Beauty ( Value ) Is In The Eye Of Beholder

 As a value investor, we focus on investing in stocks or any other assets that we believe are undervalued relative to their intrinsic or fundamental value. This approach to investing is often associated with the principles of gurus like Benjamin Graham and Warren Buffett. We often use fundamental analysis with a margin of safety, looking at ratios or figures like PE, PB, EPS Growth, Cash flow, etc. We emphasize investing in the long term, avoiding speculation, and having a diversified portfolio. We also understand that value investing requires patience and discipline. Investors may need to wait for the market to recognize the true value of their investments, which can take time, and recognize the ultimate force of “reversion to mean”.

It's important to note that value investing is a well-established investment strategy, but it is not without risks. It can take time for undervalued assets to appreciate and realize their value, and there is always the possibility that the market may never fully recognize their true worth. Like any investment approach, it's essential to do your research, stay informed, and make informed decisions based on your individual financial goals and risk tolerance.

Like any other scientific research, we need to understand that stock valuation is “subjective “not “scientific research “, it is not without its challenges and problems. Some of the key issues and problems associated with stock valuation like market sentiment, complexity and sudden or unpredictable events (black-swan events), market efficiency, and biases like “Confirmation Bias, Over-confidence, Anchoring Bias, Recency Bias, Herd Mentality, etc.”.

As a value investor, being aware of these biases and remaining disciplined in your valuation process is essential. It's also wise to use a combination of valuation methods to cross-check your results and account for inherent uncertainties. Additionally, regularly reviewing and updating your valuations in response to changing market conditions and company performance is crucial to successful value investing.

If you are interested in stock valuation and would like to learn more about this topic, I would strongly recommend his books or videos from Prof. Aswath Damodaran, he is a professor of finance at the Stern School of Business at New York University. He holds a Ph.D. in Finance from the University of California, Los Angeles, and an MBA from the Indian Institute of Management. He is an expert in the field of valuation, widely recognized as “the dean of valuation”, and has authored numerous books, academic articles, and data sets on the principles of valuation to help investors understand the subject.

 

 

Aswath Damodaran – Laws of Valuation: Revealing the Myths and Misconceptions - Nordic Business Forum

Aswath Damodaran: The DARK SIDE Of Valuation (Must Watch Lecture!)

 

《每个人心中都有一把尺》All Valuation is Biased !!

“You almost never start valuing a company or stock with a blank slate. All too often, your view on a company or stock is formed before you start inputting the numbers into the model and metrics that you use, and not surprisingly, your conclusions tend to reflect your biases. The bias in the process starts with the companies you choose to value. 

These choices are not random, it may be that you have read something in the press (good or bad) about the company or heard from a talking head that a particular company was under or overvalued. It continues when you collect the information you need to value the company. The annual report and other financial statements include not only the accounting numbers but also management discussion of performance, often putting the best possible spin on the number. “Explained Prof Aswath Damodaran in his book.

 

While valuation is important, don't rely solely on low P/E, PB ratios, High Dividend Yield, or any other metrics that might have a “shortfall” if we just look at single or one aspect of financial ratio analysis. To avoid the “Value Trap “, we should focus on the quality of the business, its competitive advantages, and its long-term prospects and ability to generate future cash flow.

 

A value trap is a situation in stock valuation where an investor is attracted to a stock because it appears to be undervalued based on traditional valuation metrics, but the stock's low price is actually a result of fundamental problems or deteriorating conditions within the company. In other words, it's a value stock that turns out to be a poor investment rather than a hidden gem.

 

Is Dividend Investing a Myth and Dangerous?

 

Dividend: “Please don’t shoot, I am just a messenger!”

 

Oh! poor “Dividend”, always kena blamed when companies’ business turns south and share prices  keeps dropping not even enough to cover the dividend received by investors. Sometimes or quite often we see this kind of “narrative” that blames “dividend” as “dangerous”. As we know, the dividend is part of the investment return but not all, we should look at our investment returns in total like Total Shareholder  Return  (T.S.R)i.e., Capital gain/ loss + Dividend  yield + Share Buyback  yield.

As mentioned above, we should focus on the quality of the business, its competitive advantages, its long-term prospects, and its ability to generate future cash flow, not just the dividend yield itself.

