Wednesday, November 7, 2007

Importance of US Job Data Report

The US job report is most eagerly awaited by stock market investors as it is the first economic indicator that covers the month just ended. Any weak number may cause weak consumer spending and lead to poorer stock market performance.

IN THIS article, we will look at the US Employment Situation Report, which we sometimes call the US job report. It is the most eagerly awaited economic indicator as it is the first US economic indicator that covers the month just concluded.

It is published very quickly in the first Friday of the following month. For example, the US job data which was released last Friday (Nov 2) was for October. As it is released ahead of all other economic indicators, it provides the latest health check on the US economy.

The US Employment Situation Report is published by the Bureau of Labour Statistics of the US Department of Labour. It includes the monthly change in non-farm employment, the trend in hours worked, the level of hourly and weekly earnings, the part-time employment level and the level of temporary workers.

This report also includes levels of employment and unemployment broken down by gender, ethnicity, age and marital status. Besides, it shows levels of employment by sector, average hours worked as well as earnings.

This report provides the latest situation in the US job market and household earnings. Normally, if this indicator shows weak numbers, in most instances, subsequent US economic indicators would also not be good.

Hence, it has very high market sensitivity as wages and salaries from employment account for the main source of household income. Any unexpected changes in the information can have a huge influence on the stock market's movement.

Personal income is the main driver of consumer spending. It is mainly derived from wages and salaries that are reported in the US Employment Situation Report.

As consumer spending is the largest sector in the economy, a higher set of numbers in wages and salaries may imply better consumer spending in the near future. Higher demand for products will cause manufacturers to increase their inventories build up.

This will lead to higher capital spending to support higher activities in manufacturing. Coupled with better profit margins, higher corporate profits will contribute to better stock market performance. In short, the stock market is closely tied to consumer spending, where wages and salaries are the primary determinants of the latter.

On the other hand, lower employment numbers or a higher unemployment number will cause lower consumer spending as well as slower growth in corporate businesses.

Usually, it will precede an economic downturn as employers try to anticipate a recession by reducing headcount. Hence, any reduction in growth rates on consumer spending may sometimes imply the beginning of a bear market.

In the US job report, the best measurement of individuals’ unit purchasing power through wages and salaries is the average hourly earnings series.

In most instances, the real hourly wage will decline before consumer spending growth peaks as a result of rising inflation caused by strong consumer spending itself.

According to Joseph H. Ellis in his book entitled Ahead of the Curve, real hourly earnings are an effective leading indicator of consumer spending. It serves as a useful leading indicator of the direction of the stock market. According to his research, real hourly wage begins to slow six to 12 months before the peak in consumer spending growth.

The number of jobs and earnings can provide useful data to economic forecasters. However, it is compiled from surveys that may not be 100% reliable. Besides, sometimes there may be some revisions in the figures of the previous months.

Nevertheless, given that stock prices are positively correlated with job creation, the investment community pays very close attention to the employment report on the first Friday of every month.

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Tuesday, August 28, 2007

Ten-year cycle of market crashes?

In this article, we look at three stock market crashes from the recent market crash to those in 1987/8 and 1997/8

Q: Are we in the 10-year stock market cycle, pending a big stock market crash?

The market crash in 2007
The recent heavy sell-down on the bond and stock markets caught a lot of retail and institutional investors by surprise. What appeared to be a haven in investment like the bond market was still subject to panic selling from institutional investors.
We believe the crash in the bond market was mainly due to the withdrawal of some foreign funds. As a result of tight liquidity, unwinding of yen carry trade and potential high losses in some hedge funds, some foreign funds might have been forced to withdraw their investments from the Asia-Pacific market.
The plummet in our stock market was mainly due to the fear of sharp drops in the US, Hong Kong, Singapore, South Korea and Japan markets.
Even though our banking institutions were not really affected by the US subprime issues, the international contagion and fear of more crashes, margin calls and panic selling from retailers caused heavy losses on Bursa Malaysia.
Nevertheless, the magnitude of our losses was far less than those in the regional markets.

The market crash in 1987/8
The market crash in October 1987 was partly attributed to strong market performance of most markets during the first nine months of the year. For example, the US market experienced more than 30% increase during the nine-month period.
However, from Oct 12 to 16, the Dow Index tumbled by 9.5%. On Black Monday of Oct 19, it plunged 22.6%, or 508 points, within a day. It was the largest single fall since 1929, in both absolute and percentage terms.
In Malaysia, the KL Composite Index (KLCI) tumbled by 12.4% on Black Monday. As a result of the overnight crash in US, the KLCI plunged another 15.7% the next trading day.

The market crash in 1997/8
The Asian stock market crash of 1997/98 began with a currency crisis in July in Thailand and quickly spread to neighbouring nations. One by one, overheated markets crashed in Thailand, Indonesia, Malaysia, the Philippines, Hong Kong, Singapore, Taiwan and South Korea. This was mostly due to the rapid industrialisation in these countries.
The US market was affected by the turmoil in Asia. Its share prices began to collapse at the beginning of October 1997. On Oct 27, the Dow Index tumbled by 554 points, or 7.2%, within a day. However, it recovered by recording a rise of 337 points the next day.
In Malaysia, the KLCI tumbled from 1,231 points in the beginning of 1997 to the low of 262 on Sept 1, 1998, representing a total percentage drop of 78.7%.
Comparing the three market crashes, the KLCI suffered its biggest daily drop of 21.5% on Sept 8, 1998. The crashes in 1997/8 and 1987/8 were also far more severe than our recent market crash.

