Buy-and-hold works - up to a
point
Key
still lies in picking low-valuation stocks and knowing when to cash
out and reinvest
Of the 16 stocks listed in
the Singapore market since 1973, Asia Pacific Breweries is the best
performer currently. Its share price has appreciated by 9.7 per
cent a year over the past 40 years. But it was not always the
leader of the pack. -- PHOTO: ASIA PACIFIC BREWERIES
Teh Hooi Ling
It's very hard for us to think
outside the environment we are in, a learned friend told me. In
other words, many times, we are products of our environment.
Take someone who,
early in his or her investment career, went through the boom years
of the 1920s only to see everything wiped out during the Great
Depression.
Most likely, such a person would have a rather
pessimistic view of the stock market.
In contrast, a person who knows only of bull
markets would have been conditioned to think that the market can
only go up.
Hence, it is always instructive to study history,
to talk to people with lengthy experience in their chosen
fields.
I have this friend who I reckon is in his 60s. He
used to run his own construction business and is now retired. He
said he was an ignorant young man in the 1980s and lost money
investing in a fund. He then resolved to educate himself about
investment. Like most value investors, he idolises famed investor
Warren Buffett.
Having experienced and seen the results of making
wise investments, this friend is fervent about convincing others of
the importance of learning that skill.
At his age, he still buys and reads books such as
Trump Strategies For Real Estate: Billionaire Lessons For The Small
Investor and Accounts Demystified by Anthony Rice.
Three years back, he asked me to help edit a
two-page message that he wanted to circulate to the younger people
around him. In it, he gave the example of his cousin.
Back in 1958, the cousin earned less than RM200 a
month as a primary school teacher. But she put some savings away
every month. By the early 1960s, she had accumulated a sum of money
that she could invest in stocks.
"She did the 'right' thing in investment," wrote my
friend. "She chose the 'good' stocks - companies with good
businesses. She held on to the stocks for the long term."
Over the years, she bought more of the stocks with
additional savings as well as the dividends received from the
stocks she held. Her stockholding also grew as the companies
distributed bonuses and issued rights.
"Thirty years later, she had become a millionaire.
She managed to send her kids to England to study. Despite her
wealth, she is still very careful with her money. As a retired
civil servant, she receives a pension of RM1,000 a month. But
dividends from her stocks come to RM3,000 a month."
The example is heartening. But again, I think it's
important to put a context to it. The period during which the
cousin grew her wealth ran from the 1960s to the 1990s. Perhaps
during that period, a buy-and-hold strategy worked. Would it still
work today?
I tracked down stocks that have been listed in the
Singapore market since 1973. There are 16 - some counters might
have been delisted, for good or bad reasons.
So there is a survivorship bias, that is, only the
good or viable ones remain.
In any case, even among the 16 stocks, the
performance varies. As of today, the best performer over the past
40 years has been Asia Pacific Breweries (APB). Its price,
excluding dividends, has appreciated by 9.7 per cent a year.
It has grown by some 40 times over the past 40
years. For those who reinvested the dividends back in the stock,
the return would have been a lot higher.
Jardine Cycle & Carriage was the second-best
performer, with price appreciation of 9.1 per cent a year. It was
followed by Fraser & Neave (F&N) with 7.8 per cent. For the
banks, prices grew by about 5 per cent a year.
Auric Pacific Group fared the worst. Back in 1973,
it was trading at about $1.50. At the start of this year, its
shares changed hands at $1.13. WBL, Haw Par and United Engineers
all managed to chalk up price appreciation of less than 2 per cent
a year.
The thing is, APB wasn't the leader of the pack
every step of the way. In the early 1980s, Straits Trading had its
days in the sun.
By the early 1990s, Natsteel (now NSL) was ready to
take its turn. The new millennium saw the spotlight fall on DBS
Group Holdings. And now it is APB that has caught the market's
fancy.
The market is such that it will be fascinated by
different themes or the latest fads at different times. During any
of these episodes, it might not be entirely rational in pricing
stocks.
At such times, when one of your stocks catches the
fancy of the market, and you think the market price has gone far
beyond the fair value of the stock (remember the valuation metrics
we discussed in the past few weeks?), it is not a bad idea to lock
in your profits.
Remember, a stock that falls 50 per cent will need
to recover by 100 per cent before it gets back to its old
levels.
To illustrate how important it is to protect your
downside, I charted the performance of the Straits Times Index as
calculated by Thomson Datastream from 1973 up to last week.
The price appreciation was 3.9 per cent a year. If
you had invested $10,000 in the index from the start, that sum
would have grown to $47,000 today. Assuming you missed the 10 worst
trading days of the past four decades - the most recent was in
October 2008 when the market fell 8 per cent - your performance
would have been boosted to 7.3 per cent a year. Your $10,000 would
have grown to $165,200.
In contrast, if you had missed the 10 best days,
that $10,000 would have grown to just $17,100 - a gain of 1.4 per
cent a year.
However, if you buy when market valuations are low,
there is a high probability that you will avoid the worst days in
the markets and yet not miss out on the best days.
The key message that investors should never ever
forget is to protect their downside. Let the upside take care of
itself.
The strategies that we have talked about in the
past few weeks - and that appear to work well - have been about
buying low-valuation stocks, taking profits and redeploying the
capital to the next batch of low-valuation stocks.
There appears to be persistence in the performance
in these kinds of strategies.
