How the yield curve forecasts recession

Very steep yield curve - inflation is likely to accelerate
Inverted yield curve - predicts coming recession
When inversion ends and begins to steep again - economic recovery, great time to buy bonds

- Rob Insana , Message of the Markets

Note: this warning sign may have become surpressed under the Fed's artificial low interest rate policy

10 Causes of Major Stock Market Crashes

10 causes of major stock market crashes:

• political events 
• government actions
• war, terrorist attack
• currency crisis
• credit crisis
• debt defaults
• bank failures
• commodity price crisis
• stock crashes in a major market becomes contagious
• technical (flash crashes)

Many of these events cannot be predicted. These events can happen anywhere in the world. Global markets are now highly correlated. Thus, to avoid these black swans with certainty, you'd have to be out of the market most of the time. 

Hence, an investor should stay invested and the safest way to invest is by value investing.

Ten Golden Rules of Equity Investing

Ten Golden Rules of Equity Investing

1. treatment of minority shareholders
2. Remember that companies are about peple not assets
3. Balance sheet strength is crucial
4. Understand what you are buying
5. Be wary of overambition
6. Think long term
7. Benchmarks are measuring devices not portfolio construction tools
8. Take advantage of irrational behaviour
9. Do your own research
10. Focus on growth industries in which it is possible to have a sustainable competitive advantage

Hugh Young, Aberdeen Asset Management

6 Criteria for Selecting Stocks

Dr. Tan Chong Koay's investment philosophy: Be fully invested near the bottom and trimmed near the peak. But should never be fully invested at all times.

Dr. Tan is one of Malaysia's eminent value investor, having managed several award winning funds under his company Pheim Asset Management.

He select stocks based on the following criteria:
1. focused management
2. high earnings growth potential
3. attractive profit margins
4. strong balance sheet with low gearing
5. market leadership in growth industries
6. reasonable valuation

His book Rising Above Financial Storms can be bought from local bookstores.

investment metrics

Fong Siling @ ColdEye 5 Investment metrics:

1. Return on equity, ROE,
2. Cash flows
3. PE ratio
4. Dividend yield and
5. Net tangible asset backing per share, NTA

normalized earnings

For cyclical firms, the easiest solution to the problem of volatile earnings over time and negative earnings in the base period is to normalize earnings. When normalizing earnings for a firm with negative earnings, we are simply trying to answer the question: What would this firm earn in a normal year? Implicit in this statement is the assumption that the current year is not a normal year and that earnings will recover quickly to normal levels. This approach, therefore, is most appropriate for cyclical firms in mature businesses. - Prof Aswath Damodaran

How this can be done (by Jae Jun)

ROE method:

1. Get the past 3 years and TTM ROE ratio
2. Take the average
3. Multiple the average ROE to the latest shareholder’s equity figure from the balance sheet to get the normalized net income
4. Divide by shares outstanding to get normalized earnings

Profit margin method:

1. Get the last three year net margin and TTM
2. Take the average
3. Mutiply the average net margin to the TTM revenue to get normalized net income
4. Divide by shares outstanding to get normalized earnings

5 Warren Buffett quotes to remember

There's a huge difference between the business that grows and requires lots of capital and the business that grows and doesn't require capital.

I look for businesses in which I think I can predict what they're going to look like in ten to fifteen years time.

You pay a very high price in the stock market for a cheery consensus.

We just try to buy businesses  with good-to-superb underlying economics run by honest and able people and buy them at sensible prices.

Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised.

Peter Lynch's strategy for buying mutual funds

1. invest 100% in stocks
2. diversify among capital appreciation, value, quaity growth, emerging growth/small cap, special situation funds
3. put new money into sectors that have lagged the market
4. stik with consistent performance
5. buy closed end funds at price less than NAV
6. country funds - buy when unpopular

Momentum Investing

Buy stocks which fulfill these criteria:

1. Stock is from sector/industry in rotation
2. Strong earnings growth and analyst rating
- earnings growth > 15% over the last 3-5 years
- earnings growth forecast > SP500 & industry growth over the next 3-5 years
-history of earnings surprise
3. positive insider and institutional ownership
4. strong sales growth and high ROE
5. bullish market sentiment
6. stock is near or at buy point (breakout)
7. positive technical indicators


(from Adam Khoo's book)

index investing using SMA

Let's consider 3 methods of investing based on market indices.

