Monday, 24 July 2017

Book Review: 5 takeaways from Howard Marks' The Most Important Thing Illuminated


About the Author:

Howard Marks is co-founder and co-chairman of Oaktree Capital Management, a market leading investment firm that first made its name investing in distressed debt. 

Oaktree's defensive strategy had proven tremendously successful over the long run. It had beaten the market handsomely over the course of its history, resulting in growth in assets under management from US$5 billion in 1995 to US$100 billion today.

About the book:

The Most Important Thing Illuminated discusses 20 important considerations that Marks believe to be essential for successful investors. It is an insightful book which offers qualitative advice to investors especially on the subject of investing psychology.

Warren Buffett writes the following about this book:

"When I see memos from Howard Marks in my mail, they're the first thing I open and read. I always learn something, and that goes double for his book."

I am in deep agreement to this - my personal opinion is that seasoned investors will find great value in this book. However, compared to the other book reviews I have written (here), this might not be as suitable for beginners.

Here are the 5 takeaways:

1) You require an idiosyncratic view to beat the market

Marks argues that the very definition of market beating returns requires an investor's expectations (and thus portfolio) to diverge from the norm. An independent, or even a contrarian, view is therefore required to beat the market.

However, it is not enough to bet against the crowd. A successful investor must not simply do things because they are opposite to what the crowd is doing. Rather, the successful investor leverages on reason and analysis to determine that the crowd is wrong.

2) Risk is not volatility

The greatest risk to investors is the likelihood of losing money, and not simply price fluctuations. 

A far more accurate definition of risk would be uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do. Given this definition, volatility is clearly not a suitable measure.

3) Returns, especially over short time frames, tells little about quality of investment decisions

Returns should be evaluated relative to the amount of risk taken to achieve it. There are many possibilities that could result with each investment decision, and a risky decision might end with a desirable outcome simply due to the presence of luck.

Results of multiple decisions made over long periods of time are a much better indicator of an investor's ability to manage risk and return relative to it (and hence alpha!).

4) All cycles end (especially credit cycles!)

Marks also offers 2 great pieces of advice relating to this:

A) Investors cannot create investment opportunities which do not exist
B) Decisions on investments should be made in relation to the current investment climate

5) Poor man's guide to market assessment

While it is near impossible to time market's peak and trough with precision, Marks offers a guide for investors to establish a sense of the current investment climate. 

If most of your choices are in red, then the market is closer to its peak, and prices are likely to be rich and without margin of safety. If the converse is true, then risks would ironically be lower by virtue of the fact that valuations are much lower!


This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.

Tuesday, 18 July 2017

Take Analyst Reports with a Pinch of Salt

I have always maintained that analyst reports are important references for investors. They contain critical information that the average investor would not have access to, such as results from site visits and insights derived from management interactions. 

However, for all the value that an investor can derive from analyst reports, I recommend to take them with a pinch of salt. While analysts are indeed professionals, that does not preclude them from mistakes. Occasionally, analysts might even be guilty of severe conflict of interests (as NRA Capital showed with 1MDB here).

I will use Japfa as an example to illustrate my point.

Introduction to Japfa:

Japfa is a vertically integrated proteins producer - their business covers feed production, breeding, fattening/milking, processing and eventually distribution of food. Proteins contributes the lion's share of Japfa's earnings while Dairy and Consumer Food are the other contributing segments.

In terms of Geography, Japfa is active in Indonesia, Vietnam, China, Myanmar and India. Japfa is headquartered and listed in Singapore.

Analyst recommendations:

In the past 2 years, Japfa was covered by 2 research houses: DBS and CIMB. You may find the analysts' reports here.


Source: Yahoo Finance, illustrations by Author

It is immediately obvious that analysts' target price (TP) fluctuates greatly. The TP, and hence implied intrinsic value of the firm, might double (Oct'15 to Nov'15 for DBS) or experience a 50% free fall (Mar'17 to Apr'17 for CIMB) within a short span of 1 month. 

Based on the sharp changes in TP alone, one might be forgiven for assuming that Japfa was hit by unexpected incidents such as wars, natural disasters, or even death of CEO. There were no such incidents, and TPs were changed primarily on demand and supply of proteins in Japfa's markets.

Despite the wild changes in TP, investors who had traded on DBS's advice can at least take solace from the fact that they had been consistent - DBS had always reiterated that Japfa was undervalued over these 2 years. Not once in 2 years had Japfa's share price hit DBS's TP.

On the other hand, investors who based their trades on CIMB's "Buy"/"Reduce" call would have registered rather significant losses in April 2017.

TL;DR

While analysts' reports have undoubted value, it is best to take them with a pinch of salt and exercise your own judgement.


This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.

Friday, 14 July 2017

Value Investing - learning from OKP's flyover collapse

Who is OKP?

OKP Holdings Limited is a company listed on Singapore Exchange. While the company also dabbles with property development and investments, their primary business remains public sector infrastructure construction and civil engineering.

How has OKP performed?

Source: Yahoo Finance

OKP's share price has performed admirably in the past 2 years, surging 126% from S$0.19 to S$0.43 before the fall in share price after the incident.

Indeed, the investment thesis for OKP was rather straightforward. Singapore's infrastructure demands are growing steadily and firms that win tender do not have to worry about receivables. When we consider OKP's reputable history of garnering these public infrastructure projects at very fair margins, there appeared to be little worth worrying about.

What happened?

OKP was awarded a S$94.6M project to construct a viaduct from Tampines Expressway (“TPE”) to the Pan Island Expressway (Westbound) and Upper Changi Road East in November 2015. In the wee hours of 14th July 2017, the unfinished viaduct collapsed, killing 1 and injuring 10 others.

(This is a tragic accident which should be thoroughly investigated. My thoughts and condolences goes to all foreign workers impacted by this incident)

OKP's share price promptly tanked 8% before the firm called for a trading halt. It is highly likely that the firm's share price will continue diving once trading is resumed as any expectations of big contract wins are now replaced by big fines slapped on the firm.

The value investor in me was immediately triggered: If a safe, defensive play like OKP (and rival Hock Lian Seng, which I am vested in) can screw up so badly, can we ever realistically find sufficient margin of safety? After some thought, I came back with 2 back-to-basic learning points.

Reminders for Value Investors

1) Nothing beats hard work

While difficult, value investors could have sniffed out OKP's construction woes. OKP was involved in a widely reported Yio Chu Kang flyover incident in 2015 (here) and was recently reported to be fined S$250,000 for that incident (here). 

MOM also maintains a list of contractors with demerit points, which OKP is listed on:

Source: MOM (here)
However, while that might have been the case, it would have still been difficult to fault value investors' investing in OKP as OKP had actually consistently won contracts while all these were going on.

Source: SGX Company Disclosure, past 12m for OKP

This brings me to the next point.

2) Diversification is important

There is no one stock that is 100% safe. No matter how great and safe a company's business or moat is, freak accidents do occur - simple as that.

While I agree with Buffett and Munger that over-diversification can be very detrimental towards any plans of achieving market beating returns, this incident has reinforced to me that some degree of diversification is indeed required to maintain true margin of safety. 

Well, my musings aside, perhaps this might be an opportunity for contrarian investors with strong convictions on this counter?

This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.