreover, its Loan-to-Value (LTV) ratio is capped at 50% of the portfolio value. If this threshold is crossed, it will have to cut debt levels. Furthermore, Class A bonds are senior to Class B bonds and shareholder equity. For Class A bonds to lose money, the portfolio that Astrea IV invests in must lose at least 64.4% of its value. So, it is quite safe, isn't it?


First of all, you need to recognise that Astrea IV, the company that you are investing into by buying the retail bond, is essentially a fund of funds. Although its LTV is capped at 50%, this is only at the Astrea IV level. The funds that Astrea IV invests into could have their own borrowings and these are not counted in the 50% LTV cap. After accounting for these borrowings at the lower levels (i.e. look-through basis), the leverage could be much higher. As a hypothetical example, Company A could have shareholder equity of $50M and bonds of $50M. Using this $100M, Company A invests into Company B. Company B borrows another $100M. Company B invests the $200M into a property. How much of the investment in the property is funded by equity and borrowings? The answer is $50M in equity and $150M in borrowings. Thus, even though the LTV at Company A's level is only 50%, on a look-through basis, the LTV is 75%! Does LTV on a look-through basis matter? For Company A's equity to be wiped out completely and its bonds to start losing money, the property's value only need to fall by 25% ($50M equity out of $200M asset value). So, LTV on a look-through basis does matter!


Secondly, most of the money are invested in buyout funds. Buyouts are usually highly leveraged operations. In the process of buying out companies, they take on large debts and usually pay a premium to acquire a 100% stake in the companies. After successfully acquiring the companies (which are usually cashflow-rich companies), they extract most of the cash from the companies to pay down their own debts. They also streamline the operations of the companies and load them with debts, such that the companies become more conscious about cutting costs and direct most of their cashflows to paring down the debts loaded onto them. Thus, the high returns of buyout funds are partly due to making the companies more efficient and partly due to the leverage employed. As an example, when 3G Capital teamed up with Berkshire Hathaway to buy Heinz for USD23.3B in 2013, they only forked out USD4.4B in capital each. The remaining was borrowed. (Note: Berkshire Hathaway also bought USD8B of preferred stocks paying 9% interest. I will leave it to readers to decide whether to classify this USD8B as equity or debt.)


Thus, in conclusion, Astrea IV is essentially a fund of leveraged buyout funds. I will not be investing in these bonds, even if its 4.35% coupon looks attractive.




See related blog posts:

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Would I Invest in Astrea IV 4.35% Bonds?
- Original Post from (The) Boring Investor

Recently, Temasek launched a Private Equity (PE) bond for retail investors known as Astrea IV 4.35% bond. It is the first PE bond open to retail investors. Would I invest my money in this bond?



First of all, let us understand what this bond is all about. This bond is issued by Astrea IV Pte Ltd, an indirect wholly owned subsidiary of Temasek, to hold a portfolio of PE investments. The investments are managed by 27 General Partners in 36 PE funds and invested in 596 companies. 86.1% of these funds are invested in buyouts, with 12.3% in growth equity and 1.6% in private debt.



Buyout funds are funds that privatise publicly listed companies, cut the excesses in the companies and streamline their operations to make them more efficient, and seek to exit the companies by selling them or listing them again. An example is Amtek Engineering, which was delisted from SGX in 2007 after being bought out by a PE fund, and was relisted as Interplex Holdings in 2010. And the story did not end there. Interplex Holdings itself was delisted in 2016 after being bought out by another PE fund.



The issuer, Astrea IV, has 3 classes of bonds, as follow:



  • Class A-1 - SGD242M 4.35% senior bonds that are open to retail investors and which are the subject of this post.

  • Class A-2 - USD210M senior bonds open only to Institutional and/or Accredited Investors. Class A-2 bonds have the same seniority as Class A-1 bonds.

  • Class B - USD110M bonds junior bonds open only toInstitutional and/orAccredited Investors.



The structure of the bonds is such that Class A bonds have priority to interest payments and bond redemption. In addition, it can borrow money from banks to make interest payments in the event that there are insufficient cashflows to do so. Moreover, its Loan-to-Value (LTV) ratio is capped at 50% of the portfolio value. If this threshold is crossed, it will have to cut debt levels. Furthermore, Class A bonds are senior to Class B bonds and shareholder equity. For Class A bonds to lose money, the portfolio that Astrea IV invests in must lose at least 64.4% of its value. So, it is quite safe, isn't it?



First of all, you need to recognise that Astrea IV, the company that you are investing into by buying the retail bond, is essentially a fund of funds. Although its LTV is capped at 50%, this is only at the Astrea IV level. The funds that Astrea IV invests into could have their own borrowings and these are not counted in the 50% LTV cap. After accounting for these borrowings at the lower levels (i.e. look-through basis), the leverage could be much higher. As a hypothetical example, Company A could have shareholder equity of $50M and bonds of $50M. Using this $100M, Company A invests into Company B. Company B borrows another $100M. Company B invests the $200M into a property. How much of the investment in the property is funded by equity and borrowings? The answer is $50M in equity and $150M in borrowings. Thus, even though the LTV at Company A's level is only 50%, on a look-through basis, the LTV is 75%! Does LTV on a look-through basis matter? For Company A's equity to be wiped out completely and its bonds to start losing money, the property's value only need to fall by 25% ($50M equity out of $200M asset value). So, LTV on a look-through basis does matter!



