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

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