I am a big fan of concentrated wisdom. There are so many things I want to learn and to master that it will take many lifetimes if I were to figure them out on my own. I wish wisdom is sold in bottles, so that I can drink it and grow wiser.
But of course, no one has quite found a way to bottle wisdom yet. That would be a feat. The one thing that comes close would be books. My favourite books are ones that are simple yet wise. They are the ones that I can read, set aside, only to pick up again after some time and still discover new things I have missed or new angles to the original issue.
Show me the Money
Journalist turned fund manager Teh Hooi Ling‘s latest book – Show Me The Money: Sound Principles to Grow Your Wealth has just been released. It comprises 45 of her articles originally published in the newspaper column of the same name. From the book, here are three lessons I have learnt and relearnt.
Guard against the downside and the upside will take care of itself – Don’t be fixated on high returns.
Returns are sexy. They arouse emotions. They are like neon flashing signboards, screaming for our attention. We are often overwhelmed by the promise of returns.
Risk on the other hand, is largely ignored. Thinking about risk is uncomfortable and emotionally draining. As human beings, we seek pleasure and avoid pain. As investor, we fantasize about returns and disregard risk.
Hooi Ling related the example of an investor who had the option of surrendering his annuity plan and investing the money in the stock market or sticking with the plan and receiving constant income. Receiving an annuity is surer but with security comes lesser returns. Investing in the market would see higher returns on the sum of money, but that option is also the riskier one. One cannot decide based on returns alone. In her wise own words
Optimise, not maximise, return.
Stock Investing: It’s all about the process
Hooi Ling shared another story about her friend who bought and sold Raffles Education. The previous stock market darling was listed in 2002 and at one time in 2008 traded as high as $7. Her friend made a six fold profit on the stock, but after he sold it, the stock went up 30 times his purchase price. The financial crisis sent it down to earth and it is now trading at 32 cents.
Most investors would have been raving mad or deeply morose about missing out on the monstrous run. Not her investor friend. He was circumspect.
If I had ridden REC on the next 30x, I would probably never sell it and thus ride it all the way back down again. However, at 30 times, I would probably have pledged shares to the bank and borrowed money to buy an enormous bungalow only to become panic stricken, possibly bankrupt, on the way down.
For being able to see beyond short term profits and loss, he deserves a medal. But even more so because of the lesson he has taught us about investing. As investors, we often confuse the process with the outcome. Processes we can control. Outcomes we cannot. A good process may or may not lead to a good outcome.
As intelligent investors we need to constantly refine our processes and ensure that they are sound. Disregard the outcome. They are random. Do not confuse lousy outcome with a bad process.
Even more so, do not confuse a good outcome with a good process. Hooi Ling’s friend did not for a moment take the outcome of the Raffles Education saga to be an indication of his ability to pick stocks and read the market. A worthy lesson for all of us indeed.
Price to Book, Worth a Look
In yet another article, Hooi Ling discusses valuation method for stocks.
Price to Earnings ratio is an indication of the company’s earning performance. A PE of 5 indicates that a company is trading at five times the yearly earnings. Low PE stocks are considered cheap while high PE stocks, ‘expensive’. Many methodologies value stocks based on their earnings potential.
Price to Book on the other hand values a company based on the assets they hold. The book value of a stock is, in simple terms, the amount a company can get if it were to liquidate all the assets it holds.
Imagine a company that has only issued one share. The share is trading at one million dollars. The company has only one asset in its book, a fully paid up property valued at 500k. The price to book ratio is hence 1000000/500000 = 2. Imagine paying double of what your house is worth; not a good buy indeed.
After a market crash, share price decreases to 250k. Price to book is now 250000/500000 = 0.5. Buying the share now allows an investor to own the property at half the price than if he were to purchase the property outright. Buying below book value allows an investor to own more, for less. That is the essence of investing in low PB stocks.
Hooi Ling built on Fama and French’s classic study in 1992 on the factors that will determine the future performance of a stock. They found PB to be most indicative.
No other measure has nearly as much predictive power – not earnings growth, price/earnings or volatility.
She is in her element with numbers and set out to rank all the stocks in the Singapore market based on their PB ratio. Splitting them into ten groups based on their ranking percentages, she discovered that investing in the group of stocks with the lowest PB ratio from 1990 to 2012 yielded the highest returns. At 17.6 percent compounded, this beats the group of stocks ranked second based on their PB ratio, which yielded only 11.5%.
In a parallel study, Hooi Ling also ranked stocks based on their PE ratio. She discovered that over the long run, buying stocks with the lowest PB beats investing in the group of stocks ranked on their PE.
Buying low PB stocks beats buying low PE stocks as a strategy!
Concentrated Wisdom at its Best
I have read all of Hooi Ling’s articles as they were published in the papers. In isolation they were insightful and thought provoking. Compiled together, they take on a whole new life. They allowed me a glimpse into the keen investing mind of the author.
Wisdom involves an integration of knowledge, experience and understanding. Wisdom allows one to see the big picture while keeping the details in perspective. This book is all of that and more!
Here’s my thoughts on Teh Hooi Ling’s 2nd book.
Earnings (and its resultant forward P/E) are difficult to forecast accurately. Peter Lynch wrote “As to the all-important future (EPS) growth rate, your guess is as good as mine”.
However, PB has its flaw too. Lynch wrote “The flaw is that the stated book value often bears little relationship to the actual worth of the company. It often understates or overstates reality by a large margin. When you buy a stock for its book value, you have to have a detailed understanding of what those values really are”. A task that could be difficult for the layman.
P/E & P/B cannot be a one-size-fits-all benchmark. For eg, I would not use P/B for fashion retail businesses.
Thanks for the comment.
To Hooi Ling’s credit, she did mention potential downsides to the strategy.
There is no single best strategy out. It is up to the investor to discover which is best suited for him or her.
Read the book to find out more!