How Long Would You Hold A Value Stock?

9 years and 11 months! That is how long I held on to a value stock known as Frencken. I recently sold it in Jun at $0.515, having first bought it in Jul 2007 at $0.535 when it was still known as ElectroTech. In between, I averaged down twice, at $0.33 in Jul 2010 and at $0.365 in Jul 2014. The figure below shows the share price performance since May 2005.

Frencken Share Price Performance Since 2005

As you can see, for a very long 9.5 years, the share price never recovered to its previous levels, until only recently. In between, it changed its name from ElectroTech to Frencken and took over not 1, but 2 SGX listed companies (ETLA and JukenTech)! It has been a very long 9.5 years for Frencken shareholders who bought it as a value stock.

In value investing, you are often told that you have to be patient; that the day will come when your value stock will rise significantly and become a potential multi-bagger. The logic is appealing: buy a $1 stock for $0.60 and eventually the market will come to recognise its value and price it at $1 or beyond! However, what is not mentioned is how long do you have to wait for this to happen. And in the case of Frencken, it took almost 10 years for it to recover to its previous levels.

You might ask, did I make a mistake for identifying Frencken as a value stock and for buying it at too high a price? I bought it in Jul 2007, so my assessment was based on the financial statements for Dec 2006. For FY2005 and FY2006, the respective earnings per share were 9.59 cents and 8.65 cents, the book value was 46.0 cents and 52.4 cents, and the dividend was 2.68 cents and 2.60 cents. Based on my original purchase price of $0.535, these translated to P/E ratios of 5.6 times and 6.2 times, P/B ratios of 1.16 times and 1.02 times, and dividend yield of 5.0% and 4.9% respectively. These figures suggest that Frencken was a value stock when I first bought it and I certainly did not pay too a high price for it.

The point I am trying to make is this: value investing does not always work. It is not a case of buying an undervalued stock and eventually it will become a multi-bagger. It is not that simple. As I later figured out, being undervalued is only a necessary but insufficient condition for a stock to rise to its intrinsic value. Some other catalysts must be present for the rise to materialise, such as a bull run, recovery in earnings, asset sales with special dividends, etc. Being undervalued alone is not sufficient.

In the case of Frencken, the recent recovery in share price is due to 2 factors: a bull run in electronics stocks that swept up not only Frencken, but also other electronics stocks such as Hi-P, Sunningdale, UMS, Valuetronics, Venture, etc. The other factor is a recovery in earnings. For the latest quarter in 1Q2017, it reported a 437% year-on-year rise in quarterly earnings. This explains the doubling in share price from $0.24 since the beginning of this year.

If being undervalued is the only necessary condition for a stock to rise, why did I have to wait for not 1, 2, 3, 4, 5, 6, 7, 8, 9, but almost 10 years for it to rise?

I used to be a value investor too. When the value stock that I bought rose, I believed that value investing worked. When the stock did not rise, I told myself to be patient, that one day the market would eventually recognise the stock's value and give it its rightful valuation. When the stock dropped further and turned into a value trap, I thought that there must be something that I missed and should work harder to improve my value investing skills. Seldom did I think that there could be some other factors at work that would determine to a larger extent whether I make money or lose money on stocks. If the value stocks rose, value investing was right (never mind that there could be a general bull market as in the case of 2004). If the stocks did not rise, value investing was not at fault!

It was only around 2011 that I realised that something was amiss with value investing. I found out that the stocks that I bought during the Global Financial Crisis did not rise as much as I expected. It was then that I finally understood that value investing does not always work. Being undervalued is only a necessary but insufficient condition for stocks to rise. From there, I kept an open mind and branched out to other investing strategies, such as growth, turnarounds, dividend, etc. 

Having said the above, value investing did not totally disappear from my investment strategies. The principles of not overpaying for investments have continued to stay with me (see What is My Target Price?). And I am actually very grateful to have learnt value investing back then in 2001. It taught me a scientific method to value stocks instead of using gut feel. But value investing could only bring me this far. To continue my investing journey, I had to understand what worked for value investing and discard what did not.

