Markets take the stairs up and the elevator down

I have a colleague, who is my soundboard on investing. We had an interesting Whatsapp conversation on Friday about the strange dichotomy between the stock market's impressive rally and the economy in the dumps right now.

One observation was the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX for short, started to spike again to a level of 40, after retreating steadily from a high of 66 during the market crash in March.

The CBOE Volatility Index, Source: Yahoo! Finance

The VIX is derived from prices transacted for the S&P 500 Index options, and is used as a proxy of investors' fear and uncertainty in the market. The higher the index, the greater the implied uncertainty.

Indeed, if you flip through financial news websites, there is no lack of articles quoting professional money managers on their hesitation of investing in the current market.

And we are talking about people who make buy and sell decisions in the quantum of billions of dollars for a living.

So if the pros aren't the ones chasing the momentum, there can only be one logical conclusion - this present rally is being driven by retail investors, notably newcomers whom had never thought of plonking money down on a stock before.

In the past, it was almost a hassle to go long on a stock. You would have to dial up your dealer, hoping he is around, check the current bid and ask quotes, and tell him (I presume it was mostly guys then) to buy 1,000 shares of Keppel for you.

Then came the Teletext, which was an improvement because you could stare at the television screen all day long to get the prices.

ST File Photo by The Straits Times

Nowadays, with the prevalence of the Internet and smartphones, buying and selling a stock is just a few clicks away. Mobile applications ("apps") such as Robinhood has made investing so simple and so cheap, it is almost game-like.

Login, select ticker, enter quantity and price, hit Buy and presto! It's game on.

But making investing easy has its dangers. This means the stock market is seeing an influx of new investors (or day traders) whom may have no idea of basic risk management, and no fear of failure. The 1997 Asian Financial Crisis and the 2008 Global Financial Crisis are a distant memory.

We are seeing proof of this naivete in the market. Bankrupt car rental company Hertz Global Holdings had just won judge's approval to sell as much as USD 1 billion dollars worth of shares to the market [news]. This comes after the stock climbed tenfold from a low of 56 US cents on May 26 to a high of US$5.53 last Monday.

Seriously?

If local water treatment firm Hyflux can perform the same magic trick, plenty of Hyflux PnP holders will be thrilled.

So it has become a game of musical chairs - Novice traders latch on a languished stock (with zero interest in the company turnaround) and wait for a bigger fool to take it off their hands at a higher price.

My own fear is this will become a vicious cycle - Millennials see their friend made a quick buck trading on Robinhood [news], decide to open an account, buy an airline stock from a hot tip, sell at a profit, boast on social media. Rinse, repeat.

And the stock market bubble blows bigger.

Till it pops.

An old investing proverb comes to mind, which may be worth remembering:

"Markets take the stairs up and the elevator down."

When every investor heads for the fire exit, there is bound to be a stampede. It is probable we will see big market swings in the weeks ahead, if the spike in VIX is any guide.

Hope you are buckled up for the ride.

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Slice and dice the P/E Ratio like a pro

The humble Price-to-Earnings (P/E) Ratio is perhaps the most widely understood metric in the investment world. But you shouldn't use it as a proxy for a trading decision. This is because the number on its own, has very little actionable insight.

You see, the P/E Ratio is a lagging indicator. The numerator (Price) is the end product of a jostle between millions of buyers and sellers in the market. It is also the best gauge of all known and expected information out there. The denominator (Earnings) is the trailing 12 months' earnings per share of the company. And we know the disclaimer that historical result is not representative of future performance.

Usually, the broker analysts provide what is known as the forward P/E Ratio, which is to take the same stock price, and divide it by their own forecast of next 12 months' earnings per share of the company.

Now, there is a lot of uncertainty baked into the analyst's estimate, and it will be a matter of which analyst do you trust the most.

So what value does the P/E Ratio have?

You can use the P/E Ratio as a yardstick to find out what other investors (a.k.a. the market) think about the stock (and the company as a whole).

If other investors are paying 25 times per dollar of earnings for this company (P/E = 25), are you willing to be the bigger fool and pay 26 times per dollar of earnings for this company?

If the answer is yes, congratulations! You can go ahead and submit the buy order. Otherwise, you need to do some more digging.

To properly evaluate the P/E Ratio, you need to research it across two dimensions: (a) against time; and (b) against peers.

(a) Against time

It is not difficult to find websites providing historical P/E data of a company. You can pull up the numbers and check where the current P/E Ratio stands relative to the highest and lowest value over history.

For example, Table 1 below gives the P/E Ratio of CapitaLand as of 10 June 2020, and its highest and lowest values over the past ten years.