We are not too sure whether we have seen the worst of the crash in 2007. However, the sell-down has caused a big disruption in our uptrend momentum. It appears to be quite difficult for the KLCI to touch the recent peak of 1,392 again.
Any market rebounds may prompt fund managers to continue offloading their equity exposure. Most of big losses in 1997/8 and 1987/8 happened in October.
As we can only know the actual exposure of the subprime issues for most of the US financial institutions when they report their third quarter results in early October, we are expecting some market volatility in that month.

>>Continue Reading<<

Thursday, July 26, 2007

Buy or Sell When Bulls Come

The Dow has hit three milestones in the past nine months: 12,000 last October, 13,000 in April and 14,000 on July 17.

If you've missed out on some of that lightning-speed run-up, you may feel one of two things:

1.Fear. You're sure if you buy stocks now, they'll tumble soon after, leaving you with a big bill and not much value.

2.Greed. You're in the camp that thinks there's still upside in the near term, so you want to make sure you don't miss the next ride up.
Your best bet: "Ignore what the Dow is doing," said certified financial planner James Whiddon, author of Wealth Without Worry and co-host of "The Investing Revolution" on Dallas-based

Older investors tend to steer clear of high-milestone markets, while younger ones tend to be more eager to jump when they see stocks moving higher, Whiddon said. But no one should be moving in and out of the market on short-term news or trends, and that includes recessions, which typically last eight- to 10 months.

With money you won't need for at least five years, "the best time to be in the market is always now," Whiddon said.

That's because trying to time the market may be more damaging to your portfolio long-term than taking an occasional bath on an investment.

If you're a bear and feel like you want to wait for cheaper stock prices, consider this: For every 20-year and 30-year rolling period since 1926, there have been more up months for stocks than down ones, according to Ibbotson Associates. And even over 10-year rolling periods, there were only two in which the months of negative stock returns exceeded those of positive ones.

Missing out on those high-return months (the timing of which you can't predict) can cost you a lot. A hundred dollars invested from 1926 to 2006 in the S&P 500 would have yielded $307,700, according to Ibbotson. But if you missed the 40 months with the highest returns you would have ended up with - no kidding - $1,823.

Granted, most people don't invest in the market for 80 years straight. But the principle holds over shorter time frames. Had you invested $100 in 1987 straight through 2006 you'd have ended up with $931. Had you been out of the market for the 17 best trading months, however, you'd have just $232.

But if you're a bull, keep in mind that the skeptics aren't crazy. If you hopped into stocks during the peak trading month right before the 1929 crash, you would have gotten a 9.4 percent annual average return through 2006, according to Ibbotson. Not bad, but not as good as the 10.5 percent return you would have gotten if you'd kept your money invested from 1926 through 2006.

You'll always be better off investing when stocks have fallen. Bill Miller, manager of the Legg Mason Value Trust, told Money Magazine's Jason Zweig, "rising stock prices mean lower future rates of return and falling stock prices mean higher rates of return. So I was much happier in the summer of '02 when you buy everything on sale than I was in the spring of 2000 when a lot of things were super-expensive." (Bill Miller speaks...from Money Magazine)

But, of course, you won't be able to predict when those sale days will occur.

So whether your impulse is to throw more money than usual into stocks now or, conversely, to steer clear, this may be one time when it pays to ignore your hunch.

The better step is to make sure you're positioned to benefit whether or not there is more upside to stocks in the near-term. That means keeping your portfolio well diversified, steadily investing the same amount of money every month so you're likely to lower your average costs over time, and rebalancing your portfolio once a year to keep your chosen asset allocation on course. (Get the rebalancing equation right.)

Unless, like Warren Buffett, you were "wired at birth to allocate capital," you might use low-cost index funds to ensure you do as well as the total market over time or, if you're investing for retirement, you might invest in a target-date retirement fund. That type of fund automatically allocates your assets based on how close you are to retiring - the closer you are, the more conservative the allocation becomes

>>Continue Reading<<

How to Survive Stock Drops and Profit from Them

Losing money never feels good. But keep things in perspective and you can boost long-term returns.

NEW YORK ( -- You have to admit: Stocks have risen to mighty heights mighty fast. The Dow has hit three milestones in nine months - crossing 12,000 in October, 13,000 in April, and just last week, 14,000.

That was Dr. Jekyll Dow talking. But Mr. Hyde Dow was always lurking.

On Thursday, the leading stock index closed down 311 points, or more than 2 percent, the second biggest point drop this year. The biggest came Feb. 27, when the Dow fell 416 points, or 3.3 percent.

What to make of this? Stocks are volatile. Or more to the point, investors' emotions are.

It takes nerves of steel to shake off a big stock drop. But the world's best investors not only shake them off - they thrive on them. (Bill Miller: 'I'm always happier at market lows')

They know sell-offs are common, perfectly normal, and even healthy. When stocks go way up in a hurry, their prices become unsustainably high. Only by falling occasionally (and even sharply) in the short run can stocks continue to rise in the long run. Without the agony of today's drop, the ecstasy of tomorrow's good returns becomes impossible.