10 years. That is how long I held on to a stock bought on the thesis of a winning formula. How many 10 years does anyone have in his investing lifetime to realise that his much cherished winning formula does not always work?

See related blog posts:

• Confessions of a Serious Investor
• Investing Is A Life-Long Learning Journey
• An Advice for Myself

Fundamentals of Stock and Bond Picking

You have probably heard of the study in which monkeys throwing darts on a dartboard with stock names on it could produce portfolios that outperform those picked by professional investors. A few reasons were given for the outperformance, such as size of the companies, Price-to-Book valuation of the stocks, etc. I wonder if the same study were to be repeated for bond picking, would monkeys still outperform professional investors?

There is no study on the above, but my answer to it is probably not. When you pick a stock to buy, you are expecting it to change in the future, whether it is the earnings or dividends increasing or the Price-to-Earnings valuation improving. In essence, you are forecasting the future. This can be seen from the various models for valuing stocks. The Dividend Discount Model, for example, estimates the intrinsic value of a stock as the summation of all future dividends discounted to the present. The Discounted Cash Flow Model does so similarly, using free cashflows instead of dividends. The present matters less in stock valuation, and yardsticks based on present assets such as Price-to-Book ratio do not feature much in investors' minds. There are good reasons for this, because if the assets cannot produce good future earnings, the assets have to be discounted from book value. 

The corollary is that, if things are not expected to change in the future, you should not pick the stock (except for dividend stocks, which have similarities with bonds). Also, since nobody can predict the future accurately, it is not surprising that monkeys can beat professional investors in stock picking. Likewise, professional investors underperform their respective stock benchmarks when they carry out tactical allocations according to their outlook for the future.

Bond investment is quite the mirror opposite of stock investment. When you pick a bond (or dividend-paying stock) to buy, you are expecting it to continue paying the same amount of coupons or dividends until they mature. In other words, you are expecting it not to change in the future. Hence, bond valuation starts with present assets and earnings and computes a margin of safety to cater for unexpected changes in the future. While the future is still important, the present plays a bigger role in bond valuation. Thus, bond valuation deals with yardsticks such as the debt-to-equity ratio, interest coverage ratio, etc. which are found in the present income statements and balance sheets.

Hence, when you compare stock and bond valuation methods, stock valuations are more of an art, because it is based on forecasts for the future, which everybody will have different opinions of. Whereas bond valuations are more of a science, because that they are based on figures in the income statements and balance sheets, which people rarely dispute. 

Hence, on the above question on whether monkeys will outperform professional investors on bond picking, my answer is probably not, since monkeys cannot analyse income statements and balance sheets. Also, based on the above argument, more professional bond investors should outperform their benchmarks compared to their stock counterparts. This is true. S&P publishes annual SPIVA (S&P Indices Versus Active) reports on whether active fund managers outperform their benchmarks. In all equities categories, active fund managers underperform their respective benchmarks. In bonds, active fund managers outperform their benchmarks in the investment-grade short and intermediate, global income and general municipal categories on a 5-year basis (see SPIVA report for US Year-End 2016).

Thus, on the question whether you should buy the stocks or bonds of a particular company, it depends on your outlook for the company in the future, summarised as follows.

Company Outlook	Bonds	Stocks	Conclusion
Changes for the Better	Good	Best	Best for Stock Investment
No Change	Good	No Good	Best for Bond Investment
Changes for the Worse	Bad	Worst	Both Investments are Bad

When things do not change in the future, bonds are better investments than stocks. When things change for the better in the future, bonds are good investments, but you can perform better by buying the stock. When things change for the worse, both are bad investments, but stocks are worse than bonds.

The above also has implications on the types of stocks we should buy. If there are no catalysts for changes such as improved earnings or dividends, asset sales or a bull market in the future, an undervalued stock will continue to remain undervalued. A growth stock will be a good investment, but only until the day its growth starts to slow down, from which it becomes a bad investment. A dividend stock is good provided things do not change or change for the better.