Date	P/E Ratio
10 Jun 2020	7.22
30 Jan 2013 (Highest)	18.57
06 Apr 2020 (Lowest)	6.26

Table 1, Source: Morningstar

CapitaLand is currently priced somewhere near the bottom end of the range. At this moment, the market is not paying top dollar for the company's earnings, which is understandable given the COVID-19 situation.

But if the P/E Ratio is near its lifetime high, take it as an omen that the market is very hopeful - wildly optimistic perhaps - about the company. Too much euphoria flashes a warning sign, because you are going to find few buyers to push up the stock price further, even when you are confident the company will perform better down the road. When demand levels off and more sellers come onboard, there is only one direction for the price to go.

Some broker analysts go one step further and derive the mean value and standard deviation of the P/E Ratio, and tell you the stock is currently trading N standard deviations below the mean.

That's applying additional statistical analysis, but it doesn't necessarily mean the stock is a buy. There must be a reason for the metric to be so far below the mean. You may want to check out recent developments and see what could be causing this deviation.

Take note that P/E Ratio is meaningless if the company has recorded a loss. It is Price-to-Earnings Ratio after all.

(b) Against peers

Another way to use the data is to compare the P/E Ratio against other competitors in the same industry. For example, Table 2 below shows the current P/E Ratio of local real estate developers listed on the Singapore Exchange as of 10 June 2020:

Security	P/E Ratio
City Developments	15.34
Hiap Hoe	13.83
Bukit Sembawang	13.18
UOL	13.00
Frasers Property	9.43
Oxley	8.81
Heeton	8.33
CapitaLand	7.22
GuocoLand	6.24
UIC	5.57
OUE	4.53
Ho Bee Land	4.20

Table 2, Source: Morningstar

Ho Bee Land has the lowest P/E Ratio on the list while City Developments Limited ("CDL") has the highest. So the market is valuing Ho Bee Land cheaper than CDL at the moment.

If you think the market - and everyone else - is wrong, that Ho Bee Land should be worth more, then congratulations again, you have found yourself another trading opportunity...

Except I wouldn't be so quick to hit the 'Buy' button just yet.

Because there can be idiosyncratic biases that cause the market to price a company more or less favourably compared to other companies in the same sector. For example, Graph 1 below plots the difference in P/E Ratio between CapitaLand and CDL over the past five years. 

Graph 1, Source: Morningstar

As seen from the graph, the market has been pricing CapitaLand at a P/E discount relative to CDL since Q1 2017. What you want to know is whether the P/E discount (premium) is expanded (compressed) now compared to other times in history. There may be a company-specific reason for this phenomenon, and it is up to the inquisitive investor to find out.

Hopefully at this juncture, I have given you sufficient ideas on how to slice and dice the P/E Ratio effectively, so as to arrive at meaningful insights on your choice stocks.

Earnings are lumpy and do not change from day to day. Hence the stock price is the bigger influencer on the P/E Ratio.

Talking about price, I would like to bring up Benjamin Graham's renowned parable of "Mr. Market", as retold by Warren Buffett in his 1987 Berkshire Hathaway Letter to Shareholders [link]:

Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy."

In other words, despite all the advice about staying invested in the market, you don't have to buy NOW if the price is unfavourable (or the P/E Ratio is too high for your comfort.)

Market goes in cycles, and there will be a new price everyday. A window of opportunity will present itself if you wait patiently. Just remember to squeeze the trigger when the time comes.

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Hope is a miraculous drug

The Edge Singapore published a special feature written by CMC Markets on 5 June 2020, titled "When fundamentals fail". It aptly sums up the equity-economic divide that we are currently seeing in the markets.

You can read the article [here].

The world is still nursing from job losses and business collapses due to the artificially imposed economic lockdowns. Yet, if you have only a window to the world through stock market lenses, you can hardly be faulted to be cheery. It looks to be all sunshine after the torrent of rain in March.

Image by Mammiya from Pixabay

On Friday, the U.S. stock markets jumped, simply because the unemployment rate was much lower than expected (13.3 per cent versus the estimated 19 per cent). The disparity was so significant, it prompted news outlets to investigate why the economists had it so wrong. (You can check out one such article by The Washington Post [here].)

The truth is - as CMC Markets pointed out - amid the death and gloom caused by the coronavirus, people want to HOPE that the worst is over and good times are coming.

"Hope is an admirable human quality, but a poor basis for investment. It’s natural that human beings want a brighter future, regardless of reality. This may explain the rally. It was largely driven by hope for a cure, hope for a vaccine, and hope for a short and consequence-free lockdown. At this stage, none of these hopes is real." - CMC Markets

Even with the Floyd protests, China tightening its grip on Hong Kong, nearly 400,000 COVID-19 related deaths and the lack of a vaccine aren't enough to dent the jubilant mood on Wall Street.

