Saturday, 12 December 2015

Three Ways You Can Punt The Market

Author: Icon8888   |   Publish date: Tue, 1 Dec 2015, 02:31 PM 

1. Introduction

One thing I pity stock market Newbies is that there are so many noises around. You simply don't know who to listen to.
When come to matters of law (for example), the lawyer speaks, and everybody keeps quiet.
However, in the stock market, EVERYBODY is an Expert. Ask the taxi driver, he will tell you his version. Ask the fishmonger in the wet market, it is another version.

So, who is right, who is wrong ?
The fact is that when come to investing, nobody has monopoly of wisdom.
There are many ways to skin the Stock MarCat.

I am not familiar with Technical Analysis. I am also not good at speculating. I only know a bit about fundamental investing. According to my version, there are three ways you can punt the market - be an Angler, Driftwood or Surf Rider.

2. Angler

(Angler identifies a place that it thinks has potential for fishes. It places its hook in the water and patiently waits for the big fish to bite)

Angling is a method of fishing by means of an "angle" (fish hook).

In the world of investing, Angler scours the market to try to identify stocks that can benefit from certain catalytic events in the future.

Angler craves visibility, it is not interested in things that it cannot see. 

Angler notices that a particular stock is not undervalued now, but in the not too distant future (usually 6 to 18 months), there is potential for dramatic earnings growth when certain productive factors fall into place. 

An Angler is mathematically oriented. It painstakingly puts together a quantitative model to try to predict future earnings of a company (or at least its direction). 

To understand an Angler's state of mind, please refer to example below. 

In 2012, Angler looked at Company B, it saw a company with reasonable balance sheet, profitability and cashflow. However, it is trading at 10 times PER. Company B is not overvalued, but it is not undervalued either. Angler does not see any good reason to gain exposure. 
In 2014, Company B announced that it is investing RM100 mil to beef up production. Angler reacted to the news and pressed the Buy button.
In 2015, Company B's investment in new machines started to bear fruits. Net profit up by more than 20%. As a result, share price is up 60%.
Angler is happy. Usually, it will take profit when it thinks the stock is toppish.

Examples of stocks that will appeal to an Angler 
(1) Geshen - acquisition of Polyplus will boost earnings substantially
(2) PRG - Development profit from Piccasso Residence will boost earnings by early 2016.   
(3) Pantech - Will benefit from massive demand of pipes from Petronas' Pengerang Project
(4) Johore Tin - Low raw material cost will boost profit margin
(5) Engtex - Beneficiary of Selangor state government spending on water industry restructuring
(6) Gadang - Profit contribution from Capital 21
(7) GOB - Profit contribution from USJ Damen development project
(Pros)  Backed by facts and figures, Angler is comfortable placing big bets on a particular stock. It usually has a portfolio that comprises only few big positions.
Some of the stocks will eventually do well, but some will not. Based on my experience, the chance of success is more than 50%.
By placing big bets on potential earnings upside, Angler will reap mouth watering return if things work well.
The best part of this method is that the converse is not necessarily true. As long as the stocks have good fundamentals, even if predictions fail to materialise, Angler will not necessarily incur huge losses. Most of the time, the penalty is the opportunity cost of waiting and the corresponding frustration. 
(Cons) Emphasis on visibility limits the number of potential stocks to be invested in. Due to the neccessity to constantly squeeze brain for ideas and carefully keeping track of companies' performance, Angling can be stressful (just look at my white beard and bald head).

3. Driftwood

Just in case you wonder what a Driftwood is, this is how it looks like.

Driftwood as per its name, is wood that drifts in the water. It stays afloat and moves around with the water irregardless of high or low tide. A passive existence, but good probability of surviving (very relaxing also, just follow the flow).

As mentioned above, Angler painstakingly puts together a mathematical model to try to predict future share price. Driftwood likes visibility also, but it can live with the unknown.

To understand how Driftwood operates, please refer to example below. 

