Complacency

Most investors, especially young and brash investors like myself, tend to be overexcited by initial success on the stock market. Many investors are besotted with short-term gains and believe that they have the bragging rights after a short period of outperformance of the stock market. Many of us can probably recall how often they have found a stock which has outperformed the market by a huge percentage and feel exceptionally proud of themselves.

However, without sounding too morbid, things in life always do happen for a reason. But whether u know the reason or not is another matter altogether. A stock might rise for numerous reasons, for e.g. M&A prospects, quarterly earnings surprise on the upside, and other short-term catalysts. For value investors, they ignore short-term catalysts, believing instead that the current market price tends to underprice the intrinsic value of the stock because it tends to lag the fundamentals. As such, value investors can be termed "long-term arbitrageurs" who tap on this window of deviation between fundamental value and current market price, and hopefully when the market realises the potential of the stock, the stock price will correct itself to its intrinsic value. However, what investors should ask themselves is, why should a stock be priced below your calculated intrinsic value? Is the market really being too short-term orientated, or is it panic selling that has led to a recent weakness in prices? Or are there other reasons behind it?

Papers have been published on the EMT and random walk theory to propose the idea that individuals will not be able to beat the market consistently, and if one does that, it is purely by coincidence or chance rather than skill. Proponents feel that a fund manager is no better at picking stocks than a monkey who chooses by throwing darts.

To a big extent, I agree. Look no further than our surroundings: can you name me an instance whereby u think that u have discovered something that someone else hasn't? simple things like the quiet corner to study in school which nobody knows of, or even a stall where you can buy the cheapest chicken rice in Singapore but without a compromise in the quantity? Now, like I'm going to emphasise again, things do happen for a reason. The reason why nobody wants to study at that secluded corner could be because the place is the furthest from the lecture theatre, or the cheapest chicken rice stall could be selling at such prices only because their rental rates are one of the cheapest in Singapore.

Now, try to apply this to the stock markets. A particular counter that you think has the best prospects e.g. high ROA and ROE, fat margins, rising profits and revenue, consistently generating high cash flow, may trading at very low PERs compared to their peers, or could be at a discount to book. Now, before you throw your hard-earned savings into this wonder counter, take a step back and try to understand this very simple concept: everybody wants to make money on the stock markets. And, if everybody has this mentality, why are they shunning away from this particular stock? In other words, does the market know something that you do not already know? Even in bear markets, where the general mentality of "long-term investors" is that the prices of securities in bear markets will only go north from here and not south, and that holding your stocks for the "long-term" would mean that your stock price will eventually go above your purchase price, the likelihood is that you might be in for a surprise.Or rather, shock.

Whenever I do a qualitative analysis of a counter, I include a particular point that I feel that: 1) either the market has viewed a particular aspect of the company too bearishly, or 2) the market has probably discounted this aspect altogether. The likelihood of (2) happening is rare, but if you think you have found a company which fits the bill, bet heavily. 3 possibilities I can think of: 1) you are already rich. 2) you are going to be very rich. 3) your last name is Buffett. Either way, please do leave a comment behind. And your contact no. as well. Please.

I'm not trying to drive across the point that it is impossible to discover such a company. But, it is better to be less complacent and figure out why the company is "depressed" according to your valuations. I came across a company recently which is in the property sector. Its ROE is nothing in the league of the big boys, nor are its profits and revenue, although both have been rising steadily. What I noticed though was that this company actually owned the property they were renting/leasing out, unlike the other developers which rented out property that they themselves had leased on a long-term basis. Now, the reason why the company is changing hands at a lower value is probably because of its less-stellar results. But, could the markets have overlooked the fact that this company actually owns the property that they rent out? Naturally, a company which owns their own property will have a lower ROE, coupled with the fact that it has been slowly scaling down on its gearing which results in an even lower ROE. It will only be a matter of time before the company's performance starts to accelerate north. This is just an example of what I think the markets could have overlooked in a company, but then again I could be wrong and have egg in my face. But at least I would have the contact no of the rich guy who leaves the comments on my blog to fall back upon. Margin of safety.

All investors in the market are generally smart. Even value investors who claim that market inefficiency is the reason why they are able to earn money actually pray for the market to be efficient. For, if not, there would never be a convergence between current market prices and their calculated intrinsic value, and Buffett would probably have to continue his newspaper selling business instead of compounding his savings at such astronomical rates. Benjamin Graham may have made famous his ficitious personna, Mr Market, who has the erratic behaviour of quoting prices which fluctuate daily. But, Mr Market wants to make money as well. And the fact is, he is not stupid.