Consider the terrible slide of 1973-74, when the S&P 500 index lost 48 percent of its value. Richard Nixon had resigned the Presidency, oil prices had quadrupled, Cleveland and New York City were on the verge of bankruptcy, and inflation had flared up to 12 percent.

If ever there's been a good time to panic, that had to be it. But as the old saying goes, things are darkest before the dawn. If you'd sold out of stocks at the end of 1974, you would have missed 1975's 37.2 percent return and 1976's 23.8 percent gain - two very strong years for the stock market.

Even after the Dow's wrenching plunge in October 1987, remember that the index actually ended up rising 2 percent in value that year. And it took only 15 months (until January 1989) for the Dow to make its way back above 2246.73, the closing price on the last trading day before Black Monday.

In fact, there's such a thing as paying too much attention to your money. In the late 1980s, Paul Andreassen, a psychologist then at Harvard University, conducted a series of laboratory experiments to determine how investors respond to financial news.

He found that people who pay close attention to news updates actually earn lower returns than people who seldom follow the news.

When you think about this a little more, it actually makes good sense. News coverage tends to make market movements seem even bigger than they are - and to make them seem likely to persist just when they are most likely to reverse.

Take action
Fortunately, there are several simple and effective steps you can take to turn a stock market crash to your advantage.

Amp up your 401(k). Since a down market can be a great time to buy solid investments at bargain prices, contribute as much to your 401(k) as you can, because you'll be picking up more shares for the money, which will pay off when the market rebounds.

If you can't contribute the maximum your plan allows, at the very least contribute as much as is required to receive the company match. Typically, companies match 50 cents on every dollar you contribute, up to 6 percent of your compensation.

That means for each dollar you invest up to 6 percent, your employer adds another 50 cents, instantly transforming your investment into $1.50. This will not only help cushion any fall in stock prices, but it will amplify your gains once the market recovers.

Adjust your risk. A market sell-off is a good time for a gut check. Did the mutual funds you own take too much risk and fall much more than their respective indexes?

Obviously you would have wished you'd known before this decline. But at least you'll know which funds you want to ride into the next one. For a good selection of mutual funds with good risk profiles, see the Money 70, Money Magazine's selection of best funds.

It's also a good time to make sure you have the right mix of stocks and bonds, which can add ballast to a portfolio during downdrafts. Even if you have a lot of years to go, a decent dose of bonds - say 10 to 20 percent - is a good idea: you'll still get a lot of the growth stocks offer without as much volatility.

Determine your deadlines. Ask yourself when you will need the money you've invested. For example, if you have a newborn child, it's a good idea to invest some money to pay college tuition down the road - and you can put most of it in stocks, since 18 years should be long enough for the market to recover from a crash.

But if you're about to make a down payment on your dream house, that money should go in a safer bucket, where a stock market crash can't hurt it; there, you want to hold mainly cash and bonds. Tuesday's drop was relatively small and you can still make those adjustments.

Spread your bets. If all you owned was U.S. stocks or stock funds, the crash has just reminded you that being diversified is the best offensive - and defensive - weapon in any investor's arsenal. Even if you're young and like to take risks, you should have some cash, some bonds, and some foreign stocks, which, over the long run, will combine with your U.S. stocks to lower your risks without crimping your returns.

>>Continue Reading<<

Wednesday, June 6, 2007

What triggers a downfall in the market?

AS a result of China's higher-than-expected economic growth of 11.1% and fear of possible further interest rate hikes in China, regional markets, including Malaysia, fell sharply last Thursday.

This was the second time after Chinese New Year (CNY) that a drop in Chinese stock prices rattled the markets across Asia.

According to Lee In Ho in his study on Market Crashes and Informational Avalanches, there are four stages in a market crash. They are boom, euphoria, trigger and panic.

Under the boom stage, the market will normally have a main theme that excites everyone about stocks.

In Malaysia, several positive measures under the Ninth Ma- laysia Plan got investors excited about the construction and property sectors. At this stage, this is seldom a bubble as companies continue showing good corporate results. A bubble will be created at the euphoria stage. The unjustified extrapolation of future earnings and the revision of higher target prices by research analysts can cause overconfidence in companies’ future performance.

A bubble will start to take shape when the general public reacts to this overconfidence. An irrational exuberance will occur when market prices and expectations about future values are far beyond the fundamentals of the companies.

However, no one will know when the rise will stop. A market will resume its upward trend until something triggers the downfall.

Usually, the stock prices get higher and steeper just before the market crash.

At the trigger stage, private information will reach a threshold that triggers other traders to alter their behaviour. At this critical situation, when almost everyone is at irrational exuberance, any event can trigger the market to tumble.

In January 1994, our stock market put the blame on former finance minister Tun Daim Zainuddin for saying that he had sold all his shares because prices had reached dangerous levels.

Until now, nobody can really understand the main reason behind the sharp plunge on the Shanghai Index right after the CNY.

According to some fund managers in China, the selling was mainly due to investors panicking when they noticed that their friends were selling stocks.

A famous researcher in behavioural finance, Robert Shiller, conducted a survey by asking institutional and individual investors what was in their mind during the stock market crash in 1987. One conclusion he drew was that the crash was due to people reacting to each other with heightened attention and emotion.

