Value Investing in Singapore - Your 2020 Guide
For Value Investors Who Want To Navigate Today's Markets Successfully and Profitably
Only principle in Value Investing is; "Buy Low, Sell High".
But yea right...its easier said than done!
While the investing superstars (ie Warren Buffett) make millions with it, we are left struggling to make it work for us.
This guide was created for you, the individual investor who wants to grow your wealth through investing.
It'll help you crack the puzzle of "Buy High, Sell Low".
If you don't have the time to read everything now, just click the link below to download this entire guide immediately. It's yours:
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Or, continue for a complete introduction to Value Investing from 5 practical Value Investing Strategies to common terms that you should know as a Value Investor and much more.
This guide is a compilation of the knowledge and wisdom from various iconic and successful value investors.
Enough small talk, let's get started!
First up, a quick glance of the exciting information to come in this extensive Value Investing Guide:
To protect ourselves, and our readers...you! All information in this guide is compiled for educational purposes. They do NOT constitute to finance advance.
What is Value Investing?
Definition of Value Investing:
Value Investing is an investment strategy where investors aim to invest in stocks that are deemed to be "undervalued" (aka under-priced) by the market.
Value investors have to master 2 skills in order to generate profits in the stock market
#1 - Stock Analysis & Valuation
Through stock analysis and valuation, value investors will investigate and determine the intrinsic or true value of a stock.
#2 - Buy Low, Sell High
Using the value derived from Skill #1, value investors will be able to:
- BUY in a stock when its price is BELOW its intrinsic value
- SELL when its price is ABOVE its intrinsic value.
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Value Investing: The Genesis
The concept of value investing was originally created by Graham and Dodd. Since then, many value investing methods have been created and tested by investors around the world.
In this short segment, we'll take a look at the genesis and evolution of Value Investing. This will help us to understand why Value Investing works, and leads into the next section that takes a swing at the biggest myth in Value Investing today.
The Birth of Value Investing
Value Investing was created in the 1920s by Benjamin Graham and David Dodd and explored in their book, Security Analysis. You can read the entire history of Value Investing here.
It was revolutionary when proposed by Graham and Dodd as investors in the 1920s were selecting stocks mostly by speculation. Graham and Dodd provided methods to research the value of a company. Graham also shares his investing strategies in his subsequent book, The Intelligent Investor.
Over the years, value investing had been learnt, practiced and modified by many distinguished investors such as Warren Buffett.
The Popularisation of Value Investing
Warren Buffett is known as one of the richest men who had made his fortunes from investing. (Interesting facts: The moment when Warren Buffett Became Famous and Warren Buffett’s Journey to Riches)
Because of his reputation, many investors have taken an interest in Value Investing. As a result, many have written best-selling books on Warren Buffett and his investing philosophy.
However, it is interesting to note that most of these books were not endorsed nor written by Warren Buffett himself. Despite having this much information around, no one is sure of the exact strategy that Warren Buffett uses.
What we can be sure of is that he has modified his investing strategies from his days under Benjamin Graham. And he admits this directly as he shares about his experience in the 2014 Berkshire Hathaway Shareholders letters:
from 2014 Berkshire Hathaway Shareholders Letters
My cigar-butt strategy worked very well while I was managing small sums. Indeed, the many dozens of free puffs I obtained in the 1950s made that decade by far the best of my life for both relative and absolute investment performance.
Even then, however, I made a few exceptions to cigar butts, the most important being GEICO. Thanks to a 1951 conversation I had with Lorimer Davidson, a wonderful man who later became CEO of the company, I learned that GEICO was a terrific business and promptly put 65% of my $9,800 net worth into its shares. Most of my gains in those early years, though, came from investments in mediocre companies that traded at bargain prices. Ben Graham had taught me that technique, and it worked.
But a major weakness in this approach gradually became apparent:
Cigar-butt investing was scalable only to a point. With large sums, it would never work well.