See related blog posts:

• What Can We Learn About Stocks From Bonds
• The Lost Art of Bond Investment
• The Investigative Approach to Stock Investments

How to Avoid Cleaning Out Your CPF Balance When Taking HDB Loan

When you apply for a loan from HDB to buy a flat, it will take all the money from your CPF Ordinary Account (OA) before giving you the loan. This is to reduce the loan amount that you need to service. If you wish to avoid an empty OA account, you can temporarily transfer some of your OA balance out of CPF before you apply for the HDB loan. The pros and cons for either approach are discussed in Clean Out CPF Balance When Taking HDB Housing Loan?

A reader recently asked me how to temporarily transfer some of the OA balance out of CPF. Note that I am not encouraging you to do it, but if you have a real need for keeping some money in the OA to meet future financial obligations such as buying/ servicing insurance policies or financing your family members' tertiary education, below is one approach for doing it.

The approach I used is to invest in some safe investment instruments. As the objective is to temporarily park the cash outside of OA, the overriding principles are safety and liquidity of the investment. As there is a foreseeable use for the money in the future, it is of utmost importance that most of the money can be returned to your CPF account subsequently. Making a positive return on the money, although welcomed, is not crucial. Secondly, you also do not wish for your money to be locked-in in that investment for longer than is necessary. Typically, the aim is to withdraw the money 1 month before the HDB appointment date and return it 1 month after the HDB appointment, making it approximately 2-3 months of investment period. The longer the money is invested, the higher is the risk.

The instruments that you can invest 100% of your OA balance (note: you cannot invest the first $20,000 of the OA balance) are fixed deposits, government bonds, statutory board bonds, some insurance products and unit trusts. I chose short-term government bonds known as Singapore Government Securities (SGS). They have no credit risks and foreign exchange risks and have local banks providing liquidity as secondary traders. However, SGS are extremely difficult to trade. Before they were listed on the Singapore Exchange, I could only trade them by making a visit to the banks. Staff at the local bank branches practically never heard of them and had to consult their Treasury department at the headquarters every time I traded SGS. Moreover, bond trading is very different from share trading. There is the concept of clean price and dirty price. Clean price is the price that you see quoted on the market. Dirty price is clean price + accrued interest and is the price that you actually pay. It is complex enough, right? For this reason, I would not encourage this approach.

The simpler approach is to buy unit trusts that have the lowest risks and are eligible for CPF-OA investment. Suitable unit trusts are those that invest in (1) bonds, that are (2) short-term, (3) issued in Singapore dollars, and preferably (4) by the government. Bonds will reduce the price volatility compared to shares. Short-term (or short-duration) bonds will minimise the risk of interest rate going up and leading to a drop in bond prices. Bonds denominated in Singapore dollar will eliminate foreign exchange risks, and government bonds will avoid the risk of companies going belly-up. It is probably difficult to find a unit trust that invests in Singapore government bonds solely, so the next best is to have a mix of government and corporate bonds. Since most unit trusts invest in a lot of bonds, the risk of any one company going belly-up and affecting the price of the unit trust significantly is usually small. A good resource for finding suitable bond unit trusts is Fundsupermart.

So, after you have invested in the unit trust, complete the appointment with HDB, and 1 month later, after you have confirmed that HDB has completed its work, sell the unit trust and return the money back to your CPF account.

Lastly, please note that no investment is 100% capital guaranteed. There will be some transaction costs from buying and selling. And if interest rate rises during this period, some capital loss is unavoidable. But by choosing unit trusts that invest in short-term Singapore dollar denominated bonds, the risks are minimised.

See related blog posts:

• Clean Out CPF Balance When Taking HDB Housing Loan?
• Housing Loan Servicing – Cash or CPF?
• Is CPF Accrued Interest Double Counting of Housing Loan Interest?

