Tuesday, 19 September 2017

Book Review: 5 takeaways from Mohnish Pabrai's The Dhandho Investor


About the Author:

Mohnish Pabrai is an accomplished fund manager and unabashed fan of Warren Buffett. Pabrai's Investment Fund had outperformed all major indices and over 99% of other managed funds by delivering an annualized return of over 28% after fees and expenses from 1999 to 2006.

About the book:

Pabrai illustrates the concept of "Dhandho" and its applications to investing through examples of how vastly different individuals became successful entrepreneurs. He then distills his stock investing approach by sharing exactly how he selects counters.

I would classify this book as a true and underappreciated classic.

Here are 5 takeaways:

1) "Heads, I win; Tails, I don't lose much"

Dhandho investing is premised on a low-risk, high-return approach to business which is in itself very similar to the concept of margin of safety. Naturally, Dhandho investing runs contrary to the conventional teachings of how high returns entails high risks.

Pabrai illustrates the Dhandho approach mainly through scenario analysis - That is, by estimating probability of various outcomes for each investment after careful research. He only invests when the probability is heavily skewed in his favour.

2) Big Bets, Infrequent Bets

Pabrai, like Greenblatt, is a proponent of a small and concentrated portfolio. However, Pabrai used a different mathematical formula to justify this: The Kelly Criterion. The Kelly Criterion is a formula to help decide how much of one's capital should be put to work on a certain idea. You can find a good read on the Kelly Criterion here.

Pabrai suggests concentrating one's portfolio in about 7-10 counters where the odds are overwhelmingly in the investor's favor.

3) Invest in Low-Risk, High-Uncertainty businesses

Investors hate uncertainty, and hence businesses with high uncertainty often command depressed stock prices - naturally, that is where value can be uncovered. As long as there are low risks involved, value investors can afford to wait for uncertainty to peter out.

Pabrai has the following tip for investors waiting to uncover these gems: Read voraciously and wait patiently, and from time to time these amazing bets will present themselves.

4) Invest in businesses with durable moats

While economic moat is a concept that should be well known to value investors, Pabrai does share further insight to this topic.

Firstly, he cites high returns on invested capital as a sign of moat.

Secondly, while businesses will undoubtedly attempt to enhance their moats, Pabrai opines that there is no such thing as a permanent moat. He suggests never calculating discounted cash flow stream for longer than 10 years or expecting a sale in year 10 to be at anything greater than 15 times cash flow.

5) Tips on selling

Pabrai shares 2 valuable tips:

Firstly, to not sell any stock bought at a loss within 2 or 3 years of buying unless one can say with a high degree of certainty that the current intrinsic value is less than the current share price

Secondly, to sell when market price is within 10% of intrinsic value.

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

Monday, 11 September 2017

Book Review: 5 takeaways from Joel Greenblatt's You Can Be A Stock Market Genius


About the Author:

Joel Greenblatt is the founder of Gotham Capital, an investment partnership that achieved 50% annualized returns from founding in 1985 till close in 1995. $1 invested with Mr Greenblatt during the partnership would have snowballed into $51.97 in less than 10 years!

About the book:

You Can Be A Stock Market Genius is the 2nd Joel Greenblatt's book that I have read. Compared to "The Little Book that still Beats the Market", this book is likely written for more advanced investors. 

The book specifically discusses the merits of investing in special situations ranging from spin-offs to restructurings. While the examples cited are mostly from the United States, the know how that Greenblatt shares can easily be implemented in any markets.

Here are 5 takeaways:

1) Don't over-diversify (amongst stocks)

While Mr Greenblatt is a fan of portfolio diversification amongst alternative investments, he cautions against over-diversifying amongst stocks. This is because the incremental reduction in market risk decreases with every stock added to one's portfolio.

Mr Greenblatt opines that the penalty for a highly selective and focused portfolio (hence one with quality investments!) - a slight increase in potential annual volatility - should be far outweighed by increased long term returns.

2) Spinoffs can be tremendously profitable

The concept that spinoffs are great is not new - Peter Lynch had mentioned the same in his book, One Up on Wall Street.

However, Joel Greenblatt goes into much greater detail on why and which spinoff characteristics investors should be taking note off. In summary, situations leading to indiscriminate selling as well as insiders' interest alignment are both key towards successful spinoffs investing.

3) Risk arbitrage is not encouraged for retail investors

Risk arbitrage is the business of buying stock in a company that is subject to an announced merger or takeover after the merger/takeover announcement had been made (to earn the spread between share price and offer price). Investors are essentially taking on 2 risks:

A) the deal might not go through &
B) the timing risk related to the time value of money

Mr Greenblatt suggests for retail investors to avoid this field as the margins are small, and retail investors often lack both the time to follow each deal closely and the expertise to correctly evaluate possible reasons for failure. Additionally, he shares experience on how each deal can fail for completely unexpected reasons.

