Another cuppa, moms and dads?

I was inspired to write this post after reading a recent article in the SMH by Noel Whittaker.

Cappuccino or latte (cafe latte) is about $3.50 in Sydney. Can you build a nest egg just by forgoing one cuppa a day? You bet.

As a parent with a young toddler, I believe starting an early savings plan for my child is an exceptional idea. With a long runway, not only can kids fully harness the power of compounding but the savings plan can teach them the benefits of delayed gratification/ savings.

The idea is to start a retirement plan the day your bundle of joy is born.

The investment horizon is 65 years (that’s sort of the average retirement age) and the fund would be invested in shares. Shares do not only produce very good long term returns (history has shown that these returns are anywhere between 6%-9%), they can also be bought with relatively small sums of money (as opposed to real estate or commodities), brokerage is cheap and they have zero maintenance cost.

A low cost ASX 200 ETF will be a reasonable way to accessing these returns.

If you start an investment plan which invests $3.50 a day (I would recommend investing into the market on an annual basis to avoid paying too much brokerage fees) for your child and assuming an annual compound return of 8%; the nominal value of the plan at the end of Year 65 would be $2.55 million (before brokerage fees and fund management costs). Assuming a 2% long run inflation rate, this would be equivalent to $704,909 in today’s dollars, not too shabby for just one latte a day huh.

I would argue that after seeing such wonderful results, your child would probably be eager to contribute much more than $3.50 a day when he/ she enters the workforce.

I’ve included the math in the table below. Like me, if you start the plan when your child is older than zero, then just subtract his/ her age from year 65 and take the value from that corresponding year.

The table below shows a combination of daily savings rate (from $1 to $10) and long run annual return (6% – 10%) and the resulting balance (nominal dollars) at the end of Year 65.


Read here for the Noel’s article. If you read his article, I suspect the difference between his figures and mine are due to different compounding frequencies.

This post gives me some motivation to update the ASX All Ordinaries long run return, originally posted here.


Bitcoin, fool’s gold

Looking back at 2017, I think the biggest financial news for the year was bitcoin’s meteoric rise from $964 on 1 Jan 2017 to a high of $19,100 on 18 Dec, a return of 1,884% in less than 12 months. After hitting the highs, its price has fallen and is currently trading at $14,000. Its volatility is not for the faint hearted.

Bitcoin started life as an alternative currency with the advantages of 1) not requiring an intermediary to make transactions and 2) free of government’s regulation. However, as its rise caught the attention of the masses, pundits started calling it the new gold.

That statement got me thinking, what makes gold valuable? So I dug around the internet to find out.

Base metals such as copper or iron derive their value from their industrial demand. Almost all of the base metals extracted are put to industrial use. Compared to the base metals, the industrial demand for gold only takes up 12% of its annual supply and yet gold is far more valuable than the base metals. For example, at current prices, a tonne of copper is worth US$7,018 and a tonne of gold is worth US$41.2 million.

To understand why gold is valuable, we have to go back to early human civilisation during the early days of coins. Gold is valuable due to its chemistry. In the early days, gold’s properties made it an ideal choice of metal to be forged into coins.

  • A currency needs stability and gold is relatively scarce and its supply steady. It is much more scarce than iron or copper but more abundant than some of the platinum group metals. Coins would have to be much smaller with more limited supply if they were made from palladium.
  • Compared with other metals, gold has a relatively low melting point (1,000c) which made it easier for ancient man to extract and smelt as compared to say aluminium, which is much harder to extract and has a melting point of 2,000c. Ancient man just didn’t have the specialist equipment to smelt metals that had high melting points.
  • Gold is “beautiful” and is non-reactive to air and water. A gold coin casted today will look pretty much the same a thousand years from now. Iron rusts, copper turns green and even silver tarnishes, gold however stays the same.

Man’s infatuation with gold has existed for at least 5,000 years if not more, its value is ingrained into our psyche and culture. Bitcoin on the other hand, has only existed since 2009.

So do I think Bitcoin is the new gold? Absolutely not.

I believe Bitcoin is in bubble territory because its current value is not supported by anything other than pure speculation. As an asset it does not generate any cash flow (so it’s nearly impossible to value) and as a form of currency, its volatility makes it undesirable. Therefore, it serves no utility for the vast majority of society.