Investors seemed to follow what other investors were doing. As a result of action and reaction, a feedback loop was created when everyone had a simultaneous reaction to common stimuli.

A market crash is described as a process that corrects a public belief that is inconsistent with the current distribution of private information. The severity of a crash will depend on whether the market is filled by “new generation” investors or experienced traders.

“New generation” investors do not know anything about the stock market but are greedy and want to get quick money from it. A market will not crash if it has experienced traders who know how to control risk and when to cut losses.

However, if a market is filled by “new generation” investors with no holding power and do not know when is the right time to sell a stock, any sharp drop in prices could result in panic selling. At this panic stage, the fear of further drops could cause big fall in prices.

When will the stock market crash again?

My usual answer for this question is the stock market will not crash as long as you continue to worry about when it will crash. The market will crash at the time when you least expect it to happen. Investors should remember that the market always performs beyond your expectations.

We should not be too worried about when the market will crash. Instead, we should consistently review our portfolio and sell those stocks whose prices have gone beyond their intrinsic value

Source: TheStar

>>Continue Reading<<

Tuesday, June 5, 2007

Why some gain and others lose?

Morgan Kelly in his research (1997) entitled, Do Noise Traders Influence Stock Prices?, identified three types of investors: smart-money traders, noise traders and passive traders.

Smart-money traders always behave rationally whereas noise traders always buy high and sell low. Passive traders do not actively participate in the market most of the time.

According to Kelly, the probability of being a noise trader declines with income. As a result of higher income, smart-money traders can acquire more reliable research reports to help them in investment decisions.

Noise traders, being in the lower income group as well as lacking critical information and having wrong information, end up losing money in the stock market most of the time. Their aim to recoup losses lead to more losses. Nevertheless, the presence of this group of traders makes it possible for smart-money traders to make money.

In general, noise traders are always affected by emotion and past experience. They rush to sell when prices fall and buy when prices go up because they believe the current trend will continue into the future.

As a result of over-confidence and lack of self-control, they are unable to act rationally. Furthermore, due to a lack of financial training and limited capacity to process information, they tend to misinterpret economic and market information.
Most of the time they put faith in the information they want to hear and if that contradicts what they have done, they will “bend'' the information to confirm their actions.

Some noise traders rely on heuristics and rules of thumb to make decisions.
Heuristic refers to the process whereby investors develop their investment rules by trial and error. These will later develop into their own rules of thumb.

An example of the rule of thumb is buying stocks when the market transacted volume falls to 100 million a day and selling when the market volume surges beyond one billion a day. However, this rule of thumb has changed of late.

With the implementation of one board lot of 100 shares, we notice that the lowest daily market volume is about 400 million to 500 million. A daily market volume of one billion shares may not imply a sell signal. Given that there is no empirical evidence to verify the effectiveness of these heuristics, noise traders tend to commit systematic forecasting errors.

Apart from the above, noise traders also like to follow others in making investment decisions. This situation is called information cascading where investors make their decisions based on the observations of others’ previous actions. They will try to gather information available from the history of previous action choices.

For example, we choose restaurants that are full of customers than otherwise, without knowing how the food tastes.

Most day traders select stocks showing higher gains and bigger market volume. They may not know the exact reason for the strong buying interest in the stocks but they believe certain people may have certain private information.

However, when the private information on these stocks is not consistent with the value of the stocks, this can cause a heavy sell-down. The sudden reversal of an information cascade is called information avalanche.

Hence, noise trading keeps us from knowing the expected return on a stock.
Smart-money traders always maintain unbiased expectations and make rational decisions. Due to the inaction of passive investors, this may help to slow the decline of a stock.

Investors need to constantly upgrade their investment skills by reading up on stock market investment or attending courses on investment.

·Ooi Kok Hwa is a licensed investment adviser and managing partner of MRR Consulting.

Source: TheStar

>>Continue Reading<<

Wednesday, April 11, 2007

Investing for the longer term

Shares that we intend to hold for the long term should have the Four “Ps'' and have enough margin of safety. We need to be patient and wait for the right time to invest, says Ooi Kok Hwa, a licensed investment and management partner of MRR Consulting.

Q: Are we able to find the next “Public Bank” that can make us millionaires after holding it for 40 years?

In Public Bank's recent AGM, founder Tan Sri Teh Hong Piow mentioned that a shareholder of 1,000 Public Bank shares in 1967 would now be owner of 129,720 Public Bank shares worth RM1.55mil (including all gross dividends)!

This represented a compounded annual return of 20% for each of the 39 years.

A lot of investors have been searching for the next “Public Bank” stock. Given the present stock market level, identifying cheap stocks is a little bit like treasure hunting.

According to Warren Buffett’s letter to Berkshire Hathaway Inc. shareholders, he said he was currently searching for companies with the following characteristics (i) large purchases; (ii) demonstrate consistent earnings power; (iii) earning good returns on equity with little or no debt; (iv) good management in place; (v) simple businesses; (vi) an offering price.

In Malaysia, not many companies are able to meet the above criteria.

According to Michael Moe on his book, “Finding the Next Starbucks”, we need to focus on Four Ps, namely People, Product, Potential and Predictability.

“People” refers to the quality of management, especially the quality of leadership.

