Must read, very good article:
Author: kcchongnz | Publish date: Fri, 14 Aug 2015, 08:03 PM
This few days, I have received a few emails like this one below:
During this very critical time in our Malaysian stock market, affected by our corrupted government's scandals, weakening currency. Kc do you mind to write up your opinions and share a little of your knowledge with us, what an investor have/should do, and what kind of mentality should have to face all these uncertainties during this rough time? I believe many of us are inexperience plus rumours are flying everywhere all over the internet, I strongly believe a few wise words from you indefinitely be helpful to us in making a right decision in stock market.”
The KLCI has dropped by 14.5% from 1862 points to the close of 1597 points on 14th August 2015 since four months ago. Most stocks have dropped by a lot more than the broad index, some even by more than 50%. For example IFCA MSC has dropped by 59% from its peak at RM1.85 to 76 sen now, Asdion 63% from its peak of RM1.60 to 60.5 sen. Even seemingly good companies like AirAsia also has its stock price plunged by 60% from just a few months ago. Oil and gas related stocks fared worst as Skpetro, Coastal and some other good companies dropped by more than 50% in the last one year. There are some big winners though, especially the export furniture stocks, but they are basically tightly held, illiquid and there is not much trading.
The viciousness of these price falls in Bursa has caused a lot of anxiety of punters, speculators and investors alike. Bursa has entered into a bear market. Some of the culprits of this predicament are the 1AMD issues, the political situation, implementation of GST, expected interest rate hike, the steep falling Ringgit, the devaluation of Yuan, Greece, the fall in crude and palm oil prices. There are indeed plenty of problems in Malaysia and abroad. They are all real. But we are living in a world of political and economic diversity, and I cannot recall which year we don’t have a lot of problems which would impact the stock markets. So at times like these what should you do?
When you first embarked on this journey of value investing with me, I have mentioned to you some of the principles of value investing. The most important principle is that Mr. Market is a crazy guy. He is something of a manic depressive whose quotes often bear no relation to the state of the underlying business – swinging from the wild enthusiasm of offering high prices to the pitiful gloom of valuing the company for a dime.
The latter seems to be happening now. Hence if we are committed to stock market investment as a source of higher returns, we have to learn how to live with this volatility.
When asked once about whether he was worried about a big drop in the value of Berkshire Munger said in a very direct way:
“Zero. This is the third time Warren and I have seen our holdings in Berkshire Hathway go down, top tick to bottom tick, by 50%. I think it’s in the nature of long term shareholding of the normal vicissitudes, of worldly outcomes, of markets that the long-term holder has his quoted value of his stocks go down by say 50%. In fact you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”
I have emphasized before that investing to build up wealth is a long-term endeavour. You are supposed to invest for a higher return than putting your money in the banks for your retirement, or university education for your kids which are usually years, or even decades away. Should you worry and lose sleep when the market has a bad run? If so, you may have to reassess if you should invest in the stock market at all.
Concentrate in your career, and switch off from the negativity of the market, trade less and detach yourself from this short term “external” loss in this bear market.
“An investor’s return is inversely related to his level of activity." Warren Buffett
Instead, spend more time now to refresh your skill in interpreting the financial statements, and especially the business valuation aspects which many of you have left behind. Share your analysis with others and receive positive feedback. Accept constructive criticisms. That is how you can improve your skills, knowledge and experience. in the process, you will find some real bargains.
Tis goeth down to a fundamental aspect that “An investment in knowledge pays the best interest” - Benjamin Franklin
The other very important principle of value investing you have learned is “price is not value”. If Mr. Market offers to buy your business which is worth RM1m for RM500k, would you sell to him when others are willingly selling him at that price? It's dangerous to react irrationally to the whims of Mr. Market. While investing for the long-term benefits from compound growth, short-term reactions are cursed by emotions and randomness and will not help you to achieve long-term goals.
In fact, if you have a lot of spare cash, the cash which you don’t need to touch for years, and for those who have little exposure in the stock market, it may be good to buy those RM1m businesses from others who are threatened by Mr. Market for less than RM500k. When the price is going down and volume is higher, there is less competition. It’s better to be too early than too late. It has been proven again and again, if you buy stocks at a big margin of safety, there is little risk and eventually market will revert to its mean. But make damn sure that you buy good companies at big discounts. As you all know about the third principle of value investing, i.e. every stock has an intrinsic value; buy at a big margin of safety from its intrinsic value, the fourth principle of value investing, is the way to go in investing. I can’t recall any good stock purchased at cheap price had not recovered and went above the purchase price.
“Achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck or extreme volatility.” Seth Klarman
In fact some well-known value investors are waiting to enter the market when bear stampedes. Tan Teng Boo of icap.biz has been waiting for that moment. I am sure others too.
But please remember, the stock market is unpredictable. Low price can go lower, or even much lower. Even Berkshire Hathaway can go down in price by 50% in a crisis. Avoid those stocks whose prices have gone up too far ahead of their fundamentals as they may drop the hardest in this volatile market. If you are uncomfortable, and can’t sleep well, it may not be advisable to invest further. And never forget the very principle that I have been propagating; never borrow money, or use margin finance to indulge in what you term as investing. It is not investing to use borrowed money, it is gambling. Avoid it like a plague. Imagine if you have used 50% margin finance to buy IFCA, or AirAsia, or some oil and gas related stocks mentioned above, and many of them are in fact good stocks, you would have lost all your money and have little chance to recover in the future. Haven’t you read about the sharp fall of the Shanghai Stock Exchange here due mostly to the margin financing?
Debt is evil, especially for personal debt in investing in the stock market. The six-sigma and black swan disastrous events in the capital market are relatively common nowadays. The axiom “Expect the unexpected” is always true in the stock market. Be prepared and take measures to prepare for the worst because the market reality can be worse that what you imagined. You have no idea what the capital market will do during a crisis.
Always consider risk and downside first over potential returns. Remember we can be wrong in our assessment, or the fundamentals can change rapidly. Hence follow the fifth and the last principle of value investing, i.e. diversification (not over-diversification), the only free lunch in investing.
You may also opt to make your positioning conservative, reserve cash so that you are able to pounce on new opportunities while others are forced to sell in the later stage.
Finally remember. No one is going to take responsibility for the crisis so you have to look out for yourself and manage your risk well. Remember of what I always say?
“In Bursa, there ain’t no tooth fairy”
In conclusion, at times like this, one sympathises with those who feel like running for the exits... after all cash is safe, stable, and certain. Or if you are feeling so uneasy now because of the market volatility. You have to run when the banks are making the margin calls though. But if one is investing for the long term and doesn't need short or medium term liquidity what's the point of second guessing the market? The market fools most of the people most of the time.
I shall sign off with a quote the following quote.
“This too shall pass” The Wisdom of King Solomon
K C Chong