 

So, please don’t blame the “dividend “if the share price of the company you invested in drops because of deteriorating business conditions within the companies or fundamental change due to competition or technological advancements which lead to “disruption”. Ultimately, we should continue to look for companies which be able to generate decent or increasing future cash flow. For me, looking at cash flow is more important (than just earning or book value) as companies can use the cash to pay dividends or do the share buyback if there is no or lack of investment opportunities.

A tech or growth company like Apple/ Alphabet or Microsoft is using the cash to do the share buyback even if they don’t or just pay minimal dividends, which leads to an appreciation in share price (in line with the decreasing outstanding share and increase in EPS). Shareholders will see their portfolio value increase instead of receiving the cash dividend.

Therefore, for me, regardless of “dividend” or “growth” investing, it is important that the companies we invest in be able to generate a healthy and decent cash flow in the long run.

It’s the Cash Flow (Economy), Stupid !

 

Sorry, it doesn’t mean to be offensive or derogatory by using this “stupid” word, but I was just borrowing the phrase coined by James Carville in 1992 when he was advising Bill Clinton in his successful run for the White House.

In 1992, the US was experiencing an economic recession, and the incumbent president, George HW Bush, was perceived as out of touch with the needs of ordinary Americans.

Carville told campaign staffers to hammer on the importance of the economy at every chance they got – he even went so far as to hang a sign in campaign headquarters reading, in part, “The economy, stupid.”

 

Free Cash Flow: Free Is Always Best <source: investopedia.com>

The best things in life are free, and that holds true for cash flow. Smart investors love companies that produce plenty of free cash flow (FCF). It signals a company's ability to pay down debt, pay dividends, buy back stock, and facilitate the growth of the business. However, while free cash flow is a great gauge of corporate health, it does have its limits and is not immune to accounting trickery.

What is free cash flow and why is it important? Example and formula <source: quickbooks. intuit.com>

Cheers!

 

STE

PS:

 

SG REIT Regression Chart

As we know, Singapore investors like to invest in REITs as they pay regular dividends as passive income, but the sectors have come under intense pressure since last year when FED started to increase the interest rate to close to 5%. This high-interest rate environment has been tough for REITs as many have seen the finance cost increase a lot in recent quarterly result announcements.

As REITs tend to be a “highly leveraged” asset class, with rising interest rates, they have to pay more on their borrowing which eventually affects their dividend payout. As such, it continues to face sell-down pressure as investors are comparing the DPU yield vs Risk-Free Rate or short-term T-Bills. Ultimately, REITs would have to offer a much more attractive payout/ yield to compete with fixed-income investment, under such a situation, the price would have to adjust downward if they can’t increase the DPU.

As you can see from the above chart, the price/index has gone down to a level never seen in the past 20 years, except once in 2008/09 (Global Finance Crisis) which is the worst.

As I mentioned before, the income or cash flow for REITs is quite “predictable” and stable, we shouldn’t expect many surprises or a bumpy revenue/ profit, the valuation could be quite straightforward as compared to the risk-free rate, a 2.5-3.5% risk premium over RFR is reasonable.

For the past 15 years after GFC, we have been in an exceptional situation of ultra-low or negative rate environment, this made us think that 2-3 % of equity (REIT) risk premium is normal, and investors are willing to pay close to $3 for Keppel DC REIT with 3+% of DPU Yield. Therefore, I think it is quite reasonable to accept or buy KDC at the current price level, with a similar level of ERP (Equity risk premium) and better risk-reward where the short-term rate already moves to a more normal level.

It's important to note that while rising interest rates can impact REITs, they are not the sole determinant of their performance. Other factors, such as the overall economic environment, property-specific factors, and the supply and demand dynamics in the real estate market, also play crucial roles. Additionally, different sectors of the REIT market may be affected differently by interest rate movements, so it's essential to consider the specific type of REIT when evaluating its sensitivity to interest rates.

 I still believe that REITs could be a good “hedge” against inflation in the long run, not to forget that the rental is “Sticky” and we have seen some of the REITs be able to increase the rental with double digits “rental reversion”.  Those interested in REITs at this point in time should carefully evaluate the composition (assets) of the REIT portfolio, their debt exposure, and their future rental income growth potential. Additionally, the performance of individual REITs can vary based on their specific property holdings and management strategies.

Proper position sizing and diversification are key factors in managing RISK and capitalizing on opportunities in the REIT market during this time of high inflation and interest rates.