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Author: kcchongnz   |   Latest post: Sun, 23 Jul 2017, 12:12 PM

 

Core Principles in Investing of Super Investors kcchongnz

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In the following article, there are a few super investors in US which I have been following on their investment principles, philosophies and methodologies.

http://klse.i3investor.com/blogs/kcchongnz/86781.jsp

They are Warren Buffet, Joel Greenblatt, Seth Klarman, and Howard Marks, and some others. If you have been reading my articles, you will notice that I have been quoting these people all the time. They are fundamental value investors, of course, but who exactly are they, and why are they worth to enumerate by fundamental value investors?

Let us look at each of them one by one from the angles of their investing philosophies, principles and methodologies.

 

Warren Buffett

Warren Buffett requires little introduction. He is the most successful investor in the world. Buffett is the chairman, CEO and largest shareholder of Berkshire Hathaway, and is consistently ranked among the world's wealthiest people with a net worth of USD62 billion.

Buffett is noted for his adherence to value investing, and a notable philanthropist.

That $1,000 invested in 1964, when Buffett took over the company and shares cost just $19, would be worth about $11.5 million dollars today. This is equivalent to a compounded annual growth rate (CAGR) of about 20% for a long period of 51 years.

Warren Buffett’s investing principles focus on return of equity, ROE. This is his thought.

Customarily, most investors measure annual company performance by looking at earnings per share (EPS). Did they increase over last year? Are they high enough to brag about? For his part, Buffett considers EPS a smokescreen. Most companies retain a portion of their previous year's earnings as a way of increasing their equity base, so he sees no reason to get excited about record EPS. There is nothing spectacular about a company that increases EPS by 10%, if at the same time, it is growing its equity base by 10%. That's no different, he explains, from putting money in a savings account and letting the interest accumulate and compound. Worse still, there are many companies borrow huge amount of money to improve EPS, but the marginal return is way below its borrowing costs.

The test of economic performance, he believes, is whether a company achieves a high earnings rate on equity capital ("without undue leverage, accounting gimmickry, etc."), not whether it has consistent gains in EPS. To measure a company's annual performance, Buffett prefers return on equity or ROE. -- The ratio of operating earnings to shareholders' equity
.”

 

Buffett looks at what he calls "owner's earnings," which is essentially cash flow available to shareholders, or technically, free cash flow to equity (FCFE), after capital expenses for the business. He focuses on the ability of a company to generate cash for shareholders, and not how much earnings produced.

Here, Buffett seeks to estimate a company's intrinsic value. He projects the future owner's earnings, then discounts them back to the present to get the intrinsic value of the company and hence its stock. He would only invest in it if there is a wide margin of safety.

On the short-term behavior of most investors trying to make quick gain, he said,

No matter how great the talent or efforts, some things just take time. You can't produce a baby in one month by getting nine women pregnant.”

This is a good advice from Warren Buffett for investors regarding the greed in the stock market:

“I've seen more people fail because of liquor and leverage—leverage being borrowed money. You really don't need leverage in this world much. If you're smart, you're going to make a lot of money without borrowing.”

 

Joel Greenblatt

I have mentioned about Joel Greenblatt in my investment articles in i3investor a lot because my investing principle is mainly based on his Magic Formula Investing. Here is one of the articles.

http://klse.i3investor.com/blogs/kcchongnz/51631.jsp

Joel Greenblatt is an American academic, hedge fund manager, investor, and writer. He is a value investor, and adjunct professor at the Columbia University Graduate School of Business.

In 1985, Greenblatt started a hedge fund, Gotham Capital, with $7 million. Through his firm Gotham Capital, Greenblatt presided over an impressive CAGR of 30% from 1985 to 2006. The $7 million capital turned into $1.7 billion 21 years later.

Joel focus on buying good companies at cheap price. Good companies again mean companies with high return on invested capital, ROIC and not earnings growth, and cheapness measured by earnings yields, and not the simplistic PE ratio.