However, I believe Bitcoin will be worth something due to its underlying demand from vice activities. Bitcoin being decentralised and anonymous is perfect for money laundering activities.

Have a happy new year and prosperous 2018!

Musings Regional Express

Unexplained volatility

I’ve owned Regional Express’ (REX) for a while now and lately I’ve noticed that the share price movements have been more volatile than usual. After yesterday’s massive 11.3% gain, I wanted to see whether the recent share price volatility made any sense.

In terms of significant announcements made by the company; the FY17 financial results, final dividend for FY17 and profit before tax (PBT) growth forecast for FY18 were announced on 28 August 2017. At the AGM yesterday, management gave an update for the FY18 PBT growth forecast. Between 28 Aug and 22 Nov there were no significant announcements and the ex-dividend date was 23 Oct 2017.

Rather than chart the share price, I have charted the company’s market capitalisation over the last 37 days to give a better perspective of the swings in the company’s value.  There were four big moves over this period which I will foolishly attempt to rationalise. The aggregate value (whether up or down) of these big movements was $89.2 million (on a sub $200 million market capitalisation company). Now over the same period, the ASX 200 went up 4% and market volatility was not remarkable (the biggest market moves were up 1%), so this suggests that the four big moves were not influenced by the general market.

The first big move increased the company’s value by $28.6 million (18.3%) over twelve trading days. Prior to this move, the market had a month to absorb the FY17 results and FY18 profit forecast announced at the end of August 2017. I’m speculating here but it appears to me that there was a rush to buy the stock before the ex-dividend date. However, this also doesn’t quite make sense to me as market participants had ample to buy the shares and the total dividend being paid out was only $11 million (10 cents per share) fully franked; far less than the $28.6 million being added to the company’s value.

The second big move resulted in a single day fall in the company’s value of $19.8 million. As Rex went ex-dividend on this date, a fall equivalent to the value of the dividend is expected. Typically, this happens due to investors competing away an arbitrage opportunity where an investor can buy shares before the ex-dividend date, sell it the next day, collect the dividend and make a profit. Rex’s dividend payout was $11.0 million (10 cents per share) which was fully franked or equivalent to $15.7 million (14.3 cents per share) grossed up. The market fell by $19.8 million exceeding both the cash value and the grossed up value of the dividend. So the dividend arbitrage strategy actually lost money here?

The third big move caused a drop in company value of $23.1 million (-13.6%) in six trading days. Over this period, the general market was flat and the only announcement by the company was an AGM date announcement. I don’t even know where to start in trying to explain this.

The fourth big move was a one day increase in market capitalisation of $17.6 million (11.3%). The AGM was held on the day and management’s  presentation showed that growth in FY18 PBT was expected to be over 20%, which was an improvement on their previous mid-teen PBT growth forecast. Using 15% as a proxy for “mid-teen”, I did some calculations to find out whether this huge movement could be explained by a 5% (20% vs 15%) uplift in FY18’s PBT. My calculations show that the difference between 15% and 20% growth in PBT is $890k. Even if I applied a 10x multiple to capitalise this PBT uplift, it would only result in a company value uplift of $8.9 million, far less than the observed market capitalisation increase of $17.6 million.

These large movements in share price are not uncommon especially outside the ASX 100 companies. It shows market psychology and momentum factors are powerful short term drivers of share price. If you are investing on a fundamental basis, it is hard to make any sense or logic for these massive moves in company value. So ….. I think the efficient market purists must also believe in the tooth fairy.


Credit and the economy

A few months ago I wrote this piece about the banking environment and ANZ where I touched on the high level of household debt in Australia. I believe that the high level of debt is a major risk to the economy so I wanted to get an idea of the total amount of Australia debt (owed by households, businesses and government). I stumbled onto a website called which had an interesting chart that I have replicated below.

According to this website, the total Australian debt currently is $6.47 trillion, this is equivalent to $258,000 owed by every man, child and dog in the country. I didn’t verify all the figures from their website but the Federal Government debt and the banking sector debt figures looks accurate. Another way to look at this debt is that it is 3.8x the GDP ($1.7 trillion) of the economy. GDP is akin to revenue so this means we have debt levels which are 3.8x revenue.

