Behavioural Finance

Glamour Stocks Vs The Ugliest Of The Ugly

"All that glisters is not gold; Often have you heard that told: Many a man his life has sold But my outside to behold: Gilded tombs do worms enfold Had you been as wise as bold, Your in limbs, in judgment old, Your answer had not been in'scroll'd Fare you well: your suit is cold.' Cold, indeed, and labour lost: Then, farewell, heat and welcome, frost!"

-William Shakespeare

I had to do this.

A quote from William Shakespeare. About how all that glitters is not gold. Or what seems to be gold on the outside may not be gold on the inside and what seems to be gold on the inside may not be readily apparent to others on the outside. The depth of this man's wisdom is timeless and such is William Shakespeare, a man remembered for his profound literary works.

This idea that not all glitters is gold can also be applied to sensible investing. The glamour stocks of today will be the down trodden of tomorrow due to the reversion to mean, a mental model borrowed from statistics.

I would have to say that in a small subset of glamour stocks, the above may not hold true. Some glamour stocks continue to be glamour stocks because of the strong moat which they posess. And this is the realm of Warren Buffet and Charles Munger. From my experience, it is very difficult to spot such opportunities. And even when you find a company that is moat-worthy , how does one determine the price to pay for such a company? That is absolutely the reason why Warren Buffet mentioned that to be successful in investing, one need only find 20 such companies in a single lifetime and sit on it. Personally, i have not reached that utopian situation. I am still working on it. But I have developed my own mental models to deal with this issue but that is beyond the scope of this article for now.


Case Study

Countering The Simple PE Ratio

The simple PE ratio, an extremely basic calculation, is a measure of valuation which is easily comprehensible to many retail investors. It is simply the price per share divided by the earnings per share. One could also take the market capitalisation of equity and divide it by the total net income of the company and get a similar figure.

A PE that is too high is an indication of overvaluation. A PE that is too low may mean undervaluation. But this is not true in every instance. A high PE stock may still be undervalued while a low PE stock may very well be overvalued. The value of a company is dependent on the future cash flows that the company can produce going forward from this point in time to the future. As such it is important to assess the value of a company by looking at things wholistically.

The corporate actions and decisions of management, the sustainability of earnings or the earnings power and the ability of the company to earn a return in excess of market rates of return all have a part to play in determining the value of a company.

A company whose earnings are cyclical may show up as a low PE stock in your screen. If you were to buy that company today, you may have overpaid for the company. Typically, cyclical companies appear cheapest when they are at the peak of their earnings cycle and expensive when they are near the trough of their earnings cycle.

One way to counter this is using a cyclically adjusted price to earnings ratio which adjusts the PE for these ebbs and flows in the earnings of a company.


Charlie Munger

Risk & The Permanent Loss Of Capital

All investors are exposed to risk when investing in any form of asset class, be it equities, bonds or  property. Risk is not this unknowable, esotheric concept that so many amongst us fail to recognise. Risk, according to Warren Buffet, really is defined as the probability of a permanent loss of capital. And taking a lesson from the world's greatest investor, I would think it unwise to define risk in any another manner. Perhaps, an example at this point would suffice to drive home a message on risk.

Company A & Company B

Let us focus on a thought experiment for a moment here. There are 2 companies, Company A and Company B. Company A has little to no debt . Company B however is a highly indebted company with a debt to equity value of more than 200%, decreasing revenue and operating income as a ratio to interest expense has deteriorated in the last couple of years . Company A has a price to book value of 0.7 while Company B has a price to book value of approximately 0.6 as well.

Would you buy Company A or B at this point? Now, bear in mind that Company B gives dividends while Company A also gives dividends. So which company would you buy? So on a dividend basis, let's take it that both companies differ only slightly and these differences are negligible. Since this is a thought experiment, let us simplify things that way.



Qian Hu Reversion To Mean

At some point recently, I looked on interestingly at Qian Hu. At a price of 9 cents, many investors felt uncomfortable with it. Well for one, its profitability had decreased drastically over the last 3 years from 0.39 million to 0.07 million. On a price to earnings basis, investors would have been turned off by Qian Hu, looking instead to blue chips such as SIA,Singtel, Starhub and maybe SPH. SPH by the way is having the time of their life right now. Maybe, I will detail this in another article. Do look out for it.

In another article, I spoke about glamour stocks versus beaten down stocks. This is an apt example of what I was trying to convey. Buying beaten down stocks, if you have the mettle and the stomach for it, may prove more profitable than buying the blue chips, the well known and the well loved by all.

So what happened?


Case Study

Disney’s Star Wars Acquisition Was Brilliant!

Disney's Amazing Purchase

I find it hard to fathom that an idea in someone's mind could blossom into a business empire spanning more than 4 decades. That idea of a quirky universe filled with 17000 characters and a few thousand planets was borne out of the legendary film maker's mind, George Lucas. Like Harry Porter, its success would be considered by any means a positive black swan.

George Lucas's Big Bet

At a point in time when movie executives did not believe in the power of the franchise and its characters, George Lucas took a bet, and a big one at that . In 1973, instead of a pay raise offered to him, he opted to receive $50,000 and all the rights to all the sequels of star wars plus all the rights to the merchandising.

What fascinates me about George Lucas was that he wasn't in it for the money. He was thinking about protecting the creative integrity of his project from what I believe. As I read these articles about George Lucas, it sure reminds me of the "why" that one should stay true to himself and not be a follower merely another has attained success in a particular way. Those values sure do speak to me as a person, as an investor.

Back to George Lucas. Those decisions made a huge dent to his life. As the franchise of star wars grew exponentially, so did the sale of merchandise, earning George Lucas hundreds of millions of dollars. The moral of this short story so far is thus this : Stay true to yourself and express yourself honestly.