This is Joel’s thoughts about stock price and value:

I just want to take advantage of prices away from value. If you do good valuation work and you are right, Mr. Market will pay you back.  In the short term, one to two years, the market is inefficient.  But in the long-term, the market has to get it right—it will pay you back in two to three years. Keep that in mind when you do your analysis. You don’t have to look at the next quarter, the next six months, if you do good valuation work—Mr. Market will pay you.”

“Buying good businesses at bargain prices is the secret to making lots of money.” 

Joel also emphasize this, like all other super investors,

“Companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above-average profits.”

The stocks of My First Portfolio published in i3investors were chosen using the Magic Formula principle of investing. It returned 116% compared to the return of KLCI of just 9.6% during the same period of two years and nine months as shown in this link here:

http://klse.i3investor.com/blogs/kcchongnz/84923.jsp

 

I particle like what Joel says here:

“Look down, not up, when making your initial investment decision. If you don’t lose money, most of the remaining alternatives are good ones.”

On leverage in investing, Joel said:

“If you are going to be a very concentrated investor, you should not use leverage. You can’t leverage because you need to live through the downturns and that is incredibly important.”

Joel also warned investors about stock tips and advice from people purportedly want to make you rich.

The odds of anyone calling you on the phone with good investment advice are about the same as winning the Lotto without buying a ticket.”

 

Seth Klarman

Seth Klarman is an American billionaire who founded the Baupost Group in 1982, which managed USD 22 Billion as of 2010. He has consistently achieved high returns. He often makes unusual investments, buying unpopular assets while they are undervalued, using complex derivatives, and buying put options.

Seth obtained 17 percent annualized return for the Baupost Group since its inception three decades ago. $100k invested in 1982 becomes $11.1m at the end of year 2012.

In 1991, Klarman authored Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor, which since has become a value investing classic. Now out of print, Margin of Safety has sold on Amazon for $1,200 and eBay for $2,000.

In 2014 Forbes listed Seth Klarman as one of the 25 Highest-Earning hedge fund managers in 2013. His 2013 total earnings was $350 million ranks him the 20th among the 25 top earning hedge fund managers.

Below is the gist of valuation technique used by him which I have been trying to follow:

To be a value investor, you must buy at a discount from underlying value. Analyzing each potential value investment opportunity therefore begins with an assessment of business value…. While a great many methods of business valuation exist, there are only three that I find useful.”

For a going concern, the Net present value would be most applicable. A frequently used but flawed shortcut method of valuing a going concern is known as private-market value”.

The net present value is to discount all future expected cash flows to the present to obtain the intrinsic value of the company, and hence its stock, or what we call the discount cash flows analysis (DCFA).

A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.”

How else should we invest if not this way, to know the value of something before we think of paying a price for it? This is the very essence of fundamental value investing.

“Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.”

Seth also talked about the behaviour of most market players here:

Few are willing and able to devote sufficient time and effort to become value investors, and only a fraction of those have the proper mind-set to succeed.”

This is also from my experience of coaching on fundamental value investing in my online courses. Many of them started with great enthusiasms which die off quickly, because of family and work commitment, or unwillingness to spend some time on this very important aspect of one’s personal finance.

Seth mentioned that “Attempting to outperform the market in the short term is futile.” He advocates on investing for the middle and long-term, same as what Warren Buffet advocates.

One of the biggest, if not the biggest risks in investing, is human behavior. Overconfidence and over optimism are inevitable elements of the human condition. Seth warns investors to be careful out there.

Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.”

This is a warning Seth gives to investors thinking about the peril of margin financing when broker can force sell your stocks without having to give you a reason when the stock or market tanks:

The trick of successful investors is to sell when they want to, not when they have to.”

 

Howard Marks

Howard Marks co-founded Oaktree Capital Management specializing on high-yield bonds, distressed debt, and private equity. According to Bloomberg, ”Oaktree’s 17 distressed-debt funds have averaged annual gains of 19 percent after fees for the past 22 years — about 7 percentage points better than its peers”.

In the 2011 Forbes rankings of the wealthiest Americans, Marks was ranked the #273 richest in the United States, with a net worth of $1.87 billion as at to date.