Why You Should Not Be Trying To Invest Like Warren Buffett
Warren Buffett has NEVER encouraged investors to invest like him. Neither has he written any official book about investing. The only literature he has written are the shareholders letters that Berkshire Hathaway publishes annually.
This is our warning to all who are still trying to invest like Warren Buffett.
As Warren Buffett’s capital grew, he realised that he had to modify his investing strategy to suit his capital size. Around the same time, he got to know Charlie Munger, his current partner at Berkshire Hathaway.
Charlie Munger is a smart investor who studies the market. Under his influence, Warren Buffett’s investing strategy shifted towards that of Philip Fisher’s.
You can watch this video where Alvin explains the story of Value Investing:
Who is Philip Fisher?
The author of another famous investment book, “Common Stocks and Uncommon Profits”, Fisher is an influential investor of his time.
Unlike Benjamin Graham who looks for a stocks that are highly discounted on the stock market, Fisher would invest in stocks which he thinks are going to be way more valuable in the future.
Here’s a simple example.
Imagine if you could invest in a big company like Facebook before it was well known.
If you were following Benjamin Graham’s investing philosophy, you would not invest in Facebook because its assets are not ‘valuable’ in your eyes.
If you were following Philip Fisher’s investing philosophy, you might see that it has a potential to grow in the future as more people are open to using digital technology to connect, and the advertising revenue has been increasing. Hence, you would likely invest in Facebook.
That being said, you will be taking a huge risk because if Facebook didn’t perform up to expectation, you would lose part of your investment capital.
Instead of looking at growth stocks and projecting their value into the future, Benjamin Graham looks at stocks that are already trading cheaper than the value today.
Warren Buffett’s advice to the small value investors
Don’t lose hope yet.
Because Warren Buffett did share how he would invest if he were a retail investor like us. He shared this key information in a Berkshire Hathaway shareholder meeting. You can watch the video here.
Alvin had decoded Warren Buffett’s reply in this article: “How Would Warren Buffett Invest If He Were You” or watch the video explanation by Alvin here: “How Would Warren Buffett Invest With Less Money”
These are the 3 key points that Alvin had picked up:
#1) Buffett would pick Graham type stocks:
“If I were working with small sum, I certainly would be much more inclined to look among, what you might call the classic Graham stocks."
Buffett acknowledged that he would be more likely to invest in Benjamin Graham’s stock picking principles. These stocks tend to be small companies, in unsexy businesses and may even have problems attached. This is a far cry from the big, glamorous companies with a competitive advantage which Buffett was known for investing in.
#2) Buffett would have more advantage:
(as a small investor)
“I would be doing far better percentage wise if I am working with small sums, there are just way too many opportunities.”
The reason to use Graham’s approach was that Buffett would be able to get a higher percentage gain, than he would if he stuck with the big companies he usually invests in. There are a lot more small companies he could buy and make money. But he cannot efficiently invest in small companies when his capital became much larger.
#3) Buffett would diversify across many stocks:
“I bought a large number of stocks in small amounts, in companies whose names I couldn’t pronounce. But the stocks as a group were so cheap, you have to make money out of it, it was Graham’s kind of stocks.”
Graham’s principle was to invest small amounts in many companies. It doesn’t matter what businesses they are in as you do not need to do in-depth research. In Buffett’s words, he didn’t even know how to pronounce the names, lest to say what the companies do. Due to a large number of stocks, it no longer matters if a few of these companies eventually go bust, but there will be some winners that would more than cover the losses. As a group, or as a portfolio of stocks, it would be an overall gain for the Graham investor.
Since Graham and Fisher, there have been various other forms of Value Investing Strategies and philosophy. We will look at some of these in the Value Investing Strategies section later.
But first up, let’s cover the fundamentals of Value Investing in the next three sections.
2 Approaches to Value Investing
Not many people are aware of the existence of the two approaches to Value Investing.
Most investors understand the qualitative method, but few have heard about the quantitative method.