Comparison of Singapore Shipping Corp with Shipping Trusts

Shipping trusts are not the only stocks that buy and rent out ships for recurrent income. There is another stock that does so -- Singapore Shipping Corp (SSC). I used to own this stock, and unlike the shipping trusts, I have fond memories of it. What are the similarities and differences between SSC and the shipping trusts like First Ship Lease Trust (FSL) and Rickmers Maritime and will SSC face similar difficulties as the shipping trusts in future?

First, a brief introduction of SSC. SSC has 2 business segments, namely ship owning and agency & logistics. The bulk of the revenue and profits are generated from the ship owning segment. The company owns a fleet of 6 Pure Car and Truck Carriers (PCTC), which it leases to shipping majors like Mitsui OSK Lines, Nippon Yusen Kabushiki Kaisha (NYK) in mostly long term time charters of more than 10 years. Thus, its business model is similar to that of Rickmers Maritime.

Rickmers started off in May 2007 with a fleet of 10 container ships leased to shipping majors in time charters of 8 years. It had a stable recurrent income from the charters from which it could pay good distributions to shareholders (USD5.64 cents in 2007). It also had low levels of debts (debt/equity ratio of 58% in 2007). However, over the next 2 years, it added more ships and more debts. The debt/equity ratio reached 196% in 2009. Unfortunately, the shipping industry then went into a downturn from which it has not recovered. As the long term charters expire, Rickmers had difficulty renewing the charters at the good rates they used to command. This resulted in inability to meet the debt obligations to banks. Eventually, Rickmers had no choice but to wind up.

SSC is also in a fleet expansion path currently. Prior to 2010, it had disposed most of its ships before the shipping downturn. It added 1 PCTC each in 2010 and 2011, 2 PCTCs in 2014 and another 1 more in 2015, making a total of 6 PCTCs. Debt levels followed similar trajectories, rising from debt/equity ratio of 0% in Mar 2010 to 161% in Mar 2015. The expansion plan has probably not ended, hence, we might potentially see debt levels increasing further.

Will SSC face similar difficulties as Rickmers when the long term charters expire? It is difficult to tell in 10 years' time whether SSC can renew its charters at good rates when they expire. However, one advantage that SSC has over shipping trusts is that it is a company and not a business trust. A company can only pay dividends out of accounting profits whereas a business trust can pay distributions out of operating cashflows. In other words, asset depreciation, which reduces accounting profits but not operating cashflows, reduces the amount of dividends a company can pay but not the amount of distributions a business trust can pay. Thus, SSC is restricted from paying out all its operating cashflows as dividends. Since 2009, it paid a constant 1 cent per share every year, translating to a dividend yield of only 3.6% at the current share price of $0.275. The cashflows retained are used to pay down debts, which SSC has done at a rapid rate. From a debt/equity ratio of 161% in Mar 2015, the debt/equity ratio has fallen to 97% in Mar 2017. At this rate, before the charters expire, SSC would have fully paid down the debts. Thus, based on this key reason, SSC would not end up being wounded up.

Nevertheless, 1 key risk that SSC faces is the ability and willingness of its customers to honour the charters if the market charter rates were to decline significantly. Its customers are NYK, Mitsui OSK Lines and Wallenius Lines. FSL, which deals with smaller shipping companies, had encountered several customer defaults in the past. Rickmers had no such problems with its customers, which are shipping majors. Nevertheless, it narrowly avoided the bankruptcy of Hanjin Shipping. A container ship leased to Hanjin expired in early 2016, just before it went into receivership in Aug 2016.

Finally, SSC had in the past sold ships when times were good and returned handsome dividends to shareholders. Between Aug 2005 and Dec 2007, SSC returned a total of 46 cents per share to shareholders. While it is not certain that market values for ships will recover to previous peaks for SSC to pull off this trick again, any special dividends from asset sales would be a bonus.

P.S. Currently not vested, but might consider.

See related blog posts:

• A Comparison of Shipping Trusts' Business Models
• Differences Between First Ship Lease Trust and Rickmers Maritime
• Valuation of First Ship Lease Trust