Hope is indeed a miraculous drug.

Are investors prescient to cast a blind eye to the decidedly dismal Q2 results, and look forward to the second half of the year for glad tidings?

Frankly, no one has the answer.

But one thing is for sure - the chasm has to close. No bull can run forever, when there is blood on Main Street.

The negative base case is for stock markets to face the truth and drop back to recessionary levels. The economy re-opening is a boon, but the consumer behaviour is altered. People are wary about going out to crowded places. With the stringent restriction on number of customers in restaurants and stores, malls are unlikely to regain its liveliness anytime soon. While the government tries its best to create new jobs for the labour force, there is a limit to the number and the private sector is unable to pick up the slack. Work-From-Home arrangement shows employees can still be productive at home without being present in an office environment. Employers review their existing commercial rental arrangement, and decide to do with less. Shops depending on the midday office crowd for brisk business are impacted from a drop in patronage.

On the other end of the aisle is a positive base case for the economy to show resilience and a quick bounce back to pre-COVID-19 activity levels. Jobs are swiftly restored, thanks to the huge stimulus provided by governments in cohesion. The consumer is happy to go out and spurge, having been cooped up in the house for so long. News of a vaccine ready by the end of the year give people hope that we are going to survive this crisis and hence the optimism in the markets is justified. Stock markets rally to new lifetime highs. Global travel resumes, and visitors start to flock back to our shores. The tour guide and the cab driver are equally delighted to get back to form again.

Granted, the real situation will be somewhere in-between, with mixed blessings.

Only time will tell.

For investors who felt you might have missed the boat, do not fret. The hard facts are that it is NOT going to be all rosy, as if the world never encountered this coronavirus. The stock market will have to re-adjust somehow, to reconcile with the real economic picture.

Until then, bide your time and keep your powder dry and ready.

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Cracking the analyst's crystal ball

I swear I don't have a beef with broker analysts and their crystal ball, but I am amused sometimes from the reasons an analyst give to tweak their forecast numbers.

Image by Bruno /Germany from Pixabay

For example, an analyst's Target Price (TP) was adjusted up because of lower interest rate used in the discounted cash flow (DCF) valuation.

Technically, if you know DCF, that's not wrong. A lower discount rate means a higher net present value of future earnings.

Sadly, ceteris paribus (all other things being equal) exists only in an ideal world. In the real world, things don't correlate in a beautiful way. Most people suffer from a present focus bias. Try telling the provision shop owner he's richer now because SIBOR has gone lower. He'll think you're nuts, because he certainly feel no change. So why would a stock buyer be inclined to pay more for the same security?

Truth be told, a broker analyst is an extremely challenging job. Any form of forecasting is more of an art than a science. But even the weathermen have an easier time. They don't get slammed when it doesn't rain the next day as expected.

For a broker analyst, your head is on the chopping board when you stick your neck out for an imaginary number. When the customers want a price to buy the shares, it is tough to say, "I don't know", especially when your next paycheck depends on it.

That is why you don't see many broker analysts providing numbers too far away from the consensus. When you go for an extremely high or low forecast, you're either placed on a pedestal when it turns out right, or burnt at the stake when you get it dead wrong.

Another interesting reason given for raising TP is the rollover of fiscal year. When FY20 EPS estimate is 20 cents and FY21 is 22 cents, the Target Price automatically jumps higher as we cross over to the new year.

It's like growing a foot taller overnight as you celebrate your birthday.

Another example: the TP was raised due to the application of a higher P/E multiple.

I doubt any investor worth his salt will wake up, decide it's a bull market today, and pay more for the same dollar of earnings yesterday.

I sense the broker analysts rolling their eyes at me. Okay, in all fairness, I have absolutely no idea how to price a stock accurately. I mean, I know the valuation techniques, but there are so many factors to consider. It is mind-boggling, and my head hurt the last time I tried to work out the target price on MS Excel.

As retail investors, we probably shouldn't worry too much about the exact price to buy a stock. Because if a company is as good (fundamentally) as it gets, by virtue of profits and retained earnings, the market will eventually award the company a higher valuation. And hence a higher share price.

Of course, I say this with a caveat - The above doesn't apply during any bubble period. If you buy a stock at sky high valuation, be prepared to wait an awfully long time to get back to cost. (Or never.)

So my dear broker analysts, I feel your pain. It is hard to draw a bullseye around an invisible target.