It isn't the fault of investors but rather, the success of Warren Buffett that puts the qualitative approach to the fore. Alvin wrote about investing in assets versus investing in earnings previously, this section goes deeper into that discussion.
Benjamin Graham coined the terms "Qualitative" and "Quantitative" approach to investing in his book, "The Intelligent Investor". We quote;
The Intelligent Investor
Our statement that the current price reflects both known facts and future expectations were intended to emphasise the double basis for market valuations. Corresponding with these two kinds of value elements are two basically different approaches to security analysis. To be sure, every competent analyst looks forward to the future rather than backward to the past, and he realizes that his work will prove good or bad depending on what will happen and not on what has happened. Nevertheless, the future itself can be approached in two different ways, which may be called the method of prediction (or projection) and the way of protection.
Those who emphasise prediction will endeavour to anticipate fairly accurately just what the company will accomplish in future years - in particular, whether earnings will show pronounced and persistent growth. These conclusions may be based on a careful study of such factors as supply and demand in the industry - or volume, price, and costs - or else they may be derived from a naive projection of the line of past growth into the future. If these authorities are convinced that the relative long-term prospects are unusually favourable, they will almost always recommend the stock for purchase without paying too much regard to the level at which it is selling...
By contrast, those who emphasise protection are always concerned with the price of the issue at the time of the study. Their main effort is to assure themselves of a substantial margin of indicated present value above the market price - which margin could absorb unfavourable developments in the future. Therefore, it is not so necessary for them to be enthusiastic over the company's long-run prospects as it is to be reasonably confident that the enterprise will get along.
The first or predictive approach could also be called the qualitative approach, since it emphasises prospects, management, and other non-measurable, albeit highly important, factors that go under the heading of quality. The second approach which is more protective is the quantitative or statistical approach, since it emphasises the measurable relationships between selling price and earnings, assets, dividends, and so forth."
Qualitative Value Investing
- The certainty with which the long-term economic characteristics of the business can be evaluated;
- The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;
- The certainty with which management can be counted on to channel the reward from the business to the shareholders rather than to itself;
- The purchase price of the business;
- The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return.
Such evaluations definitely require more guesswork, and most people will fail terribly at it. Warren Buffett has a knack of getting it right in the businesses he understands. But most retail investors are not Warren Buffett. We do not have his skills and insights to project the future with a certain degree of certainty.
Even our highly intelligent and knowledgeable financial analysts aren’t able to do it well enough.
Without a doubt, the future returns are high with the qualitative approach. However, there is no point fantasising about mouth-watering returns if we cannot do it accurately enough.
It will often backfire with disappointing returns, even worse than the stock index returns.
Quantitative Value Investing
Quantitative approach entails the analysis of the current state of the business.
While qualitative approach buys a business less than what it is worth in the future, quantitative approach pays less than what the business is worth today.
This requires the use of financial ratios such as Price-to-Book and Price-to-Earnings to evaluate the strength of the company.
Quantitaive approach’s risk management centralises on margin of safety as well as diversification.
- Buy as low as possible below the value of the company.
- Diversify into many undervalued stocks.
Below is a list of rules that Walter Schloss advocated (not exhaustive, he has more rules than these):
- Diversify into many stocks
- Stocks trading below book value
- Stocks with little to no debt
- Stocks trading at new price lows
Most of these rules are quantifiable. They are less subjective than the qualitative approach.
Quantitative value investing also doesn’t require the investor to know a company deeply to ascertain her future prospects.
The analysis of a company can be completed within minutes just by the numbers. Hence, the quantitative approach suits the investor with a full-time job, and he is unable to keep up with in-depth company research and developments.
Qualitative or Quantitative?
As authors of this guide, we are biased towards the quantitative approach.
It is our opinion that Quantitative Investing is more suited to investors who have not much time and experience, and yet it can yield decent returns of 12-15% per annum.
You will find that the financial ratios and value investing strategies that we share later in this guide are all tilted towards Quantitative analysis of Value Stocks. This is because the quantitative approach allows us to transfer the ability of profitable stock analysis to others. This is more difficult when it comes to the qualitative approach.