Moneywise, Invest, The Straits Times January 13 2013 Pg 37
There is a way to time the
market
Use PE ratio as a guide and remove
the effects of business cycles
Source: Compiled by BT with data from Thomson Datastream; * STI
as computed by Thomson Datastream. ST GRAPHICS
Teh Hooi Ling
In response to my article last
week, on the good it would do to one's portfolio if one could avoid
the 10 worst plunges in the last 40 years in the Straits Times
Index, a reader wrote: "I thought it is difficult enough to 'miss'
one worst day, and now you have to 'miss' 10 worst days.
"Who would have this kind of clairvoyance or
prophetic ability and also guts to act? It is impossible to be able
to have such high conviction to sell all of one's stocks on the eve
of the crash based on your gut feelings that the crash is
coming."
Valid questions. So the underlying question he is
asking is: Is there a way to know when to buy and when to sell the
market as a whole?
One would need, like the reader said, clairvoyance
if the stock market operates in a world of its own, detached from
the logic we know that operates in the physical world that we live
in. But here is a central truth to the stock market: Underneath it
all, there is an economic reality. Companies have to make money in
excess of their cost of capital to be of value.
In terms of the assets that the listed companies
own, there is always arbitrage around the replacement cost. For
example, if you can buy a drinks factory in the stock market for
half the price of building one, nobody will build one. Those with
money will just buy their competitors' plants via the stock
market.
This will drive up the stock price of drinks
factories. When the stock prices rise to such a high level that it
is way cheaper to build a new plant instead, a new set of
entrepreneurs will come in to build new plants. This will mark the
end of the "up" cycle in the stock prices of drinks factories.
Conversely, if you can invest to build something -
say fibre-optic cables - for $1 and sell it for $10 in the stock
market, then you can guarantee many people would want to do that
until we drown in fibre-optic cables. This is exactly what happened
in 2001 and 2002.
We keep reading it, but it is true: Greed and fear
of market participants drive stock market prices to the two ends of
the spectrum.
This week, I will show that there is a way to tell
when the market is over or undervalued. And it is not based on your
gut feelings.
Remember, we talked about using price-earnings (PE)
ratio - how many times a stock is trading relative to its earnings
- to value stocks. We can use this metric to value the entire
market as well.
But there is a problem with using the PE ratio
without regard to business cycles. For a cyclical stock say,
shipping company NOL, if it is at the peak of its cycle, yet you
are still willing to pay 20 times earnings for the stock, then you
are set to suffer a substantial capital loss on your investments.
Because the earnings will come down, and the PE of the stock will
rise sharply, say to 40 and 50 times, and the market will deem it
too expensive. Its share price will then drop.
Conversely, at the bottom of the cycle, you could
pay 50 or 100 times for NOL and you could conceivably consider it a
cheap buy.
So in valuing the market using the PE, we need to
remove the effects of business cycles. One way to do it is to take
the average earnings of the market in the past 10 years, and
compare it to the current price of the market.
That's what I have done in the accompanying chart.
The Straits Times Index (STI) data from Thomson Datastream started
in early 1973. So the first point of the PE starts only in 1983 -
10 years later.
That line is plotted against the STI. I used
monthly data. As you can see from the chart, the 10-year average PE
of the STI traded between a range of 10 and 33.5. The average is
about 21 times earnings.
The peak PE of 33.5 times was registered on Sept 1,
1987. In January 2000, it was 32.7 times. On Oct 1, 2007, it was 30
times.
If you used 25 times and above as an indication of
market overvaluation - so you get out of the market, and you get in
only at 15 times and below, you would have avoided the October 1987
Black Monday crash, the Asian financial crisis, the dot.com bubble
and the global financial crisis.
The indicator would give you the go-ahead signal to
enter the market in end-1984, but get out in the second quarter of
1987; enter again in the second half of 1998, exit by the third
quarter of 1999; enter in March 2003, exit by end-2006; and enter
again by November 2008.
Following this strategy, you would have obtained a
compounded annual return of 12.5 per cent a year. This assumes a
1.5 per cent transaction cost every time you enter and exit the
market. Dividends and interest earned in your cash holding periods
are reinvested in the market. In other words, you grow $10,000 into
$341,500 in 30 years.
A buy-and-hold strategy with dividends reinvested
yielded 7.9 per cent over the same period. It grew $10,000 to
$97,900.
Of course, you can modify your strategy. Take 15
times PE as the buying signal. But for every point that the PE goes
lower, say to 14, and then to 13, then to 12, you just increase
your investments in the market, say by 10 per cent each time. You
set your own rules. There is after all a cheap sale going on.
And you start selling when it hits 25 times PE. The
higher it goes, the more you sell. By 30 times PE, it is best to be
completely out of the market.
This way, your return would be even higher than
12.5 per cent a year.
Now the question: Where is the 10-year average PE
now? Well, it's at 14.8 times - not in extreme undervaluation
territory but just about, at our arbitrarily set buy level. But
bear in mind that we are in an extraordinarily low-interest rate
environment. To the extent that companies' earnings were boosted by
cheap financing, then the value in the market may not be as
great.
Also, you have to take a view on whether you think
Singapore companies can remain competitive going forward. Based
purely on the PE, assuming there are no structural changes in the
world compared to the past 35 years, there still appears to be a
case for being invested.
The Writer is editor of Executive Money, a weekly section
in The Business Times. Her column is available in BTInvest
(www.btinvest.com.sg), a free personal
finance and investment site of The Business Times covering five
main categories: Personal Finance, Wealth, Markets, Insurance and
Property.
Go to BTInvest for expert views on the latest market
developments and tips on how to better manage your dollars and
cents.
Moneywise, Invest, The Straits Times, January 20 2013 Pg 36