Sunday, 18 February 2018

Book Review: 5 things I learned from Joel Tillinghast's Big Money Thinks Small


About the Author:

Joel Tillinghast is a protégé of Peter Lynch who has managed Fidelity Low-Priced Stock Fund since 1989. Today, the fund manages over US$40 billion and owns over 900 counters. Despite its massive size, the fund that has outperformed both the S&P500 and Russell 2000 by an average of 4 percentage points per year.

About the Book:

From companies to avoid to stock selection, Tillinghast discusses all his investing philosophies in his book "Big Money Thinks Small". Published in 2017, the book provides both recent examples that younger investors can identify with, as well as the classic long horizon illustrations that value investors look towards.

I highly recommend this book to all intermediate investors.

Here are my 5 learning points:

1) Trade less

Tilinghast cites an interesting study done on Morningstar-listed active equity funds with more than $0.5 billion in assets - the higher the turnover, the worse the fund does. Tilinghast's advice is to take a long term view, estimate the value of stocks and don't trade for other reasons. This minimizes taxes, fees and transaction costs, all of which worsens investment results.

2) Leveraged ETFs are dangerous

With the introduction of popular triple-levered ETF such as the FAANG ETF (here), it is fitting that Tilinghast illustrates the dangers of leveraged investing with a triple-levered ETF:


Assuming that the Index takes a dip of 25% from 100 to 75. The Triple-Levered Bullish ETF will take a corresponding 75% plunge from 100 to 25. A subsequently recovery of 33.3% will leave the Index back at 100. However, a 100% increase will merely double the Triple-Levered Bullish ETF to 50.

This is a wonderful illustration of how the triple-levered ETF magnifies the downside losses which requires multiple periods of excess gains to offset these losses incurred.

3) GDP growth might not flow to stock markets

Tilinghast cites another insightful study which shows that contrary to popular belief, countries with rapid growth in GDP per capita are not the ones with the best real returns to stockholders. 

Instead, he suggests that at a horizon of 10 years, the better decision rule for choosing among countries with rule of law has been to favor markets with lower P/Es rather than those with rapid recent economic growth.

4) Share buybacks are not always good news

While share buybacks are often well regarded by shareholders, shareholders will only benefit when the repurchase is done at a discount from intrinsic value. In reality, however, share buybacks might be done when share prices are at its peak and at a premium to the companies' intrinsic value. 

A common reason could be to offset the dilution effect from hefty employee stock options which tend to become more in the money as share prices rise. To keep a constant share count, shares will then be bought back most urgently at the peak.

5) Tilinghast's Investing checklist

1) Does the stock have a high earnings yield?
2) Does the company do something unique that will allow it to earn super-profits on its growth opportunities?
3) Is the company built to last, or is it at risk from competition, fads, obsolescence, or excessive debt?
4) Are the company's finances stable and predictable into the extended future, or are they cyclical, volatile, and uncertain?

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

Sunday, 11 February 2018

Some reasons to be bearish that make sense

I wrote about some reasons to be bearish that don't make sense last week. Since then, the Dow Jones Industrial Index had posted its worst week in two years with 2 days of free fall exceeding 1000 points. In fact, had the Dow lost any ground on Friday, it would have been the index's worst week since the financial crisis in October 2008.

I guess this provides the perfect context for discussion on reasons to be bearish that makes economic sense.

1) Treasury Bond yields are rising

10 year treasury bond yields have accelerated since the start of the year and now sits 0.841% more than it's 1-year low in September. While 0.841% itself is rather insignificant on an absolute basis, it is actually quite a big deal due to September's low 2% base.

Source: CNBC

The major question is what has this got to do with equities? 

Bonds are a major alternative investment asset class to equities. Ceteris paribus, rising bond yields makes this asset class more attractive relative to equities. We will therefore see money flow from equities to bonds.

Rises in Treasury bond yields have the greatest impact on overall fixed income as Treasury bonds are seen as the safest investment. Consequently, other fixed income instruments will also see corresponding increases in yields in order to maintain their respective risk premium.

2) Inflation is rising (more than expected)

The US Labor Department reported in early February that wages in January were up 2.9% compared with a year earlier, the best pace since June 2009. Higher wages serve as a leading indicator for higher inflation.