Of course, there is nothing wrong if an investor wish to pursue the qualitative approach and aim for a higher return than a quantitative approach could. However, the success rate of the former isn’t high.
Value Investing: How It Works
In A Nutshell
In short, the aim of Value Investors is to: “Buy Low, Sell High”.
Most people would have heard of this age old advice. But implementing it is not as straightforward. And most do this instead:
These are the two key questions that every investor seek to answer:
- “What price is considered low?”
- “What price is considered high?”
In value investing, we use the ‘intrinsic value’ to determine if a stock price is considered ‘high’ or ‘low’.
Ultimately, this is what we want to do:
We want to identify the intrinsic value or true value of a stock. And then, buy when the stock price is below the intrinsic value and sell when the stock price goes above its intrinsic value.
The bigger the difference between the buy and sell points, the better because this difference is your return on investment.
In the next section, we share several methods that value investors use to determine the intrinsic value of a stock.
5 Characteristics of Value Investing
There are several characteristics or assumptions that Value Investors will have to understand and make.
These characteristics help to explain why certain stocks are said to be undervalued while others are not. Here, we list 5 key characteristics that value investors should know.
i) Irrational Market
We believe that the market is made up of irrational investors. Hence, prices on the stock market do not accurately reflect the true value of a stock.
A stock may be under-priced or overpriced mainly due to its investors’ sentiments.
And this creates opportunities for value investors who look to invest in undervalued stocks.
ii) Intrinsic Value
As value investors, we believe that every stock has its intrinsic value. This is the value of the stock, and it is not related to the price that it is currently trading at.
We aim to look for stocks that are trading at a price below its intrinsic value. Pretty much like going into a store to look for items sold at a bargain.
If our research and analysis are done right, there is a chance for the stock price to rise to its intrinsic value over time.
iii) Margin of Safety
There is risk involved in any type of investing. It is no different in Value Investing.
No matter how in-depth your analysis is, you can never guarantee that a stock’s price will move in the way you’d predict it to.
Because of point #1, some stocks’ true value will just never get realised on the stock market.
Hence to minimise our potential loss, value investors always look for a margin of safety; which is determined by the difference between its intrinsic value and its current price in the market.
Basically, we want a wider gap between the stock’s intrinsic value and its current price in the market. For example, Benjamin Graham was known to only invest in stocks that were trading at 2/3 of their intrinsic value.
iv) Time and Effort
All value investors who want to do well in value investing must be prepared to spend some time and effort.
Many value investors make use of fundamental factors to evaluate stocks, and there are little to no good fundamental stock screeners available. Even with a stock screener, value investors would still need to carry out their own due diligence to look beyond the numbers.
The market is irrational. It could take a while for a stock’s true value to be realised in the stock market. A value investor may need to wait for months or years before the stock can realise its true value for a positive return.
The waiting time for a positive ROI is something that most average investors find difficult to adhere to.
As mentioned, the market is irrational, and it is driven by investors’ sentiments. This means that the price you see on the stock market and the performance of a stock in the market reflect how investors feel about the stock.
Value investors tend not to make investment decisions according to what everyone else is doing. In fact, we believe that you have to be a contrarian to succeed as a value investor.
And it is not easy.
To buy when the rest of the market is selling (i.e. when the market is plummeting), or to sell when the rest of the market is buying (i.e. when the market is booming)
This process can be eased if you have a strategy with clear buying and selling guidelines.
Value Investing: The Real Process
Value investing is not a bed of roses. It is not likely for a stock price to immediately surge the moment you invest in it. Some stocks take years to realise their true value.
Here’s are case studies of our experience in value investing. You can find more of these case studies at https://www.drwealth.com/case-studies/.
[Case Study] TSH (SGX:574)
Buy stocks cheap and sell them dear.
How difficult can it be?
But simple doesn’t mean it's easy.