4) Merger securities are encouraged for retail investors

Merger securities are securities used to pay for an acquisition. Greenblatt shares that this could be an extremely profitable scenario especially if there is a lack of interest in these securities - as long as retail investors bother to read the fine print of the deal!

Note: There could be a lot of interest in the merger deal. The key here is lack of interest in the securities offered, which will lead to indiscriminate selling.

5) Trade the bad ones, invest in the good ones

Mr Greenblatt also shares the above selling tip in this book. Basically, while bargains might be created by special corporate events, investors should look to sell businesses without significant long term prospects as soon as value has been realized.

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

Saturday, 9 September 2017

New Counter: AEM Holdings Ltd

I am pleased to add a new counter to my portfolio, especially since it has been more than 4 months since I last bought anything. Despite the new addition, my portfolio's cash position stands at a healthy 27%, in line with my portfolio re-balancing goals (here).

Equity: AEM Holdings Ltd (SGX: AWX)

Business: Semiconductors
Markets exposed: Global
Stock exchange: SGX
Purchase price: 2.31 (Cum Dividends)
Purchase month: September

10% per annum thesis: 

AEM is now considered a fast grower, having turned their business around.

Introduction:

AEM is involved in the semiconductor industry, specifically in the back-end chip assembly and testing field. AEM's turnaround is premised on its new test handler, which key client Intel referred to as a product that "significantly reduces costs compared to traditional test platforms."

AEM owns the intellectual property rights to the test handler design.

Considerations:

1) Governance and Management

AEM has only 4 directors, 2 of which are independent. They command a respectable Singapore Governance and Transparency Index ranking of 111

AEM's non-executive chairman hails from their biggest shareholder, Novo Tellus Capital Partners. Novo Tellus currently holds 23.958% of AEM's shares, after selling 4.2% to some long only institutional funds at $2.70. 

This is significant for 2 reasons: 
Firstly, Novo had sold to long-only funds, which are generally stable and longer term investors.
Secondly, the funds deemed it fit to buy at $2.70, which is significantly higher than my purchase price.

Now, Novo Tellus' ultimate aim as a private equity fund is to grow the company and sell it for a profit. To do so, they will have to increase AEM's share price. In that sense, there is clearly strong shareholder-management interest alignment.

2) Fast Grower

Ever since the turnaround of AEM was completed at the start of the year, AEM's results had been on a tear. Revenue and profits are both trending upwards exponentially. The following shows AEM's actual and forecasted performance. 

Source: AEM's financial statements and presentations

The company had actually announced further plans to boost growth, which interested investors can read more about (here). I think it obvious that growth is in store, and will spend more time to discuss valuations in this post.

3) Low Relative Valuations

When we think of SGX listed companies in the semiconductor sector which are also heavily dependent on a major client, UMS Holdings immediately comes to mind. The following table demonstrates why AEM is not expensive relative to relevant peers in SGX.

Compiled by Author, updated 8th September

These calculations are conservative when considering that AEM had demonstrated absolute ease in outperforming announced forecasts. UMS, on the other hand, had announced expectations of moderated demand in their outlook (here).

In any case, I opine that AEM deserves a higher valuation for clear domination in efficiency ratios. I do, however, acknowledge the counter argument that UMS deserves a higher valuation for a much more attractive dividend yield. (To be perfectly honest, I find UMS at $0.90 to be undervalued as well - but that is another story altogether)

Source: Nasdaq, via Zacks Investment Research

While AEM's valuations might be considered comparable to UMS, they are way undervalued compared to their global competitors.

Risks:

A) Client Concentration

Given that AEM's business is concentrated with Intel, client concentration risk is clear. Any interested investors will have to accept this risk.

The mitigating factors are that AEM has a long standing relationship with Intel, and holds the intellectual property to the key test handler. At only 0.00009% of Intel's market capitalization, AEM definitely still has room to grow.

B) Technology Obsolence

As with all manufacturing firms dependent on technology, any development that renders your equipment obsolete would be sufficient to drive you out of business. 

Adaptation, Innovation, and continued Research & Development are all critical for AEM. Any beneficial Merger & Acquisition would be a bonus.

Conclusion:

In my opinion, AEM's share price had surged too much and too fast. Share price consolidation taking place since April is required to weed out profit takers before AEM can realize its' true valuation. Fortunately for me though, time is something that I can afford.

On a portfolio level, I have more cash to expend, and will consider to increase my shareholdings in AEM should the opportunity arise. However, I do realize as well that my portfolio is now heavily skewed towards manufacturing, and might have to reduce the exposure by year end. 

In any case, here is to wishing everyone bountiful investments!

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.