For “Product”, we need to invest in a company that is an industry leader with substantial market share through its products.

Next, the company should have a great market “Potential”. It is really not easy to identify a high growth company with consistent high growth in business and performance.

Finally, the company should have “Predictability” in its business model and operating results. Given the current high stock market level, we have companies having the above four Ps, but they may not be able to provide the margin of safety (MOS).

Margin of Safety (MOS)

Apart from the above four Ps, we should not ignore the price that we pay for a stock. MOS, which is widely used by Benjamin Graham, refers to the remotest chance of a stock losing its market value.

It is the discount at which the stock is trading below its minimum intrinsic value.

If Company A's share is selling at RM2.00 each and its minimum intrinsic value is computed at RM3.00, so the MOS will be RM1.00. It is the difference between the intrinsic value of RM3.00 versus its market price of RM2.00.

The intrinsic value that is computed by an analyst is a rough estimation of a company's value.

According to Warren Buffett, the real intrinsic value could never be precisely calculated.

As a result, he suggested that either we purchase companies with businesses that are simple and stable in character or there must be a MOS between the market value and the computed intrinsic value.

As future events are always impossible to ascertain, MOS provides a cushion to the potential margin of error in the intrinsic value computation.

According to Graham, there are two possible situations when MOS will be available to an investor.

One is when market sentiment is weak and most stocks are selling at depressive price levels, while another one is even when the general market is not particularly low.

Under normal market conditions, a suitable MOS depends more on the expected earning power than the asset value of a company.

Q: I sold most of my stocks after the Chinese New Year. But the market has gone up much higher than my previous selling level. Should I come back in?

Since the sell-off right after Chinese New Year, the market has recovered about 200 points to the current 1,300-point level.

A lot of investors have started to feel uneasy over missing the opportunity of making the extra 200 points. Most of them are currently sitting on a lot of cash.

Buffett said: “When there’s nothing to do, do nothing”.

For long-term investing, we need to be patient in order to find a stock that can meet the above four Ps coupled with a reasonable MOS. However, many retailers always feel that they have to be doing something in the market at all times.

Thus, if you regret missing the opportunity of selling your shares before Chinese New Year, you may want to consider locking in your gains now.

Source: TheStar

>>Continue Reading<<

Wednesday, March 28, 2007

Defensive way of investing

In view of the uncertainties of the stock market outlook, how to invest now?

Even though the market rebounded lately, a lot of retailers are still cautious. They still recall clearly their bad experience on how the market wiped out all their gains within a short period of time.

Despite the Government’s efforts to make Malaysia a better place to invest, our market cannot escape from potential negative external risks like the yen carry trade, the threats of possible US economic recession or the volatility in the US or Shanghai markets. Thus, retailers need to adopt a more defensive way of investing amid the current market situation.

Benjamin Graham developed a method called defensive value investing, which uses a few strict quantitative guidelines for the stock-screening process.

According to Graham, a defensive investor is one who places great emphasis on avoiding serious mistakes or losses. As he explained in his book The Intelligent Investor, the serious investor is someone who is looking for “safety and freedom from bother”. This approach emphasises the avoidance of serious mistakes but, at the same time, provides satisfactory returns.

Graham’s defensive investor screen

Adequate size of the enterprise
Graham considered this the most important factor. He recommended [in 1970] that an industrial company should have at least US$100mil of annual sales and a public utility company should have no less than US$50mil in total assets.

This was because smaller companies tended to have a more volatile performance compared with bigger corporations. As a result of the adjustment on inflation and the different industry structures of different countries, we think selecting large companies that have a market share of at least 10% in the industry should be a fair guide today.

A sufficiently strong financial condition

Graham proposed that we should select companies with a sufficiently strong financial condition – with a current asset ratio of more than two times. Also, the company’s long-term debt should be less than the net current assets (or working capital), and the debt-to-equity ratio should be less than 0.5 time.

Cash-rich companies with little borrowings would be able to fulfil these requirements. Graham’s student, Warren Buffett, did mention in his 1987 letter to shareholders that “Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage”.

Earnings growth and stability
The company should not have incurred any losses over the past 10 years and its earnings per share should have grown by one-third in the same period. Hence, companies in cyclical business may find it difficultto meet these requirements.

Dividend growth
The dividend returns are always the most important form of reward for an investor. According to Graham, the company should have a continuous record of dividend payments for at least 20 years. In Malaysia, only a handful of companies can fulfil this requirement.

Moderate price-to-earnings ratio (PER)
To safeguard investors from paying too high a price, the current price of a stock should not exceed 15 times of its average earnings for the past three years. Based on our estimation, the current market PER is selling about 15 times. There are still a lot of good fundamental stocks selling at PERs of less than 15 times. Nevertheless, they may not be able to match the above earnings and dividend requirements.

Moderate ratio of price-to-assets

Graham suggested that a defensive investor should not pay more than 1.5 times of the company’s net asset value. This acts as a safeguard against overpaying for a company. Most property companies may be able to meet these criteria, however, they may find difficulties in fulfilling guideline 2 (strong financial condition requirement) as most of them have high financial gearing.

Even though Graham did warn that many of the above might become obsolete with the passage of time, I believe some of the principles can still be applied today, given the high uncertainties in future market movements.

Source: TheStar

>>Continue Reading<<

Wednesday, March 14, 2007

To buy or to sell stocks?