Value stocks are very uncomfortable to buy. An unprepared investor would have a lot of self-doubt and might lose confidence when bad events arise.
A case in point revolves around TSH, a stock listed on the Catalist (the secondary board of the SGX).
TSH’s market capitalisation was about S$30 million when we were first looking at the stock in 2014. It was a very small cap stock which most professionals would not even take a glance at it.
Though a small company, TSH had 4 business streams.
Homeland security arm served the Defence sector, disposing ammunition and constructing civil defence shelters. This business segment also supplied and choreographed fireworks display.
Consumer electronics arm designed headphones, earphones, speakers and accessories for mobile phones and tablets. These products were made in China and sold in the U.S. through a distributor.
The property arm developed properties in Australia.
Lastly, the consulting arm organised sports event such as POSB PAssion Run for Kids, PAssion Fun Around the Bay, Home TeamNS-New Balance REAL Run, Orange Ribbon Walk, Run for Hope, Green Corridor Run, Jardine’s MINDSET Challenge (Vertical Marathon), and Love Your Heart Run.
It appeared to me that the Company was not focused. A small company shouldn’t be doing so many unrelated businesses because there weren’t enough resources to do everything well.
We practise a version of value investing known as the Conservative Net Asset Value (CNAV) strategy. The approach focused on buying companies below their asset value, as oppose to valuing companies based on their earnings.
Slightly more than 2 years ago, the Net Asset Value (NAV) of TSH was $44.6m. The assets included $23.8m cash and a freehold building worth $8.8m.
Market capitalisation was only $30m, less than the NAV of $44.6m. An undervalued stock indeed.
For the graduates of our course, you would understand if TSH had a CNAV2 discount of 19% and a POF Score of 3.
We bought some TSH shares at S$0.124 on 31 Jul 2014.
A String Of Negative Events
An undervalued stock doesn’t mean it can only go up in price.
On the contrary, the share price fell after we have invested in TSH.
We had a paper loss of 30% as the share price dropped to $0.086.
What happened? What should we do?
Some investors may panic. Some may be in denial.
We actually added our position in TSH on 15 Feb 2015 because the assets were still intact and the shares just got cheaper. Moreover, the CEO of TSH added a large position in Dec 2014. We do not usually average down though, and we believe most investors shouldn’t do it.
The annual report for FY14 was released on Apr 2015. Operating cash flow was negative, and we should have cut loss given our quantitative criteria. We analysed the situation and decided not to because the operating cash flow was impacted by a one-off large purchase of development property. Without this, the operating cash flow would remain positive.
On 4 Aug 2015, TSH invested $5m into an oil & gas company listed on the Bursa Malaysia. The Company was Hibiscus. It was a bad timing as we know that the crude oil prices tumbled in end-2015.
It was not easy for most investors to swallow one bad news after another. It would be reasonable to start thinking that you have made a mistake and indulge in self-blame for not identifying the risks in advance. How many investors would have given up hopes on the stock and suffer in silence?
The series of events are plotted on the following stock chart after the investment was made.
The Change Of Fortune
Somehow, all of a sudden, the management seemed to be enlightened and took a series of actions that benefitted the shareholders.
On 23 Dec 2015, the management sold away all the Australian properties and decided to close down this business segment. They made a small loss from this.
This kicked off the liquidation of other businesses and assets of TSH, unlocking value for the shareholders. The management declared a $0.03 dividend per share, which was a 27% dividend yield based on our average buy price of $0.108.
Of note, the homeland security business was sold to the CEO of TSH and the consumer electronics was sold to a third party. The freehold building was sold for $16m at the prevailing market value. The gain was around $7m.
TSH then became a cash company without any business operations. The management declared a special dividend and capital reduction of $0.1232 per share. This would return 82% of the NAV to the shareholders. With such a large distribution, I believe it is unlikely the management is going to buy a business and stay listed. Eventually, all the money would be returned to the shareholders.
The revised NAV per share was S$0.15, and we decided to sell off at this price with a total percentage gain of 67%.
