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Wednesday, October 20, 2021

October 2021 Portfolio Update/General Investors Expectations/Capital Allocation

SPDR Singapore Straits Times Index Fund (ES3): 9.83% (Sep 2021) -> 14.55% (as of 20-Oct-2021)
Hong Kong Tracker Fund (2800): -4.37% -> 0.33%
SPDR S&P 500 ETF (SPY): 21.45% -> 23.77%

My portfolio returns: 40.01% -> 42.95%. Helped by an increase in Alibaba and a bit of volatility from OKP's prices. Not expected to be long-lasting.

Transactions:
Sizable increase in Central China Management
Unfortunately, CCMGT suffer decline after decline, and the earnings-based valuation compels me to make additional purchase. Currently, the company should be priced at single-digit multiples on cashflow. At the worst case scenario, current prices could have already represent a decline in earnings in the upcoming years.

Slight increase in Alibaba.
Given that Alibaba was growing at about 20% yearly, a 10% cash yield represent a pretty attractive purchase. Unfortunately, prices went up significantly in recent weeks. I do not think that the price is extremely attractive now, so I went ahead to write a put contract (worth 500 shares of Alibaba traded in HKEX) at 150 HKD, representing a yield of 1% in 10 days (expiring 28-Oct).

Unfortunately, prices do surge and all I had to console myself with is a little premium. I am not ready to over-leverage (I have way more than enough cash to convert option to stock if buyer does exercise).

***

General Investors' Expectations

Recently, I had the good fortune of joining another telegram group, which opportune me to gauge general investors' sentiment going forward, long term.


I choosen the period of 10 years because I believe that is the amount of time necessary for an investor to prove his ability. 10 years is also good enough to remove the element of luck.

Given we had a riproaring 5 years just by buying flavor of the month investments, it was not surprising that most investors believe they could beat the returns from passive investing. Infact, 34/53 or 64% believe they will exceed by more than 10%.

A good 45% of the total believe they can get 10-20% off their investments (which does not necessary only consist of stocks). 

IMO, the smartest investors could only generate 20-30% long term, and it takes considerable effort to be even in the above average camp of 10-20%. 

Only 25% feels that they will fare close to, or lower than passive investing, which ... does not reflect reality. I am afraid this is a sign of markets being frothy for far too long.

***

My way of capital allocation

It has been a while since I write something educational (instead of self-serving stuff like portfolio updates).

Today, I am going to share how I allocate capital to my ideas. It is not going to be some highfalutin means-- I promise it is very practical and understandable.

Assuming I have 300,000 SGD to invest, and my objective is capital appreciation. I need to grow my wealth so that I could live off dividends. The capital allocation for living off dividends is different (more tilted to protecting against downside/ market level risk).

So when trying to increase capital, ideally I want to have 8-13 ideas. I believe that is the maximum amount of "good" ideas one could get at any time from the market. You are expected as an investor to read the financial reports and announcements from all your companies. So if you have like 50-60 companies, I doubt you could keep up!

So how much $ should we allocate, in terms of percentage, to each idea? Some investors are tempted to divide the cake up in equal amounts. If I have 300,000 and there are ten ideas, then I want a max of 30,000 in each idea.

I am not a fan of this idea. Not all ten ideas are going to be equally good. Now, what is "good?"

An idea is great when the risk is the lowest. Now my idea of risk is the difference between perceived value and price. The lower the price is against the value, the lower the risk.

I am a chicken-little, so I do not believe in allocating the full sum at one go. Instead, I will choose to put in a token amount at first (unless there is overwhelming evidence that the value-price gap is huge). So assuming a share is worth, to me, $1 a share. If the market offers me a price of 0.8, that is a good starting point. I would usually put in a small amount and let the market bring the stock to me.

If the market were to price the stock lower, it would make sense to buy somemore. But there are times where price does go up and I have a very small amount of $ in that idea... I have to accept it and move on.

If the price continues to fall precipitously, as it had for OKP, I would have bought in quite a few times. So I have 30% of my net worth in this idea.. and I would evaluate what kind of stock it is. It had the biggest downside cap in its cash to share price. It has also a decent dividend, and I think the problems it had is temporary. But you can easily find ideas like this from hard work when market is calm. So during broad market sell downs, which happen only once in a while, it is not a good idea to buy a lot of OKPs. You can find cheap companies most of the time, but good companies at a bargain is rare as a full moon.

There are other ideas in my portfolio which aren't so great. Some of their value are based on earnings, and I don't like to bet on earnings since they can be cyclical. Take for instance, a growth stock like Alibaba which was selling at a cash yield of 9% (meaning, you paying 1$ for a 0.09 free cash flow return per year). So the idea is only good if there is growth.

***

A pretty lengthy explanation on why I dislike buying stocks on earnings:

Assuming a growth rate of 15% for the next five years. If you had paid $100 for a stock that has a free cash flow of $9 per year in the past, that is not a bad stock to have.

IF things go according as planned, that cash flow of $9 becomes $10.35 (that is 9 + (9*0.15) ). Your purchase of $100 per share is now giving you $10.35 (or 10.35%) of free cash flow. Generally, the market will price the stock upwards (based on inflation and risk-free interest rates, the lower they are, the better it is for stocks). If you were to hold on to this stock for another year, and the free cash flow grows even more (10.35* 1.15= 11.9), which increases your cash yield even more so.

But what happens, if you were like more investors, excited by the incredible potential in many growth stocks, pay something like 40 times price to cashflow? 

That would translate to you paying $10 per share to a stock that has a free cash flow of $0.25 a share. If the FCF growth disappoints, either through poor execution or more commonly, competition, you could suffer permanent losses. Ultimately the majority of the market will not pay 40-50x for a stock which growth has stalled.

In short, too many good things must happen when you pay a significant premium for a good quality stock.

Now if all these sound too conservative, it really is. I do feel that there are few like-minded investors like myself these days. While everyone's attention is on growth, growth and more growth, I stood alone and ask

"How much could I lose?"

-end

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