He is known in the investment community for his "Oaktree memos" to clients which detail investment strategies and insight into the economy, and in 2011 he published the book The Most Important Thing: Uncommon Sense for the Thoughtful Investor.

Here is what Buffett has to say about Marks’s memos – “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something…”

Like most truly super investors, Howard is a modest, humble person filled with humility. Although he is a very rich man and has done very well in his funds, he used to say the market is uncertain and unknowable. He always emphasizes that investing is not easy.

“I keep going back to what Charlie Munger said to me, which is none of this is easy, and anybody who thinks it is easy is stupid. It is just not easy. There are many layers to this, and you just have to think well.”

Since I started to “advertise” my online courses in i3investor, a number of young people, after reading how some investors making big money in the stock market using borrowed money is so easy, asked me whether they should quit their job, discard their business, and go into full time investing. I have never encouraged them to do. Instead, I always ask them to read my article in the link below:

http://klse.i3investor.com/blogs/kcchongnz/77460.jsp

It is summarized here:

  1. Utilize your human capital. Get a job and career of what you are trained for. That income is most dependable.
  2. Spend within your mean
  3. Safe and invest and utilize the 8th wonder of the world in compounding
  4. Avoid bad leverage, margin financing in stock investing in particular, like a plague.
  5. Spend time and effort to learn the fundamentals of investing, one the most important things for your personal finance.

It appears that few, or even none liked to hear what I have said and sincerely believe in.

There is no “sure-win” investing method in a jungle out there. Marks said as it is not easy to invest, and Hence “Return expectations must be reasonable. Anything else will get you into trouble, usually through the acceptance of greater risk than is perceived.”

I have borrowed his wisdom and have written a couple of articles in i3investor, and the latest is here:

http://klse.i3investor.com/blogs/kcchongnz/87726.jsp

“Leverage magnifies outcomes, but doesn’t add value.”

Just like Warren Buffett, Seth Klarman, and Howard Marks discourage using borrowed money to invest. They focus on limiting the downside; recognize, understand and avoid high risks as much as possible.

Trying to avoid losses is more important than striving for great investment success. The latter can be achieved some of the time, but the occasional failure may be crippling. The former can be done more often and more dependably….and with consequences when it fails that are more tolerable.”

One way to avoid high risk is to know and understand the price-value relationship in investment.

For investing to be reliably successful, an accurate estimate of intrinsic value is the indispensable starting point. Without it, any hope for consistent success as an investor is just that: hope.”

Yes, investing by listening to rumours, or buying stocks touted in investment forums, especially when the prices have gone up high, hoping to gain from the greater fool theory is just hope, and hope is not an investing strategy.

http://klse.i3investor.com/blogs/kcchongnz/86227.jsp

Investment success doesn’t come from “buying good things,” but rather from “buying things well.”

Like many other super investors, Marks doesn’t try to predict too much into the future, for example the macro-economic thingy, or paying too much for high growth expectation. He prefers value rather than growth investing as the former is undoubtedly, more dependable.

Growth investing represents a bet on company performance that may or may not materialize in the future, while value investing is based primarily on analysis of a company’s current worth.”

We can make excellent investment decisions on the basis of present observations, with no need to make guesses about the future.”  

"Value investing" - is supposed to be about buying based on the present value of assets, rather than conjecture about profit growth in the far-off future.

 

Marks expounded the concept of Second-level thinking. First-level thinkers look for simple formulas and easy answers. Second-level thinkers know that success in investing is the antithesis of simple.

Second-level thinkers know that, to achieve superior results, they have to have an edge in either information or analysis, or both. They are on the alert for instances of misperception.

First-level thinker thinks, “This is a high growth company, must buy. Use margin finance to buy to win big”

Second-level thinker,

  1. “Is the growth value enhancing, or value destroying”
  2. If it is value enhancing, has the price been factored in?
  3. What is my downside if I am wrong?
  4. What is the upside if I aright?
  5. What is the expected value from probability analysis based on (3) and (4) above?
  6. How is the expected value compared to the price?
  7. What if the outcome turns against you, in big time?
  8. What is the motive of that buy call?
  9. Etc.