The debt chat provides a good segue into an excellent video on credit and debt by Ray Dalio (Bridgewater Capital) which I wanted to share. I think this video presentation gives a good mental model to think about the economy, credit and debt which provides some insight into how our huge debt will be ultimately resolved.


So you want to beat the index

This is a follow up to the Mr. Market and Charles Munger posts.

Long term outperformance against the index is rare. Based on this smh report, it says that 2/3 of all active Australian fund managers fail to outperform their benchmarks over a 3 year and 5 year time horizon. Another thing that is also rarely mentioned in the industry is risk adjusted returns. Returns alone do not tell the full picture. It is also important to understand how much risk was taken to make those returns. Even when risk adjusted returns are mentioned, it is usually based on statistical measures of risk such as volatility (i.e. sharp ratios). Volatility as a measure of risk is a flawed concept but that story is for another time.

I believe risk can only be qualitatively assessed by understanding 1) whether there was an adequate margin of safety in the price paid for the shares, 2) whether the company’s future can be forecast with a reasonable degree of confidence.

With the above in mind, I made an investment eight years ago which has beaten the index (ASX 200 accumulation index) by more than 4% p.a. I didn’t realise it had beaten the index by more than 56% until I actually sat down and did the calculations, so I thought I better write about it to remind myself that it is possible to:

  1. Beat the index with very low risk. Risk was very low given the entry price and the quality of the business.
  2. Beat the index with only one trade. I didn’t trade in and out of positions over the holding period, it has been a simple buy and hold strategy.
  3. Beat the index without diversifying the portfolio; you can do it easily with one single stock. For this trade, I feel that diversification would not have lowered the risks but quite likely lowered the returns.

I bought the ASX after it fell from $60 to $30 in October 2008 during the GFC. This chart shows the total returns for the ASX (11.4% compounded p.a.) as compared to the ASX 200 accumulation index (7.3% compounded p.a.) over this period.

I think this was a safe and easy trade. If you took a long term view, you could quite quickly reach the conclusion that a bet on the ASX would be a rather safe bet even in the height of the GFC. Firstly, the ASX has a near monopoly on stock market trading which is protected by regulation and secondly, capital raising and trading activities will continue to grow as a result of the growing superannuation asset class in Australia which will continue to drive earnings higher.

So although far from the highest return trade you could have done during the GFC, from a risk adjusted return perspective, I think this trade ranks pretty high (better than betting on the banks at that time in my opinion). But more importantly, you could have the confidence to bet the farm on something like this and if you did, you’d increased your wealth by 150% with taking very little actual risk.

Any feedback or comment much appreciated.



Mr. Market and Amazon

It is harder today to find bargains than when Ben Graham or Warran Buffet ran their investment funds, I don’t think there is any doubt there. Statistically cheap stocks (net nets or even massively discounted NTA) very rarely turn up and when they do, they typically have massive leverage with high default and insolvency risk. The wide spread availability of screeners has ended the statistically cheap stock game.

The game has gotten harder and can get frustrating for value investors when we sift through dozens and dozens of companies but fail to spot a bargain. Naturally the mind starts to think that the market is much more efficient nowadays and that the bargains are no longer available.

So I thought I write a piece using Amazon as an example to remind myself of the today’s market “efficiency”.

Amazon has been getting a lot of accolades lately. Its stock recently hit the $1,000 mark and Jeff Bezos has been catapulted to the no. 3 richest individual globally. Heck, even Warren Buffet recently praised Jeff Bezos as being one of the best business leaders in America today. Amazon is a great example to use for this exercise because here you have a founder CEO who laid out the principles and vision for his company in his first 1997 shareholder letter (you can read it here) and has stuck to that roadmap over last 20 years.

As shown below, the company had experience consistent annual growth in revenue and operating cash flows from 1997 to 2016. The only years where operating cash flow was negative was between 1998 to 2001.

Given the above steady growth, take a look at its share price over the same time period. The chart below is based on weekly share prices so a daily chart would show more volatility.

It’s hard to eyeball on the chart by there were massive swings in the journey from $1.50 (IPO) to $1,000. I have identified the following 2-3 year swings which cannot be explained by deterioration in the company’s fundamentals as Jeff Bezos was increasing his economic moat over this entire period.

