One may be smart; one may be experienced, but one may still fall into the same trap(s) over and over again.
In the previous article on the Value Investing Summit (VIS) 2017, we talked about what it takes to unearth a “hidden champion”. In this article, we will be sharing three mistakes that investors tend to make, as highlighted by 8I Chief Investment Officer Kee Koon Boon during his presentation.
Mistake 1: Being lazy
One of the biggest mistakes made by investors, said Koon Boon, is to rashly bet on rough ideas and trends instead of doing their research on individual picks.
Remember what happened during the US elections last year? Experts and economists had expected the stock market to crash upon a Trump victory, and Koon Boon noticed that many had invested in high-risk bearish markets when it was getting clearer as the vote counting progressed that Donald Trump would beat Hillary Clinton.
However, what they did not expect was that the US market recovered swiftly and hit record highs.
“That was an act of speculation because they were betting on a macro outcome without understanding the underlying asset quality (of what they had invested in),” remarked Koon Boon. “In other words, they were betting on directional movements without proper due diligence and analyses of the underlying asset quality.”
The same applies to other scenarios, be it concept stocks (e.g. China or Myanmar concept stocks), thematic stocks (e.g. energy, food, etc), or anything that is trending and popular—taking the short-cut approach might not get one anywhere.
“When investors make quick grabs at what is popular or fashionable, they would be at the mercy of the market manipulators, because the latter will always know how to create products that are “popular”…so you need to really understand what makes the business model worth buying, for example, is it scalable, resilient, or have good management quality, etc,” said Koon Boon.
Mistake 2: Being “cheapskate”
Investors who are too committed to the idea of “buying low and selling high” may end up committing the “error of omission”, i.e. missing out a good stock as they deem it “too expensive” to buy.
But here is what Warren Buffett had said: “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
In fact, if Buffett had been more obsessed with getting a cheap deal, he might have missed out buying See’s Candies, which his investment partner Charlie Munger later described as “the first high-quality business we ever bought”.
Koon Boon also admitted that even 8I was not infallible in this respect, as they had missed out buying Lion Corp (4912.T), thinking that it was too pricey after the first look. This is how the stock performed over the past two years…
When it comes to deciding if a stock is affordable or worth buying, Koon Boon advises investors to not just look at how low the price-earnings (P/E) ratio is, but factor in the return on equity (ROE) as well.
“For instance, if a stock has a P/E of 15 times but an ROE of 30 percent, it is not considered expensive as PE/ROE is 0.5 times. On the other hand, if P/E is 5 times but ROE is 1 percent, PE/ROE is as high as 5. We (typically) want that ratio to be less than 1,” he said.
Mistake 3: Being gullible
While we might think that value investing is surely safer than pure technical trading as the former is backed by company research, Koon Boon pointed out the alarming fact that value investing does not save investors from falling prey to companies engaging in accounting fraud.
“In fact, in the Asian context, value investing can make it even more dangerous,” he said.
He cited the example of China Environment Ltd, which had looked fabulous as a value stock with its high-profit margin, high ROE, low P/E and low price-to-book ratio, but it was later revealed that China Environment was a “classic fraud stock” that made money through “pump and dump” schemes.
Similarly, Koon Boon warned that Singapore companies with brand visibility can actually dump their expenses and debt into unconsolidated overseas firms such that the figures would still look attractive in their listed company’s report.
So how do investors spot something fishy? Koon Boon suggested that a quick way is to check for an unsecured loan in the footnotes of the company’s interim report.
It could be as simple as a 15-20 minute search for keywords such as “unsecured”, “interest-free”, “other receivables”, “other payables”, “amount due from/to related parties and directors”, “deferred tax liabilities”, “impairment”, “write-down”, “contingent liabilities” etc.
“You might be very shocked at what you find,” Koon Boon said.
The world of investment is a chaotic one, where it can be difficult to tell apart the “good” from the “evil”, but a hidden champion is a force of good in a turbulent time, he added.
At the end of the day, the key lesson is to look beyond the surface and stereotypes to fully examine the underlying intention and motivation of companies and their people.
8I Education will be conducting a 1-day complimentary Value Growth Workshop on 11th, 12th or 25th Feb 2017 where you’ll get to learn the applications and possibilities of Value Investing.