Given the spike in expected inflation, it appears that the pace of wage growth has caught investors out by surprise.

Source: Federal Bank of St Louis

The direct impact of inflation on equities differ between businesses. In general, businesses that can pass on inflation to the consumer tend to fare better. As such, industries where demand is price inelastic might be better placed than industries where demand is price inelastic.

However, the direct impact of inflation is minute compared to its indirect impact. When inflation rises more than expected, so too nominal interest rates:

 π + r
i = nominal interest rates
π = expected inflation
r = real interest rates

Higher nominal interest rates can impact borrowing costs and discount rates. As such, the impact of unexpected fluctuations in inflation on equities can be rather drastic.

3) Margin calls

Definition of 'Margin Call', as quoted from Investopedia -

A margin call is a broker's demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin. Margin calls occur when the account value depresses to a value calculated by the broker's particular formula.

An investor receives a margin call from a broker if one or more of the securities he had bought with borrowed money decreases in value past a certain point. The investor must either deposit more money in the account or sell off some of his assets.

TL;DR - When stocks plunge as suddenly as 10% in a week, investors trading on margins might be forced to sell off assets in order to maintain minimum maintenance margin. This worsens the free fall, which might then trigger another round of margin calls. If widespread, such a vicious cycle is devastating for both affected investors and the entire market.

Bull or Bear

Just as writing about some reasons to be bearish that don't make sense is not to be construed as bullishness, this post is not to be taken as an indication of bearishness. Rather, I advocate understanding the arguments for both Bull and Bear. This will help us remain calm and make rational decisions on investing (and divesting).

For those who wish to hear it from someone with more authority on the subject, here is Mark Cuban:


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.

Sunday, 4 February 2018

Why some reasons to be bearish don't make sense

Equity markets are off to a great start in 2018 with stock indices around the world scaling new heights. In fact, January 2018 was not just a good month for stocks, it was a great month even by the average "good" standards - the Standard & Poor’s 500 stock index gained 5.62%, its best January since 1997.

As the bull market runs further and longer, many investors are finding new reasons to be bearish. However, here are some recent ones that don't make sense:

1) Trailing P/E for US indices are too high relative to history

Price to Earnings ratios have been used for the longest time to gauge value; Higher P/E indicating a more expensive stock market can be considered general consensus.

However, in the current context, comparing trailing P/E to historical P/E in the US does not make much sense for 2 key reasons:

1.A) Trailing earnings are hit by tax losses

Many US firms have taken a tax loss this quarter in order to repatriate retained earnings previously held overseas. 

As an example, Microsoft reported a loss of $0.82 per share in the latest quarter due to a one time tax charge. Without the tax loss, they would have reported $0.96 profit per share. Microsoft's trailing earnings are therefore significantly hit by this one time tax loss.

If we are to replicate this effect across the American indices, trailing earnings will by default be significantly understated relative to fundamental performance. Trailing P/E would therefore naturally appear to be exorbitant.

1.B) Forward earnings are boosted by the tax cut

Investors invest for a share of the company's future profits and cash flows. Given the tax cut by Trump's government, ceteris paribus, American companies are going to see both future profits and cash flows increase.

While some of these excess profits might be competed away, most companies are still likely to be worth more with the tax cut than without - thus justifying higher trailing P/E compared to the past.

2) Dow falling 666 points is a huge deal

It appears that this week's headlines are dominated by a 666 point fall in the Dow Jones Industrial Index. The truth is that a 666 point fall is not actually a big deal when we look past these sensationalist headlines simply because of how much the Dow had grown.

Source: CNBC

While a 666 point fall in the past would have been a >5% plunge, this week's 666 point fall represented a mere 2.5% correction. If we view it in the context of 2018's bullish run thus far, a correction of 2.5% still leaves us up 2.8% year to date.

Source: Yahoo Finance

Bull or Bear

To be clear, this post is not to be taken as an indication that a bear market is unlikely to occur in the near future. While I do have a background in Macro Economics, I am definitely not an expert in predicting general stock market bull or bear trends. 

For those who are looking for some expert advice (by this, I mean real expert advice - not those "experts" who charge subscriptions after one single year of decent returns) on the likely market trend, perhaps I can refer you to one of the best macro investors of all time - Mr Ray Dalio. 


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.