Secondly, most of the money are invested in buyout funds. Buyouts are usually highly leveraged operations. In the process of buying out companies, they take on large debts and usually pay a premium to acquire a 100% stake in the companies. After successfully acquiring the companies (which are usually cashflow-rich companies), they extract most of the cash from the companies to pay down their own debts. They also streamline the operations of the companies and load them with debts, such that the companies become more conscious about cutting costs and direct most of their cashflows to paring down the debts loaded onto them. Thus, the high returns of buyout funds are partly due to making the companies more efficient and partly due to the leverage employed. As an example, when 3G Capital teamed up with Berkshire Hathaway to buy Heinz for USD23.3B in 2013, they only forked out USD4.4B in capital each. The remaining was borrowed. (Note: Berkshire Hathaway also bought USD8B of preferred stocks paying 9% interest. I will leave it to readers to decide whether to classify this USD8B as equity or debt.)



Thus, in conclusion, Astrea IV is essentially a fund of leveraged buyout funds. I will not be investing in these bonds, even if its 4.35% coupon looks attractive.





See related blog posts:



$Inv Beve Biz EURO S(J0T.SI) $Astrea IV4.35%B280614(RMRB.SI)

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Possibly The Worst Time to Invest – 4 Years On
- Original Post from (The) Boring Investor

This once-a-year post probably sounds like a broken record, but 4 years after I thought it was a bad time to invest (due to record high Dow Jones Industrial Average and record low interest rates then), the DJIA has not crashed yet, despite a series of corrections along the way, with the most recent one in Feb. I have 2 passive portfolios invested in index funds and adopting the portfolio rebalancing strategy. The plain vanilla portfolio has 70% in global equities and 30% in global bonds since Dec 2013, while the spicy portfolio has 70% in US equities and 30% in Asian bonds progressively built up over 2015.



To-date, the plain vanilla portfolio is up by 31.4% while the spicy portfolio is up by 24.2% since they were started approximately 4.5 years and 2.5 years ago. Needlessly to say, had I worried about the high stock prices and low interest rates back then and not started the 2 portfolios, I would not be sitting on such paper gains.



I am tempted to allocate more money from my active investments to the 2 passive portfolios, considering that all it takes is to monitor occasionally whether the relative allocation between the equities and bonds has moved significantly away from the initial allocation of 70% stocks and 30% bonds and rebalance them when it happens. In contrast, active investment requires a lot of hard work. I need to read the financial statements and annual reports, attend Annual General Meetings, understand pricing strategy and competitors' activities, etc. to understand how well the business is doing. Just take a look at M1, a stock that I blogged about recently. I spent no less than 6 posts (and another 3 posts on its competitors) to describe the various aspects of M1. Even then, there are probably still a lot of areas about M1 that I do not understand. Furthermore, the size of my M1 position is only 1/3 that of the 2 passive portfolios!



So, would I be worried if I were to invest more into the 2 passive portfolios and the crash finally happens? Obviously, I would be quite upset if it were to happen, but I would attribute it more to bad timing. One way to mitigate this risk is to spread out the investment, similar to what I did when I initiated the spicy portfolio. The plain vanilla portfolio was a lump-sum investment in Dec 2013, but the spicy portfolio was built up over 12 months in 2015. Furthermore, the rebalancing strategy will ensure that if stocks were to crash significantly, the bonds would be sold to buy more of the now cheaper stocks. There is inherent defence mechanism in the portfolio rebalancing strategy.



This time next year, I am not sure if I will be happy or upset over my 2 passive portfolios (which depends on whether the crash happens or not), but likely, it will be business as usual.





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$Inv Beve Biz EURO S(J0T.SI)

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Possibly The Worst Time to Invest – 4 Years On
- Original Post from (The) Boring Investor

This once-a-year post probably sounds like a broken record, but 4 years after I thought it was a bad time to invest (due to record high Dow Jones Industrial Average and record low interest rates then), the DJIA has not crashed yet, despite a series of corrections along the way, with the most recent one in Feb. I have 2 passive portfolios invested in index funds and adopting the portfolio rebalancing strategy. The plain vanilla portfolio has 70% in global equities and 30% in global bonds since Dec 2013, while the spicy portfolio has 70% in US equities and 30% in Asian bonds progressively built up over 2015.


To-date, the plain vanilla portfolio is up by 31.4% while the spicy portfolio is up by 24.2% since they were started approximately 4.5 years and 2.5 years ago. Needlessly to say, had I worried about the high stock prices and low interest rates back then and not started the 2 portfolios, I would not be sitting on such paper gains.


I am tempted to allocate more money from my active investments to the 2 passive portfolios, considering that all it takes is to monitor occasionally whether the relative allocation between the equities and bonds has moved significantly away from the initial allocation of 70% stocks and 30% bonds and rebalance them when it happens. In contrast, active investment requires a lot of hard work. I need to read the financial statements and annual reports, attend Annual General Meetings, understand pricing strategy and competitors' activities, etc. to understand how well the business is doing. Just take a look at M1, a stock that I blogged about recently. I spent no less than 6 posts (and another 3 posts on its competitors) to describe the various aspects of M1. Even then, there are probably still a lot of areas about M1 that I do not understand. Furthermore, the size of my M1 position is only 1/3 that of the 2 passive portfolios!


So, would I be worried if I were to invest more into the 2 passive portfolios and the crash finally happens? Obviously, I would be quite upset if it were to happen, but I would attribute it more to bad timing. One way to mitigate this risk is to spread out the investment, similar to what I did when I initiated the spicy portfolio. The plain vanilla portfolio was a lump-sum investment in Dec 2013, but the spicy portfolio was built up over 12 months in 2015. Furthermore, the rebalancing strategy will ensure that if stocks were to crash significantly, the bonds would be sold to buy more of the now cheaper stocks. There is inherent defence mechanism in the portfolio rebalancing strategy.


This time next year, I am not sure if I will be happy or upset over my 2 passive portfolios (which depends on whether the crash happens or not), but likely, it will be business as usual.




See related blog posts:


$Inv Beve Biz EURO S(J0T.SI)

Read more
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