We use the 3 years' chart as of Oct 9, 2011 (approximate values used). 14 market indices are used.

A - buy an index when its 30 week simple moving average (SMA) crosses above the 50 week SMA and sell the index when the opposite occurs

B - buy an index when its 50 day SMA crosses above the 200 day SMA and sell the index when the opposite occurs

C - buy an index when its 50 day SMA crosses above the 200 day SMA and sell the index when the opposite occurs but with the 200d SMA turning down

Our benchmark is D, the three year return as of Oct 2011 (approximate).

We see that method B & C have the superior performance compared to A (in green). However both underperform the benchmark for 10 indices (in yellow). This is especially for the emerging markets.

However if we took 4 years instead of 3 years, the results might have been very different. Each method would probably have outperformed the benchmark since they would have avoided the bear market of 2008.

Using method B & C would yield about 10% per annum (including US) over a 3 year period. 4 markets (ASX, TW, Hang Seng and Shanghai) return less than 6% per year! 

Note that if we managed to buy at the exact low and sell at the exact high (our holy grail!) would have return at least 30% per year for most of the markets.

Someone (I forgot who) recommended selling stocks (distribute) when the 30w SMA is below the 50w SMA while buying stocks (accumulate) when the opposite occurs. Based on the results above, I think using the faster moving 50d and 200d SMA would perform slightly better.

However I would also think that selling and buying gradually in such a manner would risk being equivalent to selling and then buying back at the same levels (e.g. sell at 1000, 800, 600 then buy at 600, 800 and 1000.) especially if the index moved sideways in the longer term.

Better of course would be sell mostly in the beginning of the bear and buy mostly at the start of the bull (based on the SMA). The risk to this would be too short bull and bear duration or sideways market in which case the commission will be costly. 

Target price

When is a stock considered cheap and when is it expensive? What is the intrinsic value of a company's stock?

When I first started out, I struggled with this concept. Many investors use different method of finding the intrinsic value. It is actually quite subjective and even Warren Buffett does not reveal how he arrives at the value of a company.

As retail investors, we love to find research reports where the target price is given. However we should beware of how the target price is arrived in most cases.

Most research analysts will give a target value based on the price-to-earnings ratio (PER) of a company. For example, the analyst takes the average PE ratio of the company over a period of time, say over 5 years. Then according to the predicted earnings (eps) at the end of FY13, for example, the target price is arrived. So if the average PE ratio is 15 and eps for FY13 is estimated to be $0.10, then the target price is 15 x $0.10 = $1.50.

We immediately see the potential problem here- the earnings estimate may be too optimistic. Or it may assume a blue sky scenario. If a black swan suddenly emerges, there will be a cut in the earnings estimate, and target price is reduced. You bought the stock last week with a potential 30% upside, suddenly new research report comes out and you are suddenly told that you should sell!

Rather than taking the average PE, some analyst may even take the PE at the high end. For example, if a stock's PE ranges from 12-18 in the past few years, the analyst may take a higher value of 16 or even 18.

Evaluating a company

In this post, I will share with you my approach in evaluating companies whose stocks are listed on the Malaysian stock exchange.

My method for evaluation is based on what I have read from a few books, mainly:

1. The Intelligent Investor - by Benjamin Graham
2. How to Make Money from Your Stock Investment Even in a Falling Market - by Ho Kok Mun
3. Secrets of Millionaire Investors - Adam Khoo and Conrad Alvin Lim

I invest in Malaysian stocks for the long term and for dividends. I do not use a trading approach.