And thank you for keeping me entertained as I read your reports throughout the circuit breaker period.

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What to do with an Annual Report before you dump it

When I was still a novice investor, I remembered feeling exuberant whenever the Annual Report of a company I own comes in through the post. Flipping the colourful, glossy pages of Duchenne smiles, well-posed directors and employees made me feel proud to be a co-owner of the enterprise. Never mind that the pictures only lasted through the first third of the publication and the rest is filled with ant-sized accounting gibberish.

Image by saralcassidy from Pixabay

Alas, nowadays in the name of caring for the environment, many companies opt to mail you a plastic CD instead, with a reply envelope stating if you DO want a physical book to be delivered (gasp!), write back to them.

It is hard to spark joy from a shiny circular thing, but I digress.

By the time you receive the Annual Report, it would have been several months since the preliminary annual results of the company had been announced. SGX has made it very convenient to retrieve the information, lest you forget whether it was 20 or 25 cents EPS last year.

So what grand purpose does the Annual Report still serve in the world of light-speed information at your fingertips today?

For a start, Annual Reports are a good way to get a handle on the qualitative aspects of a company - its directors and management. If you have five minutes to spare, I would suggest to spend it on checking out the Performance Review.

Why? You might ask.

A quick read through the segment should allow you to grasp how candid management is, in talking about the company's performance. Typically, you would get to know the achievements. What we ought to be paying attention to, are the problems:

- Has management been honest about why the foreign subsidiary is still bleeding cash?
- Did management simply attribute current year's losses to an economic downturn?
- Did management write matter-of-factly about the lawsuit a division was involved in?

You don't have to hear it from me. Hear it from legendary investor Warren Buffett. In Berkshire Hathaway's 1998 AGM, Buffett answered a shareholder's question on what he looks for when reading Annual Reports. (You can watch the video [here]. Fast forward to 1:30:00.)

Buffett said,

"We see from that report whether the management is telling us about the things that we want to know about if we owned a hundred percent of the company. And when we find a management that does tell us about those things, and that is candid in the same way that a manager of a subsidiary would be candid with us, and talks in language that we can understand, it definitely improves our feeling about investing in such a business."

And as if to emphasize the importance of this point, Buffett added,

"And the reverse turns us off, to some extent. So if we read a bunch of public relations gobbledygook, you know, and we see lots of pictures and no facts, it has some effect on our attitude toward a business. We want to understand the business better when we get through with the annual report than when we picked it up. And that is not difficult for a management to do if they want to do it. [emphasis mine]"

Even Buffett's right-hand man, Charlie Munger agrees with the observation:

"If you've got a standardized bunch of popular jargon that looks like it came out of the same consulting firm, I do think it's a big turnoff. That's not to say that some of the consulting mantras aren't right. But I think there's a lot...that for a sort of candid, simple coherent prose...a lot to be said for it."

The material may be as dry as your old school textbook. But if you ever find management honest enough with its missteps, capable enough to draft concrete plans to mitigate the failures, and steadfast enough to walk the talk, then the company will likely be in good hands.

And that five minutes before you dump the Annual Report would have given you the peace of mind.

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Singtel - Five takeaways from 4Q20 analyst conference call

Broker analysts are similar to financial bloggers, in that both have a vested interest in making accurate investment calls. The difference comes when analysts do not have 'skin' in the game, as they are restricted from acting on their own conviction due to conflict of interest.

By listening to analyst conference calls, we can get some insights on what is keeping the analysts up at night, and the important bits of information they want to know about the company's performance down the road.

I recently listened in on Singtel's 4Q20 analyst conference call. Below are my five takeaways:

1. The first volley fired was about EBITDA margin and capital expenditures (capex) for Singtel in Singapore and Optus in Australia. However, Singtel's CEO Ms. Chua Sock Koong refused to provide any guidance at this point, but she hopes to be able to provide some numbers during mid-year. As for Australia, Optus' CEO Ms. Kelly Bayer Rosmarin highlighted the structural transition from operating a proprietary network to being a service provider on the NBN (national broadband network). As NBN works off regulated pricing, they will monitor the margins carefully. Ms Bayer Rosmarin also noted the pressure from years of discounting and heavy subsidies on the mobile side is coming off, and market repair is underway.

SS comment: I take it as a good sign that Optus and competitors are no longer engaged in a price war.

2. Another key question was about the medium to long-term outlook for Singtel's dividend. Of which, Ms. Chua replied the level of the dividend this year would be no reflection of what the dividend would be going forward [emphasis mine]. At this point however, she wouldn't comment on Singtel's future dividend policy.