WHY did our stock market crash?

Investors need to understand that the stock market normally takes a longer time to go up than to go down,

When the market drops, as a result of fear and panic, it just cannot move down gradually.

In the recent market crash the KL Composite Index (KLCI) tumbled from a high of 1,283.47 on Feb 23 to a low of 1,110.69 on March 5, plummeting 173 points in six trading days.

The reasons behind the crash were attributed to the sharp drop of 8.8% on the Shanghai Composite Index, the unwinding of the yen carry trades as well as worries over a rapid slowdown in the US economy.

In addition, our own market correction after the KLCI's sharp rise of about 400 points without any major pullback – from 886.48 points on June 15, 2006 to the recent peak of 1,283.47 – also contributed to the downturn.

Hence, we should be aware that the KLCI took 8 months to put on 400 points, but needed only six days to lose 44% of those gains.

Apart from the China market, other regional major stock markets like Hong Kong, Japan and Singapore as well as the US market also made big losses over the past two weeks. We are not surprised by the losses, given that these markets have been making large gains over the past 8 months.

Rachel Campbell, Kees Koedijk and Paul Kofman in their research titled Increased Correlation in Bear Markets, found evidence of significantly increased correlation in international equity returns during the bear markets.

As a result of the international contagion, a big crash in any one market could lead to major crashes in other financial markets.

Hence, apart from monitoring changes in our KLCI, retailers need to keep track of movements on other major indices like the Shanghai Index, Hang Seng Index, Dow Jones Industrial Average Index and Nikkei 225.

Some traders even track the movement of the yen versus the US dollar in view of worries over yen carry trade.

Should I cut my losses now?

Some retailers tend to invest at the wrong time. Every time there is a bull market, the moment they start getting excited about the stocks and start to invest, the market collapses a few weeks after that.

In this recent market rally, we believe that a lot of retailers only started to invest one to two weeks before the Chinese New Year (CNY).

As a result of the market crash one week after the CNY, most retailers gave back all their gains while some even incurred losses.

According to Benjamin Graham, the word “intelligence” in intelligent investor “is a trait more of the character than of the brain”.

It has more to do with how investors control emotions when investing.

They must have the courage to take profit in a bull market and have the discipline to cut losses when the investment drops below a certain acceptable level.

At the beginning of the market crash, most retailers were reluctant to sell their stocks because the prices went below their recent highs.

For example, even though their cost of stock A was only at RM1.00, they did not want to sell the stock at RM1.70 because the stock's recent high was RM2.00.

To them, selling at RM1.70 means they are incurring a “loss” of 30 sen. In actual fact, they have already made 70% profit, given that their original cost was only RM1.00!

These investors, however, panic and want to sell when the market crashes further and when the stock price trades nearer to their original cost of RM1.00.

As a result, most retailers were unable to make money from the stock market because they bought and sold at the wrong time.

Is it a good time to buy now?

After a market crashes it needs to go through a period of consolidation before gathering the momentum to turn around.

Nobody can tell when the consolidation period will be over. In our local market, the recent low of 1,110.69 on March 5 may be the lowest level of the recent pullback. Ooi Kok Hwa, a licensed investment adviser and the managing partner of MRR Consulting, gives some advise on buying and selling of stocks

If the market goes against our view and starts to move up, we should not continue to be bearish if we have sold out all stocks. We must be then be prepared to buy them back.

Hence, we need to constantly monitor our country's economic development as well as the global economic outlook.

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Wednesday, February 28, 2007

How to select growth firms

Lately, companies that reported strong growth in sales and profits were rewarded with higher stock prices. Hence, analysts and investors are currently paying close attention to the latest financial results announcements, hoping to catch those stocks early at a low price.

Benjamin Graham defined a growth company as a company that has performed better than the industry average over a period of years and is expected to continue to do so in the future. As earnings potential is the primary driving force in stock prices, our focus will be on the potential growth in earnings, which has yet to be reflected in the current price.

When investors invest in growth companies, they are hoping to invest in companies with products or services that are in high demand and have an edge over the competition.

According to W. Chan Kim and RenĂ©e Mauborgne in their famous book, “Blue Ocean Strategy'', companies in blue oceans, where there is still ample untapped market space, have the highest opportunities for demand creation and profitable growth. Normally, they tend to be the best among their industry peers and place equal emphasis on value creation and innovation.

According to Warren Buffett, growth companies have long-term pricing power and sustainable moat. The long-term pricing power refers to the ability to increase prices even when product demand is flat or the ability to achieve large volume increases with only small additional capital investment.

A sustainable moat is regarded as the entry barrier that current competitors and potential entrants find impossible to break. Companies with the above two characteristics will normally show high growth in sales and good profit margin.

Recently, companies with great businesses and fast growth were traded at price levels that might not be unsustainable. Investors need to pay attention to the price that they pay and the expectation of future growth. In reality, it is impossible for a true growth company to exist for an infinite time period in a relatively competitive economy.

Therefore, the entry price for a growth stock is crucial. The time to purchase is when it is still on sale, and not when it’s already at the peak where everyone seems to own a piece of it.

How do I know whether this stock is considered a growth company?