In 2012, Driftwood looked at Company B, it saw a company with reasonable balance sheet, profitability and cashflow. It is trading at 10 times PER. Company B is not overvalued, but it is not undervalued either.
Driftwood is of the view that if it cannot see something in the future, it doesn't mean that it is not there. It found the company's fundamentals reasonable, it likes the management, it is ok with the industry. It pressed the Buy button and mentally prepared to hold long term, real long term.
In 2014, Company B announced that it is investing RM100 mil to beef up production.Driftwood didn't need to do anything. It just smiled.
In 2015, Company B's investment in new machines started to bear fruits. Net profit up by more than 20%. As a result, share price is up 60%.
Driftwood is happy. It can sell the stock or it can hold on. 

(Laissez faire)

Unlike Angler that bets big on several stocks, Driftwood doesn't have that luxury. Due to lack of visibility, Driftwood needs to diversify. Its portfolio usually comprises small positions of many stocks (each stock makes up lets's say 5% of portfolio).

Example of a Driftwood Stock

The chart above shows KPS Consortium's share price from January 2011 until now. This could be a stock that Driftwood might buy.
Let's go back to January 2011. KPSCB was trading at 25 sen. It was profitable, has resonable balance sheets. But it lacks a compelling growth story. It doesn't seem to have moat. It does not possess the earnings visibility that Angler craves.
But Driftwood didn't mind taking position. Afterall, it will only be a small stake, THERE IS NO NEED TO THINK TOO HARD.

Few years passed by, Ding Dong Ding Dong, KPSCB stumbled along.
It still lacks a compelling growth story, it still does not have moat.
However, if you study the chart carefully, you will notice that KPSCB has moved on to a higher trading band. It is no more in the 35 sen band, it is now trading at the 45 sen band.
Not a big deal, but I think beats putting money in FD (the stock crossed 60 sen in several instances). Afterall, this is not the end of the story yet, maybe in the not too distant future, major shareholder will privatize the company at 80 sen ?     

(Pros)  As Driftwood is not particular about short term visibility and does not aim for mouth watering return (doesn't mean that it won't get mouth watering return), it has a wider range of stocks to choose from.
(Note : this doesn't mean that Driftwood "apa pun sapu". They only buy stocks with reasonable gearing, cashflow and PER).
Due to diversification, Driftwood experiences less stress. Even if a company announces a lousy set of result, Driftwood will not feel the pinch as much as Angler (as it only affects a small part of its portoflio). It just sits it out.

(Cons)  By placing big bets on several stocks, Angler will sometime reap delighting financial return if things work out well.
Due to diversification, Driftwood is unlikely to enjoy the kick of huge portfolio upside in a particular year, even though beating FD is usually not a problem. 

4. Surf Rider

Angler tries to look into the future. Driftwood is of the view that it can thrive without knowing too much about the future (take care of the downside and the upside will take care of itself).

Surf Rider does not predict the future. For them, THE FUTURE IS ALREADY HERE.

In my opinion, there are several famous Surf Riders in i3 - Ooi Teik Bee, Rosmah, Er Kong Seng (list not exhaustive).

Surf Riders buy stocks based on fundamentals (usually PER). However, they don't waste time trying to discover hidden gems. They go for stocks that have proven profit track record. They are comfortable jumping in even though the stock's price had gone up quite a fair bit.

They are not interested to sit there waiting for fish to bite, they prefer to jump into the ocean to ride the waves.

Many of these Surf Riders had done well. I hope one day I can become a professional Surf Rider as well.

Examples of Surf Riders Stocks 
Poh Huat, Latitude, Lii Hen, Focus Lumber, Heng Huat Resources, SAM Engineering, and many many others.

(Pros)  Shorter waiting period and less risk of disappointment as the companies are already thriving.

(Cons)  Misses out on the first cut typically enjoyed by early bird Angler.     

5. Concluding Remarks

Of all the three methods discussed above, which one is the most superior ? 

It is actually a false choice. None of the three is more superior than the others.

You have to decide which one is suitable for you based on your own comfort level.

As a matter of fact, it is not a bad idea to have a combination of three. I am more inclined towards being an Angler. I enjoy the thrill of discovery and the rewards that it brings.

However, occassionally I surf as well, trading Poh Huat and SAM when they are going strong.

There are no best method. Black cat, white cat, can catch mice is good cat.

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