It is astounding that in spite of a road map given, constant increase its competitive advantage and never having a year of revenue actually going backwards (slowest annual growth was 13%) the value of Amazon has halfed on four occasions and fallen by more than one fifth on nine occasions. More impressive is that some of these falls were within a period of a couple of months.

I take comfort that Mr. Market is still the manic depressive as describe by Ben Graham in the Intelligent Investor sixty eight year ago and leave you with a fitting quote from Ben Graham:

“The Intelligent Investor shouldn’t ignore Mr. Market entirely. Instead you should do business with him but only to the extent that it serves your interest”


Finding an edge

Seth Klarman, one of the great value investing gurus talks about the important of finding their edge at Baupost Group. I also believe this is very important as investing is not that much different from sports, where if you play competitively you are always trying to find an edge over your opponent and in the world of investing, the opponent is the market.

Your edge is a useful concept to think about whether you are investing in the thousands of dollars or billions of dollars. If you can’t identify your edge and be able to play to that strength then it’s highly likely that you wouldn’t be able to beat the market; and if you can’t beat the market then don’t play the game and invest in an index ETF instead.

So I thought I write down what I think my edge (in general) is as a non-professional investor investing small sums of money.

  • A retail investor is not limited by an investment mandate in contrast to an institutional investor. This gives a retail investor huge flexibility over the institutional investor and I believe the big advantages of this flexibility are (i) the ability to invest in any security, be it small illiquid shares which are not an index constituent, (ii) lack of restrictions on diversification, so I can choose to hold 100 stocks or concentrate my holding on a single stock in my portfolio and (iii) lack of restrictions on asset allocation which means I can be 100% invested in shares or 100% invested in cash at any time.
  • Investing small sums of capital provides an edge as it means I can invest in microcap stocks and still be able to get a meaningful return on my capital. Smallcaps and microcaps are mostly neglected by the institutional investors (with huge sum of capital) as it doesn’t move their needle. In the context of the ASX, a large majority of the stocks listed have market capitalisation below A$500 million.
  • No annual benchmarking of performance. Most fund managers are benchmarked annually against some underlying index. This naturally leads to the creation of index hugging portfolios as fund managers may deem it too risky to venture too much outside the index constituents.
  • Another related point is that the annual testing of performance means that fund managers typically have to take a short term view and avoid stocks where returns require a long time horizon. But we know that great businesses take time to build and therefore big returns are played out over a 5 – 10+ year time horizon. Just look at Berkshire Hathaway and the multi decade annual returns of 20% it has generated for its shareholders.  So the point here is that there is no pressure on retail investors who can have the luxury to patiently wait for a stock to generate returns. Fund managers don’t have that luxury as it they don’t perform in the short term, their investors might move their capital elsewhere.

The above points are related to a retail investor’s natural edge over most institutional managers. Other skills which can improve your edge include:

1. Know the limits to your circle of competence
Warren Buffet says the size of your circle of competence matters far less than your awareness of its limits. I believe this is so true. If you think about it, most successful people or businesses never venture outside their core industry.  I can think of Walt Disney with children’s entertainment, Phil Knight with shoes, Frank Lowy with shopping centers, Howard Schultz with coffee, to name a few. From my own personal experience, my biggest losers are from companies where I overestimated my circle of competence.

2. Understand the business
I guess this point is fairly self explanatory. It is important to not only understand the business opportunities but the risks involved, both micro and macro.

3. Form an independent opinion and don’t be swayed by the herd.
Don’t make decisions based on movement in share prices don’t let the herd influence your decision making. This is much easier said than done. But if you can ignore the volatility of the share market then you have gained an advantage. Superior results aren’t generated by following the majority.

4. Be patient and bet big
The market is fairly efficient and opportunities don’t come along that often. So if you have done your homework and found an underpriced security, bet big. It’s no point tip toeing into a position as the opportunity may be gone tomorrow.

5. Fish where the fish are
Look for stocks which have low investor expectations. Studies have shown that these produce superior returns. Good hunting grounds include companies trading at 52 week lows, illiquid companies, spin-offs, securities are removed from indices or esoteric markets.

Investing is like any skill, it takes time to hone and the more you can play to your strengths the higher your chances of winning are.