One of the common methods used by analysts for identifying growth companies is by tracking the company’s quarterly financial results. Again, strong sales and profit growth are the two most important characteristics of a growth company. If a company is able to show consistent growth in sales, this implies that it is expanding its production capacity and activities.

The table shows the quarterly financial results of Tong Herr Resources Bhd. Over the past three quarters, from Q106 to Q406, it reported strong growth in sales and profits on a quarter-on-quarter basis as well as year-on-year basis.

As a result of lower profits reported in Q205, Q305 and Q405, its stock prices tumbled from a high of RM4.30 in early 2005 to a low of RM2.30 in February 2006. Since then, due to the strong growth in sales and profits, its share price has recovered to the RM4-level again recently.

Investors need to study a company’s financial performance to determine whether the potential of future growth has been fully reflected in its current stock price.

As a result of the extrapolation of the recent performance, when the market is already high, our analysis will tend to be over-confident, which would lead to the decision to buy or sell stocks at the wrong time.

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Wednesday, February 14, 2007

Relating earnings to stock price

Consistent growth in sales and profits reflects strong earnings power of a company. Investors need to check the company's financial performance before selling a stock.

How do I determine the earning power of a company?

As a result of higher investor confidence and stock prices, the market capitalisation of certain blue-chip stocks has surged to new highs.

Some analysts have started to revise upwards the target prices of these companies as a result of higher market valuation. It appears that the prospects of these companies have “suddenly” improved within a short period of time.

When we analyse their fundamentals, their sales, earnings or production capacity are about the same compared with the previous year's. Although certain companies may have shown better prospects due to some merger and acquisition activities, most of them have shown little change in their fundamentals. Yet, their stock prices have surged by more than 100% in less than a year!

We will not pay RM5,000 for a hand phone that is worth only RM1,000. However, we are willing to pay 5 to 10 times above the intrinsic value of a company during a bull market.

This may be attributed to our expectation of the future prospects of these companies. We may be able to judge the real value of a hand phone, but we have difficulty determining with certainty the future prospects of these companies.

Intrinsic value of the company
The fair price we need to pay for a stock will depend on the intrinsic value of the company. An investor needs to know the intrinsic value before making any purchase. According to Benjamin Graham in his book entitled Security Analysis, intrinsic value is an elusive concept.

He defined it as the price at which a stock should be sold if properly priced in a normal market and the value being justified by the facts, for example, the assets, earnings, dividends and definite prospects.

He also said the intrinsic value of a company could be determined by its earning power but admitted that it was very difficult to establish with precision a stock’s real earning power.

We can only provide an approximation on whether the value is adequate compared with its market price. However, we are unable to determine the exact intrinsic value.

Graham defined earning power as a combination of actual earnings, shown over a number of years, with a reasonable expectation that these will be approximated in the future. A company's strong earning power will imply that it has the potential to generate higher sales and earnings in future.

If the stock price of a company is highly correlated with its earnings, improved earnings will contribute to higher stock prices. If the current stock price does not reflect the strong earnings potential of the company, buying the stock at the current price can contribute to higher capital gain.

Method to determine the earning power

The following is one of the quantitative methods in determining the earning power of a company suggested by Graham. From the earlier definition, in order to check a company's potential earning power, we may need to trace its historical earning and sales performance.

The table shows the historical earnings of Transmile Group Bhd.

The consistent growth in sales and profits in the table reflects Transmile's strong earning power over the past six years.

Its stock price has also surged from the average price of RM1.81 in FY01 to RM12.45 in FY06. Any investor who had bought this stock at an average price of RM1.81 in FY01 should have made a handsome gain of 588% within a five-year period.

Unfortunately, most retailers would have sold this stock at around RM5.00 in FY04 as not many investors were able to resist the temptation of locking in their gains.

Given that most investors seldom check on the actual financial performance of a company, the decision to sell a stock would always depend on its original purchase price rather than the earning power of the company.

As a result, they usually miss the golden chance of making handsome returns from good fundamental stocks.

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Wednesday, January 31, 2007

Fundamentals key to sustain share price

Retailers are tempted to lock in their gains following the recent run-up in stock prices. They should not worry that higher prices would mean the stocks are due for a fall. It is the fundamentals of a company that determine the sustainability of its share price, writes Ooi Kok Hwa of MRR Consulting.

I have made very good returns on certain stocks. Should I lock in my gains now?

When to sell is always the toughest decision to make in investing.

Over the past week, as a result of some pull-backs on Bursa Malaysia, investors have started to wonder whether this is the right time to lock in their gains, given that the market has surged by more than 30% since the low in the middle of June 2006.

Most investors will have a sense of regret when the price of a stock that they have just sold goes up further.

To an investor who has sold Genting Bhd at around the RM25.00-level versus his original purchase price of only RM15.00, a return of 67% is supposed to be considered as a very handsome one. However, instead of feeling good about it, he may feel the other way around if the stock is currently selling at the RM38.00-level.

To him, he has missed an opportunity gain of 52% if he compares the current price of RM38.00 with his disposal price of only RM25.00. He would have earned an extra 52% if he had continued to hold the stock.

Do not sell just because the stock price has gone up

In his letters to Berkshire Hathaway shareholders, Warren Buffett said: “We need to emphasise, however, that we do not sell holdings just because they have appreciated or because we have held them for a long time”.