SS comment: In short, the 50% dividend cut this year is not symbolic of a new trend to conserve cash.

3. In winning the 5G license, Singtel had to make a commitment to provide 50% of the population coverage in two years and 95% in five years. It was explained that the rollout of 5G is not going to be overnight (within a one to two year period), but progressively while improving the existing 4G coverage.

SS comment: I take that as a hint that the 5G capex is likely to be spread over more than two fiscal years.

4. Singtel's Consumer Singapore CEO, Mr. Yuen Kuan Moon takes it as a positive sign that the fourth telco operator in Singapore (read: TPG) has finally launched commercial service. The reason being consumers are now able to do effective comparison between price and quality of each operator's 4G network.

SS comment: From recent news (here), analysts were doubtful that TPG Telecom will be able to sustain the low price point and network quality.

5. HOOQ was Singtel's organically grown video on service provider, which the management finally decided to call it quits. An analyst quizzed whether Singtel will be looking to make bolt-on accquisitions to bolster Singtel's advertising platform Amobee. Of which, Singtel's Group Digital Life CEO, Mr. Samba Natrajan commented they would prefer to invest internally on research instead.

Conclusion:

Singtel management is cautious, and will not commit to forecasts that will come back and bite them. 5G capex is going to be a mid- to long-term cash outflow, so I would not expect any urgent requirement for Singtel to raise cash in the markets. Lastly (and gladly), the much reduced 5.45 cents final dividend is not indicative of a new trend; rather it is a conservative response to the present situation. Investors will get more visibility six months down the road.

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Portfolio Summary for May 2020

As of 29 May 2020

CDP

Security	# shares	Price S$	%
DBS	400	19.47	6.74
OCBC Bank	1,500	8.55	11.10
SATS	3,900	2.66	8.98
ST Engineering	4,100	3.19	11.32
CapitaLand	1,700	2.89	4.25
Singtel	4,000	2.49	8.62
Powermatic Data	2,800	2.40	5.82
ComfortDelGro	7,900	1.44	9.85
Genting Singapore	11,700	0.785	7.95
Old Chang Kee	5,000	0.695	3.01
HRnetGroup	11,600	0.495	4.97
HC Surgical	19,100	0.305	5.04
Nam Lee Metal	28,200	0.305	7.44
Kimly	27,000	0.21	4.91

Portfolio Value = $115,533

Trade Actions
- Added 600 shares of OCBC Bank.
- Added 1,600 shares of ST Engineering.
- Added 1,900 shares of SATS.
- Added 2,000 shares of Singtel.
- Added 3,300 shares of ComfortDelGro.

SRS

Security	# shares	Price S$	%
OCBC Bank	900	8.55	12.20
SGX	1,300	8.28	17.07
SATS	2,200	2.66	9.28
ST Engineering	1,700	3.19	8.60
Singtel	2,000	2.49	7.90
CapitaCommercial Trust	5,000	1.75	13.87
Sheng Siong	8,700	1.57	21.66
HC Surgical	19,500	0.305	9.43

Portfolio Value = $63,071

Trade Actions
- None

Commentary:

SGX - Company was dealt a critical blow when MSCI decided to shift its equity index business to Hong Kong, to the benefit of HKSE. I can understand MSCI's rationale for wanting to tap a larger potential customer base in Hong Kong (due to its proximity to mainland China). It remains to be seen whether SGX management has been humbled by this episode, and how hungry and determined they are in securing SGX's lead in APAC derivative trading over the next year.

Singtel - Full year net profit declined 65% y/y to S$1.08b. Excluding Airtel, net profit declined 21% y/y to S$2.42b. Winning the 5G spectrum means high capex ahead. Board cut final dividend by half to conserve cash. Management is also looking to sell off Optus' tower assets to raise cash. At current price, we're looking at 4.8% yield - still attractive in my opinion, unless there is unexpected COVID-19 pain ahead.

SATS - Poor company got bumped out of MSCI Singapore Index. Tracking funds will likely have to sell off their holdings. Took a chance to load. Still, I'm prepping for extremely lousy Q2 results.

ComfortDelGro - Another company that got dropped from MSCI Singapore Index. Taxi division is bleeding cash, but I'm heartened management is making an effort to secure side income for the cab drivers. Downside should be limited from this price point.

ST Engineering - Company with a comfortable order backlog. Customers may opt to delay contract delivery, but so far no news of clients backing out. MRO business will take a big hit, but that is water under the bridge.

OCBC Bank - Stock got sold down, probably due to its Wing Hang bank/HK protest exposure. Dividend may shrink a bit, but I don't foresee it being skipped like Stan Chart and HSBC.

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