Yes, investing is not easy. Even Charles Munger and Howard Marks say so.

 

Conclusions

Many successful super investors defer in their investing strategies. However, they do have some common core values and principles. They recognise that investing is not easy and hence most exhibit humility. They all shun leverage like a plague. They all care about the downside and take care of it, and let the upside to take care of itself.

Super investors invest like a businessman. They focus on long-term, not the next quarter, or the next year. They know what Howard Marks means here:

That’s because in the world of investing, being correct about something isn’t at all synonymous with being proved correct right away.”        Howard Marks

All super investors are Second-level thinker; they don’t just buy good companies, but try to buy them cheap. Goodness is measured by the return on capitals, good cash flows, not earnings, or growth in earnings. In order to know if they are cheap, they have an estimate of their values, often using the discount future cash flows analysis, or better comparable, rather than the simplistic and problematic PE ratio. They like to buy when there is a wide margin of safety between the price and the estimated intrinsic value of the stocks.

Understand the core principles of super investors are pre-requisite for the success in investing. After that, prospective investors should have the knowledge of how to carry out the strategies and methodologies following those core principles.

My personal experience in investing in Bursa has been proven that these core principles work very well for me as shown from the return of my portfolios as explained.

For those who are interested to learn the implementation of these core principles to build long-term wealth in equity investment, please contact me for an online course for a small fee at

Ckc14training2@gmail.com

 

K C Chong

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  5 people like this.
 
Icon8888 Thanks KC. The articles gave a good summary of various gurus different methods of getting rich, save me the trouble of going through the books one by one. So much more to learn...
13/12/2015 13:12
Icon8888 Apart from the few highlighted in your article, there are many many other gurus

It would be nice if you can also write about them (just my wish, not imposing on you)

I will buy you coffee once I have sufficient profit to fly to New Zealand for sightseeing

X D
13/12/2015 13:16
probability After that Invite KC to Malaysia....provide ticket!
let him taste our durians la..(selling very cheap coz of RM!)
then may be we all can meet him here.:)
13/12/2015 13:18
geary Actually nothing much to learn, so boring! Bursa has very, very few durable competitive companies and high ROE, plus i tell u what, must have more important high ROTC.
13/12/2015 13:29
joe2703 Thanks KC! I always learn something from your articles. I3 without your articles will be much less interesting! Please write more whenever you can so that we can learn.
13/12/2015 13:37
geary The ROE-Return on Equity and ROTC-Return on Total Capital should be above average of 12%. If u can find in Bursa from company A to company Z, the ROE and ROTC is above 12% for at least 7 to 10 years, it should be a durable competitive advantage company. Then u can hold for long term like Carlsberg, Nestle and GAB.
13/12/2015 13:57
stockraider Return on ROE is not the correct measurement....u may get high ROE like 50% but if the share price is high.....then u r DANGEROUSLY buying an overvalue stock WITH NO MARGIN OF SAFETY loh.....!!!

HIGH ROE SHOULD BE READ WITH A REASONABLE PE TO CONFIRM IT IS NOT OVERVALUE MAH......!!
13/12/2015 14:05
Ezra Thanks KC. A very good read.
13/12/2015 15:43
geary Actually there is no such thing as long term. Even Buffett sold all his portfolios in 1969, when he saw that there were nothing to buy. All the good companies were selling at P/E of above 40 times. Munger never saw it! So Buffett and his family went for a long holidays. He bought back the companies during the stock market crashed in 1973 or 1974. Dat d difference between millionaires and billionaires!1!
13/12/2015 15:50
foodie Klse stocks now on fire sale oso no one bothers to pick tsk tsk tsk. No one cares to be a billionaire ... Hehehe
13/12/2015 16:01
geary Strong upward trend EPS growth of even by 1% every year, u can see the value of the company also will go up slowly every year. Erratic EPS trend will stagnant d price of the stock, even of high ROE and u should know negative EPS will bankrupt a company. It is all up to u to analyse it rationally.
13/12/2015 16:39
stockraider One thing investor must take note of the quality of earnings loh...!! For example An additional Rm 1 million earn by Nestle will be worth more than equivalent earn by SP setia and say Puncak loh....!!