He would only recommend a sell if the stock’s quality deteriorates or if the price rises far above the demonstrable value, or when a better opportunity arises. Except for the above three reasons, he would never sell a business whose intrinsic value continues to increase at a satisfactory rate and the current price is only temporarily above intrinsic value.

According to Buffett, the maxim that “you can’t go broke taking a profit” is a foolish premise on which to sell a good company’s stock.

Investors may miss out on the potential of greater gains if they do not have the patience to hold on to their winners for a longer period of time, as a good stock can sometimes increase 10- or 20-fold in value.

Investors get worried when there is a drop in the stock market. As they follow closely their winners’ stock prices, the chances are high that they will regret selling the stocks too early.

Sometimes, certain investors who seldom follow stock prices can sell at a better price than active investors who closely monitor the market's movements.

Hence, we should always remember that “just because a stock price has increased, does not mean it is due for a fall – the fundamentals are the determining factor, not stock price history”. (Peter Lynch)

Need to know the intrinsic value of the company

Nevertheless, it is always not easy to determine the intrinsic value of a stock.

Normal investors with limited financial training will find it difficult to determine the point at which a stock becomes fairly valued.

John Neff in his book entitled John Neff on Investing said: “Successful stocks don’t tell you when it’s time to sell them”.

In order to judge the intrinsic value of a company, investors need to know the earning power and the sustainable earnings of the company. We need to check whether the current market price has gone far beyond the company's fundamentals.

Some investors have tried to predict short-term price movements. They sell a good stock when the price appears to be too high with the expectation of buying it back at a cheaper price later.

Instead, the stock price goes up even higher after the disposal. If the fundamentals of the stock remain intact and promising, they should buy back the stock.

Unfortunately, in most instances, investors seldom buy back at a higher price when they realise that their prediction did not come true.

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Wednesday, January 17, 2007

Check risks and returns at current level

The KL Composite Index's current level of about 1,120 points poses a higher market risk than when it was at the 880-level seven months ago. Investors will face higher market risk if they decide to invest now. They need to check if the potential returns commensurate with the risk that they will take writes OOi KKok Hwa, an investment manager licensed by the Securities Commission and managing partner of MRR Consulting.

Since I missed the good opportunity to invest last year, should I invest now?

Since the low of 886 points on June 15, 2006, the KLCI has surged by 26% to the recent high of about 1,120. There had been no major pullback over the past seven months.

Investors who were not in the market last year will be wondering whether it is still not too late to invest right now.

However, investors who have invested since June 2006 are getting uneasy with the current market level and are tempted to lock in their gains.

“Buy from pessimists and sell to optimists”are investors more optimistic or pessimistic now?

Benjamin Graham said we should “buy from pessimists and sell to optimists”. We should buy stocks when nobody is interested in buying them and sell them when everyone in the stock market has become excited.

The market's recent strong gains coupled with the high trading volume of more than one billion shares per day imply that retailers are getting excited and have more confidence in the market outlook.

Obviously, if we were to follow Graham's advice, we should be selling as investors are more optimistic now compared with seven months ago.

Risk is higher if you invest now

Any investor who decides to invest at the KLCI's current level will be at a greater disadvantage compared with those who invested earlier at the 880-level.

If there is any major market crash, investors who invested at current levels will face potential selling pressure from investors who have invested earlier at the 880-level because the latter can still sell their holdings even if the market were to drop below 1,000. Investors who had bought at the 1,120-level would have to face the pressure to cut their losses.

Most investors always find it difficult to cut losses as they prefer to gamble than to recognise a sure loss. In behavioural finance, we call it “loss aversion”, whereby a sure loss is worse than the risk of losing a little bit more with the gamble. Investors feel bad when they lose money, but twice the loss does not make them feel twice as bad.

Potential 7% gain versus potential 21% loss

At the beginning of 2007, some fund managers predicted that the KLCI would touch 1,200 this year.

Assuming that their prediction is correct and the 1,200-point level is the maximum level for this year, there is only a 7% difference between 1,120 and 1,200 points.

However, if there is a major market pullback and the market gives back all its earlier gains, the KLCI can retreat by 21% to 880 points from the present 1,120 level (although the market may not tumble as much as 21%, a 7% drop is more likely than a 7% gain, given that the market has gone up 26% within seven months without a major pullback).

Hence, investors need to decide whether it is worth taking the risk on a potential 7% gain versus a potential loss of 21%.

The above calculation is based on the assumption that the maximum movement of the KLCI this year is 1,200 points, whereas the maximum pullback is at the 880 level.

Nevertheless, we would not be surprised if the KLCI went beyond 1,200 points, given that the stock market is always a place with irrational exuberance and can be a haven for speculation.

Consider the timing and the value that you pay

Although the index has surged by 26%, not all stocks have increased at the same percentage. There are still a lot of laggard stocks that are selling at low prices.

Philip A. Fisher in his book entitled Common Stocks and Uncommon Profits said: Don’t fail to consider time as well as price in buying a true growth stock”.

Some of the good and promising companies might have shown good results lately, but investors should also pay attention to the price they are going to pay.

Stocks with low prices are not necessarily cheap and vice-versa.

We need to make sure there is enough margin of safety, which means we should not invest in a stock unless there is sufficient basis for us to believe that the price being paid is substantially lower than the value being delivered.

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