Any comments or feedback much appreciated.


Painful lesson

I recently got burnt from a stock which I bought earlier in the year. I didn’t blog about this because at the time I thought it was somewhat too speculative and risky for this blog (and on hindsight wondered why I idiotically made the punt).  The stock I bought was RNY Trust, a REIT with a portfolio of commercial office properties located in the New York Tri-State area.

The shares were bought at an average price of 12 cents and are now trading at 4 cents, a whopping 68% loss. The only silver lining is that I didn’t allocate too much capital to this investment.

I thought it would be helpful to write a post mortem so that I hopefully don’t repeat the mistakes.


RNY listed on the ASX  two years prior to the GFC with an IPO price slightly above $1 and after the GFC its shares traded at a range of 75% to 90% discount to its IPO price. The share price never recovered as RNY had two anchors holding it down; first it’s gearing levels was a product of the pre-GFC era and far too high which meant that it could not afford to pay a dividend and secondly demand for its office properties which were located in the suburbs were falling. The trend with the millennials was that they preferred to work in CBD areas and that suburb offices were just not desirable.

When I acquired RNY Trust in April 2016, the share price had dropped about 50% from about 25 cents to 12 cents after the release of it’s FY2015 financial report in February 2016. The share price fell as a result of management writing down the value of the property portfolio by approximately 14%. The thing that interest me was that management was going to wind down the trust over a period of 18 to 24 months and with a reported NTA of 35 cents and the share price trading at 12 cents, it could be an opportunity to profit.

My main concern was whether the carrying values of the property reflected actual market values. I tried to mitigate this risk by performing some desktop research on comparable property sales and being quietly confident on the newly engaged valuers Cushman & Wakefield (C&W). I had assumed that the valuation was conservative as it had resulted in the write down of the carrying values and was performed with the knowledge that the assets would sold in the near future. Surely, the valuers would want to avoid looking silly or worse negligent if the actual transaction value were materially lower than their valuation.

Once I was comfortable with the carrying values of the portfolio, factoring in transaction and winding down costs for RNY, I figured that there was an adequate margin of safety at 12 cents. I had missed the forest for the trees. My margin of safety calculation was based on the assumption that the carrying values were good even though I knew that if the transaction value was 5% lower than the carrying value, this would wipe out my margin of safety.

For the period between the FY15 and the HY16 results, RNY announced a further write off to the carrying values by 4.7% after getting C&W to value the remaining properties (which were not valued by C&W in December 2015) and that RNY would step up a gear with the sale of the portfolio given pressure from its lenders (a covenant had been breached).

In response to the further write down, I recalibrated some of my transaction and winding down cost assumptions after speaking to management which enabled my calculations to still show a margin of safety albeit reduced.

RNY recently announced that they had received bids for 12 out of 19 assets of the trust and on average, it represented a 13% discount to the carrying value. The share price immediately fell more than 60%.

Post mortem

So what did I do wrong?

The first mistake was I did not fully understand the property market in the New York Tri-State area. Although the portfolio had an average occupancy was 72%, some of the properties had occupancy levels as low as 25%. This was a warning sign I ignored.

Another mistake was ignoring the level of gearing and putting too much confidence on the carrying value of the portfolio. Before I invested, I knew that a 5% drop in the carrying value would wipe out my margin of safety due to the high debt levels. After the HY16 write down, RNY was around 80% geared.

Finally, the last mistake was psychological. Even though management gave another warning in the HY16 report by further writing down the portfolio and knowing that a forced sale scenario may entice opportunistic buyers, I responded by changing my transaction and winding down cost assumptions rather than changing my stance, a classic consistency principle in psychology. The psychological bias is to remain consistent with an earlier decision or conclusion even in the face of contradicting information.

The low occupancy levels for some of the offices and high gearing levels should have been reason enough to stay away. Although I knew it was risky (risky enough not to blog about it) I still decided to punt anyway, which was stupid.


Initial Public Offerings

I read an interesting article on Bloomberg yesterday (click here to read) about Australian IPOs and how the odds of losing big from an Australian IPO is uncomfortable large. Bloomberg analysed 112 IPOs in Australia worth more than $50 million over a period from 31 Dec 2008 to 31 Dec 2015 and found that 17 out of 112 IPOs resulted in a greater than 50% loss.