Below is the summary of asset disposal and value unlocking sequence:
It's true that not all stocks would turn out as well as TSH. Some may become a permanent loss. Hence, we must manage our portfolio properly – diversify sufficiently, cut loss when necessary. Having a time stop to exit is also important to avoid value traps.
[Case Study] Chemical Industries (SGX:C05)
Read it now: How we made 100% gain on a falling business
If you thought TSH was an exciting rollercoaster ride, this next case study will give you a deeper insight into being a real value investor.
Similar to TSH, Chemical Industries gave us an emotional ride as they churn out pieces of negative news after we had invested.
Unlike TSH, with each negative news, the stock price of Chemical Industries went up.
It's a great case study to remind ourselves that we can never predict what happens in the stock market. You can read it here: Chemical Industries: How we made a 100% gain on a falling business.
As a value investor, you have to go against the herd. Most of the really cheap stocks are small caps, and many would find them uncomfortable to buy. It is also counter-intuitive to buy into problems. But it is the presence of problems that resulted in cheap stock prices.
To make it even tougher, the stock price may continue to disappoint after you have invested in a value stock and result in a huge loss, albeit on paper. It makes you doubt your investment position.
You need a lot of confidence and conviction to stick to your investment process. One day, things might just turn rosy and allow you to sell for a handsome profit.
Why are these case studies so negative?
As educators and investors ourselves, we believe in warning fellow investors of the true journey of investing.
We don't believe in over-promising high returns that are not backed by our own results. Instead, we show the ugly truth of investing and want our students to come in with the right expectations.
There are many beautiful investing stories out there, you will definitely encounter some of them as you learn about investing.
We want to be balanced and objective so we're showing the painful emotional journey that all investors have to be prepared to go through here.
Value Investing: How to Get Started?
Now that you have a basic understanding of how Value Investing works, all that is left is to take action and start looking for undervalued stocks in the market.
The Most Common Mistake of an average Investor
In investing, there are many strategies that work.
Some of these strategies work better in certain market conditions. Some strategies work better for certain types of stocks. (i.e. the CNAV strategy is efficient at finding undervalued stocks)
Most investors find themselves shopping for strategies from various mentors. And at the end of the day, they invest in a bunch of stocks that were analysed using different strategies.
Their portfolio ends up like a messy basket of stocks.
And when the market drops as a whole, they are not able to determine which stocks to sell or keep.
#1 rule of thumb
When investing in stocks, always make sure that your buying and selling decisions are made using the same strategy.
Because the same stock can appear to have ‘Great Potential” using strategy A while appear to be a “Bad buy” using Strategy B if the philosophies behind these 2 strategies are different.
Learn a complete value investing strategy and stick to it
The CNAV strategy that we use is just one of many value investing strategies that work. Dr Wealth does not believe in using leverage as it increases risk as well.
Instead, we aim to become functional ‘part-time’ investors who can pick undervalued stocks and grow our portfolio at a consistent rate of 10-15% every year.
This means that we free up a lot of our time – since there is no need to monitor the stock market constantly - we’re then able to go on with our daily lives.
Thus far, the Conservative Net Asset Value (CNAV) strategy (along with 2 other strategies) have allowed us to beat the market since 2014 by tapping into stocks with Value and Size ‘factors’.
Other than Value, we are also looking out for dividend stocks with the 'Profitability' factor and ETFs that allow us to tap into the 'Momentum' factor. We've compiled 10+ years of investing experience into a single and easy to understand guide here: The Complete Guide to Factor-Based Investing.
If you learn better at a live class, with a trainer, who can break down everything clearly for you, explore our FREE Factor Based Investing Introductory Course.
It doesn’t cost thousands of dollars to gain the ability to invest successfully. In fact, the Factor Based Investing Introductory Course is free and was created to give new beginners an overview of successful value investing and investing in general. Commit to your education, free up 2.5 hours and kick start your investing journey now. Reserve a seat.