U must also differentiate between earnings driven by fundamental earnings or speculations loh.....!!
13/12/2015 16:46
calvintaneng Foodie,

I am buying with all the money I can spare. I sold some Singapore shares & switched to KLSE stocks in this very quiet December month.

In December 15th to 17th 2014 when all the people including remisiers were in a panic I bought Jaks at 39 cents, MK land at 32 cents & Pm Corp at 18 cents. I almost got Oka which fell near 50 cents.

Geary,

You are correct to observe Warren liquidated everything in 1969.

That was before the INVENTION OF QE

You see.

For thousands of years summer, autumn, winter & spring cycle go in a cycle. Until...

Until?

Until the Invention of Agriculture in Temperature Controlled Enclosures called Green Houses! I saw lots of these in Winter travels in Korea & Japan. By these inventions you can do planting at all seasons. Will explain later why it applies to investments.

After Boom should be followed by recession or depression. It was the Roaring Twenties that Usherd in the Great Depression of 1929 to 1939

And it was the Surge in Subprime Lending that caused the Housing Bust in USA.

But Warren didn't sell even though he saw 2007/8 coming. And even now Warren didn't sell but still load up his Elephant's gun.

Why so?

You see. At the peak Warren bought into Goldman's preference shares with 10% yield. He moves into stocks with bond like nature.

Warren bought into Railways because he saw the need to transport huge quantity of China goods from West to Eastern United States

And Now just as people invented Greenhouse Planting to negate the ravages of summer or winter -

THE INTRODUCTION OF QE & MORE QE WILL PREVENT CRASHES LIKE BEFORE.

So the Investing Games Have Changed.

Times have changed.

And TTB is still behind time looking at Warren's 1969 example. He might wait till the cow comes home.

So I think this December US Interest Rate Hike is already factored into the market as Bank Negara Zeti mentioned.

If anything - Yellen will open the spigots again for QE4 & QE5
13/12/2015 16:54
r°Moi LIKE
13/12/2015 17:26
kcchongnz Posted by Icon8888 > Dec 13, 2015 01:16 PM | Report Abuse
Apart from the few highlighted in your article, there are many many other gurus
It would be nice if you can also write about them (just my wish, not imposing on you)
I will buy you coffee once I have sufficient profit to fly to New Zealand for sightseeing

Yes, there are many other gurus who are as good. I will write about some of them. I will also write about the gurus in Malaysia.

Icon, you also have your own way of fundamental investing which I think it is good too. I am sure you have made sufficient profit to balanja me coffee. We have nice coffee here.
13/12/2015 19:02
kcchongnz Posted by geary > Dec 13, 2015 04:39 PM | Report Abuse
"Strong upward trend EPS growth of even by 1% every year, u can see the value of the company also will go up slowly every year."

Really? What if a company borrows $1 billion and make additional RM10m, or 1% growth in profit for the year. Does the value of the company goes up as you said?

"Erratic EPS trend will stagnant d price of the stock, even of high ROE and u should know negative EPS will bankrupt a company. It is all up to u to analyse it rationally."

How is it possible to get negative EPS with high ROE, or low ROE? What is R in ROE if it is not net earnings?

How do you analyse rationally with your logic?
13/12/2015 19:08
Kevin Wong if Buffett had have managed to time mkt as correctly as picking long term winning stocks...he would probably be the first
$trillionaire by now...haha

All the best and good luck everybody!
13/12/2015 19:31
hissyu2 Kevin, real value investor never "time mkrt", because Mr. Market is definitely UNPREDICTABLE. Only traders do guessing... Investor like WB, they invest based on fundamental...
13/12/2015 22:14
3EMWE buffet could have been wealthier if he invested in the likes of disney or microsoft and many more in the early days but remained focus to only invest in business that he can understand which is a great advice.
14/12/2015 10:43
Ahbeng Beng Problem with fundamental investor is that....fundamental will change. Using past indicator as your fundamental guide will be very misleading. Beside, knowing the future trend and psychology of other investors in the play is equally important. If warren buffet was born 50 years earlier, in the 1900 america, using his technique will make you in bigger risk. He will not rise to his status at all, and will be ordinary loser if he applied his strategy. 1900 American companies 90% will not exist 50 years later. Many of current US companies listed was not born 100 years ago.
14/12/2015 17:09
kcchongnz Posted by Ahbeng Beng > Dec 14, 2015 05:09 PM | Report Abuse