Bloomberg chart

Considering that the ASX 200 went from 3,722 to 5,296 points (a 42% gain) during this period, the average returns from these IPOs are pretty ordinary. If you invested in the ASX 200 index, you would have been in the 2nd highest return bracket (above) but exposed to much much lower risk (your risk return profile would be significantly lower).

To me buying into an IPO is a bit like buying at the markets in many parts of Asia where you have to haggle and bargain. I always try not to buy at these markets as I’m a bad haggler and I know I can never really “win” (however low I get the price down to) due to information asymmetry. The sellers knows the wholesale price, the price which other sellers are selling it and how much he sold it to the last Aussie tourist so what are the odds of me actually winning?

Sounds a lot like the IPO market ….





Creating the right incentives 

Last week JB Hi-Fi (JBH) announced that there were some discussions with The Good Guys (GG) on a possible acquisition and that these were preliminary and exploratory in nature.  The rationale for the acquisition is that it would turbo-charge JBH’s foray into the white goods space.

Based on media reports, revenue and EBITDA for the GG’s is circa $2 billion and $110 million respectively and that the owners are looking for a $1 billion exit.  Taking these numbers at face value would imply an acquisition EBITDA multiple of 9.1x.

As a long time shareholder of JBH, I have a few issues with this potential acquisition (at the above acquisition multiple):

  1. JBH’s management are really great operators. However, it’s track record of acquisitions aren’t as great. The Clive Anthony and Hill & Stewart acquisitions were both disasters but luckily both were relatively small acquisitions. GG on the other hand would be a material acquisition for JBH, which if successful would be significantly debt funded so the risks are much greater.
  2. The GG business model is a blend of company owned stores and franchisees. This doesn’t automatically fit with the current JBH model. Negotiating with that many franchisees will have it’s challenges.
  3. JBH’s EBITDA margin last year was 6.6% and its current trading at an EBITDA multiple of 8.8x. GG’s EBITDA margin on the other hand is 5.5% (based on media reports) and the owners are asking for 9.1x EBITDA acquisition price. At this price, shareholders will end up paying more for a business which is not only less efficient but once combined will be likely to be a drag margins and return of capital.
  4. This acquisition if it goes through will be a distraction. The real threat to JBH is not Harvey Norman or any of the brick and mortar stores but rather Amazon. This threat is real and I would much rather JBH allocate its resources (including capital) to strategies on how to counter the looming Amazon threat.

Given the significant risks, incompatibility of business models and high asking price, I wonder why management is still exploring an acquisition.

Are the synergies so compelling or is there such great strategic benefits to this acquisition?

Or does the earnings per share (EPS) growth target in the long term incentive plan (LTI) have anything to do with motivating management to grow earnings despite the risks?

EPS has long been the preferred performance hurdle for JBH’s LTI plans and based on the FY2015 annual report, the majority of the LTI plan still vests upon meeting EPS based performance targets.

“70% of these options vest upon achieving 5% growth compound annual EPS growth and the remaining 30% vest upon achieving 10% compound EPS growth. Where compound EPS growth is between 5% and 10%, up to 30% will vest on a linear basis” – JBH FY2015 annual report.

JBH is a wonderful business operator but its capital allocation decisions have been woeful. Examples include:

  • Acquisition of Clive Anthony is 2004. By 2012 all the Clive Anthony stores were shut down and rebranded to JB Hi Fi home stores. Any value paid for brand or goodwill would have come to naught.
  • In 2006, JBH acquired the Hill & Stewart stores in New Zealand. By 2010, all the stores were shut down.
  • JBH went on a share buyback spree in FY2011 and bought back $173 million of stock at an average price of $16.  As a result of this, debt went from $34 million in FY2010 to $233 million in FY2011 and the share price 1 year after the buyback was completed was trading at $9.24.  This buyback was terribly wealth destroying for shareholders.

The above 3 transactions destroyed shareholder value but in the short run provided a tailwind to EPS. The buyback is a positive for EPS growth since it directly reduces the denominator in the EPS calculation.

This begs the question – is the EPS target motivating management with the right incentives for shareholder value creation? I would argue not.