Problem with fundamental investor is that....fundamental will change. Using past indicator as your fundamental guide will be very misleading. Beside, knowing the future trend and psychology of other investors in the play is equally important. If warren buffet was born 50 years earlier, in the 1900 america, using his technique will make you in bigger risk. He will not rise to his status at all, and will be ordinary loser if he applied his strategy. 1900 American companies 90% will not exist 50 years later. Many of current US companies listed was not born 100 years ago.


Well said. But let us look at these statistics and research findings regarding forecasting of future trend.

a. In US, the average 24-month forecast error is 93%, 12-month, 47% from 2001-2006 (SG Global Strategy Research)
b. There are too many variables; the economy, the path of interest rates, the sectors, the particular stocks, sales, costs, taxes etc
c. Forecast of target prices is a futile exercise. “We simply do not know” Keynes

• In four of the nine years, analysts have not even managed to get the direction of the change in prices correct!
• The absolute scale of the average forecast error is 25%

The above show that economists and professional analysts have been proven so poor in forecasting. What is the chance for yo and me to get future predictions right?

Warren Buffett's investing strategy is evergreen. It doesn't matter if he is born 50 years earlier or later, in my opinion.
15/12/2015 11:00
Kevin Wong staying invested in growth/value stocks at all times...a timeless method of investing?
15/12/2015 14:12
Ahbeng Beng kcchongnz
I said future trend, not forecast on index or share price. When come to investing, there isnt a fix set of skill applicable all time. A genius investor is versatile when come to different investment skill application. I applied Buffett method before, steady mildly growing income, good fundamental, fairly competitive, share was fair pricing ie not exp compare to overall market PE and its own segment PE, and many more follow his principal. End up the price was not going up for 5 years or so, fundamental changed, end up it was drop badly in price before it was finally acquired, lost $$. If I am not that hardcore fundamental investor and use more psychology approach, I will be fare better for that instance.

When come to apply fundamental investing, one of the thing that i look after is future trend. I believe on the future trend and make me willing to invest in it long term. In fact using past performance, past fundamental as indicator to apply fundamental investing, I am more favour on my belief of future trend of a company and fair value of share price when come to apply this investment approach.

I read your data....but it has no use to me. Often i come out with view that totally different with the market. Your data was showing how overall market was thinking/forecasting... but a lot of time my view is different, so the number a lot of time will not be right for me. The thing is, investing is very complex, I cannot guarantee i will getting all the things right, fundamental investment, like many other investment approach, will have its risk. The only safe way to invest is not to limit your world with one approach, know what situation use what approach. Easy say than done, it require a lot of experience, knowledge and luck.

Warren buffett was a legend because the trend was on his side, buying long term and keep during his time, many companies propel to big company, rise to prominent as US rise post world war 2. No way you can do that in 1900 when not many companies will live that long, looking at company with good fundamental, holding long term, etc will be extremely difficult when many will be gone after a few US bubble burst along the history. One way Buffett can use his approach in 1900 is, all in on coca cola...but all in on one share and hold it, never sell it, is very bad approach and very very risky.
16/12/2015 00:17
Ahbeng Beng Kevin Wong
staying invested in growth/value stocks at all times...a timeless method of investing?

Nope, a lot of time growth stock is not cheap too. Often it had priced in the growth factor. Once the growth stop much early than you expected, the price will response quickly and you might be in losses. When come to growth stock, I often will first see how much the premium already priced in, second, whether my view on the company is different with the market...or if same, why should i invest in it if everyone looking at the same thing, share the same opinion as me, ie no money to earn.
16/12/2015 00:29


 

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